With only one dissenting voice and to some industry support, the CFTC tamped down the final shovel of earth on the grave of Regulation AT (automated trading) and finalized its “electronic trading principles” this week, writes Sam Tyfield, partner at law firm Shoosmiths, in an email to clients.
As the FIA noted the dissenting voice was of Commissioner Behnam. He said “the rulemaking seemed merely a “victory lap” without substance, simply codifying current practices, ” and asked also why the CFTC was doing this “if [risk controls] are already being done, and being done well?”
These were fair comments/questions if one’s expectations are that a rulemaking body should always seek to codify rules and “improve” market behaviour.
During the run-up to the release of early drafts of Reg AT, there was some concern among market participants in the US that “principles” which reflected existing good market practice were a mere harbinger of granular, black-and-white rules that went further than the principles or existing good market practice; what was “good practice” became “codified baseline expectations” with “good practice” being better than expectation.
This may seem an odd concern, given the market participants’ collective intention to keep the markets safe, orderly and trustworthy, however, what it does not do is recognize that market participants come in all shapes and sizes and with varyingly deep pockets and that there is no such thing as “one size fits all” for appropriate systems and controls.
This concern may well not be relevant here. I hope it is not – although I could point out that the ESMA “guidelines” on automated trading back in 2012 (which were meant to reflect practice and interpretation of existing rules) ushered in all sorts of codified requirements, rules, regulations and changes, not all of which just reflected good market practice. Some went further, and gold-plated market practice.
One observation of note that caught my eye is that there is technical strict liability on investment firms under level 1 MiFID2, Article 17(1) for an electronic trading system if it is used to manipulate or abuse the markets – with my added emphasis – “a firm shall also have in place effective systems and risk controls to ensure the trading systems cannot be used for any purpose that is contrary to Regulation (EU) No 596/2014 [the Market Abuse Regulation] or to the rules of a trading venue to which it is connected”.
I am aware that the CFTC’s Principles are not aimed primarily at “market abuse”; they are aimed at malfunctions which could lead to, or exacerbate disorderly markets. The rules in the UK and the EU27 do make a distinction between the two also, although it is difficult to draw a line between them in practice. A malfunctioning algorithm can be both abusive/manipulative and cause a disorderly market.
The other stand-out thought on the Principles is that they are aimed at “DCMs” (“designated contracts markets”) and what rules/controls they should apply to participants, not at individual investment firms. That’s equally happy-making because it avoids a significant amount of the concern I and others raised about MiFID2 and MiFIR that the rules were aimed at the “who” not the “what”.
All in all, it’s good to see the CFTC on the principles-based rule road and, with the benefit of hindsight and watching other regulators’ efforts in the same area, the CFTC and its markets will find them useful.