Before beginning this week’s post, a quick happy Easter (and hag sameach) to everyone reading. I hope you all had a wonderful weekend and enjoyed the celebrations.
This week, we’ll be looking at a court case involving ThinkMarkets and IS Prime. The case has several strands to it and has been going on for years now, but ultimately boils down to IS Prime wanting $15m in compensation from ThinkMarkets.
The problems stem from early 2017, when IS Prime, a prime-of-prime broker that’s owned by hedge fund group ISAM, made an agreement with ThinkMarkets to be its exclusive execution venue for certain products.
But at the end of that same year, IS Prime changed the terms and conditions for trading in index swaps, which CFD providers like ThinkMarkets use to hedge the trades their own clients place.
ThinkMarkets ceased to trade index swaps with IS Prime after this point, which the latter said breached the exclusivity agreement and caused them to lose money. A long period of mudslinging followed and the two have been embroiled in court battles since, which go beyond just the losses owed because of the index swaps.
For instance, someone at ThinkMarkets may have posted fake ‘reviews’ on Glassdoor about working at IS Prime. I recommend reading a related court order just because (i) it’s not that long and (ii) it’s funny.
Although some parts of the case seem to be ongoing, the index swaps component of it does look to have drawn to a close. Last month a UK judge issued a summary judgement in ThinkMarket’s favour.
In non-legalise, that means the case won’t go to trial and, unless IS Prime appeals, ThinkMarkets won’t have to pay them anything. The index swaps represent about $13m of the $15m that IS Prime is after, so it’s a hefty chunk of the claim.
Reading the case is kind of like flicking through a page of the Summa Theologica. There is much back and forth, and you end up having some sympathy for the arguments put forth by the two opposing sides.
At the core of the disagreement is an email sent by IS Prime in December 2017 to its customers:
We are writing to inform you that ISAM Capital Markets is moving its index swap business from London to Hong Kong. This decision has been taken as a response to growing regulatory complexity and uncertainty in Europe as a result of MiFID II ..
.. Accordingly, as of Monday 18 December 2017, all index swap transactions will be entered with IS Prime Hong Kong Limited instead of IS Prime Ltd in London.
On the face of it, this does not sound good. If your stockbroker came to you and said, “hello, your account is about to be regulated. We don’t want to adhere to these regulations, so we’re going to move you to an unregulated entity,” then you probably wouldn’t be so happy about it. You may even move your account to another stockbroker.
But perhaps if you were already trading in those conditions, that wouldn’t be such a big deal. Plus if you say ‘moving to an unregulated entity’ it has some air of maliciousness about it. But maybe there was no maliciousness?
Adhering to MiFID II is really annoying and expensive. This is a piece of legislation that was costing medium-sized firms £3m – £5m to get ready for.
If you could provide exactly the same service to clients without having to go through a huge amount of costly bureaucracy, then maybe you’d choose to do that. It’s also worth remembering that there was genuine confusion about how MiFID II was supposed to be implemented across almost every area of the financial services industry that it impacted.
Having said that, MiFID II was not exactly a fastball which the regulator suddenly flung at firms – they had almost a decade to get ready for it. Many of those requirements, particularly in the OTC derivatives market that IS Prime is active in, were about transparency. So maybe there were some less scrupulous reasons why IS Prime wanted to move index swaps trading to Hong Kong.
My sense, and I have no idea if this is correct, is that the ThinkMarkets compliance team got that email in December 2017 and…
- Understood that there would be no difference, in practical terms, in how they traded index swaps but did realise it was a way out of the agreement they’d signed with IS Prime. They then all high-fived and went to the pub.
- Alternatively, they got the email and were genuinely annoyed and concerned about the new trading conditions, so decided to stop trading swaps with IS Prime.
- They got the email and were genuinely annoyed about being forced to trade with the Hong Kong entity AND realised it was a way out of the liquidity agreement. They high fived and went to the pub.
Reading through the case, my sense is that it was probably the final option but that the ‘yay, we can get out of the agreement’ element was bigger than the ‘we have to trade in Hong Kong’ factor.
The reason I say that is because the end result of the trading conditions would have been exactly the same. There would have been a functional difference but not a practical one.
Prior to the changes in December 2017, index swap trades would go to IS Prime’s UK regulated entity and then be executed on a matched-principal basis with ISFE 21, an IS Prime affiliate based in the Cayman Islands.
Post-changes, the UK entity would act as an agent, sending trades to its Hong Kong affiliate. The Hong Kong affiliate would then perform exactly the same transaction that the UK one did previously, sending order flow to IFSE 21 on a matched-principal basis.
From the end point as a client, I doubt that you would notice any difference in execution or pricing because of this change. If you weren’t told about it, you probably wouldn’t even know it was there.
You could argue that the change, because of the legal restructuring required, would expose you to some sort of credit risk. That would depend on how the move to the Hong Kong entity was structured. But if you were already trading in conditions akin to those prior to MiFID II coming into play, why would it be such a big deal to make the change?
The people at ThinkMarkets know what they’re doing and probably understand this, so while I don’t doubt there were concerns about the change, it wouldn’t surprise me if this was also a nice way of getting out of the agreement. Incidentally, the weirdest thing to me is the fact that trades are sent to ISFE 21, which seems like a completely opaque entity. Unless IS Prime tells customers who they’re executing with then you must have no idea where your liquidity is coming from.
Anyway, the arguments in the case get quite meta at some points. For instance, the ThinkMarkets lawyer made the case that, because IS Prime’s UK entity stopped offering swaps as a matched-principal, it effectively no longer offered them. If ThinkMarkets was forced to keep to the exclusivity agreement, it would leave them in the peculiar position of being forced to only trade index swaps with a company that doesn’t offer index swaps.
On the IS Prime side, my favourite argument was that, although the email said all of the swaps trades would be executed in Hong Kong, this didn’t mean that the London entity would stop offering them. Maybe I’m being crazy here but if someone you have a contract with says there will be a change to the contract on a certain date, you wouldn’t take that to mean that the old contract terms would remain in play.
So if your energy supplier sent you a letter saying, ‘your energy bill will rise by 100% next month’, your response is unlikely to be, ‘fantastic, that means I can keep paying the old rate if I want to.’
And if you did try doing that, you’d probably have as much success as IS Prime did in court. The judge’s main point was that the December 2017 letter effectively said ThinkMarkets couldn’t trade index swaps with IS Prime’s UK entity any more on a matched-principal basis. As the terms of the original agreement stated they’d be traded on that basis, ThinkMarkets didn’t have to keep using IS Prime for index swaps. Simple, right?
Have a good week.
Stuff that happened