CFTC Issues Supplemental Proposal to Reg AT Automated Trading Regulation | Practical Law

CFTC Issues Supplemental Proposal to Reg AT Automated Trading Regulation | Practical Law

The CFTC approved a supplemental proposal to its Automated Trading Regulation (Reg AT).

CFTC Issues Supplemental Proposal to Reg AT Automated Trading Regulation

Practical Law Legal Update w-004-4517 (Approx. 4 pages)

CFTC Issues Supplemental Proposal to Reg AT Automated Trading Regulation

by Practical Law Finance
Published on 09 Nov 2016 • USA (National/Federal)
The CFTC approved a supplemental proposal to its Automated Trading Regulation (Reg AT).
Update: Public comment on the supplemental proposal has been extended from January 24, 2017 to May 1, 2017. The extension of the comment deadline on the proposed Reg AT supplement was one of the first actions of new acting CFTC Chairman Giancarlo, who is known to oppose CFTC access to proprietary source codes. Comments may be submitted on the CFTC website and on the Federal eRulemaking Portal.
On November 4, 2016, the CFTC approved a supplemental notice of proposed rulemaking to its Automated Trading Regulation. The proposal would effectively expand the CFTC's access to computer codes that drive firms' automated trading strategies, and would bring more high-frequency traders under the CFTC's oversight. The CFTC is accepting public comment on this proposal for 60 days after publication in the Federal Register.
In December of 2015, the CFTC published a notice of proposed rulemaking (NPR) referred to as Regulation Automated Trading (Reg AT) which proposed a series of risk controls, transparency measures, and other safeguards for automated trading on all designated contract markets (DCMs) (see Legal Update, CFTC Proposes Rules on Automated Trading). The goal of Reg AT was to reduce risk and increase transparency in algorithmic order origination and electronic trade execution on all US futures exchanges.
The supplemental proposal would amend Reg AT by:
  • Requiring that algorithmic trading source codes be preserved and made available to the CFTC when necessary by subpoena or a special call approved by the CFTC. The CFTC would also have access to:
    • records that track changes to an AT Person's algorithmic trading source code; and
    • log files that record the activity of an AT Person's algorithmic trading system.
  • Reducing the number of market participants required to register as an "AT Person" by adding a minimum trading-volume-based quantitative test for registration (for more information on AT Persons, see Legal Update, CFTC Proposes Rules on Automated Trading: "AT Person"). This change will focus Reg AT on larger market participants. The CFTC estimates that the proposed volume-based criteria will result in approximately 120 AT Persons.
  • Revising Reg AT's proposed three-level risk control structure to concentrate pre-trade risk controls at a minimum of two levels. Under the new two-level structure, an AT Person would have the option of delegating compliance with pre-trade risk control requirements to its futures commission merchant (FCM). Additionally, risk control requirements would be expanded to encompass electronic trading, including electronic trading at the FCM and DCM levels.
  • Eliminating the obligation of DCMs to review annual compliance reports provided by FCMs and AT Persons. Instead, each DCM would be required to establish a program for effective periodic review of compliance by AT Persons and FCMs with Reg AT, and AT Persons and FCMs would be required to provide the DCM with an annual certification attesting to compliance with Reg AT.
  • Providing AT Persons with the option to comply with certain elements of Reg AT by using third-party algorithmic trading systems.
This supplemental proposal addresses concerns made by commenters regarding Reg AT's access to source code, and clarifies that access to algorithmic trading source code and related records would only be available to the CFTC through either a:
  • Subpoena.
  • In an investigatory proceeding pursuant to part 11 of the CFTC's regulations.
  • Special call authorized and approved by the CFTC and executed by the director of the Division of Market Oversight (DMO).
Currently, the CFTC can only access algorithmic trading source code with a subpoena through its administrative subpoena authority.
CFTC access to algorithmic source code and related resources has given rise to much controversy. Proponents such as CFTC Chairman Massad argue that the CFTC's automated trading regulatory regime should be modernized to provide effective surveillance to parties that trade at human speed as well as those that use machines.
However, opponents, such as the Futures Industry Association (FIA) and CFTC commissioner Giancarlo, expressed concerns regarding the ease with which the CFTC can access source code, fearing that allowing access by means other than a subpoena would, among other things:
  • Permit an unacceptable level of access to proprietary source code used to operate automated trading systems.
  • Strip owners of intellectual property of due process of law by allowing the CFTC to bypass a subpoena process and access source code through a majority vote of the CFTC and the CFTC's special call process (see third bullet, above).
  • Fail to provide adequate assurances that the CFTC will properly safeguard proprietary source codes from hackers and cyber criminals.
The CFTC has also issued a fact sheet and Q&A on the supplemental proposal.