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DominicConnor
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GAMING THE SYSTEM?

September 15th, 2004, 9:52 am

Excellent To me the interesting point is how little money Citi made from this.7 million is nice, but it's a one off hit, but they had to trade 7 billion to get it.So given the risks involved, that is not so awfully impressive, since you don't have to make a very large mistake with 7 gigabucks to endup feeling rather sad.I assume they must has tested the model in the real market, since I can't believe they'd be reckless enough to come in one day and do this just to see what happened. (I may be wrong here Since they carried out the big hit, it appears that these tests worked. I wonder why they didn't just do small hits on a regular basis ?By being greedy, they can't do it again. A lot of hard work by smart/expensive people went into this, and one assumes they have variations of this approach ready to go. Hard to see them being allowed to do it again, indeed the better the sceme the less likely it is to be approved.If of course they'd stuck at skimming 100K per day, Mr. Maheras would be buying them a very fine lunch, and in the long run, make more money.However, I think this may be the way of the future. People will pay more attention to the mechanisms of price formation and distribution, both to make money and as a defence.
 
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mdubuque
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GAMING THE SYSTEM?

February 1st, 2005, 8:39 pm

Citigroup bond trade memo is revealedBy Päivi Munter in London Published: February 1 2005 02:00 | Last updated: February 1 2005 02:00Citigroup's huge trades in the eurozone government bond market in August - described by Chuck Prince, chief executive, as "knuckle-headed" - came shortly after an internal memorandum spelt out how the US investment bank could "very profitably" destabilise the market. The memo, obtained by the Financial Times, outlines a strategy to shake up the eurozone market, where trading margins have contracted because of transparency and stiff competition. The document - dated July 20, two weeks before the trades - says Citigroup wanted to "turn the European Government bond market into one that more closely resembles" the less transparent US Treasury bond market, which is dominated by a smaller number of investment banks."Over time, this may help to kill off some of the smaller dealers," it adds.A Citigroup spokesman said: "As this is the subject of regulatory enquiry, we are unable to comment other than to say this memo is filled with inappropriate and unrealistic statements. It was not seen by, nor does it represent the views of, the supervisors who approved the trade, nor of the firm."The memo is likely to fuel the indignation of eurozone governments, many of which have lowered their borrowing costs since the euro's launch six years ago. It may also weigh against Citigroup in regulatory investigations of the trades, being led by BaFin of Germany and the UK's Financial Services Authority. Entitled "Challenging the dominance of Eurex futures", the document outlines a plan to take advantage of liquidity differentials between the German government bond [Bund] futures and cash bonds traded on the EuroMTS electronic system. "We should be able to exploit this situation in a very profitable way," it says.Eurex, the Frankfurt-based derivatives exchange, is the most important trading venue for eurozone government bonds, as its German government bond futures are used to price all eurozone government debt.While trading activity on Eurex fluctuates because of seasonal factors and economic conditions, liquidity on MTS is much more constant because it obliges its dealers to provide continuous price quotes. "When there is a liquidity imbalance ... we drive up the Bund future [and] then hit out all the cash [bids] on MTS," says the memo.On August 2, Citigroup stunned the market by selling €11bn of cash bonds in less than two minutes. About 30 minutes later, the bank bought back €4bn of the bonds at lower prices, making a profit of about €17m.The explicit intention to destabilise the Eurex futures is likely to strengthen the hand of German prosecutors, who last week launched a criminal probe into possible market manipulation.The memo, apparently written by Simon Wivell of Citigroup's European government bond trading desk in London, is addressed to Daniel Leadbetter, another member of the same team.
 
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DominicConnor
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GAMING THE SYSTEM?

February 2nd, 2005, 8:07 am

regulatory investigations of the trades, being led by BaFin of Germany and the UK's Financial Services Authority. The FSA have a lot of teeth but no brain. The outcome is random. I'm uncomfortable about the idea that liquidity arbitrage is seen as somehow "wrong". The way that price discrepancies are corrected in markets is people trading away the difference. Some people move faster than other, we regard the fast agents as the most useful because arbitrage implies inefficient markets. Such fast movers are typically rewarded very well.People put in sloppy control systems for the on line trading, and wonder why they get screwed. Are we to see government intervention to protect those people who assume constant volatility and thus lose money ? If my Excel macro crashes when the month ends on a public holiday am I to be compensated when my prices are wrong ?The regulators don't get what is going on in electronic markets. Their intuitions are blindly stupid. They lack the physics or philosophical background to understand what's going on. Typically they have a binary view of the IT problems either trivial or impossible. Here's a good question : "Where is a price ?"
Last edited by DominicConnor on February 1st, 2005, 11:00 pm, edited 1 time in total.
 
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mdubuque
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GAMING THE SYSTEM?

February 2nd, 2005, 4:41 pm

Dominic-I'm much less familiar with what advantages may accrue to a "primary dealer" in European governments, but I know that the advantages of primary dealers of US Treasuries are large (though not as great as they were 10 years ago).In the USA, primary dealers benefit from daily phone calls from the open market desk at the New York Fed each and every morning, discussing each side's perspective on the market. This inside track into Fed thinking is priceless and offers pricing advantages to the primary dealers who know when the Fed is planning to do customer or system repos before anyone else.As part of the deal in the USA in which the primary dealers get this essential inside information, they pledge to provide liquidity and to promote stability in the Treasury markets. This is an explicit commitment, and, as I recall, E. F. Hutton was banished from the club in the 1980s because they were kiting hundreds of millions of dollars in checks and harvesting the interest on the float.This brought disrepute to the Treasury markets and E.F. Hutton was banished from the old boys club (i.e. being a primary dealer) and they faded into obscurity shortly thereafter. This is my recollection.The key point here is that Citicorp actively promoted destabilizing the European treasury markets, according to the article.If the European market makers have any similar kind of unfair market advantages over other players, then this conduct should definitely be punished harshly.But again, I am less familiar with primary dealers in Europe than in the USA.Matthew
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mdubuque
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GAMING THE SYSTEM?

February 2nd, 2005, 9:19 pm

This addresses Dominic's point about why the deal wasn't larger in scope.MatthewFrom the Financial Times:Citigroup 'planned bigger deals' in controversial eurozone tradesBy Päivi Munter in London and Patrick Jenkins in Frankfurt Published: February 2 2005 02:00 | Last updated: February 2 2005 02:00The scale and impact of Citigroup's controversial eurozone government bond trades in August was intended to be far greater than previously reported, people familiar with the transactions said yesterday. Citigroup bombarded the Europe-wide MTS electronic trading system with selling orders amounting to tens of billions of euros within seconds on August 2, exceeding the month's average daily trading volume several times. However, the system failed to cope with the unprecedented volley of transactions, eventually allowing Citigroup to execute sales of "just" €12bn (£8.3bn). Even so, Citigroup selling accounted for nearly half the total MTS turnover of €28bn that day. The world's largest financial institution bought back €4bn of the bonds at lower prices soon after, making profits of an estimated €17m.The revelation about the scale of Citigroup's ambitions raises questions about its risk management. Had the markets suddenly turned against it between the selling and the subsequent buyback, the bank could have faced heavy losses.In a memorandum dated two weeks before the trades and published by the Financial Times on Tuesday, a Citigroup employee outlined a strategy to "kill off some of the smaller dealers" in the competitive eurozone government bond market.Gianluca Garbi, chief executive of MTS, yesterday expressed "astonishment" at the memo. "As a regulated market, we are obliged to get hold of this type of information and I will be writing to Citigroup," he said.The memo set out a plan by which Citigroup could exploit liquidity differentials on MTS and Eurex, the Frankfurt-based derivatives exchange, "in a very profitable way".Liquidity on Eurex varies according to the season, while on MTS dealers are obliged to provide continuous quotes -a concession to eurozone governments which are keen to maximise trading in their bonds. German government bond futures traded on Eurex are the backbone of the eurozone debt market, as they are used to price all the region's government bonds.Citigroup's August trades angered eurozone governments, as they disrupted the market. The trades are being investigated by European financial market regulators, led by BaFin in Germany and the UK's Financial Services Authority.The prosecutor's office in Frankfurt, which is undertaking a criminal investigation into suspected market manipulation by Citigroup on Eurex, said the probe centred on six members of the US bank's European government bond trading desk in London, including the head of the team. The office said it would conclude the preliminary inquiry by the end of this month and then decide whether to prosecute. Should the office establish grounds to prosecute the individuals, it could request assistance from UK authorities for questioning those being charged or ask them to take over the case.The FSA would only say that its investigation was "ongoing".Citigroup said the memo "was filled with inappropriate and unrealistic statements" and added it "had not been seen, nor does it represent the views of, the supervisors who authorised the trade or the firm". It declined to comment further.
 
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DominicConnor
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GAMING THE SYSTEM?

February 3rd, 2005, 9:32 am

m much less familiar with what advantages may accrue to a "primary dealer" in European governments,Varies by market.A common benefit is being eligible to bid competitively for new issues of bonds. They then resell for a useful riskless profit.In Britain, they get a direct influence on which maturity and coupon is issued.They also often have as in Britain access to a "professional" market, where larger amounts of stocks are traded between larger outfits. This is particularly useful to swap houses. However often firms find that the extra compliance hassle makes the activity too marginal to bother with.i[In the USA, primary dealers benefit from daily phone calls from the open market desk at the New York Fed each and every morning, discussing each side's perspective on the market. Doesn't happen in Britain, I imagine the French do this. Appallingly dodgy, can think of no justification. m much less familiar with what advantages may accrue to a "primary dealer" in European governments, but I know that the advantages of primary dealers of US Treasuries are large (though not as great as they were 10 years ago).As part of the deal in the USA in which the primary dealers get this essential inside information, they pledge to provide liquidity and to promote stability in the Treasury markets.Coercing dealers to do this is non trivial. I was up to my neck in the Britsh government's process for improving this, and I run the system linking the banks to ensure they fulfil their obligations.It was in this that the "where is the price ?" conundrum first appeared to me. In our trading systems, they are in exactly one place (sort of, we have stand by h/w).My powers of advocacy maxed out where the idea came forth that prices were "on the screen". That is the one set of places where they are not. Try to define a bid offer spread in a distributed market. This is critical for the essential constraint that quoted prices should be reaonable.A worked example. If a bid is on one of our screens, and an offer on Cantor's what is the spread ?This issue will be familiar to those who've done any relativity. If I'm in one intertial frame, what can I say about the time in yours ?What does it mean for things to happen "at the same time" in two places.I'ts very hard not to make this sound like a techie being really pedantic, but quote propagation over Interbank networks like ours is a large fraction of a second, and when you add processing overhead, is really significant.And yes, I've thought of some ways to game that A person I know actually wrote the code to do it to one of the Cantor's systems. Was scarily elegant.This is an explicit commitment, and, as I recall, E. F. Hutton was banished from the club in the 1980s because they were kiting hundreds of millions of dollars in checks and harvesting the interest on the float.Not sure you can do this with modern settlement systems. The key point here is that Citicorp actively promoted destabilizing the European treasury markets, according to the article.I am a keen reader of the novels of Bernard Cornwell. In a book set in medieaval France, a Bishop is warned by one of his lackeys that "the devil is plotting a great evil".The Bishop replies that all is well in the world. It is the role of the devil to work evil as part of God's plan, and it is our role to confound him.The European systems were badly built. Optimism is not a valid engineering discipline. Citi exploited this. I cannot really comment on the legality of this.However as someone who regards themselves as a bascially good person, I ask whether I would be proud or ashamed to have taken part in this.My tests for this are:Did Citi lie to anyone ?Did they break their word ? (contract count as giving your word here )Did someone who they had a duty to protect suffer ?Did innocent 3rd parties get hurt ?To the best of my knowledge the answer is no to all of these. If the European market makers have any similar kind of unfair market advantages over other players, then this conduct should definitely be punished harshly.Abusing a privilege raies the question as to whether privilege should exist at all ?Forgive my cynicism here. But I believe that if a German or French bank had done this, they'd be hailed as really cool hard men.
 
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mdubuque
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GAMING THE SYSTEM?

February 3rd, 2005, 3:49 pm

QuoteOriginally posted by: DCFCThe European systems were badly built. Optimism is not a valid engineering discipline. Citi exploited this. However as someone who regards themselves as a bascially good person, I ask whether I would be proud or ashamed to have taken part in this.My tests for this are:Did Citi lie to anyone ?Did they break their word ? (contract count as giving your word here )Did someone who they had a duty to protect suffer ?Did innocent 3rd parties get hurt ?To the best of my knowledge the answer is no to all of these. Hi Dominic-As usual, thanks for a thorough and informative response.Let's use the criteria you set forth here which are pretty reasonable (although I add one more criterion below). If Citicorp succeeds in cornering the market and forcing out smaller players (also stated in the leaked memo) then wouldn't the answer to "Do innocent 3rd parties get hurt?" be a "yes"?Also in terms of a "duty to protect", I would impute a duty to protect the integrity of the market and to do no harm, i.e. engage in no conduct likely to make the market less liquid and less transparent.Also I have to add an additional criterion. Over time, is the market less deep and less liquid (i.e. less free) as a result of their conduct?Matthew
 
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mdubuque
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GAMING THE SYSTEM?

February 3rd, 2005, 3:49 pm

QuoteOriginally posted by: DCFCThe European systems were badly built. Optimism is not a valid engineering discipline. Citi exploited this. However as someone who regards themselves as a bascially good person, I ask whether I would be proud or ashamed to have taken part in this.My tests for this are:Did Citi lie to anyone ?Did they break their word ? (contract count as giving your word here )Did someone who they had a duty to protect suffer ?Did innocent 3rd parties get hurt ?To the best of my knowledge the answer is no to all of these. Hi Dominic-As usual, thanks for a thorough and informative response.Let's use the criteria you set forth here which are pretty reasonable (although I add one more criterion below). If Citicorp succeeds in cornering the market and forcing out smaller players (stated as an explicit goal in the leaked FT memo below) then wouldn't the answer to "Do innocent 3rd parties get hurt?" be a "yes"?Also in terms of your criterion of a "duty to protect", I would impute a duty to protect the integrity of the market and to do no harm, i.e. engage in no conduct likely to make the market less liquid and less transparent.Also I have to add an additional criterion. Over time, is the market less deep and less liquid (i.e. less free) as a result of their conduct?Matthew
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DominicConnor
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GAMING THE SYSTEM?

February 4th, 2005, 7:20 am

If Citicorp succeeds in cornering the market and forcing out smaller players (stated as an explicit goal in the leaked FT memo below) then wouldn't the answer to "Do innocent 3rd parties get hurt?" be a "yes"?I haven't read the memo, d you have a link ?I'd think it odd that they'd want the small guys to be forced out. It is firms they make the money from, because they're the source of the money they're making.I can however see them not losing sleep over this.I suuposew we need to think about who "innocent 3rd parties" are ?My default position is that your competitors aren't in that set.Also in terms of your criterion of a "duty to protect", I would impute a duty to protect the integrity of the market and to do no harm, i.e. engage in no conduct likely to make the market less liquid and less transparent.Possibly, but my take on that term is "those in your care", basically your customers.Have they harmed the market ?Also I have to add an additional criterion. Over time, is the market less deep and less liquid (i.e. less free) as a result of their conduct?Don't know. My judgement is that they've marginally improved the market as a whole. If there are discrepancies between two divisions of the market, then it is not working efficiently.Quotes in at least one of the markets they were trying to exploit were wrong because of low liquidity. They joined the two markets exploiting this anomlay. They've made it more risky for the providers of these markets, and increased the chances that they will merget to one market, which is generally good.Thre is a profound difference between one's duty to a communtiy we shall call the market, and the vested intersts of the providers, such as Eurex whose hands I will tell you are far from clean.The fractured set of markets we experience are grossly inefficient, and I have little sympathy for government sponsore attemps to support "local chapmions".
 
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mdubuque
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GAMING THE SYSTEM?

February 4th, 2005, 4:10 pm

I wish I had a link to the memo. It looks like we have some philosophical agreement.I come from a background of reading a lot of US case law (Supreme Court decisions especially) on insider trading and protection of the integrity of the markets. And on this side of the pond, damaging the liquidity of the market as a whole is a big no-no. (Exotiq correctly points out that by several different means of measurement the SEC does a pretty decent job.)Yesterday's FT was saying that Citicorp's action threatened some of the smaller players who make markets in some of the less popular government securities. Although they didn't specify which countries, I'm thinking they were referring to MMs in Italian governments for example.If that were true, would you agree this is sanctionable? If they actually intended to and succeeded in reducing liquidity for some sovereign debt in the European Zone?My two-bit heuristic is if Paul Volcker wouldn't approve of the trade, you'd better be careful.Matthew
Last edited by mdubuque on February 3rd, 2005, 11:00 pm, edited 1 time in total.
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