But though the FSA took away all the bank's £9.96m profits from the trade, plus a £4m penalty, it decided not to class the trade as market abuse.
The regulator criticised the way Citigroup had conducted the trade, rather than the trade itself.
The bank was found to have broken Principles 2 and 3 of the FSA's code: it was guilty of "failure to act with due skill, care and diligence" and "failures in systems and controls".
The FSA's decision not to find Citigroup at fault under Principle 5, which deals with market manipulation, emboldened the bank to make confident statements to the press.
William Mills, chairman and chief executive of Citigroup's corporate and investment banking division in Europe, the Middle East and Africa, told EuroWeek: "We have been consistent in the fact that we did not break any rules or violate any market conduct activities. It has always been an issue of control to us."
Regulators in Portugal, Belgium and Italy are still investigating the trade, but a senior Citigroup bond banker told EuroWeek that employees at the firm were convinced the FSA's ruling would "draw a line" under the affair, and that other regulators would not take further action.
The FSA's 14 page final notice to Citigroup gives a detailed account of how the trade was conducted on August 2, 2004, and of its effects on the European government bond market.
But it does little to dispel the cloud of ambiguity that has surrounded the trade since it hit the market.
The EuroMTS trading platform, on which Citigroup sold Eu11.3bn of bonds in 18 seconds and then bought back Eu3.8bn an hour later, was outraged by the trade, as were many of the European governments whose bonds Citigroup sold. Besides the EuroMTS trades, Citi sold another Eu1.5bn of bonds on other markets.
But among other bond traders the reactions were more mixed. Some were infuriated to have lost money; others castigated the trade on principle; but a large group envied it.
Many market participants could at first find no clear grounds to object to what just seemed a big, bold trade. It disrupted the MTS trading system, they reasoned, but only temporarily; it cost other banks money, but trading is a battlefield; and Citigroup was acting within the rules of MTS, which obliges banks to post and honour quotes on bonds.
Perhaps, some argued, Citi had even done the market a service by pointing out the dangers in the superliquid MTS system.
Bosses disown the trade
Yet once the reaction of European governments was clear, senior Citigroup bankers from chief executive Chuck Prince down distanced the bank from the trade or apologised for it, confirming the aura of sin around it.
Later, it emerged that before selling the government bonds at 10.28am, Citigroup had driven up their price by buying Bund and Bobl futures contracts on the less liquid Eurex market in Frankfurt.
This led to accusations that Citi had distorted the market.
The German financial regulator, BaFin, launched an investigation and handed the matter over to prosecutors, but they found that none of the traders had committed any criminal offence. The only censure in Germany has been a Eu5,000 fine by Eurex because one of Citigroup's traders was not properly registered.
Then in February, an email was leaked that a Citigroup government bond trader, reported to be Simon Wivell, had written to his colleague Daniel Leadbetter on July 20, 2004, two weeks before the trade.
In it, he explained how the trading strategy would work, including pushing up the Bund futures in advance.
The trader argued how the trading strategy would be beneficial because it would destabilise MTS, lead to copycat trades, "kill off some of the smaller dealers" and open the way for a system more like the US market, which would be more profitable for big banks like Citigroup.
The email's publication hardened the attitude of other bankers against Citigroup.
The head of rates trading at one bank told EuroWeek in February: "If they [Citigroup] had these orders and sold them into MTS then it is a fair trade and no one could say otherwise. But if they were ramping the market only to spike it back down again, then frankly I think they should be banned from the market and banned from business with issuers.
"It is possible they made a mistake, but we were all calling [on August 2] to ask if they had made a mistake and we would have helped them out. We were all left long. But then they used exactly the same mechanism to buy it back."
FSA finds no distortion
The FSA's report confirms that Citigroup used the Eurex futures market to drive up the price of government bonds before selling what it planned would be Eu8bn-Eu9bn of them.
Yet the FSA stated that: "The success of the trading strategy did not depend on price positioning or other distortive behaviour."
It confirmed that the trader's email set out the strategy for the trade, but accepted Citigroup's explanation that the email was "not circulated or seen by some of the other traders or their management prior to the execution of the trade" and that "not all of the traders agreed with the author's assessment of the possible side effects and benefits of the strategy".
Instead, the FSA found fault with the degree of oversight that senior managers had exercised over the trade.
Citigroup's head of interest rate trading had "authorised the trade" on July 28 or 29, based on a proposed long futures position of around 25,000-40,000 Bund futures contracts. But the FSA was perturbed that when the trade was executed, Citigroup bought some 55,000 contracts, and that "there was not a common understanding between the traders, the head of desk and the head of interest rate trading as to the parameters of the size of the trade."
The FSA criticises Citigroup for failing to have its compliance, legal or independent risk management officials consider the trade before it was executed and for insufficiently "escalating" the trade — communicating it up the management chain.
The FSA complained that Citigroup had, as a result, not given due consideration to the franchise, execution, market impact and legal risks from the trade.
It also pointed out that traders had not received adequate training in market abuse. Yet the FSA's ruling does not separately find that the trade itself was illegal, or an instance of market abuse.
The regulator's findings under Principle 2, "failure to act with due skill, care and diligence", present the same puzzling picture.
Citigroup is criticised because it "did not have due regard to the inherent risks including the likely consequences the execution of the trading strategy could have for the efficient and orderly operation of the MTS platform."
The effect was "to cause a hiatus in visible quotes and volumes traded on the platform". Prices dropped sharply, the FSA said, and "some market participants withdrew their quotes for up to three days".
Yet the regulator did not say that trades that cause such effects are wrong — merely that Citigroup had not given due care to the foreseeable possibility that such effects would occur.
Overall, the FSA's findings about Citigroup's breaches of Principles 2 and 3 leave a central question unanswered: if Citigroup had executed the trade with due management oversight and consideration, would it have been acceptable?
"Acting carelessly"
When questioned by EuroWeek, an FSA spokesperson would only reiterate the line taken by the report. "Citigroup was acting carelessly," he said. "They didn't think through the consequences in the market and they needed to consider the likely effects of what they were going to undertake."
The five traders involved are on a leave of absence and are expected to return to work soon. No employee has been sacked over the affair.
The two supervisors, one of which is Spiros Skordos, head of euro government bond trading in London, have stayed with the company throughout.
The FSA gave Citigroup credit for having given it "very good cooperation" during its investigation, and for having taken steps to improve its internal controls.
Citigroup has made a big, firm-wide effort to tighten its escalation policies, has given all its fixed income, equity, research and investment banking employees refresher training on market conduct and has hired more compliance lawyers.
But that will do little to help the market — and in particular the EuroMTS market, where some dealers are still uneasy about the system of obligatory price quotations — draw lessons from the affair, other than that, if you stick your neck out too far, you are liable to get hit on the head.
