"Panicked" Citi Trader "Who Fired Off Repeated Sell Orders" Behind Pound Flash Crash

In what may be the latest example of unintended irony, shortly after the October 7 pound sterling flash crash, which saw the UK currency plunge by more than 9% against the dollar, falling from $1.26 to $1.14, in about 40 seconds - a historic flash crash in one of the world's most liquid currencies - we presented a forensic explanation of what happened in that minute when sterling plummeted in a bidless market from Citigroup

 

As it turns out, Citi may indeed have been the most familiar with the dynamics behind the pound crash because according to a new report from the FT, it may have been responsible for it. According to the report, a UK probe into October’s “flash crash” has focused heavily on the Japanese trading operations of Citigroup, "which fired off repeated sell orders that exacerbated the pound’s fall, according to bankers and officials involved in the inquiry."

While Citi’s traders are not believed to have started the slide in the currency in thin Asia trading, its Tokyo desk played a key role in sending the pound to its lowest levels in 31 years, the FT said. The value of the pound fell from $1.26 to $1.14, with a 9 per cent slide in about 40 seconds. The Bank of England has said publicly that the October 7 crash is “set apart by the lack of a clear fundamental trigger” but its investigation of the event focused on a single incident, according to a person briefed on the probe.

So what happened that exacerbated the plunge? In one word: panic.

People with knowledge of events at Citi that day said one of the US bank’s traders placed multiple sell orders when the currency slumped in unusually fragile market conditions. One of the people said the trader “panicked”.

As the FT logically notes, "the incident raises questions on the quality of supervision and risk management at the biggest bank in the foreign exchange business. In the wake of the crash, UK regulators have written to several banks telling them to shore up oversight of the foreign exchange desks to prevent similar shocks."

For its part Citi is defending itself: Citi said in a statement that it “managed the situation appropriately and our systems and controls functioned throughout the period”. It declined to say whether anyone had been disciplined or whether it had changed any trading practices in light of the incident.

While investigators the BoE’s Prudential Regulation Authority who probed the October 7 drop were not particularly concerned by the initial trigger, they were more interested by the second stage of the slide which "coincided with a large number of rapid-fire sell orders placed in Tokyo by a Citi trader using an electronic tool known as “Aggregator”, which sends trade instructions into a range of trading venues. A trader at another bank said at the time that was when “all hell broke loose” with the pound."

It was this "Aggregator" response that led to a bidless market: for a short time, orders to sell sterling met with zero buying interest on the other side — a highly unusual event — due to abnormally poor liquidity and entrenched bearishness about the pound in the wake of the Brexit vote.

At that point, things got worse:

Nonetheless, the sell instructions from Citi’s desk in Tokyo kept coming and started tripping over each other in a pattern known as “looping” that is normally constrained by safety nets embedded in bank trading tools. Citi declined to comment on whether those safety nets, which are part of the Aggregator programme, were operating at the time of the flash crash for its own traders.

... and worse:

Citi was not the only trading desk selling at that point, and the bank was not seeking to make a profit, multiple people briefed on the events said. Rather, they said, the trader panicked, jamming through enough trades to magnify the slide.

A Citi spokeswoman told the FT that the drop in sterling followed “a news event” at an “extremely illiquid” time of day, a reference to a Financial Times report that night that President François Hollande of France had said he would seek a tough line on Brexit. The BoE, however, confirmed our own reporting on the crash, and said in its semi-annual financial stability report that the FT news story “was not the initial trigger”.

So for those who got stopped out and lost massive amount of money, who should you blame? Well, panicked traders and miscalibrated robots to start:

Human error and the use of a “poorly calibrated execution algorithm” were among the possible reasons for the sell-off, the BoE said, without naming any particular bank or banks. “It is hard to definitively rule out these possibilities as not all activity in the foreign exchange market is observable,” the BoE concluded. The BoE declined to comment on the role played by Citi or any other bank in the incident.

 

Typically, it is close to impossible for a small handful of trades to move a major currency by such a large degree, because there is usually a wide range of buyers and sellers at any time. But on October 7, the BoE noted that during the worst point of the fall in sterling, “there was a drop off in participation on key trading systems, which points to a potentially greater role for the idiosyncratic actions of individual market participants”.

 

The BoE suggested the selling was too aggressive for market conditions at the time, noting that the flows “may have occurred without regard to underlying market conditions or [the] likely price impact of trading”.

In other words, while Citi may or may not have led to a historic flash crash in the pound, nobody really still knows anything, and some Indian trader living in his parents' house in London may still get the blame.

Some further thoughts on the incident courtesy of Mint's Bill Blain:

Themes for next year range from “Normalisation” but also “Protectionism” and “Political Consequences”- a significant risk in my mind ahead of European elections. Meanwhile, without any particular conviction today, markets are vulnerable to a number of pitfalls in the thin holiday markets.

 

As the headlines in the FT this morning are about how Citibank in Tokyo precipitated the October flash crash in Sterling in an illiquid overnight market when its “poorly-calibrated” algo-driven HST trading “Aggregator” went into meltdown, its worth remembering how skittish thin markets are to modern no-see-em trading blunders. 

 

The Sterling flash crash story is intriguing  - the excuse is the market was fragile and a trader panicked. What? Since when is trading (arguably) the worlds most liquid currency cross, Cable, fragile or subject to panic? A failure of liquidity versus modern technology? Or something more – fuelled by Brexit uncertainty and trading programmes that don’t understand the subtle nuances?

 

According to the FT, the BOE noted “a drop off in participation of key trading systems, which points to a potentially greater role for the idiosyncratic actions of individual market participants”. I should imagine there are some very nervous Citi currency execs out there!

More information is coming: the BIS, which monitors global money flows, is working on its own detailed report on the crash, with input from the BoE, to be released in January. One day we hope the BIS, and especially Benoit Gilson, will release a similar analysis for at least of the countless flash crashes observed in gold over the years.