One of the least meritocratic aspects of financial markets is the bias provided to certain individuals who have access to private inside information. Insider trading is apparently illegal in International Financial Markets (IFMs) but, one would have to add, that is news to me or to anybody else who depends on such markets for their living. In sports and football markets, insider trading is undoubtedly the driving dynamic in the marketplace and the only valid tool in an analyst’s armoury is the knowledge that the people with privileged and/or corrupt information have to disclose their hand at some point – whether to us as an organisation or to the market in general.
Many insiders gain access to critical non-public information. The Chief Executives (CEOs) of multinationals together with other board members and officers of the upper hierarchy are generally aware of proprietary knowledge related to their company considerably ahead of any people outside the loop. Such knowledge is frequently shared with other closely integrated businesses and groups via the dubiously interlocked memberships that govern our great globalised system. Similarly, in the game of football where motivation is such a key fundamental parameter in a crowded fixture schedule, the managers, coaches, team members and staff are equally ahead of the market in their knowledge regarding near future events. In a properly regulated environment, this edge would be of minimal value as the authorities would create processes whereby insider dealing is effectively outlawed. However, we are in the territory of incentives here and it is interesting to look at the value of insider information to a range of market protagonists. Although there are identical parallels between IFMs and sports markets, they each have their own unique structure of systemic regulatory capture. In a future post, we will be focusing on the IFMs entirely (aside from one particular rant that we are saving for the end of this article) but, in the main, this post will be looking at football markets as it is the close season and this is supposed to be a football blog at root after all.
My Trading Team have links to numerous clubs around Europe. We are aware of, prior to many of the market makers, match specific and competition specific information relating to the markets. There is absolutely no obstacle on a legal level to this state of affairs. This data is currency. The Asian bookmakers and brokers with whom we trade are more than willing to be the next in line to receive this privileged information as, inevitably, such information is a very precious commodity indeed. The entire structure of a trading book may be destabilised by the presence of this market input and, although we gain a slice of the action, the highly liquid Far East markets ensure a significantly greater reward for the greed merchants. There are two key determinants to the value of a piece of inside information. Firstly, how close are we to the source and, secondly, how early in the market phase are we able to source the information? The rewards are directly determined as a function of these two mechanisms. If the information is already in the price and we are only able to source the data, say, fifteen minutes prior to kick off, the info is of minimal value on either a proprietary trading or on a hedging level. If we are first in line at market opening then we’re quids in…
Evidently, we gain from this structure. We are paid for our information and we receive very privileged trading arrangements with our brokers. Additionally, we maintain beneficial constructs with the sources of the information in a non-meritocratic game of mutual back-scratching. Despite these facts, we are all in agreement in the office that we would prefer that such mechanisms be made illegal with the development of proper legislation and protection for the market operators who are a distance away from the core of our corrupt system. We win whatever but, with the current structure, a load of talentless crooks are ensured a huge financial gain merely through their proximity to the core. In a more valid system, we would still win whatever but the crooked would be peripheralised and the game that we pay our money to watch would be markedly straighter than is presently the case.
The value of inside information depreciates in the same manner as a stone dropped into a pond produces concentric circles of ever decreasing amplitude. All market makers and exchanges are very interested in gaining the acquaintances of people who are at the centre of this wave of data. In this manner, once a trading organisation has achieved the necessary degree of informational infiltration, the process is self-sustaining.
There is regulation related to IFMs but, despite the introduction of the Sarbanes-Oxley law following Enron etc together with a few historical attempts at creating ethical red tape following previous corporate criminality, such efforts are largely self-regulatory which is obviously open to abuse. The key regulatory bodies, investment banks, hedge funds, analysts, boutiques and financial media are all very happy with the current system which is established to provide for insider loopholes. By careful placing of positions by non-core participants (often relations, accountants, lawyers or associated businesses) both individuals and companies are able to by-pass the pitiful attempts at preventing inside information reaching the financial markets. A prime current example is provided below.
As we have already stated, knowledge is power in the marketplace. Two of the biggest disseminators of knowledge are The Wall Street Journal and Dow Jones. Their market position is a monopolist’s dream which is presumably why psychopath par excellence, Mr Rupert Murdoch, is in the throes of buying Dow Jones and the Wall Street Journal. Reuters and Dow Jones provide news feeds relating to breaking market information from governmental, business and regulatory sources. Clients may join up and receive these feeds in real time and are consequently able to incorporate breaking information into their market positionings at speed. Yet, faster is better. These two firms are now providing an enhanced service for hedge funds and their like whereby such clients will receive this information marginally ahead of the other recipients. This is an abuse of the inside information legislation in all but name. The privileged clients gain market edge through first mover advantage. And, in addition, it simply does not matter whether the information is valid and real or disinformational and illusory.
Let me explain as simply as possible in the time available. Hedge funds make their profits via the taking of buying and selling positions. Hedge funds also make their profits by utilising arbitrage trading (often automatically generated using algorithmic black box trading models).
Taking each of these in turn although, in essence, the situation is replicated between the two instances. If Reuters release news/information that is a strong buy or sell signal, the hedge funds get the price before the market which inevitably yields greater returns. This is, effectively, a micro version of the illegal practice of the back-dating of share options except that we are dealing in minutes and seconds rather than months and weeks. If the news/information that Reuters release is bobbins ie it is fallacious, the markets will still react to the information as if it were real until new information appears that renders the initial news to be bobbins. The privileged clients will consequently gain more than the average market participant so long as they are also ahead of the market on receiving the latter piece of information. As they are paying Reuters or Dow Jones handsomely, this will be the case. These are both risk free profits from inside information.
With respect to arbitrage trading, the same mechanism provides a beneficial edge to the clients as they seek to automatically trade concurrent buy and sell positions across the planet on markets that are inefficient. For the uninitiated, this is similar to buying a car in one territory for, say, $20000 and instantly selling it another territory for $21000. If the prices are real and actual and the trading is instantaneous, the hedge funds are guaranteed easy money.
If one is in control of the release of this information to the marketplace, one is in an incredibly powerful position. It matters not whether the data/news released is consequential or not as one is able to profit from the behavioural market dynamics in both the prime market and related markets. The claim is that this process improves market efficiency. It doesn't. Markets are efficient if the price represents the real value whereas this new micro-structure will drive markets to inefficient positions that the likes of Murdoch will be able to exploit for personal advancement as they will KNOW when the information released is reliable or disinformational. This is merely a sophisticated form of price scalping.
Furthermore, there are two analytical inputs to any market. Alpha is related to proprietary analysis and inputs based on intelligence, holistic overviews and creative modelling. We depend on alternative alpha (a particularly valuable input) for our position in the market. Beta, on the other hand, is related to market efficiency and nowadays is largely driven by algorithmic computerised trading. Beta doesn't bring new information to the market but merely dots the i's and crosses the t's, so to speak. Murdoch's little ruse is a corrupt version of beta and brings absolutely nothing to the marketplace except proprietary corruption.
The very thought of anybody being in control of this process is open to abuse but when that anybody is ol’ Rupes then one can guarantee financial shenanigans.
We would like to make a strategic prediction that there will be a future scandal involving market manipulation using this very mechanism.
Good on yer, mate (sic)...
© Football Is Fixed/Dietrological
