CFTC Supplements its Proposed Regulation AT Rulemaking to Amend the Scope of Pre-Trade Risk Control, Registration and Source Code Retention Requirements, Among Other Revisions

On November 4, 2016, the Commodity Futures Trading Commission (the "CFTC" or "Commission") voted 2 to 1 (Commissioner Christopher Giancarlo dissenting) to issue a supplemental notice of proposed rulemaking (the "Supplement") with respect to its previously issued proposed rules that would implement a framework of registration, compliance, recordkeeping and reporting rules for market participants engaging in algorithmic or automated trading activity (such persons, as further described below, "AT Persons") (the "Original Proposal"). The proposed rules are referred to as Regulation AT (or "Reg AT").

The Supplement makes several key changes to proposed Reg AT:

  • Scope of pre-trade risk controls requirement. The Supplement revises the proposed risk control framework (i.e., various regulatory-prescribed pre-trade risk controls with respect to algorithmic and electronic trading by an AT Person) to apply at two levels rather than three. Under the Supplement, the controls will be required at the level of the designated contract market ("DCM"), and they will also be required at the level of either the "executing" futures commission merchant ("FCM") or the AT Person but not both. The AT Person may delegate responsibility for implementing these pre-trade risk controls to its "executing" FCM(s) if (a) it is technologically feasible for each "executing" FCM to do this risk monitoring and (b) each "executing" FCM notifies the AT person in writing that it will do so. This delegation would relieve the AT Person of certain of the risk-monitoring framework obligations that would have been imposed under the Original Proposal.
  • Volumetric threshold for AT Person registration requirement. The Supplement modifies the AT Person registration requirement by adding a volumetric threshold below which registration would not be required. Under the Original Proposal, any person engaging in proprietary algorithmic trading on a designated contract market ("DCM") via direct electronic access ("DEA") would have been required to register as a floor trader. As amended by the Supplement, the registration requirement would only apply to a person or firm that executes an average daily volume of 20,000 contracts on DCM electronic trading facilities (across all products), over a six- month period. The count would include trades executed for a firm's own account, the accounts of customers, or both. As a reminder, firms already registered with the CFTC in another capacity will not also be required to register separately as floor traders even if they meet the AT Person definition (including exceeding this threshold), but they will be subject to all regulations applicable to AT Persons.
  • CFTC access to algorithmic trading source code. Addressing concerns related to the confidentiality and proprietary value of source code, the Supplement includes extensive changes to the Original Proposal's provisions regarding source code preservation and access. The Original Proposal required AT Persons to keep and make the source code available to the CFTC in accordance with the CFTC's general recordkeeping requirements in CFTC rule 1.31. The proposal in the Supplement would require the Commission to expressly authorize any staff access, either by subpoena or Special Call, to "algorithmic trading source code." Commissioner Giancarlo dissented largely because the proposal would not require staff to obtain a subpoena prior to accessing the algorithmic trading source code.
  • Annual certification requirement. The Supplement also replaces the provisions of the Original Proposal that would have required DCMs, AT Persons and clearing member FCMs to prepare certain annual reports, including reports for the Commission. Under the Supplement, these firms would instead be subject to a streamlined annual certification requirement. With these revisions, Reg AT would not require DCMs to review annual compliance reports from AT Persons and clearing member FCMs. Instead it would require the DCM to establish a program for effective periodic review of an AT Person's compliance with Reg AT and would require that the AT Person submit a certificate to the DCM with respect to its compliance.
  • Compliance with Reg AT when using third-party ATSs. For AT Persons using third-party algorithmic trading systems ("ATSs"), the Supplement would permit the AT Person to rely on certifications from their third-party providers (so long as it conducts due diligence to reasonably determine the accuracy and sufficiency of such certification as a means) to comply with certain aspects of Reg AT, including requirements related to the standards applicable to the development and testing of their ATSs.
  • Additional revisions to the Original Proposal. Responding to a range of commenters, the Supplement also identifies a number of changes to certain defined terms included in the Original Proposal as well as changes to certain other provisions of the Original Proposal. Notable revisions include changes that will limit the scope of the defined terms "Algorithmic Trading Compliance Issue," "Algorithmic Trading Disruption," and "Algorithmic Trading Event," in each instance limiting the scope of the compliance obligation that will be applicable to AT Persons.