Sarao effect has driven “need for speed”

Sarao effect has driven “need for speed”

The British futures trader dubbed the ‘Hound of Hounslow’ who was arrested in April over manipulative trading behaviour back in 2010 is due in court Friday for his extradition hearing. His case has sparked media and market interest, and has caused a shift in attitudes to market surveillance and the systems available to catch manipulative behaviour.

Navinder Singh Sarao was arrested earlier this year at the order of US authorities following allegations of manipulation that led to the ‘Flash Crash’ in 2010.

After months in custody – he was finally granted bail in August – Sarao is set to appear at Westminster Magistrates on Friday to fight his extradition to the US for prosecution there.

The case thrust the murky-sounding practice of ‘spoofing’ – the practice of placing an order with the intent of cancelling it before it can be completed - in to the public domain.

With the charges against Sarao including one count of wire fraud, 10 counts of commodities fraud, 10 counts of commodities manipulation and one count of spoofing, they carry a maximum sentence of 380 years.

As previously reported, US authorities have estimated that the alleged activity which led to the 'Flash Crash’ resulted in profits of $40 million from April 2010.

While there is market sentiment, especially amongst London’s prop community, that Sarao is being made ‘an example’ of, Sarao faces a long prison sentence in the US if he loses Friday’s battle.

If the recent conviction of Tom Hayes - who is now serving a 14-year sentence over rate rigging - is anything to go by, then the future looks rather gloomy for the Hound of Hounslow.

Media attention – fascination even – on how one trader’s action could cause such catastrophic market damage, has been rife, and has also led to a marked increase in company attention and investment in surveillance technology to help catch and curb manipulative behaviour, with speedier resolution increasingly a focus.

CEO of Bats Global Markets, Chris Concannon, in conversation with FOW this week, confirmed that Sarao’s alleged activity was a contributing factor in the firm’s recent push to expedite enforcement action.

The Bat’s Client Suspension Rule - which was filed with the SEC in July 2015 - would allow the group to take swifter action in prohibiting manipulative behaviour across its exchanges, such as layering and spoofing - the practice of placing an order with the intent of cancelling it before it can be completed.

Concannon also called for similar rules to be extended to all markets and asset classes.

As reported by FOW last month, greater complexity in the surveillance space is presenting challenges for trading firms, and opportunities for tech firms that can provide solutions.

Growing demand is also driving creation of ‘package offerings’ that encompass firms’ trading interests to better-meet modern market surveillance needs.

Michael O’Brien, head of product management at Nasdaq’s Smarts Trade Surveillance, told FOW Thursday, “The timing of the Sarao case and the evidence being led with ties in with the regulatory focus around order book manipulation and high-order cancel rates.”

Impending market abuse regulation in Europe focuses on unusual cancel rates and order-to-trade ratios being indicators of market abuse. When looking against that background, the Sarao evidence can be used as it is focused on these cancel rates and order to trade ratios, an FOW source added.

“The evidence of this… has crystallized in the minds of market participants that they need to have a means to analyse and pull apart the huge amounts of order data that is coming out of these electronic trading platforms. And for that reason, there’s more focus on visualization and dash boards to identify unusual cancel rates,” added O’Brien.

While Sarao’s case has definitely highlighted the issue, spoofing practices are rife according to Dan Goldberg, head of business development at London-based prop trading firm, Futex.

“When you can see someone spoofing the market, you can try to profit from it but that is very hard. I hold off… I report it all the time but the problem is that the exchange has no responsibility to report back its findings… so you never hear anything more, though once in a while you’ll hear of someone being pulled up on it, but that’s probably two years or so after the fact."

Concannon from Bats said that such behaviour has always existed, and the market watches for it, but the Sarao case has refocused and reminded the market that enforcement action, at present, cannot be taken swiftly enough, with its rule set to stop such conduct in a matter of weeks rather than the years it currently takes to reach a resolution.

The trader’s arrest was cited in the exchange group’s recent filing for approval of the rule in July. “… notes the current criminal proceedings that have commenced against Navinder Singh Sarao. Mr. Sarao’s allegedly manipulative trading activity, which included forms of layering and spoofing in the futures markets, has been linked as a contributing factor to the “Flash Crash” of 2010, and yet continued through 2015. The Exchange believes that the activities described… provide justification for the .”

Robert Powell, global head of compliance and product management at Etrali Trading Solutions, told FOW that there has been a marked increase in firms’ upping their compliance and supervision technology since the futures trader was arrested, and the conviction of Tom Hayes over Libor manipulation earlier this year.

What will be interesting to see if what – if any – changes exchanges make to prevent this from happening again, should the case prove that Sarao was able to cause the market crash, said Powell.

“Where you have groups of people acting as a firm then the risk that they will cause such an event is lessened because of the additional controls that are placed around the trades they do and they have a compliance officer to guide their behaviour. That's not the case with sole traders who only have the exchange and the rules to keep them in check. It's an interesting conundrum.”

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