Exchange set to curb rogue trading in blue chips

The Stock Exchange is bracing itself this week as its new order- driven trading system prepares to determine end-of-year share prices in market conditions that are ripe for abuse. Lea Paterson reports on a radical attempt to prevent chaos on New Year's Eve.

On 20 October at 8.30am, Gordon Brown, the Chancellor, pressed the button that launched Sets, the Stock Exchange's new electronic system. It was a baptism of fire - the first few weeks of Sets' life coincided with some of the most volatile weeks the markets had seen since the crash of 1987.

From a technical point of view the system coped admirably, with barely a hitch in the two months since launch. But the Exchange failed to anticipate how traders would react to the new system, an oversight that has proved to be Sets' Achilles heel.

"We've created a sophisticated car, but people can't get it out of first gear," said Martin Wheatley, head of markets development at the Stock Exchange, and the man spearheading Sets.

Recent difficulties with Sets have prompted the Exchange to consider introducing changes in the new year - including shorter trading hours and a new formula for calculating the closing price.

The key problem with Sets is the discrepancy between how traders actually use Sets and how the Exchange would like traders to use it. This has caused numerous problems over recent months including countless trades executed at "rogue" - or unrepresentative - prices, numerous incidents of rogue closing prices for shares and a highly publicised instance of market abuse - as well as a number of less well publicised ones.

Fear of "rogue" or unrepresentative closing prices on New Year's Eve has prompted the Exchange to take the unprecedented step of intervening directly in market trading and disregarding closing prices deemed "exceptional" by statisticians. Closing prices on New Year's Eve are used as the basis for fund valuations, and so are particularly important.

Early morning and late afternoon illiquidity in the new electronic order book is the key factor behind the problem of "rogue" share prices.

Early in the morning, traders start to input their buy and sell orders into the book. The orders then remain on the book until one trader's "buy" order matches another "sell" order, at which point the trade is executed. But as many traders - particularly those with the larger institutions - do not start inputting orders until later in the day, there tend to be few orders placed on the book early in the morning, leading to so-called early morning illiquidity.

Late in the afternoon, traders tend to delete unexecuted orders from the book, so as not to get caught out by overnight developments in the Far East. So again, there are few orders on the book and the market is illiquid.

Generally, the greater the number of orders in the book, the smaller the difference between the lowest-priced "sell" order on the book and highest-priced "buy" order, known as the "spread".

First thing in the morning and last thing in the afternoon, market illiquidity means that spreads tend to be wide. At these times of the day, "sell" orders tend to be priced higher and "buy" orders tend priced lower than they would otherwise. So, if a trader decides to deal "at best" - that is to take the best price available - he runs the risk of dealing at prices that are unrepresentative of normal trading patterns. This can hurt unwitting investors and mean that a share's closing price - the price at which the last trade was executed - can be "rogue".

Not all "rogue" prices are accidental. Sometimes they result from deliberate manipulation, as was the case late in November when two JP Morgan traders tried to push down the level of the FTSE 100 index.

The two sold a number of bundles of pharmaceutical stocks "at best" in the late afternoon. The last bundle of stocks they sold was matched with a "buy" order that, because of market illiquidity, was priced substantially lower than one mighty ordinarily expect. This pushed down both the closing level of the individual stocks - SmithKline Beecham and Glaxo Wellcome - as well as the closing level of the FTSE 100. The traders subsequently lost their jobs and earned their employer, JP Morgan, a record pounds 350,000 fine from the Exchange.

The Exchange is likely to implement a variety of measures over the next year, but no radical reform is on the cards.

The most likely reform, which could be introduced in the first few months of next year, is early closure of the Stock Exchange and the introduction of a closing auction to determine the closing level both of the FTSE 100 index and of its constituent shares.

The form of the closing auction is yet to be decided, but one possibility is that the Exchange could allow no trades to be executed at a certain period of time at the end of the trading day - say the last 10 minutes. But orders could still be placed on the book, and the Exchange would run a computer program at the end of the 10 minutes which would match buy and sell orders and thus determine a stock's closing price.

ebookA unique anthology of reporting and analysis of a crucial period of history
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Accounts Payable

£12 - £15 per hour: Cameron Kennedy Recruitment: Excellent opportunity to join...

Technical BA - Banking - Bristol - £400pd

£400 per hour: Orgtel: Technical Business Analyst - Banking - Bristol - £400pd...

Account Management Strategy Manager

£38000 - £42000 per annum + competitive: Real Staffing: Required skills:Previo...

Business Analyst Consultant (Financial Services)

£60000 - £75000 per annum: Harrington Starr: Business Analyst Consultant (Fina...

Day In a Page

A History of the First World War in 100 Moments: Peace without magnanimity - the summit in a railway siding that ended the fighting

A History of the First World War in 100 Moments

Peace without magnanimity - the summit in a railway siding that ended the fighting
Scottish independence: How the Commonwealth Games could swing the vote

Scottish independence: How the Commonwealth Games could swing the vote

In the final part of our series, Chris Green arrives in Glasgow - a host city struggling to keep the politics out of its celebration of sport
Out in the cold: A writer spends a night on the streets and hears the stories of the homeless

A writer spends a night on the streets

Rough sleepers - the homeless, the destitute and the drunk - exist in every city. Will Nicoll meets those whose luck has run out
Striking new stations, high-speed links and (whisper it) better services - the UK's railways are entering a new golden age

UK's railways are entering a new golden age

New stations are opening across the country and our railways appear to be entering an era not seen in Britain since the early 1950s
Conchita Wurst becomes a 'bride' on the Paris catwalk - and proves there is life after Eurovision

Conchita becomes a 'bride' on Paris catwalk

Alexander Fury salutes the Eurovision Song Contest winner's latest triumph
Pétanque World Championship in Marseilles hit by

Pétanque 'world cup' hit by death threats

This year's most acrimonious sporting event took place in France, not Brazil. How did pétanque get so passionate?
Whelks are healthy, versatile and sustainable - so why did we stop eating them in the UK?

Why did we stop eating whelks?

Whelks were the Victorian equivalent of the donor kebab and our stocks are abundant. So why do we now export them all to the Far East?
10 best women's sunglasses

In the shade: 10 best women's sunglasses

From luxury bespoke eyewear to fun festival sunnies, we round up the shades to be seen in this summer
Germany vs Argentina World Cup 2014: Lionel Messi? Javier Mascherano is key for Argentina...

World Cup final: Messi? Mascherano is key for Argentina...

No 10 is always centre of attention but Barça team-mate is just as crucial to finalists’ hopes
Siobhan-Marie O’Connor: Swimmer knows she needs Glasgow joy on road to Rio

Siobhan-Marie O’Connor: Swimmer needs Glasgow joy on road to Rio

18-year-old says this month’s Commonwealth Games are a key staging post in her career before time slips away
The true Gaza back-story that the Israelis aren’t telling this week

The true Gaza back-story that the Israelis aren’t telling this week

A future Palestine state will have no borders and be an enclave within Israel, surrounded on all sides by Israeli-held territory, says Robert Fisk
A History of the First World War in 100 Moments: The German people demand an end to the fighting

A History of the First World War in 100 Moments

The German people demand an end to the fighting
New play by Oscar Wilde's grandson reveals what the Irish wit said at his trials

New play reveals what Oscar Wilde said at trials

For a century, what Wilde actually said at his trials was a mystery. But the recent discovery of shorthand notes changed that. Now his grandson Merlin Holland has turned them into a play
Can scientists save the world's sea life from

Can scientists save our sea life?

By the end of the century, the only living things left in our oceans could be plankton and jellyfish. Alex Renton meets the scientists who are trying to turn the tide
Richard III, Trafalgar Studios, review: Martin Freeman gives highly intelligent performance

Richard III review

Martin Freeman’s psychotic monarch is big on mockery but wanting in malice