The Commodity Futures Trading Commission is moving forward on a controversial rule to require firms engaged in automated trading to provide access to source code and register what CFTC Chair Timothy Massad said were now the dominant players in markets.

automated trading photo
Photo by AV Hire London

Massad wants access to automated trader source code

Speaking Wednesday in Chicago at the Futures Industry Association (FIA) annual conference, Massad said he was still open to listen to privacy concerns from automated traders, but pledged to move forward with the agency’s controversial proposal.

In June the CFTC asked for comments on its 500-page proposal, Regulation Automated Trading, also known as “Reg AT,” which would mandate traders to place their computer source code into a repository so the regulatory could inspect it for market security concerns. Recent successful spoofing cases brought by the Department of Justice have relied, in part, on the concept of algorithmic intent to determine wrongdoing.

“Automated trading dominates trading,” he told the audience of nearly 1,000 derivatives professionals. “The risk of market disruption posed by use of automated trading is a significant concern that should be addressed.

In press comments after the speech, Massad noted automated traders represent the vast majority of market participants but currently have no oversight or registration. “Every firm I have talked to acknowledges (the CFTC) should have the right to access source code,” Massad told reporters. “We want to protect confidentiality but also ensure the markets are secure.”

Automated trading – CFTC strengthening clearing house security

Massad finds himself CFTC Chair at a significant point in the agency’s history. The traditionally little-noticed regulator, quietly operating in the shadows of the larger Securities and Exchange Commission, finds itself in the middle of derivatives concerns that most recently surfaced in the 2008 financial crisis but were glaringly clear during the 1998 Long Term Capital Management market disruption and visible during the Enron bankruptcy.

To mitigate the negative impact of the next financial crisis, the CFTC is working to ensure that clearing houses, which settle trades between counterparties in the regulated derivatives industry, are subject to daily stress tests and can unwind operations in an orderly fashion if another crisis were to occur. In clearing house transactions, the organization bringing together buyer and seller do not hold directional risk and take the other side of trades, as is often the case in non-cleared derivatives.

The regulator requires derivatives clearing houses to conduct daily stress tests that use as a crisis model the most damaging market downfalls in recent history, including the Lehman bankruptcy that is said to have precipitated the 2008 financial crisis and the recent Brexit vote, where an odd “V shaped” market action caught traders off guard. Massad said the clearing house’s current positions and risk management strategies will be overlaid on top of a diverse set of crisis scenarios to ensure that another 2008 financial crisis could not damage the regulated derivatives industry.

In applying a risk management protocol across the regulated derivatives industry, the CFTC is not just considering prevention of the next financial crisis but recovery after the crisis. “We want to make sure that market players are not incentivized to benefit more from a resolution (government bailout) than they are free market methods to recover after a crisis,” Massad said.

The CFTC is a player in regulated derivatives industry but not the much larger non-cleared bank SWAPs markets.