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#GDTRM15: Flash crash trader case proves gaps in surveillance - CFTC

First Published 21st May 2015

CFTC commissioner Mark Wetjen says chronic underfunding has led to inadequate surveillance and proposes partnering with exchanges. Peter Barker reports from the Global Derivatives Trading and Risk Management conference.

Mark Wetjen, Commissioner, CFTC

Mark Wetjen, Commissioner, CFTC

"From a regulatory perspective, when there is an unusual event, the immediate concern should not be whether high frequency or algorithmic trading was involved, but whether manipulation or disruptive trade practices were involved."

Amsterdam - In a bid to improve its surveillance of the derivatives marketplace and safeguard against abusive market practices, CFTC commissioner Mark Wetjen proposed accessing order book and message data from exchanges.

"To properly surveil the derivatives marketplace, the CFTC needs to have an accurate picture of market participant activity. We do not have such a picture today because we do not have regular access to order book and message data at exchanges," Wetjen told an audience at the Global Derivatives conference in Amsterdam on Thursday.

Surveillance with executed transaction data alone was not enough, said Wetjen, especially considering the changes in market structure and technological innovation.

In order to detect manipulation such as spoofing, layering, along with new types of gaming strategies, receiving order book and message data was necessary.

This data would help the CFTC understand how markets evolve and the types of participants, including what strategies they employ, what other markets they participate in, and where they hedge versus take profits, Wetjen said.

"It will help the commission understand, for instance, whether high frequency and algorithmic traders are engaging in market making strategies and providing liquidity, or engaging in alpha-seeking strategies that consume liquidity," he added.

Wetjen said that there were insufficient resources, both financial and in staff numbers, to go it alone on improving surveillance and proposed that the CFTC partner with trading venues to access and use the data.

His comments echo the sentiments of former CFTC commissioner Scott O'Malia, who dissented from a budget request last year because it did not properly fund technology. O'Malia is currently CEO of the International Swaps and Derivatives Association.

"We cannot wait for additional funding from Congress to establish a more effective surveillance programme. I propose that, as a start, the CFTC consider a partnership with the exchanges it oversees to create a joint surveillance function that analyses order book and message data," said Wetjen.

Such a joint effort could rely on the exchanges providing their technological tools, analytics software, as well as access to the data itself, he said.

Still, there is a distinction between accessing the data and turning it over to the CFTC because it lacked the technology to collect, aggregate, and analyse the information.

"The CFTC could devote its human capital to this joint effort, with the goal of expediting the training of CFTC staff and building up the agency's surveillance capabilities over time. Ideally, additional staff would be hired to help with the effort, but in the near term, existing staff could be re-assigned or devoted to the mission," he said.


Wetjen did not lay the blame for 'flash crashes' on HFT or algorithmic trading, and praised technological advances for bringing new participants providing liquidity to the derivatives markets, increasing trading volume, and narrowing bid-ask spreads.

"This is a development we should encourage given other developments affecting traditional liquidity providers, so long as we take care to address the attendant risks of an increasingly automated market," he said.

Wetjen used the 'Flash Crash' of October 15 last year as an example of the interconnectedness of derivatives and cash markets, and of the alleged market manipulation carried out by Navinder Singh Sarao as an example of how equities and derivatives markets were linked.

"These incidents also show the prevalence of high frequency and algorithmic trading. From a regulatory perspective, when there is an unusual event, the immediate concern should not be whether high frequency or algorithmic trading was involved, but whether manipulation or disruptive trade practices were involved," he said.

"Automated trading firms do not necessarily react differently from how traders have reacted historically; they just react faster."

Read Wetjen's full comments.