“QE’s Are… Cake” – The Full Walkthru How Bond Traders Manipulate Daily POMO

“QE’s Are… Cake” – The Full Walkthru How Bond Traders Manipulate Daily POMO

It has gotten to the point where even we are amused how every “conspiracy theory” we suggest becomes proven fact in the span of a few years, usually involving criminality on behalf of at least one (usually more) perpetrator.

In today’s most recent instance of “conspiracy theory” becomes “non-conspiracy” fact, we have the not so curious case of one Mark Stevenson, a former bond trader at Credit Suisse Group, who was fined 662,700 pounds ($1.1 million) and banned from working in the finance industry for “deliberately” manipulating a U.K. government bond price. Specifically, what Stevenson did, was to take advantage of the BOE’s POMO auctions in 2011 to sell some 1.2 billion-pounds of existing gilt holdings which he had accumulated previously with the express intention of selling back to the BOE during a POMO operation at an artificially high price. All this was revealed as fact earlier today by the U.K. Financial Conduct Authority, the markets regulator.

How shocking. Who could have possibly predicted that banks would abuse POMO – that noble operation meant simply to provide banks with a means to sell paper without making abnormal profits on the back of the taxpayer (because all that debt that is being issued and monetized simply means that either there will be far less growth in the future, or inflation is set to surge – no other options) – to simply enrich themselves and a few select criminal traders.

Zero Hedge, that’s who.

It was on January 11, 2011, months before Stevenson was engaged in this particular crime (in which he certainly is not alone in and where every single govvy and MBS trading desk has engaged in comparable price manipulation courtesy of POMO, with an intent and a means to sell at the highest possible price to Fed or any other central bank), when we explained precisely this:

While commenting on yesterday’s NYT joke of a profile of the New York Fed POMO group, we openly mocked the claim by one Mr. Frost who said that when monetizing debt “We are looking to get the best price we can for the taxpayer.” We politely suggested that this is a blatant, tendentious lie, and that in fact the New York Fed merely cares to gift the Primary Dealers with any price it can for their bonds just so it stays on their good side (think Primary Dealer Auction take down over 50%), and after all – it is only money that according to Steve Liesman appears out of thin air.

And… three years later we were shocked to learn we were right. Because the Stevenson case, described in clear, informative language, explains precisely how it is that Dealers took advantage of the BOE (and by extension continue to take advantage of the Fed’s) POMO, where the central bank buys back bonds from the dealer community, with zero regard for its cost-basis during the POMO reverse auction segment, to generate abnormal profits for these same dealers.

What follows is a somewhat technical narrative released earlier today by the UK’s Financial Conduct Authority, which explains precisely this. We recommend readers read it to understand precisely that the purpose of POMO is, in addition to loading up banks with reserves which can and in the case of JPM were used to corner risk markets as initial margin collatereal, is to provide bank traders with riskless profits. We certainly hope US regulators (yes, we are laughing too) read it as well, to understand just how US traders abuse the Fed’s own POMO on a day to day basis. We know they won’t because their rightful owners, the banks, will never allow this generous daily piggy bank spigot to ever be shut down.

Select excerpts from the FCA’s final notice against Mark Stevenson (pdf)

(b) Chart 2 shows the movement in the yield of the Bond (UKT 8 3 17) and the UKT 1.75% 2017 (UKT 1 75 17) and the movement of the spread between the Bond and UKT 1.75% 2017 (17/17s Yield Spread) on 10 October 2011. The yield spread moves from approximately -9 to +3 between the times Mr Stevenson placed his first bid (09:01) and when he executed his last trade (14:30).

(c) Similarly, Chart 3 shows the movement in the yield of the Bond (UKT 8 3 17) and the UKT 5% 2018 (UKT 5 18) and the movement of the spread between them on 10 October 2011. The yield spread can be seen dropping throughout the day until around 14:30, at which time it begins to increase, until approximately 15:30 when it stabilises.

Offers submitted by Mr Stevenson to the Bank of England

The QE2 reverse auction ran from 14:15 to 14:45 on 10 October 2011. During this period, the GEMMs were able to submit offers to sell gilts through the BOE’s B-Tender system during the auction period. Mr Stevenson was responsible for placing the offers in the Bond on behalf of CSSEL to the BOE.

Mr Stevenson submitted a number of offers through the B-Tender system during this time. Each offer superseded the previous one and only offers in the system as at 14:45 could be accepted by the BOE. As shown in the table below, the quantity of the Bond offered by Mr Stevenson increased from £800 million to £850 million and the price at which Mr Stevenson offered the Bond decreased during the auction.

Bond offers submitted by Mr Stevenson to the BOE on 10 October 2011

The size of Mr Stevenson’s offer of the Bond into the QE2 reverse auction on 10 October 2011 was larger than all of the other offers in the Bond on 10 October 2011 combined and represented two-thirds of the value of the Bond offered to the BOE on 10 October 2011 and the total consideration payable by the BOE to CSSEL (had the offer been accepted by the BOE) would have been 70% of the amount (£1.7 billion) it had allocated to the reverse auction on 10 October 2011.

Events following submission of the offer

At 14:56, the BOE announced the “Asset Purchase Facility gilt purchase operation results” which included the following statement:

“The Bank has decided to reject all offers against UKT_8.75_250817 following significant changes in its yield in the run up to the auction.”

The Bank therefore decided to reject all offers in the Bond – the only time that the BOE has ever taken such a step.

Shortly afterwards, the BOE contacted CSSEL. In a telephone conversation between senior representatives of the BOE and CSSEL, the BOE explained that it believed that the Bond had been traded in such a way so as to increase its price in order to sell it to the BOE at a distorted level, and that someone would contact the relevant trading desk at CSSEL to further investigate.

The BOE was concerned that the Bond was being offered to it at an inflated level, such that there would have been an additional, unacceptable cost to the taxpayer in buying at that level. The BOE therefore rejected all offers in the Bond.

The market’s view of the trading

Several gilt market participants commented on the Bond’s significant outperformance on 10 October 2011.

By 09:39 (38 minutes after Mr Stevenson began trading in the Bond), a market participant had telephoned the BOE regarding the Bond’s outperformance. Several other market participants telephoned the BOE throughout the day, suggesting that the Bond had been “squeezed”, “rammed”, and that someone “was messing around with” it. One market participant said he could see no reason for the significant trading in the Bond on 10 October 2011 other than deliberately pushing the price higher in order to sell to the BOE later in the day.

Some market participants declined to trade the Bond with clients on 10 October 2011, with one indicating that he would be prepared to do so only at the previous trading day’s closing price in view of the unusual price movements. Other market participants commented on the scale of the outperformance.

Mr Stevenson’s explanation for the trading

Mr Stevenson has stated that he bought the Bond on 10 October 2011 because he believed it was cheap and not with the definite intention of offering to sell it to the BOE later that day. He stated that he traded the Bond throughout the day on 10 October 2011 in an open and transparent manner. He said that he continued to purchase the Bond until it reached what he believed was its fair value. He said that once the Bond reached what he believed was its fair value, he was entitled to offer it into the reverse auction.

Mr Stevenson said that one reason for offering the Bond into the QE reverse auction on 10 October 2011 was in order to rebalance the trading book. He said that the Bond was offered because it had reached what he believed was its fair value, but that he could have offered a number of other gilts instead.

The Authority’s findings about Mr Stevenson’s trading in the Bond

The Authority has reached the view that Mr Stevenson made the decision to purchase the Bond with a view to offering it to the BOE in the auction. He was aware that his trading in the Bond on 10 October 2011 would not only increase CSSEL’s holding in the Bond but also increase its price. This was done in order to increase the return for CSSEL if its bid in the auction was accepted by the BOE.

The Authority has concluded that Mr Stevenson had formed an intention to offer the Bond into the next round of QE before 10 October 2011. He had an opportunity to buy more of the Bond before 10 October 2011 (both before and after QE2 was announced on 6 October 2011) but instead chose to buy an extremely large quantity on 10 October 2011 (92% of the value traded in the Bond through the IDBs and 2,700% of the Bond’s 5 month daily average volume, the only time he has traded the Bond in this volume).

Mr Stevenson’s trading in the Bond on 10 October 2011 had a significant effect on the price of the Bond, something Mr Stevenson would have been aware of at the time yet he continued to buy the Bond aggressively throughout the day. The comments made during the day by other market participants indicate how remarkable the movements in the Bond’s price and yield were compared to the Comparator Bonds during the day. The Authority has concluded that Mr Stevenson’s trading was designed to move the price of the Bond on 10 October 2011 and that he was not simply trying to acquire more of a bond that he perceived as being cheap.

Having considered these factors, the Authority has concluded that Mr Stevenson’s conduct is at level 5 in terms of seriousness and therefore, the percentage of relevant income for step 2 is 40 %. This amounts to £946,800. As this amount is larger than £100,000, the step 2 figure is £946,800.

The Authority therefore imposes a total financial penalty of £662,700 on Mark Stevenson for market abuse.

The Authority considers that Mr Stevenson deliberately acted to increase the price of the Bond on 10 October 2011 and considers that this amounted to deliberate market abuse. His behaviour is particularly egregious as it took place on the first day of QE2 and effectively sought to deprive the economy from QE’s full effect in order to maximise the potential profit from selling the Bond to the BOE in the QE2 reverse auction. The Authority considers that, as a result of this behaviour, Mr Stevenson lacks fitness and propriety in terms of his integrity.

The Authority therefore makes a prohibition order pursuant to section 56 of the Act prohibiting Mr Stevenson from performing any function in relation to any regulated activity carried on by any authorised or exempt person or exempt professional firm. This order takes effect from 20 March 2014.


That’s ok – we are confident Mr. Stevenson will live comfortably for the rest of his life away from trading, with the millions of bonuses he has collected during his tenure trading bonds in a fair and honest manner.

As for everyone else, now that you know how POMO manipulation is done, keep doing it.

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