CME Group proposed to amend its market guidance related to wash trades to make clear that its self-match prevention functionality does not prevent self matches on the opening of a market where the orders were entered in to the pre-open state on Globex. In its proposed revised guidance, CME Group also made clear that it would consider it a violation of its prohibition against wash trading for a person to enter orders during a pre-open state that it knew or should have known would match. An example of such orders would be a buy order placed above the price of a resting sell order, or a sell order placed below the price of a resting buy order. In addition, CME Group noted that indirect wash trades as well as direct wash trades are not permitted. CME posited, as an example, that a prohibited indirect wash trade would include a situation where three traders signed up for an incentive or rebate program and, with or without prearrangement, executed a series of transactions in close time proximity, buying and selling similar quantities against each other, and at the conclusion of trading the traders had no change in position. “Transactions executed for the purpose of increasing volume, while knowing or having reason to know the transactions would not be exposed to price competition or the positions exposed to market risk, are considered [impermissible] wash trades,” wrote the CME Group. Absent CFTC objection, CME Group’s proposed revised guidance, in the form of a market regulation advisory notice, will be effective December 1.
Compliance Weeds: A wash trade is a type of fictitious trade where a transaction or series of transactions give the appearance of bona fide purchases or sales, but in fact are entered into without the intent to take a bona fide market position or to expose the transactions to market risk or price competition. Specifically, CME Group prohibits as wash trades three types of conduct:
- placing or accepting buy and sell orders in the same product and expiration month, or for a put or call option, in the same strike price, where the person placing or accepting the orders “knows or reasonably should know that the purpose of the orders is to avoid taking a bona fide market position exposed to market risk”;
- entering buy and sell orders for different accounts with common beneficial ownership “with the intent to negate market risk or price competition”; or
- knowingly executing or accommodating the execution of either of the types of orders in 1 or 2, above. (Click here to access CME Group Rule 534.)
(Keep in mind that the Commodity Exchange Act Sec. 4c(a)(2), 7 U.S. Code Sec. 6c(a)(2)(A)(i) also prohibits transactions that are, are of the character of, or commonly known to the trade as a “wash sale”; click here to access. Other exchanges also have equivalent prohibitions. Click here, e.g., for Wash Sales FAQ of ICE Futures U.S.) According to the CME, a wash trade requires a “wash result,” meaning the purchase and sale of the same instrument at the same price or a similar price for accounts with the same beneficial ownership or for accounts with common beneficial ownership. There is no de minimis for common ownership. In addition, parties’ intent to achieve a wash result may be inferred from evidence of (a) prearrangement or (b) that the orders were structured, entered or executed in a manner that the party(ies) knew or reasonably should have known would produce a wash result. The following would not be considered wash sales:
- buy and sell orders for accounts with common beneficial ownership that are independently initiated for legitimate and separate business purposes by independent decision makers that coincidentally cross; or
- orders generated by algorithms operated and controlled by different trading groups that unintentionally and coincidentally cross,
provided there is no prearrangement and neither party had knowledge of the other’s order or had intent to cross. However, such trades will be subject to heightened scrutiny. Again, a person who executes or accommodates transactions (as well as initiates) that they know or reasonably should know will end in a wash result, will violate the CME Group’s prohibition against wash trades.