Stock Exchange moves to thwart New Year's Eve manipulation of FTSE

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The Stock Exchange moved yesterday to tackle problems with Sets, its new electronic order driven trading system. It has modified New Year's Eve trading rules, and intends to crack down on market abuse. Lea Paterson reports.

The London Stock Exchange will close at 12.10pm on New Year's Eve, the same time as the London International Financial and Futures Exchange (Liffe) and 20 minutes earlier than usual. A special pricing formula will be used on New Years' Eve to calculate closing prices.

The Exchange is also planning to strengthen its rules on price manipulation, following claims last week that two JP Morgan traders had tried to fix the FTSE 100 index.

Yesterday's decision was prompted by heavy criticism of Sets, the order- driven trading system launched at the end of October. At certain times of the day, particularly in the late afternoon and early morning, very few orders are placed on the Exchange's new order book and very few trades are conducted. This so-called lack of liquidity makes it easier for a small number of trades to distort the FTSE 100 index. In particular, there have been several instances of "rogue", or unrepresentative, closing prices, both for individual stocks and for the FTSE itself.

Concerns had been voiced that if the level of the FTSE were distorted on New Year's Eve, traditionally a very thin trading day, there could be serious finanical repercussions. Closing New Year's Eve prices are used, among other things, to calculate fund valuations.

The Exchange took two steps yesterday to try and head off the problem of rogue closing prices on December 31. First, the Exchange will shut at the same time as Liffe. Typically, trading is particularly thin on the London stock market once Liffe has shut.

Second, the Exchange plans to use a special formula to calculate closing New Year's Eve prices. This formula will "enable the Exchange to strike out anomalous closing prices for the purpose of valuation and index calculation," the Exchange said yesterday in a statement.

Final details of the formula will not be revealed before next week, after the Exchange has had an opportunity to consult with market particpants. But it is thought that the formula will be similar to the "uncrossing" that happens at the beginning of the trading day. At 8.30am an "uncrossing" process matches all buy and sell orders inputted between 8am and 8.30am against one another. A similar process at the end of the day should help prevent trades being executed at rogue prices.

The Exchange also moved yesterday to tighten up its rules on market manipulation. At present, when there is an illiquid market making it easy to distort the FTSE, conditions are ripe for market abuse, as illustrated by claims of FTSE manipulation two weeks ago.