As part of our series of articles discussing some of the manipulative practices and fraudulent behaviors that exist in wholesale energy markets around Europe, which are prohibited under REMIT, we now turn our attention from Wash Trades to layering and spoofing.

What is layering and spoofing?

Both layering and spoofing techniques involve the placing of orders that the trader never plans to have executed. In both spoofing or layering market manipulation, a market participant issues one large order or multiple smaller orders showing a fraudulent interest to trade. These orders are placed on one side of the order book as a way to manipulate the market price and enter into one or more transactions at a better price on the other side of the order book.

Why? Because doing so simulates a market trend, suggesting the market is moving up, down, or sideways. It creates a phantom trend that makes it look as though there is an appetite that does not actually exist in the market, and can trick other market participants to get involved. The non-genuine trader then cancels their open, non-bonafide orders, repeating this strategy on the opposite side of the market in order to close out the position. They, therefore, mislead the market by giving false signals about supply and demand or securing prices at an artificial level as a type of price positioning.

Banned under REMIT

Under REMIT, attempts to engage in market manipulation of wholesale energy markets are strictly prohibited. Article 2 of REMIT describes market manipulation (and attempted market manipulation) as the providing of false or misleading signals and information, price positioning, and orders or transactions that involve deceptive practices. Layering and spoofing may fall under all three of these headings.

There are multiple signs to watch out for to suggest spoofing or layering is taking place. One is an imbalance of trading activity on the two sides of the order book. Another is a market participant issuing large orders more frequently than the overall level of activity or participation of the same market participant. In this case, it could indicate the market participant in question has no plan or intention to genuinely execute these orders. Others might include the cancellation of a large number of orders, a surprisingly low order execution ratio on certain orders, a link between issuing non-genuine orders and price movement in the marketplace, and more.

Ultimately, there are many subtle signals that can suggest spoofing and layering. (If the signs of it weren’t subtle, bad actors would no longer be risking their livelihoods by trying to trick the system in this way.) Traders caught carrying out these illegal trades can face harsh fines and other penalties. But they’re not the only ones.

Companies must keep an eye out

Under REMIT rules, companies are responsible for monitoring the trades that take place on their watch to ensure that they are compliant. Even if it’s just an individual rogue trader and not a systemic issue within a company, the company in question can still face severe fines for not spotting, and stopping, this market manipulation from happening.

For example, in October 2020 it was reported that the American multinational financial services company JPMorgan Chase agreed to pay a cumulative $920 million in settlements following spoofing investigations by U.S. authorities. The firm admitted that former employees fraudulently acted in the precious metals and Treasury markets thousands of times in a period of almost one decade. Earlier in 2020, The Bank of Nova Scotia and Deutsche Bank also made similar deals.

Spoofing is becoming an increasing focus for regulators as they try to stop these abuses by cracking down on offenders with heavy fines and punishments. The size of fines such as the JPMorgan one shows the dissatisfaction on the part of regulators when it comes to real changes being made — and demonstrate how they will make examples of those who break the rules. This scale of a fine is concerning even for investment banks with deep pockets. The associated reputational damage can also prove extremely harmful.

Agreeing to enhance surveillance after a massive fine (as many wrongdoers claim they will) is a bit like shutting the barn door after the horse has bolted. While it can certainly help avoid similar instances happening again in the future, it also means paying a sizable fine that could otherwise have been avoided by adopting the right precautionary measures, to begin with.

Companies wishing to follow the best practices should therefore make sure that they have properly invested in the right surveillance systems that will help guarantee compliance, and — where necessary — make the information accessible to regulators to examine swiftly. Market abuse is bad news for all involved, and results in an unstable market that do not behave in a way that is intended. For reasons of both compliance and wanting a fair playing field that behaves according to proper market dynamics, companies should take steps to stamp out these bad practices wherever they’re found.