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CFTC Is Next Agency To Consider Regulating Algorithmic Trading

June 9, 2015

Author: Jenny E. Cieplak.

In a speech last week before the Global Exchange and Brokerage Conference, CFTC Chairman Massad outlined a potential new area of focus for the CFTC – regulation of futures traders that use algorithmic and other automatic trading strategies. Chairman Massad’s announcement follows the SEC’s recent proposal to revise SEC Rule 15b9-1, which would require high-frequency trading firms that fall into the SEC’s broad definition of “broker-dealer” to register with FINRA.

The SEC’s proposal focuses on eliminating an exception currently used by broker-dealer proprietary trading firms, many of which engage in high-frequency or other algorithmic trading, to avoid registering with FINRA. These proprietary firms are not currently required to register with FINRA as long as they do not carry customer accounts and they trade through another broker-dealer (including on a registered alternative trading system that is itself registered as a broker-dealer).

Similarly, under current CFTC rules, high-frequency traders in the futures markets are not required to register with the CFTC or the NFA, as long as they do not carry customer funds, handle customer orders, or trade directly on a DCM or SEF. Chairman Massad stated that the CFTC is considering requiring traders with electronic access to futures markets to register with the NFA, if they engage in algorithmic trading. Such traders are similarly situated to the broker-dealers currently taking advantage of SEC Rule 15b9-1, who have electronic access to a variety of markets through other broker-dealers.

Other potential regulations mentioned include pre-trade control requirements for algorithmic traders, and standards on the development and monitoring of algorithmic trading systems. Swap dealers and major swap participants are already required to develop policies and procedures governing the use, supervision, maintenance, testing and inspection of their algorithmic trading programs, although there is currently no similar requirement for FCMs or other futures market participants. FINRA has already published guidance on the supervision and control requirements for member firms that use algorithmic trading, and has recently proposed registration requirements for personnel of securities member firms that are engaged in the development of trading algorithms.

Although Chairman Massad’s remarks refer to “high-frequency trading,” the CFTC, like the SEC, has for now sidestepped the question of what, exactly, constitutes “high-frequency” trading. In a recent CFTC report on the use of automated trading in futures markets, the CFTC reviewed automated trades generally, including trades where algorithms were used to match orders, oversee order types such as stop-orders, and monitor general market risk. At this point it is not clear whether the CFTC would consider the use of algorithms for all of these functions to be true “algorithmic trading.”
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Jenny E. Cieplak
Counsel – Washington, D.C.
Phone: +1 202.624.2542