CME Pulls Plan to Update Wash Trade Rule Amid CFTC Criticism

CME Group Inc., the owner of the world’s largest derivatives market, withdrew an updated rule interpretation that bars traders from engaging in transactions with themselves amid criticism from a Commodity Futures Trading Commission official.

The Chicago-based exchange operator told traders in a notice on its website yesterday that it won’t implement the system on July 1, following discussions with the CFTC’s division of market oversight. The June 17 proposal clarified the circumstances that define wash trades.

Bart Chilton, a CFTC commissioner, said this week that CME’s proposal for the transactions needed more review. 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 in a June 24 speech. “We need to take a deep breath and ensure that we know, to the best of our ability, what might occur.”

Transactions in securities and futures markets are increasingly dominated by trading firms using computers to win the fastest executions. Chilton has said high-frequency firms sometimes place trades with themselves in ways that distort liquidity and transparency in derivatives markets and warrant more regulatory oversight.

‘Fantasy Liquidity’

Earlier this week, Chilton said he’d asked the agency to review whether high-frequency firms are engaging in the trades to create “fantasy liquidity” and entice others into the market.

The CFTC and Securities and Exchange Commission increased their focus on high-frequency and algorithmic trading after May 6, 2010, when a rout erased about $862 billion from U.S. stocks in 20 minutes.

The CFTC is improving its capability to oversee high-frequency traders and can analyze trades occurring in milliseconds, Chilton said this week. The agency’s staff have focused on activity at the start and close of trading sessions, analyzing millions of executions. During those periods, high-frequency traders engaged in between 100 and 500 trades per second in commodity markets.

CME Group is a self-regulatory organization under CFTC guidelines, meaning it can approve changes to its rules without the government agency’s pre-approval. This has allowed futures markets to adapt more quickly to changing trading and market practices versus regulatory systems where government approval is needed prior to adoption of new standards.

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