Sarao effect has driven “need for speed”

The British futures trader dubbed the ‘Hound of Hounslow’ whowas arrested in April over manipulative trading behaviour back in 2010 is duein court Friday for his extradition hearing. His case has sparked media andmarket interest, and has caused a shift in attitudes to market surveillance andthe systems available to catch manipulative behaviour.

Navinder Singh Sarao was arrested earlier this year at the order of USauthorities following allegations of manipulation that led to the ‘Flash Crash’in 2010.

After months in custody – he was finally granted bail in August – Sarao is set to appear at Westminster Magistrates on Friday to fight hisextradition to the US for prosecution there.

The case thrust the murky-sounding practice of ‘spoofing’ – thepractice of placing an order with the intent of cancelling it before it can becompleted - in to the public domain.

With the charges against Sarao including one count of wirefraud, 10 counts of commodities fraud, 10 counts of commodities manipulationand one count of spoofing, they carry a maximum sentence of 380 years.

As previously reported, US authorities have estimated thatthe alleged activity which led to the 'Flash Crash’ resulted in profits of $40million from April 2010.

While there is market sentiment, especially amongst London’sprop community, that Sarao is being made ‘an example’ of, Sarao faces a longprison sentence in the US if he loses Friday’s battle.

If the recent conviction of Tom Hayes - who is now serving a14-year sentence over rate rigging - is anything to go by, then the future looks rather gloomyfor the Hound of Hounslow.

Media attention – fascination even – on how one trader’saction could cause such catastrophic market damage, has been rife, and has alsoled to a marked increase in company attention and investment in surveillancetechnology to help catch and curb manipulative behaviour, with speedierresolution increasingly a focus.

CEO of Bats Global Markets, Chris Concannon, in conversationwith FOW this week, confirmed that Sarao’s alleged activity was a contributingfactor in the firm’s recent push to expedite enforcement action.

The Bat’s Client Suspension Rule - which was filed with theSEC in July 2015 - would allow the group to take swifter action in prohibitingmanipulative behaviour across its exchanges, such as layering and spoofing -the practice of placing an order with the intent of cancelling it before it canbe completed.

Concannon also called for similar rules to be extended to all markets and asset classes.

As reported by FOW last month, greater complexity in thesurveillance space is presenting challenges for trading firms, andopportunities for tech firms that can provide solutions.

Growing demand is also driving creation of ‘package offerings’ that encompass firms’ trading interests to better-meet modern marketsurveillance needs.

Michael O’Brien, head of product management at Nasdaq’s SmartsTrade Surveillance, told FOW Thursday, “The timing of the Sarao case and theevidence being led with ties in with the regulatory focus around order bookmanipulation and high-order cancel rates.”

Impending market abuse regulation in Europe focuses on unusualcancel rates and order-to-trade ratios being indicators of market abuse. Whenlooking against that background, the Sarao evidence can be used as it isfocused on these cancel rates and order to trade ratios, an FOW source added.

“The evidence of this… has crystallized in the minds ofmarket participants that they need to have a means to analyse and pull apartthe huge amounts of order data that is coming out of these electronic tradingplatforms. And for that reason, there’s more focus on visualization and dashboards to identify unusual cancel rates,” added O’Brien.

While Sarao’s case has definitely highlighted the issue,spoofing practices are rife according to Dan Goldberg, head of business development at London-based proptrading firm, Futex.

“When you can seesomeone spoofing the market, you can try to profit from it but that is veryhard. I hold off… I report it all the time but the problem is that the exchangehas no responsibility to report back its findings… so you never hear anythingmore, though once in a while you’ll hear of someone being pulled up on it, butthat’s probably two years or so after the fact."

Concannon from Bats said that such behaviour hasalways existed, and the market watches for it, but the Sarao case has refocusedand reminded the market that enforcement action, at present, cannot be takenswiftly enough, with its rule set to stop such conduct in a matter of weeksrather than the years it currently takes to reach a resolution.

The trader’s arrest was cited in the exchange group’s recentfiling for approval of the rule in July. “[BATS]… notes the current criminalproceedings that have commenced against Navinder Singh Sarao. Mr. Sarao’sallegedly manipulative trading activity, which included forms of layering andspoofing in the futures markets, has been linked as a contributing factor tothe “Flash Crash” of 2010, and yet continued through 2015. The Exchangebelieves that the activities described… provide justification for the [ClientSuspension Rule].”

Robert Powell, global head of compliance and productmanagement at Etrali Trading Solutions, told FOW that there has been a markedincrease in firms’ upping their compliance and supervision technology since thefutures trader was arrested, and the conviction of Tom Hayes over Libormanipulation earlier this year.

What will be interesting to see if what – if any – changes exchangesmake to prevent this from happening again, should the case prove that Sarao wasable to cause the market crash, said Powell.

“Where you have groups of people acting as a firm then therisk that they will cause such an event is lessened because of the additionalcontrols that are placed around the trades they do and they have a complianceofficer to guide their behaviour. That's not the case with sole traders whoonly have the exchange and the rules to keep them in check. It's an interestingconundrum.”