Commentaries

Bridging the Week by Gary DeWaal: December 15 to 19 and 22, 2014 (MiFID II, MiFIR, Block Trade Washes, AlphaMetrix, Charges for Cash, Bitcoin Options Exchange, Trading System Failures)

Jump to: AML and Bribery    Bitcoin Ecosystem    Block Trades and EFRPs    Bridging the Week    Compliance Weeds    Exchanges and Clearing Houses    Helpful to Getting the Business Done    High Frequency Trading    Managed Money    My View    Systems and Controls    Trade Practices (including Disruptive Trading)   
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Published Date: December 21, 2014

An inadvertent system logic flaw caused two affiliated broker-dealers not to perform required anti-money laundering obligations and resulted in sanctions by the Financial Industry Regulatory Authority, while automated trading system malfunctions resulted in fines to three firms by the CME Group. In addition, one clearinghouse says that posting cash with it may soon be more costly, while another entity seeks designation with the Commodity Futures Trading Commission to trade and clear options on Bitcoin. Meanwhile, MiFID II and MiFIR inch their way towards implementation in Europe. As a result, the following matters are covered in this week’s Bridging the Week:

Video Version:

Article Version:

ESMA Publishes Implementing Rules for MiFID II

The European Securities and Markets Authority issued its final technical advice and initiated a consultation regarding proposed regulatory and technical standards regarding the roll-out of the Markets in Financial Instruments Directive (MiFID II) and Regulation (MiFIR).

Among other matters, ESMA proposes: (1) pre- and post-trade transparency requirements for equity and equity-like financial instruments by trading venues and investment firms; (2) enhanced transparency regarding non-equity instruments, particularly bonds, derivatives, structured finance products and emission allowances; (3) trading of derivatives only on certain venues in line with G20 requirements such as on regulated markets and multilateral or organized trading facilities; (4) position limits and reporting requirements for commodity derivatives; (5) rules impacting algorithmic and high-frequency trading, including definitions and organizational requirements; and (6) non-discriminatory access requirements to trading venues, clearinghouses and benchmarks.

ESMA’s technical advice also has a number of provisions aimed at enhancing customer protection. These include provisions related to when portfolio managers can receive research from third parties; when investment firms can receive or pay inducements; and disclosure of costs and charges.

ESMA also proposes that investment firms “establish and maintain a permanent and effective compliance function that operates independently” and has certain enumerated responsibilities. These tasks include assessing on a “regular basis” a firm’s compliance with its MiFID obligations; assisting staff providing investment services to comply with the firm’s MiFID II obligations; reporting at least annually to the firm’s management body regarding the “implementation and effectiveness of the overall control environment for investment services and activities,” among other matters; and to monitor the firm’s complaints handling process.

Firms are also required to appoint a “single officer” responsible for matters related to the safeguarding of client assets, although this person may have other responsibilities.

The technical advice will now be sent to the European Commission for approval, while comments will be accepted by ESMA on its consultation through March 2, 2015. MiFID II and MiFIR are scheduled to go into effect on January 3, 2017.

(Click here for a general overview of MiFID II and MiFIR in the article, “European Parliament Takes Further Step to Increase Requirements for Trading Venues and Algorithmic Trading, and to Introduce Commodity Position Limits in Europe” in the April 16, 2014 edition of what is now known as Between Bridges.)

And briefly:

My View: It was an unusual experience to review Mr. Coscia’s memorandum of law to support his motion to dismiss, and find my own public writings and statements referenced three times—particularly one writing from January 2011 where I warned that the “lack of clarity is particularly troubling since certain violations [of the anti-spoofing provision of law] could potentially result in criminal action.” Then, as now, I believe that “bidding or offering with the intent to cancel the bid or offer before execution” (the statutory definition of spoofing) might be wrongful under certain circumstances, but under other circumstances has another name other than spoofing—it’s called ordinary, legitimate trading!

Helpful to Getting the Business Done: Each of the respondents in the CME Group actions was charged for its system breakdown with violating the CME Group general prohibition against committing acts detrimental to the interest or welfare of the exchange and, in one case, failure to supervise too. Although CME Group and ICE Futures U.S. have some specific requirements regarding ATS (e.g., electronic audit trail requirements: click here to access the relevant CME Group MRAN, and identification of Globex operators: click here to access a relevant CME Group publication), most of the best guidance is voluntary, with some issued by the Principal Traders Group of the Futures Industry Association (e.g., “Recommendations for Risk Controls for Trading Firms:” click here to access, and “Software Development and Change Management Recommendations:” click here to access). However, adherence to the voluntary standards might help trading firms avoid ATS breakdowns and adverse financial consequences, including exchange and other regulator fines.

Compliance Weeds: Even within the CME Group, there is a difference in permissible transactions between affiliates in the case of block trades and exchange of futures for related positions. As clarified by the CME Group’s new wash trades MRAN, block trades between accounts with the same beneficial owner are now always prohibited (CME Group staff states this always has been the case). However, EFRP trades between independently controlled accounts with common beneficial owners (i.e., the same beneficial owner or where the amount of beneficial ownership is less than 100%) are permitted, as well as between independently controlled accounts within the same legal entity—provided the accounts are in separate business units (click here for the relevant CME Group MRAN regarding EFRPs). ICE Futures U.S., on the other hand, permits block trades between accounts of affiliated persons—without regard apparently to the percentage of ownership—provided that the block trade is executed at a “fair and reasonable price,” that each party has a “separate and independent bona fide business purpose for engaging in the trades” and that the transactions are undertaken by a “separate and independent decision-maker.” (Click here for the relevant ICE Futures U.S. FAQ regarding block trades.) The devil is in the details!

December 24, 2014 Update: On December 24, 2014, CME Group reissued the new wash trades MRAN described in this article, eliminating the proposed prohibition against block trades between accounts with the same beneficial ownership (for the revised MRAN, click here). All other aspects of the MRAN are still proposed (e.g., caution against engaging in wash trades to freshen position dates in physically delivered futures contracts and reference to changes in the CME Group’s SMP functionality on CME Globex being rolled out by January 11, 2015. The new MRAN is also effective January 2, 2015.

And even more briefly:

Compliance Weeds: Every FCM, IB, CPO and CTA should compare the contents of this guide to their existing compliance manual to ensure that sections considered important by NFA are not missing.

And finally:

Culture and Ethics: This much-reported episode has engendered quite a few raised eyebrows and a fair amount of head shaking by those reading about it. That being said, I am still surprised at the harshness of Mr. Burrows’ penalty in light of the scope of his malfeasance and the seemingly unrelated nature of his actual misconduct to his regulated activity. Few would disagree that those who engage in unscrupulous behavior in our industry, or even unrelated felonies, major crimes, or even certain crimes of moral turpitude are appropriate subjects of harsh sanctions including registration or trading suspensions, let alone prohibitions. However, at some point enough is too much. Frankly, as much as what Mr. Burrows did to evade payment of his transit fares was very wrong (and seems quite arrogant too), it’s a credit to him that he consented to this seemingly disproportionate sanction. Anyone, besides me, humming Arlo Guthrie's 1967 hit song Alice's Restaurant (released by Warner Bros./Reprise)?

For more information, see:

CFTC Excuses CTA Members of DCMs From Recording Oral Communications; Will Not Require Other Market Participants to Link Certain Oral and Written Communications:
http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-147.pdf

CME Explicitly Prohibits Block Trades Between Accounts With the Same Beneficial Ownership:
http://www.cmegroup.com/rulebook/files/cme-group-ra1411-5.pdf

See also, 2013 MRAN:
http://www.cmegroup.com/rulebook/files/cme-group-ra1308-5.pdf

CME Freshens Rule Prohibiting Cattle Futures Freshening:
http://www.cmegroup.com/tools-information/lookups/advisories/market-regulation/files/SER-7261.pdf

CME Updates Crossing Rules and Pre-Execution Communication Rules to Account for Swaps:

Crossing:
http://www.cmegroup.com/tools-information/lookups/advisories/market-regulation/files/RA1409-5.pdf
Pre-Execution Communications:
http://www.cmegroup.com/tools-information/lookups/advisories/market-regulation/files/RA1410-5.pdf

Coscia Files Motion to Dismiss Criminal Spoofing Indictment:
/ckfinder/userfiles/files/Coscia-%20Motion%20to%20Dismiss%20Indictment.pdf
/ckfinder/userfiles/files/Coscia-%20Memo%20to%20Dismiss%20Indictment(2).pdf

ESMA Issues Report on HFT Trading in EU Equity Markets:
http://www.esma.europa.eu/system/files/esma20141_-_hft_activity_in_eu_equity_markets.pdf

ESMA Publishes Implementing Rules for MiFID II:

Technical Advice:
http://www.esma.europa.eu/system/files/2014-1569_final_report_-_esmas_technical_advice_to_the_commission_on_mifid_ii_and_mifir.pdf

Consultation:
http://www.esma.europa.eu/consultation/Consultation-MiFID-IIMiFIR

Fed Grants One-Year Delay for Banks to Conform Ownership Interests With Legacy Covered Funds; Another One-Year Delay on the Horizon:
http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20141218a1.pdf

FINRA Files Complaint Against Broker-Dealer and Three Employees for Alleged Submission of Falsified Documents:
http://disciplinaryactions.finra.org/viewdocument.aspx?DocNB=38275

Former Managing Director of Asset Manager Prohibited by FCA From Performing Any Regulated Activity Because of Train Fare Payment Evasion:
http://www.fca.org.uk/static/documents/final-notices/jonathan-paul-burrows.pdf

FSOC Seeks to Understand Potential Risks to the US Financial System Posed by the Asset Management Industry:
http://www.treasury.gov/initiatives/fsoc/rulemaking/Documents/Notice%20Seeking%20Comment%20on%20Asset%20Management%20Products%20and%20Activities.pdf

ICE Clear U.S. Alerts Clearing Members That Cash Deposits May Result in Negative Returns:
https://www.theice.com/publicdocs/clear_us/notices/14-105_Change_to_Fees_Charged_for_Clearing_Member_Cash_Deposits.pdf

LCH.Clearnet Ltd Authorized to Clear Swaps, Futures and Options on Futures; Four Non-US Clearinghouses Receive Extensions of Previously Granted No-Action Relief to Transact With Certain US Persons:

LCH Amended Order:
http://www.cftc.gov/ucm/groups/public/@requestsandactions/documents/ifdocs/lchltdamddcoorder12-16-14.pdf

Four Foreign Clearinghouses:

Press release: http://www.cftc.gov/PressRoom/PressReleases/pr7084-14
Representative No-Action Letter:
http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-148.pdf

LedgerX Seeks CFTC Designation as a Clearinghouse and Swap Execution Facility for Bitcoin Options:
http://sirt.cftc.gov/sirt/sirt.aspx?Topic=ClearingOrganizationsAD&Key=30998
http://sirt.cftc.gov/SIRT/SIRT.aspx?Topic=SwapExecutionFacilitiesAD&Key=30643

See also, LedgerX website:
https://ledgerx.com

NFA Proposes to Amend Interpretive Notice to Exclude Certain Additional Transactions From Prohibition Against Loans by Commodity Pools to CPOs and Related Entities:
http://www.nfa.futures.org/news/PDF/CFTC/InterpNotc_CR2-45_ProhibitLoansByCPOsRelatedEntities_112014.pdf

NFA Updates Regulatory Guide for FCMs, IBs, CPOs and CTAs:
http://www.nfa.futures.org/NFA-compliance/publication-library/regulatory-requirements-guide.pdf

Registrations of AlphaMetrix, LLC and Aleks Kins, Former CEO, Revoked by CFTC:

Alphametrix:
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfalphaopinion121814.pdf
Aleks Kins:
http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfkinsopinion121814.pdf

System Failures Result in Three Firms Being Sanctioned US $145,000 by CME Group Exchanges:

Representative cases:

/ckfinder/userfiles/files/CME-303%20Proprietary%20Trading.pdf
/ckfinder/userfiles/files/CME-Traditum%20Group%20LLC.pdf

Two Wells Fargo Entities Settle With FINRA for AML Customer Identification Program Breakdown:
http://images.magnetmail.net/images/clients/finra/attach/WF_AWC_121814.pdf

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of December 20, 2014. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP and/or Gary DeWaal may represent one or more entities mentioned in this article. Quotations attributable to speeches are from published remarks and may not reflect statements actually made.

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ABOUT GARY DEWAAL

Gary DeWaal

Gary DeWaal is currently Special Counsel with Katten Muchin Rosenman LLP in its New York office focusing on financial services regulatory matters. He provides advisory services and assists with investigations and litigation.


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