Front running is done for one
reason alone. It allows a trading desk
to tax the trade flow while taking on no risk whatsoever. That is why they magically clock monthly
profits. Their other trick is to drain a
weak market of any buying interest and then knock it down to create a forced
sale all the while borrowing paper in the float never meant to be used for
short selling. None of this is actually
legal, but who is telling?
Any trader active in a given
market knows who has size and who to go to for a price break and that alone is
not the problem. The problem is the
failure to pass the spread on to the buyer. This not a small issue.
It is possible to at least force
front running down to the originating broker which lightens the tax. That has not happened of course.
Bank Of America Caught
Frontrunning Clients
Every
time a TBTF bank releases its 10-Q, we head straight for the section, usually
well over 100 pages in, that discloses the bank's total profitable trading
days.
The
histogram below is a graphic depiction of trading volatility and illustrates
the daily level of trading-related revenue for the three months ended September
30, 2013 compared to the three months ended June 30, 2013 and March 31, 2013.
During the three months ended September 30, 2013, positive trading-related
revenue was recorded for 97 percent, or 62 trading days, of which 69
percent (44 days) were daily trading gains of over $25 million and the largest
loss was $21 million. These results can be compared to the three months ended
June 30, 2013, where positive trading-related revenue was recorded for 89
percent, or 57 trading days, of which 67 percent (43 days) were daily
trading gains of over $25 million and the largest loss was $54 million. During
the three months ended March 31, 2013, positive trading-related revenue
was recorded for 100 percent, or 60 trading days, of which 97 percent (58
days) were daily trading gains over $25 million.
###
In
summary, so far in 2013, Bank of America lost money on 9 trading days out of a
total 188.
Statistically,
this result is absolutely ridiculous when one considers that the bulk of bank
trading revenues are still in the form of prop positions disguised as
"flow" trading to evade Volcker which means the only way a bank could
make money with near uniform perfection is if it either i) consistently has
inside information that it trades on or ii) it consistently front-runs its
clients.
In
related news, the only more absurd datapoint was JPMorgan's announcement of how
many trading day losses it had in the first nine months of 2013. For those
who missed
out succinct post on the matter, the answer was
clear: zero. The absurdity becomes even clearer when one considers that in
the pre-New Normal days, JPM had an almost
normal profit/loss distribution in its trading
days.
But
back to Bank of America, where as we noted, the kind of trading result would
only be possible if the bank was aggressively insider trading or just as
aggressively frontrunning flow orders in its prop book (a topic we
covered back in 2009 as relates to Goldman
Sachs, and
which the bank sternly rejected).
We
now know that at least one of the two almost certainly happened after Reuters
report from earlier today that it discovered on the FINRA BrokerCheck page of
one of the bank's former Managing Directors, Eric Beckwith, the following
curious ongoing investigation:
WE
UNDERSTAND THAT THE USAO (US Attorney Office) -WDNC IS
INVESTIGATING WHETHER IT WAS PROPER FOR THE SWAPS DESK TO EXECUTE FUTURES
TRADES PRIOR TO THE DESK'S EXECUTION OF BLOCK FUTURE TRADES ON BEHALF OF
COUNTERPARTIES, AND WHETHER MR. BECKWITH PROVIDED ACCURATE INFORMATION TO THE
CME IN CONNECTION WITH THE CME'S INVESTIGATION OF THE SWAPS DESK'S BLOCK
FUTURES TRADING. WE ALSO UNDERSTAND THAT THE COMMODITY FUTURES TRADING
COMMISSION IS CONDUCTING A PARALLEL INVESTIGATION INTO THE TRADING ISSUE.
The
U.S. Department of Justice and the Commodity Futures Trading Commission have
both held investigations into whether Bank of America engaged in improper
trading by doing its own futures trades ahead of executing large orders for
clients, according to a regulatory filing.
The
June 2013 disclosure, which Reuters recently reviewed on a website run by the
securities industry regulator FINRA, sheds light on the basis for a warning by
the Federal Bureau of Investigation on January 8.
The
warning, in the form of an intelligence bulletin to regulators and security
officers at financial services firms, said that the FBI suspected swaps traders
at an unnamed U.S. bank and an unnamed Canadian bank may have been involved in
market manipulation and front running of orders from U.S. government-owned
mortgage giants Fannie Mae and Freddie Mac.
Only
this time it's different, because a quick check on the background of Beckwith
shows that his expertise is not trading MBS but a different product entirely.
First,
it goes without saying that Eric would promptly scrap his LinkedIn Profile as
the following URL
shows.
What
Eric, however, was unable to delete was the mention of his name as the Bank of
America contact for an "innovative new product created [by the CME and the
banks] based on client demand" - Deliverable Interest Rate Swaps
Futures, or as some call them Deliverable Interest Rate Products.
What
is this newly promoted product, and why is there demand for it? This is what
the CME had to say about the benefits of "DIRPs" (even though the
technical acronyms is DSFs):
Capital
efficient way to access interest rate swap exposure
Flexible
execution via CME Globex, Block trades, EFRPs and Open Outcry
Allows
participants to trade in an OTC manner:
Ability
to block calendar spreads
Lower
block thresholds and longer reporting times
No
block surcharges
But,
as in the case of CDS, and all other novel products, the main reason for DIRPs
is simple: an even lower margin requirement compared to Interest Rate
Swaps and Treasury Futures (margined together), allowing one to express a
position, or better, manipulate the market in Interest Rate products, using the
least amount of margin (initial capital) possible.
The
following chart explains just this:
###
Bottom
line: if you want to manipulate Treasurys in a reflexive market, where the
derivatve almost always drives the price of the underlying (as perhaps explained
best by none other than the then-member of the Fed Dino Kos),
this is the best product as you get even more firepower for your buck.
Only
in this case, anyone trading with the Bank of America DIRPs desk was apparently
also being frontrun on a consistent basis.
We
are relatively comfortable with alleging that BofA did indeed allow this to
happen (whether it neither admits nor denies guilt at the end of the day),
because a few weeks after the notice appears in Beckwith's Brokercheck profile
on June 14,2013, he promptly "left" Bank of America in July as
Reuters reports: not exactly the course of action an innocent man would take.
In
other words, while Reuters is focused on the Fannie and Freddie frontrunning
angle, it appears the frontrunning activity spread substantially to involve the
entire Treasury curve as well!
So
while HFTs frontrun all equity retail trades in open markets, major banks
frontrun all institutional block equity orders in their own dark pools, we find
out that bankers also just happen to frontrun clients in "you name
it" over the counter product, where the only reason to be involved is to
take advantage of the low margin - something JPM's CIO did quite aggressively
and quite well until it blew up of course.
But
the best news: we finally know how it is possible that every bank reports
quarter after quarter of near uniform trading perfection and close to zero
trading day losses.
Finally,
our question for the regulators: in a Volcker world in which banks are
supposedly not allowed to trade ahead of their clients, why are banks,
well, trading ahead of their clients!?
No comments:
Post a Comment