This summer, the US Commodity Futures Trading Commission (“CFTC”) published its proposal on electronic trading risk principles and withdrew previously proposed rules on automated trading (known as “Regulation AT”). The proposal has already been welcomed by the industry associations and is designed to provide a principles-based approach to addressing market disruptions and system anomalies in designated contract market (“DCM”) trading platforms due to electronic trading.
Background and implications for firms
Many exchanges have already implemented their own rules and controls to prevent, detect, and mitigate market disruptions and anomalies, thereby the proposal aims to recognise existing processes that have evolved to minimise the frequency or severity of market disruptions or system anomalies caused by malfunctioning automated trading systems. This is also exacerbated by the most recent incidents in 2019 and 2020. In particular, NYMEX fined one of its members in March 2020 for sending a large volume of non-actionable messages resulting in latencies of over one second to other market participants. Also, CME Group experienced a significant increase in messaging in the Eurodollar futures market in September and October 2019 where the volume of data generated by activity in Eurodollar futures increased tenfold.
The proposed amendments include the following new principles applicable to DCMs which are accompanied by proposed acceptable practices:
- Implementation of exchange rules to prevent and mitigate market disruptions and system anomalies;
- Implementation of exchange-based pre-trade risk controls for electronic orders;
- Notification to the CFTC of significant disruptions to DCM electronic trading platforms
Most notably, there are two additional changes to the previous approach. Firstly, the scope of the principles does not have a narrow focus on automated (algorithmic) trading and covers all electronically transmitted trading and order messages on the DCM’s electronic trading platform, including both automated and manual orders. This is an important change ensuring that all electronic trading activities should adhere to these principles irrespective of the industry’s internal interpretations. Secondly, there is an element of discretion given by the regulator to exchanges to precisely define market disruptions and system anomalies as they relate to their particular markets. This will provide exchanges with a flexible tool to adjust their rules and calibrate controls with the evolution of certain markets or technologies.
Silver bullet for regulating electronic trading governance and controls?
There are three key areas of reflection on the new approach proposed by the US regulator which we would like to explore below.
1. Unlike many previously adopted rules (e.g. MiFID II or previous Regulation AT), it does not prescribe a very detailed and specific set of rules and does give discretion to the marketplace to decide what they think would be the best way to avoid any market disruption. There is a certain element of trust and reliance on the integrity of market participants to adhere to the principles. Given how quickly the technology evolves, this may be a highly reasonable approach to ensure that the governance and controls frameworks stay adaptive and can be quickly tweaked by the industry in response to events.
2. A shift in focus to electronic trading means there would be no room for firms to exclude certain trade flows or electronic trading systems from their controls universe. This may work well for some global firms with a large exposure to different trading algorithms since their governance model would cover the entirety of electronic trading. However, this may be more challenging for those participants who previously decided not to focus on non-algorithmic trading flows.
3. The US approach could be a blueprint for other regulators. With the MiFID II reform on the horizon in Europe, this might serve as a precedent to test the new route and assess whether a similar framework could work in the electronic trading markets in other countries.
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