Traders make lucrative attack on their rivals

Ground Floor: Because it was an intra-day move in the bond markets, you had to be there to know about the Citigroup coup earlier this month, where the traders on their bond desk managed to make €15-€25 million by selling a raft of government bonds into the market, depressing the price, and then buying them back again at a profit - enraging the market makers who felt fleeced in the process.

When you're sitting at the bond desk and the market disappears from under you, it's not a very nice feeling. Especially as you haven't a clue why prices have suddenly begun to tumble.

Knowledge is everything in trading and the realisation that someone knows something you don't is terrifying. It's even worse if you're a market maker and you're suddenly left with a heap of bonds that you can't sell.

In 1985, before what became known as the Big Bang took place in the City of London, buyers and sellers of bonds were matched by stockbrokers who took a commission for their trouble. If there wasn't a buyer for the bond at the time that you wanted to sell it, you just had to wait. But technological advances and a desire for a more transparent and immediate system meant that there was a demand for change.

In 1987, the trading floor was abolished and dealing went online.

Financial institutions were able to make prices in various securities. Some became market makers. This meant that they were obliged to quote a price at which they would buy or sell a bond, whether they had it or not. Generally, market-making obligations were limited to high-volume liquid bonds but it did mean that investors could be sure of finding a two-way price for them.

In the euro zone, market making in government bonds is done via MTS, a market-making system owned by participating banks throughout Europe, which offers access to euro-denominated fixed-interest securities.

August is a particularly quiet time in European bond markets. The French, Spanish and Italians have generally gone on holidays, leaving a skeleton staff behind, while the northern Europeans settle down for whatever sporting occasion happens to have taken hold that year. Nobody expects much to happen.

Which, presumably, is why the Citigroup traders decided it would be a good time to shake things up a bit. The bid prices of all of the market-making participants of MTS were hit at the same time. Which meant that suddenly everyone had a heap of bonds that they didn't want. They immediately marked their prices down and got some more. In fact, according to the reports, the market makers owned €11 billion of unwanted bonds.

Many of the participants thought that it was a case of "the old fat finger", where a trainee, left in the sweltering office while colleagues are at the beach, hits the wrong button and sells €11 billion instead of €11 million.

They were horrified to discover that this wasn't a mistake and that they'd been roasted by a rival bond trader. They had to sell bonds or futures to hedge their positions but all this was being done at a loss. The buyer, at new lower prices, was the Citigroup bond desk.

Citigroup is unrepentant although the other market makers are furious.

Amazingly, the MTS system operated a "gentleman's agreement" that such an event wouldn't actually take place. It's kind of like putting a piece of meat among the piranhas and asking them not to bother eating it. But, to be fair to most traders, they did operate the agreement. And so Citigroup's traders are now loathed by their rivals.

The bottom line is that the Citigroup traders didn't do anything illegal and exposed a flaw in the MTS model while netting themselves a decent wedge.

MTS has now changed the rules to restrict the size and volume of trades over a two-minute period and its board is meeting next month to discuss the situation. The problem is that the MTS system is inherently sound - but only if certain checks are in place. Yet those checks make it less transparent and traders value transparency above all else.

The Financial Services Authority is looking into it - although it doesn't actually regulate MTS it does have rules on "conduct of business". But even the scorched competitors admit that it's difficult to see what it can do.

They're hoping that Citigroup's primary desk may be excluded from the relatively lucrative issuance business for a while on the basis that Europe's governments won't have been happy to see their paper being bandied around for a quick profit in the secondary market. But even if Citigroup miss out on a few placements, they're not going to worry about it too much.

Besides, in the second quarter, the group's fixed-income revenues were up 7 per cent and their proprietary investment activities had an income of $273 million (€221 million) while revenues were up 15 per cent.

Meanwhile, the trader at the centre of the raid, Spiros Skordos, has netted himself a decent bonus from the hour's trading and is apparently enjoying a break at the Olympic Games.