WASHINGTON, July 13, 2016 – The Commodity Futures Trading Commission’s efforts to regulate algorithmic trading fall short of practical rulemaking, a panel of experts told the House Agriculture Committee on Wednesday.
When the CFTC unanimously approved the proposed rule (Regulation Automated Trading, or Regulation AT) in November, the commission said the proposed rule contained a “series of risk controls, transparency measures, and other safeguards to enhance the U.S. regulatory regime for automated trading.” But witnesses at a House Ag Committee hearing said the proposed rule won’t accomplish its desired goal and could result in unconstitutional taking of proprietary information.
Perhaps the biggest gripe with the proposal is language that would require CFTC have access to “source code,” which is essentially the programming language used to execute a computer program, in this case a program making algorithmic trades. Richard Gorelick, CEO of RGM Advisors in Austin, Texas, said the source code is a trading firm’s “secret sauce,” and a government entity asking for it without subpoena or other due process is unprecedented and, he said, unnecessary.
“It’s sort of like taking a car apart and taking all the pieces and studying them in excruciating detail to try and predict traffic patterns,” Gorelick said. He noted that a source code can have millions of lines of code and can be written in a variety of computer programming languages. He said with all the complexity at play, he doesn’t think CFTC could properly evaluate all the source code it is asking for in Regulation AT.
Committee chair Mike Conaway, R-Texas, agreed, saying he was “hard-pressed to envision a circumstance where the CFTC could have on staff a cadre of people who would pick out one of these firms at random, go in, and drag through their source code in enough detail to find that glitch that had been missed.” On another note, Conaway says if there’s an issue that would allow CFTC to bring enforcement action, the code is not the issue.
“If someone has actually caused a disruption in the market, the violation is not going to be that they screwed up the code, the violation is going to be that they manipulated or hammered the market,” he said. “We don’t really care how it happened if we can prove what they did. It’s a real head-scratcher for me.”
When asked if the additional information required by Regulation AT would stop an algorithmic trading disruption, Andrew Vrabel with CME Group said no. He said determining issues with that kind of trading requires “highly complicated analysis, the type of analysis that won’t be gained from routine annual compliance reports” that are also required by the proposed rule.
Overall, the theme of the hearing was that Regulation AT would be overly broad and complicate an already complex trading environment. Conaway said the ambiguity in the language “conspire(s) to create a rulemaking that is overly complicated, yet still incomplete.” Greg Wood, the chair of the Futures Industry Association’s Market Access Committee, said CFTC would be better served using rules that are already in place.
“Regulation should build on and leverage the very successful risk controls and safeguards currently in place instead of proposing new and untested systems or procedures that would require significant investment by the industry,” he said.
The rule has not yet been finalized. In June, CFTC reopened select portions of Regulation AT for public comment for a two-week period.
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