Front-running

02.05.2024

Front-running

Why in the news?                          

          The Securities and Exchange Board of India (Sebi) recently approved changes in mutual fund regulations to prevent front-running in asset management companies (AMCs).

About Front-running:

• It is when a broker or an investor joins a trade because they have pre-existing non-public information concerning a significant transaction that may change the asset’s price, equity, or derivative to obtain economic benefits.
• It is also known as forward-trading or tailgating. It is illegal in India.
• Front-running can occur in various forms and contexts, including the stock market, commodities market, and other financial markets.
• The strategies commonly used to front-run trades are the Buy-Buy-Sell (BBS) trading pattern and the Sell-Sell-Buy (SSB) trading pattern.

What is the Buy-Buy-Sell (BBS) trading pattern?

• In this trade pattern, the alleged front-runner, by using the non-public information regarding an impending buy order of the big client, places his buy order before the big client's buy order.
• As and when the big client places a buy order, the price of the security rises, and the alleged front-runner sells the securities bought earlier.
• In this way, at the raised price, the alleged front-runner makes a profit.

What is the Sell-Sell-Buy (SSB) trading pattern?

• In this trading pattern, the alleged front-runner by using the non-public information regarding an impending sell order of the big client, places his sell orders before the big client's sell order.
• When the big client places a sell order the price of the security falls which allows the alleged front-runner to buy back the securities at a lower price to meet his obligations which he had created earlier by selling securities.

Difference Between Front Running and Insider Trading:

• Insider trading involves trading securities based on material, non-public information about a company. Insiders, such as company executives, employees, or individuals with access to confidential information, use this privileged information to make trades for personal gain.
• On the other hand, Front Running involves trading securities based on knowledge of pending orders or anticipated market movements. It typically occurs when a broker or trader exploits their position or advanced expertise to prioritize their trades over their clients or the general public.

                                                      Source: The Economic Times