Unfortunately I can no longer find it but a year or so ago, I remember seeing a post on WallStreetBets about someone trading with CMC Markets. From memory, they realised that the overnight rate had been mispriced on a specific commodity CFD. By the time CMC realised this and adjusted it, they were up something like £80,000.
I was reminded of this a week or so ago when I went for dinner with a friend who showed me two disparate swap rates on the same instrument – this time zinc – at two different brokers. One was positive long, the other positive short. Someone has to be wrong but then how does this happen in the first place?
There are a couple of factors to think about here. The first is how brokers are calculating swaps.
Larger firms, like IG Group or CMC Markets, tend to make their own CFD pricing and thus create their own overnight / swap rates. But smaller firms typically don’t do this and instead take their pricing from another firm. Sometimes they literally just copy it from other brokers.
“When we’ve got it wrong in the past, we’ve actually had complaints from competitors,” said the Head of Trading at one broker, who noted that these competitors weren’t even using them as an LP or for a data feed!
Other broker executives that TradeInformer spoke to confirmed that they have worked at companies where the dealing team just copied other firms’ rates.
A technology provider that TradeInformer spoke to also said that they set up one company with a turnkey-style solution. Shortly afterwards, they came back and complained about their clients abusing them. It turned out they simply hadn’t adjusted the swap rates from the default mode that the tech provider sets when it hands over the platform.
A more common practice that brokers seem to employ is to simply copy the swap rate they get from their LP. This is also open to ‘change’ as each entity in the LP chain often marks the swap up or down to capture extra revenue, although I suppose this is more of a problem for the end client rather than the firm itself.
Whatever method you do use, you then have to actually input this into the system. And the basic problem here seems to be a mix of human error, largely driven by employees having to manually update their backend in some way.
Like any system, this results in mistakes. One consultant, who primarily works with MetaTrader set up and operations, told TradeInformer that firms he works with often just don’t check their swaps or forget to update them.
Similarly, Roman Garanin, the CEO and Founder of tech and risk management solutions provider Yourfintech, told TradeInformer that human error and a lack of expertise often means swaps are set incorrectly.
“I even used to catch positive net swaps for the same instrument on one broker,” said Garanin. “And they used to have zero hedge margin. So just imagine that – every day you grow your position until they realize that something is wrong.”
As the CMC point at the beginning should illustrate this happens to firms across the board, although smaller firms seem more susceptible to it.
And the former Head of Quant Trading at one broker also noted that during his time at an investment bank, his team would often trade against one regional desk that consistently failed to update their swap rates. So I guess you can all feel better about yourselves – even the big players do it.
The obvious downside to all of this, as Garanin’s comment suggests, is that you become open to abuse. And because a lot of the time this involves positions that look like swing trading, they aren’t easy to detect. But that’s a topic for another time.