On November 24, 2015, the CFTC announced the new proposed Regulation Automated Trading (“Reg. AT”), which contains a variety of measures designed to prevent potential market disruptions arising from algorithmic trading. Among other things, Reg. AT proposes certain pre-trade risk and order management controls, the implementation of policies and procedures governing algorithmic trading, and additional registration and reporting obligations. Many of these proposals were foreshadowed in a recent speech by the CFTC Chair, which we blogged about here.
Generally, Reg. AT proposes controls at three levels: the trading firm level, the clearing firm level and the exchange level.
Trading Firms: Under the proposed regulation, “AT Persons” are defined as market participants required to be registered with the CFTC who engage in algorithmic trading on a U.S. Designated Contract Market (a “DCM”) and include Futures Commission Merchants (“FCMs”), swap dealers, major swap participants, floor brokers, commodity pool operators, commodity trading advisers and introducing brokers. AT Persons will be required to implement pre-trade risk and order management controls intended to prevent events that materially degrade the operation of the market, or trading on the market, or cause algorithmic trading in violation of applicable regulations. AT persons also must implement “kill switches” to cause an algorithmic system to stop trading under conditions suggesting market disturbances.
The proposed regulation would also require AT Persons to implement written policies and procedures concerning the development, testing and supervision of Algorithmic Trading Systems (“ATSs”) reasonably designed to prevent ATS-related market disturbances. Among other requirements, the policies and procedures must provide for ATS testing prior to implementation, establish a system for real-time ATS monitoring, and ensure ATS compliance with the Commodity Exchange Act and all applicable Commission regulations. Further, the policies and procedures must develop a system for the designation and training of algorithmic trading staff.
Additionally, AT Persons will face new disclosure, registration and record retention obligations. Under the regulation, AT Persons will be required to notify applicable clearing member FCMs and DCMs if they intend to engage in algorithmic trading, implement the DCMs’ self-trading prevention tools, maintain membership in a Registered Futures Association, and maintain an algorithm source code repository that may be subject to CFTC investigation.
Further, trading firms will be required to maintain books and records related to their compliance with Reg. AT, and to submit annual compliance reports, certified by their CEO or CCO, as well as copies of their written policies and procedures to the DCMs on which they operate.
Clearing Firms (FCMs). FCMs will be required to implement pre-trade risk and order management controls for automated trading orders received from AT Persons. Such controls must include, at a minimum, the pre-trade risk controls imposed on AT Persons and will vary depending on whether the trades were executed via direct access to an exchange or through the FCM as an intermediary.
Proposed Reg. AT also requires FCMs, like AT Persons, to implement written policies and procedures reasonably designed to prevent market disturbances related to algorithmic trading. These policies and procedures must establish a system to ensure that natural persons are alerted, and order cancellation systems employed, when a control parameter is breached. Lastly, FCMs will be subject to similar books and records and certification requirements as AT Persons.
Exchanges (DCMs). Proposed Reg. AT also requires DCMs to design their own pre-trade risk and order management controls for algorithmically and manually executed trades (and provide certain controls to FCMs). Focusing on transparency, the proposed regulation also will require DCMs to provide public disclosure regarding elements of their electronic trade matching platforms that could materially affect market participants, and will oblige DCMs to publically disclose additional information on their market maker and trade incentive programs. DCMs further will be required to establish and provide access to ATS testing environments, require the submission of AT Person and FCM certified risk control compliance reports, and establish and apply (or provide to market participants) self-trade prevention tools.
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CFTC Chair Timothy Massad has stated that the Commission adopted a largely principles-based approach in proposing Reg. AT, and avoided prescribing the precise parameters for the risk controls and management systems that firms and exchanges are required to implement. Instead, the text of the proposed rule is intentionally flexible so that firms may each determine for themselves how required programs and controls should be designed and calibrated. Furthermore, Commissioner Sharon Y. Brown noted that the regulation, in large part, builds off of pre-existing industry best practices. Additional regulatory guidance on the proposed regulation, which will remain subject to public comment for a 90-day period before the rules are finalized, can be found in the Fact Sheet and the FAQs published by the CFTC.