After the Flash Crash on May 6, 2010, the government’s primary market regulators, the Securities and Exchange Commission and the Commodity Futures Trading Commission, acted together and issued a joint report (pdf) dissecting how computer-driven trading caused stocks on the Dow Jones to plunge 9 percent in 20 minutes, temporarily vaporizing almost $1 trillion in market value.
In the three years since, the CFTC has been far more aggressive in trying to get its hands around the opaque world of high-frequency trading (HFT)—holding technology advisory committee meetings and sponsoring research into how speed traders affect market volatility. Its commissioners have also been much more vocal in discussing the problems related to HFT than their counterparts at the SEC.
It hasn’t been easy. It took the CFTC until last October just to call me up with a definition for high-frequency trading. And in March it had to shut down the research being done by visiting academics over concerns about the private data used. But at least it’s trying.
This week the CFTC made its first real stab at coming up with ways to curb algorithmic trading to make futures markets less vulnerable to electronic snafus and manipulative strategies. Among the new rules being considered are limits on the number of orders an HFT firm can place in the market and having firms register specifically as automated trading firms. Right now, most algorithmic trading is done by firms classified as hedge funds and proprietary trading firms, with no real distinction made among the strategies they use.
Market participants now have 90 days to submit comments on the 137 pages (pdf) of proposed rules. It may be a year or more before the CFTC passes anything concrete, but at least it’s moving forward. The SEC has been much more reactive and flat-footed in its response to HFT. On Thursday, SEC chairwoman Mary Jo White finally sat down with exchange executives to talk about the recent glitches that have plagued the equities markets, most notably the three-hour outage that Nasdaq experienced on Aug. 22. Encouraging, yes, but one wonders whether the meeting would’ve ever happened if Nasdaq hadn’t gone dark last month.
The outage was just the latest malfunction to affect markets under the SEC’s purview. The day before, Goldman Sachs (GS) experienced a software glitch in its trading system that accidentally spammed exchanges with false stock option orders. In April the Chicago Board Options Exchange went down for more than three hours. And just this morning, the CBOE had to halt trading again following a data feed error.
In its defense, the SEC is busy addressing enforcement issues related to the financial crisis, with the five-year statute of limitations looming. It also faces a much harder task in reining in HFT. The equities and options markets are far more complex and fragmented. Compared with the world of futures, which are confined to a smaller group of exchanges and participants, the equities market is a tangled web of order types and data feeds spread across 13 different exchanges. Still, that’s where the market is most in need of reform.
Even as HFT has been in retreat over the last year and appears to be far less profitable than it used to be, it’s not going away. It is in many ways the product of regulations the SEC put into place over the past decade to foment market competition and speed. Intended or not, this is the world the SEC created. It would do well to pick up the pace and start getting serious about addressing this new electronic world, especially as the CFTC is making headway on new rules.
If the CFTC gets too much further ahead and implements rules without the SEC doing anything, the equities markets would likely become even messier as HFT firms flee the new regulations of the futures market for the still unregulated world of stocks and options.