Conduct Risk: Colloquial Trading Practices

Nicolas Corry, Managing Director, nicolas.corry@skadilimited.com

Our customers constantly ask us where the next area of focus for Regulators will come from. Our predictions are that regardless of the product or market, poor conduct will be at its heart. The Fair and Effective Markets Review devotes a large part of its scope to the subject of Conduct Risk. Conduct Risk emerges from a number of powerful drivers which are challenging to define, recognise and control. A key challenge Control Functions face is how to manage Conduct Risk effectively without constraining Front Office innovation and creativity.

Skadi Limited has defined an area of risk: Colloquial Trading practices. We define these as practices traders use in their day to day activity, at best, not governed by rule structure, at worst, unknown and unrecognised by outside observers which include Management, Control and the Regulators. Examples are Last Look (now identified), No-post Trading, Grey Market Trading.

No-post trading is the practice whereby traders ask the Inter-dealer Broker and the Counterparty on the other side of a trade to agree not to broadcast the trade to the wider market place, preserving the secrecy of the transaction. Justifications for this may include an instrument being highly illiquid, when knowledge of the transaction may impact the market price for a security. The practice could be misused however. Risks include front running, creating a false market.

Grey Market Trading is dealing in a new security prior to its terms being fixed. Grey Markets are intrinsically linked to the success of a new issue placing, it is paramount therefore that members of syndicate do not trade in the Grey. Securities trading above issue price will attract orders into the book, it may also be attractive to sell into the Grey Market price to reduce the price of a security to protect the Syndicate from accusations that the terms offered to the market were too generous to the disadvantage of the Issuer. Grey Market Trading mainly occurs via the Inter-dealer Broker market, and a Grey Market may develop over a number of days, it can be difficult to track trading activity as the securities generally are not set up until the terms are known, allowing trades to be parked for a few days, and booked out at a later stage. To date we have not found regulation covering Grey Market Trading, therefore the practice is also at risk from ethical drift as new traders over time may not be aware that their participation as a Syndicate member is wrong.

We recommend our customers establish to what extent “Colloquial Trading Practices” are recognised by Front Office Management. Whether the practices have been reviewed for their application in the current market environment. c.f. last look trading borne out of a legitimate historic need but now no longer acceptable to advances and changes in the market place. Audit and Compliance need to ask Front Office to demonstrate and provide justification for their legitimate use and assess whether they are appropriately controlled.

Taking a forward look today, could help prevent a “Last Look” tomorrow.

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