Hedge funds and the European Union have a bit of a thorny relationship. Actually, they more or less loathe each other, with the latter throwing around epithets like “locusts” to describe the former, and the former returning the favor by loudly cheering and bankrolling the successful effort to extricate the U.K. from the EU, and damn the consequences.
Given this rather poisonous atmosphere, any interaction between hedge funds and European regulatory authorities is likely to be unpleasant, ending with a fine or tighter regulation or misplaced blame for the money managers.
As such, it is unusual in the extreme—and generally useless folly—for hedge funds and their ilk to turn to the EU for help of any kind. On the other hand, the continentals aren’t the biggest fans of banks or their shenanigans either, and they do love to write new rules that could get financial sorts in trouble. And so with brokers apparently front-running client trades with impunity from Lisbon to Riga and the Arctic Circle to the Mediterranean coast while hiding behind a loophole-protected euphemism, hedge funds wonder if an unlikely alliance might be in the offing.
Such trades “can often constitute front-running,” the two largest lobby groups for global hedge funds, the Managed Funds Association and Alternative Investment Management Association, told regulators. “Pre-hedging essentially places the proprietary interest of the broker ahead of the de facto client….”
The Association for Financial Markets in Europe, the main lobby group for banks and brokerages, told ESMA that there is no need for new rules and that price requests don’t typically constitute inside information.
At issue in the current ESMA review is trading done primarily through request-for-quote, or RFQ, systems in which an investor typically asks several dealers for the price of an asset, such as stocks or exchange-traded funds.
Brokers anticipating an order will “pre-hedge” by buying or selling the same or similar securities or derivatives. This can happen in split seconds or minutes before the dealer actually needs to fill the position were it to win the order. The market price can move against the client, ESMA said in late 2019 when it solicited industry views on the practice.