17 CFR Chapter I Concept Release on Risk Controls and System Safeguards for Automated Trading Environments
Enabling traders and exchanges to continue to work with regulators in a cooperative environment that recognizes the significant market incentives shared by all stakeholders to ensure trading system and market integrity is the best approach as we transition to technology-based markets.
I appreciate the opportunity to comment on the Commodity Futures Trading Commission’s “Concept Release on Risk Controls and System Safeguards for Automated Trading Environments; Proposed Rule.” The Mercatus Center at George Mason University is dedicated to bridging the gap between academic ideas and real-world problems and advancing knowledge about the effects of regulation on society. This comment does not represent the views of any particular affected party or special interest group, but is designed to assist the Commodity Futures Trading Commission (CFTC) as it explores whether existing industry practices are adequate to ensure market integrity or if additional regulatory measures are necessary.
The CFTC describes the Concept Release as a “platform for cataloguing existing industry practices, determining their efficacy and implementation to date, and evaluating the need for additional measures, if any.” The intent of the document is “to serve as a high-level enunciation of potential measures intended to reduce the likelihood of market disrupting events and mitigate their impact when they occur.” 1 While the CFTC recognizes the existence of risk controls, the Concept Release is designed to determine if enforced standardization via regulation is in the best interest of the market. The regulatory measures proposed by the CFTC within the document fail to meet this standard.
The CFTC proposes four broad categories of regulation: (1) pretrade controls, (2) post-trade reports and measures, (3) system safeguards, and (4) other risk controls. The proposal recognizes that many of theses controls are already in place, in one form or another, in most trading firms and exchanges. The alternative proposed by the CFTC is to allow traders and exchanges to continue to operate as they have if it is determined that measures already in place are sufficient to ensure the integrity of markets in automated trading environments.
The Evolving Market and Need for Reform
The transition from trading venues centered on human-initiated trading activities to a highly automated and electronically networked environment has resulted in a market that is much faster and more efficient. Documented benefits of this new environment have included increased market liquidity and more efficient price discovery, lower transaction costs, narrower spreads, wider participation in markets, reduced impacts of volatility, increased availability of direct market access, and a means to obtain better order execution for clients.
Recent market events, including the “Flash Crash” of May 2010, algorithmic failures at Knight Capital, and quote dissemination system connectivity issues at the Nasdaq stock market, have caused automated systems to come under increased scrutiny and calls for more aggressive formalized regulation.2 Regulation has already been approved by the CFTC that broadly prohibits manipulative and deceptive devices and directly or indirectly manipulating or attempting to manipulate prices.3 Additionally, the Dodd-Frank Wall Street Reform and Consumer Protection Act makes it unlawful to engage in disruptive trading practices.4 Recent fines imposed by the CFTC and others against Panther Energy Trading LLC and Michael Corsica for deliberately manipulating commodities markets in late July 2013 are examples of the enforceability of these existing regulations.5 It is safe to say that when an individual or firm is intentionally engaging in manipulative practices, a market failure exists that must be managed from a regulatory perspective.
The regulations proposed in the Concept Release are generally not directly associated with a broad market failure that requires additional formal regulation. There are no consistent and widespread issues associated with the ability of all available information to be efficiently and fully reflected in the price of securities or the market’s ability to efficiently transfer security ownership. What do exist are periodic technology problems associated with the evolving nature of financial markets to automated systems. These are not problems inherent in the technology independently, but often associated with the human interaction with the technology, particularly system programming and oversight. In that respect, the human-centered nature of markets has not changed.