The U.S. Commodity Futures Trading Commission (CFTC) is watching you…and  thinks the world would be a better place if there was more oversight and regulation. That’s the opinion posited by CFTC Commissioner Sharon Y. Bowen late last month at an Open Meeting on Regulation Automated Trading (Regulation AT).

The commodity and futures markets “have seen immense technological change over the last 15 years,” she said. Futures trading, in particular, once involved throngs of traders waving their hands to purchase futures and options. But that world is no more. While the Chicago Mercantile Exchange closed a majority of its futures pits this summer, algorithmic trading is on the rise. In 2000, “algo trading” accounted for less than 10 percent of futures volume, yet, she noted, “per CFTC staff’s estimates, for the most liquid U.S. futures contracts which account for over 75% of total trading volume, more than 90 percent of all trades make use of algorithms or some other form of automation.”

Let’s not wait for data

Of course, Bowen acknowledged, the CFTC’s estimates are just that, estimates. There is, as yet, no comprehensive, precise data on the percentage of trades created or entered by algorithms in many product classes. Yet, she countered, “I do not believe this lack of information requires that regulators passively wait for this information to emerge. Simply waiting for that kind of data to materialize could allow problems to emerge in the interim that harm investors and the broader financial system.

“Even though the amount of algorithmic trading and definitions of these various terms are not crystal clear,” she continued, “what is clear is trades involving algorithms make up a substantial portion of our markets, and algorithms can and do malfunction at times, with negative effects on the markets. As a result, I believe we are obligated to consider if it is prudent to establish some regulations on algorithmic trading in our markets. Today, we begin the process of potentially establishing those regulations.”

Will you be ready?

The proposals to regulate algo trading are, at this time, just that, proposals. However, the CFTC is urging that such regulations require entities that use algorithms to trade:

• use risk management strategies;
• be required to disclose information to regulators; and
• have people who understand the Commodity Exchange Act.

Bowen underscored that the intention of the rules proposed is not to substantially change how many firms use algorithms, nor to create significant new burdens for those firms. In effect, she said, “this rulemaking largely formalizes and mandates firms involved in algorithmic trading to engage in a variety of practices that they should already be doing for their own protection.”

Compliance will matter

Section 1.83(a) of the proposal requires that persons engaged in algorithmic trading and registered as such with the Commission must prepare and submit an annual report to the Commission. Moreover, they must include:

• a description of the pre-trade risk controls in place;
• copies of policies crafted to comply with requirements regarding the testing and development of algorithmic trading systems and how their algorithmic trading systems comply with the Commodity Exchange Act and its regulations; and
• a certification by their chief executive officer or chief compliance officer that the information in the report is accurate and complete.

Will you be ready for the CFTC?

You better be, because Bowen thinks “the current 1.83(a) does not ask registrants for enough information.” She acknowledged that she isn’t looking for traders to ‘submit a tome of several thousand pages each year that lays out every arcane factoid about their trading systems,” because that would bury her staff in paper and create a significant expense for you. Yet, she believes the CFTC “should ask for more information in the report, [because] asking for one or two more pieces of information to be included in the annual report should not be a substantial additional cost to registrants.” Right?

Complying is an undertaking without end. And with the CFTC moving into watchdog mode, you’re going to have more of it. Want more time to do your real work? Let’s talk. Ask about Patrina’s comprehensive compliance solutions specifically designed for Broker/Dealers, RIAs, and FCMs.

Let’s talk (212- 233-1155).