UNITED STATES OF AMERICA

 COMMODITY FUTURES TRADING COMMISSION

 OPEN MEETING OF THE COMMISSION

 Washington, D.C.

 Tuesday, November 24, 2015
 

 

 2 

 1 PARTICIPANTS:

 2 Commissioners:

 3 CHAIRMAN TIMOTHY G. MASSAD

 4 COMMISSIONER SHARON Y. BOWEN

 5 COMMISSIONER J. CHRISTOPHER GIANCARLO

 6 CFTC Staff:

 7 VINCE MCGONAGLE

 Division of Market Oversight

 8 

 SEBASTIAN PUJOL

 9 Division of Market Oversight

 10 MARILEE DAHLMAN

 Division of Market Oversight

 11

 JOSEPH OTCHIN

 12 Division of Market Oversight

 13 JOHN DUNFEE

 Office of General Counsel

 14

 CHRISTOPHER KIRKPATRICK

 15 Secretary of the Commission

 16

 17

 18

 19 * * * * *

 20

 21

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 3 

 1 P R O C E E D I N G S

 2 (9:00 a.m.)

 3 CHAIRMAN MASSAD: Good morning. The

 4 meeting will come to order. This is a public

 5 meeting of the Commodity Futures Trading

 6 Commission. I'd like to welcome members of the

 7 public, market participants, and members of the

 8 media, as well as those taking part on the phone

 9 or via webcast.

 10 Today we are considering a proposal that

 11 addresses the increased use of automated trading

 12 in our markets. In the futures markets, today

 13 almost all trading is electronic in some form.

 14 And over the last few years, more than 70 percent

 15 of all trading has become automated.

 16 Automated trading has brought many

 17 benefits to market participants. These include

 18 more efficient execution, lower spreads, and

 19 greater transparency. But its extensive use also

 20 raises important policy and supervisory questions

 21 and concerns. The Commission has already taken a

 22 number of steps to respond to the development of
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 automated trading in our markets.

 2 Following the 2010 flash crash, the CFTC

 3 worked with the SEC to establish certain controls

 4 to minimize the risk of market disruptions. The

 5 Commission has also required clearing members to

 6 implement policies and procedures governing the

 7 use of automated trading programs. And we've

 8 required automatic screening of orders for

 9 compliance with risk limits if they are

 10 automatically executed. But as markets continue

 11 to evolve it is important to continue looking at

 12 this issue.

 13 And, therefore, in September 2013, the

 14 Commission issued a Concept Release that requested

 15 public comment on the necessity and operation of a

 16 variety of risk controls and measures. The

 17 Commission received many written comments and also

 18 held a meeting of its Technology Advisory

 19 Committee to discuss the issues raised. The

 20 Concept Release served as a very useful way to

 21 understand existing industry practices and discuss

 22 what further actions might make sense.
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 The proposal we are considering today

 2 addresses several areas discussed in the Concept

 3 Release and incorporates much of the public input.

 4 It focuses on minimizing the potential for

 5 disruptions and other operational problems that

 6 may arise from the automation of order

 7 origination, transmission, or execution. This may

 8 come about due to malfunctioning algorithms,

 9 inadequate testing of algorithms, errors, and

 10 similar problems.

 11 Now, no set of rules can prevent all

 12 such problems, but that doesn't discharge us from

 13 our duty to take reasonable measures to minimize

 14 these risks. It is our responsibility as

 15 regulators to create a framework that promotes the

 16 integrity of these markets and I believe the

 17 proposal we are considering today helps do just

 18 that.

 19 In a moment, we will hear presentations

 20 from the staff to outline the proposal. And I

 21 want to note that this proposal is the product of

 22 a lot of hard work by the CFTC staff over a
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 significant period of time. And I want to thank

 2 all of them for that effort. The work to draft

 3 the Concept Release began in early 2013 and, in

 4 particular, I'd like to thank our staff members

 5 from the Division of Market Oversight who led this

 6 effort; the staff from the Office of the Chief

 7 Economist and the Office of the General Counsel,

 8 who made major contributions; and staff from other

 9 divisions who have helped, as well.

 10 With that, I would like to recognize my

 11 fellow Commissioners for their opening statements

 12 and I will turn first to Commissioner Bowen.

 13 COMMISSIONER BOWEN: Thank you. It's a

 14 pleasure to be here this morning to vote on the

 15 proposed rule on automated trading. I want to

 16 thank the Commission staff for the time they

 17 devoted on this proposal.

 18 As I have previously said, our markets

 19 have seen immense technological change in the last

 20 15 years. In particular, algorithmic trading has

 21 substantially increased. Sadly, we still do not

 22 have comprehensive, precise data on the percentage
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 of trades created or entered by algorithms in many

 2 of our product classes. Clearly, further research

 3 and work remains for all stakeholders, from

 4 regulators to industry participants, to academics

 5 and advocates of financial reform.

 6 Yet I do not believe that this lack of

 7 information requires that regulators passively

 8 wait for information to emerge. As I said earlier

 9 this fall, even though the amount of algorithmic

 10 trading and definitions of various terms are not

 11 crystal clear, what is clear is that trades

 12 involving algorithms make up a substantial portion

 13 of our markets and algorithms can and do

 14 malfunction at times with negative effects on the

 15 markets. As a result, I believe we are obligated

 16 to consider if it is prudent to establish some

 17 regulations on algorithmic trading in our markets.

 18 Today, we begin this process of

 19 potentially establishing those regulations. I

 20 believe the proposed regulation meets the

 21 standards of establishing a reasonable regulation

 22 on this technology, and it does so in a way that
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 allows for innovation and continued development of

 2 this nascent technology.

 3 Having said what I think lies at the

 4 core of this regulation, let me also be clear

 5 about what this regulation is not. The rule

 6 before us today should not substantially change

 7 how many firms use algorithms. In effect, this 

 8 rulemaking largely formalizes and mandates firms

 9 involved in algorithmic trading to engage in a

 10 variety of practices that they should already be

 11 doing for their own protection.

 12 I expect that some observers will have

 13 issues with this regulation for not doing more to

 14 constrain growth and use of algo-trading. And I

 15 expect that there will be further debate. I do

 16 not regard this regulation as the final word on

 17 the regulation of algo-trading. If there is clear

 18 evidence that more precise regulations are needed

 19 on this technology to protect investors or to ward

 20 off systemic risk, I would support further

 21 regulatory action. And I'm sure that given the

 22 ferocious rate of change of this technology we
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 will need to update this regulation regularly to

 2 account for those changes.

 3 In many ways this regulation is merely

 4 the first step in a process. It's a starter home

 5 rather than a two-story. But we have to start

 6 somewhere and starting with something that

 7 formalizes best practices and increases disclosure

 8 is an excellent place to start. I've said

 9 numerous times that I support smart regulation,

 10 regulation that works.

 11 That goal is especially critical when it

 12 comes to regulation to such a new, significant,

 13 and widespread technology as algo-trading. I,

 14 therefore, hope we'll get comments on this

 15 proposal from a wide swath of stakeholders, from

 16 industry participants to end users being affected

 17 by this technology, to even ordinary citizens and

 18 investors about the potential effects of

 19 algo-trading on commodity prices.

 20 I do not expect that everyone will have

 21 the same views on the subject. Even though I've

 22 only been in Washington about a year and a half,
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 I've experienced enough to know that people have

 2 different opinions on high-visibility issues such

 3 as this one. However, I do encourage people to

 4 comment so that we can get a full and fair read on

 5 popular opinion. And if people have concrete

 6 evidence that algo-trading is distorting markets

 7 and needs to be curtailed, please submit it with

 8 your comments.

 9 In closing, let me stress again that I

 10 want this rule to be both effective and workable.

 11 No one benefits from rules that work in the

 12 abstract, but are confusing, impossible to

 13 implement as written, or are full of gaps that

 14 prompt widespread regulatory arbitrage. I believe

 15 this proposal is a commonsense effort to

 16 establishing reasonable regulation of this

 17 automated trading. But if there are flaws with

 18 it, if it goes too far or not far enough, I want

 19 to know about that now before it is finalized.

 20 Thank you and I want to wish you all a

 21 safe and happy Thanksgiving holiday.

 22 CHAIRMAN MASSAD: Thank you,
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 Commissioner Bowen. Commissioner Giancarlo.

 2 COMMISSIONER GIANCARLO: Thank you. The

 3 electronification of trading over the past 30 to

 4 40 years and the advent of exponential digital

 5 technologies have transformed financial

 6 businesses, markets and entire economies. In U.S.

 7 Futures markets we see this change most presently

 8 in the area of automated trading that can lower

 9 transaction costs while increasing trader

 10 productivity through greater transaction speed,

 11 precision and sophistication. For many markets,

 12 automated trading brings trading liquidity,

 13 broader market access, enhanced transparency and

 14 greater competition.

 15 At the same time, automated trading

 16 presents new challenges. They include increased

 17 risk of sudden spikes in market volatility and

 18 phantom liquidity arising from the sheer speed of

 19 execution. They also include the risk of data

 20 misinterpretation by computerized analysis and

 21 mathematical models that increasingly replace

 22 human thought and deliberation.
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 Legal scholars raise important questions

 2 about the viability of traditional regulatory

 3 methods and concepts in automated trading markets.

 4 How markets and regulators adjust to this change

 5 from human to automated trading will be extremely

 6 important. It requires delicate balancing. To

 7 ensure vibrant, accessible and durable markets, we

 8 must embrace effective safeguards without harming

 9 innovation and promising market development.

 10 In turning to Reg AT, my staff and I

 11 brought dozens of issues and concerns to the

 12 Division of Market Oversight. While they were

 13 responsive to a few topics, many other issues

 14 require much further attention and consideration

 15 that I have summarized at length in my written

 16 statement released this morning.

 17 Still, after reading through the almost

 18 500 pages of the proposal I'm left with one major

 19 question: Does this proposal sufficiently benefit

 20 the safety and soundness of America's futures

 21 markets to outweigh its additional cost and

 22 burdens? I wish the answer was more clear.
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 I have three main concerns with

 2 Regulation AT. First, some of the requirements of

 3 the rule appear to be window dressing. That is

 4 especially the case in its requirement for

 5 development and implementation of risk controls

 6 and related testing standards that the industry

 7 has already widely adopted.

 8 Second, I'm concerned about the high

 9 cost and burdens of the proposal, especially on

 10 smaller market participants. And I'm especially

 11 concerned about its requirement that registrants

 12 hold their proprietary source code in data

 13 repositories available for inspection at any time,

 14 for any reason, to any representative of the CFTC

 15 or the U.S. Department of Justice.

 16 Third, I question the regulatory

 17 inconsistencies regarding the market participants

 18 who must comply with this rulemaking.

 19 A year ago, I set forth six principles

 20 that I would follow as I evaluate financial market

 21 regulations at the CFTC. Those principles were

 22 compiled into a mnemonic that I call SMART REG,
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 and it stands for: Solve real problems, not

 2 anecdotes of bad behavior; measure success through

 3 sound cost-benefit analysis; advance innovation

 4 and competition through flexible rules; represent

 5 the best approach amongst alternatives; take into

 6 account evidence, not assumptions; realistically

 7 set compliance deadlines; encourage employment of

 8 U.S. workers; and be grounded in law. These are

 9 the measuring rods that I will apply to Reg AT.

 10 I look forward to hearing

 11 well-considered views of market participants on

 12 whether this proposal passes muster. I will

 13 release a longer statement that will be included

 14 in the proposal and I encourage the public to

 15 weigh in on the numerous questions I pose that

 16 should be considered during the comment period.

 17 Thank you.

 18 CHAIRMAN MASSAD: Thank you. The staff

 19 will now make a presentation to the Commission on

 20 the proposed rule. After each presentation, the

 21 floor will be open for questions and comments from

 22 each of the Commissioners. Following the close of
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 discussion, the Commission expects to vote on the

 2 staff recommendation as presented. The final vote

 3 conducted in this public meeting shall be

 4 recorded. The results of a vote approving the

 5 issuance of a rulemaking document will be included

 6 with that document in the Federal Register.

 7 At this point I ask unanimous consent to

 8 allow staff to make technical corrections to the

 9 document voted on today prior to sending it to the

 10 Federal Register.

 11 COMMISSIONER GIANCARLO: No objection.

 12 CHAIRMAN MASSAD: Without objection, it

 13 is so ordered. And at this time, I would like to

 14 welcome Vince McGonagle, Sebastian Pujol, Marilee

 15 Dahlman, Joseph Otchin, all from the Division of

 16 Market Oversight, and John Dunfee, from the Office

 17 of General Counsel, for their presentations on the

 18 proposal. Thank you.

 19 MR. PUJOL: Good morning, Mr. Chairman

 20 and Commissioners, and thank you. I'd like to

 21 begin today by thanking my fellow team members for

 22 their hard work in preparing the proposals that we
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 are about to present. Dedicated staff from across

 2 the offices and divisions of the Commission were

 3 essential to completing the materials before you

 4 this morning.

 5 I would particularly like to acknowledge

 6 Mike Penick, Richard Haynes, Meghan Tente, Adam

 7 Kezsbom, John Dunfee, Andrew Ridenour, Joe Otchin,

 8 and especially Marilee Dahlman and Mark Schlegel

 9 as members of the rulemaking team.

 10 Today, staff is recommending that the

 11 Commission approve a Notice of Proposed Rulemaking

 12 regarding automated trading on U.S. designated

 13 contract markets. The proposed rules, known as

 14 "Regulation Automated Trading," or Reg AT, reflect

 15 a comprehensive approach to reducing risk and

 16 increasing transparency in both algorithmic order

 17 origination and electronic trade execution.

 18 The proposed rules would enhance the

 19 Commission's regulatory regime to keep pace with

 20 evolving markets and technologies, and would

 21 promote the continued safety and soundness of

 22 trading on U.S. derivatives markets. As a
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 threshold matter, Reg AT takes a multilayered

 2 approach to pre-trade and other risk controls with

 3 key entities in the life of an order each

 4 implementing controls that are similar in nature,

 5 but calibrated to their individual needs.

 6 Relevant entities and risk control

 7 layers for purposes of Reg AT include trading

 8 firms generating algorithmic orders; clearing

 9 FCMs, who are responsible for risk-filtering such

 10 orders; and DCMs. In each case, the proposed

 11 rules provide for flexibility in the

 12 implementation of required risk controls while

 13 simultaneously helping to ensure a uniform

 14 regulatory baseline for all relevant market

 15 participants.

 16 The basic structure of Reg AT includes

 17 four elements. First, it proposes to require the

 18 registration of persons engaged in proprietary

 19 algorithmic trading on a DCM via direct electronic

 20 access, or DEA. Such persons would be required to

 21 register under an amended definition of "floor

 22 trader," and would be subject to all relevant
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 requirements of the proposed rules. Through

 2 registration, Reg AT would help address a

 3 population of entities with a significant impact

 4 on Commission-regulated markets, but who are not

 5 currently subject to direct oversight by the CFTC.

 6 Second, Reg AT proposes to codify "AT

 7 Person" as a defined term in the Commission's

 8 rules. AT Persons would include the new floor

 9 traders described previously, as well as FCMs,

 10 floor brokers, swap dealers, major swap

 11 participants, commodity pool operators, commodity

 12 trading advisors, and introducing brokers engaged

 13 in algorithmic trading. In this regard, staff

 14 notes that "AT Person" is an important

 15 organizational concept in the proposed rules as it

 16 identifies those entities that would be subject to

 17 key requirements in Reg AT.

 18 With respect to AT Persons, the proposed

 19 rules include a range of pre-trade risk controls

 20 and related measures designed to reduce potential

 21 risks in algorithmic trading. Such measures

 22 include, for example, controls for maximum order
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 frequency and maximum order size. Other elements

 2 of the proposed rules applicable to AT Persons

 3 include order cancellation capabilities; standards

 4 for the development, testing, and supervision of

 5 algorithmic trading systems, or ATSs; and

 6 requirements that AT Persons provide DCMs with

 7 certain compliance reports regarding their pre- 

 8 trade risk controls.

 9 A third element of Reg AT includes

 10 pre-trade risk control requirements for both DCMs

 11 and clearing member FCMs with respect to their

 12 customers engaged in algorithmic trading. Such

 13 pre-trade risk controls would be similar to those

 14 required for AT Persons, including, for example,

 15 maximum order frequencies and maximum order sizes.

 16 Reg AT would also require basic

 17 compliance reports from clearing FCMs and would

 18 require that DCMs review compliance reports

 19 submitted to them.

 20 Finally, in addition to pre-trade risk

 21 controls, Reg AT is intended to accomplish a

 22 number of goals focused more closely on DCMs.
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 These include greater transparency around DCMs'

 2 electronic trade matching platforms, promoting the

 3 use of self-trade prevention tools, and greater

 4 transparency in DCM market maker and trading

 5 incentive programs. Each of these provisions will

 6 be described in greater detail over the course of

 7 this presentation.

 8 The proposals in Reg AT build on

 9 numerous efforts by entities in recent years to

 10 promote best practices and regulatory standards

 11 for automated trading, including standards for

 12 ATSs and for electronic trade matching. In

 13 preparing Reg AT, staff considered comments

 14 received in response to the Commission's 2013

 15 Concept Release. Staff also evaluated initiatives

 16 by fellow regulators, industry participants, and

 17 others to develop regulatory standards and best

 18 practices. Particularly in the area of pre-trade

 19 risk controls, the proposed rules leverage

 20 existing industry practices and seek to create an

 21 agreed-upon baseline for the mitigation of risks

 22 in automated trading.
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 Mr. Chairman and members of the

 2 Commission, with that overview in place, I'll turn

 3 to my colleague, Marilee Dahlman, for more

 4 detailed information on the pre-trade risk

 5 controls and related measures applicable to AT

 6 Persons, DCMs, and clearing FCMs under the

 7 proposed rules.

 8 MS. DAHLMAN: A fundamental element of

 9 Reg AT is a new Regulation 1.80, which requires

 10 that AT Persons implement certain risk controls.

 11 Regulation 1.80 would require AT Persons to

 12 implement pre-trade risk controls, order

 13 cancellation systems, and other measures

 14 reasonably designed to prevent a market disruption

 15 caused by an algorithmic trading malfunction.

 16 The required pre-trade risk controls

 17 are: Maximum order message frequency and maximum

 18 execution frequency per unit time, order price

 19 parameters, and maximum order size limits. The

 20 regulation would also require order cancellation

 21 systems with an ability to immediately disengage

 22 algorithmic trading and prevent the submission of
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 new orders.

 2 Consistent with comments received in

 3 response to the Concept Release, proposed 1.80

 4 provides market participants latitude in the

 5 design of required controls and, in fact, requires

 6 only a small number of specific controls that the

 7 Commission understands are already widely

 8 implemented by likely AT Persons. The proposed

 9 regulation does not mandate specific limits,

 10 calibrations, or even vendor technologies that AT

 11 Persons must use in implementing the required

 12 controls.

 13 With respect to clearing member FCMs,

 14 Reg AT proposes a new Regulation 1.82 to require

 15 clearing FCMs to implement pre-trade risk and

 16 other controls with respect to their AT Person

 17 customers. Proposed 1.82 requires that clearing

 18 FCMs implement the same types of pre-trade and

 19 other risk controls described above with respect

 20 to AT Persons.

 21 The location of the pre-trade and other

 22 risk controls that would be required of clearing
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 FCMs varies according to whether orders from an AT

 2 Person customer are placed through DEA or

 3 intermediated by the clearing FCM. In the case of

 4 algorithmic trading orders submitted through DEA,

 5 the pre-trade and other risk controls would be

 6 established by and located at the DCM, but be

 7 controlled or calibrated by the clearing FCM. For

 8 non-DEA algorithmic trading orders, the controls

 9 would not reside at the DCM. Instead, the

10 clearing FCM itself would establish the pre-trade

11 risk and other controls with respect to such

12 orders.

13 Finally, as to risk control requirements

14 on DCMs, Reg AT includes a new Regulation 40.20

15 that would require DCMs to establish pre-trade and

16 other risk controls designed to address the risks

17 that may arise from algorithmic trading on the

18 DCM. The controls required of DCMs in Regulation

19 40.20 are similar to those required of AT Persons

20 in proposed 1.80 and of clearing member FCMs in

21 1.82. Regulation 40.20 also would require

22 pre-trade risk controls and order cancellation
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 capabilities for orders that do not originate from

 2 algorithmic trading.

 3 Reg AT would also address the

 4 development, monitoring, and compliance of ATSs.

 5 Proposed Regulation 1.81 requires AT Persons to

 6 adopt written policies for developing, testing,

 7 and monitoring their ATSs. Taken together, the

 8 goal of these requirements is to standardize a set

 9 of principles in order to reduce the operational

10 risk of ATSs.

11 To provide two examples of these

12 procedures, Regulation 1.81 would require AT

13 Persons to implement written policies and

14 procedures for the development and testing of

15 ATSs, so as to better identify coding errors and

16 other problems that could arise in live trading.

17 Regulation 1.81 would also require each AT Person

18 to implement written policies and procedures to

19 designate and train its staff responsible for

20 algorithmic trading.

21 MR. PUJOL: In addition to the

22 provisions described by Marilee regarding
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 pre-trade and other risk controls, Reg AT also

 2 includes several important initiatives addressing

 3 transparency, market maker and trading incentive

 4 programs, and self-trading on DCMs. Each of these

 5 has come into greater focus through the increased

 6 automation of markets and market participants.

 7 With respect to transparency, Reg AT

 8 would codify two important requirements. First,

 9 the proposed rules would amend existing Commission

10 regulations to enhance transparency around the

11 design and operation of DCMs' electronic matching

12 platforms. Existing Commission Regulation 38.401

13 requires DCMs to disclose to both the Commission

14 and the public information regarding the rules and

15 specifications of their electronic matching

16 platforms. The proposed amendments to 38.401

17 would clarify that a DCM's obligations include

18 disclosure of any known attributes of a platform

19 that materially impact market participant orders.

20 This could include, for example, attributes that

21 impact the time or the priority of an order or

22 attributes that impact the dissemination of market
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 data or confirmations to market participants.

 2 Second, Reg AT would require DCMs to

 3 provide the Commission and the public with

 4 additional information regarding their market

 5 maker and trading incentive programs. Again,

 6 building on existing Commission requirements,

 7 proposed Regulation 40.25 would require DCMs to

 8 provide information regarding eligibility

 9 criteria, program payments or benefits, and market

10 participants' obligations pursuant to a market

11 maker or trading incentive program. The proposed

12 rules would also require DCMs to implement

13 policies and procedures reasonably designed to

14 prevent the payment of program benefits for trades

15 between accounts that are known to the DCM as

16 being under common ownership.

17 With respect to self-trading, Reg AT

18 focuses on both transparency and prevention. The

19 proposed rules would require a new Regulation

20 40.23 that DCMs provide or apply tools reasonably

21 designed to prevent self-trading. The proposed

22 rules define self-trading as the matching of
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 orders for accounts that have common beneficial

 2 ownership or are under common control as known by

 3 the DCM or identified to it by market

 4 participants.

 5 In response to public comments on the

 6 Concept Release, the proposed rules would allow

 7 DCMs to exercise discretion in the design and

 8 implementation of their self-trade prevention

 9 tools. For example, DCMs would have latitude to

10 permit self-trades between accounts under common

11 ownership if such trades were originated by

12 independent decision makers. While allowing for

13 such permitted self-trades, the rules would

14 require DCMs to publish quarterly statistics

15 regarding the amount of permitted self-trading

16 occurring on their markets.

17 Finally, to help ensure that Reg AT

18 remains current as markets and trading

19 technologies evolve, the proposed rules would

20 leverage the role of registered futures

21 associations, such as the NFA, in the Commission's

22 oversight regime. Reg AT would require a new
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 Regulation 170.18 that all AT Persons become

 2 members of an RFA. The proposed rules would

 3 further require RFAs to consider membership rules

 4 addressing algorithmic trading for each category

 5 of member in the RFA. Taken together, these

 6 provisions would allow RFAs to supplement elements

 7 of Reg AT in the future in response to industry

 8 developments.

 9 Mr. Chairman and members of the

10 Commission, this concludes staff's presentation of

11 Regulation Automated Trading. We note that the

12 Notice of Proposed Rulemaking includes over 160

13 questions on almost every aspect of the proposal.

14 Reg AT would be open for a 90-day comment period,

15 and all comments and responses are highly welcome.

16 Thank you very much for your time and

17 for your attention. And we would be happy to

18 answer any questions that you may have for us.

19 CHAIRMAN MASSAD: Thank you, Sebastian,

20 Marilee, and everyone on the team for those very

21 informative presentations.

22 To begin the Commission's discussion and
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 consideration of this rulemaking I will now

 2 entertain a motion to adopt the proposed rule as

 3 presented by the staff.

 4 COMMISSIONER BOWEN: So moved.

 5 CHAIRMAN MASSAD: Is there a second?

 6 COMMISSIONER GIANCARLO: Second.

 7 CHAIRMAN MASSAD: Let me begin then.

 8 We'll each have time for questions or further

 9 statements. I don't have any questions. I will

10 make a few comments. I will be issuing a written

11 statement in support of the rule -- or the

12 proposal.

13 Let me just say I strongly support the

14 proposal. I think it contains a number of

15 commonsense risk controls that I believe recognize

16 the benefits that automated trading has brought to

17 our markets while also seeking to protect against

18 the possibility of breakdowns and disruptions that

19 can come with it.

20 I think the multilevel approach, of

21 having controls at the exchange, the clearing

22 member, and the trading firm level is the right
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 one.

 2 And I also believe the proposal does a

 3 good job of reflecting industry-based best

 4 practices and devising standards that are

 5 principles-based and not overly prescriptive. And

 6 in this regard, I will just note the release we

 7 are issuing today is close to 500 pages. The rule

 8 itself is 19 pages.

 9 The 465 pages, of course, include the

10 preamble, 150 questions which I think appear

11 twice, the cost-benefit considerations, the

12 Paperwork Reduction Act analysis, the Regulatory

13 Flexibility analysis -- all very important

14 elements. The rule itself is 19 pages.

15 I commend the staff for their hard work

16 and diligence, particularly in incorporating

17 feedback from market participants on the Concept

18 Release. The proposal will be subject to public

19 comment for 90 days and I look forward to hearing

20 from market participants and members of the

21 public.

22 I want to just highlight a couple of
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 1 features of the rule. The first, of course, is

 2 the registration requirement for proprietary

 3 traders who access the market directly and who

 4 engage in algorithmic trading on regulated

 5 exchanges. This would ensure that all those with

 6 direct electronic access to our markets are

 7 complying with pre-trade risk controls, testing,

 8 and other requirements. And it would enhance the

 9 Commission's ability to carry out its oversight

10 responsibilities.

11 I look forward to public comment on this

12 requirement. Among the questions we have asked

13 are whether there are additional characteristics

14 of algorithmic trading firms that should be taken

15 into consideration for registration purposes. And

16 alternatively, should all firms trading through

17 direct electronic access be required to register,

18 even if they are not using algorithmic trading?

19 Many of the requirements we are

20 proposing, as the staff noted, for trading firms

21 represent the best practices already followed by

22 many firms, including larger firms. We know,
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 32

 1 however, that a faulty algorithm at a single firm,

 2 regardless of size, can potentially cause a

 3 significant problem. And as a result, we have

 4 proposed standards that are applicable regardless

 5 of size or similar attributes of a trading firm.

 6 We are cognizant of the importance of

 7 establishing effective standards without creating

 8 barriers to entry for small firms. And,

 9 therefore, I look forward to public comment on

10 whether the requirements we are proposing for

11 trading firms should vary in any way, depending on

12 size or activity level.

13 We've also proposed certain risk

14 controls at the clearing member Futures Commission

15 Merchant level with respect to their customers

16 engaged in algorithmic trading. FCMs play a

17 critical role in overall risk management, and I

18 support the requirements we are proposing today to

19 help achieve an effective multilayered approach.

20 But I look forward to public comment on whether

21 there are any aspects of those required controls

22 that may pose an undue burden on clearing member
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 33

 1 FCMs or that are unnecessary for reducing the

 2 risks associated with algorithmic trading. We've

 3 also asked about what technological development

 4 would be required by clearing members to comply

 5 with some requirements of this proposal.

 6 I've said often that it's very important

 7 that we have a robust clearing member industry and

 8 that all customers, particularly smaller ones, are

 9 able to access the markets effectively and

10 efficiently. And so we want to make sure this

11 proposal is consistent with achieving that

12 objective. It's important that we achieve a

13 proper balance between controls and measures at

14 the exchange, clearing member, and trading firm

15 level. And so we will seek efficiency and avoid

16 conflicting or unnecessary requirements among

17 those controls. On this and many other issues,

18 public comment will be very helpful.

19 So let me just conclude by saying that I

20 support the proposal as an important step to

21 ensure that we are meeting our responsibility to

22 put forth commonsense regulation that will
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 34

 1 minimize the potential for problems that may arise

 2 from automated trading. And I again wish to thank

 3 the staff for their excellent work.

 4 I would now like to open the floor to

 5 allow the Commissioners to ask any questions or

 6 make any further statements that they have. And I

 7 will turn first to Commissioner Bowen.

 8 COMMISSIONER BOWEN: Yes, thank you. I,

 9 too, have submitted a statement for your review,

10 but I want to highlight a concern that I have that

11 we may not be asking enough of our registrants,

12 particularly for them to submit information in

13 their annual reports pursuant to Section 1.83(a).

14 We've all read accounts about firms

15 going to Silicon Valley and colleges to recruit

16 quants. So I think it would be helpful for us to

17 ask a little bit more about the adequacy of the

18 training of these employees. And so I would hope

19 that with the final regulation that we would

20 expand the scope of some of the questions that we

21 would be asking these firms to certify on an

22 annual basis.
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 35

 1 CHAIRMAN MASSAD: Commissioner

 2 Giancarlo.

 3 COMMISSIONER GIANCARLO: Thank you,

 4 Chairman. I'd like to ask a few questions

 5 perhaps, Sebastian, of you, if I may.

 6 My understanding is that currently the

 7 Commission or the Justice Department may only

 8 obtain source code from a market participant

 9 pursuant to a subpoena or consent of that party.

10 Is that correct?

11 MR. McGONAGLE: Yes. Good morning,

12 Commissioner. So to the extent that the records

13 are maintained by the certain category of

14 registrants under 1.31, the Commission has

15 authorization potentially under the Commodity

16 Exchange Act Section 4g, as well as under

17 Regulation 1.31 for inspection of records. There

18 is a difference between CFTC's staff investigative

19 rights and ability to obtain copies of

20 information, if necessary. And, of course, that's

21 going to be in furtherance of staff's

22 responsibilities to evaluate compliance with the
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 36

 1 Commodity Exchange Act and the regulations.

 2 Separately, the Department of Justice,

 3 to the extent that records are available for

 4 inspection, under 1.31 the Department of Justice

 5 can otherwise inspect certain records as set forth

 6 in the regulations. And then --

 7 COMMISSIONER GIANCARLO: Vince. Excuse

 8 me.

 9 MR. McGONAGLE: Yes.

10 COMMISSIONER GIANCARLO: Records I

11 understand. Records are records of past

12 activities. But source code, intellectual

13 property of market participants, would that

14 require a subpoena or can that be obtained

15 similarly in the way you're describing?

16 MR. McGONAGLE: So I think during the

17 course of the comment period there will be some

18 articulation and questions, comments raised about

19 the nature and scope of 1.31 and how far into

20 transactions or records you would be otherwise

21 entitled to reach as part of a regular inspection

22 authority. Certainly, if there is a subpoena
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 37

 1 that's involved, then that would be pursuant to

 2 whatever authorization issues in connection with

 3 the subpoena.

 4 COMMISSIONER GIANCARLO: Sure, but, you

 5 know, neither of us are technologists, but I think

 6 basic technology would say that a software

 7 algorithm is different than a record. One is an

 8 operating system, a protocol, another one is a

 9 record of historic or current events. I think

10 there's a distinction when you're asking for

11 information that concerns positions of a market

12 participant, but then that's different than an

13 algorithm that would show in the event of certain

14 future events what that market participant would

15 do, what positions they would take in the event of

16 certain events in the future.

17 Are you saying that's subject to

18 interpretation, however?

19 MR. McGONAGLE: So I certainly

20 appreciate the comment and the question about what

21 is the scope of the recordkeeping responsibility

22 and whether a record is actually an electronic
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 38

 1 file. And then if so, does that reach to the

 2 source code?

 3 And so I think that further analysis

 4 under 1.31 would tease out the applicability of

 5 the books and records requirements. There is a

 6 provision in connection with Reg AT that would

 7 treat the source code as a books-and-record

 8 pursuant to 1.31. So I do think that that

 9 potentially calls in the right to inspection.

10 COMMISSIONER GIANCARLO: Do you know

11 whether the SEC has the right to obtain source

12 code or algorithms from their registrants?

13 MR. PUJOL: We have looked at some of

14 the measures that the SEC has done that are in 

15 parallel to Reg AT. I'm not aware of measures

16 within that particular sort of channel, but I

17 don't know whether SEC authorities more broadly

18 would allow them to treat this as a book and

19 record.

20 COMMISSIONER GIANCARLO: Certainly the

21 law of either intellectual property or accountancy

22 would treat algorithm software as intellectual
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 39

 1 property and not as books and records. Do you

 2 know of any other federal agency that has the

 3 right to obtain intellectual property of

 4 registrants without a subpoena? Does the Food and

 5 Drug Administration, for example, have the right

 6 to obtain, say, Coca-Cola's special formula

 7 without a subpoena?

 8 MR. McGONAGLE: So I appreciate that

 9 question and I would say that I'm not an expert in

 10 that area of the law, so I'm not able to address

 11 that. But for systems safeguards, for example, an

 12 expectation is that the Commission oversight

 13 responsibility, that we would have the ability to,

 14 again, ensure that there is compliance with the

 15 Commodity Exchange Act and the regulations

 16 recognize that there are significant issues with

 17 respect to proprietary information and the need to

 18 maintain confidentiality and the balance for

 19 regulatory responsibilities.

 20 And so I think, you know, as we propose

 21 an NPRM, we are looking for comment with respect

 22 to access to, and utilization of, this information
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 40

 1 in furtherance of our responsibilities.

 2 COMMISSIONER GIANCARLO: So let's say

 3 that this proposal goes forward as you would

 4 interpret it and we have this right to obtain

 5 intellectual property, algorithms, source code

 6 without a subpoena, I guess pursuant to a special

 7 call process. Do we have the capabilities here at

 8 the Commission to actually do anything with that

 9 source code? Can we interpret it? Do we know how

10 to read it? What would we do with it?

11 MR. McGONAGLE: So the ability to pull

12 in the information, you know, on an as-needed

13 basis, so that would have to be evaluated as

14 needed. What is, you know, the nature of the

15 request? Does the coding methodology -- is it

16 consistent? Is it generating trading activity

17 that is in violation of the Act and the regs. And

18 so I would be in close coordination with the

19 Division of Enforcement, for example, to the

20 extent that they undertook an inquiry, that they

21 have the relevant expertise to evaluate, cabin,

22 and ensure the security of information.
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 41

 1 You know, we discussed the fact of

 2 inspection, so inspection doesn't mean transfer.

 3 It doesn't need to mean transfer, so the ability

 4 to go to the facility and get further information

 5 about how that code is being utilized is one of

 6 the aspects of Regulation 1.31. So I would say

 7 that we don't -- in all instances would require

 8 that source code be transferred over.

 9 And also, as I mentioned earlier, in

10 looking at oversight from the CFTC perspective,

11 it's in furtherance of our obligations under the

12 Act and the regs, so whether there would be some

13 -- you know, the nature and scope of the review of

14 that source code would have to be determined

15 through the Division of Market Oversight, with

16 interaction, with the other divisions to the

17 extent that they thought it was important with

18 respect to their regulatory responsibilities.

19 COMMISSIONER GIANCARLO: As I read the

20 rule, though, Vince, I do understand we have the

21 right not only to inspect, but to obtain the

22 source code.
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 42

 1 MR. McGONAGLE: Exactly. That's exactly

 2 correct, Commissioner.

 3 COMMISSIONER GIANCARLO: So if we were

 4 to obtain the source code, it's unfortunate, but I

 5 don't think the federal government or its

 6 regulatory agencies have a great deal of

 7 credibility with the American public in terms of

 8 their ability to maintain the confidentiality of

 9 intellectual property and data. How comfortable

10 or how -- what assurances can we give the public

11 if we do obtain source code from market

12 participants that that source code will remain

13 safe and out of the hands of not just their

14 competitors, but cyber threats to the marketplace.

15 MR. McGONAGLE: Commissioner, I

16 certainly appreciate the Commission's

17 responsibility to be ever-vigilant with respect to

18 the obligations that it seeks to discharge. We

19 routinely receive confidential information as part

20 of the regular business practices of this

21 organization and we would need to be ever vigilant

22 with respect to those responsibilities.
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 43

 1 COMMISSIONER GIANCARLO: Thank you.

 2 Thanks. Let me close by thanking the team for

 3 their hard work on this. I've gone into this

 4 issue because I do think it is probably one of the

 5 more critical elements of this proposal. I think

 6 it's something that merits thoughtful

 7 consideration by the public. It's certainly an

 8 area where I will be looking carefully.

 9 We did a little bit of research in the

10 small amount of time we had. We can't find any

11 other precedent for federal agencies obtaining

12 such sensitive intellectual property of market

13 participants, so I'll be interested for the

14 public's comment on that and certainly in the

15 weeks and months to come, to educate ourselves

16 better on that. Thank you.

17 CHAIRMAN MASSAD: Okay. Did you have

18 anything else?

19 COMMISSIONER BOWEN: No.

20 CHAIRMAN MASSAD: Just to follow up.

21 Certainly, the confidentiality of information is

22 always a key requirement of the law, as well as a
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 44

 1 thing we always must keep our eyes on. There's

 2 plenty of commercially sensitive information, I

 3 think, that we get in the course of our oversight

 4 activity and our supervision activity. And I'm

 5 certainly happy to look further at the rules'

 6 implications with respect to source code, but I

 7 think it's -- I'm not sure that I see that there's

 8 a difference in -- qualitatively, if you will,

 9 given that we are constantly receiving all sorts

10 of confidential and highly commercially sensitive

11 information.

12 As to our ability to analyze an

13 algorithm, I've said repeatedly that we need to

14 invest more in IT to enhance our systems generally

15 given the electronification and increasing

16 automation of the markets. But I think given the

17 outstanding work of our Enforcement Division, in

18 looking at matters involving spoofing and so

19 forth, I would expect that they've done plenty of

20 analysis of algorithms and deconstruction of

21 algorithms in their cases.

22 If there are no other questions, I would
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 45

 1 again like to thank the staff for their work and

 2 presentations today. And having concluded the

 3 discussion would any Commissioner like to make any

 4 further statements before we proceed to a vote?

 5 All right. If the Commissioners are

 6 prepared to vote, if so, Mr. Kirkpatrick will you

 7 call the roll?

 8 MR. KIRKPATRICK: The motion now before

 9 the Commission is on the adoption of the Notice of

10 Proposed Rulemaking on Regulation Automated

11 Trading.

12 Commissioner Giancarlo?

13 COMMISSIONER GIANCARLO: Aye.

14 MR. KIRKPATRICK: Commissioner 

15 Giancarlo, aye. Commissioner Bowen?

16 COMMISSIONER BOWEN: Aye.

17 MR. KIRKPATRICK: Commissioner Bowen,

18 aye. Chairman Massad?

19 CHAIRMAN MASSAD: Aye.

20 MR. KIRKPATRICK: Chairman Massad, aye.

21 Mr. Chairman, on this matter, the ayes have three,

22 the no's have zero.
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 46

 1 CHAIRMAN MASSAD: Thank you. The ayes

 2 have it, and the motion to adopt the proposed rule

 3 is approved.

 4 Is there any other Commission business?

 5 There being no further business, I would entertain

 6 a motion to adjourn the meeting.

 7 COMMISSIONER BOWEN: So moved.

 8 CHAIRMAN MASSAD: All in favor?

 9 COMMISSIONER GIANCARLO: Second.

10 GROUP: Aye.

11 CHAIRMAN MASSAD: The motion is

12 approved. The meeting is adjourned. And again,

13 thank you all very much.

14 (Whereupon, at 9:49 a.m., the

15 PROCEEDINGS were adjourned.)

16 * * * * *

17

18

19

20

21

22
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 47

 1 CERTIFICATE OF NOTARY PUBLIC

 2 DISTRICT OF COLUMBIA

 3 I, Mark Mahoney, notary public in and

 4 for the District of Columbia, do hereby certify

 5 that the forgoing PROCEEDING was duly recorded and

 6 thereafter reduced to print under my direction;

 7 that said transcript is a true record of the

 8 testimony given by witnesses; that I am neither

 9 counsel for, related to, nor employed by any of

 10 the parties to the action in which this proceeding

 11 was called; and, furthermore, that I am not a

 12 relative or employee of any attorney or counsel

 13 employed by the parties hereto, nor financially or

 14 otherwise interested in the outcome of this

 15 action.

 16 (Signature and Seal on File)

 17 -----------------------------------

 18 Notary Public, in and for the District of Columbia

 19 My Commission Expires: March 14, 2018

 20

21

 22