Plan to Curb High-Frequency Wash Trades Needs Review

CFTC wants to prevent wash trades designed to increase volume and lure other investment, but CFTC member says plan isn't ready.

U.S. regulators should put on hold CME Group Inc.’s plan to block traders from engaging in transactions with themselves to ensure it sufficiently restricts the illegal trades, said Bart Chilton, a member of the Commodity Futures Trading Commission (CFTC).

CME’s plan to prevent wash trades, in which a party buys a contract from itself, should be put under review for additional time and not automatically take effect July 1, Chilton said in remarks prepared for a speech today at the Trading Show Chicago 2013 conference. Chilton, one of three Democrats on the commission, said the agency should take additional steps to vet the CME guidance and determine if other exchanges will have similar or better policies.

“Right now there are simply too many unanswered questions that need to be addressed from an oversight and surveillance perspective, and potentially from an enforcement perspective,” Chilton said. “We need to take a deep breath and ensure that we know, to the best of our ability, what might occur.”

The CFTC and Securities and Exchange Commission have increased their focus on high-frequency and algorithmic trading since May 6, 2010, when about $862 billion was erased from stock values in 20 minutes before share prices recovered from the plunge. Regulators have expressed concern that some firms and electronic exchanges don’t have enough control over trades or technology glitches that could roil markets.

 

Liquidity Distorted

Chilton has said high-frequency trading firms sometimes conduct transactions with themselves in ways that distort liquidity and transparency in derivatives markets and warrant more regulatory oversight. He said he’s asked the agency to review if high-frequency firms are engaging in the trades to create “fantasy liquidity” and entice other traders into the market.

The CFTC is improving its capability to oversee high-frequency traders and can analyze trades occurring in milliseconds, Chilton said. The agency’s staff have focused on trading activity primarily when markets were opening and closing, analyzing millions of trades. During those periods, high-frequency traders engaged in between 100 and 500 trades per second in commodity markets.

“We are going to come into your dens and look and analyze with experts your algo programs to see if you are violating the law,” Chilton said. “We won’t stop at getting your instant messages, your e-mails, or your text messages.”

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