Paul Axel Walter has been fined £60,090 by the FCA for committing market abuse in terms of s.118(5) of the Financial Services and Markets Act 2000 (FSMA). The conduct took place between 2 July 2014 and 8 August 2014 (the Relevant Period) and prior to the implementation of the Market Abuse Regulation which now sets down the law relating to market abuse.
Walter was an experienced and senior bond trader, working at Bank of America Merrill Lynch (BAML). His relevant trading during the Relevant Period related to Dutch Government Bonds (DSLs). By way of background, the Dutch State Treasury appoints Primary Dealers in relation to DSLs. Primary Dealers are, amongst other matters, required on a daily basis to make available a certain level of liquidity. On the day before the start of the Relevant Period, BrokerTec became a designated trading system which meant that Primary Dealers in DSLs could meet their obligations by quoting on BrokerTec. BrokerTec is an electronic inter-dealer platform which is used both for manual and algorithmic (automated) trading. Whilst BAML was not a Primary Dealer for DSLs, it did act as market maker, and Walter dealt with Primary Dealers on BrokerTec during the Relevant Period.
The FCA described Walter's abusive trading during the Relevant Period as follows. Walter would enter a quote on BrokerTec which constituted either the Best Bid or Best Offer. However, these quotes represented to the market the opposite of Walter's actual trading intention. The quotes would be in the smallest denomination permitted by the exchange: the FCA said that this was part of Walter's strategy to mitigate the impact of these orders being filled. Walter was aware that Primary Dealers' algorithms trading on BrokerTec would track his bid/offer and adjust their prices accordingly. Walter would adjust his quote when he knew he was being "tracked". When the price had reached Walter's actual desired level of bid/offer, then he would execute trades (usually to flatten his own position in DSLs after market-making for a BAML client). The executed trades were almost always of a significantly larger size than the bid/offer quote used to induce the algorithmic traders, but did occur within the then prevailing bid/offer spread. After he had executed his trades, Walter would then cancel his quote and the market would respond accordingly. Because BrokerTec does not reveal the identity of the market participant before or after the trade, the FCA said that this made it easier for Walter to conduct his strategy.
The FCA determined that Walter had conducted this strategy on 12 separate occasions during the Relevant Period. This resulted in a profit to his book of EUR 22,000, based on the prices available immediately before Walter deployed his strategy.
Towards the end of the Relevant Period, on 22 July 2016, Walter received a call from BrokerTec in response to a complaint about his trading. Walter refused to answer any questions. He later said that he had doubts as to the authenticity of the call. Despite being on notice as to the propriety of his strategy, he continued to deploy it. This was treated by the FCA as a factor relevant to its determination of seriousness when fixing the penalty.
The information that Walter provided to both BAML and the FCA during the internal process and interview respectively regarding the trading was not accepted. Walter told BAML that, whilst he could not recall, cancelled orders might represent errors and small quotes might have been needed to round his book positions. He told the FCA that he might have quoted the Best Bid when he wanted to buy and was using small denominations to be less disruptive to the market. He also said that the Best Offer was quoted to allow him to sell to those tracking him to discourage them. None of these explanations were supported by an analysis of the trades.
The FCA determined that Walter's trading during the Relevant Period was abusive, contrary to s.118(5) FSMA. The FCA accepted that the orderliness of the market was not impacted (and this was relevant on seriousness for the purpose of penalty). However, the relevant test for s118(5) was whether he created a false or misleading impression as to the supply and demand of DSLs and secured the price (momentarily) at an artificial level. The FCA also found that he had not intended to commit market abuse, but that intention was not relevant to s118(5), and Walter had in any event been negligent for not realising that the trading was abusive. The penalty imposed, following the 5-step process set out in DEPP, was £60,090. Walter was not prohibited, but appears to have had his approvals removed shortly after the Relevant Period commenced.
Much of the press coverage of this case has focussed around the "algo baiting" component. Algorithmic traders are a common feature of many markets and their trading forms part of the landscape that manual traders must negotiate. In this case Walter used the predictable response of the algorithms to his advantage, but he need not have been transacting with algorithms to deploy his strategy. Fundamentally, this case is about Walter representing an intention to the market (whether or not it had a "human" manifestation) that was directly opposite his actual intention. In this sense, the Notice is not especially radical. No doubt the FCA would have reached the same determination in a case brought under the new Market Abuse Regulation.