Electronic Trading Risk Principles, 2048-2077 [2020-27622]
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Federal Register / Vol. 86, No. 6 / Monday, January 11, 2021 / Rules and Regulations
COMMODITY FUTURES TRADING
COMMISSION
17 CFR Part 38
RIN 3038–AF04
Electronic Trading Risk Principles
Commodity Futures Trading
Commission.
ACTION: Final rule.
AGENCY:
The Commodity Futures
Trading Commission (‘‘Commission’’ or
‘‘CFTC’’) is adopting final rules
amending its part 38 regulations to
address the potential risk of a
designated contract market’s (‘‘DCM’’)
trading platform experiencing a market
disruption or system anomaly due to
electronic trading. The final rules set
forth three principles applicable to
DCMs concerning: The implementation
of exchange rules applicable to market
participants to prevent, detect, and
mitigate market disruptions and system
anomalies associated with electronic
trading; the implementation of
exchange-based pre-trade risk controls
for all electronic orders; and the prompt
notification of Commission staff by
DCMs of any significant market
disruptions on their electronic trading
platforms. In addition, the final rules
include acceptable practices
(‘‘Acceptable Practices’’), which provide
that a DCM can comply with these
principles by adopting and
implementing rules and risk controls
reasonably designed to prevent, detect,
and mitigate market disruptions and
system anomalies associated with
electronic trading.
DATES:
Effective date: The rules are effective
on January 11, 2021.
Compliance date: DCMs must be in
full compliance with the requirements
of this rule no later than July 12, 2021.
FOR FURTHER INFORMATION CONTACT:
Marilee Dahlman, Special Counsel,
mdahlman@cftc.gov or 202–418–5264;
Joseph Otchin, Special Counsel,
jotchin@cftc.gov or 202–418–5623,
Division of Market Oversight; Esen
Onur, eonur@cftc.gov or 202–418–6146,
Office of the Chief Economist; in each
case at the Commodity Futures Trading
Commission, Three Lafayette Centre,
1155 21st Street NW, Washington, DC
20581.
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SUMMARY:
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
A. Purpose and Structure of the Risk
Principles
B. TAC Meeting
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C. Existing Part 38 Framework and the Risk
Principles Proposal
D. Framework of This Final Rulemaking
1. Principles-Based Approach
2. Issues Related to a DCM-Focused
Approach
3. Issues Related to Codification in Core
Principle 4 and Overlap With Existing
Commission Regulations
II. The Final Risk Principles
A. Key Terms
1. Electronic Trading
2. Market Disruption and System Anomaly
B. The Reasonableness Standard
C. Risk Principle 1
1. Proposal
2. Rules Versus Controls and Other
Procedures
3. Scope of Electronic Trading Subject to
DCM Rules
D. Risk Principle 2—Risk Controls Listed
in Part 38
E. Risk Principle 3
1. Proposal
2. ‘‘Significant’’ Standard
3. Notification Requirement
III. Related Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
1. OMB Collection 3038–0093—Provisions
Common to Registered Entities
2. OMB Collection 3038–0052—Core
Principles and Other Requirements for
DCMs
C. Cost-Benefit Considerations
1. Introduction
2. Costs
3. Benefits
4. 15(a) Factors
D. Antitrust Considerations
I. Background
A. Purpose and Structure of the Risk
Principles
The Commission is adopting final
rules establishing a set of principles
(‘‘Risk Principles’’) and related
Acceptable Practices applicable to
DCMs for the purpose of preventing,
detecting, and mitigating market
disruptions and system anomalies
associated with the entry of electronic
orders and messages into DCMs’
electronic trading platforms. Such
market disruptions or anomalies
originating at a market participant may
negatively impact the proper
functioning of a DCM’s trading platform
by limiting the ability of other market
participants to trade, engage in price
discovery, or manage risk.
The Commission, DCMs, and market
participants all have an interest in the
effective prevention, detection, and
mitigation of market disruptions and
system anomalies associated with
electronic trading. As discussed in the
notice of proposed rulemaking for the
Electronic Trading Risk Principles
(‘‘NPRM’’) 1 and noted by several NPRM
1 Electronic Trading Risk Principles, 85 FR 42761
(July 15, 2020). NPRM commenters were as follows:
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commenters, the Commission believes
that DCMs are addressing most, if not
all, of the electronic trading risks
currently presented to their trading
platforms. DCMs and other market
participants have worked together to
better understand electronic trading
risks and adapt risk control systems
through the use of new technological
tools and safety procedures, such as ‘‘fat
finger’’ controls, dynamic price collars,
kill switches, cancel-on-disconnect,
drop copy feeds, self-match prevention,
and granular pre-trade controls to
manage limits within a product group.2
Since April 2010, FIA has published six
papers proposing industry best practices
and guidelines related to identifying
risks and strengthening safeguards
related to electronic trading in the
futures markets.3
The Risk Principles will require
DCMs to continue to monitor these risks
as they evolve along with the markets,
and make reasonable modifications as
appropriate. The Risk Principles reflect
a flexible approach that complements
industry-led initiatives and previous
Commission measures to address market
disruption risk. The Risk Principles
provide further regulatory clarity to
market participants while preserving the
DCMs’ ability to adapt to evolving
technology and markets.
B. TAC Meeting
At the Commission’s Technology
Advisory Committee (‘‘TAC’’) meeting
on July 16, 2020, the TAC’s
Subcommittee on Automated and
Modern Trading Markets
(‘‘Subcommittee’’) presented the
Subcommittee’s position regarding the
proposed Risk Principles.4 The
Americans for Financial Reform Education Fund
(‘‘AFR’’), Better Markets, Inc. (‘‘Better Markets’’),
CBOE Futures Exchange, LLC (‘‘CFE’’), CME Group
Inc. (‘‘CME’’), Commercial Energy Working Group
(‘‘CEWG’’), Futures Industry Association and FIA
Principal Traders Group (‘‘FIA/FIA PTG’’), Institute
for Agriculture and Trade Policy (‘‘IATP’’),
Intercontinental Exchange Inc. (‘‘ICE’’),
International Swaps and Derivatives Association,
Inc. and Securities Industry and Financial Markets
Association (‘‘ISDA/SIFMA’’), Managed Funds
Association (‘‘MFA’’), Minneapolis Grain Exchange,
Inc. (‘‘MGEX’’), and Optiver US LLC (‘‘Optiver’’). In
addition, the Commission received a thirteenth
comment letter from Robert Rutkowski
(‘‘Rutkowski’’) after the comment period closed.
2 FIA/FIA PTG NPRM Letter, at 2; see also CME
NPRM Letter, at 1; ICE NPRM Letter, at 3. See also
CME Group, Market Regulation Advisory Notice
RA2006–5, ‘‘Disruptive Trading Practices’’
(effective Aug. 10, 2020), available at https://
www.cmegroup.com/notices/market-regulation/
2020/08/CME-Group-RA2006-5.html (prohibiting
any market participant from intentionally or
recklessly submitting or causing to be submitted an
actionable or non-actionable message(s) that has the
potential to disrupt exchange systems).
3 FIA/FIA PTG NPRM Letter, at 1.
4 Automated and Modern Trading Markets
Subcommittee, ‘‘Discussion of the CFTC’s Proposed
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Subcommittee stated that it broadly
supports the rulemaking.5 The
Subcommittee also indicated support
for how the Commission characterized
the concepts of ‘‘electronic trading’’ and
‘‘market disruption.’’ 6 However, the
Subcommittee described the second part
of the definition of ‘‘market
disruption’’—i.e., disruption of the
ability of other market participants to
trade on the DCM on which the market
participant is trading—as
‘‘amorphous.’’ 7 The Subcommittee
noted that it is difficult to define in
advance whether or not a trade halt is
disruptive.8 The Subcommittee stated
‘‘a positive part of the principles-based
approach’’ is that it allows the
Commission and DCMs to define events
in accordance with a principle as
opposed to a list.9
The Subcommittee anticipated that
many procedures and rules adopted by
DCMs would be similar, but it is
nevertheless important to allow for
flexibility, given that DCM trading
systems have different architectures and
features.10 The Subcommittee
concluded that flexibility allows for
market resilience and best practices that
will improve over time.11
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C. Existing Part 38 Framework and the
Risk Principles Proposal
As discussed in the NPRM, the Risk
Principles supplement existing DCM
Core Principle 4 regulations in part 38,
namely Commission regulations
§§ 38.251 and 38.255.12 Existing
Commission regulation § 38.251(c)
requires each DCM to demonstrate an
effective program for conducting realtime monitoring of market conditions,
price movements, and volumes, in order
Rule on Electronic Trading Risk Principles,’’ (July
16, 2020) (‘‘Subcommittee PowerPoint’’), available
at https://www.cftc.gov/About/CFTCCommittees/
TechnologyAdvisory/tac_meetings.html.
5 See July 16, 2020 TAC Meeting Transcript at
54:5.
6 As discussed in further detail below, the NPRM
described ‘‘electronic trading’’ as all trading and
order messages submitted by electronic means to
the DCM’s electronic trading platform, including
both automated and manual order entry. The NPRM
described ‘‘market disruption’’ as generally
including an event originating with a market
participant that significantly disrupts the: (1)
Operation of the DCM on which such participant
is trading; or (2) ability of other market participants
to trade on the DCM on which such participant is
trading. See NPRM at 42765.
See id. at 54:11–55:14, 56:6–16; Subcommittee
PowerPoint at 3.
7 See July 16, 2020 TAC Meeting Transcript at
55:21–56:10.
8 See id. at 58:6–17.
9 See id.
10 See id. at 6; July 16, 2020 TAC Meeting
Transcript at 62:13–63:15.
11 See id.
12 See NPRM, supra note 1 at 42762.
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to detect abnormalities and, when
necessary, to make a good-faith effort to
resolve conditions that are, or threaten
to be, disruptive to the market.13 In
addition, existing Commission
regulation § 38.255 requires each DCM
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 DCM.14
Building on the requirements under
existing Commission regulation § 38.251
to conduct real-time monitoring and
resolve conditions that are disruptive to
the market, the Risk Principles, together
with the Acceptable Practices, require
DCMs to take reasonable steps to
prevent, detect, and mitigate material
market disruptions or system anomalies
associated with electronic trading.
Existing Commission regulations do not
fully and explicitly address the risks of
market disruptions or system anomalies
associated with electronic trading, and
the Risk Principles fill those gaps by
establishing exchange rule and risk
control requirements, as well as
notification requirements, explicitly
applicable to electronic trading.
Additionally, while there may be some
overlap between the Risk Principles and
existing Commission regulation
§ 38.255, the Commission believes the
Risk Principles are distinguishable from
existing Commission regulation § 38.255
because they focus on DCM rules, risk
controls, and notification requirements,
and are not limited to the application of
risk controls as exists in regulation
§ 38.255. The Commission also submits
that the Risk Principles will provide
greater certainty to DCMs regarding
their obligations to address certain
situations associated with electronic
trading.
D. Framework of This Final Rulemaking
The proposed rulemaking was subject
to a 60-day comment period, which
closed on August 24, 2020. As noted
above, the Commission received 13
substantive comments and held one ex
parte meeting.15 The following section
addresses comments that generally
apply to all three Risk Principles and
Acceptable Practices. Comments that
relate to individual Risk Principles and
Acceptable Practices will be addressed
in Section II.C–E.
13 17
CFR 38.251(c).
CFR 38.255.
15 See supra note 1.
14 17
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1. Principles-Based Approach
In the NPRM, the Commission
proposed a principles-based approach.
The purpose of this approach was to
provide DCMs with the flexibility to
impose the most efficient and effective
rules and pre-trade risk controls for
market participants subject to the DCMs’
respective jurisdictions. The
Commission believes that a principlesbased approach in connection with
electronic trading requirements
provides DCMs with flexibility to adapt
and evolve with changing technologies
and markets.16
a. Summary of Comments
Most commenters, including CME,
CFE, CEWG, FIA/FIA PTG, ICE, ISDA/
SIFMA, MFA, and Optiver supported a
principles-based approach.17 In
particular, FIA/FIA PTG, ISDA/SIFMA,
and MFA noted that such an approach
provides flexibility and takes into
account future technological
advances.18 Commenters also stated that
the principles-based approach is
preferable to the prescriptive nature of
prior proposals.19 ICE supported the
Commission’s view that each DCM
should have discretion to identify
market disruptions and system
anomalies as they relate to the DCM’s
market and participants’ trading
activity.20 ICE stated that what
constitutes a market disruption will not
only vary from exchange to exchange,
but also from market to market.
Therefore, tolerance levels and
thresholds must be set for each
market.21
In contrast, AFR, Better Markets,
IATP, and Rutkowski disagreed with the
Commission’s principles-based
approach, and asserted that the
incentives of DCMs and public
regulators are not fully aligned.22 Better
Markets commented that the principles
are too imprecise and unenforceable,
and lack key definitions.23 IATP
emphasized that principles-based rules
16 See
NPRM at 42762.
NPRM Letter, at 1, 12, 16; CFE NPRM
Letter, at 1; CEWG NPRM Letter, at 2; FIA/FIA PTG
NPRM Letter, at 2–4; ICE NPRM Letter, at 2, 9;
ISDA/SIFMA NPRM Letter, at 1–2; MFA NPRM
Letter, at 1–2; Optiver NPRM Letter, at 1.
18 FIA/FIA PTG NPRM Letter, at 2–4; ISDA/
SIFMA NPRM Letter, at 1; MFA NPRM Letter, at 1–
2.
19 CME NPRM Letter, at 1, 12; CFE NPRM Letter,
at 1; CEWG NPRM Letter, at 2.
20 ICE NPRM Letter, at 2.
21 See id.
22 AFR NPRM Letter, at 1–2; Better Markets
NPRM Letter, at 2, 6, 9, 10–12; IATP NPRM Letter,
at 1, 4, 8; Rutkowski NPRM Letter, at 1.
23 Better Markets NPRM Letter, at 2, 9.
17 CME
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must be enforceable.24 IATP also
asserted principles-based rules that the
Commission cannot effectively
supervise and enforce would surrender,
not delegate, the Commission’s
authority, and could legalize trading
misconduct due to lack of resources.25
AFR, Better Markets, and Rutkowski
further commented that the proposed
regulations provide too much deference
to DCMs and that the Commission failed
to address conflicts of interest concerns
that may impede DCM and selfregulatory organization (‘‘SRO’’)
independence.26
Finally, IATP made several comments
addressing the potential for market
disruption caused by ‘‘idiosyncratic’’
events, and suggested further study on
the impact of electronic trading on
intraday price volatility.27
b. Discussion
The Commission considered the
comments and is adopting the
principles-based approach to the Risk
Principles as discussed in the NPRM.
The Commission believes that a
principles-based approach provides
appropriate flexibility to allow DCMs to
adopt and implement effective and
efficient measures reasonably designed
to achieve the objectives of the Risk
Principles. The Commission submits
that prescriptive rules may not be
sufficiently flexible to enable DCMs to
adopt appropriate measures for their
particular market, and therefore, would
not be as effective in preventing market
disruptions or system anomalies.
The principles-based nature of the
Risk Principles does not mean they are
unenforceable. The Risk Principles will
be enforceable regulations that allow the
Commission to require all DCMs to
implement appropriate, reasonable risk
controls and rules to prevent, detect,
and mitigate market disruptions. The
Commission has brought enforcement
actions relating to violations of Core
Principles set forth in Commission
regulations. Recently, in 2019, the
Commission brought an action against
Options Clearing Corporation (‘‘OCC’’),
a derivatives clearing organization
(‘‘DCO’’), for violations of DCO Core
Principles under part 39.28 In particular,
the Commission determined ‘‘OCC
failed to fully comply with the specified
24 IATP
NPRM Letter, at 1.
id. at 8.
26 AFR NPRM Letter, at 1–2; Better Markets
NPRM Letter, at 2, 6, 9, 10–12; Rutkowski NPRM
Letter, at 1.
27 See supra note 25 at 2–5, 8.
28 See Order, CFTC Docket No. 19–19, at 3–5
(Sept. 4, 2019), available at https://www.cftc.gov/
media/2396/enfoptionsclearingorder090419/
download.
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25 See
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DCO Core Principles by failing to
establish, implement, and enforce
certain policies and procedures
reasonably designed to (1) consider and
produce margin levels commensurate
with every potential risk and particular
attribute of each relevant product
cleared by OCC; (2) effectively measure,
monitor and manage its credit exposure
and liquidity risk; and (3) protect the
security of certain of its information
systems.’’ 29
While the final rules do not formally
define terms such as ‘‘market
disruption’’ or ‘‘electronic trading’’ in
rule text, the Commission provided a
general discussion of those terms in the
NPRM. The Commission is providing
additional clarity concerning relevant
terms in this preamble, in order for
DCMs and other market participants to
have a sufficient understanding of how
the Commission will interpret and
enforce the Risk Principles.30 Further,
by not defining the terms in a static
way, the Commission intends to allow
for DCMs’ application of the Risk
Principles to evolve over time alongside
market developments.31
The Commission believes that DCMs
are incentivized to have risk controls to
promote the integrity of their markets,
and existing risk controls in place across
DCMs indicate that they have
implemented such measures. As FIA/
FIA PTG pointed out, ‘‘[a]ll market
participants have a shared interest in
strengthening risk controls. The
interconnectedness of the listed
derivatives markets means that all
29 Id. at 2. The order stated the Commission found
OCC had failed to comply with Core Principles in
Section 5b(c)(2)(B), (D), and (I) of the Commodity
Exchange Act (‘‘CEA’’ or ‘‘Act’’), and Commission
regulations §§ 39.11(a) and (c), 39.13(a), (b), (f), and
(g)(l) and (2), and 39.18(b)(l) and (e)(l). See id. at
3–5. The Commission issued a press release
regarding the enforcement action stating: ‘‘ ‘As this
case shows, principles-based regulation does not
mean lax oversight,’ said CFTC Chairman Heath P.
Tarbert. ‘While clearing agencies have some
discretion in crafting their risk management
policies and procedures, those policies and
procedures must be reasonable and take into
consideration relevant risks.’ ’’ See Press Release,
‘‘SEC and CFTC Charge Options Clearing Corp. with
Failing to Establish and Maintain Adequate Risk
Management Policies’’ (Sept. 4, 2019), available at
https://www.cftc.gov/PressRoom/PressReleases/
8000-19.
Additionally, in 2015, the Commission brought
an enforcement action against TeraExchange LLC, a
provisionally registered swap execution facility
(‘‘SEF’’), for violations of Core Principles requiring
SEFs to enact and enforce rules prohibiting certain
types of trade practices, including wash trading and
prearranged trading. See Press Release, ‘‘CFTC
Settles with TeraExchange LLC for Failing to
Enforce Prohibitions on Wash Trading and
Prearranged Trading in Bitcoin Swap’’ (Sept. 24,
2015), available at https://www.cftc.gov/
PressRoom/PressReleases/7240-15.
30 See Section II.A.
31 See NPRM at 42765.
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market participants are vulnerable when
risk controls fail. It is no surprise, then,
that the industry has worked diligently
to enhance and extend risk controls over
the years.’’ 32
The Risk Principles will require all
DCMs to implement an appropriate
standard for risk controls. DCMs are best
positioned to determine what risk
controls and rules are appropriate to
prevent, detect, and mitigate disruptions
on their respective markets. Permitting
them to do so is consistent with
Congressional intent to serve the public
interests of the CEA ‘‘through a system
of effective self-regulation of trading
facilities . . . under the oversight of the
Commission.’’ 33 Any conflict of interest
concerns, where DCMs might prioritize
profitability over reasonable controls,
will be addressed through regular
Commission oversight of DCMs,
including examinations.34 For example,
in an examination, Commission staff
may consider whether a DCM is
allocating sufficient financial and staff
resources to the compliance function,
the background and qualifications of the
DCM’s regulatory oversight committee
members and compliance officers, and
any role non-compliance personnel
might be taking in the DCM’s market
monitoring and investigations
processes.35
Regarding IATP’s comments, the
Commission acknowledges that market
risks, like the markets themselves, are
always evolving. The principles-based
approach provides DCMs with
flexibility to address risks to markets as
they evolve, including any idiosyncratic
events. Prescriptive regulations may
32 FIA/FIA PTG NPRM Letter, at 4. See also CME
NPRM Letter, at 1 (‘‘. . . the integrity and reliability
of our markets are cornerstones of our business
model—market participants choose to manage their
risk on the CME Group Exchanges because we offer
fair, efficient, transparent, liquid, and dynamic
markets that are conducted and operated in
accordance with the highest standards.’’; ICE NPRM
Letter, at 2 (‘‘DCMs have proactively developed a
substantial suite of risk controls, as well as
financial, operational and supervisory controls to
protect their markets and comply with existing
regulations.’’).
33 Section 3(b) of the CEA. 7 U.S.C. 5(b).
34 The Commission notes that DCMs are already
subject to Commission regulation § 38.850 (Core
Principle 16, Conflicts of Interest), which requires
DCMs to minimize conflicts of interest in the DCM’s
decision-making process and establish a process for
resolving those conflicts of interest. 17 CFR 38.850.
35 See Appendix B to Part 38—Guidance on, and
Acceptable Practices in, Compliance with Core
Principles, Core Principle 16 (Subparagraph (b))
(‘‘To comply with this Core Principle, contract
markets should be particularly vigilant for such
conflicts between and among any of their selfregulatory responsibilities, their commercial
interests, and the several interests of their
management, members, owners, customers and
market participants, other industry participants,
and other constituencies.’’).
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lack the flexibility to address such
idiosyncratic events, while principlesbased regulations would provide DCMs
with a framework through which they
can change their rules and risk controls
to address such unforeseen events. The
Commission or industry organizations
may conduct studies relevant to
electronic trading in the future, and the
Commission expects that the results will
inform regulatory oversight of DCMs
and enforcement of the Risk Principles.
The Commission notes that the Division
of Market Oversight produced a report
in 2019 examining trading functionality
across markets and found a consistent
increase in the percentage of trading
that was identified as ‘‘automated’’
relative to ‘‘manual.’’ 36 Further, the
report also showed no general
correlation (and in some instances an
inverse correlation) between the
increase in automated trading activity in
these markets and daily volatility.37
2. Issues Related to a DCM-Focused
Approach
The Commission proposed the Risk
Principles should focus specifically on
DCMs.38 The NPRM stated the
Commission will continue to monitor
whether Risk Principles of this nature
may be appropriate for other markets
such as SEFs or foreign boards of trade
(‘‘FBOTs’’).39 The Commission also
encouraged the National Futures
Association to evaluate whether it
should provide additional supervisory
guidance to its members.40 As noted in
the NPRM, each DCM may have a
different risk management program
based on its unique business model and
market, and this may result in some
degree of differences in DCM rules
implementing the Risk Principles.41
a. Summary of Comments
CEWG, FIA/FIA PTG, and Optiver
supported the Risk Principles’ focus on
DCMs and addressed issues relating to
DCM discretion in implementing the
Risk Principles.42 FIA/FIA PTG stated
that DCMs are the gatekeeper and
overseer of electronic trading platforms
and are therefore uniquely positioned to
apply pre-trade controls uniformly to all
participants and trading in their
markets.43 Optiver similarly noted that
each DCM has a unique technology
stack on which its platform is built and
must be afforded latitude to develop
rules and risk controls.44 In contrast,
AFR, Better Markets, IATP, and
Rutkowski commented that the
proposed regulations provide too much
deference to DCMs, in allowing them to
decide for themselves how to address
prevention, detection, and mitigation of
undefined market disruptions and
system anomalies.45
CME stated the Risk Principles should
apply to SEFs and FBOTs, in addition
to DCMs.46 CFE stated any Commission
assessments of DCM controls should be
across all DCMs, and the Commission
should not seek to hold all DCMs to
what the larger DCMs may have in
place.47 CME commented that each
DCM may implement different rules and
risk controls without harming market
liquidity or integrity.48 In contrast,
Better Markets commented that the Risk
Principles ensure a lack of uniformity in
DCM policies, procedures, and controls
and potentially would punish
responsible DCMs.49 Similarly, IATP
asserted competition among DCMs for
over-the-counter trading and for trading
in new products, such as digital coins,
could result in lax risk control design or
updating under competitive pressures.50
IATP asked the Commission to explain
why the lack of any uniform standard by
which DCMs should develop rules and
risk controls presents no risk of
regulatory arbitrage or migration of
market disruptions from one DCM to
another.51
While the Risk Principles apply to
DCMs, CEWG commented on their
potential effect on market participants.
In particular, CEWG requested the final
rules clarify that market participants
without access to source code used to
operate trading systems would not be
subject to DCM-imposed requirements
to implement updates, test or monitor
the operation of such software, or DCMimposed requirements under Risk
Principle 3 to implement remediation
measures for software.52
Finally, IATP commented that the
Risk Principles indiscriminately apply
to asset classes, financial speculators,
43 FIA/FIA
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36 Staff
of the Market Intelligence Branch, ‘‘Impact
of Automated Orders in Futures Markets’’ (Mar.
2019) at 4, 7, 13, available at https://www.cftc.gov/
MarketReports/StaffReports/index.htm.
37 See id.
38 See NPRM at 42763.
39 See id. at 42763 n.6.
40 See id. at 42764.
41 See id. at 42765.
42 CEWG NPRM Letter, at 3–4; FIA/FIA PTG
NPRM Letter, at 3; Optiver NPRM Letter, at 1.
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PTG NPRM Letter, at 3.
NPRM Letter, at 1.
45 AFR NPRM Letter, at 1–2; Better Markets
NPRM Letter, at 2, 6, 9, 10–12; IATP NPRM Letter,
at 6–11; Rutkowski NPRM Letter, at 1.
46 CME NPRM Letter, at 2, 13.
47 CFE NPRM Letter, at 4.
48 CME NPRM Letter, at 13.
49 Better Markets NPRM Letter, at 9.
50 IATP NPRM Letter, at 9.
51 IATP NPRM Letter, at 11.
52 CEWG NPRM Letter, at 7.
44 Optiver
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and commercial hedgers.53 IATP further
stated that the Commission should issue
a term sheet for a study to investigate
the feasibility of revising the
demutualization rule to create tiers of
DCMs with respect to physical and
financial derivatives contracts, to which
a rule on automated trading would
apply.54 IATP also commented that the
Commission should distinguish what
additional pre-trade and post-trade risk
controls the DCMs must maintain from
what is required of futures commission
merchants (‘‘FCMs’’) prescriptively.55
b. Discussion
The Commission believes that a
regulatory approach focusing on Risk
Principles applicable only to DCMs is
the correct approach. All participants
and intermediaries have a responsibility
to address the risks of electronic trading.
However, trading occurs on DCM
platforms and DCM-implemented rules
and risk controls will be most effective
in preventing, detecting, and mitigating
system anomalies and market
disruptions. As noted above, conflict of
interest concerns will be addressed
through regular Commission oversight.
DCMs are subject to Commission
regulation § 38.850 (Core Principle 16,
Conflicts of Interest), which requires
DCMs to minimize conflicts of interest
in the DCM’s decision-making process
and establish a process for resolving
those conflicts of interest.56 The
Commission believes that DCMs, and
other market participants, do have an
interest in maintaining market integrity,
and this is evidenced through existing
measures. In its comment, FIA/FIA PTG
addressed DCM tools and procedures
adopted to address electronic trading
risk, including basic ‘‘fat finger’’
controls, dynamic price collars, kill
switches, cancel-on-disconnect, drop
copy feeds, and self-match prevention,
as well as granular pre-trade controls to
manage limits within a product group.57
FIA/FIA PTG noted that development of
53 IATP
NPRM Letter, at 4–5.
id.
55 IATP NPRM Letter, at 13.
56 17 CFR 38.850. See also David Reiffen and
Michel A. Robe, Demutualization and Customer
Protection at Self-Regulatory Financial Exchanges,
Journal of Futures Markets, Vol. 31, 126–164, Feb.
2011 (in many circumstances, an exchange that
maximizes shareholder (rather than member)
income has a greater incentive to enforce
aggressively regulations that protect participants
from dishonest agents); and Kobana Abukari and
Isaac Otchere, Has Stock Exchange Demutualization
Improved Market Quality? International Evidence,
Review of Quantitative Finance and Accounting,
Dec 09, 2019, https://doi.org/10.1007/s11156-01900863-y (demutualized exchanges have realized
significant reductions in transaction costs in the
post-demutualization period).
57 FIA/FIA PTG NPRM Letter, at 2.
54 See
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risk control measures ‘‘has been an
evolving, iterative process, with market
participants, FCMs, technology vendors
and DCMs working together to build the
safeguards needed to protect our
markets. After all, it is in everyone’s
interest to have efficient, reliable
markets.’’ 58
The Commission acknowledges
IATP’s points concerning the possibility
of creating different tiers of DCMs, and
distinguishing controls required of
DCMs from those required of FCMs.
However, the Commission believes it is
preferable to have the same regulations
apply to all DCMs, and, in the
enforcement of such regulations,
recognize that each DCM has a unique
market, technological infrastructure,
and market participants. In addition,
DCMs may require different controls
from FCMs and the Commission will
not specify particular required controls.
This will serve the goal of ensuring that
all DCMs, whatever their size or
products, are subject to the same
Commission regulations while allowing
sufficient flexibility for each DCM to
adopt risk controls and rules that are
reasonably appropriate for its market.
As noted in the NPRM, the
Commission will continue to monitor
whether Risk Principles of this nature
may be appropriate for other markets
such as SEFs or FBOTs.59 The
Commission initially proposed the Risk
Principles with a focus on DCMs due to
their prominent nature in the futures
market. Application of the Risk
Principles to SEFs and FBOTs requires
further study and consideration
regarding the risks and unique attributes
of those other markets, and the
Commission expects to do so in the
future to determine whether SEFs and/
or FBOTs should be subject to the Risk
Principles or similar regulations.
The Commission acknowledges that
DCMs might implement different rules
and risk controls given differences in
their respective markets. Ongoing
Commission oversight is expected to
identify differences in DCM policies,
procedures, and controls. Differences
between and among DCMs would be
acceptable under the Risk Principles so
long as their policies, procedures, and
controls are objectively reasonable. The
Risk Principles will require DCMs to
establish rules and risk controls
reasonably designed to prevent, detect,
and mitigate market disruptions, and
this should, in turn, help prevent the
migration of market disruptions from
one DCM to another.
58 See
59 See
id.
NPRM at 42763 n.6.
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The Commission acknowledges
CEWG’s request that the final rules
clarify that market participants without
access to source code used to operate
trading systems would not be subject to
any DCM rules to implement updates,
test or monitor the operation of such
software, or DCM rules under Risk
Principle 3 to implement remediation
measures for software.60 While these
points are reasonable, the Commission
believes the extent to which market
participants would be expected to
implement software updates, tests,
operation monitoring, or remediation
measures should be left to individual
DCM reasonable discretion. The
Commission can envision unique
arrangements involving market
participant use of third-party software
and therefore believes DCMs are the
appropriate entity to adopt reasonable
rules to govern those arrangements. The
Commission notes that under existing
Commission regulation § 38.151, DCMs
must provide their members, persons
with trading privileges, and
independent software vendors with
impartial access to their markets and
services, including access criteria that
are impartial, transparent, and applied
in a non-discriminatory manner.61
3. Issues Related to Codification in Core
Principle 4 and Overlap With Existing
Commission Regulations
The NPRM noted several areas where
the Risk Principles may overlap with
existing Commission regulations,
including regulations related to the
prevention of market disruptions and
financial risk controls.62 The
Commission explained that because
DCMs have developed robust and
effective processes for identifying and
managing risks, both because of their
incentives to maintain markets with
integrity, as well as for purposes of
compliance with existing Commission
regulations, the Risk Principles may not
necessitate the adoption of additional
measures by DCMs.63 The Commission
further stated that the proposed Risk
Principles will result in DCMs
continuing to monitor risks as they
evolve along with the markets and make
reasonable modifications as
appropriate.64 Finally, the Commission
proposed codifying the Risk Principles
as part of Core Principle 4.65
60 CEWG
NPRM Letter, at 7.
CFR 38.151.
62 See NPRM 42762, 42764.
63 See NPRM 42762.
64 See id.
65 See id.
61 17
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a. Summary of Comments
CME, ICE, and Better Markets asserted
that the Risk Principles are redundant of
existing regulations.66 In particular,
CME commented that the Risk
Principles overlap with existing
regulations that require DCMs to have
controls, tools, and rule sets to prevent
and mitigate market and system
disruptions.67 CME stated that its
messaging controls, for example, are
already arguably subject to Commission
oversight pursuant to certain existing
regulations under Core Principles 2 and
4.68 CME suggested the Commission
take an alternative approach of simply
relying on existing regulations rather
than adopting new ones.69 CME also
addressed where in the part 38
regulations the Risk Principles should
be codified if adopted. CME suggested
the Risk Principles be codified as part
of Core Principle 2, particularly Risk
Principle 1, because that Core Principle
requires a DCM to adopt and implement
rules.70 CME also pointed out that Core
Principle 4 addresses manipulation,
price distortion, and disruptions of the
delivery or cash-settlement process and
that a ‘‘market disruption’’ or ‘‘system
anomaly’’ does not fit within those
elements.71
ICE commented that the proposed risk
principles largely duplicate existing
Core Principle 4 guidance and
acceptable practices.72 ICE suggested
amending existing regulations, such as
Commission regulation § 38.255, to refer
to electronic trading, rather than create
a new set of principles that may
unintentionally conflict with or create
duplicative and overlapping
standards.73 ICE stated this would track
the Commission’s approach to
regulating financial risk controls in
existing Commission regulation
§ 38.607, which it believes has proven
effective.74
Better Markets similarly commented
that the proposed regulations are
redundant of existing Commission
regulations. Specifically, Better Markets
pointed to Commission regulations
§§ 38.157, 38.251(a), 38.255, 38.607,
38.1050, and 38.1051, as well as Core
Principle 4 guidance and acceptable
practices.75 Better Markets stated the
Risk Principles give the public the false
66 CME NPRM Letter, at 12–13; ICE NPRM Letter,
at 3; Better Markets NPRM Letter, at 4–9.
67 CME NPRM Letter, at 12–13.
68 See id. at 7.
69 See id. at 12.
70 See id. at 12–13.
71 See id.
72 ICE NPRM Letter, at 3.
73 See id.
74 See id.
75 Better Markets NPRM Letter, at 4–9.
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impression that the CFTC is taking
meaningful regulatory action.76 Better
Markets also considered the
Commission’s distinction that the new
principles are ‘‘anticipatory’’ to be
unclear and possibly inaccurate.77
Better Markets further commented that
existing Commission regulation § 38.255
squarely focuses on risk controls for the
prevention and mitigation of market
disruptions.78 Better Markets stated that
existing Commission regulation § 38.255
and the proposed Risk Principles are so
similar that it is unreasonable, if not
deceptive, to finalize them under the
pretext that the Commission is setting
forth a new and improved electronic
trading framework.79
CME, CEWG, FIA/FIA PTG, ICE, and
MFA commented that DCMs already
implement controls and address risks to
their platforms.80 MFA believes the Risk
Principles will help encourage DCMs to
continue to monitor risks as they evolve
along with the markets, and to make
reasonable modifications as
appropriate.81 AFR and Rutkowski
disagreed, commenting that the NPRM
does not contain any systematic analysis
demonstrating that current DCM
practices are effective in controlling the
risks of market disruptions due to
electronic trading.82
b. Discussion
As noted in the NPRM, the Risk
Principles supplement existing
Commission regulations governing
DCMs by directly addressing certain
risks associated with electronic trading
in Core Principle 4 and its
implementing regulations, namely
Commission regulations §§ 38.251 and
38.255.83 Commission regulation
§ 38.251(c) requires DCMs to conduct
real-time monitoring and resolve
conditions that are disruptive to the
market. The Risk Principles supplement
this regulation by specifically requiring
actions by DCMs to prevent, detect, and
mitigate market disruptions and systems
anomalies. While the anticipatory
nature of the Risk Principles (involving
prevention, in addition to detection and
mitigation) is not the only justification
for these new rules, the Commission
believes it is important to clarify that
DCMs are obligated to do more than
76 See
id.
id.
78 See id.
79 See id.
80 CME NPRM Letter, at 4–7; CEWG NPRM Letter,
at 4; FIA/FIA PTG NPRM Letter, at 3; ICE NPRM
Letter, at 1; MFA NPRM Letter, at 2.
81 MFA NPRM Letter, at 2.
82 AFR NPRM Letter, at 2; Rutkowski NPRM
Letter, at 2.
83 See NPRM at 42768.
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monitor and resolve disruptive
conditions, as required by existing
Commission regulation § 38.251. In
particular, Risk Principle 1 specifically
requires the adoption of exchange-based
‘‘rules’’ that are reasonably designed to
address electronic trading risk to the
extent that such rules are not already in
place.
The NPRM further acknowledged that
the Risk Principles largely overlap with
Commission regulation § 38.255, which
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 DCM.84 Compared to
existing Commission regulation
§ 38.255, the Risk Principles specifically
address material market disruptions and
system anomalies associated with
electronic trading (e.g., excessive
messaging that may materially limit
participant access), not only market
disruptions involving market halts or
price distortions.
The Commission disagrees with
comments asserting the Risk Principles
would be more appropriately
implemented under Core Principle 2
rather than Core Principle 4. Various
regulations promulgated under Core
Principle 4 already address market
disruptions, including Commission
regulations §§ 38.251(c) and 38.255. The
Commission believes that the Risk
Principles, each dealing with market
disruptions, should likewise be codified
under Core Principle 4.
The Commission believes that it must
do more than rely on existing
regulations or add the words ‘‘electronic
trading’’ to existing regulations. For this
reason, the Commission notes that the
final Risk Principles specifically will
apply to electronic trading, thereby
requiring adoption of a DCM rule (if not
already implemented) and risk control
and notification requirements regarding
market disruptions, that is expected to
ensure the development and
implementation of reasonable measures
to address the threat of market
disruptions caused by electronic
trading. The Commission expects that
these Risk Principles will enhance the
Commission’s ability to hold DCMs to a
standard of reasonably-designed rules
and appropriate risk controls, whether
those rules and controls were already in
place or are implemented pursuant to
the Risk Principles.85
84 NPRM
at 42768.
Commission notes that it does not intend
or expect larger DCM pre-trade risk controls to be
85 The
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The NPRM noted several examples of
exchange-based risk controls and
several commenters elaborated further
on these risk controls.86 The
Commission continues to believe most
DCMs already have effective controls in
place to address electronic trading
market disruptions. These Risk
Principles will require DCMs to
continue to implement such reasonable
controls as markets and risks evolve.
II. The Final Risk Principles
A. Key Terms
The NPRM stated that the Risk
Principles focus on market disruptions
or system anomalies associated with
electronic trading activities.87 While not
defined in the regulation text, the
preamble broadly discussed the goals of
the Risk Principles through these terms.
The NPRM further stated by not
defining the terms in a static way, the
Commission intends that the
application of the Risk Principles by
DCMs and the Commission will evolve
over time along with market
developments.88 The NPRM stated that
a general discussion of those terms in
the context of today’s electronic markets
would provide the public and, in
particular, DCMs, guidance for applying
the Risk Principles.89
1. Electronic Trading
a. Proposal
For purposes of this rulemaking, the
Commission described electronic
trading as encompassing a wide scope of
trading activities, including all trading
and order messages submitted by
electronic means to a DCM’s electronic
trading platform.90 This includes both
automated and manual order entry.91
the standard for all DCMs, although there may be
risk controls that are common to all DCMs.
86 NPRM at 42768. CME commented it has a
vested interest in preserving the integrity of its
markets, and has done so through market integrity
controls such as order messaging throttles, price
limits, automated port closures, kill switches,
velocity logic controls and dynamic circuit
breakers, as well as trade practice, disciplinary and
administrative rules. CME NPRM Letter, at 4. ICE
pointed out that prior to giving a participant access
to its trading platform, ICE requires the participant
to undergo conformance testing, which is designed
to and has been successful in detecting system
anomalies. ICE NPRM Letter, at 2. ICE additionally
stated it has developed pre-trade risk controls, such
as messaging throttles, interval price limits (price
velocity collars), individual maximum order
quantities, and order reasonability limits. See id.
CFE commented it has extensive rule provisions
that provide for risk controls applicable to all
orders. CFE NPRM Letter, at 2.
87 NPRM at 42765.
88 See id.
89 See id.
90 See id.
91 See id.
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b. Summary of Comments
CME and ICE addressed whether the
Commission should modify its
description of the term electronic
trading. CME believed that the term was
sufficiently clear.92 In contrast, ICE
commented that the term is used in Risk
Principles 1 and 2 to ‘‘include all
trading and order messages submitted
by electronic means to the DCM’s
electronic trading platform, including
both automated and manual order
entry.’’ 93 ICE stated that the inclusion of
‘‘trading’’ messages is unnecessary.94
Because participants only submit
‘‘order’’ messages to the central limit
order book and not trades, ICE believes
that the term ‘‘electronic trading’’
captures off-facility transactions, such
as exchange for related positions
(‘‘EFRPs’’) and block transactions.95 ICE
stated off-facility transactions are
privately negotiated and have a low
likelihood of disrupting the central limit
order book.96
c. Discussion
The Commission clarifies that the
term ‘‘electronic trading’’ includes block
and EFRP transactions, if such
transactions are submitted electronically
to the DCM’s trading platform. The
Commission believes that DCMs should
have reasonable discretion to decide
what rules and controls—if any—should
be applied to off-exchange transactions
such as block trades and EFRPs under
Risk Principles 1 and 2. The
Commission expects DCMs to make
such a determination based on: (a) The
risk such off-exchange transactions will
disrupt DCM platforms or markets; and
(b) the rules and controls that would be
most effective to address that risk. The
Commission acknowledges that such
trades are privately negotiated and
currently may carry little risk of market
disruption. However, it is unknown
how much risk off-exchange trading will
pose as markets evolve over time. In
particular, off-exchange transactions
could become increasingly electronic or
automated, impact price formation and,
consequently, pose greater risk to DCM
markets. The Risk Principles allow DCM
discretion in assessing this risk and how
best to address it.
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2. Market Disruption and System
Anomaly
NPRM Letter, at 10.
NPRM Letter, at 2, 3–4, 5.
94 See id.
95 See id.
96 See id.
93 ICE
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b. Summary of Comments
ICE, CME, CEWG, MFA, IATP, Better
Markets, and MGEX addressed whether
the Commission should modify its
description of the terms market
disruption and system anomaly.99
ICE requested clarification on whether
the term ‘‘significant’’ qualifies ‘‘market
disruption.’’ 100 ICE also commented
that the description of ‘‘market
disruption’’ is overly broad, noting that
the Commission uses the term to refer
to an incident that disrupts the ability
of other market participants to trade on
the DCM.101 ICE asserted this could
include a range of subjective
interpretations and possibilities,
including a disruption resulting in
prices not reflective of market
fundamentals.102 ICE commented that
the term could also be interpreted to
include entering orders in a disorderly
manner, quote stuffing, causing illiquid
markets where one would not occur
otherwise, or causing the artificial
widening of markets.103 ICE stated these
scenarios could result from volatility
but not a market disruption, and,
because of the ambiguities in the Risk
Principles, market participants may be
reluctant to trade if pricing appears
aberrant or erroneous.104 CEWG
commented that the Commission should
provide further high-level guidance
with respect to events constituting
‘‘market disruptions’’ or ‘‘system
anomalies’’ to minimize the potential
for regulatory uncertainty.105
CME commented that the term
‘‘market disruption’’ is sufficiently
97 NPRM
at 42765.
id.
99 ICE NPRM Letter, at 5–6; CME NPRM Letter, at
3–4, 10–11; CEWG NPRM Letter, at 4, 5; MFA
NPRM Letter, at 3; IATP NPRM Letter, at 6; Better
Markets NPRM Letter, at 9, 10; MGEX NPRM Letter,
at 1–2, 3.
100 ICE NPRM Letter, at 5.
101 See id.
102 See id.
103 See id.
104 See id.
105 CEWG NPRM Letter, at 4.
98 See
a. Proposal
In the NPRM, the Commission stated
it considers the term ‘‘market
92 CME
disruption,’’ for purposes of the Risk
Principles, to generally mean an event
originating with a market participant
that significantly disrupts the: (1)
Operation of the DCM on which such
participant is trading; or (2) the ability
of other market participants to trade on
the DCM on which such participant is
trading.97 For the purposes of the Risk
Principles, ‘‘system anomalies’’ are
unexpected conditions that occur in a
market participant’s functional system
that cause a similar disruption to the
operation of the DCM or the ability of
market participants to trade on the
DCM.98
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clear.106 Similarly, MFA agreed with the
Commission’s approach to defining
‘‘market disruption,’’ which MFA
believes focuses correctly on events
impacting the operations of the DCM
and/or the ability of other market
participants to trade on the DCM, rather
than the impact on trading of a single
firm whose electronic trading was the
source of the disruption.107 MFA also
commented it supports that the Risk
Principles allow a DCM to exercise
discretion in identifying market
disruptions and system anomalies as
they relate to the DCM’s particular
market and the trading activities of
participants in that market.108
CME cautioned that no specific type
of market halt should be considered a
per se ‘‘market disruption’’ because
some halts prevent and mitigate market
disruptions.109 Similarly, ICE
commented that an unscheduled trading
halt caused by a market participant,
which could not readily be attributed to
market volatility or fundamental
conditions in underlying or related
markets, could constitute a market
disruption.110 CME stated that the
Commission should not characterize
any specific period of latency as per se
disruptive, because latency can occur
due to bona fide market activity, or be
based on a participant’s own system.111
CME stated that a fact-specific inquiry is
necessary to determine if there has been
a market disruption.112 Similarly, ICE
stated that latency incorporates many
factors outside a DCM’s processing of
order messages.113 As such, the
Commission should be cautious when
interpreting latency as an indication of
a market disruption.114 ICE stated it is
more meaningful to quantify the impact
on the market rather than to calculate a
subjective impact to latency.115 CEWG
commented that a disruptive event
could have a significant impact on the
market in one context, but not in
another.116 For example, a one or two
second delay in processing and
execution may constitute a market
disruption to automated trading firms
but not to manual traders.117
CME commented regarding the
preamble’s assertion that ‘‘system
anomalies’’ are unexpected conditions
106 CME
NPRM Letter, at 10–11.
NPRM Letter, at 3.
108 See id.
109 CME NPRM Letter, at 10–11.
110 ICE NPRM Letter, at 5–6.
111 CME NPRM Letter, at 10–11.
112 See id.
113 ICE NPRM Letter, at 6.
114 See id.
115 See id.
116 CEWG NPRM Letter, at 5.
117 See id.
107 MFA
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that occur in a participant’s functional
system ‘‘which cause a similar
disruption to the operation of the DCM
or the ability of market participants to
trade on the DCM.’’ 118 CME stated one
could interpret the preamble language to
mean the disruptions to the DCM must
be similar to the disruptions to the
originating participant.119 CME
suggested if the phrase ‘‘which cause a
similar disruption’’ is actually referring
to the Commission’s definition of
‘‘market disruption’’ described earlier in
the NPRM preamble, then the
Commission should clarify
accordingly.120
CME further commented that both
definitions relate to the ability of other
participants ‘‘to trade.’’ 121 CME stated
that sections of the preamble reference
participants’ inability to trade, engage in
price discovery, or manage risk.122 CME
asked the Commission to clarify
whether it always means all three
situations, or any of those situations.123
CME further commented that the
Commission reconsider using the word
‘‘ability.’’ 124 CME pointed out that not
all the examples of market disruptions
cited in the NPRM involved a
disruption to the operation of the DCM
and a participant being unable to trade,
engage in price discovery, or manage
risk.125 CME suggested that a clearer
and more objective standard would be
that the event ‘‘must significantly
disrupt other participants’ access to the
DCM.’’ 126 CME believes this standard
captures the risks identified in the
rulemaking and is something DCMs can
typically identify on their own.127
IATP commented that the
Commission grants too much discretion
to DCMs to interpret the terms of the
NPRM and to determine what is or is
not a ‘‘market disruption’’ or ‘‘system
anomaly’’ and whether to mitigate it.128
Better Markets commented that terms
such as ‘‘significant’’ and ‘‘disruption’’
are ambiguous and will lead to
divergent practices.129 Better Markets
118 CME
NPRM Letter, at 3.
id.
120 See id.
121 See id.
122 See id.
123 See id.
124 CME NPRM Letter, at 3–4.
125 See id. In particular, CME referenced 2011
disciplinary actions involving the same trading
firm, where an automated trading system
malfunction prompted selling e-mini Nasdaq 100
Index futures on the Chicago Mercantile Exchange,
and another malfunction caused a rapid buying in
oil futures on the New York Mercantile Exchange
(‘‘NYMEX’’).
126 See id. (emphasis added).
127 See id.
128 IATP NPRM Letter, at 6.
129 Better Markets NPRM Letter, at 9.
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also commented that the Risk Principles
provide essentially unfettered discretion
to each DCM in terms of how to define
market disruptions and system
anomalies as they relate to their
particular markets, and permitting
differing definitions will undermine
comparative analyses of market
disruptions across exchanges.130
MGEX commented that the
Commission should continue with its
principles-based approach to broadly
define ‘‘market disruption’’ and ‘‘system
anomalies’’ associated with electronic
trading and ensure the reasonableness
standard is approached with ample
discretion.131 MGEX considered the
general definitions of ‘‘market
disruption’’ and ‘‘system anomalies’’
stated in the NPRM to be acceptable,
with the caveat that each DCM operates
differently, and the Commission should
recognize this during its rule
enforcement reviews.132
c. Discussion
The NPRM described a market
disruption as an event originating with
a market participant that significantly
disrupts the operation of the DCM on
which such participant is trading. The
proposed regulation text for Risk
Principle 3 expressly included the term
‘‘significant,’’ while the regulation text
for Risk Principles 1 and 2 did not. The
Commission clarifies that the term
‘‘market disruption,’’ for DCMs’
definitional and rule implementation
purposes to satisfy Risk Principles 1 and
2, refers specifically to disruptions that
materially impact the proper
functioning of a DCM’s trading platform.
The term ‘‘market disruption’’ does not
encompass disruptions that have only a
de minimis effect on a DCM’s trading
platforms or the ability of other market
participants to trade, engage in price
discovery, or manage risk. For example,
a technical malfunction at a market
participant might cause excessive
messaging in a product before a DCM’s
risk controls limit trading in that
product. If the trading halt has a
material impact on other market
participants’ ability to trade in that
product, then that would constitute a
market disruption. However, if trading
is only halted for a de minimis amount
of time, and market participants can
130 See id. at 10. Better Markets cited ‘‘the Flash
Crash, recent WTI trading anomalies in the oil
markets, and the Knight Capital meltdown’’ as
examples demonstrating that electronic trading
presents ‘‘varied, complex, and potentially
extensive risks to market integrity, orderly trading,
fair competition, and the price discovery process
across the financial markets.’’ See id. at 3.
131 MGEX NPRM Letter, at 1–2.
132 See id. at 3.
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quickly resume trading in that product,
that may not rise to the level of a
material ‘‘market disruption’’ of the
DCM’s trading platform for purposes of
the Risk Principles.
CME indicated that a specific
disruption cited in the NPRM (namely
a malfunction that prompted the selling
of e-mini Nasdaq 100 Index futures on
the Chicago Mercantile Exchange, and
another malfunction that caused a rapid
buying of oil futures on NYMEX) was
not necessarily a ‘‘market disruption,’’
because the event did not disrupt the
operation of the DCM or limit market
participants’ ability to trade.133 The
Commission acknowledges that DCMs
will have some discretion to determine
whether an event constitutes a market
disruption for purposes of the Risk
Principles. However, if the malfunctions
described in the 2011 CME disciplinary
actions were to cause a material change
in price that deviated from prevailing
market prices, and the DCMs were
required to cancel numerous trades, the
Commission would likely view such a
scenario as a material market disruption
that DCMs should have reasonable rules
and risk controls in place to prevent,
detect, and mitigate. The materiality of
a market disruption would depend on,
for example, in the context of trade
errors, how quickly the DCM can correct
erroneous prices, and how many
contracts are affected. In the event of a
market disruption involving a trading
halt, materiality generally would
depend on how quickly trading is able
to resume.
Under Risk Principle 3, DCMs only
have to report market disruptions under
Risk Principles 1 and 2 that are
‘‘significant.’’ All significant market
disruptions under Risk Principle 3 are
also market disruptions under Risk
Principles 1 and 2, but the converse is
not true: Some market disruptions
under Risk Principles 1 and 2 will not
be sufficiently significant to trigger the
reporting requirement under Risk
Principle 3. Thus, the standard for a
significant market disruption under Risk
Principle 3 is higher than the standard
for a market disruption under Risk
Principles 1 and 2. The Commission
emphasizes that DCMs have reasonable
discretion to determine whether a given
market disruption had a ‘‘significant’’
impact on the trading platform, so as to
trigger Risk Principle 3 reporting.134
133 CME
NPRM Letter, at 3.
discretion’’ shall be interpreted
in the same manner as it has been used elsewhere
in the Commission’s regulations. See, e.g., Part 38
Core Principle 1, which provides that unless
otherwise determined by the Commission by rule or
regulation, a board of trade described in paragraph
134 ‘‘Reasonable
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Further, as to each Risk Principle, the
Commission clarifies that the terms
‘‘market disruption’’ and ‘‘system
anomaly’’ are intended to capture
scenarios where a participant’s ability to
trade, engage in price discovery, or
manage risk are materially impacted. All
three scenarios do not have to occur for
an event to be considered a market
disruption or system anomaly. In
addition, the Commission clarifies that
‘‘system anomalies’’ are unexpected
conditions that occur in a market
participant’s functional system that
cause a disruption to the operation of
the DCM or the ability of market
participants to trade on the DCM,
engage in price discovery, or manage
risk. The disruption on the DCM need
not be similar in nature to the
disruption in a participant’s system.
The Commission understands that
many examples of a market participant’s
ability to trade on the DCM, engage in
price discovery, or manage risk may
involve the limitation of participant
access to the DCM. However, the
Commission declines to limit the
definitions of ‘‘market disruption’’ or
‘‘system anomaly’’ to a limitation of
access, as there may be situations where
market participants cannot engage in
price discovery, regardless of whether
they have access to the DCM. For
example, a market participant may have
access to trade in a particular product,
but the product’s price has been
impacted by inadvertent rapid selling or
buying.
The Commission believes the term
‘‘market disruption’’ is not overly broad.
While one commenter asserted that
‘‘market disruption’’ could include
various events that involve prices not
reflecting market fundamentals, such as
entering orders in a disorderly manner,
quote stuffing, causing illiquid markets
where one would not occur otherwise,
or causing the artificial widening of
markets, the Commission clarifies that
intentionally or recklessly disruptive
trading behavior is not meant to be
within the scope of the Risk
Principles.135 Rather, the focus of the
Risk Principles is to address
unintentional technological
malfunctions that disrupt the operation
(a) of this section shall have reasonable discretion
in establishing the manner in which the board of
trade complies with the core principles described
in this subsection. 17 CFR 38.100 (emphasis added).
135 Intentional or reckless acts of price
manipulation, fraud, disruptive trading, wash sales,
or pre-arranged trading, among others, are
addressed through existing provisions, including,
but not limited to, Sections 4b, 4c(a)(2), 4c(a)(5), 4o,
and 9 of the CEA and Commission regulations
§§ 1.38, 180.1, 180.2, 38.152, and 38.250. See 7
U.S.C. 6b, 6c(a)(2), 6c(a)(5), 6o, 9; 17 CFR 1.38,
180.1, 180.2, 38.152, 38.250.
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of the DCM or the ability of market
participants to trade, engage in price
discovery, or manage risk. A situation
where prices do not reflect market
fundamentals is not sufficient, on its
own, to constitute a material market
disruption for purposes of the Risk
Principles.
The Commission agrees that no
specific market halt should be
considered a per se ‘‘market
disruption,’’ because certain halts
effectively prevent and mitigate market
disruptions. Further, the Commission
will not characterize any specific period
of latency as per se disruptive due to the
various causes of latency, not all of
them relating to market disruptive
events. The Commission emphasizes
that DCMs have discretion in
determining whether a trading halt is
disruptive.
In response to comments relating to
DCM discretion, the Commission
reiterates DCMs are best-positioned to
assess the material market disruption
and system anomaly risks posed by their
markets and market participant activity,
and to design appropriate measures to
address those risks. However, while
DCMs may differ in what they consider
to be a ‘‘market disruption’’ or ‘‘system
anomaly,’’ and whether and how to
mitigate such an event, this is not
unlimited discretion. The Commission
will oversee and enforce the Risk
Principles in accordance with an
objective reasonableness standard. In
other words, while a DCM has
discretion to determine what rules and
risk controls are appropriate, the
Commission as part of its oversight
responsibility will consider the
objective reasonableness of those
measures in light of the DCM’s
products, volume, market participants
and other factors, and how similarly
positioned DCMs address similar risks.
Due to differences among DCMs, the
Commission acknowledges DCMs may
have different determinations of what
constitutes a ‘‘market disruption’’ or
‘‘system anomaly.’’ In response to the
comment from Better Markets, the
Commission does not believe this will
hinder any ‘‘comparative’’ analysis of
market disruptions across exchanges.
When assessing material market
disruptions, the Commission will
consider differences among DCM
markets, technology, products, and
market participants as part of its
oversight.
As to MGEX’s comment that each
DCM operates differently, the
Commission acknowledges that each
DCM operates unique markets, with
unique market participants, products,
and technology. The Commission
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already takes this into account with
respect to its routine oversight,
including examinations.
B. The Reasonableness Standard
1. Proposal
The Commission proposed
Acceptable Practices to Risk Principles
1 and 2, which provide that a DCM can
comply with those principles by
adopting rules, and subjecting all
electronic orders to exchange-based pretrade risk controls, that are reasonably
designed to prevent, detect, and mitigate
market disruptions or system anomalies
associated with electronic trading.136
2. Summary of Comments
ICE, MGEX, CME, Better Markets, and
IATP commented on the reasonableness
standard.137 ICE supported the
Commission’s approach to give DCMs
reasonable discretion to adopt rules that
prevent, detect, and mitigate market
disruptions.138 ICE stated DCMs are
best-positioned to adopt the rules,
procedures, and system controls that fit
their market and technology.139 ICE
further commented that the proposed
Acceptable Practice for Commission
regulation § 38.251(e) provides DCMs
with sufficient discretion to adopt the
rules appropriate for their platform.140
ICE believes the supervisory obligations
set out in exchange rules, along with
requirements relating to disruptive
trading practices, have been effective in
preventing market disruptions.141
Similarly, MGEX commented that the
Commission should accept that DCMs
may differ in the rules they establish
based on the unique and different
markets and products, and DCMs must
have discretion to ensure that the rules
are ‘‘objectively reasonable’’ to address
a market disruption or system
anomaly.142
CME commented that the Commission
should add ‘‘reasonably designed’’ to
the regulation text, not just acceptable
practices, just as it is in at least 40 other
existing Commission regulations.143
CME believes this is especially
important for Risk Principle 2, which
requires controls to ‘‘prevent’’ system
anomalies.144 CME stated that the word
‘‘prevent’’ creates an impossible
136 NPRM
at 42777.
NPRM Letter, at 2; MGEX NPRM Letter,
at 2–3; CME NPRM Letter, at 4–5, 6, 13; Better
Markets NPRM Letter, at 8; IATP NPRM Letter, at
9.
138 ICE NPRM Letter, at 2.
139 See id.
140 See id.
141 See id.
142 MGEX NPRM Letter, at 2–3.
143 CME NPRM Letter, at 4–5.
144 See id. at 6.
137 ICE
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standard without a condition in the Risk
Principle explicitly stating that the
controls must be ‘‘reasonably
designed.’’ 145
Better Markets commented that the
Commission’s emphasis on DCM
flexibility suggests confusion as to
whether reasonableness is an objective
or subjective standard.146 Better Markets
believed the preamble to the final rules
should state that the Risk Principles
may require DCMs to do things
differently if their pre-trade risk controls
do not objectively satisfy the
regulations.147 Better Markets also
commented that the NPRM’s preamble
set forth a ‘‘near presumption of
reasonableness.’’ 148 Similarly, IATP
commented that the preamble indicates
it is unlikely the Commission will take
any enforcement action against
DCMs.149 IATP disagreed with the
Commission’s statement that the Risk
Principles will not result in enforcement
actions based on strict liability.150 IATP
stated that assuring DCMs that risk
control failure will not result in
enforcement action would signal to
plaintiffs in a market disruption case
that they would have to meet a high
evidentiary standard.151
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3. Discussion
The Acceptable Practices will be
adopted as proposed with the
‘‘reasonably designed’’ standard. As
stated in the NPRM, the Acceptable
Practices for implementing the Risk
Principles provide that DCMs shall have
satisfied their requirements under the
Risk Principles if they have established
and implemented rules and pre-trade
risk controls that are reasonably
designed to prevent, detect, and mitigate
market disruptions or system anomalies
associated with electronic trading.152
‘‘Reasonably designed’’ means that a
DCM’s rules and risk controls are
objectively reasonable. As noted above,
in assessing a DCM’s rules and risk
controls, the Commission as part of its
oversight responsibility will consider
the objective reasonableness of those
measures in light of the DCM’s
products, volume, market participants
and other factors, and how similarly
positioned DCMs address similar risks.
The Acceptable Practices are intended
to provide DCMs with reasonable
discretion to impose rules and risk
controls to prevent, detect, and mitigate
145 See
id. at 6–7.
Markets NPRM Letter, at 8.
147 See id.
148 See id.
149 IATP NPRM Letter, at 9.
150 See id.
151 See id.
152 See NPRM at 42763.
146 Better
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market disruption. Transferring the
reasonableness standard to the
regulation text is not necessary to allow
DCM discretion to impose rules and
controls appropriate to their own
markets.
In addition, the word ‘‘prevent,’’
when part of a reasonableness standard
applicable through Acceptable
Practices, does not create an impossible
standard to achieve. Rules and controls
implemented by DCMs need to be
reasonable, as determined by an
objective standard. Risk Principles 1
and 2 do not require DCMs to ‘‘prevent’’
market disruptions and system
anomalies in all circumstances. A goal
of these Risk Principles is to provide
DCMs with appropriate flexibility to
take reasonably designed measures
relevant to individual markets, and
improve those measures as markets
evolve.
The Commission confirms that the
reasonableness standard is an objective
one and there is no presumption of
reasonableness. While there are
differences among DCMs, what one
DCM may implement in terms of rules
and controls to address material market
disruptions may be relevant to assessing
another DCM’s compliance. For
example, if the Commission finds that a
particular DCM is an outlier in terms of
rules or controls, this may cause the
Commission to inquire further whether
there are legitimate reasons for the
differences.
The Commission confirms that DCMs
may need to impose additional rules on
their market participants, or implement
additional controls, if their rules and
controls do not objectively satisfy the
Risk Principles. The Risk Principles are
principles-based and allow for DCM
discretion in compliance, but they are
nevertheless enforceable regulations.
Market participants should not interpret
the Commission’s statements in this
preamble to articulate any particular
evidentiary standard in an enforcement
action.
C. Risk Principle 1
1. Proposal
In Risk Principle 1, the Commission
proposed that a DCM must adopt and
implement ‘‘rules’’ governing market
participants subject to its jurisdiction to
prevent, detect, and mitigate market
disruptions or system anomalies
associated with electronic trading.153
The Commission proposed that Risk
Principle 1 (and the other Risk
153 NPRM
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2057
Principles) apply to all electronic
trading.
2. Rules Versus Controls and Other
Procedures
a. Summary of Comments
Several commenters addressed Risk
Principle 1’s requirement that DCMs
implement ‘‘rules.’’ CME suggested Risk
Principle 1 should focus on rules on
participants and their conduct that are
enforced through administrative or
disciplinary processes; an example is
CME Group’s Messaging Efficiency
Policy.154 Other examples CME
provided include trade practice and
disciplinary rules and CME’s disruptive
trading practices rule (Rule 575), which
CME amended in 2020 to provide that
it is a violation ‘‘for a participant to
intentionally or recklessly engage in
activity that has the potential to disrupt
the systems of the Exchange.’’ 155
Better Markets and MGEX also
commented on the term ‘‘rule.’’ 156
Better Markets stated the Commission
should clarify that ‘‘rules’’ include
internal policies, procedures, controls,
advisories, and trading protocols
contemplated in the broad definition in
40.1.157 MGEX commented that the
Commission should ensure ‘‘rules,’’ as
described in the NPRM, include nonrules such as policies, procedures,
protocols, and controls.158
CFE stated a DCM should be able to
satisfy Risk Principle 1 through
implementing internal systems,
processes, and procedures, not just
rules.159 For example, CFE commented
a DCM may not want to publicly
disclose how it monitors particular
markets.160 CFE asserted requiring a
DCM to describe in its rules how it
monitors for market disruptions and
system anomalies is administratively
burdensome and may disincentivize a
DCM from improving its systems.161
CEWG stated DCM rules adopted
pursuant to Risk Principles 1 and 2
should be subject to Commission
approval under Commission regulation
§ 40.5 or self-certification under
Commission regulation § 40.6.162 CEWG
asserted a transparent regulatory process
would ensure that new DCM rules are
appropriately tailored.163
154 CME
NPRM Letter, at 5.
at 5–6 (emphasis in original).
156 Better Markets NPRM Letter, at 10; MGEX
NPRM Letter, at 2, 4.
157 Better Markets NPRM Letter, at 10.
158 MGEX NPRM Letter, at 2, 4.
159 CFE NPRM Letter, at 3.
160 Id.
161 Id.
162 CEWG NPRM Letter, at 7.
163 Id.
155 Id.
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b. Discussion
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With respect to the comments
addressing the scope of the term ‘‘rule’’
in Risk Principle 1, the Commission
emphasizes that the term is intended to
have the meaning set forth in part 40 of
the Commission’s regulations.
Specifically, the Commission clarifies
that for purposes of Risk Principle 1 and
the Acceptable Practices, the term
‘‘rule’’ has the meaning set forth in
existing Commission regulation
§ 40.1(i), which provides that rule
means any constitutional provision,
article of incorporation, bylaw, rule,
regulation, resolution, interpretation,
stated policy, advisory, terms and
conditions, trading protocol, agreement
or instrument corresponding thereto,
including those that authorize a
response or establish standards for
responding to a specific emergency, and
any amendment or addition thereto or
repeal thereof, made or issued by a
registered entity or by the governing
board thereof or any committee thereof,
in whatever form adopted.164 This
definition of ‘‘rule’’ is broad and can
include policies, procedures, protocols,
and controls that are not public.165 DCM
policies and other internal procedures
addressing market disruption risk could
also satisfy Risk Principle 1.
Commission regulation § 40.1(i)
would require rules to be approved or
self-certified pursuant to part 40
regulations, though DCMs would be
entitled to request confidential
treatment pursuant to the procedures in
Commission regulation § 40.8(c) with
respect to such filings.166 In particular,
under Risk Principle 1, a DCM would be
required to submit rules to the
Commission in accordance with either:
(a) Commission regulation § 40.5, which
provides procedures for the voluntary
submission of rules for Commission
review and approval; or (b) Commission
regulation § 40.6, which provides
procedures for the self-certification of
rules with the Commission.167
The part 40 rule submission process
will ensure that new rules that DCMs
implement to address the risk of market
disruption—including internal
processes—will be subject to
appropriate Commission review and
oversight. With respect to selfcertifications, the Commission stated in
the preamble to the part 40 final rules
164 17
CFR 40.1(i).
part 40, a DCM’s filing of rules under
Commission regulations §§ 40.5 or 40.6 shall be
treated as public information, unless accompanied
by a request for confidential treatment. See 17 CFR
40.8(c).
166 17 CFR 40.8(c).
167 See 17 CFR 40.5, 40.6.
165 Under
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that the explanation and analysis of
certified rules or rule amendments
should be a clear and informative—but
not necessarily lengthy—discussion of
the submission, the factors leading to
the adoption of the rule or rule
amendment, and the expected impact of
the rule or rule amendment on the
public and market participants.168
3. Scope of Electronic Trading Subject
to DCM Rules
a. Summary of Comments
Several commenters addressed the
scope of orders and trades subject to
Risk Principle 1. ICE supported
requiring DCMs to subject all electronic
orders to exchange-based pre-trade risk
controls, because all persons that trade
electronically have the potential to
disrupt markets.169 CFE asked the
Commission to clarify that under Risk
Principle 1, DCMs may have rules
governing market participants subject to
the DCM’s jurisdiction that are
applicable to a subset of market
participants, as long as those rules apply
to all electronic orders submitted to the
DCM.170 IATP supported requiring
DCMs to implement separate risk
controls for cleared and uncleared
trades.171 IATP asserted uncleared
trades pose greater counterparty credit
risks, so the Risk Principles should
require post-trade risk controls to
prevent post-trade contract defaults and
other credit events.172
b. Discussion
The Commission is adopting Risk
Principle 1 as proposed, but clarifies
that a DCM may have rules that apply
to only a subset of market participants.
The Commission understands that
DCMs have markets with a broad range
of market participants and trading
patterns. The Commission believes that
DCMs should have reasonable
discretion to determine whether risk
controls should be different for different
types of trading activity. Indeed, it may
not be advisable for a DCM to impose
the same rules under Risk Principle 1 on
all types of market participants and
trading activity present on the DCM’s
platforms. The Commission’s
principles-based approach to the Risk
Principles gives DCMs the flexibility to
impose the most efficient and effective
rules and pre-trade risk controls for
their respective markets. The
Commission believes Risk Principle 1
will help ensure DCMs continue to
monitor risks as they evolve along with
the markets, and make reasonable
changes as appropriate to address those
evolving risks.173
In response to IATP’s comment
supporting a separate set of risk controls
on uncleared trades, the Commission
notes that all transactions on or
pursuant to the rules of a DCM must be
cleared. As a result, any such separate
set of risk controls would be on a null
set of trades.174
D. Risk Principle 2—Risk Controls
Listed in Part 38
1. Proposal
Risk Principle 2 requires DCMs to
subject all electronic orders to
exchange-based pre-trade risk controls
to prevent, detect, and mitigate market
disruptions or system anomalies
associated with electronic trading.
The Commission noted in the NPRM
that certain existing provisions in part
38 list appropriate DCM-implemented
risk controls.175 For example, existing
Commission regulation § 38.255
mandates exchange-based risk controls
to prevent and reduce the potential risk
of market disruptions.176 In addition,
existing Core Principle 4’s Acceptable
Practices 177 list appropriate risk
controls, and proposed Risk Principle 2
does not change those Acceptable
Practices.
2. Summary of Comments
CME, ICE, and MGEX agree with the
Commission that the controls listed in
existing acceptable practices are
sufficient. CME stated the controls listed
in the existing acceptable practices are
effective at preventing or mitigating
market disruptions, and the
Commission should not list any others
as part of proposed Commission
regulation § 38.251(f).178 ICE
commented there is not one set of risk
controls that are most effective in
preventing market disruptions.179 ICE
173 NPRM
at 42767.
Commission has explained that all
transactions executed on or through a DCM must be
cleared through a Commission-registered DCO. See
Core Principles and Other Requirements for
Designated Contract Markets, 77 FR 36612, 36646
(June 19, 2012).
175 See NPRM at 42767–68.
176 See id. at 42768.
177 See Appendix B to Part 38—Guidance on, and
Acceptable Practices in, Compliance with Core
Principles, Core Principle 4 (Subparagraph (b)).
178 CME NPRM Letter, at 14.
179 ICE NPRM Letter, at 7.
174 The
168 Part 40 final rules, 75 FR 44776, 44782–83
(July 27, 2011). The Commission further noted that
it requires registered entities to provide a more
detailed explanation and analysis of rules
voluntarily submitted for Commission approval
under the provisions of § 40.5. Id. at 44782. See also
17 CFR 40.6(a)(7) (setting forth rule submission
requirements).
169 ICE NPRM Letter, at 3.
170 CFE NPRM Letter, at 1–2.
171 IATP NPRM Letter, at 10.
172 Id.
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further asserted the proposed
Acceptable Practices for proposed
Commission regulation § 38.251(f) and
the guidance provided in existing
Appendix B(b)(5) provide DCMs
sufficient discretion to adopt
appropriate risk controls.180 MGEX
stated the controls outlined in existing
Acceptable Practices for Core Principle
2 are sufficient.181
In contrast, IATP commented that
Risk Principle 2 should include posttrade risk controls to help protect
market participants against credit events
resulting from DCM negligence in the
design, implementation and
enforcement of its rules and risk
controls.182 IATP stated this would
follow the FIA recommendation on
post-trade risk controls.183
3. Discussion
The Commission is adopting Risk
Principle 2 as proposed and is not
adding specific controls to the
regulation text or Acceptable Practices.
As discussed in the NPRM, the purpose
of Risk Principle 2 is to require DCMs
to consider market participants’ trading
activities when designing and
implementing exchange-based risk
controls to address market disruptive
events.184 Risk Principle 2 provides
clarity to DCMs that their exchangebased risk controls must address market
disruptions caused by electronic
trading, including those related to price
movements as well as other events that
impair market participants’ ability to
trade.185
Consistent with the comments
received from CME, ICE, and MGEX, the
Commission believes the existing
Acceptable Practices set forth in Core
Principle 4 list appropriate risk controls.
Specifically, the Acceptable Practices in
existing Core Principle 4 list risk
controls including pre-trade limits on
order size, price collars or bands around
the current price, message throttles, and
daily price limits.186 The Commission
declines to impose additional pre-trade
or post-trade risk control requirements
on DCMs. The Commission does not
consider such requirements to be
necessary or consistent with the
Commission’s principles-based
approach to the Risk Principles.
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180 Id.
at 8.
NPRM Letter, at 2.
182 IATP NPRM Letter, at 10.
183 Id.
184 NPRM at 42767.
185 Id. at 42768.
186 See Appendix B to Part 38—Guidance on, and
Acceptable Practices in, Compliance with Core
Principles, Core Principle 4 (Subparagraph (b)).
181 MGEX
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E. Risk Principle 3
1. Proposal
The Commission proposed in Risk
Principle 3 that a DCM must promptly
notify Commission staff of a
‘‘significant’’ disruption to its electronic
trading platform(s) and provide timely
information on the causes and
remediation.
In the NPRM, the Commission stated
the required notification under Risk
Principle 3 would take a form similar to
current Commission regulation
§ 38.1051(e) notification.187 Further, the
Commission differentiated Risk
Principle 3 from existing Commission
regulation § 38.1501(e) by noting that,
rather than addressing a DCM’s internal
technological systems, Risk Principle 3
addresses malfunctions of the
technological systems of trading firms
and other non-DCM market participants
that cause disruptions of the DCM’s
trading platform.
In addition, the Commission asked
commenters to describe circumstances
in which it would be appropriate for a
DCM to notify other DCMs about a
significant market disruption on its
trading platform(s). The Commission
asked whether proposed Risk Principle
3 should include such a requirement.
2. ‘‘Significant’’ Standard
a. Summary of Comments
Better Markets, CME, and ICE
believed the term ‘‘significant’’ in Risk
Principle 3 is unclear. Better Markets
asserted that expectations regarding
timing and substance of reporting
‘‘significant market disruptions’’ are
imprecise and unenforceable.188 Better
Markets stated DCMs must know what
to report, where to report it, when to
report it, and under what circumstances
reporting is required.189 Better Markets
further stated Risk Principle 3 fails to (i)
provide a formal definition of market
disruptions, (ii) indicate when
disruptions cross the significance
threshold, or (iii) identify the level of
detail necessary to notify the CFTC
sufficiently.190
CME stated that while Risk Principle
3 appears to require impact to both the
operation of the DCM and market
participants, Risk Principles 1 and 2
seem to require impact to operation of
the DCM or market participants.191 CME
also commented that to be subject to the
notification requirement, Risk Principle
3 provides a significant disruption must
187 NPRM
at 42769.
Markets NPRM Letter, at 2.
189 Id. at 9.
190 Id. at 10.
191 CME NPRM Letter, at 8.
188 Better
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‘‘materially affect’’ the DCM and market
participants.192 CME supported
clarifying the distinction between
‘‘significant’’ and ‘‘material.’’ 193
MFA and MGEX supported the use of
the term ‘‘significant’’ in Risk Principle
3. MFA believed the definition of
‘‘significant’’ establishes a threshold for
when notification is required and will
promote meaningful reporting and
oversight.194 MFA agreed that an
internal disruption in a market
participant’s own trading system
‘‘should not be considered significant
unless it causes a market disruption
materially affecting the DCM’s trading
platform and other market
participants.’’ 195 MGEX believed that
‘‘significant disruption’’ provides DCMs
with discretion to interpret events in
light of the unique nature of markets
and products across DCMs and
platforms.196
b. Discussion
The Commission acknowledges the
term ‘‘significant’’ could be susceptible
to varying degrees of application based
on a particular DCM’s business model
and particular market. However, the
Commission believes in practice Risk
Principle 3 provides a workable
standard for notifications.197 This has
proven to be the case with respect to
existing Commission regulation
§ 38.1051(e), which requires DCMs to
notify Commission staff of, among other
things, ‘‘significant’’ system
malfunctions.198 The Commission notes
it originally proposed that DCMs must
report to the Commission all system
malfunctions under Commission
regulation § 38.1051(e).199 In response,
CME commented that such a
notification requirement would be
overly broad.200 The Commission
considered CME’s comment and
concluded that timely advance notice of
all planned changes to address system
malfunctions is not necessary and is
revising the rule to provide that DCMs
only need to promptly advise the
Commission of all significant system
192 Id.
193 Id.
194 MFA
NPRM Letter, at 3.
195 Id.
196 Id.
at 4.
Section II.A.2(c), discussing ‘‘significant’’
and ‘‘material.’’ In addition, in response to CME’s
comment, a market disruption for purposes of all
three Risk Principles requires impact to operation
of the DCM or market participants.
198 See 17 CFR 38.1051(e).
199 See Core Principles and Other Requirements
for Designated Contract Markets, supra note 174, at
36657–58.
200 Id. at 36658.
197 See
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malfunctions.201 Thus, similar to the
‘‘significant’’ standard under Risk
Principle 3, DCMs are already subject to
a ‘‘significant’’ threshold for notification
with respect to system safeguards rules.
The Commission does not consider it
appropriate or necessary to require
DCMs to notify Commission staff of all
market disruptions pursuant to Risk
Principle 3, especially given that such a
rule would be more burdensome on
DCMs than a mandate that they report
only ‘‘significant’’ market disruptions to
the Commission.
3. Notification Requirement
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a. Summary of Comments
CME stated that it is unsure of the
practical utility to the Commission of
receiving notifications under Risk
Principle 3, since the Commission
already collects such information
through other means.202 Better Markets
asserted the CFTC should require part
40 filings, as opposed to email
notifications.203
CME asserted the distinction from
Commission regulation § 38.1051(e) is
clear; an incident could disrupt the
trading platform without there having
been a system malfunction on the
platform.204 CME gave as an example an
incident originating with a participant
that causes a match engine to failover to
backup.205 CME further stated both
notification provisions could be
triggered by an incident arising with a
participant that causes both a market
disruption and a system malfunction.206
CEWG stated Risk Principle 3 appears
to apply a per se standard for reporting,
which leaves market participants open
to potential enforcement risk.207 CEWG
asserted the Commission should revise
Risk Principle 3 to require notifications
only where disruptions result from
grossly negligent or reckless conduct
with respect to a market participant’s
obligations to implement and maintain
pre-trade risk controls, conduct due
diligence or testing, as well as
appropriate risk mitigation measures
consistent with applicable DCM rules or
accepted industry practices related to
electronic trading activity.208
ICE recommended the Commission
define what constitutes a ‘‘significant
disruption’’ of a DCM trading platform
and how it differs from a ‘‘market
disruption,’’ e.g., whether a transient
(emphasis added).
NPRM Letter, at 16.
203 Better Markets NPRM Letter, at 10.
204 CME NPRM Letter, at 14–15.
205 Id.
206 Id. at 15.
207 CEWG NPRM Letter, at 5.
208 Id. at 6.
disruption, which temporarily results in
prices not reflecting market
fundamentals, would be reportable.209
ICE supported the Commission
incorporating into Risk Principle 3 the
requirement that a significant disruption
be caused by a ‘‘malfunction of a market
participant’s trading system.’’ 210 ICE
asserted the addition of this language
would help to differentiate the reporting
obligations under Commission
regulation § 38.1051(e).211
In response to the question in the
NPRM asking if Risk Principle 3 should
require a DCM to notify other DCMs of
a significant market disruption, CME
and ICE indicated Risk Principle 3
should not include such a requirement.
ICE stated current Appendix B(b)(5)
provides guidance on coordinating risk
controls for linked or related
contracts.212 ICE asserted in
circumstances of a significant market
disruption, it would be prudent for such
coordination to include notification to
impacted markets, at least though a
market alert.213 CME noted there are
already real-time data feeds and other
public sources that provide information
on whether a DCM is experiencing a
significant market disruption.214 CME
further noted if this proposal is adopted,
all DCMs will be required to report to
the Commission, negating the need for
notice between DCMs.215
b. Discussion
The Commission is finalizing the
notification requirement in Risk
Principle 3 as proposed, with one
clarification. In the NPRM, Risk
Principle 3 referred to ‘‘significant
disruptions to’’ a DCM’s platform(s).
Consistent with Risk Principles 1 and 2,
which use the term ‘‘market
disruption,’’ the Commission is revising
Risk Principle 3 to state a DCM must
promptly notify Commission staff of any
‘‘significant market disruptions on’’ its
platform(s). The purpose of this revision
is to clarify that the notification
requirement in Risk Principle 3 applies
to a subset of the market disruptions
under Risk Principles 1 and 2, i.e., to
those market disruptions that are
‘‘significant.’’ Consistent with the
comments received, the Commission is
not including a requirement that a DCM
201 Id.
209 ICE
202 CME
210 Id.
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NPRM Letter, at 4.
211 Id.
212 CME
III. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act
(‘‘RFA’’) requires federal agencies, in
promulgating regulations, to consider
the impact of those regulations on small
entities, and to provide a regulatory
flexibility analysis with respect to such
impact. The regulations adopted in this
final rulemaking will affect DCMs. The
Commission previously determined that
DCMs are not ‘‘small entities’’ for
purposes of the RFA because DCMs are
required to demonstrate compliance
with a number of Core Principles,
including principles concerning the
expenditure of sufficient financial
NPRM Letter, at 15; ICE NPRM Letter, at
9.
213 ICE
NPRM Letter, at 9.
214 CME NPRM Letter, at 15.
215 Id.
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notify other DCMs in the event of a
significant market disruption.216
In response to comments questioning
the utility of notifications,217 the
Commission reiterates its view that the
notification requirement under Risk
Principle 3 will assist the Commission’s
oversight and its ability to monitor and
assess market disruptions across all
DCMs. The Commission expects
notification under Risk Principle 3 to
take a similar form to the current
notification process for electronic
trading halts, cybersecurity incidents, or
activation of a DCM’s business
continuity-disaster recovery plan under
Commission regulation § 38.1051(e).
Specifically, the Commission would
expect such notification to consist of an
email containing sufficient information
to convey the nature of the market
disruption, and if known, its cause, and
the remediation.
In response to CEWG’s comment, the
Commission declines to limit the
notification requirement in Risk
Principle 3 to instances of ‘‘grossly
negligent’’ or ‘‘reckless’’ conduct. The
Commission considers such qualifiers to
be overly limiting and unduly
burdensome on DCMs that would be
required to determine whether conduct
constitutes gross negligence or
recklessness. In addition, the
Commission reiterates that an email
notification is the appropriate form of
Risk Principle 3 notification. Requiring
such notifications to be in the form of
part 40 filings would be overly
burdensome to exchanges given the
Commission’s estimate of 0–25
notifications per year. Moreover, in the
context of significant market
disruptions, prompt email notification
is preferable to the inherently slower
process of part 40 filings.
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216 In response to ICE’s comment, see discussion
at Section II.A.2(c) addressing ‘‘significant’’ and
‘‘material.’’
217 See CME NPRM Letter, at 16.
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resources to establish and maintain an
adequate self-regulatory program.218
The Commission received no comments
on the impact of the rules described in
the NPRM on small entities. Therefore,
the Chairman, on behalf of the
Commission, hereby certifies, pursuant
to 5 U.S.C. 605(b), that the regulations
adopted by this final rulemaking will
not have a significant economic impact
on a substantial number of small
entities.
B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995
(‘‘PRA’’) imposes certain requirements
on federal agencies, including the
Commission, in connection with
conducting or sponsoring any
‘‘collection of information,’’ as defined
by the PRA.219 Under the PRA, an
agency may not conduct or sponsor, and
a person is not required to respond to,
a collection of information unless it
displays a currently valid control
number from the Office of Management
and Budget (‘‘OMB’’). The PRA is
intended, in part, to minimize the
paperwork burden created for
individuals, businesses, and other
persons as a result of the collection of
information by federal agencies, and to
ensure the greatest possible benefit and
utility of information created, collected,
maintained, used, shared, and
disseminated by or for the federal
government. The PRA applies to all
information, regardless of form or
format, whenever the federal
government is obtaining, causing to be
obtained, or soliciting information, and
includes required disclosure to third
parties or the public, of facts or
opinions, when the information
collection calls for answers to identical
questions posed to, or identical
reporting or recordkeeping requirements
imposed on, ten or more persons.
The final rulemaking modifies the
following existing collections of
information previously approved by
OMB and for which the Commission has
received control numbers: (i) OMB
control number 3038–0052, Core
Principles and Other Requirements for
DCMs (‘‘OMB Collection 3038–0052’’)
and OMB control number 3038–0093,
Provisions Common to Registered
Entities (‘‘OMB Collection 3038–0093’’).
The Commission does not believe the
Risk Principles as adopted impose any
other new collections of information
that require approval of OMB under the
PRA.
218 See Policy Statement and Establishment of
Definitions of ‘‘Small Entities’’ for Purposes of the
Regulatory Flexibility Act, 47 FR 18618, 18619
(Apr. 30, 1982).
219 44 U.S.C. 3501 et seq.
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The Commission requests that OMB
approve and revise OMB control
numbers 3038–0052 and 3038–0093 in
accordance with 44 U.S.C. 3507(d) and
5 CFR 1320.11.
1. OMB Collection 3038–0093—
Provisions Common to Registered
Entities
Final Commission regulation
§ 38.251(e) (‘‘Risk Principle 1’’) provides
that DCMs must adopt and implement
rules governing market participants
subject to their respective jurisdictions
to prevent, detect, and mitigate market
disruptions or system anomalies
associated with electronic trading. As
provided in subparagraph (b)(6) of
Appendix B to part 38, such rules must
be reasonably designed to prevent,
detect, and mitigate market disruptions
or system anomalies associated with
electronic trading. Any such rules a
DCM adopts pursuant to Commission
regulation § 38.251(e) must be submitted
to the Commission in accordance with
part 40 of the Commission’s regulations.
Specifically, a DCM is required to
submit such rules to the Commission in
accordance with either: (a) Commission
regulation § 40.5, which provides
procedures for the voluntary submission
of rules for Commission review and
approval; or (b) Commission regulation
§ 40.6, which provides procedures for
the self-certification of rules with the
Commission. This information
collection is required for DCMs as
needed, on a case-by-case basis. The
Commission acknowledges that various
DCM practices in place today may be
consistent with Commission regulation
§ 38.251(e), such as rules requiring
market participants to use exchangeprovided risk controls that address
potential price distortions and related
market anomalies. Accordingly, it is
possible that some DCMs would not be
required to file new or amended rules to
satisfy Risk Principle 1.
Commission regulation § 38.251(e)
amends OMB Collection 3038–0093 by
increasing the existing annual burden
by an additional 48 hours 220 for DCMs
that would be required to comply with
part 40 of the Commission’s regulations.
As a result, the revised total annual
burden under this amended collection
would increase by 816 hours.221
220 The Commission estimates that final
Commission regulation § 38.251(e) would require
potentially 17 DCMs to make 2 filings with the
Commission a year requiring approximately 24
hours each to prepare. Accordingly, the total
burden hours for each DCM would be
approximately 48 hours per year.
221 The Commission estimates that the total
additional aggregate annual burden hours for DCMs
under final Commission regulation § 38.251(e)
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2061
Although the Commission believes that
operational and maintenance costs for
DCMs in Commission regulation
§ 38.251(e) will incrementally increase,
these costs are expected to be de
minimis.
The Commission has previously
estimated the combined annual burden
hours for both Commission regulations
§§ 40.5 and 40.6 to be 7,000 hours.
Upon implementation of final
Commission regulation § 38.251(e), the
Commission estimates that 17
exchanges may each make two rule
filings under Commission regulations
§ 40.5 or § 40.6 per year for a total of 34
submissions for all DCMs.222 The
Commission further estimates that the
exchanges may employ a combination of
in-house and outside legal and
compliance personnel to update existing
rulebooks and it will take 24 hours to
complete and file each rule submission
for a total of 48 burden hours for each
exchange and 816 burden hours for all
exchanges.
OMB Collection 3038–0093 was
created to cover the Commission’s part
40 regulatory requirements for
registered entities (including DCMs,
SEFs, DCOs, and swap data repositories)
to file new or amended rules and
product terms and conditions with the
Commission.223 OMB Control Number
3038–0093 covers all information
collections in part 40, including
Commission regulation § 40.2 (Listing
products by certification), Commission
regulation § 40.3 (Voluntary submission
of new products for Commission review
and approval), Commission regulation
§ 40.5 (Voluntary submission of rules for
Commission review and approval), and
Commission regulation § 40.6 (Selfcertification of rules). Commission
regulation § 38.251(e) adopted in this
final rulemaking modifies the existing
annual burden in OMB Collection 3038–
0093, increasing the annual burden
estimates in aggregate below:
Estimated number of respondents: 17.
Estimated frequency/timing of
responses: As needed.
Estimated number of annual
responses per respondent: 2.
Estimated number of annual
responses for all respondents: 34.
Estimated annual burden hours per
response: 24.
Estimated total annual burden hours
per respondent: 48.
would be 816 hours based on each DCM incurring
48 burden hours (17 × 48 = 816).
222 The Commission revised the number of
potential respondent-DCMs to 17 in order to reflect
the number of DCMs currently registered with the
Commission.
223 See 17 CFR part 40.
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Estimated total annual burden hours
for all respondents: 816.
2. OMB Collection 3038–0052—Core
Principles and Other Requirements for
DCMs
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Final Commission regulation
§ 38.251(g) (‘‘Risk Principle 3’’) requires
a DCM to promptly notify Commission
staff of any significant market
disruption on its electronic trading
platform(s) and provide timely
information on the cause and
remediation of such disruption.224 Risk
Principle 3 further requires that such
notification contain sufficient
information to convey the nature of the
disruption, and if known, its causes,
and remediation. The Commission
recognizes that the specific cause of the
market disruption and the attendant
remediation may not be known at the
time of the disruption and may have to
be addressed in a follow-up email or
report. This information collection will
be required for DCMs as needed, on a
case-by-case basis.
The Commission received one
comment regarding its PRA burden
analysis in the preamble to the
NPRM.225 CME in its comment letter
asserted the operation of Risk Principle
3 is unclear, and the Commission’s
estimate of approximately 50
notifications per year is ‘‘so far from
what we would have anticipated being
required under this proposal that it
merits discussion.’’ 226 CME also
indicated it questions ‘‘whether the
Commission has an interpretation of
‘significant disruption’ that is not
reflected in its proposal’’ based on the
apparent differences in notification
estimates by the Commission and
CME.227
CME further described that since
2011, ‘‘the CME Group DCMs have
brought approximately 59 disciplinary
actions for electronic trading activity
that may have disrupted markets or
other participants.’’ 228 However, based
on CME’s review of those disciplinary
actions, the exchange only identified
three cases that it believes could be
considered to have caused a significant
disruption to the operations of the DCM.
CME did not in its comments explain
how its estimate was determined or
what criteria or standard was employed
as part of this analysis.
As described above, CME is using the
number of actual disciplinary actions
224 See supra Section II.E. (discussion of the Risk
Principle 3).
225 See CME NPRM Letter, at 8.
226 See id.
227 See id.
228 See id. at 9.
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brought against market participants for
disruptions that could be detrimental to
the exchange as a ‘‘proxy’’ for the
‘‘substantial disruption’’ standard set
forth in Risk Principle 3. Without
indicating what analysis it may have
used or considered, CME asserted that
only three disciplinary actions could be
considered to have caused a significant
disruption to the operations of CME.229
Although the Commission appreciates
CME’s comments regarding the potential
number of reportable events in
connection with final Commission
regulation § 38.251(g), the Commission
does not believe the number of actual
disciplinary cases brought by an
exchange is an appropriate proxy for
reportable market disruption events.230
The Commission notes that in many
instances, basing the reportable event on
whether it is subject to a formal
disciplinary action would be underinclusive. In addition, what is a
‘‘significant’’ market disruption on one
exchange may differ from another, based
on market participant differences, the
exchange’s respective market structure,
and the technology of the underlying
exchange marketplace.
The Commission submits that its
original estimate of the reportable
events under Commission regulation
§ 38.251(g) may be too high for some
exchanges. However, the Commission
does not believe an estimate of three
reportable events since 2011, based on
the number of disciplinary actions in
the past, is a reasonable proxy.
Therefore, the Commission asserts that
a range of reportable events between 0–
25 may better reflect the potential
number of reportable significant market
disruption events for each DCM. The
Commission is accordingly revising
collection 3038–0052 to reflect the range
of potential annual reportable events by
each DCM to be between 0 and 25,
reflecting the differences in DCM
structure and operations and the market
participants accessing those DCMs.
In connection with the request for
comment in the NPRM regarding
whether the proposed information
collections are necessary for the proper
229 The NPRM cited events at CME DCMs,
including a disciplinary action from 2011, as
examples of DCMs policing electronic trading
activities that may be detrimental to the DCM.
230 The Commission submits that a reportable
event does not necessarily mean that a disciplinary
case is required, but instead suggests that there has
been a problem with the operation of the electronic
trading platform that requires additional review and
oversight. Accordingly, the notification of a
significant market disruption would typically start
a specific regulatory oversight process by the
Commission—not establish the particular
requirements that may or may not merit the
bringing of a disciplinary action, as CME suggests.
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performance of Commission functions,
CME stated it is ‘‘unsure of the practical
utility to the Commission of receiving
notifications from a DCM pursuant to
draft Principle III. From a market
oversight perspective, the Commission
already (at least with the CME Group
DCMs) collects information on these
types of events through regular
engagement and review of a DCM’s
compliance with core principles.’’ 231
The Commission does not agree with
CME’s assertion that the notification
may serve no practical utility based on
the assumption that the Commission
collects this type of information from
CME through regular engagement and
review of CME’s compliance with core
principles. As described above in
Section II.E, the purpose of the
notification requirement adopted in
Commission regulation § 38.251(g) is for
Commission staff to receive prompt
notice of a market disruption impacting
a DCM’s trading platform(s). This
notification is intended to assist the
Commission in its oversight of the
derivatives markets with the ability to
monitor and assess market disruptions
across DCMs on a near real-time basis.
CME’s argument that the current
‘‘regular’’ engagement and review of
CME’s compliance with core principles
is sufficient for this purpose is not
persuasive and would not provide the
Commission with sufficient capability
to address and monitor significant
market disruptions on a near real-time
basis.
Additionally, CME further
commented on the Commission’s
request in the NPRM relating to whether
there are ways to minimize the burden
of the proposed collections of
information on DCMs, including
through the use of appropriate
automated, electronic, mechanical, or
other technological information
collection techniques. In its comment to
this request, CME indicated that it
‘‘currently provides CFTC staff near
real-time notifications of velocity logic
events. We separately provide the CFTC
a daily file containing information
related to events that occur on the
match engine (e.g., velocity logic events,
circuit breakers, etc.). These types of
automated reports or notifications are
highly efficient and effective means to
provide CFTC staff pertinent
information.’’ 232 Although the
Commission finds the daily file that
CME voluntarily provides relating to
velocity logic events 233 to be helpful in
231 CME
NPRM Letter, at 16.
232 Id.
233 ‘‘Velocity Logic’’ is addressed on CME’s
website. Generally, it is ‘‘designed to detect market
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certain circumstances, the Commission
believes that a uniform standard across
DCMs relating to ‘‘reportable events’’ for
significant market disruption events is
necessary for its oversight and
regulatory responsibilities under the
CEA. For this reason, the Commission
notes that the notification requirement
is a foundational requirement of the
current rulemaking that is expected to
provide greater transparency and
awareness to the Commission regarding
market disruptions associated with
electronic trading.
The Commission has previously
estimated the combined annual burden
hours for part 38 to be 7,357.5 hours.
Upon implementation of final
Commission regulation § 38.251(g), the
Commission estimates that OMB
Collection 3038–0052 will be revised by
increasing the number of annual
responses by a range between 0 and 25
notifications to Commission staff per
year for a total range of between 0 and
425 234 notifications for all DCMs. The
Commission has also revised the
number of potential respondent-DCMs
to 17 in order to reflect the number of
DCMs currently registered with the
Commission. The Commission further
estimates that the DCMs may employ a
combination of in-house and outside
legal and compliance personnel to
review and prepare significant market
disruption event notifications to
Commission staff and it will take
approximately 5 burden hours to
prepare each notification resulting in a
range of burden hours between 0 and
125 235 for each event notification across
DCMs and a total range of between 0
and 2,125 burden hours annually for all
notifications to Commission staff
required for all DCMs.236 Although the
movement of a predefined number of ticks either up
or down within a predefined time.’’ Velocity Logic
introduces a momentary suspension in matching by
transitioning the futures instrument(s) and related
options into the Pre-Open or Reserved/Pause State.
See CME Velocity logic, available at https://
www.cmegroup.com/confluence/display/
EPICSANDBOX/Velocity+Logic.
234 Based on the annual aggregate range of
potential notifications under final Commission
regulation § 38.251(g) from 0 to 425 for all DCMs,
the Commission estimates that the average annual
aggregate notifications for all DCMs is 212.50 with
the annual average number of notifications per
DCM to be 13.28.
235 The Commission estimates that final
Commission regulation § 38.251(g) would require
potentially each DCM to make between 0 and 25
reports with the Commission a year requiring
approximately 5 hours each to prepare.
Accordingly, the total burden hour range for each
DCM would be between approximately 0 and 125
hours per year (0 × 5 = 0 and 25 × 5 = 125).
236 The Commission estimates that the total
aggregate annual burden hours for DCMs under
final Commission regulation § 38.251(g) would be a
range between 0 and 2,125 hours based on each
DCM incurring between 0 hours (0 × 17 = 0 burden
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Commission believes that operational
and maintenance costs for DCMs in
Commission regulation § 38.251(g) will
incrementally increase, these costs are
expected to be de minimis.
OMB Collection 3038–0052 was
created to cover regulatory requirements
for DCMs under part 38 of the
Commission’s regulations.237 OMB
Control Number 3038–0052 covers all
information collections in part 38,
including Subpart A (General
Provisions), Subparts B through X (the
DCM core principles), as well as the
related appendices thereto, including
Appendix A (Form DCM), Appendix B
(Guidance on, and Acceptable Practices
in, Compliance with Core Principles),
and Appendix C (Demonstration of
Compliance That a Contract Is Not
Readily Susceptible to Manipulation).
Commission regulation § 38.251(g)
adopted in this final rulemaking
modifies the existing annual burden in
OMB Collection 3038–0052 for
complying with certain requirements in
Subpart E (Prevention of Market
Disruption) of part 38, as estimated in
aggregate below:
Estimated number of respondents: 17.
Estimated frequency/timing of
responses: As needed.
Estimated number of annual
responses per respondent: 0–25.
Estimated number of annual
responses for all respondents: 0–425.
Estimated annual burden hours per
response: 5.
Estimated total annual burden hours
per respondent: 0–125.
Estimated total annual burden hours
for all respondents: 0–2,125.
Estimated aggregate annual
recordkeeping burden hours: 0–850.238
hours) and 2,125 hours (125 × 17 = 2,125 burden
hours). Based on these estimates, the Commission
has determined the annual average aggregate
burden hours for all DCMs to be 1,062.50 burden
hours and the annual average burden hour for each
DCM to be 66.406 burden hours.
237 See 17 CFR part 38.
238 The Commission estimates that additional
total aggregate annual recordkeeping burden hours
for DCMs under Commission regulations §§ 38.950
and 38.951 as a result of the final regulations under
this rulemaking would be between 0 and 850 hours
based on each DCM incurring between 0 and 50
burden hours (17 × 0 = 0 and 17 × 50 = 850). These
estimates are based on the range of notifications
expected to be between 0–25 per DCM annually.
The Commission estimates that each DCM would
require 2 burden hours in connection with its
recordkeeping obligations under Commission
regulations §§ 38.950 and 38.951. Based on these
estimates, the Commission also calculates the
annual average aggregate recordkeeping burden
hours for all DCMs to be 400 burden hours and the
annual average recordkeeping burden hour for each
DCM to be 25 burden hours.
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C. Cost-Benefit Considerations
1. Introduction
Section 15(a) of the CEA requires the
Commission to consider the costs and
benefits of its actions before
promulgating a regulation under the
CEA or issuing certain orders.239
Section 15(a) further specifies that the
costs and benefits shall be evaluated in
light of five broad areas of market and
public concern: (1) Protection of market
participants and the public; (2)
efficiency, competitiveness, and
financial integrity of futures markets; (3)
price discovery; (4) sound risk
management practices; and (5) other
public interest considerations. The
Commission considers the costs and
benefits resulting from its discretionary
determinations with respect to the
section 15(a) factors.
The baseline for the consideration of
costs and benefits in this final
rulemaking is the monitoring and
mitigation capabilities of DCMs, as
governed by rules in current part 38 of
the CFTC’s regulations. Under these
rules, DCMs are required to conduct
real-time monitoring of all trading
activity on their electronic trading
platforms and identify disorderly
trading activity and any market or
system anomalies.240
The Commission recognizes that the
final electronic trading risk principles
rules may impose additional costs on
DCMs and market participants. The
Commission has endeavored to assess
the expected costs and benefits of the
final rulemaking in quantitative terms,
including PRA-related costs, where
possible. In situations where the
Commission received quantitative data
related to the cost-benefit estimates
proposed in the NPRM, the Commission
included them in the cost-benefit
considerations of this final rulemaking.
The Commission also acknowledges and
took into consideration qualitative
comments with regard to the costbenefit estimates in the NPRM. When
the Commission is unable to quantify
the costs and benefits, the Commission
identifies and considers the costs and
benefits of the final rules in qualitative
terms.
a. Summary of the Rule
As discussed in more detail in the
preamble above, after considering
various comments submitted by the
commenters, the Commission decided
239 7
U.S.C. 19(a).
existing Commission regulations
§§ 38.250, 38.251, 38.255 and Appendix B to Part
38—Guidance on, and Acceptable Practices in,
Compliance with Core Principles, Core Principle 4
(Subparagraph (b)).
240 See
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on a principles-based approach and to
give discretion to each DCM in terms of
how to define precisely market
disruptions and system anomalies as
they relate to their particular markets.
As a result, each DCM will have the
flexibility to tailor the implementation
of the rules to best prevent, detect, and
mitigate market disruptions or system
anomalies in their respective markets.
This flexibility should mitigate the cost
and burden associated with DCMs’
implementation of the Risk Principles.
Therefore, the Commission adopts the
following specific Risk Principles and
associated Acceptable Practices
applicable to DCM electronic trading as
proposed.241
i. Commission Regulation § 38.251(e)—
Risk Principle 1
Commission regulation § 38.251(e)—
Risk Principle 1—provides that a DCM
must adopt and implement rules
governing market participants subject to
its jurisdiction to prevent, detect, and
mitigate market disruptions or system
anomalies associated with electronic
trading.
ii. Commission Regulation § 38.251(f)—
Risk Principle 2
Commission regulation § 38.251(f)—
Risk Principle 2—provides that a DCM
must subject all electronic orders to
exchange-based pre-trade risk controls
to prevent, detect, and mitigate market
disruptions or system anomalies
associated with electronic trading.
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iii. Commission Regulation
§ 38.251(g)—Risk Principle 3
Commission regulation § 38.251(g)—
Risk Principle 3—provides that a DCM
must promptly notify Commission staff
of a significant market disruption on its
electronic trading platform(s) and
provide timely information on the
causes and remediation.
iv. Acceptable Practices for Commission
Regulations §§ 38.251(e) and (f)
The Acceptable Practices provide
that, to comply with Commission
regulation § 38.251(e), a DCM must
adopt and implement rules that are
reasonably designed to prevent, detect,
and mitigate market disruptions or
system anomalies associated with
electronic trading. To comply with
Commission regulation § 38.251(f), the
Acceptable Practices provide that the
DCM must subject all electronic orders
to exchange-based pre-trade risk
controls that are reasonably designed to
241 As discussed above, the Commission revised
Risk Principle 3 to change the phrase ‘‘disruptions
to’’ to ‘‘market disruptions on.’’ See supra Section
II.E.
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prevent, detect, and mitigate market
disruptions or system anomalies.
2. Costs
a. Costs of Adjustments to Existing
Practices
i. Summary of Comments
A number of commenters commented
on the existing practices of DCMs. CME,
ICE, and Better Markets asserted that the
Risk Principles are redundant of
existing regulations.242 In particular,
CME commented that the Risk
Principles overlap with existing
Commission regulations, specifically
regulations promulgated under Core
Principles 2 and 4.243 CME and ICE
suggested relying on or amending
existing regulations, specifically
Commission regulation § 38.255.244 ICE
stated that this would track the
Commission’s approach to regulating
financial risk controls in Commission
regulation § 38.607, which has proven
effective.245 ICE also stated that the
DCMs could face confusion and
potential costs while determining an
appropriate notification standard and
updating existing regulations could help
with these costs.246
CME, CEWG, FIA/FIA PTG, ICE, and
MFA commented that DCMs already
implement controls and address risks to
their platforms.247 MFA believes the
Risk Principles will help encourage
DCMs to continue to monitor risks as
they evolve along with the markets, and
to make reasonable modifications as
appropriate.248
AFR and Rutkowski disagreed with
the assertion that current DCM practices
are effective in achieving what the Risk
Principles aim to achieve.249
CME had two direct comments
regarding the cost estimates presented
in the NPRM. First, CME commented
that the Commission should identify the
specific types of software enhancements
and additional data fields associated
with the 2,520 staff hours included in
the proposed rulemaking.250 Second,
CME commented that the Commission’s
estimate of 50 significant market
disruptions described in the PRA
section of the NPRM is too high, and
added that CME determined it had only
242 CME NPRM Letter, at 12–13; ICE NPRM Letter,
at 3; Better Markets NPRM Letter, at 4–9.
243 CME NPRM Letter, at 7, 12–13.
244 See id. at 12; ICE NPRM Letter, at 3.
245 See id.
246 ICE NPRM Letter, at 9.
247 CME NPRM Letter, at 4–7; CEWG NPRM
Letter, at 4; FIA/FIA PTG NPRM Letter, at 3; ICE
NPRM Letter, at 1; MFA NPRM Letter, at 2.
248 MFA NPRM Letter, at 2.
249 AFR NPRM Letter, at 2; Rutkowski NPRM
Letter, at 2.
250 CME NPRM Letter, at 17.
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three significant market disruptions in
the last decade across four DCMs based
on the number of formal disciplinary
cases brought by the DCM for electronic
trading activity that may have disrupted
markets or other participants.251
The Commission did not receive
comments on other costs associated
with adjusting existing practices, such
as costs associated with recordkeeping
or with the need for an additional
compliance officer.
ii. Discussion
The Commission acknowledges the
Risk Principles supplement existing
regulations, namely Commission
regulations §§ 38.251 and 38.255, with
some potential overlap. The
Commission believes the intended goals
of the Risk Principles cannot be solely
achieved by adding the words
‘‘electronic trading’’ to existing
regulations. To the extent that the Risk
Principles are already covered by
existing regulations as many
commenters suggested, then the
Commission does not expect much, if
any, additional costs to be associated
with the Risk Principles. While the
Commission acknowledges that DCMs
could face potential costs while
determining an appropriate notification
standard, the Commission expects
DCMs to be already collecting most, if
not all, required information to make
such a determination. As a result, the
Commission expects such costs to be
minimal. Some commenters also
disagreed with the assumption that
existing DCM practices are effective in
achieving what the Risk Principles aim
to achieve. To the extent this might be
the case, the Commission believes
DCMs will accordingly experience some
additional costs related to the
regulations, but the risks associated
with market disruptions or system
anomalies associated with electronic
trading will decrease in financial
markets. The Commission expects the
Risk Principles will minimize the risks
associated with market disruptions or
system anomalies associated with
electronic trading to a greater degree
than the existing regulations, while at
the same time minimizing the
additional cost burdens of
implementation due to the existence of
current DCM practices that are expected
to be consistent with the Risk
Principles.
As to CME’s comment on requiring
more detail with regard to potential
software enhancements that might be
required, the Commission provides a
251 See
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more detailed breakdown of the 2,520
staff hours below.
In addressing CME’s comment on the
estimated annual number of significant
market disruptions, the Commission
believes that CME’s use of the number
of formal disciplinary cases brought in
connection with electronic trading that
may have disrupted markets or other
market participants as a ‘‘proxy’’ for
significant market disruptions may
underestimate the actual number of
significant market disruptions. More
specifically, while CME states that it has
brought approximately 59 disciplinary
actions for potential market disruptions
involving electronic trading activity
since 2011, CME identified just three of
these cases to have potentially caused a
significant market disruption.252
However, CME does not provide any
information or analysis on how it
arrived at its estimate of three
significant market disruptions. The
Commission notes that each DCM may
interpret ‘‘significant’’ disruption in a
different manner based on differences in
market structures, market participants,
and the technology utilized by the DCM.
As stated above, the Commission
believes that the number of relevant
disciplinary cases brought by a DCM
could be under-inclusive of the number
of potential reportable market
disruption events and may not be an
appropriate proxy for the number of
market disruptions reportable under
Commission regulation § 38.251(g).
However, the Commission also
acknowledges that, based on CME’s
comment and further consideration, the
Commission’s original estimate of 50
annual significant market disruptions
per DCM might be too high.
Accordingly, the Commission has
updated its estimate of the annual
number of reportable market disruption
events to be 25 or less (between 0–25)
for each DCM as described below.253
iii. Costs
Consistent with the NPRM and
comments received, current risk
management practices of some DCMs
may be sufficient to comply with the
requirements of Commission regulations
§§ 38.251(e) through 38.251(g), in which
case expected costs are expected to be
minimal.254 However, some DCMs may
have to adjust some of their existing
practices to comply with the
regulations.
The Commission believes that DCMs
may have to update their software to
252 See
id. at 9.
id.
254 See NPRM at 42772; CME NPRM Letter, at 17;
ICE NPRM Letter, at 9.
253 See
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enable them to capture more efficiently
additional information regarding
participants subject to their jurisdiction
to implement rules adopted pursuant to
Commission regulation § 38.251(e). The
Commission acknowledges that the
additional information required to be
collected may be different for each DCM
because the specific rules each DCM
might need to adopt and implement
pursuant to Commission regulation
§ 38.251(e) will be different, and also
because the existing information
collection protocols already in place at
each DCM are not likely to be the same.
The Commission expects, among other
things, the required information to be
collected include the trader
identification for order entry, the means
by which traders connect to the
exchange’s platform, or any required
statistics of order message traffic
attributable to an electronic trader.
The Commission expects the design,
development, testing, and production
release of a required software update to
take 2,520 staff hours in total. The
Commission expects 360 hours of that
total to be used for establishing
requirements and design, 1,280 hours to
be used for development, 720 hours for
testing, and 160 hours for production
release. To calculate the cost estimate
for changes to DCM software, the
Commission estimates the appropriate
wage rate based on salary information
for the securities industry compiled by
the Department of Labor’s Bureau of
Labor Statistics (‘‘BLS’’).255 Commission
staff arrived at an hourly rate of $70.76
using figures from a weighted average of
salaries and bonuses across different
professions contained in the most recent
BLS Occupational Employment and
Wages Report (May 2019), multiplied by
1.3 to account for overhead and other
benefits.256 Commission staff chose this
methodology to account for the variance
255 May 2019 National Industry-Specific
Occupational Employment and Wage Estimates,
NAICS 523000—Securities, Commodity Contracts,
and Other Financial Investments and Related
Activities, available at https://www.bls.gov/oes/
current/naics4_523000.htm.
256 The Commission’s estimated appropriate wage
rate is a weighted national average of mean hourly
wages for the following occupations (and their
relative weight): ‘‘computer programmer—industry:
securities, commodity contracts, and other financial
investment and related activities’’ (25 percent);
‘‘project management specialists and business
operations specialists—industry: securities,
commodity contracts, and other financial
investment and related activities’’ (25 percent);
‘‘Software and Web Developers, Programmers, and
Testers—industry: securities, commodity contracts,
and other financial investment and related
activities’’ (25 percent); and ‘‘Software Developers
and Software Quality Assurance Analysts and
Testers—industry: securities, commodity contracts,
and other financial investment and related
activities’’ (25 percent).
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2065
in skillsets that may be used to plan,
implement, and manage the required
changes to DCM software. Using these
estimates, the Commission would
expect the software update to cost
$178,313 per DCM. The Commission
acknowledges that this is an estimate
and the actual cost of such a software
update would depend on the current
status of the specific DCM’s information
acquisition capabilities and the amount
of additional information the DCM
would have to collect as a result of
Commission regulation § 38.251(e). To
the extent that a DCM currently or
partially captures the required
information and data through its
systems and technology, these costs
would be lower.
The Commission acknowledges that
any additional rules resulting from
Commission regulation § 38.251(e) are
required to be submitted pursuant to
part 40. The Commission expects a DCM
to take an additional 48 hours annually
(two submissions on average per year,
24 hours per submission) to submit
these amendments to the Commission.
In order to estimate the appropriate
wage rate, the Commission used the
salary information for the securities
industry compiled by the BLS.257
Commission staff arrived at an hourly
rate of $89.89 using figures from a
weighted average of salaries and
bonuses across different professions
contained in the most recent BLS
Occupational Employment and Wages
Report (May 2019) multiplied by 1.3 to
account for overhead and other
benefits.258 The Commission estimates
this indirect cost to each DCM to be
$4,314.72 annually (48 × $89.89). To the
extent a DCM currently has in place
rules required under Commission
regulation § 38.251(e), these costs would
be incrementally lower.
The Commission can envision a
scenario where a DCM might also need
to update its trading systems to subject
all electronic orders to exchange-based
pre-trade risk controls to prevent,
detect, and mitigate market disruptions
or system anomalies as required by
Commission regulation § 38.251(f).
257 May 2019 National Industry-Specific
Occupational Employment and Wage Estimates,
NAICS 523000—Securities, Commodity Contracts,
and Other Financial Investments and Related
Activities, available at https://www.bls.gov/oes/
current/naics4_523000.htm.
258 The Commission’s estimated appropriate wage
rate is a weighted national average of mean hourly
wages for the following occupations (and their
relative weight): ‘‘compliance officer—industry:
securities, commodity contracts, and other financial
investment and related activities’’ (50 percent); and
‘‘lawyer—legal services’’ (50 percent). Commission
staff chose this methodology to account for the
variance in skill sets that may be used to
accomplish the collection of information.
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Depending on the extent of the update
required, the Commission anticipates
the design, development, testing, and
production release of the new trading
system to take 8,480 staff hours in total,
which the Commission expects to be
covered by more than one employee. To
calculate the cost estimate for updating
a DCM’s trading systems, the
Commission estimates the appropriate
wage rate based on salary information
for the securities industry compiled by
the BLS.259 Commission staff arrived at
an hourly rate of $70.76 using figures
from a weighted average of salaries and
bonuses across different professions
contained in the most recent BLS
Occupational Employment and Wages
Report (May 2019) multiplied by 1.3 to
account for overhead and other
benefits.260 Commission staff chose this
methodology to account for the variance
in skill sets that may be used to plan,
implement, and manage the required
update to a DCM’s trading system. Using
these estimates, the Commission would
expect the trading system update to cost
$600,036 to a DCM. The Commission
emphasizes that this is an estimate and
the actual cost could be higher or lower.
The cost may also vary across DCMs, as
each DCM has the flexibility to apply
the specific controls that the DCM
deems reasonably designed to prevent,
detect, and mitigate market disruptions
or system anomalies. In addition, the
Commission further notes that to the
extent a DCM currently or partially has
in place pre-trade risk controls
consistent with proposed Commission
regulation § 38.251(f), these costs would
be incrementally lower.
Commission regulation § 38.251(g)
requires a DCM promptly to notify
Commission staff of a significant market
disruption on its electronic trading
platform(s) and provide timely
information on the causes and
259 May 2019 National Industry-Specific
Occupational Employment and Wage Estimates,
NAICS 523000—Securities, Commodity Contracts,
and Other Financial Investments and Related
Activities, available at https://www.bls.gov/oes/
current/naics4_523000.htm.
260 The Commission’s estimated appropriate wage
rate is a weighted national average of mean hourly
wages for the following occupations (and their
relative weight): ‘‘computer programmer—industry:
securities, commodity contracts, and other financial
investment and related activities’’ (25 percent);
‘‘project management specialists and business
operations specialists—industry: securities,
commodity contracts, and other financial
investment and related activities’’ (25 percent);
‘‘Software and Web Developers, Programmers, and
Testers—industry: securities, commodity contracts,
and other financial investment and related
activities’’ (25 percent); and ‘‘Software Developers
and Software Quality Assurance Analysts and
Testers—industry: securities, commodity contracts,
and other financial investment and related
activities’’ (25 percent).
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remediation. The Commission expects
that there may be incremental costs to
DCMs from Commission regulation
§ 38.251(g) in the form of analysis
regarding which disruptions could be
significant enough to report, maintain,
and archive the relevant data, as well as
the costs associated with the act of
reporting the disruptions. The
Commission currently expects every
DCM to have the necessary means to
communicate with the Commission
promptly, and therefore, does not expect
any additional communication costs.
The Commission expects DCMs to incur
a minimal cost in determining what a
significant market disruption could be
and preparing information on its causes
and remediation. The Commission does
not expect this cost to be significant,
because the Commission believes DCMs
should already have the means
necessary to identify the causes of
market disruptions and have plans for
remediation. To the extent that
complying with Commission regulation
§ 38.251(g) requires a DCM to incur
additional recordkeeping and reporting
burdens, the Commission estimates
these additional recordkeeping
requirements to be no more than 50
hours per DCM per year, and the
additional reporting requirements to
require no more than 125 hours per
DCM per year (five hours per report and
an estimated 25 reports additionally per
DCM).
The Commission acknowledges
CME’s comment indicating that based
on its review and analysis, CME
believes to have had only three
significant market disruptions in the
past decade across its four DCMs. The
Commission appreciates the information
provided and recognizes that the
number of times a DCM might have to
identify and report significant market
disruptions pursuant to Commission
regulation § 38.251(g) may vary greatly
across DCMs. The Commission
acknowledges that the frequency of such
reporting could theoretically be less
than one in any given year for an
exchange.
In calculating the cost estimates for
recordkeeping and reporting, the
Commission estimates the appropriate
wage rate based on salary information
for the securities industry compiled by
the BLS.261 For the reporting cost,
Commission staff arrived at an hourly
rate of $76.44 using figures from a
weighted average of salaries and
261 May 2019 National Industry-Specific
Occupational Employment and Wage Estimates,
NAICS 523000—Securities, Commodity Contracts,
and Other Financial Investments and Related
Activities, available at https://www.bls.gov/oes/
current/naics4_523000.htm.
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bonuses across different professions
contained in the most recent BLS
Occupational Employment and Wages
Report (May 2019) multiplied by 1.3 to
account for overhead and other
benefits.262 In calculating the cost
estimate for recordkeeping, the
Commission staff arrived at an hourly
rate of $71.019 using figures from the
most recent BLS Occupational
Employment and Wages Report (May
2019) multiplied by 1.3 to account for
overhead and other benefits.263 The
Commission estimates the cost for
additional recordkeeping to a DCM to be
no more than $3,550.95 (50 × $71.019)
annually and the cost for additional
reporting to a DCM to be no more than
$9,555.00 (125 × $76.44) annually. As
discussed above, certain DCMs might
have no additional relevant market
disruptions to report some years, which
would translate to a zero cost estimate
of additional reporting and
recordkeeping for those years for those
DCMs.
To the extent that DCMs would need
to update their rules and internal
processes to comply with Commission
regulations §§ 38.251(e) through
38.251(g) and the associated Acceptable
Practices, the Commission expects some
DCMs also may need to update or
supplement their compliance programs,
which would involve additional costs.
However, the Commission does not
expect these costs to be significant. The
Commission believes some DCMs may
need to hire an additional full-time
compliance staff member to address the
additional compliance needs associated
with the regulation. Assuming that the
average annual salary of each
compliance officer is $94,705, the
Commission estimates the incremental
annual compliance costs to a DCM that
needs to hire an additional compliance
officer to be $119,340.264 However, the
262 The Commission’s estimated appropriate wage
rate is a weighted national average of mean hourly
wages for the following occupations (and their
relative weight): ‘‘computer programmer—industry:
securities, commodity contracts, and other financial
investment and related activities’’ (25 percent);
‘‘compliance officer—industry: securities,
commodity contracts, and other financial
investment and related activities’’ (50 percent); and
‘‘lawyer—legal services’’ (25 percent). Commission
staff chose this methodology to account for the
variance in skill sets that may be used to
accomplish the required reporting.
263 The Commission’s estimated appropriate wage
rate is the mean hourly wages for ‘‘database
administrators and architects.’’ Commission staff
chose this methodology to account for the variance
in skill sets that may be used to accomplish the
collection of information.
264 In calculating this cost estimate for reporting,
the Commission estimates the appropriate annual
wage for a compliance officer based on salary
information for the securities industry compiled by
the BLS. Commission staff used the annual wage of
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Commission notes that the exact
compliance needs may vary across
DCMs, and some DCMs may already
have adequate compliance programs
that can handle any rule updates and
internal processes required to comply
with Commission regulations
§§ 38.251(e) through 38.251(g), and
therefore the actual compliance costs
may be higher or lower than the
Commission’s estimates.
b. Cost of Periodically Updating Risk
Management Practices
i. Summary of Comments
The Commission did not receive any
comments associated with the need
periodically to update risk management
practices.
ii. Costs
The Commission expects the trading
methods and technologies of market
participants to change over time,
requiring DCMs to adjust their rules
pursuant to Commission regulation
§ 38.251(e) and adjust their exchangebased pre-trade risk controls pursuant to
Commission regulation § 38.251(f)
accordingly. As trading methodologies
and connectivity measures evolve, it is
expected that new causes of potential
market disruptions and system
anomalies could surface. To that end,
the Commission believes full
compliance would require a DCM to
implement periodic evaluation of its
entire electronic trading marketplace
and updates of the exchange-based pretrade risk controls to prevent, detect,
and mitigate market disruptions or
system anomalies, as well as updates of
the appropriate definitions of market
disruptions and system anomalies.
Therefore, rules imposed as a result of
Commission regulations §§ 38.251(e)
through 38.251(g) would need to be
flexible and fluid, and potentially
updated as needed, which may involve
additional costs. Moreover, such rule
changes would result in a cost increase
associated with the rise in the number
of rule filings that DCMs would have to
prepare and submit to the Commission.
c. Costs to Market Participants
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i. Summary of Comments
The Commission did not receive any
comments associated with costs to
market participants.
$91,800, which reflects the average annual salary
for a compliance officer contained in the most
recent BLS Occupational Employment and Wages
Report (May 2019), and multiplied it by 1.3 to
account for overhead and other benefits.
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ii. Costs
The Commission can envision a
situation where the rules adopted by
DCMs as a result of Commission
regulation § 38.251(e) change frequently,
and market participants would need to
adjust to new rules frequently. While
these adjustments might carry some
costs for market participants, such as
potential added delays to their trading
activity due to additional pre-trade
controls, the Commission expects these
changes to be communicated to the
market participants by DCMs with
enough implementation time so as to
minimize the burden on market
participants and their trading strategies.
Moreover, to the extent a DCM’s policies
and procedures require market
participants to report changes to their
connection processes, trading strategies,
or any other adjustments the DCM
deems required, there could be some
cost to the market participants. Finally,
market participants may feel the need to
upgrade their risk management practices
as a response to DCMs’ updated risk
management practices driven by the
Risk Principles. The Commission
recognizes that part of the costs to
market participants might also come
from needing to update their systems
and potentially adjust the software they
use for risk management, trading, and
reporting. These costs may be somewhat
mitigated to the extent market
participants currently comply with
DCM rules and regulations regarding
pre-trade risk controls and market
disruption protocols.
d. Regulatory Arbitrage
i. Summary of Comments
The Commission received a number
of comments regarding the possibility of
competition and regulatory arbitrage.
CME commented that the greatest risk
for regulatory arbitrage is between
DCMs and SEFs or FBOTs.265 Also,
IATP commented that the Commission
should clarify why it considers
regulatory arbitrage between DCMs
unlikely to happen.266 IATP also noted
that the competition among DCMs for
over-the-counter trading and for trading
in new products, such as digital coins,
could result in lax risk control design or
lax updating of controls under
competitive pressures.267 IATP also
mentioned the difference in competitive
pressures for cleared and uncleared
trades.268 Finally, CFE expressed
concern that if the Commission
compares all DCMs to a baseline of
controls, which are prevalent across
DCMs, there may be an expectation for
smaller DCMs to adhere to the risk
control standards of larger DCMs.269
This could become a barrier to entry for
smaller DCMs.270
ii. Discussion
As outlined the in the NPRM and in
the discussion of antitrust
considerations below,271 the
Commission acknowledges the
theoretical possibility of regulatory
arbitrage occurring as a result of the
Risk Principles but does not expect it to
materialize.272 As discussed in the
NPRM and Section I.D.2 of this final
rulemaking, the Commission will
continue to monitor whether Risk
Principles of this nature may be
appropriate for other markets such as
SEFs or FBOTs.273
The Commission acknowledges there
are differences in products and market
participants across DCMs, and DCMs
might implement different rules and
risk controls given differences in their
respective markets. It is important to
note that ongoing Commission oversight
will identify whether the differences in
DCM rules and risk controls are due to
differing contracts being offered for
trading, competitive pressure, or
regulatory arbitrage, and whether there
are resulting issues that must be
addressed.
iii. Costs
The principles-based regulations offer
DCMs the flexibility to address market
disruptions and system anomalies as
they relate to their particular markets
and market participants’ trading
activities. Similarly, DCMs are also
given the flexibility to decide how to
apply the requirements associated with
regulations in their respective markets.
This flexibility could result in
differences across DCMs, potentially
contributing to regulatory arbitrage. For
example, DCMs’ practices could differ
in the information collected from
market participants; the rules applied to
prevent, detect, and mitigate market
disruptions or system anomalies; and
the intensity of pre-trade controls. The
parameters for establishing market
disruptions or system anomalies could
be defined differently by the various
DCMs, which might lead to differing
levels of exchange-based pre-trade risk
controls.
269 CFE
NPRM Letter, at 4.
id.
271 See Section III.D of this final rulemaking.
272 See NPRM at 42763 n.6.
273 See id. and Section I.D.2 of this final
rulemaking.
270 See
265 CME
NPRM Letter, at 13.
NPRM Letter, at 11.
267 See id. at 9.
268 See id. at 10.
266 IATP
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The Commission acknowledges that
to the extent there is potential for
market participants to choose between
DCMs, those DCMs with lower
information collection requirements and
potentially less stringent pre-trade risk
controls could appear more attractive to
certain market participants. All or some
of these factors could create the
potential for market participants to
move their trading from DCMs with
potentially more stringent risk controls
to DCMs with less stringent controls,
which could cost certain DCMs
business. While the Commission
recognizes that this kind of regulatory
arbitrage could cause liquidity to move
from one DCM to another, potentially
impairing (or benefiting) the price
discovery of the contract with reduced
(or increased) liquidity, the Commission
does not expect this to occur with any
frequency. First, the Commission notes
that liquidity for a given contract in
futures markets tends to concentrate in
one DCM. This means that futures
markets are less susceptible to this type
of regulatory arbitrage. Second, while an
individual DCM decides the exchangebased pre-trade risk controls for its
markets, those risk controls must be
effective. The Commission does not
believe that differences in the
application of the Risk Principles across
DCMs would be substantial enough to
induce market participants to switch to
trading at a different DCM, even if there
were two DCMs trading similar enough
contracts. For example, DCMs currently
apply various pre-trade controls to
comply with Commission regulation
§ 38.255 requirements for risk controls
for trading, but the Commission does
not have any evidence that DCMs
compete on pre-trade controls. The
Commission expects DCMs to approach
the setting of their rules and controls to
comply with the Risk Principles in a
similar manner.
3. Benefits
a. Minimize Disruptive Behaviors
Associated With Electronic Trading and
Ensure Sound Financial Markets
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i. Summary of Comments
While not a direct comment, AFR
stated that the NPRM does not offer a
systematic assessment of the current
costs of the types of electronic
disruptions addressed by the Risk
Principles.274
ii. Discussion
The Commission acknowledges that
no such costs were present in the NPRM
and it considers such analysis not
274 AFR
NPRM Letter, at 2.
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quantitatively feasible. However, the
Commission considers market
disruption costs to be substantial and
the Commission expects that these
regulations will minimize the frequency
of market disruptions and their
associated costs. The Commission
believes this to be an important benefit
to DCMs and market participants
through ensuring a sound financial
marketplace.
iii. Benefits
The Commission believes that the
Risk Principles are crucial for the
integrity and resilience of financial
markets, as they would ensure that
DCMs have the ability to prevent,
detect, and mitigate most, if not all,
disruptive behaviors associated with
electronic trading. Commission
regulation § 38.251(e) requires DCMs to
adopt and implement rules governing
market participants subject to their
jurisdiction such that market
disruptions or system anomalies
associated with electronic trading can
be minimized. This would allow
markets to operate smoothly and to
continue functioning as efficient
platforms for risk transfer, as well as
allowing for healthy price discovery.
The Commission expects Commission
regulation § 38.251(f) to subject all
electronic orders to a DCM’s exchangebased pre-trade risk controls. The
Commission expects this to benefit the
markets as well as the market
participants sending orders to the
DCMs. First, by preventing orders that
could cause market disruptions or
system anomalies through exchangebased pre-trade risk controls,
Commission regulation § 38.251(f)
allows the markets to operate orderly
and efficiently. This benefits traders in
the markets, market participants
utilizing price discovery in the markets,
as well as traders in related markets.
Second, Commission regulation
§ 38.251(f) provides market participants
sending orders to a DCM with an
additional layer of protection through
the implementation of exchange-based
pre-trade risk controls. If an
unintentional set of messages were to
breach the risk controls of FCMs and
other market participants, Commission
regulation § 38.251(f) could prevent
those messages from reaching a DCM
and potentially resulting in unwanted
transactions. This benefits the market
participants, as well as their FCMs, by
saving them from the obligation of
unwanted and unintended transactions.
Commission regulation § 38.251(g)
ensures that significant market
disruptions will be communicated to
the Commission staff promptly, as well
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as their causes and eventual
remediation. The Commission believes
Commission regulation § 38.251(g) will
benefit the markets and market
participants by strengthening their
financial soundness and promoting the
resiliency of derivatives markets by
allowing the Commission to stay
informed of any potential market
disruptions effectively and promptly. If
needed, the Commission’s timely action
in the face of market disruptions could
help markets recover faster and stronger.
Finally, Commission regulations
§§ 38.251(e) through 38.251(g) are likely
to benefit the public by promoting
sound risk management practices across
market participants and preserving the
financial integrity of markets so that
markets can continue to fulfill their
price discovery role.
b. Value of Flexibility Across DCMs
i. Summary of Comments
Most commenters, including CME,
CFE, CEWG, FIA/FIA PTG, ICE, ISDA/
SIFMA, MFA, and Optiver supported a
principles-based approach, which
allows flexibility in the implementation
of the regulations across DCMs.275 Many
commenters noted they prefer the
principles-based approach to the
prescriptive nature of prior proposals
and that such an approach provides
flexibility and takes into account future
technological advances.276
In contrast, AFR, Better Markets,
IATP, and Rutkowski disagreed with the
principles-based approach, and asserted
that the incentives of DCMs and public
regulators are not fully aligned.277 AFR,
Better Markets, and Rutkowski
commented that the Risk Principles
provide too much deference to DCMs
and the Commission failed to address
conflicts of interest concerns that may
impede the independence of DCMs and
SROs.278
ii. Discussion
The Commission believes a
principles-based approach of Risk
Principles allows flexibility to DCMs.
Through this flexible approach, DCMs
can shape the adoption and
275 CME NPRM Letter, at 1, 12, 16; CFE NPRM
Letter, at 1; CEWG NPRM Letter, at 2; FIA/FIA PTG
NPRM Letter, at 2–4; ICE NPRM Letter, at 2, 9;
ISDA/SIFMA NPRM Letter, at 1–2; MFA NPRM
Letter, at 1–2; Optiver NPRM Letter, at 1.
276 CME NPRM Letter, at 1, 12; CFE NPRM Letter,
at 1; CEWG NPRM Letter, at 2; FIA/FIA PTG NPRM
Letter, at 2–4; ISDA/SIFMA NPRM Letter, at 1; MFA
NPRM Letter, at 1–2.
277 AFR NPRM Letter, at 1–2; Better Markets
NPRM Letter, at 2, 6, 9, 10–12; IATP NPRM Letter,
at 1, 4, 8; Rutkowski NPRM Letter, at 1.
278 AFR NPRM Letter, at 1–2; Better Markets
NPRM Letter, at 2, 6, 9, 10–12; Rutkowski NPRM
Letter, at 1.
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implementation of their rules to
effectively prevent, detect, and mitigate
risks associated with electronic trading
in their markets. Additionally, this
flexibility will also allow DCMs to
adjust their rules accordingly to respond
to future changes in their markets.
Without such flexibility, DCMs would
need to comply with prescriptive rules
that may not be as effective in
preventing, detecting, and mitigating
market disruptions and system
anomalies and that may involve higher
costs to market participants as well as
potential higher compliance costs.
The Commission notes Core Principle
16 in part 38 requires DCMs to establish
and enforce rules addressing potential
conflicts of interest.279 Furthermore, as
also mentioned in the preamble, any
conflict of interest concerns, where
DCMs might prioritize profitability over
reasonable controls, will be addressed
through regular Commission oversight
of DCMs.280
participants and the public by requiring
DCMs to adopt and implement rules
addressing the market disruptions and
system anomalies associated with
electronic trading, subject all electronic
orders to specifically-designed
exchange-based pre-trade risk controls,
and promptly report the causes and
remediation of significant market
disruptions. All of these measures create
a safer marketplace for market
participants to continue trading without
major interruptions and allow the
public to benefit from the information
generated through a well-functioning
marketplace.
c. Direct Benefits to Market Participants
ii. Benefits
The Commission believes the
implementation of the Risk Principles
will facilitate the Commission’s
capability to monitor the markets
effectively. Moreover, Commission
regulation § 38.251(g) will result in
DCMs informing the Commission
promptly of any significant market
disruptions and remediation plans. The
Commission believes this will allow it
to take steps to contain a disruption and
prevent the disruption from impacting
other markets or market participants.
Thus, the Risk Principles will facilitate
the Commission’s oversight and its
ability to monitor and assess market
disruptions across all DCMs.
Finally, the Commission expects that
the Risk Principles will better
incentivize DCMs to recognize market
disruptions and system anomalies and
examine remediation plans in a timely
fashion.
i. Summary of Comments
4. 15(a) Factors
b. Efficiency, Competitiveness, and
Financial Integrity of DCMs
The Commission believes that
Commission regulations §§ 38.251(e)
through 38.251(g) will enhance the
financial integrity of DCMs by requiring
DCMs to implement rules and risk
controls to address market disruptions
and system anomalies associated with
electronic trading. However, the
Commission also acknowledges that
market participants’ efficiency of
trading might be hindered due to
potential latencies that may occur in the
delivery and routing of orders to the
matching engine as a result of additional
pre-trade risk controls. In addition, the
Commission can envision a scenario
where the flexibility provided to DCMs
in designing and implementing rules to
prevent, detect, and mitigate market
disruptions and system anomalies, and
the differences between the updated
pre-trade risk controls and existing DCM
risk control rules, could potentially lead
to regulatory arbitrage between DCMs.
To the extent that there are significant
differences in those practices set by
competing DCMs, market participants
might choose to trade in the DCM with
the least stringent rules if competing
DCMs offer the same or relatively
similar products. The Commission
acknowledges that competitiveness
across DCMs might be hurt as a result.
However, as discussed above, the
Commission does not believe that
differences in the application of the Risk
Principles across DCMs would be
substantial enough to induce market
participants to switch to trading at a
different DCM, even if there were two
DCMs trading similar enough contracts.
a. Protection of Market Participants and
the Public
Commission regulations §§ 38.251(e)
through 38.251(g) are intended to
protect market participants and the
public from potential market
disruptions due to electronic trading.
The rules are expected to benefit market
c. Price Discovery
The Commission expects price
discovery to improve as a result of
Commission regulations §§ 38.251(e)
through 38.251(g), especially due to
improved market functioning through
the implementation of targeted pre-trade
risk controls and rules. The Commission
iii. Benefits
The Commission believes that DCMs
have markets with different trading
structures and participants with varying
trading patterns. It is possible that
market participant behavior that one
DCM considers a major risk of market
disruptions could be of less concern to
another DCM. The Commission’s
principles-based approach to
Commission regulations §§ 38.251(e)
and 38.251(f) allows DCMs the
flexibility to impose the most efficient
and effective rules and pre-trade risk
controls for their respective markets.
The Commission believes such
flexibility, including through the
Acceptable Practices, benefits DCMs by
allowing them to adopt and implement
effective and efficient measures
reasonably designed to achieve the
objectives of the Risk Principles.
Without such flexibility, DCMs would
need to comply with prescriptive rules
that may not be as effective in
preventing, detecting and mitigating
market disruptions and system
anomalies and that may potentially
involve higher compliance costs.
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ii. Benefits
Commission regulation § 38.251(e)
requires DCMs to adopt and implement
rules that are reasonably designed to
prevent, detect, and mitigate market
disruptions or system anomalies
associated with electronic trading. In
addition, Commission regulation
§ 38.251(f) requires DCMs to subject all
electronic orders to exchange-based pretrade risk controls that are reasonably
designed to prevent, detect, and mitigate
market disruptions or system anomalies
associated with electronic trading. This
approach will assist in preventing,
detecting, and mitigating market
disruptions and system anomalies and
thus protect the effectiveness of
financial markets to continue providing
the services of risk transfer and price
transparency to all market participants.
Moreover, the Commission believes that
requiring DCMs to implement these
DCM-based rules and risk controls
could incentivize market participants
themselves to strengthen their own risk
management practices.
2069
The Commission did not receive any
comments associated with benefits to
market participants.
279 See
17 CFR 38.850–51.
of interest are also discussed in the
antitrust considerations section of this final rule.
See Section III.D below.
280 Conflicts
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d. Facilitate Commission Oversight
i. Summary of Comments
The Commission did not receive any
comments associated with benefits to
Commission oversight.
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expects the new regulations to assist
with the prevention and mitigation of
market disruptions due to electronic
trading, leading markets to provide
more stable and consistent price
discovery services. However, as noted
above, adoption and implementation of
rules pursuant to Commission
regulation § 38.251(e) and pre-trade risk
controls implemented by DCMs
pursuant to Commission regulation
§ 38.251(f) could be different across
DCMs. As a result, the improvements in
price discovery across DCMs’ markets
are not likely to be uniform.
d. Sound Risk Management Practices
The Commission expects Commission
regulations §§ 38.251(e) through
38.251(g) to help promote and ensure
better risk management practices of both
DCMs and their market participants.
The Commission expects DCMs and
market participants to focus on, and
potentially update, their risk
management practices. Additionally, the
Commission believes that the
requirement for DCMs to notify
Commission staff regarding the cause of
a significant market disruption to their
respective electronic trading platforms
would also provide reputational
incentives for both DCMs and their
market participants to focus on, and
improve, risk management practices.
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e. Other Public Interest Considerations
The Commission does not expect
Commission regulations §§ 38.251(e)
through 38.251(g) to have any
significant costs or benefits associated
with any other public interests.
D. Antitrust Considerations
Section 15(b) of the CEA requires the
Commission to ‘‘take into consideration
the public interest to be protected by the
antitrust laws and endeavor to take the
least anticompetitive means of
achieving the purposes of this Act, in
issuing any order or adopting any
Commission rule or regulation
(including any exemption under section
4(c) or 4c(b)), or in requiring or
approving any bylaw, rule, or regulation
of a contract market or registered futures
association established pursuant to
section 17 of this Act.’’ 281 The
Commission believes that the public
interest to be protected by the antitrust
laws is generally to protect competition.
In the NPRM, the Commission
preliminarily determined that the Risk
Principles proposal is not
anticompetitive and has no
anticompetitive effects. The
Commission then requested comment
281 7
U.S.C. 19(b).
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on (i) whether the proposal is
anticompetitive and, if so, what the
anticompetitive effects are; (ii) whether
any other specific public interest, other
than the protection of competition, to be
protected by the antitrust laws is
implicated by the proposal; and (iii)
whether there are less anticompetitive
means of achieving the relevant
purposes of the CEA that would
otherwise be served by adopting the
proposal.
The Commission does not anticipate
that the Risk Principles rulemaking will
result in anticompetitive behavior, but
instead, believes that the principlesbased approach to DCM electronic
trading does not establish a barrier to
entry or a competitive restraint. As
noted above, the Commission
encouraged comments from the public
on any aspect of the proposal that may
have the potential to be inconsistent
with the antitrust laws or
anticompetitive in nature. The
Commission received three comments
asserting that the proposed rules may
potentially impact competition through
the existence of ‘‘regulatory arbitrage’’
and one comment regarding the
competitive impact of potential risk
control assessments to a baseline of risk
controls that are prevalent and effective
across DCMs.
IATP commented that ‘‘DCMs
compete for market participant trades,
so competitive pressures could reduce
DCM verification of market participant
compliance with DCM requirements for
market participant risk control.’’ 282
IATP focused on the potential
competitive pressures that could
potentially occur with respect to noncleared transactions, stating that these
transactions should ‘‘post higher initial
margin and maintain higher variation
margin than cleared trades.’’ 283 IATP
disagreed with the Commission’s belief
in the NPRM that a lack of uniformity
between DCMs’ rules and risk controls
does not render a particular DCM’s rules
or risk controls per se unreasonable.284
282 IATP NPRM Letter, at 9. IATP noted, among
other things, that ‘‘trading in new products, such as
digital coins, could result in lax risk control design
or lax updating of controls under competitive
pressures.’’
283 Id.
284 See NPRM at 42765. IATP commented that ‘‘If
one DCM pursues competitive advantage by
developing risk controls and rules that market
participants perceive to be less costly to implement
and/or to give them a competitive advantage in
trading, the Commission believes the DCM seeking
such a competitive advantage to comply with the
Principles, provided that the DCM rules and risk
controls are not inherently unreasonable.’’ IATP
NPRM Letter, at 11. IATP believes that, in
connection with its comments regarding the
potential competitive concerns of the Electronic
Risk Principles Rule, the Commission should
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AFR commented that the
Commission’s proposal rejected the
more active regulatory approach to
electronic trading taken in the nowwithdrawn Regulation AT and, instead,
delegates the core elements of electronic
trading oversight to for-profit exchanges
under a principles-based approach.285
AFR criticized the Commission’s
principles-based approach regarding the
regulation of electronic trading on
DCMs, stating that it disagrees with the
core assumption underlying the
principles-based approach that the
incentives of DCMs ‘‘are fully aligned
with those of public regulators in
limiting speculative and trading
practices that could threaten market
integrity.’’ 286 The basis of AFR’s
comment is that DCMs are
‘‘economically dependent on the order
flow provided by large traders and are
in direct competition with other venues
to capture that order flow.’’ 287 As a
result, AFR argues that this dependence
on order flow creates a conflict of
interest whereby DCMs may
accommodate the interests of large
brokers and traders even though there
may be risks to market integrity. AFR
further believes that conflict of interest
requires significant public regulatory
oversight of DCM market practices,
stating that ‘‘[p]ure self-regulation is not
enough.’’ 288
Better Markets similarly commented
that permitting DCMs to determine the
types of risk controls to deter and/or
prevent market disruptions is inherently
conflicted due to competitive
pressures.289 In commenting regarding
the potential competitive issues in
connection with the Risk Principles,
Better Markets cited the Commission’s
statement in the NPRM that noted the
potential for regulatory arbitrage due to
document and explain how ‘‘allowing each DCM to
develop and enforce its own rules and risk controls
presents no possibility of regulatory arbitrage
among DCMs.’’ See id.
285 See AFR NPRM Letter, at 1. See also
Rutkowski NPRM Letter, at 1. Mr. Rutkowski’s
comment largely adopts the arguments set forth in
the AFR comment.
286 See AFR NPRM Letter, at 1.
287 Id.
288 Id.
289 See Better Markets NPRM Letter, at 11. In
particular, Better Markets noted that ‘‘[e]xchanges
face conflicts of interest between maximizing profit
and shareholder value and diminishing trading
volumes through meaningful limits on certain
electronic trading practices. With competitive
pressures and revenues at stake, one exchange is
unlikely to be a first mover and absorb the costs and
rancor of market participants in implementing risk
controls and related measures that its competitors
may, for market share reasons, postpone
indefinitely. That is why a federal baseline set of
controls and regulations—revisited as often as is
necessary to ensure responsible innovation—must
be applied to all DCMs.’’ Id.
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the principles-based nature of the
requirements.290 With respect to this
competitive issue, Better Markets noted
that those DCMs with lower information
collection requirements and less
stringent pre-trade risk controls could
appear more attractive to certain market
participants and could facilitate certain
market participants to move trading
among DCMs, thereby costing certain
DCMs business.291
As noted in the NPRM and the
preamble of these final rules, the
Commission is aware that DCMs may
have conflicting and competing interests
in connection with the oversight of
electronic trading.292 However, the
Commission does not believe that
differences in the application of the Risk
Principles across DCMs would be
substantial enough to induce market
participants to switch to trading at a
different DCM.
The commenters essentially argued
that the more prescriptive regulatory
approach to electronic trading taken in
the withdrawn Regulation AT proposal
is preferable to the Risk Principles
approach that ‘‘delegates’’ elements of
electronic trading oversight to for-profit
exchanges. As support for their
argument, commenters focused on the
inherent conflict of self-regulation
whereby a for-profit entity is also tasked
with performing a certain degree of
regulatory oversight over its
marketplace. The Commission notes the
Congressional intent to serve the public
interests of the CEA ‘‘through a system
of effective self-regulation of trading
facilities . . . under the oversight of the
Commission.’’ 293 DCMs have significant
incentives and obligations to maintain
well-functioning markets as selfregulatory organizations that are subject
to specific regulatory requirements.
Specifically, the DCM Core Principles
require DCMs to, among other things,
refrain from adopting any rule or taking
any action that results in any
unreasonable restraint of trade and
imposing material anticompetitive
burdens.294 In addition, DCM Core
Principles also require DCMs to surveil
290 Better Markets specifically stated that ‘‘The
CFTC acknowledges this regulatory arbitrage
concern but minimizes such concerns due to a
belief that ‘‘differences in the application of the
proposed regulation across DCMs would [not] be
substantial enough to induce market participants to
switch to trading at a different DCM, even if there
were two DCMs trading similar enough contracts.’’
Better Markets NPRM Letter, at 11. See also NPRM
at 42774.
291 See id.
292 See NPRM at 42775 and Section III.C.4 of this
final rulemaking.
293 Section 3(b) of the CEA. 7 U.S.C. 5(b).
294 CEA section 5(d)(19), 7 U.S.C. 7(d)(19) and 17
CFR 38.1000.
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trading on their markets to prevent
market manipulation, price distortion,
and disruptions of the delivery or cashsettlement process.295 Several academic
studies, including one concerning
futures exchanges and another
concerning demutualized stock
exchanges, also support the conclusion
that exchanges are able both to satisfy
shareholder interests and meet their
self-regulatory organization
responsibilities.296
As noted above in Section III.C.3, CFE
expressed concern that smaller DCMs
could over time be expected to adopt
and implement the same pre-trade risk
controls in place at the larger DCMs
which could, therefore, impact
competition and diversity. CFE is
specifically concerned about the
statement in the NPRM regarding
assessment of risk controls comparing
‘‘all DCMs to a baseline of controls on
electronic trading and electronic order
entry that are prevalent and effective
across DCMs.’’ 297 CFE further asserted
that ‘‘what is in place at the larger DCMs
and DCM groups should not simply
become the de facto standard for what
all DCMs must employ.’’ 298
The Commission reiterates that the
Risk Principles are intended to provide
DCMs with the flexibility to adopt those
pre-trade risk controls reasonably
designed to prevent, detect, and mitigate
market disruptions or system anomalies
associated with electronic trading. As a
result, the Commission does not intend
or expect larger DCM pre-trade risk
controls to be the standard for all DCMs,
although there may be risk controls that
are common to all DCMs. As noted in
the CFE comments, it is not the
Commission’s intent to effectively
impose on all DCMs those risk controls
that are in place at larger DCMs.
The Commission also believes that
these competitive concerns raised by
commenters are mitigated because: (i)
DCMs are required to submit any
proposed rules under Commission
regulation § 38.251(e) to the
Commission for review under part 40 of
the Commission’s regulations; and (ii)
DCMs are required pursuant to the DCM
Antitrust Core Principle to refrain from
adopting any rule or taking any action
that results in any unreasonable
restraint of trade and imposing material
295 17
CFR 38.200 and 17 CFR 38.250.
David Reiffen and Michel A. Robe,
Demutualization and Customer Protection at SelfRegulatory Financial Exchanges, Journal of Futures
Markets, supra note 56, at 126–164, Feb. 2011;
Kobana Abukari and Isaac Otchere, Has Stock
Exchange Demutualization Improved Market
Quality? International Evidence, supra note 56.
297 NPRM at 42768.
298 CFE NPRM Letter, at 4.
296 See
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anticompetitive burdens.299
Accordingly, the Commission has
determined that the Risk Principles
serve the regulatory purpose of the CEA
to deter and prevent price manipulation
or any other disruptions to market
integrity.300 In addition, the
Commission notes that the Risk
Principles implement additional
purposes and policies set forth in
section 5(d)(4) of the CEA.301 The
Commission has considered the final
rules and related comments, to
determine whether they are
anticompetitive, and continues to
believe that the Risk Principles will not
result in any unreasonable restraint of
trade, or impose any material
anticompetitive burden on trading in
the markets.
List of Subjects in 17 CFR Part 38
Commodity futures, Designated
contract markets, Reporting and
recordkeeping requirements.
PART 38—DESIGNATED CONTRACT
MARKETS
1. The authority citation for part 38
continues to read as follows:
■
Authority: 7 U.S.C. 1a, 2, 6, 6a, 6c, 6d, 6e,
6f, 6g, 6i, 6j, 6k, 6l, 6m, 6n, 7, 7a–2, 7b, 7b–
1, 7b–3, 8, 9, 15, and 21, as amended by the
Dodd-Frank Wall Street Reform and
Consumer Protection Act, Pub. L. 111–203,
124 Stat. 1376.
2. In § 38.251, republish the
introductory text and add paragraphs (e)
through (g) to read as follows:
■
§ 38.251
General requirements.
A designated contract market must:
*
*
*
*
*
(e) Adopt and implement rules
governing market participants subject to
its jurisdiction to prevent, detect, and
mitigate market disruptions or system
anomalies associated with electronic
trading;
(f) Subject all electronic orders to
exchange-based pre-trade risk controls
to prevent, detect, and mitigate market
disruptions or system anomalies
associated with electronic trading; and
(g) Promptly notify Commission staff
of any significant market disruptions on
299 See Commission regulation § 38.1000 (Core
Principle 19, Antitrust Considerations).
300 Section 3(b) of the CEA, 7 U.S.C. 5(b).
301 7 U.S.C. 5(d)(4). This DCM Core Principle
focusing on the prevention of market disruption
requires that the board of trade shall have the
capacity and responsibility to prevent
manipulation, price distortion, and disruptions of
the delivery or cash-settlement process through
market surveillance, compliance, and enforcement
practices and procedures, including—(A) methods
for conducting real-time monitoring of trading; and
(B) comprehensive and accurate trade
reconstructions.
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its electronic trading platform(s) and
provide timely information on the
causes and remediation.
■ 3. In appendix B to part 38, under
‘‘Core Principle 4 of section 5(d) of the
Act: PREVENTION OF MARKET
DISRUPTION,’’ add paragraph (b)(6) to
read as follows:
Appendix B to Part 38—Guidance on,
and Acceptable Practices in,
Compliance With Core Principles
*
*
*
*
*
Core Principle 4 of section 5(d) of the Act:
PREVENTION OF MARKET DISRUPTION
* * *
(b) * * *
(6) Market disruptions and system
anomalies associated with electronic trading.
To comply with § 38.251(e), the contract
market must adopt and implement rules that
are reasonably designed to prevent, detect,
and mitigate market disruptions or system
anomalies associated with electronic trading.
To comply with § 38.251(f), the contract
market must subject all electronic orders to
exchange-based pre-trade risk controls that
are reasonably designed to prevent, detect,
and mitigate market disruptions or system
anomalies.
*
*
*
*
*
Issued in Washington, DC, on December
10, 2020, by the Commission.
Robert Sidman
Deputy Secretary of the Commission.
NOTE: The following appendices will not
appear in the Code of Federal Regulations.
Appendices to—Electronic Trading
Risk Principles Voting Summary
Chairman’s and Commissioners’
Statements
Appendix 1—Voting Summary
On this matter, Chairman Tarbert and
Commissioners Quintenz, Stump, and
Berkovitz voted in the affirmative.
Commissioner Behnam voted in the negative.
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Appendix 2—Supporting Statement of
Chairman Health P. Tarbert
The mission of the CFTC is to promote the
integrity, resilience, and vibrancy of U.S.
derivatives markets through sound
regulation. We cannot achieve this mission if
we rest on our laurels—particularly in
relation to the ever-evolving technology that
makes U.S. derivatives markets the envy of
the world. What is sound regulation today
may not be sound regulation tomorrow.
I am reminded of the paradoxical
observation of Giuseppe di Lampedusa in his
prize-winning novel, The Leopard: ‘‘If we
want things to stay as they are, things will
have to change.’’ 1
While the novel focuses on the role of the
aristocracy amid the social turbulence of 19th
century Sicily, its central thesis—that
achieving stability in changing times itself
1 Giuseppe Tomasi di Lampedusa, The Leopard
(Everyman’s Library Ed. 1991) at p. 22.
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requires change—can be applied equally to
the regulation of rapidly changing financial
markets.
Today we are voting to finalize a rule to
address the risk of disruptions to the
electronic markets operated by futures
exchanges. The risks involved are significant;
disruptions to electronic trading systems can
prevent market participants from executing
trades and managing their risk. But how we
address those risks—and the implications for
the relationship between the Commission
and the exchanges we regulate—is equally
significant.
The Evolution of Electronic Trading
A floor trader from the 1980s and even the
1990s would scarcely recognize the typical
futures exchange of the 21st Century. The
screaming and shouting of buy and sell
orders reminiscent of the film Trading Places
has been replaced with silence, or perhaps
the monotonous humming of large data
centers. Over the past two decades, our
markets have moved from open outcry
trading pits to electronic platforms. Today,
96 percent of trading occurs through
electronic systems, bringing with it the price
discovery and hedging functions
foundational to our markets.
By and large, this shift to electronic trading
has benefited market participants. Spreads
have narrowed,2 liquidity has improved,3
and transaction costs have dropped.4 And the
most unexpected benefit is that electronic
markets have been able to stay open and
function smoothly during the COVID–19
lockdowns. By comparison, traditional open
outcry trading floors such as options pits and
the floor of the New York Stock Exchange
were forced to close for an extended time.
Without the innovation of electronic trading,
our financial markets would almost certainly
have seized up and suffered even greater
distress.
But like any technological innovation,
electronic trading also creates new and
unique risks. Today’s final rule is informed
by examples of disruptions in electronic
markets caused by both human error as well
as malfunctions in automated systems—
disruptions that would not have occurred in
open outcry pits. For instance, ‘‘fat finger’’
orders mistakenly entered by people, or fully
automated systems inadvertently flooding
matching engines with messages, are two
sources of market disruptions unique to
electronic markets.
Past CFTC Attempts To Address Electronic
Trading Risks
The CFTC has considered the risks
associated with electronic trading during
2 Frank, Julieta and Philip Garcia, ‘‘Bid-Ask
Spreads, Volume, and Volatility: Evidence from
Livestock Markets,’’ American Journal of
Agricultural Economics, Vol. 93, Issue 1, p. 209
(January 2011).
3 Terrence Henderschott, Charles M. Jones, and
Albert K. Menkveld, ‘‘Does Algorithmic Trading
Improve Liquidity?’’ Journal of Finance, Volume 66,
Issue 1, p. 1 (February 2011).
4 Esen Onur and Eleni Gousgounis, ‘‘The End of
an Era: Who Pays the Price when the Livestock
Futures Pits Close?’’, Working Paper, Commodity
Futures Trading Commission Office of the Chief
Economist.
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much of the last decade. Seven years ago, a
different set of Commissioners issued a
concept release asking for public comment
on what changes should be made to our
regulations in light of the novel issues raised
by electronic trading. Out of that concept
release, the Commission later proposed
Regulation AT. For all its faults, Regulation
AT drove a very healthy discussion about the
risks that should be addressed and the best
way to do so.
Regulation AT was based on the
assumption that automated trading, a subset
of electronic trading, was inherently riskier
than other forms of trading. As a result,
Regulation AT sought to require certain
automated trading firms to register with the
Commission notwithstanding that they did
not hold customer funds or intermediate
customer orders. Most problematically,
Regulation AT also would have required
those firms to produce their source code to
the agency upon request and without
subpoena.
Regulation AT also took a prescriptive
approach to the types of risk controls that
exchanges, clearing members, and trading
firms would be required to place on order
messages. But this list was set in 2015. In
effect, Regulation AT would have frozen in
time a set of controls that all levels of market
operators and market participants would
have been required to place on trading. Since
that list was proposed, financial markets
have faced their highest volatility on record
and futures market volumes have increased
by over 50 percent.5 Improvements in
technology and computer power have been
profound. Of course, I commend my
predecessors for focusing on the risks that
electronic trading can bring. But times
change, and Regulation AT would not have
changed with them. Consequently, our
Commission formally withdrew Regulation
AT this past summer.6
An Evolving CFTC for Evolving Markets
In withdrawing Regulation AT, the CFTC
has consciously moved away from
registration requirements and source code
production. But in voting to finalize the Risk
Principles, the CFTC is committing to
address risk posed by electronic trading
while strengthening our longstanding
principles-based approach to overseeing
exchanges.
The markets we regulate are changing. To
maintain our regulatory functions, the CFTC
must either halt that change or change our
agency. Swimming against the tide of
developments like electronic markets is not
an option, nor should it be. The markets exist
to serve the needs of market participants, not
the regulator. If a technological change
improves the functioning of the markets, we
should embrace it. In fact, one of this
agency’s founding principles is that CFTC
should ‘‘foster responsible innovation.’’ 7
Applying this reasoning alongside the
5 Futures Industry Association, ‘‘A record year for
derivatives’’ (March 5, 2019), available at https://
www.fia.org/articles/record-year-derivatives.
6 Regulation Automated Trading; Withdrawal, 85
FR 42755 (July 15, 2020).
7 Commodity Exchange Act, Section 3(b), 7 U.S.C.
3(b).
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overarching theme of The Leopard leads us
to a single conclusion: As our markets
evolve, the only real course of action is to
ensure that the CFTC’s regulatory framework
evolves with it.
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The Need for Principles-Based Regulation
So then how do we as a regulator change
with the times while still fulfilling our
statutory role overseeing U.S. derivatives
markets? I recently published an article
setting out a framework for addressing
situations such as this.8 I believe that
principles-based regulations can bring
simplicity and flexibility while also
promoting innovation when applied in the
right situations. Such an approach can also
create a better supervisory model for
interaction between the regulator and its
regulated firms—but only so long as that
oversight is not toothless.
There are a variety of circumstances in
which I believe principles-based regulation
would be most effective. Regulations on how
exchanges manage the risks of electronic
trading are a prime example. This is about
risk management practices at sophisticated
institutions subject to an established and
ongoing supervisory relationship. But it is
also an area where regulated entities have a
better understanding than the regulator about
the risks they face and greater knowledge
about how to address those risks. As a result,
exchanges need flexibility in how they
manage risks as they constantly evolve.
At the same time, principles-based
regulation is not ‘‘light touch’’ regulation.
Without the ability to monitor compliance
and enforce the rules, principles-based
regulation would be ineffective. Principlesbased regulation of exchanges can work
because the CFTC and the exchanges have
constant interaction that engenders a degree
of mutual trust. The CFTC—as overseen by
our five-member Commission—has tools to
monitor how the exchanges implement
principles-based regulations through reviews
of license applications and rule changes, as
well as through periodic examinations and
rule enforcement reviews.
Monitoring compliance alone is not
enough. The regulator also needs the ability
to enforce against non-compliance.
Principles-based regimes ultimately give
discretion to the regulated entity to find the
best way to achieve a goal, so long as that
method is objectively reasonable. To that
end, the CFTC has a suite of tools to require
changes through formal action, escalating
from denial of rule change requests, to
enforcement actions, to license revocations.
The CFTC consistently needs to address the
effectiveness and appropriateness of these
levers to make sure the exchanges are
meeting their regulatory objectives. And
given that exchanges will be judged on a
reasonableness standard, it must be the
Commission itself—based on a
recommendation from CFTC staff 9—who
8 Tarbert, Heath P., ‘‘Rules for Principles and
Principles for Rules: Tools for Crafting Sound
Financial Regulation,’’ Harv. Bus. L. Rev., Vol. 10
(June 15, 2020), available at https://www.hblr.org/
volume-10-2019-2020/.
9 CFTC Staff conduct regular examinations and
reviews of our registered entities, including
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ultimately decides whether an exchange has
been objectively unreasonable in complying
with our principles.
Final Rule on Risk Principles for Electronic
Trading
This brings us to today’s finalization of the
Risk Principles that were proposed in June of
this year. The final rule, which we are
adopting by-and-large as proposed, centers
on a straightforward issue that I think we can
all agree is important for our regulations to
address. Namely, the Risk Principles require
exchanges to take steps to prevent, detect,
and mitigate market disruptions and system
anomalies associated with electronic trading.
The disruptions we are concerned about
can come from any number of causes,
including: (i) Excessive messages, (ii) fat
finger orders, or (iii) the sudden shut off of
order flow from a market maker. The key
attribute of the disruptions addressed by the
Risk Principles is that they arise because of
electronic trading.
To be sure, our current regulations do
require exchanges to address market
disruptions. But the focus of those rules has
generally been on disruptions caused by
sudden price swings and volatility. In effect,
the Risk Principles expand the term ‘‘market
disruptions’’ to cover instances where market
participants’ ability to access the market or
manage their risks is negatively impacted by
something other than price swings. This
could include slowdowns or closures of
gateways into the exchange’s matching
engine caused by excessive messages
submitted by a market participant. It could
also include instances when a market
maker’s systems shut down and the market
maker stops offering quotes.
As noted in the preamble to the final rule,
exchanges have worked diligently to address
emerging risks associated with electronic
trading. Different exchanges have put in
place rules such as messaging limits and
penalties when messages exceed filled trades
by too large a ratio. Exchanges also may
conduct due diligence on participants using
certain market access methods and may
require systems testing ahead of trading
through those methods.
It is not surprising that exchanges have
developed rules and risk controls that
comport with our Risk Principles. The
Commission, exchanges, and market
participants have a common interest in
ensuring that electronic markets function
properly. Moreover, this is an area where
exchanges are likely to possess the best
understanding of the risks presented and
have control over how their own systems
operate. As a result, exchanges have the
incentive and the ability to address the risks
exchanges and clearinghouses. As part of those
examinations and reviews, Staff may identify issues
of material non-compliance with regulations as well
as recommendations to bring an entity into
compliance. Ultimately, however, the Commission
itself must accept an examination report or rule
enforcement review report before it can become
final, including any findings of non-compliance.
Likewise, Staff are asked to make recommendations
regarding license applications, reviews of new
products and rules, and a variety of other
Commission actions, although ultimate authority
lies with the Commission.
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arising from electronic trading. Principlesbased regulations in this area will ensure that
exchanges have reasonable discretion to
adjust their rules and risk controls as the
situation dictates, not as the regulator
dictates.
The three Risk Principles encapsulate this
approach. First, exchanges must have rules to
prevent, detect, and mitigate market
disruptions and system anomalies associated
with electronic trading. In other words, an
exchange should take a macro view when
assessing potential market disruptions,
which can include fashioning rules
applicable to all traders governing items such
as onboarding, systems testing, and
messaging policies. Second, exchanges must
have risk controls on all electronic orders to
address those same concerns. Third,
exchanges must notify the CFTC of any
significant market disruptions and give
information on mitigation efforts.
Importantly, implementation of the Risk
Principles will be subject to a reasonableness
standard. The Acceptable Practices
accompanying the Risk Principles clarify that
an exchange would be in compliance if its
rules and its risk controls are reasonably
designed to meet the objectives of preventing,
detecting, and mitigating market disruptions
and system anomalies. The Commission will
have the ability to monitor how the
exchanges are complying with the Principles,
and will have avenues to sanction noncompliance.
Framework for Future Regulation
I hope that the Risk Principles we are
adopting today will serve as a framework for
future CFTC regulations. Electronic trading
presents a prime example of where
principles-based regulation—as opposed to
prescriptive rule sets—is more likely to result
in sound regulation over time. Through
thoughtful analysis of the regulatory
objective we aim to achieve, the nature of the
market and technology we are addressing, the
sophistication of the parties involved, and
the nature of the CFTC’s relationship with
the entity being regulated, we can identify
what areas are best for a prescriptive
regulation or a principles-based regulation.10
In the present context, a principles-based
approach—setting forth concrete objectives
while affording reasonable discretion to the
exchanges—provides flexibility as electronic
trading practices evolve, while maintaining
sound regulation. In sum, it recognizes that
things will have to change if we want things
to stay as they are.11
Appendix 3—Supporting Statement of
Commissioner Brian D. Quintenz
I support today’s final rule requiring
designated contract markets (DCMs) to adopt
rules that are reasonably designed to prevent,
detect, and mitigate market disruptions or
system anomalies associated with electronic
trading. It also requires DCMs to subject all
electronic orders to pre-trade risk controls
that are reasonably designed to prevent,
detect and mitigate market disruptions
having a ‘‘material’’ effect on its participants
10 Tarbert,
11 Di
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Lampedusa, at 22.
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and to provide prompt notice to the
Commission in the event the platform
experiences any material market disruptions
that meet a higher threshold of being
‘‘significant’’.
I believe all DCMs have already adopted
regulations and pre-trade risk controls
designed to address the risks posed by
electronic trading. As I have noted
previously, many—if not all—of the risks
posed by electronic trading are already being
effectively addressed through the market’s
incentive structure, including exchanges’ and
firms’ own self-interest: DCMs through their
interest in operating markets with integrity,
and firms through their interest in not
exposing their or their customers’ funds to
huge losses in a matter of minutes through
algorithmic operational error. Both exchanges
and firms have been leaders in implementing
best practices around electronic trading risk
controls. Therefore, today’s final rule merely
codifies principles underlying existing
market practice of DCMs to have reasonable
controls in place to mitigate electronic
trading risks.
Significantly, the final rule puts forth a
principles-based approach, allowing DCM
trading and risk management controls to
continue to evolve with the trading
technology itself. As we have witnessed over
the past decade, risk controls are constantly
being updated and improved to respond to
market developments. In my view, these
continuous enhancements are made possible
because exchanges and firms have the
flexibility and incentives to evolve and hold
themselves to an ever-higher set of standards,
rather than being held to a set of prescriptive
regulatory requirements which can quickly
become obsolete. By adopting a principlesbased approach, the final rule provides
exchanges and market participants with the
flexibility they need to innovate and evolve
with technological developments. DCMs are
well-positioned to determine and implement
the rules and risk controls most effective for
their markets. Under the rule, DCMs are
required to adopt and implement rules and
risk controls that are objectively reasonable.
The Commission would monitor DCMs for
compliance and take action if it determines
that the DCM’s rules and risk controls are
objectively unreasonable. Importantly, the
Appendix to the final rule points out that a
DCM will be held to a standard of
reasonableness and not to how other DCMs
implement the rule. Any horizontal review
across DCMs of rules or risk controls would
only inform objectively unreasonable
determinations, not create a baseline set of
specific risk controls that become de-facto
regulatory requirements.
The Technology Advisory Committee
(TAC), which I am honored to sponsor, has
explored the risks posed by electronic trading
at length. In each of those discussions, it has
become obvious that both DCMs and market
participants take the risks of electronic
trading seriously and have expended
enormous effort and resources to address
those risks.
For example, at one TAC meeting, we
heard how the CME Group has implemented
trading and volatility controls that
complement, and in some cases exceed, eight
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recommendations published by the
International Organization of Securities
Commissions (IOSCO) regarding practices to
manage volatility and preserve orderly
trading.1 At another TAC meeting, the
Futures Industry Association (FIA) presented
on current best practices for electronic
trading risk controls.2 FIA reported that
through its surveys of exchanges, clearing
firms, and trading firms, it has found
widespread adoption of market integrity
controls since 2010, including price banding
and exchange market halts. FIA also
previewed some of the next generation
controls and best practices currently being
developed by exchanges and firms to further
refine and improve electronic trading
systems. The Intercontinental Exchange (ICE)
also presented on the risk controls ICE
currently implements across all of its
exchanges, noting how its implementation of
controls was fully consistent with FIA’s best
practices.3 These presentations emphasize
how critical it is for the Commission to adopt
a principles-based approach that enables best
practices to evolve over time.
I believe the final rule issued today adopts
such an approach and provides DCMs with
the flexibility to continually improve their
risk controls in response to technological and
market advancements. Because this rule
allows for flexible implementation and
effectively places that burden on the market
participants with the most aligned and
motivated interests, I believe this rule will
stand the test of time and serve as a paradigm
of the CFTC’s mission statement: Sound
regulation that promotes the integrity,
resilience, and vibrancy of the U.S.
derivatives market.
Appendix 4—Dissenting Statement of
Commissioner Rostin Behnam
I would like to start by thanking DMO staff
for their tireless work on this rule. While the
Risk Principles are short, that is not reflective
of the work that has been done by staff to
produce them. This is the same DMO staff
that worked on the much broader
‘‘Regulation AT’’,1 and I appreciate all of
their work over many years.
Last June, I stated in my dissent to the
Electronic Trading Risk Principles proposal 2
that I strongly support thoughtful and
meaningful policy that addresses the everincreasing use of automated systems in our
1 Meeting of the TAC on March 27, 2019,
Automated and Modern Trading Markets
Subcommittee Presentation, transcript and webcast
available at, https://www.cftc.gov/PressRoom/
Events/opaeventtac032719.
2 Meeting of the TAC on Oct. 3, 2019, Automated
and Modern Trading Markets Subcommittee
Presentation, https://www.cftc.gov/PressRoom/
Events/opaeventtac100319.
3 Id.
1 Regulation Automated Trading, Proposed Rule,
80 FR 78824 (Dec. 17, 2015); Supplemental
Regulation AT NPRM, 81 FR 85334 (Nov. 25, 2016).
2 Rostin Behnam, Commissioner, CFTC,
Dissenting Statement of Commissioner Rostin
Behnam Regarding Electronic Trading Risk
Principles (June 25, 2020), https://www.cftc.gov/
PressRoom/SpeechesTestimony/
behnamstatement062520b.
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markets.3 The proposal regarding Electronic
Trading Risk Principles did not achieve this.
Far from utilizing over a decade of
experiences that should have profoundly
shaped how we address operational risks that
are consistently unpredictable and have
wide-ranging impacts, today’s final rule
changes only a single word from the proposal
aimed at codifying the status quo.
Accordingly, I respectfully dissent.
A little over ten years ago, on May 6, 2010,
the Flash Crash shook our markets.4 The
prices of many U.S.-based equity products,
including stock index futures, experienced
an extraordinarily rapid decline and
recovery. In 2012, Knight Capital, a securities
trading firm, suffered losses of more than
$460 million due to a trading software coding
error.5 Other volatility events related to
automated trading have followed with
increasing regularity.6 In September and
October 2019, the Eurodollar futures market
experienced a significant increase in
messaging.7 According to reports, the volume
of data generated by activity in Eurodollar
futures increased tenfold.8 A lesson of these
events is that under stressed market
conditions, automated execution of a large
sell order can trigger extreme price
movements, and the interplay between
automated execution programs and
algorithmic trading strategies can quickly
result in disorderly markets.9
Recent events further amplify that in
increasingly interconnected markets, which
are informed by growing access to real-time
data and information, we do not always
know how and where the next market stress
event will materialize. This past April 20, the
May contract for the West Texas Intermediate
Light Sweet Crude Oil futures contract (the
‘‘WTI Contract’’) on the New York Mercantile
Exchange settled at a price of -$37.63 per
barrel. The May Contract’s April 20 negative
3 The Commission’s Office of the Chief Economist
has found that over 96 percent of all on-exchange
futures trading occurred on DCMs’ electronic
trading platforms. Haynes, Richard & Roberts, John
S., ‘‘Automated Trading in Futures Markets—
Update #2’’ at 8 (Mar. 26, 2019), available at https://
www.cftc.gov/sites/default/files/2019-04/ATS_2yr_
Update_Final_2018_ada.pdf.
4 See Findings Regarding the Market Events of
May 6, 2010, Report of the Staffs of the CFTC and
SEF to the Joint Advisory Committee on Emerging
Regulatory Issues (Sept. 30, 2010), available at
https://www.cftc.gov/ucm/groups/public/@otherif/
documents/ifdocs/staff-findings050610.pdf.
5 See SEC Press Release No. 2013–222, ‘‘SEC
Charges Knight Capital With Violations of Market
Access Rule’’ (Oct. 16, 2013), available at https://
www.sec.gov/News/PressRelease/Detail/
PressRelease/1370539879795.
6 For a list of volatility events between 2014 and
2017, see the International Organization of
Securities Commissions (‘‘IOSCO’’) March 2018
Consultant Report on Mechanisms Used by Trading
Venues to Manage Extreme Volatility and Preserve
Orderly Trading (‘‘IOSCO Report’’), at 3, available
at https://www.iosco.org/library/pubdocs/pdf/
IOSCOPD607.pdf.
7 See Osipovich, Alexander, ‘‘Futures Exchange
Reins in Runaway Trading Algorithms,’’ Wall Street
Journal (Oct. 29, 2019), available at https://
www.wsj.com/articles/futures-exchange-reins-inrunaway-trading-algorithms-11572377375.
8 Id.
9 Id. at 6.
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settlement price was the first time the WTI
Contract traded at a negative price since
being listed for trading 37 years ago.
While the unusual fact that the price went
significantly negative grabbed the headlines,
the precipitousness of the price move was
every bit as significant. The price dropped
more than $39 between 2:10 and 2:30 p.m.
on April 20. Overall, the price dropped
$58.05 from the open of trading to its low on
April 20, breaking its historical relationship
with other petroleum-based contracts
including the Brent Crude futures contract.
The WTI price moved more in 20 minutes
than it does most years. A contract that had
never experienced a 10% move in a single
day fell by more than 300% in a brief 20minute period. All of the contributing factors
have yet to be accounted for, but one thing
is certain—these were stressed market
conditions. An already oversupplied global
crude oil market was hit with an
unprecedented reduction in demand caused
by the COVID–19 pandemic.10 Under
stressed market conditions, automated
trading has the potential to quickly make an
already volatile situation even worse.
Technology glitches have continued to
impact our markets. Just yesterday, a large
retail broker that was significantly impacted
by the events of April 20 suffered a
significant failure in data storage.11 Recent
technology glitches overseas have hampered
our international colleagues as well,
handcuffing markets for extended periods of
time without clear explanation. In Japan this
past September, the Tokyo Stock Exchange
shut down for a day due to technical glitches
in equities trading.12 Luckily, this glitch
happened to coincide with all other Asian
markets being closed and occurred the day
after the first Presidential debate. But this
only emphasizes the outsized impact that a
technical issue could have during volatile
market conditions. One can imagine what
would have happened if the glitch had
occurred the day before, during the leadup to
the debate.13
Just last month, Australia’s stock exchange
lost an entire day of trading due to a software
problem impacting trading of multiple
securities in a single order.14 This discrete
issue was enough to lead to inaccurate
market data that necessitated shutting down
the exchange for an entire trading day.15
As we consider today’s final rule, there is
a tendency to think that something is better
10 Interim Staff Report, Trading in NYMEX WTI
Crude Oil Futures Contract Leading Up to, on, and
around April 20, 2020 (Nov. 23, 2020), https://
www.cftc.gov/PressRoom/PressReleases/8315-20.
11 See Platt and Stafford, ‘‘Trading Outages Strike
Again for US Retail Brokers,’’ Financial Times (Dec.
7, 2020), available at https://www.ft.com/content/
cb99dc6f-a73e-41af-91fb-21a4aa606265.
12 See Dooley, Ben, ‘‘Tokyo Stock Market Halts
Trading for a Day, Citing Glitch,’’ The New York
Times (Sep. 30, 2020), available at https://
www.nytimes.com/2020/09/30/business/tokyostock-market-glitch.html.
13 Id.
14 See ‘‘Software Glitch Halts Trading on
Australia’s Stock Exchange, to Reopen Tuesday,’’
Reuters (Nov. 15, 2020), available at https://
www.reuters.com/article/us-asx-trading/softwareglitch-halts-trading-on-australias-stock-exchangeto-reopen-tuesday-idUSKBN27W020.
15 Id.
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than nothing, and that today’s risk
principles—if nothing else—demonstrate the
Commission’s belief that mitigating
automated trading risk is important.
However, I continue to question whether
these Risk Principles improve upon the
status quo, or even do anything of marginal
substance relative to the status quo.16
The preamble seems to go to great lengths
to make it clear that the Commission is not
asking DCMs to do anything. The preamble
states at the very outset that the
‘‘Commission believes that DCMs are
addressing most, if not all, of the electronic
trading risks currently presented to their
trading platforms.’’ 17 The preamble presents
each of the three Risk Principles as ‘‘new’’,
but then goes on to describe all of the actions
already taken by DCMs that meet the
principles. If the appropriate structures are in
place, and we have dutifully conducted our
DCM rule enforcement reviews and have
found neither deficiencies nor areas for
improvement, then is the exercise before us
today anything more than creating a box that
will automatically be checked?
The only potentially new aspect of these
Risk Principles is that the preamble suggests
different application in the future, as
circumstances change. As I said in regard to
the proposal, the Commission seems to want
it both ways: We want to reassure DCMs that
what they do now is enough, but at the same
time the new risk principles potentially
provide a blank check for the Commission to
apply them differently in the future.18
We do not know what the next external
event to stress market conditions will be, but
one likely possibility is climate change. In
establishing new rules for automated trading,
I would have liked the Commission to have
taken a more fulsome look at both the events
of April 20, the COVID–19 pandemic more
broadly, and the potential impacts of climate
change on our automated markets. The
recently published Interim Staff Report on
the events of April 20 provides a stark
example of what can happen to automated
markets under times of economic stress.
The April 20 price plummet triggered both
dynamic circuit breakers and velocity logic—
exactly the type of risk controls discussed in
the proposal that preceded the Electronic
Trading Risk Principles proposal, commonly
referred to as ‘‘Regulation AT.’’ Regulation
AT was formally withdrawn at the
Chairman’s direction and without my
support. Further troubling, it was withdrawn
before Commission staff had any meaningful
opportunity to consider whether and how the
risk controls in either Regulation AT or the
Electronic Trading Risk Principles as
proposed performed during trading around
April 20. There was arguably no better test
case, and yet we charged forward without
looking back. If the risk controls were
effective, we should consider whether more
specific risk controls along these lines should
be part of the Electronic Trading Risk
Principles, in order to be certain that all
DCMs are prepared to maintain orderly
trading during such a confluence of events.
16 See
Behnam, supra note 2.
Rule at 4.
18 See Behnam, supra note 2.
17 Final
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2075
If they are not, we should consider whether
stronger risk controls are necessary.
I also think the Risk Principles would be
improved if they were informed by a
consideration of the possible impacts of
climate change. The preamble states ‘‘The
principles-based approach provides DCMs
with flexibility to address risks to markets as
they evolve, including any idiosyncratic
events.’’ Referring to events such as climate
change as ‘‘idiosyncratic’’ downplays their
impact and places regulators and DCMs in a
purely reactive posture. While we cannot
know for certain what the next external event
that causes stressed market conditions will
be, that does not mean that we should remain
idle until it hits. As we will continue to
experience unanticipated and unprecedented
events that will impact our markets and the
larger U.S. economy, I am concerned that a
policy of simply checking a box will do
nothing more than shield DCMs from public
scrutiny and fault for the fallout.
So often we hear that the markets have
evolved from a technological and innovative
standpoint at an exponential rate as
compared to their regulators. Rulemakings
like this provide our greatest opportunity to
proactively close that gap. We need to be
proactive. Being proactive means studying
the incidents of the past, like the Flash Crash,
Knight Capital, and most recently April 20 so
that we can recognize the precursors of
events to come. Instead of just reacting, we
can predict, prepare for, and possibly prevent
the next crisis event.
Again, while there is a temptation to
advance this rule under the theory that
something is better than nothing, in this case
I do not think that the final rules add
anything at all beyond the opportunity to
take a victory lap. In other words, the theme
in this case is that nothing is better than
something. I believe that we can, and should,
do better. Therefore, I cannot support today’s
final rule.
Appendix 5—Supporting Statement of
Commissioner Dawn D. Stump
As I observed when we proposed these risk
principles last summer, it is a simple fact that
the markets we regulate have become
increasingly electronic (much like everything
else in our modern lives). The rulemaking
that we are now adopting appropriately
recognizes that market infrastructure
providers have already implemented a host
of measures pursuant to our existing
regulations and their own self-regulatory
responsibilities to account for the associated
risks that inherently come with the
development of electronic trading. I do not
want our adoption of additional Commission
risk principles regarding electronic trading
on designated contract markets (‘‘DCMs’’) to
be taken as an indication that adequate
attention is not being paid—or that
insufficient resources are being invested—by
the exchanges to address the lessons that
have already been learned and applied over
many years as electronic trading has become
more prevalent in these markets.
I also want to stress the significance of the
often-overlooked direction we have received
from Congress in Section 3 of the Commodity
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Exchange Act (‘‘CEA’’).1 Section 3(a) sets out
Congress’s finding that the transactions
subject to the CEA are affected with a
national public interest. Then, in Section
3(b), Congress stated that it is the purpose of
the CEA to serve this public interest ‘‘through
a system of effective self-regulation of trading
facilities, clearing systems, market
participants and market professionals under
the oversight of the Commission.’’
I support adopting these electronic trading
risk principles as an appropriate exercise of
the Commission’s oversight that Congress
expects from us, as stated in Section 3(b) of
the CEA. While, as noted, I do not question
the exchanges’ diligence in addressing the
risks in electronic trading on their platforms,
I am comfortable incorporating these
principles into our existing rule set in order
to make clear that DCMs must continue to
monitor these risks as they evolve along with
the markets, and make reasonable
modifications as appropriate.
Importantly, though, I also support the
principles-based approach of these final
rules. This approach recognizes that the
front-line responsibility for preventing,
detecting, and mitigating material risks posed
by electronic trading rests with the exchanges
themselves. The exchanges are best
positioned to execute this responsibility
because they have the best knowledge of the
trading that occurs on their own markets. At
the same time, this approach serves the
public interest through a system of effective
self-regulation of trading facilities—precisely
as Congress directed in its statement of
purpose in Section 3(b) of the CEA.
I thank and commend the Staff for the time
and energy they have put into the
preparation of this rulemaking, and for the
thoughtful consideration they have given to
these issues over the course of the past
several years.
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Appendix 6—Statement of
Commissioner Dan M. Berkovitz
I support today’s final rule on Electronic
Trading Risk Principles (‘‘Final Rule’’). The
Final Rule addresses market disruptions
associated with electronic trading through
limited requirements applicable directly to
designated contract markets (‘‘DCMs’’) and
indirectly to DCM market participants. It is
an incremental step that can enhance the
safety and soundness of electronic trading on
U.S. exchanges. I look forward to the
continuing evolution of trading in our
markets, and to the Commission’s steady
engagement with the technology and risk
controls of modern trading to determine
whether more may be needed in the future.
I am able to support the Final Rule because
it recognizes the role of both DCMs and
market participants in preventing and
mitigating market disruptions, as well as the
ultimate responsibility and authority of the
Commission to oversee the actions of our
market infrastructures and market
participants. The Final Rule codifies three
‘‘Risk Principles,’’ including new
requirements in Risk Principle 1 that DCMs
implement rules governing their market
participants to prevent, detect, and mitigate
1 CEA
Section 3, 7 U.S.C. 5.
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market disruptions and system anomalies.1
This provision, codified in Commission
regulation 38.251(e), speaks directly to new
risk-reducing practices and may be the most
helpful of the three Risk Principles.
Market participants originate, place, and
manage orders on DCMs though an array of
systems that vary in sophistication and
automation. Experience teaches that errors in
the design, testing, implementation,
operation, or supervision of such systems by
a single market participant can lead to
cascading effects that disrupt an entire
market and the ability of all market
participants to engage in price discovery and
risk mitigation. Accordingly, it is crucial that
market participants, DCMs, and the
Commission implement and enforce the Risk
Principles in meaningful ways going
forward.2
The Commission’s efforts in this regard
may be aided by Risk Principle 3, which
requires DCMs to ‘‘promptly notify
Commission staff of any significant market
disruptions’’ and ‘‘provide timely
information on the causes and
remediation.’’ 3 I support Commission efforts
to remain up-to-date as technologies evolve,
new potential sources of market disruptions
arise, and best practices for safeguarding
markets are developed. Information provided
to the Commission through Risk Principle 3
will strengthen the Commission’s daily
oversight of DCMs, and help educate the
Commission and its staff as to the most
effective risk-reducing measures.
I am also able to support the Final Rule
because it recognizes and preserves the
Commission’s authority to interpret and
enforce the standards in the Risk Principles,
and because it clarifies that Risk Principles
1 and 2 are intended to address any type of
market disruption arising from market
participants or electronic orders that
materially affects electronic trading. I thank
the Chairman for working with my office to
1 In addition, Risk Principle 2 requires DCMs to
subject all electronic orders to exchange-based pretrade risk controls to prevent, detect, and mitigate
market disruptions or system anomalies associated
with electronic trading. Risk Principle 2 overlaps
with existing Commission regulations, including
§ 38.255, which requires DCMs to ‘‘establish and
maintain risk control mechanisms to prevent and
reduce the potential risk of price distortions and
market disruptions.’’ DCMs should help drive an
effective implementation of Risk Principle 2 by
carefully examining their existing pre-trade risk
controls and ensuring that such controls are fit for
the types of market participants, technologies, and
trading practices prevalent on their markets.
2 I appreciate the concerns raised by some
commenters that the Risk Principles may be
imprecise, difficult to enforce, or provide too much
deference to DCMs. As discussed below, the Final
Rule helps mitigate some of these concerns by
emphasizing that the Risk Principles are an
objective standard and enforceable rules subject to
Commission oversight. The Commission will be
able to monitor DCMs’ compliance with the Risk
Principles through its DCM rule enforcement
review program, as well as other oversight activities
including review of new rule certifications, review
of market disruption notifications received
pursuant to Risk Principle 3, market surveillance,
and other oversight tools.
3 Risk Principle 3 is codified in new Commission
regulation 38.251(g).
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achieve these enhancements to the Final
Rule.
The Final Rule includes Acceptable
Practices in Appendix B to part 38 providing
that a DCM can comply with Risk Principles
1 and 2 through rules and pre-trade risk
controls that are ‘‘reasonably designed’’ to
prevent, detect, and mitigate market
disruptions and system anomalies. While
legitimate concerns have been raised that
these terms could lend themselves to
excessive disputes over interpretation, the
Final Rule makes clear that they are subject
to an objective standard and Commission
oversight. It notes specifically that ‘‘[t]he
Commission will oversee and enforce the
Risk Principles in accordance with an
objective reasonableness standard[,]’’ and
that the Risk Principles are ‘‘enforceable
regulations.’’ 4 I am pleased that the Final
Rule clearly articulates the seriousness with
which the Commission will monitor and
enforce the Risk Principles.
The Final Rule also makes clear that while
Risk Principle 3 addresses ‘‘significant’’
market disruptions, Risk Principles 1 and 2
include the broader set of ‘‘material’’
disruptions. As stated in the Final Rule, ‘‘the
standard for a significant market disruption
under Risk Principle 3 is higher than the
standard for a market disruption under Risk
Principles 1 and 2.’’ Markets and market
participants will benefit from the
Commission’s decision to resolve this
potential ambiguity in the proposed rule and
to implement a rigorous standard for Risk
Principles 1 and 2.
Today’s Final Rule addresses an issue that
has remained open in the Commission’s
books for far too long. Electronic trading is
no longer a new technology in Commissionregulated markets, and it has not been new
for many years. The Risk Principles are a
circumscribed but important first step in
ensuring that the Commission’s rules keep
pace with technological changes underlying
derivatives trading. The Commission must
now proceed to full, effective
implementation of the Risk Principles and to
oversight of DCMs’ own implementations. I
support these efforts, combined with
continued vigilance to determine whether
additional steps may be needed in the future.
In the preamble to the Final Rule, the
Commission stresses the potential benefits of
the principles-based approach embodied in
the Risk Principles. My support for the
principles-based approach in this particular
rulemaking, however, should not be
interpreted as an endorsement of such a
broad principles-based approach in other
circumstances, or foreclose my support for
more prescriptive measures should they
become necessary with respect to risk
4 As I articulated in my statement when the Risk
Principles were first proposed, the Dodd-Frank Act
amended the Commodity Exchange Act to make
clear that a DCM’s discretion with respect to core
principle compliance is circumscribed by any rule
or regulation that the Commission might adopt
pursuant to a core principle. In today’s Final Rule,
the Commission is requiring DCMs to adopt and
implement rules and pre-trade risk controls that are
‘‘reasonably designed to prevent, detect, and
mitigate market disruptions or system anomalies
associated with electronic trading.’’
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controls. Although the markets overseen by
the Commission have benefitted from the
flexibility of a principles-based approach in
a number of areas, in other circumstances a
more prescriptive approach has provided the
market with needed clarity and certainty.
The appropriate choice or balance between
prescriptive regulations and principles-based
regulations will depend upon the
circumstances being addressed by those
regulations.
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Whether this rulemaking will fully
accomplish its objectives will depend to a
large extent upon the diligence and
commitment to its implementation by DCMs
and market participants. If DCMs and market
participants comprehensively adopt and
maintain industry best practices to prevent,
detect, and mitigate market disruptions and
system anomalies, as well as develop and
implement measures to address emerging
issues as they arise, then further prescriptive
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2077
action by the Commission may not be
necessary.
I thank the staff of the Division of Market
Oversight for their work to address a number
of my concerns with the Final Rule, as well
as their overall work on the Final Rule.
[FR Doc. 2020–27622 Filed 1–5–21; 11:15 am]
BILLING CODE 6351–01–P
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Agencies
[Federal Register Volume 86, Number 6 (Monday, January 11, 2021)]
[Rules and Regulations]
[Pages 2048-2077]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-27622]
[[Page 2047]]
Vol. 86
Monday,
No. 6
January 11, 2021
Part II
Commodity Futures Trading Commission
-----------------------------------------------------------------------
17 CFR Part 38
Electronic Trading Risk Principles; Final Rule
Federal Register / Vol. 86 , No. 6 / Monday, January 11, 2021 / Rules
and Regulations
[[Page 2048]]
-----------------------------------------------------------------------
COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 38
RIN 3038-AF04
Electronic Trading Risk Principles
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rule.
-----------------------------------------------------------------------
SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is adopting final rules amending its part 38 regulations to
address the potential risk of a designated contract market's (``DCM'')
trading platform experiencing a market disruption or system anomaly due
to electronic trading. The final rules set forth three principles
applicable to DCMs concerning: The implementation of exchange rules
applicable to market participants to prevent, detect, and mitigate
market disruptions and system anomalies associated with electronic
trading; the implementation of exchange-based pre-trade risk controls
for all electronic orders; and the prompt notification of Commission
staff by DCMs of any significant market disruptions on their electronic
trading platforms. In addition, the final rules include acceptable
practices (``Acceptable Practices''), which provide that a DCM can
comply with these principles by adopting and implementing rules and
risk controls reasonably designed to prevent, detect, and mitigate
market disruptions and system anomalies associated with electronic
trading.
DATES:
Effective date: The rules are effective on January 11, 2021.
Compliance date: DCMs must be in full compliance with the
requirements of this rule no later than July 12, 2021.
FOR FURTHER INFORMATION CONTACT: Marilee Dahlman, Special Counsel,
[email protected] or 202-418-5264; Joseph Otchin, Special Counsel,
[email protected] or 202-418-5623, Division of Market Oversight; Esen
Onur, [email protected] or 202-418-6146, Office of the Chief Economist; in
each case at the Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
A. Purpose and Structure of the Risk Principles
B. TAC Meeting
C. Existing Part 38 Framework and the Risk Principles Proposal
D. Framework of This Final Rulemaking
1. Principles-Based Approach
2. Issues Related to a DCM-Focused Approach
3. Issues Related to Codification in Core Principle 4 and
Overlap With Existing Commission Regulations
II. The Final Risk Principles
A. Key Terms
1. Electronic Trading
2. Market Disruption and System Anomaly
B. The Reasonableness Standard
C. Risk Principle 1
1. Proposal
2. Rules Versus Controls and Other Procedures
3. Scope of Electronic Trading Subject to DCM Rules
D. Risk Principle 2--Risk Controls Listed in Part 38
E. Risk Principle 3
1. Proposal
2. ``Significant'' Standard
3. Notification Requirement
III. Related Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
1. OMB Collection 3038-0093--Provisions Common to Registered
Entities
2. OMB Collection 3038-0052--Core Principles and Other
Requirements for DCMs
C. Cost-Benefit Considerations
1. Introduction
2. Costs
3. Benefits
4. 15(a) Factors
D. Antitrust Considerations
I. Background
A. Purpose and Structure of the Risk Principles
The Commission is adopting final rules establishing a set of
principles (``Risk Principles'') and related Acceptable Practices
applicable to DCMs for the purpose of preventing, detecting, and
mitigating market disruptions and system anomalies associated with the
entry of electronic orders and messages into DCMs' electronic trading
platforms. Such market disruptions or anomalies originating at a market
participant may negatively impact the proper functioning of a DCM's
trading platform by limiting the ability of other market participants
to trade, engage in price discovery, or manage risk.
The Commission, DCMs, and market participants all have an interest
in the effective prevention, detection, and mitigation of market
disruptions and system anomalies associated with electronic trading. As
discussed in the notice of proposed rulemaking for the Electronic
Trading Risk Principles (``NPRM'') \1\ and noted by several NPRM
commenters, the Commission believes that DCMs are addressing most, if
not all, of the electronic trading risks currently presented to their
trading platforms. DCMs and other market participants have worked
together to better understand electronic trading risks and adapt risk
control systems through the use of new technological tools and safety
procedures, such as ``fat finger'' controls, dynamic price collars,
kill switches, cancel-on-disconnect, drop copy feeds, self-match
prevention, and granular pre-trade controls to manage limits within a
product group.\2\ Since April 2010, FIA has published six papers
proposing industry best practices and guidelines related to identifying
risks and strengthening safeguards related to electronic trading in the
futures markets.\3\
---------------------------------------------------------------------------
\1\ Electronic Trading Risk Principles, 85 FR 42761 (July 15,
2020). NPRM commenters were as follows: Americans for Financial
Reform Education Fund (``AFR''), Better Markets, Inc. (``Better
Markets''), CBOE Futures Exchange, LLC (``CFE''), CME Group Inc.
(``CME''), Commercial Energy Working Group (``CEWG''), Futures
Industry Association and FIA Principal Traders Group (``FIA/FIA
PTG''), Institute for Agriculture and Trade Policy (``IATP''),
Intercontinental Exchange Inc. (``ICE''), International Swaps and
Derivatives Association, Inc. and Securities Industry and Financial
Markets Association (``ISDA/SIFMA''), Managed Funds Association
(``MFA''), Minneapolis Grain Exchange, Inc. (``MGEX''), and Optiver
US LLC (``Optiver''). In addition, the Commission received a
thirteenth comment letter from Robert Rutkowski (``Rutkowski'')
after the comment period closed.
\2\ FIA/FIA PTG NPRM Letter, at 2; see also CME NPRM Letter, at
1; ICE NPRM Letter, at 3. See also CME Group, Market Regulation
Advisory Notice RA2006-5, ``Disruptive Trading Practices''
(effective Aug. 10, 2020), available at https://www.cmegroup.com/notices/market-regulation/2020/08/CME-Group-RA2006-5.html
(prohibiting any market participant from intentionally or recklessly
submitting or causing to be submitted an actionable or non-
actionable message(s) that has the potential to disrupt exchange
systems).
\3\ FIA/FIA PTG NPRM Letter, at 1.
---------------------------------------------------------------------------
The Risk Principles will require DCMs to continue to monitor these
risks as they evolve along with the markets, and make reasonable
modifications as appropriate. The Risk Principles reflect a flexible
approach that complements industry-led initiatives and previous
Commission measures to address market disruption risk. The Risk
Principles provide further regulatory clarity to market participants
while preserving the DCMs' ability to adapt to evolving technology and
markets.
B. TAC Meeting
At the Commission's Technology Advisory Committee (``TAC'') meeting
on July 16, 2020, the TAC's Subcommittee on Automated and Modern
Trading Markets (``Subcommittee'') presented the Subcommittee's
position regarding the proposed Risk Principles.\4\ The
[[Page 2049]]
Subcommittee stated that it broadly supports the rulemaking.\5\ The
Subcommittee also indicated support for how the Commission
characterized the concepts of ``electronic trading'' and ``market
disruption.'' \6\ However, the Subcommittee described the second part
of the definition of ``market disruption''--i.e., disruption of the
ability of other market participants to trade on the DCM on which the
market participant is trading--as ``amorphous.'' \7\ The Subcommittee
noted that it is difficult to define in advance whether or not a trade
halt is disruptive.\8\ The Subcommittee stated ``a positive part of the
principles-based approach'' is that it allows the Commission and DCMs
to define events in accordance with a principle as opposed to a
list.\9\
---------------------------------------------------------------------------
\4\ Automated and Modern Trading Markets Subcommittee,
``Discussion of the CFTC's Proposed Rule on Electronic Trading Risk
Principles,'' (July 16, 2020) (``Subcommittee PowerPoint''),
available at https://www.cftc.gov/About/CFTCCommittees/TechnologyAdvisory/tac_meetings.html.
\5\ See July 16, 2020 TAC Meeting Transcript at 54:5.
\6\ As discussed in further detail below, the NPRM described
``electronic trading'' as all trading and order messages submitted
by electronic means to the DCM's electronic trading platform,
including both automated and manual order entry. The NPRM described
``market disruption'' as generally including an event originating
with a market participant that significantly disrupts the: (1)
Operation of the DCM on which such participant is trading; or (2)
ability of other market participants to trade on the DCM on which
such participant is trading. See NPRM at 42765.
See id. at 54:11-55:14, 56:6-16; Subcommittee PowerPoint at 3.
\7\ See July 16, 2020 TAC Meeting Transcript at 55:21-56:10.
\8\ See id. at 58:6-17.
\9\ See id.
---------------------------------------------------------------------------
The Subcommittee anticipated that many procedures and rules adopted
by DCMs would be similar, but it is nevertheless important to allow for
flexibility, given that DCM trading systems have different
architectures and features.\10\ The Subcommittee concluded that
flexibility allows for market resilience and best practices that will
improve over time.\11\
---------------------------------------------------------------------------
\10\ See id. at 6; July 16, 2020 TAC Meeting Transcript at
62:13-63:15.
\11\ See id.
---------------------------------------------------------------------------
C. Existing Part 38 Framework and the Risk Principles Proposal
As discussed in the NPRM, the Risk Principles supplement existing
DCM Core Principle 4 regulations in part 38, namely Commission
regulations Sec. Sec. 38.251 and 38.255.\12\ Existing Commission
regulation Sec. 38.251(c) requires each DCM to demonstrate an
effective program for conducting real-time monitoring of market
conditions, price movements, and volumes, in order to detect
abnormalities and, when necessary, to make a good-faith effort to
resolve conditions that are, or threaten to be, disruptive to the
market.\13\ In addition, existing Commission regulation Sec. 38.255
requires each DCM 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 DCM.\14\
---------------------------------------------------------------------------
\12\ See NPRM, supra note 1 at 42762.
\13\ 17 CFR 38.251(c).
\14\ 17 CFR 38.255.
---------------------------------------------------------------------------
Building on the requirements under existing Commission regulation
Sec. 38.251 to conduct real-time monitoring and resolve conditions
that are disruptive to the market, the Risk Principles, together with
the Acceptable Practices, require DCMs to take reasonable steps to
prevent, detect, and mitigate material market disruptions or system
anomalies associated with electronic trading. Existing Commission
regulations do not fully and explicitly address the risks of market
disruptions or system anomalies associated with electronic trading, and
the Risk Principles fill those gaps by establishing exchange rule and
risk control requirements, as well as notification requirements,
explicitly applicable to electronic trading. Additionally, while there
may be some overlap between the Risk Principles and existing Commission
regulation Sec. 38.255, the Commission believes the Risk Principles
are distinguishable from existing Commission regulation Sec. 38.255
because they focus on DCM rules, risk controls, and notification
requirements, and are not limited to the application of risk controls
as exists in regulation Sec. 38.255. The Commission also submits that
the Risk Principles will provide greater certainty to DCMs regarding
their obligations to address certain situations associated with
electronic trading.
D. Framework of This Final Rulemaking
The proposed rulemaking was subject to a 60-day comment period,
which closed on August 24, 2020. As noted above, the Commission
received 13 substantive comments and held one ex parte meeting.\15\ The
following section addresses comments that generally apply to all three
Risk Principles and Acceptable Practices. Comments that relate to
individual Risk Principles and Acceptable Practices will be addressed
in Section II.C-E.
---------------------------------------------------------------------------
\15\ See supra note 1.
---------------------------------------------------------------------------
1. Principles-Based Approach
In the NPRM, the Commission proposed a principles-based approach.
The purpose of this approach was to provide DCMs with the flexibility
to impose the most efficient and effective rules and pre-trade risk
controls for market participants subject to the DCMs' respective
jurisdictions. The Commission believes that a principles-based approach
in connection with electronic trading requirements provides DCMs with
flexibility to adapt and evolve with changing technologies and
markets.\16\
---------------------------------------------------------------------------
\16\ See NPRM at 42762.
---------------------------------------------------------------------------
a. Summary of Comments
Most commenters, including CME, CFE, CEWG, FIA/FIA PTG, ICE, ISDA/
SIFMA, MFA, and Optiver supported a principles-based approach.\17\ In
particular, FIA/FIA PTG, ISDA/SIFMA, and MFA noted that such an
approach provides flexibility and takes into account future
technological advances.\18\ Commenters also stated that the principles-
based approach is preferable to the prescriptive nature of prior
proposals.\19\ ICE supported the Commission's view that each DCM should
have discretion to identify market disruptions and system anomalies as
they relate to the DCM's market and participants' trading activity.\20\
ICE stated that what constitutes a market disruption will not only vary
from exchange to exchange, but also from market to market. Therefore,
tolerance levels and thresholds must be set for each market.\21\
---------------------------------------------------------------------------
\17\ CME NPRM Letter, at 1, 12, 16; CFE NPRM Letter, at 1; CEWG
NPRM Letter, at 2; FIA/FIA PTG NPRM Letter, at 2-4; ICE NPRM Letter,
at 2, 9; ISDA/SIFMA NPRM Letter, at 1-2; MFA NPRM Letter, at 1-2;
Optiver NPRM Letter, at 1.
\18\ FIA/FIA PTG NPRM Letter, at 2-4; ISDA/SIFMA NPRM Letter, at
1; MFA NPRM Letter, at 1-2.
\19\ CME NPRM Letter, at 1, 12; CFE NPRM Letter, at 1; CEWG NPRM
Letter, at 2.
\20\ ICE NPRM Letter, at 2.
\21\ See id.
---------------------------------------------------------------------------
In contrast, AFR, Better Markets, IATP, and Rutkowski disagreed
with the Commission's principles-based approach, and asserted that the
incentives of DCMs and public regulators are not fully aligned.\22\
Better Markets commented that the principles are too imprecise and
unenforceable, and lack key definitions.\23\ IATP emphasized that
principles-based rules
[[Page 2050]]
must be enforceable.\24\ IATP also asserted principles-based rules that
the Commission cannot effectively supervise and enforce would
surrender, not delegate, the Commission's authority, and could legalize
trading misconduct due to lack of resources.\25\ AFR, Better Markets,
and Rutkowski further commented that the proposed regulations provide
too much deference to DCMs and that the Commission failed to address
conflicts of interest concerns that may impede DCM and self-regulatory
organization (``SRO'') independence.\26\
---------------------------------------------------------------------------
\22\ AFR NPRM Letter, at 1-2; Better Markets NPRM Letter, at 2,
6, 9, 10-12; IATP NPRM Letter, at 1, 4, 8; Rutkowski NPRM Letter, at
1.
\23\ Better Markets NPRM Letter, at 2, 9.
\24\ IATP NPRM Letter, at 1.
\25\ See id. at 8.
\26\ AFR NPRM Letter, at 1-2; Better Markets NPRM Letter, at 2,
6, 9, 10-12; Rutkowski NPRM Letter, at 1.
---------------------------------------------------------------------------
Finally, IATP made several comments addressing the potential for
market disruption caused by ``idiosyncratic'' events, and suggested
further study on the impact of electronic trading on intraday price
volatility.\27\
---------------------------------------------------------------------------
\27\ See supra note 25 at 2-5, 8.
---------------------------------------------------------------------------
b. Discussion
The Commission considered the comments and is adopting the
principles-based approach to the Risk Principles as discussed in the
NPRM. The Commission believes that a principles-based approach provides
appropriate flexibility to allow DCMs to adopt and implement effective
and efficient measures reasonably designed to achieve the objectives of
the Risk Principles. The Commission submits that prescriptive rules may
not be sufficiently flexible to enable DCMs to adopt appropriate
measures for their particular market, and therefore, would not be as
effective in preventing market disruptions or system anomalies.
The principles-based nature of the Risk Principles does not mean
they are unenforceable. The Risk Principles will be enforceable
regulations that allow the Commission to require all DCMs to implement
appropriate, reasonable risk controls and rules to prevent, detect, and
mitigate market disruptions. The Commission has brought enforcement
actions relating to violations of Core Principles set forth in
Commission regulations. Recently, in 2019, the Commission brought an
action against Options Clearing Corporation (``OCC''), a derivatives
clearing organization (``DCO''), for violations of DCO Core Principles
under part 39.\28\ In particular, the Commission determined ``OCC
failed to fully comply with the specified DCO Core Principles by
failing to establish, implement, and enforce certain policies and
procedures reasonably designed to (1) consider and produce margin
levels commensurate with every potential risk and particular attribute
of each relevant product cleared by OCC; (2) effectively measure,
monitor and manage its credit exposure and liquidity risk; and (3)
protect the security of certain of its information systems.'' \29\
---------------------------------------------------------------------------
\28\ See Order, CFTC Docket No. 19-19, at 3-5 (Sept. 4, 2019),
available at https://www.cftc.gov/media/2396/enfoptionsclearingorder090419/download.
\29\ Id. at 2. The order stated the Commission found OCC had
failed to comply with Core Principles in Section 5b(c)(2)(B), (D),
and (I) of the Commodity Exchange Act (``CEA'' or ``Act''), and
Commission regulations Sec. Sec. 39.11(a) and (c), 39.13(a), (b),
(f), and (g)(l) and (2), and 39.18(b)(l) and (e)(l). See id. at 3-5.
The Commission issued a press release regarding the enforcement
action stating: `` `As this case shows, principles-based regulation
does not mean lax oversight,' said CFTC Chairman Heath P. Tarbert.
`While clearing agencies have some discretion in crafting their risk
management policies and procedures, those policies and procedures
must be reasonable and take into consideration relevant risks.' ''
See Press Release, ``SEC and CFTC Charge Options Clearing Corp. with
Failing to Establish and Maintain Adequate Risk Management
Policies'' (Sept. 4, 2019), available at https://www.cftc.gov/PressRoom/PressReleases/8000-19.
Additionally, in 2015, the Commission brought an enforcement
action against TeraExchange LLC, a provisionally registered swap
execution facility (``SEF''), for violations of Core Principles
requiring SEFs to enact and enforce rules prohibiting certain types
of trade practices, including wash trading and prearranged trading.
See Press Release, ``CFTC Settles with TeraExchange LLC for Failing
to Enforce Prohibitions on Wash Trading and Prearranged Trading in
Bitcoin Swap'' (Sept. 24, 2015), available at https://www.cftc.gov/PressRoom/PressReleases/7240-15.
---------------------------------------------------------------------------
While the final rules do not formally define terms such as ``market
disruption'' or ``electronic trading'' in rule text, the Commission
provided a general discussion of those terms in the NPRM. The
Commission is providing additional clarity concerning relevant terms in
this preamble, in order for DCMs and other market participants to have
a sufficient understanding of how the Commission will interpret and
enforce the Risk Principles.\30\ Further, by not defining the terms in
a static way, the Commission intends to allow for DCMs' application of
the Risk Principles to evolve over time alongside market
developments.\31\
---------------------------------------------------------------------------
\30\ See Section II.A.
\31\ See NPRM at 42765.
---------------------------------------------------------------------------
The Commission believes that DCMs are incentivized to have risk
controls to promote the integrity of their markets, and existing risk
controls in place across DCMs indicate that they have implemented such
measures. As FIA/FIA PTG pointed out, ``[a]ll market participants have
a shared interest in strengthening risk controls. The
interconnectedness of the listed derivatives markets means that all
market participants are vulnerable when risk controls fail. It is no
surprise, then, that the industry has worked diligently to enhance and
extend risk controls over the years.'' \32\
---------------------------------------------------------------------------
\32\ FIA/FIA PTG NPRM Letter, at 4. See also CME NPRM Letter, at
1 (``. . . the integrity and reliability of our markets are
cornerstones of our business model--market participants choose to
manage their risk on the CME Group Exchanges because we offer fair,
efficient, transparent, liquid, and dynamic markets that are
conducted and operated in accordance with the highest standards.'';
ICE NPRM Letter, at 2 (``DCMs have proactively developed a
substantial suite of risk controls, as well as financial,
operational and supervisory controls to protect their markets and
comply with existing regulations.'').
---------------------------------------------------------------------------
The Risk Principles will require all DCMs to implement an
appropriate standard for risk controls. DCMs are best positioned to
determine what risk controls and rules are appropriate to prevent,
detect, and mitigate disruptions on their respective markets.
Permitting them to do so is consistent with Congressional intent to
serve the public interests of the CEA ``through a system of effective
self-regulation of trading facilities . . . under the oversight of the
Commission.'' \33\ Any conflict of interest concerns, where DCMs might
prioritize profitability over reasonable controls, will be addressed
through regular Commission oversight of DCMs, including
examinations.\34\ For example, in an examination, Commission staff may
consider whether a DCM is allocating sufficient financial and staff
resources to the compliance function, the background and qualifications
of the DCM's regulatory oversight committee members and compliance
officers, and any role non-compliance personnel might be taking in the
DCM's market monitoring and investigations processes.\35\
---------------------------------------------------------------------------
\33\ Section 3(b) of the CEA. 7 U.S.C. 5(b).
\34\ The Commission notes that DCMs are already subject to
Commission regulation Sec. 38.850 (Core Principle 16, Conflicts of
Interest), which requires DCMs to minimize conflicts of interest in
the DCM's decision-making process and establish a process for
resolving those conflicts of interest. 17 CFR 38.850.
\35\ See Appendix B to Part 38--Guidance on, and Acceptable
Practices in, Compliance with Core Principles, Core Principle 16
(Subparagraph (b)) (``To comply with this Core Principle, contract
markets should be particularly vigilant for such conflicts between
and among any of their self-regulatory responsibilities, their
commercial interests, and the several interests of their management,
members, owners, customers and market participants, other industry
participants, and other constituencies.'').
---------------------------------------------------------------------------
Regarding IATP's comments, the Commission acknowledges that market
risks, like the markets themselves, are always evolving. The
principles-based approach provides DCMs with flexibility to address
risks to markets as they evolve, including any idiosyncratic events.
Prescriptive regulations may
[[Page 2051]]
lack the flexibility to address such idiosyncratic events, while
principles-based regulations would provide DCMs with a framework
through which they can change their rules and risk controls to address
such unforeseen events. The Commission or industry organizations may
conduct studies relevant to electronic trading in the future, and the
Commission expects that the results will inform regulatory oversight of
DCMs and enforcement of the Risk Principles. The Commission notes that
the Division of Market Oversight produced a report in 2019 examining
trading functionality across markets and found a consistent increase in
the percentage of trading that was identified as ``automated'' relative
to ``manual.'' \36\ Further, the report also showed no general
correlation (and in some instances an inverse correlation) between the
increase in automated trading activity in these markets and daily
volatility.\37\
---------------------------------------------------------------------------
\36\ Staff of the Market Intelligence Branch, ``Impact of
Automated Orders in Futures Markets'' (Mar. 2019) at 4, 7, 13,
available at https://www.cftc.gov/MarketReports/StaffReports/index.htm.
\37\ See id.
---------------------------------------------------------------------------
2. Issues Related to a DCM-Focused Approach
The Commission proposed the Risk Principles should focus
specifically on DCMs.\38\ The NPRM stated the Commission will continue
to monitor whether Risk Principles of this nature may be appropriate
for other markets such as SEFs or foreign boards of trade
(``FBOTs'').\39\ The Commission also encouraged the National Futures
Association to evaluate whether it should provide additional
supervisory guidance to its members.\40\ As noted in the NPRM, each DCM
may have a different risk management program based on its unique
business model and market, and this may result in some degree of
differences in DCM rules implementing the Risk Principles.\41\
---------------------------------------------------------------------------
\38\ See NPRM at 42763.
\39\ See id. at 42763 n.6.
\40\ See id. at 42764.
\41\ See id. at 42765.
---------------------------------------------------------------------------
a. Summary of Comments
CEWG, FIA/FIA PTG, and Optiver supported the Risk Principles' focus
on DCMs and addressed issues relating to DCM discretion in implementing
the Risk Principles.\42\ FIA/FIA PTG stated that DCMs are the
gatekeeper and overseer of electronic trading platforms and are
therefore uniquely positioned to apply pre-trade controls uniformly to
all participants and trading in their markets.\43\ Optiver similarly
noted that each DCM has a unique technology stack on which its platform
is built and must be afforded latitude to develop rules and risk
controls.\44\ In contrast, AFR, Better Markets, IATP, and Rutkowski
commented that the proposed regulations provide too much deference to
DCMs, in allowing them to decide for themselves how to address
prevention, detection, and mitigation of undefined market disruptions
and system anomalies.\45\
---------------------------------------------------------------------------
\42\ CEWG NPRM Letter, at 3-4; FIA/FIA PTG NPRM Letter, at 3;
Optiver NPRM Letter, at 1.
\43\ FIA/FIA PTG NPRM Letter, at 3.
\44\ Optiver NPRM Letter, at 1.
\45\ AFR NPRM Letter, at 1-2; Better Markets NPRM Letter, at 2,
6, 9, 10-12; IATP NPRM Letter, at 6-11; Rutkowski NPRM Letter, at 1.
---------------------------------------------------------------------------
CME stated the Risk Principles should apply to SEFs and FBOTs, in
addition to DCMs.\46\ CFE stated any Commission assessments of DCM
controls should be across all DCMs, and the Commission should not seek
to hold all DCMs to what the larger DCMs may have in place.\47\ CME
commented that each DCM may implement different rules and risk controls
without harming market liquidity or integrity.\48\ In contrast, Better
Markets commented that the Risk Principles ensure a lack of uniformity
in DCM policies, procedures, and controls and potentially would punish
responsible DCMs.\49\ Similarly, IATP asserted competition among DCMs
for over-the-counter trading and for trading in new products, such as
digital coins, could result in lax risk control design or updating
under competitive pressures.\50\ IATP asked the Commission to explain
why the lack of any uniform standard by which DCMs should develop rules
and risk controls presents no risk of regulatory arbitrage or migration
of market disruptions from one DCM to another.\51\
---------------------------------------------------------------------------
\46\ CME NPRM Letter, at 2, 13.
\47\ CFE NPRM Letter, at 4.
\48\ CME NPRM Letter, at 13.
\49\ Better Markets NPRM Letter, at 9.
\50\ IATP NPRM Letter, at 9.
\51\ IATP NPRM Letter, at 11.
---------------------------------------------------------------------------
While the Risk Principles apply to DCMs, CEWG commented on their
potential effect on market participants. In particular, CEWG requested
the final rules clarify that market participants without access to
source code used to operate trading systems would not be subject to
DCM-imposed requirements to implement updates, test or monitor the
operation of such software, or DCM-imposed requirements under Risk
Principle 3 to implement remediation measures for software.\52\
---------------------------------------------------------------------------
\52\ CEWG NPRM Letter, at 7.
---------------------------------------------------------------------------
Finally, IATP commented that the Risk Principles indiscriminately
apply to asset classes, financial speculators, and commercial
hedgers.\53\ IATP further stated that the Commission should issue a
term sheet for a study to investigate the feasibility of revising the
demutualization rule to create tiers of DCMs with respect to physical
and financial derivatives contracts, to which a rule on automated
trading would apply.\54\ IATP also commented that the Commission should
distinguish what additional pre-trade and post-trade risk controls the
DCMs must maintain from what is required of futures commission
merchants (``FCMs'') prescriptively.\55\
---------------------------------------------------------------------------
\53\ IATP NPRM Letter, at 4-5.
\54\ See id.
\55\ IATP NPRM Letter, at 13.
---------------------------------------------------------------------------
b. Discussion
The Commission believes that a regulatory approach focusing on Risk
Principles applicable only to DCMs is the correct approach. All
participants and intermediaries have a responsibility to address the
risks of electronic trading. However, trading occurs on DCM platforms
and DCM-implemented rules and risk controls will be most effective in
preventing, detecting, and mitigating system anomalies and market
disruptions. As noted above, conflict of interest concerns will be
addressed through regular Commission oversight. DCMs are subject to
Commission regulation Sec. 38.850 (Core Principle 16, Conflicts of
Interest), which requires DCMs to minimize conflicts of interest in the
DCM's decision-making process and establish a process for resolving
those conflicts of interest.\56\ The Commission believes that DCMs, and
other market participants, do have an interest in maintaining market
integrity, and this is evidenced through existing measures. In its
comment, FIA/FIA PTG addressed DCM tools and procedures adopted to
address electronic trading risk, including basic ``fat finger''
controls, dynamic price collars, kill switches, cancel-on-disconnect,
drop copy feeds, and self-match prevention, as well as granular pre-
trade controls to manage limits within a product group.\57\ FIA/FIA PTG
noted that development of
[[Page 2052]]
risk control measures ``has been an evolving, iterative process, with
market participants, FCMs, technology vendors and DCMs working together
to build the safeguards needed to protect our markets. After all, it is
in everyone's interest to have efficient, reliable markets.'' \58\
---------------------------------------------------------------------------
\56\ 17 CFR 38.850. See also David Reiffen and Michel A. Robe,
Demutualization and Customer Protection at Self-Regulatory Financial
Exchanges, Journal of Futures Markets, Vol. 31, 126-164, Feb. 2011
(in many circumstances, an exchange that maximizes shareholder
(rather than member) income has a greater incentive to enforce
aggressively regulations that protect participants from dishonest
agents); and Kobana Abukari and Isaac Otchere, Has Stock Exchange
Demutualization Improved Market Quality? International Evidence,
Review of Quantitative Finance and Accounting, Dec 09, 2019, https://doi.org/10.1007/s11156-019-00863-y (demutualized exchanges have
realized significant reductions in transaction costs in the post-
demutualization period).
\57\ FIA/FIA PTG NPRM Letter, at 2.
\58\ See id.
---------------------------------------------------------------------------
The Commission acknowledges IATP's points concerning the
possibility of creating different tiers of DCMs, and distinguishing
controls required of DCMs from those required of FCMs. However, the
Commission believes it is preferable to have the same regulations apply
to all DCMs, and, in the enforcement of such regulations, recognize
that each DCM has a unique market, technological infrastructure, and
market participants. In addition, DCMs may require different controls
from FCMs and the Commission will not specify particular required
controls. This will serve the goal of ensuring that all DCMs, whatever
their size or products, are subject to the same Commission regulations
while allowing sufficient flexibility for each DCM to adopt risk
controls and rules that are reasonably appropriate for its market.
As noted in the NPRM, the Commission will continue to monitor
whether Risk Principles of this nature may be appropriate for other
markets such as SEFs or FBOTs.\59\ The Commission initially proposed
the Risk Principles with a focus on DCMs due to their prominent nature
in the futures market. Application of the Risk Principles to SEFs and
FBOTs requires further study and consideration regarding the risks and
unique attributes of those other markets, and the Commission expects to
do so in the future to determine whether SEFs and/or FBOTs should be
subject to the Risk Principles or similar regulations.
---------------------------------------------------------------------------
\59\ See NPRM at 42763 n.6.
---------------------------------------------------------------------------
The Commission acknowledges that DCMs might implement different
rules and risk controls given differences in their respective markets.
Ongoing Commission oversight is expected to identify differences in DCM
policies, procedures, and controls. Differences between and among DCMs
would be acceptable under the Risk Principles so long as their
policies, procedures, and controls are objectively reasonable. The Risk
Principles will require DCMs to establish rules and risk controls
reasonably designed to prevent, detect, and mitigate market
disruptions, and this should, in turn, help prevent the migration of
market disruptions from one DCM to another.
The Commission acknowledges CEWG's request that the final rules
clarify that market participants without access to source code used to
operate trading systems would not be subject to any DCM rules to
implement updates, test or monitor the operation of such software, or
DCM rules under Risk Principle 3 to implement remediation measures for
software.\60\ While these points are reasonable, the Commission
believes the extent to which market participants would be expected to
implement software updates, tests, operation monitoring, or remediation
measures should be left to individual DCM reasonable discretion. The
Commission can envision unique arrangements involving market
participant use of third-party software and therefore believes DCMs are
the appropriate entity to adopt reasonable rules to govern those
arrangements. The Commission notes that under existing Commission
regulation Sec. 38.151, DCMs must provide their members, persons with
trading privileges, and independent software vendors with impartial
access to their markets and services, including access criteria that
are impartial, transparent, and applied in a non-discriminatory
manner.\61\
---------------------------------------------------------------------------
\60\ CEWG NPRM Letter, at 7.
\61\ 17 CFR 38.151.
---------------------------------------------------------------------------
3. Issues Related to Codification in Core Principle 4 and Overlap With
Existing Commission Regulations
The NPRM noted several areas where the Risk Principles may overlap
with existing Commission regulations, including regulations related to
the prevention of market disruptions and financial risk controls.\62\
The Commission explained that because DCMs have developed robust and
effective processes for identifying and managing risks, both because of
their incentives to maintain markets with integrity, as well as for
purposes of compliance with existing Commission regulations, the Risk
Principles may not necessitate the adoption of additional measures by
DCMs.\63\ The Commission further stated that the proposed Risk
Principles will result in DCMs continuing to monitor risks as they
evolve along with the markets and make reasonable modifications as
appropriate.\64\ Finally, the Commission proposed codifying the Risk
Principles as part of Core Principle 4.\65\
---------------------------------------------------------------------------
\62\ See NPRM 42762, 42764.
\63\ See NPRM 42762.
\64\ See id.
\65\ See id.
---------------------------------------------------------------------------
a. Summary of Comments
CME, ICE, and Better Markets asserted that the Risk Principles are
redundant of existing regulations.\66\ In particular, CME commented
that the Risk Principles overlap with existing regulations that require
DCMs to have controls, tools, and rule sets to prevent and mitigate
market and system disruptions.\67\ CME stated that its messaging
controls, for example, are already arguably subject to Commission
oversight pursuant to certain existing regulations under Core
Principles 2 and 4.\68\ CME suggested the Commission take an
alternative approach of simply relying on existing regulations rather
than adopting new ones.\69\ CME also addressed where in the part 38
regulations the Risk Principles should be codified if adopted. CME
suggested the Risk Principles be codified as part of Core Principle 2,
particularly Risk Principle 1, because that Core Principle requires a
DCM to adopt and implement rules.\70\ CME also pointed out that Core
Principle 4 addresses manipulation, price distortion, and disruptions
of the delivery or cash-settlement process and that a ``market
disruption'' or ``system anomaly'' does not fit within those
elements.\71\
---------------------------------------------------------------------------
\66\ CME NPRM Letter, at 12-13; ICE NPRM Letter, at 3; Better
Markets NPRM Letter, at 4-9.
\67\ CME NPRM Letter, at 12-13.
\68\ See id. at 7.
\69\ See id. at 12.
\70\ See id. at 12-13.
\71\ See id.
---------------------------------------------------------------------------
ICE commented that the proposed risk principles largely duplicate
existing Core Principle 4 guidance and acceptable practices.\72\ ICE
suggested amending existing regulations, such as Commission regulation
Sec. 38.255, to refer to electronic trading, rather than create a new
set of principles that may unintentionally conflict with or create
duplicative and overlapping standards.\73\ ICE stated this would track
the Commission's approach to regulating financial risk controls in
existing Commission regulation Sec. 38.607, which it believes has
proven effective.\74\
---------------------------------------------------------------------------
\72\ ICE NPRM Letter, at 3.
\73\ See id.
\74\ See id.
---------------------------------------------------------------------------
Better Markets similarly commented that the proposed regulations
are redundant of existing Commission regulations. Specifically, Better
Markets pointed to Commission regulations Sec. Sec. 38.157, 38.251(a),
38.255, 38.607, 38.1050, and 38.1051, as well as Core Principle 4
guidance and acceptable practices.\75\ Better Markets stated the Risk
Principles give the public the false
[[Page 2053]]
impression that the CFTC is taking meaningful regulatory action.\76\
Better Markets also considered the Commission's distinction that the
new principles are ``anticipatory'' to be unclear and possibly
inaccurate.\77\ Better Markets further commented that existing
Commission regulation Sec. 38.255 squarely focuses on risk controls
for the prevention and mitigation of market disruptions.\78\ Better
Markets stated that existing Commission regulation Sec. 38.255 and the
proposed Risk Principles are so similar that it is unreasonable, if not
deceptive, to finalize them under the pretext that the Commission is
setting forth a new and improved electronic trading framework.\79\
---------------------------------------------------------------------------
\75\ Better Markets NPRM Letter, at 4-9.
\76\ See id.
\77\ See id.
\78\ See id.
\79\ See id.
---------------------------------------------------------------------------
CME, CEWG, FIA/FIA PTG, ICE, and MFA commented that DCMs already
implement controls and address risks to their platforms.\80\ MFA
believes the Risk Principles will help encourage DCMs to continue to
monitor risks as they evolve along with the markets, and to make
reasonable modifications as appropriate.\81\ AFR and Rutkowski
disagreed, commenting that the NPRM does not contain any systematic
analysis demonstrating that current DCM practices are effective in
controlling the risks of market disruptions due to electronic
trading.\82\
---------------------------------------------------------------------------
\80\ CME NPRM Letter, at 4-7; CEWG NPRM Letter, at 4; FIA/FIA
PTG NPRM Letter, at 3; ICE NPRM Letter, at 1; MFA NPRM Letter, at 2.
\81\ MFA NPRM Letter, at 2.
\82\ AFR NPRM Letter, at 2; Rutkowski NPRM Letter, at 2.
---------------------------------------------------------------------------
b. Discussion
As noted in the NPRM, the Risk Principles supplement existing
Commission regulations governing DCMs by directly addressing certain
risks associated with electronic trading in Core Principle 4 and its
implementing regulations, namely Commission regulations Sec. Sec.
38.251 and 38.255.\83\ Commission regulation Sec. 38.251(c) requires
DCMs to conduct real-time monitoring and resolve conditions that are
disruptive to the market. The Risk Principles supplement this
regulation by specifically requiring actions by DCMs to prevent,
detect, and mitigate market disruptions and systems anomalies. While
the anticipatory nature of the Risk Principles (involving prevention,
in addition to detection and mitigation) is not the only justification
for these new rules, the Commission believes it is important to clarify
that DCMs are obligated to do more than monitor and resolve disruptive
conditions, as required by existing Commission regulation Sec. 38.251.
In particular, Risk Principle 1 specifically requires the adoption of
exchange-based ``rules'' that are reasonably designed to address
electronic trading risk to the extent that such rules are not already
in place.
---------------------------------------------------------------------------
\83\ See NPRM at 42768.
---------------------------------------------------------------------------
The NPRM further acknowledged that the Risk Principles largely
overlap with Commission regulation Sec. 38.255, which 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 DCM.\84\ Compared to
existing Commission regulation Sec. 38.255, the Risk Principles
specifically address material market disruptions and system anomalies
associated with electronic trading (e.g., excessive messaging that may
materially limit participant access), not only market disruptions
involving market halts or price distortions.
---------------------------------------------------------------------------
\84\ NPRM at 42768.
---------------------------------------------------------------------------
The Commission disagrees with comments asserting the Risk
Principles would be more appropriately implemented under Core Principle
2 rather than Core Principle 4. Various regulations promulgated under
Core Principle 4 already address market disruptions, including
Commission regulations Sec. Sec. 38.251(c) and 38.255. The Commission
believes that the Risk Principles, each dealing with market
disruptions, should likewise be codified under Core Principle 4.
The Commission believes that it must do more than rely on existing
regulations or add the words ``electronic trading'' to existing
regulations. For this reason, the Commission notes that the final Risk
Principles specifically will apply to electronic trading, thereby
requiring adoption of a DCM rule (if not already implemented) and risk
control and notification requirements regarding market disruptions,
that is expected to ensure the development and implementation of
reasonable measures to address the threat of market disruptions caused
by electronic trading. The Commission expects that these Risk
Principles will enhance the Commission's ability to hold DCMs to a
standard of reasonably-designed rules and appropriate risk controls,
whether those rules and controls were already in place or are
implemented pursuant to the Risk Principles.\85\
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\85\ The Commission notes that it does not intend or expect
larger DCM pre-trade risk controls to be the standard for all DCMs,
although there may be risk controls that are common to all DCMs.
---------------------------------------------------------------------------
The NPRM noted several examples of exchange-based risk controls and
several commenters elaborated further on these risk controls.\86\ The
Commission continues to believe most DCMs already have effective
controls in place to address electronic trading market disruptions.
These Risk Principles will require DCMs to continue to implement such
reasonable controls as markets and risks evolve.
---------------------------------------------------------------------------
\86\ NPRM at 42768. CME commented it has a vested interest in
preserving the integrity of its markets, and has done so through
market integrity controls such as order messaging throttles, price
limits, automated port closures, kill switches, velocity logic
controls and dynamic circuit breakers, as well as trade practice,
disciplinary and administrative rules. CME NPRM Letter, at 4. ICE
pointed out that prior to giving a participant access to its trading
platform, ICE requires the participant to undergo conformance
testing, which is designed to and has been successful in detecting
system anomalies. ICE NPRM Letter, at 2. ICE additionally stated it
has developed pre-trade risk controls, such as messaging throttles,
interval price limits (price velocity collars), individual maximum
order quantities, and order reasonability limits. See id. CFE
commented it has extensive rule provisions that provide for risk
controls applicable to all orders. CFE NPRM Letter, at 2.
---------------------------------------------------------------------------
II. The Final Risk Principles
A. Key Terms
The NPRM stated that the Risk Principles focus on market
disruptions or system anomalies associated with electronic trading
activities.\87\ While not defined in the regulation text, the preamble
broadly discussed the goals of the Risk Principles through these terms.
The NPRM further stated by not defining the terms in a static way, the
Commission intends that the application of the Risk Principles by DCMs
and the Commission will evolve over time along with market
developments.\88\ The NPRM stated that a general discussion of those
terms in the context of today's electronic markets would provide the
public and, in particular, DCMs, guidance for applying the Risk
Principles.\89\
---------------------------------------------------------------------------
\87\ NPRM at 42765.
\88\ See id.
\89\ See id.
---------------------------------------------------------------------------
1. Electronic Trading
a. Proposal
For purposes of this rulemaking, the Commission described
electronic trading as encompassing a wide scope of trading activities,
including all trading and order messages submitted by electronic means
to a DCM's electronic trading platform.\90\ This includes both
automated and manual order entry.\91\
---------------------------------------------------------------------------
\90\ See id.
\91\ See id.
---------------------------------------------------------------------------
[[Page 2054]]
b. Summary of Comments
CME and ICE addressed whether the Commission should modify its
description of the term electronic trading. CME believed that the term
was sufficiently clear.\92\ In contrast, ICE commented that the term is
used in Risk Principles 1 and 2 to ``include all trading and order
messages submitted by electronic means to the DCM's electronic trading
platform, including both automated and manual order entry.'' \93\ ICE
stated that the inclusion of ``trading'' messages is unnecessary.\94\
Because participants only submit ``order'' messages to the central
limit order book and not trades, ICE believes that the term
``electronic trading'' captures off-facility transactions, such as
exchange for related positions (``EFRPs'') and block transactions.\95\
ICE stated off-facility transactions are privately negotiated and have
a low likelihood of disrupting the central limit order book.\96\
---------------------------------------------------------------------------
\92\ CME NPRM Letter, at 10.
\93\ ICE NPRM Letter, at 2, 3-4, 5.
\94\ See id.
\95\ See id.
\96\ See id.
---------------------------------------------------------------------------
c. Discussion
The Commission clarifies that the term ``electronic trading''
includes block and EFRP transactions, if such transactions are
submitted electronically to the DCM's trading platform. The Commission
believes that DCMs should have reasonable discretion to decide what
rules and controls--if any--should be applied to off-exchange
transactions such as block trades and EFRPs under Risk Principles 1 and
2. The Commission expects DCMs to make such a determination based on:
(a) The risk such off-exchange transactions will disrupt DCM platforms
or markets; and (b) the rules and controls that would be most effective
to address that risk. The Commission acknowledges that such trades are
privately negotiated and currently may carry little risk of market
disruption. However, it is unknown how much risk off-exchange trading
will pose as markets evolve over time. In particular, off-exchange
transactions could become increasingly electronic or automated, impact
price formation and, consequently, pose greater risk to DCM markets.
The Risk Principles allow DCM discretion in assessing this risk and how
best to address it.
2. Market Disruption and System Anomaly
a. Proposal
In the NPRM, the Commission stated it considers the term ``market
disruption,'' for purposes of the Risk Principles, to generally mean an
event originating with a market participant that significantly disrupts
the: (1) Operation of the DCM on which such participant is trading; or
(2) the ability of other market participants to trade on the DCM on
which such participant is trading.\97\ For the purposes of the Risk
Principles, ``system anomalies'' are unexpected conditions that occur
in a market participant's functional system that cause a similar
disruption to the operation of the DCM or the ability of market
participants to trade on the DCM.\98\
---------------------------------------------------------------------------
\97\ NPRM at 42765.
\98\ See id.
---------------------------------------------------------------------------
b. Summary of Comments
ICE, CME, CEWG, MFA, IATP, Better Markets, and MGEX addressed
whether the Commission should modify its description of the terms
market disruption and system anomaly.\99\
---------------------------------------------------------------------------
\99\ ICE NPRM Letter, at 5-6; CME NPRM Letter, at 3-4, 10-11;
CEWG NPRM Letter, at 4, 5; MFA NPRM Letter, at 3; IATP NPRM Letter,
at 6; Better Markets NPRM Letter, at 9, 10; MGEX NPRM Letter, at 1-
2, 3.
---------------------------------------------------------------------------
ICE requested clarification on whether the term ``significant''
qualifies ``market disruption.'' \100\ ICE also commented that the
description of ``market disruption'' is overly broad, noting that the
Commission uses the term to refer to an incident that disrupts the
ability of other market participants to trade on the DCM.\101\ ICE
asserted this could include a range of subjective interpretations and
possibilities, including a disruption resulting in prices not
reflective of market fundamentals.\102\ ICE commented that the term
could also be interpreted to include entering orders in a disorderly
manner, quote stuffing, causing illiquid markets where one would not
occur otherwise, or causing the artificial widening of markets.\103\
ICE stated these scenarios could result from volatility but not a
market disruption, and, because of the ambiguities in the Risk
Principles, market participants may be reluctant to trade if pricing
appears aberrant or erroneous.\104\ CEWG commented that the Commission
should provide further high-level guidance with respect to events
constituting ``market disruptions'' or ``system anomalies'' to minimize
the potential for regulatory uncertainty.\105\
---------------------------------------------------------------------------
\100\ ICE NPRM Letter, at 5.
\101\ See id.
\102\ See id.
\103\ See id.
\104\ See id.
\105\ CEWG NPRM Letter, at 4.
---------------------------------------------------------------------------
CME commented that the term ``market disruption'' is sufficiently
clear.\106\ Similarly, MFA agreed with the Commission's approach to
defining ``market disruption,'' which MFA believes focuses correctly on
events impacting the operations of the DCM and/or the ability of other
market participants to trade on the DCM, rather than the impact on
trading of a single firm whose electronic trading was the source of the
disruption.\107\ MFA also commented it supports that the Risk
Principles allow a DCM to exercise discretion in identifying market
disruptions and system anomalies as they relate to the DCM's particular
market and the trading activities of participants in that market.\108\
---------------------------------------------------------------------------
\106\ CME NPRM Letter, at 10-11.
\107\ MFA NPRM Letter, at 3.
\108\ See id.
---------------------------------------------------------------------------
CME cautioned that no specific type of market halt should be
considered a per se ``market disruption'' because some halts prevent
and mitigate market disruptions.\109\ Similarly, ICE commented that an
unscheduled trading halt caused by a market participant, which could
not readily be attributed to market volatility or fundamental
conditions in underlying or related markets, could constitute a market
disruption.\110\ CME stated that the Commission should not characterize
any specific period of latency as per se disruptive, because latency
can occur due to bona fide market activity, or be based on a
participant's own system.\111\ CME stated that a fact-specific inquiry
is necessary to determine if there has been a market disruption.\112\
Similarly, ICE stated that latency incorporates many factors outside a
DCM's processing of order messages.\113\ As such, the Commission should
be cautious when interpreting latency as an indication of a market
disruption.\114\ ICE stated it is more meaningful to quantify the
impact on the market rather than to calculate a subjective impact to
latency.\115\ CEWG commented that a disruptive event could have a
significant impact on the market in one context, but not in
another.\116\ For example, a one or two second delay in processing and
execution may constitute a market disruption to automated trading firms
but not to manual traders.\117\
---------------------------------------------------------------------------
\109\ CME NPRM Letter, at 10-11.
\110\ ICE NPRM Letter, at 5-6.
\111\ CME NPRM Letter, at 10-11.
\112\ See id.
\113\ ICE NPRM Letter, at 6.
\114\ See id.
\115\ See id.
\116\ CEWG NPRM Letter, at 5.
\117\ See id.
---------------------------------------------------------------------------
CME commented regarding the preamble's assertion that ``system
anomalies'' are unexpected conditions
[[Page 2055]]
that occur in a participant's functional system ``which cause a similar
disruption to the operation of the DCM or the ability of market
participants to trade on the DCM.'' \118\ CME stated one could
interpret the preamble language to mean the disruptions to the DCM must
be similar to the disruptions to the originating participant.\119\ CME
suggested if the phrase ``which cause a similar disruption'' is
actually referring to the Commission's definition of ``market
disruption'' described earlier in the NPRM preamble, then the
Commission should clarify accordingly.\120\
---------------------------------------------------------------------------
\118\ CME NPRM Letter, at 3.
\119\ See id.
\120\ See id.
---------------------------------------------------------------------------
CME further commented that both definitions relate to the ability
of other participants ``to trade.'' \121\ CME stated that sections of
the preamble reference participants' inability to trade, engage in
price discovery, or manage risk.\122\ CME asked the Commission to
clarify whether it always means all three situations, or any of those
situations.\123\ CME further commented that the Commission reconsider
using the word ``ability.'' \124\ CME pointed out that not all the
examples of market disruptions cited in the NPRM involved a disruption
to the operation of the DCM and a participant being unable to trade,
engage in price discovery, or manage risk.\125\ CME suggested that a
clearer and more objective standard would be that the event ``must
significantly disrupt other participants' access to the DCM.'' \126\
CME believes this standard captures the risks identified in the
rulemaking and is something DCMs can typically identify on their
own.\127\
---------------------------------------------------------------------------
\121\ See id.
\122\ See id.
\123\ See id.
\124\ CME NPRM Letter, at 3-4.
\125\ See id. In particular, CME referenced 2011 disciplinary
actions involving the same trading firm, where an automated trading
system malfunction prompted selling e-mini Nasdaq 100 Index futures
on the Chicago Mercantile Exchange, and another malfunction caused a
rapid buying in oil futures on the New York Mercantile Exchange
(``NYMEX'').
\126\ See id. (emphasis added).
\127\ See id.
---------------------------------------------------------------------------
IATP commented that the Commission grants too much discretion to
DCMs to interpret the terms of the NPRM and to determine what is or is
not a ``market disruption'' or ``system anomaly'' and whether to
mitigate it.\128\ Better Markets commented that terms such as
``significant'' and ``disruption'' are ambiguous and will lead to
divergent practices.\129\ Better Markets also commented that the Risk
Principles provide essentially unfettered discretion to each DCM in
terms of how to define market disruptions and system anomalies as they
relate to their particular markets, and permitting differing
definitions will undermine comparative analyses of market disruptions
across exchanges.\130\
---------------------------------------------------------------------------
\128\ IATP NPRM Letter, at 6.
\129\ Better Markets NPRM Letter, at 9.
\130\ See id. at 10. Better Markets cited ``the Flash Crash,
recent WTI trading anomalies in the oil markets, and the Knight
Capital meltdown'' as examples demonstrating that electronic trading
presents ``varied, complex, and potentially extensive risks to
market integrity, orderly trading, fair competition, and the price
discovery process across the financial markets.'' See id. at 3.
---------------------------------------------------------------------------
MGEX commented that the Commission should continue with its
principles-based approach to broadly define ``market disruption'' and
``system anomalies'' associated with electronic trading and ensure the
reasonableness standard is approached with ample discretion.\131\ MGEX
considered the general definitions of ``market disruption'' and
``system anomalies'' stated in the NPRM to be acceptable, with the
caveat that each DCM operates differently, and the Commission should
recognize this during its rule enforcement reviews.\132\
---------------------------------------------------------------------------
\131\ MGEX NPRM Letter, at 1-2.
\132\ See id. at 3.
---------------------------------------------------------------------------
c. Discussion
The NPRM described a market disruption as an event originating with
a market participant that significantly disrupts the operation of the
DCM on which such participant is trading. The proposed regulation text
for Risk Principle 3 expressly included the term ``significant,'' while
the regulation text for Risk Principles 1 and 2 did not. The Commission
clarifies that the term ``market disruption,'' for DCMs' definitional
and rule implementation purposes to satisfy Risk Principles 1 and 2,
refers specifically to disruptions that materially impact the proper
functioning of a DCM's trading platform. The term ``market disruption''
does not encompass disruptions that have only a de minimis effect on a
DCM's trading platforms or the ability of other market participants to
trade, engage in price discovery, or manage risk. For example, a
technical malfunction at a market participant might cause excessive
messaging in a product before a DCM's risk controls limit trading in
that product. If the trading halt has a material impact on other market
participants' ability to trade in that product, then that would
constitute a market disruption. However, if trading is only halted for
a de minimis amount of time, and market participants can quickly resume
trading in that product, that may not rise to the level of a material
``market disruption'' of the DCM's trading platform for purposes of the
Risk Principles.
CME indicated that a specific disruption cited in the NPRM (namely
a malfunction that prompted the selling of e-mini Nasdaq 100 Index
futures on the Chicago Mercantile Exchange, and another malfunction
that caused a rapid buying of oil futures on NYMEX) was not necessarily
a ``market disruption,'' because the event did not disrupt the
operation of the DCM or limit market participants' ability to
trade.\133\ The Commission acknowledges that DCMs will have some
discretion to determine whether an event constitutes a market
disruption for purposes of the Risk Principles. However, if the
malfunctions described in the 2011 CME disciplinary actions were to
cause a material change in price that deviated from prevailing market
prices, and the DCMs were required to cancel numerous trades, the
Commission would likely view such a scenario as a material market
disruption that DCMs should have reasonable rules and risk controls in
place to prevent, detect, and mitigate. The materiality of a market
disruption would depend on, for example, in the context of trade
errors, how quickly the DCM can correct erroneous prices, and how many
contracts are affected. In the event of a market disruption involving a
trading halt, materiality generally would depend on how quickly trading
is able to resume.
---------------------------------------------------------------------------
\133\ CME NPRM Letter, at 3.
---------------------------------------------------------------------------
Under Risk Principle 3, DCMs only have to report market disruptions
under Risk Principles 1 and 2 that are ``significant.'' All significant
market disruptions under Risk Principle 3 are also market disruptions
under Risk Principles 1 and 2, but the converse is not true: Some
market disruptions under Risk Principles 1 and 2 will not be
sufficiently significant to trigger the reporting requirement under
Risk Principle 3. Thus, the standard for a significant market
disruption under Risk Principle 3 is higher than the standard for a
market disruption under Risk Principles 1 and 2. The Commission
emphasizes that DCMs have reasonable discretion to determine whether a
given market disruption had a ``significant'' impact on the trading
platform, so as to trigger Risk Principle 3 reporting.\134\
---------------------------------------------------------------------------
\134\ ``Reasonable discretion'' shall be interpreted in the same
manner as it has been used elsewhere in the Commission's
regulations. See, e.g., Part 38 Core Principle 1, which provides
that unless otherwise determined by the Commission by rule or
regulation, a board of trade described in paragraph (a) of this
section shall have reasonable discretion in establishing the manner
in which the board of trade complies with the core principles
described in this subsection. 17 CFR 38.100 (emphasis added).
---------------------------------------------------------------------------
[[Page 2056]]
Further, as to each Risk Principle, the Commission clarifies that
the terms ``market disruption'' and ``system anomaly'' are intended to
capture scenarios where a participant's ability to trade, engage in
price discovery, or manage risk are materially impacted. All three
scenarios do not have to occur for an event to be considered a market
disruption or system anomaly. In addition, the Commission clarifies
that ``system anomalies'' are unexpected conditions that occur in a
market participant's functional system that cause a disruption to the
operation of the DCM or the ability of market participants to trade on
the DCM, engage in price discovery, or manage risk. The disruption on
the DCM need not be similar in nature to the disruption in a
participant's system.
The Commission understands that many examples of a market
participant's ability to trade on the DCM, engage in price discovery,
or manage risk may involve the limitation of participant access to the
DCM. However, the Commission declines to limit the definitions of
``market disruption'' or ``system anomaly'' to a limitation of access,
as there may be situations where market participants cannot engage in
price discovery, regardless of whether they have access to the DCM. For
example, a market participant may have access to trade in a particular
product, but the product's price has been impacted by inadvertent rapid
selling or buying.
The Commission believes the term ``market disruption'' is not
overly broad. While one commenter asserted that ``market disruption''
could include various events that involve prices not reflecting market
fundamentals, such as entering orders in a disorderly manner, quote
stuffing, causing illiquid markets where one would not occur otherwise,
or causing the artificial widening of markets, the Commission clarifies
that intentionally or recklessly disruptive trading behavior is not
meant to be within the scope of the Risk Principles.\135\ Rather, the
focus of the Risk Principles is to address unintentional technological
malfunctions that disrupt the operation of the DCM or the ability of
market participants to trade, engage in price discovery, or manage
risk. A situation where prices do not reflect market fundamentals is
not sufficient, on its own, to constitute a material market disruption
for purposes of the Risk Principles.
---------------------------------------------------------------------------
\135\ Intentional or reckless acts of price manipulation, fraud,
disruptive trading, wash sales, or pre-arranged trading, among
others, are addressed through existing provisions, including, but
not limited to, Sections 4b, 4c(a)(2), 4c(a)(5), 4o, and 9 of the
CEA and Commission regulations Sec. Sec. 1.38, 180.1, 180.2,
38.152, and 38.250. See 7 U.S.C. 6b, 6c(a)(2), 6c(a)(5), 6o, 9; 17
CFR 1.38, 180.1, 180.2, 38.152, 38.250.
---------------------------------------------------------------------------
The Commission agrees that no specific market halt should be
considered a per se ``market disruption,'' because certain halts
effectively prevent and mitigate market disruptions. Further, the
Commission will not characterize any specific period of latency as per
se disruptive due to the various causes of latency, not all of them
relating to market disruptive events. The Commission emphasizes that
DCMs have discretion in determining whether a trading halt is
disruptive.
In response to comments relating to DCM discretion, the Commission
reiterates DCMs are best-positioned to assess the material market
disruption and system anomaly risks posed by their markets and market
participant activity, and to design appropriate measures to address
those risks. However, while DCMs may differ in what they consider to be
a ``market disruption'' or ``system anomaly,'' and whether and how to
mitigate such an event, this is not unlimited discretion. The
Commission will oversee and enforce the Risk Principles in accordance
with an objective reasonableness standard. In other words, while a DCM
has discretion to determine what rules and risk controls are
appropriate, the Commission as part of its oversight responsibility
will consider the objective reasonableness of those measures in light
of the DCM's products, volume, market participants and other factors,
and how similarly positioned DCMs address similar risks.
Due to differences among DCMs, the Commission acknowledges DCMs may
have different determinations of what constitutes a ``market
disruption'' or ``system anomaly.'' In response to the comment from
Better Markets, the Commission does not believe this will hinder any
``comparative'' analysis of market disruptions across exchanges. When
assessing material market disruptions, the Commission will consider
differences among DCM markets, technology, products, and market
participants as part of its oversight.
As to MGEX's comment that each DCM operates differently, the
Commission acknowledges that each DCM operates unique markets, with
unique market participants, products, and technology. The Commission
already takes this into account with respect to its routine oversight,
including examinations.
B. The Reasonableness Standard
1. Proposal
The Commission proposed Acceptable Practices to Risk Principles 1
and 2, which provide that a DCM can comply with those principles by
adopting rules, and subjecting all electronic orders to exchange-based
pre-trade risk controls, that are reasonably designed to prevent,
detect, and mitigate market disruptions or system anomalies associated
with electronic trading.\136\
---------------------------------------------------------------------------
\136\ NPRM at 42777.
---------------------------------------------------------------------------
2. Summary of Comments
ICE, MGEX, CME, Better Markets, and IATP commented on the
reasonableness standard.\137\ ICE supported the Commission's approach
to give DCMs reasonable discretion to adopt rules that prevent, detect,
and mitigate market disruptions.\138\ ICE stated DCMs are best-
positioned to adopt the rules, procedures, and system controls that fit
their market and technology.\139\ ICE further commented that the
proposed Acceptable Practice for Commission regulation Sec. 38.251(e)
provides DCMs with sufficient discretion to adopt the rules appropriate
for their platform.\140\ ICE believes the supervisory obligations set
out in exchange rules, along with requirements relating to disruptive
trading practices, have been effective in preventing market
disruptions.\141\ Similarly, MGEX commented that the Commission should
accept that DCMs may differ in the rules they establish based on the
unique and different markets and products, and DCMs must have
discretion to ensure that the rules are ``objectively reasonable'' to
address a market disruption or system anomaly.\142\
---------------------------------------------------------------------------
\137\ ICE NPRM Letter, at 2; MGEX NPRM Letter, at 2-3; CME NPRM
Letter, at 4-5, 6, 13; Better Markets NPRM Letter, at 8; IATP NPRM
Letter, at 9.
\138\ ICE NPRM Letter, at 2.
\139\ See id.
\140\ See id.
\141\ See id.
\142\ MGEX NPRM Letter, at 2-3.
---------------------------------------------------------------------------
CME commented that the Commission should add ``reasonably
designed'' to the regulation text, not just acceptable practices, just
as it is in at least 40 other existing Commission regulations.\143\ CME
believes this is especially important for Risk Principle 2, which
requires controls to ``prevent'' system anomalies.\144\ CME stated that
the word ``prevent'' creates an impossible
[[Page 2057]]
standard without a condition in the Risk Principle explicitly stating
that the controls must be ``reasonably designed.'' \145\
---------------------------------------------------------------------------
\143\ CME NPRM Letter, at 4-5.
\144\ See id. at 6.
\145\ See id. at 6-7.
---------------------------------------------------------------------------
Better Markets commented that the Commission's emphasis on DCM
flexibility suggests confusion as to whether reasonableness is an
objective or subjective standard.\146\ Better Markets believed the
preamble to the final rules should state that the Risk Principles may
require DCMs to do things differently if their pre-trade risk controls
do not objectively satisfy the regulations.\147\ Better Markets also
commented that the NPRM's preamble set forth a ``near presumption of
reasonableness.'' \148\ Similarly, IATP commented that the preamble
indicates it is unlikely the Commission will take any enforcement
action against DCMs.\149\ IATP disagreed with the Commission's
statement that the Risk Principles will not result in enforcement
actions based on strict liability.\150\ IATP stated that assuring DCMs
that risk control failure will not result in enforcement action would
signal to plaintiffs in a market disruption case that they would have
to meet a high evidentiary standard.\151\
---------------------------------------------------------------------------
\146\ Better Markets NPRM Letter, at 8.
\147\ See id.
\148\ See id.
\149\ IATP NPRM Letter, at 9.
\150\ See id.
\151\ See id.
---------------------------------------------------------------------------
3. Discussion
The Acceptable Practices will be adopted as proposed with the
``reasonably designed'' standard. As stated in the NPRM, the Acceptable
Practices for implementing the Risk Principles provide that DCMs shall
have satisfied their requirements under the Risk Principles if they
have established and implemented rules and pre-trade risk controls that
are reasonably designed to prevent, detect, and mitigate market
disruptions or system anomalies associated with electronic
trading.\152\ ``Reasonably designed'' means that a DCM's rules and risk
controls are objectively reasonable. As noted above, in assessing a
DCM's rules and risk controls, the Commission as part of its oversight
responsibility will consider the objective reasonableness of those
measures in light of the DCM's products, volume, market participants
and other factors, and how similarly positioned DCMs address similar
risks.
---------------------------------------------------------------------------
\152\ See NPRM at 42763.
---------------------------------------------------------------------------
The Acceptable Practices are intended to provide DCMs with
reasonable discretion to impose rules and risk controls to prevent,
detect, and mitigate market disruption. Transferring the reasonableness
standard to the regulation text is not necessary to allow DCM
discretion to impose rules and controls appropriate to their own
markets.
In addition, the word ``prevent,'' when part of a reasonableness
standard applicable through Acceptable Practices, does not create an
impossible standard to achieve. Rules and controls implemented by DCMs
need to be reasonable, as determined by an objective standard. Risk
Principles 1 and 2 do not require DCMs to ``prevent'' market
disruptions and system anomalies in all circumstances. A goal of these
Risk Principles is to provide DCMs with appropriate flexibility to take
reasonably designed measures relevant to individual markets, and
improve those measures as markets evolve.
The Commission confirms that the reasonableness standard is an
objective one and there is no presumption of reasonableness. While
there are differences among DCMs, what one DCM may implement in terms
of rules and controls to address material market disruptions may be
relevant to assessing another DCM's compliance. For example, if the
Commission finds that a particular DCM is an outlier in terms of rules
or controls, this may cause the Commission to inquire further whether
there are legitimate reasons for the differences.
The Commission confirms that DCMs may need to impose additional
rules on their market participants, or implement additional controls,
if their rules and controls do not objectively satisfy the Risk
Principles. The Risk Principles are principles-based and allow for DCM
discretion in compliance, but they are nevertheless enforceable
regulations. Market participants should not interpret the Commission's
statements in this preamble to articulate any particular evidentiary
standard in an enforcement action.
C. Risk Principle 1
1. Proposal
In Risk Principle 1, the Commission proposed that a DCM must adopt
and implement ``rules'' governing market participants subject to its
jurisdiction to prevent, detect, and mitigate market disruptions or
system anomalies associated with electronic trading.\153\ The
Commission proposed that Risk Principle 1 (and the other Risk
Principles) apply to all electronic trading.
---------------------------------------------------------------------------
\153\ NPRM at 42776.
---------------------------------------------------------------------------
2. Rules Versus Controls and Other Procedures
a. Summary of Comments
Several commenters addressed Risk Principle 1's requirement that
DCMs implement ``rules.'' CME suggested Risk Principle 1 should focus
on rules on participants and their conduct that are enforced through
administrative or disciplinary processes; an example is CME Group's
Messaging Efficiency Policy.\154\ Other examples CME provided include
trade practice and disciplinary rules and CME's disruptive trading
practices rule (Rule 575), which CME amended in 2020 to provide that it
is a violation ``for a participant to intentionally or recklessly
engage in activity that has the potential to disrupt the systems of the
Exchange.'' \155\
---------------------------------------------------------------------------
\154\ CME NPRM Letter, at 5.
\155\ Id. at 5-6 (emphasis in original).
---------------------------------------------------------------------------
Better Markets and MGEX also commented on the term ``rule.'' \156\
Better Markets stated the Commission should clarify that ``rules''
include internal policies, procedures, controls, advisories, and
trading protocols contemplated in the broad definition in 40.1.\157\
MGEX commented that the Commission should ensure ``rules,'' as
described in the NPRM, include non-rules such as policies, procedures,
protocols, and controls.\158\
---------------------------------------------------------------------------
\156\ Better Markets NPRM Letter, at 10; MGEX NPRM Letter, at 2,
4.
\157\ Better Markets NPRM Letter, at 10.
\158\ MGEX NPRM Letter, at 2, 4.
---------------------------------------------------------------------------
CFE stated a DCM should be able to satisfy Risk Principle 1 through
implementing internal systems, processes, and procedures, not just
rules.\159\ For example, CFE commented a DCM may not want to publicly
disclose how it monitors particular markets.\160\ CFE asserted
requiring a DCM to describe in its rules how it monitors for market
disruptions and system anomalies is administratively burdensome and may
disincentivize a DCM from improving its systems.\161\
---------------------------------------------------------------------------
\159\ CFE NPRM Letter, at 3.
\160\ Id.
\161\ Id.
---------------------------------------------------------------------------
CEWG stated DCM rules adopted pursuant to Risk Principles 1 and 2
should be subject to Commission approval under Commission regulation
Sec. 40.5 or self-certification under Commission regulation Sec.
40.6.\162\ CEWG asserted a transparent regulatory process would ensure
that new DCM rules are appropriately tailored.\163\
---------------------------------------------------------------------------
\162\ CEWG NPRM Letter, at 7.
\163\ Id.
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[[Page 2058]]
b. Discussion
With respect to the comments addressing the scope of the term
``rule'' in Risk Principle 1, the Commission emphasizes that the term
is intended to have the meaning set forth in part 40 of the
Commission's regulations. Specifically, the Commission clarifies that
for purposes of Risk Principle 1 and the Acceptable Practices, the term
``rule'' has the meaning set forth in existing Commission regulation
Sec. 40.1(i), which provides that rule means any constitutional
provision, article of incorporation, bylaw, rule, regulation,
resolution, interpretation, stated policy, advisory, terms and
conditions, trading protocol, agreement or instrument corresponding
thereto, including those that authorize a response or establish
standards for responding to a specific emergency, and any amendment or
addition thereto or repeal thereof, made or issued by a registered
entity or by the governing board thereof or any committee thereof, in
whatever form adopted.\164\ This definition of ``rule'' is broad and
can include policies, procedures, protocols, and controls that are not
public.\165\ DCM policies and other internal procedures addressing
market disruption risk could also satisfy Risk Principle 1.
---------------------------------------------------------------------------
\164\ 17 CFR 40.1(i).
\165\ Under part 40, a DCM's filing of rules under Commission
regulations Sec. Sec. 40.5 or 40.6 shall be treated as public
information, unless accompanied by a request for confidential
treatment. See 17 CFR 40.8(c).
---------------------------------------------------------------------------
Commission regulation Sec. 40.1(i) would require rules to be
approved or self-certified pursuant to part 40 regulations, though DCMs
would be entitled to request confidential treatment pursuant to the
procedures in Commission regulation Sec. 40.8(c) with respect to such
filings.\166\ In particular, under Risk Principle 1, a DCM would be
required to submit rules to the Commission in accordance with either:
(a) Commission regulation Sec. 40.5, which provides procedures for the
voluntary submission of rules for Commission review and approval; or
(b) Commission regulation Sec. 40.6, which provides procedures for the
self-certification of rules with the Commission.\167\
---------------------------------------------------------------------------
\166\ 17 CFR 40.8(c).
\167\ See 17 CFR 40.5, 40.6.
---------------------------------------------------------------------------
The part 40 rule submission process will ensure that new rules that
DCMs implement to address the risk of market disruption--including
internal processes--will be subject to appropriate Commission review
and oversight. With respect to self-certifications, the Commission
stated in the preamble to the part 40 final rules that the explanation
and analysis of certified rules or rule amendments should be a clear
and informative--but not necessarily lengthy--discussion of the
submission, the factors leading to the adoption of the rule or rule
amendment, and the expected impact of the rule or rule amendment on the
public and market participants.\168\
---------------------------------------------------------------------------
\168\ Part 40 final rules, 75 FR 44776, 44782-83 (July 27,
2011). The Commission further noted that it requires registered
entities to provide a more detailed explanation and analysis of
rules voluntarily submitted for Commission approval under the
provisions of Sec. 40.5. Id. at 44782. See also 17 CFR 40.6(a)(7)
(setting forth rule submission requirements).
---------------------------------------------------------------------------
3. Scope of Electronic Trading Subject to DCM Rules
a. Summary of Comments
Several commenters addressed the scope of orders and trades subject
to Risk Principle 1. ICE supported requiring DCMs to subject all
electronic orders to exchange-based pre-trade risk controls, because
all persons that trade electronically have the potential to disrupt
markets.\169\ CFE asked the Commission to clarify that under Risk
Principle 1, DCMs may have rules governing market participants subject
to the DCM's jurisdiction that are applicable to a subset of market
participants, as long as those rules apply to all electronic orders
submitted to the DCM.\170\ IATP supported requiring DCMs to implement
separate risk controls for cleared and uncleared trades.\171\ IATP
asserted uncleared trades pose greater counterparty credit risks, so
the Risk Principles should require post-trade risk controls to prevent
post-trade contract defaults and other credit events.\172\
---------------------------------------------------------------------------
\169\ ICE NPRM Letter, at 3.
\170\ CFE NPRM Letter, at 1-2.
\171\ IATP NPRM Letter, at 10.
\172\ Id.
---------------------------------------------------------------------------
b. Discussion
The Commission is adopting Risk Principle 1 as proposed, but
clarifies that a DCM may have rules that apply to only a subset of
market participants. The Commission understands that DCMs have markets
with a broad range of market participants and trading patterns. The
Commission believes that DCMs should have reasonable discretion to
determine whether risk controls should be different for different types
of trading activity. Indeed, it may not be advisable for a DCM to
impose the same rules under Risk Principle 1 on all types of market
participants and trading activity present on the DCM's platforms. The
Commission's principles-based approach to the Risk Principles gives
DCMs the flexibility to impose the most efficient and effective rules
and pre-trade risk controls for their respective markets. The
Commission believes Risk Principle 1 will help ensure DCMs continue to
monitor risks as they evolve along with the markets, and make
reasonable changes as appropriate to address those evolving risks.\173\
---------------------------------------------------------------------------
\173\ NPRM at 42767.
---------------------------------------------------------------------------
In response to IATP's comment supporting a separate set of risk
controls on uncleared trades, the Commission notes that all
transactions on or pursuant to the rules of a DCM must be cleared. As a
result, any such separate set of risk controls would be on a null set
of trades.\174\
---------------------------------------------------------------------------
\174\ The Commission has explained that all transactions
executed on or through a DCM must be cleared through a Commission-
registered DCO. See Core Principles and Other Requirements for
Designated Contract Markets, 77 FR 36612, 36646 (June 19, 2012).
---------------------------------------------------------------------------
D. Risk Principle 2--Risk Controls Listed in Part 38
1. Proposal
Risk Principle 2 requires DCMs to subject all electronic orders to
exchange-based pre-trade risk controls to prevent, detect, and mitigate
market disruptions or system anomalies associated with electronic
trading.
The Commission noted in the NPRM that certain existing provisions
in part 38 list appropriate DCM-implemented risk controls.\175\ For
example, existing Commission regulation Sec. 38.255 mandates exchange-
based risk controls to prevent and reduce the potential risk of market
disruptions.\176\ In addition, existing Core Principle 4's Acceptable
Practices \177\ list appropriate risk controls, and proposed Risk
Principle 2 does not change those Acceptable Practices.
---------------------------------------------------------------------------
\175\ See NPRM at 42767-68.
\176\ See id. at 42768.
\177\ See Appendix B to Part 38--Guidance on, and Acceptable
Practices in, Compliance with Core Principles, Core Principle 4
(Subparagraph (b)).
---------------------------------------------------------------------------
2. Summary of Comments
CME, ICE, and MGEX agree with the Commission that the controls
listed in existing acceptable practices are sufficient. CME stated the
controls listed in the existing acceptable practices are effective at
preventing or mitigating market disruptions, and the Commission should
not list any others as part of proposed Commission regulation Sec.
38.251(f).\178\ ICE commented there is not one set of risk controls
that are most effective in preventing market disruptions.\179\ ICE
[[Page 2059]]
further asserted the proposed Acceptable Practices for proposed
Commission regulation Sec. 38.251(f) and the guidance provided in
existing Appendix B(b)(5) provide DCMs sufficient discretion to adopt
appropriate risk controls.\180\ MGEX stated the controls outlined in
existing Acceptable Practices for Core Principle 2 are sufficient.\181\
---------------------------------------------------------------------------
\178\ CME NPRM Letter, at 14.
\179\ ICE NPRM Letter, at 7.
\180\ Id. at 8.
\181\ MGEX NPRM Letter, at 2.
---------------------------------------------------------------------------
In contrast, IATP commented that Risk Principle 2 should include
post-trade risk controls to help protect market participants against
credit events resulting from DCM negligence in the design,
implementation and enforcement of its rules and risk controls.\182\
IATP stated this would follow the FIA recommendation on post-trade risk
controls.\183\
---------------------------------------------------------------------------
\182\ IATP NPRM Letter, at 10.
\183\ Id.
---------------------------------------------------------------------------
3. Discussion
The Commission is adopting Risk Principle 2 as proposed and is not
adding specific controls to the regulation text or Acceptable
Practices. As discussed in the NPRM, the purpose of Risk Principle 2 is
to require DCMs to consider market participants' trading activities
when designing and implementing exchange-based risk controls to address
market disruptive events.\184\ Risk Principle 2 provides clarity to
DCMs that their exchange-based risk controls must address market
disruptions caused by electronic trading, including those related to
price movements as well as other events that impair market
participants' ability to trade.\185\
---------------------------------------------------------------------------
\184\ NPRM at 42767.
\185\ Id. at 42768.
---------------------------------------------------------------------------
Consistent with the comments received from CME, ICE, and MGEX, the
Commission believes the existing Acceptable Practices set forth in Core
Principle 4 list appropriate risk controls. Specifically, the
Acceptable Practices in existing Core Principle 4 list risk controls
including pre-trade limits on order size, price collars or bands around
the current price, message throttles, and daily price limits.\186\ The
Commission declines to impose additional pre-trade or post-trade risk
control requirements on DCMs. The Commission does not consider such
requirements to be necessary or consistent with the Commission's
principles-based approach to the Risk Principles.
---------------------------------------------------------------------------
\186\ See Appendix B to Part 38--Guidance on, and Acceptable
Practices in, Compliance with Core Principles, Core Principle 4
(Subparagraph (b)).
---------------------------------------------------------------------------
E. Risk Principle 3
1. Proposal
The Commission proposed in Risk Principle 3 that a DCM must
promptly notify Commission staff of a ``significant'' disruption to its
electronic trading platform(s) and provide timely information on the
causes and remediation.
In the NPRM, the Commission stated the required notification under
Risk Principle 3 would take a form similar to current Commission
regulation Sec. 38.1051(e) notification.\187\ Further, the Commission
differentiated Risk Principle 3 from existing Commission regulation
Sec. 38.1501(e) by noting that, rather than addressing a DCM's
internal technological systems, Risk Principle 3 addresses malfunctions
of the technological systems of trading firms and other non-DCM market
participants that cause disruptions of the DCM's trading platform.
---------------------------------------------------------------------------
\187\ NPRM at 42769.
---------------------------------------------------------------------------
In addition, the Commission asked commenters to describe
circumstances in which it would be appropriate for a DCM to notify
other DCMs about a significant market disruption on its trading
platform(s). The Commission asked whether proposed Risk Principle 3
should include such a requirement.
2. ``Significant'' Standard
a. Summary of Comments
Better Markets, CME, and ICE believed the term ``significant'' in
Risk Principle 3 is unclear. Better Markets asserted that expectations
regarding timing and substance of reporting ``significant market
disruptions'' are imprecise and unenforceable.\188\ Better Markets
stated DCMs must know what to report, where to report it, when to
report it, and under what circumstances reporting is required.\189\
Better Markets further stated Risk Principle 3 fails to (i) provide a
formal definition of market disruptions, (ii) indicate when disruptions
cross the significance threshold, or (iii) identify the level of detail
necessary to notify the CFTC sufficiently.\190\
---------------------------------------------------------------------------
\188\ Better Markets NPRM Letter, at 2.
\189\ Id. at 9.
\190\ Id. at 10.
---------------------------------------------------------------------------
CME stated that while Risk Principle 3 appears to require impact to
both the operation of the DCM and market participants, Risk Principles
1 and 2 seem to require impact to operation of the DCM or market
participants.\191\ CME also commented that to be subject to the
notification requirement, Risk Principle 3 provides a significant
disruption must ``materially affect'' the DCM and market
participants.\192\ CME supported clarifying the distinction between
``significant'' and ``material.'' \193\
---------------------------------------------------------------------------
\191\ CME NPRM Letter, at 8.
\192\ Id.
\193\ Id.
---------------------------------------------------------------------------
MFA and MGEX supported the use of the term ``significant'' in Risk
Principle 3. MFA believed the definition of ``significant'' establishes
a threshold for when notification is required and will promote
meaningful reporting and oversight.\194\ MFA agreed that an internal
disruption in a market participant's own trading system ``should not be
considered significant unless it causes a market disruption materially
affecting the DCM's trading platform and other market participants.''
\195\ MGEX believed that ``significant disruption'' provides DCMs with
discretion to interpret events in light of the unique nature of markets
and products across DCMs and platforms.\196\
---------------------------------------------------------------------------
\194\ MFA NPRM Letter, at 3.
\195\ Id.
\196\ Id. at 4.
---------------------------------------------------------------------------
b. Discussion
The Commission acknowledges the term ``significant'' could be
susceptible to varying degrees of application based on a particular
DCM's business model and particular market. However, the Commission
believes in practice Risk Principle 3 provides a workable standard for
notifications.\197\ This has proven to be the case with respect to
existing Commission regulation Sec. 38.1051(e), which requires DCMs to
notify Commission staff of, among other things, ``significant'' system
malfunctions.\198\ The Commission notes it originally proposed that
DCMs must report to the Commission all system malfunctions under
Commission regulation Sec. 38.1051(e).\199\ In response, CME commented
that such a notification requirement would be overly broad.\200\ The
Commission considered CME's comment and concluded that timely advance
notice of all planned changes to address system malfunctions is not
necessary and is revising the rule to provide that DCMs only need to
promptly advise the Commission of all significant system
[[Page 2060]]
malfunctions.\201\ Thus, similar to the ``significant'' standard under
Risk Principle 3, DCMs are already subject to a ``significant''
threshold for notification with respect to system safeguards rules. The
Commission does not consider it appropriate or necessary to require
DCMs to notify Commission staff of all market disruptions pursuant to
Risk Principle 3, especially given that such a rule would be more
burdensome on DCMs than a mandate that they report only ``significant''
market disruptions to the Commission.
---------------------------------------------------------------------------
\197\ See Section II.A.2(c), discussing ``significant'' and
``material.'' In addition, in response to CME's comment, a market
disruption for purposes of all three Risk Principles requires impact
to operation of the DCM or market participants.
\198\ See 17 CFR 38.1051(e).
\199\ See Core Principles and Other Requirements for Designated
Contract Markets, supra note 174, at 36657-58.
\200\ Id. at 36658.
\201\ Id. (emphasis added).
---------------------------------------------------------------------------
3. Notification Requirement
a. Summary of Comments
CME stated that it is unsure of the practical utility to the
Commission of receiving notifications under Risk Principle 3, since the
Commission already collects such information through other means.\202\
Better Markets asserted the CFTC should require part 40 filings, as
opposed to email notifications.\203\
---------------------------------------------------------------------------
\202\ CME NPRM Letter, at 16.
\203\ Better Markets NPRM Letter, at 10.
---------------------------------------------------------------------------
CME asserted the distinction from Commission regulation Sec.
38.1051(e) is clear; an incident could disrupt the trading platform
without there having been a system malfunction on the platform.\204\
CME gave as an example an incident originating with a participant that
causes a match engine to failover to backup.\205\ CME further stated
both notification provisions could be triggered by an incident arising
with a participant that causes both a market disruption and a system
malfunction.\206\
---------------------------------------------------------------------------
\204\ CME NPRM Letter, at 14-15.
\205\ Id.
\206\ Id. at 15.
---------------------------------------------------------------------------
CEWG stated Risk Principle 3 appears to apply a per se standard for
reporting, which leaves market participants open to potential
enforcement risk.\207\ CEWG asserted the Commission should revise Risk
Principle 3 to require notifications only where disruptions result from
grossly negligent or reckless conduct with respect to a market
participant's obligations to implement and maintain pre-trade risk
controls, conduct due diligence or testing, as well as appropriate risk
mitigation measures consistent with applicable DCM rules or accepted
industry practices related to electronic trading activity.\208\
---------------------------------------------------------------------------
\207\ CEWG NPRM Letter, at 5.
\208\ Id. at 6.
---------------------------------------------------------------------------
ICE recommended the Commission define what constitutes a
``significant disruption'' of a DCM trading platform and how it differs
from a ``market disruption,'' e.g., whether a transient disruption,
which temporarily results in prices not reflecting market fundamentals,
would be reportable.\209\ ICE supported the Commission incorporating
into Risk Principle 3 the requirement that a significant disruption be
caused by a ``malfunction of a market participant's trading system.''
\210\ ICE asserted the addition of this language would help to
differentiate the reporting obligations under Commission regulation
Sec. 38.1051(e).\211\
---------------------------------------------------------------------------
\209\ ICE NPRM Letter, at 4.
\210\ Id.
\211\ Id.
---------------------------------------------------------------------------
In response to the question in the NPRM asking if Risk Principle 3
should require a DCM to notify other DCMs of a significant market
disruption, CME and ICE indicated Risk Principle 3 should not include
such a requirement. ICE stated current Appendix B(b)(5) provides
guidance on coordinating risk controls for linked or related
contracts.\212\ ICE asserted in circumstances of a significant market
disruption, it would be prudent for such coordination to include
notification to impacted markets, at least though a market alert.\213\
CME noted there are already real-time data feeds and other public
sources that provide information on whether a DCM is experiencing a
significant market disruption.\214\ CME further noted if this proposal
is adopted, all DCMs will be required to report to the Commission,
negating the need for notice between DCMs.\215\
---------------------------------------------------------------------------
\212\ CME NPRM Letter, at 15; ICE NPRM Letter, at 9.
\213\ ICE NPRM Letter, at 9.
\214\ CME NPRM Letter, at 15.
\215\ Id.
---------------------------------------------------------------------------
b. Discussion
The Commission is finalizing the notification requirement in Risk
Principle 3 as proposed, with one clarification. In the NPRM, Risk
Principle 3 referred to ``significant disruptions to'' a DCM's
platform(s). Consistent with Risk Principles 1 and 2, which use the
term ``market disruption,'' the Commission is revising Risk Principle 3
to state a DCM must promptly notify Commission staff of any
``significant market disruptions on'' its platform(s). The purpose of
this revision is to clarify that the notification requirement in Risk
Principle 3 applies to a subset of the market disruptions under Risk
Principles 1 and 2, i.e., to those market disruptions that are
``significant.'' Consistent with the comments received, the Commission
is not including a requirement that a DCM notify other DCMs in the
event of a significant market disruption.\216\
---------------------------------------------------------------------------
\216\ In response to ICE's comment, see discussion at Section
II.A.2(c) addressing ``significant'' and ``material.''
---------------------------------------------------------------------------
In response to comments questioning the utility of
notifications,\217\ the Commission reiterates its view that the
notification requirement under Risk Principle 3 will assist the
Commission's oversight and its ability to monitor and assess market
disruptions across all DCMs. The Commission expects notification under
Risk Principle 3 to take a similar form to the current notification
process for electronic trading halts, cybersecurity incidents, or
activation of a DCM's business continuity-disaster recovery plan under
Commission regulation Sec. 38.1051(e). Specifically, the Commission
would expect such notification to consist of an email containing
sufficient information to convey the nature of the market disruption,
and if known, its cause, and the remediation.
---------------------------------------------------------------------------
\217\ See CME NPRM Letter, at 16.
---------------------------------------------------------------------------
In response to CEWG's comment, the Commission declines to limit the
notification requirement in Risk Principle 3 to instances of ``grossly
negligent'' or ``reckless'' conduct. The Commission considers such
qualifiers to be overly limiting and unduly burdensome on DCMs that
would be required to determine whether conduct constitutes gross
negligence or recklessness. In addition, the Commission reiterates that
an email notification is the appropriate form of Risk Principle 3
notification. Requiring such notifications to be in the form of part 40
filings would be overly burdensome to exchanges given the Commission's
estimate of 0-25 notifications per year. Moreover, in the context of
significant market disruptions, prompt email notification is preferable
to the inherently slower process of part 40 filings.
III. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') requires federal agencies,
in promulgating regulations, to consider the impact of those
regulations on small entities, and to provide a regulatory flexibility
analysis with respect to such impact. The regulations adopted in this
final rulemaking will affect DCMs. The Commission previously determined
that DCMs are not ``small entities'' for purposes of the RFA because
DCMs are required to demonstrate compliance with a number of Core
Principles, including principles concerning the expenditure of
sufficient financial
[[Page 2061]]
resources to establish and maintain an adequate self-regulatory
program.\218\ The Commission received no comments on the impact of the
rules described in the NPRM on small entities. Therefore, the Chairman,
on behalf of the Commission, hereby certifies, pursuant to 5 U.S.C.
605(b), that the regulations adopted by this final rulemaking will not
have a significant economic impact on a substantial number of small
entities.
---------------------------------------------------------------------------
\218\ See Policy Statement and Establishment of Definitions of
``Small Entities'' for Purposes of the Regulatory Flexibility Act,
47 FR 18618, 18619 (Apr. 30, 1982).
---------------------------------------------------------------------------
B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (``PRA'') imposes certain
requirements on federal agencies, including the Commission, in
connection with conducting or sponsoring any ``collection of
information,'' as defined by the PRA.\219\ Under the PRA, an agency may
not conduct or sponsor, and a person is not required to respond to, a
collection of information unless it displays a currently valid control
number from the Office of Management and Budget (``OMB''). The PRA is
intended, in part, to minimize the paperwork burden created for
individuals, businesses, and other persons as a result of the
collection of information by federal agencies, and to ensure the
greatest possible benefit and utility of information created,
collected, maintained, used, shared, and disseminated by or for the
federal government. The PRA applies to all information, regardless of
form or format, whenever the federal government is obtaining, causing
to be obtained, or soliciting information, and includes required
disclosure to third parties or the public, of facts or opinions, when
the information collection calls for answers to identical questions
posed to, or identical reporting or recordkeeping requirements imposed
on, ten or more persons.
---------------------------------------------------------------------------
\219\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------
The final rulemaking modifies the following existing collections of
information previously approved by OMB and for which the Commission has
received control numbers: (i) OMB control number 3038-0052, Core
Principles and Other Requirements for DCMs (``OMB Collection 3038-
0052'') and OMB control number 3038-0093, Provisions Common to
Registered Entities (``OMB Collection 3038-0093''). The Commission does
not believe the Risk Principles as adopted impose any other new
collections of information that require approval of OMB under the PRA.
The Commission requests that OMB approve and revise OMB control
numbers 3038-0052 and 3038-0093 in accordance with 44 U.S.C. 3507(d)
and 5 CFR 1320.11.
1. OMB Collection 3038-0093--Provisions Common to Registered Entities
Final Commission regulation Sec. 38.251(e) (``Risk Principle 1'')
provides that DCMs must adopt and implement rules governing market
participants subject to their respective jurisdictions to prevent,
detect, and mitigate market disruptions or system anomalies associated
with electronic trading. As provided in subparagraph (b)(6) of Appendix
B to part 38, such rules must be reasonably designed to prevent,
detect, and mitigate market disruptions or system anomalies associated
with electronic trading. Any such rules a DCM adopts pursuant to
Commission regulation Sec. 38.251(e) must be submitted to the
Commission in accordance with part 40 of the Commission's regulations.
Specifically, a DCM is required to submit such rules to the Commission
in accordance with either: (a) Commission regulation Sec. 40.5, which
provides procedures for the voluntary submission of rules for
Commission review and approval; or (b) Commission regulation Sec.
40.6, which provides procedures for the self-certification of rules
with the Commission. This information collection is required for DCMs
as needed, on a case-by-case basis. The Commission acknowledges that
various DCM practices in place today may be consistent with Commission
regulation Sec. 38.251(e), such as rules requiring market participants
to use exchange-provided risk controls that address potential price
distortions and related market anomalies. Accordingly, it is possible
that some DCMs would not be required to file new or amended rules to
satisfy Risk Principle 1.
Commission regulation Sec. 38.251(e) amends OMB Collection 3038-
0093 by increasing the existing annual burden by an additional 48 hours
\220\ for DCMs that would be required to comply with part 40 of the
Commission's regulations. As a result, the revised total annual burden
under this amended collection would increase by 816 hours.\221\
Although the Commission believes that operational and maintenance costs
for DCMs in Commission regulation Sec. 38.251(e) will incrementally
increase, these costs are expected to be de minimis.
---------------------------------------------------------------------------
\220\ The Commission estimates that final Commission regulation
Sec. 38.251(e) would require potentially 17 DCMs to make 2 filings
with the Commission a year requiring approximately 24 hours each to
prepare. Accordingly, the total burden hours for each DCM would be
approximately 48 hours per year.
\221\ The Commission estimates that the total additional
aggregate annual burden hours for DCMs under final Commission
regulation Sec. 38.251(e) would be 816 hours based on each DCM
incurring 48 burden hours (17 x 48 = 816).
---------------------------------------------------------------------------
The Commission has previously estimated the combined annual burden
hours for both Commission regulations Sec. Sec. 40.5 and 40.6 to be
7,000 hours. Upon implementation of final Commission regulation Sec.
38.251(e), the Commission estimates that 17 exchanges may each make two
rule filings under Commission regulations Sec. 40.5 or Sec. 40.6 per
year for a total of 34 submissions for all DCMs.\222\ The Commission
further estimates that the exchanges may employ a combination of in-
house and outside legal and compliance personnel to update existing
rulebooks and it will take 24 hours to complete and file each rule
submission for a total of 48 burden hours for each exchange and 816
burden hours for all exchanges.
---------------------------------------------------------------------------
\222\ The Commission revised the number of potential respondent-
DCMs to 17 in order to reflect the number of DCMs currently
registered with the Commission.
---------------------------------------------------------------------------
OMB Collection 3038-0093 was created to cover the Commission's part
40 regulatory requirements for registered entities (including DCMs,
SEFs, DCOs, and swap data repositories) to file new or amended rules
and product terms and conditions with the Commission.\223\ OMB Control
Number 3038-0093 covers all information collections in part 40,
including Commission regulation Sec. 40.2 (Listing products by
certification), Commission regulation Sec. 40.3 (Voluntary submission
of new products for Commission review and approval), Commission
regulation Sec. 40.5 (Voluntary submission of rules for Commission
review and approval), and Commission regulation Sec. 40.6 (Self-
certification of rules). Commission regulation Sec. 38.251(e) adopted
in this final rulemaking modifies the existing annual burden in OMB
Collection 3038-0093, increasing the annual burden estimates in
aggregate below:
---------------------------------------------------------------------------
\223\ See 17 CFR part 40.
---------------------------------------------------------------------------
Estimated number of respondents: 17.
Estimated frequency/timing of responses: As needed.
Estimated number of annual responses per respondent: 2.
Estimated number of annual responses for all respondents: 34.
Estimated annual burden hours per response: 24.
Estimated total annual burden hours per respondent: 48.
[[Page 2062]]
Estimated total annual burden hours for all respondents: 816.
2. OMB Collection 3038-0052--Core Principles and Other Requirements for
DCMs
Final Commission regulation Sec. 38.251(g) (``Risk Principle 3'')
requires a DCM to promptly notify Commission staff of any significant
market disruption on its electronic trading platform(s) and provide
timely information on the cause and remediation of such
disruption.\224\ Risk Principle 3 further requires that such
notification contain sufficient information to convey the nature of the
disruption, and if known, its causes, and remediation. The Commission
recognizes that the specific cause of the market disruption and the
attendant remediation may not be known at the time of the disruption
and may have to be addressed in a follow-up email or report. This
information collection will be required for DCMs as needed, on a case-
by-case basis.
---------------------------------------------------------------------------
\224\ See supra Section II.E. (discussion of the Risk Principle
3).
---------------------------------------------------------------------------
The Commission received one comment regarding its PRA burden
analysis in the preamble to the NPRM.\225\ CME in its comment letter
asserted the operation of Risk Principle 3 is unclear, and the
Commission's estimate of approximately 50 notifications per year is
``so far from what we would have anticipated being required under this
proposal that it merits discussion.'' \226\ CME also indicated it
questions ``whether the Commission has an interpretation of
`significant disruption' that is not reflected in its proposal'' based
on the apparent differences in notification estimates by the Commission
and CME.\227\
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\225\ See CME NPRM Letter, at 8.
\226\ See id.
\227\ See id.
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CME further described that since 2011, ``the CME Group DCMs have
brought approximately 59 disciplinary actions for electronic trading
activity that may have disrupted markets or other participants.'' \228\
However, based on CME's review of those disciplinary actions, the
exchange only identified three cases that it believes could be
considered to have caused a significant disruption to the operations of
the DCM. CME did not in its comments explain how its estimate was
determined or what criteria or standard was employed as part of this
analysis.
---------------------------------------------------------------------------
\228\ See id. at 9.
---------------------------------------------------------------------------
As described above, CME is using the number of actual disciplinary
actions brought against market participants for disruptions that could
be detrimental to the exchange as a ``proxy'' for the ``substantial
disruption'' standard set forth in Risk Principle 3. Without indicating
what analysis it may have used or considered, CME asserted that only
three disciplinary actions could be considered to have caused a
significant disruption to the operations of CME.\229\ Although the
Commission appreciates CME's comments regarding the potential number of
reportable events in connection with final Commission regulation Sec.
38.251(g), the Commission does not believe the number of actual
disciplinary cases brought by an exchange is an appropriate proxy for
reportable market disruption events.\230\ The Commission notes that in
many instances, basing the reportable event on whether it is subject to
a formal disciplinary action would be under-inclusive. In addition,
what is a ``significant'' market disruption on one exchange may differ
from another, based on market participant differences, the exchange's
respective market structure, and the technology of the underlying
exchange marketplace.
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\229\ The NPRM cited events at CME DCMs, including a
disciplinary action from 2011, as examples of DCMs policing
electronic trading activities that may be detrimental to the DCM.
\230\ The Commission submits that a reportable event does not
necessarily mean that a disciplinary case is required, but instead
suggests that there has been a problem with the operation of the
electronic trading platform that requires additional review and
oversight. Accordingly, the notification of a significant market
disruption would typically start a specific regulatory oversight
process by the Commission--not establish the particular requirements
that may or may not merit the bringing of a disciplinary action, as
CME suggests.
---------------------------------------------------------------------------
The Commission submits that its original estimate of the reportable
events under Commission regulation Sec. 38.251(g) may be too high for
some exchanges. However, the Commission does not believe an estimate of
three reportable events since 2011, based on the number of disciplinary
actions in the past, is a reasonable proxy. Therefore, the Commission
asserts that a range of reportable events between 0-25 may better
reflect the potential number of reportable significant market
disruption events for each DCM. The Commission is accordingly revising
collection 3038-0052 to reflect the range of potential annual
reportable events by each DCM to be between 0 and 25, reflecting the
differences in DCM structure and operations and the market participants
accessing those DCMs.
In connection with the request for comment in the NPRM regarding
whether the proposed information collections are necessary for the
proper performance of Commission functions, CME stated it is ``unsure
of the practical utility to the Commission of receiving notifications
from a DCM pursuant to draft Principle III. From a market oversight
perspective, the Commission already (at least with the CME Group DCMs)
collects information on these types of events through regular
engagement and review of a DCM's compliance with core principles.''
\231\ The Commission does not agree with CME's assertion that the
notification may serve no practical utility based on the assumption
that the Commission collects this type of information from CME through
regular engagement and review of CME's compliance with core principles.
As described above in Section II.E, the purpose of the notification
requirement adopted in Commission regulation Sec. 38.251(g) is for
Commission staff to receive prompt notice of a market disruption
impacting a DCM's trading platform(s). This notification is intended to
assist the Commission in its oversight of the derivatives markets with
the ability to monitor and assess market disruptions across DCMs on a
near real-time basis. CME's argument that the current ``regular''
engagement and review of CME's compliance with core principles is
sufficient for this purpose is not persuasive and would not provide the
Commission with sufficient capability to address and monitor
significant market disruptions on a near real-time basis.
---------------------------------------------------------------------------
\231\ CME NPRM Letter, at 16.
---------------------------------------------------------------------------
Additionally, CME further commented on the Commission's request in
the NPRM relating to whether there are ways to minimize the burden of
the proposed collections of information on DCMs, including through the
use of appropriate automated, electronic, mechanical, or other
technological information collection techniques. In its comment to this
request, CME indicated that it ``currently provides CFTC staff near
real-time notifications of velocity logic events. We separately provide
the CFTC a daily file containing information related to events that
occur on the match engine (e.g., velocity logic events, circuit
breakers, etc.). These types of automated reports or notifications are
highly efficient and effective means to provide CFTC staff pertinent
information.'' \232\ Although the Commission finds the daily file that
CME voluntarily provides relating to velocity logic events \233\ to be
helpful in
[[Page 2063]]
certain circumstances, the Commission believes that a uniform standard
across DCMs relating to ``reportable events'' for significant market
disruption events is necessary for its oversight and regulatory
responsibilities under the CEA. For this reason, the Commission notes
that the notification requirement is a foundational requirement of the
current rulemaking that is expected to provide greater transparency and
awareness to the Commission regarding market disruptions associated
with electronic trading.
---------------------------------------------------------------------------
\232\ Id.
\233\ ``Velocity Logic'' is addressed on CME's website.
Generally, it is ``designed to detect market movement of a
predefined number of ticks either up or down within a predefined
time.'' Velocity Logic introduces a momentary suspension in matching
by transitioning the futures instrument(s) and related options into
the Pre-Open or Reserved/Pause State. See CME Velocity logic,
available at https://www.cmegroup.com/confluence/display/EPICSANDBOX/Velocity+Logic.
---------------------------------------------------------------------------
The Commission has previously estimated the combined annual burden
hours for part 38 to be 7,357.5 hours. Upon implementation of final
Commission regulation Sec. 38.251(g), the Commission estimates that
OMB Collection 3038-0052 will be revised by increasing the number of
annual responses by a range between 0 and 25 notifications to
Commission staff per year for a total range of between 0 and 425 \234\
notifications for all DCMs. The Commission has also revised the number
of potential respondent-DCMs to 17 in order to reflect the number of
DCMs currently registered with the Commission. The Commission further
estimates that the DCMs may employ a combination of in-house and
outside legal and compliance personnel to review and prepare
significant market disruption event notifications to Commission staff
and it will take approximately 5 burden hours to prepare each
notification resulting in a range of burden hours between 0 and 125
\235\ for each event notification across DCMs and a total range of
between 0 and 2,125 burden hours annually for all notifications to
Commission staff required for all DCMs.\236\ Although the Commission
believes that operational and maintenance costs for DCMs in Commission
regulation Sec. 38.251(g) will incrementally increase, these costs are
expected to be de minimis.
---------------------------------------------------------------------------
\234\ Based on the annual aggregate range of potential
notifications under final Commission regulation Sec. 38.251(g) from
0 to 425 for all DCMs, the Commission estimates that the average
annual aggregate notifications for all DCMs is 212.50 with the
annual average number of notifications per DCM to be 13.28.
\235\ The Commission estimates that final Commission regulation
Sec. 38.251(g) would require potentially each DCM to make between 0
and 25 reports with the Commission a year requiring approximately 5
hours each to prepare. Accordingly, the total burden hour range for
each DCM would be between approximately 0 and 125 hours per year (0
x 5 = 0 and 25 x 5 = 125).
\236\ The Commission estimates that the total aggregate annual
burden hours for DCMs under final Commission regulation Sec.
38.251(g) would be a range between 0 and 2,125 hours based on each
DCM incurring between 0 hours (0 x 17 = 0 burden hours) and 2,125
hours (125 x 17 = 2,125 burden hours). Based on these estimates, the
Commission has determined the annual average aggregate burden hours
for all DCMs to be 1,062.50 burden hours and the annual average
burden hour for each DCM to be 66.406 burden hours.
---------------------------------------------------------------------------
OMB Collection 3038-0052 was created to cover regulatory
requirements for DCMs under part 38 of the Commission's
regulations.\237\ OMB Control Number 3038-0052 covers all information
collections in part 38, including Subpart A (General Provisions),
Subparts B through X (the DCM core principles), as well as the related
appendices thereto, including Appendix A (Form DCM), Appendix B
(Guidance on, and Acceptable Practices in, Compliance with Core
Principles), and Appendix C (Demonstration of Compliance That a
Contract Is Not Readily Susceptible to Manipulation). Commission
regulation Sec. 38.251(g) adopted in this final rulemaking modifies
the existing annual burden in OMB Collection 3038-0052 for complying
with certain requirements in Subpart E (Prevention of Market
Disruption) of part 38, as estimated in aggregate below:
---------------------------------------------------------------------------
\237\ See 17 CFR part 38.
---------------------------------------------------------------------------
Estimated number of respondents: 17.
Estimated frequency/timing of responses: As needed.
Estimated number of annual responses per respondent: 0-25.
Estimated number of annual responses for all respondents: 0-425.
Estimated annual burden hours per response: 5.
Estimated total annual burden hours per respondent: 0-125.
Estimated total annual burden hours for all respondents: 0-2,125.
Estimated aggregate annual recordkeeping burden hours: 0-850.\238\
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\238\ The Commission estimates that additional total aggregate
annual recordkeeping burden hours for DCMs under Commission
regulations Sec. Sec. 38.950 and 38.951 as a result of the final
regulations under this rulemaking would be between 0 and 850 hours
based on each DCM incurring between 0 and 50 burden hours (17 x 0 =
0 and 17 x 50 = 850). These estimates are based on the range of
notifications expected to be between 0-25 per DCM annually. The
Commission estimates that each DCM would require 2 burden hours in
connection with its recordkeeping obligations under Commission
regulations Sec. Sec. 38.950 and 38.951. Based on these estimates,
the Commission also calculates the annual average aggregate
recordkeeping burden hours for all DCMs to be 400 burden hours and
the annual average recordkeeping burden hour for each DCM to be 25
burden hours.
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C. Cost-Benefit Considerations
1. Introduction
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of its actions before promulgating a regulation
under the CEA or issuing certain orders.\239\ Section 15(a) further
specifies that the costs and benefits shall be evaluated in light of
five broad areas of market and public concern: (1) Protection of market
participants and the public; (2) efficiency, competitiveness, and
financial integrity of futures markets; (3) price discovery; (4) sound
risk management practices; and (5) other public interest
considerations. The Commission considers the costs and benefits
resulting from its discretionary determinations with respect to the
section 15(a) factors.
---------------------------------------------------------------------------
\239\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------
The baseline for the consideration of costs and benefits in this
final rulemaking is the monitoring and mitigation capabilities of DCMs,
as governed by rules in current part 38 of the CFTC's regulations.
Under these rules, DCMs are required to conduct real-time monitoring of
all trading activity on their electronic trading platforms and identify
disorderly trading activity and any market or system anomalies.\240\
---------------------------------------------------------------------------
\240\ See existing Commission regulations Sec. Sec. 38.250,
38.251, 38.255 and Appendix B to Part 38--Guidance on, and
Acceptable Practices in, Compliance with Core Principles, Core
Principle 4 (Subparagraph (b)).
---------------------------------------------------------------------------
The Commission recognizes that the final electronic trading risk
principles rules may impose additional costs on DCMs and market
participants. The Commission has endeavored to assess the expected
costs and benefits of the final rulemaking in quantitative terms,
including PRA-related costs, where possible. In situations where the
Commission received quantitative data related to the cost-benefit
estimates proposed in the NPRM, the Commission included them in the
cost-benefit considerations of this final rulemaking. The Commission
also acknowledges and took into consideration qualitative comments with
regard to the cost-benefit estimates in the NPRM. When the Commission
is unable to quantify the costs and benefits, the Commission identifies
and considers the costs and benefits of the final rules in qualitative
terms.
a. Summary of the Rule
As discussed in more detail in the preamble above, after
considering various comments submitted by the commenters, the
Commission decided
[[Page 2064]]
on a principles-based approach and to give discretion to each DCM in
terms of how to define precisely market disruptions and system
anomalies as they relate to their particular markets. As a result, each
DCM will have the flexibility to tailor the implementation of the rules
to best prevent, detect, and mitigate market disruptions or system
anomalies in their respective markets. This flexibility should mitigate
the cost and burden associated with DCMs' implementation of the Risk
Principles. Therefore, the Commission adopts the following specific
Risk Principles and associated Acceptable Practices applicable to DCM
electronic trading as proposed.\241\
---------------------------------------------------------------------------
\241\ As discussed above, the Commission revised Risk Principle
3 to change the phrase ``disruptions to'' to ``market disruptions
on.'' See supra Section II.E.
---------------------------------------------------------------------------
i. Commission Regulation Sec. 38.251(e)--Risk Principle 1
Commission regulation Sec. 38.251(e)--Risk Principle 1--provides
that a DCM must adopt and implement rules governing market participants
subject to its jurisdiction to prevent, detect, and mitigate market
disruptions or system anomalies associated with electronic trading.
ii. Commission Regulation Sec. 38.251(f)--Risk Principle 2
Commission regulation Sec. 38.251(f)--Risk Principle 2--provides
that a DCM must subject all electronic orders to exchange-based pre-
trade risk controls to prevent, detect, and mitigate market disruptions
or system anomalies associated with electronic trading.
iii. Commission Regulation Sec. 38.251(g)--Risk Principle 3
Commission regulation Sec. 38.251(g)--Risk Principle 3--provides
that a DCM must promptly notify Commission staff of a significant
market disruption on its electronic trading platform(s) and provide
timely information on the causes and remediation.
iv. Acceptable Practices for Commission Regulations Sec. Sec.
38.251(e) and (f)
The Acceptable Practices provide that, to comply with Commission
regulation Sec. 38.251(e), a DCM must adopt and implement rules that
are reasonably designed to prevent, detect, and mitigate market
disruptions or system anomalies associated with electronic trading. To
comply with Commission regulation Sec. 38.251(f), the Acceptable
Practices provide that the DCM must subject all electronic orders to
exchange-based pre-trade risk controls that are reasonably designed to
prevent, detect, and mitigate market disruptions or system anomalies.
2. Costs
a. Costs of Adjustments to Existing Practices
i. Summary of Comments
A number of commenters commented on the existing practices of DCMs.
CME, ICE, and Better Markets asserted that the Risk Principles are
redundant of existing regulations.\242\ In particular, CME commented
that the Risk Principles overlap with existing Commission regulations,
specifically regulations promulgated under Core Principles 2 and
4.\243\ CME and ICE suggested relying on or amending existing
regulations, specifically Commission regulation Sec. 38.255.\244\ ICE
stated that this would track the Commission's approach to regulating
financial risk controls in Commission regulation Sec. 38.607, which
has proven effective.\245\ ICE also stated that the DCMs could face
confusion and potential costs while determining an appropriate
notification standard and updating existing regulations could help with
these costs.\246\
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\242\ CME NPRM Letter, at 12-13; ICE NPRM Letter, at 3; Better
Markets NPRM Letter, at 4-9.
\243\ CME NPRM Letter, at 7, 12-13.
\244\ See id. at 12; ICE NPRM Letter, at 3.
\245\ See id.
\246\ ICE NPRM Letter, at 9.
---------------------------------------------------------------------------
CME, CEWG, FIA/FIA PTG, ICE, and MFA commented that DCMs already
implement controls and address risks to their platforms.\247\ MFA
believes the Risk Principles will help encourage DCMs to continue to
monitor risks as they evolve along with the markets, and to make
reasonable modifications as appropriate.\248\
---------------------------------------------------------------------------
\247\ CME NPRM Letter, at 4-7; CEWG NPRM Letter, at 4; FIA/FIA
PTG NPRM Letter, at 3; ICE NPRM Letter, at 1; MFA NPRM Letter, at 2.
\248\ MFA NPRM Letter, at 2.
---------------------------------------------------------------------------
AFR and Rutkowski disagreed with the assertion that current DCM
practices are effective in achieving what the Risk Principles aim to
achieve.\249\
---------------------------------------------------------------------------
\249\ AFR NPRM Letter, at 2; Rutkowski NPRM Letter, at 2.
---------------------------------------------------------------------------
CME had two direct comments regarding the cost estimates presented
in the NPRM. First, CME commented that the Commission should identify
the specific types of software enhancements and additional data fields
associated with the 2,520 staff hours included in the proposed
rulemaking.\250\ Second, CME commented that the Commission's estimate
of 50 significant market disruptions described in the PRA section of
the NPRM is too high, and added that CME determined it had only three
significant market disruptions in the last decade across four DCMs
based on the number of formal disciplinary cases brought by the DCM for
electronic trading activity that may have disrupted markets or other
participants.\251\
---------------------------------------------------------------------------
\250\ CME NPRM Letter, at 17.
\251\ See id.
---------------------------------------------------------------------------
The Commission did not receive comments on other costs associated
with adjusting existing practices, such as costs associated with
recordkeeping or with the need for an additional compliance officer.
ii. Discussion
The Commission acknowledges the Risk Principles supplement existing
regulations, namely Commission regulations Sec. Sec. 38.251 and
38.255, with some potential overlap. The Commission believes the
intended goals of the Risk Principles cannot be solely achieved by
adding the words ``electronic trading'' to existing regulations. To the
extent that the Risk Principles are already covered by existing
regulations as many commenters suggested, then the Commission does not
expect much, if any, additional costs to be associated with the Risk
Principles. While the Commission acknowledges that DCMs could face
potential costs while determining an appropriate notification standard,
the Commission expects DCMs to be already collecting most, if not all,
required information to make such a determination. As a result, the
Commission expects such costs to be minimal. Some commenters also
disagreed with the assumption that existing DCM practices are effective
in achieving what the Risk Principles aim to achieve. To the extent
this might be the case, the Commission believes DCMs will accordingly
experience some additional costs related to the regulations, but the
risks associated with market disruptions or system anomalies associated
with electronic trading will decrease in financial markets. The
Commission expects the Risk Principles will minimize the risks
associated with market disruptions or system anomalies associated with
electronic trading to a greater degree than the existing regulations,
while at the same time minimizing the additional cost burdens of
implementation due to the existence of current DCM practices that are
expected to be consistent with the Risk Principles.
As to CME's comment on requiring more detail with regard to
potential software enhancements that might be required, the Commission
provides a
[[Page 2065]]
more detailed breakdown of the 2,520 staff hours below.
In addressing CME's comment on the estimated annual number of
significant market disruptions, the Commission believes that CME's use
of the number of formal disciplinary cases brought in connection with
electronic trading that may have disrupted markets or other market
participants as a ``proxy'' for significant market disruptions may
underestimate the actual number of significant market disruptions. More
specifically, while CME states that it has brought approximately 59
disciplinary actions for potential market disruptions involving
electronic trading activity since 2011, CME identified just three of
these cases to have potentially caused a significant market
disruption.\252\ However, CME does not provide any information or
analysis on how it arrived at its estimate of three significant market
disruptions. The Commission notes that each DCM may interpret
``significant'' disruption in a different manner based on differences
in market structures, market participants, and the technology utilized
by the DCM. As stated above, the Commission believes that the number of
relevant disciplinary cases brought by a DCM could be under-inclusive
of the number of potential reportable market disruption events and may
not be an appropriate proxy for the number of market disruptions
reportable under Commission regulation Sec. 38.251(g). However, the
Commission also acknowledges that, based on CME's comment and further
consideration, the Commission's original estimate of 50 annual
significant market disruptions per DCM might be too high. Accordingly,
the Commission has updated its estimate of the annual number of
reportable market disruption events to be 25 or less (between 0-25) for
each DCM as described below.\253\
---------------------------------------------------------------------------
\252\ See id. at 9.
\253\ See id.
---------------------------------------------------------------------------
iii. Costs
Consistent with the NPRM and comments received, current risk
management practices of some DCMs may be sufficient to comply with the
requirements of Commission regulations Sec. Sec. 38.251(e) through
38.251(g), in which case expected costs are expected to be
minimal.\254\ However, some DCMs may have to adjust some of their
existing practices to comply with the regulations.
---------------------------------------------------------------------------
\254\ See NPRM at 42772; CME NPRM Letter, at 17; ICE NPRM
Letter, at 9.
---------------------------------------------------------------------------
The Commission believes that DCMs may have to update their software
to enable them to capture more efficiently additional information
regarding participants subject to their jurisdiction to implement rules
adopted pursuant to Commission regulation Sec. 38.251(e). The
Commission acknowledges that the additional information required to be
collected may be different for each DCM because the specific rules each
DCM might need to adopt and implement pursuant to Commission regulation
Sec. 38.251(e) will be different, and also because the existing
information collection protocols already in place at each DCM are not
likely to be the same. The Commission expects, among other things, the
required information to be collected include the trader identification
for order entry, the means by which traders connect to the exchange's
platform, or any required statistics of order message traffic
attributable to an electronic trader.
The Commission expects the design, development, testing, and
production release of a required software update to take 2,520 staff
hours in total. The Commission expects 360 hours of that total to be
used for establishing requirements and design, 1,280 hours to be used
for development, 720 hours for testing, and 160 hours for production
release. To calculate the cost estimate for changes to DCM software,
the Commission estimates the appropriate wage rate based on salary
information for the securities industry compiled by the Department of
Labor's Bureau of Labor Statistics (``BLS'').\255\ Commission staff
arrived at an hourly rate of $70.76 using figures from a weighted
average of salaries and bonuses across different professions contained
in the most recent BLS Occupational Employment and Wages Report (May
2019), multiplied by 1.3 to account for overhead and other
benefits.\256\ Commission staff chose this methodology to account for
the variance in skillsets that may be used to plan, implement, and
manage the required changes to DCM software. Using these estimates, the
Commission would expect the software update to cost $178,313 per DCM.
The Commission acknowledges that this is an estimate and the actual
cost of such a software update would depend on the current status of
the specific DCM's information acquisition capabilities and the amount
of additional information the DCM would have to collect as a result of
Commission regulation Sec. 38.251(e). To the extent that a DCM
currently or partially captures the required information and data
through its systems and technology, these costs would be lower.
---------------------------------------------------------------------------
\255\ May 2019 National Industry-Specific Occupational
Employment and Wage Estimates, NAICS 523000--Securities, Commodity
Contracts, and Other Financial Investments and Related Activities,
available at https://www.bls.gov/oes/current/naics4_523000.htm.
\256\ The Commission's estimated appropriate wage rate is a
weighted national average of mean hourly wages for the following
occupations (and their relative weight): ``computer programmer--
industry: securities, commodity contracts, and other financial
investment and related activities'' (25 percent); ``project
management specialists and business operations specialists--
industry: securities, commodity contracts, and other financial
investment and related activities'' (25 percent); ``Software and Web
Developers, Programmers, and Testers--industry: securities,
commodity contracts, and other financial investment and related
activities'' (25 percent); and ``Software Developers and Software
Quality Assurance Analysts and Testers--industry: securities,
commodity contracts, and other financial investment and related
activities'' (25 percent).
---------------------------------------------------------------------------
The Commission acknowledges that any additional rules resulting
from Commission regulation Sec. 38.251(e) are required to be submitted
pursuant to part 40. The Commission expects a DCM to take an additional
48 hours annually (two submissions on average per year, 24 hours per
submission) to submit these amendments to the Commission. In order to
estimate the appropriate wage rate, the Commission used the salary
information for the securities industry compiled by the BLS.\257\
Commission staff arrived at an hourly rate of $89.89 using figures from
a weighted average of salaries and bonuses across different professions
contained in the most recent BLS Occupational Employment and Wages
Report (May 2019) multiplied by 1.3 to account for overhead and other
benefits.\258\ The Commission estimates this indirect cost to each DCM
to be $4,314.72 annually (48 x $89.89). To the extent a DCM currently
has in place rules required under Commission regulation Sec.
38.251(e), these costs would be incrementally lower.
---------------------------------------------------------------------------
\257\ May 2019 National Industry-Specific Occupational
Employment and Wage Estimates, NAICS 523000--Securities, Commodity
Contracts, and Other Financial Investments and Related Activities,
available at https://www.bls.gov/oes/current/naics4_523000.htm.
\258\ The Commission's estimated appropriate wage rate is a
weighted national average of mean hourly wages for the following
occupations (and their relative weight): ``compliance officer--
industry: securities, commodity contracts, and other financial
investment and related activities'' (50 percent); and ``lawyer--
legal services'' (50 percent). Commission staff chose this
methodology to account for the variance in skill sets that may be
used to accomplish the collection of information.
---------------------------------------------------------------------------
The Commission can envision a scenario where a DCM might also need
to update its trading systems to subject all electronic orders to
exchange-based pre-trade risk controls to prevent, detect, and mitigate
market disruptions or system anomalies as required by Commission
regulation Sec. 38.251(f).
[[Page 2066]]
Depending on the extent of the update required, the Commission
anticipates the design, development, testing, and production release of
the new trading system to take 8,480 staff hours in total, which the
Commission expects to be covered by more than one employee. To
calculate the cost estimate for updating a DCM's trading systems, the
Commission estimates the appropriate wage rate based on salary
information for the securities industry compiled by the BLS.\259\
Commission staff arrived at an hourly rate of $70.76 using figures from
a weighted average of salaries and bonuses across different professions
contained in the most recent BLS Occupational Employment and Wages
Report (May 2019) multiplied by 1.3 to account for overhead and other
benefits.\260\ Commission staff chose this methodology to account for
the variance in skill sets that may be used to plan, implement, and
manage the required update to a DCM's trading system. Using these
estimates, the Commission would expect the trading system update to
cost $600,036 to a DCM. The Commission emphasizes that this is an
estimate and the actual cost could be higher or lower. The cost may
also vary across DCMs, as each DCM has the flexibility to apply the
specific controls that the DCM deems reasonably designed to prevent,
detect, and mitigate market disruptions or system anomalies. In
addition, the Commission further notes that to the extent a DCM
currently or partially has in place pre-trade risk controls consistent
with proposed Commission regulation Sec. 38.251(f), these costs would
be incrementally lower.
---------------------------------------------------------------------------
\259\ May 2019 National Industry-Specific Occupational
Employment and Wage Estimates, NAICS 523000--Securities, Commodity
Contracts, and Other Financial Investments and Related Activities,
available at https://www.bls.gov/oes/current/naics4_523000.htm.
\260\ The Commission's estimated appropriate wage rate is a
weighted national average of mean hourly wages for the following
occupations (and their relative weight): ``computer programmer--
industry: securities, commodity contracts, and other financial
investment and related activities'' (25 percent); ``project
management specialists and business operations specialists--
industry: securities, commodity contracts, and other financial
investment and related activities'' (25 percent); ``Software and Web
Developers, Programmers, and Testers--industry: securities,
commodity contracts, and other financial investment and related
activities'' (25 percent); and ``Software Developers and Software
Quality Assurance Analysts and Testers--industry: securities,
commodity contracts, and other financial investment and related
activities'' (25 percent).
---------------------------------------------------------------------------
Commission regulation Sec. 38.251(g) requires a DCM promptly to
notify Commission staff of a significant market disruption on its
electronic trading platform(s) and provide timely information on the
causes and remediation. The Commission expects that there may be
incremental costs to DCMs from Commission regulation Sec. 38.251(g) in
the form of analysis regarding which disruptions could be significant
enough to report, maintain, and archive the relevant data, as well as
the costs associated with the act of reporting the disruptions. The
Commission currently expects every DCM to have the necessary means to
communicate with the Commission promptly, and therefore, does not
expect any additional communication costs. The Commission expects DCMs
to incur a minimal cost in determining what a significant market
disruption could be and preparing information on its causes and
remediation. The Commission does not expect this cost to be
significant, because the Commission believes DCMs should already have
the means necessary to identify the causes of market disruptions and
have plans for remediation. To the extent that complying with
Commission regulation Sec. 38.251(g) requires a DCM to incur
additional recordkeeping and reporting burdens, the Commission
estimates these additional recordkeeping requirements to be no more
than 50 hours per DCM per year, and the additional reporting
requirements to require no more than 125 hours per DCM per year (five
hours per report and an estimated 25 reports additionally per DCM).
The Commission acknowledges CME's comment indicating that based on
its review and analysis, CME believes to have had only three
significant market disruptions in the past decade across its four DCMs.
The Commission appreciates the information provided and recognizes that
the number of times a DCM might have to identify and report significant
market disruptions pursuant to Commission regulation Sec. 38.251(g)
may vary greatly across DCMs. The Commission acknowledges that the
frequency of such reporting could theoretically be less than one in any
given year for an exchange.
In calculating the cost estimates for recordkeeping and reporting,
the Commission estimates the appropriate wage rate based on salary
information for the securities industry compiled by the BLS.\261\ For
the reporting cost, Commission staff arrived at an hourly rate of
$76.44 using figures from a weighted average of salaries and bonuses
across different professions contained in the most recent BLS
Occupational Employment and Wages Report (May 2019) multiplied by 1.3
to account for overhead and other benefits.\262\ In calculating the
cost estimate for recordkeeping, the Commission staff arrived at an
hourly rate of $71.019 using figures from the most recent BLS
Occupational Employment and Wages Report (May 2019) multiplied by 1.3
to account for overhead and other benefits.\263\ The Commission
estimates the cost for additional recordkeeping to a DCM to be no more
than $3,550.95 (50 x $71.019) annually and the cost for additional
reporting to a DCM to be no more than $9,555.00 (125 x $76.44)
annually. As discussed above, certain DCMs might have no additional
relevant market disruptions to report some years, which would translate
to a zero cost estimate of additional reporting and recordkeeping for
those years for those DCMs.
---------------------------------------------------------------------------
\261\ May 2019 National Industry-Specific Occupational
Employment and Wage Estimates, NAICS 523000--Securities, Commodity
Contracts, and Other Financial Investments and Related Activities,
available at https://www.bls.gov/oes/current/naics4_523000.htm.
\262\ The Commission's estimated appropriate wage rate is a
weighted national average of mean hourly wages for the following
occupations (and their relative weight): ``computer programmer--
industry: securities, commodity contracts, and other financial
investment and related activities'' (25 percent); ``compliance
officer--industry: securities, commodity contracts, and other
financial investment and related activities'' (50 percent); and
``lawyer--legal services'' (25 percent). Commission staff chose this
methodology to account for the variance in skill sets that may be
used to accomplish the required reporting.
\263\ The Commission's estimated appropriate wage rate is the
mean hourly wages for ``database administrators and architects.''
Commission staff chose this methodology to account for the variance
in skill sets that may be used to accomplish the collection of
information.
---------------------------------------------------------------------------
To the extent that DCMs would need to update their rules and
internal processes to comply with Commission regulations Sec. Sec.
38.251(e) through 38.251(g) and the associated Acceptable Practices,
the Commission expects some DCMs also may need to update or supplement
their compliance programs, which would involve additional costs.
However, the Commission does not expect these costs to be significant.
The Commission believes some DCMs may need to hire an additional full-
time compliance staff member to address the additional compliance needs
associated with the regulation. Assuming that the average annual salary
of each compliance officer is $94,705, the Commission estimates the
incremental annual compliance costs to a DCM that needs to hire an
additional compliance officer to be $119,340.\264\ However, the
[[Page 2067]]
Commission notes that the exact compliance needs may vary across DCMs,
and some DCMs may already have adequate compliance programs that can
handle any rule updates and internal processes required to comply with
Commission regulations Sec. Sec. 38.251(e) through 38.251(g), and
therefore the actual compliance costs may be higher or lower than the
Commission's estimates.
---------------------------------------------------------------------------
\264\ In calculating this cost estimate for reporting, the
Commission estimates the appropriate annual wage for a compliance
officer based on salary information for the securities industry
compiled by the BLS. Commission staff used the annual wage of
$91,800, which reflects the average annual salary for a compliance
officer contained in the most recent BLS Occupational Employment and
Wages Report (May 2019), and multiplied it by 1.3 to account for
overhead and other benefits.
---------------------------------------------------------------------------
b. Cost of Periodically Updating Risk Management Practices
i. Summary of Comments
The Commission did not receive any comments associated with the
need periodically to update risk management practices.
ii. Costs
The Commission expects the trading methods and technologies of
market participants to change over time, requiring DCMs to adjust their
rules pursuant to Commission regulation Sec. 38.251(e) and adjust
their exchange-based pre-trade risk controls pursuant to Commission
regulation Sec. 38.251(f) accordingly. As trading methodologies and
connectivity measures evolve, it is expected that new causes of
potential market disruptions and system anomalies could surface. To
that end, the Commission believes full compliance would require a DCM
to implement periodic evaluation of its entire electronic trading
marketplace and updates of the exchange-based pre-trade risk controls
to prevent, detect, and mitigate market disruptions or system
anomalies, as well as updates of the appropriate definitions of market
disruptions and system anomalies. Therefore, rules imposed as a result
of Commission regulations Sec. Sec. 38.251(e) through 38.251(g) would
need to be flexible and fluid, and potentially updated as needed, which
may involve additional costs. Moreover, such rule changes would result
in a cost increase associated with the rise in the number of rule
filings that DCMs would have to prepare and submit to the Commission.
c. Costs to Market Participants
i. Summary of Comments
The Commission did not receive any comments associated with costs
to market participants.
ii. Costs
The Commission can envision a situation where the rules adopted by
DCMs as a result of Commission regulation Sec. 38.251(e) change
frequently, and market participants would need to adjust to new rules
frequently. While these adjustments might carry some costs for market
participants, such as potential added delays to their trading activity
due to additional pre-trade controls, the Commission expects these
changes to be communicated to the market participants by DCMs with
enough implementation time so as to minimize the burden on market
participants and their trading strategies. Moreover, to the extent a
DCM's policies and procedures require market participants to report
changes to their connection processes, trading strategies, or any other
adjustments the DCM deems required, there could be some cost to the
market participants. Finally, market participants may feel the need to
upgrade their risk management practices as a response to DCMs' updated
risk management practices driven by the Risk Principles. The Commission
recognizes that part of the costs to market participants might also
come from needing to update their systems and potentially adjust the
software they use for risk management, trading, and reporting. These
costs may be somewhat mitigated to the extent market participants
currently comply with DCM rules and regulations regarding pre-trade
risk controls and market disruption protocols.
d. Regulatory Arbitrage
i. Summary of Comments
The Commission received a number of comments regarding the
possibility of competition and regulatory arbitrage. CME commented that
the greatest risk for regulatory arbitrage is between DCMs and SEFs or
FBOTs.\265\ Also, IATP commented that the Commission should clarify why
it considers regulatory arbitrage between DCMs unlikely to happen.\266\
IATP also noted that the competition among DCMs for over-the-counter
trading and for trading in new products, such as digital coins, could
result in lax risk control design or lax updating of controls under
competitive pressures.\267\ IATP also mentioned the difference in
competitive pressures for cleared and uncleared trades.\268\ Finally,
CFE expressed concern that if the Commission compares all DCMs to a
baseline of controls, which are prevalent across DCMs, there may be an
expectation for smaller DCMs to adhere to the risk control standards of
larger DCMs.\269\ This could become a barrier to entry for smaller
DCMs.\270\
---------------------------------------------------------------------------
\265\ CME NPRM Letter, at 13.
\266\ IATP NPRM Letter, at 11.
\267\ See id. at 9.
\268\ See id. at 10.
\269\ CFE NPRM Letter, at 4.
\270\ See id.
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ii. Discussion
As outlined the in the NPRM and in the discussion of antitrust
considerations below,\271\ the Commission acknowledges the theoretical
possibility of regulatory arbitrage occurring as a result of the Risk
Principles but does not expect it to materialize.\272\ As discussed in
the NPRM and Section I.D.2 of this final rulemaking, the Commission
will continue to monitor whether Risk Principles of this nature may be
appropriate for other markets such as SEFs or FBOTs.\273\
---------------------------------------------------------------------------
\271\ See Section III.D of this final rulemaking.
\272\ See NPRM at 42763 n.6.
\273\ See id. and Section I.D.2 of this final rulemaking.
---------------------------------------------------------------------------
The Commission acknowledges there are differences in products and
market participants across DCMs, and DCMs might implement different
rules and risk controls given differences in their respective markets.
It is important to note that ongoing Commission oversight will identify
whether the differences in DCM rules and risk controls are due to
differing contracts being offered for trading, competitive pressure, or
regulatory arbitrage, and whether there are resulting issues that must
be addressed.
iii. Costs
The principles-based regulations offer DCMs the flexibility to
address market disruptions and system anomalies as they relate to their
particular markets and market participants' trading activities.
Similarly, DCMs are also given the flexibility to decide how to apply
the requirements associated with regulations in their respective
markets. This flexibility could result in differences across DCMs,
potentially contributing to regulatory arbitrage. For example, DCMs'
practices could differ in the information collected from market
participants; the rules applied to prevent, detect, and mitigate market
disruptions or system anomalies; and the intensity of pre-trade
controls. The parameters for establishing market disruptions or system
anomalies could be defined differently by the various DCMs, which might
lead to differing levels of exchange-based pre-trade risk controls.
[[Page 2068]]
The Commission acknowledges that to the extent there is potential
for market participants to choose between DCMs, those DCMs with lower
information collection requirements and potentially less stringent pre-
trade risk controls could appear more attractive to certain market
participants. All or some of these factors could create the potential
for market participants to move their trading from DCMs with
potentially more stringent risk controls to DCMs with less stringent
controls, which could cost certain DCMs business. While the Commission
recognizes that this kind of regulatory arbitrage could cause liquidity
to move from one DCM to another, potentially impairing (or benefiting)
the price discovery of the contract with reduced (or increased)
liquidity, the Commission does not expect this to occur with any
frequency. First, the Commission notes that liquidity for a given
contract in futures markets tends to concentrate in one DCM. This means
that futures markets are less susceptible to this type of regulatory
arbitrage. Second, while an individual DCM decides the exchange-based
pre-trade risk controls for its markets, those risk controls must be
effective. The Commission does not believe that differences in the
application of the Risk Principles across DCMs would be substantial
enough to induce market participants to switch to trading at a
different DCM, even if there were two DCMs trading similar enough
contracts. For example, DCMs currently apply various pre-trade controls
to comply with Commission regulation Sec. 38.255 requirements for risk
controls for trading, but the Commission does not have any evidence
that DCMs compete on pre-trade controls. The Commission expects DCMs to
approach the setting of their rules and controls to comply with the
Risk Principles in a similar manner.
3. Benefits
a. Minimize Disruptive Behaviors Associated With Electronic Trading and
Ensure Sound Financial Markets
i. Summary of Comments
While not a direct comment, AFR stated that the NPRM does not offer
a systematic assessment of the current costs of the types of electronic
disruptions addressed by the Risk Principles.\274\
---------------------------------------------------------------------------
\274\ AFR NPRM Letter, at 2.
---------------------------------------------------------------------------
ii. Discussion
The Commission acknowledges that no such costs were present in the
NPRM and it considers such analysis not quantitatively feasible.
However, the Commission considers market disruption costs to be
substantial and the Commission expects that these regulations will
minimize the frequency of market disruptions and their associated
costs. The Commission believes this to be an important benefit to DCMs
and market participants through ensuring a sound financial marketplace.
iii. Benefits
The Commission believes that the Risk Principles are crucial for
the integrity and resilience of financial markets, as they would ensure
that DCMs have the ability to prevent, detect, and mitigate most, if
not all, disruptive behaviors associated with electronic trading.
Commission regulation Sec. 38.251(e) requires DCMs to adopt and
implement rules governing market participants subject to their
jurisdiction such that market disruptions or system anomalies
associated with electronic trading can be minimized. This would allow
markets to operate smoothly and to continue functioning as efficient
platforms for risk transfer, as well as allowing for healthy price
discovery.
The Commission expects Commission regulation Sec. 38.251(f) to
subject all electronic orders to a DCM's exchange-based pre-trade risk
controls. The Commission expects this to benefit the markets as well as
the market participants sending orders to the DCMs. First, by
preventing orders that could cause market disruptions or system
anomalies through exchange-based pre-trade risk controls, Commission
regulation Sec. 38.251(f) allows the markets to operate orderly and
efficiently. This benefits traders in the markets, market participants
utilizing price discovery in the markets, as well as traders in related
markets. Second, Commission regulation Sec. 38.251(f) provides market
participants sending orders to a DCM with an additional layer of
protection through the implementation of exchange-based pre-trade risk
controls. If an unintentional set of messages were to breach the risk
controls of FCMs and other market participants, Commission regulation
Sec. 38.251(f) could prevent those messages from reaching a DCM and
potentially resulting in unwanted transactions. This benefits the
market participants, as well as their FCMs, by saving them from the
obligation of unwanted and unintended transactions.
Commission regulation Sec. 38.251(g) ensures that significant
market disruptions will be communicated to the Commission staff
promptly, as well as their causes and eventual remediation. The
Commission believes Commission regulation Sec. 38.251(g) will benefit
the markets and market participants by strengthening their financial
soundness and promoting the resiliency of derivatives markets by
allowing the Commission to stay informed of any potential market
disruptions effectively and promptly. If needed, the Commission's
timely action in the face of market disruptions could help markets
recover faster and stronger.
Finally, Commission regulations Sec. Sec. 38.251(e) through
38.251(g) are likely to benefit the public by promoting sound risk
management practices across market participants and preserving the
financial integrity of markets so that markets can continue to fulfill
their price discovery role.
b. Value of Flexibility Across DCMs
i. Summary of Comments
Most commenters, including CME, CFE, CEWG, FIA/FIA PTG, ICE, ISDA/
SIFMA, MFA, and Optiver supported a principles-based approach, which
allows flexibility in the implementation of the regulations across
DCMs.\275\ Many commenters noted they prefer the principles-based
approach to the prescriptive nature of prior proposals and that such an
approach provides flexibility and takes into account future
technological advances.\276\
---------------------------------------------------------------------------
\275\ CME NPRM Letter, at 1, 12, 16; CFE NPRM Letter, at 1; CEWG
NPRM Letter, at 2; FIA/FIA PTG NPRM Letter, at 2-4; ICE NPRM Letter,
at 2, 9; ISDA/SIFMA NPRM Letter, at 1-2; MFA NPRM Letter, at 1-2;
Optiver NPRM Letter, at 1.
\276\ CME NPRM Letter, at 1, 12; CFE NPRM Letter, at 1; CEWG
NPRM Letter, at 2; FIA/FIA PTG NPRM Letter, at 2-4; ISDA/SIFMA NPRM
Letter, at 1; MFA NPRM Letter, at 1-2.
---------------------------------------------------------------------------
In contrast, AFR, Better Markets, IATP, and Rutkowski disagreed
with the principles-based approach, and asserted that the incentives of
DCMs and public regulators are not fully aligned.\277\ AFR, Better
Markets, and Rutkowski commented that the Risk Principles provide too
much deference to DCMs and the Commission failed to address conflicts
of interest concerns that may impede the independence of DCMs and
SROs.\278\
---------------------------------------------------------------------------
\277\ AFR NPRM Letter, at 1-2; Better Markets NPRM Letter, at 2,
6, 9, 10-12; IATP NPRM Letter, at 1, 4, 8; Rutkowski NPRM Letter, at
1.
\278\ AFR NPRM Letter, at 1-2; Better Markets NPRM Letter, at 2,
6, 9, 10-12; Rutkowski NPRM Letter, at 1.
---------------------------------------------------------------------------
ii. Discussion
The Commission believes a principles-based approach of Risk
Principles allows flexibility to DCMs. Through this flexible approach,
DCMs can shape the adoption and
[[Page 2069]]
implementation of their rules to effectively prevent, detect, and
mitigate risks associated with electronic trading in their markets.
Additionally, this flexibility will also allow DCMs to adjust their
rules accordingly to respond to future changes in their markets.
Without such flexibility, DCMs would need to comply with prescriptive
rules that may not be as effective in preventing, detecting, and
mitigating market disruptions and system anomalies and that may involve
higher costs to market participants as well as potential higher
compliance costs.
The Commission notes Core Principle 16 in part 38 requires DCMs to
establish and enforce rules addressing potential conflicts of
interest.\279\ Furthermore, as also mentioned in the preamble, any
conflict of interest concerns, where DCMs might prioritize
profitability over reasonable controls, will be addressed through
regular Commission oversight of DCMs.\280\
---------------------------------------------------------------------------
\279\ See 17 CFR 38.850-51.
\280\ Conflicts of interest are also discussed in the antitrust
considerations section of this final rule. See Section III.D below.
---------------------------------------------------------------------------
iii. Benefits
The Commission believes that DCMs have markets with different
trading structures and participants with varying trading patterns. It
is possible that market participant behavior that one DCM considers a
major risk of market disruptions could be of less concern to another
DCM. The Commission's principles-based approach to Commission
regulations Sec. Sec. 38.251(e) and 38.251(f) allows DCMs the
flexibility to impose the most efficient and effective rules and pre-
trade risk controls for their respective markets. The Commission
believes such flexibility, including through the Acceptable Practices,
benefits DCMs by allowing them to adopt and implement effective and
efficient measures reasonably designed to achieve the objectives of the
Risk Principles. Without such flexibility, DCMs would need to comply
with prescriptive rules that may not be as effective in preventing,
detecting and mitigating market disruptions and system anomalies and
that may potentially involve higher compliance costs.
c. Direct Benefits to Market Participants
i. Summary of Comments
The Commission did not receive any comments associated with
benefits to market participants.
ii. Benefits
Commission regulation Sec. 38.251(e) requires DCMs to adopt and
implement rules that are reasonably designed to prevent, detect, and
mitigate market disruptions or system anomalies associated with
electronic trading. In addition, Commission regulation Sec. 38.251(f)
requires DCMs to subject all electronic orders to exchange-based pre-
trade risk controls that are reasonably designed to prevent, detect,
and mitigate market disruptions or system anomalies associated with
electronic trading. This approach will assist in preventing, detecting,
and mitigating market disruptions and system anomalies and thus protect
the effectiveness of financial markets to continue providing the
services of risk transfer and price transparency to all market
participants. Moreover, the Commission believes that requiring DCMs to
implement these DCM-based rules and risk controls could incentivize
market participants themselves to strengthen their own risk management
practices.
d. Facilitate Commission Oversight
i. Summary of Comments
The Commission did not receive any comments associated with
benefits to Commission oversight.
ii. Benefits
The Commission believes the implementation of the Risk Principles
will facilitate the Commission's capability to monitor the markets
effectively. Moreover, Commission regulation Sec. 38.251(g) will
result in DCMs informing the Commission promptly of any significant
market disruptions and remediation plans. The Commission believes this
will allow it to take steps to contain a disruption and prevent the
disruption from impacting other markets or market participants. Thus,
the Risk Principles will facilitate the Commission's oversight and its
ability to monitor and assess market disruptions across all DCMs.
Finally, the Commission expects that the Risk Principles will
better incentivize DCMs to recognize market disruptions and system
anomalies and examine remediation plans in a timely fashion.
4. 15(a) Factors
a. Protection of Market Participants and the Public
Commission regulations Sec. Sec. 38.251(e) through 38.251(g) are
intended to protect market participants and the public from potential
market disruptions due to electronic trading. The rules are expected to
benefit market participants and the public by requiring DCMs to adopt
and implement rules addressing the market disruptions and system
anomalies associated with electronic trading, subject all electronic
orders to specifically-designed exchange-based pre-trade risk controls,
and promptly report the causes and remediation of significant market
disruptions. All of these measures create a safer marketplace for
market participants to continue trading without major interruptions and
allow the public to benefit from the information generated through a
well-functioning marketplace.
b. Efficiency, Competitiveness, and Financial Integrity of DCMs
The Commission believes that Commission regulations Sec. Sec.
38.251(e) through 38.251(g) will enhance the financial integrity of
DCMs by requiring DCMs to implement rules and risk controls to address
market disruptions and system anomalies associated with electronic
trading. However, the Commission also acknowledges that market
participants' efficiency of trading might be hindered due to potential
latencies that may occur in the delivery and routing of orders to the
matching engine as a result of additional pre-trade risk controls. In
addition, the Commission can envision a scenario where the flexibility
provided to DCMs in designing and implementing rules to prevent,
detect, and mitigate market disruptions and system anomalies, and the
differences between the updated pre-trade risk controls and existing
DCM risk control rules, could potentially lead to regulatory arbitrage
between DCMs. To the extent that there are significant differences in
those practices set by competing DCMs, market participants might choose
to trade in the DCM with the least stringent rules if competing DCMs
offer the same or relatively similar products. The Commission
acknowledges that competitiveness across DCMs might be hurt as a
result. However, as discussed above, the Commission does not believe
that differences in the application of the Risk Principles across DCMs
would be substantial enough to induce market participants to switch to
trading at a different DCM, even if there were two DCMs trading similar
enough contracts.
c. Price Discovery
The Commission expects price discovery to improve as a result of
Commission regulations Sec. Sec. 38.251(e) through 38.251(g),
especially due to improved market functioning through the
implementation of targeted pre-trade risk controls and rules. The
Commission
[[Page 2070]]
expects the new regulations to assist with the prevention and
mitigation of market disruptions due to electronic trading, leading
markets to provide more stable and consistent price discovery services.
However, as noted above, adoption and implementation of rules pursuant
to Commission regulation Sec. 38.251(e) and pre-trade risk controls
implemented by DCMs pursuant to Commission regulation Sec. 38.251(f)
could be different across DCMs. As a result, the improvements in price
discovery across DCMs' markets are not likely to be uniform.
d. Sound Risk Management Practices
The Commission expects Commission regulations Sec. Sec. 38.251(e)
through 38.251(g) to help promote and ensure better risk management
practices of both DCMs and their market participants. The Commission
expects DCMs and market participants to focus on, and potentially
update, their risk management practices. Additionally, the Commission
believes that the requirement for DCMs to notify Commission staff
regarding the cause of a significant market disruption to their
respective electronic trading platforms would also provide reputational
incentives for both DCMs and their market participants to focus on, and
improve, risk management practices.
e. Other Public Interest Considerations
The Commission does not expect Commission regulations Sec. Sec.
38.251(e) through 38.251(g) to have any significant costs or benefits
associated with any other public interests.
D. Antitrust Considerations
Section 15(b) of the CEA requires the Commission to ``take into
consideration the public interest to be protected by the antitrust laws
and endeavor to take the least anticompetitive means of achieving the
purposes of this Act, in issuing any order or adopting any Commission
rule or regulation (including any exemption under section 4(c) or
4c(b)), or in requiring or approving any bylaw, rule, or regulation of
a contract market or registered futures association established
pursuant to section 17 of this Act.'' \281\ The Commission believes
that the public interest to be protected by the antitrust laws is
generally to protect competition. In the NPRM, the Commission
preliminarily determined that the Risk Principles proposal is not
anticompetitive and has no anticompetitive effects. The Commission then
requested comment on (i) whether the proposal is anticompetitive and,
if so, what the anticompetitive effects are; (ii) whether any other
specific public interest, other than the protection of competition, to
be protected by the antitrust laws is implicated by the proposal; and
(iii) whether there are less anticompetitive means of achieving the
relevant purposes of the CEA that would otherwise be served by adopting
the proposal.
---------------------------------------------------------------------------
\281\ 7 U.S.C. 19(b).
---------------------------------------------------------------------------
The Commission does not anticipate that the Risk Principles
rulemaking will result in anticompetitive behavior, but instead,
believes that the principles-based approach to DCM electronic trading
does not establish a barrier to entry or a competitive restraint. As
noted above, the Commission encouraged comments from the public on any
aspect of the proposal that may have the potential to be inconsistent
with the antitrust laws or anticompetitive in nature. The Commission
received three comments asserting that the proposed rules may
potentially impact competition through the existence of ``regulatory
arbitrage'' and one comment regarding the competitive impact of
potential risk control assessments to a baseline of risk controls that
are prevalent and effective across DCMs.
IATP commented that ``DCMs compete for market participant trades,
so competitive pressures could reduce DCM verification of market
participant compliance with DCM requirements for market participant
risk control.'' \282\ IATP focused on the potential competitive
pressures that could potentially occur with respect to non-cleared
transactions, stating that these transactions should ``post higher
initial margin and maintain higher variation margin than cleared
trades.'' \283\ IATP disagreed with the Commission's belief in the NPRM
that a lack of uniformity between DCMs' rules and risk controls does
not render a particular DCM's rules or risk controls per se
unreasonable.\284\
---------------------------------------------------------------------------
\282\ IATP NPRM Letter, at 9. IATP noted, among other things,
that ``trading in new products, such as digital coins, could result
in lax risk control design or lax updating of controls under
competitive pressures.''
\283\ Id.
\284\ See NPRM at 42765. IATP commented that ``If one DCM
pursues competitive advantage by developing risk controls and rules
that market participants perceive to be less costly to implement
and/or to give them a competitive advantage in trading, the
Commission believes the DCM seeking such a competitive advantage to
comply with the Principles, provided that the DCM rules and risk
controls are not inherently unreasonable.'' IATP NPRM Letter, at 11.
IATP believes that, in connection with its comments regarding the
potential competitive concerns of the Electronic Risk Principles
Rule, the Commission should document and explain how ``allowing each
DCM to develop and enforce its own rules and risk controls presents
no possibility of regulatory arbitrage among DCMs.'' See id.
---------------------------------------------------------------------------
AFR commented that the Commission's proposal rejected the more
active regulatory approach to electronic trading taken in the now-
withdrawn Regulation AT and, instead, delegates the core elements of
electronic trading oversight to for-profit exchanges under a
principles-based approach.\285\ AFR criticized the Commission's
principles-based approach regarding the regulation of electronic
trading on DCMs, stating that it disagrees with the core assumption
underlying the principles-based approach that the incentives of DCMs
``are fully aligned with those of public regulators in limiting
speculative and trading practices that could threaten market
integrity.'' \286\ The basis of AFR's comment is that DCMs are
``economically dependent on the order flow provided by large traders
and are in direct competition with other venues to capture that order
flow.'' \287\ As a result, AFR argues that this dependence on order
flow creates a conflict of interest whereby DCMs may accommodate the
interests of large brokers and traders even though there may be risks
to market integrity. AFR further believes that conflict of interest
requires significant public regulatory oversight of DCM market
practices, stating that ``[p]ure self-regulation is not enough.'' \288\
---------------------------------------------------------------------------
\285\ See AFR NPRM Letter, at 1. See also Rutkowski NPRM Letter,
at 1. Mr. Rutkowski's comment largely adopts the arguments set forth
in the AFR comment.
\286\ See AFR NPRM Letter, at 1.
\287\ Id.
\288\ Id.
---------------------------------------------------------------------------
Better Markets similarly commented that permitting DCMs to
determine the types of risk controls to deter and/or prevent market
disruptions is inherently conflicted due to competitive pressures.\289\
In commenting regarding the potential competitive issues in connection
with the Risk Principles, Better Markets cited the Commission's
statement in the NPRM that noted the potential for regulatory arbitrage
due to
[[Page 2071]]
the principles-based nature of the requirements.\290\ With respect to
this competitive issue, Better Markets noted that those DCMs with lower
information collection requirements and less stringent pre-trade risk
controls could appear more attractive to certain market participants
and could facilitate certain market participants to move trading among
DCMs, thereby costing certain DCMs business.\291\
---------------------------------------------------------------------------
\289\ See Better Markets NPRM Letter, at 11. In particular,
Better Markets noted that ``[e]xchanges face conflicts of interest
between maximizing profit and shareholder value and diminishing
trading volumes through meaningful limits on certain electronic
trading practices. With competitive pressures and revenues at stake,
one exchange is unlikely to be a first mover and absorb the costs
and rancor of market participants in implementing risk controls and
related measures that its competitors may, for market share reasons,
postpone indefinitely. That is why a federal baseline set of
controls and regulations--revisited as often as is necessary to
ensure responsible innovation--must be applied to all DCMs.'' Id.
\290\ Better Markets specifically stated that ``The CFTC
acknowledges this regulatory arbitrage concern but minimizes such
concerns due to a belief that ``differences in the application of
the proposed regulation across DCMs would [not] be substantial
enough to induce market participants to switch to trading at a
different DCM, even if there were two DCMs trading similar enough
contracts.'' Better Markets NPRM Letter, at 11. See also NPRM at
42774.
\291\ See id.
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As noted in the NPRM and the preamble of these final rules, the
Commission is aware that DCMs may have conflicting and competing
interests in connection with the oversight of electronic trading.\292\
However, the Commission does not believe that differences in the
application of the Risk Principles across DCMs would be substantial
enough to induce market participants to switch to trading at a
different DCM.
---------------------------------------------------------------------------
\292\ See NPRM at 42775 and Section III.C.4 of this final
rulemaking.
---------------------------------------------------------------------------
The commenters essentially argued that the more prescriptive
regulatory approach to electronic trading taken in the withdrawn
Regulation AT proposal is preferable to the Risk Principles approach
that ``delegates'' elements of electronic trading oversight to for-
profit exchanges. As support for their argument, commenters focused on
the inherent conflict of self-regulation whereby a for-profit entity is
also tasked with performing a certain degree of regulatory oversight
over its marketplace. The Commission notes the Congressional intent to
serve the public interests of the CEA ``through a system of effective
self-regulation of trading facilities . . . under the oversight of the
Commission.'' \293\ DCMs have significant incentives and obligations to
maintain well-functioning markets as self-regulatory organizations that
are subject to specific regulatory requirements. Specifically, the DCM
Core Principles require DCMs to, among other things, refrain from
adopting any rule or taking any action that results in any unreasonable
restraint of trade and imposing material anticompetitive burdens.\294\
In addition, DCM Core Principles also require DCMs to surveil trading
on their markets to prevent market manipulation, price distortion, and
disruptions of the delivery or cash-settlement process.\295\ Several
academic studies, including one concerning futures exchanges and
another concerning demutualized stock exchanges, also support the
conclusion that exchanges are able both to satisfy shareholder
interests and meet their self-regulatory organization
responsibilities.\296\
---------------------------------------------------------------------------
\293\ Section 3(b) of the CEA. 7 U.S.C. 5(b).
\294\ CEA section 5(d)(19), 7 U.S.C. 7(d)(19) and 17 CFR
38.1000.
\295\ 17 CFR 38.200 and 17 CFR 38.250.
\296\ See David Reiffen and Michel A. Robe, Demutualization and
Customer Protection at Self-Regulatory Financial Exchanges, Journal
of Futures Markets, supra note 56, at 126-164, Feb. 2011; Kobana
Abukari and Isaac Otchere, Has Stock Exchange Demutualization
Improved Market Quality? International Evidence, supra note 56.
---------------------------------------------------------------------------
As noted above in Section III.C.3, CFE expressed concern that
smaller DCMs could over time be expected to adopt and implement the
same pre-trade risk controls in place at the larger DCMs which could,
therefore, impact competition and diversity. CFE is specifically
concerned about the statement in the NPRM regarding assessment of risk
controls comparing ``all DCMs to a baseline of controls on electronic
trading and electronic order entry that are prevalent and effective
across DCMs.'' \297\ CFE further asserted that ``what is in place at
the larger DCMs and DCM groups should not simply become the de facto
standard for what all DCMs must employ.'' \298\
---------------------------------------------------------------------------
\297\ NPRM at 42768.
\298\ CFE NPRM Letter, at 4.
---------------------------------------------------------------------------
The Commission reiterates that the Risk Principles are intended to
provide DCMs with the flexibility to adopt those pre-trade risk
controls reasonably designed to prevent, detect, and mitigate market
disruptions or system anomalies associated with electronic trading. As
a result, the Commission does not intend or expect larger DCM pre-trade
risk controls to be the standard for all DCMs, although there may be
risk controls that are common to all DCMs. As noted in the CFE
comments, it is not the Commission's intent to effectively impose on
all DCMs those risk controls that are in place at larger DCMs.
The Commission also believes that these competitive concerns raised
by commenters are mitigated because: (i) DCMs are required to submit
any proposed rules under Commission regulation Sec. 38.251(e) to the
Commission for review under part 40 of the Commission's regulations;
and (ii) DCMs are required pursuant to the DCM Antitrust Core Principle
to refrain from adopting any rule or taking any action that results in
any unreasonable restraint of trade and imposing material
anticompetitive burdens.\299\ Accordingly, the Commission has
determined that the Risk Principles serve the regulatory purpose of the
CEA to deter and prevent price manipulation or any other disruptions to
market integrity.\300\ In addition, the Commission notes that the Risk
Principles implement additional purposes and policies set forth in
section 5(d)(4) of the CEA.\301\ The Commission has considered the
final rules and related comments, to determine whether they are
anticompetitive, and continues to believe that the Risk Principles will
not result in any unreasonable restraint of trade, or impose any
material anticompetitive burden on trading in the markets.
---------------------------------------------------------------------------
\299\ See Commission regulation Sec. 38.1000 (Core Principle
19, Antitrust Considerations).
\300\ Section 3(b) of the CEA, 7 U.S.C. 5(b).
\301\ 7 U.S.C. 5(d)(4). This DCM Core Principle focusing on the
prevention of market disruption requires that the board of trade
shall have the capacity and responsibility to prevent manipulation,
price distortion, and disruptions of the delivery or cash-settlement
process through market surveillance, compliance, and enforcement
practices and procedures, including--(A) methods for conducting
real-time monitoring of trading; and (B) comprehensive and accurate
trade reconstructions.
---------------------------------------------------------------------------
List of Subjects in 17 CFR Part 38
Commodity futures, Designated contract markets, Reporting and
recordkeeping requirements.
PART 38--DESIGNATED CONTRACT MARKETS
0
1. The authority citation for part 38 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 6, 6a, 6c, 6d, 6e, 6f, 6g, 6i, 6j,
6k, 6l, 6m, 6n, 7, 7a-2, 7b, 7b-1, 7b-3, 8, 9, 15, and 21, as
amended by the Dodd-Frank Wall Street Reform and Consumer Protection
Act, Pub. L. 111-203, 124 Stat. 1376.
0
2. In Sec. 38.251, republish the introductory text and add paragraphs
(e) through (g) to read as follows:
Sec. 38.251 General requirements.
A designated contract market must:
* * * * *
(e) Adopt and implement rules governing market participants subject
to its jurisdiction to prevent, detect, and mitigate market disruptions
or system anomalies associated with electronic trading;
(f) Subject all electronic orders to exchange-based pre-trade risk
controls to prevent, detect, and mitigate market disruptions or system
anomalies associated with electronic trading; and
(g) Promptly notify Commission staff of any significant market
disruptions on
[[Page 2072]]
its electronic trading platform(s) and provide timely information on
the causes and remediation.
0
3. In appendix B to part 38, under ``Core Principle 4 of section 5(d)
of the Act: PREVENTION OF MARKET DISRUPTION,'' add paragraph (b)(6) to
read as follows:
Appendix B to Part 38--Guidance on, and Acceptable Practices in,
Compliance With Core Principles
* * * * *
Core Principle 4 of section 5(d) of the Act: PREVENTION OF
MARKET DISRUPTION * * *
(b) * * *
(6) Market disruptions and system anomalies associated with
electronic trading. To comply with Sec. 38.251(e), the contract
market must adopt and implement rules that are reasonably designed
to prevent, detect, and mitigate market disruptions or system
anomalies associated with electronic trading. To comply with Sec.
38.251(f), the contract market must subject all electronic orders to
exchange-based pre-trade risk controls that are reasonably designed
to prevent, detect, and mitigate market disruptions or system
anomalies.
* * * * *
Issued in Washington, DC, on December 10, 2020, by the
Commission.
Robert Sidman
Deputy Secretary of the Commission.
NOTE: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to--Electronic Trading Risk Principles Voting Summary
Chairman's and Commissioners' Statements
Appendix 1--Voting Summary
On this matter, Chairman Tarbert and Commissioners Quintenz,
Stump, and Berkovitz voted in the affirmative. Commissioner Behnam
voted in the negative.
Appendix 2--Supporting Statement of Chairman Health P. Tarbert
The mission of the CFTC is to promote the integrity, resilience,
and vibrancy of U.S. derivatives markets through sound regulation.
We cannot achieve this mission if we rest on our laurels--
particularly in relation to the ever-evolving technology that makes
U.S. derivatives markets the envy of the world. What is sound
regulation today may not be sound regulation tomorrow.
I am reminded of the paradoxical observation of Giuseppe di
Lampedusa in his prize-winning novel, The Leopard: ``If we want
things to stay as they are, things will have to change.'' \1\
---------------------------------------------------------------------------
\1\ Giuseppe Tomasi di Lampedusa, The Leopard (Everyman's
Library Ed. 1991) at p. 22.
---------------------------------------------------------------------------
While the novel focuses on the role of the aristocracy amid the
social turbulence of 19th century Sicily, its central thesis--that
achieving stability in changing times itself requires change--can be
applied equally to the regulation of rapidly changing financial
markets.
Today we are voting to finalize a rule to address the risk of
disruptions to the electronic markets operated by futures exchanges.
The risks involved are significant; disruptions to electronic
trading systems can prevent market participants from executing
trades and managing their risk. But how we address those risks--and
the implications for the relationship between the Commission and the
exchanges we regulate--is equally significant.
The Evolution of Electronic Trading
A floor trader from the 1980s and even the 1990s would scarcely
recognize the typical futures exchange of the 21st Century. The
screaming and shouting of buy and sell orders reminiscent of the
film Trading Places has been replaced with silence, or perhaps the
monotonous humming of large data centers. Over the past two decades,
our markets have moved from open outcry trading pits to electronic
platforms. Today, 96 percent of trading occurs through electronic
systems, bringing with it the price discovery and hedging functions
foundational to our markets.
By and large, this shift to electronic trading has benefited
market participants. Spreads have narrowed,\2\ liquidity has
improved,\3\ and transaction costs have dropped.\4\ And the most
unexpected benefit is that electronic markets have been able to stay
open and function smoothly during the COVID-19 lockdowns. By
comparison, traditional open outcry trading floors such as options
pits and the floor of the New York Stock Exchange were forced to
close for an extended time. Without the innovation of electronic
trading, our financial markets would almost certainly have seized up
and suffered even greater distress.
---------------------------------------------------------------------------
\2\ Frank, Julieta and Philip Garcia, ``Bid-Ask Spreads, Volume,
and Volatility: Evidence from Livestock Markets,'' American Journal
of Agricultural Economics, Vol. 93, Issue 1, p. 209 (January 2011).
\3\ Terrence Henderschott, Charles M. Jones, and Albert K.
Menkveld, ``Does Algorithmic Trading Improve Liquidity?'' Journal of
Finance, Volume 66, Issue 1, p. 1 (February 2011).
\4\ Esen Onur and Eleni Gousgounis, ``The End of an Era: Who
Pays the Price when the Livestock Futures Pits Close?'', Working
Paper, Commodity Futures Trading Commission Office of the Chief
Economist.
---------------------------------------------------------------------------
But like any technological innovation, electronic trading also
creates new and unique risks. Today's final rule is informed by
examples of disruptions in electronic markets caused by both human
error as well as malfunctions in automated systems--disruptions that
would not have occurred in open outcry pits. For instance, ``fat
finger'' orders mistakenly entered by people, or fully automated
systems inadvertently flooding matching engines with messages, are
two sources of market disruptions unique to electronic markets.
Past CFTC Attempts To Address Electronic Trading Risks
The CFTC has considered the risks associated with electronic
trading during much of the last decade. Seven years ago, a different
set of Commissioners issued a concept release asking for public
comment on what changes should be made to our regulations in light
of the novel issues raised by electronic trading. Out of that
concept release, the Commission later proposed Regulation AT. For
all its faults, Regulation AT drove a very healthy discussion about
the risks that should be addressed and the best way to do so.
Regulation AT was based on the assumption that automated
trading, a subset of electronic trading, was inherently riskier than
other forms of trading. As a result, Regulation AT sought to require
certain automated trading firms to register with the Commission
notwithstanding that they did not hold customer funds or
intermediate customer orders. Most problematically, Regulation AT
also would have required those firms to produce their source code to
the agency upon request and without subpoena.
Regulation AT also took a prescriptive approach to the types of
risk controls that exchanges, clearing members, and trading firms
would be required to place on order messages. But this list was set
in 2015. In effect, Regulation AT would have frozen in time a set of
controls that all levels of market operators and market participants
would have been required to place on trading. Since that list was
proposed, financial markets have faced their highest volatility on
record and futures market volumes have increased by over 50
percent.\5\ Improvements in technology and computer power have been
profound. Of course, I commend my predecessors for focusing on the
risks that electronic trading can bring. But times change, and
Regulation AT would not have changed with them. Consequently, our
Commission formally withdrew Regulation AT this past summer.\6\
---------------------------------------------------------------------------
\5\ Futures Industry Association, ``A record year for
derivatives'' (March 5, 2019), available at https://www.fia.org/articles/record-year-derivatives.
\6\ Regulation Automated Trading; Withdrawal, 85 FR 42755 (July
15, 2020).
---------------------------------------------------------------------------
An Evolving CFTC for Evolving Markets
In withdrawing Regulation AT, the CFTC has consciously moved
away from registration requirements and source code production. But
in voting to finalize the Risk Principles, the CFTC is committing to
address risk posed by electronic trading while strengthening our
longstanding principles-based approach to overseeing exchanges.
The markets we regulate are changing. To maintain our regulatory
functions, the CFTC must either halt that change or change our
agency. Swimming against the tide of developments like electronic
markets is not an option, nor should it be. The markets exist to
serve the needs of market participants, not the regulator. If a
technological change improves the functioning of the markets, we
should embrace it. In fact, one of this agency's founding principles
is that CFTC should ``foster responsible innovation.'' \7\ Applying
this reasoning alongside the
[[Page 2073]]
overarching theme of The Leopard leads us to a single conclusion: As
our markets evolve, the only real course of action is to ensure that
the CFTC's regulatory framework evolves with it.
---------------------------------------------------------------------------
\7\ Commodity Exchange Act, Section 3(b), 7 U.S.C. 3(b).
---------------------------------------------------------------------------
The Need for Principles-Based Regulation
So then how do we as a regulator change with the times while
still fulfilling our statutory role overseeing U.S. derivatives
markets? I recently published an article setting out a framework for
addressing situations such as this.\8\ I believe that principles-
based regulations can bring simplicity and flexibility while also
promoting innovation when applied in the right situations. Such an
approach can also create a better supervisory model for interaction
between the regulator and its regulated firms--but only so long as
that oversight is not toothless.
---------------------------------------------------------------------------
\8\ Tarbert, Heath P., ``Rules for Principles and Principles for
Rules: Tools for Crafting Sound Financial Regulation,'' Harv. Bus.
L. Rev., Vol. 10 (June 15, 2020), available at https://www.hblr.org/volume-10-2019-2020/.
---------------------------------------------------------------------------
There are a variety of circumstances in which I believe
principles-based regulation would be most effective. Regulations on
how exchanges manage the risks of electronic trading are a prime
example. This is about risk management practices at sophisticated
institutions subject to an established and ongoing supervisory
relationship. But it is also an area where regulated entities have a
better understanding than the regulator about the risks they face
and greater knowledge about how to address those risks. As a result,
exchanges need flexibility in how they manage risks as they
constantly evolve.
At the same time, principles-based regulation is not ``light
touch'' regulation. Without the ability to monitor compliance and
enforce the rules, principles-based regulation would be ineffective.
Principles-based regulation of exchanges can work because the CFTC
and the exchanges have constant interaction that engenders a degree
of mutual trust. The CFTC--as overseen by our five-member
Commission--has tools to monitor how the exchanges implement
principles-based regulations through reviews of license applications
and rule changes, as well as through periodic examinations and rule
enforcement reviews.
Monitoring compliance alone is not enough. The regulator also
needs the ability to enforce against non-compliance. Principles-
based regimes ultimately give discretion to the regulated entity to
find the best way to achieve a goal, so long as that method is
objectively reasonable. To that end, the CFTC has a suite of tools
to require changes through formal action, escalating from denial of
rule change requests, to enforcement actions, to license
revocations. The CFTC consistently needs to address the
effectiveness and appropriateness of these levers to make sure the
exchanges are meeting their regulatory objectives. And given that
exchanges will be judged on a reasonableness standard, it must be
the Commission itself--based on a recommendation from CFTC staff
\9\--who ultimately decides whether an exchange has been objectively
unreasonable in complying with our principles.
---------------------------------------------------------------------------
\9\ CFTC Staff conduct regular examinations and reviews of our
registered entities, including exchanges and clearinghouses. As part
of those examinations and reviews, Staff may identify issues of
material non-compliance with regulations as well as recommendations
to bring an entity into compliance. Ultimately, however, the
Commission itself must accept an examination report or rule
enforcement review report before it can become final, including any
findings of non-compliance. Likewise, Staff are asked to make
recommendations regarding license applications, reviews of new
products and rules, and a variety of other Commission actions,
although ultimate authority lies with the Commission.
---------------------------------------------------------------------------
Final Rule on Risk Principles for Electronic Trading
This brings us to today's finalization of the Risk Principles
that were proposed in June of this year. The final rule, which we
are adopting by-and-large as proposed, centers on a straightforward
issue that I think we can all agree is important for our regulations
to address. Namely, the Risk Principles require exchanges to take
steps to prevent, detect, and mitigate market disruptions and system
anomalies associated with electronic trading.
The disruptions we are concerned about can come from any number
of causes, including: (i) Excessive messages, (ii) fat finger
orders, or (iii) the sudden shut off of order flow from a market
maker. The key attribute of the disruptions addressed by the Risk
Principles is that they arise because of electronic trading.
To be sure, our current regulations do require exchanges to
address market disruptions. But the focus of those rules has
generally been on disruptions caused by sudden price swings and
volatility. In effect, the Risk Principles expand the term ``market
disruptions'' to cover instances where market participants' ability
to access the market or manage their risks is negatively impacted by
something other than price swings. This could include slowdowns or
closures of gateways into the exchange's matching engine caused by
excessive messages submitted by a market participant. It could also
include instances when a market maker's systems shut down and the
market maker stops offering quotes.
As noted in the preamble to the final rule, exchanges have
worked diligently to address emerging risks associated with
electronic trading. Different exchanges have put in place rules such
as messaging limits and penalties when messages exceed filled trades
by too large a ratio. Exchanges also may conduct due diligence on
participants using certain market access methods and may require
systems testing ahead of trading through those methods.
It is not surprising that exchanges have developed rules and
risk controls that comport with our Risk Principles. The Commission,
exchanges, and market participants have a common interest in
ensuring that electronic markets function properly. Moreover, this
is an area where exchanges are likely to possess the best
understanding of the risks presented and have control over how their
own systems operate. As a result, exchanges have the incentive and
the ability to address the risks arising from electronic trading.
Principles-based regulations in this area will ensure that exchanges
have reasonable discretion to adjust their rules and risk controls
as the situation dictates, not as the regulator dictates.
The three Risk Principles encapsulate this approach. First,
exchanges must have rules to prevent, detect, and mitigate market
disruptions and system anomalies associated with electronic trading.
In other words, an exchange should take a macro view when assessing
potential market disruptions, which can include fashioning rules
applicable to all traders governing items such as onboarding,
systems testing, and messaging policies. Second, exchanges must have
risk controls on all electronic orders to address those same
concerns. Third, exchanges must notify the CFTC of any significant
market disruptions and give information on mitigation efforts.
Importantly, implementation of the Risk Principles will be
subject to a reasonableness standard. The Acceptable Practices
accompanying the Risk Principles clarify that an exchange would be
in compliance if its rules and its risk controls are reasonably
designed to meet the objectives of preventing, detecting, and
mitigating market disruptions and system anomalies. The Commission
will have the ability to monitor how the exchanges are complying
with the Principles, and will have avenues to sanction non-
compliance.
Framework for Future Regulation
I hope that the Risk Principles we are adopting today will serve
as a framework for future CFTC regulations. Electronic trading
presents a prime example of where principles-based regulation--as
opposed to prescriptive rule sets--is more likely to result in sound
regulation over time. Through thoughtful analysis of the regulatory
objective we aim to achieve, the nature of the market and technology
we are addressing, the sophistication of the parties involved, and
the nature of the CFTC's relationship with the entity being
regulated, we can identify what areas are best for a prescriptive
regulation or a principles-based regulation.\10\ In the present
context, a principles-based approach--setting forth concrete
objectives while affording reasonable discretion to the exchanges--
provides flexibility as electronic trading practices evolve, while
maintaining sound regulation. In sum, it recognizes that things will
have to change if we want things to stay as they are.\11\
---------------------------------------------------------------------------
\10\ Tarbert, at 11-17.
\11\ Di Lampedusa, at 22.
---------------------------------------------------------------------------
Appendix 3--Supporting Statement of Commissioner Brian D. Quintenz
I support today's final rule requiring designated contract
markets (DCMs) to adopt rules that are reasonably designed to
prevent, detect, and mitigate market disruptions or system anomalies
associated with electronic trading. It also requires DCMs to subject
all electronic orders to pre-trade risk controls that are reasonably
designed to prevent, detect and mitigate market disruptions having a
``material'' effect on its participants
[[Page 2074]]
and to provide prompt notice to the Commission in the event the
platform experiences any material market disruptions that meet a
higher threshold of being ``significant''.
I believe all DCMs have already adopted regulations and pre-
trade risk controls designed to address the risks posed by
electronic trading. As I have noted previously, many--if not all--of
the risks posed by electronic trading are already being effectively
addressed through the market's incentive structure, including
exchanges' and firms' own self-interest: DCMs through their interest
in operating markets with integrity, and firms through their
interest in not exposing their or their customers' funds to huge
losses in a matter of minutes through algorithmic operational error.
Both exchanges and firms have been leaders in implementing best
practices around electronic trading risk controls. Therefore,
today's final rule merely codifies principles underlying existing
market practice of DCMs to have reasonable controls in place to
mitigate electronic trading risks.
Significantly, the final rule puts forth a principles-based
approach, allowing DCM trading and risk management controls to
continue to evolve with the trading technology itself. As we have
witnessed over the past decade, risk controls are constantly being
updated and improved to respond to market developments. In my view,
these continuous enhancements are made possible because exchanges
and firms have the flexibility and incentives to evolve and hold
themselves to an ever-higher set of standards, rather than being
held to a set of prescriptive regulatory requirements which can
quickly become obsolete. By adopting a principles-based approach,
the final rule provides exchanges and market participants with the
flexibility they need to innovate and evolve with technological
developments. DCMs are well-positioned to determine and implement
the rules and risk controls most effective for their markets. Under
the rule, DCMs are required to adopt and implement rules and risk
controls that are objectively reasonable. The Commission would
monitor DCMs for compliance and take action if it determines that
the DCM's rules and risk controls are objectively unreasonable.
Importantly, the Appendix to the final rule points out that a DCM
will be held to a standard of reasonableness and not to how other
DCMs implement the rule. Any horizontal review across DCMs of rules
or risk controls would only inform objectively unreasonable
determinations, not create a baseline set of specific risk controls
that become de-facto regulatory requirements.
The Technology Advisory Committee (TAC), which I am honored to
sponsor, has explored the risks posed by electronic trading at
length. In each of those discussions, it has become obvious that
both DCMs and market participants take the risks of electronic
trading seriously and have expended enormous effort and resources to
address those risks.
For example, at one TAC meeting, we heard how the CME Group has
implemented trading and volatility controls that complement, and in
some cases exceed, eight recommendations published by the
International Organization of Securities Commissions (IOSCO)
regarding practices to manage volatility and preserve orderly
trading.\1\ At another TAC meeting, the Futures Industry Association
(FIA) presented on current best practices for electronic trading
risk controls.\2\ FIA reported that through its surveys of
exchanges, clearing firms, and trading firms, it has found
widespread adoption of market integrity controls since 2010,
including price banding and exchange market halts. FIA also
previewed some of the next generation controls and best practices
currently being developed by exchanges and firms to further refine
and improve electronic trading systems. The Intercontinental
Exchange (ICE) also presented on the risk controls ICE currently
implements across all of its exchanges, noting how its
implementation of controls was fully consistent with FIA's best
practices.\3\ These presentations emphasize how critical it is for
the Commission to adopt a principles-based approach that enables
best practices to evolve over time.
---------------------------------------------------------------------------
\1\ Meeting of the TAC on March 27, 2019, Automated and Modern
Trading Markets Subcommittee Presentation, transcript and webcast
available at, https://www.cftc.gov/PressRoom/Events/opaeventtac032719.
\2\ Meeting of the TAC on Oct. 3, 2019, Automated and Modern
Trading Markets Subcommittee Presentation, https://www.cftc.gov/PressRoom/Events/opaeventtac100319.
\3\ Id.
---------------------------------------------------------------------------
I believe the final rule issued today adopts such an approach
and provides DCMs with the flexibility to continually improve their
risk controls in response to technological and market advancements.
Because this rule allows for flexible implementation and effectively
places that burden on the market participants with the most aligned
and motivated interests, I believe this rule will stand the test of
time and serve as a paradigm of the CFTC's mission statement: Sound
regulation that promotes the integrity, resilience, and vibrancy of
the U.S. derivatives market.
Appendix 4--Dissenting Statement of Commissioner Rostin Behnam
I would like to start by thanking DMO staff for their tireless
work on this rule. While the Risk Principles are short, that is not
reflective of the work that has been done by staff to produce them.
This is the same DMO staff that worked on the much broader
``Regulation AT'',\1\ and I appreciate all of their work over many
years.
---------------------------------------------------------------------------
\1\ Regulation Automated Trading, Proposed Rule, 80 FR 78824
(Dec. 17, 2015); Supplemental Regulation AT NPRM, 81 FR 85334 (Nov.
25, 2016).
---------------------------------------------------------------------------
Last June, I stated in my dissent to the Electronic Trading Risk
Principles proposal \2\ that I strongly support thoughtful and
meaningful policy that addresses the ever-increasing use of
automated systems in our markets.\3\ The proposal regarding
Electronic Trading Risk Principles did not achieve this. Far from
utilizing over a decade of experiences that should have profoundly
shaped how we address operational risks that are consistently
unpredictable and have wide-ranging impacts, today's final rule
changes only a single word from the proposal aimed at codifying the
status quo. Accordingly, I respectfully dissent.
---------------------------------------------------------------------------
\2\ Rostin Behnam, Commissioner, CFTC, Dissenting Statement of
Commissioner Rostin Behnam Regarding Electronic Trading Risk
Principles (June 25, 2020), https://www.cftc.gov/PressRoom/SpeechesTestimony/behnamstatement062520b.
\3\ The Commission's Office of the Chief Economist has found
that over 96 percent of all on-exchange futures trading occurred on
DCMs' electronic trading platforms. Haynes, Richard & Roberts, John
S., ``Automated Trading in Futures Markets--Update #2'' at 8 (Mar.
26, 2019), available at https://www.cftc.gov/sites/default/files/2019-04/ATS_2yr_Update_Final_2018_ada.pdf.
---------------------------------------------------------------------------
A little over ten years ago, on May 6, 2010, the Flash Crash
shook our markets.\4\ The prices of many U.S.-based equity products,
including stock index futures, experienced an extraordinarily rapid
decline and recovery. In 2012, Knight Capital, a securities trading
firm, suffered losses of more than $460 million due to a trading
software coding error.\5\ Other volatility events related to
automated trading have followed with increasing regularity.\6\ In
September and October 2019, the Eurodollar futures market
experienced a significant increase in messaging.\7\ According to
reports, the volume of data generated by activity in Eurodollar
futures increased tenfold.\8\ A lesson of these events is that under
stressed market conditions, automated execution of a large sell
order can trigger extreme price movements, and the interplay between
automated execution programs and algorithmic trading strategies can
quickly result in disorderly markets.\9\
---------------------------------------------------------------------------
\4\ See Findings Regarding the Market Events of May 6, 2010,
Report of the Staffs of the CFTC and SEF to the Joint Advisory
Committee on Emerging Regulatory Issues (Sept. 30, 2010), available
at https://www.cftc.gov/ucm/groups/public/@otherif/documents/ifdocs/staff-findings050610.pdf.
\5\ See SEC Press Release No. 2013-222, ``SEC Charges Knight
Capital With Violations of Market Access Rule'' (Oct. 16, 2013),
available at https://www.sec.gov/News/PressRelease/Detail/PressRelease/1370539879795.
\6\ For a list of volatility events between 2014 and 2017, see
the International Organization of Securities Commissions (``IOSCO'')
March 2018 Consultant Report on Mechanisms Used by Trading Venues to
Manage Extreme Volatility and Preserve Orderly Trading (``IOSCO
Report''), at 3, available at https://www.iosco.org/library/pubdocs/pdf/IOSCOPD607.pdf.
\7\ See Osipovich, Alexander, ``Futures Exchange Reins in
Runaway Trading Algorithms,'' Wall Street Journal (Oct. 29, 2019),
available at https://www.wsj.com/articles/futures-exchange-reins-in-runaway-trading-algorithms-11572377375.
\8\ Id.
\9\ Id. at 6.
---------------------------------------------------------------------------
Recent events further amplify that in increasingly
interconnected markets, which are informed by growing access to
real-time data and information, we do not always know how and where
the next market stress event will materialize. This past April 20,
the May contract for the West Texas Intermediate Light Sweet Crude
Oil futures contract (the ``WTI Contract'') on the New York
Mercantile Exchange settled at a price of -$37.63 per barrel. The
May Contract's April 20 negative
[[Page 2075]]
settlement price was the first time the WTI Contract traded at a
negative price since being listed for trading 37 years ago.
While the unusual fact that the price went significantly
negative grabbed the headlines, the precipitousness of the price
move was every bit as significant. The price dropped more than $39
between 2:10 and 2:30 p.m. on April 20. Overall, the price dropped
$58.05 from the open of trading to its low on April 20, breaking its
historical relationship with other petroleum-based contracts
including the Brent Crude futures contract. The WTI price moved more
in 20 minutes than it does most years. A contract that had never
experienced a 10% move in a single day fell by more than 300% in a
brief 20-minute period. All of the contributing factors have yet to
be accounted for, but one thing is certain--these were stressed
market conditions. An already oversupplied global crude oil market
was hit with an unprecedented reduction in demand caused by the
COVID-19 pandemic.\10\ Under stressed market conditions, automated
trading has the potential to quickly make an already volatile
situation even worse.
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\10\ Interim Staff Report, Trading in NYMEX WTI Crude Oil
Futures Contract Leading Up to, on, and around April 20, 2020 (Nov.
23, 2020), https://www.cftc.gov/PressRoom/PressReleases/8315-20.
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Technology glitches have continued to impact our markets. Just
yesterday, a large retail broker that was significantly impacted by
the events of April 20 suffered a significant failure in data
storage.\11\ Recent technology glitches overseas have hampered our
international colleagues as well, handcuffing markets for extended
periods of time without clear explanation. In Japan this past
September, the Tokyo Stock Exchange shut down for a day due to
technical glitches in equities trading.\12\ Luckily, this glitch
happened to coincide with all other Asian markets being closed and
occurred the day after the first Presidential debate. But this only
emphasizes the outsized impact that a technical issue could have
during volatile market conditions. One can imagine what would have
happened if the glitch had occurred the day before, during the
leadup to the debate.\13\
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\11\ See Platt and Stafford, ``Trading Outages Strike Again for
US Retail Brokers,'' Financial Times (Dec. 7, 2020), available at
https://www.ft.com/content/cb99dc6f-a73e-41af-91fb-21a4aa606265.
\12\ See Dooley, Ben, ``Tokyo Stock Market Halts Trading for a
Day, Citing Glitch,'' The New York Times (Sep. 30, 2020), available
at https://www.nytimes.com/2020/09/30/business/tokyo-stock-market-glitch.html.
\13\ Id.
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Just last month, Australia's stock exchange lost an entire day
of trading due to a software problem impacting trading of multiple
securities in a single order.\14\ This discrete issue was enough to
lead to inaccurate market data that necessitated shutting down the
exchange for an entire trading day.\15\
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\14\ See ``Software Glitch Halts Trading on Australia's Stock
Exchange, to Reopen Tuesday,'' Reuters (Nov. 15, 2020), available at
https://www.reuters.com/article/us-asx-trading/software-glitch-halts-trading-on-australias-stock-exchange-to-reopen-tuesday-idUSKBN27W020.
\15\ Id.
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As we consider today's final rule, there is a tendency to think
that something is better than nothing, and that today's risk
principles--if nothing else--demonstrate the Commission's belief
that mitigating automated trading risk is important. However, I
continue to question whether these Risk Principles improve upon the
status quo, or even do anything of marginal substance relative to
the status quo.\16\
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\16\ See Behnam, supra note 2.
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The preamble seems to go to great lengths to make it clear that
the Commission is not asking DCMs to do anything. The preamble
states at the very outset that the ``Commission believes that DCMs
are addressing most, if not all, of the electronic trading risks
currently presented to their trading platforms.'' \17\ The preamble
presents each of the three Risk Principles as ``new'', but then goes
on to describe all of the actions already taken by DCMs that meet
the principles. If the appropriate structures are in place, and we
have dutifully conducted our DCM rule enforcement reviews and have
found neither deficiencies nor areas for improvement, then is the
exercise before us today anything more than creating a box that will
automatically be checked?
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\17\ Final Rule at 4.
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The only potentially new aspect of these Risk Principles is that
the preamble suggests different application in the future, as
circumstances change. As I said in regard to the proposal, the
Commission seems to want it both ways: We want to reassure DCMs that
what they do now is enough, but at the same time the new risk
principles potentially provide a blank check for the Commission to
apply them differently in the future.\18\
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\18\ See Behnam, supra note 2.
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We do not know what the next external event to stress market
conditions will be, but one likely possibility is climate change. In
establishing new rules for automated trading, I would have liked the
Commission to have taken a more fulsome look at both the events of
April 20, the COVID-19 pandemic more broadly, and the potential
impacts of climate change on our automated markets. The recently
published Interim Staff Report on the events of April 20 provides a
stark example of what can happen to automated markets under times of
economic stress.
The April 20 price plummet triggered both dynamic circuit
breakers and velocity logic--exactly the type of risk controls
discussed in the proposal that preceded the Electronic Trading Risk
Principles proposal, commonly referred to as ``Regulation AT.''
Regulation AT was formally withdrawn at the Chairman's direction and
without my support. Further troubling, it was withdrawn before
Commission staff had any meaningful opportunity to consider whether
and how the risk controls in either Regulation AT or the Electronic
Trading Risk Principles as proposed performed during trading around
April 20. There was arguably no better test case, and yet we charged
forward without looking back. If the risk controls were effective,
we should consider whether more specific risk controls along these
lines should be part of the Electronic Trading Risk Principles, in
order to be certain that all DCMs are prepared to maintain orderly
trading during such a confluence of events. If they are not, we
should consider whether stronger risk controls are necessary.
I also think the Risk Principles would be improved if they were
informed by a consideration of the possible impacts of climate
change. The preamble states ``The principles-based approach provides
DCMs with flexibility to address risks to markets as they evolve,
including any idiosyncratic events.'' Referring to events such as
climate change as ``idiosyncratic'' downplays their impact and
places regulators and DCMs in a purely reactive posture. While we
cannot know for certain what the next external event that causes
stressed market conditions will be, that does not mean that we
should remain idle until it hits. As we will continue to experience
unanticipated and unprecedented events that will impact our markets
and the larger U.S. economy, I am concerned that a policy of simply
checking a box will do nothing more than shield DCMs from public
scrutiny and fault for the fallout.
So often we hear that the markets have evolved from a
technological and innovative standpoint at an exponential rate as
compared to their regulators. Rulemakings like this provide our
greatest opportunity to proactively close that gap. We need to be
proactive. Being proactive means studying the incidents of the past,
like the Flash Crash, Knight Capital, and most recently April 20 so
that we can recognize the precursors of events to come. Instead of
just reacting, we can predict, prepare for, and possibly prevent the
next crisis event.
Again, while there is a temptation to advance this rule under
the theory that something is better than nothing, in this case I do
not think that the final rules add anything at all beyond the
opportunity to take a victory lap. In other words, the theme in this
case is that nothing is better than something. I believe that we
can, and should, do better. Therefore, I cannot support today's
final rule.
Appendix 5--Supporting Statement of Commissioner Dawn D. Stump
As I observed when we proposed these risk principles last
summer, it is a simple fact that the markets we regulate have become
increasingly electronic (much like everything else in our modern
lives). The rulemaking that we are now adopting appropriately
recognizes that market infrastructure providers have already
implemented a host of measures pursuant to our existing regulations
and their own self-regulatory responsibilities to account for the
associated risks that inherently come with the development of
electronic trading. I do not want our adoption of additional
Commission risk principles regarding electronic trading on
designated contract markets (``DCMs'') to be taken as an indication
that adequate attention is not being paid--or that insufficient
resources are being invested--by the exchanges to address the
lessons that have already been learned and applied over many years
as electronic trading has become more prevalent in these markets.
I also want to stress the significance of the often-overlooked
direction we have received from Congress in Section 3 of the
Commodity
[[Page 2076]]
Exchange Act (``CEA'').\1\ Section 3(a) sets out Congress's finding
that the transactions subject to the CEA are affected with a
national public interest. Then, in Section 3(b), Congress stated
that it is the purpose of the CEA to serve this public interest
``through a system of effective self-regulation of trading
facilities, clearing systems, market participants and market
professionals under the oversight of the Commission.''
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\1\ CEA Section 3, 7 U.S.C. 5.
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I support adopting these electronic trading risk principles as
an appropriate exercise of the Commission's oversight that Congress
expects from us, as stated in Section 3(b) of the CEA. While, as
noted, I do not question the exchanges' diligence in addressing the
risks in electronic trading on their platforms, I am comfortable
incorporating these principles into our existing rule set in order
to make clear that DCMs must continue to monitor these risks as they
evolve along with the markets, and make reasonable modifications as
appropriate.
Importantly, though, I also support the principles-based
approach of these final rules. This approach recognizes that the
front-line responsibility for preventing, detecting, and mitigating
material risks posed by electronic trading rests with the exchanges
themselves. The exchanges are best positioned to execute this
responsibility because they have the best knowledge of the trading
that occurs on their own markets. At the same time, this approach
serves the public interest through a system of effective self-
regulation of trading facilities--precisely as Congress directed in
its statement of purpose in Section 3(b) of the CEA.
I thank and commend the Staff for the time and energy they have
put into the preparation of this rulemaking, and for the thoughtful
consideration they have given to these issues over the course of the
past several years.
Appendix 6--Statement of Commissioner Dan M. Berkovitz
I support today's final rule on Electronic Trading Risk
Principles (``Final Rule''). The Final Rule addresses market
disruptions associated with electronic trading through limited
requirements applicable directly to designated contract markets
(``DCMs'') and indirectly to DCM market participants. It is an
incremental step that can enhance the safety and soundness of
electronic trading on U.S. exchanges. I look forward to the
continuing evolution of trading in our markets, and to the
Commission's steady engagement with the technology and risk controls
of modern trading to determine whether more may be needed in the
future.
I am able to support the Final Rule because it recognizes the
role of both DCMs and market participants in preventing and
mitigating market disruptions, as well as the ultimate
responsibility and authority of the Commission to oversee the
actions of our market infrastructures and market participants. The
Final Rule codifies three ``Risk Principles,'' including new
requirements in Risk Principle 1 that DCMs implement rules governing
their market participants to prevent, detect, and mitigate market
disruptions and system anomalies.\1\ This provision, codified in
Commission regulation 38.251(e), speaks directly to new risk-
reducing practices and may be the most helpful of the three Risk
Principles.
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\1\ In addition, Risk Principle 2 requires DCMs to subject all
electronic orders to exchange-based pre-trade risk controls to
prevent, detect, and mitigate market disruptions or system anomalies
associated with electronic trading. Risk Principle 2 overlaps with
existing Commission regulations, including Sec. 38.255, which
requires DCMs to ``establish and maintain risk control mechanisms to
prevent and reduce the potential risk of price distortions and
market disruptions.'' DCMs should help drive an effective
implementation of Risk Principle 2 by carefully examining their
existing pre-trade risk controls and ensuring that such controls are
fit for the types of market participants, technologies, and trading
practices prevalent on their markets.
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Market participants originate, place, and manage orders on DCMs
though an array of systems that vary in sophistication and
automation. Experience teaches that errors in the design, testing,
implementation, operation, or supervision of such systems by a
single market participant can lead to cascading effects that disrupt
an entire market and the ability of all market participants to
engage in price discovery and risk mitigation. Accordingly, it is
crucial that market participants, DCMs, and the Commission implement
and enforce the Risk Principles in meaningful ways going forward.\2\
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\2\ I appreciate the concerns raised by some commenters that the
Risk Principles may be imprecise, difficult to enforce, or provide
too much deference to DCMs. As discussed below, the Final Rule helps
mitigate some of these concerns by emphasizing that the Risk
Principles are an objective standard and enforceable rules subject
to Commission oversight. The Commission will be able to monitor
DCMs' compliance with the Risk Principles through its DCM rule
enforcement review program, as well as other oversight activities
including review of new rule certifications, review of market
disruption notifications received pursuant to Risk Principle 3,
market surveillance, and other oversight tools.
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The Commission's efforts in this regard may be aided by Risk
Principle 3, which requires DCMs to ``promptly notify Commission
staff of any significant market disruptions'' and ``provide timely
information on the causes and remediation.'' \3\ I support
Commission efforts to remain up-to-date as technologies evolve, new
potential sources of market disruptions arise, and best practices
for safeguarding markets are developed. Information provided to the
Commission through Risk Principle 3 will strengthen the Commission's
daily oversight of DCMs, and help educate the Commission and its
staff as to the most effective risk-reducing measures.
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\3\ Risk Principle 3 is codified in new Commission regulation
38.251(g).
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I am also able to support the Final Rule because it recognizes
and preserves the Commission's authority to interpret and enforce
the standards in the Risk Principles, and because it clarifies that
Risk Principles 1 and 2 are intended to address any type of market
disruption arising from market participants or electronic orders
that materially affects electronic trading. I thank the Chairman for
working with my office to achieve these enhancements to the Final
Rule.
The Final Rule includes Acceptable Practices in Appendix B to
part 38 providing that a DCM can comply with Risk Principles 1 and 2
through rules and pre-trade risk controls that are ``reasonably
designed'' to prevent, detect, and mitigate market disruptions and
system anomalies. While legitimate concerns have been raised that
these terms could lend themselves to excessive disputes over
interpretation, the Final Rule makes clear that they are subject to
an objective standard and Commission oversight. It notes
specifically that ``[t]he Commission will oversee and enforce the
Risk Principles in accordance with an objective reasonableness
standard[,]'' and that the Risk Principles are ``enforceable
regulations.'' \4\ I am pleased that the Final Rule clearly
articulates the seriousness with which the Commission will monitor
and enforce the Risk Principles.
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\4\ As I articulated in my statement when the Risk Principles
were first proposed, the Dodd-Frank Act amended the Commodity
Exchange Act to make clear that a DCM's discretion with respect to
core principle compliance is circumscribed by any rule or regulation
that the Commission might adopt pursuant to a core principle. In
today's Final Rule, the Commission is requiring DCMs to adopt and
implement rules and pre-trade risk controls that are ``reasonably
designed to prevent, detect, and mitigate market disruptions or
system anomalies associated with electronic trading.''
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The Final Rule also makes clear that while Risk Principle 3
addresses ``significant'' market disruptions, Risk Principles 1 and
2 include the broader set of ``material'' disruptions. As stated in
the Final Rule, ``the standard for a significant market disruption
under Risk Principle 3 is higher than the standard for a market
disruption under Risk Principles 1 and 2.'' Markets and market
participants will benefit from the Commission's decision to resolve
this potential ambiguity in the proposed rule and to implement a
rigorous standard for Risk Principles 1 and 2.
Today's Final Rule addresses an issue that has remained open in
the Commission's books for far too long. Electronic trading is no
longer a new technology in Commission-regulated markets, and it has
not been new for many years. The Risk Principles are a circumscribed
but important first step in ensuring that the Commission's rules
keep pace with technological changes underlying derivatives trading.
The Commission must now proceed to full, effective implementation of
the Risk Principles and to oversight of DCMs' own implementations. I
support these efforts, combined with continued vigilance to
determine whether additional steps may be needed in the future.
In the preamble to the Final Rule, the Commission stresses the
potential benefits of the principles-based approach embodied in the
Risk Principles. My support for the principles-based approach in
this particular rulemaking, however, should not be interpreted as an
endorsement of such a broad principles-based approach in other
circumstances, or foreclose my support for more prescriptive
measures should they become necessary with respect to risk
[[Page 2077]]
controls. Although the markets overseen by the Commission have
benefitted from the flexibility of a principles-based approach in a
number of areas, in other circumstances a more prescriptive approach
has provided the market with needed clarity and certainty. The
appropriate choice or balance between prescriptive regulations and
principles-based regulations will depend upon the circumstances
being addressed by those regulations.
Whether this rulemaking will fully accomplish its objectives
will depend to a large extent upon the diligence and commitment to
its implementation by DCMs and market participants. If DCMs and
market participants comprehensively adopt and maintain industry best
practices to prevent, detect, and mitigate market disruptions and
system anomalies, as well as develop and implement measures to
address emerging issues as they arise, then further prescriptive
action by the Commission may not be necessary.
I thank the staff of the Division of Market Oversight for their
work to address a number of my concerns with the Final Rule, as well
as their overall work on the Final Rule.
[FR Doc. 2020-27622 Filed 1-5-21; 11:15 am]
BILLING CODE 6351-01-P