CFTC signals it may tighten rules on high-speed trading

September 9, 2013

Federal regulators signaled on Monday that they may more strictly oversee the high-speed trading that’s come to dominate financial markets and impose risk controls in response to a series of market-disrupting technology glitches.

The 137-page “concept release” from the Commodity Futures Trading Commission comes at a time when regulators are struggling to cope with a technological revolution that has transformed trading from a human-centric endeavor to one driven by computers that execute orders at blink-of-an-eye speeds — sometimes with disastrous results.

One of the most harrowing was the May 2010 “flash crash,” when the stock market plunged nearly 1,000 points in minutes, then whipped back up. Other high-profile glitches ensued, including the runaway trades linked to faulty computers at Knight Capital last year. Technical problems halted trading in Nasdaq-listed stocks for more than three hours two weeks ago, an issue that the exchanges have been summoned by the Securities and Exchange Commission to discuss Thursday.

All these disruptions were cited in Monday’s CFTC document, which took nearly two years to complete. The commission unanimously approved it before releasing it to the public for comment. The document solicits input on more than 100 questions, including whether the government should intervene and impose risk controls on the industry.

The commission acknowledged steps that the industry has taken to address some of its vulnerabilities. But it said regulators should consider changes across the board. CFTC Commissioner Scott D. O’Malia asked if the government should “federalize” current industry practices.

“An overarching question,” O’Malia said in a statement, is “whether there is a need for regulatory action with regard to any of the measures currently in the market.”

The CFTC is the nation’s top derivatives regulator and oversees contracts for the future delivery of a wide variety of commodities, including oil and corn. In the futures market alone, the volume of electronic trading on the exchanges has shot up from 50 percent in 2009 to nearly 92 percent last year, the commission said, citing industry figures.

“Traditional risk controls and system safeguards, many of which were developed according to human speed and floor-based trading, must be evaluated in light of new market realities,” CFTC Chairman Gary Gensler said in a statement.

The release addressed a wide variety of issues, including whether high-speed trading firms should register with regulators. But speed was a recurring theme, especially as it relates to the strategies embraced by automated trading firms, including “high-frequency traders.”

The commission is trying to determine an appropriate definition of high-frequency trading and whether the risk controls for that type of trading should be different from the ones imposed on other types of automated trading.

Many market participants said the commission’s approach is a reasonable first step to what is likely to be a long process, and they expect that the government will eventually put in place some of the least controversial measures under consideration.

But a few also said the government is lagging behind the industry in its thinking.

“The questions the CFTC is posing suggest they may not be aware of everything that’s already in place,” said one trader, who asked not to be named so as not to offend the regulators. “The regulations need time to catch up with what the industry practices are.”

At least one CFTC commissioner said time is the last thing the government needs.

“It has taken way too long,” CFTC Commissioner Bart Chilton said in a statement. “If we continue at this pace, Rip Van Winkle could keep up with any possible action we might take.”

Dina ElBoghdady covers housing policy for The Washington Post.
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