The CFTC’s Technology Advisory Committee (TAC) was scheduled to meet on Tuesday to discuss three issues important to the trading industry: 1) the CFTC’s proposed Regulation Automated Trading (Reg AT); 2) swap data standardization and harmonization; and 3) the potential of blockchain and distributed ledger technology to the derivatives market.
Unfortunately, winter storm Jonas, aka Snowzilla, hit Washington DC with a record two feet of snow, and the meeting has been postponed.
In the weeks leading up to the meeting, there has been a steady stream of stories about blockchain, which is seen as a bit “sexier” than a 500-page regulatory proposal. But Reg AT has been a big topic of discussion in the trading industry, as some of its elements have sparked concern and could have a profound effect on the industry.
John Lothian News addressed the topic a while back in our article called “Trying to Stop the Next Flash Crash,” which can be found here. Also click here for a complete summary of Reg AT and here to see a selection of comment letters on automated trading regulation.
One of the people interviewed for that piece was Leslie Sutphen, president at Financial Markets Consulting, who was on the FIA committee that drafted responses to the CFTC proposal. We followed up with her last week to see what people in the industry are talking about regarding Reg AT ahead of the TAC meeting.
Despite all the press about blockchain, she said Reg AT is a crucial topic for the CFTC and the commission is eagerly awaiting what the TAC committee has to say.
The most troubling aspect of the proposed regulation may be the requirement that algorithmic trading firms make their source codes available to the CFTC, Sutphen said. Currently, the government needs a subpoena before it can access firms’ intellectual property, but the new rule would do away with that. Firms are naturally worried about protecting that property.
In a comment letter received by the CFTC, William Harts, the CEO of Modern Markets Initiative, wrote that the rule could place “the trade secrets and intellectual property of algorithmic trading firms at precarious, unwarranted and unnecessary risk.”
He also wrote that the term “source code” is not explained or defined in the regulatory proposal, and that no standardized definition of the term exists in the industry, which could mean “enormous confusion” for participants.
Chris Hehmeyer, chief executive officer of the prop trading group HTG Capital Partners, and a member of the TAC committee, said many people don’t realize the top trading firms that run algorithmic systems are all members of the CME, and that the CME has the right to look at their source code at any time. However, he said that some people would say that giving the right to the Federal government to obtain such sensitive material without a subpoena would be dangerous.
Another big concern, according to both Sutphen and Hehmeyer, is that the definitions in the proposal are new and not as clear as they need to be – in particular the definition of direct electronic access (DEA), which used to be called direct market access, Sutphen said, as well as the definition of an “AT Person.”
For example, a person trading through an ISV and using a mouse rather than an algorithmic program is excluded from the definition of an AT Person, according to Hehmeyer. However, “If limits are set for that person at the exchange level, and the person with the mouse goes over that level and the exchange cancels the order, it looks to me that the way it is worded the exchange has turned that person into an automated trader,” he said. That would greatly increase the number of entities classed as AT Persons, Sutphen said, and lead to confusion.
“I think it’s universal that the definitions of what the CFTC put out need to be refined,” said Hehmeyer, pointing out that Reg AT was a hot topic at the recent Bar Association conference in Naples, Florida. “That’s why they put [the proposal] out for comment,” he said.
Sutphen said that in her opinion – which she emphasized is not necessarily that of the FIA – Reg AT does a good job in many ways but “goes a bit beyond what we recommended.” The documentation, reporting to the exchanges, and audit trails seem overly burdensome to many in the industry because they require giving the exchanges an extraordinarily large amount of information.
The CFTC may have a lot of work ahead in refining some of the Reg AT rules. It will be helped by the TAC meeting, as well as by the comment letters that come in. So far, there are only a few comment letters on the CFTC’s web site. They can be found here.
It is expected that more will pour in closer to the end date of the comment period, which is March 16.
The industry anxiously awaits for Washington D.C. to dig out after its snowstorm and the CFTC to put the TAC meeting back on the calendar.