A British man, Mr Navinder Singh Sarao has been arrested, and faces extradition to the United States, accused of market manipulation, allegedly causing a 1,000 point drop in the Dow Jones index in 45 minutes and leading to personal enrichment to the tune of $40 million from that and similar incidents. Mr Sarao is a lone trader and was apprehended in his parents’ modest semi-detached house near Heathrow. He lives in a similar house across the street.
The profiteering is supposed to have occurred roughly like this:
- Multiple sell offers were placed on the futures market, at low prices, which the offerer had no intention (and, in all probability, not the means) of fulfilling.
- The primary market in the affected stocks, and perhaps others, fell on the flood of offers.
- The manipulator bought shares at the depressed prices.
- He withdrew the futures offers.
- The primary market recovered and the manipulator sold his shares at a profit.
Leaving aside, of course, the question of Mr Sarao’s guilt or innocence, a couple of questions spring to mind:
- When someone in London manipulates a market centred on New York, in what criminal jurisdiction is he acting?
- To what extent does this kind of behaviour occur: is it possible that major market players indulge in such manipulations but at a more discreet level?
I’m not going to speculate further on those. To me, the more interesting questions are:
- How could other market participants be so naive (it’s the politest word I can find) as to fall for such a scam?
- What could be done to reduce the chance of this kind of thing happening again?
I’m by no means an expert in the particular markets involved here. But I do know that if I see my neighbour repeatedly put his house on the market, but never actually sell it, then he’s not exactly serious. If he puts it on the market for a first time, owning a similar property, and as a middle-class Englishman, I’m naturally interested in the price. If that price is wildly high, compared to actual recent deals for similar houses that are recorded on the publically available land registry database, then I’ll conclude that, as for a second marriage, my neighbour is suffering from the triumph of hope over experience. It’s about him, not the property and not the market. Similarly, if the price is unusually low, I’ll conclude that he has fallen upon hard times and is need of ready cash, rather than immediately supposing that conditions are such that there is a surfeit of such sellers that will move the market.
If another neighbour, who drives a modest car, suddenly auctions Bentleys I’ve never seen on eBay, my suspicions would be aroused. And so on and so on. What’s important in these examples, and applicable to wider markets, is not the absolute knowledge of a person’s identity, but of his standing and track record.
If somebody offers to sell stocks at a future date, he is more credible if it can be demonstrated that he actually owns them; or somewhat more credible if it can be demonstrated he has borrowed them. If neither of those can be demonstrated, then evidence that he owns lots of other stuff, to a much higher value than what he has offered, would be reassuring. Likewise, evidence that a reasonable proportion of his offers has been fulfilled.
How might any of that be achieved? One way would be for exchanges, registrars and so on to maintain central databases of offers, trades and holdings, query-able in realtime by market participants. That would raise a number of difficulties: for example, queries could place a massive strain on centralised systems, which might also present attractive targets to hackers working on behalf of manipulators.
An alternative approach could be to implement distributed ledgers using the blockchain technology that underpins BitCoin, or a variant thereof. There would be no single point of failure, and manipulation of the record is, for all practical purposes, impossible once a chain acquires new links (new offers, new transactions, new holdings, etc) and is widely replicated. For an in-depth view of how the blockchain can provide for efficient and secure financial transactions, beyond crypto-currencies, register for the excellent Payments Forward event on 11th May in London and listen to our very own Steve Pannifer demystify the technology before the panel session featuring Lloyds Banking Group, Eris Industries and others.
To me, it is incredible, and seriously worrying, that major players in the financial markets underpinning our economic system are not alert to basic warning signals that any dealer in second-hand goods would recognise. Indeed, they cannot be, given the current infrastructure. Fortunately, technology is at hand to rectify that. Who will move?