CFTC set to propose algo trading rules

4 min read
mike kentz

The CFTC plans to issue a new rule proposal governing algorithmic trading firms that operate in futures markets this fall, after a series of high-profile market disruptions tied to algorithmic trading, CFTC Chairman Timothy Massad said at an industry conference today.

“The increase in electronic and particularly automated trading over the last several years has brought many benefits to market participants… but it also raises important policy questions,” Massad said in the keynote speech at the annual meeting of the Beer Institute, a trade group representing beer producers.

“There are concerns about operational risk: will a fat finger or faulty algorithm cause a sudden spike? And there are questions about fairness: will market participants who do not operate at the speed of light get a fair shake? There are also questions about how these changes in market structure may affect liquidity.”

The rule proposals are expected to be issued this fall and be open for public comment before finalisation.

The rules come just over a year after the agency initially telegraphed plans to crack down on algorithmic trading amid growing concerns that high-frequency trading firms, often accused of illegal trading activity in equity markets, have fully infiltrated futures markets.

Automated trading activity – a larger umbrella for electronic trading strategies that does not necessarily include algorithmic trading – now accounts for 70% of all trading in futures markets “over the last few years,” noted Massad.

The CFTC turned its attention towards the problem in earnest starting in 2011, following the calamitous Flash Crash of May 2010 that traders believed was caused by HFT firms.

But it wasn’t until last June, after a public roundtable of industry participants, that the CFTC officially flagged its intent to write new rules directly tied to algorithmic trading. (See Story “Automated trading rules approach futures markets”)

Industry response

Since then, derivatives exchanges such as CME Group – which operate as self-regulated entities – have toughened internal oversight of algorithmic traders and been formally instructed by the CFTC to tighten enforcement. (See stories “HFT crackdown threatens liquidity” and “Closer enforcement for automated futures”)

Additionally, proprietary trading firm HTG Capital Partners filed a lawsuit in a Chicago court in March alleging illegal trading activity in US Treasury futures markets in 2013 and 2014. The lawsuit seeks to force the CME to reveal the identities of the firms that HTG says attempted to “spoof” the market.

Spoofing is when a trading firm enters misleading orders at which it does not intend to execute in order to push the price of a contract up or down. The firm then pulls the order at the last second and buys or sells in the opposite direction to collect a profit.

Market concerns once again manifested in April with the arrest of Navinder Singh Sarao, a 36-year-old day trader, on accusations of spoofing futures markets between 2009 and 2014, and in so doing specifically helping to cause the 2010 Flash Crash.

Now the CFTC will turn its attention towards oversight of the activity, rather than enforcement that has dominated much of its involvement the last four years.

At the original industry roundtable last June, executives at CME and leading algorithmic trading firm Virtu Financial urged the agency not to overreact with its intended rulemaking.

“The Commission is looking closely at automated trading and specifically the use of algorithmic trading strategies… We are currently working on some additional proposals to make sure there are adequate risk controls at all levels, and to minimise the chance that algorithmic trading can cause disruptions or result in unfairness,” Massad said.

Timothy Massad