Spoofing: Regulators to Clamp Down on “Particularly Harmful” Form of Market Abuse
U.S. and European regulators are ramping up their focus on the market abuse behaviour known as ‘spoofing’ as they come to terms with the potentially devastating effects the practice could have on markets.
‘Spoofing’ is when traders place orders to their books with no intention of fulfilling the trade. Publicly placing the order makes the product look more in-demand than it actually is, raising the price for the counterparty to the trade. Having charged counterparties at an unfair price, the traders cancel their original trade before it is fulfilled. Last week, HSBC were fined $45 million by the U.S. Commodity Futures Trading Commission (CFTC) after it was found that some of the bank’s London-based traders engaged in spoofing. In the associated press release, linked below, the CFTC’s Director of Enforcement stated that the Commission will have “zero tolerance” for spoofing transactions.
Spoofing stands out as one of the most concerning market abuse behaviours for regulators. In a recent newsletter, the FCA emphasised the severity of spoofing’s impact by stating that "spoofing is particularly harmful as it undermines confidence in the integrity of markets and can lead to price distortion and reduced liquidity”. In this era of automated trading, regulators’ concerns are warranted. Algorithmic trading systems see ‘spoofed’ orders and perceive it as a sudden surge of supply or demand, reallocating their portfolio and creating artificial price movements. The effects of this can be devastating: In 2010, US financial markets experienced a systemic and temporary decline in prices on an intraday basis, known as a “flash crash”, largely attributed to bots acting on unreliable information.
Spoofing has long been deemed unlawful under UK/EU Market Abuse Regulations and the U.S. Dodd-Frank Act, but chatter from regulators indicates the topic will rocket up the agenda for the remainder of 2023 and into 2024. It is important for entities undertaking public trades to understand regulators’ hawkishness in this area. As the fine slapped on HSBC shows, this concern expands to less liquid, OTC markets.
