Concept Release on Risk Controls and System Safeguards for Automated Trading Environments, 56541-56574 [2013-22185]

Download as PDF Vol. 78 Thursday, No. 177 September 12, 2013 Part IV Commodity Futures Trading Commission mstockstill on DSK4VPTVN1PROD with PROPOSALS4 17 CFR Chapter I Concept Release on Risk Controls and System Safeguards for Automated Trading Environments; Proposed Rule VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 PO 00000 Frm 00001 Fmt 4717 Sfmt 4717 E:\FR\FM\12SEP4.SGM 12SEP4 56542 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules COMMODITY FUTURES TRADING COMMISSION 17 CFR Chapter I RIN 3038–AD52 Concept Release on Risk Controls and System Safeguards for Automated Trading Environments Commodity Futures Trading Commission. ACTION: Concept release; request for comments. AGENCY: U.S. derivatives markets have experienced a fundamental transition from human-centered trading venues to highly automated and interconnected trading environments. The operational centers of modern markets now reside in a combination of automated trading systems (‘‘ATSs’’) and electronic trading platforms that can execute repetitive tasks at speeds orders of magnitude greater than any human equivalent. Traditional risk controls and safeguards that relied on human judgment and speeds, and which were appropriate to manual and/or floor-based trading environments, must be reevaluated in light of new market structures. Further, the Commission and market participants must ensure that regulatory standards and internal controls are calibrated to match both current and foreseeable market technologies and risks. This Concept Release on Risk Controls and System Safeguards for Automated Trading Environments (‘‘Concept Release’’) reflects the Commission’s continuing commitment to the safety and soundness of U.S. derivatives markets in a time of rapid technological change. The Concept Release serves as a platform for cataloguing existing industry practices, determining their efficacy and implementation to date, and evaluating the need for additional measures, if any. The Commission welcomes all public comments. DATES: Comments must be received on or before December 11, 2013. ADDRESSES: You may submit comments, identified by RIN 3038–AD52, by any of the following methods: • CFTC Web site, via Comments Online: http://comments.cftc.gov. Follow the instructions for submitting comments through the Web site. • Mail: Melissa D. Jurgens, Secretary of the Commission, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW., Washington, DC 20581. • Hand Delivery/Courier: Same as ‘‘mail,’’ above. mstockstill on DSK4VPTVN1PROD with PROPOSALS4 SUMMARY: VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 • Federal eRulemaking Portal: http:// www.regulations.gov. Follow the instructions for submitting comments. Please submit comments by only one method. All comments should be submitted in English or accompanied by an English translation. Comments will be posted as received to http:// www.cftc.gov. You should submit only information that you wish to make available publicly. If you wish the Commission to consider information that may be exempt from disclosure under the Freedom of Information Act (‘‘FOIA’’), a petition for confidential treatment of the exempt information may be submitted according to the procedures established in 17 CFR 145.9. The Commission reserves the right, but shall have no obligation, to review, prescreen, filter, redact, refuse, or remove any or all of your submission from http://www.cftc.gov that it may deem to be inappropriate for publication, such as obscene language. All submissions that have been redacted or removed that contain comments on the merits of the rulemaking will be retained in the public comment file and will be considered as required under the Administrative Procedure Act and other applicable laws, and may be accessible under FOIA. FOR FURTHER INFORMATION CONTACT: Sebastian Pujol Schott, Associate Director, Division of Market Oversight, sps@cftc.gov or 202–418–5641; Marilee Dahlman, Attorney-Advisor, Division of Market Oversight, mdahlman@cftc.gov or 202–418–5264; Camden Nunery, Economist, Office of the Chief Economist, cnunery@cftc.gov or 202– 418–5723; or Sayee Srinivasan, Research Analyst, Office of the Chief Economist, ssrinivasan@cftc.gov or 202– 418–5309. SUPPLEMENTARY INFORMATION: I. Introduction A. Design of Concept Release and Request for Comments II. Background A. Characteristics of Automated Trading Environments 1. Automated Order Generation and Execution 2. Advances in High-Speed Communication Networks and Reductions in Latency 3. Rise of Interconnected Automated Markets 4. Manual Risk Controls and System Safeguards in Automated Trading Environments B. The Commission’s Regulatory Response to Date C. Recent Disruptive Events in Automated Trading Environments III. Potential Pre-Trade Risk Controls, PostTrade Reports, System Safeguards, and Other Protections PO 00000 Frm 00002 Fmt 4701 Sfmt 4702 A. Overview of Existing Industry Practices 1. Existing DCM Risk Controls 2. Existing Trading and Clearing Firm Risk Controls B. Overview of Risk Controls Addressed in This Concept Release C. Pre-Trade Risk Controls 1. Message and Execution Throttles 2. Volatility Awareness Alerts 3. Self-Trade Controls 4. Price Collars 5. Maximum Order Sizes 6. Trading Pauses 7. Credit Risk Limits D. Post-Trade Reports and Other PostTrade Measures 1. Order, Trade, and Position Drop Copy 2. Trade Cancellation or Adjustment Policies E. System Safeguards 1. Controls Related to Order Placement 2. Policies and Procedures for the Design, Testing and Supervision of ATSs; Exchange Considerations 3. Self-Certifications and Notifications 4. ATS or Algorithm Identification 5. Data Reasonability Checks F. Other Protections 1. Registration of Firms Operating ATSs 2. Market Quality Data 3. Market Quality Incentives 4. Policies and Procedures To Identify ‘‘Related Contracts’’ 5. Standardize and Simplify Order Types G. General Questions Regarding All Risk Controls Discussed Above IV. List of All Questions in the Concept Release V. Appendices (Specific Measures in Bold Font) A. Pre-Trade Risk Controls B. Post-Trade Reports and Other PostTrade Measures C. System Safeguards D. Other Protections I. Introduction U.S. derivatives markets have experienced a fundamental evolution from human-centered trading venues to highly automated and interconnected trading environments. Traditionally, traders and market participants directly initiated, communicated and executed orders, while other personnel provided a range of order, trade processing and back office services. In contrast, automated trading environments are characterized precisely by their high degree of automation, and by the wide array of algorithmic and information technology systems that generate, risk manage, transmit and match orders and trades, as well as systems used to confirm transactions, communicate market data and link related systems through high-speed communication networks. Automated trading environments have conferred a number of benefits upon market participants, including an expanded range of potential trading strategies, and a surge in the speed, precision and tools E:\FR\FM\12SEP4.SGM 12SEP4 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS4 available to execute such strategies. In addition to these benefits, however, automated trading environments have also presented challenges unique to their speed, interconnectedness and reliance on algorithmic systems. In recent years, a number of highprofile system events associated with automated trading have raised public, Commission and industry awareness. For example, on May 6, 2010, major equity indices in both the futures and securities markets lost more than 5% of their value in a matter of minutes when an automated order led to extreme downward price movement and a liquidity crisis in the Chicago Mercantile Exchange’s (‘‘CME’’) E-mini futures contract.1 In August 2012, a trading firm in the securities markets— Knight Capital Group—submitted a significant number of errant proprietary orders to the New York Stock Exchange (‘‘NYSE’’), causing price swings in nearly 150 securities and costing the firm approximately $440 million in the process.2 Most recently, in August 2013, trading on the Nasdaq stock market was disrupted for three hours due to malfunctions in quote dissemination systems and potential connectivity issues between it and another trading platform’s systems. These and other recent events in automated trading environments are discussed in greater detail in section II.C., below. The Commission has taken steps to address the transition to automated trading and require appropriate risk controls for designated contract markets (‘‘DCMs’’), swap execution facilities (‘‘SEFs’’), futures commission merchants (‘‘FCMs’’), swap dealers (‘‘SDs’’), major swap participants (‘‘MSPs’’) and others. In April 2012, it 1 See ‘‘Findings Regarding the Market Events of May 6, 2010, Report of the Staffs of the CFTC and SEC to the Joint Advisory Committee on Emerging Regulatory Issues,’’ September 30, 2010 [hereinafter, the ‘‘CFTC and SEC Joint Report on the Market Events of May 6, 2010’’], available at http:// www.cftc.gov/ucm/groups/public/@otherif/ documents/ifdocs/staff-findings050610.pdf. 2 See Jenny Strasburg & Jacob Bunge, ‘‘Loss Swamps Trading Firm,’’ Wall St. J. (Aug. 2, 2012), available at http://online.wsj.com/article/SB100008 72396390443866404577564772083961412.html. On October 2, 2012, the Securities and Exchange Commission (‘‘SEC’’) conducted a roundtable entitled ‘‘Technology and Trading: Promoting Stability in Today’s Markets’’ (‘‘SEC Roundtable’’). See SEC, Notice of Roundtable Discussion: Technology and Trading Roundtable, 77 FR 56697 (Sept. 13, 2012). A transcript of the SEC Roundtable [hereinafter, the ‘‘SEC Roundtable Transcript’’] is available at http://www.sec.gov/news/ otherwebcasts/2012/ttr100212.shtml. At the SEC Roundtable, then-SEC Chairman Schapiro raised the Knight Capital incident and noted that ‘‘[e]vents like these demonstrate the core infrastructure and technology issues that can be problematic in any market structure.’’ See SEC Roundtable Transcript at 11. VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 adopted final rules requiring FCMs, SDs and MSPs that are clearing members to establish risk-based limits based on position size, order size, margin requirements, or similar factors, and requiring those entities to use automated means to screen orders for compliance with the risk limits when such orders are subject to automated execution. Further, in June 2012, the Commission adopted final rules with respect to DCMs, including requirements that DCMs establish and maintain risk control mechanisms to prevent and reduce the potential for price distortions and market disruptions. Relevant controls cited in the rule include trading pauses and halts under conditions prescribed by the DCM. The Commission adopted similar requirements in its final rules for SEFs in 2013. Finally, the DCM final rules also require risk control requirements for exchanges that provide direct market access (‘‘DMA’’) to clients. The Commission has also adopted rules related to trading practices, including trading in automated environments. In July 2011, the Commission adopted final rules codified in 17 CFR Part 180 that, among other things, (i) broadly prohibit manipulative and deceptive devices, i.e., fraud and fraud-based manipulative devices and contrivances employed intentionally or recklessly, regardless of whether the conduct in question was intended to create or did create an artificial price; and (ii) codify the Commission’s long-standing authority to prohibit price manipulation by making it unlawful for any person, directly or indirectly, to manipulate or attempt to manipulate the price of any swap, or of any commodity in interstate commerce, or for future delivery on or subject to the rules of a registered entity. Further, section 747 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the ‘‘Dodd-Frank Act’’) 3 amended the Commodity Exchange Act (‘‘CEA’’ or ‘‘Act’’) to make it unlawful for any person to engage in disruptive trading practices, and the Commission has provided guidance on the scope and application of the new statutory prohibitions. The Commission’s measures to date are summarized in greater detail in section II.B., below. With respect to these measures and others discussed in this Concept Release, the Commission requests public comment regarding any 3 See Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, Public Law 111– 203, 124 Stat. 1376 (2010). PO 00000 Frm 00003 Fmt 4701 Sfmt 4702 56543 additional steps, guidance or rulemaking that it should undertake. Derivatives market participants, including DCMs, FCMs, clearing members and others, have themselves taken a number of steps to manage risks associated with automated trading. The Commission acknowledges these efforts, and, through this Concept Release, seeks public comment on the extent to which measures already in place may be sufficient to safeguard markets in automated trading environments. In particular, section III below summarizes relevant risk controls implemented by one or more market participants; requests comment regarding the extent of their implementation to date; and seeks input regarding whether existing controls would benefit from additional granularity or regulatory standardization. A. Design of Concept Release and Request for Comments This Concept Release provides an overview of the automated trading environment, including its principal actors, potential risks, and preventative measures designed to promote safe and orderly markets.4 The Concept Release was informed by controls already in use today by one or more market participants or exchanges, and best practices, recommendations and concepts developed by the CFTC’s Technology Advisory Committee (‘‘TAC’’); the Futures Industry Association’s (‘‘FIA’’) Principal Traders Group and Market Access Working Group; the International Organization of Securities Commissions (‘‘IOSCO’’); the European Securities and Markets Authority (‘‘ESMA’’); and by existing CFTC regulatory requirements. It begins with an overview of automated trading, including the development of automated order generation and execution systems; advances in highspeed communication networks; the growth of interconnected automated markets; the changed role of humans in modern markets; and a discussion of 4 Many of these concepts are in harmony with evolving views of groups responsible for setting standards and developing regulations for other markets around the world. See, e.g., IOSCO Technical Committee, ‘‘Regulatory Issues Raised by the Impact of Technological Changes on Market Integrity and Efficiency: Consultation Report’’ (July 2011) [hereinafter ‘‘IOSCO Report on Regulatory Issues Raised by Technological Changes’’], available at http://www.iosco.org/library/pubdocs/pdf/ IOSCOPD354.pdf. See also ESMA, ‘‘Final Report: Guidelines on Systems and Controls in an Automated Trading Environment for Trading Platforms, Investment Firms and Competent Authorities’’ (December 2011) [hereinafter, ‘‘ESMA Guidelines on Systems and Controls’’], available at http://www.esma.europa.eu/ system/files/2011–456_0.pdf. E:\FR\FM\12SEP4.SGM 12SEP4 56544 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS4 recent disruptive events in automated trading environments. The Concept Release then addresses these developments through a series of (1) pre-trade risk controls; (2) post-trade reports and other post-trade measures; (3) system safeguards; and (4) additional protections (collectively, ‘‘risk controls’’) that could be implemented by one or more categories of Commission registrants or other market participants. The Commission seeks extensive public comment regarding each risk control contemplated herein. Commenters should address the effectiveness of each measure, and the degree to which it may already be in use by industry participants. Each commenter should identify the specific risk controls that it already employs. For all measures discussed in this Concept Release, commenters should also address whether there is a need for regulatory action to provide more uniform risk mitigation across CFTCregulated derivatives markets.5 Comments that address this question with respect to each proposed risk control and system safeguard individually would be particularly helpful. In all cases, commenters should discuss, and quantify wherever possible, the costs and benefits of the pre-trade risk controls, post-trade reports and other post-trade measures, system safeguards, and other protections discussed in this Concept Release. The Concept Release recognizes that orders and trades in automated environments pass through multiple stages in their lifecycle from order generation, to execution, to clearing and allocation in proprietary or customer accounts, and steps in between. Accordingly, the Commission requests 5 In this regard, the Commission emphasized in the preamble to its final rules for part 38 that the efficacy of risk controls depends in part on the proper functioning of electronic systems, and that ‘‘the Commission may address electronic system testing, controls, and supervision-related issues in a subsequent proceeding.’’ See Commission, Final Rule: Core Principles and Other Requirements for Designated Contract Markets, 77 FR 36612, 36638 n.298, 36648, n.389 (Jun. 19, 2012) [hereinafter, the ‘‘DCM Final Rules’’]. Similarly, the system safeguards contemplated herein for ATSs are an outgrowth of the basic requirement in § 23.600(d)(9) that SDs and MSPs conduct testing and supervision of trading systems. There again, the Commission indicated that further measures would be forthcoming by stating that it ‘‘anticipate[d] addressing the related issues of testing and supervision of electronic trading systems and mitigation of the risks posed by high frequency trading.’’ See Commission, Final Rule: Swap Dealer and Major Swap Participant Recordkeeping, Reporting, and Duties Rules; Futures Commission Merchant and Introducing Broker Conflicts of Interest Rules; and Chief Compliance Officer Rules for Swap Dealers, Major Swap Participants, and Futures Commission Merchants, 77 FR 20128, 20141 (Apr. 3, 2012). VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 comment regarding the appropriate stage at which risk controls should be placed. Potential options include risk controls applicable to: (i) ATSs at the time of order generation; (ii) clearing firms during the order transmission process; (iii) trading platforms prior to exposing orders to the market; (iv) Derivatives Clearing Organizations (‘‘DCOs’’); and (v) other risk control focal points, including, for example, third-party ‘‘hubs’’ through which orders or order information could flow to uniformly mitigate risks across one or more trading platforms. Similarly, the Commission requests public comment regarding the appropriate focal point for system safeguards and testing and supervision standards for ATSs. Finally, the Commission requests comment regarding a series of issues central to its improved understanding and surveillance of trading in automated environments. For example, the Commission requests comments regarding any surveillance tools that it should deploy specifically for the surveillance of automated trading and areas for academic research to improve its understanding of ATSs’ impact on market microstructure. Section IV lists all questions raised in this Concept Release. The Commission’s Concept Release reflects fundamental statutory objectives under the CEA. Such objectives include fostering a system of effective selfregulation, deterring and preventing disruptions to market integrity, protecting market participants and ‘‘promot[ing] responsible innovation and fair competition among boards of trade, other markets and market participants.’’ 6 Notably, the Commission must ensure that U.S. derivatives markets continue to serve as effective centers of price discovery and risk mitigation, regardless of the technologies employed by trading platforms, market participants, and others. The Commission must further ensure that its regulatory framework and industry practices are fully adapted to the automated technologies of modern derivatives markets. II. Background A. Characteristics of Automated Trading Environments 1. Automated Order Generation and Execution Automated trading environments have developed in tandem with automated systems for both the generation and execution of orders. Systems related to the generation of 6 See PO 00000 CEA section 3(b); 7 U.S.C. 5(b). Frm 00004 Fmt 4701 Sfmt 4702 orders (‘‘automated trading systems’’ or ‘‘ATSs’’) 7 operate at the beginning of the order and trade lifecycle; they reflect a set of rules or instructions (an algorithm) and related computer systems used to automate the execution of a trading strategy.8 ATSs may operate as automated execution programs designed to minimize the price impact of large orders; achieve a benchmarked price (e.g., volume-weighted average price and time-weighted average price algorithms); or otherwise execute instructions traditionally provided by a human agent.9 They may be employed by a range of market participants, with varying degrees of sophistication, for both proprietary and customer trading. For example, buy-side firms (such as mutual funds and pension funds) may use automated systems and execution algorithms to ‘‘shred’’ one or more large orders (called ‘‘parent order’’) into a series of smaller trades (‘‘child orders’’) to be executed over time. Such systems can include additional algorithms to micro-manage the size, frequency and timing (often randomized) of child orders. In addition to automated execution, ATSs may also operate market-making programs; opportunistic, cross-asset and cross-market arbitrage programs; and a number of other strategies. In Commission-regulated markets, orders generated by ATSs are ultimately transmitted to DCMs that have themselves become automated systems for the matching and execution of orders. Broadly, these trading platforms consist of a front-end to which market participants connect and communicate using standardized messaging formats, a matching engine that automatically matches orders to buy and sell, and a back-end that automatically provides all market participants with a market feed. Trade flows may make use of straightthrough processing, where the entire trade execution process occurs without intermediation from humans, thereby 7 While the Commission has no regulatory definition of ATS, the term is generally understood to mean a computer-driven system that automates the generation and routing of orders to one or more markets. Other elements of an ATS may also include systems for analyzing market data as a precursor to order generation, managing orders for conformance with establish risk tolerances, receiving confirmations of orders placed and trades executed, etc. Section III.E.4. of this Concept Release seeks public input regarding whether the Commission should formally define ATS and if so, how ATS should be defined. 8 See IOSCO Report on Regulatory Issues Raised by Technological Changes, supra note 4, at 10. 9 See John Bates, ‘‘Algorithmic Trading and High Frequency Trading Experiences from the Market and Thoughts on Regulatory Requirements’’ (July 2010), available at http://www.cftc.gov/ucm/groups/ public/@newsroom/documents/file/tac_071410_ binder.pdf. E:\FR\FM\12SEP4.SGM 12SEP4 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS4 dramatically reducing the amount of time required to execute each transaction. The evolution from manual trading in open-outcry pits to electronic trading platforms is in many cases substantially complete. An established body of data indicates the importance of electronic and algorithmic trading in U.S. futures markets. In 2012, approximately 91.50% of exchange trading volume in U.S. futures markets was executed electronically.10 Estimates indicate that algorithmic trading first accounted for at least 50% of orders in 2009,11 and accounted for over 40% of total trading volume in 2010.12 By the end of the first quarter of 2010, ATSs accounted for over 50% of trading volume in a number of significant product categories at CME Group, Inc.’s (‘‘CME Group’’) DCMs.13 For example, ATSs accounted for approximately 51% of trade volume in E-mini S&P 500 futures and 69% of trade volume in EuroFX futures.14 Increased automation in both order generation and matching, combined with the exponentially faster communication networks discussed in section II.A.2., below, has in many cases reduced the trade lifecycle to as little as a few milliseconds. As a result, highfrequency trading (‘‘HFT’’) strategies have also become an increasingly important component of automated trading environments. The Commission is working diligently to understand and keep pace with the growth of ATSs and HFT in its regulated markets. The TAC, for example, has worked to define HFT and received a definition of HFT from its working group panel of experts. The attributes of HFT, according to the TAC’s working group, include: (a) Algorithms for decision making, order initiation, generation, routing, or execution, for each individual transaction without human direction; (b) low-latency technology that is designed to minimize response times, 10 This figure represents transactions executed competitively on DCM trading platforms and not off-exchange transactions such as block trades. 11 See Paul Zubulake & Sang Lee, The High Frequency Game Changer at 84, fig. 6.3 (John Wiley & Sons, Inc. 2011) (source of data: Aite Group). 12 See Barry Johnson, Algorithmic Trading & DMA: An Introduction to Direct Access Trading Strategies at 78, fig. 3–11 (4Myeloma Press 2010) (source of data: Aite Group). 13 See CME Group, ‘‘Algorithmic Trading and Market Dynamics’’ (July 15, 2010) at 2, available at http://www.cmegroup.com/education/files/Algo_ and_HFT_Trading_0610.pdf. At the time, the CME Group operated four DCMs: the Chicago Mercantile Exchange, the Chicago Board of Trade, the New York Mercantile Exchange (‘‘NYMEX’’), and the Commodity Exchange. 14 See id. VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 including proximity and co-location services; (c) high speed connections to markets for order entry; and (d) recurring high message rates (orders, quotes or cancellations) determined using one or more objective forms of measurement, including (i) cancel-to-fill ratios; (ii) participant-tomarket message ratios; or (iii) participant-to-market trade volume ratios.15 In addition, the TAC’s working group described automated trading as ‘‘cover[ing] systems employed in the decision-making, routing and/or execution of an investment or trading decision, which utilizes a range of technologies including software, hardware, and network components to facilitate efficient access to the financial markets via electronic trading platforms.’’ 16 Effectively, HFT is a form of automated trading, but not all automated trading is HFT.17 15 See TAC Subcommittee on Automated and High Frequency Trading, Working Group 1, Presentation to the TAC (Oct. 30, 2012), available at http://www.cftc.gov/ucm/groups/public/@ newsroom/documents/file/tac103012_wg1.pdf. In addition, the TAC Subcommittee on Automated and High Frequency Trading, Working Group 1, described high frequency trading as a mechanism used by a variety of trading strategies, including, but not limited to, liquidity provision and statistical arbitrage. 16 See id. 17 In March 2013, the German parliament approved legislation on high frequency trading (the ‘‘HFT Act’’). See Hans-Edzard Busemann, ‘‘German upper house approves rules to clamp down on highfrequency trading,’’ Reuters (March 22, 2013), available at http://uk.reuters.com/article/2013/03/ 22/uk-germany-trading-idUKBRE92L0L820130322. The legislation defines high frequency trading generally as follows: The sale or purchase of financial instruments for own account as direct or indirect participant in a domestic organized market or multilateral trading facility by means of a highfrequency algorithmic trading technique which is characterized by (i) the usage of infrastructures to minimize latency times, (ii) the decision of the system regarding the commencement, creation, transmission or execution of an order without human intervention for single transactions or orders, and (iii) a high intraday messaging volume in the form of orders, quotes or cancellations. See BaFin (Federal Financial Supervisory Authority), ‘‘High-frequency trading: new rules for trading participants’’ (March 26, 2013) (including Workshop on High Frequency Trading Act Presentations dated April 30, 2013 and Frequently Asked Questions Relating to the High Frequency Trading Act dated March 22, 2013) [hereinafter, the ‘‘BaFin HFT Act Materials’’], available at http:// www.bafin.de/SharedDocs/Veroeffentlichungen/ EN/Meldung/2013/meldung_130322_hft-gesetz_ en.html?nn=2821494. The German HFT Act also defines algorithmic trading. The HFT Act’s definition is generally as follows: Trading with financial instruments such that a computer algorithm determines automatically the individual order parameters without being merely a system for the transmission of orders to one or several trading venues or to confirm orders. Order parameters within the meaning of the preceding sentence are decisions whether the order is given, the timing, price and quantity of an order PO 00000 Frm 00005 Fmt 4701 Sfmt 4702 56545 In this regard, the Commission is aware that instability in automated trading environments may be precipitated by ATSs regardless of whether they employ high-frequency or other trading strategies. Accordingly, the risk controls, system safeguards and other measures contemplated for ATSs in this Concept Release do not distinguish on the basis of ATSs’ trading strategies. However, the Commission is interested in better understanding HFT and whether it should receive different regulatory attention than ATSs in general. The Commission requests comment on the following questions regarding HFT and related topics: 1. In any rulemaking arising from this Concept Release, should the Commission adopt a formal definition of HFT? If so, what should that definition be, and how should it be applied for regulatory purposes? 2. What are the strengths and weaknesses of the TAC working group definition of HFT provided above? How should that definition be amended, if at all? 3. The definition of HFT provided above uses ‘‘recurring high message rates (orders, quotes or cancellations)’’ as one of the identifying characteristics of HFT, and lists three objective measures (i) cancel-to-fill ratios; (ii) participant-to-market message ratios; or (iii) participant-to-market trade volume ratios) that could be used to measure message rates. Are these criteria sufficient to reliably distinguish between ATSs in general and ATSs using HFT strategies? What threshold values are appropriate for each of these measures in order to identify ‘‘high message rates?’’ Should these threshold values vary across exchanges and assets? If so, how? 4. Should the risk controls for systems and firms that engage in HFT be different from those that apply to ATSs in general? If so, how? 2. Advances in High-Speed Communication Networks and Reductions in Latency Automated trading environments are also characterized by connectivity and infrastructure solutions that enable trading platforms to process orders and execute trades at ever increasing speeds, and enable market participants (including ATSs) to communicate with platforms at ever decreasing latencies.18 or how the order will be executed with limited or no human interference. See id. As explained in footnote 103 below, the HFT Act also introduces a licensing requirement. 18 Latency means ‘‘the time it takes to learn about an event (e.g., a change in the bid), generate a E:\FR\FM\12SEP4.SGM Continued 12SEP4 56546 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS4 Notably, however, such capabilities require equally sophisticated risk management systems whose speeds are commensurate with those of low-latency order generation and trade execution systems. Public data from one exchange group, for example, indicates that roundtrip trade times on its trading platform fell from 127 milliseconds in 2004 to 4.2 milliseconds in 2011.19 Another exchange group reported in 2010 that its average blended transaction time in futures and OTC markets was 1.25 milliseconds.20 Advances in trading speeds are partly due to the development of dedicated fiber-optic and microwave communications networks that have dramatically reduced latency across large distances. As of 2012, networks were being developed to reduce roundtrip messaging between New York and London from 65 milliseconds to 60 milliseconds.21 In March 2013, CME Group Inc. and Nasdaq OMX Group Inc. announced plans to launch a wireless network that will provide roundtrip messaging between New York and Chicago in 8.5 milliseconds.22 Two common methods for reducing latency are co-location and proximity hosting, defined as the placement of a firm’s trading technology in close proximity to the trading platform. They may be offered directly by an exchange or by a third-party service provider. Colocation denotes those connectivity solutions hosted by the exchange itself, while proximity hosting indicates services offered by third parties.23 In response, and have the exchange act on the response.’’ See Joel Hasbrouck & Gideon Saar, ‘‘Low-Latency Trading’’ (May 2013) at 1, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_ id=1695460. 19 See CME Group, ‘‘Oversight of Automated Trading at CME Group’’ (March 29, 2012) at 4, available at http://www.cftc.gov/ucm/groups/ public/@aboutcftc/documents/file/tacpresentation 032912_cme.pdf. 20 See IntercontinentalExchange, ‘‘2010 Annual Report,’’ at 26, available at http:// files.shareholder.com/downloads/ICE/ 1747226327x0x456112/BF6F428C-F8B3-4835B22C-3F350FF13B89/ICE_2010AR.pdf. IntercontinentalExchange indicated that it measures round trip performance end to end within its data center and through its matching engine. 21 See Matthew Philips, ‘‘Stock Trading is About to Get 5.2 Milliseconds Faster,’’ BloombergBusinessweek (Mar. 29, 2012), available at http://www.businessweek.com/articles/2012-0329/trading-at-the-speed-of-light. 22 See Jacob Bunge, ‘‘CME, Nasdaq Plan HighSpeed Network Venture,’’ Wall St. J. (Mar. 28, 2013), available at http://online.wsj.com/article/ SB100014241278873246851045783883432215 75294.html. 23 See FIA Market Access Working Group, ‘‘Market Access Risk Management Recommendations’’ (April 2010) at 4 [hereinafter, ‘‘FIA Market Access Recommendations’’], available at http://www.futuresindustry.org/downloads/ Market_Access-6.pdf. VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 2010, the Commission published in the Federal Register a Notice of Proposed Rulemaking to require DCMs and others that offer co-location and/or proximity hosting to offer such services on an equal access basis, ensure that fees are uniform and non-discriminatory, and provide information about the latency for various connectivity options (‘‘colocation rulemaking’’).24 The Commission intends to finalize the colocation rulemaking by the end of the year. Another important latency-reducing advance in connectivity is DMA. For purposes of this Concept Release, DMA is defined as a connection method that enables a market participant to transmit orders to a trading platform without reentry or prior review by systems belonging to the market participant’s clearing firm. DMA can be provided directly by an exchange or through the infrastructure of a third-party provider. In all cases, however, DMA connectivity implies that a market participant’s order flow is not routed through its clearing firm prior to reaching the trading platform.25 Investment in high-speed communication networks and other technologies to reduce latency reflects the premium that some market participants place on speed relative to their competitors. Reductions in latency may be appropriately achieved through improvements in a range of technologies for the generation, transmission and execution of orders or management of other data. However, there are also incentives for market participants to reduce latency by minimizing pre-trade risk controls and other safeguards that might otherwise introduce unwanted delays. While latency-based incentive structures have promoted evident technological innovation in many derivatives markets, they can also lead to a competitive race to the bottom—a concern already expressed by some market participants.26 A separate 24 See Commission, Notice of Proposed Rulemaking: Co-Location/Proximity Hosting Services, 75 FR 33198 (Jun. 11, 2010). 25 The Commission has taken steps to mitigate the risk associated with DMA. Rule 1.73, passed by the Commission in April 2012, requires FCMs that are clearing members to pre-screen orders of DMA clients against risk limits that are established by the FCM. See 17 CFR 1.73(a)(2)(i). See additional discussion in section II.B. 26 As noted by FIA’s Market Access Working Group, for example: ‘‘[p]re-trade risk controls have become a point of negotiation between trading firms and clearing members because they can add latency to a trade.’’ See FIA Market Access Recommendations, supra note 23, at 8. Similarly, the TAC’s Pre-Trade Functionality Subcommittee noted that latency is a key area where trading firms and brokers are competing to gain an advantage. See TAC Pre-Trade PO 00000 Frm 00006 Fmt 4701 Sfmt 4702 concern is that market participants may simply engage in trading at speeds greater than the speed of their risk management systems. In a trading environment where a single algorithm can submit hundreds of orders per second, risk management systems operating at slower speeds could allow an algorithm that is operating in unexpected ways to disrupt one or more markets. 5. Discussions on latency often focus on the how quickly an exchange processes orders, the time taken to submit orders, and how quickly a firm can observe prices of trades transacted on the exchange. The Commission is interested in understanding whether there are other types of messages transmitted between exchanges, firms and vendors wherein differences in latency could provide opportunities for informational advantage. Recent press reports have highlighted such advantages in the transmission of trade confirmations by a specific exchange.27 Are there other exchanges and trading venues where similar differences in latency exist? The Commission is interested in understanding whether the extent of latency in any such message transmission process can have an adverse impact on market quality or fairness. Should any exchanges, vendors and firms be required to audit their systems and process on a periodic process to identify and then resolve such latency? 3. Rise of Interconnected Automated Markets In addition to greater automation and decreased latency, derivatives markets are increasingly characterized by a high degree of interconnection. ATSs and algorithms deployed to trade particular products often interact directly and indirectly with ATSs and algorithms active in other markets and jurisdictions. Increased interconnectedness is facilitated by electronic access to real-time pricing information, automated order execution, and some standardization in communication protocols at various Functionality Subcommittee, ‘‘Recommendations on Pre-Trade Practices for Trading Firms, Clearing Firms, and Exchanges Involved in Direct Market Access’’ (March 1, 2011) at 2 [hereinafter, ‘‘TAC Pre-Trade Functionality Subcommittee DMA Recommendations’’], available at http:// www.cftc.gov/ucm/groups/public/@swaps/ documents/dfsubmission/tacpresentation030111_ ptfs2.pdf. 27 See Scott Patterson, Jenny Strasburg & Liam Pleven, ‘‘High-Speed Traders Exploit Loophole,’’ Wall St. J. (May 1, 2013), available at http:// online.wsj.com/article/SB100014241278873237 98104578455032466082920.html. E:\FR\FM\12SEP4.SGM 12SEP4 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS4 trading platforms.28 ATSs can quickly execute strategies across multiple markets within very short periods of time. Often, cross-market activity is driven by latent arbitrage opportunities and faster access to multiple markets has led to a proliferation of strategies that seek to identify and trade on the basis of these relationships.29 Increased interconnectedness encourages price efficiencies when economically identical or related contracts are traded on multiple exchanges. However, it also increases the speed with which a disruption on one trading platform, or within one ATS or algorithm, can impact related markets. For example, a trading platform may experience changes in the prices, spreads or volatility of one or more of its products due to errors in an ATS or algorithm active in its markets. Even if this algorithm does not trade elsewhere, such changes are likely to quickly impact the prices, spreads, and volatility of related products on other platforms, as automated systems attempt to arbitrage price differences. The potential result is a cascading series of market disruptions, brought about by the malfunction of a single ATS or algorithm trading on a single platform. Transmission effects such as this are illustrated by events like the May 6, 2010 ‘‘Flash Crash.’’ On that day, major equity indices in both the futures and securities markets fell over 5% in minutes before recovering almost as quickly. After investigation by both the Commission and the SEC, it was found that a fundamental seller utilized an automated execution algorithm to sell 75,000 E-mini contracts (valued at approximately $4.1 billion) over an abbreviated time interval. The algorithm placed orders based on recent trading volume but was not programmed to take price or time into account; because of this lapse, a feedback loop triggered continued orders from the algorithm even as prices moved far beyond traditional daily ranges. Like the hypothetical example provided above, these declines in the derivatives market quickly filtered over to different, but closely related, products on many other exchanges.30 Soon after the initial moves in the E-mini contract, similar extreme volatility was experienced by the S&P 500 SPDR exchange traded fund and by many of the 500 underlying securities which make up the index itself. In response to the May 2010 flash crash, regulatory authorities and market participants have taken steps to address volatility in U.S. markets, including trading pauses and halts that operate as ‘‘circuit breakers.’’ For example, in May 2012, the SEC approved a ‘‘limit uplimit down’’ mechanism in which a price band is set at a percentage level above and below the average price of the stock over the immediately preceding five-minute trading period.31 If the stock’s price does not naturally move back within the price bands within 15 seconds, there will be a five-minute trading pause. The limit up-limit down mechanism began implementation in April 2013, beginning with all stocks in the S&P 500 and Russell 1000 and select exchange traded products. In addition, the SEC approved updates to market-wide circuit breaker rules that, when triggered, halt trading in all exchange-listed securities in U.S. markets. Among other things, the new rules lower the percentage-decline thresholds for triggering a market-wide trading halt. The thresholds (Level 1 (7%), Level 2 (13%), and Level 3 (20%)) are set at levels calculated daily based on the prior day’s closing price of the S&P 500 index.32 To be consistent with these circuit breakers, the CME Group, effective April 8, 2013, reduced the price limit levels for CME and CBOT U.S. equity index futures to 7%, 13% and 20%.33 When a trading halt is declared in the primary securities market in accordance with these levels, trading in the S&P 500 index futures contracts will be halted at the CME. When trading in the primary securities 28 For example, FIX language makes it possible for ATS to be ‘‘platform independent’’—to incorporate interfaces to multiple brokers, ECNs, or exchanges. See Irene Aldridge, High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems at 31 (John Wiley & Sons, Inc. 2010). See also Cliff, Brown, & Treleaven, ‘‘Technology Trends in the Financial Markets: A 2020 Vision,’’ United Kingdom Government Office for Science—Foresight, at 10, available at http:// www.bis.gov.uk/assets/foresight/docs/computertrading/11-1222-dr3-technology-trends-in-financialmarkets.pdf. 29 For example, ‘‘basis trading,’’ and ‘‘futures/ equity arbitrage’’ are statistical arbitrage strategies that seek to capitalize on deviations between prices on futures contracts and related securities contracts after macroeconomic news announcements. See Aldridge, supra note 28, at 197–98. 30 See CFTC and SEC Joint Report on the Market Events of May 6, 2010, supra note 1, at 1–6; ‘‘Recommendations Regarding Regulatory Responses to the Market Events of May 6, 2010, Summary Report of the Joint CFTC-SEC Advisory Committee on Emerging Regulatory Issues’’ (February 18, 2011), available at http:// www.cftc.gov/ucm/groups/public/@aboutcftc/ documents/file/jacreport_021811.pdf. 31 See SEC, ‘‘Investor Bulletin: New Measures to Address Market Volatility’’ (Apr. 9, 2013), available at http://www.sec.gov/investor/alerts/ circuitbreakersbulletin.htm. 32 See id. 33 See CME Group, ‘‘Changes to CME and CBOT Equity Index Price Limits: Frequently Asked Questions,’’ available at http://www.cmegroup.com/ education/files/faq-eq-hours-and-limits.pdf. VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 PO 00000 Frm 00007 Fmt 4701 Sfmt 4702 56547 market resumes after any such halt, trading in the S&P index futures contracts will resume. Similar rules apply to other equity index futures contracts listed on CME. In March 2012, ICE Futures U.S. introduced a circuit breaker functionality called Interval Price Limits, in which prices may not move more than a pre-determined amount away from the current market price within a pre-determined period.34 Throughout section III below, the Commission seeks public comment on the benefits of standardizing various risk controls and system safeguards, including through the uniform application of regulatory standards to help ensure an integrated risk management infrastructure in regulated derivatives markets. The Commission draws commenters’ particular attention to the joint regulatory and industry response to the Flash Crash summarized above and seeks public input regarding the need for similar joint efforts with respect to the pre-trade risk controls, post-trade reports, and system safeguards contemplated in this Concept Release. 4. Manual Risk Controls and System Safeguards in Automated Trading Environments Orders in automated trading environments may be initiated by ATSs and algorithms. Multiple other automated systems perform other processing, communicating, and other functions. The speed of such automated processes has necessarily shifted risk management functions to parallel automated risk management systems acting with equal speed. Within this context, manual risk controls, and particularly systems safeguards, remain crucial to orderly markets. In many cases, manual risk controls have shifted ‘‘upstream’’ to system design and ‘‘downstream’’ to system management. In automated trading, humans design and test ATSs, establish decision criteria, manage implementation, and intervene when technology systems fail. ATS designers must identify the range of market conditions that an ATS could reasonably face, and determine the range of permissible responses by the ATS to each condition. Designers must also consider the array of information that ATS operators will need to effectively monitor their ATSs and the markets in which their ATSs operate. ATS operators, in turn, must be 34 See IntercontinentalExchange, Inc., ‘‘ICE Circuit Breakers (IPL) Price Limits’’ (March 2012), available at https://www.theice.com/publicdocs/ technology/IPL_Circuit_Breaker.pdf. E:\FR\FM\12SEP4.SGM 12SEP4 56548 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules prepared to intervene when market conditions are outside of an ATS’s design parameters, when an ATS’s trading strategy must be modified, or when an ATS appears to be malfunctioning and must be shut down. Rapid decisions must be made while simultaneously digesting large quantities of information regarding multiple, fast-moving markets. Accordingly, this Concept Release contemplates a number of risk controls and system safeguards that emphasize the role and interaction of manual processes with automated trading environments, particularly ATSs. mstockstill on DSK4VPTVN1PROD with PROPOSALS4 B. The Commission’s Regulatory Response to Date The Commission has responded to the development of automated trading environments through a number of regulatory measures that address risk controls within both new and existing categories of registrants, including DCMs, SEFs, FCMs, SDs, MSPs and others. In April 2012, the Commission adopted rules requiring FCMs, SDs and MSPs that are clearing members to establish risk-based limits based on ‘‘position size, order size, margin requirements, or similar factors’’ for all proprietary accounts and customer accounts.35 The rules, codified in §§ 1.73 and 23.609, also require these entities to ‘‘use automated means to screen orders for compliance with the [risk] limits’’ when such orders are subject to automated execution (emphasis added).36 Such screening must, by definition, occur pre-trade. The Commission also adopted rules in April 2012 requiring SDs and MSPs that are clearing members to ensure that their ‘‘use of trading programs is subject to policies and procedures governing the use, supervision, maintenance, testing, and inspection of the program.’’ 37 The specific content of those policies and procedures are left up to the SDs and MSPs. The Commission has also adopted relevant rules with respect to exchange platforms, including rules with respect to DCMs (adopted in June 2012).38 Regulation 38.255, for example, requires DCMs to ‘‘establish and maintain risk control mechanisms to prevent and reduce the potential risk of price distortions and market disruptions, including, but not limited to, market restrictions that pause or halt trading in market conditions prescribed by the 35 17 CFR 1.73(a)(1) and 23.609(a)(1). CFR 1.73(a)(2)(i) and 17 CFR 23.609(a)(2)(i). 37 17 CFR 23.600(d)(9). 38 See DCM Final Rules, 77 FR 36612. 36 17 VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 designated contract market.’’ 39 In addition, the acceptable practices for DCM Core Principle 4 identify pre-trade limits on order size, price collars or bands, and message throttles as responsive measures that a DCM may implement to demonstrate compliance with elements of the core principle.40 The Commission has adopted trading pause and halt requirements for SEFs similar to those for DCMs.41 In the DCM final rules, the Commission also adopted new risk control requirements for exchanges that provide DMA to clients. Regulation 38.607 requires DCMs that permit DMA to have effective systems and controls reasonably designed to facilitate an FCM’s management of financial risk. These systems and controls include automated pre-trade controls through which member FCMs can implement financial risk limits.42 As the Commission noted in the preamble to the DCM final rules, in DMA arrangements ‘‘it is impossible for an FCM to protect itself without the aid of the DCM.’’ 43 The Commission also noted in the DCM final rules, however, that ‘‘the responsibility to utilize these [DCM-provided] controls and procedures remains with the FCM. Each FCM permitting direct access must use DCM-provided controls . . . .’’ 44 Accordingly, regulation 38.607 requires DCMs to implement and enforce rules requiring member FCMs to use these systems and controls.45 39 17 CFR 38.255. 38, Appendix B, Core Principle 4, section (b)(5), provides: Risk controls for trading. An acceptable program for preventing market disruptions must demonstrate appropriate trade risk controls, in addition to pauses and halts. Such controls must be adapted to the unique characteristics of the markets to which they apply and must be designed to avoid market disruptions without unduly interfering with that market’s price discovery function. The designated contract market may choose from among controls that include: Pretrade limits on order size, price collars or bands around the current price, message throttles, and daily price limits, or design other types of controls. Within the specific array of controls that are selected, the designated contract market also must set the parameters for those controls, so long as the types of controls and their specific parameters are reasonably likely to serve the purpose of preventing market disruptions and price distortions. If a contract is linked to, or is a substitute for, other contracts, either listed on its market or on other trading venues, the designated contract market must, to the extent practicable, coordinate its risk controls with any similar controls placed on those other contracts. If a contract is based on the price of an equity security or the level of an equity index, such risk controls must, to the extent practicable, be coordinated with any similar controls placed on national security exchanges. See DCM Final Rules, 77 FR at 36718. 41 17 CFR 37.405. 42 See 17 CFR 38.607. 43 See DCM Final Rules, 77 FR at 36648. 44 Id. 45 See 17 CFR 38.607. 40 Part PO 00000 Frm 00008 Fmt 4701 Sfmt 4702 In addition to the foregoing, section 753 of the Dodd-Frank Act amended section 6(c) of the CEA to prohibit manipulation and fraud in connection with any swap, or a contract of sale of any commodity in interstate commerce, or for future delivery on or subject to the rules of any registered entity. In July 2011, the Commission adopted final rules implementing this new authority under the CEA. CFTC Regulation 180.1, among other things, broadly prohibits manipulative and deceptive devices, i.e., fraud and fraud-based manipulative devices and contrivances employed intentionally or recklessly, regardless of whether the conduct in question was intended to create or did create an artificial price.46 CFTC Regulation 180.2 codifies the Commission’s long-standing authority to prohibit price manipulation by making it unlawful for any person, directly or indirectly, to manipulate or attempt to manipulate the price of any swap, or of any commodity in interstate commerce, or for future delivery on or subject to the rules of a registered entity.47 Finally, section 747 of the DoddFrank Act amended the CEA to make it unlawful for any person to engage in disruptive trading practices. Under section 4c(a)(5) of the CEA, it is unlawful for any person to engage in any trading, practice, or conduct on or subject to the rules of a registered entity that: Violates bids or offers, demonstrates intentional or reckless disregard for the orderly execution of transactions during the closing period, or is, is of the character of, or is commonly known to the trade as, ‘‘spoofing.’’ In May 2013, the Commission provided guidance on the scope and application of these statutory prohibitions.48 In July 2013, the Commission issued an order filing and settling charges against a high-speed trading firm for engaging in the disruptive practice of ‘‘spoofing’’ by utilizing a computer algorithm that was designed to illegally place and cancel bids and offers in futures contracts.49 C. Recent Disruptive Events in Automated Trading Environments Recent malfunctions in ATS and trading platform systems, in both derivatives and securities markets, illustrate the technological and operational vulnerabilities inherent to automated trading environments. ATSs, 46 See 17 CFR 180.1. 17 CFR 180.2. 48 See Commission, Interpretive Guidance and Policy Statement, 78 FR 31890 (May 28, 2013). 49 See Commission, Press Release No. 6649–13 (July 22, 2013), available at http://www.cftc.gov/ PressRoom/PressReleases/pr6649-13. 47 See E:\FR\FM\12SEP4.SGM 12SEP4 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS4 for example, are vulnerable to algorithm design flaws, market conditions outside of normal operating parameters, the failure of built-in risk controls, operational failures in the communication networks on which ATSs depend for market data and connectivity with trading platforms, and inadequate human supervision. Incidents involving an automated trading firm active in Commissionregulated markets are illustrative of these concerns. For example, in 2011 NYMEX fined a firm $350,000 for failing to adequately supervise, test, and have controls in place related to its ATS.50 NYMEX cited a 2010 event where the firm launched an ATS after limited testing. The firm was also fined a total of $500,000 by CME for failure to effectively supervise its ATSs on multiple occasions.51 A panel of the CME Business Conduct Committee found that the firm had experienced malfunctions with the same ATS multiple times, causing it to submit error trades. In another example, in 2012 a securities trading firm, Knight Capital Group, launched new software on the NYSE that conflicted with already existing code.52 At the time, the firm was one of the largest participants and a market maker on the NYSE. The firm’s ATS inadvertently established larger positions than intended, resulting in a $440 million loss for the firm. The malfunction impacted the broader market, creating swings in the share prices of almost 150 companies, and the high volatility linked to the algorithm designed by the firm also triggered pauses in the trading of five stocks. In addition to the software malfunction itself, some have reported that there was a delay of approximately 40 minutes before humans intervened.53 A leading example of ATS malfunction that impacted both the derivatives and securities markets in the Flash Crash of May 2010. As described in detail in section II.A.3. above, the Flash Crash illustrates the potential consequences of ATS design flaws as an automated execution algorithm failed to take price or time variables into account, and feedback loops triggered 50 See NFA, Case Summary: Infinium Capital Management, NYME 10–7565–BC (Nov. 25, 2011), available at http://www.nfa.futures.org/basicnet/ Case.aspx?entityid=0338588&case=10-7565-BC+ INFINIUM+CAPITAL+MGMT&contrib=NYME. 51 See NFA, Case Summary: Infinium Capital Management, CME 09–06562–BC (Nov. 25, 2011), available at http://www.nfa.futures.org/basicnet/ Case.aspx?entityid=0338588&case=09-06562-BC &contrib=CME. 52 See Strasburg & Bunge, supra note 2. 53 See SEC Roundtable Transcript, supra note 2, at 55–56. VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 continued orders from the algorithm even as prices moved far beyond traditional daily ranges.54 Finally, the Commission notes the recent systems malfunction at Goldman Sachs Group Inc. that inadvertently flooded U.S. options markets with a large number of unintended orders.55 In addition to ATSs, trading platforms have also suffered malfunctions and illustrate another area in which market disruptive events can occur. In November 2010, for example, untested code changes implemented by a U.S. stock exchange operator resulted in errors within its trading platforms. As a result, the platforms overfilled orders in over 1,000 stocks, resulting in $773 million of unwanted trading activity.56 In March 2012, a software problem on BATS Global Markets, whose software had undergone testing, led to a disruption of the exchange’s own IPO. The glitch caused opening orders for ticker symbols beginning within a certain letter range to become inaccessible on the platform.57 Once the system failed, circuit breakers were triggered and erroneous trades were cancelled.58 In May 2012, Facebook’s IPO experienced significant problems as a result of technical errors on Nasdaq OMX Group Inc.’s U.S. exchange.59 Many customer orders from both institutional and retail buyers were unfilled for hours or were never filled at all, while other customers ended up 54 See CFTC and SEC Joint Report on the Market Events of May 6, 2010, supra note 1. 55 See Jacob Bunge, Kaitlyn Kiernan & Justin Baer, ‘‘Bad Trades’ Ripple Effect,’’ W. St. J. (Aug. 21, 2013), available at http://online.wsj.com/article/ SB1000142412788732416520457902661141 0016876.html. 56 See Securities and Exchange Act Release No. 65556, In the Matter of EDGX Exchange, Inc., EDGA Exchange, Inc. and Direct Edge ECN LLC (Oct. 13, 2011), available at http://www.sec.gov/litigation/ admin/2011/34-65556.pdf; see also SEC News Release, 2011–208, ‘‘SEC Sanctions Direct Edge Electronic Exchanges and Orders Remedial Measures to Strengthen Systems and Controls’’ (Oct. 13, 2011), available at http://www.sec.gov/ news/press/2011/2011-208.htm. 57 See Olivia Oran, Jonathan Spicer, Chuck Mikolajczak & Carrick Mollenkamp, ‘‘BATS exchange withdraws IPO after stumbles,’’ Reuters (Mar. 24, 2012), available at http://uk.reuters.com/ article/2012/03/24/us-bats-trading-idUKBRE82 M0W020120324; Michael J. De La Merced & Ben Protess, The N.Y. Times Dealbook (Mar. 25, 2012), available at http://dealbook.nytimes.com/2012/03/ 25/little-fallout-expected-from-bats-trading-error/. 58 See id. 59 See Jenny Strasburg and Jacob Bunge, ‘‘Social network’s debut on Nasdaq disrupted by technical glitches, trader confusion,’’ Wall St. J. (May 18, 2012), available at http://online.wsj.com/article/ SB10001424052702303448404577412251723 815184.html?mod=googlenews_wsj; Jenny Strasburg, Andrew Ackerman & Aaron Lucchetti, ‘‘Nasdaq CEO Lost Touch Amid Facebook Chaos,’’ Wall St. J. (June 11, 2012), available at http:// online.wsj.com/article/SB1000142405270230 3753904577454611252477238.html. PO 00000 Frm 00009 Fmt 4701 Sfmt 4702 56549 buying more shares than they had intended. Finally, the Commission notes the recent three-hour halt in trading on the Nasdaq, which according to reports was caused when the exchange experienced a disruption in its stock quote dissemination systems and a disruption in its connectivity with another trading platform’s systems.60 Taken together, these events illustrate the importance of effective testing, circuit breakers, and error trade policies as vehicles for reducing the likelihood of disruptive events and mitigating their impact when they occur.61 A number of the risk controls contemplated in this Concept Release could help limit the extent of market disruption caused by ATS or trading platform malfunctions similar to those described above. For example, an order ‘‘kill switch’’ enables a market participant to immediately cancel all working orders generated by one or more of its ATSs, and prevents the submission of additional orders until the appropriate natural persons allow order placement to resume. Such a kill switch could be operated by the market participant generating orders, the clearing firm guaranteeing its trades, or the trading platform on which its orders would be executed. As another example, ATS monitoring and supervision standards, as well as preestablished crisis management protocols, could help ensure that human supervisors intervene quickly when ATSs experience degraded performance, and that supervision staff have the both the authority and knowledge to intervene as required. Further, requiring exchanges to calculate and disseminate market quality metrics could enable both exchanges and market participants to better anticipate and mitigate destabilizing events. In addition, the Commission believes that change management standards that are beneficial to ATSs could also be applied to trading platforms to help prevent operational or programming errors in that element of the automated trading environment. In section III below, the 60 See Chris Dieterich & Jacob Bunge, ‘‘Nasdaq Offers Details on Trading Outage,’’ Wall St. J. (Aug. 23, 2013), available at http://online.wsj.com/article/ SB1000142412788732416520457903068167 1164404.html. 61 In addition, although in some ways distinct from the events summarized above, the Commission notes the significant impact of Hurricane Sandy in October 2012. U.S. stock markets closed for two days partially in response to concerns over preparedness to trade exclusively on electronic venues while trading floors were potentially closed, as well as the availability of technology and other relevant personnel. See Jenny Strasburg, Jonathan Cheng & Jacob Bunge, ‘‘Behind Decision To Close Markets,’’ Wall St. J. (Oct. 29, 2012), available at http://online.wsj.com/article/SB10001424052 970204789304578087131092892180.html. E:\FR\FM\12SEP4.SGM 12SEP4 56550 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules Commission seeks public comment on these and other potential risk controls. III. Potential Pre-Trade Risk Controls, Post-Trade Reports, System Safeguards, and Other Protections A. Overview of Existing Industry Practices mstockstill on DSK4VPTVN1PROD with PROPOSALS4 The transition to automated trading in derivatives markets, as described above, has been followed by an evolution in what market participants, regulators and others understand to be necessary risk controls for various points in the order and trade lifecycle. Many of the measures identified herein are consistent with recommendations made by industry groups, other regulatory authorities, international standard setting bodies, and others. Certain measures, or variants of them, have been discussed within the futures industry for some time, or may already be in operation at one or more exchanges, clearing members, or market participants. For example, the system safeguards pertaining to the cancellation of orders or disconnecting a market participant in emergency situations are similar to proposals made separately by FIA’s Principal Traders Working Group and Market Access Working Group in 2010 and the TAC’s Pre-Trade Functionality Subcommittee in 2011.62 The Principal Traders Group also addressed the need to properly monitor ATSs in its 2010 recommendations by noting that ‘‘firms must ensure their [ATSs] are supervised at all times while operating in the markets. Staff must have training, experience and tools that enable them to monitor and control the trading systems and troubleshoot and respond to operational issues in a timely and appropriate manner. Firms should have processes and procedures to ensure trading operations staff is trained on the expected operating parameters of any [ATS] for which they are responsible.’’ 63 ATS design and operation was addressed by FIA’s Market Access Working Group and by ESMA, the latter requiring that market participants ‘‘make use of clearly delineated development and testing methodologies’’ for ATSs prior to their deployment or the deployment of 62 See FIA Principal Traders Group, ‘‘Recommendations for Risk Controls for Trading Firms,’’ (November 2010) at 5 [hereinafter, ‘‘FIA Recommendations for Risk Controls’’], available at http://www.futuresindustry.org/downloads/ Trading_Best_Pratices.pdf; FIA Market Access Recommendations, supra note 23, at 9; TAC PreTrade Functionality Subcommittee DMA Recommendations, supra note 26, at 5. 63 See FIA Recommendations for Risk Controls, supra note 62, at 3. VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 system updates.64 Among other considerations, ESMA emphasized that ATS testing should address embedded compliance and risk management controls and operation during stressed market conditions. As with the pre-trade and post-trade risk controls, certain system safeguards would be applicable to more than one entity or would require coordination between entities. For example, ATS design and operation tests will require that trading platform operators provide suitable test environments that accurately recreate the ‘‘live’’ trading platform. Similarly, safeguards that provide for the immediate disconnection of a market participant in the event of emergency or breach of tolerances should be available to the market participant, its clearing firm, and the relevant trading platform so that all parties have the capacity to initiate a disconnect when necessary. As with other overlapping measures contemplated in this Concept Release, the Commission requests public comment regarding the necessity of such overlaps and the most efficient way to administer them. 1. Existing DCM Risk Controls Risk controls implemented by one or more exchanges broadly address market stability. One large DCM (‘‘DCM A’’) employs price reasonability validation controls (aimed at preventing ‘‘fat finger’’ type errors) and position validation controls (both absolute limits and net long/short limits). In addition, DCM A has implemented a circuit breaker protection against price spikes. This control provides floor and ceiling price limits within a specific timeframe and market, and recalculates new floor and ceiling price limits based on current market prices for each new timeframe. If the floor or ceiling price is exceeded, the market is put in a ‘‘hold’’ state, although trading will not be halted in the opposite direction of the hold. The length of the hold varies depending on the market and orders submitted during the hold state will remain in the order book but will not be matched. DCM A has also implemented kill switches that provide it and risk managers at trading firms with the ability to halt trading. Similarly, another large DCM (‘‘DCM B’’) also employs a limit price to each market order and stop order to prevent orders from being filled at significantly aberrant price levels, and maximum order size protection to prevent entry of erroneous orders for quantities above a 64 See FIA Market Access Recommendations, supra note 23; ESMA Guidelines on Systems and Controls, supra note 4, at 33. PO 00000 Frm 00010 Fmt 4701 Sfmt 4702 designated threshold. DCM B employs a functionality that introduces a 5–20 second market pause when triggered stops would cause the market to trade outside of predefined values. This is designed to prevent excessive price movements caused by cascading stop orders. DCM B also employs a functionality that introduces a 5–20 second market pause when a subsecond, extreme market move occurs as a result of order entry. This functionality is designed to detect significant price moves of futures contracts occurring within a predetermined period of time, and triggers a pause in matching activity to provide time for additional resting orders to populate the order book. DCM A seeks to optimize message flow through both hard limits and market incentives. It employs a message throttle limit which sets a maximum message rate per second for each user session and prevents the submission of messages in excess of the maximum rate. The second form of message control used by DCM A is a system of fees based on Weighted Volume Ratio (‘‘WVR’’) calculations designed to discourage inefficient messaging among firms with high message volumes. The WVR is a ratio between the number of messages submitted by a market participant and the total volume of orders that it executes. The ratio of unfilled orders is also weighted based on how far away from the best bid or offer each unfilled order was when it was entered. Orders that are farther away from the best bid or offer when entered are weighted more heavily. The DCM assesses fees against market participants when they exceed WVR limits. DCMs A and B both employ an ‘‘orders removed upon logout’’ function in which all orders are removed upon the user’s logout or disconnection, and that they maintain error trade policies that incorporate a no cancellation range. With respect to ATSs, DCMs A and B both employ a certification and testing process for connecting entities. For example, one DCM described this process as testing a firm’s messaging ability (i.e., that firm’s ability to send and receive data). As part of the testing process, the DCM will transmit market data to the firm and this provides the firm with the opportunity to run its own algorithms and for that firm to determine if its algorithms are functioning as it intended. Firms must pass additional conformance tests when the exchange’s own system functionality changes. DCM B indicated that its testing process allows customers to test E:\FR\FM\12SEP4.SGM 12SEP4 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS4 new products prior to their production launch. In addition to their internal risk mitigation programs, DCMs also provide risk mitigation tools to intermediaries such as FCMs, allowing the intermediaries to set risk control parameters on controls that reside at the trading platform level. Clearing firms, for example, are able to set risk tolerance levels for their customers based on position size, order activity, executions, among other variables. 2. Existing Trading and Clearing Firm Risk Controls Risk controls at the level of individual market participant firms, whether trading firms or clearing firms, are necessarily entity specific. Accordingly, industry groups have collaborated to determine best practices for risk controls. As noted previously, other entities, including the TAC, have also developed best practices or recommendations. One goal of this Concept Release is to determine how consistently these, and other, recommendations are today being implemented by market participants. As noted by FIA, ‘‘all principal traders have a vested interest in well-functioning markets with effective risk controls, clear error trade policies that focus on trade certainty, and a strong regulatory framework.’’ 65 Comments to this Concept Release will allow the Commission to best ensure this strong framework. Questions about the general use of automated risk controls at the level of a firm are also informed by two reports prepared by authors affiliated with the Federal Reserve Bank of Chicago. One report details the current practices of nine proprietary trading firms, with special attention to risk mitigating practices currently applied to their automated systems.66 Through interviews, the authors found that (1) all firms have maximum order sizes in place and intraday position limits; (2) all but one firm has credit limits by account, which monitor open positions, dollar value of positions and quantity of working orders; 67 (3) half of the firms have price protection points for orders; (4) most firms had message throttles, set at order volume per unit of time; and (5) all firms had kill buttons. The risk controls included in this list, and others 65 See FIA Recommendations for Risk Controls, supra note 62, at 2. 66 See Carol Clark & Rajeev Ranjan, ‘‘How Do Proprietary Trading Firms Control the Risks of High Speed Trading?’’ (March 2012), available at http:// www.chicagofed.org/digital_assets/publications/ policy_discussion_papers/2012/PDP2012-1.pdf. 67 The final firm also sets credit limits, but only for new traders. See id. at 7. VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 discussed within the report, are expanded upon in the below discussion. In its questions for comment, the Commission seeks to understand what types of risk controls are most commonly used throughout the industry, and the degree to which those risk controls are standardized across the industry. A second report 68 summarized interviews with five Broker/Dealers (‘‘B–Ds’’) and FCMs, again detailing their current practices in automated risk controls. As at the trading level, some firms have implemented pre-trade and post-trade checks, along with other credit related controls to mitigate trading losses and resulting burdens on the clearing firm. The report details categories of risks considered by the B– D or FCM when signing on a new client, or updating controls as a client enters new businesses or expands on old ones. These include: Credit risks, market risks, counterparty risks, portfolio risks and regulatory risks. Through these assessments, clearing firms are able to determine appropriate risk thresholds for a given client, and apply them as necessary at multiple points in the trading chain. Specific controls come in forms quite similar to those outlined above in the case of the trading firm. Pre-trade risk controls span order size limits, intraday position limits, credit limits, and message throttles. These can vary by asset class, exchange, and other market factors, along with coincident market dynamics such as volatility levels and current positions of the trading firm. The monitoring done by the clearing firm is aided by post-trade measures such as the drop-copy of executions, which allows for the monitoring of positions and associated credit risks. B. Overview of Risk Controls Addressed in This Concept Release The risk controls presented below describe specific measures which could be taken by exchanges and participants in automated trading environments. To better understand current industry practices, the Commission is interested in determining, for each risk control: (1) Whether the entity commenting has implemented the control; (2) whether the entity believes implementation of the control within the marketplace is consistently applied; and (3) the benefits and costs of a regulatory mandate of the control. If the 68 See Carol Clark & Rajeev Ranjan, ‘‘How Do Broker-Dealers/Futures Commission Merchants Control the Risks of High Speed Trading?’’ (June 2012), available at http://www.chicagofed.org/ Webpages/publications/policy_discussion_papers/ 2012/pdp_3.cfm. PO 00000 Frm 00011 Fmt 4701 Sfmt 4702 56551 Commission determines that the types of risk controls employed across the industry vary widely, the Commission would be aided by understanding the extent of this variance, the reasons for it, and whether regulatory standardization can be of benefit. By gathering this information, the Commission will be better informed regarding beneficial future regulation surrounding automated systems. The Commission emphasizes that this Concept Release is intended to serve as a high-level enunciation of potential measures intended to reduce the likelihood of market disrupting events and mitigate their impact when they occur. Many of the risk controls listed below are in effect, in part or in full, across multiple entities. Others have been included in recommendations by industry groups and standard-setting bodies, or addressed by foreign regulatory authorities. The Commission also notes that a number of the measures described below offer similar risk controls at various stages in the life of an order (e.g., a safeguard applicable to the ATS generating an order and a similar safeguard applicable to the trading platform receiving such order). Added security through redundancy of risk controls is a feature of safeguard documents reviewed by the Commission in preparing this Concept Release. The Commission seeks public comment on merits of single versus redundant risk control models. Market participants and members of the public are encouraged to comment on the potential risk controls, and the Commission anticipates further refinement of the measures described herein based on the comments received. The discussion of risk controls below is followed by a number of general questions on which the Commission requests comment (see section III.G. below). These questions are applicable to all the risk controls discussed below. C. Pre-Trade Risk Controls The Commission includes below a set of pre-trade risk controls aimed at reducing market disruptions related to automated trading due to errors, system malfunctions or other events with similar effects. In general, pre-trade risk controls seek to protect against the accumulation of a large volume of orders, executions, or positions over an abbreviated period of time. Some market participants are currently using controls which address this accumulation, including maximum order size limits, message rate limits, and similar measures. Pre-trade risk controls can also promote fair and orderly markets, through the use of circuit breakers, execution throttles and self-trade E:\FR\FM\12SEP4.SGM 12SEP4 56552 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS4 monitoring. Finally, the pre-trade risk controls also include pre-trade credit limits designed to protect clearing firms, and their clients, with respect to customer and proprietary orders.69 Each of these groups is discussed below in greater detail. In order to fully address possible disruptions, the pre-trade risk controls apply at one or more of three points in the execution chain: (1) Individual firms; (2) intermediaries of many forms (including SDs, MSPs, FCMs, Floor Traders, Commodity Pool Operators (‘‘CPOs’’) and DCOs); and (3) exchanges (including DCMs and SEFs). In many cases, the same or similar risk controls are implemented at more than one point in the execution chain, such as first at the firm, then perhaps at the clearing firm, and then finally at the DCM. The Commission believes that this approach offers a number of advantages.70 First, it allows individual entities to calibrate the relevant risk control in accordance with their own objectives and risk tolerances. For example, an exchange may set a per-product maximum order size to ensure orderly trading in its markets, with the same limit applying equally to all market participants. A clearing firm, however, may wish to address its customers’ distinct risk profiles by setting different maximum order sizes for different customers. Second, by indicating that some risk controls should reside at the exchange level in addition to the market participant and clearing firm levels, the Commission is responding to competitive and ‘‘race to the bottom’’ concerns raised by several observers. FIA’s Market Access Working Group, for example, noted that ‘‘[p]re-trade risk controls have become a point of negotiation between trading firms and clearing members because they can add 69 The pre-trade risk controls contemplated herein are consistent with general principles or specific recommendations (in DMA context) expressed in the TAC Pre-Trade Functionality Subcommittee DMA Recommendations, supra note 26, at 2–5; IOSCO Technical Committee, Final Report on Principles for Direct Electronic Access to Markets (August 2010) at 20, available at http:// www.iosco.org/library/pubdocs/pdf/ IOSCOPD332.pdf; and the FIA Recommendations for Risk Controls, supra note 62, at 4. The pre-trade risk controls described herein are also consistent with the principles included in the ESMA Guidelines on Systems and Controls, supra note 4. 70 In this regard, the Commission notes that the TAC’s Pre-Trade Functionality Subcommittee described ‘‘three levels in the electronic trading ‘supply chain’ where pre-trade risk safeguards could happen: Trading firms (as principal or agent), clearing firms (as principal or agent), and exchanges.’’ The Subcommittee’s recommendations to the TAC noted that it ‘‘believe[s] strongly that all three levels of the supply chain should institute pre-trade risk management measures.’’ See TAC Pre-Trade Functionality Subcommittee DMA Recommendations, supra note 26, at 1. VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 latency to a trade. To avoid such negotiations, the Market Access Working Group believes that certain risk controls should reside at the exchange level and be required for all trading to ensure a level playing field.’’ 71 Third, the risk controls listed below acknowledge a variety of industry practices with respect to order generation, such as whether the order passes through intermediaries prior to execution. The Commission seeks to understand how increased standardization in risk controls at the level of exchanges or exchange members could provide strengthened protection for the markets and the public.72 Notably, if the Commission were to require the placement of credit controls, maximum order size limits, and maximum message rate limits at both exchanges and clearing members, it could address both traditional means of order flow (i.e., through a clearing firm) and newer DMA practices, which require controls at the exchange set by the relevant clearing firm. In combination, these reasons demonstrate the strength, in certain cases, of putting into practice standardized risk controls, 71 See FIA Market Access Recommendations, supra note 23, at 8. See also TAC Pre-Trade Functionality Subcommittee DMA Recommendations, supra note 26, at 2. The TAC Pre-Trade Functionality Subcommittee called for a ‘‘realistic view’’ of the incentives under which market participants, clearing firms, and exchanges operate. The Subcommittee identified these incentives as follows: • ‘‘Trading firms are competing with one another to have the smallest time delays (lowest latency) in getting their orders into the exchange’s matching engine, and are thus negotiating with brokers to reduce latency. At the same time they are trying to protect their capital from rogue trading, technological deficiencies or other adverse, unintended events. • Brokers (clearing FCMs) are competing with one another to attract the business of these highvolume, speed-seeking trading firms, and are thus trying to reduce latency. At the same time, they are trying to protect themselves from loss due to unauthorized trading by their trading firm clients or other adverse, unintended events. • Exchanges (Designated Contract Markets, or DCMs, and Foreign Boards of Trade, or FBOTs) are competing with one another to provide low latency execution, and will soon be competing with Swaps Execution Facilities (SEFs), to attract the business of these trading firms.’’ The Subcommittee expressed its concern that risk controls should ensure fairness so that one trading firm is not disadvantaged relative to another ‘‘because its clearing firm chose to act more responsibly.’’ 72 For example, trading platforms provide a range of risk controls, but there is limited standardization in the types of risk controls available to customers from one exchange to the next. The Commission seeks to understand whether diverse risk management tools and policies at various exchanges complicate risk management for intermediaries and traders. PO 00000 Frm 00012 Fmt 4701 Sfmt 4702 with similar goals, at multiple entity types.73 Finally, the Commission notes the importance of risk controls designed to protect the financial integrity of DCOs, and to address risks posed by market participants utilizing DMA. Throughout the range of pre-trade risk controls discussed below, and other measures discussed later in this Concept Release, the Commission specifically solicits public comment regarding the following questions: 6. Are there distinct pre-trade risk controls, including measures not listed below, or measures in addition to those already adopted by the Commission, that would be particularly helpful in protecting the financial integrity of a DCO? 7. Are there distinct pre-trade risk controls, including measures not listed below, or measures in addition to those already adopted by the Commission, that should apply specifically in the case of DMA? The following sections describe the pre-trade risk controls inquired about in this Concept Release, and present a series of questions to assist the Commission in determining the effectiveness, adoption rate, and need for any additional action with respect to these pre-trade risk controls or others that commenters may think advisable. 1. Message and Execution Throttles The Commission seeks public comment regarding the potential benefits and existing use of maximum message rate and execution rate throttles (‘‘execution throttles’’). The Commission also seeks public comments regarding the types of execution throttles that would be most effective at alerting market participants to potential algorithm malfunctions and limiting the extent of market disruption when there is a malfunction.74 73 The Commission notes that some existing regulations address pre-trade risk controls. See supra section II.B. 74 The Commission understands that some trading firms and several exchanges already have limits on the number of orders that can be sent to a trading venue during a specified period of time. See Clark & Ranjan, ‘‘How Do Proprietary Trading Firms Control the Risks of High Speed Trading,’’ supra note 66, at 7; Oliver Linton & Maureen O’Hara, ‘‘Economic impact assessments on MiFID II policy measures related to computer trading in financial markets,’’ United Kingdom Government Office for Science—Foresight (August 2012) at 24–25, available at: http://www.futuresindustry.org/epta/ downloads/Economic-Impact-assessments-onMiFID-2-policy-measures_083012.pdf. However, the Commission would like to understand whether requiring some measure of standardization and the use of such tools among exchanges, FCMs, and trading firms would provide additional protection for the market. E:\FR\FM\12SEP4.SGM 12SEP4 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS4 Execution throttles prevent an algorithm from exceeding its expected message rate or rate of execution, and when tripped, can alert monitors at both the exchange and the trading firm. Such alerts can facilitate rapid detection of malfunctioning algorithms. Depending on the nature of the malfunction, execution throttles may also reduce the damage and monetary losses caused by the disruptive algorithm during the time when it is being investigated. The Commission understands that trading firms 75 and exchanges 76 employ individual variants of throttles to limit the number of orders that can be transmitted to or processed by an exchange. The Commission requests public comment regarding the extent to which market participants that already utilize execution throttles apply them in a static manner (i.e., a fixed threshold, beyond which notifications are generated), or dynamically (i.e., dependent on the time of day or the previous activity of the algorithm).77 The Commission also requests public comments regarding the extent to which throttles are applied by trading firms on a per-algorithm basis, calibrated to take into account the expected message and execution rates of each algorithm for a given time period. In addition, the Commission asks whether maximum message rates and execution throttles could be used as a mechanism to prevent individual entities from submitting messages or executing orders at speeds that are misaligned with their risk management capabilities. Execution throttles of this type would be unique to individual firms or accounts, and could be set by the exchange or clearing firm after reviewing the risk management capabilities of the entity to which the throttle will apply. For some firms, 75 See Clark & Ranjan, ‘‘How Do Proprietary Trading Firms Control the Risks of High Speed Trading,’’ supra note 66, at 7. 76 See Carol Clark & Rajeev Ranjan, ‘‘How Do Exchanges Control the Risks of High Speed Trading?’’ (November 2011) at 3, available at http:// www.chicagofed.org/digital_assets/publications/ policy_discussion_papers/2011/PDP2011–2.pdf. 77 The Commission notes that the Futures and Options Association (‘‘FOA’’) expressed the opinion that throttles may hinder price formation and market integrity if applied dynamically during a period of market stress. However, the FOA generally supported the use of throttles that are ‘‘pre-defined, transparent and certain (i.e., the member obtains connections with a specified bandwidth in terms of maximum messages per second).’’ See FOA, ‘‘ESMA’s Consultation Paper: Guidelines on Systems and Controls in a highly automated trading environment for trading platforms, investment firms and competent authorities: A response paper by the Futures and Options Association’’ (October 2011) at 2, available at http://www.esma.europa.eu/system/files/11FOA.pdf. VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 56553 there may be a delay before effective risk management begins; in these cases, execution throttles may mitigate harm to the firm or other market participants prior to the firm’s response to a malfunction. Last, message rate limits could be used to mitigate the risk of manipulative or disruptive messaging strategies such as ‘‘order stuffing,’’ where firms use ATSs to submit large numbers of orders that are cancelled before execution in order to slow down the matching engine and create arbitrage opportunities in or across products. 8. If, as contemplated above, maximum message rates and execution throttles were used as a mechanism to prevent individual entities or accounts from trading at speeds that are misaligned with their risk management capabilities, how should this message rate be determined? 9. Message and execution throttles may be applied by trading firms (FCMs and proprietary trading firms), clearing firms, and by exchanges. The Commission requests public comment regarding the appropriate location for message and execution throttles. a. If throttles should be implemented at the trading firm level, should they be applied to all ATSs, only ATSs employing HFT strategies, or both? b. What role should clearing firms play in the operation or calibration of throttles on orders submitted by the trading firms whose trades they guarantee? 10. Should the message and execution throttles be based on market conditions, risk parameters, type of entity, or other factors? 11. What thresholds should be used for each type of market participant in order to determine when a message or execution throttle should be used? Should these thresholds be set by the exchange or the market participant? 12. Are message and execution thresholds typically set by contract, or by algorithm? What are the advantages and disadvantages to each method? 13. Who should be charged with setting message rates for products and when they are activated? 14. Would message and execution throttles provide additional protection in mitigating credit risk to DCOs? identifying market conditions that may exceed an algorithm’s parameters, or may highlight unintended effects of an algorithm’s orders. Given an alert, human monitors at the trading firm could then intervene either by halting the relevant algorithms under their control, or by conveying the information to other relevant parties. Unlike exchange trading pauses and halts, volatility awareness alerts inform firm personnel as to changes in market conditions that may disrupt the parameters within which their ATSs and algorithms were programmed to operate, rather than immediately triggering a pause in trading. 15. The Commission is aware that alarms can be disruptive or counterproductive if ‘‘false alarms’’ outnumber accurate ones. How can volatility alarms be calibrated in order to minimize the risk that false alarms could interrupt trading or cause human monitors to ignore them over time? 2. Volatility Awareness Alerts Automated volatility awareness alerts implemented by trading firms are another form of risk control contemplated in this Concept Release. Volatility awareness alerts could be triggered when price movements in a given product move beyond a certain threshold within a previously specified time period. Such alerts could assist in 78 See CME Group, ‘‘CME Globex Self-Match Prevention Functionality FAQ’’ (2013), available at http://www.cmegroup.com/globex/resources/ smpfaq.html. On July 9, 2013, CME Group requested Commission approval to issue a market regulation advisory notice intended to provide guidance with respect to the types of activity that may constitute a violation of the exchange’s wash trades rule and to provide additional information concerning its self-match prevention technology. This notice, which is under review by the Commission, is available at http://www.cftc.gov/ PO 00000 Frm 00013 Fmt 4701 Sfmt 4702 3. Self-Trade Controls A trade that results from the matching of opposing orders between a firm or a single or commonly owned account, such as a wash trade, does not shift risk between different market participants. In addition, such trades may inaccurately signal the level of liquidity in the market and may result in a nonbona fide price. Risk controls that identify and limit self-trading may result in more accurate indications of the level of market interest on both sides of the market and help ensure armslength transactions that promote effective price discovery. Some regulated exchanges have tools specifically designed to identify and limit self-trading. The Commission is interested in better understanding those risk controls and how widespread their use may be. For example, the Commission understands that in June 2013, CME Group introduced a voluntary selfmatch prevention functionality that allows market participants to prevent buy and sell orders for the same account (or for an account with common beneficial ownership) from matching with each other.78 Market participants E:\FR\FM\12SEP4.SGM Continued 12SEP4 mstockstill on DSK4VPTVN1PROD with PROPOSALS4 56554 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules that wish to opt-in to this functionality populate a new FIX tag on all orders with a ‘‘Self Match Prevention Identifier,’’ in addition to an executing firm number. When the exchange’s matching engine detects buy and sell orders at the same executable price level in a particular contract and both orders have the same Self Match Prevention Identifier and the same executing firm number, the engine will automatically cancel the resting order(s) on one side of the market and process the incoming order on the other side of the market. In addition, the Commission understands that ICE Futures U.S. (‘‘ICE’’) offers voluntary self-trade prevention functionality for preventing inter- and intra-company orders from matching in the exchange’s matching engine. This functionality was initially designed to prevent the matching of inter- and intra-company trades by automatically rejecting the taking order. The Commission understands that in May 2013, this functionality was expanded to allow for the rejection of the resting order. 16. What specific practices or tools have been effective in blocking selftrades, and what are the costs associated with wide-spread adoption of such practices or tools? 17. Please indicate how widely you believe exchange-sponsored self-trading controls are being used in the market. 18. Should self-trade controls cancel the resting order(s)? Or, instead, should they reject the taking order that would have resulted in a self-trade? If applicable, please explain why one mechanism is more effective than the other. 19. Should exchanges be required to implement self-trading controls in their matching engines? What benefits or challenges would result from such a requirement? 20. Please explain whether regulatory standards regarding the use of selftrading control technology would provide additional protection to markets and market participants. 21. If you believe that self-trading controls are beneficial, please describe the level of granularity at which such controls should operate (e.g., should the controls limit self-trading at the executing firm level? At the individual trader level?) What levels of granularity are practical or achievable? 22. If you believe that self-trading controls are beneficial, please explain whether exchanges should require such controls for market participants and stellent/groups/public/@rulesandproducts/ documents/ifdocs/rul070913cmecbotnymexcom andkc1.pdf. VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 identify the categories of participants that should be subject to such controls. For example, should exchanges require self-trading controls for all participants, some types of participants, participants trading in certain contracts, or participants in market maker and/or incentive programs? What benefits or challenges would result from imposing such controls on each category of participant? 4. Price Collars The Commission is also inquiring about price collars for both orders and executions. Price collars on orders prevent orders outside of acceptable price ranges from either entering the order book or executing at extreme levels; in effect, collars prevent market or stop orders (which execute as market orders) from trading at levels far beyond that expected at order entry. Similarly, price collars for execution prevent an order that is already in the book from being executed by the matching engine if it is outside of the acceptable range. Price collars can be contract specific and dynamic, responding to changes in market prices and market volatility for each contract. Price collars may reduce realized volatility by preventing a large, aggressive order from sweeping the book and matching at prices outside the range allowed by the collar, or allowing isolated market orders to execute during periods when one-sided liquidity is extremely low.79 23. The Commission is aware that some exchanges already have price collars in place for at least a portion of the contracts traded in their markets. Please comment on whether exchanges should utilize price collars on all contracts they list. 24. Would price collars provide additional protection in mitigating credit risk to DCOs? 5. Maximum Order Sizes Maximum order sizes are intended to protect against execution of orders for a quantity larger than a predetermined ‘‘fat finger’’ limit. Like other controls, these limits can function at multiple levels; for example, at the firm level, in which firms prevent the submission of orders beyond certain limits, or at the clearing level, in which clearing 79 The Commission currently estimates that about half of the trading firms operating ATS have limits that check orders against a specific price range before sending them to the exchange. See Clark & Ranjan, ‘‘How Do Proprietary Trading Firms Control the Risks of High Speed Trading,’’ supra note 66, at 7. However, the Commission would like to better understand whether standardizing such controls at the level of exchanges or requiring such controls at the level of trading firms would further promote stable and reliable markets. PO 00000 Frm 00014 Fmt 4701 Sfmt 4702 members prohibit transmission of customer orders in excess of predetermined limits. The Commission believes that most, if not all, exchanges currently have the capability to set maximum order sizes, but understands that such controls may vary among exchanges in their ability to set limits by product, product class, customer, or clearing member.80 The Commission is interested to understand the following: 25. Are such controls typically applied to all contracts and customers, or on a more limited basis? 26. Do exchanges allow clearing members to use the exchange’s technology to set maximum order sizes for specific customers or accounts? 27. Would additional standardization in the capabilities of this technology or more uniform application of this technology to all customers and contracts improve the effectiveness of such controls? The Commission understands that some, but perhaps not all clearing firms may utilize the exchange’s systems, and possibly their own systems, in order to conduct pre-trade maximum order size screens.81 The Commission is interested to understand the following: 28. To what extent are clearing firms and trading firms conducting pre-trade maximum order size screens? Please explain whether firms are conducting such screens by utilizing: (1) Their own technology; (2) the exchange’s technology, or (3) a combination of both. 29. Would regulatory standards regarding the use of such technology provide additional protection to the markets? 6. Trading Pauses The Commission wants to better understand the existing implementation of trading pauses for trading platforms, and whether any additional types of pause mechanisms would be beneficial. A wide range of pause methodologies are currently in effect at exchanges, such as stop-logic functionality and interval price limits. These methodologies include market pauses when the execution of resting stop orders would cause excessive price movements, when prices move in excess of a dynamic threshold over a given time period, or simply when prices have 80 See Carol Clark & Rajeev Ranjan, ‘‘How Do Exchanges Control the Risks of High Speed Trading?’’ supra note 76, at 3. 81 See, e.g., Carol Clark, Rajeev Ranjan, John McPartland, & Richard Heckinger, ‘‘What Tools Do Vendors Provide to Control the Risks of High Speed Trading?’’ (October 2011) at 2–3, available at http:// www.chicagofed.org/digital_assets/publications/ policy_discussion_papers/2011/PDP2011-1.pdf. E:\FR\FM\12SEP4.SGM 12SEP4 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules moved more than a given amount during the trading day.82 Often, the market will monitor the order book during the pause, and determine when it is ‘‘safe’’ to re-open the market to further executions or re-open after a specified interval. Trading pauses have mitigated price movements during particularly volatile times in the past.83 The Commission is interested in better understanding the relative costs and benefits of each type of pause functionality and whether certain types of pause mechanisms are more effective than others with respect to ATS trading. The Commission is also interested to understand whether additional types of pause triggers would be advisable. These might cover a wider array of adverse states of an automated central limit order book, including, for example, significant depth imbalance, a significant number of aggressive orders, or a significant number of cancelled orders. 30. Trading pauses, as currently implemented, can be triggered for multiple reasons. Are certain triggers more or less effective in mitigating the effects of market disruptions? 31. Are there additional triggers for which pauses should be implemented? If so, what are they? 32. What factors should the Commission or exchanges take into account when considering how to specify pauses or what thresholds should be used? 33. How should the re-opening of a market after a trading pause be effected? mstockstill on DSK4VPTVN1PROD with PROPOSALS4 7. Credit Risk Limits Credit risk limits are a valuable protection for limiting the activity of malfunctioning ATSs. Risk limits are most valuable when implemented as a pre-execution filter. Alternatively, lowlatency post-trade risk limits may also provide some risk mitigation. Credit risk controls may be implemented by different entities, including the trading firms that originate orders, the clearing firms that guarantee the orders, the trading platforms matching the orders, 82 The Commission understands that some triggers leading to a market pause are not necessarily best classified as ‘‘pre-trade’’ risk controls. Some pauses, as described, may be in anticipation of a certain set of executions, and are pre-trade, while others may be in response to a given execution. The discussion here implicitly includes all of the above, and the Commission requests comment on the full range of pause types. 83 See CFTC and SEC Joint Report on the Market Events of May 6, 2010, supra note 1, at 6 (noting that CME’s stop logic functionality that triggered a halt in E-Mini trading shows that pausing a market can be an effective way of providing time for market participants to reassess their strategies, for algorithms to reset their parameters, and for an orderly market to be re-established). VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 and the DCOs that clear the orders. The Commission acknowledges that some trading firms and FCMs conduct posttrade credit checks with varying degrees of latency and that pre-trade credit risk screens are already required pursuant to §§ 1.73 and 23.609.84 As noted above, however, the Commission seeks public comments regarding any additional measures that could help protect the financial integrity of DCOs, including measures discussed in this Concept Release or other measures that may be recommended by interested parties. The TAC has received proposed models for implementing certain pretrade risk controls for swaps, particularly those pertaining to credit risk.85 Relevant solutions for implementing credit-based pre-trade risk controls include those in which credit limits reside at the FCM, at the trading platform (based on instruction from the clearing firm), or, for example, at a ‘‘hub’’ which applies credit controls on a per-order basis.86 The Commission is interested to understand whether the ‘‘hub’’ model, one of several proposed solutions received by the TAC, could be usefully applied to futures markets. The Commission is also interested in credit risk limits as a mechanism for limiting the disruptive activity of a malfunctioning ATS. Therefore, the Commission requests comment on the following: 34. What positions should be included in credit risk limit calculations in order to ensure that they are useful as a tool for limiting the activity of a malfunctioning ATS? Is it adequate for such a screen to include only those positions entered into by a particular ATS or should it include all the firm’s positions? 35. Should pre-trade credit screens require a full recalculation of margin based on the effect of the order? 36. In light of your answers to the previous two questions, where in the lifecycle of an order should the credit limits be applied and what entity should be responsible for conducting such checks? 84 See Commission, Final Rule: Customer Clearing Documentation, Timing of Acceptance for Clearing, and Clearing Member Risk Management, 77 FR 21278 (Apr. 9, 2012). 85 See, e.g., ‘‘Managing Credit Lines in a SEF/ Cleared World,’’ a presentation by MarkitServ at the March 29, 2012 TAC meeting [hereinafter, the ‘‘MarkitServ Presentation’’]. Available at: http:// www.cftc.gov/ucm/groups/public/@aboutcftc/ documents/file/tacpresentation032912_ markitse.pdf. 86 See id. The presentation also noted that posttrade checks at the DCO is another form of risk control based on end-customer position or credit limits. See section III(D) for additional discussion of post-trade reports and other post-trade measures. PO 00000 Frm 00015 Fmt 4701 Sfmt 4702 56555 37. If credit checks are conducted post-trade, what should be done when a trade causes a firm to exceed a limit? 38. Please describe any technological limitations that the Commission should be aware of with respect to applying credit limits. 39. The Commission is particularly interested to receive public comment on the ‘‘hub’’ model and its applicability to different types of pre-trade risk controls. What are the strengths and weaknesses of this approach relative to other pretrade or post-trade approaches to checking trades against credit limits? How would the latency between the ‘‘hub’’ and the exchanges be managed to provide accurate limits for high frequency ATS? 40. If you believe that post-trade credit checks would be an effective safeguard against malfunctioning ATSs, what is the maximum amount of latency that should be allowed for conducting such checks? What technological or information flow challenges would have to be addressed in order to implement post-trade checks with that degree of latency? 41. With respect to any entity that you believe should be responsible for applying credit risk limits, please describe the technology necessary to implement that risk control and the cost of such technology. The pre-trade risk controls described above are summarized in Appendix A. D. Post-Trade Reports and Other PostTrade Measures The Commission understands that, even with the presence of the most robust set of pre-trade risk controls, unanticipated events occur within a complicated marketplace. For example, the emergence of unexpected feedback loops between multiple algorithms, or malfunctioning pre-trade risk controls can lead to unintended order submissions that adversely impact market quality and investor confidence. Post-trade reports have the potential to mitigate the impact of such events, particularly if the post-trade reports are made available and utilized on a lowlatency basis, such that market participants are quickly aware of any malfunction. Other post-trade measures, including enhanced error trade policies, may help counterparties to errant trades to better anticipate and address risk associated with trade uncertainty when such events occur. The post-trade reports and other measures are summarized below. 1. Order, Trade, and Position Drop Copy The Commission is inquiring about the potential advantages of increased E:\FR\FM\12SEP4.SGM 12SEP4 mstockstill on DSK4VPTVN1PROD with PROPOSALS4 56556 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules standardization of real-time order, trade, and position reports for use by clearing firms and market participants. Real-time information is critical to market participants managing the risk of their own, and their customers’ trades. The Commission is inquiring as to the advisability of requiring all exchanges and DCOs to provide real-time order and trade reports to each market participant, and the clearing firm serving that client for that particular trade. This information would give clearing firms real-time updates of their customers’ order and trading activities. These reports could improve the effectiveness of automated credit risk limits, which require current order and trade information in order to calculate current positions and monitor credit risk effectively. In some cases order information may be available to a trading platform before it is available to the relevant clearing member (e.g., in the case of DMA-enabled participants), and trade information is always available first to the trading platform. Therefore, there is a strong interdependency between exchanges, DCOs and clearing firms as the latter seek to manage their credit risk. Any time lag in the clearing firm’s ability to construct a retrospective view of their customers’ positions could diminish a clearing firm’s ability to assess its customer’s risk profile before such customer enters additional orders or establishes additional positions and accumulates greater risk. More generally, widespread use of order and trade reports may be beneficial in both DMA and non-DMA situations to help market participants to track all order and trade activity quickly and efficiently. The Commission notes that some or all DCOs already provide post-trade information to clearing members, and that some DCOs charge for that information and others do not.87 However, the Commission believes that the content of the data vary among DCOs and that not all market participants choose to purchase data when it is available. As described above, the Commission preliminarily believes that more standardized access to realtime data from exchanges and DCOs could be valuable to clearing firms, and possibly to trading firms, as they manage their risks. The Commission encourages interested parties to comment, again, on the current use of real-time reports, the consistency of this use, and the potential benefits and 87 See Carol Clark & John McPartland, ‘‘How Do Clearing Organizations Control the Risks of High Speed Trading?’’ (May 2012) at 6–7, available at http://www.chicagofed.org/Web pages/publications/ policy_discussion_papers/2012/pdp_2.cfm. VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 nature of additional order and trade reports. 42. What order and trade reports are currently offered by DCMs and DCOs? What aspects of those reports are most valuable or necessary for implementing risk safeguards? Please also indicate whether the report is included as part of the exchange or clearing service, or whether an extra fee must be paid. 43. If each order and trade report described above were to be standardized, please provide a detailed list of the appropriate content of the report, and how long after order receipt, order execution, or clearing the report should be delivered from the trading platform to the clearing member or other market participant. 2. Trade Cancellation or Adjustment Policies The Commission is interested to know whether it would be beneficial for exchanges to develop more uniform and objective trade cancellation or adjustment policies. These policies should apply to cancellation or adjustment of individual trades, as well as to cancellation or adjustment of a large quantity of trades in response to a disruptive market event at the direction of a regulatory body or in accordance with the exchange’s own determination that such cancellation or adjustment of a large quantity of trades is necessary. The policies could include (1) Clear principles on when trades will be cancelled or adjusted; (2) a requirement that traders notify the exchange of error trades within a specified number of minutes; and (3) a requirement that the exchange notify market participants of possible adjusted or busted trades immediately. Requiring traders to notify the exchange quickly and requiring the exchange to communicate the situation to market participants immediately helps to ensure that any market participants potentially affected by impending adjustment or cancellation actions are made aware of the additional risk they bear and can take steps to mitigate that risk. It may be advisable to base cancellation and adjustment policies on pre-defined, objective criteria in order to minimize the time for identification and notification. Such criteria may include the minimum trade size for which cancellation will be considered, the minimum and maximum range in which a trade will be adjusted, the time a market participant has to request the cancellation or adjustment, the specific circumstances under which trades will be adjusted or canceled (e.g., an exchange system error, specific types of human errors) and factors to be taken PO 00000 Frm 00016 Fmt 4701 Sfmt 4702 into account (e.g., market conditions, whether other market participants have relied on the price). Last, the Commission is inquiring as to the advisability of policies to favor trade adjustment over trade cancellation in order to help ensure that market participants are able to keep the positions they have entered into, even if the prices are adjusted. The Commission is interested in receiving comments on whether additional standardization in error trade policies would be beneficial, and whether this prioritization scheme is appropriate.88 44. Is a measure that would obligate exchanges to make error trade decisions (i.e., decisions to cancel a trade or to adjust its price) within a specified amount of time after an error trade is reported feasible? If so, what amount of time would be sufficient for exchanges, but would be sufficiently limited to help reduce risk for counterparties to error trades? 45. Should exchanges develop detailed, pre-determined criteria regarding when they can adjust or cancel a trade, or should exchanges be able to exercise discretion regarding when they can adjust or cancel a trade? What circumstances make predetermined criteria more effective or necessary than the ability to exercise discretion, and vice versa? 46. Do error trade policies that favor price adjustment over trade cancellation effectively mitigate risk for market participants that are counterparties to error trades? Are there certain situations where canceling trades would mitigate counterparty risk more effectively? If so, what are they and how could such situations be identified reliably by the exchange in a short period of time? 47. Should error trade policies be consistent across exchanges, either in whole or in part? If so, how would harmonization of error trade policies mitigate risks for market participants, or contribute to more orderly trading? E. System Safeguards In this Concept Release, the Commission inquires about a range of system safeguards for trading platforms,89 clearing firms, and market participants (including ATSs). Those system safeguards are intended to address a number of operational, market 88 The Commission notes that error trade policies may vary for different exchanges and for different products at each exchange. See id. at 7. 89 The Commission notes that the system safeguards contemplated herein for DCMs address trading-related risks, and are therefore distinct from the requirements of DCM Core Principle 20 and SEF Core Principle 14, which address business continuity and disaster recovery capabilities. E:\FR\FM\12SEP4.SGM 12SEP4 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules abuse and transmission risks, and may protect against potential disruptions and abuses that are unique to electronic trading. The potential system safeguards are broadly grouped into those that address (1) Controls related to order placement; (2) policies and procedures for the design, testing and supervision of ATSs; (3) self-certifications and notifications; (4) ATS or algorithm identification; and (5) data reasonability checks. Each system safeguard is summarized below. 1. Controls Related to Order Placement mstockstill on DSK4VPTVN1PROD with PROPOSALS4 a. Order Cancellation Capabilities The Commission is inquiring about various standards related to order cancellation capabilities. Auto-cancel on disconnect requirements would ensure that working orders do not remain in the limit order book when a firm loses connectivity with the exchange, ensuring that unwanted trades avoid execution even if the firm is unable to cancel them. The speed of disconnect notification and the cancellation of orders on disconnect can be helped by the exchange of ‘‘heartbeat’’ messages between exchange and user which continuously monitor the response ability of a given algorithm. In addition, by requiring exchanges to develop and maintain the capacity to selectively cancel working orders at the level of individual algorithms, individual accounts, or individual firms, as deemed necessary in an emergency, the trading platform would be able to mitigate the risk or quantity of error trades due to a malfunction.90 The Commission is also inquiring as to the advisability of requiring market participants operating ATSs, clearing members, and exchanges to develop and maintain ‘‘kill switch’’ capabilities. A market participant’s kill switch could immediately cancel all working orders from that firm to the exchange and could prevent them from submitting further orders until natural persons with the proper authority at both the firm and the exchange allow the firm to resume trading. A kill switch at clearing members could cancel all working orders attributable to the clearing member, including both proprietary 90 In addition to order cancellation capabilities, the Commission is inquiring about various related measures that concern connectivity testing, including that trading platforms and all entities connected to a trading platform for purposes of transmitting orders together must test that the systems of all such entities are properly connected to and communicating with the trading platform, and that trading platforms must provide, and market participants operating ATSs must utilize, heartbeats that indicate proper connectivity between the trading platform and an ATS. VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 orders and orders placed on behalf of their clients, and prevent the clearing member from transmitting additional orders until natural persons at both the clearing firm and the exchange allow the clearing member to resume trading. An exchange’s kill switch could cancel all working orders from an individual market participant or clearing firm and could prevent additional orders from the same market participant or clearing firm from being accepted at the exchange until authorized natural persons at both the exchange and affected market participant or clearing firm allow trading to resume. 48. The Commission’s discussion of kill switches assumes that certain benefits accrue to their use across exchanges, trading and clearing firms, and DCOs. Please comment on whether such redundant use of kill switches is necessary for effective risk control. 49. What processes, policies, and procedures should exchanges use to govern their use of kill switches? Are there any different or additional processes, policies and procedures that should govern the use of kill switches that would specifically apply in the case of DMA? 50. What processes, policies, and procedures should clearing firms use to govern their use of kill switches when using such a safeguard to cancel and prevent orders on behalf of one or more clients? 51. What objective criteria regarding kill switch triggers, if any, should entities incorporate into their policies and procedures? 52. What benefits or problems could result from standardizing processes, policies, and procedures related to kill switches across exchanges and/or clearing firms? 53. Please explain how kill switches should be designed to prevent them from canceling or preventing the submission of orders that are actually risk reducing or that offset positions that have been entered by a malfunctioning ATS. 54. The Commission requests comment regarding whether kill switches used by clearing firms already have or should have the following capabilities: (a) Distinguish client orders from proprietary orders; (b) distinguish among orders from individual clients; and (c) cancel working orders and prevent additional orders from one or more of the clearing firm’s clients, or for all the clearing firm’s proprietary accounts, without cancelling and preventing all orders from the clearing firm. 55. The Commission is aware of proposals that would enable FCMs to PO 00000 Frm 00017 Fmt 4701 Sfmt 4702 56557 establish credit limits for customers that are stored at a central ‘‘credit hub’’ for the purpose of pre-trade credit checks.91 If such a model were implemented, is it possible that it could also be enabled with kill switches that cancel existing working orders and prevent additional orders from being submitted by one or more market participants? Should such an approach be designed to complement kill switches that are controlled by exchanges, clearing members, and trading firms, or to replace these kill switches? What benefits and drawbacks would result from each approach? b. Repeated Automated Execution Throttle A further potential risk control of interest to the Commission is a ‘‘Repeated Automated Execution Throttle.’’ This risk control was highlighted in FIA’s Principal Traders Group recommendations regarding risk controls.92 For this control, ATSs would be required to monitor the number of times a strategy is filled and then reenters the market without human intervention. After a configurable number of repeated executions the system should be disabled until a human re-enables it. The Commission would like to better understand the value of this safeguard. The Commission understands that it would disable automated systems which have experienced activity levels far beyond that anticipated by its designers, and then notify monitors regarding this activity. Through this, human review would independently verify the operation of an ATS at regular intervals, and in doing so, could help to ensure that an algorithm’s strategy is currently acting as anticipated and that it is appropriately responding to current market conditions. The Commission requests comments as to whether there could be adverse effects of automatically disabling an ATS after a given number of order executions, and also requests comment regarding the potential value, proper use, and limitations of this safeguard. 2. Policies and Procedures for the Design, Testing and Supervision of ATSs; Exchange Considerations Taken as a whole, the ATS monitoring and supervision standards, ATS design and testing standards, ATS crisis management procedures standards, and ATS monitoring staff training standards inquired about in this Concept Release constitute a set of standards related to 91 See MarkitServ Presentation, supra note 85. FIA Recommendations for Risk Controls, supra note 62, at 4. 92 See E:\FR\FM\12SEP4.SGM 12SEP4 56558 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules policies and procedures for firms operating ATSs. Existing rules require SDs and MSPs to ensure that their ‘‘use of trading programs is subject to policies and procedures governing the use, supervision, maintenance, testing, and inspection of the program,’’ 93 but there is no corresponding rule for FCMs or other market participants operating ATSs. Moreover, even when applied to SDs and MSPs, section 23.600(d)(9) does not have any prescriptive requirements related to supervision and testing and does not require formal review or approval of each firm’s policies and procedures by an informed, independent party other than at the time of registration.94 As a consequence, there is no minimum amount of testing that SDs and MSPs or other market participants operating ATSs are required by the Commission to perform before deploying an algorithm or before re-deploying an algorithm that has been altered. Nor are there any minimum standards for training or sophistication in the areas of supervision, maintenance, and inspection of the ATS.95 Because of this, the Commission is interested in better understanding whether more standardized requirements, or clearer minimum standards, related to policies and procedures for firms operating ATSs would benefit the markets and the public. The policies and procedures relating to the design, testing and supervision of ATSs are summarized below, and addressed in greater detail in Section V, Appendix C. a. ATS Development, Change Management, and Testing; Development, Change Management, and Testing of Exchange Systems The Commission requests public comment regarding the necessity for ATS development, change management and testing standards in CFTC-regulated markets. Potential benefits to such standards include ensuring that ATSs are designed and modified in an environment where there is no risk that the ATS could interfere with activity in or related to the live market and ensuring that appropriate personnel 93 See 17 CFR 23.600(d)(9). CFR 23.600(b)(4) requires SDs and MSPs to ‘‘furnish a copy of its written risk management policies and procedures to the Commission, or to a futures association registered under section 17 of the Act, if directed by the Commission, upon application for registration and thereafter upon request.’’ 95 It is also possible that SDs and MSPs could fail to incorporate emerging industry best practices for managing operational risk of ATSs into their policies and procedures as effective risk management technology and practices are introduced to the market. mstockstill on DSK4VPTVN1PROD with PROPOSALS4 94 17 VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 have approved changes and verified proper testing before a system is moved to the production environment. Standards concerning the retention and control of access to current and historical versions of source code may help to ensure that changes are only made by appropriate personnel and reviewable when necessary. Finally, audit trail material may assist regulators when investigating problems. With respect to testing, a firm’s ATS testing standards could require it to test an ATS on the trading platform(s) where it will trade, prior to deploying such ATS into the live environment. Such testing standards may reduce the incidence of technical errors at the level of individual algorithms and firms. In addition, a firm’s ATS testing standards may require it to test an ATS on the trading platform(s) after modifying the underlying algorithms or other system components to a degree subject to further definition. ATS testing could include tests against historical data, especially periods for which the relevant algorithm would likely have been stressed, or would have been active during periods with unanticipated market activity. In addition, exchanges could also be required to provide a test environment to simulate production trading so that market participants can conduct exchange-based conformance testing, which would include tests of compatibility with the matching engine (including initiation and cessation of the ATS connection) and verification of risk controls required by the trading platform. The Commission is particularly interested to understand when it is most beneficial for firms to test an ATS after it has been modified. Some have asserted that the amount of testing should be calibrated to the significance of the change and the risk it poses to the proper function of the ATS.96 The Commission would like to better understand how market participants estimate the significance of a change and the risk that a given change might pose to the proper function of an ATS. Also, the Commission would like to understand what current best practices are for testing ATSs and how those practices are tailored to the extent of the modification. 56. Please describe the necessary elements of an effective ATS testing regime, in connection with both the initial deployment and the modification of an ATS. 96 See SEC Roundtable Transcript, supra note 2, at 49–51. PO 00000 Frm 00018 Fmt 4701 Sfmt 4702 57. With respect to testing of modifications, how should the Commission and market participants distinguish between major modifications and minor modifications? What are the objective criteria that can be used to make such distinctions? Should any testing regime applicable to ATS modifications distinguish between major and minor modifications, and if so, how? 58. What challenges or benefits may result from exchanges implementing standardized procedures regarding the development, change management, and testing of exchange systems? Please describe, if any, the types of standardized procedures that would be most effective. b. ATS Monitoring and Supervision The Commission is aware that many exchanges and software design firms offer extensive testing platforms to validate algorithm functionality before deployment in a live trading environment. The Commission wants to better understand the extent to which testing is utilized and would like to better understand the methodology supporting these test environments. Further, the Commission believes that many, if not all, firms operating ATSs have human monitors supervising ATSs when they are operating. However, the Commission is uncertain to what degree such monitors have been sufficiently trained in how to respond to unexpected problems, and been given the requisite authority to intervene at these times.97 A firm’s ATS training standards could require that relevant staff members be able to understand how to identify malfunctions, evaluate the risk resulting from those malfunctions, and respond constructively to those malfunctions, including elevating the problem to the attention of more senior personnel. The Commission would like to better understand whether regulatory measures or new standards in this area would promote more effective ATS monitoring and supervision. c. Crisis Management Procedures Well-designed crisis management procedures may help to ensure that 97 The Commission would like to better understand what sorts of training and policies market participants use in order to ensure that human monitors have the capability to respond to operational issues in a timely way. In particular, the Commission is interested in better understanding what training monitors receive in the rationale for the trading patterns executed by the ATS, the scope of intervention authority given to human monitors, and the procedures firms use to escalate questions or decisions from such human monitors to more senior personnel during a crisis. E:\FR\FM\12SEP4.SGM 12SEP4 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules firms are prepared to conduct rapid triage in the event of a problem, including the ability to escalate decisions quickly to the proper individuals or provide notification to their clearing firms, exchanges, or the Commission.98 Such procedures may promote common expectations among monitoring staff, firm leadership, and exchange leadership about basic procedures in the event of market destabilizing events, facilitating more rapid intervention and mitigating the effects of an individual disruption. 59. Should basic crisis management procedures be standardized across market participants? If so, what elements should be addressed in an industry-wide standard? 60. Are there specific, core requirements that should be included in any crisis management procedures? Similarly, are there specific types of crisis events that should be addressed in any crisis management procedures? If so, please identify such requirements and/or crisis events and the level of granularity or specificity that the procedures should have with respect to each. mstockstill on DSK4VPTVN1PROD with PROPOSALS4 3. Self-Certifications and Notifications a. Self-Certification and Clearing Firm Certification To ensure that market participants employ the pre-trade risk controls, posttrade reports and other measures, and system safeguards described herein, the Commission is inquiring whether it would be appropriate to require a periodic self-certification program for all market participants operating ATSs and for clearing firms providing services to those market participants. These certifications could refer to the extent of implementation of those risk control mechanisms discussed in the other sections of this Concept Release. With respect to ATSs, an acceptable certification might attest that: (1) The ATS contains structural safeguards to provide reasonable assurance that the trading system will not be disruptive to fair and equitable trading; (2) the market participant’s ATSs have been designed to avoid violations of the CEA, Commission regulations, or exchange rules related to fraud, disruptive trading practices, manipulation and trade practice violations; and (3) such systems have been sufficiently tested and documented in a manner that is appropriate to the intended design and use of that system. Additionally, the Commission asks whether the chief executive officer, chief compliance 98 See SEC Roundtable Transcript, supra note 2, at 133–34. VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 officer, or similar ranking official of each market participant should attest to the certification. The Commission is interested in receiving comment on the costs and benefits of a certification program, what elements should be included in the program, and whether that program should be self-executed, or, if not, overseen by what authority. 61. How often should a market participant certify that their pre-trade risk controls, post-trade reports and other measures, and system safeguards meet the necessary standards? 62. Which representative of the market participant should be required to attest that the certification standards have been met? Should it be the market participant’s chief executive officer, chief compliance officer, or similar high-ranking corporate official, or some other individual? 63. Which entity(ies) should receive certifications from market participants? For example, should it be the market participant’s clearing firm, its designated self-regulatory organization (if applicable), one or more trading platforms, a registered futures association, the Commission, or other entity? 64. Should DCMs, SEFs or clearing member firms be required to audit market participant certifications? What would be covered in an audit and how often should these audits occur? Should the same entity that receives the certification be required to perform the audit? b. Risk Event Notification Requirements The Commission also seeks information as to whether it would be beneficial for market participants operating ATSs to notify one or more of trading platforms, their clearing firms, the Commission, or others of risk events.99 Entities receiving notifications could, when they deem it appropriate based on the magnitude of a single event or a pattern of smaller related events, 99 The SEC is presently considering a set of rules that would require self-regulatory organizations, significant alternative trading systems, certain disseminators of market data, and exempt clearing agencies to notify SEC staff of events including systems disruptions, compliance issues, or intrusions. See SEC, Notice of Proposed Rulemaking: Regulation Systems Compliance and Integrity, 78 FR 18084 (Mar. 25, 2013). Under the proposed rules, these entities would be required to notify and provide the SEC with detailed information when such systems issues occur as well as when there are material changes in its systems. Id. The Commission notes that it may consider distinctive aspects of the SEC’s proposed rules, and public comments with respect to it, when developing any future proposals arising from this Concept Release. Commenters with respect to this Concept Release are encouraged to indicate in their comments any elements of the SEC’s proposed rules that they believe are relevant. PO 00000 Frm 00019 Fmt 4701 Sfmt 4702 56559 review further with the market participant to remedy the underlying cause(s) of the risk event. Such reviews would allow market participants, clearing firms, trading platforms, and the Commission to respond and proactively reduce risk in automated trading environments. The Commission seeks comment on the types of risk events that should be reported. For example, reportable risk events generally could include any instances where design parameters of an ATS are violated and where risk control processes or technologies do not function as anticipated, regardless of whether these events lead to error trades or market destabilization. Violated design parameters and unanticipated lapse of risk management processes and technology create conditions that may presage future malfunctions, even absent a current disruption. 65. Do commenters believe that risk event notifications would help to better understand and ultimately reduce sources of risk in automated trading environments? What information should be contained in a risk event notification to maximize its value? 66. What types of risk events should trigger reporting requirements, and what entities should receive risk event notifications from market participants operating ATSs? 67. Which entities should receive risk event notifications? 4. ATS or Algorithm Identification The Commission is considering measures to improve the identification of ATS or their underlying algorithms in messages generated by ATSs. The Commission believes that identification of ATSs or underlying algorithms could help both firms and trading platforms to more quickly identify malfunctioning systems that could disrupt markets. Fuller identification of automated systems may also improve oversight by the Commission, including the ex post analysis of disruptive events aimed at preventing or mitigating similar recurrences. The Commission is aware of the inherent complexity in any ATS or algorithm identification system and seeks public comment on this potential measure. Specific questions of interest to the Commission include: 68. Should the Commission define ATS or algorithm for purposes of any ATS identification system that may arise from this Concept Release? If so, how should ATS or algorithm be defined? Should a separate designation be reserved for high frequency trading algorithms and if so, what is the threshold difference? E:\FR\FM\12SEP4.SGM 12SEP4 56560 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules 69. What are the existing practices within trading firms for internally identifying ATSs or algorithms and for tracking their performance, including profit and loss? What elements of existing practices could be leveraged in any ATS or algorithm identification system proposed by the Commission in the future? 70. The Commission understands that an ATS may consist of numerous algorithms, each of which contributes to a trading decision. If an algorithm-based identification system is proposed, which of the potentially multiple algorithms that constitute an ATS should carry the ID? In addition, what degree of change to an algorithm should necessitate the use of a new ID, and how often does this change typically occur? What is the appropriate definition of ‘‘algorithm’’ for purposes of an algorithm identification system? 71. If the identification system resides at the ATS level, how should such IDs be structured to ensure that they are nonetheless sufficiently granular to identify components that may be leading or have led to unstable market conditions? 72. What message traffic between an ATS and a trading platform should include the ATS or algorithm ID (all messages, orders only, etc.)? 73. What relationship should this ATS ID have to the legal entity identifier (LEI)? mstockstill on DSK4VPTVN1PROD with PROPOSALS4 5. Data Reasonability Checks The Commission is interested in the range of information sources used by ATSs to inform their trading decisions, and in how market participants form reasonable beliefs as to the accuracy of such data. For example, following recent media reports regarding the adverse market impact of false information distributed through unauthorized use of a social media outlet used by the Associated Press, the Commission is asking questions to broaden its understanding of the extent to which ATSs in derivatives markets use social media to inform their trading decisions, and the extent to which information derived from social media is verified by the ATS prior to its use. One potential risk control of interest to the Commission is the ‘‘market data reasonability check,’’ which was included in FIA’s Principal Traders Group recommendations regarding risk controls.100 In those recommendations, the FIA recommended that trading 100 See FIA Recommendations for Risk Controls, supra note 62, at 4. VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 firms’ systems have ‘‘reasonability checks’’ on incoming market data. 74. Please describe existing practices in the industry concerning how and the extent to which ATSs use (1) market data; and (2) news and information providers, including social media, to inform trading decisions. 75. The Commission requests comment regarding any risk controls, including reasonability checks, currently being used by market participants operating ATSs to review market data and news and information providers, including social media. Please describe the risk control, including the purpose of the control, the extent of its use among derivatives market participants, and any other aspects of the risk control that you believe would be helpful for the Commission to understand. In addition, the data analyzed by trading algorithms can include government economic reports (e.g., GDP, unemployment, and inflation data), as well as economic reports from non-governmental organizations such as universities, trade groups, and other sources. While government reports are released pursuant to a lock-up process that is intended to ensure that no entity receives them ahead of others, it has been reported that early access to some non-government economic reports is available for a fee. For example, according to recent reports, the University of Michigan’s consumer report was available to certain investors two seconds ahead of the rest of the market.101 76. The Commission requests public comment concerning the lock-up process for government economic reports, and any additional measures that might be taken to protect against inappropriate disclosure. 77. Please describe the extent to which potentially market-moving data from non-governmental economic reports can be obtained prior to its public release for a fee. Are there specific reports or types of reports for which early disclosure should not be permitted? What process should be used for identifying non-governmental economic reports whose early release should not be permitted? Should the data release process for such reports be similar to the data lock-up process implemented for the release of government economic data? The system safeguards described above are also listed in Appendix C. 101 See Brody Mullins, Michael Rothfeld, Tom McGinty & Jenny Strasburg, ‘‘Traders Pay for Early Peek at Key Data,’’ Wall St. J. (June 12, 2013), available at http://online.wsj.com/article/SB100 01424127887324682204578515963191421602.html. PO 00000 Frm 00020 Fmt 4701 Sfmt 4702 F. Other Protections 1. Registration of Firms Operating ATSs Although the Commission can currently take several actions to seek information from firms, such as the issuance of subpoenas to investigate a firm’s trading activities on a registered exchange or to compel a firm to provide books and records, some have suggested that a registration requirement for firms operating ATSs and not otherwise registered with the Commission would enhance the Commission’s oversight capabilities. Additionally, a registration requirement may allow for wider implementation of some or all of the pre-trade controls and risk management tools discussed in this Concept Release and currently deployed in various degrees in the market today. In considering the registration of specific entities using ATSs and not otherwise registered with the Commission, the ‘‘floor broker’’ definition in CEA 1a(23), in pertinent part, states that, in general, the term ‘‘floor trader’’ means any person who, in or surrounding any pit, ring, post or other place provided by a contract market for the meeting of person similarly engaged, purchases, or sells solely for such person’s own account.102 In addition to seeking input on whether it would be beneficial to require registration, the Commission also requests specific public comments in response to the following questions:103 78. Should firms operating ATSs in CFTC-regulated markets, but not otherwise registered with the Commission, be required to register with the CFTC? If so, please explain. 79. Please identify the firm characteristics, trading practices, or technologies that could be used to trigger a registration requirement. 80. Should all firms deploying ATS be required to register, and should there be different standards for firms deploying 102 See CEA section 1a(23), as amended by section 721 of the Dodd-Frank Act; 7 U.S.C. 1a(23) (emphasis added). 103 In March 2013, the German parliament approved the HFT Act, which requires any firm using HFT strategies to become licensed as a financial services institution subject to the supervision of BaFin (Germany’s banking regulator) or to passport an existing license granted by another member state of the European Economic Area. The licensing requirement includes ‘‘indirect’’ trading, meaning that it applies to foreign firms that are trading through a direct exchange member on a German-regulated market or a German multilateral trading facility. As a result of becoming licensed, HFT firms become subject to a general regulatory framework applicable to investment firms under German statutes, and specific organizational requirements applicable to HFT firms imposed by the HFT Act. See BaFin HFT Act Materials, supra note 17. E:\FR\FM\12SEP4.SGM 12SEP4 mstockstill on DSK4VPTVN1PROD with PROPOSALS4 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules HFT strategies? What are the appropriate thresholds levels below which registration would not be required? 81. Since the floor trader distinction only addresses proprietary traders, please explain whether there is any other category of market participant, such as those deploying ATS or HFT strategies and trading on behalf of clients (aside from market participants already subject to Commission jurisdiction, such as Introducing Brokers and FCMs) that the Commission should consider with respect to potential registration requirements. 82. Should software firms providing algorithms be required to register, and under what authority? What standards should apply to such firms? 83. Please identify the functionalities discussed in this Concept Release that could be applied to floor brokers that operate ATSs. Are there any other controls not mentioned in this Concept Release that should be under consideration? 84. Please supply any information or data that would help the Commission in deciding whether firms may or may not meet the definition of ‘‘floor trader’’ in § 1a(23) of the Act. 85. Do you believe that the registration of such firms as ‘‘floor traders’’ would effectuate the purposes of the CEA to deter and detect price manipulation or any other disruptions to market integrity? 86. Considering the broad deployment of automated trading systems across both equities and derivatives markets, the Commission seeks to understand the appropriate level of coordination between itself and the SEC in defining and applying possible standards to the ATS and HFT trading space. How closely should the CFTC and SEC coordinate on possible rules and requirements for trading firms? The Commission also seeks public comment on the appropriate level of coordinated oversight between itself and relevant Self-Regulatory Organizations such as National Futures Association and FINRA. 87. Using the Flash Crash as an example, is it important to have identical definitions and remedies in the case of ATS and HFT registration requirements or do the existing market controls, such as circuit breakers, provide the necessary market protections in both the equities and derivatives markets? If the rules are not coordinated, what impact would this have on market interaction and oversight? 88. If trading venues apply mandatory functionalities to access derivatives VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 markets, what benefit would a registration requirement provide to the Commission? 2. Market Quality Data The Commission is inquiring as to the advisability of requiring each trading platform to provide market quality indicators for each product traded on its platform at a regular frequency. Some metrics of the type below are currently calculated by exchanges, often at an account level, and provided to market participants. Some metrics are currently used in aid of various exchange programs (such as order efficiency programs). Other metrics are not currently used but may, nonetheless, provide the Commission and the public potentially useful information. The Commission envisions that increased transparency through the regular disclosure of market quality indicators will allow the Commission and market participants to better understand, among other things (1) The stability and efficiency of each market, (2) the degree of informed versus uninformed order flow, and (3) the nature and degree of liquidity in each market. In addition, the transparency provided by these metrics may better enable market participants to manage their ATSs in ways that further promote market stability and integrity. The Commission is interested in receiving comment on the usefulness of various market indicators that could be prepared for each contract. The list of indicators would, for a given product and tenor, include measures of: (1) Effective spreads; (2) order-to-fill ratios; (3) execution speeds by order type and order size; (4) average aggressiveness imbalances; (5) price impact for given trade sizes; 104 (6) average order duration; 105 (7) order efficiency; 106 (8) rejection order ratios; (9) net position changes versus volume; 107 (10) branching ratios; 108 (11) volume imbalance and trade intensity; 109 (12) 104 The size of the price change that would occur if specific sizes of market orders were executed at that instant. 105 Average length of time that orders for a specific instrument remain in the book before being modified, filled, or cancelled. 106 Notional value executed vs. notional value entered or modified. 107 See CFTC Net Position Changes Data, available at http://www.cftc.gov/MarketReports/ NetPositionChangesData/index.htm. 108 See Vladimir Filimonov, David Bicchetti, Nicolas Maystre, & Didier Sornette, ‘‘Quantification of the High Level of Endogeneity and of Structural Regime Shifts in Commodity Markets’’ (Mar. 20, 2013), available at http://papers.ssrn.com/sol3/ papers.cfm?abstract_id=2237392. 109 See David Easley, Marcos M. Lopez de Prado & Maureen O’Hara, ‘‘Flow Toxicity and Liquidity in a High Frequency World’’ (Feb. 20, 2012), available PO 00000 Frm 00021 Fmt 4701 Sfmt 4702 56561 Herfindahl-Hirschman Indexes based on market share of open positions under common control; and (13) metrics on the number of price changing trades involving ATSs.110 Calculation methodologies for each of the measures would be consistent across exchanges in order to ensure compatibility and comparability across market venues.111 Several of the measures described in this Concept Release would provide additional information about market quality that market participants cannot derive exclusively from real-time order book information provided by each exchange. The Commission expects that market participants could use this additional information, together with information currently available in the order book, in order to better inform their trading efficiency and strategies and to mitigate adverse effects of their actions and other market participants’ on the market. Further, the Commission expects that these measures could be used to help understand changes in market quality. In addition, the Commission believes that providing consistent measures of market quality across exchanges would promote market efficiency through transparency and market competition. To clarify what costs and benefits these market metrics may provide to participants, the Commission requests comment to the questions below, including that, if these metrics are beneficial, the appropriate frequency of publication. 89. What market quality indicators are in place today? Please describe the metrics, how and where they are deployed, and how market participants access these indicators and at what cost. 90. What value would each of the market quality metrics described above provide to market participants receiving them? If possible, please be specific about how each market quality measure could be used to enhance reliability and risk management of ATSs. at http://papers.ssrn.com/sol3/papers.cfm?abstract_ id=1695596. 110 For a given market, such metrics would be calculated by identifying the relevant category of trader on trades that result in a price move from a previous trade and determining the percentage of those trades where an ATS was on one or both sides of the trade. 111 SEC Rules 605 (Disclosure of Order Execution Information) and 606 (Disclosure of Order Routing Information) of Regulation NMS respectively require market centers (as defined in the rules) to make publicly available standardized, monthly reports of statistical information concerning their order executions and broker-dealers to make publicly available quarterly reports that, among other things, identify the venues to which customer orders are routed for execution. See 17 CFR 242.605 (formerly Securities Exchange Act Rule 11Ac1–5) and 17 CFR 242.606 (formerly Securities Exchange Act Rule 11Ac1–6). E:\FR\FM\12SEP4.SGM 12SEP4 56562 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules 91. Conversely, could any of the market quality metrics described above be used by market participants to manipulate the order book,112 to identify competitors’ trading strategies, or to engage in other trading activities that do not contribute to effective risk management and efficient discovery the traded asset’s economic value? If so, please provide specific information regarding how such information could be misused. If possible, please provide recommendations regarding steps the Commission could take to prevent misuse. 92. Are there additional market quality metrics that the Commission should contemplate requiring exchanges to provide? If so, what value would they provide and how would they be used? 93. If the Commission determines that measures should be calculated in the same way by various exchanges in order to provide comparable measures of market quality, then how, specifically, should each of the above mentioned metrics be calculated in order to ensure that they are most valuable to market participants? 94. What timing and mode of dissemination is appropriate for each metric? For example, should measures be provided as daily averages? 95. Does the liquidity of a given market impact which market quality metrics would be reliable and useful when calculated for that market? If so, which metrics are inapplicable in less liquid markets, and why? What liquidity measures and thresholds are relevant to determining which metrics should apply to a given market? 3. Market Quality Incentives mstockstill on DSK4VPTVN1PROD with PROPOSALS4 The impact of ATSs, and particularly those implementing HFT strategies, is a topic of ongoing interest among researchers, market participants and others. Several studies have found that increases in automated trading are associated with improved market quality.113 Some researchers and market participants, however, have also noted that the presence of HFT has the potential to shape the types of liquidity 112 Meaning, behaviors that, while not strictly illegal, are used to advantage one’s own orders in ways that do not contribute to efficient price discovery. 113 See Jonathan Brogaard, Terrence Hendershott & Ryan Riordan, ‘‘High Frequency Trading and Price Discovery’’ (Apr. 22, 2013), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_ id=1928510; Hasbrouck & Saar, supra note 18; Terrence Hendershott, Charles Jones & Albert Menkveld, ‘‘Does Algorithmic Trading Improve Liquidity?’’ Journal of Finance, Vol. 66 at 1–33 (August 30, 2010), available at http:// papers.ssrn.com/sol3/papers.cfm?abstract_ id=1100635. VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 providers available in a market,114 may discourage ATSs from submitting resting orders that remain in the order book long enough for humans to react, and may also be associated with undesirable trading practices that are more easily implemented by automated systems.115 Various recommendations have been advanced to promote the benefits of HFT while simultaneously disincentivizing trading strategies that do not contribute to efficient price discovery.116 Those recommendations include for example, utilizing a trade allocation formula that is an intermediate between a cardinal ranking (time-weighted), Pro Rata allocation formula and a Price/ Time allocation formula. This would be intended to reward market makers for leaving resting orders in the order book for a longer period of time, rather than simply for being first in the order book at a given price. Second, create a new limit order type that would prioritize orders that remain resting in the order book for some minimum amount of time. Third, require orders that are not fully visible in the order book (e.g., iceberg orders) to go to the end of the queue (within limit price) with respect to trade allocation. Fourth, aggregate multiple, small orders from the same legal entity entered contemporaneously at the same price level and assign them the lowest priority time stamp of all such. Fifth, require exchanges to use batch auctions once per half second at random times rather than use continuous trade matching.117 Lastly, 114 See J. Doyne Farmer & Spyros Skouras, ‘‘An Ecological Perspective on the Future of Computer Trading,’’ Quantitative Finance (2013); IOSCO Report on Regulatory Issues Raised by Technological Changes, supra note 4; William Barker & Anna Pomeranets, ‘‘The Growth of HighFrequency Trading: Implications for Financial Stability,’’ Bank of Canada Financial System Review (June 2011), available at http:// www.bankofcanada.ca/2012/01/publications/ periodicals/fsr-article/the-growth-of-high-frequencytrading/. 115 See Farmer & Skouras, supra note 114; Eric Budish, Peter Cramton & John Shim, ‘‘The HighFrequency Trading Arms Race: Frequent Batch Auctions as a Market Design Response’’ (July 7, 2013), available at http://faculty.chicagobooth.edu/ eric.budish/research/HFTFrequentBatchAuctions.pdf; John McPartland, ‘‘Recommendations for Equitable Allocation of Trades in High Frequency Trading Environments’’ (July 25, 2013), available at http:// www.chicagofed.org/Webpages/publications/ policy_discussion_papers/2013/pdp_1.cfm. 116 See McPartland, supra note 115. 117 See Budish, supra note 115; J. Doyne Farmer & Spyros Skouras, ‘‘Review of the Benefits of a Continuous Market vs. Randomised Stop Auctions and of Alternative Priority Rules (Policy Options 7 and 12),’’ Foresight U.K. Government Office for Science, Economic Impact Assessment (2013), available at http://www.bis.gov.uk/assets/foresight/ docs/computer-trading/12-1072-eia11-continuousmarket-vs-randomised-stop-auctions.pdf. PO 00000 Frm 00022 Fmt 4701 Sfmt 4702 limit visibility into the order book to aggregate size available at a limit price. This would help to ensure that automated traders are placing orders based on their knowledge of the economic value of the asset being traded rather than their knowledge of order book dynamics or of other market participants’ trading patterns. 96. Should exchanges impose a minimum time period for which orders must remain on the order book before they can be withdrawn? If so, should this minimum resting time requirement apply to orders of all sizes or be restricted to orders smaller than a specific threshold? If there should be a specific threshold, how should that threshold be determined? 97. The Commission seeks to understand where time-weighted Pro Rata trade allocation is currently being utilized and what the effects have been. Please note examples from exchanges and, to the extent possible, please comment on the impact that such matching algorithms have had on the amount of time resting orders are left in the order book, as well as on other aspects of market quality. 98. If exchanges aggregated multiple, small orders entered by the same entity with the intent of abusing rounding conventions to gain a disproportionate share of allocations, what criteria should exchanges use to distinguish such orders from those that are entered by the same legal entity for legitimate trading purposes? Are there empirical patterns that could be used to reliably identify such manipulative intent? 99. Would batched order processing increase the number of milliseconds that are necessary for correlations among related securities to be established? If so, what specific costs would result from this change and how do those costs compare to the potential benefits described in recent research? 100. What costs and benefits result from providing market participants with real-time access to information about the order book that extends beyond aggregate size available at a limit price? Is there a legitimate economic benefit that results from market participants (both human participants, and ATSs) accessing such information? Is it possible for market participants to use such information to manipulate the order book? 101. The Commission seeks to understand whether any of the recommendations above are inapplicable or irrelevant to markets subject to the CEA. If so, please indicate which recommendation(s) and what makes it inapplicable or irrelevant to those markets. E:\FR\FM\12SEP4.SGM 12SEP4 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules 4. Policies and Procedures To Identify ‘‘Related Contracts’’ Rule 38.255 of the Commission’s regulations require DCMs to establish and maintain risk controls for trading.118 Appendix B to the Part 38 regulations provides the following guidance on such risk controls: If a contract is linked to, or is a substitute for, other contracts, either listed on [the DCM’s] market or on other trading venues, the designated contract market must, to the extent practicable, coordinate its risk controls with any similar controls placed on those other contracts.119 The guidance contained in the appendix further provides that, to the extent practicable, DCMs should coordinate not only with other DCMs, but national security exchanges as well.120 These measures could protect against market disruptions cascading from one trading platform to the next. 102. If you are a DCM, please address whether you have (i) identified all contracts that are linked to, or are a substitute for, other contracts either listed on your market or on other trading venues; and, if so, (ii) coordinated your risk controls with any similar controls placed on those other contracts. If you have not identified such contracts and coordinated risk controls on such contracts, please address any other means by which you are addressing risk controls applicable to contracts that are linked to, or are a substitute for, other contracts listed on your exchange or on other trading venues. 103. Please explain whether it would be beneficial for exchanges to develop and document policies and procedures for regularly reviewing contracts on other exchanges in order to identify those that are ‘‘linked to’’ or that are ‘‘a substitute for’’ contracts listed on its own market. mstockstill on DSK4VPTVN1PROD with PROPOSALS4 5. Standardize and Simplify Order Types This Concept Release inquires about the possible standardization and simplification of order types that have complex logic embedded within them. A proliferation of order types, both within and across exchanges, can result in a similar increase in both the expected and unexpected responses of automated systems to order and trade signals. As of November 2012, for example, it was reported that BATS Global Markets alone listed more than 118 See 17 CFR 38.255. DCM Final Rules, 77 FR at 36718. 120 See id. 119 See VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 2,000 order types.121 A review of current and proposed order types could be performed with the goal of consolidating and simplifying order types.122 A proliferation of complex order types leads to complex testing scenarios. Therefore, it is possible that consolidation of order types could reduce the potential for instability resulting from unexpected interactions of multiple ATSs using multiple means of execution within the order book.123 104. Please explain whether the standardization and simplification of order types that have complex logic embedded within them would reduce the potential for instability and other market disruptions. If not, what other measures could achieve the same effect? 105. If the Commission were to consider the standardization and simplification of order types in a future rulemaking, please identify who should conduct this review (i.e., the Commission, trading platforms, or other parties). G. General Questions Regarding All Risk Controls Discussed Above Finally, the Commission requests comment on the following general questions, with respect to each of the risk controls discussed above: 106. For each of the specified controls described above [see sections III.C–F], please indicate whether you are already using the control on customer and/or proprietary orders. If applicable, please also indicate how widely you believe the control is currently being used in the market, and how consistent the application of the control is among firms. 107. If possible, please indicate specific costs associated with implementing each of the risk controls 121 See Peter Chapman, ‘‘Too Many Order Types, Traders Fret,’’ Traders Magazine (Nov. 2012), available at http://www.tradersmagazine.com/ issues/25_344/order-types-equities-structure110515-1.html. 122 The SEC is currently in the process of reviewing order types within securities markets. See Scott Patterson & Jean Eaglesham, ‘‘Exchanges Retreat on Trading Tools,’’ Wall St. J. (Oct. 24, 2012) (quoting former Chairwoman of the SEC, Mary Schapiro: ‘‘I worry about the complexity in the market, I worry about the profusion of order types, I worry about the fragmentation.’’), available at http://online.wsj.com/article/SB100014240 52970203400604578074963881803302.html. See also SEC Roundtable Transcript, supra note 2, at 96–99. 123 See SEC Roundtable Transcript, supra note 2, at 96 (‘‘It is the proliferation of all these order types and the complexity of these order types that is adding unnecessary complexity to the market, which is already an extremely complex system as it is . . . when you have complex order types, it leads to extremely complex testing scenarios, and you are not going to pick up all the things you could or should because you don’t know what that actual matching engine logic is in general.’’). PO 00000 Frm 00023 Fmt 4701 Sfmt 4702 56563 described above [see sections III.C–F]. Please include detailed estimates, distinguishing between the cost of developing the functionality, the cost of implementation, and the cost of ongoing operations. 108. Please describe the specific benefits associated with each of the risk controls. Where possible, please indicate the market participant category(ies) to which the benefit would accrue. 109. Please comment on the appropriate order of implementation and timeline for each risk control, including any distinctions that should be made based on the category of registrant or market participant implementing the same or similar control, whether the market participant is using DMA, and whether implementation is already in place for certain categories. 110. Are any of the risk controls unnecessary, impractical for commercial or technological reasons, or inadvisable? If so, please note the control and provide reasons why. 111. A number of the pre-trade risk controls contemplated above are similar protections at distinct points in the life of an order. a. Please comment on the utility of redundant pre-trade risk controls and the desirability of risk control systems in which controls are placed at one or more than one focal points. b. If pre-trade risk controls should reside at one or more than one focal point, then please identify, for each risk control, what that focal point should be? 112. Are there risk controls that should be implemented across multiple entity types? If so, which controls and for which types of entities should they apply? Also, please comment generally on the factors the Commission should consider when determining the appropriate entity(ies) upon which to place a risk control requirement that could pertain to more than one entity. 113. Are there controls that should not be considered for overlapping implementation across exchanges, clearing members and market participants? If so, please explain which ones and why. 114. Each of the risk controls is described in general, principles-based terms. Should the Commission specify more granular or specific requirements with respect to any of the controls to improve their effectiveness or provide greater clarity to industry participants? If so, please identify the relevant control and the additional granularity or specificity that the Commission should provide. Are any of the controls, as E:\FR\FM\12SEP4.SGM 12SEP4 mstockstill on DSK4VPTVN1PROD with PROPOSALS4 56564 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules currently drafted, inadequate to achieve the desired risk-reduction? 115. To the extent that there is any need to standardize or provide greater specificity regarding any measures discussed in this Concept Release, including those that reflect industry best practices, please describe the best approach to achieve such standardization (i.e., through Commission regulation, Commissionsponsored committee or working group, or some other method). 116. How should risk control monitoring be implemented? Should compliance be audited by internal and external parties? For each control, please identify the appropriate entity(ies) to monitor compliance with the control. Also, please describe what an acceptable compliance audit would entail for each control. 117. Are there additional controls that should be considered, or other methods that could serve as alternatives to those described above [see sections III.C–F]? If so, please describe the control, its costs and benefits, the appropriate entity(ies) to implement such control, and whether there is any distinction to be drawn in the case of DMA. 118. Would any of the risk safeguards create a disincentive to innovate or create incentives to innovate in an irresponsible manner? If so, please identify the control, the concern raised, and how the control should be amended to address the concern. Responses should indicate how an amended risk control would still meet the Commission’s objectives. 119. Should the Commission consider any pre-trade risk controls, post-trade reports, or system safeguards appropriate exclusively to market makers or to ATSs used by market makers? If so, please describe such controls or safeguards. 120. Should the Commission or Congress revisit its approach to issuing civil monetary penalties for violations of the Act, particularly as they relate to automated trading environments? Currently, the maximum civil monetary penalty the Commission may issue is capped at $140,000 ‘‘per violation.’’ Is such a civil monetary penalty sufficient to deter acts that constitute violations of the Act, given that an individual violation could impose costs to the market and the public well in excess of $140,000? 121. Please describe the documentation (or categories of documents) that would demonstrate that a market participant operating an ATS has implemented each risk control addressed in this Concept Release, including, for example, computer code, VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 system testing results, certification processes and results, and calculations. 122. Would a fee (collected by, for example, the DCM or SEF) on numbers of messages exceeding a certain limit be more appropriate than a hard limit on the number or rate of messages? 123. Should such a penalty be based on a specified number or rate of messages or on the ratio of messages to orders filled over a specified time period? 124. Recent disruptive events in securities markets illustrate the importance of effective communication between exchanges’ information technology systems. The Commission requests public comments regarding relevant systems in its regulated markets, including both DCMs and SEFs. What data transfers or other communications between exchanges are necessary for safe, orderly, and wellfunctioning derivatives markets? What additional measures, if any, would help promote the soundness of such systems (e.g., testing requirements, redundancy standards, etc.)? Reductions in Latency 5. Discussions on latency often focus on the how quickly an exchange processes orders, the time taken to submit orders, and how quickly a firm can observe prices of trades transacted on the exchange. The Commission is interested in understanding whether there are other types of messages transmitted between exchanges, firms and vendors wherein differences in latency could provide opportunities for informational advantage. Recent press reports have highlighted such advantages in the transmission of trade confirmations by a specific exchange. Are there other exchanges and trading venues where similar differences in latency exist? The Commission is interested in understanding whether the extent of latency in any such message transmission process can have an adverse impact on market quality or fairness. Should any exchanges, vendors and firms be required to audit their systems and process on a periodic process to identify and then resolve such latency? IV. List of All Questions in the Concept Release Listed below are all questions raised in the preceding sections of this Concept Release. Financial Integrity of the DCO 6. Are there distinct pre-trade risk controls, including measures not listed below, or measures in addition to those already adopted by the Commission, that would be particularly helpful in protecting the financial integrity of a DCO? High Frequency Trading 1. In any rulemaking arising from this Concept Release, should the Commission adopt a formal definition of HFT? If so, what should that definition be, and how should it be applied for regulatory purposes? 2. What are the strengths and weaknesses of the TAC working group definition of HFT provided above [see section II.A.1]? How should that definition be amended, if at all? 3. The definition of HFT provided above uses ‘‘recurring high message rates (orders, quotes or cancellations)’’ as one of the identifying characteristics of HFT, and lists three objective measures ((i) cancel-to-fill ratios; (ii) participant-to-market message ratios; or (iii) participant-to-market trade volume ratios) that could be used to measure message rates. Are these criteria sufficient to reliably distinguish between ATSs in general and ATSs using HFT strategies? What threshold values are appropriate for each of these measures in order to identify ‘‘high message rates?’’ Should these threshold values vary across exchanges and assets? If so, how? 4. Should the risk controls for systems and firms that engage in HFT be different from those that apply to ATSs in general systems? If so, how? PO 00000 Frm 00024 Fmt 4701 Sfmt 4702 Risk Controls Applicable in the Case of DMA 7. Are there distinct pre-trade risk controls, including measures not listed below [see section III.C.], or measures in addition to those already adopted by the Commission, that should apply specifically in the case of DMA? Message and Execution Throttles 8. If, as contemplated above [see section III.C.1], maximum message rates and execution throttles were used as a mechanism to prevent individual entities or accounts from trading at speeds that are misaligned with their risk management capabilities, how should this message rate be determined? 9. Message and execution throttles may be applied by trading firms (FCMs and proprietary trading firms), clearing firms, and by exchanges. The Commission requests public comment regarding the appropriate location for message and execution throttles. a. If throttles should be implemented at the trading firm level, should they be applied to all ATSs, only ATSs employing HFT strategies, or both? b. What role should clearing firms play in the operation or calibration of E:\FR\FM\12SEP4.SGM 12SEP4 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules throttles on orders submitted by the trading firms whose trades they guarantee? 10. Should the message and execution throttles be based on market conditions, risk parameters, type of entity, or other factors? 11. What thresholds should be used for each type of market participant in order to determine when a message or execution throttle should be used? Should these thresholds be set by the exchange or the market participant? 12. Are message and execution thresholds typically set by contract, or by algorithm? What are the advantages and disadvantages to each method? 13. Who should be charged with setting message rates for products and when they are activated? 14. Would message and execution throttles provide additional protection in mitigating credit risk to DCOs? mstockstill on DSK4VPTVN1PROD with PROPOSALS4 Volatility Awareness Alerts 15. The Commission is aware that alarms can be disruptive or counterproductive if ‘‘false alarms’’ outnumber accurate ones. How can volatility alarms be calibrated in order to minimize the risk that false alarms could interrupt trading or cause human monitors to ignore them over time? Self-Trade Controls 16. What specific practices or tools have been effective in blocking selftrades, and what are the costs associated with wide-spread adoption of such practices or tools? 17. Please indicate how widely you believe exchange-sponsored self-trading controls are being used in the market. 18. Should self-trade controls cancel the resting order(s)? Or, instead, should they reject the taking order that would have resulted in a self-trade? If applicable, please explain why one mechanism is more effective than the other. 19. Should exchanges be required to implement self-trading controls in their matching engines? What benefits or challenges would result from such a requirement? 20. Please explain whether regulatory standards regarding the use of selftrading control technology would provide additional protection to markets and market participants. 21. If you believe that self-trading controls are beneficial, please describe the level of granularity at which such controls should operate (e.g., should the controls limit self-trading at the executing firm level? At the individual trader level?) What levels of granularity are practical or achievable? 22. If you believe that self-trading controls are beneficial, please explain VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 whether exchanges should require such controls for market participants and identify the categories of participants that should be subject to such controls. For example, should exchanges require self-trading controls for all participants, some types of participants, participants trading in certain contracts, or participants in market maker and/or incentive programs? What benefits or challenges would result from imposing such controls on each category of participant? Price Collars 23. The Commission is aware that some exchanges already have price collars in place for at least a portion of the contracts traded in their markets. Please comment on whether exchanges should utilize price collars on all contracts they list. 24. Would price collars provide additional protection in mitigating credit risk to DCOs? Maximum Order Sizes 25. Are such controls typically applied to all contracts and customers, or on a more limited basis? 26. Do exchanges allow clearing members to use the exchange’s technology to set maximum order sizes for specific customers or accounts? 27. Would additional standardization in the capabilities of this technology or more uniform application of this technology to all customers and contracts improve the effectiveness of such controls? 28. To what extent are clearing firms and trading firms conducting pre-trade maximum order size screens? Please explain whether firms are conducting such screens by utilizing: (1) Their own technology; (2) the exchange’s technology, or (3) a combination of both. 29. Would regulatory standards regarding the use of such technology provide additional protection to the markets? Trading Pauses 30. Trading pauses, as currently implemented, can be triggered for multiple reasons. Are certain triggers more or less effective in mitigating the effects of market disruptions? 31. Are there additional triggers for which pauses should be implemented? If so, what are they? 32. What factors should the Commission or exchanges take into account when considering how to specify pauses or what thresholds should be used? 33. How should the re-opening of a market after a trading pause be effected? PO 00000 Frm 00025 Fmt 4701 Sfmt 4702 56565 Credit Risk Limits 34. What positions should be included in credit risk limit calculations in order to ensure that they are useful as a tool for limiting the activity of a malfunctioning ATS? Is it adequate for such a screen to include only those positions entered into by a particular ATS or should it include all the firm’s positions? 35. Should pre-trade credit screens require a full recalculation of margin based on the effect of the order? 36. In light of your answers to the previous two questions, where in the lifecycle of an order should the credit limits be applied and what entity should be responsible for conducting such checks? 37. If credit checks are conducted post-trade, what should be done when a trade causes a firm to exceed a limit? 38. Please describe any technological limitations that the Commission should be aware of with respect to applying credit limits. 39. The Commission is particularly interested to receive public comment on the ‘‘hub’’ model and its applicability to different types of pre-trade risk controls. What are the strengths and weaknesses of this approach relative to other pretrade or post-trade approaches to checking trades against credit limits? How would the latency between the ‘‘hub’’ and the exchanges be managed to provide accurate limits for high frequency ATS? 40. If you believe that post-trade credit checks would be an effective safeguard against malfunctioning ATSs, what is the maximum amount of latency that should be allowed for conducting such checks? What technological or information flow challenges would have to be addressed in order to implement post-trade checks with that degree of latency? 41. With respect to any entity that you believe should be responsible for applying credit risk limits, please describe the technology necessary to implement that risk control and the cost of such technology. Order, Trade and Position Drop Copy 42. What order and trade reports are currently offered by DCMs and DCOs? What aspects of those reports are most valuable or necessary for implementing risk safeguards? Please also indicate whether the report is included as part of the exchange or clearing service, or whether an extra fee must be paid. 43. If each order and trade report described above were to be standardized, please provide a detailed list of the appropriate content of the E:\FR\FM\12SEP4.SGM 12SEP4 56566 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules report, and how long after order receipt, order execution, or clearing the report should be delivered from the trading platform to the clearing member or other market participant. mstockstill on DSK4VPTVN1PROD with PROPOSALS4 Trade Cancellation or Adjustment Policies 44. Is a measure that would obligate exchanges to make error trade decisions (i.e., decisions to cancel a trade or to adjust its price) within a specified amount of time after an error trade is reported feasible? If so, what amount of time would be sufficient for exchanges, but would be sufficiently limited to help reduce risk for counterparties to error trades? 45. Should exchanges develop detailed, pre-determined criteria regarding when they can adjust or cancel a trade, or should exchanges be able to exercise discretion regarding when they can adjust or cancel a trade? What circumstances make predetermined criteria more effective or necessary than the ability to exercise discretion, and vice versa? 46. Do error trade policies that favor price adjustment over trade cancellation effectively mitigate risk for market participants that are counterparties to error trades? Are there certain situations where canceling trades would mitigate counterparty risk more effectively? If so, what are they and how could such situations be identified reliably by the exchange in a short period of time? 47. Should error trade policies be consistent across exchanges, either in whole or in part? If so, how would harmonization of error trade policies mitigate risks for market participants, or contribute to more orderly trading? Order Cancellation Capabilities 48. The Commission’s discussion of kill switches assumes that certain benefits accrue to their use across exchanges, trading and clearing firms, and DCOs. Please comment on whether such redundant use of kill switches is necessary for effective risk control. 49. What processes, policies, and procedures should exchanges use to govern their use of kill switches? Are there any different or additional processes, policies and procedures that should govern the use of kill switches that would specifically apply in the case of DMA? 50. What processes, policies, and procedures should clearing firms use to govern their use of kill switches when using such a safeguard to cancel and prevent orders on behalf of one or more clients? 51. What objective criteria regarding kill switch triggers, if any, should VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 entities incorporate into their policies and procedures? 52. What benefits or problems could result from standardizing processes, policies, and procedures related to kill switches across exchanges and/or clearing firms? 53. Please explain how kill switches should be designed to prevent them from canceling or preventing the submission of orders that are actually risk reducing or that offset positions that have been entered by a malfunctioning ATS. 54. The Commission requests comment regarding whether kill switches used by clearing firms already have or should have the following capabilities: (a) Distinguish client orders from proprietary orders; (b) distinguish among orders from individual clients; and (c) cancel working orders and prevent additional orders from one or more of the clearing firm’s clients, or for all the clearing firm’s proprietary accounts, without cancelling and preventing all orders from the clearing firm. 55. The Commission is aware of proposals that would enable FCMs to establish credit limits for customers that are stored at a central ‘‘credit hub’’ for the purpose of pre-trade credit checks. If such a model were implemented, is it possible that it could also be enabled with kill switches that cancel existing working orders and prevent additional orders from being submitted by one or more market participants? Should such an approach be designed to complement kill switches that are controlled by exchanges, clearing members, and trading firms, or to replace these kill switches? What benefits and drawbacks would result from each approach? ATS Testing 56. Please describe the necessary elements of an effective ATS testing regime, in connection with both the initial deployment and the modification of an ATS. 57. With respect to testing of modifications, how should the Commission and market participants distinguish between major modifications and minor modifications? What are the objective criteria that can be used to make such distinctions? Should any testing regime applicable to ATS modifications distinguish between major and minor modifications, and if so, how? 58. What challenges or benefits may result from exchanges implementing standardized procedures regarding the development, change management and testing of exchange systems? Please describe, if any, the types of PO 00000 Frm 00026 Fmt 4701 Sfmt 4702 standardized procedures that would be most effective. Crisis Management Procedures 59. Should basic crisis management procedures be standardized across market participants? If so, what elements should be addressed in an industry-wide standard? 60. Are there specific, core requirements that should be included in any crisis management procedures? Similarly, are there specific types of crisis events that should be addressed in any crisis management procedures? If so, please identify such requirements and/or crisis events and the level of granularity or specificity that the procedures should have with respect to each. Self-Certification and Clearing Firm Certification 61. How often should a market participant certify that their pre-trade risk controls, post-trade reports and other measures, and system safeguards meet the necessary standards? 62. Which representative of the market participant should be required to attest that the certification standards have been met? Should it be the market participant’s chief executive officer, chief compliance officer, or similar high-ranking corporate official, or some other individual? 63. Which entity(ies) should receive certifications from market participants? For example, should it be the market participant’s clearing firm, its designated self-regulatory organization (if applicable), one or more trading platforms, a registered futures association, the Commission, or other entity? 64. Should DCMs, SEFs or clearing member firms be required to audit market participant certifications? What would be covered in an audit and how often should these audits occur? Should the same entity that receives the certification be required to perform the audit? Risk Event Notification Requirements 65. Do commenters believe that risk event notifications would help to better understand and ultimately reduce sources of risk in automated trading environments? What information should be contained in a risk event notification to maximize its value? 66. What types of risk events should trigger reporting requirements, and what entities should receive risk event notifications from market participants operating ATSs? 67. Which entities should receive risk event notifications? E:\FR\FM\12SEP4.SGM 12SEP4 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS4 ATS or Algorithm Identification 68. Should the Commission define ATS or algorithm for purposes of any ATS identification system that may arise from this Concept Release? If so, how should ATS or algorithm be defined? Should a separate designation be reserved for high frequency trading algorithms and if so, what is the threshold difference? 69. What are the existing practices within trading firms for internally identifying ATSs or algorithms and for tracking their performance, including profit and loss? What elements of existing practices could be leveraged in any ATS or algorithm identification system proposed by the Commission in the future? 70. The Commission understands that an ATS may consist of numerous algorithms, each of which contributes to a trading decision. If an algorithm-based identification system is proposed, which of the potentially multiple algorithms that constitute an ATS should carry the ID? In addition, what degree of change to an algorithm should necessitate the use of a new ID, and how often does this change typically occur? What is the appropriate definition of ‘‘algorithm’’ for purposes of an algorithm identification system? 71. If the identification system resides at the ATS level, how should such IDs be structured to ensure that they are nonetheless sufficiently granular to identify components that may be leading or have led to unstable market conditions? 72. What message traffic between an ATS and a trading platform should include the ATS or algorithm ID (all messages, orders only, etc.)? 73. What relationship should this ATS ID have to the legal entity identifier (LEI)? Data Reasonability Checks 74. Please describe existing practices in the industry concerning how and the extent to which ATSs use (1) market data; and (2) news and information providers, including social media, to inform trading decisions. 75. The Commission requests comment regarding any risk controls, including reasonability checks, currently being used by market participants operating ATSs to review market data and news and information providers, including social media. Please describe the risk control, including the purpose of the control, the extent of its use among derivatives market participants, and any other aspects of the risk control that you believe would be helpful for the Commission to understand. VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 76. The Commission requests public comment concerning the lock-up process for government economic reports, and any additional measures that might be taken to protect against inappropriate disclosure. 77. Please describe the extent to which potentially market-moving data from non-governmental economic reports can be obtained prior to its public release for a fee. Are there specific reports or types of reports for which early disclosure should not be permitted? What process should be used for identifying non-governmental economic reports whose early release should not be permitted? Should the data release process for such reports be similar to the data lock-up process implemented for the release of government economic data? Registration of Firms Operating ATSs 78. Should firms operating ATSs in CFTC-regulated markets, but not otherwise registered with the Commission, be required to register with the CFTC? If so, please explain. 79. Please identify the firm characteristics, trading practices, or technologies that could be used to trigger a registration requirement. 80. Should all firms deploying ATS be required to register, and should there be different standards for firms deploying HFT strategies? What are the appropriate thresholds levels below which registration would not be required? 81. Since the floor trader distinction only addresses proprietary traders, please explain whether there is any other category of market participant, such as those deploying ATS or HFT strategies and trading on behalf of clients (aside from market participants already subject to Commission jurisdiction, such as Introducing Brokers and FCMs) that the Commission should consider with respect to potential registration requirements. 82. Should software firms providing algorithms be required to register, and under what authority? What standards should apply to such firms? 83. Please identify the functionalities discussed in this Concept Release that could be applied to floor brokers that operate ATSs. Are there any other controls not mentioned in this Concept Release that should be under consideration? 84. Please supply any information or data that would help the Commission in deciding whether firms may or may not meet the definition of ‘‘floor trader’’ in § 1a(23) of the Act. 85. Do you believe that the registration of such firms as ‘‘floor PO 00000 Frm 00027 Fmt 4701 Sfmt 4702 56567 traders’’ would effectuate the purposes of the CEA to deter and detect price manipulation or any other disruptions to market integrity? 86. Considering the broad deployment of automated trading systems across both equities and derivatives markets, the Commission seeks to understand the appropriate level of coordination between itself and the SEC in defining and applying possible standards to the ATS and HFT trading space. How closely should the CFTC and SEC coordinate on possible rules and requirements for trading firms? The Commission also seeks public comment on the appropriate level of coordinated oversight between itself and relevant Self-Regulatory Organizations such as National Futures Association and FINRA. 87. Using the Flash Crash as an example, is it important to have identical definitions and remedies in the case of ATS and HFT registration requirements or do the existing market controls, such as circuit breakers, provide the necessary market protections in both the equities and derivatives markets? If the rules are not coordinated, what impact would this have on market interaction and oversight? 88. If trading venues apply mandatory functionalities to access derivatives markets, what benefit would a registration requirement provide to the Commission? Market Quality Data 89. What market quality indicators are in place today? Please describe the metrics, how and where they are deployed, and how market participants access these indicators and at what cost. 90. What value would each of the market quality metrics described above [see section III.F.2] provide to market participants receiving them? If possible, please be specific about how each market quality measure could be used to enhance reliability and risk management of ATSs. 91. Conversely, could any of the market quality metrics described above [see section III.F.2] be used by market participants to manipulate the order book, to identify competitors’ trading strategies, or to engage in other trading activities that do not contribute to effective risk management and efficient discovery the traded asset’s economic value? If so, please provide specific information regarding how such information could be misused. If possible, please provide recommendations regarding steps the Commission could take to prevent misuse. E:\FR\FM\12SEP4.SGM 12SEP4 56568 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS4 92. Are there additional market quality metrics that the Commission should contemplate requiring exchanges to provide? If so, what value would they provide and how would they be used? 93. If the Commission determines that measures should be calculated in the same way by various exchanges in order to provide comparable measures of market quality, then how, specifically, should each of the above mentioned metrics be calculated in order to ensure that they are most valuable to market participants? 94. What timing and mode of dissemination is appropriate for each metric? For example, should measures be provided as daily averages? 95. Does the liquidity of a given market impact which market quality metrics would be reliable and useful when calculated for that market? If so, which metrics are inapplicable in less liquid markets, and why? What liquidity measures and thresholds are relevant to determining which metrics should apply to a given market? Market Quality Incentives 96. Should exchanges impose a minimum time period for which orders must remain on the order book before they can be withdrawn? If so, should this minimum resting time requirement apply to orders of all sizes or be restricted to orders smaller than a specific threshold? If there should be a specific threshold, how should that threshold be determined? 97. The Commission seeks to understand where time-weighted Pro Rata trade allocation is currently being utilized and what the effects have been. Please note examples from exchanges and, to the extent possible, please comment on the impact that such matching algorithms have had on the amount of time resting orders are left in the order book, as well as on other aspects of market quality. 98. If exchanges aggregated multiple, small orders entered by the same entity with the intent of abusing rounding conventions to gain a disproportionate share of allocations, what criteria should exchanges use to distinguish such orders from those that are entered by the same legal entity for legitimate trading purposes? Are there empirical patterns that could be used to reliably identify such manipulative intent? 99. Would batched order processing increase the number of milliseconds that are necessary for correlations among related securities to be established? If so, what specific costs would result from this change and how do those costs compare to the potential benefits described in recent research? VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 100. What costs and benefits result from providing market participants with real-time access to information about the order book that extends beyond aggregate size available at a limit price? Is there a legitimate economic benefit that results from market participants (both human participants, and ATSs) accessing such information? Is it possible for market participants to use such information to manipulate the order book? 101. The Commission seeks to understand whether any of the recommendations above [see section III.F.3] are inapplicable or irrelevant to markets subject to the CEA. If so, please indicate which recommendation(s) and what makes it inapplicable or irrelevant to those markets. Policies and Procedures To Identify ‘‘Related Contracts’’ 102. If you are a DCM, please address whether you have (i) identified all contracts that are linked to, or are a substitute for, other contracts either listed on your market or on other trading venues; and, if so, (ii) coordinated your risk controls with any similar controls placed on those other contracts. If you have not identified such contracts and coordinated risk controls on such contracts, please address any other means by which you are addressing risk controls applicable to contracts that are linked to, or are a substitute for, other contracts listed on your exchange or on other trading venues. 103. Please explain whether it would be beneficial for exchanges to develop and document policies and procedures for regularly reviewing contracts on other exchanges in order to identify those that are ‘‘linked to’’ or that are ‘‘a substitute for’’ contracts listed on its own market. Standardize and Simplify Order Types 104. Please explain whether the standardization and simplification of order types that have complex logic embedded within them would reduce the potential for instability and other market disruptions. If not, what other measures could achieve the same effect? 105. If the Commission were to consider the standardization and simplification of order types in a future rulemaking, please identify who should conduct this review (i.e., the Commission, trading platforms, or other parties). General Questions Regarding All Risk Controls 106. For each of the specified controls described above [see sections III.C–F], PO 00000 Frm 00028 Fmt 4701 Sfmt 4702 please indicate whether you are already using the control on customer and/or proprietary orders. If applicable, please also indicate how widely you believe the control is currently being used in the market, and how consistent the application of the control is among firms. 107. If possible, please indicate specific costs associated with implementing each of the risk controls described above [see sections III.C–F]. Please include detailed estimates, distinguishing between the cost of developing the functionality, the cost of implementation, and the cost of ongoing operations. 108. Please describe the specific benefits associated with each of the risk controls. Where possible, please indicate the market participant category(ies) to which the benefit would accrue. 109. Please comment on the appropriate order of implementation and timeline for each risk control, including any distinctions that should be made based on the category of registrant or market participant implementing the same or similar control, whether the market participant is using DMA, and whether implementation is already in place for certain categories. 110. Are any of the risk controls unnecessary, impractical for commercial or technological reasons, or inadvisable? If so, please note the control and provide reasons why. 111. A number of the pre-trade risk controls contemplated above are similar protections at distinct points in the life of an order. a. Please comment on the utility of redundant pre-trade risk controls and the desirability of risk control systems in which controls are placed at one or more than one focal points. b. If pre-trade risk controls should reside at one or more than one focal point, then please identify, for each risk control, what that focal point should be? 112. Are there risk controls that should be implemented across multiple entity types? If so, which controls and for which types of entities should they apply? Also, please comment generally on the factors the Commission should consider when determining the appropriate entity(ies) upon which to place a risk control requirement that could pertain to more than one entity. 113. Are there controls that should not be considered for overlapping implementation across exchanges, clearing members and market participants? If so, please explain which ones and why. E:\FR\FM\12SEP4.SGM 12SEP4 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules 114. Each of the risk controls is described in general, principles-based terms. Should the Commission specify more granular or specific requirements with respect to any of the controls to improve their effectiveness or provide greater clarity to industry participants? If so, please identify the relevant control and the additional granularity or specificity that the Commission should provide. Are any of the controls, as currently drafted, inadequate to achieve the desired risk-reduction? 115. To the extent that there is any need to standardize or provide greater specificity regarding any measures discussed in this Concept Release, including those that reflect industry best practices, please describe the best approach to achieve such standardization (i.e., through Commission regulation, Commissionsponsored committee or working group, or some other method). 116. How should risk control monitoring be implemented? Should compliance be audited by internal and external parties? For each control, please identify the appropriate entity(ies) to monitor compliance with the control. Also, please describe what an acceptable compliance audit would entail for each control. 117. Are there additional controls that should be considered, or other methods that could serve as alternatives to those described above [see sections III.C–F]? If so, please describe the control, its costs and benefits, the appropriate entity(ies) to implement such control, and whether there is any distinction to be drawn in the case of DMA. 118. Would any of the risk safeguards create a disincentive to innovate or create incentives to innovate in an irresponsible manner? If so, please identify the control, the concern raised, and how the control should be amended to address the concern. Responses should indicate how an amended risk control would still meet the Commission’s objectives. 119. Should the Commission consider any pre-trade risk controls, post-trade reports, or system safeguards appropriate exclusively to market makers or to ATSs used by market makers? If so, please describe such controls or safeguards. 120. Should the Commission or Congress revisit its approach to issuing civil monetary penalties for violations of the Act, particularly as they relate to automated trading environments? Currently, the maximum civil monetary penalty the Commission may issue is capped at $140,000 ‘‘per violation.’’ Is such a civil monetary penalty sufficient to deter acts that constitute violations of the Act, given that an individual violation could impose costs to the market and the public well in excess of $140,000? 121. Please describe the documentation (or categories of 56569 documents) that would demonstrate that a market participant operating an ATS has implemented each risk control addressed in this Concept Release, including, for example, computer code, system testing results, certification processes and results, and calculations. 122. Would a fee (collected by, for example, the DCM or SEF) on numbers of messages exceeding a certain limit be more appropriate than a hard limit on the number or rate of messages? 123. Should such a penalty be based on a specified number or rate of messages or on the ratio of messages to orders filled over a specified time period? 124. Recent disruptive events in securities markets illustrate the importance of effective communication between exchanges’ information technology systems. The Commission requests public comments regarding relevant systems in its regulated markets, including both DCMs and SEFs. What data transfers or other communications between exchanges are necessary for safe, orderly, and wellfunctioning derivatives markets? What additional measures, if any, would help promote the soundness of such systems (e.g., testing requirements, redundancy standards, etc.)? V. Appendices (Specific Measures in Bold Font) A. Pre-Trade Risk Controls Potential pre-trade risk control Party(s) to implement risk control Substance of control 1a. Maximum Message Rate (Message Throttle). Market Participants Operating ATSs, Trading Platforms, and Clearing Firms. 1a. Market participants operating ATSs must establish a maximum message rate per unit time for each ATS. This control should be calibrated to address the potential for unintended message flow (including orders) from a malfunctioning ATS. Market participants’ systems must prevent the submission of messages in excess of the specified rate. Trading platforms’ systems must prevent the acceptance of messages in excess of their own specified rates and must log instances when each ATS attempted to exceed such limits. Separately, trading platforms must establish systems enabling clearing firms to set rate limits directly at the trading platform. Trading platforms, clearing firms and market participants may set rates independently of each other. In all cases, human monitors must be alerted when limits are breached. 1b. Market participants operating ATSs must establish a limit on the maximum number of orders that each of their ATSs can execute in a given direction per unit time. The limit should be unique to each ATS and should be calibrated to address the potential for unintended executions arising from a malfunctioning ATS. Additional orders in excess of the limit should not be submitted or executed. Trading platforms must establish a maximum number of orders in the same direction they will execute per unit time from a uniquely identified ATS, and must prevent execution of trades that would violate this limit. Separately, trading platforms must establish systems enabling clearing firms to set per-customer message rate limits directly at the trading platform. Trading platforms, clearing firms and market participants may set rates independently of each other. mstockstill on DSK4VPTVN1PROD with PROPOSALS4 1b. Maximum Execution Market Participants OperRate (Execution Throttle). ating ATSs, Trading Platforms, and Clearing Firms. VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 PO 00000 Frm 00029 Fmt 4701 Sfmt 4702 E:\FR\FM\12SEP4.SGM 12SEP4 56570 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules Potential pre-trade risk control Party(s) to implement risk control 2. Volatility Awareness Alerts. Market Participants Operating ATSs. 3. Self-Trade Controls ....... Trading Platforms and All Market Participants. 4. Price Collars ................... Trading Platforms and All Market Participants. 5. Maximum Order Size ..... Trading Platforms, Clearing Firms, and All Market Participants. 6. Trading Pauses .............. Trading Platforms ............... 7. Credit Risk Limits .......... Trading Platforms, Clearing Firms and/or Market Participants Operating ATSs. Substance of control Market participants operating ATSs must implement automated solutions to immediately notify system supervisors when the prices of individual or groups of assets relevant to an ATS’s trading strategies move either up or down by a given percentage within a predetermined period of time, or when the volume of individual or groups of assets relevant to an ATSs trading strategies over a specific period of time increase or decrease beyond a predetermined threshold. This control should help system supervisors identify market conditions which are not appropriate to the continued operation of a particular ATS or algorithm. The alert should be configurable by contract. Trading platforms must provide, and all market participants must apply, technologies to identify and limit the transmission of orders from their systems to a trading platform that would result in self-trades. Trading platforms must assign a range of acceptable order and execution prices for each of their products. All orders outside of this range would be automatically rejected, and orders already in the order book but outside of the acceptable range should not be elected by the matching engine. All market participants must establish similar product-specific price collars and should implement systems to ensure that orders outside of the collar are not transmitted to the relevant trading platform. Trading platforms, clearing firms, and all market participants must each establish default maximum order sizes for orders submitted, transmitted, or processed by their systems. A market participant’s systems must prevent the submission of orders in excess of its internally-specified limits. A clearing firm’s systems must prevent the transmission of customer orders in excess of its limits for that customer. Trading platforms must prevent their systems from processing or executing orders in excess of the limit specified by the trading platform. In addition, for DMA customers, trading platforms must establish similar systems enabling clearing firms to set per-customer order size limits directly at the trading platform. Limits set by market participants, clearing firms, and trading platforms may be different from, and operate independently, of each other. Trading platforms would be required to institute trading pauses, similar in nature to stop-logic functionality, but covering a wider array of adverse states of an automated central limit order book. While some trading firms and FCMs conduct post-trade credit checks with varying degrees of latency and pre-trade credit risk screens are already required pursuant to Commission regulations, the Commission seeks public comments regarding any additional measures that could help protect the financial integrity of DCOs, as well as additional input from the public regarding the appropriate location and timing in the order lifecycle for credit checks. B. Post-Trade Reports and Other PostTrade Measures Party(s) to implement report or measure Substance of report or measure 8. Order Report (Postorder drop copy). Trading platforms ............... 9. Trade Report (Posttrade drop copy). Trading platforms ............... 10. Position Report (Postclearing drop copy). DCOs .................................. 11a. Uniform Adjust or Bust Error Trade Policies. mstockstill on DSK4VPTVN1PROD with PROPOSALS4 Potential post-trade report or measure Trading platforms and All Market Participants. 11b. Standardized Reporting Window for Error Trades. ............................................. Trading platforms must provide a duplicate copy of each order to the originating market participant and to the market participant’s clearing firm(s) simultaneously with such order’s receipt by the trading platform. Trading platforms must provide a duplicate copy of each executed trade to the originating market participant and to the market participant’s clearing firm(s) simultaneously with such trade’s execution by the trading platform. DCOs must provide net position per maturity per contract to the originating market participant and the market participant’s clearing firm(s) as soon as the contract is matched at the clearinghouse. 11a. Trading platforms must establish policies for adjusting the price of trades or breaking trades that have been executed due to an error. Policies must favor price adjustments rather than trade cancellation. To the extent possible, policies must require decisions by the trading platform to be made on the basis of readily available objective criteria in order to facilitate rapid or immediate decisions. 11b. Market participants must report error trades to the trading platform within five minutes after the trades are executed. Trading platforms must notify market participants of a potential adjust-or-bust situation immediately. Trading platforms must make a decision and notify market participants of that decision within a specified period of time. VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 PO 00000 Frm 00030 Fmt 4701 Sfmt 4702 E:\FR\FM\12SEP4.SGM 12SEP4 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules 56571 C. System Safeguards Potential system safeguard Party(s) to implement safeguard Substance of safeguard CONTROLS OVER ORDER PLACEMENT. Trading Platforms, Clearing Firms, and All Market Participants. Trading platforms, clearing members, and market participants must have systems and processes in place to: 12a. Auto-cancel on disconnect. ............................................. 12b. Selective working order cancellation. 12c. Kill switch ................... ............................................. 12a. Exchanges should implement a flexible system that allows a user to determine whether their orders should be left in the market upon disconnection. This should only be implemented if the clearing firm’s risk manager has the ability to cancel working orders for the trader if the trading system is disconnected. The exchange should establish a policy whether the default setting for all market participants should be to maintain or to cancel all working orders. 12b. Immediately cancel one, multiple, or all resting orders from a market participant as deemed necessary in an emergency situation. 12c. Immediately cancel all working orders, and the ability to prevent submission (market participant), transmittal (clearing member), or acceptance (trading platform) of any new orders from a market participant, or particular trader or ATS of such market participant. 13. Market participants operating ATSs must establish a limit on the maximum number of orders that each ATS can submit. When an ATS reaches that maximum it must be automatically disabled until a human re-enables it. 14. Trading platforms must provide, and market participants operating ATSs must utilize, heartbeats that indicate proper connectivity between the trading platform and the ATS. Such heartbeats must also indicate the status of connectivity between an ATS and any systems used by the trading platform to provide the ATS with market data. If connectivity to any system is lost, the ATS should be disabled, and resting orders should be maintained or cancelled based on the pre-determined preferences of the firm that lost connectivity. 15a. Market participants operating ATSs must properly design their systems to avoid violations of the CEA, Commission regulations, or DCM and SEF rules related to fraud, disruptive trading practices, manipulation and trade practice violations. They must also ensure that their ATSs include all applicable pretrade risk controls and system safeguards as described herein. 15b. Trading platforms and market participants operating ATSs must maintain a development environment that is adequately isolated from the production trading environment. The development environment may include computers, networks, and databases, and should be used by software engineers while developing, modifying, and testing source code. Firms must maintain a source code repository to manage source code access, persistence, and changes. Firms must establish and document procedures for communicating the functionality and requirements of, and changes to, their proprietary software. These procedures must include an audit trail of material changes that would allow them to determine, for each change: Who made it, when they made it, and what the purpose was for the change. Firms must have documented policies and procedures that allow representatives from trading, risk, and software management to approve changes and to verify internal testing before a new or modified trading system can be enable in production. 15c. Market participants operating ATSs must test each ATS both internally and on each trading platform on which an ATS will operate. Relevant tests include, but are not limited to, unit testing, functional testing (both integration and regression testing), non-functional testing, and acceptance testing. Functional testing must include all applicable pre-trade risk controls, post-trade reports and other measures and system safeguards. Non-functional testing must include testing under stressed market conditions. Market participants must perform such testing on each algorithm prior to initial deployment, and prior to re-deployment, after certain modifications to the algorithm. Trading Platforms must provide test environments that simulate the production trading environment so that market participants may conduct exchange-based conformance testing on their ATSs once they have completed internal testing. Conformance testing must include tests for all ATS risk mitigation controls that are able to be tested by the exchange. Exchange-based conformance testing must be done after certain modifications to the operating code. 15d. Market participants operating ATSs must ensure that their ATSs are subject to continuous real-time monitoring and supervision by trained and qualified staff at all times while engaged in trading. Order Cancellation Capabilities ............................................. ............................................. 14. System heartbeats (see section III.E.1.a and footnote 90). ............................................. POLICIES AND PROCEDURES FOR THE DESIGN, TESTING, AND SUPERVISION OF ATSs 15a. ATS Design 15b. ATS Development and Change Management. Market Participants Operating ATSs. 15c. ATS Testing ................ mstockstill on DSK4VPTVN1PROD with PROPOSALS4 13. Repeated Automated Execution Throttle. Trading Platforms and Market Participants Operating ATSs. 15d. ATS Monitoring and Supervision. Market Participants Operating ATSs. VerDate Mar<15>2010 21:01 Sep 11, 2013 Trading Platforms and Market Participants Operating ATSs. Jkt 229001 PO 00000 Frm 00031 Fmt 4701 Sfmt 4702 E:\FR\FM\12SEP4.SGM 12SEP4 56572 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules Potential system safeguard Party(s) to implement safeguard 15e. Training for ATS Monitoring Staff (see section III(E)(2)(b) and footnote 97). Market Participants Operating ATSs. 15f. Crisis Management Procedures. Trading Platforms and Market Participants Operating ATSs. SELF-CERTIFICATIONS AND NOTIFICATIONS 16a. Self-Certification and Clearing Firm Certification. Market Participants Operating ATSs. 16b. Risk Event Notification Requirements. Market Participants Operating ATSs, Trading platforms. 17. ATS or Algorithm Identification. 18. Data Reasonability Checks. Market Participants Operating ATSs. Market Participants Operating ATSs. Substance of safeguard Appropriate supervision includes automated alerts when ATS order behavior breaches design parameters or when market conditions diverge from program expectations. It also includes automated alerts upon loss of network connectivity or data feeds. Monitoring and supervision staff must have the ability and authority to disengage the ATS and to cancel resting orders when system or market conditions require it, including the ability to contact trading platform staff to seek information and cancel orders. They must also have acceptable dashboards and control panels to monitor and interact with the ATS. Monitoring and supervision staff must record the time when they assume responsibility for an ATS and the time when they relinquish control to others. Recording must be achieved through distinct log-ins to the required control panel by each staff person. Log-in must also be subject to access controls that ensure the correct staff person is identified. 15e. Firms operating ATSs must develop training for all staff involved in monitoring or designing ATSs. Training must, at a minimum, cover design standards, event communication procedures, and requirements for notifying exchange and commission staff when risk events occur. Additionally, each firm must develop, document, and implement training policies that ensure human monitors are adequately trained for each new algorithm that is implemented. Training must include, at a minimum, the economic rationale for the algorithm and mechanics of the underlying process, as well as the automated and non-automated risk controls that are applicable to the algorithm. 15f. Trading platforms and market participants operating ATSs must develop and document procedures that direct the actions of ATS supervisors, exchange trading monitors, and support staff in the event that an algorithm malfunctions or responds to market signals in an unanticipated manner. Procedures should direct the process for evaluating, managing, and mitigating market disruption and firm risk. The procedures should also specify people to be notified in the event of an error that results in violations of risk profiles or potential violations of exchange or Commission rules. 16a. All firms operating ATSs must certify annually that their ATSs individually and collectively (i.e. at the algorithm, account, and firm levels) comply with all Commission and trading platform requirements regarding pre-trade risk controls and post-trade reports and other measures, as well as all applicable risk controls. Clearing firms must institute reasonable measures to confirm that their client trading firms implement the pre-trade risk controls that are required. 16b. Market participants operating ATSs must notify the exchange, and the exchange must notify the Commission whenever an algorithm violates its design parameters or whenever risk control technologies or processes do not function as planned even if they do not result in destabilization of the markets. The exchange must also notify the Commission whenever any of its own risk management technologies or processes violate design parameters or do not function as planned. A unique identifier would be assigned to each ATS or algorithm, and all orders submitted by that ATS or algorithm would be tagged with the identifier. All firms operating ATSs must have ‘‘reasonability checks’’ on incoming market data and other data (including social media). D. Other Protections Party(s) to implement protection Substance of protection 19. Registration of All Firms Operating ATSs. 20. Market Quality Data ..... mstockstill on DSK4VPTVN1PROD with PROPOSALS4 Potential additional protection Market Participants Operating ATSs. Trading Platforms ............... All firms operating ATSs to trade solely for their own account and not otherwise registered with the Commission must register with the Commission. Trading platforms must provide to all market participants a daily summary of market quality for each product traded on its platform. The feeds would include measures of execution quality including: (1) Effective spreads; (2) order to fill ratios; (3) execution speed for different types of orders and different order sizes; (4) aggressiveness imbalance; (5) price impact for given trade sizes; (6) average order duration; (7) order efficiency; (8) rejection order ratio; (9) net position changes versus volume; (10) branching ratios; (11) volume imbalance and trade intensity; (12) Herfindahl-Hirschman Indexes based on market share of open positions under common control; and (13) metrics on the number of price changing trades involving ATSs. VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 PO 00000 Frm 00032 Fmt 4701 Sfmt 4702 E:\FR\FM\12SEP4.SGM 12SEP4 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules Potential additional protection 56573 Party(s) to implement protection Substance of protection 21. Market Quality Incentives. Trading Platforms ............... 22. Policies and Procedures for identifying ‘‘related’’ contracts. 23. Standardize and Simplify Order Types. Trading Platforms ............... Trading platforms must implement changes that will limit market participants’ abilities to improperly advantage their own orders in ways that do not contribute to efficient price discovery, including, for example: (1) Utilize a trade allocation formula that is an intermediate between a cardinal ranking (time-weighted), Pro Rata allocation formula and a Price/Time allocation formula; (2) Create a new limit order type that would prioritize orders that remain resting in the order book for some minimum amount of time; (3) Require orders not fully visible in the order book to go to the end of the queue (within limit price) with respect to trade allocation; (4) Aggregate multiple, small orders from the same legal entity entered contemporaneously at the same price level and assign them the lowest priority time stamp of all the orders so aggregated; (5) Require exchanges to use batch auctions once per half second at random times rather than use continuous trade matching; and (6) Limit visibility into the order book to aggregate size available at a limit price. Trading platforms must develop and implement policies and procedures for identifying securities or products listed on other exchanges that would constitute ‘‘related’’ contracts to those that are listed on their own exchange. Trading platforms must work with the Commission to standardize order types across exchanges, and to reduce the overall number of order types that have complex logic embedded within them. Trading Platforms ............... Issued in Washington, DC, on September 9, 2013, by the Commission. Christopher J. Kirkpatrick, Deputy Secretary of the Commission. Appendices to Concept Release on Risk Controls and System Safeguards for Automated Trading Environments Appendix 1—Commission Voting Summary On this matter, the following Commissioners voted in the affirmative: Chairman Gensler, Commissioner Chilton (with the concurrence set out below in Appendix 3), Commissioner O’Malia (with the concurrence set out below in Appendix 4), and Commissioner Wetjen. No Commissioner voted in the negative. mstockstill on DSK4VPTVN1PROD with PROPOSALS4 Appendix 2—Statement of Support of Chairman Gary Gensler We have witnessed a fundamental shift in markets from human-based trading to highly automated electronic trading. Automated trading systems, including high frequency traders, enter the market and execute trades in a matter of milliseconds without human involvement. Electronic trading makes up over 91 percent of the futures market. The swaps market also is moving toward electronic trading. In our oversight of U.S. derivatives markets, both futures and swaps, the Commodity Futures Trading Commission (CFTC) must look to continually adapt our regulations in these changing times. Our mission to promote transparency, ensure for market integrity and prohibit abuses is just as important in the fast-moving world of electronic trading as it was when people traded over the phone, in a pit or on a floor. The CFTC already has taken a number of important steps to keep pace with rapidly evolving 21st-century markets. We have adopted rules to implement pre-trade risk filters for futures commission merchants, swap dealers, designated contract markets and swap execution facilities. We also have VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 new rules to prohibit disruptive trading practices and other market abuses. In publishing this Concept Release, we are seeking public input on what additional risk controls and system safeguards are appropriate given this ever-changing technological environment. Traditional risk controls and system safeguards, many of which were developed according to human speed and floor-based trading, must be evaluated in light of new market realities. Further, as sure as computers and programs have had technical glitches in the past, we must look to risk controls and system safeguards to protect markets when such glitches inevitably occur again. This Concept Release is intended to stir public discussion and debate on how best to protect the functioning of markets for the benefit of farmers, ranchers, merchants and other end users who rely on markets to hedge risk— particularly in light of the reality that the majority of the market is using automated trading systems. Appendix 3—Concurrence of Commissioner Bart Chilton While I concur in the concept release, am most appreciative of the staff work, and am largely pleased at the result, this has taken far too long to come to fruition. In general, those involved in financial markets seem to have blindly accepted that technology is almost always a good thing. Yet we continue to see major technology problems, like NASDAQ shutting down twice in as many weeks. Last year it was NYSE. In the futures world, we see technology glitches that simply should not occur. I acknowledge that, with the staggering volume of trading, some might simply be astounded that—in the main—it works so well. But it doesn’t work well enough if we continue to see aberrations—particularly if they are market missteps that could have been avoided. That’s to say nothing of the high frequency cheetah traders who have, some I am convinced intentionally, contorted markets in a manipulative fashion. In addition, there are a shocking number of transactions that PO 00000 Frm 00033 Fmt 4701 Sfmt 4702 appear to be wash trades—that also has the possibility of impairing the fair and effective functioning of financial markets. I’m pleased we are moving this concept release forward, but given this environment it has taken way too long. If we continue at this pace, Rip Van Winkle could keep up with any possible action we might take. We need to understand that some of these issues are urgent and need action now. They can’t wait another year or more. At the same time, there is one thing that can be done now. In fact, I suggested this policy shift be included in the concept release, but since it is a larger issue than just a technology-related matter, it was decided to omit it. That’s fine, because my suggestion is really an action for the Congress. As long as we have a puny penalty regime at the CFTC, we are going to see traders risk getting caught because the potential profits are so great. We can only impose a civil monetary penalty (CMP) of $140,000 per violation. That’s the law. Furthermore, the case history suggests that a ‘‘violation’’ may be only once per day. In these millisecond markets where we have seen a million change hands in a minute, $140k is a joke— and it’s not very funny. This Agency is hampered by staffing needs due to a lack of funding. We have hundreds of cases being investigated right now. The least Congress can do, so that we can try and keep up—and if need be, cage the cheetahs and others who violate the Commodity Exchange Act—is to increase the CMPs. Specifically, I’ve suggested increasing the maximum penalty levels to $1 million per violation for individuals and $10 million for firms. That would be a deterrent. That would stop some of the cheetahs and others out there who are tempted to use powerful technologies in unlawful ways. I look forward to receiving comments, and hope that we let no moss grow on this matter. Appendix 4—Statement of Concurrence by Commissioner Scott D. O’Malia During my time at the Commodity Futures Trading Commission (‘‘Commission’’), I have E:\FR\FM\12SEP4.SGM 12SEP4 56574 Federal Register / Vol. 78, No. 177 / Thursday, September 12, 2013 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS4 consistently emphasized that the Commission must have a strong understanding of today’s highly automated and interconnected trading environments in order to oversee its markets effectively. As head of the Commission’s Technology Advisory Committee (‘‘TAC’’), I have committed considerable TAC time and resources to strengthening our understanding of automated markets. I am grateful for all the hard work of the TAC members as well as the efforts of the members of the Subcommittee on Data Standardization and the Subcommittee on Automated and High Frequency Trading, who have devoted hours of work on issues related to automated trading systems and pre-trade functionality. I hope that this Concept Release, and in particular the public comments the Commission receives in response, will build on this work. The Concept Release asks over a hundred questions, which is appropriate given the importance of hearing from all sectors of the industry and benefiting from their knowledge VerDate Mar<15>2010 19:42 Sep 11, 2013 Jkt 229001 and views of automated trading. I would like to highlight a few questions that I believe it would be particularly constructive to receive feedback from the public on. The first is to establish what current protections are in the market today and the extent to which the technology is deployed, as well as its effectiveness. The second is an overarching question: Whether there is a need for regulatory action with regard to any of the measures currently in the market. In other words, should the Commission federalize any current industry practices/standards? Third, it would be helpful to receive public feedback on the definitions for highfrequency trading and automated trading systems that the TAC, after extensive effort by its Subcommittee on Automated and High Frequency Trading, has proposed. Finally, it would be beneficial to receive feedback on the possibility of a registration requirement for firms operating automated trading systems and not otherwise registered with the Commission. The Concept Release cites the definition of ‘‘floor broker’’ as the PO 00000 Frm 00034 Fmt 4701 Sfmt 9990 potential basis for such a requirement; I am interested to get public input on whether this, or any other provision in the Commission’s statute or regulations, can serve as a valid foundation for registration. The Concept Release is far from perfect. For example, it could have provided a more thorough and clear cataloguing of existing industry practices and recommendations; a recent TAC reference document is more clear and concise in compiling existing standards and recommendations in the market today.124 Nevertheless, I support today’s issuance of the Concept Release in order to receive input from market participants on all of the issues contained herein. I look forward to reviewing the comments submitted in response to the Concept Release. [FR Doc. 2013–22185 Filed 9–10–13; 8:45 am] BILLING CODE 6351–01–P 124 This document is available at http:// www.cftc.gov/ucm/groups/public/@newsroom/ documents/file/tac103012_reference.pdf. E:\FR\FM\12SEP4.SGM 12SEP4

Agencies

[Federal Register Volume 78, Number 177 (Thursday, September 12, 2013)]
[Proposed Rules]
[Pages 56541-56574]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-22185]



[[Page 56541]]

Vol. 78

Thursday,

No. 177

September 12, 2013

Part IV





Commodity Futures Trading Commission





-----------------------------------------------------------------------





17 CFR Chapter I





Concept Release on Risk Controls and System Safeguards for Automated 
Trading Environments; Proposed Rule

Federal Register / Vol. 78 , No. 177 / Thursday, September 12, 2013 / 
Proposed Rules

[[Page 56542]]


-----------------------------------------------------------------------

COMMODITY FUTURES TRADING COMMISSION

17 CFR Chapter I

RIN 3038-AD52


Concept Release on Risk Controls and System Safeguards for 
Automated Trading Environments

AGENCY: Commodity Futures Trading Commission.

ACTION: Concept release; request for comments.

-----------------------------------------------------------------------

SUMMARY: U.S. derivatives markets have experienced a fundamental 
transition from human-centered trading venues to highly automated and 
interconnected trading environments. The operational centers of modern 
markets now reside in a combination of automated trading systems 
(``ATSs'') and electronic trading platforms that can execute repetitive 
tasks at speeds orders of magnitude greater than any human equivalent. 
Traditional risk controls and safeguards that relied on human judgment 
and speeds, and which were appropriate to manual and/or floor-based 
trading environments, must be reevaluated in light of new market 
structures. Further, the Commission and market participants must ensure 
that regulatory standards and internal controls are calibrated to match 
both current and foreseeable market technologies and risks. This 
Concept Release on Risk Controls and System Safeguards for Automated 
Trading Environments (``Concept Release'') reflects the Commission's 
continuing commitment to the safety and soundness of U.S. derivatives 
markets in a time of rapid technological change. The Concept Release 
serves as a platform for cataloguing existing industry practices, 
determining their efficacy and implementation to date, and evaluating 
the need for additional measures, if any. The Commission welcomes all 
public comments.

DATES: Comments must be received on or before December 11, 2013.

ADDRESSES: You may submit comments, identified by RIN 3038-AD52, by any 
of the following methods:
     CFTC Web site, via Comments Online: http://comments.cftc.gov. Follow the instructions for submitting comments 
through the Web site.
     Mail: Melissa D. Jurgens, Secretary of the Commission, 
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st 
Street NW., Washington, DC 20581.
     Hand Delivery/Courier: Same as ``mail,'' above.
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.

Please submit comments by only one method. All comments should be 
submitted in English or accompanied by an English translation. Comments 
will be posted as received to http://www.cftc.gov. You should submit 
only information that you wish to make available publicly. If you wish 
the Commission to consider information that may be exempt from 
disclosure under the Freedom of Information Act (``FOIA''), a petition 
for confidential treatment of the exempt information may be submitted 
according to the procedures established in 17 CFR 145.9. The Commission 
reserves the right, but shall have no obligation, to review, prescreen, 
filter, redact, refuse, or remove any or all of your submission from 
http://www.cftc.gov that it may deem to be inappropriate for 
publication, such as obscene language. All submissions that have been 
redacted or removed that contain comments on the merits of the 
rulemaking will be retained in the public comment file and will be 
considered as required under the Administrative Procedure Act and other 
applicable laws, and may be accessible under FOIA.

FOR FURTHER INFORMATION CONTACT: Sebastian Pujol Schott, Associate 
Director, Division of Market Oversight, sps@cftc.gov or 202-418-5641; 
Marilee Dahlman, Attorney-Advisor, Division of Market Oversight, 
mdahlman@cftc.gov or 202-418-5264; Camden Nunery, Economist, Office of 
the Chief Economist, cnunery@cftc.gov or 202-418-5723; or Sayee 
Srinivasan, Research Analyst, Office of the Chief Economist, 
ssrinivasan@cftc.gov or 202-418-5309.

SUPPLEMENTARY INFORMATION: 

I. Introduction
    A. Design of Concept Release and Request for Comments
II. Background
    A. Characteristics of Automated Trading Environments
    1. Automated Order Generation and Execution
    2. Advances in High-Speed Communication Networks and Reductions 
in Latency
    3. Rise of Interconnected Automated Markets
    4. Manual Risk Controls and System Safeguards in Automated 
Trading Environments
    B. The Commission's Regulatory Response to Date
    C. Recent Disruptive Events in Automated Trading Environments
III. Potential Pre-Trade Risk Controls, Post-Trade Reports, System 
Safeguards, and Other Protections
    A. Overview of Existing Industry Practices
    1. Existing DCM Risk Controls
    2. Existing Trading and Clearing Firm Risk Controls
    B. Overview of Risk Controls Addressed in This Concept Release
    C. Pre-Trade Risk Controls
    1. Message and Execution Throttles
    2. Volatility Awareness Alerts
    3. Self-Trade Controls
    4. Price Collars
    5. Maximum Order Sizes
    6. Trading Pauses
    7. Credit Risk Limits
    D. Post-Trade Reports and Other Post-Trade Measures
    1. Order, Trade, and Position Drop Copy
    2. Trade Cancellation or Adjustment Policies
    E. System Safeguards
    1. Controls Related to Order Placement
    2. Policies and Procedures for the Design, Testing and 
Supervision of ATSs; Exchange Considerations
    3. Self-Certifications and Notifications
    4. ATS or Algorithm Identification
    5. Data Reasonability Checks
    F. Other Protections
    1. Registration of Firms Operating ATSs
    2. Market Quality Data
    3. Market Quality Incentives
    4. Policies and Procedures To Identify ``Related Contracts''
    5. Standardize and Simplify Order Types
    G. General Questions Regarding All Risk Controls Discussed Above
IV. List of All Questions in the Concept Release
V. Appendices (Specific Measures in Bold Font)
    A. Pre-Trade Risk Controls
    B. Post-Trade Reports and Other Post-Trade Measures
    C. System Safeguards
    D. Other Protections

I. Introduction

    U.S. derivatives markets have experienced a fundamental evolution 
from human-centered trading venues to highly automated and 
interconnected trading environments. Traditionally, traders and market 
participants directly initiated, communicated and executed orders, 
while other personnel provided a range of order, trade processing and 
back office services. In contrast, automated trading environments are 
characterized precisely by their high degree of automation, and by the 
wide array of algorithmic and information technology systems that 
generate, risk manage, transmit and match orders and trades, as well as 
systems used to confirm transactions, communicate market data and link 
related systems through high-speed communication networks. Automated 
trading environments have conferred a number of benefits upon market 
participants, including an expanded range of potential trading 
strategies, and a surge in the speed, precision and tools

[[Page 56543]]

available to execute such strategies. In addition to these benefits, 
however, automated trading environments have also presented challenges 
unique to their speed, interconnectedness and reliance on algorithmic 
systems.
    In recent years, a number of high-profile system events associated 
with automated trading have raised public, Commission and industry 
awareness. For example, on May 6, 2010, major equity indices in both 
the futures and securities markets lost more than 5% of their value in 
a matter of minutes when an automated order led to extreme downward 
price movement and a liquidity crisis in the Chicago Mercantile 
Exchange's (``CME'') E-mini futures contract.\1\ In August 2012, a 
trading firm in the securities markets--Knight Capital Group--submitted 
a significant number of errant proprietary orders to the New York Stock 
Exchange (``NYSE''), causing price swings in nearly 150 securities and 
costing the firm approximately $440 million in the process.\2\ Most 
recently, in August 2013, trading on the Nasdaq stock market was 
disrupted for three hours due to malfunctions in quote dissemination 
systems and potential connectivity issues between it and another 
trading platform's systems. These and other recent events in automated 
trading environments are discussed in greater detail in section II.C., 
below.
---------------------------------------------------------------------------

    \1\ See ``Findings Regarding the Market Events of May 6, 2010, 
Report of the Staffs of the CFTC and SEC to the Joint Advisory 
Committee on Emerging Regulatory Issues,'' September 30, 2010 
[hereinafter, the ``CFTC and SEC Joint Report on the Market Events 
of May 6, 2010''], available at http://www.cftc.gov/ucm/groups/public/@otherif/documents/ifdocs/staff-findings050610.pdf.
    \2\ See Jenny Strasburg & Jacob Bunge, ``Loss Swamps Trading 
Firm,'' Wall St. J. (Aug. 2, 2012), available at http://online.wsj.com/article/SB10000872396390443866404577564772083961412.html.
    On October 2, 2012, the Securities and Exchange Commission 
(``SEC'') conducted a roundtable entitled ``Technology and Trading: 
Promoting Stability in Today's Markets'' (``SEC Roundtable''). See 
SEC, Notice of Roundtable Discussion: Technology and Trading 
Roundtable, 77 FR 56697 (Sept. 13, 2012). A transcript of the SEC 
Roundtable [hereinafter, the ``SEC Roundtable Transcript''] is 
available at http://www.sec.gov/news/otherwebcasts/2012/ttr100212.shtml. At the SEC Roundtable, then-SEC Chairman Schapiro 
raised the Knight Capital incident and noted that ``[e]vents like 
these demonstrate the core infrastructure and technology issues that 
can be problematic in any market structure.'' See SEC Roundtable 
Transcript at 11.
---------------------------------------------------------------------------

    The Commission has taken steps to address the transition to 
automated trading and require appropriate risk controls for designated 
contract markets (``DCMs''), swap execution facilities (``SEFs''), 
futures commission merchants (``FCMs''), swap dealers (``SDs''), major 
swap participants (``MSPs'') and others. In April 2012, it adopted 
final rules requiring FCMs, SDs and MSPs that are clearing members to 
establish risk-based limits based on position size, order size, margin 
requirements, or similar factors, and requiring those entities to use 
automated means to screen orders for compliance with the risk limits 
when such orders are subject to automated execution. Further, in June 
2012, the Commission adopted final rules with respect to DCMs, 
including requirements that DCMs establish and maintain risk control 
mechanisms to prevent and reduce the potential for price distortions 
and market disruptions. Relevant controls cited in the rule include 
trading pauses and halts under conditions prescribed by the DCM. The 
Commission adopted similar requirements in its final rules for SEFs in 
2013. Finally, the DCM final rules also require risk control 
requirements for exchanges that provide direct market access (``DMA'') 
to clients.
    The Commission has also adopted rules related to trading practices, 
including trading in automated environments. In July 2011, the 
Commission adopted final rules codified in 17 CFR Part 180 that, among 
other things, (i) broadly prohibit manipulative and deceptive devices, 
i.e., fraud and fraud-based manipulative devices and contrivances 
employed intentionally or recklessly, regardless of whether the conduct 
in question was intended to create or did create an artificial price; 
and (ii) codify the Commission's long-standing authority to prohibit 
price manipulation by making it unlawful for any person, directly or 
indirectly, to manipulate or attempt to manipulate the price of any 
swap, or of any commodity in interstate commerce, or for future 
delivery on or subject to the rules of a registered entity. Further, 
section 747 of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (the ``Dodd-Frank Act'') \3\ amended the Commodity 
Exchange Act (``CEA'' or ``Act'') to make it unlawful for any person to 
engage in disruptive trading practices, and the Commission has provided 
guidance on the scope and application of the new statutory 
prohibitions. The Commission's measures to date are summarized in 
greater detail in section II.B., below. With respect to these measures 
and others discussed in this Concept Release, the Commission requests 
public comment regarding any additional steps, guidance or rulemaking 
that it should undertake.
---------------------------------------------------------------------------

    \3\ See Dodd-Frank Wall Street Reform and Consumer Protection 
Act of 2010, Public Law 111-203, 124 Stat. 1376 (2010).
---------------------------------------------------------------------------

    Derivatives market participants, including DCMs, FCMs, clearing 
members and others, have themselves taken a number of steps to manage 
risks associated with automated trading. The Commission acknowledges 
these efforts, and, through this Concept Release, seeks public comment 
on the extent to which measures already in place may be sufficient to 
safeguard markets in automated trading environments. In particular, 
section III below summarizes relevant risk controls implemented by one 
or more market participants; requests comment regarding the extent of 
their implementation to date; and seeks input regarding whether 
existing controls would benefit from additional granularity or 
regulatory standardization.

A. Design of Concept Release and Request for Comments

    This Concept Release provides an overview of the automated trading 
environment, including its principal actors, potential risks, and 
preventative measures designed to promote safe and orderly markets.\4\ 
The Concept Release was informed by controls already in use today by 
one or more market participants or exchanges, and best practices, 
recommendations and concepts developed by the CFTC's Technology 
Advisory Committee (``TAC''); the Futures Industry Association's 
(``FIA'') Principal Traders Group and Market Access Working Group; the 
International Organization of Securities Commissions (``IOSCO''); the 
European Securities and Markets Authority (``ESMA''); and by existing 
CFTC regulatory requirements. It begins with an overview of automated 
trading, including the development of automated order generation and 
execution systems; advances in high-speed communication networks; the 
growth of interconnected automated markets; the changed role of humans 
in modern markets; and a discussion of

[[Page 56544]]

recent disruptive events in automated trading environments. The Concept 
Release then addresses these developments through a series of (1) pre-
trade risk controls; (2) post-trade reports and other post-trade 
measures; (3) system safeguards; and (4) additional protections 
(collectively, ``risk controls'') that could be implemented by one or 
more categories of Commission registrants or other market participants.
---------------------------------------------------------------------------

    \4\ Many of these concepts are in harmony with evolving views of 
groups responsible for setting standards and developing regulations 
for other markets around the world. See, e.g., IOSCO Technical 
Committee, ``Regulatory Issues Raised by the Impact of Technological 
Changes on Market Integrity and Efficiency: Consultation Report'' 
(July 2011) [hereinafter ``IOSCO Report on Regulatory Issues Raised 
by Technological Changes''], available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD354.pdf.
    See also ESMA, ``Final Report: Guidelines on Systems and 
Controls in an Automated Trading Environment for Trading Platforms, 
Investment Firms and Competent Authorities'' (December 2011) 
[hereinafter, ``ESMA Guidelines on Systems and Controls''], 
available at http://www.esma.europa.eu/system/files/2011-456_0.pdf.
---------------------------------------------------------------------------

    The Commission seeks extensive public comment regarding each risk 
control contemplated herein. Commenters should address the 
effectiveness of each measure, and the degree to which it may already 
be in use by industry participants. Each commenter should identify the 
specific risk controls that it already employs. For all measures 
discussed in this Concept Release, commenters should also address 
whether there is a need for regulatory action to provide more uniform 
risk mitigation across CFTC-regulated derivatives markets.\5\ Comments 
that address this question with respect to each proposed risk control 
and system safeguard individually would be particularly helpful. In all 
cases, commenters should discuss, and quantify wherever possible, the 
costs and benefits of the pre-trade risk controls, post-trade reports 
and other post-trade measures, system safeguards, and other protections 
discussed in this Concept Release.
---------------------------------------------------------------------------

    \5\ In this regard, the Commission emphasized in the preamble to 
its final rules for part 38 that the efficacy of risk controls 
depends in part on the proper functioning of electronic systems, and 
that ``the Commission may address electronic system testing, 
controls, and supervision-related issues in a subsequent 
proceeding.'' See Commission, Final Rule: Core Principles and Other 
Requirements for Designated Contract Markets, 77 FR 36612, 36638 
n.298, 36648, n.389 (Jun. 19, 2012) [hereinafter, the ``DCM Final 
Rules''].
    Similarly, the system safeguards contemplated herein for ATSs 
are an outgrowth of the basic requirement in Sec.  23.600(d)(9) that 
SDs and MSPs conduct testing and supervision of trading systems. 
There again, the Commission indicated that further measures would be 
forthcoming by stating that it ``anticipate[d] addressing the 
related issues of testing and supervision of electronic trading 
systems and mitigation of the risks posed by high frequency 
trading.'' See Commission, Final Rule: Swap Dealer and Major Swap 
Participant Recordkeeping, Reporting, and Duties Rules; Futures 
Commission Merchant and Introducing Broker Conflicts of Interest 
Rules; and Chief Compliance Officer Rules for Swap Dealers, Major 
Swap Participants, and Futures Commission Merchants, 77 FR 20128, 
20141 (Apr. 3, 2012).
---------------------------------------------------------------------------

    The Concept Release recognizes that orders and trades in automated 
environments pass through multiple stages in their lifecycle from order 
generation, to execution, to clearing and allocation in proprietary or 
customer accounts, and steps in between. Accordingly, the Commission 
requests comment regarding the appropriate stage at which risk controls 
should be placed. Potential options include risk controls applicable 
to: (i) ATSs at the time of order generation; (ii) clearing firms 
during the order transmission process; (iii) trading platforms prior to 
exposing orders to the market; (iv) Derivatives Clearing Organizations 
(``DCOs''); and (v) other risk control focal points, including, for 
example, third-party ``hubs'' through which orders or order information 
could flow to uniformly mitigate risks across one or more trading 
platforms. Similarly, the Commission requests public comment regarding 
the appropriate focal point for system safeguards and testing and 
supervision standards for ATSs.
    Finally, the Commission requests comment regarding a series of 
issues central to its improved understanding and surveillance of 
trading in automated environments. For example, the Commission requests 
comments regarding any surveillance tools that it should deploy 
specifically for the surveillance of automated trading and areas for 
academic research to improve its understanding of ATSs' impact on 
market microstructure. Section IV lists all questions raised in this 
Concept Release.
    The Commission's Concept Release reflects fundamental statutory 
objectives under the CEA. Such objectives include fostering a system of 
effective self-regulation, deterring and preventing disruptions to 
market integrity, protecting market participants and ``promot[ing] 
responsible innovation and fair competition among boards of trade, 
other markets and market participants.'' \6\ Notably, the Commission 
must ensure that U.S. derivatives markets continue to serve as 
effective centers of price discovery and risk mitigation, regardless of 
the technologies employed by trading platforms, market participants, 
and others. The Commission must further ensure that its regulatory 
framework and industry practices are fully adapted to the automated 
technologies of modern derivatives markets.
---------------------------------------------------------------------------

    \6\ See CEA section 3(b); 7 U.S.C. 5(b).
---------------------------------------------------------------------------

II. Background

A. Characteristics of Automated Trading Environments

1. Automated Order Generation and Execution
    Automated trading environments have developed in tandem with 
automated systems for both the generation and execution of orders. 
Systems related to the generation of orders (``automated trading 
systems'' or ``ATSs'') \7\ operate at the beginning of the order and 
trade lifecycle; they reflect a set of rules or instructions (an 
algorithm) and related computer systems used to automate the execution 
of a trading strategy.\8\ ATSs may operate as automated execution 
programs designed to minimize the price impact of large orders; achieve 
a benchmarked price (e.g., volume-weighted average price and time-
weighted average price algorithms); or otherwise execute instructions 
traditionally provided by a human agent.\9\ They may be employed by a 
range of market participants, with varying degrees of sophistication, 
for both proprietary and customer trading. For example, buy-side firms 
(such as mutual funds and pension funds) may use automated systems and 
execution algorithms to ``shred'' one or more large orders (called 
``parent order'') into a series of smaller trades (``child orders'') to 
be executed over time. Such systems can include additional algorithms 
to micro-manage the size, frequency and timing (often randomized) of 
child orders. In addition to automated execution, ATSs may also operate 
market-making programs; opportunistic, cross-asset and cross-market 
arbitrage programs; and a number of other strategies.
---------------------------------------------------------------------------

    \7\ While the Commission has no regulatory definition of ATS, 
the term is generally understood to mean a computer-driven system 
that automates the generation and routing of orders to one or more 
markets. Other elements of an ATS may also include systems for 
analyzing market data as a precursor to order generation, managing 
orders for conformance with establish risk tolerances, receiving 
confirmations of orders placed and trades executed, etc. Section 
III.E.4. of this Concept Release seeks public input regarding 
whether the Commission should formally define ATS and if so, how ATS 
should be defined.
    \8\ See IOSCO Report on Regulatory Issues Raised by 
Technological Changes, supra note 4, at 10.
    \9\ See John Bates, ``Algorithmic Trading and High Frequency 
Trading Experiences from the Market and Thoughts on Regulatory 
Requirements'' (July 2010), available at http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/tac_071410_binder.pdf.
---------------------------------------------------------------------------

    In Commission-regulated markets, orders generated by ATSs are 
ultimately transmitted to DCMs that have themselves become automated 
systems for the matching and execution of orders. Broadly, these 
trading platforms consist of a front-end to which market participants 
connect and communicate using standardized messaging formats, a 
matching engine that automatically matches orders to buy and sell, and 
a back-end that automatically provides all market participants with a 
market feed. Trade flows may make use of straight-through processing, 
where the entire trade execution process occurs without intermediation 
from humans, thereby

[[Page 56545]]

dramatically reducing the amount of time required to execute each 
transaction. The evolution from manual trading in open-outcry pits to 
electronic trading platforms is in many cases substantially complete.
    An established body of data indicates the importance of electronic 
and algorithmic trading in U.S. futures markets. In 2012, approximately 
91.50% of exchange trading volume in U.S. futures markets was executed 
electronically.\10\ Estimates indicate that algorithmic trading first 
accounted for at least 50% of orders in 2009,\11\ and accounted for 
over 40% of total trading volume in 2010.\12\ By the end of the first 
quarter of 2010, ATSs accounted for over 50% of trading volume in a 
number of significant product categories at CME Group, Inc.'s (``CME 
Group'') DCMs.\13\ For example, ATSs accounted for approximately 51% of 
trade volume in E-mini S&P 500 futures and 69% of trade volume in 
EuroFX futures.\14\ Increased automation in both order generation and 
matching, combined with the exponentially faster communication networks 
discussed in section II.A.2., below, has in many cases reduced the 
trade lifecycle to as little as a few milliseconds. As a result, high-
frequency trading (``HFT'') strategies have also become an increasingly 
important component of automated trading environments.
---------------------------------------------------------------------------

    \10\ This figure represents transactions executed competitively 
on DCM trading platforms and not off-exchange transactions such as 
block trades.
    \11\ See Paul Zubulake & Sang Lee, The High Frequency Game 
Changer at 84, fig. 6.3 (John Wiley & Sons, Inc. 2011) (source of 
data: Aite Group).
    \12\ See Barry Johnson, Algorithmic Trading & DMA: An 
Introduction to Direct Access Trading Strategies at 78, fig. 3-11 
(4Myeloma Press 2010) (source of data: Aite Group).
    \13\ See CME Group, ``Algorithmic Trading and Market Dynamics'' 
(July 15, 2010) at 2, available at http://www.cmegroup.com/education/files/Algo_and_HFT_Trading_0610.pdf. At the time, the 
CME Group operated four DCMs: the Chicago Mercantile Exchange, the 
Chicago Board of Trade, the New York Mercantile Exchange 
(``NYMEX''), and the Commodity Exchange.
    \14\ See id.
---------------------------------------------------------------------------

    The Commission is working diligently to understand and keep pace 
with the growth of ATSs and HFT in its regulated markets. The TAC, for 
example, has worked to define HFT and received a definition of HFT from 
its working group panel of experts. The attributes of HFT, according to 
the TAC's working group, include:
    (a) Algorithms for decision making, order initiation, generation, 
routing, or execution, for each individual transaction without human 
direction;
    (b) low-latency technology that is designed to minimize response 
times, including proximity and co-location services;
    (c) high speed connections to markets for order entry; and
    (d) recurring high message rates (orders, quotes or cancellations) 
determined using one or more objective forms of measurement, including 
(i) cancel-to-fill ratios; (ii) participant-to-market message ratios; 
or (iii) participant-to-market trade volume ratios.\15\
---------------------------------------------------------------------------

    \15\ See TAC Subcommittee on Automated and High Frequency 
Trading, Working Group 1, Presentation to the TAC (Oct. 30, 2012), 
available at http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/tac103012_wg1.pdf. In addition, the TAC Subcommittee 
on Automated and High Frequency Trading, Working Group 1, described 
high frequency trading as a mechanism used by a variety of trading 
strategies, including, but not limited to, liquidity provision and 
statistical arbitrage.
---------------------------------------------------------------------------

    In addition, the TAC's working group described automated trading as 
``cover[ing] systems employed in the decision-making, routing and/or 
execution of an investment or trading decision, which utilizes a range 
of technologies including software, hardware, and network components to 
facilitate efficient access to the financial markets via electronic 
trading platforms.'' \16\ Effectively, HFT is a form of automated 
trading, but not all automated trading is HFT.\17\
---------------------------------------------------------------------------

    \16\ See id.
    \17\ In March 2013, the German parliament approved legislation 
on high frequency trading (the ``HFT Act''). See Hans-Edzard 
Busemann, ``German upper house approves rules to clamp down on high-
frequency trading,'' Reuters (March 22, 2013), available at http://uk.reuters.com/article/2013/03/22/uk-germany-trading-idUKBRE92L0L820130322. The legislation defines high frequency 
trading generally as follows: The sale or purchase of financial 
instruments for own account as direct or indirect participant in a 
domestic organized market or multilateral trading facility by means 
of a high-frequency algorithmic trading technique which is 
characterized by (i) the usage of infrastructures to minimize 
latency times, (ii) the decision of the system regarding the 
commencement, creation, transmission or execution of an order 
without human intervention for single transactions or orders, and 
(iii) a high intraday messaging volume in the form of orders, quotes 
or cancellations. See BaFin (Federal Financial Supervisory 
Authority), ``High-frequency trading: new rules for trading 
participants'' (March 26, 2013) (including Workshop on High 
Frequency Trading Act Presentations dated April 30, 2013 and 
Frequently Asked Questions Relating to the High Frequency Trading 
Act dated March 22, 2013) [hereinafter, the ``BaFin HFT Act 
Materials''], available at http://www.bafin.de/SharedDocs/Veroeffentlichungen/EN/Meldung/2013/meldung_130322_hft-gesetz_en.html?nn=2821494.
    The German HFT Act also defines algorithmic trading. The HFT 
Act's definition is generally as follows: Trading with financial 
instruments such that a computer algorithm determines automatically 
the individual order parameters without being merely a system for 
the transmission of orders to one or several trading venues or to 
confirm orders. Order parameters within the meaning of the preceding 
sentence are decisions whether the order is given, the timing, price 
and quantity of an order or how the order will be executed with 
limited or no human interference. See id. As explained in footnote 
103 below, the HFT Act also introduces a licensing requirement.
---------------------------------------------------------------------------

    In this regard, the Commission is aware that instability in 
automated trading environments may be precipitated by ATSs regardless 
of whether they employ high-frequency or other trading strategies. 
Accordingly, the risk controls, system safeguards and other measures 
contemplated for ATSs in this Concept Release do not distinguish on the 
basis of ATSs' trading strategies. However, the Commission is 
interested in better understanding HFT and whether it should receive 
different regulatory attention than ATSs in general. The Commission 
requests comment on the following questions regarding HFT and related 
topics:
    1. In any rulemaking arising from this Concept Release, should the 
Commission adopt a formal definition of HFT? If so, what should that 
definition be, and how should it be applied for regulatory purposes?
    2. What are the strengths and weaknesses of the TAC working group 
definition of HFT provided above? How should that definition be 
amended, if at all?
    3. The definition of HFT provided above uses ``recurring high 
message rates (orders, quotes or cancellations)'' as one of the 
identifying characteristics of HFT, and lists three objective measures 
(i) cancel-to-fill ratios; (ii) participant-to-market message ratios; 
or (iii) participant-to-market trade volume ratios) that could be used 
to measure message rates. Are these criteria sufficient to reliably 
distinguish between ATSs in general and ATSs using HFT strategies? What 
threshold values are appropriate for each of these measures in order to 
identify ``high message rates?'' Should these threshold values vary 
across exchanges and assets? If so, how?
    4. Should the risk controls for systems and firms that engage in 
HFT be different from those that apply to ATSs in general? If so, how?
2. Advances in High-Speed Communication Networks and Reductions in 
Latency
    Automated trading environments are also characterized by 
connectivity and infrastructure solutions that enable trading platforms 
to process orders and execute trades at ever increasing speeds, and 
enable market participants (including ATSs) to communicate with 
platforms at ever decreasing latencies.\18\

[[Page 56546]]

Notably, however, such capabilities require equally sophisticated risk 
management systems whose speeds are commensurate with those of low-
latency order generation and trade execution systems. Public data from 
one exchange group, for example, indicates that roundtrip trade times 
on its trading platform fell from 127 milliseconds in 2004 to 4.2 
milliseconds in 2011.\19\ Another exchange group reported in 2010 that 
its average blended transaction time in futures and OTC markets was 
1.25 milliseconds.\20\ Advances in trading speeds are partly due to the 
development of dedicated fiber-optic and microwave communications 
networks that have dramatically reduced latency across large distances. 
As of 2012, networks were being developed to reduce roundtrip messaging 
between New York and London from 65 milliseconds to 60 
milliseconds.\21\ In March 2013, CME Group Inc. and Nasdaq OMX Group 
Inc. announced plans to launch a wireless network that will provide 
roundtrip messaging between New York and Chicago in 8.5 
milliseconds.\22\
---------------------------------------------------------------------------

    \18\ Latency means ``the time it takes to learn about an event 
(e.g., a change in the bid), generate a response, and have the 
exchange act on the response.'' See Joel Hasbrouck & Gideon Saar, 
``Low-Latency Trading'' (May 2013) at 1, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1695460.
    \19\ See CME Group, ``Oversight of Automated Trading at CME 
Group'' (March 29, 2012) at 4, available at http://www.cftc.gov/ucm/groups/public/@aboutcftc/documents/file/tacpresentation032912_cme.pdf.
    \20\ See IntercontinentalExchange, ``2010 Annual Report,'' at 
26, available at http://files.shareholder.com/downloads/ICE/1747226327x0x456112/BF6F428C-F8B3-4835-B22C-3F350FF13B89/ICE_2010AR.pdf. IntercontinentalExchange indicated that it measures 
round trip performance end to end within its data center and through 
its matching engine.
    \21\ See Matthew Philips, ``Stock Trading is About to Get 5.2 
Milliseconds Faster,'' BloombergBusinessweek (Mar. 29, 2012), 
available at http://www.businessweek.com/articles/2012-03-29/trading-at-the-speed-of-light.
    \22\ See Jacob Bunge, ``CME, Nasdaq Plan High-Speed Network 
Venture,'' Wall St. J. (Mar. 28, 2013), available at http://online.wsj.com/article/SB10001424127887324685104578388343221575294.html.
---------------------------------------------------------------------------

    Two common methods for reducing latency are co-location and 
proximity hosting, defined as the placement of a firm's trading 
technology in close proximity to the trading platform. They may be 
offered directly by an exchange or by a third-party service provider. 
Co-location denotes those connectivity solutions hosted by the exchange 
itself, while proximity hosting indicates services offered by third 
parties.\23\ In 2010, the Commission published in the Federal Register 
a Notice of Proposed Rulemaking to require DCMs and others that offer 
co-location and/or proximity hosting to offer such services on an equal 
access basis, ensure that fees are uniform and non-discriminatory, and 
provide information about the latency for various connectivity options 
(``co-location rulemaking'').\24\ The Commission intends to finalize 
the co-location rulemaking by the end of the year.
---------------------------------------------------------------------------

    \23\ See FIA Market Access Working Group, ``Market Access Risk 
Management Recommendations'' (April 2010) at 4 [hereinafter, ``FIA 
Market Access Recommendations''], available at http://www.futuresindustry.org/downloads/Market_Access-6.pdf.
    \24\ See Commission, Notice of Proposed Rulemaking: Co-Location/
Proximity Hosting Services, 75 FR 33198 (Jun. 11, 2010).
---------------------------------------------------------------------------

    Another important latency-reducing advance in connectivity is DMA. 
For purposes of this Concept Release, DMA is defined as a connection 
method that enables a market participant to transmit orders to a 
trading platform without reentry or prior review by systems belonging 
to the market participant's clearing firm. DMA can be provided directly 
by an exchange or through the infrastructure of a third-party provider. 
In all cases, however, DMA connectivity implies that a market 
participant's order flow is not routed through its clearing firm prior 
to reaching the trading platform.\25\
---------------------------------------------------------------------------

    \25\ The Commission has taken steps to mitigate the risk 
associated with DMA. Rule 1.73, passed by the Commission in April 
2012, requires FCMs that are clearing members to pre-screen orders 
of DMA clients against risk limits that are established by the FCM. 
See 17 CFR 1.73(a)(2)(i). See additional discussion in section II.B.
---------------------------------------------------------------------------

    Investment in high-speed communication networks and other 
technologies to reduce latency reflects the premium that some market 
participants place on speed relative to their competitors. Reductions 
in latency may be appropriately achieved through improvements in a 
range of technologies for the generation, transmission and execution of 
orders or management of other data. However, there are also incentives 
for market participants to reduce latency by minimizing pre-trade risk 
controls and other safeguards that might otherwise introduce unwanted 
delays. While latency-based incentive structures have promoted evident 
technological innovation in many derivatives markets, they can also 
lead to a competitive race to the bottom--a concern already expressed 
by some market participants.\26\ A separate concern is that market 
participants may simply engage in trading at speeds greater than the 
speed of their risk management systems. In a trading environment where 
a single algorithm can submit hundreds of orders per second, risk 
management systems operating at slower speeds could allow an algorithm 
that is operating in unexpected ways to disrupt one or more markets.
---------------------------------------------------------------------------

    \26\ As noted by FIA's Market Access Working Group, for example: 
``[p]re-trade risk controls have become a point of negotiation 
between trading firms and clearing members because they can add 
latency to a trade.'' See FIA Market Access Recommendations, supra 
note 23, at 8.
    Similarly, the TAC's Pre-Trade Functionality Subcommittee noted 
that latency is a key area where trading firms and brokers are 
competing to gain an advantage. See TAC Pre-Trade Functionality 
Subcommittee, ``Recommendations on Pre-Trade Practices for Trading 
Firms, Clearing Firms, and Exchanges Involved in Direct Market 
Access'' (March 1, 2011) at 2 [hereinafter, ``TAC Pre-Trade 
Functionality Subcommittee DMA Recommendations''], available at 
http://www.cftc.gov/ucm/groups/public/@swaps/documents/dfsubmission/tacpresentation030111_ptfs2.pdf.
---------------------------------------------------------------------------

    5. Discussions on latency often focus on the how quickly an 
exchange processes orders, the time taken to submit orders, and how 
quickly a firm can observe prices of trades transacted on the exchange. 
The Commission is interested in understanding whether there are other 
types of messages transmitted between exchanges, firms and vendors 
wherein differences in latency could provide opportunities for 
informational advantage. Recent press reports have highlighted such 
advantages in the transmission of trade confirmations by a specific 
exchange.\27\ Are there other exchanges and trading venues where 
similar differences in latency exist? The Commission is interested in 
understanding whether the extent of latency in any such message 
transmission process can have an adverse impact on market quality or 
fairness. Should any exchanges, vendors and firms be required to audit 
their systems and process on a periodic process to identify and then 
resolve such latency?
---------------------------------------------------------------------------

    \27\ See Scott Patterson, Jenny Strasburg & Liam Pleven, ``High-
Speed Traders Exploit Loophole,'' Wall St. J. (May 1, 2013), 
available at http://online.wsj.com/article/SB10001424127887323798104578455032466082920.html.
---------------------------------------------------------------------------

3. Rise of Interconnected Automated Markets
    In addition to greater automation and decreased latency, 
derivatives markets are increasingly characterized by a high degree of 
interconnection. ATSs and algorithms deployed to trade particular 
products often interact directly and indirectly with ATSs and 
algorithms active in other markets and jurisdictions. Increased 
interconnectedness is facilitated by electronic access to real-time 
pricing information, automated order execution, and some 
standardization in communication protocols at various

[[Page 56547]]

trading platforms.\28\ ATSs can quickly execute strategies across 
multiple markets within very short periods of time. Often, cross-market 
activity is driven by latent arbitrage opportunities and faster access 
to multiple markets has led to a proliferation of strategies that seek 
to identify and trade on the basis of these relationships.\29\
---------------------------------------------------------------------------

    \28\ For example, FIX language makes it possible for ATS to be 
``platform independent''--to incorporate interfaces to multiple 
brokers, ECNs, or exchanges. See Irene Aldridge, High-Frequency 
Trading: A Practical Guide to Algorithmic Strategies and Trading 
Systems at 31 (John Wiley & Sons, Inc. 2010). See also Cliff, Brown, 
& Treleaven, ``Technology Trends in the Financial Markets: A 2020 
Vision,'' United Kingdom Government Office for Science--Foresight, 
at 10, available at http://www.bis.gov.uk/assets/foresight/docs/computer-trading/11-1222-dr3-technology-trends-in-financial-markets.pdf.
    \29\ For example, ``basis trading,'' and ``futures/equity 
arbitrage'' are statistical arbitrage strategies that seek to 
capitalize on deviations between prices on futures contracts and 
related securities contracts after macroeconomic news announcements. 
See Aldridge, supra note 28, at 197-98.
---------------------------------------------------------------------------

    Increased interconnectedness encourages price efficiencies when 
economically identical or related contracts are traded on multiple 
exchanges. However, it also increases the speed with which a disruption 
on one trading platform, or within one ATS or algorithm, can impact 
related markets. For example, a trading platform may experience changes 
in the prices, spreads or volatility of one or more of its products due 
to errors in an ATS or algorithm active in its markets. Even if this 
algorithm does not trade elsewhere, such changes are likely to quickly 
impact the prices, spreads, and volatility of related products on other 
platforms, as automated systems attempt to arbitrage price differences. 
The potential result is a cascading series of market disruptions, 
brought about by the malfunction of a single ATS or algorithm trading 
on a single platform.
    Transmission effects such as this are illustrated by events like 
the May 6, 2010 ``Flash Crash.'' On that day, major equity indices in 
both the futures and securities markets fell over 5% in minutes before 
recovering almost as quickly. After investigation by both the 
Commission and the SEC, it was found that a fundamental seller utilized 
an automated execution algorithm to sell 75,000 E-mini contracts 
(valued at approximately $4.1 billion) over an abbreviated time 
interval. The algorithm placed orders based on recent trading volume 
but was not programmed to take price or time into account; because of 
this lapse, a feedback loop triggered continued orders from the 
algorithm even as prices moved far beyond traditional daily ranges. 
Like the hypothetical example provided above, these declines in the 
derivatives market quickly filtered over to different, but closely 
related, products on many other exchanges.\30\ Soon after the initial 
moves in the E-mini contract, similar extreme volatility was 
experienced by the S&P 500 SPDR exchange traded fund and by many of the 
500 underlying securities which make up the index itself.
---------------------------------------------------------------------------

    \30\ See CFTC and SEC Joint Report on the Market Events of May 
6, 2010, supra note 1, at 1-6; ``Recommendations Regarding 
Regulatory Responses to the Market Events of May 6, 2010, Summary 
Report of the Joint CFTC-SEC Advisory Committee on Emerging 
Regulatory Issues'' (February 18, 2011), available at http://www.cftc.gov/ucm/groups/public/@aboutcftc/documents/file/jacreport_021811.pdf.
---------------------------------------------------------------------------

    In response to the May 2010 flash crash, regulatory authorities and 
market participants have taken steps to address volatility in U.S. 
markets, including trading pauses and halts that operate as ``circuit 
breakers.'' For example, in May 2012, the SEC approved a ``limit up-
limit down'' mechanism in which a price band is set at a percentage 
level above and below the average price of the stock over the 
immediately preceding five-minute trading period.\31\ If the stock's 
price does not naturally move back within the price bands within 15 
seconds, there will be a five-minute trading pause. The limit up-limit 
down mechanism began implementation in April 2013, beginning with all 
stocks in the S&P 500 and Russell 1000 and select exchange traded 
products.
---------------------------------------------------------------------------

    \31\ See SEC, ``Investor Bulletin: New Measures to Address 
Market Volatility'' (Apr. 9, 2013), available at http://www.sec.gov/investor/alerts/circuitbreakersbulletin.htm.
---------------------------------------------------------------------------

    In addition, the SEC approved updates to market-wide circuit 
breaker rules that, when triggered, halt trading in all exchange-listed 
securities in U.S. markets. Among other things, the new rules lower the 
percentage-decline thresholds for triggering a market-wide trading 
halt. The thresholds (Level 1 (7%), Level 2 (13%), and Level 3 (20%)) 
are set at levels calculated daily based on the prior day's closing 
price of the S&P 500 index.\32\ To be consistent with these circuit 
breakers, the CME Group, effective April 8, 2013, reduced the price 
limit levels for CME and CBOT U.S. equity index futures to 7%, 13% and 
20%.\33\ When a trading halt is declared in the primary securities 
market in accordance with these levels, trading in the S&P 500 index 
futures contracts will be halted at the CME. When trading in the 
primary securities market resumes after any such halt, trading in the 
S&P index futures contracts will resume. Similar rules apply to other 
equity index futures contracts listed on CME. In March 2012, ICE 
Futures U.S. introduced a circuit breaker functionality called Interval 
Price Limits, in which prices may not move more than a pre-determined 
amount away from the current market price within a pre-determined 
period.\34\
---------------------------------------------------------------------------

    \32\ See id.
    \33\ See CME Group, ``Changes to CME and CBOT Equity Index Price 
Limits: Frequently Asked Questions,'' available at http://www.cmegroup.com/education/files/faq-eq-hours-and-limits.pdf.
    \34\ See IntercontinentalExchange, Inc., ``ICE Circuit Breakers 
(IPL) Price Limits'' (March 2012), available at https://www.theice.com/publicdocs/technology/IPL_Circuit_Breaker.pdf.
---------------------------------------------------------------------------

    Throughout section III below, the Commission seeks public comment 
on the benefits of standardizing various risk controls and system 
safeguards, including through the uniform application of regulatory 
standards to help ensure an integrated risk management infrastructure 
in regulated derivatives markets. The Commission draws commenters' 
particular attention to the joint regulatory and industry response to 
the Flash Crash summarized above and seeks public input regarding the 
need for similar joint efforts with respect to the pre-trade risk 
controls, post-trade reports, and system safeguards contemplated in 
this Concept Release.
4. Manual Risk Controls and System Safeguards in Automated Trading 
Environments
    Orders in automated trading environments may be initiated by ATSs 
and algorithms. Multiple other automated systems perform other 
processing, communicating, and other functions. The speed of such 
automated processes has necessarily shifted risk management functions 
to parallel automated risk management systems acting with equal speed.
    Within this context, manual risk controls, and particularly systems 
safeguards, remain crucial to orderly markets. In many cases, manual 
risk controls have shifted ``upstream'' to system design and 
``downstream'' to system management. In automated trading, humans 
design and test ATSs, establish decision criteria, manage 
implementation, and intervene when technology systems fail. ATS 
designers must identify the range of market conditions that an ATS 
could reasonably face, and determine the range of permissible responses 
by the ATS to each condition. Designers must also consider the array of 
information that ATS operators will need to effectively monitor their 
ATSs and the markets in which their ATSs operate. ATS operators, in 
turn, must be

[[Page 56548]]

prepared to intervene when market conditions are outside of an ATS's 
design parameters, when an ATS's trading strategy must be modified, or 
when an ATS appears to be malfunctioning and must be shut down. Rapid 
decisions must be made while simultaneously digesting large quantities 
of information regarding multiple, fast-moving markets. Accordingly, 
this Concept Release contemplates a number of risk controls and system 
safeguards that emphasize the role and interaction of manual processes 
with automated trading environments, particularly ATSs.

B. The Commission's Regulatory Response to Date

    The Commission has responded to the development of automated 
trading environments through a number of regulatory measures that 
address risk controls within both new and existing categories of 
registrants, including DCMs, SEFs, FCMs, SDs, MSPs and others. In April 
2012, the Commission adopted rules requiring FCMs, SDs and MSPs that 
are clearing members to establish risk-based limits based on ``position 
size, order size, margin requirements, or similar factors'' for all 
proprietary accounts and customer accounts.\35\ The rules, codified in 
Sec. Sec.  1.73 and 23.609, also require these entities to ``use 
automated means to screen orders for compliance with the [risk] 
limits'' when such orders are subject to automated execution (emphasis 
added).\36\ Such screening must, by definition, occur pre-trade. The 
Commission also adopted rules in April 2012 requiring SDs and MSPs that 
are clearing members to ensure that their ``use of trading programs is 
subject to policies and procedures governing the use, supervision, 
maintenance, testing, and inspection of the program.'' \37\ The 
specific content of those policies and procedures are left up to the 
SDs and MSPs.
---------------------------------------------------------------------------

    \35\ 17 CFR 1.73(a)(1) and 23.609(a)(1).
    \36\ 17 CFR 1.73(a)(2)(i) and 17 CFR 23.609(a)(2)(i).
    \37\ 17 CFR 23.600(d)(9).
---------------------------------------------------------------------------

    The Commission has also adopted relevant rules with respect to 
exchange platforms, including rules with respect to DCMs (adopted in 
June 2012).\38\ Regulation 38.255, for example, requires DCMs to 
``establish and maintain risk control mechanisms to prevent and reduce 
the potential risk of price distortions and market disruptions, 
including, but not limited to, market restrictions that pause or halt 
trading in market conditions prescribed by the designated contract 
market.'' \39\ In addition, the acceptable practices for DCM Core 
Principle 4 identify pre-trade limits on order size, price collars or 
bands, and message throttles as responsive measures that a DCM may 
implement to demonstrate compliance with elements of the core 
principle.\40\ The Commission has adopted trading pause and halt 
requirements for SEFs similar to those for DCMs.\41\
---------------------------------------------------------------------------

    \38\ See DCM Final Rules, 77 FR 36612.
    \39\ 17 CFR 38.255.
    \40\ Part 38, Appendix B, Core Principle 4, section (b)(5), 
provides: Risk controls for trading. An acceptable program for 
preventing market disruptions must demonstrate appropriate trade 
risk controls, in addition to pauses and halts. Such controls must 
be adapted to the unique characteristics of the markets to which 
they apply and must be designed to avoid market disruptions without 
unduly interfering with that market's price discovery function. The 
designated contract market may choose from among controls that 
include: Pre-trade limits on order size, price collars or bands 
around the current price, message throttles, and daily price limits, 
or design other types of controls. Within the specific array of 
controls that are selected, the designated contract market also must 
set the parameters for those controls, so long as the types of 
controls and their specific parameters are reasonably likely to 
serve the purpose of preventing market disruptions and price 
distortions. If a contract is linked to, or is a substitute for, 
other contracts, either listed on its market or on other trading 
venues, the designated contract market must, to the extent 
practicable, coordinate its risk controls with any similar controls 
placed on those other contracts. If a contract is based on the price 
of an equity security or the level of an equity index, such risk 
controls must, to the extent practicable, be coordinated with any 
similar controls placed on national security exchanges. See DCM 
Final Rules, 77 FR at 36718.
    \41\ 17 CFR 37.405.
---------------------------------------------------------------------------

    In the DCM final rules, the Commission also adopted new risk 
control requirements for exchanges that provide DMA to clients. 
Regulation 38.607 requires DCMs that permit DMA to have effective 
systems and controls reasonably designed to facilitate an FCM's 
management of financial risk. These systems and controls include 
automated pre-trade controls through which member FCMs can implement 
financial risk limits.\42\ As the Commission noted in the preamble to 
the DCM final rules, in DMA arrangements ``it is impossible for an FCM 
to protect itself without the aid of the DCM.'' \43\ The Commission 
also noted in the DCM final rules, however, that ``the responsibility 
to utilize these [DCM-provided] controls and procedures remains with 
the FCM. Each FCM permitting direct access must use DCM-provided 
controls . . . .'' \44\ Accordingly, regulation 38.607 requires DCMs to 
implement and enforce rules requiring member FCMs to use these systems 
and controls.\45\
---------------------------------------------------------------------------

    \42\ See 17 CFR 38.607.
    \43\ See DCM Final Rules, 77 FR at 36648.
    \44\ Id.
    \45\ See 17 CFR 38.607.
---------------------------------------------------------------------------

    In addition to the foregoing, section 753 of the Dodd-Frank Act 
amended section 6(c) of the CEA to prohibit manipulation and fraud in 
connection with any swap, or a contract of sale of any commodity in 
interstate commerce, or for future delivery on or subject to the rules 
of any registered entity. In July 2011, the Commission adopted final 
rules implementing this new authority under the CEA. CFTC Regulation 
180.1, among other things, broadly prohibits manipulative and deceptive 
devices, i.e., fraud and fraud-based manipulative devices and 
contrivances employed intentionally or recklessly, regardless of 
whether the conduct in question was intended to create or did create an 
artificial price.\46\ CFTC Regulation 180.2 codifies the Commission's 
long-standing authority to prohibit price manipulation by making it 
unlawful for any person, directly or indirectly, to manipulate or 
attempt to manipulate the price of any swap, or of any commodity in 
interstate commerce, or for future delivery on or subject to the rules 
of a registered entity.\47\
---------------------------------------------------------------------------

    \46\ See 17 CFR 180.1.
    \47\ See 17 CFR 180.2.
---------------------------------------------------------------------------

    Finally, section 747 of the Dodd-Frank Act amended the CEA to make 
it unlawful for any person to engage in disruptive trading practices. 
Under section 4c(a)(5) of the CEA, it is unlawful for any person to 
engage in any trading, practice, or conduct on or subject to the rules 
of a registered entity that: Violates bids or offers, demonstrates 
intentional or reckless disregard for the orderly execution of 
transactions during the closing period, or is, is of the character of, 
or is commonly known to the trade as, ``spoofing.'' In May 2013, the 
Commission provided guidance on the scope and application of these 
statutory prohibitions.\48\ In July 2013, the Commission issued an 
order filing and settling charges against a high-speed trading firm for 
engaging in the disruptive practice of ``spoofing'' by utilizing a 
computer algorithm that was designed to illegally place and cancel bids 
and offers in futures contracts.\49\
---------------------------------------------------------------------------

    \48\ See Commission, Interpretive Guidance and Policy Statement, 
78 FR 31890 (May 28, 2013).
    \49\ See Commission, Press Release No. 6649-13 (July 22, 2013), 
available at http://www.cftc.gov/PressRoom/PressReleases/pr6649-13.
---------------------------------------------------------------------------

C. Recent Disruptive Events in Automated Trading Environments

    Recent malfunctions in ATS and trading platform systems, in both 
derivatives and securities markets, illustrate the technological and 
operational vulnerabilities inherent to automated trading environments. 
ATSs,

[[Page 56549]]

for example, are vulnerable to algorithm design flaws, market 
conditions outside of normal operating parameters, the failure of 
built-in risk controls, operational failures in the communication 
networks on which ATSs depend for market data and connectivity with 
trading platforms, and inadequate human supervision. Incidents 
involving an automated trading firm active in Commission-regulated 
markets are illustrative of these concerns. For example, in 2011 NYMEX 
fined a firm $350,000 for failing to adequately supervise, test, and 
have controls in place related to its ATS.\50\ NYMEX cited a 2010 event 
where the firm launched an ATS after limited testing. The firm was also 
fined a total of $500,000 by CME for failure to effectively supervise 
its ATSs on multiple occasions.\51\ A panel of the CME Business Conduct 
Committee found that the firm had experienced malfunctions with the 
same ATS multiple times, causing it to submit error trades.
---------------------------------------------------------------------------

    \50\ See NFA, Case Summary: Infinium Capital Management, NYME 
10-7565-BC (Nov. 25, 2011), available at http://www.nfa.futures.org/basicnet/Case.aspx?entityid=0338588&case=10-7565-BC+INFINIUM+CAPITAL+MGMT&contrib=NYME.
    \51\ See NFA, Case Summary: Infinium Capital Management, CME 09-
06562-BC (Nov. 25, 2011), available at http://www.nfa.futures.org/basicnet/Case.aspx?entityid=0338588&case=09-06562-BC&contrib=CME.
---------------------------------------------------------------------------

    In another example, in 2012 a securities trading firm, Knight 
Capital Group, launched new software on the NYSE that conflicted with 
already existing code.\52\ At the time, the firm was one of the largest 
participants and a market maker on the NYSE. The firm's ATS 
inadvertently established larger positions than intended, resulting in 
a $440 million loss for the firm. The malfunction impacted the broader 
market, creating swings in the share prices of almost 150 companies, 
and the high volatility linked to the algorithm designed by the firm 
also triggered pauses in the trading of five stocks. In addition to the 
software malfunction itself, some have reported that there was a delay 
of approximately 40 minutes before humans intervened.\53\
---------------------------------------------------------------------------

    \52\ See Strasburg & Bunge, supra note 2.
    \53\ See SEC Roundtable Transcript, supra note 2, at 55-56.
---------------------------------------------------------------------------

    A leading example of ATS malfunction that impacted both the 
derivatives and securities markets in the Flash Crash of May 2010. As 
described in detail in section II.A.3. above, the Flash Crash 
illustrates the potential consequences of ATS design flaws as an 
automated execution algorithm failed to take price or time variables 
into account, and feedback loops triggered continued orders from the 
algorithm even as prices moved far beyond traditional daily ranges.\54\ 
Finally, the Commission notes the recent systems malfunction at Goldman 
Sachs Group Inc. that inadvertently flooded U.S. options markets with a 
large number of unintended orders.\55\
---------------------------------------------------------------------------

    \54\ See CFTC and SEC Joint Report on the Market Events of May 
6, 2010, supra note 1.
    \55\ See Jacob Bunge, Kaitlyn Kiernan & Justin Baer, ``Bad 
Trades' Ripple Effect,'' W. St. J. (Aug. 21, 2013), available at 
http://online.wsj.com/article/SB10001424127887324165204579026611410016876.html.
---------------------------------------------------------------------------

    In addition to ATSs, trading platforms have also suffered 
malfunctions and illustrate another area in which market disruptive 
events can occur. In November 2010, for example, untested code changes 
implemented by a U.S. stock exchange operator resulted in errors within 
its trading platforms. As a result, the platforms overfilled orders in 
over 1,000 stocks, resulting in $773 million of unwanted trading 
activity.\56\ In March 2012, a software problem on BATS Global Markets, 
whose software had undergone testing, led to a disruption of the 
exchange's own IPO. The glitch caused opening orders for ticker symbols 
beginning within a certain letter range to become inaccessible on the 
platform.\57\ Once the system failed, circuit breakers were triggered 
and erroneous trades were cancelled.\58\ In May 2012, Facebook's IPO 
experienced significant problems as a result of technical errors on 
Nasdaq OMX Group Inc.'s U.S. exchange.\59\ Many customer orders from 
both institutional and retail buyers were unfilled for hours or were 
never filled at all, while other customers ended up buying more shares 
than they had intended. Finally, the Commission notes the recent three-
hour halt in trading on the Nasdaq, which according to reports was 
caused when the exchange experienced a disruption in its stock quote 
dissemination systems and a disruption in its connectivity with another 
trading platform's systems.\60\
---------------------------------------------------------------------------

    \56\ See Securities and Exchange Act Release No. 65556, In the 
Matter of EDGX Exchange, Inc., EDGA Exchange, Inc. and Direct Edge 
ECN LLC (Oct. 13, 2011), available at http://www.sec.gov/litigation/admin/2011/34-65556.pdf; see also SEC News Release, 2011-208, ``SEC 
Sanctions Direct Edge Electronic Exchanges and Orders Remedial 
Measures to Strengthen Systems and Controls'' (Oct. 13, 2011), 
available at http://www.sec.gov/news/press/2011/2011-208.htm.
    \57\ See Olivia Oran, Jonathan Spicer, Chuck Mikolajczak & 
Carrick Mollenkamp, ``BATS exchange withdraws IPO after stumbles,'' 
Reuters (Mar. 24, 2012), available at http://uk.reuters.com/article/2012/03/24/us-bats-trading-idUKBRE82M0W020120324; Michael J. De La 
Merced & Ben Protess, The N.Y. Times Dealbook (Mar. 25, 2012), 
available at http://dealbook.nytimes.com/2012/03/25/little-fallout-expected-from-bats-trading-error/.
    \58\ See id.
    \59\ See Jenny Strasburg and Jacob Bunge, ``Social network's 
debut on Nasdaq disrupted by technical glitches, trader confusion,'' 
Wall St. J. (May 18, 2012), available at http://online.wsj.com/article/SB10001424052702303448404577412251723815184.html?mod=googlenews_wsj; Jenny Strasburg, Andrew Ackerman & Aaron Lucchetti, ``Nasdaq 
CEO Lost Touch Amid Facebook Chaos,'' Wall St. J. (June 11, 2012), 
available at http://online.wsj.com/article/SB10001424052702303753904577454611252477238.html.
    \60\ See Chris Dieterich & Jacob Bunge, ``Nasdaq Offers Details 
on Trading Outage,'' Wall St. J. (Aug. 23, 2013), available at 
http://online.wsj.com/article/SB10001424127887324165204579030681671164404.html.
---------------------------------------------------------------------------

    Taken together, these events illustrate the importance of effective 
testing, circuit breakers, and error trade policies as vehicles for 
reducing the likelihood of disruptive events and mitigating their 
impact when they occur.\61\ A number of the risk controls contemplated 
in this Concept Release could help limit the extent of market 
disruption caused by ATS or trading platform malfunctions similar to 
those described above. For example, an order ``kill switch'' enables a 
market participant to immediately cancel all working orders generated 
by one or more of its ATSs, and prevents the submission of additional 
orders until the appropriate natural persons allow order placement to 
resume. Such a kill switch could be operated by the market participant 
generating orders, the clearing firm guaranteeing its trades, or the 
trading platform on which its orders would be executed. As another 
example, ATS monitoring and supervision standards, as well as pre-
established crisis management protocols, could help ensure that human 
supervisors intervene quickly when ATSs experience degraded 
performance, and that supervision staff have the both the authority and 
knowledge to intervene as required. Further, requiring exchanges to 
calculate and disseminate market quality metrics could enable both 
exchanges and market participants to better anticipate and mitigate 
destabilizing events. In addition, the Commission believes that change 
management standards that are beneficial to ATSs could also be applied 
to trading platforms to help prevent operational or programming errors 
in that element of the automated trading environment. In section III 
below, the

[[Page 56550]]

Commission seeks public comment on these and other potential risk 
controls.
---------------------------------------------------------------------------

    \61\ In addition, although in some ways distinct from the events 
summarized above, the Commission notes the significant impact of 
Hurricane Sandy in October 2012. U.S. stock markets closed for two 
days partially in response to concerns over preparedness to trade 
exclusively on electronic venues while trading floors were 
potentially closed, as well as the availability of technology and 
other relevant personnel. See Jenny Strasburg, Jonathan Cheng & 
Jacob Bunge, ``Behind Decision To Close Markets,'' Wall St. J. (Oct. 
29, 2012), available at http://online.wsj.com/article/SB10001424052970204789304578087131092892180.html.
---------------------------------------------------------------------------

III. Potential Pre-Trade Risk Controls, Post-Trade Reports, System 
Safeguards, and Other Protections

A. Overview of Existing Industry Practices

    The transition to automated trading in derivatives markets, as 
described above, has been followed by an evolution in what market 
participants, regulators and others understand to be necessary risk 
controls for various points in the order and trade lifecycle. Many of 
the measures identified herein are consistent with recommendations made 
by industry groups, other regulatory authorities, international 
standard setting bodies, and others. Certain measures, or variants of 
them, have been discussed within the futures industry for some time, or 
may already be in operation at one or more exchanges, clearing members, 
or market participants. For example, the system safeguards pertaining 
to the cancellation of orders or disconnecting a market participant in 
emergency situations are similar to proposals made separately by FIA's 
Principal Traders Working Group and Market Access Working Group in 2010 
and the TAC's Pre-Trade Functionality Subcommittee in 2011.\62\
---------------------------------------------------------------------------

    \62\ See FIA Principal Traders Group, ``Recommendations for Risk 
Controls for Trading Firms,'' (November 2010) at 5 [hereinafter, 
``FIA Recommendations for Risk Controls''], available at http://www.futuresindustry.org/downloads/Trading_Best_Pratices.pdf; FIA 
Market Access Recommendations, supra note 23, at 9; TAC Pre-Trade 
Functionality Subcommittee DMA Recommendations, supra note 26, at 5.
---------------------------------------------------------------------------

    The Principal Traders Group also addressed the need to properly 
monitor ATSs in its 2010 recommendations by noting that ``firms must 
ensure their [ATSs] are supervised at all times while operating in the 
markets. Staff must have training, experience and tools that enable 
them to monitor and control the trading systems and troubleshoot and 
respond to operational issues in a timely and appropriate manner. Firms 
should have processes and procedures to ensure trading operations staff 
is trained on the expected operating parameters of any [ATS] for which 
they are responsible.'' \63\ ATS design and operation was addressed by 
FIA's Market Access Working Group and by ESMA, the latter requiring 
that market participants ``make use of clearly delineated development 
and testing methodologies'' for ATSs prior to their deployment or the 
deployment of system updates.\64\ Among other considerations, ESMA 
emphasized that ATS testing should address embedded compliance and risk 
management controls and operation during stressed market conditions.
---------------------------------------------------------------------------

    \63\ See FIA Recommendations for Risk Controls, supra note 62, 
at 3.
    \64\ See FIA Market Access Recommendations, supra note 23; ESMA 
Guidelines on Systems and Controls, supra note 4, at 33.
---------------------------------------------------------------------------

    As with the pre-trade and post-trade risk controls, certain system 
safeguards would be applicable to more than one entity or would require 
coordination between entities. For example, ATS design and operation 
tests will require that trading platform operators provide suitable 
test environments that accurately recreate the ``live'' trading 
platform. Similarly, safeguards that provide for the immediate 
disconnection of a market participant in the event of emergency or 
breach of tolerances should be available to the market participant, its 
clearing firm, and the relevant trading platform so that all parties 
have the capacity to initiate a disconnect when necessary. As with 
other overlapping measures contemplated in this Concept Release, the 
Commission requests public comment regarding the necessity of such 
overlaps and the most efficient way to administer them.
1. Existing DCM Risk Controls
    Risk controls implemented by one or more exchanges broadly address 
market stability. One large DCM (``DCM A'') employs price reasonability 
validation controls (aimed at preventing ``fat finger'' type errors) 
and position validation controls (both absolute limits and net long/
short limits). In addition, DCM A has implemented a circuit breaker 
protection against price spikes. This control provides floor and 
ceiling price limits within a specific timeframe and market, and 
recalculates new floor and ceiling price limits based on current market 
prices for each new timeframe. If the floor or ceiling price is 
exceeded, the market is put in a ``hold'' state, although trading will 
not be halted in the opposite direction of the hold. The length of the 
hold varies depending on the market and orders submitted during the 
hold state will remain in the order book but will not be matched. DCM A 
has also implemented kill switches that provide it and risk managers at 
trading firms with the ability to halt trading.
    Similarly, another large DCM (``DCM B'') also employs a limit price 
to each market order and stop order to prevent orders from being filled 
at significantly aberrant price levels, and maximum order size 
protection to prevent entry of erroneous orders for quantities above a 
designated threshold. DCM B employs a functionality that introduces a 
5-20 second market pause when triggered stops would cause the market to 
trade outside of predefined values. This is designed to prevent 
excessive price movements caused by cascading stop orders. DCM B also 
employs a functionality that introduces a 5-20 second market pause when 
a sub-second, extreme market move occurs as a result of order entry. 
This functionality is designed to detect significant price moves of 
futures contracts occurring within a predetermined period of time, and 
triggers a pause in matching activity to provide time for additional 
resting orders to populate the order book.
    DCM A seeks to optimize message flow through both hard limits and 
market incentives. It employs a message throttle limit which sets a 
maximum message rate per second for each user session and prevents the 
submission of messages in excess of the maximum rate. The second form 
of message control used by DCM A is a system of fees based on Weighted 
Volume Ratio (``WVR'') calculations designed to discourage inefficient 
messaging among firms with high message volumes. The WVR is a ratio 
between the number of messages submitted by a market participant and 
the total volume of orders that it executes. The ratio of unfilled 
orders is also weighted based on how far away from the best bid or 
offer each unfilled order was when it was entered. Orders that are 
farther away from the best bid or offer when entered are weighted more 
heavily. The DCM assesses fees against market participants when they 
exceed WVR limits.
    DCMs A and B both employ an ``orders removed upon logout'' function 
in which all orders are removed upon the user's logout or 
disconnection, and that they maintain error trade policies that 
incorporate a no cancellation range.
    With respect to ATSs, DCMs A and B both employ a certification and 
testing process for connecting entities. For example, one DCM described 
this process as testing a firm's messaging ability (i.e., that firm's 
ability to send and receive data). As part of the testing process, the 
DCM will transmit market data to the firm and this provides the firm 
with the opportunity to run its own algorithms and for that firm to 
determine if its algorithms are functioning as it intended. Firms must 
pass additional conformance tests when the exchange's own system 
functionality changes. DCM B indicated that its testing process allows 
customers to test

[[Page 56551]]

new products prior to their production launch.
    In addition to their internal risk mitigation programs, DCMs also 
provide risk mitigation tools to intermediaries such as FCMs, allowing 
the intermediaries to set risk control parameters on controls that 
reside at the trading platform level. Clearing firms, for example, are 
able to set risk tolerance levels for their customers based on position 
size, order activity, executions, among other variables.
2. Existing Trading and Clearing Firm Risk Controls
    Risk controls at the level of individual market participant firms, 
whether trading firms or clearing firms, are necessarily entity 
specific. Accordingly, industry groups have collaborated to determine 
best practices for risk controls. As noted previously, other entities, 
including the TAC, have also developed best practices or 
recommendations. One goal of this Concept Release is to determine how 
consistently these, and other, recommendations are today being 
implemented by market participants. As noted by FIA, ``all principal 
traders have a vested interest in well-functioning markets with 
effective risk controls, clear error trade policies that focus on trade 
certainty, and a strong regulatory framework.'' \65\ Comments to this 
Concept Release will allow the Commission to best ensure this strong 
framework. Questions about the general use of automated risk controls 
at the level of a firm are also informed by two reports prepared by 
authors affiliated with the Federal Reserve Bank of Chicago. One report 
details the current practices of nine proprietary trading firms, with 
special attention to risk mitigating practices currently applied to 
their automated systems.\66\ Through interviews, the authors found that 
(1) all firms have maximum order sizes in place and intraday position 
limits; (2) all but one firm has credit limits by account, which 
monitor open positions, dollar value of positions and quantity of 
working orders; \67\ (3) half of the firms have price protection points 
for orders; (4) most firms had message throttles, set at order volume 
per unit of time; and (5) all firms had kill buttons. The risk controls 
included in this list, and others discussed within the report, are 
expanded upon in the below discussion. In its questions for comment, 
the Commission seeks to understand what types of risk controls are most 
commonly used throughout the industry, and the degree to which those 
risk controls are standardized across the industry.
---------------------------------------------------------------------------

    \65\ See FIA Recommendations for Risk Controls, supra note 62, 
at 2.
    \66\ See Carol Clark & Rajeev Ranjan, ``How Do Proprietary 
Trading Firms Control the Risks of High Speed Trading?'' (March 
2012), available at http://www.chicagofed.org/digital_assets/publications/policy_discussion_papers/2012/PDP2012-1.pdf.
    \67\ The final firm also sets credit limits, but only for new 
traders. See id. at 7.
---------------------------------------------------------------------------

    A second report \68\ summarized interviews with five Broker/Dealers 
(``B-Ds'') and FCMs, again detailing their current practices in 
automated risk controls. As at the trading level, some firms have 
implemented pre-trade and post-trade checks, along with other credit 
related controls to mitigate trading losses and resulting burdens on 
the clearing firm. The report details categories of risks considered by 
the B-D or FCM when signing on a new client, or updating controls as a 
client enters new businesses or expands on old ones. These include: 
Credit risks, market risks, counterparty risks, portfolio risks and 
regulatory risks. Through these assessments, clearing firms are able to 
determine appropriate risk thresholds for a given client, and apply 
them as necessary at multiple points in the trading chain. Specific 
controls come in forms quite similar to those outlined above in the 
case of the trading firm. Pre-trade risk controls span order size 
limits, intraday position limits, credit limits, and message throttles. 
These can vary by asset class, exchange, and other market factors, 
along with coincident market dynamics such as volatility levels and 
current positions of the trading firm. The monitoring done by the 
clearing firm is aided by post-trade measures such as the drop-copy of 
executions, which allows for the monitoring of positions and associated 
credit risks.
---------------------------------------------------------------------------

    \68\ See Carol Clark & Rajeev Ranjan, ``How Do Broker-Dealers/
Futures Commission Merchants Control the Risks of High Speed 
Trading?'' (June 2012), available at http://www.chicagofed.org/Webpages/publications/policy_discussion_papers/2012/pdp_3.cfm.
---------------------------------------------------------------------------

B. Overview of Risk Controls Addressed in This Concept Release

    The risk controls presented below describe specific measures which 
could be taken by exchanges and participants in automated trading 
environments. To better understand current industry practices, the 
Commission is interested in determining, for each risk control: (1) 
Whether the entity commenting has implemented the control; (2) whether 
the entity believes implementation of the control within the 
marketplace is consistently applied; and (3) the benefits and costs of 
a regulatory mandate of the control. If the Commission determines that 
the types of risk controls employed across the industry vary widely, 
the Commission would be aided by understanding the extent of this 
variance, the reasons for it, and whether regulatory standardization 
can be of benefit. By gathering this information, the Commission will 
be better informed regarding beneficial future regulation surrounding 
automated systems.
    The Commission emphasizes that this Concept Release is intended to 
serve as a high-level enunciation of potential measures intended to 
reduce the likelihood of market disrupting events and mitigate their 
impact when they occur. Many of the risk controls listed below are in 
effect, in part or in full, across multiple entities. Others have been 
included in recommendations by industry groups and standard-setting 
bodies, or addressed by foreign regulatory authorities. The Commission 
also notes that a number of the measures described below offer similar 
risk controls at various stages in the life of an order (e.g., a 
safeguard applicable to the ATS generating an order and a similar 
safeguard applicable to the trading platform receiving such order). 
Added security through redundancy of risk controls is a feature of 
safeguard documents reviewed by the Commission in preparing this 
Concept Release. The Commission seeks public comment on merits of 
single versus redundant risk control models. Market participants and 
members of the public are encouraged to comment on the potential risk 
controls, and the Commission anticipates further refinement of the 
measures described herein based on the comments received.
    The discussion of risk controls below is followed by a number of 
general questions on which the Commission requests comment (see section 
III.G. below). These questions are applicable to all the risk controls 
discussed below.

C. Pre-Trade Risk Controls

    The Commission includes below a set of pre-trade risk controls 
aimed at reducing market disruptions related to automated trading due 
to errors, system malfunctions or other events with similar effects. In 
general, pre-trade risk controls seek to protect against the 
accumulation of a large volume of orders, executions, or positions over 
an abbreviated period of time. Some market participants are currently 
using controls which address this accumulation, including maximum order 
size limits, message rate limits, and similar measures. Pre-trade risk 
controls can also promote fair and orderly markets, through the use of 
circuit breakers, execution throttles and self-trade

[[Page 56552]]

monitoring. Finally, the pre-trade risk controls also include pre-trade 
credit limits designed to protect clearing firms, and their clients, 
with respect to customer and proprietary orders.\69\ Each of these 
groups is discussed below in greater detail.
---------------------------------------------------------------------------

    \69\ The pre-trade risk controls contemplated herein are 
consistent with general principles or specific recommendations (in 
DMA context) expressed in the TAC Pre-Trade Functionality 
Subcommittee DMA Recommendations, supra note 26, at 2-5; IOSCO 
Technical Committee, Final Report on Principles for Direct 
Electronic Access to Markets (August 2010) at 20, available at 
http://www.iosco.org/library/pubdocs/pdf/IOSCOPD332.pdf; and the FIA 
Recommendations for Risk Controls, supra note 62, at 4. The pre-
trade risk controls described herein are also consistent with the 
principles included in the ESMA Guidelines on Systems and Controls, 
supra note 4.
---------------------------------------------------------------------------

    In order to fully address possible disruptions, the pre-trade risk 
controls apply at one or more of three points in the execution chain: 
(1) Individual firms; (2) intermediaries of many forms (including SDs, 
MSPs, FCMs, Floor Traders, Commodity Pool Operators (``CPOs'') and 
DCOs); and (3) exchanges (including DCMs and SEFs). In many cases, the 
same or similar risk controls are implemented at more than one point in 
the execution chain, such as first at the firm, then perhaps at the 
clearing firm, and then finally at the DCM. The Commission believes 
that this approach offers a number of advantages.\70\ First, it allows 
individual entities to calibrate the relevant risk control in 
accordance with their own objectives and risk tolerances. For example, 
an exchange may set a per-product maximum order size to ensure orderly 
trading in its markets, with the same limit applying equally to all 
market participants. A clearing firm, however, may wish to address its 
customers' distinct risk profiles by setting different maximum order 
sizes for different customers.
---------------------------------------------------------------------------

    \70\ In this regard, the Commission notes that the TAC's Pre-
Trade Functionality Subcommittee described ``three levels in the 
electronic trading `supply chain' where pre-trade risk safeguards 
could happen: Trading firms (as principal or agent), clearing firms 
(as principal or agent), and exchanges.'' The Subcommittee's 
recommendations to the TAC noted that it ``believe[s] strongly that 
all three levels of the supply chain should institute pre-trade risk 
management measures.'' See TAC Pre-Trade Functionality Subcommittee 
DMA Recommendations, supra note 26, at 1.
---------------------------------------------------------------------------

    Second, by indicating that some risk controls should reside at the 
exchange level in addition to the market participant and clearing firm 
levels, the Commission is responding to competitive and ``race to the 
bottom'' concerns raised by several observers. FIA's Market Access 
Working Group, for example, noted that ``[p]re-trade risk controls have 
become a point of negotiation between trading firms and clearing 
members because they can add latency to a trade. To avoid such 
negotiations, the Market Access Working Group believes that certain 
risk controls should reside at the exchange level and be required for 
all trading to ensure a level playing field.'' \71\
---------------------------------------------------------------------------

    \71\ See FIA Market Access Recommendations, supra note 23, at 8. 
See also TAC Pre-Trade Functionality Subcommittee DMA 
Recommendations, supra note 26, at 2. The TAC Pre-Trade 
Functionality Subcommittee called for a ``realistic view'' of the 
incentives under which market participants, clearing firms, and 
exchanges operate. The Subcommittee identified these incentives as 
follows:
     ``Trading firms are competing with one another to have 
the smallest time delays (lowest latency) in getting their orders 
into the exchange's matching engine, and are thus negotiating with 
brokers to reduce latency. At the same time they are trying to 
protect their capital from rogue trading, technological deficiencies 
or other adverse, unintended events.
     Brokers (clearing FCMs) are competing with one another 
to attract the business of these high-volume, speed-seeking trading 
firms, and are thus trying to reduce latency. At the same time, they 
are trying to protect themselves from loss due to unauthorized 
trading by their trading firm clients or other adverse, unintended 
events.
     Exchanges (Designated Contract Markets, or DCMs, and 
Foreign Boards of Trade, or FBOTs) are competing with one another to 
provide low latency execution, and will soon be competing with Swaps 
Execution Facilities (SEFs), to attract the business of these 
trading firms.''
    The Subcommittee expressed its concern that risk controls should 
ensure fairness so that one trading firm is not disadvantaged 
relative to another ``because its clearing firm chose to act more 
responsibly.''
---------------------------------------------------------------------------

    Third, the risk controls listed below acknowledge a variety of 
industry practices with respect to order generation, such as whether 
the order passes through intermediaries prior to execution. The 
Commission seeks to understand how increased standardization in risk 
controls at the level of exchanges or exchange members could provide 
strengthened protection for the markets and the public.\72\ Notably, if 
the Commission were to require the placement of credit controls, 
maximum order size limits, and maximum message rate limits at both 
exchanges and clearing members, it could address both traditional means 
of order flow (i.e., through a clearing firm) and newer DMA practices, 
which require controls at the exchange set by the relevant clearing 
firm. In combination, these reasons demonstrate the strength, in 
certain cases, of putting into practice standardized risk controls, 
with similar goals, at multiple entity types.\73\
---------------------------------------------------------------------------

    \72\ For example, trading platforms provide a range of risk 
controls, but there is limited standardization in the types of risk 
controls available to customers from one exchange to the next. The 
Commission seeks to understand whether diverse risk management tools 
and policies at various exchanges complicate risk management for 
intermediaries and traders.
    \73\ The Commission notes that some existing regulations address 
pre-trade risk controls. See supra section II.B.
---------------------------------------------------------------------------

    Finally, the Commission notes the importance of risk controls 
designed to protect the financial integrity of DCOs, and to address 
risks posed by market participants utilizing DMA. Throughout the range 
of pre-trade risk controls discussed below, and other measures 
discussed later in this Concept Release, the Commission specifically 
solicits public comment regarding the following questions:
    6. Are there distinct pre-trade risk controls, including measures 
not listed below, or measures in addition to those already adopted by 
the Commission, that would be particularly helpful in protecting the 
financial integrity of a DCO?
    7. Are there distinct pre-trade risk controls, including measures 
not listed below, or measures in addition to those already adopted by 
the Commission, that should apply specifically in the case of DMA?
    The following sections describe the pre-trade risk controls 
inquired about in this Concept Release, and present a series of 
questions to assist the Commission in determining the effectiveness, 
adoption rate, and need for any additional action with respect to these 
pre-trade risk controls or others that commenters may think advisable.
1. Message and Execution Throttles
    The Commission seeks public comment regarding the potential 
benefits and existing use of maximum message rate and execution rate 
throttles (``execution throttles''). The Commission also seeks public 
comments regarding the types of execution throttles that would be most 
effective at alerting market participants to potential algorithm 
malfunctions and limiting the extent of market disruption when there is 
a malfunction.\74\
---------------------------------------------------------------------------

    \74\ The Commission understands that some trading firms and 
several exchanges already have limits on the number of orders that 
can be sent to a trading venue during a specified period of time. 
See Clark & Ranjan, ``How Do Proprietary Trading Firms Control the 
Risks of High Speed Trading,'' supra note 66, at 7; Oliver Linton & 
Maureen O'Hara, ``Economic impact assessments on MiFID II policy 
measures related to computer trading in financial markets,'' United 
Kingdom Government Office for Science--Foresight (August 2012) at 
24-25, available at: http://www.futuresindustry.org/epta/downloads/Economic-Impact-assessments-on-MiFID-2-policy-measures_083012.pdf. 
However, the Commission would like to understand whether requiring 
some measure of standardization and the use of such tools among 
exchanges, FCMs, and trading firms would provide additional 
protection for the market.

---------------------------------------------------------------------------

[[Page 56553]]

    Execution throttles prevent an algorithm from exceeding its 
expected message rate or rate of execution, and when tripped, can alert 
monitors at both the exchange and the trading firm. Such alerts can 
facilitate rapid detection of malfunctioning algorithms. Depending on 
the nature of the malfunction, execution throttles may also reduce the 
damage and monetary losses caused by the disruptive algorithm during 
the time when it is being investigated. The Commission understands that 
trading firms \75\ and exchanges \76\ employ individual variants of 
throttles to limit the number of orders that can be transmitted to or 
processed by an exchange. The Commission requests public comment 
regarding the extent to which market participants that already utilize 
execution throttles apply them in a static manner (i.e., a fixed 
threshold, beyond which notifications are generated), or dynamically 
(i.e., dependent on the time of day or the previous activity of the 
algorithm).\77\ The Commission also requests public comments regarding 
the extent to which throttles are applied by trading firms on a per-
algorithm basis, calibrated to take into account the expected message 
and execution rates of each algorithm for a given time period.
---------------------------------------------------------------------------

    \75\ See Clark & Ranjan, ``How Do Proprietary Trading Firms 
Control the Risks of High Speed Trading,'' supra note 66, at 7.
    \76\ See Carol Clark & Rajeev Ranjan, ``How Do Exchanges Control 
the Risks of High Speed Trading?'' (November 2011) at 3, available 
at http://www.chicagofed.org/digital_assets/publications/policy_discussion_papers/2011/PDP2011-2.pdf.
    \77\ The Commission notes that the Futures and Options 
Association (``FOA'') expressed the opinion that throttles may 
hinder price formation and market integrity if applied dynamically 
during a period of market stress. However, the FOA generally 
supported the use of throttles that are ``pre-defined, transparent 
and certain (i.e., the member obtains connections with a specified 
bandwidth in terms of maximum messages per second).'' See FOA, 
``ESMA's Consultation Paper: Guidelines on Systems and Controls in a 
highly automated trading environment for trading platforms, 
investment firms and competent authorities: A response paper by the 
Futures and Options Association'' (October 2011) at 2, available at 
http://www.esma.europa.eu/system/files/11-FOA.pdf.
---------------------------------------------------------------------------

    In addition, the Commission asks whether maximum message rates and 
execution throttles could be used as a mechanism to prevent individual 
entities from submitting messages or executing orders at speeds that 
are misaligned with their risk management capabilities. Execution 
throttles of this type would be unique to individual firms or accounts, 
and could be set by the exchange or clearing firm after reviewing the 
risk management capabilities of the entity to which the throttle will 
apply. For some firms, there may be a delay before effective risk 
management begins; in these cases, execution throttles may mitigate 
harm to the firm or other market participants prior to the firm's 
response to a malfunction. Last, message rate limits could be used to 
mitigate the risk of manipulative or disruptive messaging strategies 
such as ``order stuffing,'' where firms use ATSs to submit large 
numbers of orders that are cancelled before execution in order to slow 
down the matching engine and create arbitrage opportunities in or 
across products.
    8. If, as contemplated above, maximum message rates and execution 
throttles were used as a mechanism to prevent individual entities or 
accounts from trading at speeds that are misaligned with their risk 
management capabilities, how should this message rate be determined?
    9. Message and execution throttles may be applied by trading firms 
(FCMs and proprietary trading firms), clearing firms, and by exchanges. 
The Commission requests public comment regarding the appropriate 
location for message and execution throttles.
    a. If throttles should be implemented at the trading firm level, 
should they be applied to all ATSs, only ATSs employing HFT strategies, 
or both?
    b. What role should clearing firms play in the operation or 
calibration of throttles on orders submitted by the trading firms whose 
trades they guarantee?
    10. Should the message and execution throttles be based on market 
conditions, risk parameters, type of entity, or other factors?
    11. What thresholds should be used for each type of market 
participant in order to determine when a message or execution throttle 
should be used? Should these thresholds be set by the exchange or the 
market participant?
    12. Are message and execution thresholds typically set by contract, 
or by algorithm? What are the advantages and disadvantages to each 
method?
    13. Who should be charged with setting message rates for products 
and when they are activated?
    14. Would message and execution throttles provide additional 
protection in mitigating credit risk to DCOs?
2. Volatility Awareness Alerts
    Automated volatility awareness alerts implemented by trading firms 
are another form of risk control contemplated in this Concept Release. 
Volatility awareness alerts could be triggered when price movements in 
a given product move beyond a certain threshold within a previously 
specified time period. Such alerts could assist in identifying market 
conditions that may exceed an algorithm's parameters, or may highlight 
unintended effects of an algorithm's orders. Given an alert, human 
monitors at the trading firm could then intervene either by halting the 
relevant algorithms under their control, or by conveying the 
information to other relevant parties. Unlike exchange trading pauses 
and halts, volatility awareness alerts inform firm personnel as to 
changes in market conditions that may disrupt the parameters within 
which their ATSs and algorithms were programmed to operate, rather than 
immediately triggering a pause in trading.
    15. The Commission is aware that alarms can be disruptive or 
counterproductive if ``false alarms'' outnumber accurate ones. How can 
volatility alarms be calibrated in order to minimize the risk that 
false alarms could interrupt trading or cause human monitors to ignore 
them over time?
3. Self-Trade Controls
    A trade that results from the matching of opposing orders between a 
firm or a single or commonly owned account, such as a wash trade, does 
not shift risk between different market participants. In addition, such 
trades may inaccurately signal the level of liquidity in the market and 
may result in a non-bona fide price. Risk controls that identify and 
limit self-trading may result in more accurate indications of the level 
of market interest on both sides of the market and help ensure arms-
length transactions that promote effective price discovery. Some 
regulated exchanges have tools specifically designed to identify and 
limit self-trading. The Commission is interested in better 
understanding those risk controls and how widespread their use may be.
    For example, the Commission understands that in June 2013, CME 
Group introduced a voluntary self-match prevention functionality that 
allows market participants to prevent buy and sell orders for the same 
account (or for an account with common beneficial ownership) from 
matching with each other.\78\ Market participants

[[Page 56554]]

that wish to opt-in to this functionality populate a new FIX tag on all 
orders with a ``Self Match Prevention Identifier,'' in addition to an 
executing firm number. When the exchange's matching engine detects buy 
and sell orders at the same executable price level in a particular 
contract and both orders have the same Self Match Prevention Identifier 
and the same executing firm number, the engine will automatically 
cancel the resting order(s) on one side of the market and process the 
incoming order on the other side of the market.
---------------------------------------------------------------------------

    \78\ See CME Group, ``CME Globex Self-Match Prevention 
Functionality FAQ'' (2013), available at http://www.cmegroup.com/globex/resources/smpfaq.html. On July 9, 2013, CME Group requested 
Commission approval to issue a market regulation advisory notice 
intended to provide guidance with respect to the types of activity 
that may constitute a violation of the exchange's wash trades rule 
and to provide additional information concerning its self-match 
prevention technology. This notice, which is under review by the 
Commission, is available at http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/rul070913cmecbotnymexcomandkc1.pdf.
---------------------------------------------------------------------------

    In addition, the Commission understands that ICE Futures U.S. 
(``ICE'') offers voluntary self-trade prevention functionality for 
preventing inter- and intra-company orders from matching in the 
exchange's matching engine. This functionality was initially designed 
to prevent the matching of inter- and intra-company trades by 
automatically rejecting the taking order. The Commission understands 
that in May 2013, this functionality was expanded to allow for the 
rejection of the resting order.
    16. What specific practices or tools have been effective in 
blocking self-trades, and what are the costs associated with wide-
spread adoption of such practices or tools?
    17. Please indicate how widely you believe exchange-sponsored self-
trading controls are being used in the market.
    18. Should self-trade controls cancel the resting order(s)? Or, 
instead, should they reject the taking order that would have resulted 
in a self-trade? If applicable, please explain why one mechanism is 
more effective than the other.
    19. Should exchanges be required to implement self-trading controls 
in their matching engines? What benefits or challenges would result 
from such a requirement?
    20. Please explain whether regulatory standards regarding the use 
of self-trading control technology would provide additional protection 
to markets and market participants.
    21. If you believe that self-trading controls are beneficial, 
please describe the level of granularity at which such controls should 
operate (e.g., should the controls limit self-trading at the executing 
firm level? At the individual trader level?) What levels of granularity 
are practical or achievable?
    22. If you believe that self-trading controls are beneficial, 
please explain whether exchanges should require such controls for 
market participants and identify the categories of participants that 
should be subject to such controls. For example, should exchanges 
require self-trading controls for all participants, some types of 
participants, participants trading in certain contracts, or 
participants in market maker and/or incentive programs? What benefits 
or challenges would result from imposing such controls on each category 
of participant?
4. Price Collars
    The Commission is also inquiring about price collars for both 
orders and executions. Price collars on orders prevent orders outside 
of acceptable price ranges from either entering the order book or 
executing at extreme levels; in effect, collars prevent market or stop 
orders (which execute as market orders) from trading at levels far 
beyond that expected at order entry. Similarly, price collars for 
execution prevent an order that is already in the book from being 
executed by the matching engine if it is outside of the acceptable 
range. Price collars can be contract specific and dynamic, responding 
to changes in market prices and market volatility for each contract. 
Price collars may reduce realized volatility by preventing a large, 
aggressive order from sweeping the book and matching at prices outside 
the range allowed by the collar, or allowing isolated market orders to 
execute during periods when one-sided liquidity is extremely low.\79\
---------------------------------------------------------------------------

    \79\ The Commission currently estimates that about half of the 
trading firms operating ATS have limits that check orders against a 
specific price range before sending them to the exchange. See Clark 
& Ranjan, ``How Do Proprietary Trading Firms Control the Risks of 
High Speed Trading,'' supra note 66, at 7. However, the Commission 
would like to better understand whether standardizing such controls 
at the level of exchanges or requiring such controls at the level of 
trading firms would further promote stable and reliable markets.
---------------------------------------------------------------------------

    23. The Commission is aware that some exchanges already have price 
collars in place for at least a portion of the contracts traded in 
their markets. Please comment on whether exchanges should utilize price 
collars on all contracts they list.
    24. Would price collars provide additional protection in mitigating 
credit risk to DCOs?
5. Maximum Order Sizes
    Maximum order sizes are intended to protect against execution of 
orders for a quantity larger than a predetermined ``fat finger'' limit. 
Like other controls, these limits can function at multiple levels; for 
example, at the firm level, in which firms prevent the submission of 
orders beyond certain limits, or at the clearing level, in which 
clearing members prohibit transmission of customer orders in excess of 
predetermined limits.
    The Commission believes that most, if not all, exchanges currently 
have the capability to set maximum order sizes, but understands that 
such controls may vary among exchanges in their ability to set limits 
by product, product class, customer, or clearing member.\80\ The 
Commission is interested to understand the following:
---------------------------------------------------------------------------

    \80\ See Carol Clark & Rajeev Ranjan, ``How Do Exchanges Control 
the Risks of High Speed Trading?'' supra note 76, at 3.
---------------------------------------------------------------------------

    25. Are such controls typically applied to all contracts and 
customers, or on a more limited basis?
    26. Do exchanges allow clearing members to use the exchange's 
technology to set maximum order sizes for specific customers or 
accounts?
    27. Would additional standardization in the capabilities of this 
technology or more uniform application of this technology to all 
customers and contracts improve the effectiveness of such controls?
    The Commission understands that some, but perhaps not all clearing 
firms may utilize the exchange's systems, and possibly their own 
systems, in order to conduct pre-trade maximum order size screens.\81\ 
The Commission is interested to understand the following:
---------------------------------------------------------------------------

    \81\ See, e.g., Carol Clark, Rajeev Ranjan, John McPartland, & 
Richard Heckinger, ``What Tools Do Vendors Provide to Control the 
Risks of High Speed Trading?'' (October 2011) at 2-3, available at 
http://www.chicagofed.org/digital_assets/publications/policy_discussion_papers/2011/PDP2011-1.pdf.
---------------------------------------------------------------------------

    28. To what extent are clearing firms and trading firms conducting 
pre-trade maximum order size screens? Please explain whether firms are 
conducting such screens by utilizing: (1) Their own technology; (2) the 
exchange's technology, or (3) a combination of both.
    29. Would regulatory standards regarding the use of such technology 
provide additional protection to the markets?
6. Trading Pauses
    The Commission wants to better understand the existing 
implementation of trading pauses for trading platforms, and whether any 
additional types of pause mechanisms would be beneficial. A wide range 
of pause methodologies are currently in effect at exchanges, such as 
stop-logic functionality and interval price limits. These methodologies 
include market pauses when the execution of resting stop orders would 
cause excessive price movements, when prices move in excess of a 
dynamic threshold over a given time period, or simply when prices have

[[Page 56555]]

moved more than a given amount during the trading day.\82\ Often, the 
market will monitor the order book during the pause, and determine when 
it is ``safe'' to re-open the market to further executions or re-open 
after a specified interval. Trading pauses have mitigated price 
movements during particularly volatile times in the past.\83\
---------------------------------------------------------------------------

    \82\ The Commission understands that some triggers leading to a 
market pause are not necessarily best classified as ``pre-trade'' 
risk controls. Some pauses, as described, may be in anticipation of 
a certain set of executions, and are pre-trade, while others may be 
in response to a given execution. The discussion here implicitly 
includes all of the above, and the Commission requests comment on 
the full range of pause types.
    \83\ See CFTC and SEC Joint Report on the Market Events of May 
6, 2010, supra note 1, at 6 (noting that CME's stop logic 
functionality that triggered a halt in E-Mini trading shows that 
pausing a market can be an effective way of providing time for 
market participants to reassess their strategies, for algorithms to 
reset their parameters, and for an orderly market to be re-
established).
---------------------------------------------------------------------------

    The Commission is interested in better understanding the relative 
costs and benefits of each type of pause functionality and whether 
certain types of pause mechanisms are more effective than others with 
respect to ATS trading. The Commission is also interested to understand 
whether additional types of pause triggers would be advisable. These 
might cover a wider array of adverse states of an automated central 
limit order book, including, for example, significant depth imbalance, 
a significant number of aggressive orders, or a significant number of 
cancelled orders.
    30. Trading pauses, as currently implemented, can be triggered for 
multiple reasons. Are certain triggers more or less effective in 
mitigating the effects of market disruptions?
    31. Are there additional triggers for which pauses should be 
implemented? If so, what are they?
    32. What factors should the Commission or exchanges take into 
account when considering how to specify pauses or what thresholds 
should be used?
    33. How should the re-opening of a market after a trading pause be 
effected?
7. Credit Risk Limits
    Credit risk limits are a valuable protection for limiting the 
activity of malfunctioning ATSs. Risk limits are most valuable when 
implemented as a pre-execution filter. Alternatively, low-latency post-
trade risk limits may also provide some risk mitigation. Credit risk 
controls may be implemented by different entities, including the 
trading firms that originate orders, the clearing firms that guarantee 
the orders, the trading platforms matching the orders, and the DCOs 
that clear the orders. The Commission acknowledges that some trading 
firms and FCMs conduct post-trade credit checks with varying degrees of 
latency and that pre-trade credit risk screens are already required 
pursuant to Sec. Sec.  1.73 and 23.609.\84\ As noted above, however, 
the Commission seeks public comments regarding any additional measures 
that could help protect the financial integrity of DCOs, including 
measures discussed in this Concept Release or other measures that may 
be recommended by interested parties.
---------------------------------------------------------------------------

    \84\ See Commission, Final Rule: Customer Clearing 
Documentation, Timing of Acceptance for Clearing, and Clearing 
Member Risk Management, 77 FR 21278 (Apr. 9, 2012).
---------------------------------------------------------------------------

    The TAC has received proposed models for implementing certain pre-
trade risk controls for swaps, particularly those pertaining to credit 
risk.\85\ Relevant solutions for implementing credit-based pre-trade 
risk controls include those in which credit limits reside at the FCM, 
at the trading platform (based on instruction from the clearing firm), 
or, for example, at a ``hub'' which applies credit controls on a per-
order basis.\86\ The Commission is interested to understand whether the 
``hub'' model, one of several proposed solutions received by the TAC, 
could be usefully applied to futures markets.
---------------------------------------------------------------------------

    \85\ See, e.g., ``Managing Credit Lines in a SEF/Cleared 
World,'' a presentation by MarkitServ at the March 29, 2012 TAC 
meeting [hereinafter, the ``MarkitServ Presentation'']. Available 
at: http://www.cftc.gov/ucm/groups/public/@aboutcftc/documents/file/tacpresentation032912_markitse.pdf.
    \86\ See id. The presentation also noted that post-trade checks 
at the DCO is another form of risk control based on end-customer 
position or credit limits. See section III(D) for additional 
discussion of post-trade reports and other post-trade measures.
---------------------------------------------------------------------------

    The Commission is also interested in credit risk limits as a 
mechanism for limiting the disruptive activity of a malfunctioning ATS. 
Therefore, the Commission requests comment on the following:
    34. What positions should be included in credit risk limit 
calculations in order to ensure that they are useful as a tool for 
limiting the activity of a malfunctioning ATS? Is it adequate for such 
a screen to include only those positions entered into by a particular 
ATS or should it include all the firm's positions?
    35. Should pre-trade credit screens require a full recalculation of 
margin based on the effect of the order?
    36. In light of your answers to the previous two questions, where 
in the lifecycle of an order should the credit limits be applied and 
what entity should be responsible for conducting such checks?
    37. If credit checks are conducted post-trade, what should be done 
when a trade causes a firm to exceed a limit?
    38. Please describe any technological limitations that the 
Commission should be aware of with respect to applying credit limits.
    39. The Commission is particularly interested to receive public 
comment on the ``hub'' model and its applicability to different types 
of pre-trade risk controls. What are the strengths and weaknesses of 
this approach relative to other pre-trade or post-trade approaches to 
checking trades against credit limits? How would the latency between 
the ``hub'' and the exchanges be managed to provide accurate limits for 
high frequency ATS?
    40. If you believe that post-trade credit checks would be an 
effective safeguard against malfunctioning ATSs, what is the maximum 
amount of latency that should be allowed for conducting such checks? 
What technological or information flow challenges would have to be 
addressed in order to implement post-trade checks with that degree of 
latency?
    41. With respect to any entity that you believe should be 
responsible for applying credit risk limits, please describe the 
technology necessary to implement that risk control and the cost of 
such technology.
    The pre-trade risk controls described above are summarized in 
Appendix A.

D. Post-Trade Reports and Other Post-Trade Measures

    The Commission understands that, even with the presence of the most 
robust set of pre-trade risk controls, unanticipated events occur 
within a complicated marketplace. For example, the emergence of 
unexpected feedback loops between multiple algorithms, or 
malfunctioning pre-trade risk controls can lead to unintended order 
submissions that adversely impact market quality and investor 
confidence. Post-trade reports have the potential to mitigate the 
impact of such events, particularly if the post-trade reports are made 
available and utilized on a low-latency basis, such that market 
participants are quickly aware of any malfunction. Other post-trade 
measures, including enhanced error trade policies, may help 
counterparties to errant trades to better anticipate and address risk 
associated with trade uncertainty when such events occur. The post-
trade reports and other measures are summarized below.
1. Order, Trade, and Position Drop Copy
    The Commission is inquiring about the potential advantages of 
increased

[[Page 56556]]

standardization of real-time order, trade, and position reports for use 
by clearing firms and market participants. Real-time information is 
critical to market participants managing the risk of their own, and 
their customers' trades. The Commission is inquiring as to the 
advisability of requiring all exchanges and DCOs to provide real-time 
order and trade reports to each market participant, and the clearing 
firm serving that client for that particular trade. This information 
would give clearing firms real-time updates of their customers' order 
and trading activities.
    These reports could improve the effectiveness of automated credit 
risk limits, which require current order and trade information in order 
to calculate current positions and monitor credit risk effectively. In 
some cases order information may be available to a trading platform 
before it is available to the relevant clearing member (e.g., in the 
case of DMA-enabled participants), and trade information is always 
available first to the trading platform. Therefore, there is a strong 
interdependency between exchanges, DCOs and clearing firms as the 
latter seek to manage their credit risk.
    Any time lag in the clearing firm's ability to construct a 
retrospective view of their customers' positions could diminish a 
clearing firm's ability to assess its customer's risk profile before 
such customer enters additional orders or establishes additional 
positions and accumulates greater risk.
    More generally, widespread use of order and trade reports may be 
beneficial in both DMA and non-DMA situations to help market 
participants to track all order and trade activity quickly and 
efficiently. The Commission notes that some or all DCOs already provide 
post-trade information to clearing members, and that some DCOs charge 
for that information and others do not.\87\ However, the Commission 
believes that the content of the data vary among DCOs and that not all 
market participants choose to purchase data when it is available. As 
described above, the Commission preliminarily believes that more 
standardized access to real-time data from exchanges and DCOs could be 
valuable to clearing firms, and possibly to trading firms, as they 
manage their risks. The Commission encourages interested parties to 
comment, again, on the current use of real-time reports, the 
consistency of this use, and the potential benefits and nature of 
additional order and trade reports.
---------------------------------------------------------------------------

    \87\ See Carol Clark & John McPartland, ``How Do Clearing 
Organizations Control the Risks of High Speed Trading?'' (May 2012) 
at 6-7, available at http://www.chicagofed.org/Web pages/
publications/policy_discussion_papers/2012/pdp_2.cfm.
---------------------------------------------------------------------------

    42. What order and trade reports are currently offered by DCMs and 
DCOs? What aspects of those reports are most valuable or necessary for 
implementing risk safeguards? Please also indicate whether the report 
is included as part of the exchange or clearing service, or whether an 
extra fee must be paid.
    43. If each order and trade report described above were to be 
standardized, please provide a detailed list of the appropriate content 
of the report, and how long after order receipt, order execution, or 
clearing the report should be delivered from the trading platform to 
the clearing member or other market participant.
2. Trade Cancellation or Adjustment Policies
    The Commission is interested to know whether it would be beneficial 
for exchanges to develop more uniform and objective trade cancellation 
or adjustment policies. These policies should apply to cancellation or 
adjustment of individual trades, as well as to cancellation or 
adjustment of a large quantity of trades in response to a disruptive 
market event at the direction of a regulatory body or in accordance 
with the exchange's own determination that such cancellation or 
adjustment of a large quantity of trades is necessary. The policies 
could include (1) Clear principles on when trades will be cancelled or 
adjusted; (2) a requirement that traders notify the exchange of error 
trades within a specified number of minutes; and (3) a requirement that 
the exchange notify market participants of possible adjusted or busted 
trades immediately. Requiring traders to notify the exchange quickly 
and requiring the exchange to communicate the situation to market 
participants immediately helps to ensure that any market participants 
potentially affected by impending adjustment or cancellation actions 
are made aware of the additional risk they bear and can take steps to 
mitigate that risk.
    It may be advisable to base cancellation and adjustment policies on 
pre-defined, objective criteria in order to minimize the time for 
identification and notification. Such criteria may include the minimum 
trade size for which cancellation will be considered, the minimum and 
maximum range in which a trade will be adjusted, the time a market 
participant has to request the cancellation or adjustment, the specific 
circumstances under which trades will be adjusted or canceled (e.g., an 
exchange system error, specific types of human errors) and factors to 
be taken into account (e.g., market conditions, whether other market 
participants have relied on the price). Last, the Commission is 
inquiring as to the advisability of policies to favor trade adjustment 
over trade cancellation in order to help ensure that market 
participants are able to keep the positions they have entered into, 
even if the prices are adjusted. The Commission is interested in 
receiving comments on whether additional standardization in error trade 
policies would be beneficial, and whether this prioritization scheme is 
appropriate.\88\
---------------------------------------------------------------------------

    \88\ The Commission notes that error trade policies may vary for 
different exchanges and for different products at each exchange. See 
id. at 7.
---------------------------------------------------------------------------

    44. Is a measure that would obligate exchanges to make error trade 
decisions (i.e., decisions to cancel a trade or to adjust its price) 
within a specified amount of time after an error trade is reported 
feasible? If so, what amount of time would be sufficient for exchanges, 
but would be sufficiently limited to help reduce risk for 
counterparties to error trades?
    45. Should exchanges develop detailed, pre-determined criteria 
regarding when they can adjust or cancel a trade, or should exchanges 
be able to exercise discretion regarding when they can adjust or cancel 
a trade? What circumstances make pre-determined criteria more effective 
or necessary than the ability to exercise discretion, and vice versa?
    46. Do error trade policies that favor price adjustment over trade 
cancellation effectively mitigate risk for market participants that are 
counterparties to error trades? Are there certain situations where 
canceling trades would mitigate counterparty risk more effectively? If 
so, what are they and how could such situations be identified reliably 
by the exchange in a short period of time?
    47. Should error trade policies be consistent across exchanges, 
either in whole or in part? If so, how would harmonization of error 
trade policies mitigate risks for market participants, or contribute to 
more orderly trading?

E. System Safeguards

    In this Concept Release, the Commission inquires about a range of 
system safeguards for trading platforms,\89\ clearing firms, and market 
participants (including ATSs). Those system safeguards are intended to 
address a number of operational, market

[[Page 56557]]

abuse and transmission risks, and may protect against potential 
disruptions and abuses that are unique to electronic trading. The 
potential system safeguards are broadly grouped into those that address 
(1) Controls related to order placement; (2) policies and procedures 
for the design, testing and supervision of ATSs; (3) self-
certifications and notifications; (4) ATS or algorithm identification; 
and (5) data reasonability checks. Each system safeguard is summarized 
below.
---------------------------------------------------------------------------

    \89\ The Commission notes that the system safeguards 
contemplated herein for DCMs address trading-related risks, and are 
therefore distinct from the requirements of DCM Core Principle 20 
and SEF Core Principle 14, which address business continuity and 
disaster recovery capabilities.
---------------------------------------------------------------------------

1. Controls Related to Order Placement
a. Order Cancellation Capabilities
    The Commission is inquiring about various standards related to 
order cancellation capabilities. Auto-cancel on disconnect requirements 
would ensure that working orders do not remain in the limit order book 
when a firm loses connectivity with the exchange, ensuring that 
unwanted trades avoid execution even if the firm is unable to cancel 
them. The speed of disconnect notification and the cancellation of 
orders on disconnect can be helped by the exchange of ``heartbeat'' 
messages between exchange and user which continuously monitor the 
response ability of a given algorithm. In addition, by requiring 
exchanges to develop and maintain the capacity to selectively cancel 
working orders at the level of individual algorithms, individual 
accounts, or individual firms, as deemed necessary in an emergency, the 
trading platform would be able to mitigate the risk or quantity of 
error trades due to a malfunction.\90\
---------------------------------------------------------------------------

    \90\ In addition to order cancellation capabilities, the 
Commission is inquiring about various related measures that concern 
connectivity testing, including that trading platforms and all 
entities connected to a trading platform for purposes of 
transmitting orders together must test that the systems of all such 
entities are properly connected to and communicating with the 
trading platform, and that trading platforms must provide, and 
market participants operating ATSs must utilize, heartbeats that 
indicate proper connectivity between the trading platform and an 
ATS.
---------------------------------------------------------------------------

    The Commission is also inquiring as to the advisability of 
requiring market participants operating ATSs, clearing members, and 
exchanges to develop and maintain ``kill switch'' capabilities. A 
market participant's kill switch could immediately cancel all working 
orders from that firm to the exchange and could prevent them from 
submitting further orders until natural persons with the proper 
authority at both the firm and the exchange allow the firm to resume 
trading. A kill switch at clearing members could cancel all working 
orders attributable to the clearing member, including both proprietary 
orders and orders placed on behalf of their clients, and prevent the 
clearing member from transmitting additional orders until natural 
persons at both the clearing firm and the exchange allow the clearing 
member to resume trading. An exchange's kill switch could cancel all 
working orders from an individual market participant or clearing firm 
and could prevent additional orders from the same market participant or 
clearing firm from being accepted at the exchange until authorized 
natural persons at both the exchange and affected market participant or 
clearing firm allow trading to resume.
    48. The Commission's discussion of kill switches assumes that 
certain benefits accrue to their use across exchanges, trading and 
clearing firms, and DCOs. Please comment on whether such redundant use 
of kill switches is necessary for effective risk control.
    49. What processes, policies, and procedures should exchanges use 
to govern their use of kill switches? Are there any different or 
additional processes, policies and procedures that should govern the 
use of kill switches that would specifically apply in the case of DMA?
    50. What processes, policies, and procedures should clearing firms 
use to govern their use of kill switches when using such a safeguard to 
cancel and prevent orders on behalf of one or more clients?
    51. What objective criteria regarding kill switch triggers, if any, 
should entities incorporate into their policies and procedures?
    52. What benefits or problems could result from standardizing 
processes, policies, and procedures related to kill switches across 
exchanges and/or clearing firms?
    53. Please explain how kill switches should be designed to prevent 
them from canceling or preventing the submission of orders that are 
actually risk reducing or that offset positions that have been entered 
by a malfunctioning ATS.
    54. The Commission requests comment regarding whether kill switches 
used by clearing firms already have or should have the following 
capabilities: (a) Distinguish client orders from proprietary orders; 
(b) distinguish among orders from individual clients; and (c) cancel 
working orders and prevent additional orders from one or more of the 
clearing firm's clients, or for all the clearing firm's proprietary 
accounts, without cancelling and preventing all orders from the 
clearing firm.
    55. The Commission is aware of proposals that would enable FCMs to 
establish credit limits for customers that are stored at a central 
``credit hub'' for the purpose of pre-trade credit checks.\91\ If such 
a model were implemented, is it possible that it could also be enabled 
with kill switches that cancel existing working orders and prevent 
additional orders from being submitted by one or more market 
participants? Should such an approach be designed to complement kill 
switches that are controlled by exchanges, clearing members, and 
trading firms, or to replace these kill switches? What benefits and 
drawbacks would result from each approach?
---------------------------------------------------------------------------

    \91\ See MarkitServ Presentation, supra note 85.
---------------------------------------------------------------------------

b. Repeated Automated Execution Throttle
    A further potential risk control of interest to the Commission is a 
``Repeated Automated Execution Throttle.'' This risk control was 
highlighted in FIA's Principal Traders Group recommendations regarding 
risk controls.\92\ For this control, ATSs would be required to monitor 
the number of times a strategy is filled and then re-enters the market 
without human intervention. After a configurable number of repeated 
executions the system should be disabled until a human re-enables it. 
The Commission would like to better understand the value of this 
safeguard. The Commission understands that it would disable automated 
systems which have experienced activity levels far beyond that 
anticipated by its designers, and then notify monitors regarding this 
activity. Through this, human review would independently verify the 
operation of an ATS at regular intervals, and in doing so, could help 
to ensure that an algorithm's strategy is currently acting as 
anticipated and that it is appropriately responding to current market 
conditions. The Commission requests comments as to whether there could 
be adverse effects of automatically disabling an ATS after a given 
number of order executions, and also requests comment regarding the 
potential value, proper use, and limitations of this safeguard.
---------------------------------------------------------------------------

    \92\ See FIA Recommendations for Risk Controls, supra note 62, 
at 4.
---------------------------------------------------------------------------

2. Policies and Procedures for the Design, Testing and Supervision of 
ATSs; Exchange Considerations
    Taken as a whole, the ATS monitoring and supervision standards, ATS 
design and testing standards, ATS crisis management procedures 
standards, and ATS monitoring staff training standards inquired about 
in this Concept Release constitute a set of standards related to

[[Page 56558]]

policies and procedures for firms operating ATSs. Existing rules 
require SDs and MSPs to ensure that their ``use of trading programs is 
subject to policies and procedures governing the use, supervision, 
maintenance, testing, and inspection of the program,'' \93\ but there 
is no corresponding rule for FCMs or other market participants 
operating ATSs. Moreover, even when applied to SDs and MSPs, section 
23.600(d)(9) does not have any prescriptive requirements related to 
supervision and testing and does not require formal review or approval 
of each firm's policies and procedures by an informed, independent 
party other than at the time of registration.\94\ As a consequence, 
there is no minimum amount of testing that SDs and MSPs or other market 
participants operating ATSs are required by the Commission to perform 
before deploying an algorithm or before re-deploying an algorithm that 
has been altered. Nor are there any minimum standards for training or 
sophistication in the areas of supervision, maintenance, and inspection 
of the ATS.\95\ Because of this, the Commission is interested in better 
understanding whether more standardized requirements, or clearer 
minimum standards, related to policies and procedures for firms 
operating ATSs would benefit the markets and the public. The policies 
and procedures relating to the design, testing and supervision of ATSs 
are summarized below, and addressed in greater detail in Section V, 
Appendix C.
---------------------------------------------------------------------------

    \93\ See 17 CFR 23.600(d)(9).
    \94\ 17 CFR 23.600(b)(4) requires SDs and MSPs to ``furnish a 
copy of its written risk management policies and procedures to the 
Commission, or to a futures association registered under section 17 
of the Act, if directed by the Commission, upon application for 
registration and thereafter upon request.''
    \95\ It is also possible that SDs and MSPs could fail to 
incorporate emerging industry best practices for managing 
operational risk of ATSs into their policies and procedures as 
effective risk management technology and practices are introduced to 
the market.
---------------------------------------------------------------------------

a. ATS Development, Change Management, and Testing; Development, Change 
Management, and Testing of Exchange Systems
    The Commission requests public comment regarding the necessity for 
ATS development, change management and testing standards in CFTC-
regulated markets. Potential benefits to such standards include 
ensuring that ATSs are designed and modified in an environment where 
there is no risk that the ATS could interfere with activity in or 
related to the live market and ensuring that appropriate personnel have 
approved changes and verified proper testing before a system is moved 
to the production environment. Standards concerning the retention and 
control of access to current and historical versions of source code may 
help to ensure that changes are only made by appropriate personnel and 
reviewable when necessary. Finally, audit trail material may assist 
regulators when investigating problems.
    With respect to testing, a firm's ATS testing standards could 
require it to test an ATS on the trading platform(s) where it will 
trade, prior to deploying such ATS into the live environment. Such 
testing standards may reduce the incidence of technical errors at the 
level of individual algorithms and firms. In addition, a firm's ATS 
testing standards may require it to test an ATS on the trading 
platform(s) after modifying the underlying algorithms or other system 
components to a degree subject to further definition. ATS testing could 
include tests against historical data, especially periods for which the 
relevant algorithm would likely have been stressed, or would have been 
active during periods with unanticipated market activity. In addition, 
exchanges could also be required to provide a test environment to 
simulate production trading so that market participants can conduct 
exchange-based conformance testing, which would include tests of 
compatibility with the matching engine (including initiation and 
cessation of the ATS connection) and verification of risk controls 
required by the trading platform.
    The Commission is particularly interested to understand when it is 
most beneficial for firms to test an ATS after it has been modified. 
Some have asserted that the amount of testing should be calibrated to 
the significance of the change and the risk it poses to the proper 
function of the ATS.\96\ The Commission would like to better understand 
how market participants estimate the significance of a change and the 
risk that a given change might pose to the proper function of an ATS. 
Also, the Commission would like to understand what current best 
practices are for testing ATSs and how those practices are tailored to 
the extent of the modification.
---------------------------------------------------------------------------

    \96\ See SEC Roundtable Transcript, supra note 2, at 49-51.
---------------------------------------------------------------------------

    56. Please describe the necessary elements of an effective ATS 
testing regime, in connection with both the initial deployment and the 
modification of an ATS.
    57. With respect to testing of modifications, how should the 
Commission and market participants distinguish between major 
modifications and minor modifications? What are the objective criteria 
that can be used to make such distinctions? Should any testing regime 
applicable to ATS modifications distinguish between major and minor 
modifications, and if so, how?
    58. What challenges or benefits may result from exchanges 
implementing standardized procedures regarding the development, change 
management, and testing of exchange systems? Please describe, if any, 
the types of standardized procedures that would be most effective.
b. ATS Monitoring and Supervision
    The Commission is aware that many exchanges and software design 
firms offer extensive testing platforms to validate algorithm 
functionality before deployment in a live trading environment. The 
Commission wants to better understand the extent to which testing is 
utilized and would like to better understand the methodology supporting 
these test environments. Further, the Commission believes that many, if 
not all, firms operating ATSs have human monitors supervising ATSs when 
they are operating. However, the Commission is uncertain to what degree 
such monitors have been sufficiently trained in how to respond to 
unexpected problems, and been given the requisite authority to 
intervene at these times.\97\ A firm's ATS training standards could 
require that relevant staff members be able to understand how to 
identify malfunctions, evaluate the risk resulting from those 
malfunctions, and respond constructively to those malfunctions, 
including elevating the problem to the attention of more senior 
personnel. The Commission would like to better understand whether 
regulatory measures or new standards in this area would promote more 
effective ATS monitoring and supervision.
---------------------------------------------------------------------------

    \97\ The Commission would like to better understand what sorts 
of training and policies market participants use in order to ensure 
that human monitors have the capability to respond to operational 
issues in a timely way. In particular, the Commission is interested 
in better understanding what training monitors receive in the 
rationale for the trading patterns executed by the ATS, the scope of 
intervention authority given to human monitors, and the procedures 
firms use to escalate questions or decisions from such human 
monitors to more senior personnel during a crisis.
---------------------------------------------------------------------------

c. Crisis Management Procedures
    Well-designed crisis management procedures may help to ensure that

[[Page 56559]]

firms are prepared to conduct rapid triage in the event of a problem, 
including the ability to escalate decisions quickly to the proper 
individuals or provide notification to their clearing firms, exchanges, 
or the Commission.\98\ Such procedures may promote common expectations 
among monitoring staff, firm leadership, and exchange leadership about 
basic procedures in the event of market destabilizing events, 
facilitating more rapid intervention and mitigating the effects of an 
individual disruption.
---------------------------------------------------------------------------

    \98\ See SEC Roundtable Transcript, supra note 2, at 133-34.
---------------------------------------------------------------------------

    59. Should basic crisis management procedures be standardized 
across market participants? If so, what elements should be addressed in 
an industry-wide standard?
    60. Are there specific, core requirements that should be included 
in any crisis management procedures? Similarly, are there specific 
types of crisis events that should be addressed in any crisis 
management procedures? If so, please identify such requirements and/or 
crisis events and the level of granularity or specificity that the 
procedures should have with respect to each.
3. Self-Certifications and Notifications
a. Self-Certification and Clearing Firm Certification
    To ensure that market participants employ the pre-trade risk 
controls, post-trade reports and other measures, and system safeguards 
described herein, the Commission is inquiring whether it would be 
appropriate to require a periodic self-certification program for all 
market participants operating ATSs and for clearing firms providing 
services to those market participants. These certifications could refer 
to the extent of implementation of those risk control mechanisms 
discussed in the other sections of this Concept Release. With respect 
to ATSs, an acceptable certification might attest that: (1) The ATS 
contains structural safeguards to provide reasonable assurance that the 
trading system will not be disruptive to fair and equitable trading; 
(2) the market participant's ATSs have been designed to avoid 
violations of the CEA, Commission regulations, or exchange rules 
related to fraud, disruptive trading practices, manipulation and trade 
practice violations; and (3) such systems have been sufficiently tested 
and documented in a manner that is appropriate to the intended design 
and use of that system. Additionally, the Commission asks whether the 
chief executive officer, chief compliance officer, or similar ranking 
official of each market participant should attest to the certification. 
The Commission is interested in receiving comment on the costs and 
benefits of a certification program, what elements should be included 
in the program, and whether that program should be self-executed, or, 
if not, overseen by what authority.
    61. How often should a market participant certify that their pre-
trade risk controls, post-trade reports and other measures, and system 
safeguards meet the necessary standards?
    62. Which representative of the market participant should be 
required to attest that the certification standards have been met? 
Should it be the market participant's chief executive officer, chief 
compliance officer, or similar high-ranking corporate official, or some 
other individual?
    63. Which entity(ies) should receive certifications from market 
participants? For example, should it be the market participant's 
clearing firm, its designated self-regulatory organization (if 
applicable), one or more trading platforms, a registered futures 
association, the Commission, or other entity?
    64. Should DCMs, SEFs or clearing member firms be required to audit 
market participant certifications? What would be covered in an audit 
and how often should these audits occur? Should the same entity that 
receives the certification be required to perform the audit?
b. Risk Event Notification Requirements
    The Commission also seeks information as to whether it would be 
beneficial for market participants operating ATSs to notify one or more 
of trading platforms, their clearing firms, the Commission, or others 
of risk events.\99\ Entities receiving notifications could, when they 
deem it appropriate based on the magnitude of a single event or a 
pattern of smaller related events, review further with the market 
participant to remedy the underlying cause(s) of the risk event. Such 
reviews would allow market participants, clearing firms, trading 
platforms, and the Commission to respond and proactively reduce risk in 
automated trading environments.
---------------------------------------------------------------------------

    \99\ The SEC is presently considering a set of rules that would 
require self-regulatory organizations, significant alternative 
trading systems, certain disseminators of market data, and exempt 
clearing agencies to notify SEC staff of events including systems 
disruptions, compliance issues, or intrusions. See SEC, Notice of 
Proposed Rulemaking: Regulation Systems Compliance and Integrity, 78 
FR 18084 (Mar. 25, 2013). Under the proposed rules, these entities 
would be required to notify and provide the SEC with detailed 
information when such systems issues occur as well as when there are 
material changes in its systems. Id. The Commission notes that it 
may consider distinctive aspects of the SEC's proposed rules, and 
public comments with respect to it, when developing any future 
proposals arising from this Concept Release. Commenters with respect 
to this Concept Release are encouraged to indicate in their comments 
any elements of the SEC's proposed rules that they believe are 
relevant.
---------------------------------------------------------------------------

    The Commission seeks comment on the types of risk events that 
should be reported. For example, reportable risk events generally could 
include any instances where design parameters of an ATS are violated 
and where risk control processes or technologies do not function as 
anticipated, regardless of whether these events lead to error trades or 
market destabilization. Violated design parameters and unanticipated 
lapse of risk management processes and technology create conditions 
that may presage future malfunctions, even absent a current disruption.
    65. Do commenters believe that risk event notifications would help 
to better understand and ultimately reduce sources of risk in automated 
trading environments? What information should be contained in a risk 
event notification to maximize its value?
    66. What types of risk events should trigger reporting 
requirements, and what entities should receive risk event notifications 
from market participants operating ATSs?
    67. Which entities should receive risk event notifications?
4. ATS or Algorithm Identification
    The Commission is considering measures to improve the 
identification of ATS or their underlying algorithms in messages 
generated by ATSs. The Commission believes that identification of ATSs 
or underlying algorithms could help both firms and trading platforms to 
more quickly identify malfunctioning systems that could disrupt 
markets. Fuller identification of automated systems may also improve 
oversight by the Commission, including the ex post analysis of 
disruptive events aimed at preventing or mitigating similar 
recurrences.
    The Commission is aware of the inherent complexity in any ATS or 
algorithm identification system and seeks public comment on this 
potential measure. Specific questions of interest to the Commission 
include:
    68. Should the Commission define ATS or algorithm for purposes of 
any ATS identification system that may arise from this Concept Release? 
If so, how should ATS or algorithm be defined? Should a separate 
designation be reserved for high frequency trading algorithms and if 
so, what is the threshold difference?

[[Page 56560]]

    69. What are the existing practices within trading firms for 
internally identifying ATSs or algorithms and for tracking their 
performance, including profit and loss? What elements of existing 
practices could be leveraged in any ATS or algorithm identification 
system proposed by the Commission in the future?
    70. The Commission understands that an ATS may consist of numerous 
algorithms, each of which contributes to a trading decision. If an 
algorithm-based identification system is proposed, which of the 
potentially multiple algorithms that constitute an ATS should carry the 
ID? In addition, what degree of change to an algorithm should 
necessitate the use of a new ID, and how often does this change 
typically occur? What is the appropriate definition of ``algorithm'' 
for purposes of an algorithm identification system?
    71. If the identification system resides at the ATS level, how 
should such IDs be structured to ensure that they are nonetheless 
sufficiently granular to identify components that may be leading or 
have led to unstable market conditions?
    72. What message traffic between an ATS and a trading platform 
should include the ATS or algorithm ID (all messages, orders only, 
etc.)?
    73. What relationship should this ATS ID have to the legal entity 
identifier (LEI)?
5. Data Reasonability Checks
    The Commission is interested in the range of information sources 
used by ATSs to inform their trading decisions, and in how market 
participants form reasonable beliefs as to the accuracy of such data. 
For example, following recent media reports regarding the adverse 
market impact of false information distributed through unauthorized use 
of a social media outlet used by the Associated Press, the Commission 
is asking questions to broaden its understanding of the extent to which 
ATSs in derivatives markets use social media to inform their trading 
decisions, and the extent to which information derived from social 
media is verified by the ATS prior to its use. One potential risk 
control of interest to the Commission is the ``market data 
reasonability check,'' which was included in FIA's Principal Traders 
Group recommendations regarding risk controls.\100\ In those 
recommendations, the FIA recommended that trading firms' systems have 
``reasonability checks'' on incoming market data.
---------------------------------------------------------------------------

    \100\ See FIA Recommendations for Risk Controls, supra note 62, 
at 4.
---------------------------------------------------------------------------

    74. Please describe existing practices in the industry concerning 
how and the extent to which ATSs use (1) market data; and (2) news and 
information providers, including social media, to inform trading 
decisions.
    75. The Commission requests comment regarding any risk controls, 
including reasonability checks, currently being used by market 
participants operating ATSs to review market data and news and 
information providers, including social media. Please describe the risk 
control, including the purpose of the control, the extent of its use 
among derivatives market participants, and any other aspects of the 
risk control that you believe would be helpful for the Commission to 
understand.
    In addition, the data analyzed by trading algorithms can include 
government economic reports (e.g., GDP, unemployment, and inflation 
data), as well as economic reports from non-governmental organizations 
such as universities, trade groups, and other sources. While government 
reports are released pursuant to a lock-up process that is intended to 
ensure that no entity receives them ahead of others, it has been 
reported that early access to some non-government economic reports is 
available for a fee. For example, according to recent reports, the 
University of Michigan's consumer report was available to certain 
investors two seconds ahead of the rest of the market.\101\
---------------------------------------------------------------------------

    \101\ See Brody Mullins, Michael Rothfeld, Tom McGinty & Jenny 
Strasburg, ``Traders Pay for Early Peek at Key Data,'' Wall St. J. 
(June 12, 2013), available at http://online.wsj.com/article/SB10001424127887324682204578515963191421602.html.
---------------------------------------------------------------------------

    76. The Commission requests public comment concerning the lock-up 
process for government economic reports, and any additional measures 
that might be taken to protect against inappropriate disclosure.
    77. Please describe the extent to which potentially market-moving 
data from non-governmental economic reports can be obtained prior to 
its public release for a fee. Are there specific reports or types of 
reports for which early disclosure should not be permitted? What 
process should be used for identifying non-governmental economic 
reports whose early release should not be permitted? Should the data 
release process for such reports be similar to the data lock-up process 
implemented for the release of government economic data?
    The system safeguards described above are also listed in Appendix 
C.

F. Other Protections

1. Registration of Firms Operating ATSs
    Although the Commission can currently take several actions to seek 
information from firms, such as the issuance of subpoenas to 
investigate a firm's trading activities on a registered exchange or to 
compel a firm to provide books and records, some have suggested that a 
registration requirement for firms operating ATSs and not otherwise 
registered with the Commission would enhance the Commission's oversight 
capabilities. Additionally, a registration requirement may allow for 
wider implementation of some or all of the pre-trade controls and risk 
management tools discussed in this Concept Release and currently 
deployed in various degrees in the market today.
    In considering the registration of specific entities using ATSs and 
not otherwise registered with the Commission, the ``floor broker'' 
definition in CEA 1a(23), in pertinent part, states that, in general, 
the term ``floor trader'' means any person who, in or surrounding any 
pit, ring, post or other place provided by a contract market for the 
meeting of person similarly engaged, purchases, or sells solely for 
such person's own account.\102\
---------------------------------------------------------------------------

    \102\ See CEA section 1a(23), as amended by section 721 of the 
Dodd-Frank Act; 7 U.S.C. 1a(23) (emphasis added).
---------------------------------------------------------------------------

    In addition to seeking input on whether it would be beneficial to 
require registration, the Commission also requests specific public 
comments in response to the following questions:\103\
---------------------------------------------------------------------------

    \103\ In March 2013, the German parliament approved the HFT Act, 
which requires any firm using HFT strategies to become licensed as a 
financial services institution subject to the supervision of BaFin 
(Germany's banking regulator) or to passport an existing license 
granted by another member state of the European Economic Area. The 
licensing requirement includes ``indirect'' trading, meaning that it 
applies to foreign firms that are trading through a direct exchange 
member on a German-regulated market or a German multilateral trading 
facility. As a result of becoming licensed, HFT firms become subject 
to a general regulatory framework applicable to investment firms 
under German statutes, and specific organizational requirements 
applicable to HFT firms imposed by the HFT Act. See BaFin HFT Act 
Materials, supra note 17.
---------------------------------------------------------------------------

    78. Should firms operating ATSs in CFTC-regulated markets, but not 
otherwise registered with the Commission, be required to register with 
the CFTC? If so, please explain.
    79. Please identify the firm characteristics, trading practices, or 
technologies that could be used to trigger a registration requirement.
    80. Should all firms deploying ATS be required to register, and 
should there be different standards for firms deploying

[[Page 56561]]

HFT strategies? What are the appropriate thresholds levels below which 
registration would not be required?
    81. Since the floor trader distinction only addresses proprietary 
traders, please explain whether there is any other category of market 
participant, such as those deploying ATS or HFT strategies and trading 
on behalf of clients (aside from market participants already subject to 
Commission jurisdiction, such as Introducing Brokers and FCMs) that the 
Commission should consider with respect to potential registration 
requirements.
    82. Should software firms providing algorithms be required to 
register, and under what authority? What standards should apply to such 
firms?
    83. Please identify the functionalities discussed in this Concept 
Release that could be applied to floor brokers that operate ATSs. Are 
there any other controls not mentioned in this Concept Release that 
should be under consideration?
    84. Please supply any information or data that would help the 
Commission in deciding whether firms may or may not meet the definition 
of ``floor trader'' in Sec.  1a(23) of the Act.
    85. Do you believe that the registration of such firms as ``floor 
traders'' would effectuate the purposes of the CEA to deter and detect 
price manipulation or any other disruptions to market integrity?
    86. Considering the broad deployment of automated trading systems 
across both equities and derivatives markets, the Commission seeks to 
understand the appropriate level of coordination between itself and the 
SEC in defining and applying possible standards to the ATS and HFT 
trading space. How closely should the CFTC and SEC coordinate on 
possible rules and requirements for trading firms? The Commission also 
seeks public comment on the appropriate level of coordinated oversight 
between itself and relevant Self-Regulatory Organizations such as 
National Futures Association and FINRA.
    87. Using the Flash Crash as an example, is it important to have 
identical definitions and remedies in the case of ATS and HFT 
registration requirements or do the existing market controls, such as 
circuit breakers, provide the necessary market protections in both the 
equities and derivatives markets? If the rules are not coordinated, 
what impact would this have on market interaction and oversight?
    88. If trading venues apply mandatory functionalities to access 
derivatives markets, what benefit would a registration requirement 
provide to the Commission?
2. Market Quality Data
    The Commission is inquiring as to the advisability of requiring 
each trading platform to provide market quality indicators for each 
product traded on its platform at a regular frequency. Some metrics of 
the type below are currently calculated by exchanges, often at an 
account level, and provided to market participants. Some metrics are 
currently used in aid of various exchange programs (such as order 
efficiency programs). Other metrics are not currently used but may, 
nonetheless, provide the Commission and the public potentially useful 
information.
    The Commission envisions that increased transparency through the 
regular disclosure of market quality indicators will allow the 
Commission and market participants to better understand, among other 
things (1) The stability and efficiency of each market, (2) the degree 
of informed versus uninformed order flow, and (3) the nature and degree 
of liquidity in each market. In addition, the transparency provided by 
these metrics may better enable market participants to manage their 
ATSs in ways that further promote market stability and integrity.
    The Commission is interested in receiving comment on the usefulness 
of various market indicators that could be prepared for each contract. 
The list of indicators would, for a given product and tenor, include 
measures of: (1) Effective spreads; (2) order-to-fill ratios; (3) 
execution speeds by order type and order size; (4) average 
aggressiveness imbalances; (5) price impact for given trade sizes; 
\104\ (6) average order duration; \105\ (7) order efficiency; \106\ (8) 
rejection order ratios; (9) net position changes versus volume; \107\ 
(10) branching ratios; \108\ (11) volume imbalance and trade intensity; 
\109\ (12) Herfindahl-Hirschman Indexes based on market share of open 
positions under common control; and (13) metrics on the number of price 
changing trades involving ATSs.\110\ Calculation methodologies for each 
of the measures would be consistent across exchanges in order to ensure 
compatibility and comparability across market venues.\111\
---------------------------------------------------------------------------

    \104\ The size of the price change that would occur if specific 
sizes of market orders were executed at that instant.
    \105\ Average length of time that orders for a specific 
instrument remain in the book before being modified, filled, or 
cancelled.
    \106\ Notional value executed vs. notional value entered or 
modified.
    \107\ See CFTC Net Position Changes Data, available at http://www.cftc.gov/MarketReports/NetPositionChangesData/index.htm.
    \108\ See Vladimir Filimonov, David Bicchetti, Nicolas Maystre, 
& Didier Sornette, ``Quantification of the High Level of Endogeneity 
and of Structural Regime Shifts in Commodity Markets'' (Mar. 20, 
2013), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2237392.
    \109\ See David Easley, Marcos M. Lopez de Prado & Maureen 
O'Hara, ``Flow Toxicity and Liquidity in a High Frequency World'' 
(Feb. 20, 2012), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1695596.
    \110\ For a given market, such metrics would be calculated by 
identifying the relevant category of trader on trades that result in 
a price move from a previous trade and determining the percentage of 
those trades where an ATS was on one or both sides of the trade.
    \111\ SEC Rules 605 (Disclosure of Order Execution Information) 
and 606 (Disclosure of Order Routing Information) of Regulation NMS 
respectively require market centers (as defined in the rules) to 
make publicly available standardized, monthly reports of statistical 
information concerning their order executions and broker-dealers to 
make publicly available quarterly reports that, among other things, 
identify the venues to which customer orders are routed for 
execution. See 17 CFR 242.605 (formerly Securities Exchange Act Rule 
11Ac1-5) and 17 CFR 242.606 (formerly Securities Exchange Act Rule 
11Ac1-6).
---------------------------------------------------------------------------

    Several of the measures described in this Concept Release would 
provide additional information about market quality that market 
participants cannot derive exclusively from real-time order book 
information provided by each exchange. The Commission expects that 
market participants could use this additional information, together 
with information currently available in the order book, in order to 
better inform their trading efficiency and strategies and to mitigate 
adverse effects of their actions and other market participants' on the 
market. Further, the Commission expects that these measures could be 
used to help understand changes in market quality. In addition, the 
Commission believes that providing consistent measures of market 
quality across exchanges would promote market efficiency through 
transparency and market competition.
    To clarify what costs and benefits these market metrics may provide 
to participants, the Commission requests comment to the questions 
below, including that, if these metrics are beneficial, the appropriate 
frequency of publication.
    89. What market quality indicators are in place today? Please 
describe the metrics, how and where they are deployed, and how market 
participants access these indicators and at what cost.
    90. What value would each of the market quality metrics described 
above provide to market participants receiving them? If possible, 
please be specific about how each market quality measure could be used 
to enhance reliability and risk management of ATSs.

[[Page 56562]]

    91. Conversely, could any of the market quality metrics described 
above be used by market participants to manipulate the order book,\112\ 
to identify competitors' trading strategies, or to engage in other 
trading activities that do not contribute to effective risk management 
and efficient discovery the traded asset's economic value? If so, 
please provide specific information regarding how such information 
could be misused. If possible, please provide recommendations regarding 
steps the Commission could take to prevent misuse.
---------------------------------------------------------------------------

    \112\ Meaning, behaviors that, while not strictly illegal, are 
used to advantage one's own orders in ways that do not contribute to 
efficient price discovery.
---------------------------------------------------------------------------

    92. Are there additional market quality metrics that the Commission 
should contemplate requiring exchanges to provide? If so, what value 
would they provide and how would they be used?
    93. If the Commission determines that measures should be calculated 
in the same way by various exchanges in order to provide comparable 
measures of market quality, then how, specifically, should each of the 
above mentioned metrics be calculated in order to ensure that they are 
most valuable to market participants?
    94. What timing and mode of dissemination is appropriate for each 
metric? For example, should measures be provided as daily averages?
    95. Does the liquidity of a given market impact which market 
quality metrics would be reliable and useful when calculated for that 
market? If so, which metrics are inapplicable in less liquid markets, 
and why? What liquidity measures and thresholds are relevant to 
determining which metrics should apply to a given market?
3. Market Quality Incentives
    The impact of ATSs, and particularly those implementing HFT 
strategies, is a topic of ongoing interest among researchers, market 
participants and others. Several studies have found that increases in 
automated trading are associated with improved market quality.\113\ 
Some researchers and market participants, however, have also noted that 
the presence of HFT has the potential to shape the types of liquidity 
providers available in a market,\114\ may discourage ATSs from 
submitting resting orders that remain in the order book long enough for 
humans to react, and may also be associated with undesirable trading 
practices that are more easily implemented by automated systems.\115\ 
Various recommendations have been advanced to promote the benefits of 
HFT while simultaneously disincentivizing trading strategies that do 
not contribute to efficient price discovery.\116\
---------------------------------------------------------------------------

    \113\ See Jonathan Brogaard, Terrence Hendershott & Ryan 
Riordan, ``High Frequency Trading and Price Discovery'' (Apr. 22, 
2013), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1928510; Hasbrouck & Saar, supra note 18; 
Terrence Hendershott, Charles Jones & Albert Menkveld, ``Does 
Algorithmic Trading Improve Liquidity?'' Journal of Finance, Vol. 66 
at 1-33 (August 30, 2010), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1100635.
    \114\ See J. Doyne Farmer & Spyros Skouras, ``An Ecological 
Perspective on the Future of Computer Trading,'' Quantitative 
Finance (2013); IOSCO Report on Regulatory Issues Raised by 
Technological Changes, supra note 4; William Barker & Anna 
Pomeranets, ``The Growth of High-Frequency Trading: Implications for 
Financial Stability,'' Bank of Canada Financial System Review (June 
2011), available at http://www.bankofcanada.ca/2012/01/publications/periodicals/fsr-article/the-growth-of-high-frequency-trading/.
    \115\ See Farmer & Skouras, supra note 114; Eric Budish, Peter 
Cramton & John Shim, ``The High-Frequency Trading Arms Race: 
Frequent Batch Auctions as a Market Design Response'' (July 7, 
2013), available at http://faculty.chicagobooth.edu/eric.budish/research/HFT-FrequentBatchAuctions.pdf; John McPartland, 
``Recommendations for Equitable Allocation of Trades in High 
Frequency Trading Environments'' (July 25, 2013), available at 
http://www.chicagofed.org/Webpages/publications/policy_discussion_papers/2013/pdp_1.cfm.
    \116\ See McPartland, supra note 115.
---------------------------------------------------------------------------

    Those recommendations include for example, utilizing a trade 
allocation formula that is an intermediate between a cardinal ranking 
(time-weighted), Pro Rata allocation formula and a Price/Time 
allocation formula. This would be intended to reward market makers for 
leaving resting orders in the order book for a longer period of time, 
rather than simply for being first in the order book at a given price. 
Second, create a new limit order type that would prioritize orders that 
remain resting in the order book for some minimum amount of time. 
Third, require orders that are not fully visible in the order book 
(e.g., iceberg orders) to go to the end of the queue (within limit 
price) with respect to trade allocation. Fourth, aggregate multiple, 
small orders from the same legal entity entered contemporaneously at 
the same price level and assign them the lowest priority time stamp of 
all such. Fifth, require exchanges to use batch auctions once per half 
second at random times rather than use continuous trade matching.\117\ 
Lastly, limit visibility into the order book to aggregate size 
available at a limit price. This would help to ensure that automated 
traders are placing orders based on their knowledge of the economic 
value of the asset being traded rather than their knowledge of order 
book dynamics or of other market participants' trading patterns.
---------------------------------------------------------------------------

    \117\ See Budish, supra note 115; J. Doyne Farmer & Spyros 
Skouras, ``Review of the Benefits of a Continuous Market vs. 
Randomised Stop Auctions and of Alternative Priority Rules (Policy 
Options 7 and 12),'' Foresight U.K. Government Office for Science, 
Economic Impact Assessment (2013), available at http://www.bis.gov.uk/assets/foresight/docs/computer-trading/12-1072-eia11-continuous-market-vs-randomised-stop-auctions.pdf.
---------------------------------------------------------------------------

    96. Should exchanges impose a minimum time period for which orders 
must remain on the order book before they can be withdrawn? If so, 
should this minimum resting time requirement apply to orders of all 
sizes or be restricted to orders smaller than a specific threshold? If 
there should be a specific threshold, how should that threshold be 
determined?
    97. The Commission seeks to understand where time-weighted Pro Rata 
trade allocation is currently being utilized and what the effects have 
been. Please note examples from exchanges and, to the extent possible, 
please comment on the impact that such matching algorithms have had on 
the amount of time resting orders are left in the order book, as well 
as on other aspects of market quality.
    98. If exchanges aggregated multiple, small orders entered by the 
same entity with the intent of abusing rounding conventions to gain a 
disproportionate share of allocations, what criteria should exchanges 
use to distinguish such orders from those that are entered by the same 
legal entity for legitimate trading purposes? Are there empirical 
patterns that could be used to reliably identify such manipulative 
intent?
    99. Would batched order processing increase the number of 
milliseconds that are necessary for correlations among related 
securities to be established? If so, what specific costs would result 
from this change and how do those costs compare to the potential 
benefits described in recent research?
    100. What costs and benefits result from providing market 
participants with real-time access to information about the order book 
that extends beyond aggregate size available at a limit price? Is there 
a legitimate economic benefit that results from market participants 
(both human participants, and ATSs) accessing such information? Is it 
possible for market participants to use such information to manipulate 
the order book?
    101. The Commission seeks to understand whether any of the 
recommendations above are inapplicable or irrelevant to markets subject 
to the CEA. If so, please indicate which recommendation(s) and what 
makes it inapplicable or irrelevant to those markets.

[[Page 56563]]

4. Policies and Procedures To Identify ``Related Contracts''
    Rule 38.255 of the Commission's regulations require DCMs to 
establish and maintain risk controls for trading.\118\ Appendix B to 
the Part 38 regulations provides the following guidance on such risk 
controls: If a contract is linked to, or is a substitute for, other 
contracts, either listed on [the DCM's] market or on other trading 
venues, the designated contract market must, to the extent practicable, 
coordinate its risk controls with any similar controls placed on those 
other contracts.\119\ The guidance contained in the appendix further 
provides that, to the extent practicable, DCMs should coordinate not 
only with other DCMs, but national security exchanges as well.\120\ 
These measures could protect against market disruptions cascading from 
one trading platform to the next.
---------------------------------------------------------------------------

    \118\ See 17 CFR 38.255.
    \119\ See DCM Final Rules, 77 FR at 36718.
    \120\ See id.
---------------------------------------------------------------------------

    102. If you are a DCM, please address whether you have (i) 
identified all contracts that are linked to, or are a substitute for, 
other contracts either listed on your market or on other trading 
venues; and, if so, (ii) coordinated your risk controls with any 
similar controls placed on those other contracts. If you have not 
identified such contracts and coordinated risk controls on such 
contracts, please address any other means by which you are addressing 
risk controls applicable to contracts that are linked to, or are a 
substitute for, other contracts listed on your exchange or on other 
trading venues.
    103. Please explain whether it would be beneficial for exchanges to 
develop and document policies and procedures for regularly reviewing 
contracts on other exchanges in order to identify those that are 
``linked to'' or that are ``a substitute for'' contracts listed on its 
own market.
5. Standardize and Simplify Order Types
    This Concept Release inquires about the possible standardization 
and simplification of order types that have complex logic embedded 
within them. A proliferation of order types, both within and across 
exchanges, can result in a similar increase in both the expected and 
unexpected responses of automated systems to order and trade signals. 
As of November 2012, for example, it was reported that BATS Global 
Markets alone listed more than 2,000 order types.\121\ A review of 
current and proposed order types could be performed with the goal of 
consolidating and simplifying order types.\122\ A proliferation of 
complex order types leads to complex testing scenarios. Therefore, it 
is possible that consolidation of order types could reduce the 
potential for instability resulting from unexpected interactions of 
multiple ATSs using multiple means of execution within the order 
book.\123\
---------------------------------------------------------------------------

    \121\ See Peter Chapman, ``Too Many Order Types, Traders Fret,'' 
Traders Magazine (Nov. 2012), available at http://www.tradersmagazine.com/issues/25_344/order-types-equities-structure-110515-1.html.
    \122\ The SEC is currently in the process of reviewing order 
types within securities markets. See Scott Patterson & Jean 
Eaglesham, ``Exchanges Retreat on Trading Tools,'' Wall St. J. (Oct. 
24, 2012) (quoting former Chairwoman of the SEC, Mary Schapiro: ``I 
worry about the complexity in the market, I worry about the 
profusion of order types, I worry about the fragmentation.''), 
available at http://online.wsj.com/article/SB10001424052970203400604578074963881803302.html. See also SEC 
Roundtable Transcript, supra note 2, at 96-99.
    \123\ See SEC Roundtable Transcript, supra note 2, at 96 (``It 
is the proliferation of all these order types and the complexity of 
these order types that is adding unnecessary complexity to the 
market, which is already an extremely complex system as it is . . . 
when you have complex order types, it leads to extremely complex 
testing scenarios, and you are not going to pick up all the things 
you could or should because you don't know what that actual matching 
engine logic is in general.'').
---------------------------------------------------------------------------

    104. Please explain whether the standardization and simplification 
of order types that have complex logic embedded within them would 
reduce the potential for instability and other market disruptions. If 
not, what other measures could achieve the same effect?
    105. If the Commission were to consider the standardization and 
simplification of order types in a future rulemaking, please identify 
who should conduct this review (i.e., the Commission, trading 
platforms, or other parties).

G. General Questions Regarding All Risk Controls Discussed Above

    Finally, the Commission requests comment on the following general 
questions, with respect to each of the risk controls discussed above:
    106. For each of the specified controls described above [see 
sections III.C-F], please indicate whether you are already using the 
control on customer and/or proprietary orders. If applicable, please 
also indicate how widely you believe the control is currently being 
used in the market, and how consistent the application of the control 
is among firms.
    107. If possible, please indicate specific costs associated with 
implementing each of the risk controls described above [see sections 
III.C-F]. Please include detailed estimates, distinguishing between the 
cost of developing the functionality, the cost of implementation, and 
the cost of ongoing operations.
    108. Please describe the specific benefits associated with each of 
the risk controls. Where possible, please indicate the market 
participant category(ies) to which the benefit would accrue.
    109. Please comment on the appropriate order of implementation and 
timeline for each risk control, including any distinctions that should 
be made based on the category of registrant or market participant 
implementing the same or similar control, whether the market 
participant is using DMA, and whether implementation is already in 
place for certain categories.
    110. Are any of the risk controls unnecessary, impractical for 
commercial or technological reasons, or inadvisable? If so, please note 
the control and provide reasons why.
    111. A number of the pre-trade risk controls contemplated above are 
similar protections at distinct points in the life of an order.
    a. Please comment on the utility of redundant pre-trade risk 
controls and the desirability of risk control systems in which controls 
are placed at one or more than one focal points.
    b. If pre-trade risk controls should reside at one or more than one 
focal point, then please identify, for each risk control, what that 
focal point should be?
    112. Are there risk controls that should be implemented across 
multiple entity types? If so, which controls and for which types of 
entities should they apply? Also, please comment generally on the 
factors the Commission should consider when determining the appropriate 
entity(ies) upon which to place a risk control requirement that could 
pertain to more than one entity.
    113. Are there controls that should not be considered for 
overlapping implementation across exchanges, clearing members and 
market participants? If so, please explain which ones and why.
    114. Each of the risk controls is described in general, principles-
based terms. Should the Commission specify more granular or specific 
requirements with respect to any of the controls to improve their 
effectiveness or provide greater clarity to industry participants? If 
so, please identify the relevant control and the additional granularity 
or specificity that the Commission should provide. Are any of the 
controls, as

[[Page 56564]]

currently drafted, inadequate to achieve the desired risk-reduction?
    115. To the extent that there is any need to standardize or provide 
greater specificity regarding any measures discussed in this Concept 
Release, including those that reflect industry best practices, please 
describe the best approach to achieve such standardization (i.e., 
through Commission regulation, Commission-sponsored committee or 
working group, or some other method).
    116. How should risk control monitoring be implemented? Should 
compliance be audited by internal and external parties? For each 
control, please identify the appropriate entity(ies) to monitor 
compliance with the control. Also, please describe what an acceptable 
compliance audit would entail for each control.
    117. Are there additional controls that should be considered, or 
other methods that could serve as alternatives to those described above 
[see sections III.C-F]? If so, please describe the control, its costs 
and benefits, the appropriate entity(ies) to implement such control, 
and whether there is any distinction to be drawn in the case of DMA.
    118. Would any of the risk safeguards create a disincentive to 
innovate or create incentives to innovate in an irresponsible manner? 
If so, please identify the control, the concern raised, and how the 
control should be amended to address the concern. Responses should 
indicate how an amended risk control would still meet the Commission's 
objectives.
    119. Should the Commission consider any pre-trade risk controls, 
post-trade reports, or system safeguards appropriate exclusively to 
market makers or to ATSs used by market makers? If so, please describe 
such controls or safeguards.
    120. Should the Commission or Congress revisit its approach to 
issuing civil monetary penalties for violations of the Act, 
particularly as they relate to automated trading environments? 
Currently, the maximum civil monetary penalty the Commission may issue 
is capped at $140,000 ``per violation.'' Is such a civil monetary 
penalty sufficient to deter acts that constitute violations of the Act, 
given that an individual violation could impose costs to the market and 
the public well in excess of $140,000?
    121. Please describe the documentation (or categories of documents) 
that would demonstrate that a market participant operating an ATS has 
implemented each risk control addressed in this Concept Release, 
including, for example, computer code, system testing results, 
certification processes and results, and calculations.
    122. Would a fee (collected by, for example, the DCM or SEF) on 
numbers of messages exceeding a certain limit be more appropriate than 
a hard limit on the number or rate of messages?
    123. Should such a penalty be based on a specified number or rate 
of messages or on the ratio of messages to orders filled over a 
specified time period?
    124. Recent disruptive events in securities markets illustrate the 
importance of effective communication between exchanges' information 
technology systems. The Commission requests public comments regarding 
relevant systems in its regulated markets, including both DCMs and 
SEFs. What data transfers or other communications between exchanges are 
necessary for safe, orderly, and well-functioning derivatives markets? 
What additional measures, if any, would help promote the soundness of 
such systems (e.g., testing requirements, redundancy standards, etc.)?

IV. List of All Questions in the Concept Release

    Listed below are all questions raised in the preceding sections of 
this Concept Release.

High Frequency Trading

    1. In any rulemaking arising from this Concept Release, should the 
Commission adopt a formal definition of HFT? If so, what should that 
definition be, and how should it be applied for regulatory purposes?
    2. What are the strengths and weaknesses of the TAC working group 
definition of HFT provided above [see section II.A.1]? How should that 
definition be amended, if at all?
    3. The definition of HFT provided above uses ``recurring high 
message rates (orders, quotes or cancellations)'' as one of the 
identifying characteristics of HFT, and lists three objective measures 
((i) cancel-to-fill ratios; (ii) participant-to-market message ratios; 
or (iii) participant-to-market trade volume ratios) that could be used 
to measure message rates. Are these criteria sufficient to reliably 
distinguish between ATSs in general and ATSs using HFT strategies? What 
threshold values are appropriate for each of these measures in order to 
identify ``high message rates?'' Should these threshold values vary 
across exchanges and assets? If so, how?
    4. Should the risk controls for systems and firms that engage in 
HFT be different from those that apply to ATSs in general systems? If 
so, how?

Reductions in Latency

    5. Discussions on latency often focus on the how quickly an 
exchange processes orders, the time taken to submit orders, and how 
quickly a firm can observe prices of trades transacted on the exchange. 
The Commission is interested in understanding whether there are other 
types of messages transmitted between exchanges, firms and vendors 
wherein differences in latency could provide opportunities for 
informational advantage. Recent press reports have highlighted such 
advantages in the transmission of trade confirmations by a specific 
exchange. Are there other exchanges and trading venues where similar 
differences in latency exist? The Commission is interested in 
understanding whether the extent of latency in any such message 
transmission process can have an adverse impact on market quality or 
fairness. Should any exchanges, vendors and firms be required to audit 
their systems and process on a periodic process to identify and then 
resolve such latency?

Financial Integrity of the DCO

    6. Are there distinct pre-trade risk controls, including measures 
not listed below, or measures in addition to those already adopted by 
the Commission, that would be particularly helpful in protecting the 
financial integrity of a DCO?

Risk Controls Applicable in the Case of DMA

    7. Are there distinct pre-trade risk controls, including measures 
not listed below [see section III.C.], or measures in addition to those 
already adopted by the Commission, that should apply specifically in 
the case of DMA?

Message and Execution Throttles

    8. If, as contemplated above [see section III.C.1], maximum message 
rates and execution throttles were used as a mechanism to prevent 
individual entities or accounts from trading at speeds that are 
misaligned with their risk management capabilities, how should this 
message rate be determined?
    9. Message and execution throttles may be applied by trading firms 
(FCMs and proprietary trading firms), clearing firms, and by exchanges. 
The Commission requests public comment regarding the appropriate 
location for message and execution throttles.
    a. If throttles should be implemented at the trading firm level, 
should they be applied to all ATSs, only ATSs employing HFT strategies, 
or both?
    b. What role should clearing firms play in the operation or 
calibration of

[[Page 56565]]

throttles on orders submitted by the trading firms whose trades they 
guarantee?
    10. Should the message and execution throttles be based on market 
conditions, risk parameters, type of entity, or other factors?
    11. What thresholds should be used for each type of market 
participant in order to determine when a message or execution throttle 
should be used? Should these thresholds be set by the exchange or the 
market participant?
    12. Are message and execution thresholds typically set by contract, 
or by algorithm? What are the advantages and disadvantages to each 
method?
    13. Who should be charged with setting message rates for products 
and when they are activated?
    14. Would message and execution throttles provide additional 
protection in mitigating credit risk to DCOs?

Volatility Awareness Alerts

    15. The Commission is aware that alarms can be disruptive or 
counterproductive if ``false alarms'' outnumber accurate ones. How can 
volatility alarms be calibrated in order to minimize the risk that 
false alarms could interrupt trading or cause human monitors to ignore 
them over time?

Self-Trade Controls

    16. What specific practices or tools have been effective in 
blocking self-trades, and what are the costs associated with wide-
spread adoption of such practices or tools?
    17. Please indicate how widely you believe exchange-sponsored self-
trading controls are being used in the market.
    18. Should self-trade controls cancel the resting order(s)? Or, 
instead, should they reject the taking order that would have resulted 
in a self-trade? If applicable, please explain why one mechanism is 
more effective than the other.
    19. Should exchanges be required to implement self-trading controls 
in their matching engines? What benefits or challenges would result 
from such a requirement?
    20. Please explain whether regulatory standards regarding the use 
of self-trading control technology would provide additional protection 
to markets and market participants.
    21. If you believe that self-trading controls are beneficial, 
please describe the level of granularity at which such controls should 
operate (e.g., should the controls limit self-trading at the executing 
firm level? At the individual trader level?) What levels of granularity 
are practical or achievable?
    22. If you believe that self-trading controls are beneficial, 
please explain whether exchanges should require such controls for 
market participants and identify the categories of participants that 
should be subject to such controls. For example, should exchanges 
require self-trading controls for all participants, some types of 
participants, participants trading in certain contracts, or 
participants in market maker and/or incentive programs? What benefits 
or challenges would result from imposing such controls on each category 
of participant?

Price Collars

    23. The Commission is aware that some exchanges already have price 
collars in place for at least a portion of the contracts traded in 
their markets. Please comment on whether exchanges should utilize price 
collars on all contracts they list.
    24. Would price collars provide additional protection in mitigating 
credit risk to DCOs?

Maximum Order Sizes

    25. Are such controls typically applied to all contracts and 
customers, or on a more limited basis?
    26. Do exchanges allow clearing members to use the exchange's 
technology to set maximum order sizes for specific customers or 
accounts?
    27. Would additional standardization in the capabilities of this 
technology or more uniform application of this technology to all 
customers and contracts improve the effectiveness of such controls?
    28. To what extent are clearing firms and trading firms conducting 
pre-trade maximum order size screens? Please explain whether firms are 
conducting such screens by utilizing: (1) Their own technology; (2) the 
exchange's technology, or (3) a combination of both.
    29. Would regulatory standards regarding the use of such technology 
provide additional protection to the markets?

Trading Pauses

    30. Trading pauses, as currently implemented, can be triggered for 
multiple reasons. Are certain triggers more or less effective in 
mitigating the effects of market disruptions?
    31. Are there additional triggers for which pauses should be 
implemented? If so, what are they?
    32. What factors should the Commission or exchanges take into 
account when considering how to specify pauses or what thresholds 
should be used?
    33. How should the re-opening of a market after a trading pause be 
effected?

Credit Risk Limits

    34. What positions should be included in credit risk limit 
calculations in order to ensure that they are useful as a tool for 
limiting the activity of a malfunctioning ATS? Is it adequate for such 
a screen to include only those positions entered into by a particular 
ATS or should it include all the firm's positions?
    35. Should pre-trade credit screens require a full recalculation of 
margin based on the effect of the order?
    36. In light of your answers to the previous two questions, where 
in the lifecycle of an order should the credit limits be applied and 
what entity should be responsible for conducting such checks?
    37. If credit checks are conducted post-trade, what should be done 
when a trade causes a firm to exceed a limit?
    38. Please describe any technological limitations that the 
Commission should be aware of with respect to applying credit limits.
    39. The Commission is particularly interested to receive public 
comment on the ``hub'' model and its applicability to different types 
of pre-trade risk controls. What are the strengths and weaknesses of 
this approach relative to other pre-trade or post-trade approaches to 
checking trades against credit limits? How would the latency between 
the ``hub'' and the exchanges be managed to provide accurate limits for 
high frequency ATS?
    40. If you believe that post-trade credit checks would be an 
effective safeguard against malfunctioning ATSs, what is the maximum 
amount of latency that should be allowed for conducting such checks? 
What technological or information flow challenges would have to be 
addressed in order to implement post-trade checks with that degree of 
latency?
    41. With respect to any entity that you believe should be 
responsible for applying credit risk limits, please describe the 
technology necessary to implement that risk control and the cost of 
such technology.

Order, Trade and Position Drop Copy

    42. What order and trade reports are currently offered by DCMs and 
DCOs? What aspects of those reports are most valuable or necessary for 
implementing risk safeguards? Please also indicate whether the report 
is included as part of the exchange or clearing service, or whether an 
extra fee must be paid.
    43. If each order and trade report described above were to be 
standardized, please provide a detailed list of the appropriate content 
of the

[[Page 56566]]

report, and how long after order receipt, order execution, or clearing 
the report should be delivered from the trading platform to the 
clearing member or other market participant.

Trade Cancellation or Adjustment Policies

    44. Is a measure that would obligate exchanges to make error trade 
decisions (i.e., decisions to cancel a trade or to adjust its price) 
within a specified amount of time after an error trade is reported 
feasible? If so, what amount of time would be sufficient for exchanges, 
but would be sufficiently limited to help reduce risk for 
counterparties to error trades?
    45. Should exchanges develop detailed, pre-determined criteria 
regarding when they can adjust or cancel a trade, or should exchanges 
be able to exercise discretion regarding when they can adjust or cancel 
a trade? What circumstances make pre-determined criteria more effective 
or necessary than the ability to exercise discretion, and vice versa?
    46. Do error trade policies that favor price adjustment over trade 
cancellation effectively mitigate risk for market participants that are 
counterparties to error trades? Are there certain situations where 
canceling trades would mitigate counterparty risk more effectively? If 
so, what are they and how could such situations be identified reliably 
by the exchange in a short period of time?
    47. Should error trade policies be consistent across exchanges, 
either in whole or in part? If so, how would harmonization of error 
trade policies mitigate risks for market participants, or contribute to 
more orderly trading?

Order Cancellation Capabilities

    48. The Commission's discussion of kill switches assumes that 
certain benefits accrue to their use across exchanges, trading and 
clearing firms, and DCOs. Please comment on whether such redundant use 
of kill switches is necessary for effective risk control.
    49. What processes, policies, and procedures should exchanges use 
to govern their use of kill switches? Are there any different or 
additional processes, policies and procedures that should govern the 
use of kill switches that would specifically apply in the case of DMA?
    50. What processes, policies, and procedures should clearing firms 
use to govern their use of kill switches when using such a safeguard to 
cancel and prevent orders on behalf of one or more clients?
    51. What objective criteria regarding kill switch triggers, if any, 
should entities incorporate into their policies and procedures?
    52. What benefits or problems could result from standardizing 
processes, policies, and procedures related to kill switches across 
exchanges and/or clearing firms?
    53. Please explain how kill switches should be designed to prevent 
them from canceling or preventing the submission of orders that are 
actually risk reducing or that offset positions that have been entered 
by a malfunctioning ATS.
    54. The Commission requests comment regarding whether kill switches 
used by clearing firms already have or should have the following 
capabilities: (a) Distinguish client orders from proprietary orders; 
(b) distinguish among orders from individual clients; and (c) cancel 
working orders and prevent additional orders from one or more of the 
clearing firm's clients, or for all the clearing firm's proprietary 
accounts, without cancelling and preventing all orders from the 
clearing firm.
    55. The Commission is aware of proposals that would enable FCMs to 
establish credit limits for customers that are stored at a central 
``credit hub'' for the purpose of pre-trade credit checks. If such a 
model were implemented, is it possible that it could also be enabled 
with kill switches that cancel existing working orders and prevent 
additional orders from being submitted by one or more market 
participants? Should such an approach be designed to complement kill 
switches that are controlled by exchanges, clearing members, and 
trading firms, or to replace these kill switches? What benefits and 
drawbacks would result from each approach?

ATS Testing

    56. Please describe the necessary elements of an effective ATS 
testing regime, in connection with both the initial deployment and the 
modification of an ATS.
    57. With respect to testing of modifications, how should the 
Commission and market participants distinguish between major 
modifications and minor modifications? What are the objective criteria 
that can be used to make such distinctions? Should any testing regime 
applicable to ATS modifications distinguish between major and minor 
modifications, and if so, how?
    58. What challenges or benefits may result from exchanges 
implementing standardized procedures regarding the development, change 
management and testing of exchange systems? Please describe, if any, 
the types of standardized procedures that would be most effective.

Crisis Management Procedures

    59. Should basic crisis management procedures be standardized 
across market participants? If so, what elements should be addressed in 
an industry-wide standard?
    60. Are there specific, core requirements that should be included 
in any crisis management procedures? Similarly, are there specific 
types of crisis events that should be addressed in any crisis 
management procedures? If so, please identify such requirements and/or 
crisis events and the level of granularity or specificity that the 
procedures should have with respect to each.

Self-Certification and Clearing Firm Certification

    61. How often should a market participant certify that their pre-
trade risk controls, post-trade reports and other measures, and system 
safeguards meet the necessary standards?
    62. Which representative of the market participant should be 
required to attest that the certification standards have been met? 
Should it be the market participant's chief executive officer, chief 
compliance officer, or similar high-ranking corporate official, or some 
other individual?
    63. Which entity(ies) should receive certifications from market 
participants? For example, should it be the market participant's 
clearing firm, its designated self-regulatory organization (if 
applicable), one or more trading platforms, a registered futures 
association, the Commission, or other entity?
    64. Should DCMs, SEFs or clearing member firms be required to audit 
market participant certifications? What would be covered in an audit 
and how often should these audits occur? Should the same entity that 
receives the certification be required to perform the audit?

Risk Event Notification Requirements

    65. Do commenters believe that risk event notifications would help 
to better understand and ultimately reduce sources of risk in automated 
trading environments? What information should be contained in a risk 
event notification to maximize its value?
    66. What types of risk events should trigger reporting 
requirements, and what entities should receive risk event notifications 
from market participants operating ATSs?
    67. Which entities should receive risk event notifications?

[[Page 56567]]

ATS or Algorithm Identification

    68. Should the Commission define ATS or algorithm for purposes of 
any ATS identification system that may arise from this Concept Release? 
If so, how should ATS or algorithm be defined? Should a separate 
designation be reserved for high frequency trading algorithms and if 
so, what is the threshold difference?
    69. What are the existing practices within trading firms for 
internally identifying ATSs or algorithms and for tracking their 
performance, including profit and loss? What elements of existing 
practices could be leveraged in any ATS or algorithm identification 
system proposed by the Commission in the future?
    70. The Commission understands that an ATS may consist of numerous 
algorithms, each of which contributes to a trading decision. If an 
algorithm-based identification system is proposed, which of the 
potentially multiple algorithms that constitute an ATS should carry the 
ID? In addition, what degree of change to an algorithm should 
necessitate the use of a new ID, and how often does this change 
typically occur? What is the appropriate definition of ``algorithm'' 
for purposes of an algorithm identification system?
    71. If the identification system resides at the ATS level, how 
should such IDs be structured to ensure that they are nonetheless 
sufficiently granular to identify components that may be leading or 
have led to unstable market conditions?
    72. What message traffic between an ATS and a trading platform 
should include the ATS or algorithm ID (all messages, orders only, 
etc.)?
    73. What relationship should this ATS ID have to the legal entity 
identifier (LEI)?

Data Reasonability Checks

    74. Please describe existing practices in the industry concerning 
how and the extent to which ATSs use (1) market data; and (2) news and 
information providers, including social media, to inform trading 
decisions.
    75. The Commission requests comment regarding any risk controls, 
including reasonability checks, currently being used by market 
participants operating ATSs to review market data and news and 
information providers, including social media. Please describe the risk 
control, including the purpose of the control, the extent of its use 
among derivatives market participants, and any other aspects of the 
risk control that you believe would be helpful for the Commission to 
understand.
    76. The Commission requests public comment concerning the lock-up 
process for government economic reports, and any additional measures 
that might be taken to protect against inappropriate disclosure.
    77. Please describe the extent to which potentially market-moving 
data from non-governmental economic reports can be obtained prior to 
its public release for a fee. Are there specific reports or types of 
reports for which early disclosure should not be permitted? What 
process should be used for identifying non-governmental economic 
reports whose early release should not be permitted? Should the data 
release process for such reports be similar to the data lock-up process 
implemented for the release of government economic data?

Registration of Firms Operating ATSs

    78. Should firms operating ATSs in CFTC-regulated markets, but not 
otherwise registered with the Commission, be required to register with 
the CFTC? If so, please explain.
    79. Please identify the firm characteristics, trading practices, or 
technologies that could be used to trigger a registration requirement.
    80. Should all firms deploying ATS be required to register, and 
should there be different standards for firms deploying HFT strategies? 
What are the appropriate thresholds levels below which registration 
would not be required?
    81. Since the floor trader distinction only addresses proprietary 
traders, please explain whether there is any other category of market 
participant, such as those deploying ATS or HFT strategies and trading 
on behalf of clients (aside from market participants already subject to 
Commission jurisdiction, such as Introducing Brokers and FCMs) that the 
Commission should consider with respect to potential registration 
requirements.
    82. Should software firms providing algorithms be required to 
register, and under what authority? What standards should apply to such 
firms?
    83. Please identify the functionalities discussed in this Concept 
Release that could be applied to floor brokers that operate ATSs. Are 
there any other controls not mentioned in this Concept Release that 
should be under consideration?
    84. Please supply any information or data that would help the 
Commission in deciding whether firms may or may not meet the definition 
of ``floor trader'' in Sec.  1a(23) of the Act.
    85. Do you believe that the registration of such firms as ``floor 
traders'' would effectuate the purposes of the CEA to deter and detect 
price manipulation or any other disruptions to market integrity?
    86. Considering the broad deployment of automated trading systems 
across both equities and derivatives markets, the Commission seeks to 
understand the appropriate level of coordination between itself and the 
SEC in defining and applying possible standards to the ATS and HFT 
trading space. How closely should the CFTC and SEC coordinate on 
possible rules and requirements for trading firms? The Commission also 
seeks public comment on the appropriate level of coordinated oversight 
between itself and relevant Self-Regulatory Organizations such as 
National Futures Association and FINRA.
    87. Using the Flash Crash as an example, is it important to have 
identical definitions and remedies in the case of ATS and HFT 
registration requirements or do the existing market controls, such as 
circuit breakers, provide the necessary market protections in both the 
equities and derivatives markets? If the rules are not coordinated, 
what impact would this have on market interaction and oversight?
    88. If trading venues apply mandatory functionalities to access 
derivatives markets, what benefit would a registration requirement 
provide to the Commission?

Market Quality Data

    89. What market quality indicators are in place today? Please 
describe the metrics, how and where they are deployed, and how market 
participants access these indicators and at what cost.
    90. What value would each of the market quality metrics described 
above [see section III.F.2] provide to market participants receiving 
them? If possible, please be specific about how each market quality 
measure could be used to enhance reliability and risk management of 
ATSs.
    91. Conversely, could any of the market quality metrics described 
above [see section III.F.2] be used by market participants to 
manipulate the order book, to identify competitors' trading strategies, 
or to engage in other trading activities that do not contribute to 
effective risk management and efficient discovery the traded asset's 
economic value? If so, please provide specific information regarding 
how such information could be misused. If possible, please provide 
recommendations regarding steps the Commission could take to prevent 
misuse.

[[Page 56568]]

    92. Are there additional market quality metrics that the Commission 
should contemplate requiring exchanges to provide? If so, what value 
would they provide and how would they be used?
    93. If the Commission determines that measures should be calculated 
in the same way by various exchanges in order to provide comparable 
measures of market quality, then how, specifically, should each of the 
above mentioned metrics be calculated in order to ensure that they are 
most valuable to market participants?
    94. What timing and mode of dissemination is appropriate for each 
metric? For example, should measures be provided as daily averages?
    95. Does the liquidity of a given market impact which market 
quality metrics would be reliable and useful when calculated for that 
market? If so, which metrics are inapplicable in less liquid markets, 
and why? What liquidity measures and thresholds are relevant to 
determining which metrics should apply to a given market?

Market Quality Incentives

    96. Should exchanges impose a minimum time period for which orders 
must remain on the order book before they can be withdrawn? If so, 
should this minimum resting time requirement apply to orders of all 
sizes or be restricted to orders smaller than a specific threshold? If 
there should be a specific threshold, how should that threshold be 
determined?
    97. The Commission seeks to understand where time-weighted Pro Rata 
trade allocation is currently being utilized and what the effects have 
been. Please note examples from exchanges and, to the extent possible, 
please comment on the impact that such matching algorithms have had on 
the amount of time resting orders are left in the order book, as well 
as on other aspects of market quality.
    98. If exchanges aggregated multiple, small orders entered by the 
same entity with the intent of abusing rounding conventions to gain a 
disproportionate share of allocations, what criteria should exchanges 
use to distinguish such orders from those that are entered by the same 
legal entity for legitimate trading purposes? Are there empirical 
patterns that could be used to reliably identify such manipulative 
intent?
    99. Would batched order processing increase the number of 
milliseconds that are necessary for correlations among related 
securities to be established? If so, what specific costs would result 
from this change and how do those costs compare to the potential 
benefits described in recent research?
    100. What costs and benefits result from providing market 
participants with real-time access to information about the order book 
that extends beyond aggregate size available at a limit price? Is there 
a legitimate economic benefit that results from market participants 
(both human participants, and ATSs) accessing such information? Is it 
possible for market participants to use such information to manipulate 
the order book?
    101. The Commission seeks to understand whether any of the 
recommendations above [see section III.F.3] are inapplicable or 
irrelevant to markets subject to the CEA. If so, please indicate which 
recommendation(s) and what makes it inapplicable or irrelevant to those 
markets.

Policies and Procedures To Identify ``Related Contracts''

    102. If you are a DCM, please address whether you have (i) 
identified all contracts that are linked to, or are a substitute for, 
other contracts either listed on your market or on other trading 
venues; and, if so, (ii) coordinated your risk controls with any 
similar controls placed on those other contracts. If you have not 
identified such contracts and coordinated risk controls on such 
contracts, please address any other means by which you are addressing 
risk controls applicable to contracts that are linked to, or are a 
substitute for, other contracts listed on your exchange or on other 
trading venues.
    103. Please explain whether it would be beneficial for exchanges to 
develop and document policies and procedures for regularly reviewing 
contracts on other exchanges in order to identify those that are 
``linked to'' or that are ``a substitute for'' contracts listed on its 
own market.

Standardize and Simplify Order Types

    104. Please explain whether the standardization and simplification 
of order types that have complex logic embedded within them would 
reduce the potential for instability and other market disruptions. If 
not, what other measures could achieve the same effect?
    105. If the Commission were to consider the standardization and 
simplification of order types in a future rulemaking, please identify 
who should conduct this review (i.e., the Commission, trading 
platforms, or other parties).

General Questions Regarding All Risk Controls

    106. For each of the specified controls described above [see 
sections III.C-F], please indicate whether you are already using the 
control on customer and/or proprietary orders. If applicable, please 
also indicate how widely you believe the control is currently being 
used in the market, and how consistent the application of the control 
is among firms.
    107. If possible, please indicate specific costs associated with 
implementing each of the risk controls described above [see sections 
III.C-F]. Please include detailed estimates, distinguishing between the 
cost of developing the functionality, the cost of implementation, and 
the cost of ongoing operations.
    108. Please describe the specific benefits associated with each of 
the risk controls. Where possible, please indicate the market 
participant category(ies) to which the benefit would accrue.
    109. Please comment on the appropriate order of implementation and 
timeline for each risk control, including any distinctions that should 
be made based on the category of registrant or market participant 
implementing the same or similar control, whether the market 
participant is using DMA, and whether implementation is already in 
place for certain categories.
    110. Are any of the risk controls unnecessary, impractical for 
commercial or technological reasons, or inadvisable? If so, please note 
the control and provide reasons why.
    111. A number of the pre-trade risk controls contemplated above are 
similar protections at distinct points in the life of an order.
    a. Please comment on the utility of redundant pre-trade risk 
controls and the desirability of risk control systems in which controls 
are placed at one or more than one focal points.
    b. If pre-trade risk controls should reside at one or more than one 
focal point, then please identify, for each risk control, what that 
focal point should be?
    112. Are there risk controls that should be implemented across 
multiple entity types? If so, which controls and for which types of 
entities should they apply? Also, please comment generally on the 
factors the Commission should consider when determining the appropriate 
entity(ies) upon which to place a risk control requirement that could 
pertain to more than one entity.
    113. Are there controls that should not be considered for 
overlapping implementation across exchanges, clearing members and 
market participants? If so, please explain which ones and why.

[[Page 56569]]

    114. Each of the risk controls is described in general, principles-
based terms. Should the Commission specify more granular or specific 
requirements with respect to any of the controls to improve their 
effectiveness or provide greater clarity to industry participants? If 
so, please identify the relevant control and the additional granularity 
or specificity that the Commission should provide. Are any of the 
controls, as currently drafted, inadequate to achieve the desired risk-
reduction?
    115. To the extent that there is any need to standardize or provide 
greater specificity regarding any measures discussed in this Concept 
Release, including those that reflect industry best practices, please 
describe the best approach to achieve such standardization (i.e., 
through Commission regulation, Commission-sponsored committee or 
working group, or some other method).
    116. How should risk control monitoring be implemented? Should 
compliance be audited by internal and external parties? For each 
control, please identify the appropriate entity(ies) to monitor 
compliance with the control. Also, please describe what an acceptable 
compliance audit would entail for each control.
    117. Are there additional controls that should be considered, or 
other methods that could serve as alternatives to those described above 
[see sections III.C-F]? If so, please describe the control, its costs 
and benefits, the appropriate entity(ies) to implement such control, 
and whether there is any distinction to be drawn in the case of DMA.
    118. Would any of the risk safeguards create a disincentive to 
innovate or create incentives to innovate in an irresponsible manner? 
If so, please identify the control, the concern raised, and how the 
control should be amended to address the concern. Responses should 
indicate how an amended risk control would still meet the Commission's 
objectives.
    119. Should the Commission consider any pre-trade risk controls, 
post-trade reports, or system safeguards appropriate exclusively to 
market makers or to ATSs used by market makers? If so, please describe 
such controls or safeguards.
    120. Should the Commission or Congress revisit its approach to 
issuing civil monetary penalties for violations of the Act, 
particularly as they relate to automated trading environments? 
Currently, the maximum civil monetary penalty the Commission may issue 
is capped at $140,000 ``per violation.'' Is such a civil monetary 
penalty sufficient to deter acts that constitute violations of the Act, 
given that an individual violation could impose costs to the market and 
the public well in excess of $140,000?
    121. Please describe the documentation (or categories of documents) 
that would demonstrate that a market participant operating an ATS has 
implemented each risk control addressed in this Concept Release, 
including, for example, computer code, system testing results, 
certification processes and results, and calculations.
    122. Would a fee (collected by, for example, the DCM or SEF) on 
numbers of messages exceeding a certain limit be more appropriate than 
a hard limit on the number or rate of messages?
    123. Should such a penalty be based on a specified number or rate 
of messages or on the ratio of messages to orders filled over a 
specified time period?
    124. Recent disruptive events in securities markets illustrate the 
importance of effective communication between exchanges' information 
technology systems. The Commission requests public comments regarding 
relevant systems in its regulated markets, including both DCMs and 
SEFs. What data transfers or other communications between exchanges are 
necessary for safe, orderly, and well-functioning derivatives markets? 
What additional measures, if any, would help promote the soundness of 
such systems (e.g., testing requirements, redundancy standards, etc.)?

V. Appendices (Specific Measures in Bold Font)

A. Pre-Trade Risk Controls

----------------------------------------------------------------------------------------------------------------
                                           Party(s) to implement risk
    Potential pre-trade risk control                control                       Substance of control
----------------------------------------------------------------------------------------------------------------
1a. Maximum Message Rate (Message         Market Participants          1a. Market participants operating ATSs
 Throttle).                                Operating ATSs, Trading      must establish a maximum message rate
                                           Platforms, and Clearing      per unit time for each ATS. This control
                                           Firms.                       should be calibrated to address the
                                                                        potential for unintended message flow
                                                                        (including orders) from a malfunctioning
                                                                        ATS. Market participants' systems must
                                                                        prevent the submission of messages in
                                                                        excess of the specified rate.
                                                                       Trading platforms' systems must prevent
                                                                        the acceptance of messages in excess of
                                                                        their own specified rates and must log
                                                                        instances when each ATS attempted to
                                                                        exceed such limits.
                                                                       Separately, trading platforms must
                                                                        establish systems enabling clearing
                                                                        firms to set rate limits directly at the
                                                                        trading platform. Trading platforms,
                                                                        clearing firms and market participants
                                                                        may set rates independently of each
                                                                        other.
                                                                       In all cases, human monitors must be
                                                                        alerted when limits are breached.
1b. Maximum Execution Rate (Execution     Market Participants          1b. Market participants operating ATSs
 Throttle).                                Operating ATSs, Trading      must establish a limit on the maximum
                                           Platforms, and Clearing      number of orders that each of their ATSs
                                           Firms.                       can execute in a given direction per
                                                                        unit time. The limit should be unique to
                                                                        each ATS and should be calibrated to
                                                                        address the potential for unintended
                                                                        executions arising from a malfunctioning
                                                                        ATS. Additional orders in excess of the
                                                                        limit should not be submitted or
                                                                        executed.
                                                                       Trading platforms must establish a
                                                                        maximum number of orders in the same
                                                                        direction they will execute per unit
                                                                        time from a uniquely identified ATS, and
                                                                        must prevent execution of trades that
                                                                        would violate this limit.
                                                                       Separately, trading platforms must
                                                                        establish systems enabling clearing
                                                                        firms to set per-customer message rate
                                                                        limits directly at the trading platform.
                                                                        Trading platforms, clearing firms and
                                                                        market participants may set rates
                                                                        independently of each other.

[[Page 56570]]

 
2. Volatility Awareness Alerts..........  Market Participants          Market participants operating ATSs must
                                           Operating ATSs.              implement automated solutions to
                                                                        immediately notify system supervisors
                                                                        when the prices of individual or groups
                                                                        of assets relevant to an ATS's trading
                                                                        strategies move either up or down by a
                                                                        given percentage within a predetermined
                                                                        period of time, or when the volume of
                                                                        individual or groups of assets relevant
                                                                        to an ATSs trading strategies over a
                                                                        specific period of time increase or
                                                                        decrease beyond a predetermined
                                                                        threshold. This control should help
                                                                        system supervisors identify market
                                                                        conditions which are not appropriate to
                                                                        the continued operation of a particular
                                                                        ATS or algorithm. The alert should be
                                                                        configurable by contract.
3. Self-Trade Controls..................  Trading Platforms and All    Trading platforms must provide, and all
                                           Market Participants.         market participants must apply,
                                                                        technologies to identify and limit the
                                                                        transmission of orders from their
                                                                        systems to a trading platform that would
                                                                        result in self-trades.
4. Price Collars........................  Trading Platforms and All    Trading platforms must assign a range of
                                           Market Participants.         acceptable order and execution prices
                                                                        for each of their products. All orders
                                                                        outside of this range would be
                                                                        automatically rejected, and orders
                                                                        already in the order book but outside of
                                                                        the acceptable range should not be
                                                                        elected by the matching engine.
                                                                       All market participants must establish
                                                                        similar product-specific price collars
                                                                        and should implement systems to ensure
                                                                        that orders outside of the collar are
                                                                        not transmitted to the relevant trading
                                                                        platform.
5. Maximum Order Size...................  Trading Platforms, Clearing  Trading platforms, clearing firms, and
                                           Firms, and All Market        all market participants must each
                                           Participants.                establish default maximum order sizes
                                                                        for orders submitted, transmitted, or
                                                                        processed by their systems.
                                                                       A market participant's systems must
                                                                        prevent the submission of orders in
                                                                        excess of its internally-specified
                                                                        limits. A clearing firm's systems must
                                                                        prevent the transmission of customer
                                                                        orders in excess of its limits for that
                                                                        customer. Trading platforms must prevent
                                                                        their systems from processing or
                                                                        executing orders in excess of the limit
                                                                        specified by the trading platform.
                                                                       In addition, for DMA customers, trading
                                                                        platforms must establish similar systems
                                                                        enabling clearing firms to set per-
                                                                        customer order size limits directly at
                                                                        the trading platform.
                                                                       Limits set by market participants,
                                                                        clearing firms, and trading platforms
                                                                        may be different from, and operate
                                                                        independently, of each other.
6. Trading Pauses.......................  Trading Platforms..........  Trading platforms would be required to
                                                                        institute trading pauses, similar in
                                                                        nature to stop-logic functionality, but
                                                                        covering a wider array of adverse states
                                                                        of an automated central limit order
                                                                        book.
7. Credit Risk Limits...................  Trading Platforms, Clearing  While some trading firms and FCMs conduct
                                           Firms and/or Market          post-trade credit checks with varying
                                           Participants Operating       degrees of latency and pre-trade credit
                                           ATSs.                        risk screens are already required
                                                                        pursuant to Commission regulations, the
                                                                        Commission seeks public comments
                                                                        regarding any additional measures that
                                                                        could help protect the financial
                                                                        integrity of DCOs, as well as additional
                                                                        input from the public regarding the
                                                                        appropriate location and timing in the
                                                                        order lifecycle for credit checks.
----------------------------------------------------------------------------------------------------------------

B. Post-Trade Reports and Other Post-Trade Measures

----------------------------------------------------------------------------------------------------------------
                                             Party(s) to implement
 Potential post-trade report or measure        report or measure             Substance of report or measure
----------------------------------------------------------------------------------------------------------------
8. Order Report (Post-order drop copy)..  Trading platforms..........  Trading platforms must provide a
                                                                        duplicate copy of each order to the
                                                                        originating market participant and to
                                                                        the market participant's clearing
                                                                        firm(s) simultaneously with such order's
                                                                        receipt by the trading platform.
9. Trade Report (Post-trade drop copy)..  Trading platforms..........  Trading platforms must provide a
                                                                        duplicate copy of each executed trade to
                                                                        the originating market participant and
                                                                        to the market participant's clearing
                                                                        firm(s) simultaneously with such trade's
                                                                        execution by the trading platform.
10. Position Report (Post-clearing drop   DCOs.......................  DCOs must provide net position per
 copy).                                                                 maturity per contract to the originating
                                                                        market participant and the market
                                                                        participant's clearing firm(s) as soon
                                                                        as the contract is matched at the
                                                                        clearinghouse.
11a. Uniform Adjust or Bust Error Trade   Trading platforms and All    11a. Trading platforms must establish
 Policies.                                 Market Participants.         policies for adjusting the price of
                                                                        trades or breaking trades that have been
                                                                        executed due to an error.
                                                                       Policies must favor price adjustments
                                                                        rather than trade cancellation. To the
                                                                        extent possible, policies must require
                                                                        decisions by the trading platform to be
                                                                        made on the basis of readily available
                                                                        objective criteria in order to
                                                                        facilitate rapid or immediate decisions.
11b. Standardized Reporting Window for    ...........................  11b. Market participants must report
 Error Trades.                                                          error trades to the trading platform
                                                                        within five minutes after the trades are
                                                                        executed.
                                                                       Trading platforms must notify market
                                                                        participants of a potential adjust-or-
                                                                        bust situation immediately.
                                                                       Trading platforms must make a decision
                                                                        and notify market participants of that
                                                                        decision within a specified period of
                                                                        time.
----------------------------------------------------------------------------------------------------------------


[[Page 56571]]

C. System Safeguards

----------------------------------------------------------------------------------------------------------------
                                             Party(s) to implement
       Potential system safeguard                  safeguard                     Substance of safeguard
----------------------------------------------------------------------------------------------------------------
CONTROLS OVER ORDER PLACEMENT...........  Trading Platforms, Clearing  Trading platforms, clearing members, and
                                           Firms, and All Market        market participants must have systems
                                           Participants.                and processes in place to:
     Order Cancellation Capabilities
 
12a. Auto-cancel on disconnect..........  ...........................  12a. Exchanges should implement a
                                                                        flexible system that allows a user to
                                                                        determine whether their orders should be
                                                                        left in the market upon disconnection.
                                                                        This should only be implemented if the
                                                                        clearing firm's risk manager has the
                                                                        ability to cancel working orders for the
                                                                        trader if the trading system is
                                                                        disconnected. The exchange should
                                                                        establish a policy whether the default
                                                                        setting for all market participants
                                                                        should be to maintain or to cancel all
                                                                        working orders.
12b. Selective working order              ...........................  12b. Immediately cancel one, multiple, or
 cancellation.                                                          all resting orders from a market
                                                                        participant as deemed necessary in an
                                                                        emergency situation.
12c. Kill switch........................  ...........................  12c. Immediately cancel all working
                                                                        orders, and the ability to prevent
                                                                        submission (market participant),
                                                                        transmittal (clearing member), or
                                                                        acceptance (trading platform) of any new
                                                                        orders from a market participant, or
                                                                        particular trader or ATS of such market
                                                                        participant.
13. Repeated Automated Execution          ...........................  13. Market participants operating ATSs
 Throttle.                                                              must establish a limit on the maximum
                                                                        number of orders that each ATS can
                                                                        submit. When an ATS reaches that maximum
                                                                        it must be automatically disabled until
                                                                        a human re-enables it.
14. System heartbeats (see section        ...........................  14. Trading platforms must provide, and
 III.E.1.a and footnote 90).                                            market participants operating ATSs must
                                                                        utilize, heartbeats that indicate proper
                                                                        connectivity between the trading
                                                                        platform and the ATS. Such heartbeats
                                                                        must also indicate the status of
                                                                        connectivity between an ATS and any
                                                                        systems used by the trading platform to
                                                                        provide the ATS with market data.
                                                                       If connectivity to any system is lost,
                                                                        the ATS should be disabled, and resting
                                                                        orders should be maintained or cancelled
                                                                        based on the pre-determined preferences
                                                                        of the firm that lost connectivity.
POLICIES AND PROCEDURES FOR THE DESIGN,   Market Participants          15a. Market participants operating ATSs
 TESTING, AND SUPERVISION OF ATSs          Operating ATSs.              must properly design their systems to
15a. ATS Design.........................                                avoid violations of the CEA, Commission
                                                                        regulations, or DCM and SEF rules
                                                                        related to fraud, disruptive trading
                                                                        practices, manipulation and trade
                                                                        practice violations. They must also
                                                                        ensure that their ATSs include all
                                                                        applicable pretrade risk controls and
                                                                        system safeguards as described herein.
15b. ATS Development and Change           Trading Platforms and        15b. Trading platforms and market
 Management.                               Market Participants          participants operating ATSs must
                                           Operating ATSs.              maintain a development environment that
                                                                        is adequately isolated from the
                                                                        production trading environment. The
                                                                        development environment may include
                                                                        computers, networks, and databases, and
                                                                        should be used by software engineers
                                                                        while developing, modifying, and testing
                                                                        source code.
                                                                       Firms must maintain a source code
                                                                        repository to manage source code access,
                                                                        persistence, and changes.
                                                                       Firms must establish and document
                                                                        procedures for communicating the
                                                                        functionality and requirements of, and
                                                                        changes to, their proprietary software.
                                                                        These procedures must include an audit
                                                                        trail of material changes that would
                                                                        allow them to determine, for each
                                                                        change: Who made it, when they made it,
                                                                        and what the purpose was for the change.
                                                                       Firms must have documented policies and
                                                                        procedures that allow representatives
                                                                        from trading, risk, and software
                                                                        management to approve changes and to
                                                                        verify internal testing before a new or
                                                                        modified trading system can be enable in
                                                                        production.
15c. ATS Testing........................  Trading Platforms and        15c. Market participants operating ATSs
                                           Market Participants          must test each ATS both internally and
                                           Operating ATSs.              on each trading platform on which an ATS
                                                                        will operate. Relevant tests include,
                                                                        but are not limited to, unit testing,
                                                                        functional testing (both integration and
                                                                        regression testing), non-functional
                                                                        testing, and acceptance testing.
                                                                        Functional testing must include all
                                                                        applicable pre-trade risk controls, post-
                                                                        trade reports and other measures and
                                                                        system safeguards. Non-functional
                                                                        testing must include testing under
                                                                        stressed market conditions.
                                                                       Market participants must perform such
                                                                        testing on each algorithm prior to
                                                                        initial deployment, and prior to re-
                                                                        deployment, after certain modifications
                                                                        to the algorithm.
                                                                       Trading Platforms must provide test
                                                                        environments that simulate the
                                                                        production trading environment so that
                                                                        market participants may conduct exchange-
                                                                        based conformance testing on their ATSs
                                                                        once they have completed internal
                                                                        testing. Conformance testing must
                                                                        include tests for all ATS risk
                                                                        mitigation controls that are able to be
                                                                        tested by the exchange.
                                                                       Exchange-based conformance testing must
                                                                        be done after certain modifications to
                                                                        the operating code.
15d. ATS Monitoring and Supervision.....  Market Participants          15d. Market participants operating ATSs
                                           Operating ATSs.              must ensure that their ATSs are subject
                                                                        to continuous real-time monitoring and
                                                                        supervision by trained and qualified
                                                                        staff at all times while engaged in
                                                                        trading.

[[Page 56572]]

 
                                                                       Appropriate supervision includes
                                                                        automated alerts when ATS order behavior
                                                                        breaches design parameters or when
                                                                        market conditions diverge from program
                                                                        expectations. It also includes automated
                                                                        alerts upon loss of network connectivity
                                                                        or data feeds.
                                                                       Monitoring and supervision staff must
                                                                        have the ability and authority to
                                                                        disengage the ATS and to cancel resting
                                                                        orders when system or market conditions
                                                                        require it, including the ability to
                                                                        contact trading platform staff to seek
                                                                        information and cancel orders. They must
                                                                        also have acceptable dashboards and
                                                                        control panels to monitor and interact
                                                                        with the ATS.
                                                                       Monitoring and supervision staff must
                                                                        record the time when they assume
                                                                        responsibility for an ATS and the time
                                                                        when they relinquish control to others.
                                                                        Recording must be achieved through
                                                                        distinct log-ins to the required control
                                                                        panel by each staff person. Log-in must
                                                                        also be subject to access controls that
                                                                        ensure the correct staff person is
                                                                        identified.
15e. Training for ATS Monitoring Staff    Market Participants          15e. Firms operating ATSs must develop
 (see section III(E)(2)(b) and footnote    Operating ATSs.              training for all staff involved in
 97).                                                                   monitoring or designing ATSs. Training
                                                                        must, at a minimum, cover design
                                                                        standards, event communication
                                                                        procedures, and requirements for
                                                                        notifying exchange and commission staff
                                                                        when risk events occur.
                                                                       Additionally, each firm must develop,
                                                                        document, and implement training
                                                                        policies that ensure human monitors are
                                                                        adequately trained for each new
                                                                        algorithm that is implemented. Training
                                                                        must include, at a minimum, the economic
                                                                        rationale for the algorithm and
                                                                        mechanics of the underlying process, as
                                                                        well as the automated and non-automated
                                                                        risk controls that are applicable to the
                                                                        algorithm.
15f. Crisis Management Procedures.......  Trading Platforms and        15f. Trading platforms and market
                                           Market Participants          participants operating ATSs must develop
                                           Operating ATSs.              and document procedures that direct the
                                                                        actions of ATS supervisors, exchange
                                                                        trading monitors, and support staff in
                                                                        the event that an algorithm malfunctions
                                                                        or responds to market signals in an
                                                                        unanticipated manner.
                                                                       Procedures should direct the process for
                                                                        evaluating, managing, and mitigating
                                                                        market disruption and firm risk. The
                                                                        procedures should also specify people to
                                                                        be notified in the event of an error
                                                                        that results in violations of risk
                                                                        profiles or potential violations of
                                                                        exchange or Commission rules.
SELF-CERTIFICATIONS AND NOTIFICATIONS
16a. Self-Certification and Clearing      Market Participants          16a. All firms operating ATSs must
 Firm Certification.                       Operating ATSs.              certify annually that their ATSs
                                                                        individually and collectively (i.e. at
                                                                        the algorithm, account, and firm levels)
                                                                        comply with all Commission and trading
                                                                        platform requirements regarding pre-
                                                                        trade risk controls and post-trade
                                                                        reports and other measures, as well as
                                                                        all applicable risk controls.
                                                                       Clearing firms must institute reasonable
                                                                        measures to confirm that their client
                                                                        trading firms implement the pre-trade
                                                                        risk controls that are required.
16b. Risk Event Notification              Market Participants          16b. Market participants operating ATSs
 Requirements.                             Operating ATSs, Trading      must notify the exchange, and the
                                           platforms.                   exchange must notify the Commission
                                                                        whenever an algorithm violates its
                                                                        design parameters or whenever risk
                                                                        control technologies or processes do not
                                                                        function as planned even if they do not
                                                                        result in destabilization of the
                                                                        markets. The exchange must also notify
                                                                        the Commission whenever any of its own
                                                                        risk management technologies or
                                                                        processes violate design parameters or
                                                                        do not function as planned.
17. ATS or Algorithm Identification.....  Market Participants          A unique identifier would be assigned to
                                           Operating ATSs.              each ATS or algorithm, and all orders
                                                                        submitted by that ATS or algorithm would
                                                                        be tagged with the identifier.
18. Data Reasonability Checks...........  Market Participants          All firms operating ATSs must have
                                           Operating ATSs.              ``reasonability checks'' on incoming
                                                                        market data and other data (including
                                                                        social media).
----------------------------------------------------------------------------------------------------------------

D. Other Protections

----------------------------------------------------------------------------------------------------------------
                                             Party(s) to implement
     Potential additional protection               protection                   Substance of protection
----------------------------------------------------------------------------------------------------------------
19. Registration of All Firms Operating   Market Participants          All firms operating ATSs to trade solely
 ATSs.                                     Operating ATSs.              for their own account and not otherwise
                                                                        registered with the Commission must
                                                                        register with the Commission.
20. Market Quality Data.................  Trading Platforms..........  Trading platforms must provide to all
                                                                        market participants a daily summary of
                                                                        market quality for each product traded
                                                                        on its platform.
                                                                       The feeds would include measures of
                                                                        execution quality including: (1)
                                                                        Effective spreads; (2) order to fill
                                                                        ratios; (3) execution speed for
                                                                        different types of orders and different
                                                                        order sizes; (4) aggressiveness
                                                                        imbalance; (5) price impact for given
                                                                        trade sizes; (6) average order duration;
                                                                        (7) order efficiency; (8) rejection
                                                                        order ratio; (9) net position changes
                                                                        versus volume; (10) branching ratios;
                                                                        (11) volume imbalance and trade
                                                                        intensity; (12) Herfindahl-Hirschman
                                                                        Indexes based on market share of open
                                                                        positions under common control; and (13)
                                                                        metrics on the number of price changing
                                                                        trades involving ATSs.

[[Page 56573]]

 
21. Market Quality Incentives...........  Trading Platforms..........  Trading platforms must implement changes
                                                                        that will limit market participants'
                                                                        abilities to improperly advantage their
                                                                        own orders in ways that do not
                                                                        contribute to efficient price discovery,
                                                                        including, for example: (1) Utilize a
                                                                        trade allocation formula that is an
                                                                        intermediate between a cardinal ranking
                                                                        (time-weighted), Pro Rata allocation
                                                                        formula and a Price/Time allocation
                                                                        formula; (2) Create a new limit order
                                                                        type that would prioritize orders that
                                                                        remain resting in the order book for
                                                                        some minimum amount of time; (3) Require
                                                                        orders not fully visible in the order
                                                                        book to go to the end of the queue
                                                                        (within limit price) with respect to
                                                                        trade allocation; (4) Aggregate
                                                                        multiple, small orders from the same
                                                                        legal entity entered contemporaneously
                                                                        at the same price level and assign them
                                                                        the lowest priority time stamp of all
                                                                        the orders so aggregated; (5) Require
                                                                        exchanges to use batch auctions once per
                                                                        half second at random times rather than
                                                                        use continuous trade matching; and (6)
                                                                        Limit visibility into the order book to
                                                                        aggregate size available at a limit
                                                                        price.
22. Policies and Procedures for           Trading Platforms..........  Trading platforms must develop and
 identifying ``related'' contracts.                                     implement policies and procedures for
                                                                        identifying securities or products
                                                                        listed on other exchanges that would
                                                                        constitute ``related'' contracts to
                                                                        those that are listed on their own
                                                                        exchange.
23. Standardize and Simplify Order Types  Trading Platforms..........  Trading platforms must work with the
                                                                        Commission to standardize order types
                                                                        across exchanges, and to reduce the
                                                                        overall number of order types that have
                                                                        complex logic embedded within them.
----------------------------------------------------------------------------------------------------------------


    Issued in Washington, DC, on September 9, 2013, by the 
Commission.
Christopher J. Kirkpatrick,
Deputy Secretary of the Commission.

Appendices to Concept Release on Risk Controls and System Safeguards 
for Automated Trading Environments

Appendix 1--Commission Voting Summary

    On this matter, the following Commissioners voted in the 
affirmative: Chairman Gensler, Commissioner Chilton (with the 
concurrence set out below in Appendix 3), Commissioner O'Malia (with 
the concurrence set out below in Appendix 4), and Commissioner 
Wetjen. No Commissioner voted in the negative.

Appendix 2--Statement of Support of Chairman Gary Gensler

    We have witnessed a fundamental shift in markets from human-
based trading to highly automated electronic trading. Automated 
trading systems, including high frequency traders, enter the market 
and execute trades in a matter of milliseconds without human 
involvement. Electronic trading makes up over 91 percent of the 
futures market. The swaps market also is moving toward electronic 
trading.
    In our oversight of U.S. derivatives markets, both futures and 
swaps, the Commodity Futures Trading Commission (CFTC) must look to 
continually adapt our regulations in these changing times. Our 
mission to promote transparency, ensure for market integrity and 
prohibit abuses is just as important in the fast-moving world of 
electronic trading as it was when people traded over the phone, in a 
pit or on a floor.
    The CFTC already has taken a number of important steps to keep 
pace with rapidly evolving 21st-century markets. We have adopted 
rules to implement pre-trade risk filters for futures commission 
merchants, swap dealers, designated contract markets and swap 
execution facilities. We also have new rules to prohibit disruptive 
trading practices and other market abuses.
    In publishing this Concept Release, we are seeking public input 
on what additional risk controls and system safeguards are 
appropriate given this ever-changing technological environment. 
Traditional risk controls and system safeguards, many of which were 
developed according to human speed and floor-based trading, must be 
evaluated in light of new market realities.
    Further, as sure as computers and programs have had technical 
glitches in the past, we must look to risk controls and system 
safeguards to protect markets when such glitches inevitably occur 
again. This Concept Release is intended to stir public discussion 
and debate on how best to protect the functioning of markets for the 
benefit of farmers, ranchers, merchants and other end users who rely 
on markets to hedge risk--particularly in light of the reality that 
the majority of the market is using automated trading systems.

Appendix 3--Concurrence of Commissioner Bart Chilton

    While I concur in the concept release, am most appreciative of 
the staff work, and am largely pleased at the result, this has taken 
far too long to come to fruition.
    In general, those involved in financial markets seem to have 
blindly accepted that technology is almost always a good thing. Yet 
we continue to see major technology problems, like NASDAQ shutting 
down twice in as many weeks. Last year it was NYSE. In the futures 
world, we see technology glitches that simply should not occur. I 
acknowledge that, with the staggering volume of trading, some might 
simply be astounded that--in the main--it works so well. But it 
doesn't work well enough if we continue to see aberrations--
particularly if they are market missteps that could have been 
avoided. That's to say nothing of the high frequency cheetah traders 
who have, some I am convinced intentionally, contorted markets in a 
manipulative fashion. In addition, there are a shocking number of 
transactions that appear to be wash trades--that also has the 
possibility of impairing the fair and effective functioning of 
financial markets.
    I'm pleased we are moving this concept release forward, but 
given this environment it has taken way too long. If we continue at 
this pace, Rip Van Winkle could keep up with any possible action we 
might take. We need to understand that some of these issues are 
urgent and need action now. They can't wait another year or more.
    At the same time, there is one thing that can be done now. In 
fact, I suggested this policy shift be included in the concept 
release, but since it is a larger issue than just a technology-
related matter, it was decided to omit it. That's fine, because my 
suggestion is really an action for the Congress.
    As long as we have a puny penalty regime at the CFTC, we are 
going to see traders risk getting caught because the potential 
profits are so great. We can only impose a civil monetary penalty 
(CMP) of $140,000 per violation. That's the law. Furthermore, the 
case history suggests that a ``violation'' may be only once per day. 
In these millisecond markets where we have seen a million change 
hands in a minute, $140k is a joke--and it's not very funny.
    This Agency is hampered by staffing needs due to a lack of 
funding. We have hundreds of cases being investigated right now. The 
least Congress can do, so that we can try and keep up--and if need 
be, cage the cheetahs and others who violate the Commodity Exchange 
Act--is to increase the CMPs. Specifically, I've suggested 
increasing the maximum penalty levels to $1 million per violation 
for individuals and $10 million for firms. That would be a 
deterrent. That would stop some of the cheetahs and others out there 
who are tempted to use powerful technologies in unlawful ways.
    I look forward to receiving comments, and hope that we let no 
moss grow on this matter.

Appendix 4--Statement of Concurrence by Commissioner Scott D. O'Malia

    During my time at the Commodity Futures Trading Commission 
(``Commission''), I have

[[Page 56574]]

consistently emphasized that the Commission must have a strong 
understanding of today's highly automated and interconnected trading 
environments in order to oversee its markets effectively. As head of 
the Commission's Technology Advisory Committee (``TAC''), I have 
committed considerable TAC time and resources to strengthening our 
understanding of automated markets. I am grateful for all the hard 
work of the TAC members as well as the efforts of the members of the 
Subcommittee on Data Standardization and the Subcommittee on 
Automated and High Frequency Trading, who have devoted hours of work 
on issues related to automated trading systems and pre-trade 
functionality. I hope that this Concept Release, and in particular 
the public comments the Commission receives in response, will build 
on this work.
    The Concept Release asks over a hundred questions, which is 
appropriate given the importance of hearing from all sectors of the 
industry and benefiting from their knowledge and views of automated 
trading. I would like to highlight a few questions that I believe it 
would be particularly constructive to receive feedback from the 
public on. The first is to establish what current protections are in 
the market today and the extent to which the technology is deployed, 
as well as its effectiveness. The second is an overarching question: 
Whether there is a need for regulatory action with regard to any of 
the measures currently in the market. In other words, should the 
Commission federalize any current industry practices/standards? 
Third, it would be helpful to receive public feedback on the 
definitions for high-frequency trading and automated trading systems 
that the TAC, after extensive effort by its Subcommittee on 
Automated and High Frequency Trading, has proposed. Finally, it 
would be beneficial to receive feedback on the possibility of a 
registration requirement for firms operating automated trading 
systems and not otherwise registered with the Commission. The 
Concept Release cites the definition of ``floor broker'' as the 
potential basis for such a requirement; I am interested to get 
public input on whether this, or any other provision in the 
Commission's statute or regulations, can serve as a valid foundation 
for registration.
    The Concept Release is far from perfect. For example, it could 
have provided a more thorough and clear cataloguing of existing 
industry practices and recommendations; a recent TAC reference 
document is more clear and concise in compiling existing standards 
and recommendations in the market today.\124\ Nevertheless, I 
support today's issuance of the Concept Release in order to receive 
input from market participants on all of the issues contained 
herein. I look forward to reviewing the comments submitted in 
response to the Concept Release.
---------------------------------------------------------------------------

    \124\ This document is available at http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/tac103012_reference.pdf.

[FR Doc. 2013-22185 Filed 9-10-13; 8:45 am]
BILLING CODE 6351-01-P