Slowing down the U.S. futures market by requiring that offers tobuy and sell remain available for a minimum amount of time wouldhurt investors by driving up their costs, an industry trade grouptold the nation's main derivatives regulator.

The Futures Industry Association (FIA) objected to such curbs ina comment letter yesterday to the U.S. Commodity Futures TradingCommission (CFTC), which had asked for input on reshaping themarket. The regulator is considering restrictions on high-frequencytrading, which involves computers capable of automatically placingorders in thousandths of a second or less.

Mandating a minimum resting time for orders, “while technicallyfeasible, will impose higher costs,” Jim Overdahl, an FIA adviserwho helped write the comment letter, said on a call with reporterstoday. Being able to quickly revise offered prices is how marketmakers control their risk, he said.

While criticism of high-speed trading has centered on the U.S.stock market, the CFTC began a formal review of whether thepractice harms derivatives trading by issuing a concept release inSeptember, seeking responses to 124 questions. Its queries includedwhether to expand testing and supervision of automated strategiesas well as limits on how many orders a firm can place during aspecific period of time.

Avoiding Mishaps

Recent malfunctions in the U.S. stock market, including an Aug.22 software error that paused trading for thousands of companieslisted by Nasdaq OMX Group Inc., have underscored concerns aboutthe reliability of electronic markets.

Futures exchanges have largely avoided similar mishaps. Whilethere are more than 50 venues where U.S. stocks trade, which addscomplexity, futures exchanges essentially have monopolies on thecontracts they trade, given their role in clearing alltransactions. That means a trader who buys a future at CME GroupInc. must also sell it there. U.S. equity trades, on the otherhand, take place on whatever market has the best price at a givenmoment.

The CFTC is right to evaluate automated trading systems, ChicagoFederal Reserve President Charles Evans said in his own commentletter to the regulator dated yesterday.

“We wholeheartedly agree with the commission's observation thattraditional risk controls and safeguards that relied on humanjudgment and human speeds must be re-evaluated in light of newmarket structures” that support automated and electronic trading,he wrote.

About 92 percent of exchange volume in U.S. futures markets wasexecuted electronically last year, according to the CFTC's conceptrelease. The industry is vulnerable to flawed algorithms andinsufficient testing, according to the agency, which noted that CMEGroup, owner of the world's largest futures exchange, fined a firmfor inadequately supervising and testing controls.

The CFTC asked for information on a variety of topics, such ashow market participants use news and data feeds, as well as socialmedia, to construct their trading systems. It also asked how marketparticipants currently gauge the quality of offers to buy and sellfutures and how risks should be defined.

To help answer those questions, FIA conducted surveys withmembers of its principal trading group and the banks that act asfutures brokers. None of the 26 principal trading firms queriedsaid they use social media such as Twitter Inc.'s service to makedecisions on when to trade, while all firms but one said they usepricing and data feeds from exchanges.

Twitter Hoax

The risks from social media were emphasized in April whenhackers placed a false item on the Associated Press's Twitter feedthat said the White House was attacked, moving markets.

The FIA recommended in its letter that the CFTC classify tradersby how they connect to exchanges. Some firms connect directly toexchanges, bypassing their futures broker, as a way to increase thespeed with which they can buy and sell. Such a distinction would bemore valuable in determining which traders might see stricterregulation rather than trying to define “high-frequency trading,”Overdahl said.

Writing such a definition isn't “an easy thing to do, and it'snot clear it's the type of trading that you're interested in tosafeguard the system,” he said.

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