In the Joint Staff Report on the U.S. Treasury Market on October 15, 2014, the authors noted that there was a higher than usual level of self-trading during the period of market volatility. Although we haven’t seen the data, according to the report, many principal traders stayed engaged in the market on October 15 while many banks withdrew for periods of time. So it would seem logical that, with fewer market participants, there was a higher probability of self-trades.
Nevertheless, the report stirred up a number of questions about self-trades, beginning with the most basic: what is a self-trade, anyway?
The Joint Staff Report defined self-trades simply: “for the purpose of this report, self-trading is defined as a transaction in which the same entity takes both sides of the trade so that no change in beneficial ownership results.”
Why does a self-trade occur? As the report noted, professional market participants “can run multiple separate trading algorithms simultaneously. For instance, one of these algorithms could specialize in placing buy or sell limit orders at the top of the order book while another could specialize in initiating trades given specific conditions in that market, potentially leading one algorithm to end up being matched with another algorithm from the same firm.”
This match isn’t intentional—it occurs when two separate desks within a firm are running separate strategies and the market’s matching engine happens to match their buy and sell orders.
It’s important to understand that there is a clear regulatory distinction between unintentional self-match trades and intentional, manipulative (and illegal) wash trades.
Intentional wash trades are illegal self-matches that can manipulate markets by giving the impression of legitimate trading interest or activity at a certain price, time, and size. FIA PTG supports efforts to prohibit this activity.
There are also two forms of self-matches that can occur unintentionally.
One type is part of legitimate price discovery in a competitive marketplace, and it occurs when trades from different units within the same firm happen to cross each other. This can happen when independent decision makers initiate trades for legitimate and separate business purposes without knowledge of the other’s order.
The other type occurs when, despite good faith efforts to avoid self-matching, trades from the same trading desk or unit are matched. This is due in part to the technical and operational limits of today’s matching engine technology.
FIA PTG supports controls that help to prevent inadvertent self-matches, which we noted in our comments to the CFTC in response to their Concept Release on Risk Control and System Safeguards for Automated Trading Environments. We also support the development and enhancement of self-match prevention technology by exchanges and other market centers, which we expect will ultimately be effective in significantly reducing the number of inadvertent self-matches without hindering legitimate trading.
Interested in learning more? Read pages 25 – 28 of our comments to the CFTC here.