On November 19th, the CME issued its Market Regulation Advisory Notice 1308-5, relating to CME Group Rule 534 (“Wash Trades Prohibited”).  The notice itself is relatively short and sets forth the text of the rule – this posting is intended to provide our readers with a brief overview of the particular “questions and answers” (“Q & As”) that relate to unintentional and incidental crossing (or self-match) situations.

A “wash trade” is a trade that gives the appearance of a bona fide purchase and sale of an exchange-traded contract, but for the fact that the trades had been entered into without the intent to i) take a bona fide market position; or ii) executed bona fide transactions subject to market risk or price competition. In essence, a wash trade can result from the simultaneous purchase and sale of the same instrument at the same price for commonly owned trading accounts.

A violation of the wash trade prohibitions requires “intent” to not enter into a bona fide trade, although market participants do from time to time receive inquiry from exchanges about unintentional “self-matches” that occur due to trading in the same contract across different desks, in different jurisdictions, through different commonly-owned affiliates, or as a result of a combination of some or all of these factors. In short, this can happen when traders in the same firm (or at different commonly-owned affiliates) end up on both sides of the same trade (which is likely to be more common in relatively illiquid markets). Ultimately, a market participant may well be able to demonstrate that they intended to enter into a bona fide trade and, as a result, the matching of the buy and the sell was incidental (assuming, of course, that these trades were limited and the circumstances were isolated relative to the trading program and activity as a whole).  However, in our experience, responding to these sorts of exchange inquiries make the legal, compliance, and trading functions very nervous.

Therefore, we have prepared this posting to provide our readers with a summary of the Q&As that relate to incidental matching.   In particular, for a discussion of these types of self-match scenarios and the use of CME’s Self-Match Prevention functionality, see the following Q&As:

Q&A 10, p. 4 of the Advisory Notice – Identifying the fact that a coincidental cross of trades in the market, may not rise to the level of a wash trade, but may “draw additional regulatory scrutiny”

Q&A 12, p. 4 of the Advisory Notice – Wash trade prohibitions not necessarily implicated if multiple traders of the same firm make fully independent trading decisions, subject to demonstration of a bona-fide trades being entered into without prearrangement or knowledge of other positions

Q&A 15, p. 4 of the Advisory Notice  – Market participants are to monitor trading and minimize both the potential and occurrence for self-match events; and

Q&A 16 and 17, pp. 5 and 6 of the Advisory Notice  – Highlighting the availability of the CME Group’s Self-Match Prevention functionality as a tool to manage self-match risk.

 The notice is available here.  Good morning.  Good reminder.  TSR