CFTC Commissioner Bart Chilton gave a speech entitled “Deciphering Chaos“ to the High-Frequency Trading Leaders Forum in Chicago on October 9, 2012. The speech was posted on the Harvard Law School Forum on Corporate Governance and Financial Regulation on November 3, 2012. Chilton channeled the movie Wayne’s World to make some interesting points. Party on!
Chilton spoke about Dodd-Frank and did a nice job of summarizing the rules into 4 buckets. From the speech:
Bucket 1—Transparency: The previously unregulated, off-the-grid, over-the-counter (OTC) trading (swaps) volume is in the hundreds-of-trillions of dollars—like $650 trillion or more worldwide. To put that in perspective, our agency currently regulates about $5 trillion in annualized trading on registered exchanges. I can’t even demonstrate that appropriately with a body chart. What’s important are those off-the-grid trades, what have been termed “dark pools” who’ve never seen the regulatory light of day, will be brought onto regulated exchanges. Transparency is the best disinfectant for murky markets. Data will be collected by what are called Swap Data Repositories—or SDRs. The SDRs will provide the transparency in the precise markets that got us into such trouble in 2008. And by the way, except for excessive speculation, it wasn’t the regulated markets that were the trouble-makers—not at all. It was the trillions in unregulated trades of which nobody had a visual. That’s about to change.
Bucket 2—Lowering Systemic Risk: We want to ensure that folks don’t take risks that undermine the whole financial system. Risk is part of markets, sure, and people should take as much as they’re comfortable with. But, if they slip and tumble, our economy shouldn’t stumble. So, we’re instituting new capital and margin requirements. That will avoid the over-leveraging problem that we saw in 2008 with Bear Stearns and Lehman and others.
Bucket 3—Accountability: I’m often asked why nobody went to jail for what happened to the economy in 2008? This has become an even more pressing question given that taxpayers bailed out, to the tune of $400-plus billion, many of the very firms that took a wrecking ball to the economy to begin with. Since that time, the sector in our economy that has made more profits than all other sectors, more than all of them, was—wait for it—the financial sector. Exqueezeme? Certain folks who did the damage are doing better than others in our economy. It’s enough, Wayne, to make a fella hurl. So, how come nobody went to jail? Well, much of what was done wasn’t against the law.
That will change with the Dodd-Frank rules. There will be more financial firm accountability to the public. We will, in the near future, make some significant improvements. We will address in concrete, comprehensive, and crystal clear terms, our complement of customer protection rules, with a focus on meaningful controls and control-based examinations. And finally;
Bucket 4—Market Integrity: We all want these markets to perform the functions originally envisioned—that is to manage risk and discover prices—good stuff for commercial producers and good for consumers. At their core, that is why we have futures markets. They weren’t set up as gambling parlors, but risk management markets for commercial hedgers—those with some physical commodity and to lessen price volatility for consumers. Let’s ensure those fundamental principles are maintained in markets no matter who the players are or what technology they use.
The Commissioner also spoke about technology. He cited numerous recent technology glitches – a problem which caused Kraft Foods stock to rise nearly 30% the same day the stock was moving from the NYSE to the Nasdaq, a glitch at the National Stock Exchange of India which erased $58 billon of value and was caused by just 59 trades, a 12% drop in silver in about that many minutes, and, of course, the $440 million loss at Knight Capital. So what to do? Chilton’s remarks on liquidity were telling. Chilton refers to high frequency traders as Cheetahs – hence the language below:
“…Liquidity—The Cheetahs themselves add liquidity to markets. I’m not convinced the liquidity is as wicked awesome as some contend. I mean, sometimes that liquidity is there for a half second, then the cheetah bails—they’re outta there. A farmer isn’t going to hedge his wheat crop for a half second; he wants it hedged for the growing season. The cheetahs, on the other hand, want to be flat—or level—at the end of the day (although for some, there never is an end). I call the liquidity provided by the cheetahs “fleeting liquidity,” but it is liquidity nonetheless.
So, I’m not of the opinion that this trading is so very incomprehensible and scary that we need to stop it. I’m not even to the point of suggesting that it be slowed, although I don’t rule out that possibility. I think we don’t know enough…”
Chilton’s “to do” list is:
1. Cheetah Registration: They need to be registered. That’s sort of a pedestrian first step. Can you believe they aren’t even required to be registered with us? If they are not registered, we can’t command their books and trading records. They gotta be registered.
2. Testing: They should be required to test their programs before they are released in a live production trading environment. Most of the big cheetahs do this already.
3. Kill Switches: They should be required to have kill switches in the event that cheetah programs go feral. I am pleased that the Securities and Exchange Commission (SEC), some exchanges and my Agency are looking into that.
4. Wash Blocker Technology: Cheetahs should also be required to establish pre-trade risk controls with available wash blocker technology to prevent wash—or cross—trading (trading with themselves). After all, those trades are illegal.
5. Compliance Reports: I’ve also suggested that there be periodic compliance reports from the cheetahs and that the senior executives sign their names and be held responsible for any false or misleading information. The days of “he said, she said” accountability in financial markets needs to stop, and now.
6. Penalties: Finally, and this goes to accountability, too. If there is another flash crash where people are harmed (they lose money) due to a rogue cheetah, I think there needs to be steep penalties. And when I say penalties, I’m talking not just for the firm, but for individuals at the firm. If the cheetahs want to be involved in the high-flying, incomprehensible world, okay, but if you cause harm to markets and consumers, we shouldn’t stand for it.
A link to the speech is here.
A link to the Harvard Law School Forum on Corporate Governance and Financial Regulation is here.
Are you younger than 25 and/or spent your life under a rock? Never heard of “Wayne’s World”? Start here.