Guest commentary by Zachary Ziliak.
Zachary Ziliak runs Ziliak Law, LLC, a law firm that focuses on the needs of trading companies and the vendors that service them. Prior to law school, Ziliak worked in the financial sector as a trader and quantitative analyst. He then spent six years in Mayer Brown’s Litigation & Dispute Resolution practice, with a concentration in complex financial, mathematical, and computer-related concerns, before breaking off in May 2013 to found his own firm. As such, he is particularly suited to comprehending the legal ramifications of algorithmic and high frequency trading regulation. Following is his summary and commentary of the CFTC Technology Advisory Committee meeting, September 12, 2013.
The Commodity Futures Trading Commission’s Technology Advisory Committee (CFTC TAC) met Thursday to address swap regulations and automated trading (AT). Most press attention focused on the CFTC’s “Concept Release on Risk Controls and System Safeguards for Automated Trading Environments,” which appeared in the Federal Register the same day. The Concept Release summarizes the agency’s thoughts on regulation of AT and solicits industry comments on 124 questions, with responses due December 11.
Sebastian Pujol Schott, Associate Director of the CFTC’s Division of Market Oversight, presented the Concept Release, which discusses several pre- and post-trade risk controls and more general safeguards. Included are many of the controls raised at SEC and CFTC meetings last fall (see MarketsReformWiki featured commentary from October 2012 and November 2012), such as kill switches, throttles, size limits, price collars, drop copies, systems to block self-trades, identification of automated trading systems (ATSs), and registration of firms that employ ATSs.
Several attendees commented on the Concept Release’s focus on AT generally and not specifically on high-frequency trading (HFT). Commissioner Bart Chilton complained that the Concept Release appeared to say fast was good and to treat “cheetahs” (his term for HFTs) just like floor traders. He warned against too quickly assuming all technology is beneficial. Chairman Gary Gensler, by contrast, supported emphasis on AT and direct market access without special rules for HFT. Staking out the middle ground, Prof. Michael Gorham of the Illinois Institute of Technology recommended regulating particular activities or characteristics of HFT, such as high order-to-fill ratios, rather than formulating a definition for HFT in order to decide what to regulate. Speakers such as Cliff Lewis of Eris Exchange and Greg Wood of Deutsche Bank Securities highlighted the difficulty of clearly demarcating HFT when many other trading operations use at least some automated processes that can create similar risks. And as always, there was much debate over the net societal benefits of HFT.
With Chairman Gensler and the Concept Release acknowledging strides made by the industry toward controlling AT and HFT risk, participants debated how much more pressure was needed from the government. Bryan Durkin of the CME Group suggested that the Concept Release did not sufficiently recognize the work completed by the industry in recent years, while Commissioner Chilton derided the industry’s tendency to pat itself on the back and deem risk controls necessary only if they have already been implemented. Others such as Tom Farley of ICE suggested that in contrast to older market participants, the new swap execution facilities (SEFs) warranted more prescriptive regulatory guidance—an interesting position to take in a room still filled with representatives of SEFs and swap data repositories. Supurna VedBrat of BlackRock advocated principles-based guidelines over intricate mandates, with regulated entities free to design their own systems that satisfied regulatory standards. Eris’s Lewis agreed, observing that the appropriate risk controls for oat futures likely differed from those for bond futures.
Some attendees expressed concern that the Concept Release was already too intricate. Gary DeWaal of Gary DeWaal and Associates recounted a previous debate over whether to allow traders to wear headsets, and worried that the Concept Release’s focus on minutiae might render it archaic all too soon. Keith Fishe of TradeForecaster Global Markets called for a careful cost-benefit analysis, as the full suite of controls being discussed could prove too expensive to implement. John Lothian of John Lothian News agreed, noting that a doctor should be able to open an office without being required to build an entire hospital so as to meet every possible patient need.
Even if all of the envisioned controls are implemented, however, one should not expect complete elimination of market problems. Evelyn Fuhrer of Promontory Financial Group called for more explicit management of expectations, for “as we continue to use technology in the markets, things are going to happen,” including “unanticipated events and unanticipated combinations of events, both internal and external, that … we are not going to be able to anticipate.” Chairman Gensler agreed, commenting that he believes “there will be glitches in the future.” In his view, safeguards such as those discussed in the Concept Release aim to ensure that “the central function of the markets” will continue uninterrupted in spite of such glitches.
From here, the Commission will await responses from the public to its 124 questions and then decide what if any additional regulation to propose. Commissioner Chilton pushed for a more aggressive agenda, calling for the CFTC to act on ATS registration, testing, and kill switches by the end of the year. Some other participants likewise called for parallel tracks in the regulation process, with Christopher Concannon of Virtu Financial, for instance, asking that mandates for better pre- and post-trade risk controls not be held hostage by an endless discussion of minimum resting times for orders.
Naturally a single two-hour session did not resolve the debate in this area, but Chairman Gensler commented that the vibrant discussion convinced him that issuing the Concept Release had been the right thing to do. Not everyone would agree with what the CFTC had written, he said, but the Commission would surely learn from what it hears in response.