CME Proposes New Guidance Regarding Wash Trades Effective September 9, 2013 Pending CFTC Approval

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Published Date : June 23, 2013

[Note: The Market Regulation Advisory Notice (MRAN) referenced in the article below that was first discussed on this website on June 24, 2013, was resubmitted to the CFTC for its approval on July 9, 2013. CME had hoped the CFTC would approve this MRAN so that its guidance would be effective as of September 9, 2013. Instead this approval is still pending, following the CFTC's solicitation of public comments through August 14 related to this MRAN. In response to this solicitation, the CFTC received three comments that generally were supportive of the MRAN, although issues were identified related to the CME's Self-match Prevention functionality on its GLOBEX platform.

This Advisory Notice initially was previously submitted to the CFTC in materially the same form by the CME on self-certification, and originally due to become effective on July 1, 2013. However, it was withdrawn on June 28, 2013, following dialogue between the CME and the CFTC's Division of Market Oversight. In the interim period,  the CME reconfirmed applicability of its prior guidance from November 2009 on the same subject. For more, see: CME's MRAN submission to the CFTC:; Comments received by the CFTC:]

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The Chicago Mercantile Exchange proposes to update its November 2009 guidance regarding prohibited wash trades in a new Market Regulatory Advisory Notice (RA 1308-5), which is scheduled effective September 9, 2013, pending approval by the US Commodity Futures Trading Commission. This is important reading for traders (including proprietary trading groups), FCMs and floor brokers, among others.

According to the proposed CME Regulatory Advisory Notice, a wash trade is a type of fictitious trade in which a transaction or series of transactions give the appearance of bona fide purchases or sales, but in fact are entered into without the intent to take a bona fide market position or to expose the transactions to market risk or price competition. Specifically, the CME's prohibits as wash trades three types of conduct (see Rule 534):

  1. placing or accepting buy and sell orders in the same product and expiration month, or for a put or call option, in the same strike price, where the person placing or accepting the orders "knows or reasonably should know that the purpose of the orders is to avoid taking a bona fide market position exposed to market risk;"
  2. entering buy and sell orders for different accounts with common beneficial ownership "with the intent to negate market risk or price competition;" or
  3. knowingly executing or accommodating the execution of either of the types of orders in 1 or 2, above

(Keep in mind that the Commodity Exchange Act (Sec. 4c(a)(2)) also prohibits transactions that are, are of the character of, or commonly known to the trade as a "wash sale.")

According to the CME, a wash trade requires a "wash result," meaning the purchase and sale of the same instrument at the same price or a similar price for accounts with the same beneficial ownership or for accounts with common beneficial ownership. There is no de minimis for common ownership.

In addition, parties' intent to achieve a wash result may be inferred from evidence of (a) prearrangement or (b) that the orders were structured, entered or executed in a manner that the party(ies) knew or reasonably should have known would produce a wash result.

Importantly, not only traders can be liable for wash trades, but recipients and executors too (eg, account executives and floor brokers). This results in a pro-active obligation of recipients to question when buy and sell orders are placed for simultaneous execution.

If a recipient receives buy and sell orders simultaneously for common beneficial ownership, one of the orders should be entered first and executed in full prior to the entry of the other order. Simply ensuring a delay in the placement of the offsetting orders is not sufficient; nor is placing offsetting orders with different FCMs or floor brokers.

The following will not be considered wash sales:

  1. buy and sell orders for accounts with common beneficial ownership that are independently initiated for legitimate and separate business purposes by independent decision makers that coincidentally cross; or
  2. orders generated by algorithms operated and controlled by different trading groups that unintentionally and coincidentally cross,

provided there is no prearrangement and neither party had knowledge of the other's order or had intent to cross. However, such trades will be subject to heightened scrutiny.

This seems to help proprietary trading groups in which multiple traders make fully independent trading decisions for commonly owned accounts and all trades are entered independently in good faith without prearrangement, or generated by algorithms operated and controlled by independent traders.

That being said, if self-matching occurs on more than an incidental basis by a single trader, group of traders, or algorithm, (even if unintentional) the CME may deem such transactions wash trades. Consequently, the CME recommends such trader, group of traders, or person responsible for the algorithm employ functionality to minimize the potential for buy and sell orders to match. Along those lines, the CME now offers a Self-Match Prevention (SMP) functionality on Globex to block buy and sell orders for commonly owned accounts. However such functionality works by cancelling in full the original order when a new order is entered that may even only partially cross against the original order. This may not be an acceptable outcome to many traders.

Block trades between different accounts with common ownership are permitted provided:

  1. each party's decision to enter into the block trade is made by an independent decision maker;
  2. each party has a legal and independent bona fide purpose to enter into the trade; and
  3. the block trade is executed at a fair and reasonable price.

This is important proposed guidance by the CME, and traders, FCMs' and floor brokers should be preparing to amend their procedures in anticipation of CFTC approval of the CME's Market Regulatory Advisory Notice, although approval is by no means certain. Further information can be obtained by contacting CME staff.

For further information, see:

CME's MRAN submission to the CFTC:
CME's November 2009 Guidance related to Wash Trades:

The information contained in this article is not legal advice. For legal advice, please consult with your attorney. The information in this article is derived from sources believed to be reliable as of June 24, 2013, but no representation or warranty is made regarding the accuracy of any statement. To ensure compliance with requirements imposed by U.S. Treasury Regulations, Gary DeWaal and Associates LLC informs you that any U.S. tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Gary DeWaal and Associates may represent one or more entities mentioned in this article.


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