High-speed trading in U.S. futures markets is being dominated by a small number of firms that should be forced to register with regulators to ensure adequate oversight, the Commodity Futures Trading Commission’s former chief economist will tell lawmakers.
The firms, which can account for more than half of trading volume in some markets, should face new record-keeping rules and be required to have consistent policies and safeguards, according to Andrei Kirilenko, who left the CFTC in 2012 after he led a study of high-speed trading following the May 2010 flash crash.
“It is time to go at least this far, so when the next flash crash or technological malfunction happens, the regulators could go deeper into the market ecosystem to piece things together,” Kirilenko said in testimony prepared for a Senate Agriculture Committee hearing on high-frequency trading scheduled for today. He urges creating a broad registration category for “automated brokers and traders,” according to a copy of his remarks obtained by Bloomberg News.
Kirilenko, a professor at the Massachusetts Institute of Technology, was called to testify along with Terrence Duffy, executive chairman of CME Group Inc., and Vince McGonagle, head of the CFTC’s market oversight unit. The Senate panel is holding the hearing amid regulatory scrutiny of high-speed trading firms, which drew broader public attention when “Flash Boys” author Michael Lewis accused them of using technological advantages to rig markets and harm other investors.
The CFTC last year asked for feedback on possible new regulations for high-speed and automated trading, including whether firms should be required to register. Scott O’Malia, a Republican CFTC commissioner, said last week that the agency is beginning to consider regulatory proposals.
Ari Rubenstein, co-founder and chief executive officer of the New York-based automated firm Global Trading Systems LLC, said yesterday that additional regulatory requirements in commodity markets could help promote investor confidence.
“Certainly firms should not be acting below the radar,” Rubenstein said in a phone interview. “We’d welcome any smart regulatory infrastructure. We would absolutely be a participant in that. While it can be a headwind and it will be, it is for the benefit of the whole financial landscape and investor confidence.”
In a statement yesterday, CME’s Duffy said the current structure and protections in the futures market “strikes the right balance of regulating the market without inhibiting true price discovery.”
Kirilenko is the co-author of a study that concludes high-frequency traders earn consistent profits, often at the expense of smaller and retail participants. The research, released again last month with co-authors Jonathan Brogaard of the University of Washington and Matthew Baron of Princeton University, was based on proprietary transaction-level data collected at the CFTC about trading in the E-mini S&P 500 futures contract from August 2010 through August 2012.
The researchers concluded that a small number of firms are consistently profitable and benefit by trading faster than their rivals. The small number of firms competing for ever-faster trades can lead to inefficient investments in technology by “driving an arms race” and warding off new participants in the market, according to Kirilenko, who said regulators should investigate why the industry is concentrated among so few firms while new participants struggle to compete.
“With limited competition from new entrants to engage incumbent HFTs, we may not be seeing the gains in market quality that we would otherwise see,” he said in the Senate testimony. “The reasons for such high concentration might be benign, but the regulators should not just believe it to be so. They should get a solid understanding of why competition may not be working among the black boxes and take the steps to encourage it.”