The Institute for Agriculture and Trade Policy (“IATP”)2 appreciates this opportunity to comment on the Commission’s proposed regulation for Automated Trading Systems (“ATS”). IATP commented on the Commission’s “Concept Release and System Safeguards for Automated Trading Environments” (“Concept Release”) in December 2013.3 We became interested in the impact of ATS on commodity prices after reading research demonstrating the sustained and high price correlations among agricultural contracts, energy contracts and the S&P E Mini Futures Index of equities resulting from High Frequency Trading (“HFT”). Indeed, as the open interest share of commodity index trading has waned somewhat, active and even aggressive HFT arbitrage strategies across all asset classes have increased.4 The Commission’s study of two years of futures contract data showed that “ATSs were presented in at least 38 percent of [agricultural] futures volume analyzed” (Federal Register, Vol: 80, No. 42, December 17, 2013, p. 78826, footnote 6).
For farmers and ranchers who rely on futures markets to provide reliable benchmarks for forward contracting row crops, livestock and soft commodities, ATS price correlations and volatility may seem a distant concern in the current below cost of production futures and forwards price environment.5 However, according to Commission’s own research, agricultural price formation is not immune to the mini-flash crashes that affected oil prices 35 times in 2015.6 If you are either hedging in the futures market or forwarding contracting in a mini-flash crash environment, price formation will be distorted to an extent and in a time frame that commercial hedging strategies will not be able to manage.
As the Commission notes in the discussion of this NPRM, IATP was among the commenters who proposed a prescriptive approach to regulating ATSs (FR 78838). Our approach was dictated by concern over HFT as a front-running trading strategy that employs ATS algorithms to disrupt market integrity and price discovery, and cash in on the induced volatility. The Commission has proposed a principles-based regulation “not intended to discriminate across registration categories, connectivity methods or even “high-frequency” or slower trading strategies. Rather, Regulation AT is focused on reducing risk, increasing transparency and disclosure and related DCM [Designated Contract Market] procedures” (FR 78828). The proposed rule focuses less on how ATS are used in algorithmic investment strategies than on the “how” of automated trading technique and risks, i.e. “automation of order origination, transmission and execution and the risks that may arise from such activity” (FR, 78827). The NPRM synthesizes and codifies industry best practices in controlling pre-trade risks and testing ATS algorithms at various points in the trading cycle from order origination to clearing.
Commissioner Christopher Giancarlo questions the need for the NPRM, suggesting that proposed Regulation AT would add no value to the industry’s own self-regulation “while adding heavy compliance costs” (FR 78945). IATP disagrees with Commissioner Giancarlo’s suggestion both that there is a “dearth of [ATS price formation disruptive] incidents” (FR 78945) to justify the NPRM and that a finalized Regulation would add no value to industry best practices. As Chairman Timothy Massad notes, “our staff estimates that roughly 35 percent of the futures trading in our markets is done by traders who use direct electronic access and are not registered with us” (FR 78944). Registration of those traders and their consequent compliance with the proposed pre-trade risk controls, algorithm testing and other requirements will add value to U.S. industry best practices. Furthermore, the Commission must finalize and implement a Regulation AT, if only to have a legal and operational basis with which to negotiate an equivalence agreement for cross-border automated trading with the European Commission concerning the rules on ATS and HFT authorized by the revised Market in Financial Instruments Directive (MiFID II), as discussed below.
IATP will respond to a few of the 168 questions posed (FR 78926-78936) in the NPRM, but not without first discussing some of the risks in a proposed rule that largely overlooks HFT trading strategies, to focus on risks attendant to ATS order origination and trade execution
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