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CFTC Seeks to Define Elusive High-Frequency Traders

The Commodity Futures Trading Commission (CFTC) last week took a major step forward to regulate high-frequency trading (HFT) by proposing a definition for the term, which so far has proved to be elusive.

A working group of the CFTC's Technology Advisory Committee (TAC) has been been studying the HFT issue for months and unveiled the draft definition, which will serve as the basis for regulation of HFT transactions, at a day-long TAC meeting Wednesday.

"My goal is to have a working description of the attributes of HFT activities in order to better understand the impact they have on our markets...Before we implement a new regulatory regime on any continent or in cyberspace, I believe we need to agree on what and who comprises this growing segment of our markets," said CFTC Commissioner Scott O'Malia, who also is TAC chairman, in a speech last week.

He said HFT currently accounts for a majority (56% in 2011) of U.S. equity volumes and is approaching 50% of U.S. futures market transactions. "The influx of high-frequency traders [is] behind the massive trading volume increases."

Much to the chagrin of HFT traders, the working group defined HFT very broadly as a form of trading, at rapid-fire speed, that uses computer programs to make decisions in markets without human direction.

Specifically, the working group defined HFT as a form of automated trading that employs algorithms -- programs that tell a computer what it's going to do and how it's going to do it -- for decision-making, order initiation, generation, routing or execution, for each individual transaction without human direction. HFT also uses high-speed connections to markets for order entry, and high message rates (orders, quotes or cancellations), the agency said in its draft definition.

"The Commission is continuing to adapt our oversight to changing market structure, including emerging trends related to electronic trading," said CFTC Chairman Gary Gensler. "Regulators cannot assume that the algorithms in the market are well designed, tested or supervised. To give hedgers and investors confidence in markets, our regulations have to adapt to markets that are increasingly moving from man to machine."

The issue of technology in trading is an "issue that we will be continually facing as these markets morph at warp speed," said Commissioner Bart Chilton. "On the issue of high-frequency traders, who I've termed 'cheetahs,' I've been suggesting for a long time now that they be registered with our agency. We don't even know who is out there, and as a pedestrian first step they simply ought to be registered so we at least know who they are.

"Secondly, I believe that in addition to the registration requirement, we require testing of algo [algorithm] programs [both HFTs and automated trading systems] before they are engaged in the market production environment. Also, the programs should have kill switches in case they go feral," Chilton said. Moreover, "we need to require quarterly reports on their wash sales, and we need to make sure that they undertake efforts to stop those from occurring. After all, they are illegal."

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