Slower May Mean Pricier in Futures Markets

As CFTC considers restricting high-frequency futures trades by requiring a minimum resting time for orders, industry insiders say the change would drive up costs.

Slowing down the U.S. futures market by requiring that offers to buy and sell remain available for a minimum amount of time would hurt investors by driving up their costs, an industry trade group told the nation’s main derivatives regulator.

The Futures Industry Association (FIA) objected to such curbs in a comment letter yesterday to the U.S. Commodity Futures Trading Commission (CFTC), which had asked for input on reshaping the market. The regulator is considering restrictions on high-frequency trading, which involves computers capable of automatically placing orders in thousandths of a second or less.

Mandating a minimum resting time for orders, “while technically feasible, will impose higher costs,” Jim Overdahl, an FIA adviser who helped write the comment letter, said on a call with reporters today. Being able to quickly revise offered prices is how market makers 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 the practice harms derivatives trading by issuing a concept release in September, seeking responses to 124 questions. Its queries included whether to expand testing and supervision of automated strategies as well as limits on how many orders a firm can place during a specific 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 companies listed by Nasdaq OMX Group Inc., have underscored concerns about the reliability of electronic markets.

Futures exchanges have largely avoided similar mishaps. While there are more than 50 venues where U.S. stocks trade, which adds complexity, futures exchanges essentially have monopolies on the contracts they trade, given their role in clearing all transactions. That means a trader who buys a future at CME Group Inc. must also sell it there. U.S. equity trades, on the other hand, take place on whatever market has the best price at a given moment.

The CFTC is right to evaluate automated trading systems, Chicago Federal Reserve President Charles Evans said in his own comment letter to the regulator dated yesterday.

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

About 92 percent of exchange volume in U.S. futures markets was executed electronically last year, according to the CFTC’s concept release. The industry is vulnerable to flawed algorithms and insufficient testing, according to the agency, which noted that CME Group, owner of the world’s largest futures exchange, fined a firm for inadequately supervising and testing controls.

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

To help answer those questions, FIA conducted surveys with members of its principal trading group and the banks that act as futures brokers. None of the 26 principal trading firms queried said they use social media such as Twitter Inc.’s service to make decisions on when to trade, while all firms but one said they use pricing and data feeds from exchanges.


Twitter Hoax

The risks from social media were emphasized in April when hackers placed a false item on the Associated Press’s Twitter feed that said the White House was attacked, moving markets.

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

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

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