May 9, 2019
Buy side and regulators need to work together fight sell side misconduct in central risk book. Many of sell side central risk books are secretly doing prop trading. For example, BAMLs central risk book was its prop trading desk QSA. Many people in this desk were prop trading professionals.These are people who know all about regulation and its circumvention. Even worse, client flow data is not safe in central risk book. In some sell side firm,central risk book has real-time visibility of client order details. Trade execution data stored in relation to IOIs may also be used for finding alpha to trade against client. As the nexus of client activity, the desks have a high level of visibility across the market. Some firms central risk book team is larger than any of its competitors, which is suspicious. This team talks about alpha trading everyday. They argue that they need the data for purely quant analytical purposes (maybe in a "strategy group"). Desk head instructed team to use client data to backtest and develop alpha trading strategies. Some of central risk books action is fraudulent. For example,sell side central risk book misrepresent natural liquidity when sending out IOI and it increased info leakage for customer. In low touch child order facilitation, some firms central risk book used sensitive and confidential client order fill level percentage done information as alpha signal without any disclosure to client. Clients have no idea that this is going on. With client order data, CRB team found several trading signals to cherry picking client orders in low touch facilitation. CRBs hedging activities caused CRB frequently trade ahead of customers.The so called hedge often cause principal orders took place while customers gave open orders in the same name. Because central risk desks are automated trading teams, it's possible for them to analyze the client data they have access to and to incorporate the signals they find there into their trading models. Trader and the large quant trading strategists team found a new way to trading using client data by tweak alpha parameters they found from client data. CRB in sell side often advertised client can access premium liquidity like retail flow or internal derivatives hedging flow. However, clients used to have access through firms ATS with better price. Sell side central risk book shall not deprive customers. It's time both buy side and regulator wake up to the dangers. For the sake of stability and transparency in financial markets, central risk books need to be very heavily regulated. Central risk desks are supposed to be about risk internalization and monitoring and as such they don't need so many traders and trading "strategists". The more traders and "strategists" they employ, the greater the likelihood that these desks will simply become a foil for prop trading and the inappropriate use of client data.