When the tail wags the market dog: There is a lot of finger-pointing at derivatives players for unfair influence on prices

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The Independent Online
WHEN the FT-SE 100 index rose sharply last February, dealers pointed to holders of more than pounds 4bn of expiring equity index options buying shares to cover their positions.

Events like this, where the tail wags the dog - the equity derivatives move the price of the underlying shares - have raised concerns among UK institutions and the Securities and Investments Board, the senior regulator.

Perceived faults in existing regulation and the pace at which new markets have evolved led the SIB to write its discussion paper, Regulation of the United Kingdom Equity Markets, published this week. Although the London Stock Exchange continues to dominate physical trade in UK shares, investors can buy an exposure to share price movements through American Depositary Receipts traded in the United States, UK euro-convertibles and derivative instruments, otherwise known as futures and options.

The SIB's discussion paper makes these suggestions:

Disclosure to investors of market makers' quotes to inter- dealer brokers, since these quotes are invariably inside quotes displayed to investors.

Publication of prices and aggregate volumes of all share transactions on recognised exchanges and on trading systems operating under the SIB's service company regime.

Publication of over-the- counter derivative transactions equating to 3 per cent or more of a UK listed company's shares.

A review of the Stock Exchange rules permitting delays in publication of transactions. The aim is to allow delay only for large-risk transactions where market makers require protection until both sides have completed if the liquidity of the market is not to be impaired.

Publication of investors' short interest to the market, at any event during the period between announcement of an issue of shares (such as the Wellcome or BT3 issues) and completion.

The SIB also wants to establish one body to monitor all transactions in UK equities and their derivatives.

It asks a number of questions, including: 'What is the extent of misconduct in the UK equity markets? Is much misconduct undetected? What are the main forms of misconduct that take place?'

There is a lot of finger- pointing at derivatives players for unfairly manipulating prices - something they deny. Alastair Cooper, a director at Morgan Stanley, believes there is very little abuse in the UK markets. 'I do not think there is a problem. I do not think it happens,' he said.

It is said that traders often try to manipulate the prices of options contracts in their favour by buying or selling. But a senior trader at one of the biggest derivatives houses said even if this was true, price movements only reflected supply and demand for shares. He agreed that the shares might be moving for technical rather than fundamental reasons, but said technical factors had always influenced shares in the short term.

More insidious, perhaps, is the perception of many market participants that the SIB might have been influenced by the great and the good in the City who are not reaping rewards from the derivatives business.

The likes of Cazenove and SG Warburg have not made any impact in derivatives. Instead, the business is largely dominated by new boys. Important players include Salomon Brothers, Goldman Sachs, Bankers Trust, Swiss Bank Corporation, Credit Suisse First Boston, Morgan Stanley and, to a lesser extent, BZW.

One derivatives specialist added: 'Because of the naivety of people about these products you have this irrational fear.'

SIB's discussion paper does not go far enough. It should be asking whether the existing Seaq system should be scrapped and a new fully automated, trade-driven system used. Those who deal on all the European markets say London's is one of the least efficient. Far better to have prices quoted on screens that you know you can deal at, they say, and stamp out opportunities to benefit from manipulating the markets.

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