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From Securities Regulation Daily, November 4, 2015

Chair Massad warns on disruptive automated trading

By Lene Powell, J.D.

A day after a jury issued a guilty verdict in the first criminal prosecution of the disruptive market practice of “spoofing,” CFTC Chairman Timothy Massad issued a warning to firms that use automated trading strategies. Asked what implications the verdict has for high-frequency trading firms, Massad replied, “If their algorithms are entering a lot of trades without the intention to consummate, then they should go talk to their lawyers.”

Chairman Massad also discussed challenges relating to swap data reporting and upcoming CFTC proposals to improve the quality of swaps data. In addition, the CFTC will soon publish a preliminary report looking at the swap dealer de minimis exemption, and there will be an opportunity for public comment.

Spoofing. The Dodd-Frank Act amended the Commodity Exchange Act (CEA) to add “spoofing” as a new form of prohibited market manipulation. CEA Section 4c defines spoofing as “bidding or offering with the intent to cancel the bid or offer before execution.” In the first criminal prosecution of spoofing, on November 3, 2015, a jury returned a guilty verdict on 12 counts against Michael Coscia.

According to the indictment, Coscia used an automated trading strategy in which a software program entered and canceled a series of orders in a matter of milliseconds, and nearly simultaneously entered orders in the other direction, which were executed. The cancelled orders had the effect of creating false market demand and driving prices in the desired direction. The criminal verdict against Coscia followed the CFTC’s civil case, in which Coscia and his firm were ordered in 2013 to disgorge $1.4 million in trading profits and pay a $1.4 million civil monetary penalty.

The CFTC issued guidance in 2013 on what it considers spoofing, but some uncertainty has remained. Asked if the Coscia verdict clarifies the law, Massad said, “I think it underscores that spoofing is a crime.” The CFTC will soon consider proposals relating to automated trading, including possible safeguards like kill switches, maximum order size limits, as well as whether proprietary traders should be required to register with the CFTC. Massad anticipates that the proposals will be principles-based and consistent with best practices already followed at many firms.

Swap data reporting. Massad said there has been important progress on swap data reporting since the dark days of the 2008 financial crisis, when there was virtually no data on swaps. However, significant challenges remain. In the futures markets, there are a relatively small number of reporting entities and contracts are highly standardized. In the swaps markets, there are thousands of entities reporting an infinite variety of contracts.

It is critical to have both complete and consistent data, but swap data repositories (SDRs) have reported problems on both fronts, said Massad. One SDR has produced yearly “heat maps” showing that many data fields are simply not being reported. Reporting has improved from September 2014 to September 2015, but problems remain. And, the SDRs are not sure they have the legal authority to reject submissions for incompleteness. Massad believes the CFTC should empower SDRs to validate completeness and accuracy of data, and reject submissions if there are problems. He expects that the CFTC will propose rules on this next year.

Another problem is a lack of consistency, Massad said. When the CFTC issued reporting rules, they expected the industry would standardize swap terms, but that hasn’t happened. For example, the WM Reuters FX benchmark is reported nine different ways. Therefore, the CFTC will be proposing rules to refine data fields. The agency is also tackling this issue internationally.

Swap dealer de minimis exemption. Currently, the threshold for swaps activity requiring registration as a swaps dealer is $8 billion, but the amount will fall to $3 billion in about two years unless the CFTC takes action. The CFTC is conducting a study to determine if $3 billion is an appropriate level for the threshold. Massad said the preliminary report will be released soon, with an opportunity for the public to give feedback. The report will show gaps in the data, but as a result of receiving data from swaps reporting, the CFTC is now in a position to have the conversation, said Massad.

MainStory: TopStory CommodityFutures Derivatives DoddFrankAct Enforcement Swaps

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