Remarks as prepared:
Good Morning, and welcome to the Committee’s hearing on Regulation Automated Trading.
Over the past three decades, our financial markets have been quietly revolutionized by computers. Sometimes called the “electronification” of markets, computer networks have slowly replaced the traditional trading pits. Electronic markets allow computers to seamlessly input orders, giving rise to trading directed and conducted entirely by computer algorithms.
Electronic markets and algorithms offer easier access, reduced transaction costs, and support sophisticated tools that even the smallest market participants use. Today, algorithmic trading is essential to our futures markets. However, the transition to computers has not been without its challenges. Computer algorithms sometimes interact in unintended ways and markets have suffered disruptions that remain difficult to explain.
In response to this changing market structure, CFTC staff began work several years ago to address the rise of automated trading across its markets. Since 2012, CFTC staff has held roundtables, participated in advisory committee hearings, put forward a concept release, and no doubt held countless other smaller meetings. Regulation Automated Trading represents the culmination of all this work hard work.
Reg AT is summarized as “a comprehensive approach to reducing risk and increasing transparency in automated trading.” While I am certainly supportive of reducing risks and increasing transparency, the approach proposed by the Commission falls short of those goals.
Requiring firms to provide the CFTC and the Department of Justice with on-demand access to sensitive intellectual property is fraught with danger. There is a legitimate fear among market participants that allowing more people, even regulators, to view and store their intellectual property increases their cybersecurity risks.
While the rule is unclear about the CFTC’s intentions, at least one interest group interpreted the rules to suggest that the CFTC will use its newly self-granted authority to “involve itself in the workings of [automated trading systems] to anticipate problems…” Such an interpretation of the rule would require CFTC staff to oversee hundreds of algorithmic trading companies, each running dozens of interdependent algorithms, each written with tens of thousands of lines of code. It isn’t a stretch to say that using source code to “anticipate problems” in the market place would require CFTC analysists to interpret hundreds of millions of lines of code.
The CFTC cannot perform even a fraction of that work in any meaningful way. Yet, absent such a proactive effort to monitor algorithms, it is unclear why else the Commission would require source code be produced without a subpoena.
Reg AT creates a definition, the AT Person, to identify the entities covered by rule which must comply with all of the registration, reporting, testing, compliance, control, and source code repository requirements. Included in that definition are any entities already registered by the CFTC and “engaged in algorithmic trading,” as well as those registered as floor traders. Twenty-five years ago, this Committee sought to prevent individuals with felonies from trading in the pits by requiring the individuals trading for their own account in futures pits to register as floor traders, be fingerprinted, and undergo background checks.
Under Reg AT, this concept is being repurposed to try and expand the categories of registered market participants, despite no Congressional change to the current registration requirements. Beyond the obvious legal question, there is a practical problem to using the floor trader definition in this way: the new definition of floor trader could wind up unintentionally capturing thousands of end-users as AT Persons. Reg AT’s vague boundaries and prescriptive requirements conspire to create a rulemaking that is overly complicated, yet still incomplete.
However, the rule does not have to be this complicated. The most confusing parts of Reg AT – the source code rules, the registration regime, the reporting requirements, and the inflexible risk controls – are unnecessary to achieve the Commission’s stated goals. Market participants already have incentives to police bad algorithms, prevent disruptions, and plan for recovery. In many cases, there are already ongoing processes across the industry to impose and refine risk controls. A more modest proposal by the Commission might start by leveraging these inherent incentives and requiring universal adoption of a flexible framework for best practices.
While I believe the instincts and intentions of the rule are good, its broad scope and sweeping requirements lead me to conclude that it cannot be implemented in its current form. I am heartened that Chairman Massad is open to finalizing the rule in phases and taking more time to get it right. I look forward to seeing the Commission’s next proposal.
I’ll close by thanking today’s witnesses, each of whom traveled from out of town to be here today. We appreciate you for taking the time to prepare testimony and your willingness to share your expertise with us. Thank you.
With that, I’ll turn to the Ranking Member for his remarks.
