How Malleable are Financial Markets really?

A conviction as strong as it is controversial that banks and large financial institutions would be able to manipulate the financial markets, a real "legend" that hovers in the world of retail trading and which essentially serves to justify various errors that are made both in the analysis of the market and in terms of the work of the traders themselves. Usually, the expression "the markets are manipulated" is pronounced by those who are part of the so-called "bulk of oxen", i.e. that group of small operators which is systematically demolished by large changes in market sentiment.

Market manipulation, "the strong hands" of the market that would decide the fate of the performance of a financial instrument, are all rumors that should be demonstrated and which systematically find no evidence other than in some scandals that occurred in the past and which essentially concerned markets to which retail traders do not have the slightest access.

So let’s take a look at some historical examples of market manipulation and how these have entered the incorrect beliefs of retail operators with a straight leg.

Market manipulation, the Libor scandal

The Libor is the British equivalent of the Euribor, ie an interest rate relating to interbank exchanges that take place overnight (ie in a night time slot) and strictly with closed markets. This market expects banks to set a interest rate for interbank liquidity exchange at 11am each day, generally lower than the central bank policy rate. This mechanism allows banks to respect reserve requirements, a key element for a bank’s solvency.

Between 2005 and 2009, a pool of banks in England allegedly manipulated the interest rate, the "price" of which is not established by the classic supply and demand criteria, but by a fixing, i.e. by an estimate that the bank expresses when communicating the rate. In practice, it is much harder to establish whether there has been manipulation of an estimate than it is to demonstrate manipulation of a market where supply and demand exist.

Then e-mails and phone calls between bank managers and traders emerged, documents that led to the assumption that there had been a manipulation of the Libor, a scandal that led a giant like Barclays to pay a a fine of around 450 million dollars and which also involved other banks, giants of the financial world such as Citigroup, RBS, Ubs, Deutsche Bank and other investment banks in the investigation.

The 2013 Forex Scandal

A scandal involving the largest market in the world in terms of volumes and by definition a market that "cannot be regulated", the Forex. The story involved many traders of large investment banks inserted in some chats called “the Cartel”, “the Bandits Club”, “The Mafia”, denominations which, in fact, already anticipated the content of the same.

In the aforementioned chats, the traders of these large banks exchanged information about the volume and prices of their customers’ orders, thus causing real information asymmetries on which they could easily profit, a real conflict of interest .

Regulators have established that between 2008 and 2013, traders at these banks engaged in misconduct in terms of the pricing of instruments and with respect to the “confidentiality” of information of their clients. The resulting fines reached $10 billion and involved large banking groups that are part (or have been part) of the "Bulge Bracket" such as Ubs, HSBC, RBS, Citibank, JpMorgan, BofA and Barclays.

JpMorgan’s "Spoofing" Case 2020

Major investment bank JpMorgan found itself paying a 920 million dollar fine for manipulating the prices of futures on precious metals and the US treasuries market. JpMorgan’s traders allegedly employed a unfair trading strategy called "spoofing" which consists of placing large orders on either the supply or demand side, then removing them at the right moment in order to move market quotations.

This tactic is typically used in a type of trading that we could define as "scalping", or very short-term trading, an obviously incorrect tactic which is fully part of the market manipulation practices ” punished by international regulators.

The myth of the "manipulated market"

These just described the most glaring scandals of recent years involving large banking groups, those who actually turn out to be the "strong hands" of the market. In this context we have to analyze what happened and actually see if this market manipulation coincides with the beliefs of retail traders.

The first scandal, that of the Libor, is the most important in terms of size of the market, to which only the large banking groups have access and which the retail trader, at an operational level, does not even consider.

The second scandal mainly concerned large banks and their counterparts who usually move volumes that a retail trader could not afford so easily and mainly involved the exploitation of information against the customers themselves.

The third scandal directly concerns the market to which many retail traders also have access, but in fact the manipulation mainly concerns the very short term and does not allow the manipulation of prices in the long term in the slightest.

Basically, the strong hands of the market cannot determine the direction of the market in the long run due to a matter of number of operators. In addition to banks, we have large hedge funds, investment funds (SICAVs, pension funds, etc.), large family offices, large trading companies. Furthermore, most banks, after 2008, can no longer do proprietary trading but only limit themselves to doing what is defined as “market making”, i.e. act as counterparty to their customers.

Furthermore, the financial markets are highly competitive and regulated and by definition cannot be manipulated, therefore the saying "the markets are manipulated" appears to be only an excuse that operators use to justify their own incapacity and scarcity of results.

Original article published on Money.it Italy 2023-03-23 07:18:00. Original title: I mercati finanziari sono davvero manipolabili?