Jane Street vs. SEBI: what does it mean for your market abuse risk assessment and surveillance practices?
Huge amounts of retail participation in equity options have made Indian derivatives markets a notable success story in recent years, with volumes expanding rapidly. Such an influx of, what some might dismissively deride as ‘dumb money’, into derivatives markets makes for an irresistible opportunity for brokers and proprietary traders, many of whom have profited greatly. However, now a very public market abuse case focussed on one of the world’s leading proprietary trading and market making groups, Jane Street, suggests some may have over-stepped the mark in profiting from this tantalising opportunity.
It is important to note that while the allegations made by the Securities and Exchange Board of India (SEBI) are extremely serious, Jane Street has vehemently denied the allegations, setting the scene for a battle between the regulator and the firm which could drag on for months or even years. The two sides versions of events can be summed up simply as:
SEBI accuses Jane Street of one of the oldest tricks in the market manipulation playbook – exploiting an illiquid or thinly traded cash market to push around the value of a much larger derivatives trading position. In this case it is alleged that large options positions in the NIFTY Bank Index were manipulated by trading in the much less liquid cash and futures markets.
Jane Street however maintains that’s no manipulation took place, and that its strategy was a traditional arbitrage play, profiting from small price differences between the related instruments.
The first question this raises for compliance teams is – how might you conclusively tell the difference? The definition of abusive behaviour in markets can often have significant shades of grey, and the kind of cross-product manipulation alleged to have taken place is notoriously difficult to distinguish from legitimate trading behaviour. The difference between a great trading strategy, or ‘edge’, and manipulation can be hard to prove, and it would take a very brave compliance officer to challenge such a profitable strategy.
As a first step, Compliance teams working with similar cross-product strategies should consider how these are categorised in their market abuse risk assessments. Thought should be given as to which trading strategies can be considered low risk or within risk tolerances, and what indicators may suggest that a trader, desk or strategy may have crossed a line into abusing the market. Often these will require a high degree of judgement, rather than being based purely on quantitative thresholds – i.e. measures like ‘excessive profitability’ may be of particularly limited value, where the aim of the organisation is to find very profitable trading opportunities. The compliance team need to have both the experience, and the influence within the organisation, to challenge when they believe lines have been crossed.
Firms trading complex strategies, and trading venues and regulators, should also give consideration as to whether their surveillance capabilities could identify similar potentially manipulative strategies. A large number of different instruments, across cash markets and derivatives, on exchange and OTC, could potentially be utilised in such a strategy. Firms should proactively consider whether their current arrangements allow them to get a holistic view of a trader or desks positions across all markets to identify potential abuse. Meanwhile, trading venues and regulators should review whether they can gather sufficient evidence in a holistic way to prove manipulation has occurred. In the case of SEBI vs. Jane Street it seems likely that the evidence in question will ultimately need to hold up to the scrutiny of the courts.
Whatever the outcome, the reputation of Jane Street, SEBI and Indian capital markets are all likely to be tarnished to some degree. Such reputational concerns should arguably also factor into market abuse risk assessments of higher risk trading strategies. The amount of scrutiny likely to result for Jane Street, not just from SEBI but also other regulators who are likely to want to conduct their own reviews, may ultimately outweigh the profits the strategy yielded.
Finally, given the high-profile nature of the case, it is likely other trading venues and regulators will launch their own reviews, to see if abusive behaviour of a similar nature has taken root in their markets. Firms and trading venues should review their market abuse risk assessments and surveillance practices, particularly around market manipulation, to ensure that they are robust enough to satisfy regulators.
Get in touch if you’d like to discuss this in more detail.