The Commodity Futures Trading Commission proposed a comprehensive set of new rules that, if adopted, potentially would impose many new obligations on certain CFTC registrants that use automated or algorithmic trading systems to trade futures, options or swaps on designated contract markets (but not on swap execution facilities). Potentially impacted registrants are future commission merchants, floor brokers, swap dealers, major swap participants, commodity pool operators, commodity trading advisors, introducing brokers and certain persons proposed to be registered as floor traders for the first time because of their automated or algorithmic trading activities. FCMs who are clearing members of DCMs and carry accounts for covered algorithmic traders; DCMs (but not SEFs); and the National Futures Association would also be impacted by the CFTC’s proposed new requirements. The CFTC’s proposed new rules would also mandate the registration with the CFTC as a floor trader any person who uses an algorithmic trading system that electronically and directly routes orders to a DCM other than first through a clearing-member FCM, unless such person is otherwise registered with the CFTC in another approved capacity. All current categories of CFTC registrants that engage in algorithmic trading and newly required to be registered floor traders would be required to maintain copies of all source code used in a production environment, including all changes, in accordance with general CFTC record-keeping requirements (e.g., retain for five years), and, upon request, make available such source code for inspection by CFTC and US Department of Justice staff without subpoena or other process of law. The proposed new rules also impose new requirements on compliance officers of algorithmic trading firms, as well as of FCMs that carry positions for algorithmic trading customers. (Click here for a detailed article on this matter, “CFTC’s Proposed New Algorithmic Trading Rules Augur Potential Increased Obligations and Costs, and a New Registration Requirement” in the November 29, 2015 edition of Between Bridges.)
My View: As I reflected in my initial commentary on proposed Regulation AT, the Commodity Future Trading Commission's proposed rules were designed with noble objectives – to prevent and ameliorate the potential impact of algorithmic trading systems breaking down and causing widespread adverse market impact or being used for nefarious purposes. The proposed rules generally are not prescriptive, but attempt to federalize already existing best practices and, in many cases, rules of exchanges and the National Futures Association. That being said, there are material provisions in the proposed regulation that hopefully will be fixed in any final rule. Among other things, source code should not be required to be made available as easily as contemplated to the Commodity Futures Trading Commission or US Department of Justice staff. Moreover, the role of compliance officers at so-called “AT Persons” must be clarified. The CFTC must make it clear that compliance officers are not potentially exposed to liability if an algorithmic trading program goes haywire simply because AT persons are required to ensure that non-compliance staff and compliance staff have a plan “of internal coordination and communication between [such persons] regarding design, changes, testing and controls,” which plan should be constructed “to detect and prevent” breaches of law and rules by algorithmic systems. Finally, threshold issues must be considered: is there a better way to build upon best practices already adopted by many algorithmic traders and other industry participants, rather than to create a new federal infrastructure? Might the implications under proposed Regulation AT of a breach of internal procedures by AT persons prompt AT persons to formally lessen already implemented best practices to avoid potential regulatory issues? Finally, under the proposed regulation, the National Futures Association is potentially required to “establish and maintain a program,” among other things, for “perfecting the mechanisms of trading on designated contract markets by adopting rules for each category of member” dealing with pre-trade risk controls, standards for system development, testing and other matters, and training of staff” (emphasis added). NFA may have very talented staff, but it might be a bit too much to expect even these highly qualified professionals to come up with measures that “perfect” a process! Moreover, as one of my colleagues at Katten Muchin Rosenman has pointed out to me, it appears unlikely that NFA has the current authority to create any such program – perfect or less than perfect – under its prevailing Articles of Incorporation (click here to access the relevant potentially problematic provision – Article III, Section 2(b)).