FMAP Essay

FMAP Essay

1. Manipulation

   • Types
     • Long & short
     • 'Corner' & 'squeeze' (mainly associated with long)
       • Good explanations in Hull, Bailey and Futures Mag article
     • Using front running
   • Origins
   • Infamous cases
     • Feruzzi soybean episode
     • Hunt silver manipulation (1979-80)
   • Definitions
     • Operation of monopoly power (price making ability) when contracts are close to their expiration dates
     • One manipulator, or a group, create an artificial price via planned behaviour
     • Wide disagreement on what constitutes improper conduct, in this context
     • Intentional creation of an artificial price - doesn't reflect the basic forces of supply and demand

2. A brief history of futures markets

3. Detecting manipulation

   • Characteristics
     • 1. Ability to influence price (dominant market position)
       • Perhaps a result of information asymmetries/inefficiencies/imperfections
     • 2. Creation/existence of an artificial price
     • 4. Intention to cause the artificial price
       • Attempted & actual
     • More generally: fraud, deceit, use of false info, or violation of exchange rules
     • Legitimate transactions coupled with improper motive
     • 3. Culprit actually caused the artificial price
   • Difficulties
     • Hard to identify and prove intention/motive
       • Forms of evidence? SEE BAILEY p.385-86
       • Often rely on circumstantial evidence
     • Multiple definitions for an artificially created price
     • Artificial price typically exists for a very short period of time
     • Anonymity of futures contracts - other traders unaware of manipulative intent
       • Sometimes exchanges have discretion to identify counterparty to a contract
     • Complexity of trades themselves - proving what actually happened
       • Near limitless possible underlying reasons and methods of manipulation
     • No universal test - fact-specific, case-by-case consideration

4. Regulation

   • Purposes
     • Promote public interest - manipulations hurt social welfare
       • Harm risk-shifting behaviour e.g. reduce effectiveness and prevalence of hedging
       • Damage price discovery - see paper for definition
       • Prevent fraud/abusive trade practices
       • Traders restrict participation (less liquid markets) under fear of being subject to manipulation
     • Ensure that new contracts (or changes to existing contracts) serve some economic purpose. E.g. aiding hedgers as well as speculators
       • Significant barrier to innovation in contract design?
       • Contracts not catering to hedgers likely to fail anyway?
     • Transparency
     • Monitoring trading & taking disciplinary action
     • Arbitraging disputes
     • Foster competition (perhaps indirectly)
     • Restrict # contracts single investor allowed to hold (usually via exchanges)
     • Ensure markets operate in manner conducive to performing their economic function
     • 1. Ensure appropriate contract design
     • 2. Active market surveillance
   • Effectiveness?
   • Can we improve methods?
     • Concentrate regulation efforts on markets for certain commodities?
       • Regulation unnecessary in futures markets with high liquidity?
       • Set regulations in association with elasticity of demand for commodities
       • Cocoa vs. sugar regulation effectiveness in NY/LON - 1980s
   • Harmonisation across nations?
   • External bodies responsible
     • UK?
     • US?
   • Self vs. gov regulation
     • Drawbacks of gov reg
       • Costly
       • Reg capture
       • Lax reg
       • Rules hard to enforce
     • Self reg via futures exchanges
     • Self reg cannot stop collective manipulations and full discovery of info in futures prices
     • Self reg has some precautions against market power
     • Not mutually exclusive - use in tandem!

5. Feasible to live without gov regulation today?

   • Seriously consider this?!
   • Lessons from 07-08 crisis (albeit in a market for a different type of security)
   • Much more hard-nosed approach on regulation now e.g. Tom Hayes and LIBOR
   • High complexity of today's financial markets - require some oversight
   • Do manipulators, on average, profit from their activities?
     • Put forward in Bailey
   • Is ex-post detection and punishment less costly to society?
     • Preventative measures = bureaucracy distorts markets
     • Discourages propensity to engage in manipulation
     • Put forward in Bailey (originated from Pirrong)