Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

FSA Fine on Citigroup is total nonsense

The order
that the Financial Services Authority (FSA) of the UK has passed
against Citigroup Global Markets Limited (CGML) in the Euro MTS case
imposing a fine of $25 million is total
nonsense. Clearly, the FSA lacked either the evidence or the courage to say
that Citigroup had manipulated the markets. At the same time, the FSA was
unwilling to let them off without any penalty. What they have done therefore
is to impose a penalty under regulations that have no bearing on the case
at all. This means a penalty is imposed without having to prove any serious
charges against Citigroup.

The event that led to the fine was quite simple. On 2 August 2004,
Citigroup “executed a trading strategy on the European government
bond markets which involved the building up and rapid exit from
very substantial long positions. The centrepiece of the strategy was
the simultaneous execution of a large
number of trades on the MTS platform using specially configured technology.”

FSA claims that in executing these trades, Citigroup contravened the
following two Principles of Business of the FSA:

  • “A firm must conduct its business with due skill, care and
  • “A firm must take reasonable care to organise and control
    its affairs responsibly and effectively, with adequate risk management

On the face of it, it is difficult to see how Citigroup’s trading violated
either of these principles. On the contrary, it would appear that its
actions demonstrated a high degree of skill and sound risk
containment systems.

FSA however believes that due skill and care were lacking because
Citigroup did not consider the likely consequences of the execution of
the trading strategy could have for the efficient and orderly
operation of the MTS platform. This statement is absolute nonsense.
The whole strategy was predicated on a clear understanding of these
consequences which were highly beneficial to Citigroup. More importantly,
Citigroup’s understanding of these consequences was quite correct.

FSA also believes that there were

  • “a failure within CGML to
    escalate the detailed trading strategy on 2 August 2004 adequately and
    in advance to senior management, and a failure to consult with
    applicable control functions” and
  • “inadequate
    systems for the supervision of traders”.

This would be a perfectly
valid argument provided the FSA had first established that the
trading strategy itself violated the rules of market conduct. The
FSA does not however want to assert that the trading strategy was
manipulative. If it does not do so, then it is difficult to see why
a trade, even if it is very large, needs clearance from senior management.

I think the FSA has simply taken the easy route out. Perhaps,
for Citigroup too, paying a $25 million fine is an easy solution to
its problems.


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