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  • Address of CFTC Commissioner J. Christopher Giancarlo to the American Enterprise Institute

    “21st Century Markets Need 21st Century Regulation”

    September 21, 2016

    Introduction

    Good afternoon ladies and gentlemen. Thank you for your kind welcome.

    Before I begin, let me say that my remarks reflect my own views and are not necessarily the views of the Commodity Futures Trading Commission (CFTC), my fellow CFTC commissioners or the CFTC staff.

    My thanks to Peter Wallison for that warm introduction and for hosting today’s program. I am indebted to Peter for his incomparable scholarship, especially on the causes of the 2008 financial crisis.

    And let me say what an honor it is to speak at the American Enterprise Institute (AEI), truly one of the great pillars of American free enterprise and achievement. Like so many, my professional and intellectual life over the past three and a half decades has been enormously influenced by the work of AEI, especially distinguished AEI scholar, Michael Novak, and the tenets of his influential “Spirit of Democratic Capitalism”1 and Arthur Brooks and his superb “Road to Freedom.”2

    Today, I want to talk about the ongoing transformation of the world’s trading markets from analog to digital, from human to algorithmic trading and from stand-alone centers to seamless trading webs. I will describe how market regulation by the CFTC, particularly, and other agencies, generally, has not kept pace with this transformation and why that curtails its effectiveness in overseeing the safety and soundness of contemporary markets. I will outline a forward-looking agenda for the CFTC and other market regulators that supports America’s vital national interest in maintaining the world’s deepest, most durable and most vibrant capital and risk transfer markets in the algorithmic, digital world of the 21st century.

    21st Century Digital Transformation

    A few months ago, I had the pleasure of visiting Ellis County, Texas about an hour south of Dallas. In the tiny railroad depot town of Bardwell (population 649), I met with Bob Beakley, a grower of corn, cotton, sunflowers and winter wheat. As we drove in his truck along a back road, we passed by a freshly cut wheat field. Mr. Beakley said that he and his son cut the field the night before.

    He then pulled over, took out his iPhone and said, “You want to see something cool?” Mr. Beakley swiped it a few times and then showed me a video taken in the dark of night of a combine with its cab lights on cutting the wheat and loading it into a grain cart being pulled side by side with a tractor. Mr. Beakley explained that his drone camera took the video from the air, GPS satellite drove the combine and wireless vehicle telemetry guided the tractor and cart.

    Think about this for a minute: A farmer harvesting a crop in the middle of the night. Farming, an occupation almost as old as mankind, has always been a daylight endeavor – until now, thanks to digital technology. Like so much of our world today – from information to music to manufacturing to transportation to commerce3 – farming is undergoing a digital transformation.4

    The Digitization of Financial Markets

    It should be no surprise then that our capital, commodity and futures markets are going through the same digital transformation. The electronification of markets over the past 30 to 40 years and the advent of exponential digital technologies have altered trading, markets and the entire financial landscape with far ranging implications for capital formation and risk transfer.

    Automated trading now constitutes up to 70 percent of regulated futures markets.5 Similarly, automated trading now makes up approximately 80 percent of cash equities markets and 70 percent of foreign exchange spot markets.6 It will continue to dominate trading with new and innovative developments far into the future. Automated trading can enhance trading liquidity, increase market access and lower transaction costs while increasing trader productivity through greater transaction speed, precision and sophistication.7 At the same time, automated trading presents a host of new challenges, including increased spikes in market volatility from sheer speed of execution,8 flawed algorithms9 and position crowding10 and the risk of data misinterpretation by computerized analysis and mathematical models that increasingly replace human thought and deliberation.11

    Other breaking digital innovations present equal regulatory challenges. They include “big data” capability to enable more sophisticated data analysis and interpretation,12 artificial intelligence to guide highly dynamic trade execution,13 “smart” contracts that value themselves and calculate payments in real-time,14 and distributed ledger technology, more commonly known as blockchain15 that will challenge orthodoxies that are foundational to today’s financial market infrastructure.16

    The world is changing. Our parents’ financial markets are gone. The 21st century digital transformation is well underway. The genie won’t go back in the bottle. If the American economy is to remain the world’s premier, then American market regulation must keep pace with the rapid evolution of digital technologies.

    CFTC Caught in Analog Time Warp

    Yet, despite these 21st century innovations, the CFTC remains stuck in a 20th century time warp. The CFTC’s practices and culture are indifferent to today’s financial technology revolution. The CFTC’s swaps rules stifle technological innovation. The CFTC’s futures rules are still geared towards regulating fast-disappearing analog markets. The CFTC’s response to the digital transformation of markets is decidedly 20th century. The CFTC remains an analog regulator of an increasingly digital marketplace. In that, it is not alone among other U.S. market regulators. I will illustrate these concerns.

    Inhospitality to Financial Technology Innovation

    I start with the obvious observation that capital and risk transfer markets in global financial centers like New York, London and Hong Kong are in daily competition with each other to attract the world’s investment and trading. Global capital readily flees inhospitable trading environments for more salutary ones. Capital seeks access to cash and derivatives marketplaces that are the most vibrant and durable with deep and immediate trading liquidity that accommodate modern methods of doing business.17

    It should be no surprise then that there is a global contest underway among world financial centers to attract a new generation of financial technology (FinTech) businesses and the jobs and investment they bring. It is a contest in which the U.S. is falling behind. In fact, the British FinTech sector employs more people than that of New York.18 One key reason is the relative simplicity, transparency and innovation-friendly approach of British regulators.19 The warm welcome is being emulated by financial market regulators in Singapore, Japan, Australia20 and, most recently, Hong Kong.21 These regulators say to FinTech firms, “Your innovation looks helpful to markets and market participants. Let’s see how our rules can be adapted to support what you do and still achieve public policy goals.”

    In contrast, U.S. regulatory frameworks, including those managed by the CFTC, are widely seen as complex, conservative and, in some respects, opaque with limited regulatory initiatives directed towards FinTech.22 Unfortunately, U.S. regulators seem to say to innovators, “No, our rules do not let you do that. You must change your business model. Otherwise, we will refer you to our enforcement division.”

    SEF Rules Stifle Innovation

    The CFTC’s resistance to innovation is also evident in its implementation of important Dodd-Frank reforms on swaps trading. In 2013, the CFTC adopted final rules for the registration and operation of swap execution facilities (SEFs).23 Unfortunately, the rules were poorly designed and overly engineered, disproportionately modeled on the U.S. futures markets and biased against both human discretion and technological innovation.24 They limit the manner of execution of a broad segment of swaps products to last century’s trading methodologies.25 They are closed to the unfolding science of platform market economics and digital auction technology.26 As such, the SEF rules do not accord with the letter or spirit of the Dodd-Frank Act.27 They remain fundamentally mismatched to the evolving liquidity and trading dynamics of the four hundred trillion dollar global swaps market.

    Futures Rules Designed for Analog Markets

    It is not just CFTC swaps rules that are rigidly focused on the past. Most of the CFTC’s rulebook for listed futures was written for 20th century analog markets, in which trading pits in Minneapolis, New York and Chicago conducted open outcry trading with colorful shouting and distinctive hand signals. Today, those trading pits are dormant, largely supplanted with electronic trade execution by remote software algorithms and, increasingly, artificial intelligence. Yet, CFTC oversight is still founded on recognition of such occupations as “floor traders” and “floor brokers.” Despite an emerging world of automated, non-human decision-making, CFTC market supervision and enforcement still turns on human states of mind underlying the traditional legal concepts of foreseeability, mens rea and failure to supervise.

    Proposed Regulation Automated Trading

    In November 2015, the CFTC put out for comment Regulation Automated Trading, known as “Reg. AT.”28 The proposal is a first attempt by the agency to catch up to the digital revolution in U.S. futures markets. As I said at the time of adopting the notice of proposed rulemaking, Reg. AT seeks to draw on industry best practices,29 provides some flexibility in setting risk control parameters and does not require the pre-approval or pre-testing of algorithms.30 That is positive. Less positive is the proposed regulation’s broad scope, hazy objectives and several significant inconsistencies, especially in activity covered by the rule.31

    Most disappointing is that Reg. AT is, at heart, a 20th century analog response to the 21st century digital revolution in trading markets. Its broad design is to compel a broader swath of market participants to register with the CFTC, subjecting them to additional rules, reporting requirements and costs.

    Reg. AT is regulatory empire building. It is also a classic Washington maneuver: force as many businesses as possible into the regulatory framework so there is someone to investigate if something goes wrong.

    Yet, registration, by itself, is not public policy and policy making is not necessarily furthered by registering thousands of new market participants. The relatively blunt act of registering automated traders does not begin to address the complex public policy considerations that arise from the digital revolution in modern markets.

    For example:

    • What do traditional legal concepts like reasonableness, foreseeability, mens rea, scienter and failure to supervise mean in transactions that are not initiated by immediate human action, but by pre-set programming and even artificial intelligence?
    • How do we adapt regulatory frameworks and surveillance practices designed to catch “bad-guys” to detect bad “algos”?
    • What regulatory penalty, if any, should market participants, service providers and market operators have for inadvertently faulty algorithms and what public policy is served by any such imposition?
    • What rules are appropriate to recondition 20th century trading markets and their essential institutions so as to benefit from 21st century automated trading, while maximizing marketplace safety, soundness, efficiency and resiliency?

    These are the types of critically important questions raised by automated trading and the digitization of financial markets. Unfortunately, Reg. AT does not even begin to answer them.

    Worse, Reg. AT contains the notorious requirement that proprietary source code used in trading algorithms be accessible at any time to the CFTC and the U.S. Justice Department without a subpoena.32 As I anticipated, this requirement has garnered an enormous amount of attention from market participants33 concerned with the prospect of handing over highly valuable, proprietary business source code to an agency of the U.S. government that has an imperfect record as a guardian of confidential information.34 If the CFTC adopts this provision, I expect the Securities and Exchange Commission (SEC) may mimic it.35 Other regulators may then do the same. The potential of losing a trading firm’s most sensitive intellectual property in a hack of a government agency will have a chilling effect on automated trading and FinTech innovation in the United States.36 Such a requirement is yet another element of seeming U.S. regulatory inhospitality to financial technology and innovation.37

    Implications of Technological Change

    This past July I went to Michigan to talk to agricultural producers.38 In the tiny town of Henderson, Michigan, I met with 20 local area farmers and farm service providers. Many of them said they were concerned about the impact of electronic trading in futures markets. Some said they were reluctant to enter into futures contracts for fear of being “run over” by the enormous speed and trading volatility incurred by proprietary algorithmic traders.39

    I found the discussion challenging. I did not have adequate answers to their questions. 40 I knew that the CFTC does not have a thorough understanding of the effect on markets by automated trading and the broader dimensions of technology and digitization.

    I believe the reasons for this challenge include a lack of quantitative data and data analytical capability in both swaps and futures and the current regulatory focus on market participant misconduct over concerns for the overall durability, vibrancy and liquidity of American markets.

    A great amount of hard work and effort has gone into gathering swaps market data, including establishing swap data repositories (SDRs) under the Dodd-Frank Act.41 Yet, eight years after the financial crisis regulators still do not have sufficient quality data42 from which to piece together a comprehensive picture of swaps counterparty dynamics and exposures in global markets.43

    For futures markets, the CFTC has high quality transaction and counterparty data, but limited access to order book (message) data necessary to more thoroughly analyze the impact of algorithmic trading on markets. In my observation, the CFTC devotes insufficient human capital, technological capability and data analysis automation to thoroughly understand changing futures market dynamics.

    I believe that, with the resources it has, the agency should devote more attention to troubling systemic conditions like diminishment of liquidity, volatility spikes, participant concentration and market fragmentation.44 The CFTC needs to do a better job addressing the concerns I heard from Michigan farmers about changing market dynamics caused by the prevalence of high volume algorithmic trading.

    Yet, it is not for regulators to guarantee the quality of every participant’s trading experience in the marketplace. The emerging field of trading platform economics holds that marketplace operators have a competitive incentive to operate well-functioning marketplaces that participants want to patronize.45 It is the job of designated contract markets and SEFs, not that of regulators, to conduct platform engineering and marketplace management.46 It is the role of regulators, instead, to make sure that marketplace operators do their job to police market behavior and are ready to take action when they do not.

    Catching Up to the 21st Century

    Now that I have discussed the transformation of financial markets from analog to digital and the lack of commensurate regulatory response, I will now outline a forward-looking agenda for U.S. market regulators to follow in order to catch up to the 21st century digital markets. I believe the CFTC and other U.S. market regulators must follow five steps to regulate digital markets effectively:

      1. Embrace Innovation

      2. Stand Up for Intellectual Property

      3. Repurpose Rules for Digital Age

      4. Unburden the U.S. Economy

      5. Champion American Markets

    1. Embrace Innovation

    Let me start with regulators’ approach to technological change. I believe that the CFTC and its fellow U.S. market regulators must affirmatively embrace innovation. That means that its rules must “first, do no harm” to blockchain and other promising FinTech innovations using the same forward-thinking approach American regulators took two decades ago in the early days of the Internet.47 Embracing innovation also means regulators must take positive steps to promote American innovation, such as hiring innovation-savvy regulatory staff who speak the language of FinTech. It also means regulators must give FinTech firms “breathing room” to develop, collaborate with them in commercial FinTech experiments, listen and learn about the rules that need to be adapted to allow for technical advances and collaborate with other regulators both here and abroad.48

    The benefit of this approach for American innovation and financial markets is rather obvious. What may be less obvious is the benefit to market regulators. I have previously spoken about the great promise that distributed ledger or “blockchain” technology holds for regulators in meeting their mission to view and analyze accurate trading data, oversee healthy markets and mitigate financial and operational risk. It is imperative that we open wider our agency doors and regulatory minds to benefit from FinTech innovation.

    Regulators must engage in a constant and evolving dialogue with innovators precisely because we need to understand the impact they are having on the very marketplaces we are charged to supervise.49 We must partner with them, experiment with them, learn from them and innovate alongside them, if we are ever to keep pace with the digitization of modern markets and protect their 21st century participants.

    2. Stand Up for Intellectual Property

    If the U.S. and its financial markets are to remain the world’s most attractive for technological innovation and modern capital investment, then property rights, including rights in intellectual property, must be well protected under law. Since America’s founding, those rights include the necessity for the government and its regulatory agencies to obtain a subpoena before taking private property. Nothing has changed to haphazardly set aside long-established, due process protections afforded by agency subpoena practice.50 The CFTC must continue to obtain a subpoena to access the source code of market participants. Doing otherwise damages the integrity of the Commission and antagonizes its traditional relationship with market participants.

    Yet, we must do more than just reaffirm the subpoena process in obtaining source code. Regulators must ensure that whenever market participants provide data or intellectual property to regulators pursuant to a subpoena or otherwise, it is protected from theft, breaches and misappropriation.51

    Cyber risk is undoubtedly the number one threat to 21st century financial markets.52 It is also a threat against which the federal government53 has been a poor guardian of private confidential information.54 This must improve.55 Regulators’ system security must be no less robust and effective than is expected of the businesses under their jurisdiction. If market regulators are to be effective in overseeing digital markets, then they must not themselves be a weak link in the financial system’s resilience to cyber-attack. If we are to attract digital innovators to American shores, we must regulate in a way that intellectual property is less – not more – vulnerable than in competing jurisdictions.56

    3. Repurpose Rules for Digital Age

    If regulators are going to be effective overseers of 21st century markets, we must repurpose our rules so that they can keep pace with the digital transformation. It starts with recognizing that most of our legislative authority was written for last century’s human markets. We must reconsider and repurpose our analog rules for today’s digital markets.57 At the CFTC, this can only be done with a return to its traditional approach of principles-based regulation.58

    Repurposing rules for the digital age also means moving beyond tired, old command and control government solutions and working more cooperatively with marketplace intermediaries and self-regulatory organizations. It means eschewing regulatory empire building. Requiring ever more firms to obtain government licenses before doing business does nothing by itself to help regulators to keep pace with the digital transformation of our markets.

    Moreover, the CFTC must allow market participants, including SEFs to conduct business as they believe is best suited to meet their customer needs and not as regulators arbitrarily see fit.59 Regulators can best enhance the durability, resilience and vibrancy of our financial markets by encouraging increasing diversity of business models and market structures.60 That includes active participation by both large and small enterprises, including, where permitted, individual investors and end-users. Ultimately, the success of U.S. derivatives markets will be measured not just by how successfully modern algorithmic “prop shops” can trade without disrupting the markets, but how end-users like the farmers I met in Michigan can safely and successfully hedge their costs of production. At the CFTC, we must make it our mission to address their concerns so they may be confident in the continued suitability of U.S. futures markets for their needs in the digital 21st century.

    4. Unburden the U.S. Economy

    As you know, Americans are living through the worst U.S. economic recovery since the great depression. The average rate of economic growth since the financial crisis has been 2.1 percent.61 That compares to an average growth rate of 3.9 percent for economic recoveries since the 1960s.62

    As a former business executive, I know that unbalanced regulation is a major contributor to America’s economic doldrums. Regulation now costs the U.S. 11 percent of GDP or almost $2 trillion annually.63 It amounts to nearly $15,000 per U.S. household per year, falling particularly hard on small employers.64 Overregulation is a barrier to capital investment that would otherwise stimulate job creation and wage growth.65

    I believe that this “new mediocre”66 economy is just not good enough for America. I believe that we regulators have to do our part to unchain investors, innovators and job creators to spark America back to strong and sustainable growth and job participation. To do so, we must carefully consider our rules to determine whether they advance or restrain economic progress. Such review requires the capabilities of qualified market economists, rather than clever legal wordsmiths. At the CFTC, we must return the Office of the Chief Economist (OCE) to historic levels of capacity and econometric productivity67 if we are to ensure our rules do not restrain American economic growth in the new digital 21st century.

    Moreover, healthy financial and risk transfer markets are essential to long-term economic growth.68 To enable broad-based prosperity, we must foster vibrant and competitive markets that support free enterprise, personal choice, voluntary exchange and legal protection of property. We must ensure that U.S. markets continue to play their essential role in marshaling resources and deploying them in productive ways: linking savers and investors, risk takers and risk transferors and shifting capital to those who can best utilize it and production risk to those who can best bear it.69 We must harness our rapidly evolving digital markets to be engines for economic freedom and opportunity70 – the ingredients that have always been, and always will be, essential for American prosperity.

    5. Champion American Markets

    If America is to protect its vital national interest in robust financial markets, then market regulators must begin to oversee markets in a holistic fashion. We must take greater account of troubling systemic conditions like diminishment of liquidity, volatility spikes, participant concentration and market fragmentation. We must imbue our regulatory agencies with an institutional culture that is concerned for the overall durability, vibrancy and healthy functioning of American markets and not just with enforcing rules against market manipulation.

    Championing American markets also means being their fierce advocates in broader policy making considerations with other U.S. and overseas regulators, including central banks and prudential regulators. I have been an outspoken critic of the Financial Stability Oversight Council (FSOC) set up under the Dodd-Frank Act for its failure to coordinate Dodd-Frank’s hundreds of new rules and regulations.71 I have faulted FSOC for doing little analysis of the impact of new bank capital rules and leverage ratios on trading liquidity and systemic risk.72 I believe that market regulators should use their participation on FSOC to require it to produce a thorough and unbiased analysis of the full effect of capital constraining bank regulations on America’s capital and risk-transfer markets.

    Championing American markets also means not putting them at a competitive disadvantage to overseas markets. Just a few weeks ago, I warned of a liquidity crunch that could occur if the CFTC and U.S. bank regulators barreled ahead with the September 1st implementation of new margin rules despite the delay of the same rules by 21 out of 24 overseas regulators.73 I said imposing the rules would put U.S. industrial and other companies needing to hedge risks at a competitive disadvantage to their overseas competitors.74 I said that American businesses would either face higher costs or choose not to hedge their risks, undermining the ostensible purpose of Dodd-Frank – reducing systemic risk.75

    Sure enough, one day after my warning, Asian swaps markets almost ground to a halt amidst chaos and confusion over the application of the new margin rules.76 I received reports of counterparties avoiding trading with U.S. persons. Many trades were rejected.

    This disruption was totally avoidable if the CFTC and its fellow U.S. regulators had been less concerned with sticking to an arbitrary deadline and more concerned with the impact of a self-induced market shock on the welfare of American business. Worse, it demonstrated an astonishing lack of concern by a principal U.S. markets regulator to the functioning of a critical, global financial market.

    Championing American markets means no longer asking U.S. market participants to go it alone and take it on the chin in implementation of global regulatory reform. Rather, it means standing up for America’s capital and risk transfer markets and treating them as the vital national interests that they are.77 It means taking a holistic approach to their health, vibrancy, safety and soundness in the algorithmic, digital world of the 21st century.

    Conclusion

    In drawing to a close, the question of how U.S. market regulators handle the digitization of modern markets is critically important. It requires delicate balancing. To ensure vibrant, accessible and durable markets, regulators must cultivate and embrace new technologies without harming innovation. There certainly must be effective safeguards of market integrity and credibility with strong rule enforcement, but those safeguards should not bar promising innovation and continuous market development.

    Good regulation should not inhibit technological innovation. Rather, innovation should foster better and smarter regulation.

    The world is changing. Our parents’ financial markets are gone. Tired, old command and control government solutions are bumping up against the new flexible, digital economy. 21st Century Markets require 21st Century Regulation.

    It is time for government agencies like the CFTC to embrace innovation, champion intellectual property, repurpose its rules, unchain the U.S. economy and stand up for American markets.

    I believe that regulators have a responsibility to ensure that today’s digital markets continue to serve our domestic end-users, whether Michigan farmers, North Dakota oilmen or Illinois manufacturers. We must better address the concerns of America’s energy and agricultural producers, not only in Henderson, Michigan, but throughout the country, so that they may be confident in the continued suitability of U.S. futures markets for the effective hedging of their production risks.

    And beyond that, regulators must harness these new technologies in support of healthy U.S. capital and risk transfer markets. We must enhance our markets’ competitiveness in attracting the world’s capital. We must further enable investors, innovators and job creators to drive the U.S. economy back to strong growth and prosperity. We must ensure our markets remain the world’s deepest, most durable and most vibrant risk transfer markets in the algorithmic, digital world of the 21st century.

    This is our challenge. It is in America’s vital national interest that we succeed.

    Thank you.

    1 Michael Novak, The Spirit of Democratic Capitalism (Simon & Schuster 1982).

    2 Arthur C. Brooks, The Road to Freedom: How to Win the Fight for Free Enterprise (Basic Books 2012).

    3 See generally Erik Brynjolfsson and Andrew McAfee, The Second Machine Age: Work, Progress, and Prosperity in a Time of Brilliant Technologies (W.W. Norton & Company 2014).

    4 See generally Martin Ford, Rise of the Robots: Technology and the Threat of a Jobless Future, 23-27 (Basic Books 2015).

    5 A recent internal report by the CFTC's Chief Economist looked at over 1.5 billion transactions across over 800 products on the Chicago Mercantile Exchange over a two-year period. It found that the percentage of automated trading in financial futures – such as those based on interest rates, currencies or equity indices – was 60 to 80 percent. But even among many physical commodities, there was a high degree of automated trading, such as 40 to 50 percent for many energy and metals products.

    6 McKinsey & Company and Greenwich Associates reprinted in Bank for International Settlements, Markets Committee, Electronic Trading in Fixed Income Markets, Jan. 2016, http://www.bis.org/publ/mktc07.pdf.

    7 See Futures Industry Association, Comment Letter on Concept Release on Risk Controls and System Safeguards for Automated Trading Environments, at 2, Dec. 11, 2013, http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=59445&SearchText=Futures%20Industry%20Association; see also CME Group, Comment Letter on Concept Release on Risk Controls and System Safeguards for Automated Trading Environments, at 2-3, Dec. 11, 2013, http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=59445&SearchText=Futures%20Industry%20Association; Guest Lecture of Commissioner J. Christopher Giancarlo, Harvard Law School, Fidelity Guest Lecture Series on International Finance, Dec. 1, 2015, http://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo-11.

    8 Tom C.W. Lin, The New Investor, 60 UCLA L. Rev. 678, 692, 703 (2013) (explaining that “[d]uring periods of high uncertainty . . . high-frequency trading can exacerbate volatility and hurt liquidity by removing significant trading positions from the markets at warp speeds” and that “[t]he enhanced speed and interconnectedness of cyborg finance makes it more endogenously vulnerable to volatile crashes . . . .”); Katy Burne, The New Bond Market: Algorithms Trump Humans, Wall St. J., Sept. 24, 2015, http://www.wsj.com/articles/the-new-bond-market-algorithms-trump-humans-1443051304.

    9 Yesha Yadav, How Algorithmic Trading Undermines Efficiency in Capital Markets, 68 Vand. L. Rev. 101, 138–46 (2015) (forthcoming).

    10 Lin, supra note 8, at 716.

    11 Id. at 712; Yadav, supra note 9, at 107–08.

    12 Trevir Nath, How Big Data Has Changed Finance, Investopedia, Apr. 9, 2015, http://www.investopedia.com/articles/active-trading/040915/how-big-data-has-changed-finance.asp.

    13 Tom Upchurch, Technology: AI and the Spectre of Automation, Euromoney, Aug. 2016, http://www.euromoney.com/Article/3575461/Technology-AI-and-the-spectre-of-automation.html.

    14 Nigel Farmer, Making Contracts Smarter, TabbForum, May 3, 2016, http://tabbforum.com/opinions/making-contracts-smarter?print_preview=true&single=true&ticket=ST-14742885819637-OxE2RQ6CSK3LXd6HsvaWwJ8v3ewjlyh208guDvuC; Jay Cassano, What Are Smart Contracts? Cryptocurrency’s Killer App, Fast Company, Sept. 17, 2014, https://www.fastcompany.com/3035723/app-economy/smart-contracts-could-be-cryptocurrencys-killer-app.

    15 Keynote Address of Commissioner J. Christopher Giancarlo before the Markit Group, 2016 Annual Customer Conference, May 10, 2016, http://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo-15.

    16 Oscar Williams-Grut, WEF: Blockchain Will Become the ‘Beating Heart’ of Finance, Business Insider, Aug. 12, 2016, http://www.businessinsider.com/world-economic-forum-potential-of-blockchain-in-financial-services-2016-8; see generally, William Mougayar, The Business Blockchain: Promise, Practice, and Application of the Next Internet Technology (Wiley 2016).

    17 Christopher Giancarlo, Vibrant, Highly Liquid Markets Are the Path to Prosperity, RealClearMarkets, May 4, 2016, http://www.realclearmarkets.com/articles/2016/05/04/vibrant_highly_liquid_markets_are_the_path_to_prosperity_102151.html; see also Mervyn King, The End of Alchemy: Money, Banking, and the Future of the Global Economy, 140-141 (W. W. Norton & Company, 2016) (explaining the importance of functioning finance and derivatives markets for economic development).

    18 Ernst & Young, UK FinTech: On the Cutting Edge, at 7, 2016 (Commissioned by H.M. Treasury), http://www.ey.com/Publication/vwLUAssets/EY-UK-FinTech-On-the-cutting-edge-Executive-summary/$FILE/EY-UK-FinTech-On-the-cutting-edge-exec-summary.pdf.

    19 Id. at 11.

    20 Press Release, MAS Proposes a “Regulatory Sandbox” for FinTech Experiments, Monetary Authority of Singapore, Jun. 6, 2016, http://www.mas.gov.sg/News-and-Publications/Media-Releases/2016/MAS-Proposes-a-Regulatory-Sandbox-for-FinTech-Experiments.aspx; Press Release, Establishment of “Panel of Experts on FinTech Start-ups,” Japan Financial Services Agency, Apr. 27, 2016, http://www.fsa.go.jp/en/news/2016/20160427-1.html; Press Release, ASIC Consults on a Regulatory Sandbox Licensing Exemption, Australian Securities & Investment Commission, Jun. 8, 2016, http://asic.gov.au/about-asic/media-centre/find-a-media-release/2016-releases/16-185mr-asic-consults-on-a-regulatory-sandbox-licensing-exemption/.

    21 Tsering Namgyal, Hong Kong Looks to Lure US Fintech Start-Ups, MLex, Sept. 2, 2016.

    22 Ernst & Young, supra note 18, at 51.

    23 Core Principles and Other Requirements for Swap Execution Facilities, 78 Fed. Reg. 33476 (Jun. 4, 2013).

    24 See generally J. Christopher Giancarlo, Pro-Reform Reconsideration of the CFTC Swaps Trading Rules: Return to Dodd-Frank, White Paper, Jan. 29, 2015, http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/sefwhitepaper012915.pdf.

    25 Id. at 21-27.

    26 Id. at 55-56. Auction technology lies at the heart of today’s “gig economy” in everything from online retail shopping to hailing a taxi by smart phone to borrowing money and funding start-up businesses. See generally Ray Fishman and Tim Sullivan, The Inner Lives of Markets: How People Shape Them – and They Shape Us (Public Affairs 2016).

    27 CEA section 1a(50); 7 U.S.C. 1a(50). Allowing flexible methods of execution as Dodd-Frank authorized would open U.S. swaps markets to promising technological advances and further Congress’s goal of promoting the trading of swaps on SEFs with pre-trade price transparency.

    28 Regulation Automated Trading, 80 Fed. Reg. 78824 (Dec. 17, 2015).

    29 It appears that in some cases Reg. AT over assumes the state of industry best practices that may be still aspirational but not yet technically practicable.

    30 80 Fed. Reg. at 78945-948.

    31 Id. It is unclear, but it appears that Reg. AT is trying to address only high volume, automated trading through direct electronic access. If so, then it seems inconsistent to apply its requirements to entities such as Commodity Pool Operators that are otherwise registered with the CFTC, but that may not utilize direct market access.

    32 80 Fed. Reg. at 78947. There is no apparent legal foundation on which to haphazardly set aside long-established, due process protections afforded by agency subpoena practice. It erodes the Constitutional relationship between American citizens and the federal government, the authority of which is both limited and specifically enumerated in law. It is for the people’s representatives in Congress, and not unelected agency officials, to decide whether valuable private property may be taken without specific authority arising from a legal proceeding.

    33 See e.g., Managed Funds Association Comment Letter, at 23-26, Mar. 16, 2016, http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=60742&SearchText=; Futures Industry Association Comment Letter, at 8-9, Mar. 16, 2016, http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=60744&SearchText=; CME Group Comment Letter, at 37-38, Mar. 16, 2016, http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=60765&SearchText=; Bart Chilton, New CFTC Trading Rule is ‘Extreme Overkill,’ CNBC, Jun. 21, 2016, http://www.cnbc.com/2016/06/21/new-trading-rule-is-extreme-overkill-bart-chilton-commentary.html; Transcript, Examining the CFTC’s Proposed Rule: Regulation Automated Trading, House of Representatives, Committee on Agriculture, Jul. 13, 2016, http://agriculture.house.gov/uploadedfiles/114-56_-_20912.pdf.

    34 Chilton, supra note 33.

    35 Congressman Sean P. Duffy Letter to SEC Chair Mary Jo White, Aug. 10, 2016, http://modernmarketsinitiative.org/wp-content/uploads/2016/08/16.08.10-Automated-Trading-Letter-to-SEC.pdf.

    36 In the six months after Reg. AT was proposed, hackers breached the computer networks of the Federal Deposit Insurance Corporation and the Federal Reserve. Incredibly, the U.S. Office of Personnel Management that gave up 21.5 million personnel records in a year-long cyber penetration was still unable pass a security audit last November – six months after the breach was discovered. In fact, federal, state and local government agencies rank last in cyber security when compared against 17 major private industries, including transportation, retail and healthcare. See Opening Statement of Commissioner J. Christopher Giancarlo before the CFTC Staff Roundtable on Regulation Automated Trading, Jun. 10, 2016, http://www.cftc.gov/PressRoom/SpeechesTestimony/giancarlostatement061016.

    37 Letter from 8 members of Congress to CFTC Chairman Timothy Massad, Jun. 10, 2016, http://duffy.house.gov/sites/duffy.house.gov/files/wysiwyg_uploaded/CFTC_Letter.pdf (noting that China suspended a policy that would have required companies that sell computer equipment to Chinese banks to turn over source code after pressure from the U.S. government and industry).

    38 In the twenty-seven months I have served on the Commission, I have traveled to Indiana, Illinois, Iowa, Louisiana, Texas, Kentucky, North Dakota, South Dakota, New Jersey, Minnesota and Michigan to meet with users of derivatives contracts.

    39 Patrick Temple-West, CFTC’s Giancarlo Finds Heartland Heartburn Over Computer Trading, POLITICO Pro, Jul. 27, 2016, https://www.politicopro.com/financial-services/story/2016/07/cftcs-giancarlo-finds-heartland-heartburn-over-high-frequency-traders-125113.

    40 Id. (quoting Giancarlo, "We're studying very carefully the impact of algorithmic trading on the markets…. What's written into that code and how does that drive a market? How do we make our markets remain suitable for you to conduct your activities in a way that's fair and safe?”).

    41 At the heart of the 2008 financial crisis was the inability of regulators to assess and quantify the counterparty credit risk of large banks and swap dealers. See Financial Crisis Inquiry Commission, Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States 298–300, 329, 363, 386 (2011), http://fcic-static.law.stanford.edu/cdn_media/fcic-reports/fcic_final_report_full.pdf. The legislative solution was to establish SDRs under the Dodd-Frank Act. See also Peter Wallison, Hidden in Plain Sight: What Really Caused the World’s Worst Financial Crisis and Why It Could Happen Again, Ch. 10 (Encounter Books, 2015) (explaining how the financial crisis was magnified by the lack of transparency of the presence of nontraditional mortgages in securitized debt obligations held by large bank dealers). This dangerous opacity was not addressed by the Dodd-Frank Act.

    42 Among the reasons for the current lack of analyzable market data are the failure of domestic and international harmonization of global reporting protocols and data fields across jurisdictions, inconsistent sharing of data across jurisdictions, lack of universal regulatory recognition of national and regional trade repositories, incomplete establishment of global universal trade identifiers (UTIs) and universal product identifiers (UPIs), failure of global agreement on a specific set of data needed for systemic risk identification and analysis, lack of universal methodology for worldwide data aggregation, and unsatisfactory validation of data integrity.

    43 Of all the many mandates to emerge from the financial crisis, visibility into counterparty credit risk of major financial institutions was perhaps the most pressing. The failure to accomplish it is certainly the most disappointing, especially as emerging technologies, such as blockchain, are so promising.

    44 I have identified diminishment of trading liquidity and volatility spikes, participant concentration and market fragmentation (along with cyber threats, digital transformation and central bank market intervention) as the six “mega trends” facing capital and risk transfer markets in the early 21st century. Giancarlo, Harvard Guest Lecture, supra note 7.

    45 Id., Fishman and Sullivan, supra note 26, at 105-126.

    46 Fishman and Sullivan, supra note 26, at 124.

    47 Keynote Address of CFTC Commissioner J. Christopher Giancarlo Before the Cato Institute, Cryptocurrency: The Policy Challenges of a Decentralized Revolution, Apr. 12, 2016, http://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo-14.

    48 I recently proposed several practical steps for market regulators to encourage financial technology innovation. See Giancarlo, Markit Keynote Address, supra note 15.

    49 As part of this effort, the CFTC should revitalize its Technology Advisory Committee to support the agency with practical technology expertise and advice.

    50 Giancarlo Reg. AT Roundtable, supra note 36.

    51 See generally CFTC Office of Inspector General, Review of the Commodity Futures Trading Commission’s Response to Allegations Pertaining to the Office of Chief Economist, Feb. 21, 2014, http://www.cftc.gov/idc/groups/public/@aboutcftc/documents/file/cftc_046841.pdf; Joe Davidson, FDIC Reports Five ‘Major Incidents’ of Cybersecurity Breaches Since Fall, Washington Post, May 9, 2016, https://www.washingtonpost.com/news/powerpost/wp/2016/05/09/fdic-reports-five-major-incidents-of-cybersecurity-breaches-since-fall/.

    52 Giancarlo, Harvard Guest Lecture, supra note 7. The Dodd-Frank Act provides no guidance whatsoever about cyber risk to the systemic safety of U.S. financial markets and the U.S. economy.

    53 Giancarlo Reg. AT Roundtable, supra note 36.

    54 Report, The OPM Data Breach: How the Government Jeopardized Our National Security for More than a Generation, U.S. House of Representatives, Committee on Oversight and Government Reform, Sept. 7, 2016, https://oversight.house.gov/wp-content/uploads/2016/09/The-OPM-Data-Breach-How-the-Government-Jeopardized-Our-National-Security-for-More-than-a-Generation.pdf; Davidson, supra note 51.

    55 President Obama has proposed a new “Cybersecurity National Action Plan” that would address some of these concerns. President Barack Obama, Protecting U.S. Innovation From Cyberthreats, Wall Street Journal, Feb. 9, 2016, http://www.wsj.com/articles/protecting-u-s-innovation-from-cyberthreats-1455012003.

    56 I have called on the CFTC to designate a qualified cyber security information coordinator to work with our registered companies to help them navigate the maze of federal defense and law enforcement agencies to ensure they have ready access to the most up-to-date cyber security information available. Keynote Address of CFTC Commissioner J. Christopher Giancarlo before the 2015 ISDA Annual Asia Pacific Conference, Top Down Financial Market Regulation: Disease Mislabeled as Cure (Oct. 26, 2015), http://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo-10.

    57 For the CFTC, it means, among other things, reconsidering traditional floor broker and floor trader definitions, standards of conduct for digital trading and the role of self-regulatory organizations and designated contract markets in enforcing best practices.

    58 A principles-based approach would allow market regulators to establish the underlying standard and desired outcome of a rule written in a time of analog trading and then put forward guidelines about how to achieve an appropriate outcome in modern digital markets.

    59 U.S. SEFs must be permitted to operate their business models to best meet customer needs through any means of interstate commerce as Congress instructed and competing overseas regulators currently allow. Giancarlo, White Paper, supra note 24, at 21-27, 55-56.

    60 See generally Nassim Nicholas Taleb, Antifragile: Things That Gain From Disorder (Random House 2012) (warning that naïve over-intervention in complex systems such as financial markets make them more vulnerable, not less, to cascading runaway chains of reactions and ultimately fragile in the face of outsized crisis events. He argues that that financial markets that are, instead, allowed to grow organically through trial and error and gain and loss, with plenty of diversity, redundancy, cyclical stresses and disorders, best resemble biological organisms that adapt and, indeed, thrive, in the face of shock and partial destruction).

    61 Press Release, National Income and Product Accounts, Gross Domestic Product: Second Quarter 2016 (Second Estimate), Corporate Profits: Second Quarter 2016 (Preliminary Estimate), Bureau of Economic Analysis, Aug. 26, 2016, http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm; Trading Economics, United States GDP Growth Rate, http://www.tradingeconomics.com/united-states/gdp-growth (last visited Sept. 20, 2016); Terence P. Jeffrey, U.S. Has Record 10th Straight Year Without 3% Growth in GDP, CNSNews, Feb. 26, 2016, https://www.cnsnews.com/news/article/terence-p-jeffrey/us-has-record-10th-straight-year-without-3-growth-gdp; Phil Gramm and Michael Solon, Why This Recovery is So Lousy, Wall Street Journal, Aug. 3, 2016, http://www.wsj.com/articles/why-this-recovery-is-so-lousy-1470266675.

    62 Id.

    63 Clyde Wayne Crews Jr., Ten Thousand Commandments: An Annual Snapshot of the Federal Regulatory State, Competitive Enterprise Institute (2015), https://cei.org/sites/default/files/10%2C000%20Commandments%202015%20-%2005-12-2015.pdf; W. Mark Crain and Nicole V. Crain, The Cost of Federal Regulation to the U.S. Economy, Manufacturing and Small Business, National Association of Manufacturers, Sept. 10, 2014, http://www.nam.org/Data-and-Reports/Cost-of-Federal-Regulations/Federal-Regulation-Full-Study.pdf.

    64 Editorial, So Many Rules, So Few Opportunities, Wall Street Journal, May 6, 2016, http://www.wsj.com/articles/so-many-rules-so-few-opportunities-1462575067.

    65 “If it is not instituted wisely, with restraint and foresight, regulation becomes a drag on the economy, a tax on job creation, a barrier to innovation. It also boosts ‘compliance,’ America’s great new growth industry. Indeed, in these days of the gig economy, it is said that if you want lifetime employment, go into compliance.” Daniel Yergin, Markets Run Into Skepticism – and Regulators, Wall Street Journal, Jul. 19 2016, http://www.wsj.com/articles/markets-run-into-skepticismand-regulators-1468884200.

    66 Phrase used by the Managing Director of the International Monetary Fund, Christine Lagarde, in warning that the world economy was facing a prolonged period of low economic growth. Robin Harding, Lagarde Warns of ‘New Mediocre’ Era, Financial Times, Oct. 2, 2014, http://www.ft.com/cms/s/0/2bfa11d6-4a44-11e4-8de3-00144feab7de.html#axzz4KSN5Y26Z.

    67 OCE is understaffed today at 14 full-time economists. Despite a 71 percent increase in the CFTC’s operating budget since the financial crisis ($146 million in FY 2009 and now at $250 million), the number of economists has only increased by two over the average number of 12 economists at the agency since 2008. See CFTC Historical Reports, http://www.cftc.gov/About/CFTCReports/cftcreports_historical. The CFTC is understood to have had over 20 economists on staff in the early 1990s.

    68 See generally Yongeok Shin, Financial Markets: An Engine for Economic Growth, St. Louis Fed., Jul 2013, https://www.stlouisfed.org/publications/regional-economist/july-2013/financial-markets--an-engine-for-economic-growth; Stanley Fischer, The Importance of Financial Markets in Economic Growth, Aug. 21, 2003, http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.200.5347&rep=rep1&type=pdf.

    69 Giancarlo, White Paper, supra note 24, at 18.

    70 Markets for futures, swaps and other derivatives are especially important for economic growth by allowing enterprises to undertake or limit production, price and other risk thereby freeing up resource capacity for investment and expansion.

    71 Among other statutory duties. 12 U.S.C. § 5322; see also J. Christopher Giancarlo and Michael S. Piwowar, Banking Regulators Heighten Financial Market Risk, Reuters, Jul. 12, 2015, http://www.reuters.com/article/column-seccftc-idUSL1N0ZP29520150712.

    72 J. Christopher Giancarlo, American Prosperity Requires Capital Freedom, Cato Journal, Vol. 35, No. 3 (Fall 2015), http://object.cato.org/sites/cato.org/files/serials/files/cato-journal/2015/9/cj-v35n3-10.pdf.

    73 Statement of Commissioner J. Christopher Giancarlo Regarding the Implementation Date for Margin for Uncleared Swaps, Aug. 31, 2016, http://www.cftc.gov/PressRoom/SpeechesTestimony/giancarlostatement083116.

    74 Id.

    75 Id.

    76 Masayuki Kitano and Michelle Price, Asia Swaps Trading Stumbles amid Confusion over Margin Rules, Reuters, Sept. 1, 2016, http://www.cnbc.com/2016/09/01/reuters-america-update-2-asia-swaps-trading-stumbles-amid-confusion-over-margin-rules.html, see also, Staff article, CFTC Relief Caps Day of Swaps Margin Mayhem: Banks Unable to Face Up to 50% of Counterparties Due to Custodian Bottlenecks, Risk.net, Sept. 2, 2016, http://www.risk.net/risk-magazine/news/2469566/cftc-relief-caps-day-of-swaps-margin-mayhem.

    77 A number of America’s overseas economic competitors are quite apparent in treating financial and commodity markets are vital national interests. In 2012, the London Metals Exchange (LME) was acquired by Hong Kong Exchanges and Clearing Limited (HKEx), the largest shareholder of which is the Chinese government. Damian Reece, Like a Lamb London surrenders London Metal Exchange, The Telegraph, Jun. 15, 2012, http://www.telegraph.co.uk/finance/comment/damianreece/9335026/Like-a-lamb-London-surrenders-London-Metal-Exchange.html. China was also at the time the world's biggest consumer of industrial metals, including forty percent of world copper, the global price of which is set on the LME. Id. The purchase price paid by HKEx was reportedly 124 times LME’s operating profit and beat out all competing bids. Id. By way of comparison, Facebook’s valuation at its initial public offering was 76 times operating profit. Id.

    Last Updated: September 21, 2016