THE days of trading in the "pit" are long gone, replaced by powerful computers with complex programs that can execute many thousands of trades in the time it takes two traders to use hand signals.
This high-frequency trading has made headlines recently and was the focus of Senate Agriculture Committee members during a May 13 hearing that was part of a larger effort to reauthorize the Commodity Futures Trading Commission (CFTC).
High-frequency trading, a form of automated trading, can use computer algorithms and advanced technological tools to conduct trades rapidly, in fractions of a second. The technology presents new challenges and questions on how best to regulate the markets to ensure fairness and integrity.
Prior to the hearing, CFTC commissioner Scott O'Malia said the agency isn't keeping up with high-speed derivatives trading and needs to invest in tools to detect manipulative and disruptive practices.
"The CFTC lacks the technology necessary to routinely oversee the millions of messages traders send every day to futures exchanges operated by CME Group Inc. and IntercontinentalExchange Group Inc.," O'Malia said in a speech prepared for a Tabb Forum conference in Chicago, Ill.
The hearing included some discussion on how regulators could more easily investigate problems in the market. Andrei Kirilenko, the agency's former chief economist, suggested creating a broad registration category for automated brokers and traders.
"It's time for the HFT (high-frequency trading) crowd to stand up and be counted," Bart Chilton, a senior policy adviser at DLA Piper LLP and former CFTC commissioner, said in a statement. "Unless HFTs step up to the plate and support thoughtful regulation, there could very well be some moment of negative political and policy inertia that really harms the HFT business."
Senate Agriculture Committee chair Debbie Stabenow (D., Mich.) said the latest technologies like automated trading have created new sets of challenges, and oversight of the derivatives markets must evolve with the technology.
Stabenow said it's critical that regulators like CFTC have the appropriate authority and tools to sufficiently protect the markets.
"These markets have changed dramatically over the years," Stabenow said. "For a 21st-century market, we need a 21st-century regulator. That means the CFTC needs the right authority and the right tools to ensure that markets are working. That means they need enough people, and it means they need up-to-date technology."
Vince McGonagle, director of the CFTC division of market oversight, said his department faces "substantial staff shortages." If additional funds were provided to CFTC, it could conduct additional surveillance and increase staff levels to form analytics on data received on current trades.
CME Group executive chairman and president Terrence Duffy said CME has worked closely with Congress and CFTC to maintain a level playing field. He said it's important for CFTC to be funded at a level that allows it to conduct the necessary enforcement.
"I believe the CME doesn't have a credible business if we don't have a credible regulatory" body, he said of CFTC.
Following the hearing, Sen. Saxby Chambliss (R., Ga.) introduced the End-User Protection Act, which would clarify for CFTC how to best protect end users that use the futures markets to purchase commodities and use derivatives to hedge risks.
"I have seen many instances, of late, where (CFTC), in its zeal to finalize rules, has not given due consideration to those farmers, ranchers and end users (that the Dodd-Frank Wall Street Reform & Consumer Protection Act) sought to protect," Chambliss said. "Time and again, end users brought their concerns to the commission, and the end user exemptions I helped author were not honored. This bill ensures the CFTC will apply Dodd-Frank as Congress intended — not as they see fit."
One component of Chambliss' bill addresses bona fide hedging, which many in the grain industry have voiced concerns about. The term "bona fide hedging" has multiple definitions in several rules CFTC has either examined or is in the process of examining. The bill clarifies the definition and makes clear that Congress does not intend for CFTC to move forward with an overly restrictive definition.