Courtside View
It’s all anyone can talk about this week in India’s equity markets — the big derivatives hustle. So far the focus has been on market regulator SEBI’s allegations of price manipulation by Jane Street, which led to a temporary market ban and recovery of profits. Soon it will be the Wall Street firm’s turn to put the regulator in the dock.
As the matter inevitably heads to court, it will test SEBI’s most intensive investigation ever of complex trade and risk data across cash and derivative markets, according to a person close to the matter who preferred to remain anonymous for confidentiality reasons.
For over a year, a cross-functional team of investigators drawn from SEBI’s surveillance and regulation departments and supported by officials from the National Stock Exchange worked to extract relevant data from over billions of trades to understand Jane Street’s trading patterns.
The team narrowed their scrutiny to Jan. 17, 2024, the most profitable day for the trader in a two-year period. To understand how Jane Street made a profit of close to $86 million that day, they plotted minute-by-minute values of the delta and profit and loss of its index options portfolio, alongside the Bank Nifty Index price and activity in the cash, futures and options market. It’s the first time the regulator has undertaken such visualization, helping it identify patches of prima facie manipulation across market segments, the person said.
As the investigation expanded to more days and manipulative patterns, in February the regulator asked the NSE to issue a caution letter to Jane Street, advising it to refrain from taking large positions and undertaking certain trading patterns.
The effect of that letter lasted two months. By May Jane Street was back to running large positions across market segments. That’s when SEBI officials decided to bar the trader even though the investigation is unfinished and Jane Street’s defense unheard. To make up for that, SEBI, in an uncommon and smart legal move, allowed for the market ban on Jane Street to be lifted if the firm deposits the so-called illegal profits of manipulation in an escrow account.
It took another month of several long nights, the person said, to write up an 105-page interim order with 500 pages of annexures and QR codes to access the charts.
But the hard part is yet to come.
SEBI’s preliminary findings will be put to the test when Jane Street files an appeal in court against the market ban and having to pay 48.4 billion rupees ($570 million).
Typically at this stage, such a plea is focused on interim relief from an interim order — such as a suspension of the ban until the investigation is completed. Though even to decide that judges may seek to understand the gravity of the alleged offenses.
That will come down to SEBI’s claim of manipulation versus what Jane Street may describe as arbitrage trades. The two can look pretty similar, writes Bloomberg Opinion’s Matt Levine. Even market experts I’ve spoken to are divided over this — imagine how tough it will be for judges.
Both sides may have to deploy other arguments to sway the judges.
SEBI could argue that Jane Street had been warned by NSE but didn’t change its trading patterns. The regulator may also spotlight the need for strict enforcement in a distorted market where derivatives turnover is more than 300 times larger than cash equities due to the outsized presence of retail investors. Especially as these small traders persistently lose money — a total $12 billionlast fiscal — even as the big boys clean up. Jane Street generated over $2.3 billion in net revenue from equity derivatives in India last year.
The Wall Street firm may highlight that it’s being punished without a hearing, or that the impounding of a large sum of money may cause financial difficulties. It could argue that SEBI has allowed gamification of the derivatives market and having failed to keep amateurs out is now thwarting sophisticated players that provide liquidity and efficiency. It could play up the impact on India’s ambition to be a top economy and market in world.
Whichever way this goes, I’m clearing my schedule for a courtside view of a case unprecedented for its complexity and for what’s at stake.
Source: Bloomberg
