Public Statements & Remarks

"Deciphering Chaos"

Keynote Address of Commissioner Bart Chilton Before the High-Frequency Trading Leaders Forum, Chicago, IL

October 9, 2012


Say, hey! Good morning.  I really am pleased and excited to spend some time with you to discuss markets and technology and to decipher some of the seeming chaos out there. Thanks to Edgar Perez for the kind invitation to join you at the High-Frequency Trading Leaders Forum. It is also fantastic to be with you here in Chicago—my favorite city.

Wayne’s World

How many people here are not from Chicago or the Chicagoland area? It’s great to see you here. For those of you from the area, we all know the city of Aurora—the second largest city in Illinois. Most of you, and I’m sure a lot of others here, recall the movie Wayne's World based upon the Saturday Night Live sketch? From a location near to us now, in that Aurora basement, long-haired Wayne Campbell and Garth Algar (played by the comedic masters Mike Myers and Dana Carvey) filmed their weekly low budget public-access Cable 10 television show, Wayne's World. At the beginning and end of their show, and at various points Wayne plays a chord on his Fender Stratocaster and the duo sing, "Wayne's World, Wayne's World, party time, excellent." That's their "go to" when they get excited or there is a lull in conversation.

Well, there won’t be too many lulls in our conversation today, and I really am very excited to be with you—party time, excellent.

So, game on! Before we talk technology and about those wily high frequency cheetah traders—those fast, fast, fast speed traders out there nearly all of the time trying to scoop up micro dollars in milliseconds, I want to speak about Dodd-Frank.

The Status Gladys

It doesn’t matter if you’re an algo trader, a cheetah, a pit trader, an investor or a consumer—you want to know the rules of the road when it comes to financial reform.

It has been four years since the economy tanked and more than two years since Dodd-Frank became law.  There are almost 400 rules to craft under Dodd-Frank.  Overall, the regulators working to implement the new law have been slow.  Most of the rules were to be completed within a year.  That means the law called for almost everything to be completed by July of 2011.  Of the 398 regulations that need to be finalized, only 131 are done.  That’s a mere 33 percent.  We’re not worthy. We’re not worthy.

My agency, by the way, has done better—party on. We’ve approved 39 final rules out of roughly 60. Given this epic undertaking, it’s not unforeseen that these new regulations would raise questions and concerns regarding compliance and implementation.


There are some things that take effect on this Friday, October 12th. Right now, we’ve got a couple hundred requests for clarification and or regulatory relief in some fashion on approximately three dozen discrete issues.  These requests—each one of them—deserve our careful, deliberate, thoughtful consideration and resolution.  Every single request deserves a response.  Once that clearness is provided on reasonable requests, then—of course—compliance with all final rules is required.

Just to be specific, if folks haven’t sent us some kind of request, then we assume they will be fully compliant with all pending deadlines. Providing clarity as to current requests does not equate with some kind of “blanket pass” on compliance.

In the event we don’t answer people before this Friday, it would not be appropriate, reasonable, or responsible for the Commission to proceed against entities for non-compliance with a Dodd-Frank rule. I certainly cannot envision the Commission moving forward with such an action. As Wayne says to Alice Cooper at one point, “We’re not mental or anything, so don’t be afraid.”

Dodd-Frank: The Buckets

I'm not going to go over all the individual rules (you're very welcome, I’m from the government and here to help), but summarize what we are doing by putting all the rules into four buckets:  Transparency, Lowering Systemic Risk, Accountability, and Market Integrity.

Bucket 1—Transparency:  The previously unregulated, off-the-grid, over-the-counter (OTC) trading (swaps) volume is in the hundreds-of-trillions of dollars—like $650 trillion or more worldwide.  To put that in perspective, our agency currently regulates about $5 trillion in annualized trading on registered exchanges.  I can’t even demonstrate that appropriately with a body chart.  What’s important are those off-the-grid trades, what have been termed “dark pools” who’ve never seen the regulatory light of day, will be brought onto regulated exchanges.  Transparency is the best disinfectant for murky markets.  Data will be collected by what are called Swap Data Repositories—or SDRs.  The SDRs will provide the transparency in the precise markets that got us into such trouble in 2008.  And by the way, except for excessive speculation, it wasn’t the regulated markets that were the trouble-makers—not at all.  It was the trillions in unregulated trades of which nobody had a visual.  That’s about to change.

Bucket 2—Lowering Systemic Risk:  We want to ensure that folks don’t take risks that undermine the whole financial system.  Risk is part of markets, sure, and people should take as much as they’re comfortable with.  But, if they slip and tumble, our economy shouldn’t stumble. So, we’re instituting new capital and margin requirements.  That will avoid the over-leveraging problem that we saw in 2008 with Bear Stearns and Lehman and others.

Bucket 3—Accountability:  I'm often asked why nobody went to jail for what happened to the economy in 2008? This has become an even more pressing question given that taxpayers bailed out, to the tune of $400-plus billion, many of the very firms that took a wrecking ball to the economy to begin with. Since that time, the sector in our economy that has made more profits than all other sectors, more than all of them, was—wait for it—the financial sector. Exqueezeme? Certain folks who did the damage are doing better than others in our economy. It’s enough, Wayne, to make a fella hurl. So, how come nobody went to jail? Well, much of what was done wasn't against the law.

That will change with the Dodd-Frank rules. There will be more financial firm accountability to the public. We will, in the near future, make some significant improvements. We will address in concrete, comprehensive, and crystal clear terms, our complement of customer protection rules, with a focus on meaningful controls and control-based examinations. And finally;

Bucket 4—Market Integrity:  We all want these markets to perform the functions originally envisioned—that is to manage risk and discover prices—good stuff for commercial producers and good for consumers. At their core, that is why we have futures markets.  They weren’t set up as gambling parlors, but risk management markets for commercial hedgers—those with some physical commodity and to lessen price volatility for consumers. Let's ensure those fundamental principles are maintained in markets no matter who the players are or what technology they use.

It is on this last area of market integrity that we can spend the remainder of our time. The two fundamental issues let’s do an “extreme close-up” on are: speculative position limits and technology.

Position Limits

Right on—first, let’s talk limits. As many of you know, this has been in the news lately.

Since 2008, I've been working to get these limits in place because, and this is backed up with many studies, excessive speculation can push prices around.

Nobody can justify nearly $150 a barrel oil in 2008 based upon supply and demand. Well, Dodd-Frank required that we implement limits, even instructing us to do so within six months, sooner than the rest of the rules we spoke about earlier.

Here’s the issue:  Not everybody agreed. That's okay.  Diversity of opinion is good. A group of international bankers and another group filed a lawsuit to stop us from going forward with limits.  Eleven days ago, the Court said we could not go forward with implementation on October 12th. I’ve said we should immediately appeal. I hope we do so within days.

At the same time, I support approving yet another rulemaking regarding position limits. Here is why: in brief, the Court opined that the Commission could impose limits on excessive speculation in two scenarios:

One: Pursuant to the unambiguous language of the Commodity Exchange Act—4a(a)(1) for you lawyers—making a finding of necessity.

With regard to that way to move forward, we’ve been there, done that.  In 1938, the Commission made a finding of necessity regarding position limits rules, making the self-evident point that a very large speculative position has a tendency “to cause sudden and unreasonable fluctuations and changes” in prices and that limits on speculative trading were necessary to prevent the undue burden that could arise from excessive speculation.  Accordingly, position limits as a prophylactic measure are necessary to diminish, eliminate, or prevent the undue burdens—risk of manipulative activity and market disruptions, for example—due to excessive speculation.  Our necessity finding in the new rule can parallel the Commission’s first articulation in 1938, supported with decades of additional experience indicating that limits are necessary in today’s markets.  This is solid ground.

The second way the Court opined that the Commission could impose limits on excessive speculation is this:

Two: Pursuant to what the Court says is ambiguous language of Dodd-Frank—4a(a)(2)—and a permissible construction of that provision, providing a justification for the agency’s action.

Here’s how we could address this second way to move forward. The Commission’s rulemaking could impose “appropriate” limits based on its experience with the markets.  We have seen speculative trading activity in physical commodity markets that moves the market price away from what it would have been in the absence of price-distorting speculation.  We’ve seen large speculative positions in physical commodities cause uneconomic price distortions, which create unreasonable market burdens and or the incentive to manipulate market prices.  Again, these aren’t hypothetical—they’re real.  Therefore, the justification for imposing appropriate limits, as we have experienced, are required in these markets.   Again, this is solid ground.

So, I am confident that the Commission can, and should, issue a new rulemaking that is rock-solid under both standards.  That is, as I said, in addition to our appeal.

Gas, Gas, Gas

Ironically, just before the Court ruling vacating the position limits rule came out, there was more than a seven percent spike in gasoline futures prices over the previous day’s close.  I’m not saying those two things are related.  At the same time, though, this price spike was not unlike others that can be attributed to overwhelming speculation.  It just serves as an illustration that the problem of excessive speculation remains.  What a reminder on the very day speculative position limits suffered a setback.

Okay, enough of that stuff on limits. On to the main event: technology.

Garth's Short Circuit

There is a time in the movie—in Wayne’s World—where Wayne unexpectedly leaves Garth to fend for himself in front of the live television camera. Garth doesn’t know what to make of the situation and he is sort of frozen. His head starts buzzing and I think smoke comes out of his ears. He simply can't get a grip on the reality of the circumstances in which he finds himself. His brain is short-circuiting.

Deciphering Chaos

Well, there's a reason I bring that up. Many people today can't comprehend—like Garth—what is going on in electronic super-fast trading—cheetah trading. They may think it seems like chaos. In fact, deciphering the market chaos is exactly what the cheetahs and their programs try to do.

The early cheetahs were mathematicians in the 1960's who honed their probabilities, first by the way, with blackjack. (Scott Patterson's book The Quants is a great read on this, and while I'm at it, his new book, Dark Pools about contemporary speed traders is really interesting). These mathematical gamblers were very effective, in fact, so much so that a few were banned from Las Vegas.

I don't know how many of you remember another movie, 21, from 2008. The movie was an unexpected smash and beat all other movies two weekends in a row. In the film based upon a true story, Kevin Spacey plays a mathematics professor at MIT (Massachusetts Institute of Technology) and coaches the blackjack team. One night, his ace students (the team) win $640,000. It is a good movie.

The early cheetahs did just that. They used math, figured probabilities and gambled. Then, they turned their gambling probabilities to Wall Street. Many years have passed, but the descendants of those first cheetahs are alive and well today in markets throughout the world.

Those of us who aren't mathematics whiz kids, however, still don’t totally comprehend how all this trading is done or the speed with which what they do is acted upon. Our capacity to comprehend this trading, like Garth’s predicament, is nearly impossible for many.

How We Think: Trading Structures

That’s because we have a market interpretation based upon our perception about how long we believe it would take us to react to changing prices if we were trading. That's not today’s reality. It isn’t how things work now.

The old timer customers saw a price on a TV screen and called their broker. The broker would provide current pricing and an order would be given. Then, the order would be phoned in. The order would be stamped. A runner would take it to the pit and give it to a broker. It would be placed in the deck or immediately filled. The runner then goes back, calls the broker, and the broker calls the client. That's a pretty time-consuming process.

That shifted to where a customer simply entered an order into the computer that links to the floor and the order is passed to a broker.

Now, a customer can enter an order into the computer directly to an electronic platform for placement in the exchange order matching engine by the futures commission merchant (FCM). The execution causes the customer to directly receive the fill from clearing. Lickety-split, it is done.

These three structures of trading time and stride are totally comprehensible for us. Our brains do not short-circuit. They make sense, logistically, to us. We can even look at sudden and intense market fluctuations and understand them given how those structures operate. We can visualize it happening. We "get it."

How Fast is Fast?

But, in today's cheetah trading world, we see futures trading in a period of milliseconds. The trades happen faster than a wink—much faster, actually. No way! Way.

Try to decipher it. A millisecond is one, one thousandth of a second. It is hard to comprehend without your head starting to vibrate and short-circuit like Garth.

Here is an example I found on the web, so it must be true. If you are travelling at 100 miles per hour, a millisecond is the time it takes you to go 2 inches. That explains it all, right?

Does that make anyone feel better trying to understand it? Not me. About the best I can do is say—it is faster than I can get a grip on. It is really super, super-fast. And thinking about it doesn’t make me feel any less frightened or scared about how such hurried trading could go wrong—in a heartbeat, or half a heartbeat…whatever.

In real time, no human brain can follow this trading—maybe Rain Man? Nah, nobody can do it. It’s simply not possible. Someone can follow trends in the trading, but by the time there is something to look at, what is on the screen is totally toasted. What is seen on the screen is an illusion in as far as what is happening. It is yesterday's news, even though it happened two seconds ago. As one of our senior folks at the Agency said, what we see is a "dead carcass of something that lived, died, decayed and is now fertilizer."

That is pretty chilling stuff and I can see why some might just jump to the conclusion that, like a monster or a serial killer, “It must be stopped.” Because that scariness can pretty quickly turn into concern about the fragility of markets that determine the price for just about everything we purchase being subjected to this incomprehensibly fast trading.

Technology SNAFUs

If there were no technology glitches—zero, zip, zilch—perhaps there would be some sense of security with the technology in markets and cheetah trading. However, we see problems all the time—all the time. In fact, I wrote the bulk of this speech last Wednesday on a long plane ride, and I’ve had to update it twice because of new technology snafus. By the way, I’d forgotten where the word “snafu” originated. It is an old military acronym: Situation Normal—All Fouled Up (as you might guess, that’s the PG version).

Here is what I added: Last week, Nasdaq had its second high-profile technology difficulty in six months when it was forced to cancel Kraft Foods trades after a technology anomaly caused the company’s shares to rise 28.9 percent. That may sound bad, but it was worse. Kraft was just switching from NYSE (New York Stock Exchange) to Nasdaq. The former Kraft CEO rang the opening Nasdaq bell. In the first minute—in 60 seconds—the stock price took that large leap of nearly 30 percent. Trades were subsequently cancelled. On the day, Kraft was down 1.2 percent. It was reported that the problems were due to faulty speed trading algorithms. Of course, most of us recall that Nasdaq had a big technology issue with Facebook’s initial public offering in May. I’m not picking on Nasdaq. Technology seems to be an equal opportunity agitator.

It is a global problem, too. And this is the other thing I added:
Late last week, the National Stock Exchange of India said 59 erroneous orders provoked a dive in equities that temporarily erased about $58 billion—$58 billion!—in value. That’s a major “my bad” and a lot of rupees.

A few weeks back, the Tokyo Stock Exchange shut down due to technology issues.  We’ve seen a few contracts shut down for different periods here in Chicago in the last month. We've seen market volatility increase wildly:  natural gas dropping 8 percent in 15 seconds last year.  One day silver dropped 12 percent in about as many minutes.  One energy trader lost $1 million in one second—in a second!  We saw crude drop $3 in a minute last month.  I mentioned gasoline dropping earlier. We continually see sharp rises and falls in precious metals.  Knight Capital Group, in August, lost $440 million based on software trading errors—tossing it to the brink of bankruptcy. There are many more examples. Sometime I’ll give the entire list if I can figure out a way to do it without making folks want to spew. Wayne’s World, Wayne’s World.

Nevertheless, all of these snafus underscore the concern I’ve been raising for a few years about how regulators need to get a better handle on what is going on in markets with technology. Regulators have a proactive responsibility to do so. Few others will. Too many folks are making too much money to second-guess what is going on at these warp speeds (there, “warp” speeds—I stooped to using a fictitious measure of speed to try and describe it, “damn fast” or “fast, fast, fast” maybe the best).

A Balanced To Do List

So, the case that the trading and technology is fast and scary and that snafus are taking place all-too-frequently is easy to make. That’s an easy breezy case because the facts are irrefutable.

The question for us is: What should be on our To Do List? The status quo certainly can’t be acceptable. What do we do about all of this? Should we slow the cheetahs down as the European Parliament proposed very recently? Perhaps require resting time for bids and offers—half a second, 5 seconds and 200 milliseconds, 15 seconds? Slow the cheetahs down with governors on their engines? Ban the cheetahs? Put them on the endangered species list?

Those are all answers, although I don’t think they are spot-on. Like most things, we need to search for an appropriate balance—a balance which accepts that as scary as the cheetah trading and other technology may seem, warts and all, there are benefits.

Access—Technology provides access to markets like never before. You could be in Wayne’s basement in Aurora trading.

Smarter—Plus, cheetah programs should make trading smarter, and therefore markets more efficient.

Liquidity—The Cheetahs themselves add liquidity to markets. I'm not convinced the liquidity is as wicked awesome as some contend. I mean, sometimes that liquidity is there for a half second, then the cheetah bails—they’re outta there. A farmer isn't going to hedge his wheat crop for a half second; he wants it hedged for the growing season. The cheetahs, on the other hand, want to be flat—or level—at the end of the day (although for some, there never is an end). I call the liquidity provided by the cheetahs “fleeting liquidity,” but it is liquidity nonetheless.

So, I'm not of the opinion that this trading is so very incomprehensible and scary that we need to stop it. I’m not even to the point of suggesting that it be slowed, although I don’t rule out that possibility. I think we don’t know enough.

I've said it many times, although I'm not sure folks believe me, I don't think we should endanger the cheetahs as a species. At the same time, there are some things we should do and do fast. Cheetahs—HFTs—were not even mentioned in Dodd-Frank. There was not one word about them. The new law was passed and signed just shortly after the Flash Crash in May of 2010. If we don't get on the stick and develop some reforms without legislation, I know there will be efforts to mandate us to do so. Should something like another flash crash take place and a cheetah instigates it, you'd better believe there will be a spontaneous posse formed on Capitol Hill and they will be tracking all the cheetahs and they may, then, become endangered.

We need some market protections on our To Do List, however. Here are things that I think represent a balanced approach to seeking safer markets while not going too far:

1. Cheetah Registration: They need to be registered. That's sort of a pedestrian first step. Can you believe they aren’t even required to be registered with us?  If they are not registered, we can’t command their books and trading records. They gotta be registered.

2. Testing: They should be required to test their programs before they are released in a live production trading environment.  Most of the big cheetahs do this already.

3. Kill Switches: They should be required to have kill switches in the event that cheetah programs go feral.  I am pleased that the Securities and Exchange Commission (SEC), some exchanges and my Agency are looking into that.

4. Wash Blocker Technology: Cheetahs should also be required to establish pre-trade risk controls with available wash blocker technology to prevent wash—or cross—trading (trading with themselves).  After all, those trades are illegal.

As it stands now, things are moving so fast in this gizmo-gadget trading world that some cheetahs claim they don’t even know when a wash trade happens.  “I didn’t know” should get the same response that one receives when they drive a hundred miles per hour and tell the officer they didn’t know.

5. Compliance Reports: I’ve also suggested that there be periodic compliance reports from the cheetahs and that the senior executives sign their names and be held responsible for any false or misleading information.  The days of “he said, she said” accountability in financial markets needs to stop, and now. 

6. Penalties: Finally, and this goes to accountability, too. If there is another flash crash where people are harmed (they lose money) due to a rogue cheetah, I think there needs to be steep penalties. And when I say penalties, I'm talking not just for the firm, but for individuals at the firm. If the cheetahs want to be involved in the high-flying, incomprehensible world, okay, but if you cause harm to markets and consumers, we shouldn't stand for it.


So, that's it. Thanks for your time, and may the forces of evil become confused in their eternal search for you guys. Oh wait, that’s not the ending we want. Remember Wayne and Garth would dissolve the scene and go to another, or one of the different endings.

Here is our mega-happy ending: As you can tell, not just with Dodd-Frank, but with market integrity through position limits and technology, there’s still a lot to do on regulatory reform. We may not have deciphered all the chaos in these last few minutes, but hopefully, we can see a path forward that isn't too scary for anyone. We can have even more efficient and effective markets devoid of fraud, abuse and manipulation. We can have markets that are good for traders—both commercial and speculative traders—for consumers, our economy and our country.

Thanks for your time. Party on!

Last Updated: October 9, 2012