CFTC One Step Closer To Reg AT, Requiring Access to Algos
(this article originally appeared on ValueWalk.com)
Amid spirited debate, the Commodity Futures Trading Commission last Friday approved amendments to Regulation Automated Trading, commonly known as Reg AT. The controversial proposal requires algorithmic trading firms engaged in more than 20,000 trades per month to become registered with the CFTC and, most contested, allows investigators quick access to confidential source code in the case of suspected market manipulation. The proposed rule will now be published in the Federal Register and will be open to a 60-day comment period, after which the CFTC will vote again.
By a vote of 2 to 1, the commission approved rulemaking changes that would ultimately empower investigators to issue a “special call” notice to registered participant. Much like a subpoena request, requesting the special call action would first require approval by a vote of CFTC commissioners. Unlike a subpoena, under Reg AT as proposed the trader would not be given the right to object in court to the move.
CFTC Chair Timothy Massad, who championed the proposal, argued that the rules for algorithmic traders should not be different from human traders. Those engaging in market manipulation “should not be able to hide behind machines,” he said, arguing the authority granted the commission is not materially different from the current investigative process of human traders, who frequently detail to regulators trade logic and execution methods behind their trading decisions.
Modern Markets Initiative CEO Bill Harts, an advocate for the algorithmic trading industry, took issue with Massad’s comments. “The only thing hidden is the CFTCs reason for not using a procedure that has served it well,” he said in a ValueWalk interivew.
Massad, like numerous policy makers, is concerned about market stability and seeks to prevent future flash crashes, pointing to the need to update its regulations. “We have to recognize that we do need to modernize our markets, part of that is the ability to update essentially the surveillance function we have been engaged in for decades, where we do look at all sorts of information, confidential, proprietary information of great value,” he said. “Today, similar information is embodied in ones and zeros in code and it should not make a fundamental difference.”
CFTC Commissioner J. Christopher Giancarlo, the sole dissenter, said the ability of government to force private business to disclose source code would lead to a slippery slope.
“For the past few years, American tech firms have been supported by the U.S. government and state department in fighting a Chinese law that would force them to hands over source code to the agencies of the (Peoples Republic of China) government,” Giancarlo, with a background working in the derivatives industry, said. “Do you think that what we are trying to do here is at odds with our government’s efforts to prevent Chinese obtaining source code of tech firms.”
He noted the German government, upset with Google’s “news coverage” of their policies, has asked to inspect the search firm’s proprietary news search algorithms. Giancarlo said he expects other governments around the world to follow the CFTC’s lead.
Giancarlo and Harts have problems with Reg AT and the special call methodology’s lack of due process. “We live in the United States of America,” Harts said. “We have due process rights guaranteed by the Constitution.”
Harts wants to specifically understand why subpoena power is not enough for investigators. “We are disappointed the CFTC voted to propose a new process that ignores due process and private property rights of US citizens, while not stating if or why the current subpoena process doesn’t work,” Harts said. “Why is there a necessity to bypass these important Constitutional protections and put US businesses’ intellectual property at risk?”
Giancarlo pushed this point hard. “Abrogating the legal rights of property owners is not assuaged by imposing a few additional procedural burdens on the government agency seizing their property,” he said. “Source code owners will have lost any say in the matter. The proposal gives unchecked power to the CFTC to decide if, when and how property owners must turn over their source code.”
Massad, for his part, noted that regulators already had this authority. The National Futures Association, under authority granted by the CFTC, has the ability to inspect the premises of its members and their records without a subpoena.
“If you trade in our markets in old world ways, you are subject to surveillance,” he said, wondering why if someone traded using algorithms the same standard wouldn’t apply. “We are not changing our process but updating rules (to fit with algorithmic markets).” Massad said the slippery slope metaphor is inaccurate. “It’s an uphill climb. Markets have evolved much faster than regulatory framework” and the CFTC needs to keep pace.
In public comments, Giancarlo mentioned the possibility of a lawsuit if the measure is adopted after a 60-day comment period, citing concerns over an expensive legal process that would derail other CFTC enforcement efforts. Harts, for his part, said he hopes the CFTC would abandon what he called a “confused policy” but would not comment on a potential lawsuit.
With Eugene Kanevsky, James Redbourn, and Joanna Wong, CLSA
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