Regulation AT: If you think it does not apply to you, think again
: 05 Apr 2016
Algorithmic trading typically conjures up thoughts of Michael Lewis’ “Flash Boys” and high frequency traders. The objections to these market participants have come from many areas and they have been blamed for bouts of volatility that make little sense. The response from regulators has been expected, but certainly not in the scattershot form of Regulation AT (CFTC proposed regulation RIN 3038-AD52, Regulation Automated Trading[1]). The CFTC states as its purpose “to address the risks of algorithmic trading through a series of pre-trade risk controls and other measures that AT Persons, clearing member FCMs and DCMs must implement.” Any new regulatory proposal raises hackles, but this one, with its all-inclusiveness as well as potential risks, has caused outright howling.
At the heart of the regulation are the definition of two terms: Algorithmic Trading and AT Persons. An AT person is an entity that uses Algorithmic Trading and would then be subject to the provisions of the proposed regulations. Unfortunately, the CFTC has chosen definitions for these terms that would result in virtually any organization that trades an electronic market to be considered an AT Person.
Essentially, it defines Algorithmic Trading[2] as using one or more computer algorithms or systems in the trading, input or modification of an order. Which says if a computer generates an order - with the sole exception of a person typing it exactly into a computer with no further discretion by any computer system - it is Algorithmic Trading.
But that’s not all. Let’s say that after you type the order into the trading platform, you use an auto-spreader or have the order worked as a TWAP or VWAP order, you would now be doing Algorithmic trading. If you were a long-term trend follower, generated signals once per day and produced an order file that you emailed to an FCM that imported it into an X-Trader system on your behalf, you are doing Algorithmic trading. If you were an energy provider and used Excel to help size the number of Natural Gas contracts needed to hedge your contracted deliveries, then transferred those requirements into an electronic platform (say WebICE) for execution, you are doing Algorithmic trading.
As you can see, the net has been cast far and wide for this definition.
The definition of AT Person is equally expansive:
“entities that may be considered an AT Person: persons registered or required to be registered as FCMs, floor brokers, SDs, MSPs, CPOs, CTAs, or IBs that engage in Algorithmic Trading on or subject to the rules of a DCM, or persons registered or required to be registered as floor traders.
Such persons or entities would be AT Persons if they engage in Algorithmic Trading on or subject to the rules of a DCM, or persons registered or required to be registered as floor traders as defined in § 1.3(x)(3).”
This encompasses just about any organization involved in trading futures especially because the definition of floor trader is proposed to be expanded to include anyone with direct market access, which includes using platforms such as CQG, TT, and Bloomberg, or exchange-specific interfaces such as WebICE and is not restricted to those traders using direct connections using FIX.
Many of the 88 comment[3] letters were from firms concerned the new rule would subject their source codes to cyber hackers, not believing the CFTC has strong enough firewall protections, not to mention staff leaving with the knowledge of their algorithms. CTA Two Sigma’s letter noted: “Trade secret protection depends on our efforts to prevent unauthorized disclosure of our confidential information and, as proposed, Reg AT inadvertently lessens those protections.”
But in addition to that concern, Regulation AT would force organizations to:
- Implement specific Pre-Trade and other risk controls (message and execution throttles, maximum order sizes, price collars, and other automated controls)
- Implement specific standards for the development, testing, monitoring, and compliance of the trading systems
- Implement maintaining source code for trading systems in accordance with Commission regulation § 1.31, meaning it must be available for the CFTC and DOJ for inspection at any time.
- Prepare and submit compliance reports to DCMs
CFTC Commissioner J. Christopher Giancarlo has gone on record[4] questioning whether the regulation “sufficiently benefits the safety and soundness of America’s futures markets so as to outweigh its additional costs and burdens?”
He specifically raised concerns about how the costs of the proposal may disproportionately impact small market participants especially because the commission admits in the proposal that they do not have a good understanding of how many organizations would be affected. That said, the proposal was unanimously passed and put out for comment. CFTC Chairman Tim Massad has stated that the CFTC handles confidential information “all the time,” adding that with Regulation AT, the CFTC wants to make sure the “source code is preserved and is available to us when we need to reconstruct market events.”
The comment period closed the day Chairman Massad spoke to the Futures Industry Association in Boca Raton, Fla. He assured the audience the CFTC would “review comments carefully and decide if there are any issues on which it would be beneficial to invite additional comment.” This is a good sign, meaning the regulator may be open to more industry input. Then again, he says they want the rule finalized by year’s end, so steel yourself to the possibility of new regulation that comes with more administrative burdens, costs, and yes, questionable impact.
Dana M. Comolli is president of DMAXX (dmaxx.com), a back office software design firm for alternative investment managers. TheBooks software is designed for the trader, and is built to do price, position and order management, reconciliation, trade accounting, performance reporting, risk and data management and act as a gateway to a wide variety of execution platforms. You can reach Dana at: dana@dmaxx.com
[1] http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/federalregister112415.pdf
[2] CFTC defines Algorithmic Trading as:
“trading in any commodity interest as defined in Regulation 1.3(yy) 169 on or subject to the rules of a DCM, where: (1) one or more computer algorithms or systems determines whether to initiate, modify, or cancel an order, or otherwise makes determinations with respect to an order, including but not limited to: the product to be traded; the venue where the order will be placed; the type of order to be placed; the timing of the order; whether to place the order; the sequencing of the order in relation to other orders; the price of the order; the quantity of the order; the partition of the order into smaller components for submission; the number of orders to be placed; or how to manage the order after submission; and (2) such order, modification or order cancellation is electronically submitted for processing on or subject to the rules of a DCM; provided, however, that Algorithmic Trading does not include an order, modification, or order cancellation whose every parameter or attribute is manually entered into a front-end system by a natural person, with no further discretion by any computer system or algorithm, prior to its electronic submission for processing on or subject to the rules of a DCM.”
[3] http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1646
[4] http://www.cftc.gov/PressRoom/SpeechesTestimony/giancarlostatement112415