A market participant may not place, accept or execute simultaneous buy and sell orders for accounts with common beneficial ownership in the same product and expiration month or option series, if the execution produces a wash result.
Let’s look at some different scenarios in which market participants need to be aware of their trading responsibilities.
Responsibilities for your own account
A market participant trading for his or her own account may not place a buy order at a specific price in a product and contract month and subsequently place a sell order for the same account in the same product and contract month at the same or better price, where the market participant knows or reasonably should know that the two orders will match.
This rule is also applicable if the orders are placed and executed for accounts with common beneficial ownership.
Responsibilities in a brokering capacity
If a person acting in a brokering capacity receives simultaneous buy and sell orders placed by another party, the person receiving the orders has an independent obligation to determine whether the orders are bona fide.
Parties receiving simultaneous buy and sell orders for execution must make an inquiry that is sufficient to confirm whether the orders are for accounts with common beneficial ownership.
This is called a “duty to inquire”.
If the party receiving the simultaneous buy and sell orders cannot assure himself that the orders are for accounts that do not have common beneficial ownership, the party receiving the orders should refuse to accept them.
Accepting or executing simultaneous buy and sell orders without such assurance creates potential regulatory exposure for the party handling the orders if the execution of the orders yields a wash result.
Proprietary trading operations within a firm
It is recognized that many trading firms have proprietary trading operations in which multiple traders making fully independent trading decisions enter orders for the firm’s proprietary account that may unintentionally and coincidentally match with each other on the electronic platform.
If the respective orders of each independent trader are entered in good faith for executing bona fide transactions, are entered without prearrangement, and are entered without the knowledge of the other trader’s order, then such trades do not violate the prohibition on wash trades.
Examining some what-if scenarios
You may be asking: what if buy and sell orders for accounts with common beneficial ownership are simultaneously entered for a legitimate purpose?
In the electronic venue, one of the orders should be entered on the electronic trading platform and executed in full prior to the entry of the second order. This will ensure that the orders are not executed opposite each other and will provide a clear audit trail with respect to the entry and execution of the orders. In this circumstance, a written and timestamped record must be made of any order that is not entered on the electronic platform immediately upon receipt.
In the Open Outcry venue, the buy and sell orders should be timestamped immediately upon receipt.
One of the orders should be entered in the pit, executed and timestamped out prior to submitting the second order to the pit for execution. The second order should be timestamped again when it is submitted to the pit. This methodology will ensure that the orders are not executed opposite each other and the accurate timestamping will provide evidence that the orders were not entered for simultaneous execution.
In either the electronic or open outcry venue, simply ensuring that there is a delay between the entry of the buy and sell orders may not, depending on the terms of the orders, preclude the orders from trading in whole or in part against each other.
To the extent that the orders trade opposite each other either directly or indirectly through a common third party, the trade may be deemed an illegal wash trade notwithstanding the fact that the orders were entered at different times.
Market participants are responsible for monitoring their trading, whether that trading is manual or automated, and are responsible for minimizing the potential for, and the occurrence of, self-match events.
More than de minimis self-matching in this context will result in additional regulatory scrutiny and may be deemed to violate the prohibition on wash trades.
The incidence of self-matching in these circumstances will be evaluated in the context of the activity of the trader, trading group, or algorithm, and relative to the trades and volume in the instrument traded.
If there is the potential for more than minimal self-match events, market participants are expected to either adjust their trading strategies or employ functionality to mitigate the occurrence of self-match events.
The Market Regulation Department permits the electronic self-reporting of any trades which a market participant believes to violate of our rules. This includes the self-reporting of self-match events and wash trades. Self-reports are made using a self-reporting link available in the Market Regulation Section of the CME Group website.
Market participants must monitor their trading activity and, where appropriate, employ automated functionality to minimize self-matches.
This is part of a course on wash trades. For official regulatory guidance on wash trades, reference the applicable Market Regulation Advisory Notice.
Test your knowledge
In case you didn’t know, the CFA Institute allows its members to self-determine and report continuing education credits earned from external sources. CFA Institute members are encouraged to self-document such credits in their online CE tracker. CME Institute offers a variety of courses, webinars, and white papers to support your professional education.