“The Anatomy of Speed”
Keynote Address of Commissioner Bart Chilton to the Trading Show Chicago 2013, Chicago, Illinois
June 24, 2013
Jambo! Hello. I wanted to lay a little Swahili greeting on you this morning because we are going to talk a little about Tanzania and technology. Isn’t that what you were expecting, a little Tanzania and technology? Jambo … and you say … Jambo. That’s very good! A hearty hello to you. See how we are already learning and having some fun. Let’s keep it going. I have some new information and data to share with you later.
Does anyone here still read magazines, ya know made of paper, that sorta stuff? I do. I still do. Remember when folks used to collect magazines? One collectable magazine was usually stored in your father’s closet.
The other one I’m thinking of was stored in a den or basement. It was a different size and had a yellow binder. I want you guys to all say it out loud. One thoughtful guess in: three, two one, go! You got it, National Geographic. Whoever said the phone book must have had a late night.
We still get Nat Geo at our house and I love it. Sure I enjoy Bloomberg Businessweek but that’s so much like work for me, it’s not very relaxing. I categorically enjoy Rolling Stone, especially Matt Taibbi’s great writing (although sometimes that’s a little like work for me), but the rest of Rolling Stone is just entertaining and enjoyable fun stuff. I can never get enough of Mick and Keith or the Boss. But Nat Geo is really neat in that it takes you to faraway places and has those wonderful photographs.
Last November I was reading a Nat Geo and there’s this story “Cheetahs on the Edge” written by Roff Smith with photos by Frans Lanting. It’s really very well done. It starts off in Tanzania. (How do you say hello in Swahili? Jambo!)
The story describes how the cheetahs live, how they can survive in the cold and heat, and how they are so very adept at knowing the territory and terrain to provide their prey the fewest opportunities to escape. I just couldn’t help but think of the similarities between actual cheetahs and market cheetahs. Quite frankly, I have not once felt that I gave HFTs an incorrect moniker. Reading this article confirms it all in my mind. It is very apt, indeed.
Market cheetahs are out there almost all of the time searching for their food—micro dollars—in milliseconds. They know the market terrain super well, just like cheetahs in the wild in Tanzania.
The Nat Geo story conveys how cheetahs have been, and are today, highly-prized. Well, I’m sure there are a lot of law firms that would like to have a few highly-prized cheetahs on retainer. I’m sure a lot of politicians would value a good campaign-related relationship with some of these cheetahs. Strike that; I know many already do have those relationships right here in this town.
The Nat Geo story also notes that cheetahs are actually a breed apart, a distinct genus, in fact—unlike the other big cats. Cheetahs have claws that are only semi-retractable and work like a sprinter’s shoes which allow them to go from zero to 60 mph in three seconds! And cheetahs aren’t just fast; they have a super short turning radius. They can change directions in a flash, or quicker than a flash. Well, duh on the market cheetahs. They may be like automated trading systems (ATSs) in some ways, like cheetahs in the wild are similar to lions, but they are both distinctly different from other cats in the wild and in markets. The speed of our market cheetahs make them definitively diverse from anything we have seen before. They are a breed apart.
Finally, a study late last year, which was conducted in conjunction with the CFTC, said in essence that cheetah trading imposes quantifiable costs on small investors. Aggressive cheetahs make a lot of money, and they make their biggest paydays when they trade with small, traditional traders. A cheetah trading with a fundamental trader makes $1.92 on a $50,000 trade but if that same trade is made with a small trader, the number goes up to $3.49. This could end up pushing smaller, non-cheetah traders out of markets.
All this is to say that the term cheetah for HFTs is more fitting today than ever. For the record, the word for cheetah in Swahili is “duma.” Sounds like puma, but duma with a “d.” Got it? Good, there may be a quiz.
The PROTECT Act—HR 2292
One thing I dislike is repeating things I’ve said, particularly when someone in the audience may have heard me discuss the matter before. One can’t avoid it all the time, but I try. In this regard, I’ll just say that I’ve been calling for a few key things to regulate the cheetahs over the years. I won’t go through them all because thankfully there has been some new and thoughtful leadership on these issues in Congress.
Representative Ed Markey has been one of my heroes since I began working in the House of Representatives back in 1985. I couldn’t be more impressed that he has taken it upon himself and his staff to work in this regard and I’m very supportive of his thoughtful legislation, HR 2292, the PROTECT Act. The legislation would require cheetah registration, testing, kill switches, and increased penalties for violations of the Commodity Exchange Act (CEA). The provisions of the PROTECT Act related to penalties aren’t just for cheetahs, but for all violations of the CEA. It would increase penalties from the current $140,000 fine per violation to $1,000,000 for individuals and $10,000,000 for entities. And the PROTECT Act gives discretion to the CFTC for how often a violation occurs. Currently, a violation has been considered to be only once per day. That makes no sense in today’s millisecond market environment. It is my hope that the PROTECT Act will become part of legislation to reauthorize the CFTC this year.
Cheetahs Today—New Data
Alright, with all that done, let’s get to some new stuff, shall we? Cheetahs are relatively new to markets. There isn’t one single word in any of the recent financial reform law—Dodd-Frank—about HFTs. Yet, they comprise a large percentage of the daily trading volume—roughly 30 to 50 percent. That’s an average. There are times—feeding times—when they have a much greater percentage of the volume. In fact, some new data I’m discussing for the first time today is fascinating.
Here it is: During the last year, we looked at 20 million trading seconds. Of those 20 million, we pinpointed 189,000 seconds, primarily around the open and close of markets. In those 189,000 seconds we found something astounding: Cheetahs traded at rates of 100-500 trades per second in a major commodity market! By any standards that exist, or have ever been discussed in public, that’s a shell-shocker data point. Trading 100 to 500 times per second, as a cluster, in one commodity contract? Holy mother of cheetahs! That's a mammoth market number any way you look at it. It’s actually pretty hard to even comprehend. This is my head exploding—pooofff!
If anyone says they know all about what’s going on with these cheetahs and markets, don’t believe them. How could they? Are they from another planet and have superhuman supercomputer powers? The best case is that some very smart folks know a portion of what is going on. But to suggest that they understand all of this isn’t correct. And, what is going on at this incomprehensible rate raises all sorts of policy, oversight and enforcement issues that our Commission needs to consider.
One such issue has been sort of a dirty little secret. That’s the matter of fantasy liquidity created by what are called “wash” trades.
If one trades with yourself, that is putting a price out and hitting that price for yourself, you take no risk, yet create the market impression that a legitimate trade has occurred. It appears to the market as if there is liquidity. If this was only for a few trades, it wouldn’t make much of a difference to the market. It wouldn’t seem like much liquidity. However, if there is a lot of trading going on with only one trader “washing” the trades by themselves, that is not only wrong; it is illegal.
Section 4c of the Commodity Exchange Act states that it is: "unlawful for any person to offer to enter into, or confirm the execution of a transaction involving the purchase or sale of any commodity for future delivery … if the transaction … (i) is, of the character of, or is commonly known to the trade as, a ‘‘wash sale.”
At the same time, there are exchange rules out there that say, "No person shall place or accept buy and sell orders in the same product and expiration month … where the person knows or reasonably should know that the … transaction(s) [is a] wash sale(s). Buy and sell orders for different accounts with common beneficial ownership that are entered with the intent to negate market risk or price competition shall also be deemed to violate the prohibition on wash trades." Another exchange rule says, “No Market Participant shall … make or report any wash trade...."
Wash sales are clearly a violation of the law, and against exchange rules. When they occur, they create fantasy liquidity. However, given the enormous volumes, I believe some cheetahs are engaging in this type of activity—that is, trading that arguably could qualify as “wash” trading under the CEA.
I’ve asked: Why would cheetahs do that? Are they trying to create fantasy liquidity in an effort to entice easy prey into the markets so that the cheetahs can pounce? That theory is something I’ve suggested we review at the Agency.
Here’s another theoretical answer to my question about why cheetahs might be engaged in creating fantasy liquidity: Many cheetahs are part of exchange market maker programs. Market maker programs pay traders for providing liquidity. When there’s lots of what is perceived as trading volume, it encourages others to trade. When there’s lots of liquidity, exchanges can boast their markets are deep and liquid. So, exchanges often pay cheetahs and other market makers to trade.
However, if a cheetah is truly washing the trades, they aren’t taking on any market risk whatsoever and they are violating the law. The fantasy liquidity may make it appear positive for exchanges, but the exchanges can’t allow that to occur.
By the way, wash trading is clearly unfair to other traders and, if it impacts price discovery, unfair to consumers.
Wash Blockers—For Cleaner Markets
So, one might think the exchanges would put in place what are called “wash blockers.” And great, “wash blockers—for cleaner markets!” Guess what, proposed guidance from an exchange—the CME—on this issue is on the table right now.
You might think that as a regulator who has complained about voluminous wash sales that I’d be all for it. You exchange folks go to town—implement, implement, implement. But, whoa doggies, not so fast. What is it they are going to do exactly? How are they going to do it? Are all exchanges going to do the same thing? If not, does one exchange have a better idea than the other? Do we have a better idea? Are there any mitigating circumstances that the Commission needs to consider prior to allowing the exchanges to implement these wash blocker measures?
Well, for me, all of those questions, as well as a few others, need to be vetted internally before we allow the exchanges to self-certify and move forward.
My concern is the same concern that I’ve had with cheetahs and technology in markets, in general. We have all too often just accepted things that are occurring or that folks want to do. The results are that we see market SNAFUs all the time. I used to keep a list of all of the tech issues gone bad. It became too long. We need to take a deep breath and ensure that we know, to the best of our ability, what might occur. Regulators are always so darn reactive. Rather, we need to be more nimble and quick and think about what might be around the corner.
That’s why today, I’m suggesting that we take a chill pill on allowing the new wash blocker guidance without a more thorough review. I’m not saying in a few weeks or so we won’t give the go ahead. I’m just saying, right now there are simply too many unanswered questions that need to be addressed from an oversight and surveillance perspective, and potentially from an enforcement perspective.
Looking into your Dens
On that happy note, I guess I want to leave our fine furry cheetah friends with a message. You are the fastest predators in the market and we are watching you. That doesn’t mean we have all the tools or resources we need or want. We don’t. But, we are working on it. We have, as of fairly recently, developed the capacity to see trades in the milliseconds. That is, one-one-thousandth of a second. We can see what you are doing. We can see all of your trading, even when it is many, many times per second. We won’t stop at getting your instant messages, your emails or your text messages. We are going to come into your dens and look and analyze with experts your algo programs to see if you are violating the law. New regulatory world order, cats. If you are playing by the rules, and I know many of you are, all will be cool. You won’t have anything to worry about. If you aren’t playing by the rules, watch out. You can’t hide. We may be slower than you, but we are a persistent breed of our own.
Finally, we all want efficient and effective markets that are devoid of fraud, abuse, manipulation and things like wash trading. Right? Right. That will make it better for everyone. It will make it better for other market participants, but it will make it better for consumers and our nation’s economy.
Asante! That means thanks. Asante, asante, guys. Thank you
Last Updated: June 24, 2013