Cross-market spoofing

Abstract

Since 2012, regulatory investigations have revealed widespread manipulation and collusive practices among banks active in over-the-counter (OTC) markets. These discoveries have resulted in fines and settlements amounting to billions of US dollars, criminal proceedings and stricter regulation worldwide. However, recent legal cases and regulatory reports indicate that authorities have stepped up their efforts to crack down on so-called “cross-market spoofing”. The manipulative tactic involves a combination of a genuine order in one market and a spoof order in another, which is notoriously difficult to detect. In this paper, we use a high-frequency data set of limit order book snapshots from the foreign exchange (FX) spot market to develop and test a methodology to assess the feasibility, and hence potential prevalence, of cross-market spoofing. Our findings show that predictable reactions follow potential single-market spoofs that a market manipulator may exploit. Crucially, we also find that predictability may be observed in closely related markets. In particular, we discover that EUR/JPY offers a reliable pathway for a manipulator to exploit via spoof orders at deeper levels in the EUR/USD or USD/JPY limit order books. The findings suggest that a manipulator is more likely to submit a spoof order in a liquid market and a resting order in a less liquid but closely related market, rather than vice versa. Moreover, cross-market spoof orders are more likely to be found in markets that act as hedging markets.