It has been an interesting week for the CME: first it was revealed a week ago that in order to "stimulate" the market, the CME is willing to pay central banks a liquidity rebate in order for the world's monetary authorities to "make markets" in the most important S&P 500 future, the E-Mini, confirming not only that central banks directly trade the S&P 500, but are incentivized to nudge it along the preferred central bank direction: up. Then last week, none other than the CME's own 10-K proved that something changed in 2013, when for the first time central banks officially became counted as clients of the biggest US derivative exchange.
Today, the CME's fall from efficient market grace accelerate when it advised the CFTC that the derivative market would be adopting a new Rule 575 to eliminate "Disruptive Practices Prohibited."
The good news: starting September 15, 2014 the CME will no longer tolerate what is affectionately calls "Disruptive market practices."
The bad news: the CME was not only tolerating and turning a blind eye toward such disruptive market practices until this point, in many cases it was compensating the "liquidity providing" perpetrators!
But what are these "disruptive" market practices? Nothing short of a who's-who lexicon of terms we introduced and discussed starting some time in late 2009 and 2010. From the CME:
Among other disruptive practices, Rule 575 prohibits certain of the disruptive practices added to Section 4c(a) of the Commodity Exchange Act (“Act”) as subparagraph (5) by Section 747 of thee Dodd-Frank Act. Specifically, Rule 575 prohibits the type of activity identified by the Commission as “spoofing,” “quote stuffing practices” and the disorderly execution of transactions during the closing period.
That's just a sample: here is the exhaustive list:
Some examples of manipulative behavior in practice:
- A market participant enters one or more orders to generate selling or buying interest in a specific contract. By entering the orders, often in substantial size relative to the contracts’ overall pending order volume, the market participant creates a misleading and artificial appearance of buy- or sell-side pressure. The market participant places these large orders at or near the best bid and offer prevailing in the market at the time. The market participant benefits from the market’s reaction by either receiving an execution on an already resting order on the opposite side of the book from the larger order(s) or by obtaining an execution by entering an opposing side order subsequent to the market’s reaction. Once the smaller orders are filled, the market participant cancels the large orders that had been designed to create the false appearance of market activity. Placing a bona fide order on one side of the market while entering order(s) on the other side of the market without intention to trade those orders violates Rule 575.
- A market participant places buy (or sell) orders that he intends to have executed, and then immediately enters numerous sell (or buy) orders for the purpose of attracting interest to the resting orders. The market participant placed these subsequent orders to induce, or trick, other market participants to execute against the initial order. Immediately after the execution against the resting order, the market participant cancels the open orders.
- A market participant enters one or more orders in a particular market (Market A) to identify algorithmic activity in a related market (Market B). Knowing how the algorithm will react to order activity in Market A, the participant first enters an order or orders in Market B that he anticipates would be filled opposite the algorithm when ignited. The participant then enters an order or orders in Market A for the purpose of igniting the algorithm and creating momentum in Market B. This results in the participant’s order(s) in Market B being filled opposite the algorithm. This conduct violates Rule 575.A., as the orders in Market A were not intended to be executed, and Rule 575.B., as the orders in Market A were intended to mislead participants in related markets. If the conduct resulted in a disruption to the orderly execution of transactions, it may also violate Rule 575.D.
- A market participant places large quantity orders at the beginning of the pre-opening period in an effort to artificially increase or decrease the IOP with the intent to attract other market participants. Once others join the market participant’s bid or offer, the market participant cancels his orders shortly before the no-cancel period, which is a predetermined time before the trading session opens when orders can be entered but not cancelled or modified. Consequently, those other market participants did not have an opportunity to react to the cancelled bids or offers prior to the open when their orders became executable.
- During the pre-opening period on CME Globex, a market participant enters a large order priced through the IOP (a bid higher than the existing best bid or an offer lower than the existing best offer) and continues to systematically enter successive orders priced further through the IOP until he causes a movement in the IOP, which prompts him to cancel all of his orders. The market participant continues to employ this strategy on both sides of the market for the purpose of determining the depth of support at a specific price level for the product before the market opens.
- During the pre-opening period on CME Globex, a market participant enters an order priced through the IOP (a bid higher than the existing best bid or an offer lower than the existing best offer) for the purpose of identifying hidden liquidity (e.g., resting stop and iceberg orders). The market participant then cancels that initial order and enters a new order based on the information obtained.
- A market participant enters a large number of orders and/or cancellations/updates for the purpose of overloading the quotation systems of other market participants with excessive market data messages to create “information arbitrage.”
- A market participant enters order(s) or other messages for the purpose of creating latencies in the market or in information dissemination by the Exchanges for the purpose of disrupting the orderly functioning of the market.
- A market participant enters a large aggressor buy (sell) order at the best offer (bid) price, trading opposite the resting sell (buy) orders in the book, which results in the remainder of the original aggressor order resting first in the queue at the new best bid (offer). As the market participant anticipated and intended, other participants join his best bid (offer) behind him in the queue. The market participant then enters a large aggressor sell (buy) order into his now resting buy (sell) order at the top of the book. The market participant’s use of CME Group’s Self-Match Prevention functionality or other wash blocking functionality cancels the market participant’s resting buy (sell) order, such that market participant’s aggressor sell (buy) order then trades opposite the orders that joined and were behind the market participant’s best bid (offer) in the book.
Well, this is a problem, because the examples above cover about 99.9% of all "practices" in today's market, period.
And, as a reminder, in addition to the CME's favorite and most lucrative client, HFTs of course, the ban will also apply to that other segment of CME clients: central banks.
So yes, dear CME market-rigging clients: for years and years, the various form of market manipulative and rigging activity was not encouraged, and in the cases of central banks, even compensated. But now, 6 years after Lehman, it is frowned upon. So no more rigging and manipulation: now everyone please pinky swear and so on.
Full Rule 575 below: