The definitions that govern disruptive trading practices are constantly evolving and one area that has garnered an increasing amount of surveillance interest in the last several years concerns activities that occur immediately before and during the market open. As an example of this focus, the CME Group has issued a new Market Regulation Advisory Notice (MRAN) that deals specifically with this period of time in the trading day. While this MRAN is primarily a clarification and consolidation of previously issued guidance, its publication is an indication of how important the opening period and Indicative Opening Prices (IOPs) are to futures markets. The contents of this new IOP MRAN are a helpful guide to understanding the ins-and-outs of surveilling the market and the compliance issues that are either best observed or avoided.

Two Rules to Follow

Rules and guidance around activities in the pre-opening period are a subset of CME Group rules 575 and 534 that govern disruptive trading practices and wash trading respectively.

Rule 575 relates to disruptive activities such as spoofing, layering or quote stuffing. The rule states that:

  • “All orders must be entered for the purpose of executing bona fide transactions. Additionally, all non-actionable messages must be entered in good faith for legitimate purposes.”

The rule goes on to list specific guidelines that govern quoting with an intent to cancel, attempting to mislead market participants, entering orders in an attempt to adversely affect the functioning of the exchange, or otherwise disrupt the markets.

Rule 534 states that:

  • “No person shall place or accept buy and sell orders in the same product and expiration month…where the person knows or reasonably should know that the purpose of the orders is to avoid taking a bona fide market position exposed to market risk (transactions commonly known or referred to as wash sales)”

Wash trades are typically executed between accounts that share common beneficial ownership.

Examples of disruptive behavior

In addition to providing details on specific questions relating to the use of specific order types, guidance regarding automated trading systems, and testing during the opening period (hint: don’t do it!), the CME give several examples of activities that are prohibited during the pre-open period. Prohibited activities include, but are not limited to:

  • Scanning the book for hidden orders such as stops or icebergs,
  • Testing market depth by entering orders until the IOP changes,
  • Entering an order after the lockdown period (the time just prior to the opening when orders may no longer be canceled) so as to create a washed trade, and
  • Manipulating the level of the IOP by entering large quantity orders at the beginning of the pre-open period, thereby attracting – and deceiving – other market participants.

The examples listed are not meant to be exhaustive but, instead, detail some of the most common behaviors that the CME is paying attention to.

Lessons to live by

The rules that govern the pre-open and even the examples cited by the CME are generally not new and could, in most cases, be applied to other exchanges and include other parts of the trading day, especially the close. However, the fact that the exchange found it necessary to consolidate guidance regarding the opening period in a new MRAN highlights both the importance of the opening period for markets and the ways in which market surveillance is evolving and growing. Prohibited activities such as spoofing, layering, quote stuffing, or wash trades continue to be in the regulatory crosshairs. Both compliance and market participants will do well to have a robust surveillance program covering their and their customer’s market activities to ensure that they stay on the straight and narrow. It’s 100% certain that the CME, other exchanges and the myriad regulators will only increase their diligence going forward.

 

The full text of Rules 575 and 534 are available online in the CME Rulebook: https://www.cmegroup.com/content/dam/cmegroup/rulebook/CME/I/5/5.pdf