CFTC on Automated Trading Rules
Commodity
Futures Trading Commission
Open
Meeting – Proposed Rule on Automated Trading
Tuesday,
November 24, 2015
Key
Topics & Takeaways
- Unanimous
Approval: The Commodity Futures Trading Commission (CFTC) unanimously agreed
to publish a notice of proposed rulemaking on automated trading. Chairman
Massad expressed his strong support for the proposal, and argued that its
multi-layered approach is the “right one.” He also explained that the proposal
reflects industry best practices as well as takes a principles-based approach
to avoid being “overly prescriptive.” In doing so, Massad explained that the
proposed rule, itself, is “only 19 pages” long and will be subject to public
comment for 90 days.
- Access to
Proprietary Data: Commissioner Giancarlo expressed several
concerns related to some aspects of the proposed rule, including those that
would grant the CFTC and Department of Justice (DOJ) access to proprietary
algorithms used by automated trading firms. He remained skeptical as to whether
the Commission or other federal agencies had the authority to obtain such data
without a subpoena, which he argued is one of the “critical elements” of the
proposal. Giancarlo reiterated that it is necessary to protect intellectual
property and confidentiality and called on the Commission to “better educate”
itself on these issues.
Speakers
-
Timothy G. Massad,
Chairman
-
Sharon Y. Bowen,
Commissioner
-
J. Christopher Giancarlo, Commissioner
-
Vince McGonagle, Division of Market
Oversight
-
Sebastian Pujol, Division of Market
Oversight
- Marilee Dahlman, Division of Market
Oversight
Opening Statements
Massad
opened
by noting that almost all trading is electronic in some form, and more than 75%
of trading is automated, which has brought more efficient execution, lower
spreads and greater transparency.
Massad
cautioned, however, that such a paradigm also raises important supervisory
concerns. He noted that the proposal being considered by the CFTC focuses on
minimizing the potential for disruptions from automated trading to protect the
integrity of markets, and further stated that staff incorporated comments
received from its 2013
concept release on risk controls and system safeguards for automated
trading environments.
Bowen
noted
the immense technological change that has taken place in markets over the last
fifteen years, particularly in the growth of algorithmic trading. She
highlighted the lack of information on automated trading activities across
asset classes, and indicated that further work remains for regulators and
industry participants to address those issues. Bowen stated that algorithms
malfunction at times, which negatively impacts markets. She also explained that
the proposed rule codifies many existing industry practices so it should not
substantially change how many firms use algorithms. Bowen also signaled that
this rule would not be the “final word” on algorithmic trading, and indicated
that she supports further regulatory action to keep up with market changes and
“ward off systemic risks.” She finally invited comments on flawed or
impractical elements of the proposed rule.
Commissioner Christopher Giancarlo
Giancarlo
noted
that the electronification of trading has transformed financial markets and
economies generally, and increases trader productivity and reduces transaction
costs in futures markets, particularly. Still, he recognized that the rise of
automated trading presents new challenges, such as sudden spikes in market
volatility, “phantom liquidity” and mathematical models that increasingly
replace “human thought.” Giancarlo noted that rulemaking in this area requires
a delicate balance to impose safeguards without harming innovation or
compromising product development. He shared several concerns with the draft
rule, including: 1) that the rule constitutes “window dressing” since testing
standards are already widely adopted within the industry; 2) the high costs and
burdens of proposals, particularly on smaller market participants; and 3) the
obligation for proprietary source code to be held in repositories for
examination by CFTC or DOJ staff at any time.
Staff Presentation: Notice of Proposed Rulemaking
Sebastian
Pujol, Division of Market Oversight
Pujol
explained that Regulation Automated Trading (“Reg. AT”) reflects a
comprehensive approach to reduce risk and improve transparency in automated
trading in order for the Commission to promote safety and soundness within
evolving markets. He stated that the rule takes a multi-layered approach to
establish pre-trade risk controls within trading firms that generate
algorithmic orders, as well as with clearing futures commodity merchants (FCMs)
on designated contract markets (DCMs). Pujol noted that the four key elements
of the proposed rulemaking include: 1) a registration requirement for
proprietary automated traders; 2) codification of the definition of “AT
persons” which includes brokers that engage in algorithmic trading on or
subject to the rules of a DCM and floor traders, among others; 3) requirements
that pre-trade risk controls are established to reduce potential risks in
automated trading; and 4) transparency requirements for electronic trade
matching platforms and trader incentive programs; among other requirements. In
summary, Pujol claimed that the proposed rule leverages existing industry
practices to mitigate risks in automated markets.
Marilee Dahlman, Division of Market Oversight
Marilee
Dahlman, also of the Division of Market Oversight, explained that the proposed
Section 1.80 of the rule requires pre-trade risk controls, order cancellation
systems and other safeguards to be implemented to prevent risks stemming from a
malfunctioning automated trading system. She noted, however, that the proposal
provides significant latitude in the design of such risk controls to enable
automated traders to implement the required controls as they deem appropriate.
Dahlman also explained that Section 1.82 requires clearing FCMs to implement
pre-trade risk controls pertaining to their automated trader customers. In addition,
she continued, Section 40.20 requires the establishment of pre-trade risk
controls and order cancellation capabilities for orders that do not emanate
from algorithmic trading.
Pujol
further explained there are several transparency requirements included in the
proposed rule, such as amendments to existing requirements for electronic trade
matching platforms and requirements for DCMs to provide information regarding
their market maker and trading incentive programs. In addition, he explained,
the rule would require all automated traders to become members of registered
futures associations, such as the National Futures Association.
Closing Statements & Question and Answer
Massad
expressed his strong support for the proposal and his belief that the
multi-layered approach is the “right one.” Massad also explained that the
proposal reflects industry best practices, and takes a principles-based
approach to avoid being “overly prescriptive.” In doing so, Massad explained
that the proposed rule, itself, is “only 19 pages” long and will be subject to
public comment for 90 days. With regard to the proposed risk controls at a
clearing member FCM, Massad expressed interest in hearing whether any aspects
of the proposed reforms would impose an undue burden on clearing member FCMs or
are otherwise unnecessary; and he reiterated his goal to ensure that all
clearing members are able to access the markets effectively and efficiently.
Commissioner
Bowen
Bowen
expressed concern that the proposal does not ask enough questions about
registrants, including the adequacy of training of employees of algorithmic
trading firms. She suggested expanding the scope of some questions to ensure
firms would have to certify the adequacy of such training on an annual basis.
Giancarlo
asked several questions about the CFTC’s authority to access proprietary data
(including source codes for algorithms) used by automated trading firms. Vince McGonagle, Division of Market Oversight, expressed the view
that the Commission has such authority under its investigative rights
authority, and explained that obtaining such information for inspection is
necessary to ensure firms are compliant with the regulations. McGonagle
acknowledged, however, that the proposed rule raises questions about the nature
and scope of the regulator’s inspection authority, unless there is a subpoena
issued. Giancarlo raised several concerns about the Commission’s and other
federal agencies’ authority to obtain such data without a subpoena, which he
argued is one of the “critical elements” of the proposal. Further, he stated
that there is a “distinction” between software algorithms and records, noting
that books and records look to “past activity,” while a source code or
algorithm software is an operating system/protocol which concerns a position a
market participant would take in the future. Giancarlo reiterated that it is
necessary to protect intellectual property and confidentiality and called on
the Commission to “better educate” itself on these issues, highlighting that he
is not aware of any federal agency that has the right to obtain intellectual
property of registrants without a subpoena.
In
response to Giancarlo’s line of questioning, Massad agreed that confidentiality
of information is always a “key requirement of the law,” and noted that the
Commission currently handles a great deal of commercially sensitive information
in the course of its oversight and supervision activities. He agreed to further
consider the rule’s implications with respect to source code, including the
Commission’s need to invest in more information technology to enhance its
ability to analyze such algorithms. Still, Massad recalled that the
Commission’s enforcement division analyzes allegations of “spoofing,” which
leads him to believe that they have the requisite tools and know-how to
deconstruct algorithms in their investigation and enforcement cases.
Vote
The
Commission unanimously
agreed to adopt the notice of proposed rule on automated trading.
More
information about this event can be accessed here.
,Blog Tags:,Blog Categories:,Blog TrackBack:,Blog Pingback:No,Hearing Summaries Issues:Technology/High Frequency Trading,Hearing Summaries Agency:CFTC,Publish Year:2015
Commodity
Futures Trading Commission
Open
Meeting – Proposed Rule on Automated Trading
Tuesday,
November 24, 2015
Key
Topics & Takeaways
- Unanimous
Approval: The Commodity Futures Trading Commission (CFTC) unanimously agreed
to publish a notice of proposed rulemaking on automated trading. Chairman
Massad expressed his strong support for the proposal, and argued that its
multi-layered approach is the “right one.” He also explained that the proposal
reflects industry best practices as well as takes a principles-based approach
to avoid being “overly prescriptive.” In doing so, Massad explained that the
proposed rule, itself, is “only 19 pages” long and will be subject to public
comment for 90 days.
- Access to
Proprietary Data: Commissioner Giancarlo expressed several
concerns related to some aspects of the proposed rule, including those that
would grant the CFTC and Department of Justice (DOJ) access to proprietary
algorithms used by automated trading firms. He remained skeptical as to whether
the Commission or other federal agencies had the authority to obtain such data
without a subpoena, which he argued is one of the “critical elements” of the
proposal. Giancarlo reiterated that it is necessary to protect intellectual
property and confidentiality and called on the Commission to “better educate”
itself on these issues.
Speakers
-
Timothy G. Massad,
Chairman -
Sharon Y. Bowen,
Commissioner -
J. Christopher Giancarlo, Commissioner
-
Vince McGonagle, Division of Market
Oversight -
Sebastian Pujol, Division of Market
Oversight - Marilee Dahlman, Division of Market
Oversight
Opening Statements
Massad
opened
by noting that almost all trading is electronic in some form, and more than 75%
of trading is automated, which has brought more efficient execution, lower
spreads and greater transparency.
Massad
cautioned, however, that such a paradigm also raises important supervisory
concerns. He noted that the proposal being considered by the CFTC focuses on
minimizing the potential for disruptions from automated trading to protect the
integrity of markets, and further stated that staff incorporated comments
received from its 2013
concept release on risk controls and system safeguards for automated
trading environments.
Bowen
noted
the immense technological change that has taken place in markets over the last
fifteen years, particularly in the growth of algorithmic trading. She
highlighted the lack of information on automated trading activities across
asset classes, and indicated that further work remains for regulators and
industry participants to address those issues. Bowen stated that algorithms
malfunction at times, which negatively impacts markets. She also explained that
the proposed rule codifies many existing industry practices so it should not
substantially change how many firms use algorithms. Bowen also signaled that
this rule would not be the “final word” on algorithmic trading, and indicated
that she supports further regulatory action to keep up with market changes and
“ward off systemic risks.” She finally invited comments on flawed or
impractical elements of the proposed rule.
Commissioner Christopher Giancarlo
Giancarlo
noted
that the electronification of trading has transformed financial markets and
economies generally, and increases trader productivity and reduces transaction
costs in futures markets, particularly. Still, he recognized that the rise of
automated trading presents new challenges, such as sudden spikes in market
volatility, “phantom liquidity” and mathematical models that increasingly
replace “human thought.” Giancarlo noted that rulemaking in this area requires
a delicate balance to impose safeguards without harming innovation or
compromising product development. He shared several concerns with the draft
rule, including: 1) that the rule constitutes “window dressing” since testing
standards are already widely adopted within the industry; 2) the high costs and
burdens of proposals, particularly on smaller market participants; and 3) the
obligation for proprietary source code to be held in repositories for
examination by CFTC or DOJ staff at any time.
Staff Presentation: Notice of Proposed Rulemaking
Sebastian
Pujol, Division of Market Oversight
Pujol
explained that Regulation Automated Trading (“Reg. AT”) reflects a
comprehensive approach to reduce risk and improve transparency in automated
trading in order for the Commission to promote safety and soundness within
evolving markets. He stated that the rule takes a multi-layered approach to
establish pre-trade risk controls within trading firms that generate
algorithmic orders, as well as with clearing futures commodity merchants (FCMs)
on designated contract markets (DCMs). Pujol noted that the four key elements
of the proposed rulemaking include: 1) a registration requirement for
proprietary automated traders; 2) codification of the definition of “AT
persons” which includes brokers that engage in algorithmic trading on or
subject to the rules of a DCM and floor traders, among others; 3) requirements
that pre-trade risk controls are established to reduce potential risks in
automated trading; and 4) transparency requirements for electronic trade
matching platforms and trader incentive programs; among other requirements. In
summary, Pujol claimed that the proposed rule leverages existing industry
practices to mitigate risks in automated markets.
Marilee Dahlman, Division of Market Oversight
Marilee
Dahlman, also of the Division of Market Oversight, explained that the proposed
Section 1.80 of the rule requires pre-trade risk controls, order cancellation
systems and other safeguards to be implemented to prevent risks stemming from a
malfunctioning automated trading system. She noted, however, that the proposal
provides significant latitude in the design of such risk controls to enable
automated traders to implement the required controls as they deem appropriate.
Dahlman also explained that Section 1.82 requires clearing FCMs to implement
pre-trade risk controls pertaining to their automated trader customers. In addition,
she continued, Section 40.20 requires the establishment of pre-trade risk
controls and order cancellation capabilities for orders that do not emanate
from algorithmic trading.
Pujol
further explained there are several transparency requirements included in the
proposed rule, such as amendments to existing requirements for electronic trade
matching platforms and requirements for DCMs to provide information regarding
their market maker and trading incentive programs. In addition, he explained,
the rule would require all automated traders to become members of registered
futures associations, such as the National Futures Association.
Closing Statements & Question and Answer
Massad
expressed his strong support for the proposal and his belief that the
multi-layered approach is the “right one.” Massad also explained that the
proposal reflects industry best practices, and takes a principles-based
approach to avoid being “overly prescriptive.” In doing so, Massad explained
that the proposed rule, itself, is “only 19 pages” long and will be subject to
public comment for 90 days. With regard to the proposed risk controls at a
clearing member FCM, Massad expressed interest in hearing whether any aspects
of the proposed reforms would impose an undue burden on clearing member FCMs or
are otherwise unnecessary; and he reiterated his goal to ensure that all
clearing members are able to access the markets effectively and efficiently.
Commissioner
Bowen
Bowen
expressed concern that the proposal does not ask enough questions about
registrants, including the adequacy of training of employees of algorithmic
trading firms. She suggested expanding the scope of some questions to ensure
firms would have to certify the adequacy of such training on an annual basis.
Giancarlo
asked several questions about the CFTC’s authority to access proprietary data
(including source codes for algorithms) used by automated trading firms. Vince McGonagle, Division of Market Oversight, expressed the view
that the Commission has such authority under its investigative rights
authority, and explained that obtaining such information for inspection is
necessary to ensure firms are compliant with the regulations. McGonagle
acknowledged, however, that the proposed rule raises questions about the nature
and scope of the regulator’s inspection authority, unless there is a subpoena
issued. Giancarlo raised several concerns about the Commission’s and other
federal agencies’ authority to obtain such data without a subpoena, which he
argued is one of the “critical elements” of the proposal. Further, he stated
that there is a “distinction” between software algorithms and records, noting
that books and records look to “past activity,” while a source code or
algorithm software is an operating system/protocol which concerns a position a
market participant would take in the future. Giancarlo reiterated that it is
necessary to protect intellectual property and confidentiality and called on
the Commission to “better educate” itself on these issues, highlighting that he
is not aware of any federal agency that has the right to obtain intellectual
property of registrants without a subpoena.
In
response to Giancarlo’s line of questioning, Massad agreed that confidentiality
of information is always a “key requirement of the law,” and noted that the
Commission currently handles a great deal of commercially sensitive information
in the course of its oversight and supervision activities. He agreed to further
consider the rule’s implications with respect to source code, including the
Commission’s need to invest in more information technology to enhance its
ability to analyze such algorithms. Still, Massad recalled that the
Commission’s enforcement division analyzes allegations of “spoofing,” which
leads him to believe that they have the requisite tools and know-how to
deconstruct algorithms in their investigation and enforcement cases.
Vote
The
Commission unanimously
agreed to adopt the notice of proposed rule on automated trading.
More
information about this event can be accessed here.