From the April 01, 2011 issue of Futures Magazine • Subscribe!

Merger mania and the clearing bonanza: Trader's view of the world

Regulatory Backlash

Beyond the mergers, a growing wave of anti-speculator fervor is growing around the world. Many blame rising wheat prices for the current turmoil in the Middle East, and French President Nicolas Sarkozy has implied that outlawing speculation in food products might not be a bad idea.

Algorithmic trading remains under fire after last May’s flash crash that sent the Dow down more than 900 points in a matter of minutes, only to see it bounce right back up. That sparked a mad scramble to develop safeguards (see "Bust or adjust: Inside the error can of worms," January 2011) that exchanges and traders now say are too restrictive.

Recently, sugar went the other way — spiking more than 150 points above equilibrium price, with no news to drive it and no similar moves in related commodities.

World Sugar Committee Chairman Sean Diffley immediately blamed "parasitic" algorithms that aim to "flip" the market by identifying where the stops are and then hitting the area with a barrage of orders that cause a quick — and quickly-reversed — move. It’s a practice as old as the pits — and before the advent of electronic trading it was called "running the stops."

ICE responded by vowing to scratch trades that meet its criteria for being suspect (big, brief moves with no discernible spark, for example) and revived its "implied matching engine" that electronically matches different bids and offers to keep the market running smoothly.

Like all measures implemented by exchanges in the wake of the volatility this past year, it’s an imperfect solution, and time will tell if it’s improved upon or abandoned.

On a larger level, the CFTC, in response to a new mandate implemented under the Dodd-Frank financial reform law, has asked participants for input on how to deal with "spoofing" (entering a massive order, letting the market see it and the cancelling just before it’s hit) and "banging the close" (throwing in massive orders on the close to impact the settlement price), as well as dealing with algorithmic trading in general.

Dodd-Frank calls for new rules to be in place by July, but the new wave of House Republicans voted to slash the agency’s funding by one third — an action unlikely to pass the Senate.

However these events play out, it’s clear that the already turbulent global derivatives landscape has plenty of seismic action left in it, and the growing exchange sector is now pitting regulators against the five major banks, while at the same time lining up with the banks to tell the world that speculation is good.

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