November 24, 2015
Today, the Commission has approved a proposal that addresses the increased use of automated trading in our markets. I strongly support this important action. In the futures markets, today almost all trading is electronic in some form. And over the last few years, more than 70 percent of all trading has become automated.
Automated trading has brought many benefits to market participants. These include more efficient execution, lower spreads and greater transparency. But its extensive use also raises important policy and supervisory questions and concerns.
The Commission has already taken a number of steps to respond to the development of automated trading in our markets. Following the 2010 “Flash Crash,” the CFTC worked with the SEC to establish certain controls to minimize the risk of market disruptions. The Commission has also required clearing members to implement policies and procedures governing the use of automated trading programs. We have also required automatic screening of orders for compliance with risk limits if they are automatically executed.
But as markets continue to evolve, it is important to continue looking at this issue. Therefore, in September 2013, the Commission issued a Concept Release that requested public comment on the necessity and operation of a variety of risk controls and measures. The Commission received many written comments and also held a meeting of its Technological Advisory to discuss the issues raised. It served as a very useful way to understand existing industry practices and discuss what further actions might make sense.
The proposal approved today addresses several areas discussed in the Concept Release, and incorporates much of that public input. It focuses on minimizing the potential for disruptions and other operational problems that may arise from the automation of order origination, transmission or execution. They may come about due to malfunctioning algorithms, inadequate testing of algorithms, errors and similar problems.
No set of rules can prevent all such problems. But that doesn’t discharge us from our duty to take reasonable measures to minimize these risks. It is our responsibility as regulators to create a framework that promotes the integrity of these markets. And I believe this proposed rule helps do that.
Our futures market infrastructure is already very strong. Our regulatory framework – and the controls and measures that exist at the exchange and clearing member level in particular – have helped create the best futures markets in the world. Our proposal seeks to maintain that strength as our markets evolve further.
We have proposed a number of measures that largely reflect what are industry best practices to minimize the risk of disruptions and similar problems. We have tried to be principles-based. We have set forth requirements for certain controls, but we have avoided prescribing the parameters or levels at which they should be set. The proposed risk controls will apply regardless of whether the automated trading is high- or low-frequency. The proposal does not define high frequency trading.
A key principal of this proposed rule is to have risk controls at three levels – the exchange level, clearing member level and trading firm level. Market participants generally supported this multi-level approach in response to the Concept Release, and I believe it is important to achieving a sound framework. But in doing so, we must seek efficiency, and avoid conflicting or unnecessary requirements at multiple levels.
In order to make the multi-level approach effective, we are proposing to require the registration of proprietary traders who engage in algorithmic trading on our regulated exchanges via “direct electronic access.” Today, our staff estimates that roughly 35 percent of the futures trading in our markets is done by traders who use direct electronic access and are not registered with us. A registration requirement will ensure that all those with direct electronic access to our markets are complying with pre-trade risk controls, testing and other requirements. And it would enhance the Commission’s ability to carry out its oversight responsibilities.
While we believe a registration requirement is appropriate, we have also invited market participants to comment on whether there are alternatives that can achieve the proposal’s underlying objectives. We have also asked whether the registration requirement should be limited to trading firms meeting certain volume, order or message levels – or be based on other characteristics. Further, we are seeking comment on whether all firms trading through direct electronic access should be required to register, even if they are not using algorithmic trading.
We believe that many of the requirements we are proposing for trading firms represent the best practices already followed by many larger firms. However, we know that a faulty algorithm at a single firm, regardless of size, can potentially cause a significant problem. As a result, we have proposed standards that are applicable regardless of the size or similar attributes of a trading firm. We also are cognizant of the importance of establishing effective standards without creating barriers to entry for small firms. So we welcome comment on whether these requirements should vary in any way depending on the size or activity level of the trading firm.
We have also proposed certain risk controls for clearing member futures commission merchants (FCMs) with respect to their customers engaged in algorithmic trading. FCMs play a critical role in overall risk management. As I noted earlier, they have implemented measures already to require order limits and screening of orders. We believe the requirements we are proposing today help achieve an effective multi-layered approach.
We have asked for public comment on whether there are any aspects of the required controls that may pose an undue burden on clearing member FCMs or that are unnecessary for reducing the risks associated with algorithmic trading. We’ve also asked about what technological development would be required by clearing members to comply with some requirements of this proposal.
I’ve said frequently that it’s very important that we have a robust clearing member industry and that all customers—particularly smaller ones—are able to access the markets effectively and efficiently. We want to make sure this proposal is consistent with achieving that objective.
We have also included measures on some additional topics not covered in the Concept Release. These include provisions to increase transparency for exchanges’ electronic trade matching platforms, as well as for market maker and trading incentive programs, which have become more significant as automated trading has increased.
There are concerns that have been raised with respect to automated trading that also go beyond the scope of this proposal. These include whether our markets are best served by this speed, and what are its impacts on volatility and liquidity? These are important topics for market participants and the Commission to continue to study and discuss.
This proposal provides some common-sense risk controls that I believe embrace the benefits that automated trading has brought to our markets, while also protecting against the increased possibility of breakdowns and disruptions that come with it. We encourage – and welcome – public comment, which will carefully be taken into account before we take any final action.
Last Updated: November 24, 2015