Streetwise Professor

July 4, 2009

Werewolves of London

Filed under: Commodities,Derivatives,Energy,Exchanges,Politics — The Professor @ 7:01 pm

A trader at British oil brokerage PVM Oil Associates has been identified as a rogue trader who entered buy orders for 9mm barrels of Brent crude futures on ICE Futures in London during the illiquid early morning hours, causing a spike in the price of oil–and costing PVM $10 million.  To me, the most interesting aspect of this is the potential for can’t-change-their-mind-won’t-change-the-subject fanaticism of American legislators railing against the “London loophole”:

Unauthorised trading in oil futures in London and the corridors of power in the US Congress may not seem to have much in common.

But London’s markets have become easy targets for US lawmakers eager to show that loose practices on foreign energy markets are hurting US consumers.

Traders, so the theory goes, are carrying out nearly half the world’s global crude oil futures trades on ICE Futures Europe under the eyes of the Financial Services Authority.

The  PVM case  could re-ignite such concerns, just as US politicians are again railing against “excessive speculation” in energy and commodity markets.

This week Bart Chilton, a commissioner at the US futures watchdog, the Commodity Futures Trading Commission, said it was looking for signs of excessive speculation in commodity markets, with specific attention on oil prices.

Last month senator Carl Levin, a Michigan Democrat who has long campaigned for  tighter regulation of energy markets, said the US futures markets regulator needed to enforce strict position limits to curb speculation that last year caused record  wheat prices  that could not be explained by the dynamics of supply and demand.

A year ago, Mr Levin became convinced that improper trading of oil futures was taking place in the UK’s financial centre without sufficiently tight supervision by regulators.

A version of the West Texas Intermediate crude oil contract is traded in London on ICE Futures Europe, and regulated by the FSA. It is similar to the WTI contract traded on the New York Mercantile Exchange, regulated by the US futures watchdog, the CFTC.

Dubbing this the “London Loophole”, Mr Levin forced the CFTC to forge closer ties with the FSA, including a system by which the FSA would report irregular market activity much more quickly to the US.

Yet it does not seem to have worked as intended in the PVM case. CFTC officials claimed they were kept in the dark for several hours in spite of last year’s agreement for closer co-operation.

The FSA said on Friday: “We work very closely with the CFTC to ensure fair and orderly markets. The way we oversee the commodity markets is adequate for the UK regime.”

If there was any delay, regulatory experts say that could easily have been due to the time it took for FSA officials to get a clear picture of what had taken place at PVM, not a break-down in communications with the CFTC.

“The last thing they want to do is start rumours if they don’t know all the facts,” said one.

For the record: rogue trading is an international problem. A few choice examples: Singapore’s China Aviation Oil (2004, $550 million); France/Germany, SocGen’s Jerome Kervial, (2007-2008, $6.5 billion) (yes, with a “b”); Japan/Singapore, MItsui Oil Asia (2006, $81 million).  

Oh, and the United States.  We don’t know whether the 22 September, 2008 spike in the oil price–which dwarfed the recent spike apparently caused by the PVM trader–was due to a rogue trader, but it is highly suspect nonetheless.

And who can forget the MF Global trader in Memphis who lost $141.5 million in a day on Minneapolis wheat?  

I could go on.  

Where does rogue trading occur?  Well, where trading occurs.  There is a lot of trading in London, so it is inevitable that some rogue trading will occur there.  When assessing the adequacy, or not, of regulatory oversight in a market, it would be worthwhile to control for the magnitude of trading activity.  On that score, Singapore looks like a more dodgy place (with the infamous Nick Leeson/Barings episode in addition to the two cases listed above).  So, actions relating to the London Loophole (a vastly overrated financial bogey man in any event) are unlikely to have any effect on the frequency of rogue trading.  

It is primarily a problem of internal controls, but there is no system of controls that is capable of eliminating rogue trading altogether.  (Moreover, as with anything, there is a trade off, and it would be inefficient to invest in controls sufficient to eliminate such trading.)   And the US is hardly immune to the problem.  So although regulatory jingoism may feel good, it can happen here.  And it does.

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  1. I support rogue trading.

    Comment by Sublime Oblivion — July 4, 2009 @ 8:07 pm

  2. PVM as I understand it only facilitates trades for others, so who was that rogue order from? Call me paranoid and a Goldman Sachs hater, but, could it have been for them? Rumor has it they have been gaming oil futures. There simply are no fundamentals that would price oil this high in a global recession of this magnitude. The GS creeps with our TARP money mind you have been gaming the market keeping SPY afloat since March by placing large program trades before most market closes and after. It’s on the tapes. They will do everything I suspect in collusion with Team Obama to keep Joe Sixpack from taking another 401k hit.

    If Shakespeare were a contemporary he would recommend killing the financiers first.

    Comment by penny — July 5, 2009 @ 9:50 pm

  3. S.O., do me a favor, find a nice girl, get married, have two kids, get a mortgage and all that follows. I’m saying this in the most motherly terms as I had a kid a little like yourself, Miss Wiseguy, for awhile. Every family gets one if you have enough kids. Fortunately time and reality took its toll and now with a family and a mortgage there are no more silly utopian and throwaway utterances from her. As Margaret Thatcher observed “the facts of life are conservative”.

    Hey, I thought I was a socialist when I was young, why not, I had no responsibilites or as they say “no skin in the game”. It was fun, it was good, mindless of course, but, then, time and adult responsibilites intervened. Most of us leave that stage at some point. Peter Pan was a work of fiction and not a role model.

    Comment by penny — July 5, 2009 @ 10:18 pm

  4. Penny–

    1. The fact that PVM is a broker, and from what I have read does not trade as a principal, does raise the question as to just who was the principal. I don’t know.
    2. You are obviously quite interested in GS & Russia, in which case you will find this VERY interesting. Apparently someone named Sergey Aleynikov stole huge amounts of highly secret proprietary trading software from a “financial institution” rumored to be Goldman Sachs. I will follow this, and blog on it if I have anything interesting to say.

    The ProfessorComment by The Professor — July 5, 2009 @ 10:33 pm

  5. Penny–

    BTW, Aleynikov was arrested by the FBI.

    The ProfessorComment by The Professor — July 5, 2009 @ 10:44 pm

  6. Of course you’re right, penny. I agree with you 100%.

    Socialism and other leftard ideologies should be left at the door when it comes to making s***loads of money / being rich 😉

    Comment by Sublime Oblivion — July 5, 2009 @ 11:46 pm

  7. Professor, Zerohedge is all over the Aleynikov story. link to this guy.

    The comments are very insightful, someone dug up this hilarious vanity production he did on Youtube:

    He smacks of a cheesy Russian gangster. This wasn’t his first foray into problems with the law. I am loving it as a Goldman Sachs hater who relishes any amount of discomfort suffered by those blood sucking market manipulating vampires. Makes you pause and wonder how good GS is at vetting their hires.

    Comment by penny — July 6, 2009 @ 5:37 pm

  8. Poor Aleynikov won’t be able to raise his bail either, hum, a motive for his crime?

    You’ve got to wonder who this guy was thinking he could sell his GS theft to?

    Comment by penny — July 6, 2009 @ 6:41 pm

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