CFTC learns HFT lessons from equities market

The Commodity Futures Trading Commission will craft rules to meet greater automating of trading in derivatives and avoid some of the problems seen in equities markets caused by the industry’s push towards low-latency trading.

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The Commodity Futures Trading Commission (CFTC) will craft rules to meet greater automating of trading in derivatives and avoid some of the problems seen in equities markets caused by the industry’s push towards low-latency trading.

The CFTC concept release will focus on four areas, namely pre-trade risk controls; post-trade reports; system safeguards of automated trading systems; and additional protections to promote orderly markets.

The rules will form a pre-emptive push by the Commission to avoid automated trading-driven issues that have affected equity markets, such as exchange glitches, which are in part exacerbated by high-frequency trading (HFT).

Sean Owens, director of fixed income research and consulting, for Woodbine Associates, told theTRADEnews.com the Commission would focus on avoiding the retrospective manner in which automated trading rules have formed in equities markets.

“The CFTC is looking at this now to try and prevent the shortcomings of automated trading that have developed in the equities market,” he said. “On the back of Dodd-Frank, there will be a strong focus on creating a well functioning, level playing field with an emphasis on transparency.”

In a statement, the CFTC said new rules would build on existing rules designed to help transition to automated trading including risk controls for designated contract markets, SEFs, futures commission merchants, swap dealers and major swap participants.

The concept releases comes weeks before new trading venues for trading OTC derivatives, swap execution facilities (SEFs), formally become operational. Although the CFTC said SEFs, which will allow for a greater automation of trading, were a key element of the release, they may not actually facilitate HFT activity.

“The launch of SEFs is a factor, but while HFT on SEFs is a long way off if it occurs at all because the volume of these formerly bilateral OTC transactions will be lower than other asset classes, other types of automated strategies are likely,” Owens said.

Robert Stowsky, senior analyst at consultancy Aite Group, said the Commission’s Technology Advisory Committee, which has focused on automated trading since the 2010 flash crash, has based its approach on industry practices.

“The working groups that have worked on this concept release have looked at best practices from the industry and are looking for public input for which practices to codify into regulation,” Stowsky said.

He said the 124 questions in the concept release let market participants avoid the burden of rules that could limit trading.

“There isn’t anything in this concept release that suggests the CFTC will restrict trading. It’s really looking at finding ways to prevent and deal with conditions where errors have occurred due to automated trading,” he said. 

One element that would attract particular attention, Stowsky added, was the potential for a utility-like pre-trade credit check hub mooted by financial services provider Markit. The industry would essentially have to decide whether or not firms should maintain control of credit checks, or if such a utility option would be more effective.

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