To channel my inner Shakespeare, “to re-paper or not re-paper – that is the question”. I could continue with something like, “whether ‘tis nobler in the mind to stand by the price and wear the loss, or run crying to the authorities and try to get it cancelled” but that kind of loses poetic effect.
Either way, market makers often get a hard time from the outside world – typical of this is how one trader at a Profit & Loss conference (whose strategy seemed rather to rely upon having as many quotes, as tight as possible, streaming to him at one time – but perish the thought it was arbitrage related!) complained about the quality of prices he was getting from the banks.
I garnered the odd gasp, more chuckles and even a smattering of applause when I pointed out that if the pricing was that bad he could always stick a bid or offer in himself (which he probably now does as a “market maker”), but his viewpoint is largely reflected in a lot of other places. There is a sense of entitlement – thanks in part to the marketing of the liquidity providers themselves – that “there should always be a price for me”.
Most of the time there is, of course, but occasionally there isn’t and normally this is around liquidity events. At the risk of this column becoming over-obsessed with flash events, I want to talk about the recent flash crash in Jardine Matheson shares in Singapore and specifically about apparent attempts to re-paper trades.
The details of the event are wearyingly familiar to those in the markets; order book imbalance at a time of thin liquidity, programme traders exacerbating the move because their signals told them to, and liquidity disappearing. But of course, it didn’t totally because according to a report by Bloomberg News two institutions – named as Goldman Sachs and Morgan Stanley – wanted to re-paper trades. There were, apparently, other calls for trades to be cancelled but the Singapore Exchange said – as is its right – that sellers had ample time to remove their orders and as such all trades stand.
It was pointed out to me that some of these sellers may have be official market makers and thereby subject to certain criteria in providing pricing to the exchange – in which case the question has to be, is this fair in a liquidity-stressed environment? At face value I would say no, but of course, the flash crash happened in the pre-open, (which itself confuses me – surely a market is either open or it is not?) and so, if you’re allowed to trade before the official open, then this means the exchange market is suddenly OTC and as such the market maker has no obligation (which in turn asks yet another question, if there is no obligation, what were they doing making markets?)
If that isn’t enough questions, here’s another – at a broader level should there be allowances for market makers subject to criteria when it comes to earning their rewards? I understand that on some exchanges there is an average that needs to be hit and that this is fairly generous and allows a market maker to withdraw during an event. The problem is, these events are happening more regularly so the average may be impacted.
My personal view has always been the same, we need “no-tears” pricing and trading in financial markets if they are not to descend at some stage into chaos, but this needs to come with a balance, and that is that market makers should not be obliged to stream a price – if things get hairy, then they should be able to pull out without sanction.
This would exacerbate moves, especially if market makers get even more sensitive to events and err on the side of caution, but perhaps one answer to this is more intelligent execution on the part of the market taker? If liquidity isn’t there, don’t chase the market unless there are sound fundamental reasons for it to be lower or higher.
I had some very robust discussions with one or two banks post-SNB about how I thought trades should not be re-papered under any circumstances and, as I have reported before, their argument was that they wanted to re-paper trades at, for example, 1.13, which their clients refused, but then those same clients wanted to re-paper trades at 0.70.
Neither should be allowed – and hence I totally support Singapore Exchange’s position – all trades should stand. In the case of the SNB event if someone is stupid enough or has such little control over their execution algos that they sold EUR/CHF at 0.000125 then they should wear the consequences. Anyone could tell that the Eurozone wasn’t about to be financially destroyed or that Switzerland had found $10 trillion worth of gold in a vault somewhere that it now owned, so the flash element of the move – and frankly anything under parity – was irrational in the extreme. Why should markets go through the pain, misery and grind of re-papering trades because someone is thicker than my Labrador?
Likewise, has Jardine Matheson been showing signs of collapsing recently? Is it a company with huge issues? Was Procter & Gamble, which famously went to one cent during the May 2010 flash crash, bankrupt? No it wasn’t – and even if it were, the plant, machinery and property owned by the company was probably worth a few dollars per share.
Markets have always been irrational, that’s half the fun, but there are genuine limits to irrationality. Brexit was a major shock to the system and totally unexpected in most quarters – that was about as big as these unexpected events get, but even there the FX market, while moving 20 big figures and more, understood that there was still value in the pound and that 1.30-ish was a rational level (a level to which, I would point out, Cable remains close to this day, which shows how well the event was priced in those few hours). The thing is though, given the massive shock that was the Brexit result, would Cable have gone to 0.001? If it had, is there anyone who would seriously have thought that was a rational reflection of economic realities?
So the key theme here is why should markets pander to the stupid or the inept? Well the problem is it’s not always the stupid that cause these events, sometimes there are genuine errors made such as a fat finger trade.
I stand by my assertion that market makers should have no recourse to re-papering trades if they made what they thought at the time was the right price because their pricing is the result of information which should be properly assessed. The problem is what happens with a genuine fat finger error that triggers thousands more trades, making it harder to actually see whether the original trade needed re-papering?
Well I think the market participant concerned can self-report the fat finger trade and the exchange, or in the OTC world a body like the GFXC or BIS Markets Committee (or the local central bank of course), can rule that it was indeed an error and all trades in the window of the event are cancelled. This would be a considered ruling by an independent body – it is actually the type of event of the like that ACI’s Committee for Professionalism has been studying and advised on for many years – and should take the emotion out of the issue.
There are those who, if we see such an event, believe that same independent body can make a ruling on what the high or low should be. At the moment, the FX market does have this to a degree in the EBS and Matching high/lows for the various currency pairs but there was quite a bit of dissatisfaction (obviously from those who lost out) over how both handled certain aspects of the events that took place in their core currencies, so perhaps it is better taken out of their hands?
If the independent body looks at the situation, and rather than state where it thinks the market should have stopped, which is very subjective, perhaps it can declare where the market became irrational – in other words, the point at which people should have thought, “hang on a minute, what am I doing selling down here?” The problem is this is again pandering to someone (or something) that clearly lost control and lost the power of rational thought.
Yes, such a mechanism would be harsh on some people, but I would suggest the first time it happens market participants will make sure they are very careful going forward with how they trade, or let their algos trade – and a better, more considered, and therefore more robust market would result.
I am afraid that people selling at $11 per share in Jardine Matheson when it closed at $66, at 0.000125 in EUR/CHF and one cent in Procter & Gamble are merely serving to highlight their lack of operational proficiency – why should they be allowed to get away with that when their actions represent a risk to the health of the wider market ecosystem and even the global economy itself?