78824 Federal Register / Vol. 80, No. 242 / Thursday, December 17, 2015 / Proposed Rules

COMMODITY FUTURES TRADING The Commission welcomes all public Senior Trial Attorney, Division of COMMISSION comments. Enforcement, [email protected] or DATES: Comments must be received on 202–418–5438; or John Dunfee, 17 CFR Parts 1, 38, 40, and 170 or before March 16, 2016. Assistant General Counsel, Office of ADDRESSES: You may submit comments, General Counsel, [email protected] or RIN 3038–AD52 identified by RIN 3038–AD52, by any of 202–418–5396. the following methods: SUPPLEMENTARY INFORMATION: Regulation Automated Trading • CFTC Web site: http:// Table of Contents AGENCY: Commodity Futures Trading comments.cftc.gov. Follow the I. Introduction Commission. instructions for submitting comments through the Comments Online process A. Overview—Development of Automated ACTION: Notice of proposed rulemaking. Trading Environment on the Web site. • B. Risks and Potential Benefits Associated SUMMARY: The Commodity Futures Mail: Send to Christopher With Automated Trading Trading Commission (‘‘CFTC’’ or Kirkpatrick, Secretary of the C. The Proposed Regulations ‘‘Commission’’) is proposing a series of Commission, Commodity Futures 1. Overview of NPRM risk controls, transparency measures, Trading Commission, Three Lafayette 2. The Proposed Regulations Under Parts 1, and other safeguards to enhance the Centre, 1155 21st Street, NW., 38, 40, and 170 II. Background on Regulatory Responses to regulatory regime for automated trading Washington, DC 20581. • Hand Delivery/Courier: Same as Automated Trading on U.S. designated contract markets A. The Commission’s Regulatory Response (‘‘DCMs’’) (collectively, ‘‘Regulation Mail, above. • Federal eRulemaking Portal: http:// to Date AT’’). The Commission’s proposals B. The Commission’s 2013 Concept Release build on efforts by numerous entities in www.regulations.gov. Follow the C. Other Recent Regulatory Responses recent years to promote best practices instructions for submitting comments. 1. SEC Regulatory Initiatives and regulatory standards for automated Please submit comments by only one 2. FINRA Initiatives trading, including standards and best method. All comments should be 3. European and Other Regulatory Initiatives practices for algorithmic trading systems submitted in English or accompanied by an English translation. Comments will D. Industry and Regulatory Best Practices (‘‘ATSs’’), electronic trade matching and Recommendations engines, and new connectivity methods be posted as received to http:// www.cftc.gov. You should submit only 1. NFA Compliance Rule 2–9: Supervision that characterize modern financial 2. FIA Reports on Automated Trading information that you wish to make markets. In 2012 the Commission 3. IOSCO Reports on Electronic Trading adopted rules requiring futures available publicly. If you wish the 4. CFTC TAC Subcommittee commission merchants (‘‘FCMs’’), swap Commission to consider information 5. FIX Risk Management Working Group dealers (‘‘SDs’’), and major swap that may be exempt from disclosure 6. Senior Supervisors Group (SSG) Briefing under the Freedom of Information Act Note participants (‘‘MSPs’’) to use automated 7. Treasury Market Practices Group Best means to screen orders for compliance (‘‘FOIA’’), a petition for confidential treatment of the exempt information Practices with certain risk-based limits. It also III. Recent Disruptive Events in Automated adopted rules requiring certain financial may be submitted according to the procedures established in 17 CFR 145.9. Trading Environments risk control requirements for DCMs IV. Overview of Regulation AT offering direct market access to their The Commission reserves the right, but A. Concept Release/Regulation AT customers. In 2013 the Commission shall have no obligation, to review, Terminology published an extensive Concept Release prescreen, filter, redact, refuse, or B. Commenter Preference for Principles- on Risk Controls and System Safeguards remove any or all of your submission Based Regulations from http://www.cftc.gov that it may C. Multi-Layered Approach to Pre-Trade for Automated Trading Environments Risk Controls and Other Measures (‘‘Concept Release’’), compiling in one deem to be inappropriate for publication, such as obscene language. D. Codification of Defined Terms Used document a comprehensive discussion Throughout Regulation AT of industry practices, Commission All submissions that have been so treated that contain comments on the 1. ‘‘Algorithmic Trading’’—§ 1.3(zzzz) regulations, and evolving concerns in 2. ‘‘Algorithmic Trading Compliance merits of the rulemaking will be automated trading.1 Now, through this Issue’’—§ 1.3(tttt) retained in the public comment file and notice of proposed rulemaking 3. ‘‘Algorithmic Trading Disruption’’— will be considered as required under the (‘‘NPRM’’) for Regulation AT, the § 1.3(uuuu) Administrative Procedure Act and other Commission seeks to update 4. ‘‘Algorithmic Trading Event’’— applicable laws, and may be accessible § 1.3(vvvv) Commission rules in response to the under FOIA. 5. ‘‘AT Order Message’’—§ 1.3(wwww) evolution from pit trading to electronic 6. ‘‘AT Person’’—§ 1.3(xxxx) FOR FURTHER INFORMATION CONTACT: trading. In particular, the Commission is 7. ‘‘Direct Electronic Access’’—§ 1.3(yyyy) proposing to adopt a comprehensive Sebastian Pujol Schott, Associate E. Registration of Certain Persons Not approach to reducing risk and Director, Division of Market Oversight, Otherwise Registered With increasing transparency in automated [email protected] or 202–418–5641; Marilee Commission—§ 1.3(x) trading. Proposed Regulation AT is Dahlman, Special Counsel, Division of 1. Concept Release Comments designed to consolidate previous work Market Oversight, [email protected] 2. Description of Regulation by industry participants, the or 202–418–5264; Mark Schlegel, 3. Policy Discussion Special Counsel, Division of Market 4. Request for Comments Commission, and fellow regulators into F. RFA Standards for Automated Trading a unified body of law addressing Oversight, [email protected] or 202– 418–5055; Michael Penick, Economist, and Algorithmic Trading Systems— automation in order placement and § 170.19 execution in U.S. derivatives markets. Office of the Chief Economist, 1. Policy Discussion [email protected] or 202–418–5279; 2. Description of Regulation 1 Concept Release on Risk Controls and System Richard Haynes, Economist, Office of 3. Request for Comments Safeguards for Automated Trading Environments, the Chief Economist, [email protected] G. AT Persons Must Become Members of 78 FR 56542 (Sept. 12, 2013). or 202–418–5063; Andrew Ridenour, an RFA—§ 170.18

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1. Policy Discussion 1. Policy Discussion I. Introduction 2. Description of Regulation 2. Description of Regulations 3. Request for Comments 3. Request for Comments A. Overview—Development of H. Pre-Trade and Other Risk Controls for V. Related Matters Automated Trading Environment AT Persons—§ 1.80 A. Calculation of Number of Persons U.S. derivatives markets have 1. Concept Release Comments on Pre-Trade Subject to Regulations historically relied on manual processes and Other Risk Controls 1. Request for Comments 2. Description of Regulation for the origination of orders, B. Calculation of Hourly Wage Rates Used transmission of information, and 3. Policy Discussion in Related Matters 4. Request for Comments execution of trades. Trading decisions C. Regulatory Flexibility Act I. Standards for Development, Testing, were typically initiated by natural Monitoring, and Compliance of 1. FCMs and DCMs persons, and transmitted through 2. AT Persons Algorithmic Trading Systems—§ 1.81 intermediaries via comparatively simple 3. Request for Comments 1. Concept Release Comments communications networks. Execution 2. Description of Regulation D. Paperwork Reduction Act 1. Information Provided by Reporting occurred in open-outcry trading pits 3. Policy Discussion operated by DCMs. Access to these pits 4. Request for Comments Entities/Persons J. Risk Management by Clearing Member a. § 1.3(x)(3)—Submissions by newly was limited to brokers and traders FCMs—§ 1.82 registered floor traders granted trading privileges by the 1. Concept Release Comments b. § 1.83(a)—Compliance reports submitted exchange. A range of other processing 2. Description of Regulation by AT Persons to DCMs and risk management services were 3. Policy Discussion c. § 1.83(b)—Compliance reports submitted equally reliant on manual processes, 4. Discussion of Persons Subject to by clearing member FCMs to DCMs and the complete trading system could Proposed §§ 1.80 and 1.82 d. § 1.83(c)—AT Person retention and move only as fast as its human decision- 5. Request for Comments production of books and records makers. Trading information was often K. Compliance Reports Submitted by AT e. § 1.83(d)—Clearing member FCM recorded on paper order tickets and Persons and Clearing FCMs to DCMs; retention and production of books and Related Recordkeeping Requirements— trading cards, and time-stamps were records recorded only to the nearest minute. § 1.83 f. § 38.401(a) and (c)—Public dissemination 1. Concept Release Comments The physical element of trading was of information by DCMs pertaining to 2. Description of Regulation reflected in exchange or Commission electronic matching platforms 3. Policy Discussion rules governing diverse matters such as g. § 40.23—Information publicly 4. Request for Comments the types of trading permitted from the disseminated by DCMs regarding self- L. Risk Controls for Trading: Direct top step of a futures pit,2 as well as trade prevention Electronic Access Provided by DCMs— requirements that certain orders for § 38.255(b) and (c) h. § 40.25—Information in public rule filings provided by DCMs regarding execution in a trading pit be recorded in 1. Concept Release Comments ‘‘non-erasable ink.’’ This basic structure 2. Description of Regulation Market Maker and Trading Incentive 3. Policy Discussion Programs remained constant for decades, and 4. Request for Comments i. § 40.26—Information provided by DCMs produced a parallel regulatory M. Disclosure and Transparency in DCM to the Division of Market Oversight upon framework also premised on natural Trade Matching Systems—§ 38.401(a) request regarding Market Maker and persons and human decision-making 1. Concept Release Comments Trading Incentive Programs speeds. 2. Description of Regulation 2. Information Collection Comments Today, derivatives markets have 3. Policy Discussion E. Cost Benefit Considerations transitioned from the manual processes 4. Request for Comments 1. The Statutory Requirement for the described above to highly automated N. Pre-Trade and Other Risk Controls at Commission to Consider the Costs and trading and trade matching systems. DCMs—§ 40.20 Benefits of its Actions Modern DCMs and DCM market 1. Concept Release Comments 2. Concept Release Comments Regarding participants, in particular, are 2. Description of Regulation Costs and Benefits 3. Policy Discussion characterized by a wide array of 3. The Commission’s Cost-Benefit algorithmic and electronic systems for 4. Request for Comments Consideration of Regulation AT— the generation, transmission, O. DCM Test Environments for AT Baseline Point Persons—§ 40.21 4. The Commission’s Cost-Benefit management, and execution of orders, 1. Concept Release Comments Consideration of Regulation AT—Cross- as well as systems used to confirm 2. Description of Regulation Border Effects transactions, communicate market data, 3. Request for Comments 5. General Request for Comment and link markets and market P. DCM Review of Compliance Reports by 6. The Commission’s Cost-Benefit participants through high-speed AT Persons and Clearing FCMs; DCM Consideration of Regulation AT— networks. Collectively, such DCM and Rules Requiring Certain Books and Proposed Definitions market participant trading systems Records; and DCM Review of Such 7. Pre-Trade Risk Controls, Testing and Books and Records as Necessary— constitute the ‘‘automated trading § 40.22 Supervision of Automated Systems, 1. Concept Release Comments Requirement to Submit Compliance 2 For example, press reports surrounding the 2. Description of Regulation Reports, and Other Related Algorithmic initiation of CME’s ‘‘top step’’ rule in the S&P 500 stock-index pit in 1987 indicated that brokers 3. Policy Discussion Trading Requirements 8. Requirements for Certain Entities to preferred the top step to ‘‘get a panoramic view of 4. Request for Comments the trading activity and quickly grab customer order Q. Self-Trade Prevention Tools—§ 40.23 Register as Floor Traders sheets being relayed by nearby clerks.’’ They 1. Concept Release Comments 9. Transparency in Exchange Trade described a trading pit where ‘‘[s]ome 400 traders 2. Commission Analysis of Amount of Self- Matching Systems are jammed shoulder-to-shoulder in the Trading in the Marketplace 10. Self-Trade Prevention amphitheater-like pit, which accounts for three- 3. Description of Regulation 11. Market-Maker and Trading Incentive fourths of the nation’s stock-index futures trading.’’ Programs See Jouzaitis, Carol, ‘‘Merc Launches ‘Top-step’ 4. Policy Discussion Reform,’’ Chicago Tribune (June 22, 1987) available 5. Request for Comments VI. Aggregate Estimated Cost of Regulation at http://articles.chicagotribune.com/1987-06-22/ R. DCM Market Maker and Trading AT business/8702160155_1_dual-trading-stock-index- Incentive Programs—§§ 40.25–40.28 VII. List of All Questions in the NPRM futures-market-chicago-mercantile-exchange.

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environment’’ at the center of Commission staff indicates that in an The largely complete transition of Regulation AT. Automated trading approximately two-year period through DCMs to electronic trade matching environments often make use of October 2014, over 95 percent of all on- platforms has occurred alongside an automated systems for either the exchange futures trading occurred on equally important shift in the generation or the execution of orders (in DCMs’ electronic trade matching technologies used by market many cases, both). Such automated platforms.6 In this regard, the participants to place and manage orders. systems are based on sets of rules or Commission notes that CME Group, the Market participants have applied a instructions (commonly referred to as largest U.S. exchange operator, range of sophisticated technological algorithms) and related computer announced in February 2015 its tools to their trading. For example, systems used to automate the execution intention to close all but one of its open- market participants are increasingly of a trading strategy.3 In futures markets, outcry trading floors for futures.7 using ATSs, often coupled with high- orders generated by automated trading IntercontinentalExchange, the second speed communication networks. Market systems are ultimately transmitted to largest DCM operator, ended all futures participants are also increasingly relying DCMs that accept, manage and match open-outcry trading in March 2008, and on electronic market and other data orders by automated means. ended all options open-outcry trading in feeds to inform trading decisions, and While technologies have evolved, the October 2012. On-exchange trading on on multiple computer algorithms to underlying functions of derivatives DCMs other than the CME Group generate, manage, or route orders to markets remain the same, as do the exchanges and DCMs. Market participants may also Commission’s responsibilities under the IntercontinentalExchange now occurs make use of direct electronic access Commodity Exchange Act (the ‘‘CEA’’ or exclusively on electronic matching and/or co-location services to minimize ‘‘Act’’). Such markets, typically platforms. Concurrent with their latencies between an ATS, market data operated by DCMs, provide valuable transition to electronic trade matching systems, and a DCM’s electronic trading risk mitigation and price discovery platforms, DCMs have taken steps to matching platform. services for numerous financial and increase the speed of trading in their Data available to the Commission physical commodities businesses, markets. These include offering co- highlights the importance of ATS including producers and consumers of location and proximity hosting services trading on DCMs today. The energy, foodstuff, metals, and other raw to reduce latencies between the DCM Commission’s analysis of data covering materials, as well as natural person and market participants, as well as the same approximately two-year period investors. The Commission is measures taken by DCMs to reduce addressed above (through October 2014) committed to the safety and integrity of processing times within their electronic indicates that ATSs were present on at U.S. markets as they continue their trade matching platform. The two least one side in almost 80 percent of rapid technological change. Through largest DCMs, for example, have for foreign exchange futures volume, 67 proposed Regulation AT, the several years indicated in their public percent of interest rate futures volume, Commission is taking its next steps in materials average or median order entry and 62 percent of equity futures volume ensuring that its regulatory standards round trip times of less than one analyzed. They were also present on at 8 and industry practices properly address millisecond. least one side in approximately 47 current and foreseeable risks arising percent of metals and energy product from automated trading, and promote 500 futures contract, the first CME product volumes. Even in agricultural products, available exclusively on Globex, including during a category not typically associated with responsible innovation and fair regular (open-outcry) trading hours in other CME competition among markets and market products. Globex monthly volume exceeded automation in recent years, ATSs were participants.4 100,000 contracts for the first time in 1997. In 1999, present in at least 38 percent of futures Within U.S. derivatives markets, CME for the first time began offering ‘‘side-by-side’’ volume analyzed. Finally, in the trading, allowing its Eurodollar contract to be aggregate, ATSs were present in over 60 DCMs represent a significant catalyst in traded both on Globex and in open-outcry during the transition to automated trading. regular trading hours. Side-by-side trading was percent of all futures volume traded From its beginnings with CME Globex expanded in the ensuing years, including for across all products in the nearly two- in 1992, DCM on-exchange trading now example to FX products in 2001. Globex average year period that the Commission daily volume exceeded 1,000,000 contracts for the examined. In highly liquid product occurs almost exclusively on electronic first time in 2002. By 2004, Globex trading volume matching platforms, using internal began exceeding open-outcry volume for the first categories, ATSs represented both sides algorithms to rapidly match incoming time. Through agreements or mergers, CME began of the transaction over 50 percent of the listing NYMEX products (2006) and CBOT products time.9 orders from an array of market (2007) on Globex as well. See Aldinger, Lori, and 5 Market participants using ATSs may participants. Data available to Labuszewski, John W., ‘‘ELECTRONIC TRADING Twenty Years of CME Globex’’ (2012), available at transact on DCMs through registered 3 See IOSCO Report on Regulatory Issues Raised http://www.cmegroup.com/education/files/globex- intermediaries, including their clearing by Technological Changes, infra note 103 at 10. retrospective-2012-06-12.pdf. members. Such intermediaries 4 See CEA Section 3, ‘‘Findings and Purposes,’’ 6 Haynes, Richard & Roberts, John S., ‘‘Automated themselves often rely on extensive noting in Section 3(a) that transactions subject to Trading in Futures Markets,’’ CFTC Office of Chief automation, using ATSs for functions the CEA are ‘‘affected with a national public Economist (Mar. 13, 2015), available at http:// interest’’ and in Section 3(b) that ‘‘[t]o foster these www.cftc.gov/ucm/groups/public/@economic ranging from simple order routing to the public interests, it is further the purpose of this Act analysis/documents/file/oce_automatedtrading.pdf. generation of independent trading to deter...any other disruptions to market 7 See CME Press Release, ‘‘CME Group to Close decisions. These registered integrity; to ensure the financial integrity of all Most Open Outcry Futures Trading in Chicago and intermediaries include FCMs, transactions subject to the Act and the avoidance New York by July; Most Options Markets to Remain of systemic risk;...and to promote responsible Open,’’ (Feb. 4, 2014) available at http:// commodity pool operators (‘‘CPOs’’), innovation and fair competition among boards of cmegroup.mediaroom.com/2015-02-04-CME-Group- commodity trading advisors (‘‘CTAs’’), trade...and market participants.’’ to-Close-Most-Open-Outcry-Futures-Trading-in- introducing brokers (‘‘IBs’’), and floor 5 Trading on CME Globex was initially limited to Chicago-and-New-York-by-July-Most-Options- brokers (‘‘FBs’’). In addition, ‘‘after-hours’’ periods when the Exchange’s open- Markets-to-Remain-Open?pagetemplate=article. Commission-registered SDs and MSPs outcry pits were closed. The first products offered 8 See CME Group, ‘‘The World’s Leading on Globex in 1992 included German mark and Electronic Platform: CME Globex,’’ (2014) at 3, Japanese yen futures and options on futures available at http://www.cmegroup.com/globex/files/ http://ir.theice.com/∼/media/Files/I/Ice-IR/annual- contracts, followed by other FX and currency globexbrochure.pdf; IntercontinentalExchange, reports/2010/ice-2010ar.pdf. products. In 1997, CME launched the E-mini S&P 2010 Annual Report, (2011) at 26, available at 9 See Haynes & Roberts, supra note 6 at 4.

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may use ATSs to conduct trading on tools to engage in unlawful conduct); more prominent as automated trading DCMs. As discussed in more detail transmission risks (shocks based on becomes the dominant market model. below, each of these categories of erroneous orders impacting multiple The Commission notes that Commission registrants may be subject markets); clearing and settlement risks Regulation AT generally does not to Regulation AT in the event that they (as more firms gain access to trading address trading activity on swap conduct algorithmic trading on a DCM. platforms, trades may not be subject to execution facilities (‘‘SEFs’’). The sufficient settlement risk mitigation Commission believes that neither B. Risks and Potential Benefits execution nor order entry on SEF Associated With Automated Trading techniques); and risks to effective risk management (the speed of trade markets are sufficiently automated at Regulation AT proposes a series of execution may make critical risk this time to require the degree of pre-trade risk controls and other mitigation devices less effective). automated safeguards proposed measures intended to address the risks herein.14 In addition, Regulation AT is Notwithstanding the risks described related to automated trading on DCMs. not proposing a number of measures above, several commentators have The proposed rules primarily address discussed in the Concept Release, such argued that algorithmic trading results operational risk issues, as well as as the following: Proposals to in a more efficient marketplace. A related issues such as self-trading and implement various post-trade reports recent study of the equities market market maker and trading incentive (post-order drop copies, post-trade drop programs. concluded that algorithmic trading copies, and post-clearing drop copies), The potential risks of automated narrows spreads, reduces adverse ‘‘reasonability checks’’ on incoming trading were recently described in a selection, and reduces trade-related 11 market data used by firms operating report discussing the events of October price discovery. The study also automated systems, policies and 15, 2014, when the market for U.S. suggested that algorithmic trading procedures for identifying ‘‘related’’ Treasury securities, futures, and other improves liquidity and enhances the contracts, and proposals to standardize closely related financial markets information provided in quotes. and simplify order types, each of which experienced an unusually high level of Another recent study of low latency was discussed in the Concept Release.15 volatility and a very rapid round-trip in activity in the equities market (typically Market participants using automated prices. On July 13, 2015, five regulatory associated with high frequency trading) trading include an important population agencies issued a joint staff report on concluded that ‘‘an increase in low- of proprietary traders that, while the unusual market events of October latency activity reduces quoted spreads responsible for significant trading 15, 2014 (the ‘‘October 15 Joint Staff and the total price impact of trades, volumes and liquidity in key futures Report’’).10 In addition to discussing the increases depth in the limit order book, products, are not registered with the events of October 15, the report includes and lowers short-term volatility.’’ 12 Commission. These unregistered an Appendix C that summarizes many C. The Proposed Regulations proprietary traders include a number of of the risks of automated trading. These traders engaged in high-frequency risks include the following: Operational 1. Overview of NPRM trading (‘‘HFT’’). The Commission risks (ranging from malfunctioning and notes, however, that the risk control incorrectly deployed algorithms to The Commission is pursuing a requirements under proposed algorithms reacting to inaccurate or number of goals in proposed Regulation Regulation AT do not vary in response unexpected data); market liquidity risks AT. As an overarching goal, the to a market participant’s algorithmic (arising from abrupt changes in trading Commission seeks to update trading strategies; the same risk controls strategies even when a firm executes its Commission rules in response to the would be required in connection with strategy perfectly); market integrity risks evolution from pit trading to electronic high-frequency and low-frequency (automated trading can provide new trading. The risk controls and other algorithmic trading. In particular, HFT rules proposed in this NPRM are is not specifically identified under the 10 See Joint Staff Report: The U.S. Treasury focused on algorithmic order origination proposed regulations, and is not Market on October 15, 2014 (July 13, 2015) or routing by market participants, and regulated in a different fashion from [hereinafter ‘‘October 15 Joint Staff Report’’], electronic order execution by DCMs. In prepared by the U.S. Department of Treasury, Board other types of algorithmic trading under of Governors of the Federal Reserve System, Federal addition to mitigating risks arising from proposed Regulation AT. Instead, the Reserve Bank of New York, U.S. Securities and algorithmic trading activity, the proposed regulations focus on Exchange Commission, and U.S. Commodity proposed rules are intended to increase automation of order origination, Futures Trading Commission, available at http:// transparency around DCM electronic cftc.wss/OCE/conceptrelease/documentlibrary/ transmission and execution, and the Regulation%20AT/Reg%20AT%20--%20DRAFT trade matching platforms and the use of risks that may arise from such activity. %20PREAMBLE/October%2015%20report/ self-trade prevention tools on DCMs.13 As discussed above, nearly universal treasury-market-volatility-10-14-2014-joint- Furthermore, the proposed rules are electronic order matching at DCMs is report.pdf. The report discusses the preliminary intended to foster transparency with findings regarding the conditions that may have contributed to the October 15 volatility, particularly respect to DCM programs and activities, 14 The requirements on DCMs arising out of in the ‘‘event window’’ that began at 9:33 a.m. ET. including market maker and trading Regulation AT may ultimately be imposed on SEFs. Among other potential causes of this volatility, the incentive programs, that have become However, an important consideration for the October 15 Joint Staff Report states that several Commission is that SEFs and SEF markets are much large transactions occurred between the release of newer and less liquid than the more established and certain U.S. retail sales data and the start of the 11 See, e.g., Hendershott, Jones and Menkveld, liquid DCMs and DCM markets. While SEFs and event window; that there was a significant ‘‘Does Algorithmic Trading Improve Liquidity?,’’ SEF markets are still in this nascent stage, the reduction in market depth following the retail sales The Journal of Finance, Vol. LXVI, No. 1 (Feb. Commission does not want to impose additional data release, which appears to have resulted from 2011), available at http://faculty.haas.berkeley.edu/ requirements that may have the effect of decreasing a high volume of transactions and bank-dealers and hender/algo.pdf. the number of SEFs or decreasing liquidity. For principal trading firms changing their participation 12 See Hasbrouck and Saar, ‘‘Low-latency these reasons, and in light of the lesser degree of in the cash and futures order books; that latency trading,’’ Journal of Financial Markets 16 (2013) at automation in SEF markets, the policy associated with a significant increase in message 646–679, available at http://people.stern.nyu.edu/ considerations underlying Regulation AT are not as traffic due to order cancellations increased just jhasbrou/Research/LowLatencyTradingJFM.pdf. critical, at least at this time, in the SEF context. before the event window; and there was a higher 13 See section IV(Q) below for a discussion of the 15 See Concept Release, 78 FR at 56569–73 for a incidence of ‘‘self-trading’’ during the event term ‘‘self-trade’’ and proposed regulations with summary of measures discussed in the Concept window. Id. at 4–6. respect to self-trade prevention. Release.

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increasingly complemented by regulations that may be impacted by the requiring AT Persons and their clearing algorithmic order origination among growth of automated trading member FCMs to provide to DCMs market participants. Against this environments. annual compliance reports, and to keep backdrop, the Commission believes that In preparing this NPRM, the and provide upon request to DCMs appropriate pre-trade and other risk Commission has reviewed relevant certain related books and records. controls are necessary at the level of industry practices, measures taken by Regulation AT also proposes to market participants, clearing FCMs, and other U.S. and foreign regulators, and amend part 38 of the Commission’s DCMs, in order to ensure the integrity best practices or guidance set forth by regulations. Specifically, it would of Commission-regulated markets and other informed parties. In these sources amend existing § 38.255—Risk controls provide market participants with greater and comments received in response to for trading, to require DCMs to have in confidence that intentional, bona fide the Concept Release, the Commission place systems reasonably designed to transactions are being executed. has identified an emerging consensus facilitate the FCM’s management of the Principal elements of Regulation AT around pre-trade risk controls for risks that may arise from their for market participants and clearing automated trading and supervision customers’ Algorithmic Trading using FCMs include: (i) Codification of standards for ATSs. The Commission Direct Electronic Access. Regulation AT defined terms used throughout also notes comments received in would also make corresponding changes Regulation AT; (ii) registration of certain response to the Concept Release that are to the discussion of risk controls in entities not otherwise registered with supportive of risk controls placed in Appendix B—Guidance on, and the Commission; (iii) new algorithmic multiple stages across the life-cycle of Acceptable Practices in, Compliance trading procedures for trading firms and order generation, transmission, with Core Principles (Subsection clearing firms, including pre-trade and management and execution (i.e., similar (b)(5)—Acceptable Practices for Risk other risk controls; (iv) testing, risk controls placed at the levels of controls for trading). Finally in part 38, monitoring, and supervision market participants, clearing member Regulation AT would amend existing requirements for ATSs; and (v) FCMs, and DCMs). Proposed Regulation § 38.401(a) to require DCMs to provide requirements that certain persons AT attempts to balance flexibility in a additional public disclosure regarding submit compliance reports to DCMs rapidly changing technological their electronic matching platforms. regarding their ATSs. Principal landscape with the need for a regulatory Regulation AT would also amend part elements for DCMs include: (i) New risk baseline that provides a robust and 40 of the Commission’s regulations. It controls for Direct Electronic Access sufficiently clear standard for pre-trade would create the following new (‘‘DEA’’) provided by DCMs; (ii) risk controls, supervision standards, and regulations: § 40.20—requiring DCMs to transparency in DCM electronic trade other safeguards for automated trading implement pre-trade risk controls and matching platforms; and (iii) new risk environments. The specific regulations other related measures; § 40.21— control procedures, including pre-trade and amendments proposed by requiring DCMs to provide a test risk controls, compliance report review Regulation AT are discussed in greater environment to AT Persons; § 40.22— standards, self-trade prevention tool detail below. requiring DCMs to implement a review requirements, and market-maker and program for compliance reports 2. The Proposed Regulations Under regarding Algorithmic Trading trading incentive program disclosure Parts 1, 38, 40, and 170 and related requirements. submitted by AT Persons and clearing Regulation AT proposes new As mentioned above, Regulation AT is member FCMs, require that certain regulations or amendments to existing not intended to discriminate across books and records be maintained by regulations in parts 1, 38, 40, and 170 registration categories, connectivity such persons, and review such books of the Commission’s regulations. It methods, or even ‘‘high-frequency’’ or and records as necessary; § 40.23— proposes to amend part 1 by inserting slower trading strategies. Rather, requiring DCMs to implement self-trade the following defined terms: § 1.3(tttt)— Regulation AT is focused on reducing prevention tools, mandate their use, and Algorithmic Trading Compliance Issue; risk, increasing transparency and publish statistics concerning self- § 1.3(uuuu)—Algorithmic Trading disclosure, and related DCM trading; and §§ 40.25–40.28—requiring Disruption; § 1.3(vvvv)—Algorithmic DCMs to provide disclosure and procedures.16 In developing Regulation Trading Event; § 1.3(wwww)—AT Order implement other controls regarding AT, the Commission built on the Message; § 1.3(xxxx)—AT Person; their market maker and trading Concept Release and relevant comments § 1.3(yyyy)—Direct Electronic Access; incentive programs. Finally, Regulation received, which are discussed further in and § 1.3(zzzz)—Algorithmic Trading. AT would make changes to the section II(B) below. However, interested Regulation AT also proposes to amend definition of Rule in § 40.1(i) in parties will observe that the existing § 1.3(x), which defines Floor response to certain of the changes Commission has chosen not to pursue Trader. proposed above. certain measures discussed in the In addition, Regulation AT would Finally, Regulation AT proposes to Concept Release (as discussed above), create a new subpart A in part 1 that amend part 170 of the Commission’s while also proposing a small number of includes the following new regulations regulations. It would require in new new measures not addressed in the applicable to AT Persons and their § 170.18 that all AT Persons become Concept Release. In addition, Regulation clearing FCMs: § 1.80—requiring AT members of at least one registered AT in certain cases seeks only to clarify Persons to implement pre-trade risk futures association (‘‘RFA’’). Regulation the scope of existing Commission controls and other related measures; AT would create a new subpart D in § 1.81—requiring AT Persons to part 170, and require in proposed 16 See, e.g., the compliance reports required to be submitted by AT Persons and clearing member implement standards for the § 170.19 that RFAs adopt membership firms of AT Persons under § 1.83, the statistics development, testing, monitoring, and rules, as deemed appropriate by the required to be reported by DCMs regarding self- compliance of their ATSs; § 1.82— RFA, requiring pre-trade risk controls trading that they have both authorized and requiring clearing member FCMs to and other measures for ATSs; standards prevented on their platforms under § 40.23, and the disclosure required of DCMs with respect to market implement pre-trade risk controls and for the development, testing, maker and trading incentive programs under other related measures for orders from monitoring, and compliance of ATSs; § 40.25. their AT Person customers; and § 1.83— designation and training of algorithmic

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trading staff; and clearing FCM risk ‘‘policies and procedures governing the implemented by Commission registrants management standards. use, supervision, maintenance, testing, or other market participants. The and inspection’’ of automated trading Concept Release reflects the II. Background on Regulatory programs.23 The Commission also Commission’s ongoing commitment to Responses to Automated Trading adopted regulations requiring SDs and the safety and soundness of U.S. A. The Commission’s Regulatory MSPs that are clearing members to derivatives markets in times of Response to Date ensure that their ‘‘use of trading technological change, including the programs is subject to policies and growth of automated trading. The Commission has responded to the procedures governing the use, The Concept Release was published development of automated trading supervision, maintenance, testing, and in the Federal Register on September environments through a number of inspection of the program.’’ 24 12, 2013.27 The initial 90-day comment regulatory measures that address risk Finally, the Commission adopted final period closed on December 11, 2013, controls within both new and existing rules implementing new authority but was reopened from January 21 categories of registrants, including under the CEA to, among other things, through February 14, 2014, in DCMs, SEFs, FCMs, SDs, MSPs and broadly prohibit manipulative and conjunction with a meeting of the 17 others. While focused to a degree on deceptive devices and price CFTC’s Technology Advisory financial and related risks, these manipulation.25 The Commission also Committee (‘‘TAC’’). The Concept provisions reflect the Commission’s provided guidance on the scope and Release requested public comment on ongoing commitment to maintaining the application of CEA Section 4c(a)(5), 124 separate questions regarding the safety and soundness of automated which makes it unlawful for any person necessity and operation of potential pre- trading in modern derivatives markets. to engage in any trading, practice, or trade risk controls, post-trade reports The Commission has adopted conduct on or subject to the rules of a and other measures, system safeguards regulations with respect to DCMs and registered entity that violates bids or and additional protections (such as SEFs that require exchanges to establish offers, demonstrates intentional or proposals to identify ‘‘related’’ contracts risk control mechanisms to prevent reckless disregard for the orderly on trading platforms, and proposals to market disruptions, including execution of transactions during the standardize and simplify order types). mechanisms that pause or halt trading.18 closing period, or is, is of the character The Concept Release served as a vehicle The guidance and acceptable practices of, or is commonly known to the trade to catalogue existing industry practices, to the SEF and DCM rules in part 37 and as, ‘‘spoofing.’’ 26 determine their efficacy and 38, respectively, provide examples of implementation to date, and evaluate 19 B. The Commission’s 2013 Concept acceptable risk controls. In addition, the need for additional measures. The Release in the DCM final rules, the Commission Concept Release was not a proposed adopted new risk control requirements Overview of Concept Release. As rule, but rather a prior step designed to for exchanges that provide DEA to noted above, in 2013 the Commission facilitate a public dialogue and educate clients. Regulation 38.607 requires issued a ‘‘Concept Release on Risk the Commission so that it may make an DCMs that permit DEA to have effective Controls and System Safeguards for informed determination as to whether systems and controls reasonably Automated Trading Environments,’’ rulemaking is necessary and, if so, the designed to facilitate an FCM’s which provided an overview of the substantive requirements of such a management of financial risk.20 automated trading environment and rulemaking. The Commission also adopted discussed a series of pre-trade risk Topics Discussed in Concept Release. relevant regulations for FCMs, SDs, and controls, post-trade reports and other The Concept Release highlighted data MSPs. Such firms that are clearing measures, system safeguards, and on the increased importance of members must establish risk-based additional protections that could be electronic and algorithmic trading limits based on position size, order size, across a number of U.S. markets margin requirements, or similar factors 23 17 CFR 1.11(e)(3)(ii). The Commission notes (including equities, futures and fixed for all proprietary accounts and that the requirements of § 1.11(e)(3)(ii) fall within income markets). The Concept Release an FCM’s broader obligation in § 1.11 to establish 21 customer accounts. The regulations, and maintain a formal ‘‘Risk Management also noted that the infrastructure of codified in §§ 1.73 and 23.609, also Program.’’ Such program must include a risk automated trading environments has require these entities to ‘‘use automated management unit independent of the business unit; progressively decreased the time quarterly risk exposure reports to senior means to screen orders for compliance management and the governing body of the FCM, necessary to process orders and execute with the [risk] limits’’ when such orders with copies to the Commission; and other trades, reducing the communication are subject to automated execution.22 In substantive requirements. Proposed Regulation AT times between market participants and addition, § 1.11 requires FCMs to have would not require FCMs to subsume applicable trading venues.28 One exchange group requirements into their § 1.11 Risk Management ‘‘automated financial risk management Programs. However, the Commission is seeking now indicates that its ‘‘median inbound controls reasonably designed to prevent public comment in the questions below regarding latency for order entry’’ on its trading the placing of erroneous orders’’ and whether, in any final rules arising from this NPRM, platform is fifty-two (52) microseconds FCMs should in fact be required to incorporate within its ‘‘four walls.’’ 29 As discussed 17 elements of Regulation AT proposed in §§ 1.80, These measures are discussed in more detail in 1.81, 1.83(a), and 1.83(c) into their § 1.11 Risk in the Concept Release, advances in the Concept Release. See Concept Release, 78 FR at Management Programs. Such incorporation could trading speeds are partly due to the 56548. help improve the interaction between an FCM’s 18 development of dedicated fiber-optic See Core Principles and Other Requirements for operational risk efforts pursuant to § 1.11(e)(3)(ii) and microwave communications Designated Contract Markets, 77 FR 36612, 36703 and its pre-trade risk controls and development, (June 19, 2012) [hereinafter ‘‘DCM Final Rules’’]; monitoring, and compliance efforts pursuant to networks that have dramatically Core Principles and Other Requirements for Swap §§ 1.80, 1.81, 1.83(a), and 1.83(c). It could also help reduced transmission times across large Execution Facilities, 78 FR 33476, 33590 (June 4, ensure that an FCM’s §§ 1.80, 1.81, 1.83(a), and 2013) [hereinafter ‘‘SEF Final Rules’’]. 1.83(c) processes benefit from the same internal 27 Concept Release, 78 FR 56542. 19 See DCM Final Rules, 77 FR at 36718; SEF rigor and independence required by § 1.11. 28 See id. at 56546–47. Final Rules, 78 FR at 33601. 24 17 CFR 23.600(d)(9). 29 See CME Group, ‘‘The World’s Leading 20 See 17 CFR 38.607. 25 See 17 CFR 180.1 and 180.2. Electronic Platform. CME Globex,’’ (2014) at 3, 21 17 CFR 1.73(a)(1) and 23.609(a)(1). 26 See Antidisruptive Practices Authority, 78 FR available at http://www.cmegroup.com/globex/files/ 22 17 CFR 1.73(a)(2)(i) and 23.609(a)(2)(i). 31890 (May 28, 2013). globexbrochure.pdf.

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distances.30 On a smaller scale, co- concern is that market participants may the Futures Industry Association location and proximity hosting are two simply engage in trading at speeds (‘‘FIA’’) conducted surveys to gauge common methods for reducing the beyond the abilities of their risk existing risk-management practices. distance, and thus latency, between management systems, or those tasked Other commenters provided academic market participants and the exchanges. with monitoring their activity. Risk papers in support of their points of Co-location services are now provided management systems operating at these view. by most large electronic trading misaligned speeds could allow an active Staff reviewed all comments received platforms within the United States. algorithm to breach its prescribed risk and made recommendations to the Another important latency-reducing controls and disrupt one or more Commission. This NPRM reflects the advance in connectivity discussed in markets. Commission’s decision to propose the Concept Release is Direct Market In light of the potential for disruptive regulations in certain areas addressed by Access (‘‘DMA’’). For purposes of the trading events related to such high- the Concept Release, including: Concept Release, the Commission speed algorithmic trading, the Concept Registration of certain entities not defined DMA as a connection method Release addressed 23 potential risk otherwise registered with the that enables a market participant to controls and other measures broadly Commission; enhanced identification of transmit orders to a trading platform grouped into four categories. The first orders placed on exchanges; pre-trade without reentry or prior review by includes ‘‘pre-trade risk controls,’’ such risk controls at exchanges, trading firms systems belonging to the market as controls designed to prevent potential and clearing firms; standards for participant’s clearing firm.31 DMA can errors or disruptions from reaching development, testing and supervision of be provided directly by an exchange or trading platforms, or to minimize their algorithmic systems; trading firm and through the infrastructure of a third- impact once they have. A second clearing member FCM compliance party provider, but in all cases, DMA category of safeguards includes ‘‘post- reports regarding algorithmic trading; implies that an order is not routed trade reports’’ and ‘‘other post-trade and self-trade prevention tools. through a clearing firm prior to reaching measures.’’ Examples in this category Regulation AT also addresses several the trading platform.32 For purposes of include reports that promote the flow of areas not covered in the Concept Regulation AT, as discussed in section order, trade and position information; Release, including transparency in IV(D)(7) below, the Commission uniform trade adjustment or exchange trade matching systems and proposes to define a slightly modified cancellation policies; and standardized market-maker protections, and in term: ‘‘Direct Electronic Access’’ error trade reporting obligations. The certain cases seeks to clarify the scope (‘‘DEA’’), as opposed to Direct Market third category of risk controls discussed of existing Commission regulations that Access. Despite the slightly modified in the Concept Release is termed may be impacted by the growth of name, the Commission intends that the ‘‘system safeguards,’’ including automated trading environments. term ‘‘Direct Electronic Access’’ has a safeguards for the design, testing and meaning similar to ‘‘Direct Market supervision of ATSs, as well as C. Other Recent Regulatory Responses Access,’’ as such term was used in the measures such as ‘‘kill switches’’ that 1. SEC Regulatory Initiatives Concept Release.33 facilitate emergency intervention in the The SEC has recently taken regulatory The Concept Release discussed a set case of malfunctioning ATSs.35 Finally, steps related to automated trading, of risk controls that would be intended the Concept Release presented a fourth aimed at preventing instability in the to operate at the same rapid speed at category of measures focusing on equities markets. Most significantly, the which trading occurs in the automated various options for improving market SEC adopted the Market Access Rule trading environment. As the industry functioning or structure. reduces latency through improvements Comments Received on Concept and Regulation SCI. in technologies for the generation, Release and Commission Response. The The Securities Exchange Act Rule transmission and execution of orders or Commission received a total of 43 15c3–5—Risk Management Controls for management of other data, there is public comments on the Concept Brokers or Dealers with Market Access concern that the drive for ever lower Release, including comments from (the ‘‘Market Access Rule’’), adopted in latencies may lead to a competitive race DCMs, an array of trading firms, trade November 2010, requires brokers and toward progressively less stringent risk associations, public interest groups, dealers to have risk controls in place controls.34 A separate, but related, members of academia, and consulting, before providing their customers with 36 technology and information service access to the market. Specifically, the 30 See Concept Release, 78 FR at 56546. providers in the financial industry. All Market Access Rule requires risk 31 See id. comments are available on controls that prevent entry of (i) orders 32 See id. www.cftc.gov. Many of the comments exceeding appropriate pre-set credit or 33 The Commission notes that the term ‘‘direct received are detailed and thorough, and capital thresholds in the aggregate for electronic access’’ is also used in existing each customer and the broker-dealer; Commission regulation 38.607. Regulation AT does not modify § 38.607, and the term ‘‘direct electronic at 2 [hereinafter ‘‘CFTC TAC Recommendations’’], and (ii) erroneous orders, by rejecting access’’ in § 38.607 will continue to have the available at http://www.cftc.gov/ucm/groups/ orders that exceed appropriate price or meaning specified in that section. public/@swaps/documents/dfsubmission/ size parameters, on an order-by-order 34 As noted by the Futures Industry Association’s tacpresentation030111_ptfs2.pdf. basis or over a short period of time, or 35 Market Access Working Group, for example: ‘‘[p]re- As explained in section IV(A) below, the those that indicate duplicative orders.37 trade risk controls have become a point of Concept Release used the term ‘‘ATS’’ or negotiation between trading firms and clearing ‘‘automated trading system’’ to refer to the members because they can add latency to a trade.’’ algorithms used to automate the generation and 36 See Market Access Rule, 75 FR 69792 (Nov. 15, See FIA Market Access Risk Management execution of a trading strategy. For purposes of this 2010); see also SEC Press Release No. 2010–210, Recommendations, infra note 97 at 8. Similarly, the NPRM, the Commission has determined to use the ‘‘SEC Adopts New Rule Preventing Unfiltered TAC’s Pre-Trade Functionality Subcommittee noted term ‘‘Algorithmic Trading’’ or ‘‘algorithmic trading Market Access’’ (Nov. 3, 2010), available at http:// that latency is a key area where trading firms and system’’ (abbreviated as ATS), as opposed to the www.sec.gov/news/press/2010/2010-210.htm. brokers are competing to gain an advantage. See term ‘‘automated trading system.’’ For purposes of 37 See Market Access Rule, supra note 36 at TAC Pre-Trade Functionality Subcommittee, discussing comments to the Concept Release, the 69825–26; see also SEC, Responses to Frequently ‘‘Recommendations on Pre-Trade Practices for Commission may use the terms ATS and automated Asked Questions Concerning Risk Management Trading Firms, Clearing Firms, and Exchanges trading system as such terms were used in the Controls for Brokers or Dealers with Market Access Involved in Direct Market Access’’ (Mar. 1, 2011) Concept Release. (Apr. 15, 2014), available at https://www.sec.gov/

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These risk controls must be under the was originally designed to accommodate activities such as insider trading and direct and exclusive control of the exchange specialists and other floor market manipulation, and improve the broker-dealer (subject to certain members that might need to conduct ability to reconstruct broad-based exceptions) and regularly reviewed for limited hedging or other off-exchange market events in an accurate and timely effectiveness.38 In October 2013, the activities ancillary to their business.43 manner.49 The SROs submitted the plan SEC brought its first enforcement action Over time, proprietary trading firms on September 30, 2014.50 In addition, in under the Market Access Rule, securing were able to take advantage of this response to policy recommendations a $12 million settlement with Knight exemption.44 The SEC’s proposed rules resulting from the Flash Crash events of Capital in connection with the firm’s would amend the exemption to target May 6, 2010, the SEC and the securities August 2012 trading incident that those broker-dealers for which it was industry implemented market-wide disrupted the markets.39 originally designed, and require broker- circuit breakers as well as a ‘‘limit up- On November 19, 2014, the SEC dealers trading in off-exchange venues limit down’’ mechanism in order to adopted Regulation Systems to become members of a national moderate price volatility in individual Compliance and Integrity (‘‘Reg SCI’’).40 securities association. In the securities securities.51 The SEC is also working to Reg SCI applies to alternative trading markets, this association is the Financial update its regulatory regime to improve systems, certain self-regulatory Industry Regulatory Authority firms’ risk management of trading organizations (including registered (‘‘FINRA’’).45 algorithms and to enhance regulatory clearing agencies), plan processors, and The SEC’s Chair explained that the oversight over their use.52 The SEC is exempt clearing agencies (collectively, proposed rule ‘‘embodies a simple but also developing an anti-disruptive ‘‘SCI entities’’). Under Reg SCI, SCI powerful principle of the federal trading rule to address the use of entities are required to have securities laws—the protection of aggressive, potentially destabilizing comprehensive policies and procedures investors and the stability of our trading strategies during vulnerable in place for their technological systems. markets require that trading is overseen market periods.53 The SCI entities must, among other by both the Commission and a strong Finally, while not directly relevant to 46 things, take appropriate corrective self-regulatory organization.’’ In its Commission-regulated markets, the SEC action when systems issues occur; preamble to the proposed rule, the SEC is working with equities exchanges and provide notifications and reports to the explained that, in the event that a FINRA to minimize latency between SEC regarding systems problems and broker-dealer trades electronically different market feeds. Specifically, systems changes; inform members and across a range of exchange and off- exchanges must not transmit data participants about systems issues; exchange venues, an individual directly to customers any sooner than conduct business continuity testing; exchange of which the broker-dealer is they transmit data to a securities implement standards that result in SCI a member may be unable to effectively information processor (‘‘SIP’’), the systems being designed, developed, regulate the off-exchange activity of the system that consolidates market feeds tested, maintained, operated, and broker-dealer, because the exchange from all platforms and publishes the may lack the resources or expertise to public price ticker. In addition, the surveilled in a manner that facilitates 47 the successful collection, processing, oversee such off-exchange activity. technology used for transmitting data to and dissemination of market data; and The SEC viewed FINRA, the self- the SIP must be on a par with what is regulatory organization (‘‘SRO’’) to used for transmitting data to direct conduct annual reviews of their 54 automated systems, which must be which off-exchange trades are reported, feeds. Finally, the SEC is working to as being in the best position to regulate address concerns associated with the summarized in a report that is provided cross-market activity by broker- fragmentation of trading venues, dark to the SEC.41 dealers.48 trading venues, and broker conflicts.55 The SEC has also taken action in the The SEC has taken additional 2. FINRA Initiatives area of enhancing oversight of regulatory initiatives in this area. On proprietary trading firms. In March July 11, 2012, the SEC adopted Rule 613 In addition to the SEC, FINRA is 2015, the SEC proposed a rule that under Regulation NMS, requiring SROs developing rules focused on automated would narrow an exemption that to submit a plan to the SEC to create, trading and transparency in the equities currently exempts certain broker-dealers implement, and maintain a consolidated markets. In March 2015, FINRA from membership in a national published a Request for Comment 42 audit trail (‘‘CAT’’). This audit trail is securities association. The exemption intended to increase the data available proposing to require registration (as a to regulators investigating illegal ‘‘Limited Representative—Equity divisions/marketreg/faq-15c-5-risk-management- Trader’’) persons that are (1) primarily controls-bd.htm. 38 See Market Access Rule, supra note 36 at Registration’’], available at http://www.sec.gov/ responsible for the design, development 69826. news/pressrelease/2015-48.html#.VSbd9KwpBaQ; 39 See SEC Press Release No. 2013–222, ‘‘SEC Exemption for Certain Exchange Members, 80 FR 49 See SEC Press Release No. 2012–134, ‘‘SEC Charges Knight Capital With Violations of Market 18036, 18042–43 (Apr. 2, 2015) [hereinafter ‘‘SEC Approves New Rule Requiring Consolidated Audit Access Rule’’ (Oct. 16, 2013), available at http:// Proposed Rule on Exemption for Certain Exchange Trail to Monitor and Analyze Trading Activity’’ www.sec.gov/News/PressRelease/Detail/ Members’’]. (July 11, 2012), available at http://www.sec.gov/ PressRelease/1370539879795 [hereinafter ‘‘SEC 43 See SEC Press Release on Broker-Dealer News/PressRelease/Detail/PressRelease/1365 Knight Capital Release’’]. Registration, supra note 42. 171483188#.VKQkAqxOlaQ. 40 See Reg SCI, 79 FR 72252 (Dec. 5, 2014); see 44 See id. The SEC estimates that there are 50 See SEC, ‘‘Rule 613 (Consolidated Audit also SEC Press Release No. 2014–260, ‘‘SEC Adopts approximately 125 firms exempt from association Trail),’’ available at http://www.sec.gov/divisions/ Rules to Improve Systems Compliance and membership, which includes some of the most marketreg/rule613-info.htm. Integrity’’ (Nov. 19, 2014), available at http:// active cross-market proprietary trading firms. See 51 See Mary Jo White, Chairman, Securities and www.sec.gov/News/PressRelease/Detail/ SEC Proposed Rule on Exemption for Certain Exchange Commission, Enhancing Our Equity PressRelease/1370543496356#.VKQS2qxOlaQ. Exchange Members, 80 FR at 18042. Market Structure (June 5, 2014), available at http:// 41 See Reg SCI, supra note 40 at 72437–39. 45 See SEC Press Release on Broker-Dealer www.sec.gov/News/Speech/Detail/Speech/1370542 004312#.VKP_o6xOlaS. 42 See SEC, Press Release No. 2015–48, ‘‘SEC Registration, supra note 42. 52 Proposes Rule to Require Broker-Dealers Active in 46 See id. See id. Off-Exchange Market to Become Members of 47 SEC Proposed Rule on Exemption for Certain 53 See id. National Securities Association’’ (Mar. 25, 2015) Exchange Members, 80 FR at 18042–43. 54 See id. [hereinafter ‘‘SEC Press Release on Broker-Dealer 48 See id. at 18041–45. 55 See id.

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or significant modification of an 3. European and Other Regulatory trading platforms, financial risk algorithmic strategy; or (2) responsible Initiatives controls, and controls that block a 56 for supervising such functions. FINRA a. ESMA trader’s orders if they are for a financial explained that given today’s highly instrument that the trader does not have automated environment (according to The European Securities and Markets permission to trade.66 As to orders FINRA, where firms trade using Authority (‘‘ESMA’’) is an independent submitted via direct market access and automated systems that initiate pre- EU Authority established in January sponsored access, ESMA recommended, programmed trading instructions based 2011. ESMA published guidelines on among other things, that such orders be on specified variables, referred to as automated trading in February 2012, submitted to the same pre-trade risk algorithmic trading strategies), it is which became effective across the controls that it recommends for concerned that persons involved in European Union on May 1, 2012.61 The investment firms (including, for preparing or supervising algorithmic ESMA guidelines addressed the example, price and size parameters).67 trading may lack adequate knowledge of operation of an electronic trading On March 18, 2015, ESMA released a securities rules and regulations, which system by a regulated market or a report finding that all 30 participating could result in algorithms that do not multilateral trading facility; the use of European Economic Area members have comply with applicable rules.57 an electronic trading system, including incorporated the Guidelines into their Accordingly, FINRA believes such a trading algorithm, by an investment legal framework, and all except three persons should meet the same minimum firm for dealing on its own account or have incorporated it into their competency standards for knowledge of for the execution of orders on behalf of supervisory framework.68 The report securities regulations that apply to clients; and the provision of direct went on to identify challenges to further individual traders.58 market access or sponsored access by an enhancing compliance including: In March 2015, FINRA published a investment firm as part of the service of Market complexity, IT-knowledge, regulatory notice (15–09) providing the execution of orders on behalf of additional on-site inspections of 62 guidance on supervision and control clients. markets, testing of trading halts, and practices for algorithmic trading Among other elements, the ESMA setting up ring-defense against cyber- strategies in the equities markets.59 The guidelines recommended that trading attacks.69 notice offered guidance on practices in platforms should have: Arrangements to As discussed below, ESMA has five general areas: General risk prevent the excessive flooding of the performed additional work in the area of assessment and response; software/code order book; arrangements (such as automated trading, such as developing development and implementation; throttling) to prevent capacity limits on technical standards for the requirements software testing and system validation; messaging from being breached; and of MiFID II. trading systems; and compliance. arrangements (for example, volatility Among other practices, the notice interruptions or automatic rejection of b. MiFID II recommended that firms should orders which are outside of certain set The European Commission published consider: Implementing a development volume and price thresholds) to a new Directive on markets in financial and change management process that constrain trading or to halt trading in instruments (‘‘MiFID II’’) on June 12, tracks the development of new trading individual or multiple financial 2014.70 The Directive contains a code or material changes to existing instruments when necessary.63 The definition of both ‘algorithmic trading’ code; implementing a basic summary ESMA guidelines also recommended and ‘high-frequency algorithmic trading description of algorithmic trading that trading platforms should have technique,’ which is defined as a strategies that enables supervisory and procedures in place to identify potential specific type of algorithmic trading. compliance staff to understand the market abuse in an automated trading Among other requirements, the intended function of an algorithm; environment, such as ping orders, quote Directive requires that an investment conducting testing to confirm that core stuffing, momentum ignition, and firm engaged in algorithmic trading code components operate as intended layering and spoofing.64 must have effective systems and risk and do not produce unintended In addition, the ESMA guidelines controls to ensure that its trading consequences; implementing controls, recommended that investment firms systems are resilient and have sufficient monitors, alerts and reconciliation should make use of clearly delineated capacity, are subject to appropriate processes that enable the firm to quickly development and testing methodologies trading thresholds and limits, and identify whether an algorithmic is prior to deploying an electronic trading prevent the sending of erroneous orders experiencing unexpected results; and system or a trading algorithm, and or other system activity that may create providing for adequate communication should monitor their electronic trading or contribute to a disorderly market.71 between supervisory and compliance systems, including trading algorithms, Such a firm must also have effective 65 staff related to the function and control in real-time. ESMA also recommended business continuity arrangements to of algorithms such that the firm meets that investment firms implement price deal with any failure of its trading its regulatory obligations.60 and size parameters, systems that control messaging traffic to individual 66 See id. at 14–15. 56 See FINRA, Regulatory Notice 15–06, 67 See id. at 21–23. ‘‘Registration of Associated Persons Who Develop 61 See ESMA, ‘‘Systems and controls in an 68 ESMA, Automated Trading Guidelines: ESMA Algorithmic Trading Strategies’’ (Mar. 2015), automated trading environment for trading Peer Review Among National Competent available at http://www.finra.org/sites/default/files/ platforms, investment firms and competent Authorities (Mar. 18, 2015), available at http:// notice_doc_file_ref/Notice_Regulatory_15-06.pdf. authorities’’ (Feb. 24, 2012) [hereinafter ‘‘ESMA www.esma.europa.eu/system/files/esma-2015-592- 57 See id. at 3. Guidelines’’], available at http:// automated_trading_peer_review_report_ _ _ _ 58 See id. www.esma.europa.eu/system/files/esma 2012 122 publication.final_.pdf. 59 See FINRA, Regulatory Notice 15–09, ‘‘Equity en.pdf and accompanying public statement, 69 See id. at 9–10. Trading Initiatives: Supervision and Control available at http://www.esma.europa.eu/system/ 70 See European Commission, ‘‘Updated rules for Practices for Algorithmic Trading Strategies’’ (Mar. files/2012-128.pdf. markets in financial instruments: MiFID 2’’ (June 2015) [hereinafter ‘‘FINRA Notice 15–09’’], 62 See id. at 3. 12, 2014) [hereinafter ‘‘MiFID II’’], available at available at https://www.finra.org/industry/notices/ 63 See id. at 13. http://ec.europa.eu/finance/securities/isd/mifid2/ 15-09. 64 See id. at 16–17. index_en.htm. 60 See id. 65 See id. at 10. 71 See id. at Article 17(1).

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systems and must ensure its systems are 2014 paper.77 The comment period for ‘‘High-frequency Trading Act’’). 81 The fully tested and properly monitored.72 the December 19, 2014 consultation High-frequency Trading Act requires Furthermore, an investment firm that paper closed in March 2015. In late that firms engaged in high-frequency engages in a high-frequency algorithmic 2014, ESMA released a final report trading must be licensed.82 In summary, trading technique must store in an covering technical advice in certain high-frequency trading is defined to approved form accurate and time areas, including the definition of include each of the following four sequenced records of all its placed algorithmic trading, HFT, and direct elements: (i) Trading for one’s own orders, including cancellations of electronic access.78 In July 2015, ESMA account, or by proprietary trading firms; orders, executed orders and quotations released final technical advice relating (ii) trading algorithmically without on trading venues and make them to investor protection topics, including human intervention; (iii) trading using available to the competent authority procedures for financial services firms low-latency infrastructures; and (iv) upon request.73 to apply for authorized status, trading that generates a high intraday information required of firms applying message rate.83 In addition, exchanges The MiFID II Directive also requires a must impose, on a product-by-product regulated market to be able to to passport into other jurisdictions, and co-operation between regulatory basis, an excessive system usage fee and temporarily halt or constrain trading if authorities.79 On September 28, 2015, an order-to-trade ratio limit intended to there is a significant price movement in ESMA released a final report on draft prevent unnecessary messaging.84 a financial instrument on that market or regulatory and implementing technical Finally, the High-frequency Trading Act a related market during a short period. standards for MiFID II (‘‘2015 Final requires identification of algorithmically In exceptional cases, a regulated market Draft Regulatory Standards’’).80 This generated orders and trading algorithms, must be able to cancel, vary or correct report provides regulatory standards for which is intended to enhance any transaction.74 In addition, the 85 investment firms engaged in algorithmic monitoring of manipulative activity. Directive requires a regulated market to trading as well as for trading venues that In May 2015, the Bank of England’s have in place effective systems, allow algorithmic trading. Details Prudential Regulation Authority procedures and arrangements, including regarding ESMA’s standards are (‘‘PRA’’), the United Kingdom’s requiring members or participants to discussed below as relevant to the prudential supervisor of major trading carry out appropriate testing of Commission’s proposed regulations firms, announced that it would assess algorithms. A regulated market must relating to risk controls and other the adequacy of existing risk also provide environments to facilitate measures that AT Persons, clearing measurement and management practices such testing, to ensure that algorithmic member FCMs and DCMs must with respect to trading algorithms, trading systems cannot create or implement. including whether controls around contribute to disorderly trading algorithmic trading are ‘‘fit for conditions on the market. The Directive c. Other European Regulatory Initiatives purpose.’’ 86 The PRA discussed the requires a regulated market to growth of automated trading in financial implement systems to limit the ratio of In May 2013, Germany enacted the markets, which has included incidents unexecuted orders to transactions that Act on the Prevention of Risks and of extreme volatility. For example, Abuse in High-frequency Trading (the may be entered into the system by a volatility seen in the Swiss Franc member or participant, to be able to exchange rate on January 15, 2015, 77 slow down the flow of orders if there is ESMA, ‘‘Consultation Paper,’’ (Dec. 19, 2014) following the Swiss central bank’s and accompanying Annexes A and B, available at a risk of its system capacity being http://www.esma.europa.eu/system/files/2014-1570 decision to remove a floor to the reached, and to limit and enforce the _cp_mifid_ii.pdf. exchange rate, may have been minimum tick size that may be executed 78 ESMA, ‘‘ESMA’s Technical Advice to the exacerbated by high-frequency on the market.75 Commission on MiFID II and MiFIR,’’ (Dec. 19, trading.87 2014) [hereinafter ‘‘ESMA Technical Advice Final Finally, in July 2015, the United The European Commission requested Report’’], available at http://www.esma.europa.eu/ Kingdom’s Financial Conduct Authority that ESMA develop technical and system/files/2014-1569_final_report_-_esmas_ technical_advice_to_the_commission_on_mifid_ii_ issued a consultation paper addressing implementing standards for MiFID II. and_mifir.pdf. strengthening accountability in On May 22, 2014, ESMA published a 79 ESMA, Final Report: MiFID II/MiFIR draft consultation paper seeking comments Technical Standards on authorization, passporting, 81 See online summaries of High-frequency on certain topics in connection with registration of third country firms and cooperation Trading Act (2013), available at http:// MiFID II, including ‘‘micro-structural between competent authorities, Art. 6(g) (June 29, www.bafin.de/SharedDocs/Veranstaltungen/EN/ 2015), available at http://www.esma.europa.eu/ WA11_20130430_hft_workshop_en.html. issues’’ such as testing and risk control system/files/2015-esma-1006_-_mifid_ii_final_ 82 See id.; see also Morgan, Megan, Tabb Forum, report_on_mifid_ip_technical_standards.pdf. requirements for investment firms ‘‘Decoding the German HFT Act: A Guide to 80 engaged in algorithmic trading and ESMA, Final Report: Draft Regulatory and Regulating Electronic Markets’’ (Oct. 17, 2014), trading venues.76 ESMA published Implementing Technical Standards MiFID II/MiFIR available at http://tabbforum.com/opinions/ (Sept. 28, 2015) [hereinafter, the ‘‘ESMA September another consultation paper on December decoding-the-german-hft-act-how-to-regulate- 2015 Final Draft Standards Report’’], available at electronic-markets. 19, 2014, seeking further comments on https://www.esma.europa.eu/system/files/2015- 83 See id. esma-1464_-_final_report_-_draft_rts_and_its_on_ technical and implementing standards 84 mifid_ii_and_mifir.pdf; ESMA, Regulatory technical See id. in connection with the implementation 85 and implementing standards—Annex 1 (Sept. 28, See id. of MiFID II and summarizing comments 2015) [hereinafter, the ‘‘ESMA September 2015 86 See Bailey, Andrew, Bank of England, received in response to ESMA’s May Final Draft Standards Report Annex 1’’], available ‘‘Financial Markets: Identifying risks and at https://www.esma.europa.eu/system/files/2015- appropriate responses,’’ at 9 (May 15, 2015), esma-1464_annex_i_-_draft_rts_and_its_on_mifid_ii available at http://www.bankofengland.co.uk/ 72 See id. _and_mifir.pdf; ESMA, Cost-Benefit Analysis— publications/Documents/speeches/2015/ 73 See id. at Article 17(2). Annex II, Draft Regulatory and Implementing speech814.pdf. 74 See id. at Article 48(5). Technical Standards MiFID II/MiFIR (Sept. 28, 87 See id. at 5–6; Binham, Caroline, ‘‘High- 75 See id. at Article 48(6). 2015), [hereinafter, the ‘‘ESMA September 2015 frequency trading faces tougher Bank of England 76 ESMA, ‘‘Consultation Paper,’’ (May 22, 2014), Cost-Benefit Annex II’’], available at https:// scrutiny,’’ Financial Times (May 15, 2015), available at http://www.esma.europa.eu/system/ www.esma.europa.eu/system/files/2015-esma-1464 available at http://www.ft.com/intl/cms/s/0/ files/2014-549_-_consultation_paper_mifid_ii_-_ _annex_ii_-_cba_-_draft_rts_and_its_on_mifid_ii_ f7d4e438-fb20-11e4-9aed- mifir.pdf. and_mifir.pdf. 00144feab7de.html#axzz3aUzgwb2N.

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banking.88 The proposed rule trading, including the National Futures attendant to [their] customer specifically set out to capture Association (‘‘NFA’’), the FIA, ESMA, relationship[s].’’ individuals responsible for the and the International Organization of Among other requirements, deployment of trading algorithms in its Securities Commissions (‘‘IOSCO’’), Interpretive Notice 9046 addresses the Certification Regime.89 Pursuant to the among others. following standards for automated proposal, individuals responsible for: systems: (1) Approving the deployment of a 1. NFA Compliance Rule 2–9: • Pre-Execution Controls (including trading algorithm or a material part of Supervision both credit and ‘‘fat-finger’’ protections): one; (2) approving the deployment of a NFA, a registered futures association ‘‘An AORS should allow the Member to material amendment to a trading under Section 17 of the Act, has set limits for each customer based on algorithm or a material part of one, or provided guidance regarding ATSs to commodity, quantity, and type of order the combination of trading algorithms; industry participants since 2002. or based on margin requirements. It and (3) monitoring or deciding whether Specifically, NFA Interpretive Notice should allow the Member to impose or not the use or deployment of a 9046 addresses the ‘‘Supervision of the limits pre-execution and to trading algorithm is or remains Use of Automated Order-Routing automatically block any orders that compliant with the firm’s obligations Systems’’ in the context of NFA’s exceed those limits.’’ 93 • would be captured and subject to the overarching supervision requirements in Post-Execution Controls: ‘‘For Certification Regime.90 Compliance Rule 2–9 (Supervision).92 customers subject to post-execution controls, the Member should have the d. The October 15 Joint Staff Report The Commission believes that Compliance Rule 2–9 and Interpretive ability to monitor trading promptly. The As discussed above in section I(B), on Notice 9046 are especially relevant AORS should generate alerts when July 13, 2015, five regulatory agencies because of their wide applicability as limits are exceeded through that system. issued the October 15 Joint Staff Report NFA membership rules, binding on The system should also allow the on the unusually high level of volatility FCMs, IBs, CPOs, CTAs, and other NFA Member to block subsequent orders, and rapid round-trip in prices that members. In addition, these provisions either in their entirety or by kind (e.g., occurred on October 15, 2014 in the and interpretations have been in place to block orders that create a new market for U.S. Treasury securities, since at least 2006, such that NFA position or increase an existing position futures and other closely related members—and by extension many AT but not orders that liquidate some or all 91 94 financial markets. In addition to Persons—will have been subject to of an existing position).’’ • Direct Access Systems: ‘‘When discussing the events of October 15, the regulatory requirements concerning authorizing [customer] use of a direct report includes an Appendix C that algorithmic trading for many years. access system that does not allow the summarizes many of the risks of Compliance Rule 2–9 requires each Member to monitor trading promptly, automated trading. These risks include NFA member to ‘‘diligently supervise its the Member should utilize pre- the following: Operational risks (ranging employees and agents in the conduct of execution controls, if available, to set from malfunctioning and incorrectly their commodity futures activities for or pre-execution limits for each customer, deployed algorithms to algorithms on behalf of the Member.’’ Interpretive regardless of the nature of the reacting to inaccurate or unexpected Notice 9046, first issued in 2002 and data); market liquidity risks (arising customer.’’ revised in 2006, states that NFA’s board • Review: ‘‘Members should use from abrupt changes in trading of directors ‘‘firmly believes that strategies even when a firm executes its AORSs in conjunction with their credit- supervisory standards do not change strategy perfectly); market integrity risks review/risk-management systems and with the medium used. How those (automated trading can provide new should evaluate the controls imposed on standards are applied, however, may be tools to engage in unlawful conduct); each customer as part of their regular affected by technology.’’ To fulfill their transmission risks (shocks based on credit and risk-control procedures.’’ supervisory responsibilities, NFA erroneous orders impacting multiple A number of the controls summarized members ‘‘must adopt and enforce markets); clearing and settlement risks above are in keeping with the written procedures to examine the (as more firms gain access to trading Commission’s proposed requirements security, capacity, and credit and risk- platforms, trades may not be subject to for AT Persons, including proposed management controls provided by the sufficient settlement risk mitigation § 1.80, which requires pre-trade risk techniques); and risks to effective risk firm’s automated order-routing systems controls and other measures reasonably management (the speed of trade (AORSs).’’ Interpretive Notice 9046 designed to prevent an Algorithmic execution may make critical risk applies to systems ‘‘that are within a Trading Event, including but not limited mitigation devices less effective). Member’s control, including AORSs that to maximum order message and are provided to the Member by an execution frequencies per unit time; D. Industry and Regulatory Best application service provider or an order price parameters and maximum Practices and Recommendations independent software vendor.’’ NFA order sizes; and certain order Widely recognized organizations and acknowledges that NFA members will cancellation capabilities. The governmental entities or agencies have not control an AORS chosen by an NFA Commission notes once again its intent issued ‘‘best practices’’ for automated customer, such as direct access systems in much of Regulation AT to build on provided by exchanges. In such 88 Financial Conduct Authority (‘‘FCA’’), CP15/22 circumstances, the NFA member must 93 Interpretive Notice 9046 does not require NFA Strengthening accountability in banking: Final rules nevertheless adopt procedures members to ‘‘impose pre-execution controls on all (including feedback on CP14/31 and CP15/5) and ‘‘reasonably expected to address the customers, however. The Member should review consultation on extending the Certification Regime the customer’s sophistication, credit-worthiness, to wholesale market activities, at 46 (July 2015), trading, clearing, and other risks objectives, and trading practices and strategies available at https://www.fca.org.uk/your-fca/ when determining whether to impose controls pre- documents/consultation-papers/cp15-22. 92 NFA, ‘‘9046—Compliance Rule 2–9: execution or post-execution and deciding what 89 Id. Supervision of the Use of Automated Order-Routing levels to use when setting limits.’’ 90 Id. Systems,’’ (Dec. 12, 2006), available at https:// 94 The Interpretive Notice adds that ‘‘[t]his ability 91 See October 15 Joint Staff Report, supra note www.nfa.futures.org/nfamanual/ can be provided by the AORS or through other risk- 10. NFAManual.aspx?RuleID=9046&Section=9. management systems.’’

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existing regulatory requirements and The Commission encourages industry securities regulation. Its membership industry practices so that its proposed participants to consider FIA’s regulates more than 95% of the world’s regulations facilitate an ongoing recommendations. In the event that the securities markets in more than 115 transition to effective risk controls in FIA Guide recommends best practices jurisdictions.102 In October 2011, IOSCO algorithmic trading. The Commission that are not proposed in Regulation AT, released recommendations to promote believes that the existence of related the Commission encourages industry the integrity and efficiency of markets in regulatory standards enforced by NFA participants to consider implementing order to mitigate risks posed by the since 2002 and updated in 2006 would the FIA best practices if they are latest technological developments.103 help minimize any potential disruptions appropriate to their business and are Among other things, IOSCO or burdens that would otherwise be reasonably designed to prevent an recommended that regulators ensure associated with a number of the Algorithmic Trading Event. FIA’s that trading venues have in place Commission’s proposed rules for AT recommendations may also serve as a suitable trading control mechanisms Persons. The Commission also believes useful starting point for an RFA such as trading halts, volatility that NFA’s prior experience in this area considering potential measures in interruptions, and limit-up/limit-down will assist in complying with the response to proposed § 170.19, controls to deal with volatile market requirements of proposed § 170.19, discussed in section IV(F) below. conditions, as well as trading systems discussed in detail in section IV(F) FIA has issued several additional that have the ability to adjust to changes below. reports related to the appropriate best in message traffic (including sudden practices that should be implemented increases).104 In addition, IOSCO 2. FIA Reports on Automated Trading with respect to automated trading. In recommended that all order flow of April 2010, FIA issued a report trading participants, regardless of On March 23, 2015, FIA released the addressing the risks of direct market whether they access the market directly, ‘‘FIA Guide to the Development and access and providing recommendations be subject to appropriate controls, Operation of Automated Trading for risk controls to be implemented by including automated pre-trade controls. Systems’’ (the ‘‘FIA Guide’’), which exchanges and applied across all trading IOSCO also recommended that provides recommendations concerning firms.97 In November 2010, FIA’s regulators should identify any risks appropriate risk controls at the trader, Principal Traders Group (‘‘FIA PTG’’) arising from currently unregulated 95 broker and exchange levels. Risk released a report setting out direct participants of trading venues and controls recommended by FIA include recommended risk controls for trading take steps to address them.105 maximum order size limits, maximum firms that have direct access to More recently, in April 2015, IOSCO intraday position limits, market data exchange matching engines,98 as well as released a consultation report entitled reasonability checks, price tolerance a global survey of futures exchanges to ‘‘Mechanisms for Trading Venues to limits, repeated automated execution determine what controls were in place Effectively Manage Electronic Trading limits, exchange dynamic price collars, to manage the risks in providing trading Risks and Plans for Business exchange market pauses, exchange firms with direct market access.99 In Continuity.’’ 106 The report compiles the message programs, message throttles, March 2012, FIA PTG and FIA European results of a survey that IOSCO sent to self-trade prevention tools, kill Principal Traders Association issued trading venues across more than 30 switches, cancel-on-disconnect service recommendations to assist trading firms different jurisdictions. Based on the and exchange-provided order in establishing internal procedures, information compiled, the report management tools. FIA also processes and controls for the proposes best practices that should be recommended audit trail procedures development, testing and deployment of considered by trading venues when that identify automated trading system trading software.100 Finally, in developing and implementing risk operators; certain post-trade measures to September 2013, FIA released mitigation mechanisms. These practices monitor for potential credit events or recommendations for increasing the are intended to promote the integrity, unintended trading; measures related to usefulness of drop copy systems in resiliency and reliability of trading co-location services; and disaster exchange-traded markets.101 systems and business continuity plans. recovery and business continuity With respect to managing risks procedures. Finally, FIA recommended 3. IOSCO Reports on Electronic Trading originating from market participant measures related to automated trading IOSCO is an international body of technology, the report explains that system development and support, securities regulators. IOSCO develops, most trading venues have policies, including general principles related to implements and promotes adherence to procedures and tools to detect and testing; policies and procedures related internationally recognized standards for address the operational risks associated to security; systems monitoring with electronic trading. These tools procedures; and documentation 97 FIA, ‘‘Market Access Risk Management procedures. Consistent with the Recommendations,’’ (Apr. 2010), available at 102 See IOSCO’s public Web site, available at _ approach the Commission intends to http://www.futuresindustry.org/downloads/Market https://www.iosco.org/about/?subsection=about_ Access-6.pdf. iosco. pursue in Regulation AT, the FIA Guide 98 FIA PTG, ‘‘Recommendations for Risk Controls 103 Technical Committee of the IOSCO, states that, ‘‘[c]are should be taken to for Trading Firms,’’ (Nov. 2010), available at ‘‘Regulatory Issues Raised by the Impact of avoid implementing overly prescriptive http://www.futuresindustry.org/downloads/Trading Technological Changes on Market Integrity and standards or rules that impose a one- _Best_Pratices.pdf. Efficiency: Final Report,’’ (Oct. 2011), available at 99 96 Sutphen, Leslie, ‘‘Exchange Survey Finds Wide http://www.iosco.org/library/pubdocs/pdf/ size-fits-all approach to all entities.’’ Range of Risk Controls in Place,’’ (Jan. 2011), IOSCOPD361.pdf. available at http://www.futuresindustry.org/ 104 See id. 95 FIA, ‘‘FIA Guide to the Development and downloads/RC-survey.pdf. 105 See id. Operation of Automated Trade Systems’’ (Mar. 23, 100 FIA PTG & EPTA, ‘‘Software Development and 106 IOSCO, ‘‘Mechanisms for Trading Venues to 2015) [hereinafter ‘‘FIA Guide’’], available at Change Management Recommendations,’’ (Mar. 14, Effectively Manage Electronic Trading Risks and https://fia.org/sites/default/files/FIA%20 2012), available at http://www.futuresindustry.org/ Plans for Business Continuity: Consultation Guide%20to%20the%20Development%20and%20 downloads/Software_Change_Management.pdf. Report,’’ (Apr. 2015) [hereinafter ‘‘IOSCO 2015 Operation%20of%20Automated%20Trading%20 101 FIA, ‘‘Drop Copy Recommendations,’’ (Sept. Consultation Report’’], available at http:// Systems.pdf. 2013), available at http://www.futuresindustry.org/ www.iosco.org/library/pubdocs/pdf/ 96 Id. at 6. downloads/FIA-Drop_Copy(FINAL).pdf. IOSCOPD483.pdf.

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include, among others, pre-trade risk policies that allow for automatic The Note focused on how large financial controls (such as price and volume cancellation of orders on disconnect, institutions currently monitor and controls or filters and order entry and the ability for clearing firms to view control for the risks associated with controls), the ability to block, suspend their firm’s orders and to cancel algorithmic trading during the trading or disconnect a user (e.g., a kill switch), working orders. day. The Note identified several risks measures to halt trading in the event of that SSG believes are common to 5. FIX Risk Management Working Group sudden price movements, and throttles algorithmic trading across jurisdiction that constrain the number or frequency Additional organizations have and asset class: (i) Systemic risk may be of messages from any given released best practices documents, amplified; (ii) algorithmic trading desks participant.107 IOSCO also explained including FIX Protocol Ltd.’s (‘‘FIX’’) may face a significant amount of risk that many trading venue participants Americas Risk Management Working intraday without transparency and use pre-trade risk controls such as order Group. FIX is a non-profit, industry robust controls; (iii) internal controls volume, price per security, credit, standards association that owns, may not have kept pace with speed and notional value of order, order value, maintains and continuously develops market complexity; and (iv) without capital, position checks, price deviation the Financial Information eXchange adequate controls, losses can thresholds, and regulatory integrity (FIX) Protocol in response to market accumulate and spread rapidly.116 The checks.108 Finally, IOSCO addressed requirements. In 2012, FIX released risk Note provided a list of principles for direct market access by referring to a control guidelines for algorithmic supervisors to consider when evaluating previous report it issued in 2010, called trading orders and direct market access controls over algorithmic trading at ‘‘Principles for Direct Electronic Access orders.111 FIX identified typical order banks: (a) Controls must keep pace with to Markets.’’ In that report, IOSCO scenarios that brokers attempt to detect, technological complexity and trading recommended that intermediaries which include the following: An order speeds; (b) governance and management (including clearing firms) have adequate for an exceedingly large quantity; an oversight can limit exposure to losses operational and technical capability to order that will adversely impact the and improve transparency; (c) testing appropriately manage the risks posed by market for a given security; an order needs to be conducted during all phases DEA.109 with incomplete or conflicting of a trading product’s lifespan, namely instructions; an order that is potentially during development, rollout to 4. CFTC TAC Subcommittee duplicative or unintentionally production, and ongoing maintenance; In 2011, the Pre-Trade Functionality repeating; an order where adverse or and (d) when assessing control depth Subcommittee (‘‘TAC Subcommittee’’) favorable price moves impact the order and suitability, management should of the CFTC’s TAC issued while it is working; and an order that ensure sufficient involvement of control recommendations for pre-trade controls may be stale or may have been replaced functions (including compliance, for trading firms, clearing firms and by the client or a system.112 FIX technology, legal, and controllers), as exchanges which use, or provide, direct explained that the absence of well as business-unit management.117 110 market access. The TAC appropriate risk controls can result in 7. Treasury Market Practices Group Best Subcommittee recommended the market dislocation, failure to settle/ Practices following risk controls for trading firms: deliver, conflict between the client’s Quantity limits on individual orders; intent and order execution, and trading In June 2015, the Treasury Market price collars; execution throttles; the wrong product.113 FIX provides a Practices Group, a group sponsored by message throttles; and a kill switch that recommended matrix of risk controls, the Federal Reserve Bank of New York, would cancel all existing orders and which includes maximum order and comprised of legal, compliance and prevent the firm from placing new quantity, average daily volume checks, business representatives from orders. The TAC Subcommittee further price limit checks, favorable/adverse institutions related to U.S. Treasury recommended that clearing firms price move checks, position limits, market primary and secondary trading, trading on their own behalf should credit checks, and stale, runaway, and released a white paper on Automated 118 comply with those risk controls. In duplicate order checks.114 Trading and an updated Best addition, clearing firms should confirm Practices document for trading in U.S. that their client firms are implementing 6. Senior Supervisors Group (SSG) cash Treasury securities markets.119 The such controls, approve the parameters Briefing Note used by the trading firm, and have In April 2015, the Senior Supervisors www.newyorkfed.org/newsevents/news/banking/ 2015/SSG-algorithmic-trading-2015.pdf. The SSG access to the kill switch. Exchanges Group (‘‘SSG’’), composed of the staff of includes staff from the following organizations: should implement, and require trading banking and other financial regulatory Canadian Office of the Superintendent of Financial firms to use, pre-trade quantity limits on agencies from ten countries and the Institutions, the European Central Bank Banking individual orders; intra-day position European Union, issued an Supervision, the French Prudential Control and 115 Resolution Authority, the German Federal Financial limits; price collars; and message ‘‘Algorithmic Trading Briefing Note.’’ Supervisory Authority, the Bank of Italy, the throttles. The TAC Subcommittee also Japanese Financial Services Agency, the recommended that exchanges 111 See FPL Americas Risk Management Working Netherlands Bank, the Bank of Spain, the Swiss implement clear and consistent error Group, ‘‘Recommended Risk Control Guidelines,’’ Financial Market Supervisory Authority, the United (2012), available at http:// Kingdom’s Prudential Regulatory Authority, and, in trade policies, order cancellation www.fixtradingcommunity.org/mod/file/ the United States, the Office of the Comptroller of view.php?file_guid=32127. the Currency, the Securities and Exchange 107 See id. at 20–21. 112 See id. at 5. Other scenarios include an order Commission, and the Federal Reserve. 108 See id. where the symbology cannot be resolved to a single 116 See id. at 2–3. 109 See id. at 22–23. IOSCO uses the term DEA or security and large accrued long or short positions 117 See id. at 3–4. ‘‘direct electronic access’’ to mean an arrangement that may result in settlement and/or delivery risk 118 See Treasury Market Practices Group, where a client of an intermediary obtains access to if the client cannot settle the trade. ‘‘Automatic Trading in Treasury Markets,’’ (June the market through the intermediary’s infrastructure 113 See id. 2015), available at http://www.newyorkfed.org/ or access without using the intermediary’s systems. 114 See id. at 22. tmpg/TPMG_June%202015_automated%20trading_ See id. at 20 n.56. 115 See Senior Supervisors Group, ‘‘Algorithmic white%20paper.pdf. 110 See CFTC TAC Recommendations, supra note Trading Briefing Note,’’ (Apr. 2015) [hereinafter 119 See Treasury Market Practices Group, ‘‘Best 34. ‘‘SSG 2015 Note’’], available at http:// Practices for Treasury, Agency Debt, and Agency

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Best Practice updates, among other The malfunction impacted the broader on the market.131 The existing risk things, expanded the scope of market, creating swings in the share management controls and supervisory recommended risk controls that address prices of almost 150 companies; these procedures in place at Goldman failed the risks of automated trading price swings were high enough to trigger to stop the erroneous orders, and human (automated trading, for purposes of the pauses in the trading of five stocks.124 error and failure to follow best practices Best Practices document, means the Foreign markets have also exacerbated the errors.132 While some subset of electronic trading that relies experienced disruptive events in recent erroneous orders were able to be on computer algorithms for decision- years. For example, in May 2012 in cancelled, Goldman’s loss ultimately making and execution of order Mexico, a ‘‘fat finger’’ error by a market totaled $38 million.133 submissions), including the participant resulted in the execution of Disruptive events illustrate the documentation of internal policies and 1.13 million shares (representing U.S. importance of effective risk controls. procedures, additional transparency in $3.78 billion).125 In February 2015, The risk controls contemplated in exchange or trading platform market there was a five minute delay in Regulation AT are intended to limit the data, error trade rules and exchange opening futures and options on the extent of market disruption caused by provided services, expanded design and Eurex exchange in Germany because a ATSs or trading platform malfunctions. testing environments at firms and market participant’s system was For example, a pre-trade risk control exchanges, and updated risk controls transmitting duplicate orders.126 In such as a message throttle will prevent that align with the speed of trading February 2014, trading in three-year submission of orders that exceed a technology. The white paper notes that Korean treasury bonds was halted for predetermined frequency per unit time. these updates were issued in a period almost two hours at the Korea Exchange Such a control could be operated by the when cash Treasury securities markets, due to a system malfunction resulting market participant generating orders, like many other asset classes, have from an improper order from a the clearing firm guaranteeing its trades, experienced a strong increase in brokerage house.127 On October 26, or the trading platform on which orders automated trading on electronic 2011, the Bombay Stock Exchange had would be executed, and would limit the platforms. to cancel all derivatives trading due to impact of an algorithmic trading system unusually high volumes and price not operating as intended. As another III. Recent Disruptive Events in example, monitoring and supervision Automated Trading Environments volatility as a result of a flawed algorithm used by a member firm.128 standards for algorithmic trading may The Concept Release discussed help ensure that human supervisors Goldman Sachs was recently fined $7 malfunctions in automated trading intervene quickly when automated million by the SEC for violating its systems, in both derivatives and systems experience unexpected or Market Access Rule and causing a securities markets, that illustrate the degraded performance, and that disruptive trading event.129 On August technological and operational supervision staff have the both the 20, 2013, a configuration error in one of vulnerabilities inherent to automated authority and knowledge to take Goldman’s options order routers trading environments.120 As an appropriate steps in this scenario. example, the Flash Crash of May 2010 erroneously sent thousands of limit involved an automated trading system orders to the options exchanges prior to IV. Overview of Regulation AT 130 with a design flaw that impacted both the start of regular market trading. By A. Concept Release/Regulation AT the derivatives and securities markets. the time the creation of additional Terminology orders was disabled, and efforts to According to the CFTC/SEC joint report The Concept Release used the term on the Flash Crash, an automated cancel unintended orders were taken, approximately 1.5 million unintended ‘‘automated trading system’’ execution algorithm did not take price (abbreviated ‘‘ATS’’) to refer to the or time variables into account. Given the orders (representing 150 million underlying shares) had been executed algorithms used to automate the parameters of the program, the generation and execution of a trading algorithm continued to send orders even 134 124 See Strasburg, Jenny and Bunge, Jacob, ‘‘Loss strategy. In discussing comments to as prices moved far beyond traditional the Concept Release, the Commission daily ranges.121 In another example, in Swamps Trading Firm,’’ Wall St. J. (Aug. 2, 2012), available at http://online.wsj.com/article/SB1000 will continue to use the term automated 2012 a securities trading firm, Knight 0872396390443866404577564772083961412.html trading system. However, for greater Capital Group, made a coding error in and Valetkevitch, Caroline and Mikolajczak, Chuck, precision, the proposed rules and ‘‘Error by Knight Rips Through Stock Market,’’ an automated equity router, and then preamble for Regulation AT instead incorrectly deployed new code in the Reuters (Aug. 1, 2012), available at http:// 122 www.reuters.com/article/2012/08/01/us-usa-nyse- refer to ‘‘algorithmic trading system’’ same router. Because of these coding tradinghalts-idUSBRE8701BN20120801. (also abbreviated ‘‘ATS’’). This change errors, the firm’s automated trading 125 See IOSCO 2015 Consultation Report, supra is intended only as a change in in system inadvertently built up note 106 at 1 n.6. nomenclature. ATSs as described herein unintended positions in the equity 126 See id. and ‘‘Technical Failure Delays Eurex should not be confused with alternative market, eventually resulting in losses of Trading in Futures, Options,’’ Bloomberg (Feb. 17, 123 2015), available at http://www.bloomberg.com/ trading systems in equities markets. more than $460 million for the firm. news/articles/2015-02-17/eurex-futures-options- opening-delayed-after-technical-problem. B. Commenter Preference for Principles- Mortgage-Backed Securities Markets,’’ (June 2015), 127 See ‘‘Treasuries trading system disrupted,’’ Based Regulations available at http://www.newyorkfed.org/tmpg/ Korea Times (Feb. 14, 2014), available at https:// TPMG_June%202015_Best%20Practices.pdf. www.koreatimes.co.kr/www/news/biz/2014/09/488_ As an initial matter, the Commission 120 See Concept Release, 78 FR at 56548–49. 151619.html. notes a preference expressed in 121 See U.S. Commodity Futures Trading 128 See ‘‘Sebi probes Muhurat trading mishap on comments to the Concept Release for Commission and U.S. Securities and Exchange BSE,’’ Business Standard (Nov. 12, 2011), available principles-based, as opposed to Commission, ‘‘Findings Regarding the Market at http://www.business-standard.com/article/ prescriptive, regulations. Fifteen Events of May 6, 2010,’’ (September 30, 2010) markets/sebi-probes-muhurat-trading-mishap-on- [hereinafter, the ‘‘Flash Crash Report’’], available at bse-111111200083_1.html. http://www.cftc.gov/ucm/groups/public/@otherif/ 129 See In re Goldman, Sachs & Co., No. 3–16665 131 Id. documents/ifdocs/staff-findings050610.pdf. (SEC June 30, 2014) (order instituting 132 Id. at 3. 122 See SEC Knight Capital Release, supra note 39. administrative and cease-and-desist proceedings). 133 Id. at 2. 123 See id. 130 Id. at 2. 134 Concept Release, 78 FR 56542, 56544.

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commenters advocated a limited or controls to the specific risks associated C. Multi-Layered Approach to Pre-Trade ‘‘principles-based’’ approach to any with their business.’’ 141 Risk Controls and Other Measures regulation arising from the Concept In addition, five commenters In response to the Commission’s 135 Release. Commenters indicated that indicated that the Commission already questions in the Concept Release about prescriptive requirements will become has robust regulations in place to the appropriate location for risk controls obsolete, stifle innovation, discourage address the risks of automated and other measures, commenters self-reporting of technological failures, 142 generally supported a multi-layered may not account for the unique trading. Such comments cited the 143 approach to risk controls, with each characteristics of market participants, DCM and SEF Core Principles; Commission regulations 1.73, 23.609, level—trading firm, clearing firm, and and would result in participants exchange—implementing risk controls designing around such measures.136 38.255, and 38.607; 144 and CEA and 137 Commission market manipulation and that are adjusted depending on More specifically, FIA and CME 149 disruptive trading practices rules.145 circumstance. Group, Inc. (‘‘CME’’) suggested that the For example, FIA commented that best way to achieve standardization of In contrast to a limited or principles- ‘‘[i]ntroducing redundant risk controls risk controls is through implementing based approach to regulation, several at more than one focal point in the ‘‘best practices’’ developed through commenters supported a more trading lifecycle may increase the working groups of DCMs, FCMs, and prescriptive approach to a rulemaking integrity of the marketplace when other market participants.138 Similarly, addressing the risks of automated careful consideration is given to their IntercontinentalExchange, Inc. (‘‘ICE’’) trading.146 These commenters include differences in roles, implementations indicated that ‘‘exchanges are able to the Institute for Agriculture and Trade and configurations.’’ 150 However, FIA better implement and update risk also stated that ‘‘we caution against a controls on a market-by-market basis Policy (‘‘IATP’’), Better Markets, and mandated proliferation of redundant than through a Commission Americans for Financial Reform risk controls because the existence of rulemaking,’’ and should be allowed (‘‘AFR’’). For example, IATP stated that similar but not identically implemented flexibility in designing exchange risk unless the Commission receives risk controls may do more harm than controls.139 Susquehanna International documentation that the risk controls of good. Each new implementation of a Group (‘‘SIG’’) stated that the firms and exchanges are consistent and control will increase complexity and Commission should ‘‘allow the effective, the Commission should may cause misunderstanding between exchanges to work with firms on assume that regulatory standardization traders and risk managers as a tailoring the rules for implementation in will be beneficial for each risk control consequence of conflicting risk ways that best consider the technical and at each phase of the trade limits.’’ 151 As an example of a control intricacies between firms and lifecycle.147 In addition, several that may be appropriately implemented exchanges.’’ 140 Virtu Financial LLC academic commenters discussed at multiple levels, FIA stated that (‘‘VFL’’) suggested that ‘‘mandating risk concerns with automated, high speed maximum order size limits may be controls and supervisory systems that trading and advocated specific changes implemented at both market participant are ‘reasonably designed’ or ‘provide to the trade matching or order and FCM levels without redundancy reasonable assurance’ of protection submission process to increase market because they reflect the different would allow participants to tailor these 148 liquidity and efficiency. responsibilities of each participant.152 As discussed below, consistent with FIA further explained that if an FCM 135 The Futures Industry Association (‘‘FIA’’) Comment Letter (Dec. 11, 2013) at 2, 12; CME comments received, the Commission has implemented customer-specific Group (‘‘CME’’) Comment Letter (Dec. 11, 2013) at has taken a balanced approach to the controls within its infrastructure, it 3, 41–42; Gelber Group, LLC (‘‘Gelber’’) Comment regulations it believes are necessary to would be redundant to use the same Letter (Dec. 9, 2013) at 1–2; KCG Holdings, Inc. controls at the DCM level, though as an (‘‘KCG’’) Comment Letter (Dec. 11, 2013) at 3; The manage the risks of algorithmic trading. Alternative Investment Management Association For example, the Commission proposes additional protection, it is permissible (‘‘AIMA’’) Comment Letter (Dec. 11, 2013) at 1; The a principles-based approach to its risk to set higher limits at the DCM that 153 Minneapolis Grain Exchange (‘‘MGEX’’) Comment controls requirements, in that it would apply across all customers. Letter (Dec. 11, 2013) at 1; CBOE Futures Exchange, CME cited the TAC Subcommittee’s require particular controls but allow the LLC (‘‘CFE’’) Comment Letter (Dec. 11, 2013) at 2; ‘‘Recommendations on Pre-Trade Managed Funds Association (‘‘MFA’’) Comment relevant entity—a trading firm, clearing Practices for Trading Firms, Clearing Letter (Dec. 11, 2013) at 2; Holly Bell (Bell’’) member FCM, or DCM—discretion in Comment Letter (Dec. 11, 2013) at 3; Virtu Financial Firms and Exchanges involved in Direct LLC (‘‘VFL’’) Comment Letter (Jan. 10, 2014) at 2– the design of such control and the Market Access,’’ and commented that 3; Chris Barnard Comment Letter (Jan. 29, 2014) at parameters that would be used. 2; Susquehanna International Group (‘‘SIG’’) ‘‘each level of the ‘electronic trading Comment Letter at 2; IntercontinentalExchange ‘supply chain’ (trading firms, clearing 141 Group, Inc. (‘‘ICE’’) Comment Letter (Feb. 14, 2014) VFL at 3. firms, and exchanges) must share in the 142 at 1–2; 3Red Trading LLC (‘‘3Red’’) Comment Letter CME at 3; FIA at 5; MFA at 6; Gelber at 2, 5, effort to preserve market integrity (Feb. 14, 2014) at 2; OneChicago, LLC 20; Bell at 2, 4. (‘‘OneChicago’’) Comment Letter (Feb. 14, 2015) at 143 Gelber at 21; CFE at 1; MFA at 6. through the implementation of effective 5. 144 MFA at 4; CFE at 1. risk controls, no matter if that 136 FIA at 2, 12; CME at 3–4, 7; Gelber at 1–2; 145 Gelber at 2, 5, 20; CFE at 3; CME at 3; MFA participant has direct market access or Tellefsen and Company, L.L.C. (‘‘TCL’’) Comment at 6; Bell at 2. is routing to the exchange via its Letter (Oct. 31, 2013) at 5, 18; AIMA at 1, 2; CFE 146 The Institute for Agriculture and Trade Policy clearing member firm’’.154 Specifically at 2; VFL at 3; Bell at 3. (‘‘IATP’’) Comment Letter (Dec. 11, 2013) at 4; 137 The Commission notes that six entities Better Markets Inc. (‘‘Better Markets’’) Comment 149 submitted letters in support of FIA’s comment Letter (Dec. 11, 2013) at 1; Americans for Financial CME at 8–9; FIA at 61; Federal Reserve Bank letter: RGM Advisors, LLC, Allston Trading LLC, Reform (‘‘AFR’’) Comment Letter (Dec. 11, 2013) at of Chicago (‘‘Chicago Fed’’) Comment Letter (Dec. Geneva Trading USA, LLC, Tibra Trading America 6. 11, 2013) at 2; AIMA at 7; KCG at 2; VFL at 2. 150 LLC, DRW Trading Group and IMC Financial 147 IATP at 4. FIA at 61. 151 Markets. 148 Eric Budish et al. Comment Letter (Feb. 14, See id. 138 FIA at 63; CME at 41. 2014) at 1; Brian F. Mannix Comment Letter 152 FIA at 62. 139 ICE at 1–2. (Dec.10, 2013) at 2; Elaine Wah et al. Comment 153 See id. 140 SIG at 2. Letter (Dec. 11, 2013) at 2. 154 CME at 7–8.

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with respect to kill switch functionality, The Commission notes that ESMA’s the definition of ATS is self-evident and CME indicated that kill switch 2015 Final Draft Regulatory Standards has been in use for a long time, and that functionality deployed at multiple require pre-trade risk controls at both ATS, or automated orders, are orders levels should not be considered investment firms and trading venues.162 that are generated and/or routed without redundant.155 CME further suggested ESMA acknowledged commenter human intervention. This includes that while multi-layered kill switch disagreement with such redundancy orders generated by a computer system functionality is not necessary for and stated, ‘‘ESMA believes that at least as well as orders that are routed using effective risk control, it is nevertheless two lines of defence are appropriate in functionality that manages order beneficial as it adds additional measures this complex business and thus submission by automated means (i.e., of protection.156 CME made a general continues to require the pre-trade risk execution algorithms).166 Another point that registrants should establish controls conducted by both investment commenter, Gelber Group, LLC controls appropriate to the nature of firms and trading venues.’’ 163 ESMA’s (‘‘Gelber’’), stated that the Commission their business that are reasonably regulatory standards further provide should adopt a ‘‘strong but designed to control access, effectively that where a client is granted market appropriately flexible definition’’ of monitor trading, and prevent errors as access either through an intermediary’s ATS aligned with existing exchange well as other inappropriate activity.157 systems, or directly without using the definitions.167 CME indicated that, regardless of intermediary’s systems, the direct The Commission’s evaluation of this whether orders are entered manually electronic access provider must apply issue is also informed by the work of the through an electronic system or entered the required pre-trade risk controls.164 TAC Subcommittee. In particular, the through an automated trading system, Regulation AT requires pre-trade and TAC Subcommittee described such principles are equally important, other risk controls at both the AT Person ‘‘automated trading’’ as follows: because the method of order entry does and clearing member FCM level (as well ‘‘[Automated trading] covers systems not lessen the impact of a particular as the DCM level) based on its employed in the decision-making, order on the market.158 understanding that the risks—and the routing and/or execution of an investment or trading decision, which Other commenters supported a multi- resulting calibration levels of the controls—may be different given those utilizes a range of technologies layered approach to risk controls. AIMA including software, hardware, and indicated that risk controls should be entities’ distinct priorities and understanding of the risks to themselves network components to facilitate ‘‘broadly similar’’ and applied at the efficient access to the financial markets trading firm, clearing firm, and and their customers. Below is a summary of each element via electronic trading platforms.’’ 168 exchange levels.159 KCG stated that of Regulation AT. For each element, the ‘‘risk management is most effective b. Description of Regulation Commission addresses relevant Concept when it is multi-layered and Release comments, summarizes the While the Commission does not overlapping.’’ 160 VFL stated that a proposed regulation, and asks questions define the term ‘‘ATS’’ in this NPRM, ‘‘multilayered system of risk controls is concerning the proposed regulation. the Commission does propose a new a key ingredient to protect the market § 1.3(zzzz) that defines the related from disruptive events.’’ 161 D. Codification of Defined Terms Used activity of ‘‘Algorithmic Trading.’’ This The Commission agrees with the Throughout Regulation AT proposed term means trading in any comments above that it should adopt a 1. ‘‘Algorithmic Trading’’—§ 1.3(zzzz) commodity interest as defined in multi-layered approach to regulations Regulation 1.3(yy) 169 on or subject to a. Concept Release Comments intended to mitigate the risks of the rules of a DCM, where: (1) One or automated trading. As explained below, The Concept Release requested more computer algorithms or systems the Commission proposes to impose comment concerning whether the determines whether to initiate, modify, requirements at multiple stages of the Commission should define ATS or or cancel an order, or otherwise makes lifecycle of an order. The Commission algorithm for purposes of any ATS determinations with respect to an order, acknowledges FIA’s comment that the identification system. Commenters including but not limited to: the product different role of entities at various stages disagreed on whether the Commission to be traded; the venue where the order in the trade lifecycle must be carefully should adopt a definition of ‘‘ATS.’’ FIA will be placed; the type of order to be evaluated. While Regulation AT and CME opposed a regulatory placed; the timing of the order; whether requires the same types of pre-trade and definition, arguing that industry already to place the order; the sequencing of the other risk controls to be implemented by has a definition of automated trading order in relation to other orders; the different entities, the Commission notes system.165 FIA and CME indicated that price of the order; the quantity of the that the proposed regulations allow for discretion in the appropriate design and 162 ESMA September 2015 Final Draft Standards 166 FIA at 41; CME at 29. parameters of each risk control. Report, supra note 80 at 201. 167 Gelber at 2–3. 163 See id. 168 CFTC Technology Advisory Committee Accordingly, a trading firm, clearing 164 ESMA September 2015 Final Draft Standards Subcommittee on Automated and High-Frequency member FCM, and DCM may each Report Annex 1, supra note 80 at 218. Trading, Presentation to the TAC (Oct. 12, 2012), choose to design and calibrate the same 165 FIA at 41–42; CME at 29. CME defines ‘‘ATS’’ available at http://www.cftc.gov/ucm/groups/ control in different ways, depending on as ‘‘a trading method in which a computer makes public/@newsroom/documents/file/tac103012_ how the control is used by each entity decisions and enters orders without a person wg1.pdf. entering those orders. This is a programmatic way 169 Regulation 1.3(yy) provides that the term to manage risks. of representing the trader.’’ See CME Glossary, ‘‘commodity interest’’ means (1) any contract for the available at http://www.cmegroup.com/education/ purchase or sale of a commodity for future delivery; 155 CME at 22. glossary.html. ICE defines ‘‘ATS’’ as ‘‘any system (2) any contract, agreement or transaction subject to 156 See id. that automates the generation and submission of a Commission regulation under section 4c or 19 of orders to ICE.’’ See ICE Notice, Revision to the Act; and (3) Any contract, agreement or 157 CME at 43–44. Authorized Trader Requirements (Jan. 4, 2011) at 3, transaction subject to Commission jurisdiction 158 See id. available at https://www.theice.com/publicdocs/otc/ under section 2(c)(2) of the Act; and (4) Any swap 159 AIMA at 7. advisory_notices/ICE%20Advisory%20Notice%20 as defined in the Act, by the Commission, or jointly 160 KCG at 2. for%20Authorized%20Trader%20 by the Commission and the Securities and 161 VFL at 2. Registration%20010411.pdf. Exchange Commission. See 17 CFR 1.3(yy).

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order; the partition of the order into However, the definition of algorithmic Commission anticipates that entities smaller components for submission; the trading under MiFID II does not include using automated order routers will be number of orders to be placed; or how systems that only make decisions as to using similar or related automated to manage the order after submission; the routing of orders to one or more technology to determine other and (2) such order, modification or trading venues.173 Similarly, for parameters of an order. In addition to order cancellation is electronically purposes of a proposal relating to the consideration that order routing submitted for processing on or subject to registration of persons who develop systems have the potential to disrupt the the rules of a DCM; provided, however, algorithmic trading strategies, FINRA’s market, the Commission believes that, that Algorithmic Trading does not definition of ‘‘algorithmic trading given the interconnectedness of trading include an order, modification, or order strategy’’ does not include an order firm systems, carving out a particular cancellation whose every parameter or router alone.174 In contrast to MiFID II subset of automated systems from the attribute is manually entered into a and FINRA, the Commission intends definition of Algorithmic Trading, e.g., front-end system 170 by a natural person, that the definition of Algorithmic order routing systems, would introduce with no further discretion by any Trading includes systems that make unnecessary complexity and reduce the computer system or algorithm, prior to determinations regarding any aspect of effectiveness of the safeguards provided its electronic submission for processing the routing of an order, i.e., systems that in its proposed regulations.178 on or subject to the rules of a DCM.171 only make decisions as to the routing of The Commission notes that even if a The term ‘‘Algorithmic Trading’’ is a orders to one or more trading venues. computer algorithm or system makes critical underpinning of other elements The Commission believes that one or more determinations with respect of this NPRM. Specifically, the automated order routers have the to an order (such as product, timing, Commission proposes a number of potential to disrupt the market to a price or quantity), the submission of the requirements related to Algorithmic similar extent as other types of order would not constitute Algorithmic Trading, including that trading firms automated systems, and therefore Trading if every parameter or attribute (i.e., AT Persons, as defined in section should not be treated differently under of the order is manually entered into a IV(D) below), clearing member FCMs, the proposed regulations. For example, front-end system by a natural person, and DCMs implement certain pre-trade the SEC determined that Knight Capital with no further discretion by any risk controls for Algorithmic Trading; made errors related to the coding and computer system or algorithm, prior to that trading firms implement certain testing of an automated equity router, its electronic submission for processing standards for the development, testing, which caused the firm to acquire several on or subject to the rules of a DCM. monitoring, and compliance of ATSs; billion dollars in unwanted positions However, if a natural person does not and that trading firms and clearing and sustain a loss of more than $460 manually enter an order as described in members FCMs submit compliance million, in addition to causing the preceding sentence, but nonetheless reports describing the new pre-trade risk substantial market disruption.175 intervenes in the order in some other controls. In addition, the term The Commission has taken this and more limited manner, the ‘‘Algorithmic Trading’’ is employed in approach to automated order routers submission of the order would still the proposed definition of ‘‘AT Person,’’ after considering existing industry represent Algorithmic Trading if the a term that identifies those persons or definitions of ‘‘automated trading other elements of the definition are met. entities subject to the Commission’s systems.’’ For example, CME defines The Commission believes that the risks proposed new pre-trade risk control ‘‘ATS’’ as ‘‘a trading method in which of Algorithmic Trading continue to exist requirements, among other a computer makes decisions and enters in trading where there is some limited requirements. orders without a person entering those natural person intervention at particular The Commission notes that its orders. This is a programmatic way of stages of order submission or execution, definition of Algorithmic Trading is representing the trader.’’ 176 Similarly, and Regulation AT requirements should similar to the definition of algorithmic ICE defines ‘‘ATS’’ as ‘‘any system that apply to such trading to the same extent trading adopted by the European automates the generation and that it does to trading that is entirely 172 Commission under MiFID II. submission of orders to ICE.’’ 177 The automated. In sum, the only circumstance in which natural person 170 The reference to a ‘‘front-end system’’ may ESMA Technical Advice Final Report states at 323, intervention by definition would cause include a system provided by an independent ‘‘There is limited or no human intervention (and trading to not represent Algorithmic software vendor (‘‘ISV’’), a broker or an exchange, therefore algorithmic trading) when the system at or developed internally. Trading is if the proviso in clause (2) of least makes independent decisions at any stage of 171 the definition of Algorithmic Trading The Commission notes that if a customer order-execution processes, either on initiating, submits an order to its clearing FCM, which then routing or executing orders. It is noted that the were met. submits the order to a DCM, such order would still reference to ‘orders’ encompasses ‘quotes’ as well.’’ Finally, the Commission clarifies that be considered ‘‘electronically submitted for 173 See ESMA Technical Advice Final Report, there are certain automated functions processing on or subject to the rules of a designated supra note 78 at 324. contract market,’’ notwithstanding the fact that the that do not fall within the proposed 174 order is routed through the intervening clearing See FINRA, Regulation Notice 15–06, definition of Algorithmic Trading. For FCM. ‘‘Registration of Associated Persons Who Develop example, the use of automated programs 172 See ESMA Technical Advice Final Report, Algorithmic Trading Strategies,’’ (Mar. 2015), available at http://www.finra.org/sites/default/files/ that incorporate electronic indicators or supra note 78 at 318. Article 4(1)(39) of MiFID II _ _ _ _ _ defines algorithmic trading as ‘‘trading in financial notice doc file ref/Notice Regulatory 15-06.pdf. In instruments where a computer algorithm the Notice, FINRA defines an ‘‘algorithmic trading Authorized%20Trader%20Registration%20 automatically determines individual parameters of strategy’’ as ‘‘any program that generates and routes 010411.pdf. orders such as whether to initiate the order, the (or sends for routing) orders (and order-related 178 The Commission notes that Forex Capital timing, price or quantity of the order or how to messages, such as cancellations) in securities on an Markets, LLC (‘‘FXCM’’) commented in response to manage the order after its submission, with limited automated basis.’’ Id. at 3. the Concept Release that automatic order routing or no human intervention, and does not include any 175 See SEC Knight Capital Release, supra note 39. systems be excluded from any definition of ‘‘high- system that is only used for the purpose of routing 176 See CME Glossary, available at http:// frequency trading,’’ arguing that such systems are orders to one or more trading venues or for the www.cmegroup.com/education/glossary.html. already subject to extensive regulatory oversight processing of orders involving no determination of 177 See ICE Notice, Revision to Authorized Trader and control. See FXCM 1–2. For the reasons stated any trading parameters or for the confirmation of Requirements (Jan. 4, 2011) at 3, available at above, the Commission determined to include such orders or the post-trade processing of executed https://www.theice.com/publicdocs/otc/advisory_ systems within the definition of Algorithmic transactions.’’ See MiFID II, supra note 70. The notices/ICE%20Advisory%20Notice%20for%20 Trading.

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other technical analysis features to inappropriately includes or excludes a Commission requests comment on this notify a trader regarding specified particular type or aspect of trading. proposed expansion of the definition of market activity (e.g., a product reaches 2. Should the Commission adopt a Algorithmic Trading, which the a particular price) would not in itself definition of ‘‘Algorithmic Trading’’ that Commission may implement in the final represent Algorithmic Trading, unless is more closely aligned with any rulemaking for Regulation AT. The the same program makes the definition used by another regulatory Commission requests comment on the determinations described in clause (1) organization? costs and benefits of this proposal, in of the definition, and clause (2) is also 3. For purposes of the Commission’s addition to any other comments met. Similarly, if an entity (such as an definition of Algorithmic Trading, is it regarding the effectiveness of this introducing broker) uses certain necessary for the Commission to define proposal in terms of risk reduction. electronic systems as part of its business ‘‘computer algorithms or systems’’? If 2. ‘‘Algorithmic Trading Compliance practices, but does not submit orders to so, please explain what should be Issue’’—§ 1.3(tttt) a trading platform, that entity’s use of included in such a definition. electronic systems would not of itself be 4. Should the Commission’s a. Description of Regulation considered Algorithmic Trading. definition of ‘‘Algorithmic Trading’’ The Commission proposes to define Finally, the application of risk filters to include systems that only make three new, related terms: ‘‘Algorithmic an order that is otherwise entered determinations as to the routing of Trading Compliance Issue,’’ through entirely manual means (i.e., an orders to different venues (which is ‘‘Algorithmic Trading Disruption,’’ and order whose every parameter or contemplated in the proposed ‘‘Algorithmic Trading Event’’ (which attribute is manually entered into a definition)? With respect to the encompasses Algorithmic Trading front-end system by a natural person, definition of ‘‘Algorithmic Trading,’’ Compliance Issues or Algorithmic with no further discretion by any should the Commission differentiate Trading Disruptions). As a general computer system or algorithm) 179 between different types of algorithms, matter, the proposed regulations would not be considered Algorithmic such as alpha-generating algorithms and contained in Regulation AT are Trading solely due to the use of risk order routing algorithms? intended to address the risks of 5. Is the Commission’s understanding filters. For example, existing §§ 1.11 and automated trading. Malfunctioning or correct that most entities using 1.73 require FCMs and clearing member incorrectly deployed algorithms automated order routers will be using FCMs, respectively, to establish certain deploying erroneous messages to trading similar or related automated technology automated financial or risk-based venues can significantly impact markets to determine other parameters of an controls, including limits based on and market participants. The speed at position size, order size and margin order? 6. The Commission posits a scenario which trading occurs can magnify the requirements or capital, credit or harm caused by a malfunctioning volume thresholds. The application of in which an AT Person submits orders through Algorithmic Trading, and a system, for example, in driving such automated controls would not, on unwarranted price changes. The their own, cause an order to fall within non-clearing FCM or other entity acts only as a conduit for these AT Person proposed definitions work in the definition of Algorithmic Trading. conjunction with proposed regulations The Commission notes that ESMA’s orders. If the non-clearing FCM or other entity does not make any requiring certain risk controls and other 2015 Final Draft Regulatory Standards measures and are intended to describe address the distinction between determinations with respect to such orders, the conduit entity would not be the types of market disruptions, ‘‘investment decision algorithms’’ regulatory violations, or other events engaged in Algorithmic Trading, as that (which make automated trading that Regulation AT is designed to definition is currently proposed. Should decisions by determining which assets prevent or mitigate. to purchase or sell) and ‘‘order the definition of Algorithmic Trading be The three proposed terms Algorithmic execution algorithms’’ (which optimize modified to capture a conduit entity Trading Compliance Issue, Algorithmic order execution processes by automatic such as a non-clearing FCM in this Trading Disruption, and Algorithmic generation and submission of orders or scenario, thereby making the entity an Trading Event have analogues under quotes to one or several trading venues AT Person subject to Regulation AT? In Reg SCI’s definitions of ‘‘Systems once the investment decision is made). other words, should non-clearing FCMs compliance issue,’’ ‘‘Systems ESMA’s standards provide that pure be required to manage the risks of AT disruption,’’ and ‘‘SCI event.’’ 181 The investment decision algorithms which Person customers? How would non- term ‘‘SCI event,’’ under Reg SCI, generate orders that are only to be clearing FCMs do so if the non-clearing encompasses systems compliance issues executed by non-automated means and FCMs do not have risk controls and systems disruptions. Similar to with human intervention are excluded comparable to the risk controls specified Regulation AT, Reg SCI requires that an from ESMA testing requirements.180 in proposed § 1.82? SCI entity’s policies and procedures 7. The Commission, recognizing that c. Request for Comments must include monitoring of systems to natural person traders who manually identify potential SCI events, and that 1. Is the Commission’s definition of enter orders also have the potential to SCI entities must establish escalation ‘‘Algorithmic Trading’’ generally cause market disruptions, is considering procedures to quickly inform consistent with what algorithmic expanding the definition of Algorithmic responsible SCI personnel of potential trading is understood to mean in the Trading to encompass orders that are SCI events.182 industry? If not, please explain how it generated using algorithmic methods The term ‘‘Algorithmic Trading is inconsistent and how the definition (e.g., an algorithm generates a buy or Compliance Issue’’ is defined in should be modified. In your answer, sell signal at a particular time), but are proposed § 1.3(tttt), and means ‘‘an please explain whether the definition then manually entered into a front-end event at an AT Person that has caused system by a natural person, who any Algorithmic Trading of such entity 179 See the discussion of front-end systems supra determines all aspects of the routing of to operate in a manner that does not note 170. the orders. Such order entry would not 180 See ESMA September 2015 Final Draft Standards Report Annex 1, supra note 80 at 201– represent Algorithmic Trading under 181 See Reg SCI, supra note 40 at 72437. 02. the currently proposed definition. The 182 Id. at 72437.

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comply with the CEA or the rules and materially degrades, (1) the Algorithmic Disruption originating with an AT regulations thereunder, the rules of any Trading of such AT Person, (2) the Person, and which may negatively designated contract market to which operation of the designated contract impact the relevant designated contract such AT Person submits orders through market on which such AT Person is market, other market participants, or Algorithmic Trading, the rules of any trading or (3) the ability of other market other persons? Alternatively, should the registered futures association of which participants to trade on the designated scope of the definition be reduced, and such AT Person is a member, the AT contract market on which such AT if so, why? 183 Person’s own internal requirements, or Person is trading.’’ The Commission 11. In addition, should the reference the requirements of the AT Person’s notes that it interprets clause (3) of the to ‘‘materially degrades’’ in the clearing member, in each case as definition broadly (‘‘an event originating definition of Algorithmic Trading applicable.’’ with an AT Person that disrupts, or Disruption be expanded or otherwise The term is relevant to Regulation materially degrades . . . the ability of modified to encompass other types of AT’s pre-trade risk and other control other market participants to trade on the disruptions that may impact the requirements for AT Persons as designated contract market on which relevant designated contract market, provided in proposed § 1.80, which such AT Person is trading.’’) Among other market participants, or other requires the specified controls and other events that would meet the persons? Please provide examples of measures to be reasonably designed to Commission’s understanding of real-world events originating with AT prevent or mitigate an ‘‘Algorithmic ‘‘disrupts, or materially degrades,’’ the Persons (as defined under Regulation Trading Event.’’ The term Algorithmic Commission interprets clause (3) as AT) that resulted in disruptions that Trading Event, as discussed below, including an event originating with an may not be captured by the reference to means either an Algorithmic Trading AT Person that prohibits other market ‘‘materially degrades’’ in the definition. Compliance Issue or an Algorithmic participants from trading on the Trading Disruption. The defined term designated contract market on which 4. ‘‘Algorithmic Trading Event’’— Algorithmic Trading Compliance Issue such AT Person is trading. § 1.3(vvvv) is also relevant to Regulation AT’s The term Algorithmic Trading proposed testing requirements on AT Disruption is relevant to Regulation Regulation AT proposes a new Persons. Specifically, proposed § 1.81(c) AT’s pre-trade risk and other control definition in § 1.3(vvvv) (Algorithmic requires each AT Person to establish requirements for AT Persons and FCMs Trading Event) that means either an procedures requiring its staff to review that are clearing members for a DCO, as Algorithmic Trading Compliance Issue Algorithmic Trading systems in order to provided in proposed §§ 1.80 and or an Algorithmic Trading Disruption. detect potential Algorithmic Trading 1.82(a), respectively. The controls and As noted above, the term Algorithmic Compliance Issues. Regulation § 1.81(c) measures required by proposed § 1.80 Trading Event is used in proposed also would require a plan of internal must be reasonably designed to prevent § 1.80 requiring AT Persons to coordination and communication or mitigate an ‘‘Algorithmic Trading implement risk controls that are between compliance staff of the AT Event,’’ The term ‘‘Algorithmic Trading reasonably designed to prevent or Person and staff of the AT Person Event,’’ as discussed below, means mitigate an ‘‘Algorithmic Trading responsible for Algorithmic Trading either an ‘‘Algorithmic Trading Event.’’ The proposed definition is also designed to detect and prevent Compliance Issue’’ or an ‘‘Algorithmic used in rules under proposed § 1.81(a) Algorithmic Trading Compliance Issues. Trading Disruption.’’ The controls and that require AT Persons to conduct Finally, proposed § 40.20 requires a measures required of clearing member regular back-testing of Algorithmic DCM to establish and maintain pre-trade FCMs in proposed § 1.82(a), in contrast Trading using historical transaction, and other risk controls reasonably to those required of AT Persons in order, and message data to identify designed to prevent the occurrence of an proposed § 1.80, must be reasonably circumstances that may contribute to Algorithmic Trading Disruption (or designed to prevent or mitigate only the future Algorithmic Trading Events. The similar disruption) or an Algorithmic narrower Algorithmic Trading definition is also used in rules under Trading Compliance Issue. The Disruption. Finally, proposed § 40.20 proposed § 1.81(b) that require AT proposed definition of Algorithmic requires a designated contract market to Persons to conduct continuous real-time Trading Compliance Issue was not establish and maintain pre-trade and monitoring of Algorithmic Trading to discussed in the Concept Release. other risk controls reasonably designed identify potential Algorithmic Trading to prevent an Algorithmic Trading b. Request for Comments Events, and in rules under proposed Disruption. The proposed definition of § 1.81(d) that require AT Persons to 8. Should the definition of Algorithmic Trading Disruption was not establish training procedures for Algorithmic Trading Compliance Issue discussed in the Concept Release. communicating and escalating instances be modified to include other potential b. Request for Comments of Algorithmic Trading Events to the compliance failures involving an AT appropriate personnel. The proposed Person that may have a significant 9. Should the definition of definition was not discussed in the detrimental impact on such AT Person, Algorithmic Trading Disruption be Concept Release. the relevant DCM, or other market modified to include other types of participants? disruptive events that may originate 5. ‘‘AT Order Message’’—§ 1.3(wwww) with an AT Person? 3. ‘‘Algorithmic Trading Disruption’’— a. Description of Regulation 10. Should the definition be expanded § 1.3(uuuu) to include other types of disruptive The Commission is proposing to a. Description of Regulation downstream consequences that may define an ‘‘AT Order Message’’ (new Regulation AT proposes a defined result from an Algorithmic Trading § 1.3(wwww)) as each new order or term ‘‘Algorithmic Trading Disruption.’’ quote submitted through Algorithmic 183 The term is defined in new § 1.3(uuuu), The Commission notes that, under this Trading to a DCM by an AT Person and definition, an Algorithmic Trading Disruption may each change or deletion submitted and means ‘‘an event originating with be the result of intentional or unintentional acts by an AT Person that disrupts, or an AT Person. through Algorithmic Trading by an AT

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Person 184 with respect to such an order clearing member FCM and DCM levels IV(E) below on Registration of Certain or quote. This term is used in the serves important policy goals. Order Persons Not Otherwise Registered with proposed regulations requiring AT entry frequencies that are much larger the Commission). Such persons or Persons, clearing member FCMs and than intended could result in an entities would be AT Persons if they DCMs to implement pre-trade risk accumulation or reduction of positions engage in Algorithmic Trading on or controls and other measures with at speeds that outpace or overload subject to the rules of a DCM. See respect to AT Order Messages. The associated risk management systems. section IV(H) below for a more detailed proposed controls include a maximum Large quantities of unintended orders discussion of which persons would be AT Order Message frequency per unit could also impact the market by designated as AT Persons for purposes time, which is also known as a message increasing engine matching times or of proposed § 1.80 and other throttle requirement.185 The order submission latencies. regulations, and which persons would Commission notes that its definition of not be AT Persons, but would b. Request for Comments AT Order Message is consistent with nonetheless be subject to proposed ESMA’s definition of message in its HFT 12. Please comment on the proposed § 1.82. analysis.186 The proposed language does scope of the Commission’s definition of b. Request for Comments not impose specific requirements AT Order Message. Is the proposed concerning the design of the AT Order definition too expansive, in that it 13. The Commission notes that the Message throttle or the particular would limit the submission of messages FIA Guide recommends certain pre- thresholds that must be used. that do not have the potential to disrupt trade risk controls and contemplates The Commission believes that the market? Alternatively, is the scope three levels at which these controls can defining AT Order Message is necessary of the AT Order Message too limited, in be placed: Automated trader, broker, in proposed §§ 1.80, 1.82, 38.255(b) and that it could allow messages not related and exchange. FIA defines ‘‘automated (c), and 40.20(a)(1) to specify the type of to orders (i.e., heartbeat messages or trader’’ as any trading entity that uses an messages that should be subject to requests for mass quotes) to automated system, including hedge frequency controls. The Commission intentionally or unintentionally flood funds, buy-side firms, trading firms, and intends that required maximum message the DCM’s systems and slow down the brokers who deploy automated frequency controls would apply to new matching engine? Please explain how algorithms, and defines ‘‘broker’’ as orders, order cancellations, and changes this definition would be more FCMs, other clearing firms, executing to important order terms that have the appropriately limited or expanded. brokers and other financial 187 intermediaries that provide access to an potential to impact the market. 6. ‘‘AT Person’’—§ 1.3(xxxx) Notwithstanding the foregoing, while exchange. the definition of AT Order Message a. Description of Regulation a. Should the Commission’s definition would only apply to order-related The Concept Release did not of ‘‘AT Person’’ explicitly include or messages, the Commission recognizes specifically address whether regulations exclude any of the classes of parties that certain message types outside of the in the area of algorithmic trading should included in FIA’s term ‘‘automated definition of AT Order Message may include a defined term ‘‘AT Person.’’ trader’’? Please explain. Are there any cause market disruptions by affecting However, the Commission determined types of entities not present in this list the operation of a DCM’s electronic that such a defined term is necessary in that should be included in the ‘‘AT matching platform. A DCM has the order to identify which entities are Person’’ definition? discretion to implement controls subject to the proposed regulations b. Should Regulation AT use the term throttling excessive heartbeat 188 or addressing trading firms’ management ‘‘broker,’’ as understood by FIA? If so, administrative-type messages if it of the risks of algorithmic trading. These please explain. Is there another term believes that such controls are necessary regulations include, for example, pre- that would be more appropriate in to prevent fraud or manipulation or trade and other risk controls on the defining the scope of AT Persons? otherwise ensure the proper functioning orders initiated by the trading firm; 14. Algorithmic Trading carries of its electronic matching platform and development, testing and supervision technological and personnel costs, and market. standards; and the requirement to the Commission expects that such As discussed below, the Commission submit compliance reports regarding the trading will be performed by entities, believes that requiring maximum order new risk controls. not natural persons. Is this a reasonable message frequencies at the trading firm, The proposed definition under new assumption? For purposes of § 1.3(xxxx) lists those particular persons quantifying the number of AT Persons 184 The definition of AT Person is discussed in or entities that may be considered an AT that will be subject to the regulations, section IV.D.6. Person: Persons registered or required to do you believe that any AT Person (a 185 The regulation are proposed §§ 1.80 (for AT definition that encompasses the Persons), 1.82 (for FCMs), 38.255(b) and (c) (for be registered as FCMs, floor brokers, DCMs permitting direct electronic access), and SDs, MSPs, CPOs, CTAs, or IBs that following persons if engaged in 40.20 (for DCMs). engage in Algorithmic Trading on or Algorithmic Trading: FCMs, floor 186 Specifically, ESMA considered one message to subject to the rules of a DCM, or persons brokers, swap dealers, major swap mean ‘‘each content that needs independent participants, commodity pool operators, processing,’’ and further explained that ‘‘messages registered or required to be registered as to be counted for these purposes are each new order floor traders as defined in § 1.3(x)(3).189 commodity trading advisors, or quote, each successful change to an order or Regulation § 1.3(x)(3) is a proposed introducing brokers, and newly quote and each successful deletion of an order or revision to the Commission’s existing registered floor traders using Direct quote.’’ See ESMA Technical Advice Final Report, supra note 78 at 320. definition of floor trader, and is Electronic Access) will be a natural 187 Order terms that have the potential to impact discussed in detail below (see section person or a sole proprietorship with no the market might include, but are not limited to, employees other than the sole changes to price, quantity, and order type. 189 As a result, any person who is required to be proprietor? 188 By ‘‘heartbeat’’ messages, the Commission registered as one of these registration categories and 15. The Commission recognizes that a means signals sent at regular intervals to ensure that who is engaged in Algorithmic Trading will be CPO could use Algorithmic Trading to the connection between the trading firm and the subject to all requirements of an AT Person under DCM’s electronic matching platform is in a normal this regulation, regardless of whether such person enter orders on behalf of a commodity state. has actually registered with the Commission. pool which it operates. In these

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circumstances, should the Commission FCM’s infrastructure to route orders, the term ‘‘direct market access’’ as it is consider the CPO that operates the and ‘‘Indirect ATS Participants,’’ used in Commission-regulated markets. commodity pool or the underlying characterized by use of an ATS that The Commission determined to employ commodity pool itself as ‘‘engaged in routes orders through an FCM’s the term Direct Electronic Access, as Algorithmic Trading’’ pursuant to the infrastructure.193 FIA stated that all opposed to direct market access, in the definition of AT Person? 190 types of market access create risks; interest of regulatory consistency. The 16. The Commission notes that therefore, the same principles should term ‘‘Direct Electronic Access’’ by FCM pursuant to § 1.57(b) of the apply to all types of market access.194 customers is used in existing Regulation Commission’s regulations IBs may not FIA also explained that since market 38.607, where it is described as carry proprietary accounts. However, participants may now access a DCM ‘‘allowing customers of futures certain customer relationships may directly without passing through an commission merchants to enter orders cause an IB to fall under the definition FCM’s infrastructure, ‘‘the only directly into a designated contract of AT Person. The Commission requests consistent opportunity for risk control is market’s trade matching system for comment on the types of IB customer at the DCM and the market execution.’’ 201 relationships that could cause IBs to fall participant.’’ 195 The Commission proposes that the under the definition of AT Persons. Additional commenters made similar term ‘‘Direct Electronic Access’’ means What activities are currently being points. CME stated that all entities— an arrangement where a person conducted by IBs that could cause an IB whether they have direct market access electronically transmits an order to a to be considered engaging in or not—must ‘‘share in the effort to DCM, without the order first being Algorithmic Trading on or subject to the preserve market integrity.’’ 196 ICE routed through a separate person who is rules of a DCM and would therefore explained that it treats every order and a member of a DCO to which the DCM cause the IB to be considered an AT trade equally regardless of connection submits transactions for clearing. By Person? method or participant type.197 KCG ‘‘routed,’’ the Commission means the 17. Should the definition of AT Holdings, Inc. (‘‘KCG’’) commented that process by which an order physically Person be limited to persons using DEA? ‘‘any pre-trade risk control requirements goes from a customer to a designated 202 In other words, should the definition [must] be applied so as to not permit contract market. As indicated below, capture persons registered or required to market participants to avoid their the Commission requests comment on be registered as FCMs, floor brokers, application based on the manner in its definition of DEA and whether there SDs, MSPs, CPOs, CTAs, or IBs that which the participant accesses the are particular scenarios where it would 198 engage in Algorithmic Trading on or market.’’ VFL commented that ‘‘the be unclear whether a customer is subject to the rules of a DCM, or persons privilege of direct exchange access trading through DEA. registered or required to be registered as should bring with it the obligation to DEA is relevant to several of the proposed regulations. As explained floor traders as defined in § 1.3(x)(3), in deploy a system designed to protect the 199 below, DEA is used as a filter to help each case if such persons are using integrity of the marketplace.’’ VFL define a new category of market DEA? The Commission requests explained that all exchange members participants required to register as floor comment on the costs and benefits of should be required to employ pre- and traders and be subject to the this approach, including comments on post-trade risk controls, and all non- requirements of Regulation AT (see whether this more limited definition of members should be required to access proposed § 1.3(x)(3), discussed below). AT Persons would adequately mitigate exchanges only through a member’s risk control layer.200 In addition, the term DEA is relevant to the risks associated with algorithmic revised § 38.255, which would require trading. b. Description of Regulation DCMs to have in place systems and 7. ‘‘Direct Electronic Access’’— Consistent with the comments controls reasonably designed to § 1.3(yyyy) discussed above, the Commission facilitate FCM’s management of the risks proposes a new § 1.3(yyyy) that defines that may arise from Algorithmic a. Concept Release Comments ‘‘Direct Electronic Access’’ (‘‘DEA’’) Trading, and proposed § 1.82, which The Concept Release asked whether and, through other proposed rules, requires FCMs to implement such DCM- there are specific risk controls that requires that AT Order Messages provided controls for DEA orders. This should apply in the context of direct originating with an AT Person and approach recognizes that when DEA is market access, and whether the submitted by AT Persons through such used, clearing FCMs do not have the implementation of risk controls should DEA be subjected to the same types of ability to apply market risk controls to be modified in the context of direct pre-trade and other risk controls that orders they receive for clearing before market access.191 such orders would pass through if they these orders reach the DCM. This Several commenters agreed that any flowed through the infrastructure of an approach of enabling clearing FCMs to potential risk controls should also apply FCM before entering the market. implement DCM-based controls is to those with direct access to the The Commission notes that the market.192 For example, FIA described Concept Release used the term ‘‘direct 201 In addition, in the context of foreign boards of market participants’ access to markets as market access,’’ or ‘‘DMA,’’ and such trade, Section 4(b)(1)(A) of the CEA defines ‘‘direct term is commonly used in industry. The access’’ as ‘‘an explicit grant of authority by a consisting of two broad categories: foreign board of trade to an identified member or ‘‘Direct ATS Participants,’’ Commission intends that ‘‘Direct other participant located in the United States to characterized by use of an ATS directly Electronic Access’’ be consistent with enter trades directly into the trade matching system connected to a DCM without using an of the foreign board of trade.’’ 193 FIA at 8–9. 202 The Commission notes that the operative 194 element of DEA is submission of an order to a DCM 190 The Commission notes that CPOs are separate FIA at 12, 15. 195 FIA at 8–9; 61–62. without the order first being routed through a legal entities from the underlying commodity pools separate person who is a member of a DCO to which 196 CME at 7–8. which they operate. the DCM submits transactions for clearing. Other 197 191 See section II(B) above for a discussion of ICE at 2. factors, such as co-location, or use of FCM-provided direct market access in the Concept Release. 198 KCG at 2. software, are not on their own determinative of 192 FIA at 12, 15; KCG at 2; CME at 7–8; VFL at 199 VFL at 2. whether a customer is submitting orders through 2; AIMA at 1. 200 See id. DEA.

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similar to how the Commission please explain why and how the Commission’s oversight capabilities and addresses financial risk management by definition should be revised. allow for wider implementation of some FCMs, as reflected in existing DCM 19. Should the Commission define or all of the pre-trade controls and risk regulation § 38.607. ‘‘routed’’ in its definition of DEA? If so, management tools discussed in this The Commission’s proposed how? Are there specific examples of NPRM and currently used in the market definition of DEA differs from SEC, trading or routing arrangements where it today. In particular, registration will ESMA and IOSCO terminology. The would be unclear whether trading was help ensure that all market participants SEC characterizes ‘‘direct market performed through DEA? that actively trade on Commission- access’’ as an arrangement whereby a 20. Should the Commission use the regulated markets implement broker-dealer permits customers to enter term ‘‘direct market access’’ instead of appropriate controls, including those orders into a trading center but such DEA, and if so why? trading firms that access the market orders flow through the broker-dealer’s 21. Should the Commission define directly and use algorithmic trading trading systems prior to reaching the sub-categories of DEA, such as systems that could malfunction and trading center.203 ‘‘Sponsored access’’ sponsored market access? create systemic risk to all market generally refers to an arrangement 22. The Commission’s proposed participants. whereby a broker-dealer permits definition of DEA in § 1.3(yyyy) differs In the Concept Release, the customers to enter orders into a trading from definitions of direct electronic Commission requested specific center that bypass the broker-dealer’s access in § 38.607 and direct access for comment on whether firms operating trading system and are routed directly to FBOTs in § 48.2(c). The Commission ATSs to trade solely for their own a trading center, in some cases believes that the more technical account would meet the definition of supported by a service bureau or other definition in proposed 1.3(yyyy) is ‘‘floor trader’’ in Section 1a(23) of the third-party technology provider.204 appropriate for Regulation AT. The Act, and whether registering such firms ‘‘Unfiltered’’ or ‘‘naked’’ access is a Commission solicits comment regarding as floor traders would effectuate the subset of sponsored access, where pre- proposed 1.3(yyyy), whether all purposes of the Act. The ‘‘floor trader’’ trade filters or controls are not applied definitions of ‘‘direct’’ access should be definition in CEA 1a(23) states that, in to orders before such orders are harmonized across the Commission’s general, the term ‘‘floor trader’’ means submitted to an exchange or ATS.205 rules, and if so how. Do you believe that any person who, in or surrounding any Similarly, ESMA and IOSCO refer to two definitions would create confusion pit, ring, post or other place provided by ‘‘direct electronic access’’ as including with respect to Commission a contract market for the meeting of direct market access and sponsored requirements as to direct electronic persons similarly engaged, purchases, or access; ‘‘direct market access,’’ as an access? With respect to §§ 1.80, 1.82 and sells solely for such person’s own arrangement where a member of a 38.255(b) and (c) provisions imposing account.207 Given the evolution of trading venue provides a connecting risk control requirements on AT futures trading over recent years, system to a person to transmit orders; Persons, FCM and DCMs, should the electronic trading platforms have now and ‘‘sponsored access’’ as an Commission use the existing definition become a primary ‘‘other place’’ in arrangement where such an of direct electronic access provided in which proprietary market making and infrastructure is not used by a person.206 § 38.607? trading generally, takes place. While the Commission’s proposed Seven commenters (including FIA, E. Registration of Certain Persons Not terminology differs from that used by CME, MFA and the Chicago Fed) Otherwise Registered With other regulatory organizations, the opposed registration for reasons Commission—§ 1.3(x) Commission believes that its defined including: DCMs already use Operator term DEA is consistent with existing The Commission proposes to amend IDs; the DCM audit trail already satisfies Commission regulations. References to the definition of ‘‘Floor trader’’ in the goals of registration; implementing ‘‘DEA’’ and ‘‘Direct Electronic Access’’ Commission regulation 1.3(x), in order the Commission’s final rule on throughout this preamble shall refer to to facilitate the registration of ownership and control reporting the term proposed in § 1.3(yyyy). proprietary traders using DEA for (‘‘OCR’’) will provide additional Algorithmic Trading on a DCM. Such information on trading identities; and c. Request for Comments persons would be required to register as the Commission already has access to 18. Please explain whether the Floor traders pursuant to proposed trade data (i.e., Regulation 1.40 and part Commission’s proposed definition of § 1.3(x)(3), assuming that they were not 38’s mandate that DCMs require market DEA will encompass all types of access already registered or required to register participants to submit to a DCM’s commonly understood in Commission- with the Commission in another regulated markets as ‘‘direct market capacity. The remainder of this section 207 CEA Section 1a(23)(A) provides that the term access.’’ In light of the proposed presents Concept Release comments on ‘‘floor trader,’’ in general, means any person (i) who, in or surrounding any pit, ring, post, or other regulations concerning pre-trade and this topic, a description of the proposed place provided by a contract market for the meeting other risk controls and standards for the regulation, a discussion of the policy of persons similarly engaged, purchases, or sells development, testing and supervision of justification for the proposal, and a solely for such person’s own account (I) any algorithmic trading systems, do you request for comments on the proposal. commodity for future delivery, security futures product, or swap; or (II) any commodity option believe that the proposed definition of 1. Concept Release Comments authorized under section 4c; or (ii) who is Direct Electronic Access is too limited registered with the Commission as a floor trader. A (or, alternatively, too expansive)? If so, The Concept Release requested further definition of the term ‘‘floor trader’’ is comment on whether all firms operating provided for by Section 1a(23)(B), which states that the Commission, by rule or regulation, may include 203 ATSs to trade solely for their own See Risk Management Controls for Brokers or within, or exclude from, the term ‘‘floor trader’’ any Dealers With Market Access, 75 FR 69792, 69793 account should be required to register person in or surrounding any pit, ring, post, or (Nov. 15, 2010). with the Commission. As discussed in other place provided by a contract market for the 204 See id. greater detail below, a registration meeting of persons similarly engaged who trades 205 See id. requirement for firms operating ATSs solely for such person’s own account if the 206 ESMA Technical Advice Final Report supra Commission determines that the rule or regulation note 78 at 340; IOSCO 2015 Consultation Report, and not otherwise registered with the will effectuate the purposes of the Act. 7 U.S.C. supra note 106 at 20 n.56. Commission would enhance the 1a(23).

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jurisdiction).208 In response to the sells futures or swaps solely for such flexibility in this area, the definition of Concept Release question seeking person’s own account in a place floor trader in Rule 1.3(x) states that it information concerning whether firms provided by a contract market for the shall include any person required to operating ATSs would meet the meeting of persons similarly engaged, register as [a floor trader] by rule or definition of ‘‘floor trader’’ under the where such place is accessed by such regulation of the Commission pertaining CEA, CME and Gelber stated that the person in whole or in part through DEA to the operation of an electronic trading term floor trader is an anachronism that (as defined in proposed § 1.3(yyyy)) for system.’’ 220 is irrelevant to automated trading Algorithmic Trading, and such person is On July 21, 2010, President Obama environments.209 not otherwise registered with the signed the Dodd-Frank Wall Street In contrast, Better Markets, AFR, and Commission as a futures commission Reform and Consumer Protection Act TCL supported ATS registration.210 AFR merchant, swap dealer, floor broker, (‘‘Dodd-Frank Act’’).221 Title VII of the stated that ‘‘[t]he enhancement of major swap participant, commodity Dodd-Frank Act amended the CEA investigative authority is extraordinarily pool operator, commodity trading definition of ‘‘floor trader.’’ 222 This important given that the Commission advisor, or introducing broker. The amendment maintained the language staff would often need to involve itself Commission notes, however, that from the 1992 Act defining a floor trader in the workings of the ATSs to persons otherwise registered or required as a person ‘‘who, in or surrounding any anticipate problems and to detect and to register with the Commission in pit, ring, post, or other place provided investigate problems that have occurred. another capacity (e.g., as a swap dealer) by a contract market . . . for the HFT firms should have the highest would not be exempt from such meeting of persons similarly engaged, priority.’’ 211 registration simply by registering as a purchases, or sells solely for such Finally, AIMA and VFL supported Floor trader pursuant to proposed person’s own account’’ any commodity registration for participants with direct § 1.3(x)(3). for future delivery. However, the market access.212 VFL commented that CEA 1a(23) states that the term ‘‘floor amended definition also applied to if an exchange provides a participant trader’’ means any person who, in or trading in swaps, and provided that the the ability to connect directly, then that surrounding any pit, ring, post or other definition includes ‘‘anyone who is participant enjoys all of the rights of a place provided by a contract market for registered with the Commission as a member and should be regulated at the the meeting of persons similarly floor trader.’’ Finally, the amendment federal and exchange level.213 Finally, engaged, purchases, or sells solely for allows for the Commission by regulation while Chicago Fed opposed a such person’s own account.215 The term to include within the definition or requirement that ATSs register with the was added to the Act in the Futures exclude from the definition anyone who Commission, it suggested that Trading Practice Act of 1992 (the ‘‘1992 meets the statutory definition. participants with direct market access Act’’).216 The 1992 Act also amended Subsequently, the Commission must register with the exchange.214 Section 4e of the Act to require amended the definition of floor trader in 2. Description of Regulation registration of floor traders, and tasked Rule 1.3(x) to precisely mirror the the Commission with issuing rules to language contained in section 1a(23)(A) The Commission proposes to require implement the requirement within 180 of the Act.223 the registration of proprietary traders days of the date of enactment. 3. Policy Discussion using DEA for Algorithmic Trading on In 1993, pursuant to the 1992 Act, the a DCM. As discussed in greater detail in Commission finalized rules regarding In order to enhance the Commission’s section 3 below, registration of entities registration of floor traders.217 The oversight capabilities as they relate to with DEA as floor traders would mean Commission established a definition for entities with DEA and allow for wider that such firms must implement the pre- the term ‘‘floor trader’’ in Regulation implementation of some or all of the trade controls and risk management 1.3(x). The Commission noted in the pre-trade controls and risk management tools that Regulation AT requires of AT preamble to that final rule that ‘‘certain tools discussed in this NPRM and Persons. If the Commission were to only persons trading through electronic currently used in the market today, the require those firms that are already systems come within the [floor trader] Commission proposes amending registered with the Commission to definition.’’ 218 Given the prevalence of Regulation 1.3(x) to expressly include implement such controls, some market pit trading in 1992 and the short time such firms within the definition of participants conducting Algorithmic frame to implement floor trader ‘‘floor trader.’’ The Commission Trading on Commission-regulated registration, the Commission emphasizes that the ‘‘floor trader’’ markets would not be subject to the determined to require registration for definition is not being expanded to Commission’s risk control requirements. floor traders operating ‘‘on the trading capture all proprietary traders engaged In order to achieve registration of floor of an exchange’’ and ‘‘to defer in Algorithmic Trading; rather, the proprietary traders using DEA for consideration of the application of floor revised floor trader definition is limited Algorithmic Trading on a DCM, the trader registration requirements to to firms using DEA to engage in Commission proposes amending the persons using electronic trading systems Algorithmic Trading. Historically, definition of ‘‘Floor trader’’ in and to reconsider the subject at a later pursuant to the Commission’s preamble Commission regulation 1.3(x). The date.’’ 219 The Commission expressly discussion in the Registration of Floor amended definition would expressly stated that, ‘‘[i]n order to preserve Traders Rule and the original include any person who purchases or formulation of Regulation 1.3(x) 215 See supra note 207. discussed above, the Commission has 208 FIA at 43–46; CME at 32–34; Gelber at 22–24; 216 Futures Trading Practices Act of 1992, Pub. L. KCG at 18; MFA at 3; AIMA at 2, 24; Chicago Fed 102–546, 106 Stat. 3590, 3625–28 (1992). 220 Id. at 3. 217 Registration of Floor Traders; Mandatory 221 Dodd-Frank Wall Street Reform and Consumer 209 CME at 34; Gelber at 22–24. Ethics Training for Registrants; Suspension of Protection Act, Pub. L. 111–203, 124 Stat. 1376 210 Better Markets at 13; AFR at 8–9; TCL at 17. Registrants Charged with Felonies, 58 FR 19575 (2010). 211 AFR at 8–9. (1993) (hereinafter ‘‘Registration of Floor Traders 222 See supra note 207. 212 AIMA at 24; VFL at 3. Rule’’). 223 See Final Rule, Adaptation of Regulations to 213 VFL at 3. 218 Id. at 19576. Incorporate Swaps, 77 FR 66288, 66317 (Nov. 2, 214 Chicago Fed at 4. 219 Id. 2012).

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only required registration of floor firm would be considered an AT Person F. RFA Standards for Automated traders conducting business on the under clause (1) of the proposed Trading and Algorithmic Trading physical trading floor of an exchange. definition of AT Person, and would not Systems—§ 170.19 However, the Act contemplates floor be required to also register as a floor To fully effectuate the design and traders in ‘‘other places’’ besides the trader. The proposed requirement under intent of Regulation AT, the trading floor, and the Commission has revised § 1.3(x) is intended to require Commission is proposing a new previously noted that the Act’s firms not otherwise registered to become § 170.19 requiring RFAs to adopt certain definition applies to persons using registered with the Commission. Given membership rules—as deemed 224 electronic trading systems. that a technological malfunction in a appropriate by the RFA—relevant to Registration of entities with DEA as single trading firm’s systems can algorithmic trading for each category of floor traders would enhance the pre- significantly impact other markets and member in the RFA. RFAs would have trade controls and risk management market participants, the proposed discretion as to the rules they issue and tools discussed elsewhere in this NPRM registration requirement is critical to the categories of members to which their by making such entities subject to the ensuring that all such firms are subject rules apply. Further, to ensure that all various regulations governing AT to appropriate risk control, testing, and AT Persons are subject to rules of an Persons under the NPRM. For example, other requirements of Regulation AT. RFA regarding algorithmic trading, the the pre-trade risk controls listed in 4. Request for Comments Commission is also proposing a new proposed § 1.80—maximum AT Order § 170.18 requiring AT Persons to Message frequencies per unit time, become members of at least one RFA. maximum execution frequencies per 23. Should firms operating Algorithmic Trading systems in CFTC- Proposed § 170.18 is discussed in detail unit time, order price parameters and in section G below. Taken together, maximum order size limits—must be regulated markets, but not otherwise registered with the Commission, be §§ 170.18 and 170.19 would allow RFAs established and used by all AT Persons. to supplement elements of Regulation If the Commission were to only require required to register with the CFTC? If not, what alternatives are available to AT as markets and trading technologies those firms that are already registered evolve over time, and allow frontline with the Commission to implement fully effectuate the purpose and design of Regulation AT? regulators to drive future incremental such controls, it would be ignoring a enhancements to the Commission’s 24. Should all firms deploying significant number of market basic regulatory structure for Algorithmic Trading systems be participants that actively trade on algorithmic trading by AT Persons. Commission-regulated markets, each of required to register with the which has ATSs that could malfunction Commission? Are there additional 1. Policy Discussion and create systemic risk to all market characteristics of AT Persons that In developing Regulation AT, the participants. Registration as floor traders should be taken into consideration for Commission sought to balance would also require entities using DEA, registration purposes? For example, meaningful regulatory baselines against as AT Persons, to maintain certain should the Commission limit the need for standards sufficiently books and records, thus enhancing the registration to trading firms meeting flexible to keep pace with changing Commission’s ability to gather certain trading volume, order or industry practices and technologies. The information. message levels? In other words, should Commission’s determination to balance The Commission estimates that there there be a minimum volume, order or both interests is particularly reflected in are approximately one hundred message test in order to meet the its treatment of AT Persons and in proprietary trading firms engaged in definition of ‘‘floor trader,’’ or otherwise proposed §§ 1.80, 1.81, and 1.82, which Algorithmic Trading in Commission- to meet the definition of AT Person? If address: (1) Pre-trade risk controls and regulated markets. Some of these firms so, what should be measured and what other measures for ATSs; (2) standards may already be registered with the specific thresholds should be used? for the development, testing, Commission in some capacity. In the 25. In the alternative, should the monitoring, and compliance of ATSs; event that one of these firms engaged in Commission broaden the registration (3) designation and training of Algorithmic Trading is already requirements in proposed § 1.3(x)(3)(ii) algorithmic trading staff; and (4) registered with the Commission, the so that all persons trading on a contract clearing FCM risk management. A number of the proposed sections and 224 market through DEA are required to Registration of Floor Traders Rule, 58 FR at subsections in these rules include well- 19576. Further, the Commission notes that it is not register, instead of only those who are the first to observe the degree to which the tangible engaged in Algorithmic Trading? established risk control and other technological infrastructure provided by DCMs for practices among market participants. 26. Please supply any information or trading, including for example electronic trade The proposed pre-trade risk controls in matching platforms or co-location or proximity data that would help the Commission in § 1.80(a), for example, are generally hosting facilities, can constitute a ‘‘place.’’ Futures deciding whether firms may or may not limited to risk controls identified as best Industry magazine, a publication of FIA, noted the meet the definition of ‘‘floor trader’’ in following in a 2007 article describing co-location practices by FIA in 2015, and the text and proximity hosting: ‘‘[t]he pit is back. Just a few Section 1a(23) of the Act. of the rules is intentionally flexible so years since the concept of a commodity exchange 27. Do you believe that the that AT Persons may determine for as a tangible ‘place’ had begun to seem hopelessly old-fashioned, many traders now want to be at the registration of such firms as ‘‘floor themselves how required pre-trade risk heart of the action once more. At Eurex, customers traders’’ would help effectuate the controls and other measures should be that until recently were scattered all over the globe purposes of the CEA to deter and detect designed and calibrated. Other proposed are moving closer to the exchange, ‘forming a price manipulation or any other rules addressing AT Persons offer physical community like a pit again,’ says Matthias Kluber, head of networks and infrastructure disruptions to market integrity? If you flexibility in that they require AT operations at Deutsche Bo¨rse Systems, which builds believe that registration of such firms Persons to implement specific programs, and operates the Eurex trading and clearing will not help effectuate the purposes of but provide latitude regarding how such systems.’’ See Bennet Voyles, Co-Location Catches the CEA, or that the same purposes can programs are to be designed. Thus, On, Futures Industry (July/Aug. 2007) at 28, available at: https://secure.fia.org/downloads/Jul- be achieved by other means, please proposed § 1.81(a)(1)(vi) requires AT Aug_Colocatiion.pdf. explain. Persons to maintain a source code

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repository to manage source code rules and can supplement Commission trading, proposed § 170.19 would also access, persistence, copies of production rules as appropriate. RFAs can also require RFAs to consider how such code, and changes to production code, operate examination programs to rules could help prevent fraudulent and but does not impose a prescriptive monitor members’ compliance with manipulative acts, protect the public standard for how the source code association rules, and can sanction interest, and perfect the mechanisms of repository must be structured or members for non-compliance. The trading on DCMs (prong 2 above). The maintained. Similarly, proposed Commission believes that RFAs are Commission believes that these are §§ 1.81(a)(1)(iii) and (a)(1)(iv) require well-positioned to address rules in areas important elements in the requirements regular back testing of Algorithmic experiencing rapid evolution in market proposed to be codified in § 170.19. Trading and stress testing of ATSs, but practices and technologies, including RFAs should be cognizant, for example, impose no specific testing protocols and particularly §§ 1.80, 1.81, and 1.82. of the overarching requirement in do not specify a minimum testing Proposed § 170.19 is described below. proposed § 1.80 that AT Persons take frequency. The Commission also notes steps reasonably designed to prevent an 2. Description of Regulation the existence of numerous other pre and Algorithmic Trading Event, defined in post-trade risk controls and measures Proposed § 170.19 would require proposed § 1.3(vvvv) to include both available to AT Persons but not RFAs to (1) establish and maintain a Algorithmic Trading Compliance Issues incorporated as requirements in program (2) for the prevention of and Algorithmic Trading Disruptions. Regulation AT. Some, such as drop- fraudulent and manipulative acts and Algorithmic Trading Compliance Issues copy reporting, were raised in the practices, the protection of the public include events at an AT Person that Concept Release, and others were interest, and perfecting the mechanisms cause its algorithmic trading to operate addressed in responsive public of trading on DCMs (3) by adopting in a manner that does not comply with comments. rules for each category of member, as the CEA, Commission regulations, or the The Commission has determined to deemed appropriate by the RFA, rules of a DCM. Algorithmic Trading focus in Regulation AT on areas where requiring: (i) Pre-trade risk controls and Disruptions include events originating the safety and soundness of derivatives other measures for ATSs (§ 170.19(a)(1)); with an AT Person that disrupt or markets would benefit from a core set of (ii) standards for the development, materially degrade the operation of a pre-trade risk controls and other testing, monitoring, and compliance of DCM or the ability of other market measures applicable to all AT Persons. ATSs (§ 170.19(a)(2)); (iii) designation participants to trade on the DCM. In As noted above, the Commission and training of algorithmic trading staff short, an AT Person’s algorithmic believes that effective rules for AT (§ 170.19(a)(3)); and (iv) operational risk trading should neither disrupt the Persons are best structured as clear management standards for clearing market nor violate law. RFAs should regulatory requirements combined with member FCMs with respect to customer consider these factors when determining embedded flexibility to adapt to orders originating with ATSs whether and what further rules they changing markets and technologies. (§ 170.19(a)(4)). With respect to rules may promulgate over time pursuant to Accordingly, the Commission’s (prong 3 above), the areas RFAs must § 170.19. proposed rules in §§ 1.80, 1.81, and 1.82 address pursuant to proposed § 170.19 Proposed § 170.19 would require an address only a subset of potentially are similar to those that AT Persons and RFA to ‘‘establish and maintain a responsive risk controls and other clearing FCMs must address in program’’ (prong 1 above) for the measures. Each AT Person shall also proposed §§ 1.80, 1.81, and 1.82. RFAs, prevention of fraud and manipulation, determine what additional safeguards however, would be required in § 170.19 protection of the public interest, and would be reasonably designed to to consider whether additional rules or perfecting the mechanisms of trading on prevent an Algorithmic Trading Event granularity are appropriate as baseline DCMs. The Commission anticipates that given its trading strategies, technologies, SRO requirements and binding an RFA would include in its routine or the markets in which it participates. membership rules for one or more examinations of members pursuant to The proposed rules also provide a categories of RFA members.226 The such program a verification that such degree of flexibility regarding the Commission notes that § 170.19 would members are complying with any rules design, implementation, or calibration require that RFAs consider the need for that the RFA may determine to issue pursuant to proposed § 170.19. The of those pre-trade risk control or other additional rules, and issue such rules Commission intends for proposed measures that are specifically required where appropriate. However, § 170.19 § 170.19 to provide RFAs with a wide in §§ 1.80, 1.81, and 1.82, again would not require RFAs to issue any measure of latitude in both the rules allowing each AT Person to adapt the rules pursuant to § 170.19 where the they may elect to adopt and in the rules to its own trading and technology. RFA believes they are unnecessary. members to whom they apply such Given the structure of proposed Rather, the proposed regulation leaves rules. It is the Commission’s further §§ 1.80, 1.81, and 1.82 as regulatory discretion to the RFAs to determine intent that RFAs consider the need for baselines with a degree of embedded what rules would prevent fraudulent rules pursuant to proposed § 170.19, flexibility, the Commission has and manipulative acts and practices, and that they adopt such rules where determined to provide RFAs with a protect the public interest, and perfect the RFA considers it necessary. discretionary role in augmenting the the mechanisms of trading on DCMs. However, the determination as to both requirements of Regulation AT for AT When evaluating potential the necessity of rules and their Persons.225 RFAs serve a vital regulatory membership rules regarding algorithmic application to specific categories of function as frontline regulators of their 226 members remains with the RFA. members, which would include all AT In this regard, the Commission distinguishes Finally, the Commission notes that Persons pursuant to proposed § 170.18. an RFA’s obligation to establish memberships rules—i.e., mandatory requirements for all persons while proposed § 170.19 would require RFAs promulgate binding membership in the relevant membership category—from steps RFAs to issue rules as they deem that a single AT Person or clearing member FCM appropriate, RFAs would remain free to 225 The Commission notes an exception in may voluntary take to augment its pre-trade risk proposed § 1.83, which requires the submission of controls or other measures based on its unique take other steps when potential rules annual reports from AT Persons and their clearing trading or technology and its obligations pursuant regarding algorithmic trading are not yet FCMs to DCMs. to proposed §§ 1.80, 1.81, and 1.82. ripe. As both membership and self-

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regulatory organizations, RFAs are will include examination and members. In particular, floor brokers uniquely positioned to gain insights enforcement components. Is this the and floor traders, who have historically from members through examination appropriate approach? been overseen by the DCMs on which programs and coordination with other 31. The Commission requests they operate, are not required by self-regulatory or standard-setting comment on whether proposed § 170.19 §§ 170.15, 170.16, or 170.17 to become bodies. In addition to rulemaking when may result in duplicative obligations on members of an RFA. In order to ensure necessary, RFAs could leverage these AT Persons or any other market that all AT Persons will be subject to resources to issue guidance or best participant. In particular, please any rules promulgated by an RFA practices, hold periodic discussions comment on potential duplication, if pursuant to proposed § 170.19, with relevant stakeholders, and any, between algorithmic trading including floor brokers and floor otherwise provide leadership as risks, requirements that an RFA may impose traders, the Commission is proposing a risk control technologies, market upon its members pursuant to § 170.19, new § 170.18. This provision would practices evolve over time. The and similar requirements that may be require that all AT Persons that are not Commission also affirms that proposed imposed by a DCM in its role as a self- otherwise required to be a member of a § 170.19 is not intended to create regulatory organization. What RFA pursuant to §§ 170.15, 170.16, or conflicting obligations between an amendments would be appropriate in 170.17 be a member of an RFA. RFA’s role in establishing algorithmic any final rules arising from this NPRM 2. Description of Regulation trading standards for its members and a to clarify that unintended overlap DCM’s role as a self-regulatory between the role of an RFA and a DCM The Commission is proposing a new organization. Accordingly, the in this context? § 170.18 to require all Commission requirements of proposed § 170.19 registrants that are AT Persons to be G. AT Persons Must Become Members of specifically address pre-trade risk members of an RFA. The membership an RFA—§ 170.18 controls for ATSs, standards for the requirements proposed by § 170.18 will designing, testing, monitoring, and 1. Policy Discussion ensure that all AT Persons would be subject to membership rules supervision of ATSs, and the An RFA is an association of persons promulgated by an RFA, including those designation and training of algorithmic registered with the Commission as such membership rules promulgated trading staff. The Commission believes pursuant to section 17 of the CEA.227 pursuant to proposed § 170.19 to that these areas are appropriate for Subject to Commission oversight, RFAs address algorithmic trading. potential future standards issued by an serve a vital self-regulatory role by Specifically, proposed § 170.18 requires RFA in an evolving technological and functioning as frontline regulators of that each registrant that is an AT Person market environment, and that such their members, including in large that is not otherwise required to be a standards will be best implemented as measure most Commission registrants member of an RFA pursuant to uniform requirements of an RFA for its who will qualify as AT Persons relevant members as opposed to §§ 170.15, 170.16, or 170.17 must pursuant to proposed § 1.3(xxxx).228 potentially varying approaches by become and remain a member of at least Entities that are not members of an RFA, individual DCMs. one RFA that provides for the however, are not bound by the rules of membership of such registrant, unless 3. Request for Comments the RFA.229 As such, the Commission no such futures association is so previously adopted §§ 170.15 and 28. The Commission requests registered. comment on the scope of 170.16 to require each registered FCM, responsibilities assigned to RFAs under and each registered SD and MSP, 3. Request for Comments proposed § 170.19. Should RFAs be respectively, to be an RFA member, 32. The Commission requests responsible for fewer or additional areas subject to an exception for certain notice comment on whether the regulatory regarding AT Persons, ATSs, and registered securities brokers or framework established by Regulation algorithmic trading than specified in dealers.230 The Commission also AT would require all AT Persons to be proposed § 170.19, prongs (1), (2), (3), recently adopted § 170.17 to require that members of an RFA in order to be and (4) (§ 170.19(a)(1)–(a)(4))? all registered IBs and CPOs, and most effective. Alternatively, could the goals Regulation 170.19 requires RFAs to registered CTAs, to become RFA of Regulation AT be realized without consider the need for rules in the areas members.231 requiring all AT Persons to be members listed in prongs (1)–(4) (§ 170.19(a)(1)– Together §§ 170.15, 170.16, and of an RFA? (a)(4)). Should RFAs be responsible for 170.17 require many, but not all, H. Pre-Trade and Other Risk Controls considering whether to adopt rules in Commission registrants who may be for AT Persons—§ 1.80 fewer or additional areas? considered AT Persons pursuant to 29. The Commission requests proposed § 1.3(xxxx) to become RFA The Commission proposes as a comment on the latitude afforded to fundamental element of Regulation AT RFAs in proposed § 170.19. Should 227 7 U.S.C. 21. a new § 1.80 of its regulations, requiring 228 RFAs have more or less latitude to issue RFA members also remain subject to oversight AT Persons to implement pre-trade risk by the Commission. rules than specified in proposed 229 Those Commission registrants that are not controls, order cancellation systems, § 170.19? RFA members are nevertheless subject to the rules and other measures reasonably designed 30. The Commission requests and regulations of the Commission. See 7 U.S.C to prevent an Algorithmic Trading comment on RFAs’ obligation in 21(e), which specifies that any person registered Event. Such controls include, but are under the CEA, who is not an RFA member, ‘‘in proposed § 170.19 to establish and addition to the other requirements and obligations not limited to, maximum AT Order maintain a program for the prevention of [the CEA] and the regulations thereunder shall Message frequency and maximum of fraud and manipulation, protection of be subject to such other rules and regulations as the execution frequency per unit time; order the public interest, and perfecting the Commission may find necessary to protect the price parameters and maximum order public interest and promote just and equitable mechanisms of trading, including principles of trade.’’ size limits; order cancellation and through rules it may determine to adopt 230 17 CFR 170.15 and 170.16. Algorithmic Trading disconnect pursuant to § 170.19. The proposed 231 See Membership in a Registered Futures systems; and connectivity monitoring rules anticipate that an RFA’s program Association, 80 FR 55022 (Sept. 14, 2015). systems for AT Persons with DEA. In

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addition, proposed § 1.80 requires AT members and found that almost all firms b. Maximum Order Sizes Persons to: Notify applicable clearing that responded used message and Commenters indicated that maximum 236 member FCMs and DCMs that the AT execution throttles. Commenters order size controls are already used in Person will engage in Algorithmic noted certain benefits to messaging and the industry. According to FIA PTG’s Trading; and calibrate or otherwise execution throttles, including that they survey, all responding trading firms use implement DCM-provided self-trade may mitigate the risk and impact of maximum order size limits.246 AIMA prevention tools.232 It would also disruptive events, alert market indicated that many market participants require AT Persons to periodically participants to potential problems with use maximum order sizes limits,247 and review the sufficiency and effectiveness their automated order entry systems, Gelber, a trading firm, stated that it uses of their compliance with § 1.80. The and help ensure a level playing field for this risk control.248 KCG, Gelber and remainder of this section presents 237 all market participants. Commenters 3Red commented that market Concept Release comments on this also noted that message or execution participants should use exchange- topic, a description of the proposed limits have potential negative effects provided maximum order size regulation, a discussion of the policy because they can block risk-reducing controls.249 justification for the proposal, and a orders.238 With respect to implementing request for comments on the proposal. Commenters addressing this topic did maximum order size limits, FIA and 1. Concept Release Comments on Pre- not support regulations mandating CME indicated that this control should Trade and Other Risk Controls throttle thresholds because appropriate be applied per product or contract.250 The Concept Release requested limits will vary per market participant, KCG suggested that exchange-provided comment on various pre-trade and other depending on each participant’s unique maximum order size controls should types of risk controls, including message systems and trading strategy.239 MFA provide flexibility to the market and execution throttles, maximum order strongly advised against required use of participant in setting different levels for sizes, price collars, and order the repeated automated execution users within a firm, for example, based 251 management controls, such as throttle, stating that it is best for market on trader ID or customer. connectivity monitoring services, participants to determine which Alternatively, the market participant automatic cancellation of orders on should rely on tighter internal controls are most appropriate for their 252 disconnect and kill switches. The ATSs.240 IATP commented on the controls. CME and KCG opposed Concept Release contemplated that such difficulty in setting standardized standardization of maximum order size protections, stating that implementation controls would apply at the trading throttle thresholds, and alternatively of this control depends on individual firm, clearing member and trading suggested standardizing a graduated customers and the market,253 while FIX platform levels. As discussed below, the levy on order cancellations.241 Finally, and IATP supported uniformity with Commission has determined to require Chicago Fed commented that regulators 233 respect to these controls.254 that AT Persons, FCMs, and DCMs should assess the methodology that implement such pre-trade and other risk trading firms use to set throttle limits, c. Price Collars controls. Relevant comments to the the reasonableness of those limits, and Concept Release are discussed below. The Concept Release requested the procedures followed when they are comment on price collars, a control in a. Message and Execution Throttles breached.242 which trading platforms would assign a The Concept Release described As to the appropriate design of range of acceptable order and execution message throttles as establishing throttles, CME and AIMA commented prices for each product and all market maximum message rates per unit in time that throttles implemented by market participants would establish similar and execution throttles as establishing participants should be based on the limits to ensure that orders outside of a limits on the maximum number of specific attributes of an entity or particular price range are not orders that an ATS can execute in a account, including the nature of a firm’s transmitted to the trading platform. given direction per unit in time. The trading strategies, the market it trades While most comments addressing this Concept Release also sought comment in, and the speed of its systems.243 topic focused on price collars on a particular form of execution AIMA indicated that applying throttles implemented by exchanges, FIA throttle, the repeated automated on a per-algorithm basis would distort indicated that its FIA PTG survey execution throttle, which would disable the output of the ATS because an reflected that almost all responding a trading system after a configurable algorithm interacts with many other trading firms used either price collars or number of repeated executions until a algorithms within the same ATS.244 In trading pauses.255 234 human re-enables the system. The contrast, AFR indicated that in order to d. Connectivity Indications and Cancel Concept Release stated that the throttles detect a malfunctioning algorithm, the on Disconnect would be calibrated to address the threshold should be based on the potential for unintended message flow algorithm’s trading strategy.245 The Concept Release requested or executions from a malfunctioning comment regarding ‘‘system heartbeats’’ 235 that would indicate proper connectivity ATS. 236 FIA at 59–60. Commenters indicated that message 237 FIA at 12, 15–17, 65; CME at 8–9; Gelber 7; between a trading firm’s automated and execution throttles are widely used AFR at 6–7; KCG at 3–5; Better Markets at 6–7. in the industry. FIA PTG surveyed its 238 KCG at 3–5; MFA at 7, 13. See also Bell at 3– 246 FIA at 59–60. 4. 247 AIMA at 13. 239 248 Gelber at 10. 232 See section IV(Q) below for a discussion of the FIA at 12; CME at 8–9; MFA at 7, 13; Gelber 249 term ‘‘self-trade’’ and proposed regulations with at 5–7; AIMA at 8; KCG at 3–4. KCG at 8; Gelber at 10; 3Red at 2. respect to self-trade prevention. 240 MFA at 7, 13. 250 FIA at 18–19; CME at 15. 233 The pre-trade and other risk controls for DCMs 241 IATP at 3–5. 251 KCG at 8. in proposed § 40.20 are discussed below in a 242 Chicago Fed at 2. 252 See id. separate section. 243 CME at 8–9; AIMA at 8. 253 CME at 15–16; KCG at 8. 234 Concept Release, 78 FR at 56571. 244 AIMA at 9. 254 FIX at 3; IATP at 5. 235 Concept Release, 78 FR at 56569. 245 AFR at 6–7. 255 FIA at 60.

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trading system and the trading platform, tool that enables clearing firms and end- orders. CME argued that allowing entry and ‘‘auto-cancel on disconnect,’’ an users to cancel orders at a more granular of risk reducing orders as an exception exchange tool allowing trading firms to level.259 Another exchange explained to the kill switch process introduces too determine whether their orders will be that it can cancel orders and quotes in much uncertainty and complexity.268 left in the market upon disconnection. an emergency and it also provides a kill Finally, commenters discussed Two exchanges stated that they provide switch to clearing members that cancels procedures concerning activation of a an optional cancel-on-disconnect all orders and quotes from a market kill switch. For example, FIA and functionality.256 FIA characterized participant.260 While commenters noted Gelber suggested that a kill switch have cancel-on-disconnect as a ‘‘widely the importance of placing kill switches both automated and manual triggers.269 adopted DCM-hosted pre-trade risk at the DCM level,261 several commenters KCG suggested that if the total risk of a control’’ and indicated that it is stated that kill switches should be portfolio exceeds certain thresholds, increasingly common for FCMs to implemented by market participants firm systems should automatically send employ cancel-on-disconnect for their and clearing firms in addition to only risk reducing orders and connections to the DCM.257 Several exchanges.262 supervisors should be able to stop commenters indicated that they support Commenters stressed the importance trading entirely.270 TCL commented that exchanges offering system heartbeats of flexibility in the design of kill an exchange or ATS operator will not and/or cancel-on-disconnect to their switches 263 and generally opposed implement a system that abdicates market participants.258 prescriptive requirements regarding control to an automated kill switch. TCL their design and implementation.264 suggested that monitoring systems e. Order Cancellation Systems Reasons included challenges concerning identify irregular market activity and The Concept Release also addressed setting the correct level of granularity alert staff that have access to a kill selective working order cancellation, a (i.e., whether the control should apply switch.271 Similarly, Chicago Fed tool that enables an exchange to to one participant and not others at the recommended that a human decide immediately cancel one, multiple, or all same firm); the possibility that kill whether to use a kill switch based on resting orders from a market participant switches may prevent a firm from being internal and market conditions.272 as necessary in an emergency situation. able to enter risk-reducing orders; Additional Concept Release Such a tool will mitigate impact to the prescriptive requirements will become comments, including comments on kill market of a malfunctioning Algorithmic outdated; that time is of the essence, switch functionality, are discussed Trading system because it will limit and therefore exchanges and firms need below with respect to Regulation AT additional erroneous orders from being to be free from time-consuming pre-trade risk and other control submitted to a trading platform and processes concerning the use of the kill requirements on FCMs and DCMs. executed. The Concept Release also switch; the standardization of kill 2. Description of Regulation considered order cancellation switches, if poorly calibrated or too mechanisms that would immediately widely applied, could result in The Commission proposes a new cancel all working orders and prevent increased costs and disruption of § 1.80 of its regulations to require that submission (by the market participant), legitimate trading operations; and a AT Persons implement pre-trade risk transmittal (by the clearing member), or concern over adding more layers of controls and other measures for all AT acceptance (by the trading platform) of complexity into an already complex Order Messages that are reasonably any new orders from a market market.265 designed to prevent an Algorithmic participant or a particular trader or ATS A critical concern raised by Trading Event. Relevant controls and of such market participant. commenters was how order cancellation measures required by § 1.80 include, but In response to the Concept Release, mechanisms should address risk- are not limited to: Maximum AT Order numerous commenters addressed kill reducing activity.266 Gelber and KCG Message frequency and maximum switches, discussing industry use; suggested that kill switches enable a execution frequency per unit time; order opposition to prescriptive requirements; firm to mitigate risk through manual price parameters and maximum order the importance of flexibility in design; order entry, and that allowing the size limits; order cancellation and ATS potential triggers; and content of kill market participant to set trigger disconnect systems; and connectivity switch procedures. For purposes of this thresholds will help ensure that orders monitoring systems. They also include discussion, the term ‘‘kill switch’’ entered for the purpose of reducing risk several other specific requirements, means generally any order cancellation are not cancelled.267 In contrast, CME such as notification by AT Persons to tools that cancels or prevents stated that a kill switch should exist applicable DCMs and clearing member submission of orders. Commenters solely to completely remove an entity FCMs that they will engage in generally indicated that kill switches from the market, and that other tools Algorithmic Trading; calibrating or could be beneficial, but also stressed the can be used to enter risk reducing otherwise implementing DCM-provided complexity involved in their design and self-trade prevention tools; and periodic use. 259 CME at 23–24. consideration of the sufficiency and Several commenters described order 260 CFE at 11. effectiveness of the controls that an AT 261 FIA at 29–33; Citadel LLC (‘‘Citadel’’) cancellation mechanisms currently Comment Letter (December 11, 2013) at 3; AIMA at Person has implemented. Consistent employed in the industry. One exchange 3, 18; MFA at 12–13; KCG at 13. with comments received in response to commented that it has two kill switch 262 FIA at 30; Citadel at 3; CME at 22; Chicago Fed the Concept Release, proposed § 1.80 tools: A kill switch used by the at 2; MFA at 12–13; Gelber at 14. provides market participants latitude in exchange, clearing firm, or trading firm 263 FIA at 29–33; TCL at 8; AIMA at 18; MFA at the design and implementation of to remove an entity from the market 12; KCG at 13–14. required controls, and in fact requires 264 FIA at 29–33; CME at 23; Gelber at 14–15; completely; and an order management AIMA at 19. 265 FIA at 29–33; CME at 23; Gelber at 14–15; 268 CME at 24. 256 CME at Appendix A–4; CFE at 9–10. AIMA at 19; TCL at 8. 269 FIA at 29–33; Gelber at 14–15. 257 FIA at 14. 266 FIA at 29–33; TCL at 8; Gelber at 14–15; CME 270 KCG at 14. 258 FIA at 14; KCG at 12; MFA at 12; Chicago Fed at 24; KCG at 13; SIG at 8. 271 TCL at 8. at 2. 267 Gelber at 14–15; KCG at 13. 272 Chicago Fed at 2.

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only a small number of specific controls § 1.80 to determine whether it has trading venue, strategy or product.277 that the Commission understands are effectively implemented sufficient ESMA requires that the controls be already widely implemented by likely measures reasonably designed to calibrated as appropriate for the AT Persons (e.g., proposed §§ 1.80(a), prevent an Algorithmic Trading Event. investment firm’s capital base, clearing 1.80(b) and 1.80(c)). In this regard, Each AT Person must take prompt arrangements, trading strategy, risk proposed § 1.80 provides each AT action to remedy any deficiencies it tolerance and experience.278 ESMA Person with the flexibility to identify identifies. further requires that firms take into and implement any additional controls account variables such as length of time a. Maximum AT Order Message and that such AT Person believes are since engaged in algorithmic trading Execution Frequencies appropriate for its Algorithmic Trading. and reliance on third-party vendors, and The Commission is cognizant that Proposed § 1.80(a)(1)(i) requires AT firms must re-calibrate in order to prescriptive regulations in this area may Persons to set pre-trade risk controls account for the changing impact of the fail to take into account the unique that establish maximum AT Order orders on the relevant market due to characteristics of market participants Message and execution frequencies per different price and liquidity levels.279 In and trading strategies, or may become unit time. These controls are commonly addition, the calculations supporting obsolete as technology evolves. The referred to in industry as message and each control should take into account Commission has attempted to provide execution throttles. These controls are all orders sent to a trading venue.280 FIA appropriate flexibility to accommodate designed to prevent excessive messaging has recently recommended that such variety and evolution, while also or trading which could disrupt, slow automated traders implement message establishing a regulatory floor that down, or impede normal market throttles and repeated automated reflects its evaluation of basic activity. The Commission’s proposed execution limits.281 requirements for all AT Persons.273 regulation on maximum order message As to the appropriate thresholds of and execution frequencies is aimed at these controls, the Commission agrees 3. Policy Discussion preventing market disruptions caused with Concept Release comments Proposed § 1.80 requires AT Persons by either inadvertent or intentional indicating that regulations should not to implement pre-trade risk controls and submission of AT Order Messages. This mandate specific thresholds because, other measures reasonably designed to proposed regulation should not prevent among other things, flexibility is prevent an Algorithmic Trading Event. DCMs from maintaining any and all necessary to respond to the dynamics of This requirement is central to the additional safeguards intended to the market, and appropriate limits will purposes of § 1.80. As discussed below, prevent intentional activity such as vary by participant.282 For example, the Commission believes that proposed quote stuffing, or to apply such commenters suggested that message and § 1.80 would reduce the potential for safeguards to message or data flows that execution throttles should be based on market disruptions arising from system are broader than the proposed definition the specific attributes of the trading firm malfunctions, other errors, or of AT Order Messages. As indicated or account, including the nature of the intentional disruptive conduct. The above, commenters to the Concept firm’s trading strategies, the market it Commission notes that the risks of such Release indicated that message and trades in, and the speed of its disruptions are heightened by the execution throttles are already widely systems.283 Therefore, the proposed increased use of high-speed algorithmic used in the industry.274 Commenters rules do not prescribe particular limits trading, which makes the indicated that the benefits of these risk or thresholds, aside from the implementation of pre-trade risk controls include mitigating the risk and overarching requirement that the controls and other measures even more impact of disruptive events, alerting controls be reasonably designed to necessary. Without effective risk market participants to potential prevent an Algorithmic Trading Event, controls, erroneous orders can problems with their automated trading and § 1.80(a)(2)’s requirement that the significantly impact many market systems, helping to ensure a level controls be set at the level of each AT participants in a short amount of time. playing field for all market participants, Person, or such other more granular The prevention of Algorithmic Trading and deterring predatory and disruptive level as the AT Person may determine, Events pursuant to § 1.80 would help activities.275 In light of these benefits, including but not limited to, by product, ensure the integrity of Commission- and the already extensive use of this account number or designation, or one regulated markets and provide market risk control, the Commission includes or more identifiers of natural persons participants with greater confidence that maximum AT Order Message and associated with an AT Order Message. intentional, bona fide transactions are execution frequencies in its proposed While several commenters supported being executed. rule. greater Commission involvement in The pre-trade risk controls and other The Commission notes that ESMA’s setting risk control parameters, the measures required by proposed § 1.80 2015 Final Draft Regulatory Standards Commission believes that it is not in the include, but are not limited to, those require investment firms to establish a best position to determine the described in clauses (a)–(e) of § 1.80. maximum messages limit and repeated appropriate message or execution rate The Commission believes that each of automated execution throttle.276 The for each trading firm, trading strategy, these enumerated controls and other execution throttle should limit the product, and every other potentially measures will promote the goals of number of times a strategy is applied relevant factor that should be taken into § 1.80, as described above. Proposed only where appropriate to the specific account when establishing thresholds. § 1.80(f) also promotes the goals of 277 § 1.80, by requiring each AT Person to 274 See FIA at 59–60 (FIA’s surveys of member See id.; ESMA September 2015 Final Draft periodically review its compliance with firms and FCMs) and comment indicating that Standards Report, supra note 80 at 200. 278 exchanges already use throttles (CME at 8–9; CFE See id. 279 See id. 273 See section IV(H) below for a more detailed at 5–6; TCL at 6; KCG at 4; MFA at 7; and AIMA 280 discussion of which persons will be designated as at 8). See id. AT Persons for purposes of proposed § 1.80 and 275 See FIA at 12, 15–17, 65; MFA at 7; CME at 281 FIA Guide, supra note 95 at 10, 12. other regulations, and which persons will not be AT 8; Gelber at 5–7; AFR at 6–7. 282 See FIA at 12; CME at 9; Gelber at 5–7; AIMA Persons, but will nonetheless be subject to proposed 276 ESMA September 2015 Final Draft Standards at 8; KCG at 3–4; OneChicago at 5. § 1.82. Report Annex 1, supra note 80 at 214–15. 283 CME at 8–9; AIMA at 8.

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As discussed below, DCMs would price may deviate from a pre- Accordingly, the Commission receive information as to the specific determined price, such as the last trade proposes to require that each order pass quantitative settings used by each AT price, or the market open price.284 By through price parameter and maximum Person as part of Commission-required requiring ‘‘maximum order size limits,’’ order size limit checks in order to compliance reports pursuant to the Commission means the risk control protect the natural price discovery proposed § 1.83. Pursuant to this generally understood in industry as ‘‘fat- process from disruptive behavior such reporting process, DCMs would be able finger’’ limits. Commenters to the as unintentionally large orders. to identify AT Persons that have Concept Release indicated that Consistent with the Commission’s message or execution throttle thresholds maximum order size controls are approach to the other pre-trade risk that appear insufficient. already widely used by trading firms controls, the Commission will not The Commission notes that several and that this control is effective at impose thresholds, but will leave design commenters cited potential negative reducing the likelihood that an of the control and specific thresholds to effects of controls establishing message exchange would need to make use of its the discretion of market participants. or execution limits (e.g., they can block error trade policy.285 Finally, the Commission notes that risk-reducing orders and decrease The Commission notes that ESMA’s market participants could comply with liquidity). The Commission believes 2015 Final Draft Regulatory Standards the pre-trade and other risk controls that the overall benefits to maximum require investment firms to establish required by Regulation AT in multiple order message and execution price collars, maximum order value ways: By internally developing such frequencies, as noted above, outweigh limits and maximum order volume controls from scratch, upgrading potential negative effects. In addition, limits, appropriately calibrated for their existing systems, or purchasing a risk allowing market participants discretion capital base, clearing arrangements, management solution from an outside in the design and implementation of trading strategy, risk tolerance and vendor. The Commission understands message and execution throttles, as well experience.286 IOSCO has also indicated that market participants may also be as in establishing appropriate that many market participants already able to purchase some risk management thresholds, would enable market employ order price and volume solutions from DCMs. The Commission 287 participants to address and limit the limits. In addition, FIA has recently notes that implementation of exchange- potential negative effects of this risk recommended that automated traders provided controls, such as a maximum control. employ maximum order size and price order size limit, would comply with 288 Finally, as noted above, proposed tolerance limits. Finally, the Regulation AT’s requirement that AT § 1.80(a)(2) requires the controls to be Commission also notes that the SEC’s Persons use that control. However, an implemented at the AT Person-level. Market Access Rule requires controls AT Person’s use of a DCM-provided Consistent with § 1.80’s overarching that prevent entry of erroneous orders, maximum order size limit would not requirement that an AT Person shall by rejecting orders that exceed constitute DCM compliance with implement pre-trade risk controls and appropriate price or size parameters, on proposed regulations requiring that other measures reasonably designed to an order-by-order basis or over a short DCMs implement maximum order sizes prevent an Algorithmic Trading Event, period of time, or that indicate limits at the exchange level. each AT Person must evaluate whether duplicative orders.289 the controls should be set at a more Given the usefulness of price and c. Order Management Controls granular level—for example, by product, order size parameters in preventing the account number or designation, or one execution of erroneous trades, the Proposed § 1.80(b) requires that AT or more identifiers of natural persons Commission determined to require that Persons implement certain order associated with an AT Order Message. AT Persons establish such controls on management controls. The required Where deemed appropriate by the AT all orders submitted through controls must have the ability to: (i) Person, the controls should be set at Algorithmic Trading. The proposed Immediately disengage Algorithmic such more granular levels. In addition, regulations are intended to be Trading; (ii) cancel selected or up to all proposed § 1.80(a)(3) requires that sufficiently flexible so that as required resting orders when system or market natural person monitors at the AT controls improve or new types controls conditions require it; and (iii) prevent Person be promptly alerted when the emerge, they may be incorporated into submission of any new AT Order controls are breached. The purpose of an AT Person’s pre-trade risk control Messages (i.e., a ‘‘kill switch’’). The this requirement is to ensure that the AT program and satisfy the requirements of parameters for the order cancellation Person would take any further action proposed § 1.80(a). Similarly, this systems must be reasonably designed to that is necessary to prevent or mitigate regulation is intended to be sufficiently prevent an Algorithmic Trading Event. an Algorithmic Trading Event. flexible that exchanges, AT Persons, and In addition, proposed § 1.80(c) requires clearing member FCMs may set the that AT Persons with Direct Electronic b. Order Price Parameters and specific thresholds that will be most Access (as defined in proposed Maximum Order Size Limits effective in preventing an Algorithmic § 1.3(yyyy)) must implement systems to Proposed § 1.80(a)(1)(ii) requires pre- Trading Event. indicate on an ongoing basis whether trade risk controls that limit the prices they have proper connectivity with the and quantities associated with 284 See FIA Guide, supra note 95 at 10. trading platform and any systems used individual order messages. By requiring 285 FIA at 18–19, 23; CME at 15; Gelber at 10; KCG by a DCM to provide the AT Person ‘‘order price parameters,’’ the at 8; 3Red at 2. with market data. Proposed § 1.80(b)(2) 286 See ESMA September 2015 Final Draft Commission means that AT Persons Standards Report Annex 1, supra note 80 at 214– requires that prior to an AT Person’s must establish price limits intended to 15. initial use of Algorithmic Trading to prevent orders with prices far from the 287 See IOSCO 2015 Consultation Report, supra submit a message or order to a DCM’s prevailing market from entering the note 106 at 21. trading platform, such AT Person must market. At the trading firm or clearing 288 See FIA Guide, supra note 95 at 8, 10. notify the applicable DCM whether all member level, such controls may be 289 See SEC, Responses to Frequently Asked of its resting orders should be cancelled Questions Concerning Risk Management Controls called ‘‘price tolerance limits’’ that for Brokers or Dealers with Market Access, supra or suspended in the event of disconnect define a maximum amount that an order note 37. with the trading platform.

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The order cancellation systems procedures concerning when the control d. Notification of Algorithmic Trading requirements provided in proposed must be triggered, or require that the Proposed § 1.80(d) requires that, prior § 1.80(b) and (c) are intended to protect functionality must allow for submission to an AT Person’s initial use of against erroneous trading activity of risk-reducing orders. Rather, Algorithmic Trading to submit a caused by an algorithmic trading system § 1.80(b)(1) would require that AT message or order to a DCM, such AT malfunction. As to connectivity Persons have the ability and authority to Person must notify its clearing member monitoring and cancel-on-disconnect, disengage Algorithmic Trading, cancel FCM, as well as the DCM on which the several commenters supported selected resting orders, and prevent AT Person is trading, that it will engage exchanges offering such functionality to submission of new AT Order Messages, in Algorithmic Trading. The 290 trading firms. Given the possibility of but does not specify when such Commission intends that this a technology failure that causes a market functionality should be triggered. The requirement ensure that clearing participant’s orders to be left in the Commission allows flexibility for AT member FCMs and exchanges have market upon disconnect, leaving the Persons to design and implement sufficient advance notice to implement trader or trading firm unable to manage appropriate parameters and procedures and calibrate pre-trade and other risk the orders, the Commission believes that that are appropriate for their trading controls to manage risks arising from the systems indicating proper connectivity AT Person’s trading. and cancel-on-disconnect are important strategy or markets. risk management tools that should be The Commission’s approach to order e. Self-Trade Prevention Tools required. The Commission notes that cancellation systems is consistent with Proposed § 1.80(e) requires that, to the commenters to the Concept Release current recommendations in the extent that implementation of a DCM’s indicated cancel-on-disconnect European regulatory context. ESMA’s self-trade prevention tools requires functionality should be a flexible tool, 2015 Final Draft Regulatory Standards calibration or other action by an AT allowing market participants to require that investment firms know Person, such AT Person must calibrate determine whether orders should be left which algorithm and which trader, or take such other action as is necessary in the market upon disconnection.291 trading desk or, where applicable, client to apply such tools. This proposed FIA has explained that automated is responsible for each order, and have regulation is designed to operate in traders must decide whether the ability, as an emergency measure, to conjunction with proposed § 40.23, cancellation upon disconnect mitigates cancel unexecuted orders submitted to which requires DCMs to either apply, or 292 or increases risk. Accordingly, the individual trading venues originated by provide and require the use of, self-trade Commission does not require individual traders, trading desks, or prevention tools.297 cancellation or suspension of orders where applicable, clients. Investment upon disconnect. Rather, it requires AT f. Periodic Review for Sufficiency and firms must also have the ability, as an Effectiveness Persons, prior to engaging in emergency measure, to immediately Algorithmic Trading, to notify the DCM cancel all the firm’s outstanding orders Finally, proposed § 1.80(f) requires as to what action it should take in the at all trading venues to which it is that each AT Person shall periodically event of disconnect, which may depend connected.294 The Commission also review its compliance with § 1.80 to on the facts and circumstances. determine whether it has effectively As to ‘‘kill switch’’ functionality, notes that FIA recently recommended that automated traders build their own implemented sufficient measures comments to the Concept Release reasonably designed to prevent an indicated that exchanges already kill switch functionality into their trading systems where it is possible to Algorithmic Trading Event. Proposed provide kill switch functionality for use § 1.80(f) would also require that an AT by market participants or clearing implement it on a sufficiently granular level to identify individual trading Person take prompt action to remedy members, and additional commenters any deficiencies it identifies. The systems.295 FIA also recommended that suggested that such functionality should Commission recognizes through where an exchange provides a kill be implemented by market participants proposed § 1.80(f) that trading practices, switch, there should be a registration and clearing firms in addition to technologies for algorithmic trading, 293 process and entitlement system that exchanges. The Commission notes and best practices in risk controls will the challenges identified by commenters requires automated traders or brokers to necessarily evolve over time. It believes around setting the correct level of specify which staff are authorized to use 296 that periodic review by AT Persons of granularity of an order cancellation tool, the functionality. The Commission their own pre-trade risk controls and and of the potential need for trading believes that FIA (in its recent Guide to other measures will help to ensure firms to submit risk-reducing orders. the Development and Operation of compliance with proposed § 1.80 in an The Commission believes that requiring Automated Trading Systems), other engaged and proactive manner. that order cancellation tools allow for industry organizations, and commenters submission of risk-reducing orders may to the Concept Release provided g. Certain Measures Not Adopted in introduce too much uncertainty or reasonable recommendations as to the This NPRM complexity into the market, or may be design and implementation of order The Commission determined not to technically infeasible at this time. In cancellation systems. The Commission address in this NPRM some measures light of such considerations, the urges AT Persons and other market that were discussed in the Concept Commission’s proposed regulations do participants to consider such Release and supported by Concept not mandate specific elements of kill recommendations in the Release commenters. For example, switch design, such as the parameters or implementation of order cancellation various commenters favored and connectivity systems. standardization around drop copies and 290 FIA at 14; KCG at 12; MFA at 12; Chicago Fed at 2. error trade policies. FIA commented 291 CME at Appendix A–4; CFE at 9–10; MFA at 294 See ESMA September 2015 Final Draft that drop copies should be available for 12. Standards Report Annex 1, supra note 80 at 211– 292 FIA Guide, supra note 95 at 15. 12. 297 See section IV(Q) below for a discussion of 293 FIA at 30; Citadel at 3; CME at 22–24; Chicago 295 See FIA Guide, supra note 95 at 14. proposed § 40.23 and requests for comment in Fed at 2; MFA at 12–13; Gelber at 14; CFE at 11. 296 See id. at 14. connection with the proposed regulations.

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all trading venues and products 34. Are there additional pre-trade or public comment regarding whether one whenever technologically practicable other risk controls that should be or more of the proposed requirements and that trade reports and other specifically enumerated in proposed applicable to FCMs in §§ 1.80, 1.81, information provided by drop copy § 1.80? 1.83(a), and 1.83(c) (as described below) should be disseminated to the consumer 35. Do you believe that the pre-trade should be incorporated within an FCM’s in real-time or as near real-time as and other risk controls required in Risk Management Program and be practicable.298 As to error trade policies, § 1.80 sufficiently address the subject to the requirements of such FIA suggested that they be clear and possibility of technological advances in program as described in § 1.11. In this deterministic enough for all participants trading, and the development of new, regard, any final rules arising from this to understand, promote a marketplace more effective controls that should be NPRM could place all requirements where all trades stand as executed, implemented by AT Persons? applicable to FCMs in §§ 1.80, 1.81, protect participants who are 36. The Commission welcomes 1.83(a), and 1.83(c) within the counterparties to error trades, and not comment on whether the regulation’s operational risk measures required in be subject to discretion.299 KCG, MFA, requirements relating to the design of § 1.11(e)(3)(ii). Such incorporation Citadel and SIG also made similar controls and the levels at which the could help improve the interaction comments.300 The Commission believes controls should be set are appropriate between an FCM’s operational risk that standardization of drop copy and sufficiently granular. efforts and its pre-trade risk controls; reports and error trade policies, as well 37. The Commission notes that development, monitoring, and as other measures addressed in the § 1.80(d) requires that prior to initial use compliance efforts; and reporting and Concept Release, merit further of Algorithmic Trading, an AT Person recordkeeping requirements, pursuant consideration within the Commission as must notify its clearing member FCM to §§ 1.80, 1.81, 1.83(a), and 1.83(c). It well as in industry. However, the and the DCM that it will engage in could also help ensure that an FCM’s Commission determined to include Algorithmic Trading. The Commission §§ 1.80, 1.81, 1.83(a), and 1.83(c) particular risk controls in Regulation welcomes comment on whether the processes benefit from the same internal AT, and not others, based on its content of that notification requirement rigor and independence required by the understanding of the critical importance is sufficient, or whether clearing Risk Management Program in § 1.11. of controls required in proposed § 1.80 member FCMs and DCMs should also be 40. The Commission proposes to in preventing and mitigating market notified of additional information. For adopt a multi-layered approach to disruptions, as well as their current example, should AT Persons be required regulations intended to mitigate the widespread industry use. to notify their clearing member FCMs of risks of automated trading, including In addition, as noted above, the particular changes to their Algorithmic pre-trade risk controls and other Commission has taken a principles- Trading systems that would affect the procedures applicable to AT Persons, based approach to its requirements risk controls applied by the clearing clearing member FCMs and DCMs. relating to risk controls and other member FCM? Please comment on whether an 38. Is § 1.80(f)’s requirement that each measures. Proposed § 1.80 provides alternative approach, for example one AT Person periodically review its market participants discretion in the which does not impose requirements at compliance with § 1.80 appropriate? design and implementation of controls, each of these three levels, would more Should there be more prescriptive and and requires only a small number of effectively mitigate the risks of granular requirements to ensure that specific controls that the Commission automated trading and promote the each AT Person periodically reviews its understands are already widely other regulatory goals of Regulation AT. pre-trade and other risk controls and implemented. Proposed § 1.80 provides takes appropriate steps to update or I. Standards for Development, Testing, AT Persons with flexibility to identify recalibrate them in order to prevent an Monitoring, and Compliance of and implement any additional controls Algorithmic Trading Event? Algorithmic Trading Systems—§ 1.81 appropriate for their Algorithmic Alternatively, is § 1.80(f) necessary? The Commission proposes regulations Trading. The Commission is aware that Does the Commission need to explicitly under § 1.81 requiring AT Persons to prescriptive regulations in this area may require AT Persons to conduct a establish policies and procedures that not take into account the unique periodic review of their compliance accomplish a number of objectives with characteristics of each market with § 1.80? respect to the development, testing, participant, and may become obsolete. 39. AT Persons that are registered monitoring, and compliance of The proposed regulation reflects the FCMs are required by existing Algorithmic Trading. The proposed Commission’s intent to accommodate Commission regulation 1.11 to have regulations are intended to standardize the diverse and evolving nature of formal ‘‘Risk Management Programs,’’ a set of principles in order to reduce the market participants’ businesses and including, pursuant to § 1.11(e)(3)(ii), operational risk of such systems. The technology, while establishing basic ‘‘automated financial risk management remainder of this section presents regulatory requirements of essential risk controls reasonably designed to prevent Concept Release comments on this controls and related measures that each the placing of erroneous orders’’ and topic, a description of the proposed market participant engaged in ‘‘policies and procedures governing the regulation, a discussion of the policy Algorithmic Trading should have. use, supervision, maintenance, testing, justification for the proposal, and a 4. Request for Comments and inspection of automated trading request for comments on the proposal. programs.’’ As described in § 1.11, an 33. Are any pre-trade and other risk FCM’s Risk Management Program must 1. Concept Release Comments controls required by § 1.80 ineffective, include a risk management unit The Concept Release requested not already widely used by AT Persons, independent of the business unit; comment on testing procedures for or likely to become obsolete? quarterly risk exposure reports to senior ATSs. The Concept Release contemplated, among other things, that 298 FIA at 13. management and the governing body of 299 See id. the FCM, with copies to the market participants operating ATSs 300 KCG at 10–11; MFA at 2, 10–12; Citadel at 3, Commission; and other substantive must test each ATS internally and on 4–5; SIG at 8–9. requirements. The Commission requests each trading platform on which it will

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operate, and trading platforms must already subject to DCM Core Principle described their own testing practices. provide test environments that simulate 20 and Commission regulation CME indicated that market participants the production environment. In 38.1051(h), which require DCMs to routinely test in their own testing particular, the Concept Release asked conduct periodic, objective testing and environments using historical data to for comment on when it is most review of their automated systems to test trading strategies against a range of beneficial for firms to test an ATS after ensure that they are reliable, secure, and market conditions, and that exchanges it has been modified, and how the have adequate scalable capacity.308 In commonly make their own historical Commission and market participants addition, KCG argued that a ‘‘testing data available for testing purposes. CME should distinguish between major process that creates too many frictions explained that it requires all systems modifications and minor modifications. can discourage making changes that interfacing with CME Globex to be Commenters support ATS testing and improve a system.’’ 309 Similarly, TCL certified on the order entry and/or discussed current and best practices, but stated that the testing procedures market data interfaces prior to disagreed as to whether regulatory suggested in the Concept Release are deployment.317 CFE provides a user measures are appropriate to standardize overly broad and could force ATS testing environment that simulates the these practices. Most commenters operators to take a narrow view of what production environment.318 TCL (including FIA, CME, CFE, and MFA) constitutes a change.310 described FIA industry-wide testing of oppose standardized ATS testing In contrast, several commenters backup systems.319 procedures.301 FIA indicated that it is support regulatory involvement in this FIX stated that it has a working group impractical to implement prescriptive area. Chicago Fed noted that many that is developing best practices related standardized procedures for industries have standards-setting to testing and is working to increase the development, testing and change bodies, but because there is no corollary availability of test financial management given the diversity of for the development of ATSs within an instruments.320 Similarly, IIT technologies and business operations at ‘‘HFT environment,’’ market commented that a working group named DCMs. FIA pointed to the testing participants and the TAC should work AT 9000, which is affiliated with the recommendations outlined in its March together to formulate such standards International Organization for 2012 ‘‘Software Development and and guidelines that will help mitigate Standardization, is developing a quality Change Management the impact of operational risks.311 IATP management system for automated Recommendations’’ as best practices for stated that out of all of the safeguards trading. The goals of AT 9000 are to trading firms, which could also apply to addressed in the Concept Release, ATS help automated trading industry all participants. FIA described different testing has the greatest potential to organizations satisfy their responsibility types of testing and supports DCMs reduce market disruptions. IATP for trading safety, to satisfy regulatory providing robust test environments and recommended that the Commission requirements, and to improve the market participants using such review and select from current best efficiency and effectiveness of environments.302 CME cited the FIA practices.312 MFA recommended that automated trading.321 PTG’s ‘‘Recommendations for Risk industry engage in more robust testing, The Concept Release also requested Controls for Trading Firms’’ as an and that trading platforms should offer comment on ATS development and appropriate principles-based approach testing where a firm’s software interacts change development. Among other to management, oversight, and testing of with other types of software.313 things, the Concept Release electronic trading systems.303 CME AIMA opposes standardization, and contemplated that trading platforms and noted that exchange systems vary suggested alternatively that ‘‘CFTC market participants operating ATSs widely, and each exchange should principles’’ create a legal requirement must maintain a development develop and test in a manner that for a certain standard of testing and environment that is adequately isolated comports with industry best change management. AIMA cited as an from the production trading practices.304 example the Department of Energy environment, and that market SIG indicated that DCMs should Software Engineering Methodology.314 participants must have policies and provide test environments and stated While MFA also opposes procedures concerning approval and that ATS testing procedures should be standardization, it stated that ‘‘rules or verification of changes to their trading standardized ‘‘where possible.’’ 305 industry practice should encourage systems. In particular, the Concept Gelber stated that standardizing more robust and more routine testing at Release asked for comment on what development, testing and change the trading platform level.’’ 315 challenges or benefits may result from management might be helpful, but it is Finally, as to current ATS testing the implementation of standardized more important that these procedures practices, MFA indicated that ‘‘many, if development and change management are clear and comprehensive at each not all, exchanges provide market procedures. exchange than that they are participants a test facility to test trading FIA described the core components of standardized.306 software and algorithms, as well as offer a change management as including Both FIA and CME noted the test symbols to trade.’’ 316 CME and CFE authorization (effective pre-deployment difficulty of establishing objective review of the proposed change) and criteria to determine what constitutes a 308 CFE at 2–3. auditability (procedures for ‘‘major’’ or ‘‘minor’’ modification of an 309 KCG at 15–16. communicating requirements, changes ATS.307 CFE noted that DCMs are 310 TCL at 15. and functionality related to proprietary 311 Chicago Fed at 3. software and technical infrastructure). 312 IATP at 7. 301 FIA at 34–38; CME at 26; CFE at 2–3; AIMA FIA indicated that prescriptive 313 MFA, Presentation Before the CFTC at 3, 20–21; TCL at 15; KCG at 15–16; MFA at 2, Technology Advisory Committee Meeting on Risk 12–13; OneChicago at 2–3. Controls and System Safeguards for Automated 317 CME at 25–26. 302 FIA at 34–38. Trading Environments (Feb. 10, 2014) at 13, 318 CFE at 12. 303 CME at 25. available at: http://www.cftc.gov/idc/groups/public/ 319 TCL at 11–14. 304 _ CME at 26. @newsroom/documents/file/tac021014 mfa.pdf. 320 FIX Trading Community (‘‘FIX’’) Comment 305 SIG at 9. 314 AIMA at 3, 20–21. Letter (December 11, 2013) at 4–5. 306 Gelber at 15–16. 315 MFA at 13. 321 Illinois Institute of Technology (‘‘IIT’’) 307 FIA at 34–38; CME at 25–26. 316 MFA at 13. Comment Letter (February 11, 2014) at 1–2.

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development and change management the design, testing, and supervision of contribute to future Algorithmic Trading standards are impractical given the Algorithmic Trading. The proposed Events (such testing must be conducted diversity of market participants, but regulations are intended to standardize both internally with the AT Person and principles such as authorization and a set of principles in order to reduce the on each designated contract market on auditability can serve as ‘‘building operational risk of such systems. The which Algorithmic Trading will occur); blocks’’ that market participants can use proposed regulations require each AT (iii) regular back-testing of Algorithmic to tailor a change management process Person to: Implement written policies Trading using historical transaction, to fit their needs.322 and procedures for the development and order, and message data to identify Similarly, TCL indicated that testing of ATSs (§ 1.81(a)); implement circumstances that may contribute to exchanges and ATSs should have formal written policies and procedures future Algorithmic Trading Events; (iv) processes for change management, reasonably designed to ensure that each regular stress tests of Algorithmic which include a production installation of its ATSs is subject to continuous real- Trading systems to verify their ability to authorization process in which no one time monitoring and supervision by operate in the manner intended under a may change the production systems knowledgeable and qualified staff while variety of market conditions; (v) after it has been submitted for such ATS is engaged in trading procedures for documenting the strategy authorization, followed by a formal (§ 1.81(b)); implement written policies and design of proprietary Algorithmic signoff.323 KCG recommended that and procedures reasonably designed to Trading software used by an AT Person, policies for deploying new software ensure that ATSs operate in a manner as well as any changes to such software include staged deployment (deploying that complies with the CEA and the if such changes are implemented in a new software in phases, with explicit rules and regulations thereunder, and production environment; and (vi) rollback procedures), and validation ensure that staff are familiar with the maintaining a source code repository to (manual and automated evaluation of CEA and the rules and regulations manage source code access, persistence, whether a change is successful).324 thereunder, the rules of any DCM to copies of all code used in the In addition, the Concept Release which such AT Person submits orders production environment, and changes to requested comment on ATS monitoring through Algorithmic Trading, the rules such code (such source code repository and supervision. In particular, the of any RFA of which such AT Person is must include an audit trail of material Concept Release requested comment on a member, the AT Person’s own internal changes to source code that would allow the extent to which human monitors requirements, and the requirements of AT Persons to determine, for each such have been trained in how to respond to the AT Person’s clearing member FCM, material change: Who made it; when unexpected problems, and been given in each case as applicable (§ 1.81(c)); they made it; and the coding purpose of the requisite authority to intervene at and implement written policies and the change. The source code must also these times. The Concept Release procedures to designate and train staff be maintained in accordance with suggested that market participants responsible for Algorithmic Trading Commission regulation § 1.31). operating ATSs must ensure that their (§ 1.81(d)). The proposed rules are Monitoring of Algorithmic Trading ATSs are subject to continuous real-time described in greater detail below. Systems. Regulation AT proposes a new monitoring and supervision by trained As a complement to the proposed requirement (§ 1.81(b)) that each AT and qualified staff at all times while design and testing requirements, Person must implement written policies engaged in trading. Two commenters Regulation AT proposes a new and procedures reasonably designed to addressed ATS monitoring and requirement that DCMs (under proposed ensure that each of its ATSs is subject § 40.21, discussed in section IV(O) supervision, but did not specifically to continuous real-time monitoring by below) provide a test environment that express support or opposition to knowledgeable and qualified staff while will enable market participants to regulatory action. KCG recommended such ATS is engaged in trading. Such simulate production trading and that a monitoring process identify policies and procedures must at a conduct exchange-based conformance ‘‘smoke signals’’ (unusual or abnormal minimum include the following: (i) testing of their Algorithmic Trading behaviors), investigate the cause of the Continuous real-time monitoring of smoke signals, and, if the smoke signal systems. Development and Testing of Algorithmic Trading to identify is an error, the monitoring alerts should potential Algorithmic Trading Events; be adjusted to take that information into Algorithmic Trading Systems. Regulation AT proposes a new (ii) automated alerts when an ATS’s AT account.325 MFA commented that there requirement (§ 1.81(a)(1)) that each AT Order Message behavior breaches design should be at least one designated Person must implement written policies parameters, upon loss of network individual who is available and and procedures for the development and connectivity or data feeds, or when authorized to suspend a firm’s trading testing of its Algorithmic Trading market conditions approach the program. MFA also suggested that FCMs systems. Such policies and procedures boundaries within which an ATS is should have ‘‘plan-of-action’’ protocols must at a minimum include the intended to operate, to the extent that include scenarios where trading is 327 following: (i) Maintaining a applicable; (iii) monitoring staff of suspended based on specific types of development environment that is the AT Person shall have the ability and events.326 adequately isolated from the production authority to disengage an Algorithmic 2. Description of Regulation trading environment (the development Trading system and to cancel resting environment may include computers, orders when system or market The Commission proposes regulations conditions require it, including the requiring AT Persons to establish networks, and databases, and should be used by software engineers while ability to contact staff of the applicable policies and procedures that accomplish designated contract market and clearing a number of objectives with respect to developing, modifying, and testing source code); (ii) testing of all firm, as applicable, to seek information 322 FIA at 4, 36–37. Algorithmic Trading code and related 327 For example, if an ATS is designed to operate 323 systems and any changes to such code TCL at 15. within certain ranges of volatility, liquidity, or 324 KCG at 17. and systems prior to their order or trade prices, automated alerts may be 325 KCG at 17–18. implementation, including testing to triggered when volatility or a moving average 326 MFA at 14. identify circumstances that may approaches the pre-determined ranges.

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and cancel orders; and (iv) procedures following: (i) Procedures for designating Guidelines, Best Practices and that will enable AT Persons to track and training all staff involved in Regulatory Standards on Testing and which monitoring staff is responsible for designing, testing and monitoring Development an Algorithmic Trading system during Algorithmic Trading, and documenting As noted above, the ESMA guidelines trading hours. The Commission believes training events (training must, at a recommended that investment firms that staff persons who are responsible minimum, cover design and testing should make use of clearly delineated for monitoring the trading of other AT standards, Algorithmic Trading Event development and testing methodologies Person staff should typically not be communication procedures, and prior to deploying an electronic trading actively engaged in trading at the same requirements for notifying staff of the system or a trading algorithm, and time, because it would be difficult to applicable designated contract market should monitor their electronic trading adequately and consistently monitor when Algorithmic Trading Events systems, including trading algorithms, trading of other AT Person staff while occur); (ii) training policies reasonably in real-time.329 The MiFID II Directive 328 engaged in trading activities. designed to ensure that natural person requires a regulated market to have in Compliance of Algorithmic Trading monitors are adequately trained for each place effective systems, procedures and Systems. Regulation AT proposes a new Algorithmic Trading system or strategy arrangements, including requiring requirement (§ 1.81(c)) that each AT (or material change to such system or members or participants to carry out Person shall implement written policies strategy) for which such monitors are appropriate testing of algorithms and and procedures reasonably designed to providing environments to facilitate ensure that each of its Algorithmic responsible; and (iii) escalation procedures to inform senior staff as soon such testing. The Directive seeks to Trading systems operates in a manner reduce the likelihood that algorithmic that complies with the CEA and the as Algorithmic Trading Events are identified. The training described in trading systems may create or contribute rules and regulations thereunder. AT to disorderly trading conditions, and to Persons must also implement clause (ii) above must include, at a minimum, the trading strategy for the promote effective resolution of any procedures requiring staff of the AT disorderly trading conditions that do Person to review Algorithmic Trading Algorithmic Trading system, as well as the automated and non-automated risk arise from algorithmic trading systems in order to detect potential systems.330 With respect to MiFID II, Algorithmic Trading Compliance Issues. controls that are applicable to the Algorithmic Trading system or strategy. ESMA’s 2015 Final Draft Regulatory Such staff must include staff of the AT Standards include requirements relating Adequate training should ensure that Person familiar with the CEA and the to the role of compliance and monitors are effectively educated rules and regulations thereunder, the monitoring staff, testing (including regarding the typical behavior of each rules of any DCM to which such AT conformance testing, stress testing, and Algorithmic Trading system or strategy Person submits orders through testing environments), annual review Algorithmic Trading, the rules of any (or material change to such system or and validation of systems, change RFA of which such AT Person is a strategy) that they are responsible for management procedures, and real-time member, the AT Person’s own internal overseeing in production. It should also market monitoring procedures.331 These requirements, and the requirements of allow monitors to understand when risk standards include, among other things, the AT Person’s clearing member FCM, controls may be triggered, and how to that a firm must have clear lines of in each case as applicable. The respond once they are. As result of the accountability for the development, procedures should also include a plan training they receive, monitors should deployment and updates of algorithms, of internal coordination and be capable of making rapid, appropriate and effective procedures for communication between compliance decisions in real time to help contain or communication of information; staff of the AT Person and staff of the mitigate ATS issues. compliance staff must have a general AT Person responsible for Algorithmic 3. Policy Discussion understanding of how trading systems Trading regarding Algorithmic Trading and algorithms operate, and be in design, changes, testing, and controls, Consistent with the comments continuous contact with persons with which plan should be designed to detect received, the Commission is taking a detailed technical knowledge of trading and prevent Algorithmic Trading principles-based approach in this area, systems and algorithms; testing must Compliance Issues. which is intended to provide discretion ensure that systems conform with the Designation and Training of to AT Persons, particularly with respect rules and systems of the trading venue, Algorithmic Trading Staff. Regulation to the development and testing of risk controls work as intended, and AT proposes a new requirement Algorithmic Trading systems. The systems will not contribute to disorderly (§ 1.81(d)) that each AT Person must Commission acknowledges that trading and can continue to work implement written policies and prescriptive regulations in this area may effectively in stressed market procedures to designate and train its fail to take into account the unique conditions; firms must run an annual staff responsible for Algorithmic characteristics of various market validation process, which includes Trading. Such policies and procedures participants’ trading strategies, and may preparation of a validation report; firms must at a minimum include the become obsolete as technology and must keep records of material changes development standards evolve. For made to software, including when a 328 The Commission notes that the supervision example, the Commission recognizes change was made, who made it, who requirement of proposed § 1.81(b) is analogous to approved it, and the nature of the the supervision requirements for Commission that software development practices registrants under the customer protection rules of continue to evolve, and therefore is not change; and monitoring systems must Commission regulation 166.3. The Commission imposing very granular coding or testing have real-time alerts that assist staff in further notes that ESMA’s draft regulatory standards requirements. The Commission believes identifying when an algorithm is not for MiFID II provide that real-time monitoring behaving as expected, and firms must should be performed by a risk function that is that this principles-based approach is independent from the trader, to ensure an consistent with other regulatory 329 See ESMA Guidelines, supra note 61 at 10. appropriate segregation between the trading desk initiatives and best practice guides and supporting functions. See ESMA September 330 See MiFID II, Article 48(6). 2015 Final Draft Standards Report, supra note 80 issued in this area, as further discussed 331 ESMA September 2015 Final Draft Standards at 201. below. Report Annex 1, supra note 80 at 205–16.

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have a process for remedial action when Note, published in April 2015, regarding Algorithmic Trading design, alerts occur, including a process for an recommended that market participants changes, testing, and controls; and orderly withdrawal from the market.332 using algorithmic trading conduct procedures for documenting the strategy With respect to the U.S. securities testing during all phases of a trading and design of proprietary Algorithmic markets, the SEC’s Reg SCI requires SCI product’s lifestyle, namely during Trading software used by an AT Person, entities to implement a program to development, rollout to production, and among other controls. The review and keep current systems ongoing maintenance.338 standardization of such written policies development and testing methodology The rules proposed under § 1.81 are and procedures may make disruptive for SCI systems, and to implement intended to be consistent with these events like the Knight Capital incident standards that result in SCI systems regulatory initiatives and best practices. less likely in the future. The Commission believes that most being designed, developed, tested, 4. Request for Comments maintained, operated, and surveilled in market participants and DCMs have a manner that facilitates the successful implemented controls regarding the 41. The Commission understands that collection, processing, and design, testing, and supervision of the requirements for developing, testing, dissemination of market data.333 In Algorithmic Trading systems, in light of and supervising algorithmic systems addition, FINRA Notice 15–09, the numerous best practices and proposed in § 1.81(a)–(d) are already published in March 2015, offered regulatory requirements promulgated in widely used throughout the industry. guidance on effective supervision and this area. The proposed regulations are Are any specific requirements proposed control practices for market participants intended to standardize a set of in this section not widely used by that use algorithmic trading strategies in principles relating to the design, testing, persons that would be designated as AT the equities market. The FINRA notice and supervision of Algorithmic Trading Persons under Regulation AT, and if provided guidance in five general areas: systems in order to reduce the not, why not? If any requirements General risk assessment and response; operational risk of such systems. In their described in § 1.81(a)–(d) are not widely software/code development and response to the Concept Release, IATP used, please provide an estimate of the implementation; software testing and noted that, out of all the safeguards cost that would be incurred by an AT system validation; trading systems; and discussing in the Release, they believed Person to implement such requirements. compliance.334 ATS testing had the greatest potential to 42. Are there any aspects of § 1.81(a)– 339 The Commission further notes that reduce market disruptions. By (d) that are unnecessary for purposes of the FIA Guide provides an overview of standardizing principles in this area, reducing the risks from Algorithmic development and testing procedures, Regulation AT is intended to reduce the Trading, and should not be mandated by including software development, source risk of disorderly trading, including the regulation? If so, please explain. code management and implementation, risk that orders will be unintentionally 43. Are the procedures described exchange-based conformance testing, sent into the marketplace by a poorly above for the development and testing and post-deployment verification, while designed or insufficiently supervised of Algorithmic Trading sufficient to noting that ‘‘market participants and algorithm. ensure that algorithmic systems are For example, the regulations proposed exchanges should have the flexibility thoroughly tested before being used in under § 1.81 may reduce the risk of necessary to establish procedures that production, and will operate in the market disruptions such as the 2012 are appropriate and proportional to their manner intended in the production incident involving Knight Capital. The operations.’’ 335 The IOSCO 2015 environment? SEC later concluded that, among other 44. Are there any additional Consultation Report notes that ‘‘many failures, Knight Capital did not have procedures for the development and regulatory authorities have introduced adequate controls and procedures for testing of Algorithmic Trading that specific requirements and guidelines code deployment and testing for its should be required under Regulation regarding the introduction of new order router, did not have sufficient AT? systems and changes to existing controls and written procedures to 45. Are any of the required systems,’’ and recommends that trading guide employees’ responses to procedures for the development and venues should consider establishing significant technological and testing of Algorithmic Trading likely to policies and procedures related to the compliance incidents, and did not have become obsolete in the near future as development, modification, testing and an adequate written description of its development and testing standards implementation of critical systems, and risk management controls.340 As evolve? establishing a governance model for the discussed above, proposed § 1.81 46. Are the procedures for designating management of critical systems.336 The requires written policies and procedures and training Algorithmic Trading staff IOSCO report also notes that most relating to the following: Testing of all of AT Persons sufficient to ensure that trading venues have procedures and Algorithmic Trading code and relates such staff will be knowledgeable in the tools designed to address the systems and any changes to such code strategy and operation of Algorithmic operational risk associated with and systems prior to their Trading, and capable of identifying electronic trading, including monitoring implementation; regular stress tests of Algorithmic Trading Events and of trading in real-time (or near real- Algorithmic Trading systems to verify promptly escalating them to appropriate time), and monitoring of the trading their ability to operate in the manner staff members? venue’s system performance in real- 47. Is it typical that persons 337 intended under a variety of market time. Finally, the Senior Supervisors conditions; a plan of internal responsible for monitoring algorithmic Group Algorithmic Trading Briefing coordination and communication trading do not simultaneously engage in between compliance staff of the AT trading activity? 332 See id. 48. Proposed §§ 1.80, 1.81, and 1.83 333 Person and staff of the AT Person See Reg SCI, supra note 40 at 72437. would impose certain requirements on 334 See FINRA Notice 15–09, supra note 59 at 1. responsible for Algorithmic Trading 335 See FIA Guide, supra note 95 at 23–30. all AT Persons regardless of the size, 336 See IOSCO 2015 Consultation Report, supra 338 See SSG 2015 Note, supra note 115 at 3. sophistication, or other attributes of note 106 at 14, 19. 339 IATP at 7. their business. The Commission 337 Id. at 21. 340 See SEC Knight Capital Release, supra note 39. requests public comment regarding

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whether these requirements should vary limits. These limits should be and that exchanges should make this in some manner depending on the AT documented and discussed with market same protection available to executing Person. If commenters believe proposed participants to ensure that they are brokers executing for customers for §§ 1.80, 1.81, and 1.83 should vary, appropriate for the participants’ type of whom they do not clear.355 please describe how and according to activity.346 FIA further stated that FCMs b. Maximum Order Sizes what criteria. that choose to implement message rate limits within their infrastructure should Commenters indicated that clearing J. Risk Management by Clearing Member be transparent to their customers FCMs—§ 1.82 members already use maximum order regarding the reason for the control and sizes. FIA explained that FIA PTG The Commission proposes a new the maximum message rate that can be conducted a survey and all responding § 1.82 to require clearing member FCMs supported by the FCM.347 In the case of FCMs used this control.356 CME to implement pre-trade risk and order direct access, FIA explained that the commented that it allows clearing management controls with respect to AT FCM should rely on DCM-provided members to use its technology to set Order Messages originating with an AT message rate limits and any controls maximum order sizes for specific Person. Specifically, such clearing implemented by the market participants customers or accounts.357 CFE stated member FCMs must make use of pre- themselves.348 that it allows clearing members to set trade risk controls reasonably designed Additional commenters indicated that maximum order size limits by product, to prevent or mitigate an Algorithmic FCMs should implement messaging or and then set maximum order and quote 349 Trading Disruption, including at a execution limits. For example, Gelber size limits by the ‘‘log-in’’ of trading minimum, those pre-trade risk controls stated that ‘‘in many cases, FCMs privilege holders.358 FIX indicated that described in § 1.80(a)(1). The remainder receive fills from the exchanges and it is becoming increasingly common for of this section presents Concept Release have no control over the amount of futures and equities exchanges to comments on this topic, a description of messaging coming from a customer provide tools that allow an FCM the the proposed regulation, a discussion of controlled-and-run applications. ability to set checks for each client that the policy justification for the proposal, Therefore, FCMs need to have the accesses the exchange directly.359 AIMA and a request for comments on the ability to coordinate throttle rates suggested that many market participants proposal. through the account identifier at the already use maximum order sizes when exchange.’’ 350 Gelber indicated that 1. Concept Release Comments trading through their brokers, but may such limits should take into account have less access to this control in the The Concept Release inquired about financial risk and FCMs’ understanding 360 351 case of direct market access. MFA clearing members’ use of the same pre- of their clients’ business. MFA stated commented that some FCMs already trade and other risk controls discussed that clearing members, as the gateways offer their customers this control, which above in section IV(H) with respect to to the markets, should have financial can be set at the following levels: Each AT Persons. and regulatory risk management direct market access order, each controls to reduce risks associated with individual algorithmic order, net sell a. Message and Execution Throttles market access.352 Similarly, CME and buy order limits, and total contract supported allowing clearing members to FIA indicated that message and limits.361 MFA suggested that all FCMs provide direct market access to their execution throttles are already widely offer this maximum order size control at customers as long as the clearing used by clearing members. FIA PTG the trader-level.362 Similarly, KCG member has appropriately vetted the surveyed its members and found that all believes that exchange-provided client and implemented appropriate risk responding FCMs used message and maximum order size controls should management controls.353 CME stated execution throttles, either internally or allow the market participant flexibility 341 that clearing firms should decide the at the exchange level. FIA also in setting different maximum order size exact nature of the throttles to impose indicated that most DCMs provide tools levels for different users within a firm, to allow FCMs to set pre-trade controls across their customer base, taking into consideration financial risk to the extent such as based on trader ID or for their customers, which are a customer.363 Chicago Fed supports a prerequisite for an FCM to provide possible and their understanding of their clients’ businesses.354 Finally, SIG requirement that clearing firms must use direct access to a market participant this control at the account level.364 without routing orders through the commented that clearing firms should FCM’s infrastructure.342 FIA explained have the ability to throttle orders at the c. Price Collars that FCMs encourage DCMs to provide exchange level in connection with credit limits set by the clearing firm, Most comments addressing this pre-trade risk controls that can be set at control focused on price collars various levels, whether at session level, 346 implemented by exchanges. However, customer level or account level.343 CFE FIA at 16. 347 the FIA FCM Survey reflected that commented that it provides an FIA at 12. 348 FIA at 16. almost all responding FCMs used price execution throttle to clearing 349 KCG at 3; Gelber at 6; MFA at 4–5; CME at 344 collars, administered either internally or members. 7–9; AIMA at 7; Chicago Fed at 2; SIG at 3. The at the exchange level.365 FIA stated that DCM message rate Commission notes that the same concern discussed limits should be supplemented at the in the AT Person context that message or execution limits have potential negative effects because they 355 345 See id. market participant or FCM level. FIA can block risk-reducing orders would also apply to 356 FIA at 59–60. explained that where an FCM facilitates message or execution limits applied by an FCM. To 357 CME at 15. that end, the Commission notes that FIA market access, it has the ability to 358 commented that a FCM should never reject an order CFE at 7. impose the FCM’s own message rate cancellation request due to message rate limits. See 359 FIX at 3. FIA at 16. 360 AIMA at 13. 341 FIA at 59–60. 350 Gelber at 6. 361 MFA at 9. 342 FIA at 13. 351 Gelber at 5–7. 362 See id. 343 FIA at 13. 352 MFA at 4–5. 363 KCG at 8. 344 CFE at 7. 353 CME at 7. 364 Chicago Fed at 2. 345 FIA at 12, 16. 354 CME at 9. 365 FIA at 60.

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d. Order Management Controls clearing member FCMs must make use the FCM are promptly alerted when pre- As noted above, the Concept Release of pre-trade risk controls reasonably trade risk control parameters established requested comment regarding ‘‘system designed to prevent or mitigate an pursuant to this section are breached, heartbeats’’ and ‘‘auto-cancel on Algorithmic Trading Disruption, and make use of the order cancellation disconnect,’’ and commenters that including at a minimum, those pre-trade systems described in § 1.80(b)(1). (The addressed this topic indicated that risk controls described in § 1.80(a)(1). order cancellation systems are the same exchanges provide these tools. In (Proposed § 1.80(a)(1) requires AT controls that proposed § 1.80(b)(1) addition, FIA indicated that it is Persons to implement, at a minimum, requires AT Persons to implement, i.e., increasingly common for FCMs to maximum AT Order Message frequency systems that have the ability to employ cancel-on-disconnect for their per unit time and maximum execution immediately disengage Algorithmic connections to the DCM.366 frequency per unit time, order price Trading, cancel selected or up to all Some commenters addressed the parameters and maximum order size resting orders when system or market implementation of ‘‘kill switch’’ limits.) The Commission notes that conditions require it, and prevent the functionality by FCMs. Two exchanges proposed § 1.82 requires clearing submission of new orders.) Pursuant to proposed § 1.82(b) and commented that their kill switch member FCMs to address ‘‘Algorithmic (c), the location of the pre-trade and functionality allows clearing firms to Trading Disruptions,’’ rather than the other risk controls calibrated by the cancel orders 367 and several broader ‘‘Algorithmic Trading Events’’ clearing member FCM varies, according commenters stated that kill switches that AT Persons are required to address to whether an AT Person’s orders are should be implemented by market under proposed § 1.80. As discussed in placed through DEA or intermediated by participants and clearing firms in section IV(D) above, an Algorithmic its clearing FCM. addition to exchanges.368 Barclays Trading Disruption is defined in proposed § 1.3(uuuu) as an event DEA Orders—Controls Reside at commented that if a kill switch is DCM. Proposed § 1.82(b) addresses AT located at the FCM level, then the originating with an AT Person that disrupts, or materially degrades, (1) the Order Messages originating with an AT Commission should provide ‘‘clear Person and submitted through DEA. In regulatory guidance’’ about when the Algorithmic Trading of such AT Person, (2) the operation of the DCM on which the case of DEA, pre-trade and other risk FCM should alter or cancel orders, given controls would be established by and that altering or cancelling orders could such AT Person is trading or (3) the ability of other market participants to located at the DCM, and be controlled expose the FCM to significant financial or calibrated by the clearing FCM. This 369 trade on the DCM on which such AT or legal liability. approach recognizes that clearing FCMs FIA explained that if a DCM cannot Person is trading. In contrast to an Algorithmic Trading Event (defined in do not have the ability to apply market provide the appropriate level of risk controls to customers’ DEA orders proposed § 1.3(vvvv)), an Algorithmic granularity in the function of its kill before they reach a DCM. With respect Trading Disruption does not specifically switch, the focus of this functionality to financial risk, existing § 38.607 370 incorporate violations of the CEA or the should be at the FCM level. FIA requires DCMs to establish controls rules thereunder. The Commission recommended that a kill switch facilitating FCMs’ management of anticipates that some Algorithmic implemented by an FCM should be able financial risk, and existing § 1.73 Trading Disruptions may be the result of to be invoked ‘‘at the finest resolution provides requirements with respect to violations of the CEA or Commission possible’’ and should include both clearing FCMs’ implementation of such regulations, and some Algorithmic manual and automated methods for controls.373 Consistent with that 371 Trading Disruptions may not. Proposed triggering the kill switch. FIA structure, proposed amendments to § 1.82 requires clearing member FCMs stressed that a kill switch should be § 38.255 establish a similar structure in used as a ‘‘final measure’’ only when to make use of pre-trade risk controls which DCMs must establish pre-trade other processes have not been reasonably designed to prevent or and other risk controls addressing the successful, and that policies and mitigate an Algorithmic Trading risks of Algorithmic Trading for use by procedures for when an FCM will Disruption, regardless of whether such FCMs. Proposed § 1.82(b), accordingly, invoke a kill switch should be clearly disruptions were the result of a requires FCMs to implement such communicated to the market violation of the CEA or Commission controls residing at the DCM. participant.372 regulations. It otherwise does not Non-DEA Orders—FCM Implements require clearing member FCMs to ensure 2. Description of Regulation and Calibrates Controls. Proposed that their customers’ order flow does not § 1.82(c) addresses the scenario in The Commission proposes a new violate the CEA or Commission which AT Order Messages originating § 1.82 to require clearing member FCMs regulations. However, nothing in with an AT Person are not submitted to to implement pre-trade risk controls and proposed § 1.82 relieves FCMs of their a trading platform through DEA, but order management controls with respect obligations under all other applicable instead are routed through a clearing to AT Order Messages originating with Commission regulations. member FCM. In the case of such an AT Person. Specifically, such Proposed § 1.82 also requires that pre- intermediated orders, the controls trade risk controls must be set at the would not reside at the DCM. Instead, 366 FIA at 14. level of each AT Person, or such other the clearing member FCM itself would 367 CME at 23–24; CFE at 11. more granular level as the clearing FCM have the obligation to implement and 368 Citadel at 3; CME at 22; Chicago Fed at 2. may determine, including but not 369 Barclays Capital Inc. (‘‘Barclays’’) Comment 373 The Commission notes that § 23.609 imposes Letter (December 10, 2013) at 1. Similarly, FIA limited to: By product, account number the same risk-based limit requirements on SDs and commented that where FCMs rely on DCM- or designation, or one or more MSPs as § 1.73 does on clearing FCMs. SDs and provided controls, and such controls fail to operate identifiers of natural persons associated MSPs do not carry customer accounts; accordingly, according to the instructions of the FCM, FCMs with an AT Order Message. In addition, any firm that has customer accounts must be a should be deemed to have met their regulatory § 1.82 would require the clearing registered FCM and implement the controls obligations. FIA at 19–20. required by new § 1.82. Furthermore, any SD or 370 member FCM to have policies and FIA at 30. MSP that engages in Algorithmic Trading for its 371 Id. at 31. procedures reasonably designed to own account will have to comply with the AT 372 Id. ensure that natural person monitors at Person requirements of proposed § 1.80.

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calibrate pre-trade risk and other is granted access to the market via an Algorithmic Trading) and to proposed controls with respect to such orders. intermediary’s systems or directly, § 1.82 (as a clearing member). The The Commission notes that while the without using the intermediary’s Commission is providing further clarity controls implemented by the FCM are systems. IOSCO has recommended that regarding who would be AT Persons for the same types of controls that would be intermediaries (including clearing firms) purposes of § 1.80 and other regulations, implemented by AT Persons pursuant to have adequate operational and technical including some detailed order flow § 1.80 (and by DCMs pursuant to capabilities to manage appropriately the scenarios that demonstrate the § 40.20, discussed below), each entity risks posed by such access.375 ESMA’s application of §§ 1.80 and 1.82, below. would be responsible for ensuring the 2015 Final Draft Regulatory Standards Question One: In the scenario in appropriate calibration of the control. require that the intermediary providing which a non-clearing FCM trading for a Accordingly, an FCM’s setting of a access apply pre-trade risk controls on proprietary account submits orders to a maximum order size limit, for example, the order flow of their clients.376 separate clearing FCM, could the may be different from the setting used ESMA’s regulatory standards provide clearing FCM ever engage in by an AT Person, depending on each that the direct electronic access provider Algorithmic Trading and be an AT entity’s assessment of the potential for may use its own proprietary controls, Person? an Algorithmic Trading Event or an controls purchased from a third-party, If an FCM trading for a proprietary Algorithmic Trading Disruption, as or controls offered by a trading venue, account submits an order to a separate applicable. The Commission will not but in each of those circumstances the clearing FCM, the separate clearing FCM mandate exactly when intervention by provider remains responsible for the could be an AT Person if it uses an FCM to modify or cancel orders is effectiveness of those controls and is computer algorithms or systems to necessary; rather, the Commission solely entitled to set or modify any determine any of the elements of the believes that each FCM is best parameters and limits.377 definition of Algorithmic Trading (e.g., positioned to determine appropriate determinations regarding order routing). parameters that will prevent or mitigate 4. Discussion of Persons Subject to If the clearing FCM is not making any an Algorithmic Trading Disruption. Proposed §§ 1.80 and 1.82 of these determinations, the clearing Furthermore, the Commission will not The following discussion is intended FCM is not an AT Person. specify a mandate which, if complied to provide detailed examples of which If an FCM trading for a proprietary with by an FCM, would absolve the persons will be subject to proposed account submits an order to a separate FCM of liability (as requested by §§ 1.80 (applicable to all AT Persons non-clearing FCM who then submits it Barclays).374 when acting as such) and 1.82 to an additional separate clearing FCM, 3. Policy Discussion (applicable only to clearing FCMs). the clearing FCM is not engaged in Proposed § 1.80 would apply to AT Algorithmic Trading, provided that it is The Commission agrees with Persons—i.e., any FCM, floor broker, not determining any of the elements of comments to the Concept Release that SD, MSP, CPO, CTA, IB or floor trader the definition of Algorithmic Trading. suggested that all types of market access as defined in proposed § 1.3(x)(3) when Question Two: Is it correct to say that create risks; therefore, the same engaged in Algorithmic Trading on or all FCMs using Algorithmic Trading to principles should apply to all types of subject to the rules of a DCM. In engage in proprietary trading are AT market access. When an order does not contrast, proposed § 1.82 would apply Persons? pass through a clearing member FCM’s to clearing FCMs when acting as Yes. A non-clearing or clearing FCM infrastructure before entering the clearing members for their customers that uses Algorithmic Trading to engage market, it is critical that DCMs provide with respect to an AT Order Message. in proprietary trading is an AT Person. clearing member FCMs with the ability Question Three: Is it correct to say to subject such orders to controls that An entity could be subject to both § 1.80 and § 1.82 in certain that an FCM accepting orders from its prevent or mitigate the impact of customer may be an AT Person, if its unintended or disruptive trading. In circumstances. For example, in the event that a clearing FCM engages in computer algorithms or systems addition, where orders pass through a determine any of the elements of the clearing member FCM’s infrastructure both Algorithmic Trading for its own account and acts a clearing member definition of Algorithmic Trading? before entering the market, that clearing Yes. A non-clearing or clearing FCM with respect to its customers’ AT Order member FCMs should subject such that accepts customer orders, and that Messages, such clearing FCM would be orders to similar controls. The uses computer algorithms or systems to subject to both proposed § 1.80 (as an Commission believes that an order determine any of the elements of the AT Person with respect to its own should pass through the same pre-trade definition of Algorithmic Trading (e.g., risk controls regardless of trading 375 IOSCO 2015 Consultation Report, supra note determinations regarding order routing), strategy or means of market access, and 106 at 22–23. would be an AT Person with respect to that all market participants have a 376 See ESMA September 2015 Final Draft the customer’s orders. responsibility to implement risk Standards Report Annex 1, supra note 80 at 218. Below are some detailed order flow controls appropriate to their role in the ESMA’s 2015 Final Draft Regulatory Standards scenarios that demonstrate the further require, among other things, that direct lifecycle of an order. electronic access providers have the ability to stop application of §§ 1.80 (which applies to As discussed above, commenters order flow of their clients, carry out a review of the AT Persons) and 1.82. indicated that the required controls (i.e., internal risk controls systems of the client, and have Example 1: Order flow prior to execution the ability to identify the different trading desks message and execution throttles and by DCM: (i) Customer to (ii) non-clearing price and size parameters) are already and traders of its clients. The direct electronic access provider must also perform due diligence on FCM to (iii) separate clearing FCM. Customer widely used by clearing members, either its clients covering, among other things, the type of is not registered with the Commission; uses internally or as provided by the DCM. strategies the client will use, the operational set-up, algorithms but not DEA. Neither the non- The Commission also notes that IOSCO systems and controls of the client, its historical clearing FCM nor the clearing FCM make any and ESMA have stressed the importance trading pattern and behavior, an assessment of the of the determinations regarding the order level of expected trading and order volume, and the of adequate risk controls where a user described in the definition of Algorithmic ability of the client to meet its financial obligations. Trading. See id. at 219–20. 374 See Barclays at 1. 377 See id. Who is an AT Person?

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(i) The customer is not an AT Person, because it engages in Algorithmic originating with an AT Person. The because it is not registered and does not Trading. Commission is considering modifying use DEA. (ii) The clearing FCM is not an AT proposed § 1.82 to require clearing (ii) The non-clearing FCM is not an Person, because it doesn’t make any FCMs to implement controls with AT Person, because it doesn’t make any determinations regarding the order and respect to all orders, including orders determinations regarding the order and therefore doesn’t engage in Algorithmic that are manually submitted or are therefore doesn’t engage in Algorithmic Trading. But the clearing FCM is subject entered through algorithmic methods Trading. to § 1.82, because the FCM originating that nonetheless do not meet the (iii) The clearing FCM is not an AT the orders is an AT Person. definition of Algorithmic Trading. Such Person, for the same reason as (ii). The a requirement would correspond to the 5. Request for Comments clearing member FCM is also not subject requirement under proposed § 40.20(d) to 1.82, because the customer in (i) 49. Are any pre-trade or other risk that DCMs implement risk controls for originating orders isn’t an AT Person. controls required by § 1.82 ineffective, orders that do not originate from Example 2: Order flow prior to execution not already widely used by clearing Algorithmic Trading. If the Commission by DCM: (i) Customer to (ii) non-clearing member FCMs, or likely to become were to incorporate such amendments FCM to (iii) separate clearing FCM. Customer obsolete? in any final rules arising from this is not registered with the Commission; uses 50. Are there any aspects of proposed NPRM, its intent would be to further algorithms but not DEA. Non-clearing FCM’s § 1.82 that pose an undue burden for reduce risk by ensuring that all orders, computer algorithms or systems make some clearing member FCMs and are regardless of source, are screened for of the determinations regarding the order unnecessary for purposes of reducing risk at both the clearing member FCM described in the definition of Algorithmic the risks associated with Algorithmic and the DCM level. Risk controls at the Trading. Trading? If so, please explain (1) the point of order origination would Who is an AT Person? burden; (2) why it is not necessary to continue to be limited to AT Persons. (i) The customer is not an AT Person, reduce the risks associated with The Commission requests comment on because it is not registered and does not Algorithmic Trading, particularly in the this proposed amendment to § 1.82, use DEA. case of DEA. What alternatives are which the Commission may implement (ii) The non-clearing FCM is an AT available consistent with the purposes in the final rulemaking for Regulation Person, because it engages in of Regulation AT? AT. The Commission requests comment Algorithmic Trading regarding the 51. Please describe the technological on the costs and benefits to clearing customer’s order. development that would be required by FCMs of this proposal, in addition to (iii) The clearing FCM is not an AT clearing member FCMs to comply with any other comments regarding the Person, assuming it doesn’t make any the requirement to implement and effectiveness of this proposal in terms of determinations regarding order and calibrate the pre-trade and other risk risk reduction. therefore doesn’t engage in Algorithmic controls required by § 1.82(c) for non- Trading. The clearing FCM is also not DEA orders. To what extent have K. Compliance Reports Submitted by AT subject to 1.82, because the customer clearing member FCMs already Persons and Clearing FCMs to DCMs; originating orders isn’t an AT Person developed the technology required by Related Recordkeeping Requirements— § 1.83 (even though the non-clearing FCM in this provision, for example in the order flow is an AT Person). connection with existing requirements The Commission is proposing new Example 3: Order flow prior to execution under § 1.11, and §§ 1.73 and 38.607 for § 1.83(a) and (b) of its regulations to by DCM: (i) Customer to (ii) a clearing FCM. clearing FCMs to manage financial require that AT Persons and clearing Customer is not registered with the risks? member FCMs provide the DCMs on Commission; uses algorithms but not DEA. 52. Are there additional pre-trade or which they operate with information Clearing FCM just clears trades, and does not other risk controls that should be regarding their compliance with make any of the determinations regarding the specifically required pursuant to §§ 1.80(a) and 1.82(a)(1). Specifically, order described in the definition of proposed § 1.82? the proposed rules would require AT Algorithmic Trading. 53. Do you believe that the pre-trade Persons prepare, certify, and submit Who is an AT Person? and other risk controls required in annual reports regarding their controls (i) The customer is not an AT Person, § 1.82 sufficiently address the for: (1) Maximum AT Order Message because it is not registered and does not possibility of technological advances in frequency; (2) maximum execution use DEA. trading and development of new, more frequency; (3) order price parameters; (ii) The clearing FCM is not an AT effective controls that should be and (4) maximum order sizes. The Person, because it doesn’t make any implemented by FCMs? proposed rules would require each FCM determinations regarding the order and 54. The Commission welcomes that is a clearing member for an AT therefore doesn’t engage in Algorithmic comment on whether the requirements Person to prepare, certify, and submit Trading. The clearing FCM is also not of § 1.82 relating to the design of annual reports regarding its program for subject to 1.82, because the customer controls and the levels at which the establishing and maintaining those same originating orders isn’t an AT Person. controls should be set are appropriate controls for its AT Persons (in the Example 4: Order flow prior to execution and sufficiently granular. aggregate). As described in section IV(H) by DCM: (i) FCM trading for its proprietary 55. Proposed § 1.82 does not require and (J) above, the use of such pre-trade account to (ii) a separate clearing FCM. The FCMs to have connectivity monitoring risk controls would be mandatory for FCM trading for a proprietary account uses such as ‘‘system heartbeats’’ or both AT Persons and clearing member Algorithmic Trading; clearing member FCM automatic cancel-on-disconnect FCMs pursuant to §§ 1.80(a)(1) and does not make any of the determinations functions. Do you believe that § 1.82 1.82(a)(1), respectively. described in the definition of Algorithmic should require FCMs to have such The reports proposed by § 1.83, Trading. functionality? together with the DCM review program Who is an AT Person? 56. Proposed § 1.82 requires clearing proposed by § 40.22, will enable DCMs (i) The FCM trading for the FCMs to implement controls with to have a clearer understanding of the proprietary account is an AT Person, respect to AT Order Messages pre-trade risk controls of all AT Persons

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that are engaged in Algorithmic Trading receive the certification; and (4) should CCO and CRO to make certain that on such DCM. Furthermore, because AT DCMs, SEFs, or clearing member FCMs responsibility for the underlying Persons and clearing member FCMs will be required to audit the certifications of systems and algorithms is taken by have great flexibility in how they market participants.380 those officers having direct implement their pre-trade risk controls Commenters were mixed in their responsibility.’’ 391 CME commented pursuant to proposed §§ 1.80(a)(1) and support of a certification requirement that any attestation should lie with the 1.82(a)(1), the annual reporting for market participants operating ATSs supervisors with business line obligations in proposed § 1.83 and DCM and for clearing firms that provide responsibility for, and knowledge of, the review provisions in § 40.22 will help clearing services to those market systems at issue. CME also stated that ensure that such controls are being participants. Some commenters, such as the certifications ‘‘should be tendered to implemented and are reasonably AFR, supported certifications.381 each level of the supply chain with designed and calibrated. Others, such as AIMA, FIA, and CME, supervisory authority.’’ 392 As a complement to the compliance oppose a certification requirement set With respect to the frequency of the report program described above, by the Commission.382 AIMA argued certifications, Gelber commented that proposed § 1.83(c) and (d) would that a certification requirement ‘‘could market participants should certify twice require AT Persons and clearing merely create extra administrative costs per year and whenever there has been member FCMs for AT Persons to keep for firms and the CFTC.’’ 383 FIA and a material change to a program that they and provide upon request to DCMs CME stated that it should be left to employ.393 TCL stated that ATSs should books and records regarding their individual DCMs to define certification be required to make the certification compliance with §§ 1.80 and 1.81 (for policies for their market participants.384 annually, or whenever a major AT Persons) and § 1.82 (for clearing FIA commented that instead of formal functional change to their business member FCMs). certification, market access should environment is implemented.394 With The remainder of this section presents depend on attestation that the highest respect to the auditing of the Concept Release comments on this quality standards are maintained and certifications, FIA argued that audit topic, a description of the proposed appropriate risk controls and escalation responsibilities should only be regulation, a discussion of the policy procedures are in place.385 CME argued determined after standards are in justification for the proposal, and a that ‘‘[g]iven the breadth of risk profiles place.395 Alternatively, Gelber argued request for comments on the proposal. across the spectrum of clients, it would that exchanges should require firms to 1. Concept Release Comments be unduly burdensome and cost- maintain certifications and produce prohibitive for the exchanges or the them upon request. Gelber stated that it The Concept Release requested Commission to mandate specific risk should be at the exchanges’ discretion comment on whether it would be management parameters and the as to whether they audit such appropriate to require periodic self- continuous auditing or formal certifications.396 certifications by all market participants certification thereof.’’ 386 operating ATSs and by clearing firms With respect to what information 2. Description of Regulation that provide clearing services to those might be included in the certifications, 378 Compliance Report Program. market participants. In the Concept Gelber argued that ‘‘[a] market Proposed § 1.83(a) and (b) would require Release, the Commission set forth participant should certify that each of that AT Persons and clearing member potential areas that a self-certification its ATS employs pre-trade risk controls, FCMs, respectively, provide the DCMs for market participants might cover. The post-trade reports and system on which they operate with information Commission stated that a certification safeguards.’’ 387 FIA and CME also regarding their compliance with might attest that: ‘‘(1) The ATS contains commented that if the Commission were §§ 1.80(a) and 1.82(a)(1). Specifically, structural safeguards to provide to impose a certification requirement, the proposed rules would to require AT reasonable assurance that the trading the standards for such requirement Persons to prepare, certify, and submit 388 system will not be disruptive to fair and should be principles-based. annual reports regarding their controls equitable trading; (2) the market Most commenters support requiring for: (1) Maximum AT Order Message participant’s ATSs have been designed senior management to make the frequency; (2) maximum execution to avoid violations of the CEA, certification. FIA argued that if a frequency; (3) order price parameters; Commission regulations, or exchange certification requirement is imposed, and (4) maximum order sizes. The rules related to fraud, disruptive trading this certification should be the proposed rules would require each FCM responsibility of senior management at practices, manipulation and trade that is a clearing member for one or the market participant, DCM or FCM.389 practice violations; and (3) such systems more AT Persons to prepare, certify, and Gelber commented that the certification have been sufficiently tested and submit annual reports regarding its should be from a chief technology documented in a manner that is program for establishing and officer or equivalent, and attested to by appropriate to the intended design and maintaining those same controls for its 379 another c-level executive officer.390 AFR use of that system.’’ The Concept AT Persons in the aggregate. As commented that certifications ‘‘should Release also requested comment on a described in section IV(H) and (J) above, be made by the CEO, as well as both the number of different aspects of a self- the use of such pre-trade risk controls certification program. These included: would be mandatory for AT Persons 380 Id. (1) Whether the chief executive officer pursuant to § 1.80(a)(1), and mandatory or chief compliance officer, or similar 381 AFR at 8. 382 for clearing member FCMs pursuant to ranking official of each market AIMA at 21; FIA at 4; CME at 27. 383 § 1.82(a)(1). participant should attest to the AIMA at 21. 384 FIA at 4; CME at 27. certification; (2) how often should a 385 FIA at 40. 391 AFR at 8. market participant make the self- 386 CME at 28. 392 CME at 28. certification; (3) which entities should 387 Gelber at 17. 393 Gelber at 17. 388 FIA at 4; CME at 27. 394 TLC at 15. 378 Concept Release, 78 FR 56559. 389 FIA at 39. 395 FIA at 40. 379 Id. 390 Gelber at 17. 396 Gelber at 17.

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The Commission is also proposing a business (e.g., diversity of trading § 40.22(c) 399 would require DCMs to new § 40.22 (discussed in more detail systems and connectivity methods, and establish a program for effective below) to require that each DCM that the speed of trading). The validation periodic review and evaluation of AT receives a report described in § 1.83 report must be approved by the firm’s Person and clearing member FCM establish a program for effective review senior management and the firm must reports. and evaluation of the reports. The remedy any deficiencies identified. Recordkeeping Requirements. As a complement to the compliance report reports proposed by § 1.83 and the While not identical to the certification review program, proposed § 1.83(c) and review program proposed by § 40.22 required of broker-dealers in the Market would enable DCMs to have a clearer (d) would require AT Persons and Access Rule or ESMA’s annual self- understanding of the pre-trade risk clearing member FCMs for AT Persons assessment process for investment controls and compliance procedures of to keep and provide upon request to firms, the compliance report program all AT Persons that are engaged in DCMs books and records regarding their proposed by § 1.83 and § 40.22 is Algorithmic Trading on such DCM. The compliance with proposed §§ 1.80 and proposed reports and review program similarly designed to ensure that market 1.81 (for AT Persons) and § 1.82 (for will also give DCMs a better participants have effective risk controls clearing member FCMs). Related to understanding of the program for in place and that these risk controls are these provisions, the Commission is also establishing and maintaining the pre- regularly reviewed. Specifically, proposing a new § 40.22(d) (discussed trade risk controls used by any FCM of proposed § 1.83(a) would require each in more detail below) to require DCMs an AT Person that is engaged in AT Person to annually prepare a report, to implement rules that require each AT Algorithmic Trading on such DCM. and submit such report by June 30 to Person to keep and provide to the DCM The Commission notes that the SEC’s each DCM on which such AT Person books and records regarding such AT Market Access Rule, as discussed in engaged in Algorithmic Trading, that Person’s compliance with all greater detail above, has a similar covers from May 1 of the previous year requirements pursuant to § 1.80 and certification requirement for certain to April 30 of the year such report is § 1.81, and require each clearing broker-dealers.397 The Market Access submitted. Together with the annual member FCM to keep and provide to the Rule requires that certain broker-dealers report, each AT Person would be DCM books and records regarding such maintain a system for regularly required to submit copies of the written clearing member FCM’s compliance reviewing the effectiveness of the risk policies and procedures developed to with all requirements pursuant to § 1.82. management controls and supervisory comply with § 1.81(a) and (c). The Finally, proposed § 40.22(e) would procedures required by the Market report must include descriptions of the require DCMs to review and evaluate, as Access Rule. It also requires that the AT Person’s pre-trade risk controls necessary, books and records Chief Executive Officer (or equivalent required by proposed § 1.80(a)(1), and maintained by AT Persons and clearing officer) of a broker-dealer subject to the the parameters and specific quantitative member FCMs regarding their Market Access Rule certify, on an settings used for the risk controls. The compliance with §§ 1.80 and 1.81 (for annual basis, that the risk management report would also be required to include AT Persons) and § 1.82 (for clearing controls and supervisory procedures a certification by the chief executive member FCMs). established by the broker-dealer comply officer or chief compliance officer of the 3. Policy Discussion with the Market Access Rule, and that AT Person that, to the best of his or her the broker-dealer conducted the knowledge and reasonable belief, the The Commission is proposing § 1.83 required review of the risk management information contained in the report is because it believes that Regulation AT controls and supervisory procedures. accurate and complete. must include a mechanism to ensure that AT Persons and clearing member The certification required by the Market Proposed § 1.83(b) would require each FCMs are complying with the Access Rule must be preserved by the FCM that is a clearing member for an requirement to implement certain pre- broker-dealer as part of its books and AT Person to annually prepare a report, trade risk controls. Moreover, an records. and submit such report by June 30 to assessment of such compliance requires The Commission also notes that each DCM on which such AT Person an adequate level of expertise and ESMA’s 2015 Final Draft Regulatory engaged in Algorithmic Trading, that knowledge of markets and market Standards require an annual self- covers from May 1 of the previous year participants’ technological systems and assessment and validation process in to April 30 of the year such report is trading strategies. In this regard, the which investment firms must review submitted. The report must include a Commission notes that reports proposed their algorithmic trading systems and description of the FCM’s program for by § 1.83 will enable DCMs to have a trading algorithms, and overall establishing and maintaining the pre- better understanding of the pre-trade compliance with Article 17 of Directive trade controls required by proposed risk controls of all AT Persons engaged 2014/65/EU (MiFID II’s requirements on § 1.82(a)(1) for its AT Persons (in the in Algorithmic Trading. Furthermore, firms that engage in Algorithmic aggregate) at the DCM. The requirements 398 because the Commission’s pre-trade risk Trading). ESMA sets out elements of proposed § 1.83(b) apply to the pre- control requirements in proposed that investment firms should consider trade risk controls implemented by the §§ 1.80(a)(1) and 1.82(a)(1) offer in its self-assessment, which include FCM for AT Persons using DEA, as well substantial flexibility, the annual elements relating to the nature of its as for AT Persons that do not use DEA. reporting obligations in proposed § 1.83 business (e.g., level of automation, types The report would also be required to will help ensure that such controls are of strategies it employs, latency include a certification by the chief reasonably designed and calibrated. The sensitivity), the scale of its business executive officer or chief compliance Commission believes that a review (e.g., number of algorithms, number of officer of the FCM that, to the best of his program requiring AT Persons and trading desks, messaging volume or her knowledge and reasonable belief, clearing member FCMs to provide capabilities), and the complexity of its the information contained in the report information concerning compliance is accurate and complete. Related to 397 17 CFR 240.15c3–5(e). these reporting requirements in 398 ESMA September 2015 Final Draft Standards 399 See section IV(P) below for a discussion of Report Annex 1, supra note 80 at 210, 224–26. proposed § 1.80(a) and (b), proposed DCMs’ obligations under proposed § 40.22.

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with §§ 1.80(a) and 1.82(a)(1), and clearing member FCMs and are member FCMs to make use of the requiring DCMs to review such unnecessary for purposes of reducing systems provided by DCMs pursuant to information, is the most effective the risks associated with Algorithmic § 38.255(b). The remainder of this method to ensure that all market Trading? If so, please explain (1) the section presents Concept Release participants are implementing measures burden; (2) why it is not necessary to comments on this topic, a description of that are reasonably designed to prevent reduce the risks associated with the proposed regulation, a discussion of an Algorithmic Trading Event or Algorithmic Trading, particularly in the the policy justification for the proposal, Algorithmic Trading Disruption. case of DEA. What alternatives are and a request for comments on the The recordkeeping requirements available consistent with the purposes proposal.400 proposed under § 1.83(c) and (d) and of Regulation AT, including in 1. Concept Release Comments § 40.22(d) and (e) complement the particular Regulation AT’s intent that compliance report program. These § 1.83 reports benefit from the third- As noted above in section IV(D)(7), in provisions will enable DCMs to review party SRO review performed by DCMs the Commission’s discussion of its the compliance of AT Persons and with respect to such reports? proposed definition of Direct Electronic clearing member FCMs with their 62. Should the reports required by Access, several commenters agreed that various obligations under §§ 1.80, 1.81, proposed § 1.83 be sent to any entity any potential risk controls should also and 1.82, by inspecting the books and other than each DCM on which the AT apply to those with direct access to the records of AT Persons and clearing Person operates, such as the markets.401 FIA stated, for example, that member FCMs as necessary. For Commission or an RFA? For example, all types of market access create risks.402 example, a DCM may find it necessary should the Commission require that AT Similarly, CME stated that all entities— to conduct such a review if: It becomes Persons that are members of a RFA send whether they have direct market access aware if an AT Person’s kill switch is compliance reports to RFA upon NFA’s or not—must ‘‘share in the effort to frequently activated, or otherwise request? preserve market integrity.’’ 403 In performs in an unusual manner; if a 63. Proposed § 1.83(c) includes addition, commenters indicated that DCM becomes aware that an AT recordkeeping requirements imposed on exchanges already provide certain pre- Person’s algorithm frequently performs AT Persons, and proposed § 1.83(d) trade risk controls for use by clearing in a manner inconsistent with its includes recordkeeping requirements firms. Please see the discussion at design, which may raise questions about imposed on clearing member FCMs. section IV(H)(1) above for a discussion the design or monitoring of the AT Should the recordkeeping requirements of Concept Release comments with Person’s algorithms; if a DCM identifies of § 1.83(c) be distributed throughout respect to clearing firms’ use of frequent trade practice violations at an the sections of the Commission’s exchange-provided pre-trade and other AT Person, which are related to an regulations that contain recordkeeping risk controls. requirements for various categories of algorithm of the AT Person; or if an AT 2. Description of Regulation Person represents significant volume in Commission registrants that will be a particular product, thereby requiring classified as AT Persons? Should The Commission proposes to amend heightened scrutiny, among other § 1.83(d) be transferred to section 1.35 of § 38.255 (Risk controls for trading) to reasons. the Commission’s regulations, which require DCMs to have in place systems contains recordkeeping requirements for and controls designed to facilitate a 4. Request for Comments clearing member FCMs? clearing member FCM’s management of the risks that may arise from 57. The Commission welcomes L. Risk Controls for Trading: Direct comment on the type of information that Algorithmic Trading by its AT Person Electronic Access Provided by DCMs— customers using DEA (as defined in should be included in the reports § 38.255(b) and (c) required by proposed § 1.83. Should proposed § 1.3(yyyy)). The DCM different or additional descriptions be The Commission proposes to amend regulations already address financial included in the reports, which will be § 38.255 (Risk controls for trading) by risk using a similar structure. Existing evaluated by DCMs under proposed adding new § 38.255(b) requiring DCMs § 38.607 provides that, in the context of § 40.22? to implement systems and controls direct electronic access, a DCM must 58. How often should the reports reasonably designed to facilitate a have in place systems and controls required by proposed § 1.83 be clearing FCM’s management of designed to facilitate an FCM’s submitted to the relevant DCMs? Should Algorithmic Trading risks arising from management of ‘‘financial risk.’’ The the report be submitted more or less its DEA customers. The Commission DCM must also require FCMs to use frequently than annually? also proposes to amend § 38.255 by such controls. 59. When should the reports required adding new paragraph (c), which would The pre-trade risk controls and order by proposed § 1.83 be submitted to the require that DCMs who permit DEA also cancellation systems that DCMs must relevant DCMs? Should the reports be mandate the use of § 38.255(b) risk provide to clearing member FCMs are submitted on a date other than June 30 controls by all clearing member FCMs the same as those that proposed of each year? with respect to the Algorithmic Trading § 1.80(a) requires AT Persons to 60. Should a representative of the AT of their DEA customers. The implement, i.e., maximum AT Order Person or clearing member FCM other Commission notes that the risk controls Message frequency per unit time and than the chief executive officer or the and requirements described in proposed maximum execution frequency per unit chief compliance officer be responsible § 38.255(b) and (c), while provided by time, and order price parameters and for certifying the reports required by and residing at the DCM, are maximum order size limits. The order proposed § 1.83? Should only the chief fundamentally intended to facilitate a executive officer be permitted to certify clearing member FCM’s management of 400 The proposed amendments would also re- the report? Alternatively, should only the risks posed by the clearing member designate the existing requirements in § 38.255 as § 38.255(a). the chief compliance officer be FCM’s DEA customers. In this regard, 401 FIA at 12, 15; KCG at 2; CME at 7–8; VFL at permitted to certify the report? proposed § 38.255(b) and (c) should be 2; AIMA at 1. 61. Are there any aspects of proposed read in conjunction with proposed 402 FIA at 12, 15. § 1.83(b) that pose an undue burden for § 1.82(b), which would require clearing 403 CME at 7–8.

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cancellation systems that DCMs must capabilities to manage appropriately the cancel-on-disconnect functions. Should establish for implementation by the risks posed by direct electronic § 38.255 require such functionality? clearing member FCM are the same access.406 In addition, as discussed M. Disclosure and Transparency in DCM controls that proposed § 1.80(b)(1) above, ESMA’s 2015 Final Draft Trade Matching Systems—§ 38.401(a) requires AT Persons to implement, i.e., Regulatory Standards require direct systems that have the ability to electronic access providers to apply pre- Regulation AT proposes to amend immediately disengage Algorithmic trade controls on the order flow of their § 38.401(a) of the Commission’s Trading, cancel selected or up to all clients consistent with the controls that regulations to enhance public resting orders when system or market ESMA requires for investment firms.407 transparency regarding the design and conditions require it, and prevent the ESMA’s standards further provide, operation of a DCM’s electronic submission of new orders. among other things, that trading venues matching platform. Currently, The proposed regulation text is must have public rules pursuant to § 38.401(a) requires DCMs to have articulated broadly enough to allow which direct electronic access providers procedures, arrangements, and DCMs the flexibility to design controls provide their service, and in the case of resources for disclosing to the for use by clearing member FCMs that sponsored access (where a client Commission, market participants, and are appropriate to their markets and transmits orders directly to a trading the public accurate information on the market participants. Proposed platform without such orders passing rules and specifications of their § 38.255(b)(1)(ii) provides that the pre- through an intermediary’s electronic matching platforms or trade trade risk controls established by the infrastructure), the trading venue must execution facilities. The proposed DCMs must enable the clearing member require such firms to implement the amendments to § 38.401(a) would FCM to set the controls at the level of same pre-trade risk controls as the clarify that such existing obligations each AT Person, product, account trading venue’s members.408 The include disclosure of any attributes of number or designation, and one or more Commission believes that requiring an electronic matching platform or trade identifiers of natural persons associated DCMs to establish pre-trade risk execution facility that materially impact with an AT Order Message. DCM rules controls and order management controls market participant orders, but which are should permit clearing member FCMs to for use by clearing member FCMs with not readily apparent to a market choose the level at which they place the respect to their direct access customers participant. The proposed amendments control, as long as clearing member will ensure that all orders, regardless of recognize that the structure, architecture, mechanics, characteristics, FCMs use at least one of the levels. access method, are subjected to the attributes, or other elements of an Similarly, proposed § 38.255(b)(2) same tools that mitigate the risks posed electronic matching platform or trade provides that the DCM-provided order by Algorithmic Trading. cancellation systems should enable the execution facility—elements that are clearing member FCM to apply such 4. Request for Comments under the design control of the DCM— systems to orders from each AT Person, 64. Are there any pre-trade and other may affect how market participant product, account number or risk controls required by § 38.255(b) and orders are received or executed. The designation, or one or more identifiers (c) that will be ineffective, not already Commission believes that each market of natural persons associated with an widely provided by DCMs for use by participant should have ready access to AT Order Message. A DCM that permits FCMs, or likely to become obsolete? information that explains the existence and operation of any attribute within an DEA must require FCMs to use the 65. Are there additional pre-trade or electronic matching platform or trade § 38.255(b) controls with respect to all other risk controls that DCMs should be execution facility that will impact how AT Order Messages originating with an specifically required to provide to FCMs a market participant experiences the AT Person that are submitted through pursuant to proposed § 38.255(b) and market. The remainder of this section DEA. (c)? presents Concept Release comments on 66. Do you believe that the pre-trade 3. Policy Discussion this topic, a description of the proposed and other risk controls required regulation, a discussion of the policy The Commission believes that its pursuant to § 38.255(b) sufficiently justification for the proposal, and a proposed amendments to § 38.255, and address the possibility of technological request for comments on the proposal. corresponding proposed § 1.82 advances in trading? For example, do applicable to clearing member FCMs, is they appropriately address the potential 1. Concept Release Comments consistent with those comments to the for the future development of additional Concept Release that suggested that pre- As noted above, the proposed effective controls that should be amendments to § 38.401(a) focus in trade risk controls should apply to those provided by DCMs and implemented by with direct market access.404 As FIA large measure on attributes of an FCMs? electronic matching platform or trade explained, all types of market access 67. The Commission welcomes create risks; therefore, the same execution facility that impact the timing comment on whether § 38.255(b)’s and sequencing of specific events on the principles should apply to all types of requirements relating to the design of 405 exchange. While the Concept Release market access. In addition, the controls and the levels at which the Commission’s approach to controls that did not directly address proposed controls should be set are appropriate § 38.401(a), it did ask for public should exist in the context of DEA is and sufficiently granular. consistent with recommendations of or comment on latencies in the 68. Proposed § 38.255(b) and (c) do transmission of various types of steps taken by other regulatory not require DCMs to provide to FCMs organizations. For example, IOSCO has messages between exchanges, firms and connectivity monitoring systems such as vendors wherein differences in latency recommended that intermediaries ‘‘system heartbeats’’ or automatic (including clearing firms) should have could provide opportunities for informational advantage.409 It pointed to adequate operational and technical 406 IOSCO 2015 Consultation Report, supra note 106 at 22–23. press reports that one exchange sent 404 FIA at 12, 15; KCG at 2; CME at 7–8; VFL at 407 See ESMA September 2015 Final Draft confirmations to the traders involved in 2; AIMA at 1. Standards Report Annex 1, supra note 80 at 218. 405 FIA at 12, 15. 408 See id. at 269–70. 409 Concept Release, 78 FR 56546.

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an executed transaction before the DCM information.416 Even if no latencies product listings, rules, rule posted the transaction on its market data existed within an exchange’s amendments, or other changes to feed to the marketplace as a whole.410 infrastructure, market participants may previously-disclosed information, The Commission asked for comments still face latencies in clearing and concurrent with filing such submissions on: (a) Whether the extent of latency in executing firms’ systems.417 with the Commission. The proposed message transmission can have an Several commenters addressed the amendments to § 38.401 build on these adverse impact on market quality or specific issue of whether participants in disclosure, accuracy, and timing fairness; and (b) whether exchanges, a trade should receive confirmations of requirements, and extend the disclosure vendors and firms should be required to that trade before, or at least not after, the requirements to cover certain attributes audit their systems and processes on a trade is reflected in market data sent to of the operation of electronic matching periodic basis to identify and resolve all market participants (‘‘confirmation- platforms. such latencies.411 first latency’’).418 FIA commented that The Commission proposes to amend The Concept Release also asked for the confirmation-first latency on one § 38.401(a)(1)(iii) to require DCMs to public comment on the advisability of exchange was not hidden, and that it disclose to the Commission, market requiring each trading platform to could be measured and understood by participants and the public accurate provide market quality indicators on a anyone with the proper market information pertaining to rules or periodic basis for each product traded access.419 FIA stated that it is specifications pertaining to the on its platform.412 The Concept Release imperative that the market data operation of the electronic matching also asked for comments on what types broadcast to all market participants not platform or trade execution facility, of market quality data would be helpful be sent before the participants to a trade including but not limited to those to market participants and promote know that the trade was executed pertaining to the operation of its market efficiency through transparency (‘‘market data-first latency’’).420 FIA also electronic matching platform that and market competition. stated that market data-first latency materially affect the time, priority, price, or quantity of execution, or the Several commenters supported would cause liquidity providing participants to be unaware of their ability to cancel, modify, or limit increased transparency by the display of market participant orders. exchanges in the operation of their positions and therefore hamper their ability to hedge risk effectively. The The Commission also proposes to electronic matching platforms. AIMA, amend § 38.401(a)(1) by adding a new for example, would welcome new commenter believed that this would cause market makers to widen the requirement (§ 38.401(a)(1)(iv)) that requirements for transparency by DCMs must disclose to all market exchanges on issues of latency, noting spreads they offer. OneChicago suggested that confirmation-first latency participants any known attributes of the that market participants without DMA electronic matching platform, other than should not be considered an unfair are currently not able to calculate many those already disclosed in rules or advantage.421 SIG suggested that measures of latency and market quality specifications under section (a)(1)(iii), 413 confirmation-first latency would that are available to those with DMA. that materially affect the time, priority, encourage liquidity by allowing an Bell noted that the disclosure of price, or quantity of execution of market executing trader to hedge a position latencies in CME’s electronic matching participant orders, the ability to cancel, before quickly responding momentum platform removed the informational modify, or limit display of market traders exhausted available liquidity in advantage held by those market participant orders, or the dissemination the market.422 participants who knew of the latency of real-time market data to market compared to those who did not.414 2. Description of Regulation participants, including but not limited However, Bell also cautioned that the to latencies or other variability in the Current § 38.401(a) requires DCMs to threat of sanctions against an exchange electronic matching platform and the have procedures, arrangements, and for the existence of a latency arbitrage transmission of message resources for disclosing to the opportunity in an electronic matching acknowledgements, order Commission, market participants, and platform could discourage that exchange confirmations, or trade confirmations, or the public accurate information on, inter from publicly disclosing such dissemination of market data. The alia, the rules and specifications information. FIA noted that real-time Commission notes, however, that concerning the operation of the DCM’s access to additional information proposed § 38.401(a)(1)(iii) and (iv) are electronic matching platform or trade regarding the order book creates a more not intended to require the disclosure of execution facility. Current § 38.401(b) transparent marketplace, which trade secrets by any DCM. ultimately breeds confidence among requires DCMs to provide such Finally, the Commission also market participants.415 information that ‘‘it believes, to the best proposes to amend § 38.401(c) by of its knowledge, is accurate and CME and FIA noted that latency is a adding a new requirement complete, and must not omit material natural component of market structure (§ 38.401(c)(3)) that a DCM, in making information.’’ Current § 38.401(c) because of the time it takes computer available on its Web site information requires DCMs to make publicly systems to process information as well pursuant to paragraphs (a)(1)(iii) and available on their Web sites any new as the communications systems (iv) of § 38.401(c), must place such information and submissions on its Web involved in transmitting order message 416 CME at 6–7; FIA at 47–48. site within a reasonable time, but no 417 CME at 48. 410 Scott Patterson, Jenny Strasburg, & Liam 418 FIA at 47–48; SIG at 2; OneChicago at 1. The later than 10 business days, following Pleven, ‘‘High-Speed Traders Exploit Loophole,’’ Commission is using the term ‘‘confirmation-first the identification of or changes to such Wall St. J. (May 1, 2013), available at http:// latency’’ for ease of reference; it was not used in the attributes. Such information shall be www.wsj.com/articles/SB10001424127 comment letters. disclosed prominently and clearly in 887323798104578455032466082920. 419 FIA at 48. plain English. The Commission 411 Concept Release, 78 FR 56546. 420 Id. The Commission is using the term ‘‘market 412 Id. at 56561. data-first latency’’ for ease of reference; it was not emphasizes that the disclosure of 413 AIMA at 7. used in the comment letters. information prominently and clearly by 414 Bell at 3. 421 OneChicago at 1. a DCM precludes such DCM from 415 FIA at 51. 422 SIG at 2. placing information required by this

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rule behind registration, log in, user latencies within the matching engine platform systems or components that are name, password or other walls on the and any data feeds.425 monitored, leased from, or otherwise DCM’s Web site. The Commission’s proposals under operated by an affiliate or third party.427 § 38.401(a)(1)(iii) and (iv) apply to The Commission has also proposed a. What Must Be Disclosed Under the ‘‘electronic matching platforms,’’ which under amended § 38.401(a)(2) that a Proposed Regulations comprise all systems under the control DCM must provide a description of or operation of the DCM that interact The proposed § 38.401(a)(1)(iii) and known attributes of its electronic trading with market participant order messages (iv) would apply to all known attributes platform under paragraph (a)(1)(iv). and are involved in market data of an electronic matching platform that However, this may not relieve an dissemination. Such systems are not materially affect the time, priority, exchange of the obligation to disclose price, or quantity of execution of market limited to matching engines, but would apply more broadly to the network information if the exchange should have participant order messages, or the known of an attribute. The Commission ability to cancel, modify, or limit architecture that accepts and processes order messages, and disseminates notes that DCMs must regularly test and display of, market participant order 428 market data and messages to market review their automated systems, messages. The Commission proposes a monitor trading on their facilities, and ‘‘materiality’’ threshold to such participants. To the extent that they impact order entry and execution, the identify any market or system obligations so that the disclosure anomalies.429 The Commission requirements would not capture aspects electronic matching platform would also include pre-trade risk management cautions, however, that compliance of exchange systems that do not have a with Regulation AT’s disclosure discernible effect on how orders are systems and controls such as self-trade 426 requirements may not absolve a DCM of entered or executed.423 prevention tools. The Commission’s proposals under other statutory or regulatory obligations. An ‘‘attribute’’ for purposes of § 38.401(a)(1)(iii) and (iv) are intended For instance, DCMs must promote fair proposed § 38.401(a)(1)(iv) would mean to apply to various aspects of how an and equitable trading and protect any aspect of the structure, architecture, electronic platform operates, beyond the markets and market participants from mechanics, characteristics, or other technical process of how any order is abusive practices.430 elements of the design or operation of actually matched. The proposed b. How Information Should Be an electronic matching platform that regulations explicitly require the materially affects how market disclosure of information relating to Disclosed participant orders are received and latencies in the matching of orders and The Commission proposes under executed, and how information on such transmission of that information to orders and executed trades are § 38.401(a)(1)(iv) that DCMs be required market participants. In addition, if they to disclose any known attributes of their communicated to other market have a material impact on market participants. ‘‘Attributes’’ would electronic matching platform, other than participants, exchanges must disclose those already disclosed pursuant to include, but are not limited to, aspects information on exchange functions such of the platform that may provide an § 38.401(a)(1)(iii). This description as self-trade prevention, implied spread should, at a minimum, identify what the advantage or disadvantage to a category markets, and priority assignment of of market participants.424 ‘‘Attributes’’ attribute is and how it may affect market orders in a central limit order book, participant orders. To the extent such would also include aspects of the where applicable. Exchanges also must information is necessary for market platform that affect orders from all disclose how available order types participants to understand the market participants regardless of access would be executed (or not) under significance of an attribute, the method or membership status, such as different market conditions, where description may need to provide applicable. The Commission is mindful 423 In evaluating what attributes of a platform that DCMs should only be required to statistics or examples. As with all would be material, the Commission would look to describe attributes of their own systems. information provided to market the substantial case law on the issue of materiality. However, such systems would include participants under current regulation See, e.g., R&W Tech. Servs., Ltd. v. CFTC, 205 F.3d 38.401, the description must include 165, 169 (5th Cir. 2000) (‘‘A statement or omitted fact is ‘material’ if there is a substantial likelihood 425 As an illustration of attributes that should be information that the DCM believes, to that a reasonable investor would consider the disclosed to market participants (and the best of its knowledge, to be accurate information important in making a decision to acknowledging the more complex order types and and complete, and not omit material invest.’’); see also CFTC v. R.J. Fitzgerald & Co., 310 modes of execution in the equities market), the F.3d 1321, 1332 (11th Cir. 2002) (finding Commission notes two recent SEC enforcement misrepresentations material where ‘‘an objectively actions against the operators of alternative trading 427 The Commission is mindful that some DCMs reasonable investor’s decision-making process systems for selective disclosure or non-disclosure use electronic matching platforms leased from or would be substantially affected’’ by them and the regarding how certain order types operate under otherwise provided by other DCMs or non-DCM misrepresentations would ‘‘as a matter of law, alter different market conditions. See In the Matter of entities. However, each DCM would be required the total mix of relevant information available to the UBS Securities LLC., No. 3–16338 (SEC, Jan. 15, under this provision to provide information on any potential . . . investor.’’). Materiality in the context 2015); In the Matter of EDGA Exchange, Inc., No. electronic matching platform it uses, regardless of of attributes of an electronic matching platform 3–16332 (SEC, Jan. 12, 2015). whether that platform is owned or leased by the would include those attributes whose existence or 426 The Commission notes that the proposed DCM. degree a reasonable market participant would disclosure requirements in large part would address 428 Both DCMs and SEFs are obligated to consider when making a decision on whether, when IOSCO’s recommendation relating to sound ‘‘conduct regular, periodic, objective testing and or how to place orders on an exchange’s platform. practices on controls surrounding the development review of their automated systems to ensure that 424 For purposes of this discussion, ‘‘categories of of new or changes to critical systems at trading they are reliable, secure, and have adequate scalable market participants’’ may be based on access venues. IOSCO, after reviewing current member capacity.’’ Regulations §§ 37.1401(g) and method, colocation, involvement in a market maker state regulations, recommended ‘‘[e]stablishing and 38.1051(h), 17 CFR 37.1401(g) and 38.1051(h) incentive program, or membership status, among implementing communication protocols that govern (2014). other things. DCMs are currently required to submit the sharing of information regarding the 429 See regulation 37.203(e), 17 CFR 37.203(e) as rule changes under Part 40 any changes to these introduction of new, or changes to, critical (2014), for real-time market monitoring obligations programs. As discussed more fully below, the systems[,]’’ including information on the timing of of SEFs. See regulation 38.157, 17 CFR 38.157 proposed transparency requirement would only such new systems or changes to provide market (2014), for real-time monitoring obligations of require disclosure of attributes not already participants sufficient lead time to make changes or DCMs. disclosed through submissions under Part 40, 17 adjustments to their own systems. See IOSCO 2015 430 DCM Core Principle 12, Section 5(d)(12) of the CFR 40.1, et seq. (2014). Consultation Report, supra note 106 at 13–20. Act, 7 U.S.C. 7(d)(12) (2012).

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information.431 Cost estimates for the regulations common to all registered available to market participants that Commission amendments to § 38.401 entities.432 The proposed change to the may influence their choice of trading are provided in this NPRM’s cost-benefit definition of ‘‘rule’’ would track venue. The Commission believes that considerations below. language in the transparency such will foster competition among The Commission proposes under requirements under proposed exchanges by incentivizing them to § 38.401(c)(3) that DCMs be required to § 38.401(a)(1)(iv) (which applies only to provide the most efficient and fairest disclose information on the attributes of DCMs). The proposed change to the venue for trading. Should an exchange their platforms ‘‘prominently and definition would make clear that intentionally or unintentionally clearly’’ on their Web sites. The ‘‘trading protocols’’ includes ‘‘any structure its trading systems to Commission also proposes under operation of an electronic matching potentially or actually advantage one § 38.401(c)(3) that information regarding platform that materially affects the time, category of market participant over attributes of the electronic matching priority, price, or quantity of execution others, the potentially disadvantaged platforms be provided in ‘‘plain of market participant orders, the ability market participants may opt to trade on English.’’ Because market participants to cancel, modify, or limit display of another venue. may have different degrees of technical market participant orders, or the One Concept Release commenter understanding, the Commission aims to dissemination of real-time market data noted that market participants, if they make information on the electronic to market participants.’’ As with any have direct market access, could matching platforms accessible to market other rule change, changes to a calculate market quality metrics participants regardless of their technical registered entity’s trading protocols including latencies and therefore would proficiency or sophistication. Providing must be submitted to the Commission be aware of many of the attributes of a highly complex information on the pursuant to existing §§ 40.5 or 40.6. platform that affect order execution. The platforms may allow more technically- The Commission notes that this requirements proposed under proficient market participants to proposed amendment to the definition § 38.401(a)(1)(iii) and (iv) give all understand the operations of the of ‘‘rule’’ also adds a reference to market market participants an equal footing in platform, but may be inaccessible to maker and trading incentive programs. terms of understanding how the other market participants. This change clarifies and codifies the platform operates independent of access c. When Information Should Be Commission’s current interpretation of methods and services such as Disclosed the definition of ‘‘rule’’ under § 40.1(i), colocation. in which registered entities are required The Commission’s proposals on DCM to submit new rules and rule 4. Request for Comments transparency are intended to account for amendments to the Commission when 69. The Commission has proposed two situations: (1) Where the DCM changes are made to, among other that certain components of an makes a change to the platform, things, matching algorithms, market exchange’s market architecture should resulting in an impact on the execution maker or trading incentive program be considered part of the ‘‘electronic of market participant orders, and (2) agreements, and available order types. matching platform’’ for purposes of the where the DCM becomes aware of an This proposed change to § 40.1(i), which DCM transparency provision. Are there existing attribute within the platform reflects the Commission’s any additional systems that should fall that affects the execution of such orders. understanding of ‘‘rule’’, should be within the meaning of ‘‘electronic Under the first situation, as clarified in distinguished from the proposed matching platforms’’ for purposes of the proposed amendment to the regulations regarding market maker and proposed § 38.401(a)? definition of ‘‘rule’’ under § 40.1(i), trading incentive programs under 70. The Commission has specifically information submitted to the §§ 40.25–40.28, which represent new identified, as ‘‘attributes’’ that must be Commission under §§ 40.5(a) or 40.6(a) requirements that apply only to DCMs. disclosed, latencies within a platform would be public information, except to and how a self-trade prevention tool the extent that confidential treatment is 3. Policy Discussion determines whether to cancel an order. granted pursuant to § 40.8. Furthermore, With the proposed transparency Are there any other attributes that a DCM would be required to post the requirements, the Commission aims to would materially affect the execution of relevant submission on its Web site increase the relevant information market participant orders and therefore concurrent with the provision of such should be made known to all market submission to the Commission pursuant 432 Part 40 of the Regulations applies to all participants? Should the Commission to current § 38.401(c). Under the second registered entities, which include DCMs, SEFs, revise the final rule so that it only situation, the Commission’s proposals derivative clearing organizations (‘‘DCOs’’), swap applies to latencies within a platform would require the DCM to make the data repositories (‘‘SDRs’’), and certain electronic trading facilities and boards of trade registered and how a self-trade prevention tool relevant information available ‘‘within a under Section 5c of the Act. As discussed below in determines whether to cancel an order? reasonable time, but no later than 10 the cost benefit consideration section (sections 71. What information should be days’’ following the identification or V(E)(9) and (11)), none of the proposed amendments to § 40.1(i) should create new costs for disclosed as part of the description of change to the attribute. DCMs must also any registered entity, because the amendments relevant attributes of the platform? For ensure that information can be accessed merely clarify and codify the Commission’s instance, with latencies within a by visitors to the Web site without the interpretation of the definition of ‘‘rule.’’ See, e.g., platform, should statistics on latencies need to register, log in, provide a user the Final Rule for Provisions Common to Registered Entities, published in the Federal Register in 2011, be required? If so, what statistics would name, or obtain a password. in which the Commission stated with respect to help market participants assess any d. Changes in Definition of ‘‘Rule’’ market maker and trading incentive programs, ‘‘The impact on their orders? Would a Commission continues to view such programs as The Commission also proposes ‘agreements * * * corresponding’ to a ‘trading narrative description of attributes be amending the definition of ‘‘rule’’ under protocol’ within the § 40.1 definition of ‘rule’ and, preferable, including a description of § 40.1(i), which is relevant to as such, all market maker and trading incentive how the attributes might affect market programs must be submitted to the Commission in participant orders under different accordance with procedures established in part 40.’’ 431 See regulation 38.401(b), 17 CFR 38.401(b) Final Rule, Provisions Common to Registered market conditions, such as during times (2014). Entities, 76 FR 44776, 44778 (July 27, 2011). of increased messaging activity?

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72. The Commission notes that participants? How are DCMs currently automated trading. In particular, the proposed § 38.401(a)(1)(iii) and (iv) are handling these situations? measures required of DCMs in § 40.20 not intended to require the disclosure of 76. The Commission proposes that are similar to those required of AT a DCM’s trade secrets. The Commission DCMs provide a description of the Persons in proposed § 1.80(a)(1) and requests comments on whether the relevant material attributes in a single (b)(1), and also similar to those required proposed rules might inadvertently document ‘‘disclosed prominently and of clearing member FCMs in § 1.82(a). require such disclosure, and if so, how clearly’’ on the exchange’s Web site. The The Commission intends to offer AT they might be amended to address this Commission also proposes that this Persons, clearing member FCMs and concern. Furthermore, the Commission document be written in ‘‘plain English’’ DCMs the flexibility to design and anticipates that the mechanisms and to allow market participants, even those calibrate such controls according to standards for requesting confidential not technically proficient, to understand their own distinct priorities and treatment already codified in existing the attributes described. Would these understanding of the risks to § 40.8 could be used by DCMs to requirements be practical and help themselves, their customers, and the identify and request confidential market participants locate and broader market. In this regard, while treatment for information otherwise understand the information provided? certain proposed rules may appear required to be disclosed pursuant to 77. The Commission proposes duplicative on their face, Regulation AT proposed § 38.401(a)(1)(iii) and (iv), for requiring DCMs to disclose information is designed to address the diverse needs example by incorporating § 40.8’s on the relevant attributes: (a) When of market participants trading across mechanisms and standards into any filing a rule change submission with the multiple markets, by spreading the final rules arising from this NPRM. If Commission for changes to the requirement to impose risk controls commenters believe that the electronic matching platform; or (b) across AT Persons, clearing member mechanisms and standards in § 40.8 are within a ‘‘reasonable time, but no later FCMs and DCMs and encouraging them inappropriate for this purpose, please than ten days’’ following the to each independently calibrate such describe any other mechanism that identification of such attribute. Do the controls. should be included in any final rules to proposed timeframes provide sufficient The remainder of this section presents facilitate DCM requests for confidential time for DCMs to disclose the relevant Concept Release comments on this treatment of information otherwise information? Do the proposed topic, a description of the proposed required to be disclosed pursuant to timeframes offer sufficient notice of regulation, a discussion of the policy proposed § 38.401(a)(1)(iii) and (iv). changes or discovered attributes to justification for the proposal, and a market participants to allow them to 73. The Commission notes that DCMs request for comments on the proposal. adjust any systems or strategies, are required, as part of voluntary including any algorithmic trading 1. Concept Release Comments submissions of new rules or rule systems? The Concept Release requested amendments under § 40.5(a) and self- 78. The Commission proposes comment on various pre-trade and other certification of rules and rule requiring disclosure of newly identified types of risk controls, including message amendment under § 40.6(a), to provide attributes within 10 days of discovery. and execution throttles, maximum order inter alia an explanation and analysis of Does this provide DCMs sufficient time sizes, price collars, and order the operation, purpose and effect of the to analyze the attribute and provide a management controls, such as proposed rule or rule amendment. description? Should DCMs be required connectivity monitoring services, Would the information required under to provide notice of the existence of the automatic cancellation of orders on §§ 40.5(a) or 40.6(a) provide market attribute and supplement as further disconnect and kill switches. The participants and the public with analysis is performed? Concept Release contemplated that such sufficient information regarding controls would apply at the trading material attributes of an electronic N. Pre-Trade and Other Risk Controls at firm, clearing member and trading matching platform? DCMs—§ 40.20 platform levels. As explained above, 74. The Commission recognizes that The Commission proposes a new proposed § 1.80 requires AT Persons to DCMs are required to have system § 40.20 to require DCMs to establish pre- implement certain pre-trade risk safeguards to ensure information trade and other risk controls specifically controls and order management security, business continuity and designed to address the risks that may controls. By reference to the proposed disaster recovery under DCM Core arise from Algorithmic Trading. The § 1.80 regulations, proposed § 40.20 will Principle 20. The Commission Commission is also proposing to codify require DCMs to establish similar pre- understands that some attributes of an in § 40.20 basic pre-trade risk control trade and other risk controls specifically electronic matching platform designed requirements and order cancellation designed to address the risks that may to implement those safeguards should capabilities for orders that do not arise from Algorithmic Trading, and to be maintained as confidential to prevent originate from Algorithmic Trading. In establish similar controls for orders cybersecurity or other threats. Does this regard, the Commission recognizes entered manually. Relevant comments existing § 40.8, 17 CFR 40.8 (2014) that natural person traders manually to the Concept Release addressing pre- provide sufficient basis for DCMs to entering orders also have the potential trade and other risk controls for DCMs publicly disclose the relevant attributes to cause market disruptions. While the are discussed below. of their platforms while maintaining as majority of the pre-trade and other risk confidential information concerning controls in Regulation AT address a. Message and Execution Throttles system safeguards? Algorithmic Trading, the Commission As discussed above, the Concept 75. With respect to material attributes believes it is also important to promote Release described message throttles as affecting market participant orders a basic degree of risk control for all establishing maximum message rates caused by temporary or emergency trading regardless of source. per unit of time and execution throttles situations, such as network outages or The pre-trade and other risk controls as establishing limits on the maximum the temporary suspension of certain required of DCMs pursuant to proposed number of orders that an ATS can market functionality, what is the best § 40.20 reflect Regulation AT’s layered execute in a given direction per unit in way for DCMs to alert market approach to risk mitigation in time. The Concept Release also sought

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comment on a particular form of performance of a DCM’s network and and CFE described their own price execution throttle, the repeated matching engine and the matching collar mechanisms.451 automated execution throttle, which algorithm; and the market participant’s FIA indicated that price collars are a would disable a trading system after a role (i.e., liquidity providers may be ‘‘widely adopted’’ DCM-hosted risk configurable number of repeated excluded from limits).442 FIA noted that control and are effective at preventing executions until a human re-enables the a DCM’s message rate limit should not orders from disrupting the market and 452 system.433 The Concept Release stated adjust to market conditions because affecting the price discovery process. that the throttles would be calibrated to participants must always know what the FIA further explained that they have been proven to minimize erroneous address the potential for unintended limit is.443 Chicago Fed commented that trading by controlling the range of message flow or executions from a regulators should assess the 434 execution prices and can ensure the malfunctioning ATS. methodology that trading venues use to Commenters indicated that DCMs are integrity of trades cleared through the set throttle limits, the reasonableness of already implementing messaging rate DCO by dramatically reducing the those limits, and the procedures chance that a trade may be deemed limits. Two exchanges described their 444 own message rate limits 435 and four followed when they are breached. erroneous and subsequently adjusted or commenters stated generally that many Finally, IATP commented on the busted.453 FIA recommended that price exchanges have messaging rate limits in difficulty in setting standardized collars be used on all contracts, set by place.436 Commenters generally throttle thresholds, and alternatively the DCM based on estimates of volatility discussed throttles at the exchange as suggested standardizing a graduated and market conditions.454 FIA being ‘‘messaging’’ limits. KCG levy on order cancellations.445 cautioned that price collars should not be mandated at the same levels across explained that many participants’ b. Maximum Order Sizes trading strategies include trading all products.455 activity on multiple markets, and thus Commenters indicated that exchanges Other commenters made similar the responsibility for establishing limits already implement maximum order size points. KCG stated that ‘‘the futures on executions must reside with the limits. Two exchanges, CME and CFE, markets’ price collars work well,’’ and market participant and its clearing stated that they apply order size limits reduce the potential for erroneous 437 trades.456 KCG supports requiring firm. Benefits of exchange-based on each of their products.446 AIMA also exchanges to establish price collars on messaging limits noted by commenters stated that maximum order sizes are all contracts, but believes that include identifying potentially normally applied per product at the malfunctioning ATSs, preventing a 447 exchanges should have discretion in DCM or FCM level to all customers. setting the price collars.457 Gelber stated platform overload that would impact the Chicago Fed commented that exchanges processing of messages across all market that exchanges should establish price should implement maximum order size participants, ensuring a level playing collars and that this control protects limits.448 MFA also recommended that field for all market participants, DCOs and market participants from maximum order size controls be 458 mitigating risk to the DCO, and volatile markets. MFA stated that implemented at the FCM and/or deterring predatory and disruptive price collars in the futures markets have exchange level, and apply to both been effective in maintaining fair and activities that require high message 449 traffic.438 SIG cautioned that exchanges manual and automated traders. FIA orderly markets, and have fewer should not impose ‘‘speed-bump’’ commented that while it ‘‘has been a unintended consequences than trading throttles on order messaging as a means proponent of standardization of pre- pauses.459 SIG also stated that the to ‘‘slow down trading for its own trade risk controls across DCMs we markets benefit from price collars.460 sake.’’ 439 FIA suggested that a DCM understand that each DCM needs to Finally, Chicago Fed and AFR should never reject an order have discretion on how these controls recommended that trading venues cancellation request due to message rate are implemented.’’ 450 implement price collars.461 440 In contrast to the above comments, limits. c. Price Collars Commenters indicated that exchanges AIMA acknowledged that price collars should have flexibility in setting The Concept Release requested may be beneficial, but explained that messaging limits because exchanges are comment on price collars, a control in price collars have potentially negative in the best position to respond to the consequences in that they may impede which trading platforms would assign a 462 dynamics of the market, monitor the range of acceptable order and execution the efficient price discovery process. In particular, AIMA suggested that activity of all participants, and prices for each product and all market 441 market participants should be determine the impact of messaging. participants would establish similar encouraged to place bids and offers far Commenters indicated that throttle limits to ensure that orders outside of a limits implemented by DCMs should be above or below the current market particular price range are not price.463 Among other things, AIMA based on the unique characteristics of transmitted to the trading platform. each product; the capacity and Commenters indicated that exchanges 451 CME at 13–14; 16–17, CME at Appendix A– already implement price collars. CME 6; CFE at 6–8. 433 Concept Release, 78 FR 56571. 452 FIA at 18. 434 Concept Release, 78 FR 56569. 442 453 FIA at 18. 435 CME at 8–9; CME at Appendix A, 3–4, 6; CFE FIA at 15; CME at 8–9; Gelber at 5–7; KCG at 454 at 5–6. 4; AIMA at 8. Id. at 13–14. 455 436 TCL at 6; KCG at 4; MFA at 7; AIMA at 8. 443 FIA at 12, 16. Id. at 18. 456 437 KCG at 5. 444 Chicago Fed at 2. KCG at 7–8. 457 438 FIA at 12, 15–17, 65; MFA at 7; CME at 8; 445 IATP at 3–5. See id. Gelber at 5–7; AFR at 6–7; SIG at 3. 446 CME at 15, Appendix A–1; CFE at 7. 458 Gelber at 9. 439 SIG at 3. 447 AIMA at 13. 459 MFA at 8–9. 440 FIA at 16. 448 Chicago Fed at 2; MFA at 2, 9; Gelber at 10; 460 SIG at 8–9. 441 FIA at 12, 15–17; CME at 8–9; MFA at 13; KCG at 8. 461 Chicago Fed at 3; AFR at 7. Gelber at 5–7; KCG at 3–4; AIMA at 8; OneChicago 449 MFA at 9. 462 AIMA at 12–13. at 5. 450 FIA at 18–19. 463 See id.

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suggested that brief trading pauses were switch to clearing members that cancels contact the market participant before preferable to price collars, and that if a all orders and quotes from a market activating the kill switch.478 FIA also collar or pause is activated, market participant.469 suggested that a DCM be allowed to participants should be notified as soon Some commenters noted the terminate market access without as possible.464 importance of placing kill switches at contacting the participant if necessary to the DCM level.470 For example, Citadel d. Connectivity Indications and Cancel protect market integrity or the financial noted that ‘‘kill switches can operate at 479 on Disconnect integrity of participants. Citadel a number of levels—at the market commented that exchange systems As noted above, the Concept Release participant, at the clearing firm, or at the should employ robust and reliable requested comment regarding ‘‘system trading platform. While all are systems that automatically identify heartbeats’’ that would indicate proper advisable, their use at the trading potentially erroneous activity, and this connectivity between a trading firm’s platform level is of paramount activity could trigger automatic automated trading system and the importance. Trading platforms sit at the notifications to the participant; review trading platform, and ‘‘auto-cancel on center of trading and are therefore best by exchange staff; automatic blocks of disconnect,’’ an exchange tool that positioned to efficiently and further activity; and, under appropriate allows trading firms to determine consistently monitor activity across a circumstances, a confidential whether their orders will be left in the 471 wide variety of market participants.’’ notification to other trading platforms market upon disconnection. Two While commenters generally opposed that a firm’s trading is halted.480 KCG exchanges stated that they provide an prescriptive kill switch requirements stressed that market participants should optional cancel-on-disconnect and indicated the challenges of establish thresholds for kill switches,481 functionality 465 and FIA characterized standardization, several noted that there and Gelber cautioned that exchanges cancel-on-disconnect as a ‘‘widely could be some benefits to standardized should apply kill switches on an ATS, adopted DCM-hosted pre-trade risk kill switch processes across not firm-wide, level.482 SIG suggested control.’’ 466 Several commenters exchanges.472 indicated that they support exchanges Commenters also stressed the that exchanges set kill switches at the gateway level, firm level, or an account offering system heartbeats and/or importance of clear, transparent 483 cancel-on-disconnect to their market procedures governing use of the kill level. participants.467 switch.473 FIA stated that ‘‘a failure to An issue related to pre-trade and communicate policies that govern the other risk controls implemented by e. Order Cancellation Systems use of kill switches, any potential DCMs is the testing of exchange As discussed above, the Concept changes to such policies, or the systems. The Concept Release did not Release addressed selective working utilization of a kill switch in a live directly explore the testing of DCM order cancellation, a tool in which an trading environment without prior automated systems. Moreover, exchange can immediately cancel one, notification can introduce significant commenters did not raise the issue. multiple, or all resting orders from a risk to a market participant’s trading Nevertheless, the Commission notes that market participant as necessary in an operation as well as the wider there have been incidents following emergency situation and well as order marketplace.’’ 474 MFA commented that automated system changes that might cancellation mechanisms that would trading platforms should have clear and have been prevented or mitigated by immediately cancel all working orders objective policies detailing the additional testing. For example, in early and prevent submission (by the market circumstances that warrant use of a kill 2015, certain European futures participant), transmittal (by the clearing switch.475 In contrast, CME stressed that exchanges experienced outages in their member), or acceptance (by the trading the kill switch tool must be free of trading platforms following updates to platform) of any new orders from a restrictive policies and procedures, their automated systems.484 In market participant or a particular trader because time is of the essence in use of September 2010, 30,000 test orders were or ATS of such market participant. The the kill switch. However, CME stated accidentally submitted to the CME Commission notes that comments to the that if policies do govern an exchange’s Globex system (due to human error), Concept Release generally discussing use of a kill switch, such policies resulting in numerous executed the design and implementation of kill should define a hierarchy of authority trades.485 In April 2014, the Globex switches are addressed above with for who can send kill instructions.476 system halted, forcing traders to execute respect to order cancellation systems Regarding activation of the kill futures trades on the trading floor.486 requirements on AT Persons. switch, FIA cautioned that this tool Specifically as to exchanges, the should only be used as a ‘‘final 478 FIA at 29–33. Commission notes that one exchange safeguard’’ that should be a redundant 479 FIA at 29–33. indicated that it has two kill switch control as long as appropriate risk 480 Citadel at 3–4. tools: A kill switch used by the controls are implemented at the FCM 481 KCG at 13. 482 exchange, clearing firm, or trading firm and DCM levels.477 FIA suggested that Gelber at 14. 483 SIG at 8. to remove an entity from the market a kill switch have both automated and completely; and an order management 484 See ‘‘Euronext Derivatives Trading Resumes manual triggers, but a DCM should Following One-Hour Halt,’’ Bloomberg (March 30, tool that enables clearing firms and end- 2015), available at http://www.bloomberg.com/ users to cancel orders at a more granular 469 CFE at 11. news/articles/2015-03-30/euronext-derivatives- 468 level. Another exchange explained 470 FIA at 29–33; Citadel at 3; AIMA at 3, 18; MFA trading-halted-because-of-technical-issue. that it can cancel orders and quotes in at 12–13; KCG at 13. 485 See ‘‘CME Test Orders Went Live,’’ Wall St. an emergency and also provides a kill 471 Citadel at 3. J. (September 15, 2010), available at http:// www.wsj.com/articles/SB10001424052748703376 472 FIA at 29–33; CME at 23; AIMA at 18; SIG at 504575491971336921954. 464 8; Gelber at 14–15. See id. 486 See ‘‘Technical Glitch Hits CME Trading,’’ 465 473 FIA at 29; MFA at 12; Citadel at 3. CME at Appendix A–4; CFE at 9–10. Wall St. J. (April 8, 2014), available at http:// 474 466 FIA at 14. FIA at 29. www.wsj.com/articles/SB1000142405270230481 467 FIA at 14; KCG at 12; MFA at 12; Chicago Fed 475 MFA at 12. 9004579489683245107384. The Commission notes at 2. 476 CME at 23. that moving to the floor will no longer be available 468 CME at 23–24. 477 FIA at 29–33; Gelber at 14–15. Continued

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The Commission further notes that acceptance or submission of any new The Commission believes that the IOSCO published in April 2015 a orders; and (iv) cancel or suspend all controls required in proposed § 40.20 consultation report recommending that resting orders from AT Persons in the are in many cases largely consistent exchanges consider ‘‘establishing event of disconnect with the trading with controls already used by DCMs. As policies and procedures related to the platform. The connectivity monitoring discussed above, commenters to the development, modification, testing and systems established by the DCM must Concept Release addressing this topic implementation of new, or changes to, enable the systems of AT Persons with generally indicated that exchanges critical systems.’’ 487 Existing DEA to indicate to the AT Persons on already use message rate limits, § 38.1051(h) requires DCMs to ‘‘conduct an intermittent or continuous basis maximum order size limits, and price regular, periodic, and objective testing whether they have proper connectivity limits. Comments to the Concept of its automated systems to ensure that with the trading platform, including any Release indicated that order they are reliable, secure, and have systems used by a DCM to provide the cancellation systems and connectivity adequate scalable capacity’’ and AT Person with market data. monitoring systems are already used by § 38.1051(a)(5) requires exchanges to Finally, the Commission is amending DCMs as well. Although some address risk analysis and oversight for the Acceptable Practices for Core commenters did indicate that execution ‘‘systems development and quality Principle 4 in part 38 of the DCM throttles are more appropriate for assurance.’’ While the Commission is regulations. The existing Acceptable trading firms than for DCMs, the not proposing any amendments to Practices provide that the DCM may Commission believes that pre-trade risk § 38.1051 in this NPRM, the choose from risk controls, including controls and other measures serve Commission requests comment on pre-trade limits on order size, price different functions and may be designed whether the existing rule provides the collars or bands around the current or calibrated distinctly at each entity in Commission with adequate authority to price, message throttles and daily price the life-cycle of an AT Order Message. require DCMs to adequately test limits, to comply with Core Principle 4. As noted above, proposed § 40.20 and planned changes to their matching Such controls are now required. other elements of Regulation AT reflect engines and other automated systems. Accordingly, the Acceptable Practices the proposed rules’ layered approach to will be revised to correspond to the new risk mitigation in automated trading. In 2. Description of Regulation requirements set forth in § 40.20. this regard, Regulation AT is designed Existing § 38.255 requires DCMs to to address the diverse needs of market 3. Policy Discussion establish risk control mechanisms to participants trading across multiple prevent and reduce the potential risk of Consistent with its multi-layered markets, by spreading the requirement price distortions and market approach to regulations intended to to impose risk controls across AT disruptions, including market mitigate the risks of automated trading, Persons, clearing member FCMs and restrictions that pause or halt trading. the Commission proposes in § 40.20 to DCMs and encouraging them to each The Commission proposes a new § 40.20 require that DCMs establish and make independent use of such controls. to require DCMs to establish pre-trade implement certain pre-trade risk The Commission notes that IOSCO and other risk controls specifically controls and order management controls has recently explained that most trading designed to address the risks that may that are broadly similar to those that venues have tools used to mitigate the arise from Algorithmic Trading, and to would be required of AT Persons and operational risks of electronic trading, establish similar controls for orders clearing member FCMs. The and such tools include price and entered manually. Commission’s determination to require volume controls, messaging throttles, The controls required by § 40.20 are DCM-implemented controls is and kill switches.491 In addition, consistent with the controls that consistent with several Concept Release ESMA’s 2015 Final Draft Regulatory Regulation AT would require AT comments that indicated that pre-trade Standards require that trading venues Persons and clearing member FCMs to risk and order management controls have price collars that automatically implement. By reference to the pre-trade should be placed at the exchange level, block or cancel orders that do not meet and other risk controls required of AT with one commenter explaining that set price parameters with respect to Persons pursuant to § 1.80(a)(1), exchanges sit at the center of trading, different financial instruments, on an proposed § 40.20 would require message and are therefore best positioned to order-by-order basis; and maximum and execution throttles and controls monitor activity across a wide variety of order value and maximum order volume establishing price and size parameters. participants.488 The Commission notes limits.492 ESMA’s regulatory standards Proposed § 40.20 would also require that its approach is consistent with also require throttles limiting the DCMs to implement the above risk ESMA’s 2015 Final Draft Regulatory number of orders each member may controls for orders that do not originate Standards, in that ESMA requires pre- submit per second.493 Trading venues from Algorithmic Trading. trade risk controls at both the must also determine a maximum ratio of The proposed regulation, by reference investment firm and trading venue unexecuted orders to transactions at a to § 1.80(b) and (c), would also require level.489 In addition, with respect to kill level they deem appropriate, consistent DCMs to establish certain order switch functionality, ESMA’s 2015 Final with a calculation methodology cancellation and connectivity Draft Regulatory Standards set out two provided by ESMA.494 ESMA standards monitoring systems. The cancellation different obligations: Trading venues further require a kill functionality to systems must have the ability to: (i) must have their own kill functionality, cancel unexecuted orders upon request Immediately disengage Algorithmic and separately, investment firms must of a market participant that is Trading; (ii) cancel selected or up to all have the ability to cancel unexecuted technically unable to delete its own resting orders when system or market orders.490 conditions require it; (iii) prevent 491 IOSCO 2015 Consultation Report, supra note 488 FIA at 29–33; Citadel at 3; AIMA at 3, 18; MFA 106 at 21. as a backup as the CME was planning to close most at 12–13; KCG at 13. 492 See ESMA September 2015 Final Draft futures trading pits in July 2015. 489 ESMA September 2015 Final Draft Standards Standards Report Annex 1 at 269. 487 See IOSCO 2015 Consultation Report, supra Report, supra note 80 at 201–02. 493 See id. at 266. note 106 at 19. 490 See id. 494 See id. at 285–88.

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orders, when the order book is could be detrimental, given the speed 82. The Commission proposes, with corrupted by erroneous duplicated with which a kill switch may need to be respect to its kill switch requirements, orders, or following a suspension implemented.499 The Commission to allow DCMs the discretion to design initiated by the market operator or the believes that exchanges should have a kill switch that allows a market competent authority.495 clear and public policies governing use participant to submit risk-reducing The Commission’s proposed rules do of a kill switch, but understands that the orders. The Commission also does not not impose a ‘‘one-size-fits-all’’ standard specifics of such policies may different mandate particular procedures for alerts on DCMs for compliance. Rather, the depending on the nature of an or notifications concerning kill switch DCM’s pre-trade risk controls must be exchange’s market and market triggers. Does the proposed rule allow set at the level of each AT Person, and participants. Therefore, the Commission for sufficient flexibility in the design of exchanges must evaluate whether the has determined that its proposed rules kill switch mechanisms and the policies controls should be set at a more granular in this area should provide exchanges and procedures concerning their level, including by product or one or with the discretion to design policies implementation? Should the more identifiers of natural persons and procedures appropriate to their Commission consider more prescriptive associated with an AT Order Message, market. The Commission stresses that rules in this area? and then take appropriate action to set exchanges should clearly communicate 83. Does existing § 38.1051 provide the controls at that more granular level. such policies and procedures to market the Commission with adequate The Commission expects that it will participants. authority to require DCMs to adequately often be beneficial to set controls at a The Commission notes that § 40.20(d) test planned changes to their matching more granular level. As noted above, would require a DCM to implement the engines and other automated systems? while some commenters to the Concept pre-trade and other risk control Release indicated that Commission O. DCM Test Environments for AT mechanisms described in § 40.20(a) and Persons—§ 40.21 involvement in setting thresholds for (b)(1)(i) (meaning, message and these controls might be useful, the execution throttles and order and price The Commission proposes a new Commission agrees with those parameters and order cancellation § 40.21 to require DCMs to provide a test commenters indicating that exchanges systems) for orders that do not originate environment that will enable AT need discretion to determine how these from Algorithmic Trading, after making Persons to simulate production trading. controls are implemented. The any adjustments to such controls that 1. Concept Release Comments Commission believes that it is not in the the DCM determines are appropriate for best position to determine the such orders. The Commission The Concept Release contemplated appropriate control parameters for each recognizes that certain activity that such that trading platforms must provide to trading strategy, product, capacity of controls are designed to address can be their market participants test exchange matching engine, and every caused by manual order entry in environments that simulate the other potentially relevant factor that addition to Algorithmic Trading. For production environment. FIA supports should be taken into account by a DCM example, fat-finger errors are a DCMs providing robust test when establishing thresholds. The environments and market participants commonly-cited example of an 500 proposed rules do not prescribe unintentional error that can have a using such environments. SIG also particular limits or thresholds. Rather, indicated that DCMs should provide test significant disruptive effect, which can 501 they require that the DCM set the be caused by, and may even be more environments. MFA indicated that controls at levels intended to prevent an likely to occur in the context of, manual many, if not all, exchanges currently Algorithmic Trading Event. order entry. provide market participants a test The Commission believes that facility to test trading software and allowing DCMs discretion in the design 4. Request for Comments algorithms.502 and implementation of risk controls is 79. The Commission proposes to 2. Description of Regulation particularly important in the area of require DCMs to set pre-trade risk Regulation AT proposes a new order cancellation functions. FIA has controls at the level of the AT Person, requirement that DCMs (under proposed stated that ‘‘[a]ctivation of a kill switch and allows discretion to set controls at § 40.21) provide a test environment that is based on a decision that such action a more granular level. Should the will enable AT Persons to simulate protects market integrity or the financial Commission eliminate this discretion, production trading. The required test integrity of the counterparties and require that the controls be set at a environment should provide access to involved,’’ and should ‘‘only be invoked specific, more granular, level? If so, historical transaction, order and based on a qualitative decision taken as please explain the more appropriate message data. The test environment a last resort when other actions have level at which pre-trade risk controls 496 should also enable AT Persons to failed or may not be feasible.’’ should be set by a DCM. Furthermore, FIA has explained that the conduct conformance testing of their 80. The Commission requests public conditions under which a kill switch Algorithmic Trading systems to verify comment on the pre-trade and other risk may be used by an exchange should be compliance with the requirements of controls required of DCMs in proposed clearly communicated to the proposed § 1.80(a)–(c) (which address § 40.20. Are any of the risk controls counterparties.497 Similarly, MFA pre-trade risk controls and other required in the proposed rules commented that trading platforms measures), § 1.81(a)(1)(ii)–(iv) and unhelpful to operational or other risk should have clear and objective policies § 1.81(c)(1) (which address the testing mitigation, or to market stability, when detailing when a kill switch will be and compliance of algorithmic trading implemented at the DCM level? used.498 CME indicated that restrictive systems). The Commission anticipates 81. Are there additional pre-trade or policies governing use of a kill switch that AT Persons would use the DCM test other risk controls that should be environment in connection with the 495 See id. at 266–67. specifically enumerated in proposed 496 See FIA Guide, supra note 95 at 14. § 40.20? 500 FIA at 34–38. 497 See id. 501 SIG at 9. 498 MFA at 12. 499 CME at 23. 502 MFA at 13.

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testing of their Algorithmic Trading 1. Concept Release Comments performs in a manner inconsistent with systems, to identify issues that may As noted in the discussion of its design, which may raise questions arise in a production environment that proposed § 1.83 above, the Concept about the design or monitoring of the may not have been identified through Release requested comment on whether AT Person’s algorithms; if a DCM testing in the AT Person’s development it would be appropriate to require identifies frequent trade practice environment. periodic self-certifications by all market violations at an AT Person, which are participants operating ATSs and by related to an algorithm of the AT 3. Request for Comments Person; or if an AT Person represents clearing firms that provide clearing significant volume in a particular 84. Should the test environment services to those market participants.503 product, thereby requiring heightened Comments addressing this topic are provided by DCMs under proposed scrutiny, among other reasons. An addressed in section IV(I)(1) above. § 40.21 offer any other functionality or appropriate review pursuant to data inputs that will promote the 2. Description of Regulation § 40.22(e) should include measures by effective design and testing of the DCM reasonably designed to Algorithmic Trading by AT Persons? Proposed § 40.22 complements the requirement under § 1.83 for AT Persons identify and remediate any insufficient mechanisms, policies, and procedures P. DCM Review of Compliance Reports and clearing member FCMs to submit described in such books and records. by AT Persons and Clearing FCMs; DCM compliance reports to DCMs. Proposed Rules Requiring Certain Books and § 40.22(a) requires a DCM to implement 3. Policy Discussion Records; and DCM Review of Such rules that require each AT Person that In proposing this regulation, the Books and Records as Necessary— trades on the DCM, and each FCM that Commission disagrees with comments § 40.22 is a clearing member of a DCO for such to the Concept Release opposing such a AT Person, to submit the reports The Commission proposes a new review requirement and suggesting that described in § 1.83(a) and (b), it would merely create extra § 40.22 that complements the respectively. Under proposed § 40.22(b), administrative costs.504 The requirement under § 1.83 for AT Persons a DCM must require the submission of Commission acknowledges that the and clearing member FCMs to submit such reports by June 30th of each year. review program required by § 40.22 compliance reports to DCMs. Sections Proposed § 40.22(c) requires a DCM to would impose costs on DCMs, but 40.22(a) and (b) would require a DCM to establish a program for effective believes that Regulation AT must require each AT Person that trades on periodic review and evaluation of include a mechanism to ensure that AT the DCM, and each FCM that is a reports described in paragraph (a) of Persons and clearing member FCMs are clearing member for such AT Person, to § 40.22, and of the measures described complying with the requirement to submit the reports described in § 1.83(a) therein. An effective program must implement certain pre-trade and other and (b) annually. Further, § 40.22(c) include measures by the DCM risk controls. Moreover, an assessment would require each DCM to establish a reasonably designed to identify and of such compliance requires an program for effective review of such remediate any insufficient mechanisms, adequate level of expertise and reports and remediation of any policies and procedures described in knowledge of markets and market deficiencies found. DCMs would have such reports, including identification participants’ technological systems and considerable latitude, however, in the and remediation of any inadequate trading strategies. The Commission design of their review programs. quantitative settings or calibrations of believes that a review program requiring Proposed § 40.22(d) would require pre-trade risk controls required of AT AT Persons to describe the pre-trade DCMs to implement rules that require Persons pursuant to § 1.80(a). risk controls required by § 1.80(a) and each AT Person to keep and provide to In addition, as an additional clearing member FCMs to describe their the DCM books and records regarding complement to the compliance report program for establishing and such AT Person’s compliance with all review program described above, maintaining the pre-trade risk controls requirements pursuant to § 1.80 and proposed § 40.22(d) requires DCMs to required by 1.82(a)(1), and requiring § 1.81, and require each clearing implement rules requiring each AT DCMs to review such information, is the Person to keep and provide to the DCM member FCM to keep and provide to the most effective method to ensure that all books and records regarding their DCM books and records regarding such market participants are implementing compliance with all requirements measures that are reasonably designed clearing member FCM’s compliance pursuant to § 1.80 and § 1.81, and to prevent an Algorithmic Trading Event with all requirements pursuant to § 1.82. requires each clearing member FCM to or Algorithmic Trading Disruption. The Finally, proposed § 40.22(e) would keep and provide to the DCM market requirements of proposed § 40.22(d) and require DCMs to review and evaluate, as books and records regarding their (e) will enable DCMs to perform a more necessary, books and records compliance with all requirements intensive review, as necessary, of AT maintained by AT Persons and clearing pursuant to § 1.82. Finally, proposed Persons’ compliance with §§ 1.80 and member FCMs regarding their § 40.22(e) requires DCMs to review and 1.81, and clearing member FCMs’ compliance with §§ 1.80 and 1.81 (for evaluate, as necessary, books and compliance with § 1.82, by among other AT Persons) and § 1.82 (for clearing records required to be kept pursuant to factors, helping to ensure that necessary member FCMs). This proposed proposed § 40.22(d), and the measures books and records are maintained and provision also provides DCMs with described therein. A DCM could find it available to a DCM. considerable latitude in the necessary to conduct such a review if: The Commission notes, in particular, implementation of their review It becomes aware if an AT Person’s kill that DCMs are best positioned to assess function. The remainder of this section switch is frequently activated, or the measures taken by market presents Concept Release comments on otherwise performs in an unusual participants on their exchange, and this topic, a description of the proposed manner; if a DCM becomes aware that identify outliers that may not have regulation, a discussion of the policy an AT Person’s algorithm frequently implemented adequate measures or justification for the proposal, and a request for comments on the proposal. 503 Concept Release, 78 FR at 56559. 504 See, e.g., AIMA at 21; FIA at 4; CME at 47.

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particular parameters as compared to intervals (e.g., once every two years), or trades, and hence is proposing to other market participants. The it could require review in response to provide DCMs and market participants Commission believes that it is in the specific events related to the the appropriate flexibility in interest of the DCM, as well as all Algorithmic Trading of AT Persons. implementation of the self-trade market participants trading on the DCM, Please comment on the appropriateness prevention tools. DCMs have begun to ensure that no market participants are of these alternative approaches. offering self-trade prevention tools to conducting Algorithmic Trading 88. Does § 40.22 leave enough market participants in recent years, and without adequate protections in place. discretion to the DCM in determining a large fraction of market participants Some commenters indicated that any how to design and implement an have started using these tools. Analysis certification requirements should be effective compliance review program of self-match use at DCMs has found principles-based.505 The Commission regarding Algorithmic Trading? that the majority of orders in many agrees that a DCM should have Alternatively, is there any aspect of this liquid contracts already make use of this discretion in the design and regulation that should be more specific tool. While acknowledging the growing implementation of its review program. or prescriptive? use of such tools, the Commission is Accordingly, proposed § 40.22 provides 89. Should § 40.22 specifically interested in strengthening regulatory a general framework for the DCM’s authorize a DCM to establish further standards to increase transparency and review program: e.g., a DCM must standards for the organization, method ensure more effective limitation of require the submission of reports by of submission, or other attributes of the unintentional self-trades. By June 30 of each year; and the DCM must reports described in § 40.22(a)? standardizing self-trade prevention use establish a program for effective across firms, it should be easier for the periodic review and evaluation of the Q. Self-Trade Prevention Tools—§ 40.23 marketplace as a whole to differentiate reports, including measures by the DCM The Commission understands that permitted self-trading. The reasonably designed to identify and self-trade activity has grown as trading Commission’s proposed rules on self- remediate any insufficient mechanisms, has migrated to an electronic trading trade prevention are also intended as a policies and procedures described in environment. The Commission has complement to the prohibition under such reports. Beyond the specific determined to propose rules in this area, the CEA regulations regarding wash requirements set forth in proposed which would address both intentional trades.507 Wash trading has been § 40.22, however, each DCM may tailor and unintentional self-trading activity, defined as ‘‘entering into, or purporting its review program in the manner it with the goal of benefiting market to enter into, transactions to give the believes will be most effective to participants and enhancing the price appearance that purchases and sales understand the measures its market discovery process. Specifically, the have been made, without incurring participants have taken to address the Commission is proposing § 40.23(a) to market risk or changing the trader’s risks of Algorithmic Trading, and require DCMs to implement rules market position.’’ 508 Therefore, evaluate whether they are sufficient. reasonably designed to prevent self- intentional self-trades could constitute 4. Request for Comments trading, excluding certain ‘‘permitted wash trades. self-trades’’ described below. Proposed The remainder of this section presents 85. In lieu of a DCM’s affirmative § 40.23(a) defines self-trading as the Concept Release comments on this obligation in proposed § 40.22 to review matching of orders for accounts that topic, a Commission analysis of the AT Person and clearing member FCM have common beneficial ownership 506 amount of self-trading in the compliance reports, should DCMs or are under common control. As marketplace, a description of the instead be permitted to rely on the CEO discussed below, a trade that results proposed regulation, a discussion of the or CCO representations required by from the matching of opposing orders policy justification for the proposal, and proposed § 1.83(a)(2)? If so, what events both generated by a firm or a single or a request for comments on the proposal. in the Algorithmic Trading of an AT commonly owned account does not shift 1. Concept Release Comments Person should trigger review obligations risk between different market by the DCM? participants. There is a possibility that The Concept Release requested 86. Should § 40.22(c) provide more such trades may inaccurately signal the comment on self-trading controls. The specific requirements regarding a DCM’s level of liquidity in the market and may Concept Release considered whether establishment of a program for effective result in a non-bona fide price. Risk trading platforms should provide, and periodic review and evaluation of AT controls that identify and limit self- market participants apply, technologies Person and clearing member FCM trading may result in more accurate to identify and limit the transmission of orders from their systems to a trading reports? For example, § 40.22(c) could indications of the level of market platform that would result in self-trades. require review at specific intervals (e.g., interest on both sides of the market and Numerous commenters addressed self- once every two years). Alternatively, help ensure arms-length transactions trading controls, including the extent of § 40.22(c) could provide greater that promote effective price discovery. discretion to DCMs in establishing their The Commission recognizes that there their use by industry; the types of trades programs for the review of reports. could be legitimate reasons for self- that self-trade controls should prevent; Please comment on the appropriateness and the appropriate design of self-trade controls. Commenters disagreed as to of these alternative approaches. 506 The Commission is requesting public 87. Should § 40.22(e) provide more comment in the questions below regarding whether whether there should be regulation in specific requirements regarding the it should define ‘‘common beneficial ownership’’ in this area, but most either oppose triggers for a DCM to review and any final rules arising from this NPRM, and if so, regulation or express concern about how how the term should be defined. The Commission it would be implemented, for reasons evaluate the books and records of AT notes in its request for public comment that its Persons and clearing member FCMs aggregation rules in § 150.4 are a potential model similar to those stated by FIA: ‘‘To required to be kept pursuant to for defining common beneficial ownership in any § 40.22(d)? For example, § 40.22(e) final rules. The Commission is also requesting 507 See Section 4c(a) of the CEA, 7 U.S.C. public comment regarding whether the definition of 6c(a)(2)(A), and Commission regulation 1.38(a). could require review at specific common beneficial ownership for purposes of 508 See CFTC Glossary, available at: http:// § 40.23 should be left to the individual discretion www.cftc.gov/ConsumerProtection/ 505 See, e.g., FIA at 4, CME at 27. of each DCM. EducationCenter/CFTCGlossary/index.htm#W.

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require the adoption of DCM-based self- using a self-trade prevention tool (i.e., self-trading, but that ‘‘market match prevention as a ‘one-size-fits-all’ trading firms may choose to simply participants must be able to approach may result in unnecessary modify their trading strategies).518 demonstrate, through information financial exposure caused by the OneChicago commented that self- barriers or other effective policies and inherent blocking of legitimate trading controls should be implemented procedures, that any self-trading is transactions. . . . The options for this and calibrated at the clearing firm level, between unrelated strategies and not type of functionality must be flexible not at the DCM level.519 designed with a manipulative enough so that market participants can In contrast, IATP and AFR support intent.’’ 529 choose the method that best suits their the Commission requiring exchanges Commenters also addressed the business and preserves legitimate and market participants to use self- appropriate level at which self-trade trading.’’ 509 trading controls.520 SIG believes that controls should be calibrated.530 Several Commenters indicated that exchange- exchanges should offer self-trade stressed that DCMs should allow market provided self-trading controls are prevention functionality, with participants to tailor this control to their widely used by market participants.510 parameters set by firms.521 own needs.531 FIA commented that self- The FIA PTG Survey reflected that 25 of As to cost considerations, CME stated trade controls should be offered at 26 responding firms use such that self-trade controls require varying levels of granularity (i.e., firm controls.511 Both CME and ICE provide significant investments in technology level, group level, trader ID level, self-trade prevention controls, a and resources by exchanges and trading customer account level and strategy capability which was introduced, and firms.522 MFA noted that it is more cost- level), and certain levels can be refined, in recent years.512 CME’s self- effective for exchanges, rather than combined.532 AIMA stated that self- trade control is optional rather than market participants, to develop self- trade controls set at the firm trader ID required. It allows market participants trade controls.523 level could be ‘‘gamed’’ by traders to prevent buy and sell orders for the Finally, comments addressed the creating a shell company under a same account, or accounts with specific functionality of self-trade different ID.533 SIG suggested that the common beneficial ownership, from controls currently used by exchanges controls be customizable at the matching with each other. CME noted and firms. For example, five comments ‘‘aggregation unit level’’ and ‘‘user- that its self-trade control can be applied addressed the type of trades that such defined tag level.’’ 534 by market participants at the executing controls should prevent.524 FIA Six comments addressed whether firm level or at more granular levels, explained that self-trading controls exchanges should require market including at an individual user level.513 should only address trades submitted by participants to use the exchanges’ self- CME stated that more than 100 firms the same trading desk that are matched trading controls.535 CME noted that it is have registered for this control since it despite best efforts to avoid self-trading. optional for market participants to use was launched in June 2013.514 ICE This is different from wash trades, its self-trade tools, and FIA supported 536 noted that its self-trade prevention tool which are intentional self-trades that this approach. In contrast, AIMA is mandatory for proprietary traders Commission and DCM rules already suggested mandatory confidential with DEA.515 Another exchange, CFE, effectively address, and bona fide self- flagging of self-trades to the market commented that it will be employing trades, which are buy and sell orders for participant, but only optional 537 self-trade prevention functionality in accounts with common beneficial cancellations of orders. Gelber and 516 the near future. ownership that are independently KCG support mandatory use at the 538 While FIA believes that DCMs should initiated for legitimate business ‘‘trader ID’’ level. Gelber noted that offer self-trading controls, FIA and four ICE’s controls are mandatory for some purposes, but which coincidentally 539 other commenters (including CME) cross.525 FIA and Gelber stated that market participants. Finally, IATP oppose self-trading regulation at this suggested requiring exchanges to 517 CME’s November 19, 2013 advisory time. Reasons articulated by FIA and notice on wash trades 526 provides an provide self-trading controls and apply other commenters included: The accurate description of when self- them to all participants and all technology supporting this risk control matching is acceptable.527 SIG stated products, arguing that requiring such is not sufficiently developed, although that exchanges should focus on trades controls for some but not others creates arbitrage opportunities.540 industry is already working to improve that would create material, not Comments also addressed order it and is in the best position to do so; immaterial, market misperceptions.528 regulating self-trading controls would cancellation options in order to prevent Finally, KCG stated that it does not self-trading, which can include cancel lock in standards or technology that will believe the CFTC needs to prohibit all become obsolete; self-trade controls may resting, cancel new, cancel both, and decrement order quantity (canceling the cause an accumulation of either resting 518 FIA at 25–27; CME at 11–12; AIMA at 11–12; orders or new orders, depending on how Gelber at 7. smaller order and reducing the larger the controls are calibrated, which does 519 OneChicago at 2. not advance the regulatory goal of 520 IATP at 5; AFR at 7. 529 KCG at 7. protecting the marketplace; and there 521 SIG at 9. 530 FIA at 25–27; Gelber at 7–9; CME at 12; AIMA 522 CME at 10. at 10–12; SIG at 9. are ways to prevent self-trades without 531 523 MFA at 8. FIA 25–27; Gelber at 7–9; CME at 12; SIG at 9. 524 FIA at 25; Gelber at 9; KCG at 7; AIMA at 11; 509 FIA at 27–28. 532 SIG at 9. FIA at 27. 510 FIA at 26; Gelber at 7–9. 533 AIMA at 10–12. 525 FIA at 25. 511 FIA at 26, 59–60. 534 SIG at 9. 526 See the CME Group Advisory Notice RA 1308- 512 535 FIA at 25–27; MFA at 8; Gelber at 7–9; FAIMA 5 (Nov. 19, 2013), available at http:// FIA at 25–27; CME at 13, Appendix A–4; at 10; IATP at 5. www.cmegroup.com/rulebook/files/cme-group- Gelber at 7–9; KCG at 7; AIMA at 2, 10–11; IATP 513 CME at 12. ra1308–5.pdf. The FAQ in the Advisory Notice at 5. 514 Id. at 11–12. discusses various types of acceptable self-matching 536 CME at 13, Appendix A–4; FIA at 25–27. 515 ICE at 2. that would not violate CME Rule 534 (‘‘Wash 537 AIMA at 2, 10–11. 516 CFE at 6. Trades Prohibited’’). 538 Gelber at 7–9; KCG at 7. 517 FIA at 25–27; CME at 10–12; Gelber at 7–9; 527 FIA at 25; Gelber at 9. 539 Gelber at 7–9. MFA 5, 8; AIMA at 11–12. 528 SIG at 9. 540 IATP at 5.

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order by the size of the smaller 3. Description of Regulation prohibited from trading with each other. 541 order). As described below, the The Commission is proposing new The proposed regulations allow DCMs Commission’s proposed self-trade requirements under § 40.23 that would to exercise discretion in the design and prevention requirements do not require DCMs to apply, or provide and implementation of self-trade prevention mandate a particular technological require the use of, tools reasonably tools, in response to Concept Release approach, nor do they specify which designed to prevent self-trading. commenter concerns that the technology order or set of orders should be canceled Proposed § 40.23 defines self-trading for supporting this control is still being in order to prevent a self-trade. purposes of this regulation as the developed, and overly prescriptive matching of orders for accounts that regulations in this area may lock in 2. Commission Analysis of Amount of standards or technology that will Self-Trading in the Marketplace have common beneficial ownership or are under common control. These become obsolete. requirements are intended to prevent Description of § 40.23(b). The The pervasive growth of algorithmic requirements of proposed § 40.23(a) are trading by firms deploying large self-trading, while still allowing what FIA has characterized as ‘‘bona fide and subject to the proviso in § 40.23(b) that numbers of strategies has likely a DCM may, in its discretion, implement increased the incidence of self-trading desirable self-match trades,’’ i.e. buy and sell orders for accounts with rules that permit a self-trade resulting activity. In order to estimate the from the matching of orders for accounts percentage of self-trading in the common beneficial ownership that are independently initiated for legitimate with common beneficial ownership marketplace, the Commission recently where such orders are initiated by reviewed twelve months of trade data business purposes, but which coincidentally cross.543 While the independent decision makers. A DCM received from several large DCMs, could, through its rules, further define focusing primarily on the most active proposed rules contain exceptions for bona fide self-match trades (described in for its market participants ‘‘independent products. Among other findings, the decision makers.’’ This exception is Commission learned that intra-firm self- § 40.23(b)), they are intended to address all unintentional self-trading, and do closely based on FIA’s comment letter trades, including both proprietary and description of how a bona fide self-trade customer trades, can comprise a not include a de minimis exception for 544 a certain percentage of unintentional that should be permitted to occur. meaningful percentage of daily trading The Commission considered FIA’s activity in individual futures self-trading. In addition, the proposed rules would provide for an important concept of permissible self-trading to be contracts.542 For example, in February a reasonable one, which would be easily 2015 intra-firm self-trades in one new element of transparency around bona fide self-match trades to furnish all understood by exchanges and market examined futures contract were almost participants. In addition to the foregoing 10 percent of all trades in that contract, market participants with greater information regarding the markets on exception relating to common beneficial increasing to almost 15 percent on ownership, § 40.23(b) allows a DCM to individual days. Self-trade rates for a which they trade. Description of § 40.23(a). Regulation permit a self-trade resulting from the few other contracts were around 5 40.23(a) would require a DCM to matching of orders for accounts under percent of total activity. The implement rules reasonably designed to common control where such orders Commission found similar patterns at prevent self-trading by market comply with the DCM’s cross-trade, individual firm levels, with cumulative participants, except as specified in minimum exposure requirements or self-trade volumes at times in the paragraph (b). The regulation defines similar rules, and are for accounts that millions of contracts for some market ‘‘self-trading,’’ for purposes of § 40.23, are not under common beneficial participants over the course of the 12- as the matching of orders for accounts ownership. month sample period. The average size that have common beneficial ownership Description of § 40.23(c). Under of a firm’s self-trades ranged from or are under common control. proposed § 40.23(c), a DCM must approximately two contracts per trade to Regulation 40.23(a) would require that a require market participants to receive over two thousand contracts per trade. DCM shall either apply, or provide and approval from the DCM to forego self- require the use of, self-trade prevention trade prevention tools with respect to 541 FIA at 26; CME at 11. FIA, Gelber and SIG tools that are reasonably designed to specific accounts under common support the DCM offering cancellation options to prevent self-trading and are applicable beneficial ownership or control, on the the market participant. FIA at 26; Gelber at 7–9; SIG basis that they meet the criteria of at 9. In its comment letter, CME stated that its self- to all orders on its electronic trade match prevention system was, at the time of the matching platform. If a DCM does not paragraph (b). The DCM must require comment letter, structured to cancel the resting implement and apply self-trade that such approval request be provided order, retaining orders based on more current to it by a compliance officer or senior market information. (CME has more recently prevention tools, then it must provide such tools to its market participants and officer of the market participant. The expanded the number of cancellation choices.) The Commission emphasizes that the benefit of the opposite approach, canceling the require all market participants to use the taking order, is that it favors the priority of orders tools. For purposes of complying with approval request to not apply self-trade resting in the order book. CME at 11. Similarly, prevention tools to certain orders MFA stated that it disagrees with the approach of the requirements of proposed § 40.23, a DCM could either determine for itself should not be made by an individual canceling the resting order, because it causes a trader or other non-management or more participant to lose its resting orders even if the which accounts should be prohibited orders have been working in the queue. MFA noted from trading with each other, or require junior employee of the trading firm. that other exchanges, such as NYSE Euronext, offer market participants to identify to the Market participants must withdraw or options such as cancelling the taking order and DCM which accounts should be amend an approval request if any decrementing order quantity. MFA at 8. AFR change occurs that would cause the supports cancellation of the taking order, reasoning that the taking order is more likely to be the 543 FIA at 25. See also FIA Guide, supra note 95 information provided in such approval erroneous order. AFR at 7. Finally, AIMA favors at 13, which describes bona fide and allowable self- request to be no longer accurate or rejection of both the resting order and the taking match trades as ‘‘buy and sell orders for accounts complete. The Commission notes that order. AIMA at 11. with common beneficial ownership that are any approval request submitted to the 542 Self-trading identified in the Commission’s independently initiated for legitimate and separate analysis could include trading between accounts business purposes by independent decision makers DCM would be subject to section 9(a)(4) controlled by separate independent decision and which coincidentally cross with each other in makers. the competitive market.’’ 544 See FIA at 25.

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of the Act, 7 U.S.C. 13(a)(4) (2012), The Commission has included self- Commission action in this area, the which prohibits, inter alia, making false, trade prevention requirements in commenters also indicated that self- fictitious, or fraudulent statements to a Regulation AT to ensure that there are trade prevention tools are already registered entity. regulatory standards to more effectively widely implemented in industry.546 Description of § 40.23(d). Finally, and fairly limit unintentional self- Moreover, FINRA Rules already address proposed § 40.23(d) would require that trading across Commission-regulated self-trade prevention. In June 2014, for each product and expiration month markets, aiding in the risk management FINRA published a regulatory notice traded on a DCM in the previous and trading efficiency of individual stating that the SEC had approved new quarter, the DCM must prominently firms. supplementary material to FINRA Rule display on its Web site the following In addition, while existing 5210 (Publications of Transactions and information: (i) The percentage of trades Commission regulations address market Quotations) to address transactions in a in such product including all expiration manipulation and wash sales, these security resulting from the months that represent self-trading types of violative behavior require some unintentional interaction of orders approved (pursuant to paragraph (c) of level of intent. Therefore, the originating from the same firm that § 40.23) by the DCM, expressed as a Commission has determined to propose involve no change in the beneficial percentage of all trades in such product regulations in the area of self-trading ownership of the security (self- 547 and expiration month; (ii) the that address both matching of orders for trades). Effective August 25, 2014, percentage of volume of trading in such accounts that have common beneficial firms must have policies and procedures product including all expiration months ownership or are under common in place that are reasonably designed to that represents self-trading approved control, independent of intent. review their trading activity for, and The proposed regulations are (pursuant to paragraph (c) of § 40.23) by prevent, a pattern or practice of self- intended to take into account Concept the DCM, expressed as a percentage of trades resulting from orders originating Release comments advising that the all volume in such product and from a single algorithm or trading desk, Commission should not be overly expiration month; and (iii) the ratio of or related algorithms or trading desks. prescriptive in requiring specific types orders in such product and expiration In addition, the FIA Guide sets forth of self-trade prevention tools, or specific month whose matching was prevented guidelines for self-trade prevention, and settings or controls in connection with recommends that exchanges should by the self-trade prevention tools such tools, because such tools are still described in paragraph (a) of § 40.23, offer participants a selection of self- technologically evolving. Furthermore, trade tools to allow market participants expressed as a ratio of all trades in such the Commission agrees with comments product and expiration month. The to tailor self-trade prevention to their stating that exchanges are in the individual needs by offering various Commission emphasizes that the position, from a technology standpoint, ‘‘prominent display’’ of information by options (e.g., cancel resting, cancel new, to develop these types of controls. cancel both, and decrement order size) a DCM precludes such DCM from Accordingly, the Commission proposes placing information required by this and various levels of granularity (e.g., to require the use of self-trade firm level, group level, trader ID level, rule behind registration, log in, user prevention tools in proposed § 40.23, name, password or other walls on the customer account level and strategy but allow exchanges and market 548 DCM’s Web site. level). The FIA Guide recommends participants the discretion to tailor the that the use of such self-trade tools by 4. Policy Discussion design of such tools and how to most market participants should remain effectively calibrate them in order to optional.549 The new Regulation AT The Commission understands that for prevent unintentional self-matching. various reasons, firms might operate requirements, by contrast, would make The Commission believes that the use of exchange-provided self-trade multiple algorithms, each following a requirements of proposed § 40.23 are different trading strategy, but prevention tools mandatory by market generally consistent with how participants. transacting in the same instrument/ exchange-provided self-trade prevention futures contract. This can cause buy and tools currently operate, as indicated by 5. Request for Comments sell orders for the same instrument to be comment letters.545 The proposed 90. The Commission seeks to require generated at the same instant by regulations would also require DCMs to self-trade prevention tools that screen different algorithms, which in turn can publish statistics on their Web site out unintentional self-trading, while get matched with each other as self- regarding self-trading that they have permitting bona-fide self-matched trades trades. Certain firms might choose to both authorized and prevented on their that are undertaken for legitimate prevent these self-trades from occurring, platform. The Commission is proposing business purposes. Under the or limit the extent of self-trades. They this Web site reporting requirement regulations proposed above, DCMs shall could choose to do this by building because it understands that the design implement rules reasonably designed to tools that scan all orders being of self-trade prevention tools may vary prevent self-trading (‘‘the matching of generated from within the firm and stop among DCMs. These statistics will serve orders for accounts that have common those that could potentially result in a critical purpose in disclosing to beneficial ownership or are under self-trades. But there are challenges in market participants the extent of self- common control’’), but DCMs may in building efficient firm-level solutions, trading that occurs in each product. The their discretion implement rules that especially in modern low latency Commission believes that such permit ‘‘the matching of orders for markets. In response, DCMs have transparency is a key element of the implemented self-trade prevention tools proposed rules as it will help furnish all 546 See, e.g., FIA at 26; Gelber at 7–9; CME at 11– to help firms manage and limit the market participants with better 12; ICE at 2. extent of self-trades that would information regarding the markets in 547 See FINRA, ‘‘Regulatory Notice 14–28: Self otherwise be generated by these which they trade. Trades; SEC Approves FINRA Rule Concerning Self-Trades ’’ (June 2014), available at http:// algorithms. These trading system-level While some commenters to the www.finra.org/sites/default/files/NoticeDocument/ solutions appear to be more efficient in Concept Release were not supportive of p540972.pdf. helping firms manage their self-trade 548 See FIA Guide, supra note 95 at 13. activity. 545 See, e.g., CME at 11–12; ICE at 2. 549 Id.

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accounts with common beneficial addition to the exceptions permitted in and if so, what additional regulations ownership where such orders are § 40.23(b)(1) and (2)? If so, please would ensure that DCMs are able to: initiated by independent decision describe such other types of acceptable Ensure that such tools are comparable to makers.’’ self-trading and explain why they DCM-provided tools; monitor the a. Do these standards accomplish the should be permitted. performance of such tools; and goal of preventing only unintentional 92. Proposed § 40.23 provides that otherwise review such tools and ensure self-trading, or would other standards be DCMs may comply with the that they are sufficiently rigorous to more effective in accomplishing this requirement to apply, or provide and meet the requirements of § 40.23. goal? For example, should the require the use of, self-trade prevention 95. Is it appropriate to require Commission consider adopting in any tools by requiring market participants to final rules arising from this NPRM an identify to the DCM which accounts implementation of self-trade prevention alternative requirement modeled on should be prohibited from trading with tools with respect to all orders? Should FINRA Rule 5210 and require market each other. With respect to this account such controls be mandatory for only a participants to implement policies and identification process, the Commission’s particular subset of orders, i.e., orders procedures to review their trading principal goal is to prevent from AT Persons or orders submitted activity for, and a prevent a pattern of, unintentional self-trading; the through DEA? self-trades? Commission does not have a specific 96. Please comment on the b. While the regulations contain interest in regulating the manner by requirement that DCMs disclose self- exceptions for bona fide self-match which market participants identify to trade statistics. Is the data required to be trades (described in § 40.23(b)), the DCMs the account that should be disclosed appropriate? Is there any other regulations are intended to prevent all prohibited from trading from each other, category of self-trade data that DCMs unintentional self-trading, and do not so long as this goal is met. Should any should be required to disclose? include a de minimis exception for a other identification methods be 97. Should DCMs be required to certain percentage of unintentional self- permitted in § 40.23? For example, disclose the amount of unintentional trading. Should the regulations permit a please comment on whether the self-trading that occurs each month, certain de minimis amount of opposite approach is preferable: market alongside the self-trade statistics unintentional self-trading, and if so, participants would identify to DCMs the required to be published under what amount should be permitted (e.g., accounts that should be permitted to proposed § 40.23(d)? as a percentage of monthly trading trade with each other (as opposed to volume)? those accounts that should be prevented 98. As noted above, the Commission c. The following terms are used in from trading with each other). understands that there is some potential proposed § 40.23(a) and (b): (1) Self- 93. The Commission believes that its for self-trade prevention tools to be used trading, (2) common beneficial requirements concerning self-trade for wrongful activity that may include ownership, (3) independent decision prevention tools must strike the disruptive trading or other violations of makers, and (4) common control. Do any appropriate balance between flexibility the Act or Commission regulations on of these terms require further definition? (allowing market participants with DCMs. Are there ways to design self- If so, how should they be defined? diverse trading operations and strategies trade prevention tools so that they do Should any alternatives be used and, if the discretion in implementation so as not facilitate disruptive trading (such as so, how should such substitute terms be effectively prevent only unintentional spoofing) or other violations of the Act defined? self-trades) and simplicity (a variety of or Commission regulations on DCMs? d. With respect to ‘‘common design and implementation options may Are additional regulations warranted to beneficial ownership,’’ the Commission render this control too complex to be ensure that such tools are not used to requests comment on the minimum effective).550 Does the Commission facilitate such activities? degree of ownership in an account that allow sufficient discretion to exchanges should trigger a determination that such R. DCM Market Maker and Trading and market participants in the design Incentive Programs—§§ 40.25–40.28 account is under common beneficial and implementation of self-trade ownership. For example, should an prevention tools? Is there any area Proposed §§ 40.25–40.28 would account be deemed to be under common where the Commission should be more require DCMs to provide additional beneficial ownership between two prescriptive? The Commission is public information regarding their unrelated persons if each person particularly interested in whether there market maker and trading incentive directly or indirectly has a 10% or more is a particular level at which it should programs, restrict certain types of ownership or equity interest in such require implementation of self-trade payments by DCMs in connection with account? The Commission refers prevention tools, i.e., if the tools must such programs, and require DCMs to commenters to the aggregation rules in prevent matching of orders from the perform surveillance of such programs part 150 of its regulations, including same trading firm, the same trader, the to prevent abusive practices. The specifically § 150.4, and requests same trading algorithm, or some other remainder of this section presents a comment on a potential Commission level. description of the proposed regulation, definition of common beneficial 94. Proposed § 40.23(a) would require a discussion of the policy justification ownership that is modeled on § 150.4. DCMs to either apply, or provide and for the proposal, and a request for e. The Commission also requests require the use of, self-trade prevention comments on the proposal. comment on whether ‘‘common tools. Please comment whether beneficial ownership’’ should be § 40.23(a) should, in addition, permit 1. Policy Discussion defined in any final rules arising from market participants to use their own this NPRM, or whether such definition Although not discussed in the self-trade prevention tools to meet the Concept Release, the Commission has should be left to each DCM with respect requirements of proposed § 40.23(a), to its program for implementing determined to address in Regulation AT certain aspects of DCM market maker proposed § 40.23. 550 See FIA Guide, supra note 95 at 13 (discussing 91. Are there any other types of self- balance between flexibility and complexity with and trading incentive programs that it trading that should be permitted in respect to self-trade prevention tools). believes are particularly relevant in the

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context of automated trading.551 Formal DCM and Commission rules. Notably for Proposed § 40.25 will enhance the types market making and incentive programs purposes of Regulation AT, market of information that DCMs should expect were not common in the days of pit participants using ATSs can magnify to provide the Commission when trading. In the modern trading these concerns in several respects. First, requesting approval or self-certifying environment, DCM trading incentive the automation and speed of ATSs can market-maker or trading incentive programs (which may also be called a allow market participants to quickly programs, and will also require that liquidity provider program) typically reach market-maker or trading incentive information regarding market-maker and compensate one or more market program thresholds, depending on the trading incentive programs be easily participants with financial or non- liquidity of a market and threshold located on a DCM’s Web site. financial incentives or benefits for levels. Second, the trading strategies The Commission notes that in June meeting certain volume thresholds or pursued through ATSs can sometimes 2012 it adopted core principles and providing liquidity. A market maker result in a large number of trades final rules modernizing the regulatory program (which may also be called, for between the same ATS or between two regime applicable to all DCMs (‘‘DCM example, a market specialist, designated or more ATSs owned or controlled by Final Rules’’). The DCM Final Rules market maker, lead market maker, or the same market participants. In this emphasized DCMs’ obligations as the liquidity provider program) is a more regard, the Commission is also front-line regulators of their markets, focused offering that involves a proposing new § 40.23 to help prevent including extensive trade practice and contractual agreement between the DCM self-trading on DCMs, and provide market surveillance responsibilities. In and a market participant. It typically market participants with greater addition, the Commission codified new compensates one or more market transparency around DCM depth and requirements that a DCM offer its participants with financial or non- liquidity when self-trading does ‘‘members [and] persons with trading financial incentives or benefits for occur.552 privileges . . . with impartial access to fulfilling certain affirmative obligations Proposed §§ 40.25–40.28 will further its markets and services,’’ including: (1) in a particular product or products, such the Commission’s policy objectives in ‘‘Access criteria that are impartial, as maintaining two way prices and three key areas: (1) Transparency; (2) transparent and applied in a non- volumes or a pre-determined minimum market integrity; and (3) effective self- discriminatory manner’’ and (2) bid/ask spread for a specified period of regulation by all DCMs. The proposed ‘‘comparable fee structures . . . for the trading day. regulations would further transparency equal access to, or services from’’ the The number of such programs self- through proposed §§ 40.25 and 40.26, DCM. Taken together, proposed certified to the Commission has risen which would require greater disclosure §§ 40.25–40.28 will facilitate the sharply in recent years, as has the of information to the public and to the Commission’s oversight of DCMs’ complexity of the programs and size of Commission regarding market maker market maker and trading incentive the incentives. In 2010, 56 market maker and trading incentive programs. programs, and will also help the and incentive programs were self- Together with proposed amendments to Commission ensure that market maker certified by DCMs; in 2013, DCMs had the definition of ‘‘rule’’ in § 40.1(i) to and trading incentive programs are in self-certified 341 programs, an increase explicitly include market maker and compliance with Commission rules by over 600 percent compared to the trading incentive programs, the regarding trade practice and market number of programs self-certified by proposed regulations would also help surveillance and impartial access DCMs in 2010. In 2012, nearly every eliminate any potential ambiguity that requirements. contract at one DCM was part of a may exist regarding the Commission’s Importantly, the proposed regulations 553 would promote market integrity by market maker or incentive program, authority over such programs. requiring in proposed § 40.27(a) that including highly liquid contracts. The Commission understands that 552 See Section IV(Q) above for a discussion of DCMs implement policies and self-trading and proposed § 40.23. DCMs have launched market making procedures reasonably designed to 553 In the Final Rule for Provisions Common to prevent payment of market maker or and other incentive programs to Registered Entities, the Commission stated with encourage liquidity provisioning and respect to market maker and trading incentive trading incentive program benefits for order flow to their electronic trading programs, ‘‘The Commission continues to view self-trades. In this regard, the proposed platforms. While the Commission does such programs as ‘‘agreements * * * regulations are designed to ensure that corresponding’’ to a ‘‘trading protocol’’ within the market maker or trading incentive not object to such goals, the § 40.1 definition of ‘‘rule’’ and, as such, all market Commission’s proposed regulations in maker and trading incentive programs must be programs do not incentivize abusive, §§ 40.25–40.28 reflect its concern that submitted to the Commission in accordance with manipulative, or disruptive trading market maker and trading incentive procedures established in part 40.’’ In this Final practices, and also do not encourage or Rule, the Commission also stated, specifically with facilitate behavior that distorts markets programs could have the potential to respect to DCMs, that ‘‘[a] DCM’s rules spur market participants to trade in implementing market maker and trading incentive and give the appearance of false market ways designed to collect program programs fall within the Commission’s oversight depth. Proposed § 40.28 clarifies DCMs’ benefits, independently of any authority. Indeed, a number of core principles surveillance obligations regarding touch upon trading issues that may be implicated market maker or trading incentive contribution they may be making to by the design of such programs. Core Principle 9, liquidity or price discovery. Such for example, establishes the Commission’s programs and their participants. practices may potentially also lead to framework for regulating the execution of Separately, the Commission believes abusive trading practices in violation of transactions, requiring DCMs . . . to provide a that proposed §§ 40.25–40.28 will also competitive, open, and efficient market and provide DCMs and market participants mechanism for execution. The newly-amended Core 551 The Commission notes that ESMA’s 2015 Principle 12 also requires DCMs to establish and with greater certainty as to what types Final Draft Regulatory Standards address market enforce rules to protect markets and market of trading incentive and market maker maker schemes. The standards address the participants from abusive practices and to promote programs are inappropriate. The circumstances under which an investment firm fair and equitable trading on designated contract proposed regulations are described in must enter into a market making agreement with a markets. In addition, market maker and trading trading venue, and the content that should be incentive programs frequently touch upon Core detail below. The proposed rules will included in such an agreement. See ESMA Principle 19, which requires that DCMs avoid September 2015 Final Draft Standards Report adopting any rules or taking any actions that result Provisions Common to Registered Entities, 76 FR Annex 1, supra note 80 at 279–80. in unreasonable restraints of trade.’’ Final Rule, 44776, 44777–8 (July 27, 2011).

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work in conjunction with the proposed the potential service(s) rendered by a Proposed § 40.25(c) would require a amendments to the definition of ‘‘rule’’ market participant to which the market DCM to notify the Commission upon the in proposed § 40.1(i) to explicitly maker or trading incentive program termination of a market maker or trading include market maker and trading applies (e.g., trading at certain hours; incentive program when such program incentive programs. trading originating from certain terminates prior to the date previously In sum, the Commission’s proposed geographic zones; trading originating notified the Commission. Any extension amendments to § 40.1(i) and new with certain types or categories or or renewal of a market maker or trading §§ 40.25–40.28 will increase market participants; or the bid/ask incentive program beyond its original transparency around DCM market- spread to be maintained by a market termination date would require a new maker and trading incentive programs, participant); (4) a description of any rule filing pursuant to this part. underline existing regulatory eligibility criteria or categories of market Proposed § 40.26 would require that, expectations, and introduce basic participants defining who may upon request by the Commission or the safeguards in the conduct of such participate in the program; (5) for any Director of the Division of Market programs. The proposed regulations market maker or trading incentive Oversight, a DCM must provide such would make clear that market-maker program that is not open to all market information and data as may be and trading incentive programs are participants, an explanation of why the requested regarding participation in ‘‘rules’’ for purposes of part 40, and program is limited to the chosen market maker or trading incentive establish information and disclosure eligibility criteria or categories of market programs offered by the DCM, including requirements when DCMs request participants, and an explanation of how but not limited to, individual program Commission approval or self-certify new such limitation complies with the agreements, names of program rules pursuant to part 40. They would impartial access and comparable fee participants, benchmarks achieved by also make clear that DCMs’ existing structure requirements of § 38.151(b) for program participants, and payments or surveillance responsibilities in part 38 DCMs; (6) an explanation of how other benefits conferred upon program apply equally to market-maker and persons eligible for the market maker or participants. trading incentive programs. Finally, the trading incentive program may apply to Proposed § 40.27(a) would require a proposed regulations would codify the participate, and how eligibility will be DCM to implement policies and Commission’s expectation that DCM evaluated by the DCM; (7) a description procedures reasonably designed to market-maker and trading incentive of any payments, incentives, discounts, prevent payment of market maker or programs should not provide payments considerations, inducements or other trading incentive program benefits, or incentives for market-maker or benefits that program participants may including but not limited to payments, trading activity between accounts under receive, including any non-financial discounts, or other considerations, for common ownership. incentives (non-financial incentives trades between accounts that are: (1) 2. Description of Regulations may include, for example, enhanced Identified to the DCM as under common trading priorities or preferential access beneficial ownership pursuant to the Proposed §§ 40.25–40.28 would to market data, including order and approval process described in § 40.23(c); require DCMs to provide additional trade data); (8) a description of the or (2) otherwise known to the DCM as public information regarding their obligations, benchmarks, or other under common ownership.556 market maker and trading incentive measures that a participant in a market Finally, proposed § 40.28 would programs. Proposed § 40.25(a) would maker or trading incentive program require that a DCM, consistent with its require that, when submitting a rule must meet to receive the benefits obligations pursuant to subpart C of part regarding a market maker or trading described in paragraph (a)(7) of this 38, must review all benefits accorded to incentive program pursuant to § 40.5 or section; and (9) a description of any participants in market maker and § 40.6, a DCM must, in addition to legal affiliation between the DCM and trading incentive programs, including information required by such sections, any entity acting as a market maker or but not limited to payments, discounts, include specific additional information participating in a market maker or or other considerations, to ensure that 554 in its public rule filing. Additional trading incentive program.555 Proposed such benefits are not earned through information to be provided would § 40.25(b) would require that, in abusive practices. The Commission include: (1) The name of the market addition to any public notice required notes that such determination is not maker program or trading incentive pursuant to part 40 (including without intended as a substitute for DCMs’ trade program, the date on which it will limitation the requirements of practice surveillance, market begin, and the date on which it will § 40.5(a)(6) and § 40.6(a)(2)), a DCM surveillance, and other surveillance terminate (if applicable); (2) an must ensure that the information obligations with respect to all trading. explanation of the specific purpose for required by § 40.25(a)(1)–(8) is easily 3. Request for Comments the program; (3) a list of the product(s) located on its public Web site during the the trading of which is eligible for lifetime of the market maker or trading 99. To what extent do market benefits under the market maker or incentive program, that is, from the time participants currently trade in ways trading incentive program, and list of that the DCM begins accepting designed primarily to collect market participants in the program through the maker or trading incentive program 554 The Commission is cognizant that a DCM may benefits, rather than for risk consider certain information required by proposed time the program ceases operation. § 40.25(a) to be non-public. In this regard, the management purposes? Commission notes that § 40.8 of its existing 555 Commission staff has historically required regulations provides a mechanism for registered enhanced DCM surveillance procedures when a 556 The Commission notes that proposed entities to request confidential treatment when DCM market maker is operated by an affiliate of the § 40.27(a) prohibits payments for trades between submitting rule filings pursuant to §§ 40.5 or 40.6. DCM. Proposed § 40.25(a)(9) will assist the accounts (i) identified to the DCM as under Among other requirements, a registered entity must Commission in identifying potential conflicts of common beneficial ownership or (ii) known to the file a ‘‘detailed written justification’’ for its interest between a DCM, its market makers, and DCM as under common ownership. This distinction confidential treatment request. Regulation 40.8 participants in market maker or trading incentive reflects that the Commission’s belief that DCMs may remains available to DCMs for any § 40.25(a) filings programs, and also assist the Commission in not always have beneficial ownership information that may be required in the future. See 17 CFR 40.8; promoting appropriate surveillance in such unless it has been provided to them, pursuant for see also 17 CFR 145.9. circumstances. example to proposed § 40.23.

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100. To what extent do that market 106. In any final rules arising from exchange, and indicators of whether the maker and trading incentive programs this NPRM, should the Commission also order is associated to an automated currently provide benefits for self- prohibit DCMs from providing trading system. Using this participant-identified trades? To what extent do market incentive program benefits where such data, the Commission estimated the participants collect such benefits for benefits on a per-trade basis are greater number of unique firms actively sending self-trades? than the fees charged per trade by such in algorithmic orders to the DCMs, 101. The Commission requests DCMs and its affiliated DCO (if making them potentially subject to comment regarding whether the applicable)? The Commission also requirements of AT Persons. information proposed to be collected in specifically requests comment on the Some of the firms included in this § 40.25 would be sufficient for it to extent, if any, to which one or more count, although they use automated determine whether a DCM’s market- DCMs engage in this practice. systems, may not fully satisfy the maker or trading incentive program 107. Proposed § 40.25(b) imposes requirements for an AT Person, possibly complies with the impartial access certain transparency requirements with making the current estimate higher than requirements of § 38.151(b). If respect to both market maker and the actual number of AT Persons. For additional or different information trading incentive programs. The example, firms identified in the data set would be helpful, please identify such Commission requests public comment as submitting algorithmic orders may information. regarding: not be required to register with the 102. The Commission requests a. The most appropriate place or Commission under current or proposed comment regarding whether DCMs manner for a DCM to disclose the rules and thus would not be AT Persons should be required to maintain on their information required by proposed (e.g., registration triggers under public Web sites the information § 40.25(b); proposed § 1.3(x)(3)(ii) include a DEA required by proposed § 40.25(a) and (b) b. The benefits or any harm that may component in addition to an for an additional period beyond the end result from such transparency, Algorithmic Trading component). of the market maker or trading incentive including any anti-competitive effect or However, because the Commission does program. The Commission may pro-competitive effect among DCMs or not historically receive the complete determine to include in any final rules market participants; order book audit trail, the estimate by arising from this NPRM a requirement c. Whether transparency as proposed necessity only used a subset of all that such information remain publicly in § 40.25(b) is equally appropriate for orders sent into the DCMs. To generate available pursuant to proposed both market maker programs and an accurate estimate of automated order § 40.25(b) for an additional period up to trading incentive programs, or are the activity, the estimate included many of the most active products on the DCMs, six months following the end of a proposed requirements more or less where participant diversity would be market maker or trading incentive appropriate for one type of program over greatest. This analysis resulted in program. the other? approximately 350 potential AT 103. The Commission requests d. Whether any of the enumerated Persons. To further address AT Persons comment regarding whether the text of items required to be posted on a DCM’s public Web site pursuant to proposed that may not be identified in its data set, proposed § 40.27(a) identifies with the Commission increased its finding of sufficient particularity the types of § 40.25(b) could reasonably be considered confidential information that approximately 350 potential AT Persons trades that are not eligible for payments by 20 percent, yielding a total of 420 or benefits pursuant to a DCM market- should not be available to the public, and if so, what process should be potential AT Persons subject to the rules maker or trading incentive program. proposed herein. The Commission What amendments, if any, are necessary available for a DCM to request from the Commission an exemption from the understands and acknowledges that this to clearly identify trades that are not could lead to estimates which are eligible? requirements of proposed § 40.25(b) for that specific enumerated item? incomplete, and welcomes any 104. Section 40.27(a) provides that comments which might provide a more DCMs shall implement policies and V. Related Matters complete and/or more accurate count of procedures that are reasonably designed AT Persons. This estimate of 420 AT to prevent the payment of market-maker A. Calculation of Number of Persons Subject to Regulations Persons is used for purposes of the or trading incentive program benefits for calculations in the Related Matters trades between accounts under common AT Persons. The Related Matters discussion below. ownership. Are there any other types of discussion below includes a number of Floor Traders (A Component of AT trades or circumstances under which hourly burden estimates and cost Persons). As noted in section IV(E) the Commission should also prohibit or estimates for persons subject to new or above, the Commission proposes to limit DCM market-maker or trading revised regulations under Regulation require the registration of proprietary incentive program benefits? AT. In order to estimate the number of traders using DEA for Algorithmic 105. The Commission is proposing in AT Persons, the Commission used a Trading on a DCM. In order to achieve § 40.27(a) certain requirements sample of orders sent to DCMs. This registration, the Commission proposes regarding DCM payments associated data includes new orders, modifications amending the definition of ‘‘Floor with market maker and trading to orders, and cancellations of the same. trader’’ in Commission Regulation incentive programs. Please address Of those available to the Commission, 1.3(x). Newly registered floor traders whether the proposed rules will this data set is the one most closely would be included in the definition of diminish DCMs’ ability to compete or related to the requirements included in AT Persons. In order to estimate the build liquidity by using market maker or the proposed rules. It includes the data number of these firms, the Commission trading incentive programs. Does any elements potentially generated by an made use of reference information for DCM consider it appropriate to provide algorithm, often routed through a the connection methods used by active market maker or trading incentive clearing member, and accepted by the futures trading firms. These data files program benefits for trades between matching engine for execution. The data include information about the accounts known to be under common set includes identifiers for the firm that characteristics of the connection, beneficial ownership? generated and/or routed the order to the including the location where orders are

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generated. In order to identify direct FCMs, based on the financial data for B. Calculation of Hourly Wage Rates connections, the Commission isolated FCMs reported on the CFTC Web site. Used in Related Matters those connections associated with co- This data states that there were 57 FCMs The Related Matters discussion below location or other services likely related in March 2015 that required estimates the cost of various regulations to DEA. These filters generated an ‘‘Customer’s Segregation of Funds.’’ 557 proposed under Regulation AT. These estimate of approximately 100 potential The Commission arrived at an estimate costs incorporate hourly wage rates firms that may need to register under of 15 DCMs, based on the list of derived from salary information proposed § 1.3(x)(3). This calculation designated DCMs as of the date of this compiled by the Securities Industry and did not exclude those firms which may NPRM, as reported on the CFTC Web Financial Markets Association already be registered with the site.558 This number does not include (‘‘SIFMA’’). Specifically, the hourly Commission in some capacity. As a dormant or pending DCMs. wage rates are based on salaries and result, the 100 estimate is potentially bonuses across different professions that higher than the actual number of floor 1. Request for Comments are listed in the SIFMA Report on traders that would register under the Management & Professional Earnings in new provision. 108. The Commission requests comment on its calculation of the the Securities Industry 2013, modified Clearing member FCMs and DCMs. number of AT Persons, newly registered to account for an 1800-hour work-year Finally, the Commission estimated the floor traders, clearing member FCMs, and multiplied by 1.3 to account for number of clearing member FCMs and overhead and other benefits.559 The and DCMs that will be subject to DCMs that would be subject to proposed following professions and hourly wages Regulation AT. Regulation AT. The Commission arrived are referenced throughout the Related at an estimate of 57 clearing member Matters:

Total mean 2012 2013 SIFMA report profession and code Description of role in related matters compensation with Hourly wage rate bonus—2013 (rounded) 560 SIFMA report

Project Manager (1030) ...... Project Manager ...... 561 97,138 $70 Business Analyst (Intermediate) (602) ...... Business Analyst ...... 562 72,650 52 Business Analyst (Intermediate) (602) ...... Tester ...... 563 72,650 52 Programmer Analyst (Senior) (1607) ...... Developer ...... 564 103,851 75 Compliance Examiner (Senior) (409) ...... Senior Compliance Examiner ...... 565 79,992 58 Compliance Specialist (Senior) (406) ...... Senior Compliance Specialist ...... 566 78,250 57 Chief Compliance Officer (Mutual Funds/Invest- Chief Compliance Officer ...... 567 192,367 139 ment Advisory Services) (413). Compliance Attorney (1103) ...... Compliance Attorney ...... 568 133,059 96

C. Regulatory Flexibility Act 1. FCMs and DCMs Commission invites public comment on this determination. The Regulatory Flexibility Act The Commission has previously (‘‘RFA’’) requires that agencies consider determined that FCMs and clearing 2. AT Persons whether the rules they propose will members are not small entities for Regulation AT would also impose have a significant economic impact on purposes of the RFA.571 The requirements on ‘‘AT Persons,’’ a a substantial number of small entities Commission has also previously definition that includes: FCMs, floor and, if so, provide a regulatory determined that DCMs are not small brokers, SDs, MSPs, CPOs, CTAs or IBs, flexibility analysis regarding the entities for purposes of the RFA.572 as well as ‘‘floor traders’’ as defined in impact.569 A regulatory flexibility Accordingly, the Chairman, on behalf of proposed § 1.3(x)(3), that engage in analysis or certification is typically the Commission, hereby certifies Algorithmic Trading. required for ‘‘any rule for which the pursuant to 5 U.S.C. 605(b) that the The Commission has previously agency publishes a general notice of rules proposed in Regulation AT determined that FCMs, foreign brokers, proposed rulemaking’’ pursuant to the imposing requirements on FCMs and SDs, MSPs, CPOs, and natural persons notice-and-comment provisions of the DCMs would not have a significant are not small entities for purposes of the Administrative Procedure Act, 5 U.S.C. economic impact on a substantial RFA.573 As indicated above, the 553(b).570 number of small entities. The Commission believes that it is likely that no natural persons will be AT

557 See CFTC, Financial Data for FCMs, available 561 See 2013 SIFMA Report, supra note 559 at FR 43851 at 43860 (July 22, 2011) (clearing at http://www.cftc.gov/MarketReports/Financial 273. members). DataforFCMs/index.htm. 562 See id.at 136. 572 76 FR 44776, 44789 (July 27, 2011) 558 See CFTC, DCM Industry Filings, available at 563 Id. (‘‘Provisions Common to Registered Entities’’); see http://sirt.cftc.gov/SIRT/SIRT.aspx?Topic=Trading 564 66 FR 45064, 45609 (Aug. 29, 2001); 47 FR 18618, Organizations&implicit=true&type=DCM&Custom See id.at 395. ColumnDisplay=TTTTTTTT. 565 See id.at 113. 18619 (Apr. 30, 1982). 559 The SIFMA Report on Management & 566 See id. at 104. 573 See respectively and as indicated: 47 FR Professional Earnings in the Securities Industry 567 See id. at 119. 18618, 18619 (April 30, 1982) (FCMs, CPOs); 72 FR (2013) (‘‘2013 SIFMA Report’’), available at http:// 568 See id. at 279. 34417 at 34418 (June 22, 2007) (foreign brokers); 76 www.sifma.org/research/item.aspx?id=8589940603. FR 71626 at 71680 (November 18, 2011) (SDs); 77 569 5 U.S.C. 601 et seq. 560 The hourly wage rate represents the total mean FR 2613, 2620 (Jan. 19, 2012) (SDs and MSPs). See 570 5 U.S.C. 601(2), 603, 604 and 605. 2012 compensation with bonus divided by 1800 also 5 U.S.C. 601(6) (natural persons are not entities 571 See 47 FR 18618 (April 30, 1982) (FCMs); and hours and multiplied by 1.3 to account for overhead for purposes of the RFA). and other benefits. 76 FR 71626 at 71680 (November 18, 2011) and 76

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Persons, given the technological and to enact new and amended regulations of how the Commission generated this personnel costs associated with requiring risk controls, testing standards estimate. Algorithmic Trading. The Commission, and other measures that will safeguard • CTAs. Based on NFA’s registration pursuant to question #106 below, asks the integrity of markets. directory, the Commission estimates whether this assumption is correct. ii. A Succinct Statement of the that there are approximately 2,464 The Commission has previously 578 decided to evaluate, within the context Objectives of, and Legal Basis for, the CTAs. The Commission notes that of a particular rule proposal, whether all Proposals some registered CTAs are individuals, or some floor brokers, floor traders, The objective of Regulation AT is to and not all CTAs will be engaged in CTAs, and IBs should be considered to address the risks of algorithmic trading Algorithmic Trading. It is not feasible be small entities, and if so, to analyze through a series of pre-trade risk for the Commission to estimate what the economic impact on them of any controls and other measures that AT portion of the 420 AT Persons will be such rule.574 In 2012, the Commission Persons, clearing member FCMs and CTAs. stated that it has not made a DCMs must implement. The legal • IBs. Based on NFA’s registration determination regarding floor traders, authority for the proposed rules is directory, the Commission estimates since all registered traders at the time Sections 4c(a)(6), 4s(b)(4) 1a(23), 3(b) that there are approximately 1,375 were individuals, and individuals are and 8a(5) of the CEA.576 IBs.579 The Commission notes that some not subject to the small entity analysis registered IBs are individuals, and not under the RFA.575 iii. A Description of and, Where Accordingly, the Commission must Feasible, an Estimate of the Number of all IBs will be engaged in Algorithmic address whether, in the context of Small Entities to Which the Proposed Trading. It is not feasible for the Regulation AT, floor brokers, floor Rules Will Apply Commission to estimate what portion of traders, CTAs, and IBs that engage in The small entities to which the the 420 AT Persons will be IBs. Algorithmic Trading should be proposed amendments may apply are Beyond the above estimates of the considered small entities for purposes of those floor brokers, floor traders (as maximum number of floor brokers, floor the RFA. As discussed below, the defined in proposed § 1.3(x)(3)), CTAs traders (as defined in proposed Commission believes that the proposed and IBs that engage in Algorithmic § 1.3(x)(3)), CTAs and IBs, it is not rules regarding pre-trade and other risk Trading and fall within the definition of feasible for the Commission to provide controls, as well as standards relating to a ‘‘small entity’’ under the RFA, a more exact estimate of the number of the design, testing, and supervision of including size standards established by small entities to which Regulation AT Algorithmic Trading, are already being the Small Business Administration.577 will apply. The Commission estimates widely implemented in industry. Each of the categories of persons that no floor brokers will be ‘‘small Accordingly, while Regulation AT discussed below would fall within the entities’’ for purposes of the RFA, and would have a significant economic definition of ‘‘AT Persons.’’ As that a maximum of 100 proprietary impact on entities that are not currently discussed in section V(A) above, the implementing such measures, based on firms engaged in Algorithmic Trading Commission estimates that will be considered ‘‘floor traders’’ under its best understanding, the Commission approximately 420 persons will be AT believes that it would not have a § 1.3(x)(3) of the proposed rulemaking. Persons. The Commission estimates that the significant economic impact on a • Floor brokers. The Commission’s information collection will apply to no substantial number of small entities. best understanding is that at this time, more than a total of 320 CTAs and IBs, However, the Commission is not in a all floor brokers are natural persons. position to determine how many of such Given the technological and personnel and likely significantly less than 320. entities would be affected, or the extent costs associated with Algorithmic Based on the numbers described above, of such impact, given the varying sizes, Trading, the Commission’s expectation the Commission does not believe that a technological systems, and business is that only entities, not natural persons, substantial number of small entities will strategies of such entities. Therefore, will meet the definition of ‘‘AT Person.’’ be impacted by the information pursuant to 5 U.S.C. 603, the Accordingly, the Commission estimates collection. Further, the definition of AT Commission offers for public comment that no floor brokers will be ‘‘small Person is limited to entities that conduct this initial regulatory flexibility analysis entities’’ for purposes of the RFA. Algorithmic Trading and, the definition addressing the impact of Regulation AT • Floor traders. The Commission of new floor traders under proposed on small entities: estimates that there is a maximum of § 1.3(x)(3) is further limited to those i. A Description of the Reasons Why 100 proprietary firms engaged in entities with Direct Electronic Access. Action Is Being Considered Algorithmic Trading that will be The Commission believes that entities The Commission is taking action considered ‘‘floor traders’’ under with such capabilities are generally not because the increased use of algorithmic proposed § 1.3(x)(3) of Regulation AT. small entities. This NPRM asks specific trading and increasingly interconnected See section V(A) above for a discussion questions on the issue of how the nature of markets means that a proposed regulations may affect small 576 7 U.S.C. 6c(a)(6) (rulemaking authority with entities, in particular, whether sole technological malfunction or error can respect to disruptive trading practices); 7 U.S.C. have widespread, significant impact on 6s(b)(4) (rulemaking authority with respect to swap proprietorships would be considered many market participants. In this time dealers and major swap participants); 7 U.S.C. AT Persons and whether Regulation AT of technological change, the 1a(23) (Definitions); 7 U.S.C. 5(b) (Findings and requirements should vary depending on Commission believes that it is necessary purpose); 7 U.S.C. 12a(5) (Rules and Regulations). the size, sophistication or other 577 15 U.S.C. 601(3) (defining ‘‘small business’’ to have the same meaning as the term ‘‘small business attributes of the AT Person. 574 See 47 FR 18618, 18620 (Apr. 30, 1982) (floor concern’’ in the Small Business Act); 15 U.S.C. brokers); and 58 FR 19575, 19588 (Apr. 15, 1993) 632(a)(1) (defining ‘‘small business concern’’ to 578 (floor traders); 47 FR at 18619 (CTAs); 48 FR 35248, include an agricultural enterprise with annual See NFA Directories, available at: http:// 35276–77 (Aug. 3, 1983) (IBs). receipts not in excess of $750,000); 13 CFR 121.201 www.nfa.futures.org/NFA-registration/NFA- 575 See Commission, Final Rule: Registration of (establishing size standards for small business directories.HTML. Intermediaries, 77 FR 51898, 51901 (Aug. 28, 2012). concerns). 579 See id.

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iv. A Description of the Projected result in requiring the 100 new floor may already have these systems in place Reporting, Recordkeeping, and Other traders that will be registered pursuant in order to comply with the SEC’s Compliance Requirements of the Rules, § 1.3(x)(3) to become members of an Market Access Rule, which requires Including an Estimate of the Classes of RFA. The Commission estimates that brokers and dealers to have risk controls Small Entities Which Will Be Subject to the floor trader registrants will incur that prevent the entry of erroneous the Requirements and the Type of initial and annual RFA membership orders, by rejecting orders that exceed Professional Skills Necessary for dues of $5,625.581 Accordingly, appropriate price or size parameters, on Preparation of the Report or Record assuming (as discussed above) that there an order-by-order basis or over a short The following section discusses the are 100 new floor trader members, the period of time, or that indicate 590 projected reporting, recordkeeping, and total initial cost of RFA membership duplicative orders. other compliance requirements that will would be approximately $562,500 and Nevertheless, the Commission be imposed upon AT Persons under the the annual cost would be approximately recognizes that there may be some proposed rules. $562,500. trading firms within a given registration • category that do not yet implement the • § 1.3(x)(3)—New Registration of Floor § 1.80—Pre-Trade Risk Controls risk controls required by Regulation AT, Traders Based on Concept Release comments, or that may need to upgrade their Regulation AT would impose new best practices documents issued by systems in order to comply with registration requirements on certain industry or regulatory organizations, as Regulation AT. Accordingly, Regulation entities with Direct Electronic Access as well as existing regulations, the AT would impose technology and a result of the proposed amendment to Commission believes that a significant personnel costs on this subset of trading the definition of ‘‘Floor trader’’ in number of trading firms already firms; these costs would likely include Commission Regulation 1.3(x). The implement the specifically-enumerated both initial risk control creation costs Commission provides detailed estimates pre-trade and other risk controls and ongoing maintenance costs. of the costs associated with registration required pursuant to proposed § 1.80. The Commission provides detailed as a floor trader in section E below. As For example, in its survey of member estimates of the implementation costs of 591 discussed more fully below, the firms, PTG found the following: (i) 25 risk controls in section E below. The Commission estimates that new out of 26 responding firms use message Commission considered the possibility registrants will incur a one-time cost of and execution throttles; (ii) all 26 that a trading firm already implements approximately $2,106 per registrant responding firms use maximum order the controls required by proposed ($1,050 in application fees plus $1,056 size limits, either using their own § 1.80, but the controls may not comply in preparation costs). Accordingly, technology, the exchange’s technology, with every aspect of the regulation. In assuming (as discussed above) that there or some combination; 582 and (iii) 24 out such a case, as discussed in greater are 100 new registrants as Floor traders, of 26 responding firms use either price detail below, the Commission estimates the total one-time cost of registration collars or trading pauses.583 As to order that it will cost an AT Person would be approximately $210,600.580 management controls, two comments to approximately $79,680 to upgrade its the Concept Release from exchanges controls (i.e., evaluate current systems, • § 170.18—AT Persons Must Become stated that they provide an optional modify or create new code, and test Members of an RFA cancel-on-disconnect functionality.584 systems) in order to comply with § 1.80. Regulation AT would require all Those exchanges also indicated that Accordingly, assuming (as discussed registrants that are AT Persons that are they provide kill switch functionality to above) that there are 420 AT Persons, not otherwise required to become market participants.585 In addition, the the Commission estimates that the total members of an RFA pursuant to types of controls required by proposed industry cost to implement § 1.80 would §§ 170.15, 170.16, or 170.17 to become § 1.80 have been included in best be approximately $33,465,600. members of an RFA. Taken together, practices documents for years, such • § 1.81—Standards for Development, §§ 170.15, 170.16, and 170.17 require those best practices documents issued Testing and Monitoring of Algorithmic most registrants who may be considered by FIA PTG,586 ESMA,587 the CFTC Trading Systems AT Persons to become RFA members. TAC 588 and the TMPG.589 Finally, The Commission estimates that the many trading firms that do securities The Commission believes that most requirements of proposed § 170.18 will trading in addition to futures trading market participants and DCMs have implemented controls regarding the design, testing, and supervision of 580 Pursuant to part 3 of its regulations, the 581 The Commission notes that NFA is currently Commission has delegated its registration functions the only entity registered as an RFA. The ATSs, in light of the numerous best to the National Futures Association (NFA). Non- Commission estimates for RFA membership dues practices and regulatory requirements natural person floor trader entities register with the are based on its analysis of NFA dues. promulgated in this area. These efforts Commission and apply for membership in NFA via 582 AIMA indicated that many market participants include the FIA PTG’s November 2010 CFTC Form 7–R. Principals of non-natural person use maximum order size limits, and Gelber, a floor trader entities register via Form 8–R. Based on trading firm, stated that it uses this risk control. See ‘‘Recommendations for Risk Controls for a review of the principals associated with registered AIMA at 13; Gelber at 10. Trading Firms,’’ FIA’s March 2012 FCMs, the Commission estimates that each non- 583 FIA at 59–60. ‘‘Software Development and Change natural person floor trader entity will have 584 CME at Appendix A–4; CFE at 9–10. In Management Recommendations,’’ approximately 10 principals and therefore need to addition, FIA characterized cancel-on-disconnect as ESMA and MiFID II guidelines and file approximately 10 Forms 8–R. In the event that a ‘‘widely adopted DCM-hosted pre-trade risk a natural person meets the definition of Floor control.’’ See FIA at 14. Trader in proposed § 1.3(x)(3), and is therefore 590 See SEC, Responses to Frequently Asked 585 CME at 23–24; CFE at 11. required to register with the Commission and 586 Questions Concerning Risk Management Controls become a member of NFA, such person would only FIA PTG, ‘‘Recommendations for Risk for Brokers or Dealers with Market Access, supra be required to complete Form 8–R and would face Controls for Trading Firms,’’ (Nov. 2010) at 4–5. note 37. 587 substantially lower costs than those estimated here. ESMA Guidelines, supra note 61 at 14–15. 591 The Commission notes that trading firms can Because registration with the Commission and 588 CFTC TAC Recommendations, supra note 34 choose not to develop these controls internally, but membership in NFA make use of the same forms at 2–3. rather may purchase a solution from an outside and process, the Commission anticipates that the 589 TMPG, ‘‘Best Practices for Treasury, Agency vendor (or DCM or clearing member) in order to costs associated with proposed § 1.3(x)(3) and Debt, and Agency Mortgage-Backed Securities comply with § 1.80. The Commission has requested proposed § 170.18 will be one and the same. Markets’’ (June 2015). comments providing estimates of such costs.

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directives on the development and $22,204); 3 Testers, working for a 10 hours (10 × $139 per hour = $1,390) testing of algorithmic systems, Reg SCI combined 1,173 hours (1,173 × $52 = for a total cost of $4,240 per year. The requirements on the development, $60,996); and 2 Developers, working for approximately 420 AT Persons to which testing, and monitoring of SCI systems, a combined 427 hours (427 × $75 = § 1.83(a) would apply would therefore FINRA’s March 2015 Notice 15–09 on $32,025). incur a total annual cost of $1,780,800 effective supervision and control Designation and Training of Staff. The (420 × $4,240) to prepare and submit the practices for market participants that Commission estimates that an AT report required by § 1.83(a). use algorithmic trading strategies in the Person that has not implemented any of • § 1.83(c)—AT Person Recordkeeping equities market, IOSCO’s April 2015 the requirements of proposed § 1.81(d) Requirements Consultation Report, summarizing best (designation and training of Algorithmic practices that should be considered by Trading staff) would incur a total cost of Proposed § 1.83(c) would require each trading venues when developing and $101,600 to implement these AT Person to keep, and provide upon implementing risk mitigation requirements. This cost is broken down request to each DCM on which such AT mechanisms, and the Senior as follows: 1 Senior Compliance Person engages in Algorithmic Trading, Supervisors Group (SSG) April 2015 Specialist, working for 500 hours (500 × books and records regarding such AT Algorithmic Trading Briefing Note, $57 = $28,500); 1 Project Manager, Person’s compliance with all which described how large financial working for 500 hours (500 × $70 = requirements pursuant to proposed institutions currently monitor and $35,000); 1 Developer, working for 300 §§ 1.80 and 1.81. control for the risks associated with hours (300 × $75 = $22,500); and 1 The Commission estimates that, on an algorithmic trading during the trading Business Analyst, working for 300 hours initial basis, an AT Person will incur a day. (300 × $52 = $15,600). cost of $5,130 to draft and update Notwithstanding the standards Notwithstanding these estimates, the recordkeeping policies and procedures described above, the Commission has Commission believes that proposed and make technology improvements to calculated a maximum cost to an AT § 1.81 standardizes existing industry recordkeeping infrastructure. This cost Person that has not implemented any of practices in this area, but does not is broken down as follows: 1 the design, testing, and supervision impose additional requirements that are Compliance Attorney, working for 30 standards required by proposed § 1.81. not already followed by the majority of hours (30 × $96 = $2,880); and 1 Development and Testing. The market participants. As a result, the Developer, working for 30 hours (30 × Commission estimates that an AT Commission does not believe that § 1.81 $75 = $2,250). The 420 AT Persons Person that has not implemented any of would impose additional costs on AT would therefore incur a total initial cost the requirements of proposed § 1.81(a) Persons. of $2,154,600 (420 × $5,130). (development and testing of Algorithmic • The Commission estimates that, on an § 1.83(a)—Compliance Reports annual basis, an AT Person will incur a Trading Systems) would incur a total Submitted by AT Persons cost of $349,865 to implement these cost of $2,670 to ensure continued requirements. This cost is broken down Proposed § 1.83 would require AT compliance with DCM recordkeeping as follows: 1 Project Manager, working Persons and FCMs that are clearing rules relating to § 1.82 compliance, for 1,707 hours (1,707 × $70 = members for AT Persons to annually including the updating of policies and $119,490); 2 Business Analysts, working submit reports regarding their procedures and technology for 853 hours (853 × $52 = $44,356); 3 compliance with § 1.80(a) and pursuant infrastructure, and in respond to DCM Testers, working for a combined 2,347 to § 1.82(a)(1), respectively, to each record requests. This cost is broken hours (2,347 × $52 = $122,044); and 2 DCM on which they operate. The report down as follows: 1 Compliance Developers, working for a combined 853 prepared by an AT Person pursuant to Attorney, working for 20 hours (20 × hours (853 × $75 = $63,975).592 § 1.83(a) would include a description of $96 = $1,920); and 1 Developer, working Monitoring. The Commission the AT Person’s pre-trade risk controls for 10 hours (10 × $75 = $750). The 420 estimates that an AT Person that has not and the parameters and specific AT Persons would therefore incur a implemented any of the requirements of quantitative settings used for such pre- total annual cost of $1,121,400 (420 × § 1.81(b) (monitoring of Algorithmic trade risk controls. Together with the $2,670). annual report, each AT Person would be Trading Systems) would incur a total • § 40.23(c)—Approval Requests cost of $196,560 to implement these required to submit copies of the written policies and procedures developed to Submitted by Market Participants re: requirements. This cost is broken down Self-Trading Controls as follows: 1 Senior Compliance comply with § 1.81(a) and (c). The Specialist, working for 2,080 hours report would also be required to include Market participants will incur costs in (2,080 × $57 = $118,560); and 1 a certification by the chief executive the event that they prepare and submit Business Analyst, working for 1,500 officer or chief compliance officer of the the self-trading approval requests hours (1,500 × $52 = $78,000). AT Person that, to the best of his or her contemplated by proposed § 40.23(c). Compliance. The Commission knowledge and reasonable belief, the This provision, which is discussed in estimates that an AT Person that has not information contained in the report is more detail in section IV(Q) above, implemented any of the requirements of accurate and complete. requires market participants to request § 1.81(c) (compliance of Algorithmic AT Person Compliance Reports. AT approval from the DCM that self-trade Trading Systems) would incur a total Persons will incur the cost of annually prevention tools not be applied with cost of $174,935 to implement these preparing and submitting the reports to respect to specific accounts under requirements. This cost is broken down their DCMs. The Commission estimates common beneficial ownership or as follows: 1 Project Manager, working that an AT Person will incur a total control. The Commission estimates that, for 853 hours (853 × $70 = $59,710); 2 annual cost of $4,240 to draft the report on an annual basis, a market participant Business Analysts, working for a required by proposed § 1.83(a). This cost will incur a cost of $3,810 to prepare combined 427 hours (427 × $52 = is broken down as follows: 1 Senior and submit these approval requests. Compliance Specialist, working for 50 This cost is broken down as follows: 1 × 592 See section V(B) above for the calculation of hours (50 $57 per hour = $2,850) and Business Analyst, working for 30 hours hourly wage rates used in this analysis. 1 Chief Compliance Officer, working for (30 × $52 per hour = $1,560); and 1

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Developer, working for 30 hours (30 × vi. A description of any significant Person. Proposed § 40.22 would require $75 per hour = $2,250).593 alternatives to the proposed rule which DCMs to establish a program for The Commission cannot predict how accomplish the stated objectives of effective periodic review and evaluation many market participants would likely applicable statutes and which minimize of these reports. The Commission has any significant impact of the proposed submit the approval requests proposed these regulations, using the rule on small entities. These may deadlines described above, because it contemplated by proposed § 40.23(c) on include, for example, (1) the believes they represent an appropriate an annual basis. The Commission establishment of differing compliance or balancing of the transparency and risk believes that not all market participants reporting requirements or timetables reduction provided by the reports trading on a DCM would submit such that take into account the resources against the burden placed on AT requests. In the view of the Commission, available to small entities; (2) the Persons and DCMs of providing and for example, a limited subset of market clarification, consolidation, or reviewing the reports. The Commission participants will own two or more simplification of compliance and is considering the alternative of accounts, but operate them through reporting requirements under the rule requiring AT Persons to submit such ‘‘independent decision makers,’’ as for such small entities; (3) the use of reports more or less frequently than contemplated by proposed § 40.23(b). performance rather than design annually. The Commission is also Similarly, a limited subset of market standards; and (4) an exemption from considering the alternatives of placing participants will find it advantageous to coverage of the rule, or any part thereof, the responsibility for certifying the incur the costs associated with the self- for such small entities. reports required by proposed § 1.83 only trading described by § 40.23(b), such as A potential alternative to Regulation on the chief executive officer, only on trading costs and clearing fees. In AT that would minimize any significant the chief compliance officer, or addition, the Commission believes that impact on small entities would be to permitting certification from other market participants submitting orders amend or propose new rules requiring officers of the AT Person. The through Algorithmic Trading are more trading firms implement pre-trade and Commission notes that it considered the likely than traders submitting orders other risk controls, but limit application alternative of requiring additional manually to inadvertently self-trade of such requirements to entities that information to be included in the § 1.83 through independent decision-makers. would not be considered ‘‘small reports, such as descriptions of how AT The Commission estimates that, entities’’ for purposes of the RFA. Persons comply with § 1.81 notwithstanding the fact that the DCM However, the Commission does not requirements and how clearing member rules described in § 40.23(c) are directed believe that this is a viable alternative. FCMs comply with all § 1.82 to all market participants, the number of A principal basis for Regulation AT’s requirements. In the interest of minimizing costs to AT Persons and market participants that will submit the risk control requirements is that a clearing member FCMs, the Commission approval requests described therein are technological malfunction or error can determined at this time to require, equivalent to the number of AT Persons have a significant, detrimental impact 594 on other market participants across pursuant to proposed § 1.83(c) and (d), calculated above (420). On this basis, that AT Persons and clearing member the Commission estimates that market Commission-regulated markets. Importantly, such a technological FCMs instead retain and provide to participants will incur a total annual DCMs books and records regarding their cost of $1,600,200 to submit the malfunction or error can arise from any size of firm, including a very small compliance with §§ 1.80, 1.81 and 1.82 approval requests contemplated by proprietary trading firm with few requirements. Proposed § 40.22(d) § 40.23(c) ($3,810 per market participant includes a corresponding requirement × employees. In today’s interconnected 420 market participants). markets, where a small error can cause that DCMs implement rules requiring v. An Identification, to the Extent a severe disruption in minutes, it is AT Persons and clearing member FCMs to keep and provide such books and Practicable, of All Relevant Federal equally important that small firms have records. Rules Which May Duplicate, Overlap or risk controls as large firms. The Conflict With the Rules Commission believes that the risk Finally, the Commission is controls required by Regulation AT will considering alternatives with respect to The Commission is unaware of any help ensure that all entities—not just proposed § 40.23. This proposed Federal rules that could duplicate, large entities with the most regulation provides that DCMs may overlap, or conflict with the proposal. technological and financial resources— comply with the requirement to apply, will have effective risk controls. The or provide and require the use of, self- Commission is aware that smaller firms trade prevention tools by requiring may have different trading strategies market participants to identify to the and technology than larger firms; DCM which accounts should be accordingly, the proposed regulations prohibited from trading with each other. allow all trading firms, including small With respect to this account entities, the discretion to design identification process, the Commission’s controls appropriate to their own principal goal is to prevent business and to implement them in the unintentional self-trading; the most cost-effective manner. Commission does not have a specific The Commission is also considering interest in regulating the manner by alternatives with respect to proposed which market participants identify to § 1.83, which would require AT Persons DCMs the account that should be to submit compliance reports to DCMs prohibited from trading from each other, 593 See section V(B) above for the calculation of on an annual basis. Such reports would so long as this goal is met. The hourly wage rates used in this analysis. need to be submitted and certified Commission has considered whether 594 See section V(A) above for the calculation of annually by the chief executive officer other identification methods should be the number of person subject to Regulation AT. or the chief compliance officer of the AT made available to market participants

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when submitting the approval requests Regulation Automated Trading. An competition among boards of trade, described in § 40.23. For example, the agency may not conduct or sponsor, and other markets and market Commission has requested comment on a person is not required to respond to, participants.596 Proposed regulations whether the opposite approach is a collection of information unless it requiring registration with the preferable: Market participants would displays a currently valid control Commission, submission of compliance identify to DCMs the accounts that number. The OMB has not yet assigned reports to DCMs, implementation of should be permitted to trade with each this collection a control number. As self-trade prevention tools and other (as opposed to those accounts that used below, ‘‘burden’’ means the total increased disclosure of certain aspects should be prevented from trading with time, effort, or financial resources of electronic matching platforms and each other). expended by persons to generate, market maker and trading incentive maintain, retain, disclose or provide programs, will help prevent or mitigate 3. Request for Comments information to or for a federal agency. technological malfunctions that will 109. The Commission requests Additional Regulation AT disrupt market integrity, protect market comment on each element of its RFA requirements will amend existing participants from fraudulent or analysis. In particular, the Commission collections of information. Proposed disruptive practices, and promote fair specifically invites comment on the § 1.3(x)(3) (requiring certain persons competition among boards of trade, accuracy of its estimates of potential with DEA to prepare and submit forms other markets and market participants. firms that could be considered ‘‘small to register with the Commission) would If the proposed regulations are entities’’ for RFA purposes. amend existing collection of adopted, responses to the collections of 110. The Commission also requests information ‘‘Registration Under the information would be mandatory. The comment on whether any natural Commodity Exchange Act,’’ OMB Commission will protect proprietary persons will be designated as AT Control Number 3038–0023. Proposed information according to the Freedom of Persons under the proposed definition § 38.401(a) and (c) (requiring DCMs to Information Act and 17 CFR part 145, of that term. publicly post information regarding ‘‘Commission Records and D. Paperwork Reduction Act certain aspects of their electronic Information.’’ In addition, Section matching platforms) and § 40.26 8(a)(1) of the CEA strictly prohibits the The Paperwork Reduction Act (permitting the Commission or the Commission, unless specifically 595 (‘‘PRA’’) imposes certain director of DMO to require certain authorized by the CEA, from making requirements on Federal agencies in information from DCMs regarding their public ‘‘data and information that connection with their conducting or market-maker or trading incentive would separately disclose the business sponsoring any collection of programs) would amend existing transactions or market positions of any information as defined by the PRA. This collection of information ‘‘Core person and trade secrets or names of proposed rulemaking would result in Principles and Other Requirements for customers.’’ The Commission is also new collection of information DCMs,’’ OMB Control Number 3038– required to protect certain information requirements within the meaning of the 0052. Finally, proposed § 40.25 contained in a government system of PRA. The Commission therefore is (requiring DCMs to provide the records according to the Privacy Act of submitting this proposal to the Office of Commission with certain information 1974, 5 U.S.C. 552a. Management (OMB) for review in regarding their market-maker and 1. Information Provided by Reporting accordance with 44 U.S.C. 3507(d) and trading incentive programs when Entities/Persons 5 CFR 1320.11. The following submitting such programs as rules requirements of this rulemaking will pursuant to part 40) would amend The following is a brief description of result in new collection of information existing collection of information ‘‘Part the PRA responsibilities of various requirements within the meaning of the 40, Provisions Common to Registered entities under Regulation AT. In PRA: § 1.83(a) would require AT Entities,’’ OMB Control Number 3038– summary, § 1.3(x)(3) would require Persons to submit reports to DCMs 0093. certain floor traders with DEA to concerning compliance with § 1.80(a), The collections of information under prepare and submit forms to register as well as copies of the written policies these proposed regulations are with the Commission; § 1.83(a) and (b) and procedures developed to comply necessary to implement certain would require AT Persons and clearing with § 1.81(a) and (c); § 1.83(b) would provisions of the CEA, as amended by member FCMs to submit reports to require clearing member FCMs to the Dodd-Frank Act. Section 8a(5) of the DCMs concerning compliance with submit reports to DCMs concerning CEA provides the Commission with § 1.80(a) and § 1.82(a)(1), respectively; compliance with § 1.82(a)(1); § 1.83(c) authority to promulgate rules as § 1.83(c) and (d) would require AT and (d) would require AT Persons and reasonably necessary to effectuate any of Persons and clearing member FCMs, clearing member FCMs, respectively, to the provisions or to accomplish any of respectively, to keep and provide upon keep and provide upon request to DCMs the purposes of the Act, and Section request to DCMs books and records books and records regarding their 4c(a)(6) of the CEA provides rulemaking regarding their compliance with §§ 1.80 compliance with §§ 1.80 and 1.81 (for authority to prohibit disruptive trading and 1.81 (for AT Persons) and § 1.82 (for AT Persons) and § 1.82 (for clearing practices. As provided in Section 3(b) of clearing member FCMs); § 38.401(a) and member FCMs); § 40.23(c) states that a the CEA, it is the purpose of the CEA (c) would require DCMs to publicly post DCM must require market participants to deter and prevent price manipulation information regarding certain aspects of to request approval from the DCM that or any other disruptions to market their electronic matching platforms; self-trade prevention tools not be integrity; to ensure the financial § 40.23(c) states that a DCM must applied with respect to certain types of integrity of all transactions subject to require market participants to request accounts; § 40.23(d) would require that this chapter and the avoidance of approval from the DCM that self-trade DCMs display information about systemic risk; to protect all market prevention tools not be applied with percentage and ratio of self-trading. The participants from fraudulent or other respect to certain types of accounts; title for this collection of information is abusive sales practices and misuses of § 40.23(d) would require that DCMs customer assets; and to promote 595 44 U.S.C. 3501 et seq. responsible innovation and fair 596 7 U.S.C. 5.

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display information about percentage under § 1.3(×)(3) would therefore incur Burden: Compliance reports and ratio of self-trading; § 40.25 would a total one-time cost of $105,600 (100 × submitted by clearing member FCMs to require DCMs to provide the $1,506).599 DCMs. Commission with certain information Respondents/Affected Entities: 57 b. § 1.83(a)—Compliance Reports regarding their market-maker and clearing member FCMs. Submitted by AT Persons to DCMs trading incentive programs when Estimated number of responses: 57. submitting such programs as rules The Commission estimates that the Estimated total burden on each pursuant to part 40; and § 40.26 would proposed rules requiring AT Persons to respondent: 110 hours. permit the Commission or the director submit annual reports regarding their Frequency of collection: Annual. of DMO to require certain information pre-trade risk controls required Burden statement-all respondents: 57 from DCMs regarding their market- pursuant to proposed § 1.80(a) (as well respondents × 110 hours = 6,270 Burden maker or trading incentive programs. as copies of the written policies and Hours per year. a. § 1.3(×)(3)—Submissions by Newly procedures developed to comply with The Commission estimates that, on an Registered Floor Traders § 1.81(a) and (c)) to each DCM on which annual basis, a clearing member FCM The Commission estimates that the they operate will result (on an annual will incur a cost of $7,090 to submit the proposed rules requiring certain floor basis) in 60 hours of burden per AT compliance reports required by traders with Direct Electronic Access to Person, and 25,200 burden hours in § 1.83(b). This cost is broken down as register will result in 11 hours of burden total. The estimated burden was follows: 1 Senior Compliance Specialist, per affected entity, and 1100 burden calculated as follows: working for 100 hours (100 × $57 = hours in total. The Commission Burden: Compliance reports $5,700); and 1 Chief Compliance × estimates that each affected entity will submitted by AT Persons to DCMs. Officer, working for 10 hours (10 $139 602 require 1 hour to prepare and submit Respondents/Affected Entities: 420 = $1,390). The 57 clearing member one Form 7–R (for the entity) and 10 AT Persons. FCMs that will be subject to § 1.83(b) hours to prepare and submit 10 Forms would therefore incur a total annual Estimated number of responses: 420. 8–R (one form for each principal of the cost of $404,130 (57 ×$7,090).603 entity).597 The estimated burden was Estimated total burden on each d. § 1.83(c)—AT Person Retention and calculated as follows: respondent: 60 hours. Burden: Complete Form 7–R and 8–R Frequency of collection: Annual. Production of Books and Records to register as a floor trader. Burden statement-all respondents: Initial Costs. The Commission Respondents/Affected Entities: 100 420 respondents × 60 hours = 25,200 estimates that rules pursuant to new floor traders. Burden Hours per year. proposed § 1.83(c) requiring AT Persons Estimated number of responses: 100. The Commission estimates that, on an to keep and provide books and records Estimated total burden on each annual basis, an AT Person will incur a relating to §§ 1.80 and 1.81 compliance respondent: 11 hours. cost of $4,240 to submit the compliance will result in initial costs of 60 hours of Frequency of collection: One-time reports required by proposed § 1.83(a). burden per AT Person, and 25,200 initial registration fee. This cost is broken down as follows: 1 burden hours in total. The estimated Burden statement-all respondents: Senior Compliance Specialist, working burden was calculated as follows: × 100 respondents 1 hour = 100 Burden for 50 hours (50 × $57 = $2,850); and 1 Burden: Rule requiring AT Persons to Hours. Chief Compliance Officer, working for keep and produce records relating to The Commission estimates that a new 10 hours (10 × $139 = $1,390).600 The §§ 1.80 and 1.81 compliance. registrant will incur a one-time cost of 420 AT Persons that will be subject to Respondents/Affected Entities: 420 $96 to complete one Form 7–R and a § 1.83(a) would therefore incur a total AT Persons. one-time cost of $960 to complete 10 annual cost of $1,780,800 (420 Estimated total burden on each Forms 8–R. These costs represent the ×$4,240).601 respondent: 60 hours. work of 1 Compliance Attorney per Burden statement&all respondents: affected entity, working for 1 hour per c. § 1.83(b)—Compliance Reports 420 respondents × 60 hours = 25,200 form (a total of 11 hours × $96 = Submitted by Clearing Member FCMs to Burden Hours initial year. $1,056).598 The 100 entities that will be DCMs The Commission estimates that, on an subject to the registration requirement The Commission estimates that the initial basis, an AT Person will incur a proposed rules requiring clearing cost of $5,130 to draft and update 597 CFTC Form 7–R is used to apply for recordkeeping policies and procedures registration with the Commission as a non-natural member FCMs to submit annual reports person floor trader, and is also used for such (describing the clearing member FCM’s and make technology improvements to entities to apply for membership in NFA. Form 8– program for establishing and recordkeeping infrastructure. This cost R is used to identify principals of non-natural maintaining the pre-trade risk controls is broken down as follows: 1 person floor trader entities. As noted previously, required by proposed § 1.82(a)(1) for its Compliance Attorney, working for 30 the Commission estimates that each non-natural × person floor trader entity will have approximately AT Person customers in the aggregate) hours (30 $96 = $2,880); and 1 10 principals and therefore need to file to each DCM on which they operate will Developer, working for 30 hours (30 × approximately 10 Forms 8–R. In the event that a result (on an annual basis) in 110 hours $75 = $2,250). The 420 AT Persons natural person meets the definition of Floor Trader of burden per clearing member, and would therefore incur a total initial cost in proposed § 1.3(×)(3) and is therefore required to × register with the Commission and become a 6,270 burden hours in total. The of $2,154,600 (420 $5,130). member of NFA, such person would only be estimated burden was calculated as Annual Costs. The Commission required to complete Form 8–R and would face follows: estimates that rules pursuant to substantially lower costs than those estimated here. proposed § 1.83(c) requiring AT Persons Because registration with the Commission and membership in NFA make use of the same forms 599 See section V(A) above for the calculation of to keep and provide books and records and process, the Commission anticipates that the the number of persons subject to Regulation AT. costs associated with proposed § 1.3(×)(3) and 600 See section V(B) above for the calculation of 602 See section V(B) above for the calculation of proposed § 170.18 will be one and the same. hourly wage rates used in this analysis. hourly wage rates used in this analysis. 598 See section V(B) above for the calculation of 601 See section V(A) above for the calculation of 603 See section V(A) above for the calculation of hourly wage rates used in this analysis. the number of persons subject to Regulation AT. the number of persons subject to Regulation AT.

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relating to §§ 1.80 and 1.81 compliance incur a total initial cost of $292,410 (57 Burden: Public Dissemination of will result in annual costs of 30 hours × $5,130). Information by DCMs—Electronic of burden per AT Person, and 12,600 Annual Costs. The Commission Matching Platforms. burden hours in total. The estimated estimates that that DCM rules pursuant Respondents/Affected Entities: 15 burden was calculated as follows: to proposed § 1.83(d) requiring clearing DCMs. Burden: Rules requiring AT Persons member FCMs to keep and provide Estimated total burden on each to keep and produce records relating to books and records relating to § 1.82 respondent: 200 hours per year. §§ 1.80 and 1.81 compliance. compliance will result in annual costs Frequency of collection: Intermittent. Respondents/Affected Entities: 420 of 30 hours of burden per clearing Burden statement-all affected entities: × AT Persons. member FCM, and 1,710 burden hours 15 affected entities 200 hours = 3,000 Estimated number of responses: 420. in total. The estimated burden was Burden Hours per year. Estimated total burden on each calculated as follows: The Commission estimates that, on an respondent: 30 hours. Burden: Rules requiring clearing annual basis, a DCM will incur a cost of Frequency of collection: $19,200 to comply with amended Intermittent.Burden statement-all member FCMs to keep and produce records relating to § 1.82 compliance. § 38.401(a) and (c). This cost represents respondents: 420 respondents × 30 the work of 1 Compliance Attorney, hours = 12,600 Burden Hours per year. Respondents/Affected Entities: 57 working for 200 hours (200 × $96 = The Commission estimates that, on an clearing member FCMs. $19,200).604 The 15 DCMs that will be annual basis, an AT Person will incur a Estimated number of responses: 57. subject to amended §§ 38.401(a) and (c) cost of $2,670 to ensure continued Estimated total burden on each would therefore incur a total annual compliance with the § 1.83(c) respondent: 30 hours. cost of $288,000 (15 × $19,200).605 The recordkeeping rules relating to § 1.82 Frequency of collection: Intermittent. Commission anticipates that this figure compliance, including the updating of Burden statement-all respondents: 57 would decrease in subsequent years as policies and procedures and technology respondents × 30 hours = 1,710 Burden the descriptions provided would only infrastructure, and to respond to DCM Hours per year. need to be amended to reflect changes record requests. This cost is broken The Commission estimates that, on an to the electronic matching platform or down as follows: 1 Compliance annual basis, a clearing member FCM the discovery of previously unknown Attorney, working for 20 hours (20 × will incur a cost of $2,670 to ensure attributes. $96 = $1,920); and 1 Developer, working continued compliance with the § 1.83(d) for 10 hours (10 × $75 = $750). The 420 g. § 40.23—Information Publicly recordkeeping rules relating to § 1.82 AT Persons would therefore incur a Disseminated by DCMs Regarding Self- compliance, including the updating of total annual cost of $1,121,400 (420 × Trade Prevention policies and procedures and technology $2,670). infrastructure, and to respond to DCM Regulation AT proposes a new e. § 1.83(d)—Clearing Member FCM record requests. This cost is broken requirement (§ 40.23) that a DCM shall Retention and Production of Books and down as follows: 1 Compliance implement rules reasonably designed to Records Attorney, working for 20 hours (20 × prevent self-trading by market $96 = $1,920); and 1 Developer, working participants, except as specified in Initial Costs. The Commission × paragraph (b) of § 40.23. Section estimates that rules pursuant to for 10 hours (10 $75 = $750). The 57 clearing member FCMs would therefore 40.23(b) states that a DCM may, in its proposed § 1.83(d) requiring clearing discretion, implement rules that permit member FCMs to keep and provide incur a total annual cost of $152,190 (57 × $2,670). the matching of orders for accounts with books and records relating to § 1.82 common beneficial ownership where compliance will result in initial costs of f. § 38.401(a) and (c)—Public such orders are initiated by independent 60 hours of burden per clearing member Dissemination of Information by DCMs decision makers. A DCM may also FCM, and 3,420 burden hours in total. Pertaining to Electronic Matching permit under § 40.23(b) the matching of The estimated burden was calculated as Platforms orders for accounts under common follows: The proposed amendments to control where such orders comply with Burden: Rules requiring clearing the DCM’s cross-trade, minimum member FCMs to keep and produce regulations 38.401(a) and 38.401(c) require DCMs to publicly post exposure requirements or similar rules, records relating to § 1.82 compliance. and are for accounts that are not under Respondents/Affected Entities: 57 information regarding certain aspects of their electronic matching platforms. common beneficial ownership. Section clearing member FCMs. 40.23(c) states that a DCM must require Estimated total burden on each DCMs should already be performing market participants to request approval respondent: 60 hours. tests on their electronic matching from the DCM that self-trade prevention Burden statement-all respondents: 57 platforms that would identify such tools not be applied with respect to respondents × 60 hours = 3,420 Burden attributes; therefore the added burden specific accounts under common Hours initial year. under the proposed amendments would The Commission estimates that, on an be limited to drafting the description of beneficial ownership or control, on the initial basis, a clearing member FCM such attributes and making the basis that they meet the criteria of will incur a cost of $5,130 to draft and description available on the DCM’s Web paragraph (b). update recordkeeping policies and site. The Commission estimates that the Proposed § 40.23(d) would require procedures and make technology proposed rules will result (on an annual that for each product and expiration improvements to recordkeeping basis) in 200 hours of burden per DCM, month traded on a DCM in the previous infrastructure. This cost is broken down and 3,200 burden hours in total. This quarter, the DCM must prominently as follows: 1 Compliance Attorney, estimate assumes that DCMs are already display on its Web site the following working for 30 hours (30 × $96 = compliant with the requirements to post 604 See section V(B) above for the calculation of $2,880); and 1 Developer, working for the specifications of their electronic × hourly wage rates used in this analysis. 30 hours (30 $75 = $2,250). The 57 matching platform under current 605 See section V(A) above for the calculation of clearing member FCMs would therefore regulation 38.401(a). the number of persons subject to Regulation AT.

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information: (1) The percentage of = $2,250).607 The estimated 420 market payments, incentives, discounts, trades in such product including all participants that will be subject to considerations, inducements or other expiration months that represent self- § 40.23(c) would therefore incur a total benefits that program participants may trading approved (pursuant to paragraph annual cost of $1,600,200 (420 x receive; and other requirements. To (c)(2) of § 40.23) by the DCM, expressed $3,810).608 ensure public transparency in market- as a percentage of all trades in such DCM Publication of Statistics maker and trading incentive programs, product and expiration month; (2) the Regarding Self-Trade Prevention. The proposed § 40.25 would require DCMs percentage of volume of trading in such Commission estimates that the to ensure that the information described product including all expiration months requirement under proposed § 40.23(d) above is easily located on their public that represents self-trading approved that DCMs publish statistics regarding Web sites. (pursuant to paragraph (c)(2) of § 40.23) self-trade prevention will result (on an While proposed § 40.25 may appear by the DCM, expressed as a percentage annual basis) in 100 hours of burden per on its face to require substantial new of all volume in such product and DCM, and 1,500 burden hours in total information from DCMs regarding their expiration month; and (3) the ratio of for all 15 DCMs. The estimated burden market-maker or trading incentive orders in such product and expiration was calculated as follows: programs, the proposed rule is largely month whose matching was prevented Burden: DCM Publication of Statistics similar to existing rule filing by the self-trade prevention tools Regarding Self-Trade Prevention. requirements in part 40. For example, described in paragraph (a) of § 40.23, Respondents/Affected Entities: 15 existing §§ 40.5 and 40.6 each require a expressed as a ratio of all trades in such DCMs. DCM requesting approval or self- product and expiration month. Estimated total burden on each certifying rules to provide the Market Participant Approval affected entity: 100 hours per year for Commission with the rule text; the Requests. Market participants will incur DCMs to generate and publish statistics. proposed effective date or date of costs in the event that they prepare and Frequency of collection: 4 DCM Web intended implementation; and an submit the approval requests site updates per year (one per quarter). ‘‘explanation and analysis of the Burden statement-all affected entities: contemplated by proposed § 40.23(c). operation, purpose, and effect’’ of the 15 respondents × 100 hours of DCM This provision requires market proposed rule. Existing §§ 40.5 and 40.6 time per year = 1,500 Burden Hours per participants to request approval from also require each DCM to provide the year. Commission with an assessment of the the DCM that self-trade prevention tools The Commission estimates that, on an not be applied with respect to specific rule’s ‘‘compliance with applicable annual basis, a DCM will incur a cost of provisions of the Act, including core accounts under common beneficial $6,650 to publish the statistics required ownership or control. The Commission principles, and the Commission’s by proposed § 40.23(d). This cost is regulations thereunder;’’ and ‘‘a brief estimates that § 40.23(c) will result (on broken down as follows: 1 Senior explanation of any substantive opposing an annual basis) in 60 hours of burden Compliance Examiner, working for 50 views expressed to [the DCM] by per market participant, and 185,340 hours (50 × $58 per hour = $2,900); and governing board or committee members, burden hours in total. The estimated 1 Developer, working for 50 hours (50 members of the entity or market burden was calculated as follows: × $75 per hour =$3,750).609 The 15 participants that were not incorporated Burden: Market Participant DCMs that will be subject to § 40.23(d) into the rule . . . .’’ Further, these Submission of Self-Trade Approval would therefore incur a total annual existing provisions each require a DCM Requests. cost of $99,750 (15 × $6,650).610 to certify that the DCM posted on its Respondents/Affected Entities: public Web site a notice of pending rule 420.606 h. § 40.25—Information in Public Rule Filings Provided by DCMs Regarding or certification and to also post a copy Estimated number of responses: 1 per of the DCM’s submission to the respondent per year. Market Market Maker and Trading Incentive Programs Commission on the DCM’s Web site. participants may choose to submit The Commission believes proposed approval requests more frequently, but Proposed § 40.25 would require DCMs § 40.25 adds important clarity to regardless of how frequently market to provide the Commission with certain existing rule filing requirements in part participants submit approval requests, information regarding their market- 40 when such filings pertain to market- the Commission estimates a total burden maker and trading incentive programs maker or trading incentive programs. of 60 hours per market participant per when submitting such programs as rules However, the Commission also believes year. pursuant to part 40. Among other that there is significant overlap between Estimated total burden on each information, DCMs would be required to proposed § 40.25 and existing respondent: 60 hours per year. provide a description of any categories requirements for DCMs in §§ 40.5 and Burden statement—all respondents: of market participants or eligibility 40.6. Proposed § 40.25 does not create a 420 respondents × 60 hours per year = criteria limiting who may participate in new category of rule filings, nor does it 25,200 Burden Hours per year. the program. They would also be or require more frequent filings. For The Commission estimates that, on an required to provide an explanation of these reasons, the Commission believes annual basis, a market participant will the specific purpose for a market-maker that any additional Paperwork incur a cost of $3,810 to prepare and or trading incentive program; a list of all Reduction Act obligations in proposed submit the approval requests products or services to which the § 40.25 will be minor per DCM. contemplated by 40.23(c). This cost is program applies; a description of any Burden: Information regarding market broken down as follows: 1 Business maker and trading incentive program Analyst, working for 30 hours (30 × $52 607 See section V(B) above for the calculation of rule filings pursuant to part 40. per hour = $1,560); and 1 Developer, hourly wage rates used in this analysis. Respondents/Affected Entities: 15 608 See section V(A) above for the calculation of working for 30 hours (30 × $75 per hour DCMs. the number of persons subject to Regulation AT. Estimated total burden on each 609 See section V(B) above for the calculation of 606 See section V(E)(8)(b) below for a discussion hourly wage rates used in this analysis. affected entity: 156 hours of DCM time of how this estimate of affected entities was 610 See section V(A) above for the calculation of per year. performed. the number of persons subject to Regulation AT. Frequency of collection: Intermittent.

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Burden statement-all affected entities: Evaluate whether the proposed feasible, the Commission has 15 respondents × 156 hours of DCM collections of information are necessary endeavored to estimate quantifiable time per year = 2,340 Burden Hours per for the proper performance of the costs and benefits. The Commission also year. functions of the Commission, including identifies and describes costs and whether the information will have benefits qualitatively. i. § 40.26—Information Provided by practical utility; (ii) evaluate the DCMs to the Division of Market 2. Concept Release Comments Regarding accuracy of the Commission’s estimate Oversight Upon Request Regarding Costs and Benefits of the burden of the proposed Market Maker and Trading Incentive collections of information; (iii) In the Concept Release, the Programs determine whether there are ways to Commission sought comments on most Proposed § 40.26 would permit the enhance the quality, utility, and clarity of the measures now addressed by Commission or the director of DMO to of the information proposed to be Regulation AT. Six commenters made require certain information from DCMs collected; and (vi) minimize the burden general points on cost-benefit regarding their market-maker or trading of the proposed collections of considerations. Specifically, FIA and incentive programs. The Commission information on those who are to CME noted that the cost of believes that proposed § 40.26 will respond, including through the use of implementing risk controls varies 612 impose no additional Paperwork appropriate automated collection widely. FIA stated that many of the Reduction Act burdens on DCMs. The techniques or other forms of information risk controls addressed in the Concept proposed regulation permits the technology. Release are already used in the futures Commission or the director of DMO to Those desiring to submit comments industry and their benefit is clearly require information from a DCM on the proposed information collection understood.613 FIA further stated that regarding the DCM’s market-maker or requirements should submit them the implementation cost to individual trading incentive programs. It is a more directly to the Office of Information and firms varies widely based on the targeted iteration of existing § 38.5, Regulatory Affairs, OMB, by fax at (202) systems they have and the market and 614 which requires a DCM to file with the 395–6566, or by email at products they trade. Similarly, CME Commission such ‘‘information related [email protected]. Please indicated that as to risk controls, to its business as a designated contract provide the Commission with a copy of specific costs as to development, market’’ as the Commission may submitted comments so that all implementation and ongoing require. Section 38.5 also requires a comments can be summarized and operational figures will vary widely DCM upon request by the Commission addressed in the final rule preamble. across the futures industry supply 615 or the director of DMO to file ‘‘a written Refer to the ADDRESSES section of this chain. CME declined to provide demonstration’’ that the DCM ‘‘is in detailed analysis as to its own notice of proposed rulemaking for 616 compliance with one or more core comment submission instructions to the expenditures. CFE commented that if the principles as specified in the request’’ or Commission. ‘‘satisfies its obligations under the Act,’’ Commission proposes risk control including ‘‘supporting data, information E. Cost Benefit Considerations requirements, it should perform a careful cost-benefit analysis and allow and documents.’’ Proposed § 40.26 does 1. The Statutory Requirement for the DCMs at least two years to implement not alter a DCM’s existing obligations Commission To Consider the Costs and the controls.617 TCL stated that most under § 38.5, but rather makes clear that Benefits of Its Actions Commission and DMO information entities have the technology to address Section 15(a) of the CEA requires the requests may pertain specifically to the ‘‘spirit’’ of the controls described in Commission to ‘‘consider the costs and 618 market-maker and trading incentive the Concept Release. AFR noted that benefits’’ of its actions before cost-benefit analysis should be based on programs. It imposes no new obligation promulgating a regulation under the costs and benefits to the public as a to provide information, and does not CEA or issuing certain orders.611 whole, not on private benefits to increase the frequency which Section 15(a) further specifies that the individual actors.619 Finally, IATP information must be provided. costs and benefits must be evaluated in Burden: Information requests from the stated that the Concept Release asked light of the following five broad areas of Commission or the Director of the more frequently about costs of risk market and public concern: (1) Division of Market Oversight. controls as compared to benefits of Respondents/Affected Entities: 15 Protection of market participants and increased market stability, which can be 620 DCMs. the public; (2) efficiency, more difficult to quantify. competitiveness, and financial integrity Estimated total burden on each 3. The Commission’s Cost-Benefit of futures markets; (3) price discovery; affected entity: 0 hours of DCM time per Consideration of Regulation AT— (4) sound risk management practices; year. Baseline Point Frequency of collection: Intermittent. and (5) other public interest Burden statement-all affected entities: considerations. The Commission As a preliminary matter, the 15 respondents × 0 hours of DCM time considers the costs and benefits Commission notes that certain aspects per year = 0 Burden Hours per year. resulting from its discretionary of Regulation AT, as discussed below, determinations with respect to the codify existing norms and best practices 2. Information Collection Comments section 15(a) factors below. As a general of trading firms, clearing member FCMs The Commission invites the public to matter, the Commission considers the comment on any aspect of the incremental costs and benefits of these 612 FIA at 60; CME at 41. paperwork burdens discussed herein. proposed rules, taking into account 613 FIA at 60. 614 Copies of the supporting statements for what it believes is industry practice See id. 615 CME at 41. the collections of information from the given the Commission’s existing 616 See id. Commission to OMB are available by regulations and industry best practices, 617 CFE at 2. visiting RegInfo.gov. Pursuant to 44 as described below. Where reasonably 618 TCL at 18. U.S.C. 3506(c)(2)(B), the Commission 619 AFR at 2. solicits comments in order to: (i) 611 7 U.S.C. 19(a). 620 IATP at 3.

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and DCMs. In that regard, in 2013, FIA the risk controls and other measures benefits of the alternatives that the surveyed FCMs and FIA PTG member proposed in Regulation AT. Commission discussed in this release, firms regarding their use of risk controls and any other alternatives appropriate 4. The Commission’s Cost-Benefit and self-trade controls and found that Consideration of Regulation AT—Cross- under the CEA that commenters believe all or most respondents currently use Border Effects would provide superior benefits relative such controls.621 Comment letters to the to costs; (g) data and any other Concept Release indicated that The Commission notes that the information to assist or otherwise implementation of pre-trade and other consideration of costs and benefits inform the Commission’s ability to risk controls was already widespread. below is based on the understanding quantify or qualitatively describe the Moreover, existing statutory schemes that the markets function benefits and costs of the proposed rules; (e.g., the SEC’s Market Access Rule and internationally, with many transactions and (h) substantiating data, statistics, the CFTC’s requirements relating to involving U.S. firms taking place across and any other information to support financial risk) means that many entities international boundaries; with some positions posited by commenters with will already have systems in place Commission registrants being organized respect to the Commission’s relevant to the controls proposed in outside of the United States; with consideration of costs and benefits. Regulation AT. Accordingly, as leading industry members typically discussed below, the existing norms or conducting operations both within and 6. The Commission’s Cost-Benefit best practices serve as the Commission’s outside the United States; and with Consideration of Regulation AT— guide for determining the status quo industry members commonly following Proposed Definitions baseline against which to measure the substantially similar business practices incremental costs and benefits of the wherever located. Where the The Commission notes that proposed regulations. The Commission Commission does not specifically refer Regulation AT proposes certain defined recognizes, however, that some to matters of location, the below terms, including ‘‘AT Person,’’ individual firms currently may not be discussion of costs and benefits refers to ‘‘Algorithmic Trading,’’ and ‘‘Direct operating at industry best practice the effects of the proposed rules on all Electronic Access’’ (as an element of the levels; for such firms costs and benefits activity subject to the proposed and revised definition of the term ‘‘Floor attributable to the proposed regulations amended regulations, whether by virtue Trader’’). While the defined terms will be incremental to a lower status of the activity’s physical location in the themselves do not impose costs, the quo baseline. In many cases, the United States or by virtue of the Commission recognizes that the scope of Commission assumes that compliance activity’s connection with or effect on such definitions will impact the with regulations will require an upgrade U.S. commerce under CEA Section potential costs of other regulations. For to existing systems, rather than building 2(i).622 In particular, the Commission example, proposed § 1.80 imposes risk risk control systems from scratch. notes that some AT Persons are located control requirements on ‘‘AT Persons,’’ To assist the Commission and the outside of the United States. and the defined term ‘‘Algorithmic public in assessing and understanding 5. General Request for Comment Trading’’ is an element of the term AT the economic costs and benefits of the Person. The broader the definition of AT proposed rule, the Commission has 111. Beyond specific questions Person and Algorithmic Trading, the analyzed the costs of the proposed interspersed throughout its discussion, greater the number of firms that would regulations that impose additional the Commission generally requests be required to meet the requirements of requirements on trading firms, clearing comment on all aspects of its § 1.80. consideration of costs and benefits, member FCMs and DCMs above and The Commission believes its beyond the baseline. In many instances, including: (a) Identification, definition of AT Person is appropriate full quantification of the costs is not quantification, and assessment of any and its inclusion of ‘‘floor traders,’’ reasonably feasible because costs costs and benefits not discussed therein; consistent with the proposed changes to depend on the size, structure, and (b) whether any of the proposed § 1.3(x), will mean that certain currently practices of trading firms, clearing regulations may cause FCMs or DCMs to unregistered market participants who member FCMs and DCMs. Within each raise their fees for their customers, or category of entity, the size, structure and otherwise result in increased costs for actively trade on Commission-regulated practices of such entities will vary market participants and, if so, to what markets will be subject to risk control markedly. In addition, the extent; (c) whether any category of requirements that will prevent or quantification may require information Commission registrants will be mitigate the risks of malfunctioning or data that the Commission does not disproportionately impacted by the algorithmic trading systems. Similarly, have or was not provided in response to proposed regulations, and if so whether the proposed definition of Algorithmic the Concept Release or other requests. the burden of any regulations should be Trading captures such trading activity The Commission notes that to the extent appropriately shifted to other that has the potential, when there is a that the regulations proposed in this Commission registrants; (d) what, if any, technological malfunction, to harm rulemaking results in additional costs, costs would likely arise from market market participants and disrupt markets those costs will be realized by trading participants engaging in regulatory at a speed that is difficult to mitigate. firms, clearing member FCMs and arbitrage by restructuring their trading The Commission asks questions exchanges in order to protect market activities to trade on platforms not concerning the scope of the definition of participants and the public. Finally, in subject to the proposed regulations, or Algorithmic Trading, for example general, full quantification of the taking other steps to avoid costs whether order routing systems should benefits of the proposed rule is also not associated with the proposed be included within such definition. The reasonably feasible, due to the difficulty regulations; (e) quantitative estimates of Commission acknowledges that any in quantifying the benefits of a the impact on transaction costs and change made to scope of AT Person and reduction in market disruptions and liquidity of the proposals contained Algorithmic Trading made in other significant market events due to herein; (f) the potential costs and accordance with any comments received will impact the cost of regulations that 621 FIA at 3, 59–60. 622 7 U.S.C. 2(i). use those definitions.

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7. Pre-Trade Risk Controls, Testing and necessary, books and records required to by § 1.80(a). Together with such annual Supervision of Automated Systems, be kept pursuant to § 40.22(d), and the reports, each AT Person would also be Requirement To Submit Compliance measures described therein (§ 40.22(e)). required to submit copies of the written Reports, and Other Related Algorithmic The pre-trade risk controls and other policies and procedures developed to Trading Requirements measures required by §§ 1.80, 1.82, comply with § 1.81(a) and (c). Proposed 38.255, and 40.20 would require the a. Summary of Proposed Rules § 1.83(b) would require clearing member following enumerated pre-trade risk FCMs for AT Persons to submit reports This section addresses the following controls: Maximum AT Order Message to DCMs describing their program for proposed regulations: (i) The and execution frequencies, price establishing and maintaining the pre- requirement that AT Persons implement parameters, and maximum order size trade risk controls required by pre-trade risk controls and other related limits. The regulations would also § 1.82(a)(1). The Commission is also measures (§ 1.80); (ii) standards for the require certain order management proposing a new § 40.22(c) to require development, testing, and monitoring of controls, including kill switch and that each DCM that receives a report Algorithmic Trading systems by AT cancel-on-disconnect functionalities. described in § 1.83 establishes a Persons (§ 1.81); (iii) registered futures Proposed § 170.19 would require an program for effective periodic review association (‘‘RFA’’) standards for RFA to adopt certain membership and evaluation of the reports. In algorithmic trading systems (‘‘ATSs’’) rules—as deemed appropriate by the addition, proposed § 1.83(c) and (d) operated by their members and clearing RFA—relevant to ATSs and algorithmic would require AT Persons and clearing member FCMs with respect to customer trading for each category of member in member FCMs for AT Persons to keep orders originating with ATSs (§ 170.19); the RFA. Proposed § 170.18 would and provide upon request to DCMs (iv) the requirement that AT Persons require all AT Persons to be registered books and records regarding their must become a member of a futures as a member of an RFA. compliance with §§ 1.80 and 1.81 (for association (§ 170.18); (v) the Proposed § 1.81 would require AT AT Persons) and § 1.82 (for clearing requirement that clearing member FCMs Persons to establish policies and member FCMs). The Commission is also implement pre-trade risk controls and procedures that accomplish a number of proposing a new § 40.22(d) and (e) to other related measures (§ 1.82); (vi) the objectives relating to the design, testing, require that DCMs implement rules requirements of § 1.83, including that: and supervision of Algorithmic Trading. requiring AT Persons and clearing AT Persons submit compliance reports More specifically, proposed § 1.81 member FCMs to keep and provide such to DCMs regarding their § 1.80(a)- would require each AT Person to: books and records, and to require DCMs required risk controls, as well as copies Implement written policies and to review and evaluate such books and of the written policies and procedures procedures for the development and records, and identify and remediate any developed to comply with § 1.81(a) and testing of ATSs (§ 1.81(a)); implement insufficient mechanisms, policies and (c) (§ 1.83(a)); clearing member FCMs written policies and procedures procedures therein. submit compliance reports to DCMs reasonably designed to ensure that each regarding their program for establishing of its ATSs is subject to continuous real- b. Costs and Benefits and maintaining the pre-trade risk time monitoring and supervision by i. § 1.80 Costs—Pre-Trade and Other controls required by § 1.82(a)(1) for AT knowledgeable and qualified staff while Risk Controls (AT Persons) Person customers (§ 1.83(b)); AT such ATS is engaged in trading Based on Concept Release comments, Persons keep and provide upon request (§ 1.81(b)); implement written policies best practices documents issued by to DCMs books and records regarding and procedures reasonably designed to industry or regulatory organizations, as their compliance with §§ 1.80 and 1.81 ensure that ATSs operate in a manner well as existing regulations, the (§ 1.83(c)); and clearing member FCMs that complies with the CEA and the Commission believes that a significant keep and provide upon request to DCMs rules and regulations thereunder, and number of AT Persons already books and records regarding their ensure that staff are familiar with the implement the specifically-enumerated compliance with § 1.82 (§ 1.83(d)); (vii) CEA and the rules and regulations pre-trade and other risk controls the requirement that DCMs implement thereunder, the rules of any DCM to required pursuant to proposed § 1.80. pre-trade risk controls and other related which such AT Person submits orders Specifically, in its survey of member measures (§§ 38.255 and 40.20); (viii) through Algorithmic Trading, the rules firms, PTG found the following: (i) 25 the requirement that DCMs provide test of any RFA of which such AT Person is out of 26 responding firms use message environments where AT Persons may a member, the AT Person’s own internal and execution throttles; (ii) all 26 test their ATSs (§ 40.21); and (ix) the requirements, and the requirements of responding firms use maximum order requirements of § 40.22, including that the AT Person’s clearing member FCM, size limits, either using their own DCMs: implement rules requiring AT in each case as applicable (§ 1.81(c)); technology, the exchange’s technology, Persons and clearing member FCMs to and implement written policies and or some combination; 623 and (iii) 24 out submit compliance reports each year procedures to designate and train staff of 26 responding firms use either price (§ 40.22(a) and (b)), establish a program responsible for Algorithmic Trading collars or trading pauses.624 As to order for effective periodic review and (§ 1.81(d)). As a complement to the management controls, two comments to evaluation of the reports (§ 40.22(c)), proposed design and testing the Concept Release from exchanges implement rules that require each AT requirements, proposed § 40.21 would stated that they provide an optional Person to keep and provide to the DCM require DCMs to provide a test cancel-on-disconnect functionality.625 books and records regarding their environment that will enable market compliance with all requirements participants to simulate production 623 AIMA indicated that many market participants pursuant to § 1.80 and § 1.81, and trading and conduct exchange-based use maximum order size limits, and Gelber, a require each clearing member FCM to conformance testing of their trading firm, stated that it uses this risk control. See keep and provide to the DCM market Algorithmic Trading systems. AIMA at 13; Gelber at 10. books and records regarding their Proposed § 1.83(a) would require AT 624 FIA at 59–60. 625 CME Appendix at A–4; CFE at 9–10. In compliance with all requirements Persons to submit annual reports to each addition, FIA characterized cancel-on-disconnect as pursuant to § 1.82 (§ 40.22(d)), and DCM on which they operate regarding a ‘‘widely adopted DCM-hosted pre-trade risk require DCMs to review and evaluate, as their pre-trade risk controls as required control.’’ See FIA at 14.

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Those exchanges also indicated that commodity futures activities for or on may cause some AT Persons to reduce, they provide kill switch functionality to behalf of the Member.’’ Interpretive or cease, their activities in certain market participants.626 Notice 9046, first issued in 2002 and markets. This may result in a decrease The Commission notes that these revised in 2006, provided, among other in market liquidity, which may cause types of controls have been included in things, that an AORS should allow the the costs of trading to increase. In order industry best practices for years. For Member to set limits for each customer to mitigate these potential concerns, the example, FIA PTG recommended, based on commodity, quantity, and type Commission has (as discussed further in among other things, that trading firms of order or based on margin the consideration of alternatives) implement message limits, a repeated requirements, and should allow the limited the compliance requirements to automated execution throttle, fat-finger Member to impose limits pre-execution what it preliminarily believes is the limits and price collars, as well as and to automatically block any orders minimum level needed to protect ‘‘heartbeats’’ with the exchange, use of that exceed those limits. In addition, the market participants and the public. In exchange-provided cancel-on- interpretive notice provided that when addition, as discussed in section (ii) disconnect functionality, and a kill authorizing use of a direct access below, the Commission believes that the button that disables the system’s ability system, the Member should utilize pre- standardization of risk controls may to trade and cancels all resting execution controls, if available, to set result in the provision of additional orders.627 In addition, ESMA guidelines pre-execution limits for each customer, liquidity. from 2012 recommended, among other regardless of the nature of the customer. Other potential costs related to risk things, that investment firms implement Although proposed § 1.80 is controls are similarly hard to quantify. messaging traffic controls and price or consistent with accepted industry best Kill switches aim to cease unintended size parameters.628 The Commission practices of long standing and existing message behavior, and the potential also notes that the SEC’s Market Access Commission and SEC regulations to losses and disruption associated with Rule, adopted in November 2010, which many AT Persons now comply, such behavior. However, the mandatory requires brokers and dealers to have risk Regulation AT’s risk control triggering of a kill switch when not controls that prevent entry of erroneous requirements will impose technology appropriate to a particular firm could orders, by rejecting orders that exceed and personnel costs on AT Persons. also prevent the firm’s legitimate, risk- appropriate price or size parameters, on These costs include initial risk control reducing activity, and instead result in an order-by-order basis or over a short creation costs and possibly ongoing increased costs for such firm. This period of time, or that indicate maintenance costs. Many AT Persons distinction emphasizes the need to duplicative orders.629 Given that many already have the controls required by appropriately calibrate risk controls on firms are registered both with the SEC Regulation AT in place, and will only an individual basis, and the and the CFTC, it is likely that there is need to upgrade such controls to ensure Commission has proposed rules that overlap between the set of firms covered compliance. To the extent some AT accommodate that need. While the under the SEC’s Market Access Rule and Persons may be outliers that do not Commission attempts to quantify costs this Proposed Rule. Finally, in 2011, the currently implement risk controls to individual firms, the Commission is CFTC TAC recommended, among other consistent with industry best practice— also aware of the broader impact of the things, that trading firms implement a number the Commission lacks data to proposed rules on markets once firms message and execution throttles, accurately identify and quantify—these apply the proposed risk controls, maximum quantity limits, price collars, firms would incur costs greater than including potential effects on liquidity. and a kill button.630 ‘‘upgrade’’ costs. The costs to any such The Commission welcomes comments The Commission also notes that, as outlier firms would vary based on each on these and other potential market- discussed in detail above in section firm’s unique size, business model, wide effects of the proposed regulations. II.E.1, NFA has provided guidance technology and existing risk controls. In addition to the potential costs to regarding ATSs to industry participants The Commission recognizes that some the market as a whole discussed above, since 2002. Such guidance includes firms will already have entirely individual AT Persons may incur costs NFA Interpretive Notice 9046, which compliant systems requiring no upgrade of risk control implementation, in addresses the ‘‘Supervision of the Use of and, at the other end of the spectrum, particular the cost of upgrading systems Automated Order-Routing Systems’’ in some firms may not be currently in order to comply with the proposed the context of NFA’s overarching implementing the § 1.80 required risk regulations. Specifically, if a particular supervision requirements in controls at all. Accordingly, the AT Person’s systems are not already Compliance Rule 2–9 (Supervision). Commission estimates the ‘‘upgrade’’ compliant with § 1.80, it will need to This rule and interpretive notice are costs for AT Persons to comply with comply with the pre-trade and other risk widely applicable to almost all Regulation AT risk control controls in one of several ways: By registered futures market participants requirements, and welcomes comment internally developing such controls and therefore apply to many AT on the accuracy of such estimates. from scratch, upgrading existing Persons. In particular, Compliance Rule Aside from costs to individual AT systems, or through purchasing a risk 2–9 requires each NFA member to Persons in creating and maintaining the management solution from an outside ‘‘diligently supervise its employees and controls required by Regulation AT, in vendor. Each approach potentially has agents in the conduct of their quantifying costs of § 1.80, the initial costs and annual ongoing costs. Commission considered that this Based on responses to the FIA survey, 626 CME at 23–24; CFE at 11. regulation may impose general costs to industry best practice standards, and 627 FIA PTG, ‘‘Recommendations for Risk the marketplace as a whole. For existing regulations both in Controls for Trading Firms,’’ (Nov. 2010) at 4–5. example, while the Commission expects Commission-regulated markets as well 628 ESMA Guidelines, supra note 61 at 14–15. that most AT Persons will only need to as SEC-regulated markets, the 629 See 17 CFR 240.15c3–5(e); SEC, Responses to upgrade systems in order to comply Commission believes that many AT Frequently Asked Questions Concerning Risk with Regulation AT, it is possible that Persons will be able to substantially Management Controls for Brokers or Dealers with Market Access (Apr. 15, 2014), supra note 37. costs related to the implementation of satisfy the risk control requirements of 630 CFTC TAC Recommendations, supra note 34 new risk controls could lead to adverse Regulation AT with their existing at 2–3. effects. For example, compliance costs systems and controls. For others, the

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costs of upgrading and introducing the required programming changes could be the Commission estimates that the total required systems would vary applied using flexible and generalizable one-time industry cost to implement considerably based on current controls methods and leveraged across all § 1.80 would be approximately and procedures, as well as particular algorithms. The Commission recognizes $33,465,600. business models.631 that execution speed is considered to be The Commission notes that AT Rather than develop or upgrade its a significant factor in algorithmic Persons could choose not to develop own systems, AT Persons may choose to trading, and understands that controls these controls internally, but rather may purchase a risk management solution have the potential to impact execution purchase a solution from an outside from a third-party vendor, a DCM, or a speed; however, the Commission vendor (or DCM or clearing member clearing member FCM. These costs believes that requiring a base set of risk FCM) in order to comply with § 1.80. could similarly vary, depending on the controls will, rather than further The Commission welcomes comments AT Persons’ current systems and increasing speed disadvantages across providing estimates concerning the cost controls in place, the types of trading market participants, partially reduce for an AT Person to use an outside strategies it uses, the volume and speed them by ensuring that no firm avoids vendor to comply with this proposed of its trading activity, and the pricing the use of a given control to gain an regulation. model utilized by the software vendor. advantage. Because each AT Person is SEC Estimates. The proposing release As one example, the Commission notes unique and technological systems across for the SEC’s Market Access Rule, which that CME provides a number of risk AT Persons will vary, the following requires brokers and dealers to have risk management tools to its market estimates reflect staff’s best efforts, and controls in place before providing their participants and clearing firms. These the Commission welcomes comments customers with access to the market, tools include: Cancel-on-disconnect, on their accuracy. provided compliance costs estimates.635 CME Globex credit controls, a Risk Estimate—Upgrade of Controls. The The Commission’s upgrade estimates Management Interface (RMI) (which Commission considered the scenario are generally consistent with the cost allows clearing members to manage where an AT Person already estimates provided by the SEC. For risk), drop copy, FirmSoft (the ability to implements controls as required by example, the SEC estimated that it view and cancel orders), a kill switch (a proposed § 1.80, but the controls may would cost a broker-dealer single step shutdown of trading activity) not comply with every aspect of the approximately $270,404 ($167,904 in and self-trade prevention.632 As another regulation. In such instance, an AT technology personnel costs and example, NASDAQ OMX Group, Inc. Person will need to evaluate its current $102,500 in hardware and software offers risk management tools that risk control systems to determine costs) to build a risk control include fat finger price checks, whether it is compliant with new management system from scratch and maximum order quantity checks, daily regulatory requirements; modify that it would cost a broker-dealer accumulated quantity checks, maximum existing code or creating new code to $39,401 ($27,984 for technology order rate per second checks, disconnect address any gaps between current risk personnel and $11,517 for hardware and safeguards, email notifications when control systems and new regulatory software) to substantially upgrade an limits or warning levels are breached, requirements; and test current systems existing risk control system.636 The SEC and an administration interface that and new code to verify correct operation estimated that the total annual ongoing allows emergency actions.633 Many of and compliance. The Commission cost to maintain an in-house risk control these mirror, or complement, risk assumes that AT Persons will generally management system would be $47,300 controls included within this proposed already have some code in place for the per broker-dealer ($26,800 for rule. basic controls required by § 1.80, or for technology personnel and $20,500 for The Commission estimated the costs something similar that can be added to hardware and software).637 Finally, with for AT Persons to comply with proposed or modified, rather than need to build respect to outsourcing such controls, the § 1.80. In making its estimates, the entire pre-trade systems from scratch. SEC estimated that a broker-dealer Commission made several assumptions. For example, an AT Person may have an would pay approximately $8,000 per The Commission assumes that the effort existing library of ‘‘code blocks,’’ with a month ($96,000 annually) for a startup to adjust any one control (by ‘‘control,’’ block being useful for multiple related contract.638 To be conservative, the SEC in this context, the Commission means purposes. estimated the same amount for an the pre-trade risk controls, order Accordingly, the Commission annual ongoing cost.639 cancellation systems, and connectivity estimates that an AT Person would The Commission notes that in systems required by § 1.80) would incur a one-time cost of $79,680 to addition to the general requirements of require assessment and possible upgrade its systems to comply with proposed § 1.80 to implement pre-trade modifications to all controls.634 The proposed § 1.80. This cost is broken risk controls, order cancellation systems down as follows: 1 Project Manager, and connectivity systems, § 1.80 631 For example, the needs of a particular AT working for 320 hours (320 × $70 per imposes additional requirements Person will vary based on its current systems and hour = $22,400); 1 Business Analyst, relating to such controls. Regulation controls in place, the comprehensiveness of its × § 1.80(a)(2) provides requirements as to controls and procedures, the types of trading working for 320 hours (320 $52 per strategies it uses, and the volume and speed of its hour = $16,640); 1 Tester, working for the level at which pre-trade risk controls trading activity. 320 hours (320 × $52 per hour = should be set and § 1.80(a)(3) requires 632 CME Group, ‘‘Risk Management Tools $16,640); and 1 Developer, working for that natural person monitors be Introduction,’’ available at: http:// 320 hours (320 × $75 per hour = promptly alerted when such parameters www.cmegroup.com/globex/trading-cme-group- are breached. The Commission assumes products/risk-management-tools.html. $24,000). The Commission estimates 633 NASDAQ OMX Group, Inc., ‘‘Pre-Trade Risk that if an AT Person already has at least Management—Genium INET,’’ available at: http:// some of the controls required by § 1.80, 635 See Securities Exchange Act Release No. www.nasdaqomx.com/nordicprm/geniuminet. there will be no additional annual costs 61379 (January 19, 2010), 75 FR 4007 (January 26, 634 The Commission also assumes that the most 2010) (File No. S7–03–10). to maintain the modifications required 636 difficult control to implement will be message and See id. at 4022. execution throttles because such throttles will need to bring the systems into compliance 637 See id. to be coordinated among many complex algorithms with § 1.80. Assuming (as discussed 638 See id. running simultaneously. above) that there are 420 AT Persons, 639 See id.

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that such requirements impose no requires AT Persons to annually submit market orders in the order book. In additional costs or are part of the costs reports regarding their pre-trade risk addition to these losses, and potentially described above. Establishing particular controls required pursuant to proposed uncertain trading positions, sudden, parameters of controls is a necessary § 1.80(a) and copies of the written large unintentional market activity can part of establishing and implementing policies and procedures developed to disrupt the efficiency, competitiveness any control. In addition, as discussed comply with § 1.81(a) and (c) to each and financial integrity of the futures below, the Commission assumes that it DCM on which they operate. markets. Because much of the impact of is already industry practice to employ a Accordingly, the Commission believes such unintended trades is independent natural person to test and monitor a that articulating such requirement of connection method, it is in the firm’s algorithmic trading systems. explicitly in the final subsection of this individual trading firm’s interest, and Accordingly, requiring that natural rule will not engender costs separate the interest of Commission-regulated person monitors at the AT Person be from those previously discussed and markets as a whole, to have all types of alerted with pre-trade risk control considered. algorithmic trading orders, regardless of parameters are breached should not The Commission emphasizes that access method, be subjected to sound impose additional costs on AT Persons. costs for each AT Person will vary. risk controls. Proposed § 1.80(d) requires each AT Finally, the Commission notes that, as As noted, the Commission believes Person, prior to its initial use of indicated above, these estimates may that proposed regulation § 1.80 Algorithmic Trading, to submit a overstate the actual costs to the standardizes existing industry practices message or order to a DCM’s trading industry. Based on Concept Release in this area, and does not impose platform, must notify its clearing comments, best practices issued by additional requirements beyond existing member FCM and the DCM on which it industry and regulatory organizations, best practices that most market will be trading that it will engage in as well as existing regulations, the participants satisfy. Accordingly, the Algorithmic Trading. Subject to Commission believes that all or most AT Commission notes that many of the consideration of relevant comments, the Persons are already using the pre-trade benefits of § 1.80 are already being Commission preliminarily believes that and other risk controls required by realized. This proposed rule, however, this requirement of this initial proposed § 1.80. The Commission may serve to limit a ‘‘race to the notification to clearing firms and DCMs welcomes public comment on the above bottom’’ in which certain entities will impose minimal or no costs on AT analysis and estimates. sacrifice effective risk controls in order Persons. The Commission welcomes ii. § 1.80 Benefits—Pre-Trade and comment on the costs, if any, of this to minimize costs or increase the speed Other Risk Controls (AT Persons) notification requirement. of trading. The proposed rules, by Proposed § 1.80(e) requires AT Proposed § 1.80 should benefit market standardizing the risk controls required Persons to implement a DCM’s self-trade participants by mitigating credit, to be used by firms, would help ensure prevention tools. The Commission’s market, and operational risks faced by that the benefits of these risk controls self-trade prevention requirements are trading firms. Standardization of pre- are more evenly distributed across a principally directed toward DCMs, in trade and other risk controls is wide set of market participants, and that § 40.23 would require DCMs to particularly critical in the context of reduce the likelihood that an outlier apply, or provide and require the use of, potential outlier trading firms that have firm without sufficient risk controls self-trade prevention tools. The chosen not to implement appropriate causes significant market disruption. Commission believes that DCMs would risk controls in the absence of Incidents like the one involving incur the costs of developing or regulation. As noted above (for example, Knight Capital highlight the importance upgrading such tools as necessary to with respect to the Knight Capital of using pre-trade and other risk control comply with § 40.23. To the extent that incident), a technological malfunction at protections. Specifically, an SEC AT Persons are not already complying such a single firm can have far-reaching investigation found that Knight Capital with DCM-provided self-trade impact across markets and market did not have adequate safeguards in prevention tools already used in participants. Credit, market and place to limit the risks posed by its industry, the Commission believes that operational risks are mitigated through access to the markets, and, as a result, the cost to an AT Person in calibrating ensuring that each order accurately failed to prevent the entry of millions of or otherwise applying such a tool would reflects the intentions of the participant erroneous orders.640 Knight Capital also be a minimal, involving provision of the and does not otherwise violate the CEA failed to conduct adequate reviews of relevant account or other necessary or Commission regulations. The pre- control effectiveness.641 The SEC information in the DCM in order to trade and other risk controls required by charged Knight Capital with multiple apply the tool. The Commission proposed § 1.80 should improve both violations of the SEC’s Market Access welcomes comment on the costs, if any, price efficiency and price transparency Rule, which included failure to have to an AT Person in complying with in Commission-regulated markets by adequate controls at a point § 1.80(e). reducing the chances of large, immediately prior to its submission of Finally, proposed § 1.80(f) requires unintended orders moving prices away orders to the market, such as a control that each AT Person shall periodically from appropriate market values. Absent to compare orders leaving the router review its compliance with § 1.80 to protections, unintended and erroneous with those entered.642 Knight also failed determine whether it has effectively trades resulting from a malfunctioning to adequately review its business implemented sufficient measures trading system could potentially expose activity in connection with its market reasonably designed to prevent an not just the original market participant, access to ensure the overall Algorithmic Trading Event. AT Persons but any participant exposed to the given effectiveness of its risk management must take prompt action to document market, to unexpected financial burdens controls and supervisory procedures.643 and remedy deficiencies in such as a result of price moves. These policies and procedures. The burdens may include the financial 640 See SEC Knight Capital Release, supra note 39. Commission believes that this periodic impact on market participants with 641 See id. review is necessary to comply with open positions impacted by price 642 See id. § 1.83(a), which, as discussed below, moves, or market participants with 643 See id.

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As a result of these failures, the SEC experience when unfavorable price Development and Testing. The found that Knight put not only movements occur due to the behavior of Commission estimates that an AT themselves, but the markets in general, another market participant’s faulty Person that has not implemented any of at risk. The Commission views algorithm. As a result, the Commission, the requirements of proposed § 1.81(a) prevention of disruptive events like that subject to consideration of comments, (development and testing of Algorithmic involving Knight Capital as an views the proposed standardized risk Trading Systems) would incur a total important benefit of § 1.80 that impacts controls as a tool likely to encourage AT cost of $349,865 to implement these all market participants and the public. Persons and other market participants to requirements. This cost is broken down By requiring, and standardizing, provide additional liquidity, mitigating as follows: 1 Project Manager, working certain risk controls implemented by the potential negative impact on market for 1,707 hours (1,707 × $70 = traders and trading firms, the liquidity from certain costs associated $119,490); 2 Business Analysts, working Commission intends to foster a level with Regulation AT, as previously for a combined 853 hours (853 × $52 = playing field across market participants, discussed in section (i) above. $44,356); 3 Testers, working for a and avoid a situation where firms with × iii. § 1.81 Costs—Development, combined 2,347 hours (2,347 $52 = stronger risk control systems face speed $122,044); and 2 Developers, working disadvantages. The Commission also Testing and Supervision of Algorithmic × Systems (AT Persons) for a combined 853 hours (853 $75 = recognizes that in the absence of a rule $63,975).644 requiring implementation of certain risk The Commission believes that most Monitoring. The Commission controls, some market participants may market participants and DCMs have estimates that an AT Person that has not be compelled by competitive and implemented controls regarding the implemented any of the requirements of economic pressures to submit orders, or design, testing, and supervision of proposed § 1.81(b) (monitoring of allow the submission of orders, without Algorithmic Trading systems, in light of Algorithmic Trading Systems) would appropriate controls to safeguard against the numerous best practices and incur a total cost of $196,560 to the risks of a malfunctioning algorithm. regulatory requirements promulgated in implement these requirements. This The race for speed may reduce the this area. For this fully compliant cost is broken down as follows: 1 Senior incentive to add risk controls, and the majority, the codification of such Compliance Specialist, working for absence of risk controls can magnify the standards in proposed § 1.81 should not 2,080 hours (2,080 × $57 = $118,560); effect, and cost, of errors in the high engender additional costs. For any and 1 Business Analyst, working for market participants that are not fully speed trading environment. In addition, 1,500 hours (1,500 × $52 = $78,000).645 compliant, some additional costs may the mitigation of significant system risks Compliance. The Commission be expected. These efforts include the should help ensure market integrity and estimates that an AT Person that has not FIA PTG’s November 2010 provide the investing public with implemented any of the requirements of ‘‘Recommendations for Risk Controls for greater confidence that all transactions, proposed § 1.81(c) (compliance of Trading Firms,’’ FIA’s March 2012 along with the resulting price Algorithmic Trading Systems) would ‘‘Software Development and Change movements, are intentional and bona incur a total cost of $174,935 to Management Recommendations,’’ fide. Regulation AT should promote implement these requirements. This ESMA and MiFID II guidelines and investor confidence as well as enhance cost is broken down as follows: 1 Project the fair and efficient operation of the directives on the development and × testing of algorithmic systems, SEC Manager, working for 853 hours (853 markets. $70 = $59,710); 2 Business Analysts, The Commission believes that market Regulation SCI requirements on the working for a combined 427 hours (427 participants, in particular those development, testing, and monitoring of × $52 = $22,204); 3 Testers, working for currently using risk controls, may face SCI systems, FINRA’s March 2015 × a number of disadvantages due to the Notice 15–09 on effective supervision a combined 1,173 hours (1,173 $52 = $60,996); and 2 Developers, working for fact that risk controls for algorithmic and control practices for market × trading are not standardized, and that participants that use algorithmic trading a combined 427 hours (427 $75 = these disadvantages may discourage strategies in the equities market, $32,025). market participants from providing IOSCO’s April 2015 Consultation Designation and Training of Staff. liquidity. Market participants may be Report, summarizing best practices that The Commission estimates that an AT concerned about their exposure to should be considered by trading venues Person that has not implemented any of potential losses due to Algorithmic when developing and implementing risk the requirements of proposed § 1.81(d) Trading events and various market mitigation mechanisms, and the Senior (designation and training of Algorithmic abuses in the absence of standardized Supervisors Group (SSG) April 2015 Trading staff) would incur a total cost of risk controls and other measures. Algorithmic Trading Briefing Note, $101,600 to implement these Market participants may also be which described how large financial requirements. This cost is broken down concerned whether market orders and institutions currently monitor and as follows: 1 Senior Compliance × trades in fact reflect the intent of the control for the risks associated with Specialist, working for 500 hours (500 market participants submitting them. algorithmic trading during the trading $57 = $28,500); 1 Project Manager, × The Commission thus expects, subject day. working for 500 hours (500 $70 = to consideration of comments, that The Commission has calculated an $35,000); 1 Developer, working for 300 × standardization of risk control estimated maximum cost to an AT hours (300 $75 = $22,500); and 1 requirements for all AT Persons via Person that has not implemented any of Regulation AT will reduce such costs the design, testing, and supervision 644 See section V(B) above for the calculation of hourly wage rates used in this analysis. and trading disincentives for market standards required by proposed § 1.81 645 As discussed above, the Commission notes participants arising from Algorithmic as further described below. To the that staff persons who are responsible for Trading events and market abuses. The extent an AT Person is already in partial monitoring the trading of other AT Person staff Commission also expects, subject to compliance with § 1.81, as the should not simultaneously be actively engaged in trading. The Commission believes that it would not consideration of comments, that Commission believes many are likely to be possible to adequately and consistently monitor standardization will reduce unexpected be, their costs should be less than the trading of other AT Person staff while engaged in costs that market participants currently maximum described. trading activities.

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Business Analyst, working for 300 hours changes, testing, and controls; and rules. For purposes of this exercise, the (300 × $52 = $15,600). procedures for documenting the strategy Commission anticipates that an RFA Notwithstanding these estimates, the and design of proprietary Algorithmic could potentially seek to codify industry Commission believes that proposed Trading software used by an AT Person, best practices in order to establish a § 1.81 standardizes existing industry among other controls. The baseline of regulatory standardization practices in this area, but does not standardization of such written policies around such practices. impose additional requirements that are and procedures may make disruptive not already followed by the majority of events like the Knight Capital incident The Commission believes that the market participants. As a result, subject less likely in the future. work of adopting these rules would fall to consideration of relevant comments, As noted, the Commission believes primarily to legal, information the Commission preliminarily believes that proposed regulation § 1.81 technology, and compliance staff within that regulation § 1.81 would not impose standardizes existing industry practices an RFA. It estimates 450 hours of additional costs on the majority of AT in this area, and does not impose burden for an RFA to adopt rules. This Persons and that the costs imposed on additional requirements that are not includes analysis of existing industry AT Persons that are in partial already followed by the majority of best practices, consultation with market compliance with § 1.81 will be less than market participants. Accordingly, the participants, drafting rules, further the amounts described above. Commission notes that many of the consultations, including potentially benefits of § 1.81 are already being iv. § 1.81 Benefits—Development, with Commission staff, and adoption of realized. The proposed rule would help Testing and Supervision of Algorithmic final rules. The Commission estimates a ensure that the benefits of the required Systems (AT Persons) total cost of $34,200 for these efforts. testing and supervision will be fully This cost is broken down as follows: 2 The rules proposed with respect to realized and sustained into the future. Compliance Attorneys, working for a the design, testing, and supervision of × Algorithmic Trading systems are v. § 170.19 Costs—RFA Standards for combined 150 hours (150 hours $96 intended to further mitigate the risk of Automated Trading and Algorithmic per hour = $14,400); 2 Developers, Algorithmic Trading. In their response Trading Systems (RFAs) working for a combined 150 hours (150 × to the Concept Release, IATP noted that, Proposed § 170.19 requires an RFA to hours $75 per hour = $11,250); and 2 out of all the safeguards discussing in establish and maintain a program for the Senior Compliance Specialists, working the Release, they believed ATS testing prevention of fraudulent and for a combined 150 hours (150 hours × had the greatest potential to reduce manipulative acts and practices, the $57 per hour = $8,550), for a total cost market disruptions.646 By standardizing protection of the public interest, and of $34,200.648 principles in this area, Regulation AT is perfecting the mechanisms of trading on The Commission notes that an RFA, intended to reduce the risk of disorderly designated contract markets through after familiarizing itself with relevant trading, including the risk that orders membership rules, as deemed best practices, may determine that will be unintentionally sent into the appropriate by the RFA, requiring: (1) additional membership rules pursuant marketplace by a poorly designed or Pre-trade risk controls and other to proposed § 170.19 are unnecessary. insufficiently supervised algorithm. measures for ATSs; (2) standards for the Under those circumstances, elements of For example, the regulations proposed development, testing, monitoring, and under § 1.81 may reduce the risk of compliance of ATSs; (3) designation and the work described above would not be market disruptions such as the 2012 training of algorithmic trading staff; and required, and the total estimated cost of incident involving Knight Capital. The (4) operational risk management $34,200 would not be incurred. The SEC later concluded that, among other standards for clearing member FCMs Commission believes, for example, that failures, Knight Capital did not have with respect to customer orders Compliance Attorneys, Developers, and adequate controls and procedures for originating with algorithmic trading Senior Compliance Specialists could code deployment and testing for its systems. analyze best practices and determine order router, did not have sufficient Proposed § 170.19 will impose costs that additional membership rules are controls and written procedures to on an RFA to establish and maintain a not required after a combined 150 hours guide employees’ responses to program as described in the rule. of work (50 hours of work for each significant technological and However, RFAs would only be required professional role). The Commission compliance incidents, and did not have to adopt rules as they deem appropriate; estimates a total cost of $11,400 for an adequate written description of its any rulemaking pursuant to proposed these efforts. This cost is broken down risk management controls.647 Proposed § 170.19 would be entirely at the as follows: 2 Compliance Attorneys, § 1.81 requires written policies and discretion of the RFA. The Commission working for a combined 50 hours (50 procedures relating to the following: believes that the costs to an RFA of hours × $96 per hour = $4,800); 2 Testing of all Algorithmic Trading code proposed § 170.19 cannot reasonably be Developers, working for a combined 40 quantified given RFAs’ complete and relates systems and any changes to hours (50 hours × $75 per hour = discretion to adopt many, several, or no such code and systems prior to their $3,750); and 2 Senior Compliance rules in the foreseeable future pursuant implementation; regular stress tests of Specialists, working for a combined 50 to § 170.19. In addition, relevant ATSs to verify their ability to operate in hours (50 hours × $57 per hour = the manner intended under a variety of rulemaking by an RFA is likely to be $2,850), for a total cost of $11,400.649 market conditions; a plan of internal episodic, as circumstances warranting coordination and communication rulemaking will typically not arise on an annual basis. With those caveats, between compliance staff of the AT 648 however, for purposes of this analysis See section V(B) above for the calculation of Person and staff of the AT Person hourly wage rates used in this analysis. and as a basis for comment, the responsible for Algorithmic Trading 649 In this regard, the Commission estimates that regarding Algorithmic Trading design, Commission is using its own experience total costs for an RFA could range between $11,400 to quantify the potential costs of and $34,200 based on the amount of work invested 646 IATP at 7. proposed § 170.19 to an RFA on those before the RFA determined not to pursue additional 647 See SEC Knight Capital Release, supra note 39. occasions when it determines to adopt membership rules pursuant to proposed § 170.19.

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vi. § 170.19 Benefits—RFA Standards vii. § 170.18 Costs—AT Person As discussed above, proposed § 170.18 for Automated Trading and Algorithmic Membership in a Registered Futures will likely only affect those floor traders Trading Systems (RFAs) Association (AT Persons) that were required to register with the Proposed § 170.18 requires each Commission pursuant to § 1.3(x)(3). The Commission believes that registrant that is an AT Person that is NFA, as the only currently registered proposed § 170.19, by requiring RFAs to not otherwise required to be a member RFA, has not to date promulgated any establish and maintain a program of an RFA pursuant to §§ 170.15, 170.16, rules specific to floor traders or AT addressing the automated trading and or 170.17 to become and remain a Persons. As a result, the only current algorithmic trading systems of its member of at least one RFA that NFA membership rules that these members, will help to advance the goals provides for the membership of such entities would be required to follow are described in § 170.19: Prevention of registrant, unless no such futures those rules that are generally applicable fraudulent and manipulative acts and association is so registered. Proposed to all NFA members. Many of these practices, the protection of the public § 170.18 would only affect those entities rules are general in nature and mirror interest, and perfecting the mechanisms that are not required to become current Commission regulations or those of trading on designated contract members of an RFA pursuant to proposed in Regulation AT. markets. §§ 170.15, 170.16, or 170.17. Floor Accordingly, these entities would not brokers and floor traders, who have incur any additional general, ongoing RFAs serve a vital regulatory function compliance costs as a result of NFA as frontline regulators of their members, historically been overseen by the DCMs on which they operate, are not required membership. which would include all AT Persons by §§ 170.15, 170.16, or 170.17 to pursuant to proposed § 170.18. RFAs viii. § 170.18 Benefits—AT Person become members of an RFA and would promulgate binding membership rules Membership in a Registered Futures likely be the entities impacted by Association (AT Persons) and can supplement Commission rules proposed regulation 170.18. The new Because entities that are not members as appropriate. RFAs can also operate membership requirements would of an RFA are not bound by the rules of examination programs to monitor require affected entities to pay initial members’ compliance with association and annual NFA membership dues. the RFA, the Commission is proposing rules, and can sanction members for NFA charges each FCM registrant § 170.18 to ensure that all AT Persons non-compliance. The Commission $5,625 in initial membership dues and (including newly registered floor believes that because RFAs have these $5,625 per year for continuing NFA traders) would become members of an and other tools at their disposal, RFAs membership where NFA is the SRO. RFA and would therefore be subject to are well-positioned to address rules in The Commission estimates that any membership rules promulgated by such RFA. Regulation AT proposes to areas experiencing rapid evolution in membership dues for AT Person floor establish a role for RFAs in setting the market practices and technologies, traders or floor brokers may also be $5,625, but that actual dues may be framework in which AT Persons including particularly §§ 1.80, 1.81, and operate. Proposed § 170.19, which is 1.82. different than this. This is because while NFA will generally have more described in greater detail above, The Commission believes that the limited oversight responsibilities for AT requires an RFA to adopt rules, as structure of proposed §§ 1.80, 1.81, and Person floor traders and floor brokers, it deemed appropriate by the RFA, 1.82 makes it particularly appropriate to may pass on the costs of proposed requiring (i) pre-trade risk controls for give RFAs a discretionary role in § 170.19 to AT Person members in the ATSs; (ii) standards for the augmenting the requirements of form of higher dues.650 The Commission development, testing, monitoring and Regulation AT for AT Persons. Proposed estimates that there will be compliance of ATSs; (iii) designation §§ 1.80, 1.81, and 1.82 address only a approximately 100 entities that are AT and training of algorithmic trading staff; subset of potentially responsive risk Persons and will register as floor traders and (iv) operational risk management controls and other measures. Each AT under the new registration requirements standards for clearing member FCMs Person remains free to adopt additional of § 1.3(x)(3). It is likely that these 100 with respect to customer orders safeguards reasonably designed to entities will be the only entities that originating with ATSs. The benefits of prevent an Algorithmic Trading Event will be required to become members of these risk controls and other measures an RFA pursuant to proposed regulation are described in more detail throughout given its trading strategies, technologies, 651 or the markets in which it participates. 170.18. Accordingly, the Commission this section. The proposed rules also provide a estimates that entities affected by ix. § 1.82 Costs—Pre-Trade and Other degree of flexibility regarding the proposed regulation 170.18 will incur a Risk Controls (FCMs) total initial cost of about $562,500 for design, implementation, or calibration NFA membership dues (about $5,625 in Based on Concept Release comments, of those pre-trade risk control or other annual membership dues per registrant, best practices documents issued by measures that are specifically required paid each year by 100 registrants) and industry or regulatory organizations, as in §§ 1.80, 1.81, and 1.82, again a total annual cost of about $562,500. well as existing regulations, the allowing each AT Person to adapt the The Commission also preliminarily Commission believes that clearing rules to its own trading and technology. believes that the rule may impose member FCMs already implement the Given the degree of flexibility certain compliance costs on affected specifically-enumerated pre-trade and embedded in these rules, RFAs will be entities. However, such costs should not other risk controls required pursuant to well positioned to work with their be substantially different from or proposed § 1.82. Specifically, in its member AT Persons to develop significantly exceed the costs associated survey of FCMs, FIA found that all standards that are appropriate to each with current Commission regulations responding firms used message and AT Person’s specific trading approach and proposed Regulation AT generally. execution throttles, maximum order and technology, and that best serve to sizes, price collars, and order promote the goals described in § 170.19. 650 Currently, while floor traders and floor brokers register with the NFA, they do not become NFA 651 See, e.g., the discussion of benefits related to members, and, thus, do not pay membership dues. proposed §§ 1.80, 1.81, and 1.82.

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cancellation capabilities, including a example, the needs of a clearing controls to ensure that they comply with kill switch, either administered member will vary based on its current the regulation. The Commission internally or at the exchange level.652 systems and controls in place, the estimates that the cost for a clearing FIA also indicated that most DCMs comprehensiveness of its controls and member to assess and update its provide tools to allow the FCM to set procedures, the types of trading implementation of such controls is pre-trade controls for their customers, strategies its customers use, and the $159,360. This cost is broken down as which are a prerequisite for an FCM to volume and speed of its customers’ follows: 1 Project Manager, working for provide direct access to a market trading activity. 640 hours (640 × $70 per hour = participant without routing orders Estimate-DEA Orders, Update to $44,800); 1 Business Analyst, working through the FCM’s infrastructure.653 Controls. The Commission also for 640 hours (640 × $52 per hour = Two exchanges commented that their estimated costs to a clearing member $33,280); 1 Tester, working for 640 kill switch functionality allows clearing that already uses DCM-provided hours (640 × $52 per hour = $33,280); firms to cancel orders.654 controls with respect to DEA orders and and 1 Developer, working for 640 hours The Commission notes that these only needs to assess and update its (640 × $75 per hour = $48,000). The 57 types of controls have been subject of implementation in order to ensure it clearing members that will be subject to industry best practices for years. For fully complies with § 1.82. The § 1.82 would therefore incur a total one- example, FIA’s Market Access Risk Commission assumed that message time cost of $9,083,520 (57 × $159,360) Management Recommendations from handling already exists and little is to update their controls.659 The 2010 recommended, among other needed to update the clearing member’s Commission estimates that if a clearing things, that a clearing firm providing systems in order to comply with § 1.82. member already implements at least direct access to a market should As noted above with respect to AT some of the DCM-provided controls implement maximum quantity limits, Persons and compliance with § 1.80, the required by § 1.82, there will be no price banding or dynamic price limits Commission believes that upgrading additional annual costs to maintain the and exchange-provided order existing systems to comply with § 1.82 modifications required to bring the cancellation capabilities.655 The ESMA would involve evaluating current risk clearing member’s systems into Guidelines from 2012 recommended control systems to determine compliance with § 1.82. that firms providing direct market compliance with new regulatory The Commission emphasizes that access or sponsored access (as such requirements; modifying existing code costs listed above are estimates, and it terms are defined by ESMA) 656 must, or creating new code to address gaps welcomes comment on their accuracy. among other things, implement controls between current risk control systems The Commission further emphasizes that limit messaging traffic and establish and new regulatory requirements; and that the costs for each clearing member price and size parameters.657 testing current systems and new code to will vary. Finally, the Commission notes Nevertheless, the Commission verify correct operation and compliance. that, as indicated above, these estimates recognizes that there could be costs The Commission estimates that the cost may overstate the actual costs to the associated with implementation of the for a clearing member to assess and industry. Based on Concept Release risk controls in § 1.82. Specifically, for update its implementation of controls comments, best practices issued by purposes of Direct Electronic Access required by § 1.82 is $49,800. This cost industry and regulatory organizations, (DEA), defined in proposed § 1.3(yyyy), is broken down as follows: 1 Project as well as existing regulations, the if clearing members do not already use Manager, working for 200 hours (200 × Commission believes that clearing DCM-provided systems, they will need $70 per hour = $14,000); 1 Business members are largely already using the to implement additional DCM-provided Analyst, working for 200 hours (200 × pre-trade and other risk controls systems. For non-DEA orders, clearing $52 per hour = $10,400); 1 Tester, required by § 1.82. firms will need to internally develop working for 200 hours (200 × $52 per such controls from scratch, upgrade hour = $10,400); and 1 Developer, x. § 1.82 Benefits—Pre-Trade and existing systems, or purchase a risk working for 200 hours (200 × $75 per Other Risk Controls (FCMs) management solution from an outside hour = $15,000). The 57 clearing The Commission notes that many of vendor. Each approach potentially has members that will be subject to § 1.82 the benefits discussed above with initial costs and annual ongoing costs, would therefore incur a total one-time respect to pre-trade and other risk although the costs of upgrading and cost of $2,838,600 (57 × $49,800) to controls required of trading firms implementing the required systems update their controls.658 The pursuant to § 1.80 also apply with would vary considerably based on Commission estimates that if a clearing respect to the benefits of controls that current controls and procedures, as well member already implements at least FCMs must implement pursuant to as particular business models. For some of the DCM-provided controls proposed § 1.82. Specifically, requiring required by § 1.82, there will be no such controls contributes to orderly 652 FIA at 60. additional annual costs to maintain the markets by preventing orders that are 653 FIA at 13. Two exchanges commented that modifications required to bring the outside of pre-determined parameters they provide technology allowing clearing members to set maximum order size limits. See CME at 23– clearing member’s systems into and ensuring a level-playing field 24; CFE at 11. compliance with § 1.82. among clearing members. The benefits 654 CME at 23–24; CFE 11. Estimate-Non-DEA Orders, Update to also include allowing clearing members 655 FIA Market Access Working Group, ‘‘Market Controls. The Commission also to have control over the trading flow of Access Risk Management Recommendations,’’ estimated costs to clearing members to (April 2010) at 8–10. their customers, regardless of their 656 ESMA defines direct market access as an comply with § 1.82’s requirements with customers’ method of access—DEA or investment firm’s client transmitting orders to a respect to non-DEA orders assuming non-DEA. trading platform using the investment firm’s that the clearing member already has the In addition, given that different infrastructure, and sponsored access as a client pre-trade and other risk controls in entities have differing information about transmitting orders directly to a trading platform without such orders passing through the investment place, and must only update the the trading activities of their customers/ firm’s infrastructure. See ESMA Guidelines, supra note 61 at 4–5. 658 See section V(A) above for the calculation of 659 See section V(A) above for the calculation of 657 See id. at 14–15, 21–23. the number of persons subject to Regulation AT. the number of persons subject to Regulation AT.

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users, identification of unintended keep and provide to the DCM books and their current infrastructure to market behavior may be easier for records regarding the AT Person’s accommodate new DCM rules relating to certain entity types, such as trading compliance with all §§ 1.80 and 1.81 recordkeeping, and AT Persons and firms. For example, with respect to requirements, and each clearing member clearing member FCMs will not have trading firms that mostly trade through FCM to keep and provide to the DCM substantial expenditures related to new a single clearing member, but across a books and records regarding such recordkeeping technology or re- disparate set of products, these metrics clearing member FCM’s compliance programming existing recordkeeping may be more easily calculated at the with all § 1.82 requirements. The technology. The Commission expects FCM than at the DCM. To protect proposed recordkeeping requirements that additional expenditure related to against the broadest set of errors, there will cause AT Persons and clearing § 1.83(c) and (d) recordkeeping are benefits to implementing risk member FCMs to incur costs, as requirements would be limited to the controls at multiple points in the order discussed below. drafting and maintenance of chain, including the FCM. AT Person Compliance Reports. AT recordkeeping policies and procedures As noted, the Commission believes Persons and FCMs that are clearing by in-house counsel and programmer that proposed § 1.82 standardizes members of AT Persons will incur the burden hours associated with existing industry practices in this area, cost of annually preparing and recordkeeping technology and some of the requirements are submitting the reports to their DCMs, as improvements, as well as annual costs already followed by the majority of well as the written policies and in ensuring that recordkeeping policies clearing members. Accordingly, the procedures developed to comply with and procedures and related technology Commission notes that many of the § 1.81(a) and (c). The Commission comply with DCM rules. As noted benefits of § 1.82 are already being estimates that an AT Person will incur below, with respect to § 40.22(e), the realized. This proposed rule may serve a total annual cost of $4,240 to draft the Commission estimates that a DCM to limit a ‘‘race to the bottom’’ in which report and submit the policies and would find it necessary to review the some entities sacrifice effective risk procedures as required by § 1.83(a). This books and records of approximately controls in order to minimize costs or cost is broken down as follows: 1 Senior 10% of AT Persons and clearing increase the speed of trading. Thus, the Compliance Specialist, working for 50 member FCMs on an annual basis. The proposed rule would help ensure that hours (50 × $57 per hour = $2,850) and production of such records would result the benefits of the required risk controls 1 Chief Compliance Officer, working for in additional burden hours by AT will be fully realized. 10 hours (10 × $139 per hour = $1,390) Person and clearing member FCM in- for a total cost of $4,240 per year. The xi. § 1.83 Costs—AT Persons and FCM house counsel, a consideration which approximately 420 AT Persons to which Clearing Members Must Submit the Commission included in its annual § 1.83(a) would apply would therefore Compliance Reports and Maintain cost estimates below. incur a total annual cost of $1,780,800 AT Person Recordkeeping Costs. The Certain Books and Records (420 × $4,240) to prepare and submit the Commission estimates that, on an initial Proposed § 1.83 would require AT report and written policies and basis, an AT Person will incur a cost of Persons and FCMs that are clearing procedures required by § 1.83(a). $5,130 to draft and update members for AT Persons to annually Clearing Member FCM Compliance recordkeeping policies and procedures submit reports regarding compliance Reports. The Commission further and make technology improvements to with § 1.80(a) and § 1.82(a)(1), estimates that an FCM will incur a total recordkeeping infrastructure. This cost respectively, to each DCM on which cost annually of $7,090 to draft the is broken down as follows: 1 they operate. The reports prepared by report required by § 1.83(b). This cost is Compliance Attorney, working for 30 AT Persons would have descriptions of broken down as follows: 1 Senior hours (30 × $96 = $2,880); and 1 the AT Person’s pre-trade risk controls Compliance Specialist, working for 100 Developer, working for 30 hours (30 × as required by proposed § 1.80(a). The hours (100 × $57 per hour = $5,700) and $75 = $2,250). The 420 AT Persons reports prepared by FCMs that are 1 Chief Compliance Officer, working for would therefore incur a total initial cost clearing members for AT Persons would 10 hours (10 × $139 per hour = $1,390), of $2,154,600 (420 × $5,130). have a description of the FCM’s program for a total cost of $7,090 per year. The The Commission estimates that, on an for establishing and maintaining the 57 FCMs to which § 1.83(b) would apply annual basis, an AT Person will incur a pre-trade risk controls required by would therefore incur a total annual cost of $2,670 to ensure continued proposed § 1.82(a)(1) for its AT Persons cost of $404,130 (57 × $7,090) to prepare compliance with DCM recordkeeping at the DCM. The reports would also be and submit the report required by rules relating to § 1.82 compliance, required to include a certification by the § 1.83(b). including the updating of policies and chief executive officer or chief AT Person and Clearing Member FCM procedures and technology compliance officer of the AT Person or Retention of Books and Records. As infrastructure, and in respond to DCM clearing member FCM, as applicable, discussed above, the Commission record requests. This cost is broken that, to the best of his or her knowledge believes that AT Persons and clearing down as follows: 1 Compliance and reasonable belief, the information member FCMs already implement the Attorney, working for 20 hours (20 × contained in the report is accurate and risk controls, testing standards and $96 = $1,920); and 1 Developer, working complete. other measures that would be required for 10 hours (10 × $75 = $750). The 420 In addition, proposed § 1.83(c) and (d) pursuant to §§ 1.80, 1.81, and 1.82. AT Persons would therefore incur a would require AT Persons and clearing Retention of records relating to such total annual cost of $1,121,400 (420 × member FCMs for AT Persons to keep measures is prudent business practice $2,670). and provide upon request to DCMs and the Commission anticipates that Clearing Member FCM Recordkeeping books and records regarding their many AT Persons and clearing member Costs. The Commission estimates that, compliance with §§ 1.80 and 1.81 (for FCMs already maintain some form of on an initial basis, a clearing member AT Persons) and § 1.82 (for clearing these records in the ordinary course of FCM will incur a cost of $5,130 to draft member FCMs). The Commission is also their business. Accordingly, the and update recordkeeping policies and proposing pursuant to § 40.22(d) that Commission believes that AT Persons procedures and make technology DCMs must require each AT Person to and clearing member FCMs will adapt improvements to recordkeeping

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infrastructure. This cost is broken down with §§ 1.80 and 1.81 (for AT Persons) at least some of the controls required by as follows: 1 Compliance Attorney, and § 1.82 (for clearing member FCMs). § 38.255(b), there will be no additional working for 30 hours (30 × $96 = The reports and recordkeeping proposed annual costs to maintain the $2,880); and 1 Developer, working for by § 1.83, and the review program modifications required to bring the 30 hours (30 × $75 = $2,250). The 57 proposed by § 40.22, will enable DCMs systems into compliance with this clearing member FCMs would therefore to have a clearer understanding of the regulation. incur a total initial cost of $292,410 (57 pre-trade risk controls of all AT Persons Accordingly, the Commission × $5,130). that are engaged in Algorithmic Trading estimates that the 15 DCMs that will be The Commission estimates that that on such DCM. The proposed reports subject to § 38.255(b) would therefore DCM rules pursuant to proposed will also enable DCMs to set up the incur a total one-time cost of $2,332,800 § 40.22(d) requiring clearing member review program required by § 40.22. The (15 × $155,520) to update their controls. FCMs to keep and provide books and review program would improve the The Commission believes that the records relating to § 1.82 compliance standardization of market participants’ above estimates would change if a DCM will result in annual costs of 30 hours pre-trade risk controls. The must upgrade its systems in order to of burden per clearing member FCM, standardization of such systems and comply with § 40.20 (discussed below). and 1,710 burden hours in total. The procedures should further reduce the Under such circumstances, where the estimated burden was calculated as risk that a market participant will DCM is already upgrading controls for follows: engage in disorderly trading due to its own implementation pursuant to The Commission estimates that, on an inadequate pre-trade risk controls. § 40.20, total cost to upgrade controls for annual basis, a clearing member FCM use by FCMs pursuant to § 38.255 will incur a cost of $2,670 to ensure xiii. § 38.255(b) and (c) Costs—DCMs should decrease. The controls required continued compliance with DCM Must Provide Controls to FCMs by § 40.20 should include interfaces to recordkeeping rules relating to § 1.82 As noted above with respect to support external interactions and compliance, including the updating of proposed § 1.82, based on Concept expanding them to support FCMs policies and procedures and technology Release comments, best practices should not have additional costs. infrastructure, and in respond to DCM documents issued by industry or The Commission emphasizes that record requests. This cost is broken regulatory organizations, as well as costs listed above are estimates, and it down as follows: 1 Compliance existing regulations, the Commission welcomes comment on their accuracy. Attorney, working for 20 hours (20 × believes that most DCMs already have The Commission further emphasizes $96 = $1,920); and 1 Developer, working established the specifically-enumerated that the costs for each DCM will vary. for 10 hours (10 × $75 = $750). The 57 pre-trade and other risk controls for use Finally, the Commission notes that, as clearing member FCMs would therefore by clearing members that would be indicated above, these estimates may incur a total annual cost of $152,190 (57 required pursuant to revised § 38.255. overstate the actual costs to DCMs. × $2,670). The Commission also notes that existing Based on Concept Release comments, As discussed further in the § 38.607 requires that DCMs that permit best practices issued by industry and consideration of § 15(a) factors below, direct electronic access must have in regulatory organizations, as well as the Commission also acknowledges that place effective systems and controls existing regulations, the Commission the compliance requirements of reasonably designed to facilitate an believes that DCMs have largely already Regulation AT could have adverse FCM’s management of financial risk, established and are providing to FCMs effects on small clearing firms. Any such as automated pre-trade controls the pre-trade and other risk controls compliance costs that go beyond that enable member FCMs to implement required by § 38.255(b). appropriate financial risk limits. existing industry practice could xiv. § 38.255(b) and (c) Benefits—DCMs Accordingly, even if DCMs do not potentially cause some FCMs to scale Must Provide Controls in DEA Context back operation. Thus the rule has some currently and voluntarily implement the potential to contribute to increased specific controls addressing the risks of An additional benefit to Regulation concentration among clearing firms, i.e., Algorithmic Trading proposed under AT is the reduction of system risk in the fewer competing clearing firms. § 38.255(b), they should already have in context of Direct Electronic Access. As The Commission emphasizes that place similar systems addressing FCMs’ noted above, the Commission believes costs listed above are estimates, and it management of financial risk pursuant that Algorithmic Trading creates risks welcomes comment on their accuracy. to existing § 38.607. regardless of the method of access. The Commission further emphasizes Estimate-Upgrade of Controls. With Because of this, the Commission seeks that the costs for each AT Person and respect to a DCM that already has the to ensure that all types of trading, each FCM will vary. controls required by § 38.255(b) in including through DEA, is subject to place, and only needs to update them to pre-trade and other risk controls. The xii. § 1.83 Benefits—AT Persons and meet regulatory requirements (i.e., requirements of proposed § 38.255(b) FCM Clearing Members Must Submit evaluate current systems, modify or specifically address the structure of Compliance Reports and Maintain create new code, and test systems), the DEA, in which orders submitted by an Certain Books and Records Commission estimates that the cost to AT Person do not flow through the Proposed § 1.83 would require AT the DCM would be $155,520. This cost clearing member FCM’s infrastructure Persons and FCMs that are clearing is broken down as follows: 1 Project prior to submission to the DCM. members for AT Persons to annually Manager, working for 480 hours (480 × Currently, credit risk in the DEA context submit reports regarding compliance $70 per hour = $33,600); 1 Business is addressed through clearing member with § 1.80(a) and § 1.82(a)(1), Analyst, working for 480 hours (480 × FCM-implemented controls provided by respectively, to each DCM on which $52 per hour = $24,960); 1 Tester, the DCM, as required pursuant to they operate. Proposed § 1.83(c) and (d) working for 480 hours (480 × $52 per existing regulations §§ 38.607 and 1.73. would require AT Persons and clearing hour = $24,960); and 2 Developers, Proposed § 38.255(b) and (c) follow a member FCMs, respectively, to keep and working for a combined 960 hours (960 similar approach that would allow provide upon request to DCMs books × $75 per hour = $72,000). Commission clearing members to have control over and records regarding their compliance staff estimates that if a DCM already has the trading flow of their DEA customers

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for purposes of addressing the While the Commission believes that above estimates for § 40.20 would operational risks of Algorithmic most DCMs already implement the change if a DCM is simultaneously Trading. Accordingly, § 38.255(b) would controls required by § 40.20, it upgrading its systems in order to contribute to orderly markets by acknowledges that there may be DCMs comply with § 38.255. Where the DCM preventing orders that are outside of that do not currently implement such is already upgrading controls for FCM pre-determined parameters and controls, and those DCMs would incur implementation pursuant to § 38.255, ensuring a level-playing field among some costs to comply with this the cost of upgrading controls for its clearing members. regulation. An initial investment would own implementation pursuant to § 40.20 As noted, the Commission believes be required to develop and implement should decrease. that proposed regulations § 38.255(b) processes necessary for compliance, and The Commission emphasizes that and (c) standardize existing industry ongoing costs would be incurred to costs listed above are estimates, and it practices in this area, and that many of maintain such controls. The costs for welcomes comment on their accuracy. the requirements are already followed each DCM will vary depending on the The Commission further emphasizes by the majority of DCMs. Accordingly, degree to which its current practices are that the costs for each DCM will vary. the Commission notes that many of the or are not in compliance, as well as the Finally, the Commission notes that, as benefits of § 38.255(b) and (c) are procedures it selects and implements in indicated above, these estimates may already being realized. The proposed order to comply. In addition, as noted overstate the actual costs to DCMs. rule would help ensure that the benefits above with respect to § 38.255(b) and Based on Concept Release comments, of the required risk controls will be fully (c), the Commission acknowledges that best practices issued by industry and realized across all DEA active Regulation AT could have adverse regulatory organizations, as well as participants and sustained in the future. effects on smaller DCMs. Any existing regulations, the Commission compliance costs that go beyond believes that DCMs are largely already xv. § 40.20 Costs—Pre-Trade and existing industry practice could using the pre-trade and other risk Other Risk Controls (DCMs) potentially cause some DCMs to cease or controls required by § 40.20. Based on Concept Release comments, scale back operation, and could xvi. § 40.20 Benefits—Pre-Trade and best practices documents issued by potentially impact the entry of new Other Risk Controls (DCMs) industry or regulatory organizations, as DCMs. well as existing regulations, the Estimate—Upgrade of Controls. With The Commission believes that the pre- Commission believes that most DCMs respect to a DCM that already has the trade risk and order management already implement the specifically- controls required by proposed § 40.20 in control requirements that DCMs must enumerated pre-trade and other risk place, and only needs to update them to implement pursuant to proposed controls required pursuant to proposed meet regulatory requirements (i.e., § 40.20, inasmuch as they are not § 40.20. In response to the Concept evaluate current systems, modify or currently implemented, will contribute Release, CME and CFE indicated that create new code, and test systems), the to a system-wide reduction in they implement message rate limits,660 Commission estimates that the cost to operational risk, and will help order size limits, and price collar the DCM would be $155,520. This cost standardize risk management practices mechanisms.661 In addition, they is broken down as follows: 1 Project across exchanges. These enhanced risk indicated that they provide an optional Manager, working for 480 hours (480 × management practices should help cancel-on-disconnect functionality 662 $70 per hour = $33,600); 1 Business reduce unintended market volatility and and kill switch tools.663 The Analyst, working for 480 hours (480 × mitigate and prevent significant Commission notes that these types of $52 per hour = $24,960); 1 Tester, disruptive activity caused by × controls have been subject of industry working for 480 hours (480 $52 per algorithmic trading malfunctions. In addition, given that FCMs may best practices for years. For example, hour = $24,960); and 2 Developers, have differing information about the ESMA guidelines from 2012 working for a combined 960 hours (960 × trading activities of their customers/ recommended that trading platforms $75 per hour = $72,000). The users, a DCM may be better able to implement, among other things, Commission estimates that if a DCM identify unintended market behavior. throttling limits and controls filtering already has at least some of the controls For example, with respect to a trading order price and quantity.664 In addition, required by § 40.20, there will be no firm active in a single product and using the CFTC TAC recommended in 2011 additional annual costs to maintain the multiple clearing firms, identifying total that exchanges implement, among other modifications required to bring the order frequencies or inventory levels things, message throttles, order quantity systems into compliance with this may be more easily done at the market limits, price collars, and order regulation. venue. To protect against the broadest cancellation policies that allow clearing Accordingly, the Commission set of errors, there are benefits to firms and clients to opt for automatic estimates that the 15 DCMs that will be implementing risk controls at multiple cancellation of order upon disconnect subject to § 40.20 would therefore incur points in the order chain, including the and provide clearing firms with a tool a total one-time cost of $2,332,800 (15 × DCM. that allows them to view and cancel $155,520) to update their controls. The Commission notes that a DCM As noted, the Commission believes orders.665 can choose not to develop these controls that proposed § 40.20 standardizes internally, but rather may purchase a existing industry practices in this area, 660 In addition, four commenters stated generally that many exchanges have messaging rate limits in solution from an outside vendor (or and that many of the requirements are place. See TCL at 6; KCG at 4; MFA at 7; AIMA at another DCM) in order to comply with already followed by the majority of 8. § 40.20. The Commission welcomes DCMs. Accordingly, the Commission 661 CME at 8–9, 13–17; CME Appendix A–1, 3– comments providing estimates notes that many of the benefits of 4, 6; CFE at 5–8. concerning the cost for a DCM to use § 40.20 are already being realized. The 662 CME at 23–24, Appendix A–4; CFE at 9–10. 663 CME at 23–24. technology solution from an outside proposed rule would help ensure that 664 ESMA Guidelines, supra note 61 at 12–13. party to comply with this proposed the benefits of the required risk controls 665 CFTC TAC Recommendations, supra note 34 regulation. In addition, as discussed will be fully realized and sustained in at 4–5. above, the Commission believes that the the future.

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xvii. § 40.21 Costs—DCM Test commonly make their own historical reasonably designed to identify and Environments for AT Persons (DCMs) data available for testing purposes. CME remediate any insufficient mechanisms, The Commission believes that the stated that it requires all systems policies, and procedures described in majority of DCMs have implemented interfacing with CME Globex to be such books and records. DCM Establishment of Review test environments in which market certified on the order entry and/or market data interfaces prior to Program. The Commission estimates participants may test their algorithmic deployment.667 FIA also recommended that a DCM will incur a total one-time systems. The Commission received the use of DCM test environments, cost of $37,000 to establish the review comments in response to the Concept noting in its comment letter, ‘‘We program required by proposed § 40.22. Release that ‘‘many, if not all, exchanges encourage DCMs to develop more robust This cost is broken down as follows: 1 provide market participants a test test environments that more closely Tester, working for 200 hours (200 × $52 facility to test trading software and simulate trading in the production per hour = $10,400); 1 Developer, algorithms, as well as offer test symbols environment, and market participants to working for 200 hours (200 × $75 per to trade.’’ 666 The Commission believes thoroughly test new and modified hour = $15,000); and 1 Senior that most if not all DCM’s already software in these DCM provided Compliance Examiner, working for 200 provide test environments that would simulators when necessary.’’ 668 hours (200 × $58 per hour = $11,600).669 comply with proposed § 40.21. As a The 15 DCMs to which § 40.22 would result, subject to consideration of xix. § 40.22 Costs—DCM Review of apply would therefore incur a total one- relevant comments, the Commission Compliance Reports (DCMs) time cost of $555,000 (15 × 37,000) to preliminarily believes that DCMs will Proposed § 40.22 complements the establish the review program required not incur any material additional costs requirement under § 1.83 for AT Persons by § 40.22.670 to comply with the proposed regulation. and clearing member FCMs to submit DCM Review of Compliance Reports The Commission is therefore not compliance reports to DCMs. Proposed (§ 40.22(c)). Proposed § 40.22(a) and (b) estimating any costs for DCMs in 40.22(a) requires a DCM to implement would require DCMs to implement rules connection with the proposed rules that require each AT Person that that require AT Persons, and FCMs that regulation in this discussion. trades on the DCM, and each FCM that are clearing members for AT Persons, to xviii. § 40.21 Benefits—DCM Test is a clearing member of a DCO for such submit the reports required of AT Environments for AT Persons (DCMs) AT Person, to submit the reports Persons and clearing member FCMs by described in § 1.83(a) and (b), proposed § 1.83. Proposed § 40.22(c) As noted, the Commission believes respectively. Under proposed § 40.22(b), requires a DCM to establish a program that proposed § 40.21 standardizes a DCM must require the submission of for effective periodic review and existing industry practices in this area, such reports by June 30th of each year. evaluation of reports described in and that the requirements are already Proposed § 40.22(c) requires a DCM to paragraph (a) of § 40.22, and of the followed by the majority of DCMs. establish a program for effective measures described therein. As Accordingly, the Commission notes that periodic review and evaluation of discussed in section V(D)(e) above, many of the benefits of § 40.21 are reports described in paragraph (a) of Commission staff estimates that each already being realized. The proposed § 40.22, and of the measures described DCM will review 120 reports per year rule will help ensure that the benefits therein. An effective program must pursuant to § 40.22(c). The Commission are being realized at all DCMs and include measures by the DCM estimates that a DCM will incur a total sustained in the future. Proposed reasonably designed to identify and cost of $925 to review each report § 40.21 requires DCMs to provide test remediate any insufficient mechanisms, required by § 40.22. This cost is broken environments in which market policies and procedures described in down as follows: 1 Tester, working for participants may test their algorithmic such reports, including identification 5 hours (5 × $52 per hour = $260); 1 systems. This regulation is designed to and remediation of any inadequate Developer, working for 5 hours (5 × $75 promote testing of algorithmic systems quantitative settings or calibrations of per hour = $375); and 1 Senior using data and market conditions that pre-trade risk controls required of AT Compliance Examiner, working for 5 approximate as closely as possible those Persons pursuant to § 1.80(a). hours (5 × $58 per hour = $290), for a of a live trading environment. Such In addition, as a complement to the total review cost of $925 per report. If testing should enable market compliance report review program a DCM reviews an average of 120 reports participants to discover potential issues described above, proposed § 40.22(d) per year, a DCM would require 1,800 in the design of their algorithmic requires each AT Person to keep and hours per year to review the 120 reports systems that were not discovered in provide to the DCM books and records (15 hours × 120 reports), and would their own test environment, thereby regarding their compliance with all incur a cost of $111,000 per year. The mitigating the risk that algorithmic requirements pursuant to § 1.80 and 15 DCMs to which § 40.22 would apply systems cause market disruptions by § 1.81, and requires each clearing would incur a total annual cost of failing to operate as intended in the member FCM to keep and provide to the $1,665,000 (15 × $111,000) to conduct production environment. Comments DCM market books and records such a review. received in response to the Concept regarding their compliance with all DCM Communication of Remediation Release indicate that DCMs recognize requirements pursuant to § 1.82. Finally, Instructions (§ 40.22(c)). Proposed the benefit of providing such test proposed § 40.22(e) requires DCMs to § 40.22(c) states that an effective review environments to their market review and evaluate, as necessary, books program must include measures by the participants. For example, CME and records required to be kept DCM reasonably designed to identify indicated that market participants pursuant to § 40.22(d), and the measures and remediate any insufficient routinely test in their own testing described therein. An appropriate mechanisms, policies and procedures environments using historical data to review pursuant to § 40.22(e) should test trading strategies against a range of include measures by the DCM 669 See section V(B) above for the calculation of market conditions, and that exchanges hourly wage rates used in this analysis. 667 CME at 25–26. 670 See section V(A) above for the calculation of 666 MFA at 13. 668 FIA at 35. the number of persons subject to Regulation AT.

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described in such reports, including Person’s algorithm frequently performs scale back operation, and impact the identification and remediation of any in a manner inconsistent with its entry of new DCMs. inadequate quantitative settings or design, which may raise questions about xx. § 40.22 Benefits—DCM Review of calibrations of pre-trade risk controls the design or monitoring of the AT Compliance Reports (DCMs) required of AT Persons pursuant to Person’s algorithms; if a DCM identifies proposed § 1.80(a). The Commission frequent trade practice violations at an Proposed § 40.22 is a complement to estimates that a DCM will communicate AT Person, which are related to an proposed § 1.83, which would require remediation instructions in connection algorithm of the AT Person; or if an AT AT Persons, and FCMs that are clearing with approximately 20% of the reports Person represents significant volume in members for AT Persons, to submit reviewed on an annual basis (or 24 a particular product, thereby requiring reports regarding compliance with reports, which is 20% of 120 reports). heightened scrutiny, among other § 1.80(a) and pursuant to § 1.82(a)(1), The Commission estimates that a DCM reasons. DCMs may find it appropriate respectively, to each DCM on which will incur a total cost of $925 to to review the books and records of AT they operate, and to keep and provide communicate remediation instructions Persons and clearing member FCMs on upon request to DCMs books and for a report required by § 40.22. This a more or less frequent basis, depending records regarding their compliance with cost is broken down as follows: 1 Tester, on other relevant considerations. all §§ 1.80 and 1.81 (for AT Persons) and × working for 5 hours (5 $52 per hour The Commission estimates that AT § 1.82 (for clearing member FCMs) = $260); 1 Developer, working for 5 Persons will generally be active on half requirements. New § 40.22 would × hours (5 $75 per hour = $375); and 1 of the 15 DCMs. If a DCM reviews the require each DCM that receives a report Senior Compliance Examiner, working books and records of 10% of AT Persons described in § 1.83 to establish a × for 5 hours (5 $58 per hour = $290), and clearing member FCMs on an program for effective review and evaluation of the reports. By requiring for a total review cost of $925 per report annual basis, a DCM will review 24 DCMs to review the reports, identify giving rise to remediation instructions. entities on an annual basis (420 AT outliers, and communicate instructions If a DCM provides remediation Persons + 57 clearing member FCMs = to outliers in order to remediate their instructions in connection with 24 477. 477/2 = 239 entities. 239 × .1 = 24). pre-trade risk controls, proposed § 40.22 reports per year, a DCM would require The Commission estimates that a DCM will standardize market participants’ 360 hours per year to review the 24 will incur a total cost of $4,620 to × pre-trade risk controls required reports (15 hours 24 reports), and review the books and records of an pursuant to proposed § 1.80(a). Further, would incur a cost of $22,200 per year. entity pursuant to § 40.22(e). This cost DCM review of compliance reports is an The 15 DCMs to which § 40.22(c) would is broken down as follows: 1 Senior important safeguard to prevent trading apply would incur a total annual cost of Compliance Examiner, working for 30 $333,000 (15 × $22,200) to conduct such × firms, the ‘‘outliers’’ described above, hours (30 $58 per hour = $1,740); and from operating without sufficient a review. 1 Compliance Attorney, working for 30 DCM Review of Books and Records controls. Proposed § 40.22(e) will hours (5 × $96 per hour = $2,880), for (§ 40.22(e)). Proposed § 40.22(d) requires complement the review of compliance a total review cost of $4,620 per entity each AT Person to keep and provide to reports, by requiring DCMs to review reviewed by a DCM. If a DCM reviews the DCM books and records regarding and evaluate, as necessary, the books the books and records of 24 entities per their compliance with all requirements and records kept by AT Persons to year, a DCM would require 1,440 hours pursuant to §§ 1.80 and 1.81, and demonstrate their compliance with per year to review the 24 entities (60 requires each clearing member FCM to §§ 1.80 and 1.81, and the books and hours × 24 entities), and would incur a keep and provide to the DCM market records kept by clearing member FCMs cost of $110,880 per year. The 15 DCMs books and records regarding their to demonstrate their compliance with compliance with all requirements to which § 40.22(e) would apply would § 1.82. A single Algorithmic Trading incur a total annual cost of $1,663,200 pursuant to § 1.82. The cost of these × malfunction at a single market obligations to AT Persons and clearing (15 $110,880) to review such books participant can significantly impact member FCMs under § 40.22(d) is and records. markets and market participants. discussed above in this section. Total Cost to DCMs for Proposed Accordingly, all DCMs and market Proposed § 40.22(e) requires DCMs to § 40.22 Requirements. A DCM will participants benefit from a review review and evaluate, as necessary, books therefore incur $133,200 ($111,000 + program that ensures that market and records required to be kept $22,200) on an annual basis to review participants conducting Algorithmic pursuant to § 40.22(d), and the measures all reports received at least once every Trading have adequate pre-trade risk described therein. The Commission two years, communicate instructions to controls in place. notes that § 40.22(e) does not prescribe persons whose controls the DCM has c. Section 15(a) Factors how frequently DCMs should perform determined are insufficient, and will this review, or how many AT Persons incur $110,880 on an annual basis to This section discusses the CEA and clearing member FCMs should be review the books and records of 24 AT section 15(a) factors for the following evaluated on an annual basis. For Persons and clearing member FCMs. proposed regulations: (i) The purposes of generating a cost estimate, The 15 DCMs to which § 40.22 would requirement that AT Persons implement the Commission anticipates that a DCM apply would therefore incur a total pre-trade risk controls and other related will find it necessary to review the annual cost of $3,661,200 ($1,665,000 + measures (§ 1.80); (ii) standards for the books and records of approximately $333,000 + $1,663,200) to maintain the development, testing, and monitoring of 10% of AT Persons and clearing review program required by § 40.22. Algorithmic Trading systems by AT member FCMs on an annual basis. For The Commission also acknowledges Persons (§ 1.81); (iii) RFA standards for example, a DCM may find it necessary that the compliance requirements on automated trading and algorithmic to conduct such a review if: it becomes DCMs in Regulation AT could have trading systems of their members aware if an AT Person’s kill switch is adverse effects on smaller DCMs. Any (§ 170.19); (iv) the requirement that AT frequently activated, or otherwise compliance costs that go beyond Persons must become a member of a performs in an unusual manner; if a existing industry practice could futures association (§ 170.18); (v) the DCM becomes aware that an AT potentially cause some DCMs to cease or requirement that clearing member FCMs

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implement pre-trade risk controls and effective risk and order management wide set of market participants, and other related measures (§ 1.82); (vi) the controls, may reduce the likelihood that reduce the likelihood that an outlier requirement that AT Persons submit market participants execute trades at firm without sufficient risk controls compliance reports to DCMs regarding terms they do not intend. This is causes significant market disruption. their risk controls and Algorithmic particularly important as to price, as In particular, the implementation of Trading procedures and clearing market participants and members of the such controls and systems would help member FCMs submit compliance public rely on the prices of trades prevent the occurrence of unintended reports to DCMs regarding their risk executed on DCMs, often for products and erroneous trades, and therefore control program for AT Person not directly traded on the DCM. The contribute to market efficiency and customers, and that AT Persons and requirements of proposed § 40.22, integrity. For example, Regulation AT clearing member FCMs keep and which requires DCMs to review the requires that trading firms, clearing provide upon request to DCMs certain compliance reports and the books and members and exchanges implement related books and records (§ 1.83); (vii) records of AT Persons and clearing maximum order size limits. That control the requirement that DCMs implement member FCMs, may promote protection is intended to prevent unintentionally pre-trade risk controls and other related of market participants and the public by large orders from entering the market measures (§§ 38.255 and 40.20); (viii) helping to ensure that the risk control and causing unintended executions. The the requirement that DCMs provide test rules are followed in a consistent Commission believes that a positive environments where AT Persons may manner and may further reduce the trading intention behind an execution is test their Algorithmic Trading systems likelihood of Algorithmic Trading integral to the operations of an efficient (§ 40.21); and (ix) the requirements of Events and Algorithmic Trading § 40.22, including that DCMs: Disruptions. Applying Regulation AT to market and to market integrity. By implement rules requiring AT Persons all market levels—the trading firm, the limiting the potential for erroneous and clearing member FCMs to submit clearing member, and the exchange— executions, Regulation AT should compliance reports each year (§ 40.22(a) may further protect market participants enhance market efficiency and integrity and (b)); establish a program for and the public by providing multiple by minimizing the number of trades that effective periodic review and evaluation layers of protection against market are subsequently broken and ensuring of the reports (§ 40.22(c)); require each disruptions. In addition, including that publicly reported transaction prices AT Person to keep and provide to the automated order routers in the are valid. Similarly, Regulation AT DCM books and records regarding their Algorithmic Trading definition may requires message and execution compliance with all requirements protect market participants and the throttles, which mitigate the risks of pursuant to §§ 1.80 and 1.81, and public by providing these protections to executing large numbers of unintended require each clearing member FCM to a wider set of automated systems that orders, potentially harming market keep and provide to the DCM market may have the potential to disrupt the efficiency and integrity. Ensuring that books and records regarding their markets. only bona fide and intentional orders compliance with all requirements Finally, the absence of pre-trade risk are entered into the market may also pursuant to § 1.82 (§ 40.22(d)); and and order management controls at help promote market competitiveness require DCMs to review and evaluate, as automated firms increases the chances by helping to ensure that a single entity necessary, books and records required to for unintended trading behavior, does not inadvertently dominate the be kept pursuant to § 40.22(d), and the including algorithms acting beyond market due to unintended excessive measures described therein (§ 40.22(e)). their parameters or risk levels, resulting orders. in unexpected market volatility or The Commission acknowledges that i. Protection of Market Participants and market disruptions (potentially across the Public certain aspects of Regulation AT, such multiple market venues), distorted as the compliance reports, could have The Commission preliminarily prices, and risks that could harm the adverse effects on some trading firms believes that Regulation AT would economy and the public. due to the cost of creating and protect market participants and the submitting the compliance reports, and public by limiting a ‘‘race to the ii. Efficiency, Competitiveness, and Financial Integrity of Futures Markets to the extent that firms do not already bottom,’’ in which certain entities do so, implementing and maintaining sacrifice effective risk controls in order The Commission preliminarily the proposed regulation’s required pre- to minimize costs or increase the speed believes that by addressing pre-trade trade risk and order management of trading. The proposed rules, by risk controls, testing, and order controls. In order to mitigate costs to standardizing the risk controls required management controls at all market trading firms, the Commission is to be used by firms, would help ensure levels—the trading firm, the clearing restricting the need for trading firm that the benefits of these risk controls member, and the exchange—Regulation level risk controls and the associated AT provides standards that can be are more evenly distributed across a compliance reports to those entities that interpreted and enforced in a uniform wide set of market participants, and are registered with the Commission in manner. Implementation of Regulation reduce the likelihood that an outlier some capacity. For those who are not AT would help mitigate instabilities in firm without sufficient risk controls required to register, pre-trade risk the markets and ensure market causes significant market disruption. controls will be executed by the entity’s efficiency and integrity. Regulation AT The requirements under proposed clearing firm and the contract market may serve to limit a ‘‘race to the §§ 170.18 and 170.19 that all AT the entity trades on and compliance Persons be registered as a member of a bottom,’’ in which certain entities reports will be submitted by the clearing futures association, and subject to an sacrifice effective risk controls in order FCM. RFA program promulgating standards to minimize costs or increase the speed for automated trading and algorithmic of trading. The proposed rules, by According to a study by the trading systems, further promotes the standardizing the risk controls required Commission’s Division of Swap Dealer standardization of risk controls. to be used by firms, would help ensure and Intermediary Oversight that was Moreover, the proposed rules, to the that the benefits of these risk controls presented to the Commission’s extent that they increase the usage of are more evenly distributed across a Agricultural Advisory Committee on

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September 22, 2015,671 the number of benefits that Regulation AT provides to control requirements contained in active FCMs has declined in recent the market, such as the protection of Regulation AT will contribute to a years from 180 in 2005 to 76 in market integrity and efficiency, which system-wide reduction in operational December 2014. The decline over this were impacted by previous disruptive risk, and will help standardize risk period in the number of FCMs holding market events. As noted in section III management practices across similar customer assets was not as large as the above, for example, the events at Knight entities within the marketplace. The overall decline in the number of FCMs: Capital significantly impacted the reduction in operational risk may from 85 to 60. The decline in the equities market. Due to coding errors in simplify the tasks associated with sound number of FCMs can be attributed to a Knight’s systems, the firm’s automated risk management practices. These number of factors, including low trading system inadvertently built up enhanced risk management practices interest rates (which can reduce FCM unintended positions in the equity should help reduce unintended market profitability by lowering the rate of market, eventually resulting in losses of volatility, which will aid in efficient return on the investment of customer more than $460 million for the firm.672 market making, and reduce overall funds) and the changing regulatory In addition, the Flash Crash in 2010 transaction costs as they relate to price environment. The compliance and other impacted market efficiency in several movements, which should encourage costs on clearing FCMs that go beyond respects; for example, due to the market participants to trade in existing industry practice could, in extreme price movement, the exchanges Commission-regulated markets. Market conjunction with existing factors that and FINRA made a determination to participants and those who rely on are pressuring FCMs, potentially cause cancel a significant number of trades prices as determined within regulated some additional FCMs to scale back that were executed during the crash.673 markets should benefit from markets operations, or make it less likely that The Commission has preliminarily that behave in an orderly and expected new FCMs will enter the market. The determined that burdens placed on fashion. Commission also notes the possibility market participants, FCMs, and DCMs that if clearing FCMs are required to imposed by Regulation AT is justified v. Other Public Interest Considerations establish and maintain pre-trade risk by the benefits in ensuring that all The Commission has not identified controls and order cancellation systems orders submitted through Algorithmic any effects that these proposed rules pursuant to § 1.82(c) with respect to AT Trading pass through effective controls would have on other public interest Order Messages originating with AT and systems that mitigate the risks of considerations other than those Persons that do not use DEA and to malfunctioning automated trading addressed above. submit compliance reports regarding systems. The Commission has their risk controls, they may refuse to endeavored to minimize the compliance d. Consideration of Alternatives serve such firms in light of the burden in Regulation AT to the i. Pre-Trade and Other Risk Controls additional costs or may raise trading minimum level necessary to protect In proposing these regulations, the fees to cover these costs. Such potential market participants and the public. Commission considered alternatives increased costs may make it more The proposed rules may promote the suggested by comments to the Concept difficult for new trading firms to enter financial integrity of futures markets by Release. The Commission notes that the the market and for certain existing reducing the likelihood of flash crashes Concept Release raised numerous trading firms to remain in the market. and other automated trading potential measures and controls, not all This could happen if FCMs determines disruptions. Such disruptions can place of which are proposed in Regulation to cease serving firms that, in light of financial strain on market participants, AT. Accordingly, comments supporting the increased costs, are no longer intermediaries, and DCOs. profitable for the FCM. However, it is or opposing regulation in the area of iii. Price Discovery possible that the rule will create a automated trading were made without market opportunity for certain FCMs to Requiring trading firms, clearing the benefit of knowing specifically what specialize in monitoring the operation members and exchanges to implement regulations would be proposed. Some of Algorithmic Trading systems used by pre-trade risk controls, testing, and commenters indicated that there was trading firms that do not use DEA. This order management control requirements already sufficient regulation in the area may mitigate the impact of other FCMs in order to mitigate the risk of a of risk controls. For example, FIA exiting the market or new FCMs malfunctioning trading algorithm or suggested that ‘‘the best approach to choosing not to enter the market and automated trading disruption promotes achieve standardization is to reflect may mitigate the impact on trading the price discovery process by reducing industry best practices through working the likelihood of transactions at prices groups of DCMs, FCMs and market firms. 674 The potential reduction in the number that do not accurately reflect market participants.’’ CFE stated that there is of clearing FCMs and market forces. already sufficient regulation of DCMs in relation to risk controls and that participants due to increased costs iv. Sound Risk Management Practices could reduce liquidity and increase exchange risk control practices should transaction costs in futures markets. The The Commission believes that the pre- evolve as technology and markets 675 proposed rules also impose costs on trade risk and order management evolve. MFA indicated that current DCMs that, to the extent they go beyond CFTC regulations and existing best existing industry practice (including the 672 See SEC Knight Capital Release, supra note 39. practices require entities to have 673 costs of reviewing submissions from AT As noted in the Flash Crash Report, ‘‘during sufficient and effective pre-trade risk the 20 minute period between 2:40 p.m. and 3:00 controls.676 ICE commented that Persons and FCMs pursuant to proposed p.m., over 20,000 trades (many based on retail- § 40.22), may significantly affect small customer orders) across more than 300 separate exchanges are better able to implement or start-up DCMs. However, the securities, including many ETFs, were executed at and update risk controls on a market-by- prices 60% or more away from their 2:40 p.m. market basis than through a Commission emphasizes the general prices. After the market closed, the exchanges and FINRA met and jointly agreed to cancel (or break) 671 The presentation is available at http:// all such trades under their respective ‘clearly 674 FIA at 63. www.cftc.gov/idc/groups/public/@aboutcftc/ erroneous’ trade rules.’’ See the Flash Crash Report, 675 CFE at 1–2. documents/file/aac092215presentations_dsio.pdf. supra note 121 at 6. 676 MFA at 5.

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Commission rulemaking.677 OneChicago they implement risk controls, the the definition of Algorithmic Trading indicated that ‘‘additional mandates’’ as specific design and operation of risk would therefore be limited. to exchange risk controls will increase controls should not be mandated by In the event that a non-clearing FCM costs and complexity.678 regulation. Rather, given the wide or other entity acts only as a conduit for As noted above, the Concept Release variety of trading firms, technology, orders, and does not make any addresses a number of potential trading strategies, markets, and determinations with respect to such measures that are not proposed as part products, the relevant entities—trading orders, the conduit entity would not be of Regulation AT. With respect to the firms, clearing firms, and DCMs— engaged in Algorithmic Trading, as that pre-trade risk and other controls should have the discretion to determine definition is currently proposed. The proposed in this NPRM, the the appropriate design of the specific Commission preliminarily believes that Commission acknowledges that many controls required by Regulation AT. expanding the definition to include best practices as to risk controls have The remainder of this discussion conduit entities would not sufficiently been developed without a regulatory focuses on various alternative measures enhance the benefits associated with mandate, and that trading firms, that the Commission considered in Regulation AT relative to the additional clearing member FCMs, and DCMs are proposing these regulations, some of costs. in the best position to determine the which were discussed in the Concept The Commission determined not to most effective design of their own Release, and some of which are extend Regulation AT to SEFs, a particular risk controls and innovate contained in other regulatory systems. proposal that was supported by one new forms of controls. However, the The Commission evaluated various Concept Release commenter. CFE stated Commission believes that regulation in regulatory definitions of algorithmic that any risk control requirements this area will better foster trading when considering how to draft should apply to SEFs, in addition to standardization of controls across all a definition for purposes of this NPRM. DCMs. CFE explained that there must be entities, including smaller firms or The Commission has proposed that the a level playing field between both DCMs exchanges that may, without regulation, definition of Algorithmic Trading will and SEFs and that there be no regulatory implement some but not all of the include systems that make disparities that would make it more controls required by Regulation AT. determinations regarding any aspect of advantageous to list a swap on a SEF as This rulemaking may serve to limit a the routing of an order, i.e., systems that opposed to a DCM.680 The Commission ‘‘race to the bottom’’ in which some only make decisions as to the routing of believes in fostering a level playing field entities sacrifice effective risk controls orders to one or more trading venues. in its markets, and as a result any in order to minimize costs or increase The Commission notes analogous requirements on DCMs arising out of the speed of trading. In the context of definitions adopted by the European Regulation AT may ultimately be automated trading, a technological Commission under MiFID II and by imposed on SEFs at a later date. malfunction at a single firm can have a FINRA do not include automated However, as noted in section (C)(1) significant impact across markets and systems that only route orders as above, an important consideration for market participants.679 Given that algorithmic trading. Excluding the Commission is that SEFs and SEF reality, it is insufficient that some, but automated order routers would reduce markets are much newer and less liquid not all, industry participants have the the number of automated systems than the more established and liquid appropriate risk controls. Requiring the captured by Regulation AT relative to DCMs and DCM markets. While SEFs implementation of certain risk controls the Commission’s proposal and may and SEF markets are still in this nascent through regulation will help ensure that reduce the number of AT Persons stage, the Commission does not want to all industry participants have the subject to the costs of the regulation. impose additional requirements that appropriate risk controls, thus fostering Nevertheless, the Commission believes may have the effect of decreasing the trade certainty and market integrity for that automated order routers have the number of SEFs or decreasing liquidity. all market participants. In determining potential to disrupt the market to a Moreover, the Commission, based on its which risk controls discussed in the similar extent as other types of present knowledge, believes that Concept Release should be proposed in automated systems, and that there are automated trading is not as prevalent in this NPRM, the Commission has significant benefits to including SEF markets as compared to DCM attempted to propose those core risk automated order routers in the proposed markets. Therefore, the policy controls that it believes are currently regulations. considerations underlying Regulation implemented by the majority of market The Commission is also considering AT are not as critical, at least at this participants, foregoing certain risk expanding the definition of Algorithmic time, in the SEF context. controls that are implemented by Trading to encompass orders that are Proposed § 1.82 requires clearing FCMs to implement controls with relatively few market participants and generated using algorithmic methods respect to AT Order Messages may be of less value in mitigating risk. (e.g., an algorithm generates a buy or In addition, some commenters to the sell signal at a particular time), but are originating with an AT Person. The Concept Release explained the then manually entered into a front-end Commission is considering modifying appropriate implementation or design of system by a natural person, who proposed § 1.82 to require clearing particular pre-trade risk controls, which determines all aspects of the routing of FCMs to implement controls with are discussed above as relevant to each the orders. Such an alternative would respect to all orders, including orders control. Also as discussed above, the increase the number of automated that are manually submitted. Such a Commission determined that, while it systems captured by Regulation AT requirement would correspond to the believes that these comments are relative to the Commission’s proposal requirement under proposed § 40.20(d) reasonable and merit further and may increase the number of AT that DCMs implement risk controls for consideration by market participants as Persons subject to the costs of the orders that do not originate from regulation. The Commission Algorithmic Trading. The Commission 677 ICE at 1. preliminarily believes that such is considering this modification because 678 OneChicago at 4–5. manually entered orders present less it recognizes that manually entered 679 See, e.g., the discussion of Knight Capital in risk than fully automated orders and section III above. that the benefits of including them in 680 CFE at 2.

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orders also have the potential to cause to AT Persons and to the DCMs that will unique or additional costs that will be significant market disruption. The be required to review the reports under imposed on such persons to develop the Commission requests comment on this proposed § 40.22, while retaining the technology and systems necessary to proposed alternative formulation of benefits of protecting market implement the pre-trade and other risk § 1.82, which the Commission may participants and the public from controls required by Regulation AT. implement in the final rulemaking for disruptions and other adverse events 116. In question 14, the Commission Regulation AT. The Commission associated with automated trading. asks whether there are any AT Persons acknowledges that this proposed Requirements related to RFAs. The who are natural persons. Would AT alternative formulation would impose Commission is considering making Persons who are natural persons (or sole additional costs on clearing FCMs adjustments to the scope of RFA proprietorships with no employees relative to the currently proposed § 1.82. responsibility under proposed § 170.19. other than the sole proprietor) be The Commission requests comment on For example, RFAs could be responsible required to hire staff to comply with the the potential benefits of this proposal for fewer or additional areas regarding risk control, testing and monitoring, or relative to the increased costs to clearing AT Persons, ATSs, and algorithmic compliance requirements of Regulation FCMs, in addition to any other trading than specified in proposed AT? comments regarding the effectiveness of § 170.19 and could have more or less 117. Do you agree with the accuracy this proposal in terms of risk reduction. latitude to issue rules than under the of cost estimates provided by the proposal. Commission as to how much it will cost ii. Compliance Reports a trading firm, clearing member FCM or Proposed § 1.83 would require AT e. Request for Comments DCM to internally develop the Persons and clearing FCMs to submit Pre-Trade and Other Risk Controls technology and systems necessary to compliance reports to DCMs on an implement the pre-trade and other risk annual basis. Such reports would need 112. How would an alternative controls required by Regulation AT? If to be submitted and certified annually definition of Algorithmic Trading that you disagree with the Commission’s by the chief executive officer or the excludes automated order routers affect analysis, please provide your own chief compliance officer of the AT the costs and benefits of the pre-trade quantitative estimates, as well as data or Person or FCM. Proposed § 40.22 would and other risk controls in comparison to other information in support. Please require DCMs to establish a program for the costs and benefits of the proposed specify in your answer the type of entity effective periodic review and evaluation definition that includes automated order and which specific pre-trade risk or of the reports. The Commission has routers? Would such an alternative order management controls for which proposed these regulations, using the definition reduce the number of AT you are providing estimates. deadlines described above, because it Persons captured by Regulation AT? In addition, please differentiate believes they represent an appropriate 113. Would the benefits of Regulation between the situations where an entity balancing of the transparency and risk AT be enhanced significantly if the (i) already has partially compliant reduction provided by the reports definition of Algorithmic Trading were controls in place, and only needs to against the burden placed on AT modified to capture a conduit entity upgrade such technology and systems to Persons, clearing FCMs, and DCMs of such as a non-clearing FCM, thereby bring it into compliance with the providing and reviewing the reports. making the entity an AT Person subject regulations; and (ii) needs to build such The Commission is considering the to Regulation AT? How would such a technology and systems from scratch. alternatives of requiring AT Persons and modification affect costs? Please include, as applicable, hardware clearing FCMs to submit such reports 114. Would the benefits of Regulation and software costs as well as the hourly more or less frequently than annually. AT be enhanced significantly if the wage information of the employee(s) The Commission is also considering the definition of Algorithmic Trading were necessary to develop such risk controls alternatives of placing the responsibility expanded to encompass orders that are (i.e., technology personnel such as for certifying the reports required by generated using algorithmic methods programmer analysts, senior proposed § 1.83 only on the chief (e.g., an algorithm generates a buy or programmers and senior systems executive officer, only on the chief sell signal at a particular time), but are analysts). compliance officer, or permitting then manually entered into a front-end 118. The Commission has assumed certification from other officers of the system by a natural person? How would that the effort to adjust any one risk AT Person or FCM. While proposed such a modification affect costs? Please control (by ‘‘control,’’ in this context, § 40.22 would require DCMs to establish comment on the costs and benefits of an the Commission means the pre-trade a program for effective periodic review alternative whereby the Commission risk controls, order cancellation and evaluation of the reports, the would implement specific rules systems, and connectivity systems Commission is considering the regarding the appropriate design of the required by § 1.80) will require alternative of requiring DCMs to review specific controls required by Regulation assessment and possible modifications the reports at more specific intervals. AT and compare them to the costs and to all controls. Is this assumption The Commission considered the benefits of the Commission’s proposal correct, and if not, why not? alternative of requiring additional whereby the relevant entities—trading 119. As indicated above, the information in the reports by AT firms, clearing firms, and DCMs—would Commission lacks sufficient information Persons to DCMs under proposed § 1.83, have the discretion to determine the to provide full estimates of costs that a including (1) descriptions of order appropriate design of those controls. trading firm, clearing member FCM or cancellation systems; (2) policies and 115. Does one particular segment of DCM will incur if it chooses not to procedures for the development, testing, trading firms, clearing member FCMs or internally develop such controls, and and monitoring of Algorithmic Trading DCMs (e.g., smaller entities) currently instead purchases the solutions of an systems; and (3) policies and procedures implement fewer of the pre-trade and outside vendor in order to comply with for the training of Algorithmic Trading other risk controls required by Regulation AT’s pre-trade and other risk staff. The Commission determined not Regulation AT than some other segment controls requirements. Please provide to propose these additional of trading firms, clearing member FCMs quantitative estimates of such costs, requirements in order to limit costs both or DCMs? If so, please describe any including supporting data or other

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information. In addition, please specify complying with each of the following 129. Has the Commission accurately in your answer the type of entity and specific requirements of § 1.80: estimated that approximately 100 which specific pre-trade risk or order a. § 1.80(a)(2) (pre-trade risk control entities will be affected by the management control for which you are threshold requirements); membership requirements of § 170.18? providing estimates. b. § 1.80(a)(3) (natural person 130. The Commission invites In addition, please differentiate monitors must be alerted when estimates on the cost to an RFA to between the situations where an entity thresholds are breached) establish and maintain the program (i) already uses an outside vendor to at c. § 1.80(d) (notification to DCM and required by § 170.19, and the amount of least some extent to implement the clearing member FCM that AT Person that cost that will be passed along to controls; and (ii) does not currently will use Algorithmic Trading); individual categories of AT Person implement the controls and must obtain d. § 1.80(e) (self-trade prevention members in the RFA. all applicable technology and systems tools); and Development, Testing, and Supervision from an outside vendor necessary to e. § 1.80(f) (periodic review of pre- of Algorithmic Systems comply with Regulation AT. Please trade risk controls and other measures 131. Proposed § 1.81(a) establishes include, if applicable, hardware and for sufficiency and effectiveness). principles-based standards for the software costs as well as the hourly 124. The Commission welcomes wage information of the employee(s) development and testing of Algorithmic comment on the estimated costs of the Trading systems and procedures, necessary to effectuate the pre-trade risk controls proposed in implementation of such controls from including requirements for AT Persons § 1.80 as compared to the annual to test all Algorithmic Trading code and an outside vendor. industry expenditure on technology, 120. Do you agree with the related systems and any changes to such risk mitigation and/or technology Commission’s estimates of how much it code and systems prior to their compliance systems. will cost a trading firm, clearing implementation. AT Persons would also member FCM or DCM to annually 125. Please comment on the costs to be required to maintain a source code maintain the technology and systems for AT Persons and clearing member FCMs repository to manage source code the pre-trade and other risk controls of complying with DCM rules requiring access, persistence, copies of all code required by Regulation AT, if it uses retention and production of records used in the production environment, internally developed technology and relating to §§ 1.80, 1.81, and 1.82 and changes to such code, among other systems? If not please provide compliance, pursuant to § 40.22(d), requirements. Are any of the quantitative estimates and supporting including without limitation on the requirements of § 1.81(a) not already data or other information with respect to extent to which AT Persons and clearing followed by the majority of market how much it will cost a trading firm, member FCMs already have policies, participants that would be subject to clearing member FCM or DCM to procedures, staffing and technological § 1.81(a) (or some particular segment of annually maintain the technology and infrastructure in place to retain such market participants), and if so, how systems for pre-trade and other risk records and produce them upon DCM much will it cost for a market controls required by Regulation AT, if it request. participant to comply with such uses an outside vendor’s technology and 126. The Commission anticipates that requirement(s)? systems. Regulation AT may promote confidence 132. Proposed § 1.81(b) requires that 121. Is it correct to assume that many among market participants and reduce an AT Person’s Algorithmic Trading is of the trading firms subject to § 1.80 are market risk, consequently reducing subject to continuous real-time also subject to the SEC’s Market Access transaction costs, but has not estimated monitoring and supervision by Rule, and, accordingly, already this reduction in transaction costs. The knowledgeable and qualified staff at all implement many of the systems Commission welcomes comment on the times while Algorithmic Trading is required by Regulation AT for purposes extent to which Regulation AT may occurring. Proposed § 1.81(b) also of their securities trading? impact transaction costs and effects on requires automated alerts when an Please specify in your answer the type liquidity provision more generally. Algorithmic Trading system’s AT Order Message behavior breaches design of entity and which specific pre-trade AT Person Membership in RFA; RFA parameters, upon loss of network risk or order management control is Standards for Automated Trading and connectivity or data feeds, or when already required pursuant to the Market Algorithmic Trading Systems Access Rule, and the extent of the market conditions approach the overlap. 127. The Commission estimates that boundaries within which the ATS is 122. Please comment on the costs and the costs of membership in an RFA intended to operate, to the extent benefits (including quantitative associated with proposed § 170.18 will applicable, among other monitoring estimates with supporting data or other encompass certain costs, such as those requirements. Are any of the information) to clearing FCMs of an associated with NFA membership dues. requirements of § 1.81(b) not already alternative to proposed § 1.82 that Has the Commission correctly identified followed by the majority of market would require clearing FCMs to the costs associated with membership in participants that would be subject to implement controls with respect to all an RFA? § 1.81(b), and if so, how much will it orders, including orders that are 128. The Commission expects that cost for a market participant to comply manually submitted or are entered entities that will be required to become with such requirement(s)? through algorithmic methods that members of an RFA would not incur 133. Proposed § 1.81(c) requires that nonetheless do not meet the definition any additional compliance costs as a AT Persons implement policies of Algorithmic Trading and compare result of their membership in an RFA. designed to ensure that Algorithmic those costs and benefits to those costs The Commission requests comment on Trading operates in a manner that and benefits of proposed § 1.82. the accuracy of this expectation. What complies with the CEA and the rules 123. Please comment on the additional compliance costs, if any, and regulations thereunder. Among additional costs (including quantitative would a registrant face as a result of other controls, the policies should estimates with supporting data or other being required to become a member of include a plan of internal coordination information) to AT Persons of an RFA pursuant to proposed § 170.18? and communication between

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compliance staff of the AT Person and sufficient magnitude to potentially Costs for Submitting Applications. In staff of the AT Person responsible for cause smaller market participants, addition, the Commission estimates that Algorithmic Trading regarding FCMs, or DCMs to cease or scale back new registrants will incur a total one- Algorithmic Trading design, changes, operations? Do these costs create time cost of $105,600 to prepare and testing, and controls. Are any of the significant barriers to entry? submit Forms 7–R and 8–R. This cost requirements of § 1.81(c) not already represents the work of 1 Compliance 8. Requirements for Certain Entities To followed by the majority of market Attorney per registrant, working for 11 Register as Floor Traders participants that would be subject to hours (11 × $96 = $1,056 per § 1.81(c), and if so, how much will it a. Background registrant).682 The 100 new registrants cost for a market participant to comply The Commission proposes to require will therefore incur a total one-time cost with such requirement(s)? registration for certain market of $105,600. Other Indirect Costs. The Commission 134. Proposed § 1.81(d) requires that participants with Direct Electronic preliminarily believes that there are AT Persons implement policies to Access. To achieve registration, the additional indirect costs, beyond the designate and train their staff Commission proposes amending the responsible for Algorithmic Trading, cost of registration, to new registrants definition of ‘‘Floor trader’’ in resulting from the new registration which policies should include Commission regulation 1.3(x). The procedures for designating and training requirement. New floor traders required amended definition would include any to register under proposed § 1.3(x)(3) all staff involved in designing, testing person who purchases or sells futures or and monitoring Algorithmic Trading. will be included in the definition of swaps solely for such person’s own ‘‘AT Person.’’ These proposed rules Are any of the requirements of § 1.81(d) account in any other place provided by not already followed by the majority of establish various requirements for AT a contract market for the meeting of Persons, including the implementation market participants that would be persons similarly engaged where such subject to § 1.81(d), and if so, how much of risk controls for algorithmic systems place is accessed for Algorithmic (proposed § 1.80), the implementation of will it cost for a market participant to Trading by such person in whole or in comply with such requirement(s)? standards for development, testing, and part through Direct Electronic Access supervision of algorithmic systems AT Person and FCM Compliance (as defined in proposed § 1.3(yyyy)). (proposed § 1.81), and the submission to Reports b. Costs DCMs of compliance reports regarding 135. Please comment on whether any risk controls and, upon request, certain Registration and Membership Fees. of the alternatives discussed above related books and records (proposed The new registration requirements regarding compliance reports would § 1.83). Because these provisions apply imposed on certain entities with Direct provide a superior cost-benefit profile to AT Persons, new floor traders under Electronic Access would require these relative to the Commission’s proposal. Proposed § 1.3(x)(3) will only be entities to pay certain one-time required to follow these provisions as a DCM Test Environments registration charges. NFA currently result of their status as a floor trader. 136. Do any DCMs not currently offer charges non-natural persons applying Thus, any costs associated with these a test environment that simulates for registration as floor traders $200 per rules are also indirect costs of production trading to their market application (on Form 7–R), and charges registration itself.683 participants, as would be required by individuals $85 per application (on c. Benefits proposed § 40.21? If so, how much Form 8–R). The Commission estimates would it cost a DCM to implement a test that there will be approximately 100 The Commission preliminarily environment that would comply with entities with Direct Electronic Access believes that registration of certain the requirements of § 40.21? that will register as Floor Traders under entities with Direct Electronic Access the new registration requirements. The would enhance the pre-trade controls DCM Review of Compliance Reports Commission further estimates that each and risk management tools discussed 137. Please comment on the cost entity will be required to file 10 Forms elsewhere in this NPRM. For example, estimates provided above with respect 8–R in relation to its principals. the pre-trade risk controls listed in to DCMs’ review of compliance reports Accordingly, the Commission estimates proposed § 1.80(a)—maximum AT provided under § 40.22 and related that new registrants will incur one-time Order Message frequencies per unit review requirements, including the registration costs of $105,500 for Form time, maximum execution frequencies estimated cost for DCMs to: Establish 7–R and 8–R fees combined (Form 7–Rs per unit time, order price parameters the review program required by § 40.22; submitted by 100 new registrants, at and maximum order size limits—must review the reports provided by AT $200 per Form 7–R plus 10 Forms 8–R be established and used by all AT Persons and clearing member FCMs; submitted by each of 100 new Persons. If the Commission were to only communicate remediation instructions registrants, at $85 per Form 8–R).681 require those trading firms or clearing to a subset of AT Persons and clearing member FCMs that are already member FCMs; and review and 681 As noted previously, the Commission has registered with the Commission to delegated its registration functions to NFA. Non- implement such controls, it would be evaluate, as necessary, books and natural person floor trader entities register with the records of AT Persons and clearing Commission and apply for membership in NFA via ignoring a significant number of market member FCMs as contemplated by CFTC Form 7–R. Principals of non-natural person participants that actively trade on proposed § 40.22(e). floor trader entities register via Form 8–R. The Commission-regulated markets, each of Commission estimates that each non-natural person which has algorithmic trading systems Section 15(a) Considerations floor trader entity will have approximately 10 principals and therefore need to file approximately 138. The Commission requests 10 Forms 8–R. In the event that a natural person R fees estimated here are based on NFA’s current comment on its discussion of the effects meets the definition of Floor Trader in proposed fees. of the proposed rules on the § 1.3(x)(3), and is therefore required to register with 682 See section V(B) above for the calculation of the Commission and become a member of NFA, hourly wage rates used in this analysis. considerations in § 15(a) of the CEA. such person would only be required to complete 683 See Section V(E)(7)(b) above for a discussion 139. Are the compliance costs Form 8–R and would face substantially lower costs of costs associated with Proposed §§ 1.80, 1.81, and associated with the proposed rules of than those estimated here. The Form 7–R and 8– 1.83.

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that could malfunction and create serve to limit a ‘‘race to the bottom,’’ in help ensure the furtherance of price systemic risk to all market participants. which certain entities sacrifice effective discovery protections that these tools The Commission estimates that there are risk controls in order to minimize costs provide as discussed above. approximately one hundred proprietary or increase the speed of trading. The iv. Sound Risk Management Practices trading firms engaged in Algorithmic proposed rules, by standardizing the Trading in Commission-regulated risk controls required to be used by The Commission preliminarily markets. However, a technological firms, would help ensure that the believes that requiring market malfunction in a single trading firm’s benefits of these risk controls are more participants with direct market access to systems can significantly impact other evenly distributed across a wide set of register with the Commission will also markets and market participants. market participants, and reduce the further sound risk management Accordingly, the proposed registration likelihood that an outlier firm without practices by enhancing the requirement accomplished through sufficient risk controls causes Commission’s ability to seek revised § 1.3(x) is critical to ensuring significant market disruption. Thus, the information from such firms and allow that all such firms are registered and proposed registration requirement may for wider implementation of many of subject to appropriate risk control, help ensure the protections of market the pre-trade controls and risk testing, and other requirements of participants and the public that these management tools discussed in this Regulation AT. tools provide as discussed above. release. Broader use of these tools will A number of commenters to the reduce the likelihood of market ii. Efficiency, Competitiveness, and disruptions that may interfere with Concept Release pointed out benefits of Financial Integrity of Futures Markets additional registration.684 AFR stated sound risk management practices. Thus, that ‘‘[t]he enhancement of investigative The Commission preliminarily the proposed registration requirement authority is extraordinarily important believes that requiring market may help ensure the furtherance of given that the Commission would often participants with Direct Electronic sound risk management practices that need to involve itself in the workings of Access to register with the Commission these tools provide as discussed above. will further the efficiency, the ATSs to anticipate problems and to v. Other Public Interest Considerations detect and investigate problems that competitiveness, and financial integrity The Commission has not identified have occurred. HFT firms should have of futures markets by enhancing the any effects that these proposed rules the highest priority.’’ 685 Commission’s ability to seek AIMA and VFL specifically information from such firms and allow would have on other public interest emphasized benefits of registration for for wider implementation of many of considerations other than those participants with direct market the pre-trade risk controls and other addressed above. access.686 VFL commented that if an tools discussed in this release. Broader e. Consideration of Alternatives exchange provides a participant the use of these tools will reduce the likelihood of market disruptions that The Commission considered a ability to connect directly, then that number of alternatives to the proposed participant enjoys all of the rights of a may adversely impact the efficiency and integrity of the futures markets. approach of requiring registration for member and should be regulated at the entities with Direct Electronic Access. federal and exchange level.687 Consistent use of these tools may also even the playing field within groups of In the Concept Release, the Commission d. Section 15(a) Factors automated firms, such as market- sought comments regarding broader This section discusses the section makers, or across firms with differing registration of proprietary traders 15(a) factors for the proposed strategies. This consistency can improve generally. Based upon the comments amendment of the definition of ‘‘Floor firm competitiveness and reduce received, many of which did not trader’’ in Commission Regulation disadvantages experienced by those support registration, the Commission is 1.3(x), for purposes of registering firms who would employ more not proposing broad registration of participants with Direct Electronic comprehensive risk control and order proprietary traders at this time. As an alternative to requiring the Access. management programs even absent a rule requiring use of such tools. Thus, registration of entities engaged in i. Protection of Market Participants and the proposed registration requirement proprietary Algorithmic Trading the Public may help ensure the furtherance of through DEA, the Commission The Commission preliminarily efficiency, competitiveness, and considered reaching such entities believes that requiring market financial integrity that these tools indirectly through the DCMs on which participants with Direct Electronic provide as discussed above. they trade. This approach would have necessitated that DCMs implement rules Access to register with the Commission iii. Price Discovery will further the protection of market requiring relevant entities to meet the participants and the public by The Commission preliminarily substantive standards of Regulation AT. enhancing the Commission’s ability to believes that requiring market These DCM rules would have needed to seek information from such firms and participants with direct market access to require, for example, that relevant allow for wider implementation of many register with the Commission will also entities implement pre-trade risk of the pre-trade risk controls and other further price discovery by enhancing the controls, establish policies and tools discussed in this release. Broader Commission’s ability to seek procedures for testing and monitoring of use of these tools will reduce the information from such firms and allow ATSs, and provide compliance reports likelihood of market disruptions that for wider implementation of many of regarding their algorithmic trading to adversely impact market participants the pre-trade controls and risk DCMs (which are currently proposed as and the public. Regulation AT may management tools discussed in this direct obligations upon AT Persons release. Broader use of these tools will under §§ 1.80, 1.81, and 1.83, 684 Better Markets 13; AFR 8–9; TCL 17. reduce the likelihood of market respectively). This alternative would 685 AFR 8–9. disruptions that may interfere with the have reduced the costs for such entities, 686 AIMA 24; VFL 3. price discovery process. Thus, the since they would not be required to 687 VFL 3. proposed registration requirement may register with the Commission. However,

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such costs would instead have been not the primary purpose of the proposed Are there alternate, or additional, borne by DCMs, and potentially passed registration requirement, and therefore characteristics of trading activity to back on to relevant entities. The believes that the goals of Regulation AT determine registration status that would Commission did not pursue this can only be realized by requiring be preferable from a cost-benefit approach for a number of other reasons currently unregistered entities to standpoint? For example, should as well. In particular, the Commission register with the Commission as floor persons with trading volume or message wanted to ensure that such entities are traders. volume below a specified threshold be directly subject to Commission As discussed more fully in section exempted from registration? regulations, rather than impose IV(E)(3) above, the ‘‘floor trader’’ 144. Will any currently unregistered obligations indirectly through DCMs. In definition is not being expanded to entities change their business model or addition, the Commission wanted to capture all proprietary traders engaged exit the market in order to avoid the ensure a uniform baseline of regulatory in Algorithmic Trading; rather, the proposed registration requirement? expectations which might not arise revised floor trader definition is limited 145. The Commission believes that where numerous DCMs are to firms using DEA to engage in the risk control protocols required of independently producing their own self- Algorithmic Trading. Registration of registered entities, specifically those regulatory standards in lieu of the entities with DEA as floor traders would under the new registration category, will Commission’s standards. Furthermore, enhance the pre-trade controls and risk provide a general benefit to the safety the Commission also wanted to combine management tools discussed elsewhere and soundness of market activity and the requirement to register with the in this NPRM by making such entities price formation. Has the Commission Commission with the requirement subject to the various regulations correctly identified the type and level of under § 170.18 that all AT Persons must governing AT Persons under the NPRM. benefits which arise from placing these become a member of a registered futures For example, the pre-trade risk controls requirements on a new set of significant association, so that the RFA can listed in proposed § 1.80—maximum AT market participants? consider adopting standards for Order Message frequencies per unit 146. The Commission requests automated trading and ATSs applicable time, maximum execution frequencies comment on its discussion of the effects to AT Persons. These standards are per unit time, order price parameters of the proposed rules on the described under § 170.19. As discussed and maximum order size limits—must considerations in Section 15(a) of the above, the Commission believes that be established and used by all AT CEA. §§ 170.18 and 170.19 would allow RFAs Persons. The Commission is also to supplement elements of Regulation considering whether it is appropriate to 9. Transparency in Exchange Trade AT as markets and trading technologies further limit the registration Matching Systems evolve over time, and do so in a uniform requirement by adding a de minimis a. Background manner that would not be available exception, whereby only those persons The proposed regulations concerning through separate initiatives by with DEA who also meet certain trading additional disclosure by DCMs individual DCMs. volume or message volume thresholds regarding their trade matching systems The Commission also considered not would be required to register. (amendments to §§ 38.401(a) and requiring currently unregistered entities f. Request for Comments 40.1(i)) provide that DCMs publicly to register with the Commission as floor disclose certain information traders. A number of commenters 140. The Commission estimates that prominently and clearly. These supported such an approach, including the costs of registration will encompass proposed regulations would require FIA, which suggested ‘‘[r]ather than direct costs (those associated with NFA DCMs to provide a description of creating a new registration framework, membership, and reporting and attributes of trade matching systems that expanding the information required in recordkeeping with the Commission), materially affect the entry and execution [the DCM’s] audit trail may be a more and indirect costs (e.g. those associated of orders and requests for quotes, direct and efficient way to address the to risk control requirements placed on including any changes to trade matching Commission’s concerns.’’ 688 Other all registered entities). Has the systems that would cause such effects. commenters also focused on whether Commission correctly identified the the Commission already had access to costs associated with the new b. Costs the information that registration would registration category? What firm characteristics would change the level The Commission notes that DCMs are ostensibly enable it to acquire. currently obligated under DCM core Commenters pointed out that: DCMs of direct and indirect costs associated with the registration? principles and existing regulations to already use Operator IDs; the DCM audit make available certain types of trail already satisfies the goals of 141. Has the Commission accurately estimated that approximately 100 information concerning the operation of registration; implementing the their electronic matching platforms Commission’s final rule on ownership currently unregistered entities will be captured by the new registration through publication of rulebooks and and control reporting (OCR) will through the required posting of provide additional information on requirement in proposed § 1.3(x)(3). 142. Has the Commission accurately specifications of platforms on their Web trading identities; and the Commission estimated that each currently site. DCMs are also obligated under already has access to trade data (i.e., unregistered entity captured by the new DCM core principles and existing Regulation 1.40 and part 38’s mandate registration requirement in proposed regulations to establish and maintain a that DCMs require market participants § 1.3(x)(3) will have approximately 10 program of risk analysis and oversight to to submit to jurisdiction).689 The persons required to file Form 8–R? identify and minimize sources of Commission notes that obtaining 143. As defined, the new floor trader operation risk, which should identify information from proprietary traders is category restricts the registration and remediate aspects of an electronic requirement to those who make use of matching platform that could negatively 688 FIA at 44. 689 FIA 43–46; CME at 32–34; Gelber at 22–24; Direct Electronic Access. Is this affect market participants’ orders. KCG at 18; MFA at 3; AIMA at 2, 24; Chicago Fed requirement overly restrictive or unduly Therefore, to a large extent, the at 3. broad from a cost-benefit perspective? Commission believes that the disclosure

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requirements under proposed priority, price, or quantity of execution i. Protection of Market Participants and § 38.401(a) would not materially impact of market participant orders, the ability the Public a DCM’s operations costs. to cancel, modify, or limit display of The Commission preliminarily The Commission anticipates that market participant orders, or the believes that the proposed disclosure additional costs under proposed dissemination of real-time market data requirement and the enhanced § 38.401(a) would be staff hours to market participants)’’ would not transparency that it would foster will associated with drafting descriptions of result in any additional costs for DCMs. protect market participants by providing such attributes that the DCMs should The Commission notes that the them with a better understanding of already be determining as part of their proposed change to Regulation 40.1(i) how their order messages interact with systems testing and disclosure of clarifies and codifies the Commission’s an electronic matching platform, thus platform specifications. Such drafting existing interpretation of the term facilitating their ability to tailor their may also require additional ‘‘rule.’’ Moreover, the proposal is orders to their understanding of the determinations as to the materiality of consistent with industry practice, matching engine and reducing the attributes and, where applicable, whereby DCMs have submitted as rule likelihood of unpleasant surprises additional testing of systems to ensure changes information regarding proposed regarding order fills. an accurate description of those changes to electronic trade matching attributes in public documents. This platform that affect the entry and ii. Efficiency, Competitiveness, and may also involve attorneys’ fees execution of market participant orders Financial Integrity of Futures Markets associated with reviewing any and quotes. Therefore, the Commission Requiring submissions for changes to disclosures. does not anticipate that DCMs will be available order types and platform The proposed amendments to required to file submissions relating to functionalities also ensures § 38.401(a) and (c) require DCMs to any changes to the platform that should transparency on the operation of such publicly post information regarding not already be filed under current platforms, further encouraging certain aspects of their electronic Commission interpretation and industry competition among DCMs and matching platforms. The Commission practice. enhancing market integrity. The anticipates that DCMs are likely to be c. Benefits increased transparency may increase aware of these aspects of their platforms investor confidence and expand based on their daily work in operating The Commission believes that the participation in the futures markets. their matching engines, monitoring additional disclosure by DCMs performance, and receiving customer regarding their trade matching systems, iii. Price Discovery feedback, among other internal pursuant to the proposed amendments The proposed rule may protect and monitoring activities. As a result, the to §§ 38.401(a) and 40.1(i), would have enhance the price discovery process by added burden under the proposed substantial benefits for market providing market participants and the amendments would be limited to participants. With a better public with a better understanding of drafting the description of such understanding of how their order how buy and sell orders interact on the attributes and making the description messages interact with an electronic trading platform, thus making the price available on the DCM’s Web site. matching platform, market participants discovery process more transparent. The Commission estimates that a can more efficiently use the electronic iv. Sound Risk Management Practices DCM would incur an annual cost of markets to hedge risks. Moreover, the $19,200 to comply with amended disclosure required by the proposed rule The proposal may promote sound risk § 38.401(a)–(c), assuming the DCM is would foster greater transparency in the management practices by providing already compliant with the operation of electronic markets. This market participants with more detailed requirements to post the specifications enhanced transparency would foster information regarding how their order of its electronic matching platform confidence in the markets and ensure messages will be processed once they under current § 38.401(a). This cost the availability of efficient markets to reach the trading platform, and how represents the work of 1 Compliance hedge risks. Finally, this increased their messages will interact with Attorney, working for 200 hours (200 × transparency would encourage messages from other market $96 per hour = $19,200).690 The 15 competition among DCMs to provide the participants, including the priority with DCMs that would be subject to amended best platforms for market participants, which they will be executed. This § 38.401(a)–(c) would therefore incur a as market participants would be able to information will enable market total annual cost of $288,000 (15 × evaluate better the relative benefits of participants to calibrate their risk $19,200).691 The Commission trading on individual exchanges. The controls more effectively. Commission believes that, to the extent anticipates that this figure would v. Other Public Interest Considerations decrease in subsequent years as the that DCMs are currently in compliance descriptions provided would only need with the proposed amendments to The Commission has not identified to be amended to reflect changes to the §§ 38.401(a) and 40.1(i), many of the any effects that these proposed rules electronic matching platform or the benefits of the proposed amendments would have on other public interest discovery of previously unknown are already being realized. The proposed considerations other than those attributes. rule will ensure that the benefits are addressed above. being realized by market participants at The proposed amendment to vi. Consideration of Alternatives all DCMs. Regulation 40.1(i) that adds the The Commission is considering the language ‘‘(including but not limited to d. Section 15(a) Factors alternative of applying the transparency any operation of an electronic matching This section discusses the Section requirement only with respect to platform that materially affects the time, 15(a) factors for the proposed latencies within a platform and how a regulations requiring additional self-trade prevention tool determines 690 See section V(B) above for the calculation of hourly wage rates used in this analysis. disclosure by DCMs regarding their whether to cancel an order. The 691 See section V(A) above for the calculation of trade matching systems (amendments to Commission preliminarily believes that the number of persons subject to Regulation AT. §§ 38.401(a) and 40.1(i)). the broader language that it is proposing

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would better ensure that DCMs disclose the matching of orders for accounts with Tester, working for 480 hours (480 × $52 any additional attributes of an electronic common beneficial ownership where = $24,960); and 2 Developers, working matching platform that may materially such orders are initiated by independent for a combined 960 hours (960 × $75 = impact market participant orders and decision makers. Under § 40.23(b), a $72,000).694 Notwithstanding these any material attributes that may arise in DCM could also permit the matching of estimates, the Commission believes that the future as the structures of matching orders for accounts under common the requirement under proposed engines continue to evolve. This control where such orders comply with § 40.23(a) that DCMs either apply self- additional information may enable the DCM’s cross-trade, minimum trade prevention tools, or provide such market participants to make better and exposure requirements or similar rules, tools to market participants, more informed decisions about their and are for accounts that are not under standardizes existing industry practice. trading decisions. common beneficial ownership. As a result, subject to consideration of Proposed § 40.23(c) states that a DCM e. Request for Comments relevant comments, the Commission may only permit the self-trading preliminarily believes that this 147. The Commission anticipates that described in § 40.23(b) if the DCM requirement under § 40.23(a) will not costs associated with the transparency complies with certain requirements, impose additional costs on DCMs. requirement would come from some including the requirement under additional testing of platform systems § 40.23(c) that the DCM requires market DCM Review of Approval Requests. and from drafting and publishing participants to request approval from DCMs will, however, incur additional descriptions of any relevant attributes of the DCM that self-trade prevention tools costs in connection with proposed the platform. What new costs would be not be applied with respect to specific § 40.23(c). This provision requires associated with providing descriptions accounts under common beneficial market participants to request approval of attributes of electronic matching ownership or control, on the basis that from the DCM that self-trade prevention platforms that affect market participant they meet the criteria of § 40.23(b). tools not be applied with respect to orders and quotes? Finally, proposed § 40.23(d) would specific accounts under common 148. Please compare the costs and require DCMs to publish statistics on beneficial ownership or control, on the benefits of the alternative of applying their Web site with respect to self- basis that they meet the criteria of the transparency requirement only with trading activity on their platform. For § 40.23(b). DCMs will incur costs to respect to latencies within a platform example, each DCM would be required review these § 40.23(c) approval and how a self-trade prevention tool to describe the amount of trading on its requests. These costs may vary determines whether to cancel an order platform that represents permitted self- significantly depending on the number with the costs and benefits of the trading approved pursuant to § 40.23(b). of approval requests a DCM receives. The Commission has therefore proposed rule. b. Costs 149. What benefits might market estimated the average annual costs that participants receive through increased The Commission assumes that most, if a DCM will incur, while acknowledging transparency into the operation of not all, DCMs currently offer self-trade that DCMs may incur lower or higher electronic matching platforms, prevention controls or plan to costs depending on the number of particularly for those market implement them and provide them for requests received. On average, the participants without direct electronic use by market participants in the near Commission estimates that, on an access who may not be able to future. FIA recommends that DCMs annual basis, a DCM will incur a cost of accurately measure latencies or other offer such controls,692 and several DCMs $22,000 to review these approval metrics of market efficiency? provide the controls, a capability which requests. This cost is broken down as 150. The Commission requests was introduced, and refined, in recent follows: 1 Senior Compliance Examiner, 693 × comment on its discussion of the effects years. As a result, subject to working for 200 hours (200 $58 per of the proposed rules on the consideration of relevant comments, the hour = $11,600); and 1 Business × considerations in Section 15(a) of the Commission preliminarily believes that Analyst, working for 200 hours (200 695 CEA. DCMs would not incur additional costs $52 per hour = $10,400). The 15 to develop and offer self-trade DCMs that will be subject to § 40.23(c) 10. Self-Trade Prevention prevention controls as required by would therefore incur a total annual a. Background § 40.23(a). The Commission has, cost of $330,000 (15 × 22,000).696 nonetheless, estimated the cost to a DCM Publication of Statistics Regulation AT proposes a new DCM that does not currently offer self- requirement (§ 40.23) that a DCM shall Regarding Self-Trade Prevention. In trade prevention tools to develop and addition, DCMs will incur costs to implement rules reasonably designed to implement such tools for purposes of prevent self-trading by market generate and publish the self-trade complying with § 40.23(a). statistics on their Web site required by participants, except as specified in Cost to DCMs to Implement Self- paragraph (b) of § 40.23. ‘‘Self-trading’’ § 40.23(d). The Commission estimates Trade Prevention Tools. The that, on an annual basis, a DCM will is defined for purposes of § 40.23 as the Commission estimates that a DCM matching of orders between accounts incur a cost of $6,650 to generate and would incur a total one-time cost of publish these statistics. This cost is that have common beneficial ownership $155,520 to implement these § 40.23(a) or are under common control. A DCM broken down as follows: 1 Developer, requirements, in the absence of any working for 50 hours (50 × $75 per hour must either apply, or provide and existing controls. This cost is broken require the use of, self-trade prevention = $3,750); and 1 Senior Compliance down as follows: 1 Project Manager, Examiner, working for 50 hours (50 × tools that are reasonably designed to working for 480 hours (480 × $70 = prevent self-trading and are applicable $33,600); 1 Business Analyst, working 694 See section V(B) above for the calculation of to all orders on its electronic trade for 480 hours (480 × $52 = $24,960); 1 matching platform. This requirement is hourly wage rates used in this analysis. 695 See section V(B) above for the calculation of subject to the proviso in proposed 692 FIA at 25–27. hourly wage rates used in this analysis. § 40.23(b) that a DCM may, in its 693 FIA at 25–27; MFA at 8; Gelber 7–9; AIMA at 696 See section V(A) above for the calculation of discretion, implement rules that permit 10; IATP at 5. the number of persons subject to Regulation AT.

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$58 per hour = $2,900).697 The 15 DCMs all market participants trading on a supply or demand or distortions in that will be subject to § 40.23(c) and (d) DCM would submit such requests. In prices. While Section 4c of the CEA would therefore incur a total annual the view of the Commission, for prohibits wash sales, unintentional self- cost of $99,750 (15 × 6,650).698 These example, a limited subset of market trades are not specifically prohibited costs may vary significantly depending participants will own two or more under the statute. While existing on the size of a DCM and the number accounts, but operate them through Commission rules address market of products it lists for trading. ‘‘independent decision makers’’ that manipulation, including wash sales, the As noted above, proposed § 40.23 initiate orders for ‘‘separate business use of self-trade tools (as compared to requires DCMs to apply, or provide and purposes,’’ as contemplated by an electronic market without such require the use of, self-trade prevention § 40.23(b). Similarly, a limited subset of controls) can improve market tools that are reasonably designed to market participants will find it functioning, aid firm and market prevent self-trading and are applicable advantageous to incur the costs efficiency, and minimize unintentional, to all orders on its electronic trade associated with the self-trading and often unnecessary, trading by firms matching platform. To the extent that a described by § 40.23(b), such as trading that may be difficult for firms to track DCM offers self-trade prevention tools to costs and clearing fees. In addition, the on their own. Absent self-trade controls, market participants, in lieu of the DCM Commission believes that market it has become even more difficult for internalizing and directly applying participants submitting orders through firms to avoid unintentional self- these tools, then market participants Algorithmic Trading are more likely matches due to their use of automated will be required to use these tools. than traders submitting orders manually strategies, which make trading decisions Commenters indicated that exchange- to inadvertently self-trade through in isolation from the rest of the firm at provided self-trading controls are independent decision-makers. The very high speeds. The Commission widely used by market participants.699 Commission estimates that, preliminarily believes that the proposed The FIA PTG Survey indicated that 25 notwithstanding the fact that the DCM rule, by standardizing the use of self- of 26 responding firms use such rules described in § 40.23(c) are directed trade controls, will ensure that these controls.700 In the event that a market to all market participants, the number of benefits of self-trade controls will be participant is required to use self-trade market participants that will submit the available to all market participants. The prevention tools in the scenario approval requests described therein are Commission believes that DCMs are best described above, and was not previously equivalent to the number of AT Persons situated to promulgate rules designed to using such tools, the Commission calculated above (420).702 On this basis, limit the frequency of self-trading on estimates that the market participant the Commission estimates that market their platforms, and to provide will not incur any additional costs participants will incur a total annual disclosure to the marketplace regarding beyond those costs already incurred to cost of $1,600,200 to submit the the frequency of self-trade activity on implement the pre-trade risk controls approval requests contemplated by their platform. required by Regulation AT. § 40.23(c) ($3,810 per market participant Market Participant Approval × 420 market participants). Proposed § 40.23(c) requires market Requests. Market participants will, participants to request approval from however, incur additional costs in the c. Benefits DCMs on which they are active that self- event that they prepare and submit the The Commission notes that, to the trade prevention tools not be applied approval requests contemplated by extent that DCMs are offering self-trade with respect to specific accounts under § 40.23(c). This provision requires prevention tools and market common beneficial ownership or market participants to request approval participants are using them, many of the control. The Commission preliminarily from DCMs on which they are active benefits of the proposed rules are believes that this rule will benefit the that self-trade prevention tools not be already being realized. Nonetheless, the market by providing, to the DCMs, applied with respect to specific Commission has determined to propose additional transparency on the accounts under common beneficial rules in the area of self-trading that relationships between accounts and ownership or control. The Commission address both intentional and trading strategies within a firm. In estimates that, on an annual basis, a unintentional matching of orders for addition, the rule will better ensure that market participant will incur a total cost accounts that have common beneficial firms will apply self-trade prevention of $3,810 to prepare and submit these ownership or are under common tools in a consistent manner. approval requests to the DCMs on which control, with the goal of benefiting The Commission preliminarily the market participant is active. This markets and market participants. In believes that publication of self-trade cost is broken down as follows: 1 particular, the proposed rules would statistics by DCMs (proposed § 40.23(d)) Business Analyst, working for 30 hours codify a regulatory baseline for self- will benefit market participants by (30 × $52 per hour = $1,560); and 1 trade prevention across DCMs, and Developer, working for 30 hours (30 × providing transparency about the provide all market participants with frequency of certain categories of self- $75 per hour = $2,250).701 enhanced transparency regarding the The Commission cannot predict how trades on each DCM, which can aid in products in which they trade. a better understanding of the sources, many market participants would likely Regulation AT addresses certain self- submit the approval requests and characteristics, of liquidity demand trading as provided in § 40.23(a) and (b) and supply across futures products. contemplated by § 40.23(c) on an annual (trades between accounts that have basis. The Commission believes that not common beneficial ownership or are d. Section 15(a) Factors under common control, with certain 697 See section V(B) above for the calculation of exceptions). At their extreme, This section discusses the Section hourly wage rates used in this analysis. intentional self-trades, or wash sales, 15(a) factors for the new proposed 698 See section V(A) above for the calculation of may indicate an intent to manipulate a requirement (§ 40.23) that a DCM shall the number of persons subject to Regulation AT. implement rules reasonably designed to 699 FIA at 26; Gelber at 7–9. market by creating a false impression of 700 FIA at 26, 59–60. prevent self-trading by market 701 See section V(B) above for the calculation of 702 See section V(A) above for the calculation of participants, except as specified in hourly wage rates used in this analysis. the number of person subject to Regulation AT. paragraph (b) of § 40.23.

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i. Protection of Market Participants and unintentional self-trading; the of exchange-provided self-trade the Public Commission does not have a specific prevention tools, when active on a DCM The Commission preliminarily interest in regulating the manner by that provides, but does not require such believes that the proposed rule would which market participants identify to tools? Please provide an estimate of the protect market participants and the DCMs the accounts that should not cost to such a market participant to public by codifying the use of self-trade trade with each other, so long as this initially calibrate and use exchange- controls and increasing transparency goal is met. The Commission has provided self-trade prevention tools, in around self-trading as required by requested comment on whether other accordance with § 40.23. Please also proposed § 40.23(d). It may also identification methods should be comment on any other direct or indirect incentivize practices that help to reduce permitted in § 40.23. For example, the costs to a market participant that does Commission has requested comment on the likelihood of wash trades and self- not currently use self-trade prevention trades. whether the opposite approach is preferable: market participants would tools arising from the proposed ii. Efficiency, Competitiveness, and identify to DCMs the accounts that requirement to implement such tools. Financial Integrity of Futures Markets should be permitted to trade with each 156. The Commission estimates above The Commission preliminarily other (as opposed to those accounts that that the number of market participants believes that the proposed rule should be prevented from trading with that will submit the approval requests standardizing the use of self-trade each other). The Commission has also described by § 40.23(c) is approximately controls and increasing transparency asked for comment on whether other equivalent to the number of AT Persons. around self-trading would promote the identification methods would reduce Please comment on whether the efficiency of the markets. The use of costs for market participants or be easier estimate of the number of market self-trade controls may promote for both market participants and DCMs participants submitting such approval financial integrity by helping to limit to administer. Upon consideration of requests should be higher or lower. For self-trades (including intentional and comments, the Commission may choose example, should the estimate be raised potentially manipulative self-trades). to adopt these other methods in lieu of to account for proprietary algorithmic what is now proposed. Moreover, requiring that DCMs provide traders that will not be AT Persons, self-trade controls and that market f. Request for Comments because they do not use Direct participants use them may enhance 151. Please comment on the cost Electronic Access and therefore will not competitiveness by preventing a race to estimates described above for DCMs and be required to register as floor traders? the bottom; that is, eliminating the market participants to comply with the possibility that a DCM or market 157. Proposed § 40.23 provides that requirements of § 40.23. The participant could elect not to require or DCMs may comply with the Commission is interested in commenter implement self-trade prevention in requirement to apply, or provide and opinion on all aspects of its analysis, order to gain competitive advantage. require the use of, self-trade prevention including its estimate of the number of tools by requiring market participants to iii. Price Discovery entities impacted by the proposed identify to the DCM which accounts The proposed rule may protect and regulation and the amount of costs such should be prohibited from trading with enhance the price discovery process by entities may incur to comply with the each other. With respect to this account standardizing the use of self-trade regulation. 152. Please comment on the benefits identification process, the Commission’s controls and increasing transparency principal goal is to prevent around self-trading. described above. Do you agree with the Commission’s position that self-trade unintentional self-trading; the iv. Sound Risk Management Practices prevention requirements will result in Commission does not have a specific The proposed rule may promote more accurate indications of the level of interest in regulating the manner by sound risk management practices since market interest on both sides of the which market participants identify to self-trade controls (which the rule market and help ensure arms-length DCMs the account that should be codifies) give market participants transactions that promote effective price prohibited from trading from each other, greater ability to avoid unintentional discovery? Are there additional benefits so long as this goal is met. Should any self-trading that could expose them to to regulatory self-trade prevention other identification methods be various financial risks. requirements not articulated above? permitted in § 40.23? For example, 153. Are there any DCMs that neither please comment on whether the v. Other Public Interest Considerations internalize and apply self-trade opposite approach is preferable: market The Commission has not identified prevention tools, nor provide self-trade participants would identify to DCMs the any effects that these proposed rules prevention tools to their market accounts that should be permitted to would have on other public interest participants? If so, please provide an trade with each other (as opposed to considerations other than those estimate of the cost to such a DCM to those accounts that should be prevented addressed above. comply with the requirement under from trading with each other). In § 40.23(a) to apply, or provide and e. Consideration of Alternatives particular, please comment on whether require the use of, self-trade prevention this approach or other identification Proposed § 40.23 provides that DCMs tools. methods would reduce costs for market may comply with the requirement to 154. Would any DCMs that currently apply, or provide and require the use of, offer self-trade prevention tools need to participants or be easier for both market self-trade prevention tools by requiring update their tools to meet the participants and DCMs to administer. market participants to identify to the requirements of § 40.23? If so, please 158. The Commission requests DCM which accounts should be provide an estimate of the cost to such comment on its discussion of the effects prohibited from trading with each other. a DCM to comply with the requirements of the proposed rules on the With respect to this account of § 40.23. considerations in Section 15(a) of the identification process, the Commission’s 155. What percentage of market CEA. principal goal is to address participants do not currently make use

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11. Market-Maker and Trading Incentive impose minor incremental costs, they contract market’’ as the Commission Programs should not require entirely new may require. Section 38.5 also requires a. Summary of Proposed Rules programs, systems, or categories of a DCM upon request by the Commission employees for DCMs that are already or the director of DMO to file ‘‘a written The Commission is proposing new compliant with parts 38 and 40 of the demonstration’’ that the DCM ‘‘is in regulations in part 40 to increase Commission’s regulations. compliance with one or more core transparency around DCM market- The Commission proposes to amend principles as specified in the request’’ or maker and trading incentive programs, § 40.1(i) to make clear that market- ‘‘satisfies its obligations under the Act,’’ underline existing regulatory maker and trading incentive programs including ‘‘supporting data, information expectations, and introduce basic are ‘‘rules’’ for purposes of part 40. This and documents.’’ safeguards in the conduct of such codification of a previously articulated Proposed § 40.26 does not alter a programs. The proposed regulations Commission standard with broad DCM’s existing obligations under § 38.5, would amend existing § 40.1(i), which industry-wide acceptance should not but rather makes clear that Commission applies to all registered entities, to make give rise to new costs for market and DMO information requests may clear that market-maker and trading participants. The Commission has pertain specifically to market-maker and incentive programs are ‘‘rules’’ for previously stated its view, in a Final trading incentive programs. It also purposes of part 40, and therefore Rule regarding Provisions Common to provides a non-exhaustive list of the subject to part 40’s rule filing Registered Entities, that a market-maker types of ‘‘supporting data, information requirements. They would also establish or trading incentive program is an and documents’’ that the Commission or information requirements when DCMs ‘‘agreement’’ corresponding to ‘‘trading the director of DMO may request that is file rules for Commission approval protocol’’ as such terms are used within particularly appropriate to market- pursuant to existing § 40.5 or self-certify § 40.1(i)’s existing definition of maker and trading incentive programs. rules pursuant to existing § 40.6. ‘‘rule.’’ 703 In the same Final Rule, the Proposed § 40.26 imposes no new Information requirements would be Commission stated that ‘‘all market obligation to provide information, and codified in proposed § 40.25, including maker and trading incentive programs does not increase the frequency which § 40.25(a) for information to be provided must be submitted to the Commission in information must be provided. The to the Commission and § 40.25(b) accordance with the procedures Commission is aware that DCMs already specifying information that must be established in part 40.’’ 704 DCMs, for employ legal, business, technology, and available on a DCM’s public Web site. example, certify numerous market- other staff and resources necessary to Relatedly, proposed § 40.26 would maker and trading incentive programs to respond to § 38.5 information requests. permit the Commission or the director the Commission annually, including The Commission believes that the same of DMO to require certain information 341 such self-certifications in 2013. For staff will be appropriate for any § 40.26 from DCMs regarding their market- these and other rule filings, DCMs information request that it may issue to maker or trading incentive programs, already employ corresponding staff and focus specifically on market-maker or including but not limited to copies of other resources to comply with their trading incentive programs. program agreements, names of program part 40 obligations. The proposed Accordingly, the Commission believes participants, and payments or other amendments to § 40.1(i) do not create a that proposed § 40.26 will impose no benefits conferred pursuant to a new category of rule filings, nor do they additional costs on DCMs. program. require more frequent filings. ii. Rule 40.25—Additional Public The most substantive provisions of Furthermore, the proposed amendments the Commission’s proposed rules for Information Required for Market Maker would require no additional staff or and Trading Incentive Programs; and market-maker and trading incentive other resources beyond those already in programs are in new § 40.27(a). Rule 40.28—Surveillance of Market place to meet existing rule filing Maker and Trading Incentive Programs Proposed § 40.27(a) would codify requirements in part 40. Accordingly, DMO’s long-standing guidance to DCMs the Commission believes that the Proposed § 40.25(a) would require that market-maker and trading incentive proposed amendments to § 40.1(i) will DCMs to provide the Commission with programs should not provide payments impose no additional costs on the certain information regarding their or incentives for trades between registered entities to which it applies. market-maker and trading incentive accounts under common ownership. Proposed § 40.26 is a new regulatory programs when submitting such Finally, the proposed regulations would provision that would permit the programs as rules pursuant to part 40. also make clear in § 40.28 that DCMs’ Commission or the director of DMO to Specifically, when requesting approval existing trade practice and market require certain information from DCMs of a new program pursuant to § 40.5, or surveillance responsibilities in subparts regarding their market-maker or trading self-certifying a program pursuant to C and E of part 38 apply equally to incentive programs. As with § 40.1(i), § 40.6, DCMs would be required to market-maker and trading incentive the Commission believes that proposed provide the name of the program, the programs. § 40.26 will impose no additional costs date on which it begins, and the date on b. Costs on DCMs. The proposed regulation is a which it terminates (if applicable). DCMs would also be required to provide i. Rule 40.1(i)—Definition of ‘‘Rule’’; more targeted iteration of existing § 38.5, which requires a DCM to file a description of any categories of market and Rule 40.26—Information Requests participants or eligibility criteria From the Commission or the Director of with the Commission such ‘‘information related to its business as a designated limiting who may participate in the the Division of Market Oversight program. For any market-maker or Proposed amendments to § 40.1 and 703 See Final Rule, Provisions Common to trading incentive program open to only new § 40.26 serve in large part to Registered Entities, 76 FR 44776, 44778 (July 27, some market participants, proposed emphasize existing regulatory 2011), where the Commission stated, specifically § 40.25(a) would require DCMs to requirements and Commission or staff with respect to DCMs, that ‘‘[a] DCM’s rules explain why the program was limited to implementing market maker and trading incentive authorities. As such, they are not programs fall within the Commission’s oversight the chosen participants or criteria. expected to impose meaningful costs on authority.’’ Proposed § 40.25(a) would also require DCMs. While they may in some cases 704 See id. DCMs to include in their rule filings an

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explanation of how persons eligible for of the DCM’s submission to the ensure that such benefits are not earned a market-maker or trading incentive Commission on the DCM’s Web site. through abusive practices.’’ Notably, the program would apply to participate, and The Commission believes proposed proposed regulation points to how eligibility would be evaluated by § 40.25 adds important clarity to preexisting requirements in the the DCM. existing rule filing requirements in part Commission’s rules—and to costs that Separately, proposed § 40.25(a) would 40 when such filings pertain to market- DCMs must already assume require DCMs to provide an explanation maker or trading incentive programs. independently of proposed § 40.28. of the specific purpose for a market- However, it also recognizes important Subpart C of part 38, entitled maker or trading incentive program, and overlaps between proposed § 40.25 and ‘‘Compliance with Rules,’’ requires a list of all products or services to which existing regulations in §§ 40.5 and 40.6. DCMs to prohibit abusive trading the program applies. It would also Furthermore, proposed § 40.25 does not practices on its markets by all members require a description of any payments, create a new category of rule filings, nor and market participants, including but incentives, discounts, considerations, does it or require more frequent filings. not limited to a series of enumerated inducements or other benefits that For these reasons, the Commission trade practice violations. It also requires program participants may receive, believes that additional costs to DCMs DCMs to have the capacity to detect and including any non-financial incentives. attributable to § 40.25 will not be investigate rule violations, including Finally, proposed § 40.25(a) would significant. As an example of such costs, sufficient compliance staff and require a description of the obligations, DCMs will need to evaluate § 40.25 and resources, automated trade surveillance benchmarks, or other measures that assess whether and what filings must be systems, and real-time market participants in a market-maker or made to comply with the regulation. In monitoring. Subpart E, ‘‘Prevention of trading incentive program must meet to addition, the more explicit requirements Market Disruptions,’’ requires DCMs to receive benefits. of proposed § 40.25, as compared to ‘‘collect and evaluate data on individual To ensure public transparency in existing regulations, may prompt DCMs traders’ market activity on an ongoing market-maker and trading incentive to make filings that they otherwise may basis in order to detect and prevent programs, proposed § 40.25(b) would not have made. The Commission manipulation, [and] price distortions.’’ enlarge upon DCMs’ existing obligations estimates the costs of proposed § 40.25 In addition, subpart E requires a DCM in part 40 to provide public notice and per DCM as described below. to have the ability to ‘‘comprehensively other information regarding their rule The Commission believes that the and accurately’’ reconstruct trading on filings. Specifically, proposed § 40.25(b) work of proposed § 40.25 will fall its markets, obtain information from its would require DCMs to ensure that the primarily upon DCM Compliance market participants, and implement information described above in Attorneys already employed in additional requirements for cash-settled § 40.25(a) is easily located on their completing part 40 rule filings. The and physically-settled contracts. Proposed § 40.28 does not add to the public Web sites. Lastly, proposed Commission estimates that a DCM oversight responsibilities outlined § 40.25(c) would require DCMs to notify (through its Compliance Attorneys) will incur a total annual cost of $14,976 to above, but rather makes clear that a the Commission upon the termination of DCM’s existing obligations in subparts C a market maker or trading incentive comply with proposed § 40.25. This cost is broken down as follows: 1 and E of part 38 apply equally in the program. context of market-maker and trading While proposed § 40.25 would require Compliance Attorney, working for 156 705 × incentive programs. The Commission information from DCMs regarding their hours (156 $96 per hour = $14,976).706 On average, the 15 DCMs to believes that proposed § 40.28 will market-maker or trading incentive impose no significant new costs on programs, the Commission believes it which proposed § 40.25 would apply would therefore incur a total annual DCMs, but acknowledges that it may largely incorporates existing rule filing × result in minor administrative costs. requirements in part 40. For example, cost of $224,640 (15 $14,976) to comply with proposed § 40.25. The Specifically, a DCM not already doing existing §§ 40.5 and 40.6 each require a so will be required to ensure DCM requesting approval or self- Commission notes, however, that actual costs per DCM may vary depending on appropriate communication between its certifying rules to provide the compliance staff tasked with detecting Commission with the rule text; the the number of market-maker and trading incentive program rule filings submitted abusive practices and its business staff proposed effective date or date of that may administer the DCM’s market- intended implementation; and an by an individual DCM on an annual basis. maker or trading incentive programs. ‘‘explanation and analysis of the For example, in the case of an incentive operation, purpose, and effect’’ of the Finally, proposed § 40.28 requires that a DCM, ‘‘consistent with its obligations program based on a market participant’s proposed rule. Existing §§ 40.5 and 40.6 gross trading volume, compliance staff also require each DCM to provide the pursuant to subparts C and E of part 38 . . . review all benefits accorded to would be required to inform business Commission with an assessment of the staff of trades that should not be rule’s ‘‘compliance with applicable participants in market maker and trading incentive programs . . . to credited towards the incentive program provisions of the Act, including core because they were conducted in principles, and the Commission’s 705 The Commission estimates that a Compliance violation of an exchange rule. The regulations thereunder;’’ and ‘‘a brief Attorney will be required to spend an additional Commission believes that the costs explanation of any substantive opposing three hours per week over the course of a 52 week associated with proposed § 40.28 are not views expressed to [the DCM] by year to comply with proposed § 40.25. Such hours significant due in part to DCMs’ existing governing board or committee members, are additional because DCMs are already required to provide substantial information regarding surveillance capabilities, which are members of the entity or market market-maker and trading incentive program rule typically highly automated. participants that were not incorporated filings pursuant to existing requirements in §§ 40.5 The Commission estimated the costs into the rule. . . . ’’ Furthermore, these and 40.6 as discussed above. Three additional hours of complying with proposed § 40.28. In existing provisions each require a DCM per week across a 52 week year yields making its estimates, the Commission approximately 156 additional hours per year per to certify that the DCM posted on its DCM to comply with proposed § 40.25. determined that the primary costs public Web site a notice of pending rule 706 See section V(B) above for the calculation of associated with the regulation will be or certification and to also post a copy hourly wage rates used in this analysis. communication between a DCM’s

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compliance and business staffs. The policies and procedures reasonably new §§ 40.25–40.28 will facilitate Commission estimates that a DCM will designed to ensure that any other self- Commission oversight; increase public incur a total annual cost of $12,710 to trades known to the DCM do not receive transparency; and help ensure market- comply with proposed § 40.28. This cost market-maker or trading incentive maker and trading incentive programs is broken down as follows: 1 payments, discounts or other that are compliant with the Act and Compliance Attorney, working for 62 considerations. Commission regulations. The proposed hours (62 × $96 per hour = $5,952); 1 The Commission believes a DCM rules are consistent with existing Senior Compliance Specialist, working could efficiently implement proposed regulatory expectations. To the extent for 62 hours (62 × $57 per hour = § 40.27(a) by requiring the DCM’s that they impose requirements beyond $3,534); and 1 Business Analyst, compliance staff (Senior Compliance those of existing Commission working for 62 hours (62 × $52 per hour Specialist) to periodically provide its regulations and to the extent that DCMs = $3,224).707 In the event that no DCM business staff (Business Analyst) with are currently not in compliance with the is currently in compliance with summary statistics regarding self-trades proposed rules, the Commission expects proposed § 40.28, the 15 DCMs to which by market participants. Business the rules to increase transparency proposed § 40.28 would apply would Analysts responsible for administering a around DCM market-maker and trading therefore incur a total annual cost of market-maker or trading incentive incentive programs, and introduce basic $190,650 (15 × $12,710) to comply with program could then discount such safeguards in the conduct of such proposed § 40.28.708 trades from any payments, benefits, or programs. Building on the Dodd-Frank other considerations made pursuant to a iii. Rule § 40.27—Payment for Trades Act, the Commission adopted in June program. Reports regarding self-trades With No Change in Ownership 2012 core principles and final rules could be automated at the DCM’s Prohibited modernizing the regulatory regime discretion. When necessary, Senior applicable to all DCMs (‘‘DCM Final The Commission is also proposing Compliance Specialists could Rules’’). Among other areas, the DCM new § 40.27(a) to require that DCMs collaborate with the DCM’s legal staff Final Rules emphasized DCMs’ implement policies and procedures (Compliance Attorney) to address obligations as the front-line regulators of reasonably designed to prevent the instances in which the existence of a their markets. These include extensive payment of market-maker or trading self-trade is unclear. Similarly, Business trade practice responsibilities pursuant incentive payments for trades between Analysts could collaborate with legal or to subpart C of part 38, and market accounts identified to the DCM as under compliance counterparts where a surveillance responsibilities pursuant to common beneficial common ownership market participant challenges the DCM’s subpart E. In addition, the Commission or known to the DCM as under common determinations or payments. The codified new requirements that a DCM ownership. Proposed § 40.27(a) is Commission believes that a similar offer its ‘‘members [and] persons with consistent with guidance provided to process of information flow to Business trading privileges . . . with impartial DCMs by the Commission that incentive Analysts administering payments, access to its markets and services,’’ payments should not be made for ‘‘self- benefits, or other considerations including: (1) ‘‘Access criteria that are trades.’’ In this regard, the proposed pursuant to a market-maker or trading impartial, transparent and applied in a regulation ratifies staff’s previous incentive program would also be non-discriminatory manner’’ and (2) guidance 709 and further develops the appropriate to implement proposed ‘‘comparable fee structures . . . for Commission’s expectations regarding § 40.27(a). The Commission estimates equal access to, or services from’’ the appropriate uses of market-maker and the costs of compliance as described DCM. trading incentive programs. However, below. Substantively, the Commission because the subject matter of proposed The Commission estimates that a believes that the proposed regulations § 40.27(a) is not explicitly addressed in DCM will incur a total annual cost of for market-maker and trading incentive existing regulations, the Commission is $30,108 to comply with proposed programs will help facilitate analyzing it as an entirely new cost to § 40.27(a). This cost is broken down as Commission oversight by eliminating DCMs for this purpose. follows: 1 Compliance Attorney, any potential ambiguity that may exist The Commission believes that the working for 52 hours (52 × $96 per hour regarding its authority over such costs associated with proposed = $4,992); 1 Senior Compliance programs. Proposed amendments to the § 40.27(a) will be administrative in Specialist, working for 156 hours (156 × definition of ‘‘rule’’ in § 40.1(i), in nature. DCMs will be required to $57 per hour = $8,892); and 1 Business particular, will codify previous implement policies and procedures Analyst, working for 312 hours (312 × statements by the Commission regarding reasonably designed to ensure that self- $52 per hour = $16,224).710 The 15 trades permitted pursuant to § 40.23 the treatment of market-maker and DCMs to which proposed § 40.27(a) trading incentive programs as ‘‘rules’’ nonetheless do not receive market- would apply would therefore incur a maker or trading incentives payments, × pursuant to part 40, which statements total annual cost of $451,620 (15 however were not explicitly reflected in discounts or other considerations. DCMs $16,224) to comply with proposed will also be required to implement 711 existing § 40.1(i). Proposed § 40.25 will § 40.27(a). enhance the types of information that 707 See section V(B) above for the calculation of c. Benefits DCMs should expect to provide the hourly wage rates used in this analysis. The Commission anticipates that the Commission when requesting approval 708 The Commission estimates that each such staff proposed amendments to § 40.1(i) and or self-certifying market-maker or person will be required to dedicate approximately trading incentive programs. Such 1 hour per week over the course of a 52 week year, yielding approximately 52 hours per year. The 710 See section V(B) above for the calculation of information will include a description Commission is increasing these estimates by an hourly wage rates used in this analysis. of any eligibility criteria for additional 20 percent to account for more 711 The Commission estimates that a Compliance participation in a market-maker or complicated circumstances that may arise. This Attorney will require 1 hour per week, a Senior trading incentive program, and an yields a total of approximately 62 hours per year Compliance Specialist will require 3 hours per for each relevant staff role. week, and a Business Analyst will require 6 hours explanation for programs with limited 709 See Final Rule, Provisions Common to per week, in each case over the course of a 52 week eligibility. Proposed § 40.25 will also Registered Entities, 76 FR 44776, 44778. year. require that information regarding

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market-maker and trading incentive trades. It may also reduce the frequency considerations other than those programs be easily located on a DCM’s of self-trades, and eliminate incentives addressed above. Web site. Taken together, these that may encourage market participants e. Consideration of Alternatives measures will for example facilitate the to engage in illegal behavior such as Commission’s oversight of DCMs’ wash trading, by prohibiting market- As discussed, the proposed rules compliance with impartial access and maker or trading incentive program regarding market-maker and trading comparable fee structure requirements payments for transactions involving incentive programs largely refer to and in § 38.151(b) adopted by the accounts under common ownership. clarify the Commission’s existing rules Commission in 2012. and guidance and make Commission Proposed § 40.27(a) is designed to ii. Efficiency, Competitiveness, and expectations more clear to new and promote market integrity and to Financial Integrity of Futures Markets existing DCMs. The Commission discourage abusive trading practices. The Commission preliminarily considered not proposing these rules. The Commission believes it is believes that the proposed rule would Absent these rules, the Commission imperative that market participants are promote the efficiency, competitiveness could still realize many of the benefits not incentivized to trade solely for the and financial integrity of futures by enforcing the existing regulations, purpose of collecting market-maker or markets by clarifying Commission but it would be more difficult to ensure trading incentive program benefits. requirements and expectations that DCMs provide information Trading for the sake of collecting such regarding market-maker and trading regarding market-maker and trading benefits may, for example, inaccurately incentive programs. The proposed rule incentive programs prominently on signal the level of liquidity in the regarding payments to accounts with their Web sites. Moreover, absent the market and may result in a non-bona common ownership may reduce proposed rule, there would only be fide price. Key public statistics incentives to self-trade and thus may guidance rather than a rule regarding published by DCMs regarding trades, also help further ensure (beyond the payments for self-trades. The orders, and other measures of liquidity rules related to self-trades also being Commission has determined to propose on their markets must not be inflated proposed in this release) that market these rules to provide increased through trading strategies that may be volumes reflect only trades that shift regulatory certainty to DCMs and market violative of DCM or Commission rules risk between different counterparties participants regarding market-maker and that are designed solely to collect and thus accurately reflect supply and and trading incentive programs and to incentives or to meet market-maker demand in the market and true market ensure that such programs do not permit program requirements. For example, the liquidity. The proposed rule regarding self-trade payments. Commission seeks to eliminate payments to accounts with common f. Request for Comments incentives that may encourage market ownership may promote financial participants to engage in illegal behavior integrity by helping to prevent 159. The Commission requests such as wash trading, which is intentional self-trades (wash trades) that comment on the accuracy of its cost prohibited under the CEA and could lead to price distortions. estimates. Commission regulations.712 160. To what extent are the costs iii. Price Discovery imposed on the DCMs by the proposed d. Section 15(a) Factors The Commission expects that the rule already incurred pursuant to This section discusses the Section proposed rule regarding payments to existing rules? 15(a) factors for the proposed new accounts with common ownership to 161. To what extent are the benefits regulations in part 40 to increase protect and enhance the price discovery of the proposed rule currently being transparency around DCM market- process by helping to prevent realized? maker and trading incentive programs, intentional self-trades (wash trades) that 162. Do DCM Web sites currently underline existing regulatory could lead to price distortions. The provide adequate information regarding expectations, and introduce basic proposed rules also would make clear market-maker and trading incentive safeguards in the conduct of such Commission requirements designed to programs, and is such information programs. The proposed regulations prevent market-maker and trading easily located? would amend existing § 40.1(i) and incentive programs from interfering 163. To what extent do DCMs create new §§ 40.25- 40.28. with or doing harm to the price currently make payments for self-trades discovery process. pursuant to market-maker and trading i. Protection of Market Participants and incentive programs? the Public iv. Sound Risk Management Practices 164. The Commission requests The Commission preliminarily The proposed rule regarding comment on its discussion of the effects believes that the proposed rule would payments to accounts with common of the proposed rules on the protect market participants and the ownership may promote sound risk considerations in Section 15(a) of the public by eliminating potential management practices by helping to CEA. ensure that market-maker and trading ambiguity that may exist regarding the VI. Aggregate Estimated Cost of incentive programs do not incentivize Commission’s expectations and Regulation AT requirements with respect to market- self-trades or wash trades. The proposed maker and trading incentive programs rules also would make clear Summarizing the cost estimates and by guarding against such programs Commission requirements designed to presented above, the Commission incentivizing self-trading. By so doing, prevent market-maker and trading estimates that Regulation AT will the proposed rules would help ensure incentive programs from deterring impose the following costs on persons that volume reports accurately reflect sound risk management considerations. subject to its rules. These costs are broken into one-time costs for initial levels of bona fide risk shifting v. Other Public Interest Considerations transactions activity rather than self- compliance, and annual costs following The Commission has not identified thereafter. As discussed in section V 712 See Section 4c(a) of the CEA, 7 U.S.C. any effects that these proposed rules above, the Commission calculated costs 6c(a)(2)(A), and Commission regulation 1.38(a). would have on other public interest for certain risk mitigation procedures,

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but determined that they generally will In addition, as noted above, the included in the one-time costs chart not be imposed upon market Commission believes that the risk below. However, the Commission participants because, among other controls and other measures required by believes that because market reasons, they relate to procedures or §§ 1.80 and 1.82 are already widely used participants already have these systems controls that are already widely used in by market participants. Upgrading such in place, the proposed regulations will the industry.713 The two charts below systems to come into full compliance generally not result in increased annual do not include such costs. with the proposed regulations will costs to maintain suchsystems. impose initial one-time costs, which are One-time costs:

Cost for all Regulation Description Cost per entity entities

New Floor Traders (100 Entities)

1.3(x)/170.18 714 ...... Registration of new floor traders with CFTC and as members of RFA— $200 $20,000 Form 7–R Fee. 1.3(x)/170.18 ...... Registration of new floor traders with CFTC and as members of RFA— 96 9,600 preparation of Form 7–R. 1.3(x)/170.18 ...... Registration of new floor traders with CFTC and as members of RFA— 850 85,000 Form 8–R Fee for 10 principals. 1.3(x)/170.18 ...... Registration of new floor traders with CFTC and as members of RFA— 960 96,000 preparation of Form 8–R for 10 principals.

Total New Floor Traders ...... 2,106 210,600

AT Persons (420 Entities)

1.80 ...... Risk controls ...... 79,680 33,465,600 1.83(c) ...... Recordkeeping ...... 5,130 2,154,600

Total AT Persons ...... 84,810 35,620,200

Clearing Member FCMs (57 Entities)

1.82 ...... Risk controls—DEA orders ...... 49,800 2,838,600 1.82 ...... Risk controls—non-DEA orders ...... 159,360 9,083,520 1.83(d) ...... Recordkeeping ...... 5,130 292,410

Total Clearing Member FCMs ...... 214,290 12,214,530

DCMs (15 Entities)

38.255(b) ...... Provide controls to FCMs ...... 155,520 2,332,800 40.20 ...... Risk controls ...... 155,520 2,332,800 40.22(c) ...... Establish compliance report review program ...... 37,000 555,000

Total DCMs ...... 348,040 5,220,600

Total All Entities ...... 53,265,930

Annual costs:

Cost for all Regulation Description Cost per entity entities

New Floor Traders (100 Entities)

170.18 ...... RFA annual membership dues (payable first year of membership and $5,625 $562,500 each year after).

Total New Floor Traders ...... 5,625 562,500

AT Persons (420 Entities)

1.83(a) ...... Submit compliance reports/written policies ...... 4,240 1,780,800 1.83(c) ...... Recordkeeping ...... 2,670 1,121,400 40.23 ...... Submit approval requests to DCMs to forego self-trade controls ...... 3,810 1,600,200

Total AT Persons ...... 10,720 4,502,400

713 See, e.g., the calculation of costs for are discussed in section V(E)(7) above. These costs 714 See supra note 597. procedures related to the testing, monitoring and are not included in the charts in this section VI. supervision of Algorithmic Trading systems, which

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Cost for all Regulation Description Cost per entity entities

Clearing Member FCMs (57 Entities)

1.83(b) ...... Submit compliance reports ...... 7,090 404,130 1.83(d) ...... Recordkeeping ...... 2,670 152,190

Total Clearing Member FCMs ...... 9,760 556,320

DCMs (15 Entities)

38.401 ...... Disclosure of trade matching programs ...... 19,200 288,000 40.22(c) ...... Review of compliance reports ...... 111,000 1,665,000 40.22(c) ...... Remediation of compliance reports ...... 22,200 333,000 40.22(e) ...... Review books and records ...... 110,880 1,663,200 40.23(c) ...... Review approval requests from market participants re self-trading ...... 22,000 330,000 40.23(d) ...... Publish statistics on self-trading ...... 6,650 99,750 40.25 ...... Provide information on market maker programs in rule filings ...... 14,976 224,640 40.27 ...... Restrictions on payments under marker maker programs ...... 30,108 451,620 40.28 ...... Surveillance of market maker programs for abusive practices ...... 12,710 190,650

Total DCMs ...... 349,724 5,245,860

Total All Entities ...... 10,867,080

The Commission is also presenting Commission anticipates that an RFA Episodic costs: the following costs applicable to an RFA will incur these costs on an episodic pursuant to proposed § 170.19. The basis in connection with § 170.19.

Cost for all Regulation Description Cost per entity entities

RFAs (1 Entity)

170.19 ...... RFA Standards ...... $34,200 $34,200

Total RFAs ...... 34,200 34,200

VII. List of All Questions in the NPRM definition used by another regulatory only as a conduit for these AT Person organization? orders. If the non-clearing FCM or other Listed below are all questions raised 3. For purposes of the Commission’s entity does not make any in the preceding sections of this NPRM, definition of Algorithmic Trading, is it determinations with respect to such organized according to the section of the necessary for the Commission to define orders, the conduit entity would not be NPRM in which the question appears. ‘‘computer algorithms or systems’’? If engaged in Algorithmic Trading, as that The Commission welcomes any and all so, please explain what should be definition is currently proposed. Should comments on any aspect of Regulation included in such a definition. the definition of Algorithmic Trading be AT regardless of whether it is addressed modified to capture a conduit entity by a particular question. If responding 4. Should the Commission’s such as a non-clearing FCM in this to a specific question enumerated in this definition of ‘‘Algorithmic Trading’’ scenario, thereby making the entity an NPRM, the Commission requests that include systems that only make AT Person subject to Regulation AT? In commenters in their comment letters determinations as to the routing of other words, should non-clearing FCMs refer to that question being answered. orders to different venues (which is contemplated in the proposed be required to manage the risks of AT IV(D) Codification of Defined Terms definition)? With respect to the Person customers? How would non- clearing FCMs do so if the non-clearing ‘‘Algorithmic Trading’’—§ 1.3(zzzz) definition of ‘‘Algorithmic Trading,’’ should the Commission differentiate FCMs do not have risk controls 1. Is the Commission’s definition of between different types of algorithms, comparable to the risk controls specified ‘‘Algorithmic Trading’’ generally such as alpha-generating algorithms and in proposed § 1.82? consistent with what algorithmic order routing algorithms? 7. The Commission, recognizing that trading is understood to mean in the 5. Is the Commission’s understanding natural person traders who manually industry? If not, please explain how it correct that most entities using enter orders also have the potential to is inconsistent and how the definition automated order routers will be using cause market disruptions, is considering should be modified. In your answer, similar or related automated technology expanding the definition of Algorithmic please explain whether the definition to determine other parameters of an Trading to encompass orders that are inappropriately includes or excludes a order? generated using algorithmic methods particular type or aspect of trading. 6. The Commission posits a scenario (e.g., an algorithm generates a buy or 2. Should the Commission adopt a in which an AT Person submits orders sell signal at a particular time), but are definition of ‘‘Algorithmic Trading’’ that through Algorithmic Trading, and a then manually entered into a front-end is more closely aligned with any non-clearing FCM or other entity acts system by a natural person, who

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determines all aspects of the routing of to orders (i.e., heartbeat messages or Algorithmic Trading’’ pursuant to the the orders. Such order entry would not requests for mass quotes) to definition of AT Person? 715 represent Algorithmic Trading under intentionally or unintentionally flood 16. The Commission notes that the currently proposed definition. The the DCM’s systems and slow down the pursuant to § 1.57(b) of the Commission requests comment on this matching engine? Please explain how Commission’s regulations IBs may not proposed expansion of the definition of this definition would be more carry proprietary accounts. However, Algorithmic Trading, which the appropriately limited or expanded. certain customer relationships may Commission may implement in the final ‘‘AT Person’’—§ 1.3(xxxx) cause an IB to fall under the definition rulemaking for Regulation AT. The of AT Person. The Commission requests Commission requests comment on the 13. The Commission notes that the comment on the types of IB customer costs and benefits of this proposal, in FIA Guide recommends certain pre- relationships that could cause IBs to fall addition to any other comments trade risk controls and contemplates under the definition of AT Persons. regarding the effectiveness of this three levels at which these controls can What activities are currently being proposal in terms of risk reduction. be placed: Automated trader, broker, conducted by IBs that could cause an IB ‘‘Algorithmic Trading Compliance and exchange. FIA defines ‘‘automated to be considered engaging in Issue’’—§ 1.3(tttt) trader’’ as any trading entity that uses an Algorithmic Trading on or subject to the 8. Should the definition of automated system, including hedge rules of a DCM and would therefore Algorithmic Trading Compliance Issue funds, buy-side firms, trading firms, and cause the IB to be considered an AT be modified to include other potential brokers who deploy automated Person? compliance failures involving an AT algorithms, and defines ‘‘broker’’ as 17. Should the definition of AT Person that may have a significant FCMs, other clearing firms, executing Person be limited to persons using DEA? detrimental impact on such AT Person, brokers and other financial In other words, should the definition the relevant DCM, or other market intermediaries that provide access to an capture persons registered or required to participants? exchange. be registered as FCMs, floor brokers, a. Should the Commission’s definition SDs, MSPs, CPOs, CTAs, or IBs that ‘‘Algorithmic Trading Disruption’’— engage in Algorithmic Trading on or § 1.3(uuuu) of ‘‘AT Person’’ explicitly include or exclude any of the classes of parties subject to the rules of a DCM, or persons 9. Should the definition of included in FIA’s term ‘‘automated registered or required to be registered as Algorithmic Trading Disruption be trader’’? Please explain. Are there any floor traders as defined in § 1.3(x)(3), in modified to include other types of types of entities not present in this list each case if such persons are using disruptive events that may originate that should be included in the ‘‘AT DEA? The Commission requests with an AT Person? Person’’ definition? comment on the costs and benefits of 10. Should the definition be expanded this approach, including comments on to include other types of disruptive b. Should Regulation AT use the term whether this more limited definition of downstream consequences that may ‘‘broker,’’ as understood by FIA? If so, AT Persons would adequately mitigate result from an Algorithmic Trading please explain. Is there another term the risks associated with algorithmic Disruption originating with an AT that would be more appropriate in trading. Person, and which may negatively defining the scope of AT Persons? impact the relevant designated contract 14. Algorithmic Trading carries ‘‘Direct Electronic Access’’—§ 1.3(yyyy) market, other market participants, or technological and personnel costs, and 18. Please explain whether the other persons? Alternatively, should the the Commission expects that such Commission’s proposed definition of scope of the definition be reduced, and trading will be performed by entities, DEA will encompass all types of access if so, why? not natural persons. Is this a reasonable commonly understood in Commission- 11. In addition, should the reference assumption? For purposes of regulated markets as ‘‘direct market to ‘‘materially degrades’’ in the quantifying the number of AT Persons access.’’ In light of the proposed definition of Algorithmic Trading that will be subject to the regulations, regulations concerning pre-trade and Disruption be expanded or otherwise do you believe that any AT Person (a other risk controls and standards for the modified to encompass other types of definition that encompasses the development, testing and supervision of disruptions that may impact the following persons if engaged in algorithmic trading systems, do you relevant designated contract market, Algorithmic Trading: FCMs, floor believe that the proposed definition of other market participants, or other brokers, swap dealers, major swap Direct Electronic Access is too limited persons? Please provide examples of participants, commodity pool operators, (or, alternatively, too expansive)? If so, real-world events originating with AT commodity trading advisors, please explain why and how the Persons (as defined under Regulation introducing brokers, and newly definition should be revised. AT) that resulted in disruptions that registered floor traders using Direct 19. Should the Commission define may not be captured by the reference to Electronic Access) will be a natural ‘‘routed’’ in its definition of DEA? If so, ‘‘materially degrades’’ in the definition. person or a sole proprietorship with no how? Are there specific examples of employees other than the sole ‘‘AT Order Message’’—§ 1.3(wwww) trading or routing arrangements where it proprietor? 12. Please comment on the proposed would be unclear whether trading was scope of the Commission’s definition of 15. The Commission recognizes that a performed through DEA? CPO could use Algorithmic Trading to AT Order Message. Is the proposed 20. Should the Commission use the enter orders on behalf of a commodity definition too expansive, in that it term ‘‘direct market access’’ instead of pool which it operates. In these would limit the submission of messages DEA, and if so why? that do not have the potential to disrupt circumstances, should the Commission consider the CPO that operates the the market? Alternatively, is the scope 715 commodity pool or the underlying The Commission notes that CPOs are separate of the AT Order Message too limited, in legal entities from the underlying commodity pools that it could allow messages not related commodity pool itself as ‘‘engaged in which they operate.

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21. Should the Commission define traders’’ would help effectuate the framework established by Regulation sub-categories of DEA, such as purposes of the CEA to deter and detect AT would require all AT Persons to be sponsored market access? price manipulation or any other members of an RFA in order to be 22. The Commission’s proposed disruptions to market integrity? If you effective. Alternatively, could the goals definition of DEA in § 1.3(yyyy) differs believe that registration of such firms of Regulation AT be realized without from definitions of direct electronic will not help effectuate the purposes of requiring all AT Persons to be members access in § 38.607 and direct access for the CEA, or that the same purposes can of an RFA? FBOTs in § 48.2(c). The Commission be achieved by other means, please IV(H) Pre-Trade and Other Risk Controls believes that the more technical explain. definition in proposed 1.3(yyyy) is for AT Persons—§ 1.80 appropriate for Regulation AT. The IV(F) RFA Standards for Automated 33. Are any pre-trade and other risk Commission solicits comment regarding Trading and Algorithmic Trading controls required by § 1.80 ineffective, proposed 1.3(yyyy), whether all Systems—§ 170.19 not already widely used by AT Persons, definitions of ‘‘direct’’ access should be 28. The Commission requests or likely to become obsolete? harmonized across the Commission’s comment on the scope of 34. Are there additional pre-trade or rules, and if so how. Do you believe that responsibilities assigned to RFAs under other risk controls that should be two definitions would create confusion proposed § 170.19. Should RFAs be specifically enumerated in proposed with respect to Commission responsible for fewer or additional areas § 1.80? requirements as to direct electronic regarding AT Persons, ATSs, and 35. Do you believe that the pre-trade access? With respect to §§ 1.80, 1.82, algorithmic trading than specified in and other risk controls required in and 38.255(b) and (c) provisions proposed § 170.19, prongs (1), (2), (3), § 1.80 sufficiently address the imposing risk control requirements on and (4) (§ 170.19(a)(1)–(a)(4))? possibility of technological advances in AT Persons, FCM and DCMs, should the Regulation 170.19 requires RFAs to trading, and the development of new, Commission use the existing definition consider the need for rules in the areas more effective controls that should be of direct electronic access provided in listed in prongs (1)–(4) (§ 170.19(a)(1)– implemented by AT Persons? § 38.607? (a)(4)). Should RFAs be responsible for 36. The Commission welcomes considering whether to adopt rules in comment on whether the regulation’s IV(E) Registration of Certain Persons fewer or additional areas? requirements relating to the design of Not Otherwise Registered With 29. The Commission requests controls and the levels at which the Commission—§ 1.3(x) comment on the latitude afforded to controls should be set are appropriate 23. Should firms operating RFAs in proposed § 170.19. Should and sufficiently granular. Algorithmic Trading systems in CFTC- RFAs have more or less latitude to issue 37. The Commission notes that regulated markets, but not otherwise rules than specified in proposed § 1.80(d) requires that prior to initial use registered with the Commission, be § 170.19? of Algorithmic Trading, an AT Person required to register with the CFTC? If 30. The Commission requests must notify its clearing member FCM not, what alternatives are available to comment on RFAs’ obligation in and the DCM that it will engage in fully effectuate the purpose and design proposed § 170.19 to establish and Algorithmic Trading. The Commission of Regulation AT? maintain a program for the prevention welcomes comment on whether the 24. Should all firms deploying of fraud and manipulation, protection of content of that notification requirement Algorithmic Trading systems be the public interest, and perfecting the is sufficient, or whether clearing required to register with the mechanisms of trading, including member FCMs and DCMs should also be Commission? Are there additional through rules it may determine to adopt notified of additional information. For characteristics of AT Persons that pursuant to § 170.19. The proposed example, should AT Persons be required should be taken into consideration for rules anticipate that an RFA’s program to notify their clearing member FCMs of registration purposes? For example, will include examination and particular changes to their Algorithmic should the Commission limit enforcement components. Is this the Trading systems that would affect the registration to trading firms meeting appropriate approach? risk controls applied by the clearing certain trading volume, order or 31. The Commission requests member FCM? message levels? In other words, should comment on whether proposed § 170.19 38. Is § 1.80(f)’s requirement that each there be a minimum volume, order or may result in duplicative obligations on AT Person periodically review its message test in order to meet the AT Persons or any other market compliance with § 1.80 appropriate? definition of ‘‘floor trader,’’ or otherwise participant. In particular, please Should there be more prescriptive and to meet the definition of AT Person? If comment on potential duplication, if granular requirements to ensure that so, what should be measured and what any, between algorithmic trading each AT Person periodically reviews its specific thresholds should be used? requirements that an RFA may impose pre-trade and other risk controls and 25. In the alternative, should the upon its members pursuant to § 170.19, takes appropriate steps to update or Commission broaden the registration and similar requirements that may be recalibrate them in order to prevent an requirements in proposed § 1.3(x)(3)(ii) imposed by a DCM in its role as a self- Algorithmic Trading Event? so that all persons trading on a contract regulatory organization. What Alternatively, is § 1.80(f) necessary? market through DEA are required to amendments would be appropriate in Does the Commission need to explicitly register, instead of only those who are any final rules arising from this NPRM require AT Persons to conduct a engaged in Algorithmic Trading? to clarify that unintended overlap periodic review of their compliance 26. Please supply any information or between the role of an RFA and a DCM with § 1.80? data that would help the Commission in in this context? 39. AT Persons that are registered deciding whether firms may or may not FCMs are required by existing meet the definition of ‘‘floor trader’’ in IV(G) AT Persons Must Become Commission regulation 1.11 to have Section 1a(23) of the Act. Members of an RFA—§ 170.18 formal ‘‘Risk Management Programs,’’ 27. Do you believe that the 32. The Commission requests including, pursuant to § 1.11(e)(3)(ii), registration of such firms as ‘‘floor comment on whether the regulatory ‘‘automated financial risk management

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controls reasonably designed to prevent cost that would be incurred by an AT available consistent with the purposes the placing of erroneous orders’’ and Person to implement such requirements. of Regulation AT? ‘‘policies and procedures governing the 42. Are there any aspects of § 1.81(a)– 51. Please describe the technological use, supervision, maintenance, testing, (d) that are unnecessary for purposes of development that would be required by and inspection of automated trading reducing the risks from Algorithmic clearing member FCMs to comply with programs.’’ As described in § 1.11, an Trading, and should not be mandated by the requirement to implement and FCM’s Risk Management Program must regulation? If so, please explain. calibrate the pre-trade and other risk include a risk management unit 43. Are the procedures described controls required by § 1.82(c) for non- independent of the business unit; above for the development and testing DEA orders. To what extent have quarterly risk exposure reports to senior of Algorithmic Trading sufficient to clearing member FCMs already management and the governing body of ensure that algorithmic systems are developed the technology required by the FCM, with copies to the thoroughly tested before being used in this provision, for example in Commission; and other substantive production, and will operate in the connection with existing requirements requirements. The Commission requests manner intended in the production under § 1.11, and §§ 1.73 and 38.607 for public comment regarding whether one environment? clearing FCMs to manage financial or more of the proposed requirements 44. Are there any additional risks? applicable to FCMs in §§ 1.80, 1.81, procedures for the development and 52. Are there additional pre-trade or 1.83(a), and 1.83(c) should be testing of Algorithmic Trading that other risk controls that should be incorporated within an FCM’s Risk should be required under Regulation specifically required pursuant to Management Program and be subject to AT? proposed § 1.82? the requirements of such program as 45. Are any of the required 53. Do you believe that the pre-trade described in § 1.11. In this regard, any procedures for the development and and other risk controls required in final rules arising from this NPRM could testing of Algorithmic Trading likely to § 1.82 sufficiently address the place all requirements applicable to become obsolete in the near future as possibility of technological advances in FCMs in §§ 1.80, 1.81, 1.83(a), and development and testing standards trading and development of new, more 1.83(c) within the operational risk evolve? effective controls that should be measures required in § 1.11(e)(3)(ii). 46. Are the procedures for designating implemented by FCMs? Such incorporation could help improve and training Algorithmic Trading staff 54. The Commission welcomes the interaction between an FCM’s of AT Persons sufficient to ensure that comment on whether the requirements operational risk efforts and its pre-trade such staff will be knowledgeable in the of § 1.82 relating to the design of risk controls; development, monitoring, strategy and operation of Algorithmic controls and the levels at which the and compliance efforts; and reporting Trading, and capable of identifying controls should be set are appropriate and recordkeeping requirements, Algorithmic Trading Events and and sufficiently granular. pursuant to §§ 1.80, 1.81, 1.83(a), and promptly escalating them to appropriate 55. Proposed § 1.82 does not require 1.83(c). It could also help ensure that an staff members? FCMs to have connectivity monitoring FCM’s §§ 1.80, 1.81, 1.83(a), and 1.83(c) 47. Is it typical that persons such as ‘‘system heartbeats’’ or processes benefit from the same internal responsible for monitoring algorithmic automatic cancel-on-disconnect rigor and independence required by the trading do not simultaneously engage in functions. Do you believe that § 1.82 Risk Management Program in § 1.11. trading activity? should require FCMs to have such 40. The Commission proposes to 48. Proposed §§ 1.80, 1.81, and 1.83 functionality? adopt a multi-layered approach to would impose certain requirements on 56. Proposed § 1.82 requires clearing regulations intended to mitigate the all AT Persons regardless of the size, FCMs to implement controls with risks of automated trading, including sophistication, or other attributes of respect to AT Order Messages pre-trade risk controls and other their business. The Commission originating with an AT Person. The procedures applicable to AT Persons, requests public comment regarding Commission is considering modifying clearing member FCMs and DCMs. whether these requirements should vary proposed § 1.82 to require clearing Please comment on whether an in some manner depending on the AT FCMs to implement controls with alternative approach, for example one Person. If commenters believe proposed respect to all orders, including orders which does not impose requirements at §§ 1.80, 1.81, and 1.83 should vary, that are manually submitted or are each of these three levels, would more please describe how and according to entered through algorithmic methods effectively mitigate the risks of what criteria. that nonetheless do not meet the automated trading and promote the definition of Algorithmic Trading. Such IV(J) Risk Management by Clearing other regulatory goals of Regulation AT. a requirement would correspond to the Member FCMs—§ 1.82 requirement under proposed § 40.20(d) IV(I) Standards for Development, 49. Are any pre-trade or other risk that DCMs implement risk controls for Testing, Monitoring, and Compliance of controls required by § 1.82 ineffective, orders that do not originate from Algorithmic Trading Systems—§ 1.81 not already widely used by clearing Algorithmic Trading. If the Commission 41. The Commission understands that member FCMs, or likely to become were to incorporate such amendments the requirements for developing, testing, obsolete? in any final rules arising from this and supervising algorithmic systems 50. Are there any aspects of proposed NPRM, its intent would be to further proposed in § 1.81(a)–(d) are already § 1.82 that pose an undue burden for reduce risk by ensuring that all orders, widely used throughout the industry. clearing member FCMs and are regardless of source, are screened for Are any specific requirements proposed unnecessary for purposes of reducing risk at both the clearing member FCM in this section not widely used by the risks associated with Algorithmic and the DCM level. Risk controls at the persons that would be designated as AT Trading? If so, please explain (1) the point of order origination would Persons under Regulation AT, and if burden; (2) why it is not necessary to continue to be limited to AT Persons. not, why not? If any requirements reduce the risks associated with The Commission requests comment on described in § 1.81(a)–(d) are not widely Algorithmic Trading, particularly in the this proposed amendment to § 1.82, used, please provide an estimate of the case of DEA. What alternatives are which the Commission may implement

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in the final rulemaking for Regulation imposed on clearing member FCMs. should be made known to all market AT. The Commission requests comment Should the recordkeeping requirements participants? Should the Commission on the costs and benefits to clearing of § 1.83(c) be distributed throughout revise the final rule so that it only FCMs of this proposal, in addition to the sections of the Commission’s applies to latencies within a platform any other comments regarding the regulations that contain recordkeeping and how a self-trade prevention tool effectiveness of this proposal in terms of requirements for various categories of determines whether to cancel an order? risk reduction. Commission registrants that will be 71. What information should be classified as AT Persons? Should disclosed as part of the description of IV(K) Compliance Reports Submitted by relevant attributes of the platform? For AT Persons and Clearing FCMs to § 1.83(d) be transferred to § 1.35 of the Commission’s regulations, which instance, with latencies within a DCMs; Related Recordkeeping platform, should statistics on latencies Requirements—§ 1.83 contains recordkeeping requirements for clearing member FCMs? be required? If so, what statistics would 57. The Commission welcomes help market participants assess any comment on the type of information that IV(L) Direct Electronic Access Provided impact on their orders? Would a should be included in the reports by DCMs—§ 38.255(b) and (c) narrative description of attributes be required by proposed § 1.83. Should 64. Are there any pre-trade and other preferable, including a description of different or additional descriptions be risk controls required by § 38.255(b) and how the attributes might affect market included in the reports, which will be (c) that will be ineffective, not already participant orders under different evaluated by DCMs under proposed widely provided by DCMs for use by market conditions, such as during times § 40.22? FCMs, or likely to become obsolete? of increased messaging activity? 58. How often should the reports 65. Are there additional pre-trade or 72. The Commission notes that required by proposed § 1.83 be other risk controls that DCMs should be proposed § 38.401(a)(1)(iii) and (iv) are submitted to the relevant DCMs? Should specifically required to provide to FCMs not intended to require the disclosure of the report be submitted more or less pursuant to proposed § 38.255(b) and a DCM’s trade secrets. The Commission frequently than annually? (c)? requests comments on whether the 59. When should the reports required 66. Do you believe that the pre-trade proposed rules might inadvertently by proposed § 1.83 be submitted to the and other risk controls required require such disclosure, and if so, how relevant DCMs? Should the reports be pursuant to § 38.255(b) sufficiently they might be amended to address this submitted on a date other than June 30 address the possibility of technological concern. Furthermore, the Commission of each year? advances in trading? For example, do anticipates that the mechanisms and 60. Should a representative of the AT they appropriately address the potential standards for requesting confidential Person or clearing member FCM other for the future development of additional treatment already codified in existing than the chief executive officer or the effective controls that should be § 40.8 could be used by DCMs to chief compliance officer be responsible provided by DCMs and implemented by identify and request confidential for certifying the reports required by FCMs? treatment for information otherwise proposed § 1.83? Should only the chief 67. The Commission welcomes required to be disclosed pursuant to executive officer be permitted to certify comment on whether § 38.255(b)’s proposed § 38.401(a)(1)(iii) and (iv), for the report? Alternatively, should only requirements relating to the design of example by incorporating § 40.8’s the chief compliance officer be controls and the levels at which the mechanisms and standards into any permitted to certify the report? controls should be set are appropriate final rules arising from this NPRM. If 61. Are there any aspects of proposed and sufficiently granular. commenters believe that the § 1.83(b) that pose an undue burden for 68. Proposed § 38.255(b) and (c) do mechanisms and standards in § 40.8 are clearing member FCMs and are not require DCMs to provide to FCMs inappropriate for this purpose, please unnecessary for purposes of reducing connectivity monitoring systems such as describe any other mechanism that the risks associated with Algorithmic ‘‘system heartbeats’’ or automatic should be included in any final rules to Trading? If so, please explain (1) the cancel-on-disconnect functions. Should facilitate DCM requests for confidential burden; (2) why it is not necessary to § 38.255 require such functionality? treatment of information otherwise reduce the risks associated with required to be disclosed pursuant to Algorithmic Trading, particularly in the IV(M) Disclosure and Transparency in proposed § 38.401(a)(1)(iii) and (iv). case of DEA. What alternatives are DCM Trade Matching Systems— 73. The Commission notes that DCMs available consistent with the purposes § 38.401(a) are required, as part of voluntary of Regulation AT, including in 69. The Commission has proposed submissions of new rules or rule particular Regulation AT’s intent that that certain components of an amendments under § 40.5(a) and self- § 1.83 reports benefit from the third- exchange’s market architecture should certification of rules and rule party SRO review performed by DCMs be considered part of the ‘‘electronic amendment under § 40.6(a), to provide with respect to such reports? matching platform’’ for purposes of the inter alia an explanation and analysis of 62. Should the reports required by DCM transparency provision. Are there the operation, purpose and effect of the proposed § 1.83 be sent to any entity any additional systems that should fall proposed rule or rule amendment. other than each DCM on which the AT within the meaning of ‘‘electronic Would the information required under Person operates, such as the matching platforms’’ for purposes of §§ 40.5(a) or 40.6(a) provide market Commission or an RFA? For example, proposed § 38.401(a)? participants and the public with should the Commission require that AT 70. The Commission has specifically sufficient information regarding Persons that are members of a RFA send identified, as ‘‘attributes’’ that must be material attributes of an electronic compliance reports to RFA upon NFA’s disclosed, latencies within a platform matching platform? request? and how a self-trade prevention tool 74. The Commission recognizes that 63. Proposed § 1.83(c) includes determines whether to cancel an order. DCMs are required to have system recordkeeping requirements imposed on Are there any other attributes that safeguards to ensure information AT Persons, and proposed § 1.83(d) would materially affect the execution of security, business continuity and includes recordkeeping requirements market participant orders and therefore disaster recovery under DCM Core

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Principle 20. The Commission Commission eliminate this discretion, § 40.22(c) could provide greater understands that some attributes of an and require that the controls be set at a discretion to DCMs in establishing their electronic matching platform designed specific, more granular, level? If so, programs for the review of reports. to implement those safeguards should please explain the more appropriate Please comment on the appropriateness be maintained as confidential to prevent level at which pre-trade risk controls of these alternative approaches. cybersecurity or other threats. Does should be set by a DCM. 87. Should § 40.22(e) provide more existing § 40.8, 17 CFR 40.8 (2014) 80. The Commission requests public specific requirements regarding the provide sufficient basis for DCMs to comment on the pre-trade and other risk triggers for a DCM to review and publicly disclose the relevant attributes controls required of DCMs in proposed evaluate the books and records of AT of their platforms while maintaining as § 40.20. Are any of the risk controls Persons and clearing member FCMs confidential information concerning required in the proposed rules required to be kept pursuant to system safeguards? unhelpful to operational or other risk § 40.22(d)? For example, § 40.22(e) 75. With respect to material attributes mitigation, or to market stability, when could require review at specific affecting market participant orders implemented at the DCM level? intervals (e.g., once every two years), or caused by temporary or emergency 81. Are there additional pre-trade or it could require review in response to situations, such as network outages or other risk controls that should be specific events related to the the temporary suspension of certain specifically enumerated in proposed Algorithmic Trading of AT Persons. market functionality, what is the best § 40.20? Please comment on the appropriateness way for DCMs to alert market 82. The Commission proposes, with of these alternative approaches. participants? How are DCMs currently respect to its kill switch requirements, 88. Does § 40.22 leave enough handling these situations? to allow DCMs the discretion to design discretion to the DCM in determining 76. The Commission proposes that a kill switch that allows a market how to design and implement an DCMs provide a description of the participant to submit risk-reducing effective compliance review program relevant material attributes in a single orders. The Commission also does not regarding Algorithmic Trading? document ‘‘disclosed prominently and mandate particular procedures for alerts Alternatively, is there any aspect of this clearly’’ on the exchange’s Web site. The or notifications concerning kill switch regulation that should be more specific Commission also proposes that this triggers. Does the proposed rule allow or prescriptive? document be written in ‘‘plain English’’ for sufficient flexibility in the design of 89. Should § 40.22 specifically to allow market participants, even those kill switch mechanisms and the policies authorize a DCM to establish further not technically proficient, to understand and procedures concerning their standards for the organization, method the attributes described. Would these implementation? Should the of submission, or other attributes of the requirements be practical and help Commission consider more prescriptive reports described in § 40.22(a)? market participants locate and rules in this area? IV(Q) Self-Trade Prevention Tools— understand the information provided? 83. Does existing § 38.1051 provide § 40.23 77. The Commission proposes the Commission with adequate requiring DCMs to disclose information authority to require DCMs to adequately 90. The Commission seeks to require on the relevant attributes: (a) When test planned changes to their matching self-trade prevention tools that screen filing a rule change submission with the engines and other automated systems? out unintentional self-trading, while Commission for changes to the permitting bona-fide self-matched trades electronic matching platform; or (b) IV(O) DCM Test Environments for AT that are undertaken for legitimate within a ‘‘reasonable time, but no later Persons—§ 40.21 business purposes. Under the than ten days’’ following the 84. Should the test environment regulations proposed above, DCMs shall identification of such attribute. Do the provided by DCMs under proposed implement rules reasonably designed to proposed timeframes provide sufficient § 40.21 offer any other functionality or prevent self-trading (‘‘the matching of time for DCMs to disclose the relevant data inputs that will promote the orders for accounts that have common information? Do the proposed effective design and testing of beneficial ownership or are under timeframes offer sufficient notice of Algorithmic Trading by AT Persons? common control’’), but DCMs may in changes or discovered attributes to their discretion implement rules that IV(P) DCM Review of Compliance market participants to allow them to permit ‘‘the matching of orders for Reports by AT Persons and Clearing adjust any systems or strategies, accounts with common beneficial FCMs—§ 40.22 including any algorithmic trading ownership where such orders are systems? 85. In lieu of a DCM’s affirmative initiated by independent decision 78. The Commission proposes obligation in proposed § 40.22 to review makers.’’ requiring disclosure of newly identified AT Person and clearing member FCM a. Do these standards accomplish the attributes within 10 days of discovery. compliance reports, should DCMs goal of preventing only unintentional Does this provide DCMs sufficient time instead be permitted to rely on the CEO self-trading, or would other standards be to analyze the attribute and provide a or CCO representations required by more effective in accomplishing this description? Should DCMs be required proposed § 1.83(a)(2)? If so, what events goal? For example, should the to provide notice of the existence of the in the Algorithmic Trading of an AT Commission consider adopting in any attribute and supplement as further Person should trigger review obligations final rules arising from this NPRM an analysis is performed? by the DCM? alternative requirement modeled on 86. Should § 40.22(c) provide more FINRA Rule 5210 and require market IV(N) Pre-Trade and Other Risk Controls specific requirements regarding a DCM’s participants to implement policies and at DCMs—§ 40.20 establishment of a program for effective procedures to review their trading 79. The Commission proposes to periodic review and evaluation of AT activity for, and a prevent a pattern of, require DCMs to set pre-trade risk Person and clearing member FCM self-trades? controls at the level of the AT Person, reports? For example, § 40.22(c) could b. While the regulations contain and allows discretion to set controls at require review at specific intervals (e.g., exceptions for bona fide self-match a more granular level. Should the once every two years). Alternatively, trades (described in § 40.23(b)), the

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regulations are intended to prevent all prohibited from trading from each other, category of self-trade data that DCMs unintentional self-trading, and do not so long as this goal is met. Should any should be required to disclose? include a de minimis exception for a other identification methods be 97. Should DCMs be required to certain percentage of unintentional self- permitted in § 40.23? For example, disclose the amount of unintentional trading. Should the regulations permit a please comment on whether the self-trading that occurs each month, certain de minimis amount of opposite approach is preferable: market alongside the self-trade statistics unintentional self-trading, and if so, participants would identify to DCMs the required to be published under what amount should be permitted (e.g., accounts that should be permitted to proposed § 40.23(d)? as a percentage of monthly trading trade with each other (as opposed to 98. As noted above, the Commission volume)? those accounts that should be prevented understands that there is some potential c. The following terms are used in from trading with each other). for self-trade prevention tools to be used proposed § 40.23(a) and (b): (1) Self- 93. The Commission believes that its for wrongful activity that may include trading, (2) common beneficial requirements concerning self-trade disruptive trading or other violations of ownership, (3) independent decision prevention tools must strike the the Act or Commission regulations on makers, and (4) common control. Do any appropriate balance between flexibility DCMs. Are there ways to design self- of these terms require further definition? (allowing market participants with trade prevention tools so that they do If so, how should they be defined? diverse trading operations and strategies not facilitate disruptive trading (such as Should any alternatives be used and, if the discretion in implementation so as spoofing) or other violations of the Act so, how should such substitute terms be effectively prevent only unintentional or Commission regulations on DCMs? defined? self-trades) and simplicity (a variety of Are additional regulations warranted to d. With respect to ‘‘common design and implementation options may ensure that such tools are not used to beneficial ownership,’’ the Commission render this control too complex to be facilitate such activities? requests comment on the minimum effective).716 Does the Commission degree of ownership in an account that IV(R) DCM Market Maker and Trading allow sufficient discretion to exchanges should trigger a determination that such Incentive Programs—§§ 40.25–40.28 and market participants in the design account is under common beneficial 99. To what extent do market and implementation of self-trade ownership. For example, should an participants currently trade in ways prevention tools? Is there any area account be deemed to be under common designed primarily to collect market where the Commission should be more beneficial ownership between two maker or trading incentive program unrelated persons if each person prescriptive? The Commission is benefits, rather than for risk directly or indirectly has a 10% or more particularly interested in whether there management purposes? ownership or equity interest in such is a particular level at which it should 100. To what extent do that market account? The Commission refers require implementation of self-trade maker and trading incentive programs commenters to the aggregation rules in prevention tools, i.e., if the tools must currently provide benefits for self- part 150 of its regulations, including prevent matching of orders from the trades? To what extent do market specifically § 150.4, and requests same trading firm, the same trader, the participants collect such benefits for comment on a potential Commission same trading algorithm, or some other self-trades? definition of common beneficial level. 101. The Commission requests ownership that is modeled on § 150.4. 94. Proposed § 40.23(a) would require comment regarding whether the e. The Commission also requests DCMs to either apply, or provide and information proposed to be collected in comment on whether ‘‘common require the use of, self-trade prevention § 40.25 would be sufficient for it to beneficial ownership’’ should be tools. Please comment whether determine whether a DCM’s market- defined in any final rules arising from § 40.23(a) should, in addition, permit maker or trading incentive program this NPRM, or whether such definition market participants to use their own complies with the impartial access should be left to each DCM with respect self-trade prevention tools to meet the requirements of § 38.151(b). If to its program for implementing requirements of proposed § 40.23(a), additional or different information proposed § 40.23. and if so, what additional regulations would be helpful, please identify such 91. Are there any other types of self- would ensure that DCMs are able to: information. trading that should be permitted in ensure that such tools are comparable to 102. The Commission requests addition to the exceptions permitted in DCM-provided tools; monitor the comment regarding whether DCMs § 40.23(b)(1) and (2)? If so, please performance of such tools; and should be required to maintain on their describe such other types of acceptable otherwise review such tools and ensure public Web sites the information self-trading and explain why they that they are sufficiently rigorous to required by proposed § 40.25(a) and (b) should be permitted. meet the requirements of § 40.23. for an additional period beyond the end 92. Proposed § 40.23 provides that 95. Is it appropriate to require of the market maker or trading incentive DCMs may comply with the implementation of self-trade prevention program. The Commission may requirement to apply, or provide and tools with respect to all orders? Should determine to include in any final rules require the use of, self-trade prevention such controls be mandatory for only a arising from this NPRM a requirement tools by requiring market participants to particular subset of orders, i.e., orders that such information remain publicly identify to the DCM which accounts from AT Persons or orders submitted available pursuant to proposed should be prohibited from trading with through DEA? § 40.25(b) for an additional period up to each other. With respect to this account 96. Please comment on the six months following the end of a identification process, the Commission’s requirement that DCMs disclose self- market maker or trading incentive principal goal is to prevent trade statistics. Is the data required to be program. unintentional self-trading; the disclosed appropriate? Is there any other 103. The Commission requests Commission does not have a specific comment regarding whether the text of proposed § 40.27(a) identifies with interest in regulating the manner by 716 See FIA Guide, supra note 95 at 13 (discussing which market participants identify to balance between flexibility and complexity with sufficient particularity the types of DCMs the account that should be respect to self-trade prevention tools). trades that are not eligible for payments

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or benefits pursuant to a DCM market- and if so, what process should be to costs; (g) data and any other maker or trading incentive program. available for a DCM to request from the information to assist or otherwise What amendments, if any, are necessary Commission an exemption from the inform the Commission’s ability to to clearly identify trades that are not requirements of proposed § 40.25(b) for quantify or qualitatively describe the eligible? that specific enumerated item? benefits and costs of the proposed rules; 104. Section 40.27(a) provides that and (h) substantiating data, statistics, Related Matters—A. Calculation of DCMs shall implement policies and and any other information to support Number of Persons Subject to procedures that are reasonably designed positions posited by commenters with Regulations to prevent the payment of market-maker respect to the Commission’s or trading incentive program benefits for 108. The Commission requests consideration of costs and benefits. trades between accounts under common comment on its calculation of the ownership. Are there any other types of number of AT Persons, newly registered § 1.80 Pre-Trade and Other Risk trades or circumstances under which floor traders, clearing member FCMs, Controls the Commission should also prohibit or and DCMs that will be subject to 112. How would an alternative limit DCM market-maker or trading Regulation AT. definition of Algorithmic Trading that excludes automated order routers affect incentive program benefits? Related Matters—C. Regulatory 105. The Commission is proposing in the costs and benefits of the pre-trade Flexibility Act Analysis § 40.27(a) certain requirements and other risk controls in comparison to regarding DCM payments associated 109. The Commission requests the costs and benefits of the proposed with market maker and trading comment on each element of its RFA definition that includes automated order incentive programs. Please address analysis. In particular, the Commission routers? Would such an alternative whether the proposed rules will specifically invites comment on the definition reduce the number of AT diminish DCMs’ ability to compete or accuracy of its estimates of potential Persons captured by Regulation AT? build liquidity by using market maker or firms that could be considered ‘‘small 113. Would the benefits of Regulation trading incentive programs. Does any entities’’ for RFA purposes. AT be enhanced significantly if the DCM consider it appropriate to provide 110. The Commission also requests definition of Algorithmic Trading were market maker or trading incentive comment on whether any natural modified to capture a conduit entity program benefits for trades between persons will be designated as AT such as a non-clearing FCM, thereby accounts known to be under common Persons under the proposed definition making the entity an AT Person subject beneficial ownership? of that term. to Regulation AT? How would such a 106. In any final rules arising from Related Matters—E. Cost Benefit modification affect costs? 114. Would the benefits of Regulation this NPRM, should the Commission also Considerations prohibit DCMs from providing trading AT be enhanced significantly if the incentive program benefits where such 111. Beyond specific questions definition of Algorithmic Trading were benefits on a per-trade basis are greater interspersed throughout its discussion, expanded to encompass orders that are than the fees charged per trade by such the Commission generally requests generated using algorithmic methods DCMs and its affiliated DCO (if comment on all aspects of its (e.g., an algorithm generates a buy or applicable)? The Commission also consideration of costs and benefits, sell signal at a particular time), but are specifically requests comment on the including: (a) Identification, then manually entered into a front-end extent, if any, to which one or more quantification, and assessment of any system by a natural person? How would DCMs engage in this practice. costs and benefits not discussed therein; such a modification affect costs? Please 107. Proposed § 40.25(b) imposes (b) whether any of the proposed comment on the costs and benefits of an certain transparency requirements with regulations may cause FCMs or DCMs to alternative whereby the Commission respect to both market maker and raise their fees for their customers, or would implement specific rules trading incentive programs. The otherwise result in increased costs for regarding the appropriate design of the Commission requests public comment market participants and, if so, to what specific controls required by Regulation regarding: extent; (c) whether any category of AT and compare them to the costs and a. The most appropriate place or Commission registrants will be benefits of the Commission’s proposal manner for a DCM to disclose the disproportionately impacted by the whereby the relevant entities—trading information required by proposed proposed regulations, and if so whether firms, clearing firms, and DCMs—would § 40.25(b); the burden of any regulations should be have the discretion to determine the b. The benefits or any harm that may appropriately shifted to other appropriate design of those controls. result from such transparency, Commission registrants; (d) what, if any, 115. Does one particular segment of including any anti-competitive effect or costs would likely arise from market trading firms, clearing member FCMs or pro-competitive effect among DCMs or participants engaging in regulatory DCMs (e.g., smaller entities) currently market participants; arbitrage by restructuring their trading implement fewer of the pre-trade and c. Whether transparency as proposed activities to trade on platforms not other risk controls required by in § 40.25(b) is equally appropriate for subject to the proposed regulations, or Regulation AT than some other segment both market maker programs and taking other steps to avoid costs of trading firms, clearing member FCMs trading incentive programs, or are the associated with the proposed or DCMs? If so, please describe any proposed requirements more or less regulations; (e) quantitative estimates of unique or additional costs that will be appropriate for one type of program over the impact on transaction costs and imposed on such persons to develop the the other? liquidity of the proposals contained technology and systems necessary to d. Whether any of the enumerated herein; (f) the potential costs and implement the pre-trade and other risk items required to be posted on a DCM’s benefits of the alternatives that the controls required by Regulation AT. public Web site pursuant to proposed Commission discussed in this release, 116. In question 14, the Commission § 40.25(b) could reasonably be and any other alternatives appropriate asks whether there are any AT Persons considered confidential information that under the CEA that commenters believe who are natural persons. Would AT should not be available to the public, would provide superior benefits relative Persons who are natural persons (or sole

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proprietorships with no employees not currently implement the controls d. § 1.80(e) (self-trade prevention other than the sole proprietor) be and must obtain all applicable tools); and required to hire staff to comply with the technology and systems from an outside e. § 1.80(f) (periodic review of pre- risk control, testing and monitoring, or vendor necessary to comply with trade risk controls and other measures compliance requirements of Regulation Regulation AT. Please include, if for sufficiency and effectiveness). AT? applicable, hardware and software costs 124. The Commission welcomes 117. Do you agree with the accuracy as well as the hourly wage information comment on the estimated costs of the of cost estimates provided by the of the employee(s) necessary to pre-trade risk controls proposed in Commission as to how much it will cost effectuate the implementation of such § 1.80 as compared to the annual a trading firm, clearing member FCM or controls from an outside vendor. industry expenditure on technology, DCM to internally develop the 120. Do you agree with the risk mitigation and/or technology technology and systems necessary to Commission’s estimates of how much it compliance systems. implement the pre-trade and other risk will cost a trading firm, clearing 125. Please comment on the costs to controls required by Regulation AT? If member FCM or DCM to annually AT Persons and clearing member FCMs you disagree with the Commission’s maintain the technology and systems for of complying with DCM rules requiring analysis, please provide your own the pre-trade and other risk controls retention and production of records quantitative estimates, as well as data or required by Regulation AT, if it uses relating to §§ 1.80, 1.81, and 1.82 other information in support. Please internally developed technology and compliance, pursuant to § 40.22(d), specify in your answer the type of entity systems? If not please provide including without limitation on the and which specific pre-trade risk or quantitative estimates and supporting extent to which AT Persons and clearing order management controls for which data or other information with respect to member FCMs already have policies, you are providing estimates. how much it will cost a trading firm, procedures, staffing and technological In addition, please differentiate clearing member FCM or DCM to infrastructure in place to retain such between the situations where an entity annually maintain the technology and records and produce them upon DCM (i) already has partially compliant systems for pre-trade and other risk request. controls in place, and only needs to controls required by Regulation AT, if it 126. The Commission anticipates that upgrade such technology and systems to uses an outside vendor’s technology and Regulation AT may promote confidence bring it into compliance with the systems. among market participants and reduce regulations; and (ii) needs to build such 121. Is it correct to assume that many market risk, consequently reducing technology and systems from scratch. of the trading firms subject to § 1.80 are transaction costs, but has not estimated Please include, as applicable, hardware also subject to the SEC’s Market Access this reduction in transaction costs. The and software costs as well as the hourly Rule, and, accordingly, already Commission welcomes comment on the wage information of the employee(s) implement many of the systems extent to which Regulation AT may necessary to develop such risk controls required by Regulation AT for purposes impact transaction costs and effects on (i.e., technology personnel such as of their securities trading? Please liquidity provision more generally. programmer analysts, senior programmers and senior systems specify in your answer the type of entity AT Person Membership in RFA; RFA analysts). and which specific pre-trade risk or Standards for Automated Trading and 118. The Commission has assumed order management control is already Algorithmic Trading Systems that the effort to adjust any one risk required pursuant to the Market Access 127. The Commission estimates that control (by ‘‘control,’’ in this context, Rule, and the extent of the overlap. the costs of membership in an RFA the Commission means the pre-trade 122. Please comment on the costs and associated with proposed § 170.18 will risk controls, order cancellation benefits (including quantitative encompass certain costs, such as those systems, and connectivity systems estimates with supporting data or other associated with NFA membership dues. required by § 1.80) will require information) to clearing FCMs of an Has the Commission correctly identified assessment and possible modifications alternative to proposed § 1.82 that the costs associated with membership in to all controls. Is this assumption would require clearing FCMs to an RFA? correct, and if not, why not? implement controls with respect to all 128. The Commission expects that 119. As indicated above, the orders, including orders that are entities that will be required to become Commission lacks sufficient information manually submitted or are entered members of an RFA would not incur to provide full estimates of costs that a through algorithmic methods that any additional compliance costs as a trading firm, clearing member FCM or nonetheless do not meet the definition result of their membership in an RFA. DCM will incur if it chooses not to of Algorithmic Trading and compare The Commission requests comment on internally develop such controls, and those costs and benefits to those costs the accuracy of this expectation. What instead purchases the solutions of an and benefits of proposed § 1.82. additional compliance costs, if any, outside vendor in order to comply with 123. Please comment on the would a registrant face as a result of Regulation AT’s pre-trade and other risk additional costs (including quantitative being required to become a member of controls requirements. Please provide estimates with supporting data or other an RFA pursuant to proposed § 170.18? quantitative estimates of such costs, information) to AT Persons of 129. Has the Commission accurately including supporting data or other complying with each of the following estimated that approximately 100 information. In addition, please specify specific requirements of § 1.80: entities will be affected by the in your answer the type of entity and a. § 1.80(a)(2) (pre-trade risk control membership requirements of § 170.18? which specific pre-trade risk or order threshold requirements); 130. The Commission invites management control for which you are b. § 1.80(a)(3) (natural person estimates on the cost to an RFA to providing estimates. In addition, please monitors must be alerted when establish and maintain the program differentiate between the situations thresholds are breached); required by § 170.19, and the amount of where an entity (i) already uses an c. § 1.80(d) (notification to DCM and that cost that will be passed along to outside vendor to at least some extent to clearing member FCM that AT Person individual categories of AT Person implement the controls; and (ii) does will use Algorithmic Trading); members in the RFA.

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Development, Testing, and Supervision 134. Proposed § 1.81(d) requires that membership, and reporting and of Algorithmic Systems AT Persons implement policies to recordkeeping with the Commission), 131. Proposed § 1.81(a) establishes designate and train their staff and indirect costs (e.g. those associated principles-based standards for the responsible for Algorithmic Trading, to risk control requirements placed on development and testing of Algorithmic which policies should include all registered entities). Has the Trading systems and procedures, procedures for designating and training Commission correctly identified the including requirements for AT Persons all staff involved in designing, testing costs associated with the new to test all Algorithmic Trading code and and monitoring Algorithmic Trading. registration category? What firm related systems and any changes to such Are any of the requirements of § 1.81(d) characteristics would change the level code and systems prior to their not already followed by the majority of of direct and indirect costs associated implementation. AT Persons would also market participants that would be with the registration? be required to maintain a source code subject to § 1.81(d), and if so, how much 141. Has the Commission accurately repository to manage source code will it cost for a market participant to estimated that approximately 100 access, persistence, copies of all code comply with such requirement(s)? currently unregistered entities will be captured by the new registration used in the production environment, AT Person and FCM Compliance requirement in proposed § 1.3(x)(3). and changes to such code, among other Reports requirements. Are any of the 142. Has the Commission accurately 135. Please comment on whether any requirements of § 1.81(a) not already estimated that each currently of the alternatives discussed above followed by the majority of market unregistered entity captured by the new regarding compliance reports would participants that would be subject to registration requirement in proposed provide a superior cost-benefit profile § 1.81(a) (or some particular segment of § 1.3(x)(3) will have approximately 10 relative to the Commission’s proposal. market participants), and if so, how persons required to file Form 8–R? much will it cost for a market DCM Test Environments 143. As defined, the new floor trader participant to comply with such category restricts the registration 136. Do any DCMs not currently offer requirement to those who make use of requirement(s)? a test environment that simulates 132. Proposed § 1.81(b) requires that Direct Electronic Access. Is this production trading to their market requirement overly restrictive or unduly an AT Person’s Algorithmic Trading is participants, as would be required by subject to continuous real-time broad from a cost-benefit perspective? proposed § 40.21? If so, how much Are there alternate, or additional, monitoring and supervision by would it cost a DCM to implement a test knowledgeable and qualified staff at all characteristics of trading activity to environment that would comply with determine registration status that would times while Algorithmic Trading is the requirements of § 40.21? occurring. Proposed § 1.81(b) also be preferable from a cost-benefit requires automated alerts when an DCM Review of Compliance Reports standpoint? For example, should Algorithmic Trading system’s AT Order 137. Please comment on the cost persons with trading volume or message Message behavior breaches design estimates provided above with respect volume below a specified threshold be parameters, upon loss of network to DCMs’ review of compliance reports exempted from registration? connectivity or data feeds, or when provided under § 40.22 and related 144. Will any currently unregistered market conditions approach the review requirements, including the entities change their business model or boundaries within which the ATS is estimated cost for DCMs to: Establish exit the market in order to avoid the intended to operate, to the extent the review program required by § 40.22; proposed registration requirement? applicable, among other monitoring review the reports provided by AT 145. The Commission believes that requirements. Are any of the Persons and clearing member FCMs; the risk control protocols required of requirements of § 1.81(b) not already communicate remediation instructions registered entities, specifically those followed by the majority of market to a subset of AT Persons and clearing under the new registration category, will participants that would be subject to member FCMs; and review and provide a general benefit to the safety § 1.81(b), and if so, how much will it evaluate, as necessary, books and and soundness of market activity and cost for a market participant to comply records of AT Persons and clearing price formation. Has the Commission with such requirement(s)? member FCMs as contemplated by correctly identified the type and level of 133. Proposed § 1.81(c) requires that proposed § 40.22(e). benefits which arise from placing these AT Persons implement policies requirements on a new set of significant designed to ensure that Algorithmic Section 15(a) Considerations market participants? Trading operates in a manner that 138. The Commission requests 146. The Commission requests complies with the CEA and the rules comment on its discussion of the effects comment on its discussion of the effects and regulations thereunder. Among of the proposed rules on the of the proposed rules on the other controls, the policies should considerations in Section 15(a) of the considerations in Section 15(a) of the include a plan of internal coordination CEA. CEA. and communication between 139. Are the compliance costs compliance staff of the AT Person and Transparency in Exchange Trade associated with the proposed rules of Matching Systems staff of the AT Person responsible for sufficient magnitude to potentially Algorithmic Trading regarding cause smaller market participants, 147. The Commission anticipates that Algorithmic Trading design, changes, FCMs, or DCMs to cease or scale back costs associated with the transparency testing, and controls. Are any of the operations? Do these costs create requirement would come from some requirements of § 1.81(c) not already significant barriers to entry? additional testing of platform systems followed by the majority of market and from drafting and publishing participants that would be subject to Registration—§ 1.3(x)(3) descriptions of any relevant attributes of § 1.81(c), and if so, how much will it 140. The Commission estimates that the platform. What new costs would be cost for a market participant to comply the costs of registration will encompass associated with providing descriptions with such requirement(s)? direct costs (those associated with NFA of attributes of electronic matching

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platforms that affect market participant that provides, but does not require such 160. To what extent are the costs orders and quotes? tools? Please provide an estimate of the imposed on the DCMs by the proposed 148. Please compare the costs and cost to such a market participant to rule already incurred pursuant to benefits of the alternative of applying initially calibrate and use exchange- existing rules? the transparency requirement only with provided self-trade prevention tools, in 161. To what extent are the benefits respect to latencies within a platform accordance with § 40.23. Please also of the proposed rule currently being and how a self-trade prevention tool comment on any other direct or indirect realized? determines whether to cancel an order costs to a market participant that does 162. Do DCM Web sites currently with the costs and benefits of the not currently use self-trade prevention provide adequate information regarding proposed rule. tools arising from the proposed market-maker and trading incentive 149. What benefits might market requirement to implement such tools. programs, and is such information participants receive through increased 156. The Commission estimates above easily located? transparency into the operation of that the number of market participants electronic matching platforms, 163. To what extent do DCMs that will submit the approval requests currently make payments for self-trades particularly for those market described by § 40.23(c) is approximately participants without direct electronic pursuant to market-maker and trading equivalent to the number of AT Persons. incentive programs? access who may not be able to Please comment on whether the 164. The Commission requests accurately measure latencies or other estimate of the number of market comment on its discussion of the effects metrics of market efficiency? participants submitting such approval of the proposed rules on the 150. The Commission requests requests should be higher or lower. For considerations in Section 15(a) of the comment on its discussion of the effects example, should the estimate be raised CEA. of the proposed rules on the to account for proprietary algorithmic considerations in Section 15(a) of the traders that will not be AT Persons, List of Subjects CEA. because they do not use Direct 17 CFR Part 1 Self-Trade Prevention Electronic Access and therefore will not 151. Please comment on the cost be required to register as floor traders? Commodity futures, Commodity pool estimates described above for DCMs and 157. Proposed § 40.23 provides that operators, Commodity trading advisors, market participants to comply with the DCMs may comply with the Definitions, Designated contract requirements of § 40.23. The requirement to apply, or provide and markets, Floor brokers, Futures Commission is interested in commenter require the use of, self-trade prevention commission merchants, Introducing opinion on all aspects of its analysis, tools by requiring market participants to brokers, Major swap participants, including its estimate of the number of identify to the DCM which accounts Reporting and recordkeeping entities impacted by the proposed should be prohibited from trading with requirements, Swap dealers. regulation and the amount of costs such each other. With respect to this account 17 CFR Part 38 entities may incur to comply with the identification process, the Commission’s regulation. principal goal is to prevent Commodity futures, Designated 152. Please comment on the benefits unintentional self-trading; the contract markets, Reporting and described above. Do you agree with the Commission does not have a specific recordkeeping requirements. interest in regulating the manner by Commission’s position that self-trade 17 CFR Part 40 prevention requirements will result in which market participants identify to more accurate indications of the level of DCMs the account that should be Commodity futures, Definitions, market interest on both sides of the prohibited from trading from each other, Designated contract markets, Reporting market and help ensure arms-length so long as this goal is met. Should any and recordkeeping requirements. other identification methods be transactions that promote effective price 17 CFR Part 170 discovery? Are there additional benefits permitted in § 40.23? For example, to regulatory self-trade prevention please comment on whether the Commodity futures, Commodity pool requirements not articulated above? opposite approach is preferable: Market operators, Commodity trading advisors, 153. Are there any DCMs that neither participants would identify to DCMs the Floor brokers, Futures commission internalize and apply self-trade accounts that should be permitted to merchants, Introducing brokers, Major prevention tools, nor provide self-trade trade with each other (as opposed to swap participants, Reporting and prevention tools to their market those accounts that should be prevented recordkeeping requirements, Swap participants? If so, please provide an from trading with each other). In dealers. estimate of the cost to such a DCM to particular, please comment on whether For the reasons stated in the comply with the requirement under this approach or other identification preamble, the Commodity Futures § 40.23(a) to apply, or provide and methods would reduce costs for market Trading Commission proposes to amend require the use of, self-trade prevention participants or be easier for both market 17 CFR chapter I as follows: tools. participants and DCMs to administer. 154. Would any DCMs that currently 158. The Commission requests PART 1—GENERAL REGULATIONS offer self-trade prevention tools need to comment on its discussion of the effects UNDER THE COMMODITY EXCHANGE update their tools to meet the of the proposed rules on the ACT requirements of § 40.23? If so, please considerations in Section 15(a) of the provide an estimate of the cost to such CEA. ■ 1. The authority citation for part 1 a DCM to comply with the requirements Market-Maker and Trading Incentive continues to read as follows: of § 40.23. Programs Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 155. What percentage of market 6d, 6e, 6f, 6g, 6h, 6i, 6k, 6l, 6m, 6n, 6o, 6p, participants do not currently make use 159. The Commission requests 6r, 6s, 7, 7a–1, 7a–2, 7b, 7b–3, 8, 9, 10a, 12, of exchange-provided self-trade comment on the accuracy of its cost 12a, 12c, 13a, 13a–1, 16, 16a, 19, 21, 23, and prevention tools, when active on a DCM estimates. 24 (2012).

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■ 2. In § 1.3, add paragraphs (x)(3), (tttt), to a designated contract market by an 1.81 Standards for the development, (uuuu), (vvvv), (wwww), (xxxx), (yyyy), AT Person and each change or deletion monitoring, and compliance of and (zzzz) to read as follows: submitted through Algorithmic Trading Algorithmic Trading systems. by an AT Person with respect to such an 1.82 Clearing futures commission merchant § 1.3 Definitions. risk management. order or quote. 1.83 AT Person and clearing member * * * * * (xxxx) AT Person. This term means (x) * * * futures commission merchant reports any person registered or required to be and recordkeeping. (3)(i) Who, in or surrounding any registered as a— other place provided by a contract (1) Futures commission merchant, Subpart A—Requirements for market for the meeting of persons floor broker, swap dealer, major swap Algorithmic Trading similarly engaged purchases or sells participant, commodity pool operator, solely for such person’s own account— § 1.80 Pre-trade risk controls for AT (A) Any commodity for future commodity trading advisor, or Persons. introducing broker that engages in delivery, security futures product, or For all AT Order Messages, an AT Algorithmic Trading on or subject to the swap; or Person shall implement pre-trade risk rules of a designated contract market; or (B) Any commodity option authorized controls and other measures reasonably under section 4c of the Act; and (2) Floor trader as defined in designed to prevent an Algorithmic (ii) Who uses Direct Electronic Access paragraph (x)(3) of this section. Trading Event, including but not limited as defined in paragraph (yyyy) of this (yyyy) Direct Electronic Access. This to: section, in whole or in part, to access term means an arrangement where a (a) Pre-Trade Risk Controls. (1) The such other place for Algorithmic person electronically transmits an order pre-trade risk controls shall include, at Trading; and to a designated contract market, without a minimum, the following: (iii) Who is not registered with the the order first being routed through a (i) Maximum AT Order Message Commission as a futures commission separate person who is a member of a frequency per unit time and maximum merchant, floor broker, swap dealer, derivatives clearing organization to execution frequency per unit time; and major swap participant, commodity which the designated contract market (ii) Order price parameters and pool operator, commodity trading submits transactions for clearing. maximum order size limits. advisor, or introducing broker. (zzzz) Algorithmic Trading. This term (2) Pre-trade risk controls shall be set * * * * * means trading in any commodity at the level of each AT Person, or such (tttt) Algorithmic Trading Compliance interest as defined in paragraph (yy) of other more granular level as the AT Issue. This term means an event at an this section on or subject to the rules of Person may determine, including but AT Person that has caused any a designated contract market, where: not limited to, by product, account Algorithmic Trading of such entity to (1) One or more computer algorithms number or designation, or one or more operate in a manner that does not or systems determines whether to identifiers of natural persons associated comply with the Commodity Exchange initiate, modify, or cancel an order, or with an AT Order Message. Act or the rules and regulations otherwise makes determinations with (3) Natural person monitors at the AT thereunder, the rules of any designated respect to an order, including but not Person shall be promptly alerted when contract market to which such AT limited to: The product to be traded; the pre-trade risk control parameters Person submits orders through venue where the order will be placed; established pursuant to this section are Algorithmic Trading, the rules of any the type of order to be placed; the breached. registered futures association of which timing of the order; whether to place the (b) Order Cancellation Systems. (1) such AT Person is a member, the AT order; the sequencing of the order in Systems that have the ability to: Person’s own internal requirements, or relation to other orders; the price of the (i) Immediately disengage Algorithmic the requirements of the AT Person’s order; the quantity of the order; the Trading; clearing member, in each case as partition of the order into smaller (ii) Cancel selected or up to all resting applicable. components for submission; the number orders when system or market (uuuu) Algorithmic Trading of orders to be placed; or how to manage conditions require it; and Disruption. This term means an event the order after submission; and (iii) Prevent submission of new AT originating with an AT Person that (2) Such order, modification or order Order Messages. (2) Prior to an AT Person’s initial use disrupts, or materially degrades— cancellation is electronically submitted of Algorithmic Trading to submit a (1) The Algorithmic Trading of such for processing on or subject to the rules message or order to a designated AT Person, of a designated contract market; contract market’s trading platform, such (2) The operation of the designated provided, however, that Algorithmic AT Person must notify the designated contract market on which such AT Trading does not include an order, contract market on which it conducts Person is trading, or modification, or order cancellation Algorithmic Trading whether all of its (3) The ability of other market whose every parameter or attribute is resting orders should be cancelled or participants to trade on the designated manually entered into a front-end suspended in the event that the AT contract market on which such AT system by a natural person, with no Person’s Algorithmic Trading system Person is trading. further discretion by any computer disconnects with the trading platform. (vvvv) Algorithmic Trading Event. system or algorithm, prior to its (c) System Connectivity. AT Persons This term means an event at an AT electronic submission for processing on with Direct Electronic Access as defined Person that constitutes— or subject to the rules of a designated in § 1.3(yyyy) shall implement systems (1) An Algorithmic Trading contract market. to indicate on an ongoing basis whether Compliance Issue; or ■ (2) An Algorithmic Trading 3. Add subpart A to read as follows: they have proper connectivity with the Disruption. Subpart A—Requirements for Algorithmic trading platform and any systems used (wwww) AT Order Message. This Trading by a designated contract market to term means each new order or quote Sec. provide the AT Person with market submitted through Algorithmic Trading 1.80 Pre-trade risk controls for AT Persons. data.

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(d) Notification of Algorithmic (v) Procedures for documenting the is responsible for an Algorithmic Trading. Prior to an AT Person’s initial strategy and design of proprietary Trading system during trading hours. use of Algorithmic Trading to submit a Algorithmic Trading software used by (2) Each AT Person shall periodically message or order to a designated an AT Person, as well as any changes to review the effectiveness of the policies contract market’s trading platform, such such software if such changes are and procedures required by this AT Person shall notify its clearing implemented in a production paragraph (b), and take prompt action to member and the designated contract environment. document and remedy deficiencies in market on which it will be trading that (vi) Maintaining a source code such policies and procedures. it will engage in Algorithmic Trading. repository to manage source code (c) Compliance of Algorithmic (e) Self-Trade Prevention Tools. To access, persistence, copies of all code Trading Systems. (1) Each AT Person the extent that implementation of a used in the production environment, shall implement written policies and designated contract market’s self-trade and changes to such code. Such source procedures reasonably designed to prevention tools requires calibration or code repository must include an audit ensure that each of its Algorithmic other action by an AT Person, such AT trail of material changes to source code Trading systems operates in a manner Person shall calibrate or take such other that would allow the AT Person to that complies with the Commodity action as is necessary to apply such determine, for each such material Exchange Act and the rules and tools. change: who made it; when they made regulations thereunder. (f) Periodic Review for Sufficiency and it; and the coding purpose of the (2) Each AT Person shall implement Effectiveness. Each AT Person shall change. Each AT Person shall keep such written policies and procedures periodically review its compliance with source code repository, and make it requiring: (i) Staff of the AT Person to review this section to determine whether it has available for inspection, in accordance Algorithmic Trading systems in order to effectively implemented sufficient with § 1.31. detect potential Algorithmic Trading measures reasonably designed to (2) Each AT Person shall periodically Compliance Issues. Procedures shall prevent an Algorithmic Trading Event. review the effectiveness of the policies indicate that such staff shall include Each AT Person shall take prompt and procedures required by this staff of the AT Person familiar with the action to remedy any deficiencies it paragraph (a), and take prompt action to Commodity Exchange Act and the rules identifies. document and remedy deficiencies in and regulations thereunder, the rules of such policies and procedures. § 1.81 Standards for the development, any designated contract market to which monitoring, and compliance of Algorithmic (b) Monitoring of Algorithmic Trading such AT Person submits AT Order Trading systems. Systems. (1) Each AT Person shall Messages, the rules of any registered (a) Development and testing of implement written policies and futures association of which such AT Algorithmic Trading Systems. (1) Each procedures reasonably designed to Person is a member, the AT Person’s AT Person shall implement written ensure that each of its Algorithmic own internal requirements, and the policies and procedures for the Trading systems is subject to continuous requirements of the AT Person’s development and testing of its real-time monitoring by knowledgeable clearing member, in each case as Algorithmic Trading systems. Such and qualified staff while such applicable. policies and procedures shall at a Algorithmic Trading system is engaged (ii) A plan of internal coordination minimum include the following: in trading. Such policies and procedures and communication between (i) Maintaining a development shall at a minimum include the compliance staff of the AT Person and environment that is adequately isolated following: staff of the AT Person responsible for from the production trading (i) Continuous real-time monitoring of Algorithmic Trading regarding environment. The development Algorithmic Trading to identify Algorithmic Trading design, changes, environment may include computers, potential Algorithmic Trading Events. testing, and controls, which plan should networks, and databases, and should be (ii) Automated alerts when an be designed to detect and prevent used by software engineers while Algorithmic Trading system’s AT Order Algorithmic Trading Compliance Issues. developing, modifying, and testing Message behavior breaches design (3) Each AT Person shall periodically source code. parameters, upon loss of network review the effectiveness of the policies (ii) Testing of all Algorithmic Trading connectivity or data feeds, or when and procedures required by this code and related systems and any market conditions approach the paragraph (c), and take prompt action to changes to such code and systems prior boundaries within which the document and remedy deficiencies in to their implementation, including Algorithmic Trading system is intended such policies and procedures. testing to identify circumstances that to operate, to the extent applicable. (d) Designation and training of may contribute to future Algorithmic (iii) Monitoring staff of the AT Person Algorithmic Trading staff. (1) Each AT Trading Events. Such testing must be shall have the ability and authority to Person shall implement written policies conducted both internally within the disengage an Algorithmic Trading and procedures to designate and train AT Person and on each designated system and to cancel resting orders its staff responsible for Algorithmic contract market on which Algorithmic when system or market conditions Trading. Such policies and procedures Trading will occur. require it, including the ability to shall at a minimum include the (iii) Regular back-testing of contact staff of the applicable following: Algorithmic Trading using historical designated contract market and clearing (i) Procedures for designating and transaction, order, and message data to firm, as applicable, to seek information training all staff involved in designing, identify circumstances that may and cancel orders. Such monitoring staff testing and monitoring Algorithmic contribute to future Algorithmic Trading must also have dashboards and control Trading, and documenting training Events. panels to monitor and interact with the events. Training must, at a minimum, (iv) Regular stress tests of Algorithmic Algorithmic Trading systems for which cover design and testing standards, Trading systems to verify their ability to they are responsible. Algorithmic Trading Event operate in the manner intended under a (iv) Procedures that will enable AT communication procedures, and variety of market conditions. Persons to track which monitoring staff requirements for notifying staff of the

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applicable designated contract market the pre-trade risk controls and order (2) A certification by the chief when Algorithmic Trading Events cancellation systems provided by executive officer or chief compliance occur. designated contract markets pursuant to officer of the futures commission (ii) Training policies reasonably § 38.255(b) and (c) of this chapter. merchant that, to the best of his or her designed to ensure that natural person (c) Non-Direct Electronic Access knowledge and reasonable belief, the monitors are adequately trained for each orders. For all AT Order Messages information contained in the report is Algorithmic Trading system or strategy originating with an AT Person that are accurate and complete. (or material change to such system or not submitted to a trading platform (c) AT Person recordkeeping. Each AT strategy) for which such monitors are through Direct Electronic Access as Person shall keep, and provide upon responsible. Training must include, at a defined in § 1.3(yyyy), the futures request to each designated contract minimum, the trading strategy for the commission merchant that is the market on which such AT Person Algorithmic Trading as well as the clearing member for the AT Person shall engages in Algorithmic Trading, books automated and non-automated risk comply with the requirements of and records regarding such AT Person’s controls that are applicable to the paragraphs (a)(1), (2), and (4) of this compliance with all requirements Algorithmic Trading. section by itself establishing and pursuant to §§ 1.80 and 1.81. (iii) Escalation procedures to inform maintaining the pre-trade risk controls (d) Clearing member futures senior staff of the AT Person as soon as and order cancellation systems commission merchant recordkeeping. Algorithmic Trading Events are described therein. Each futures commission merchant that identified. is a clearing member for an AT Person (2) Each AT Person shall periodically § 1.83 AT Person and clearing member shall keep, and provide upon request to review the effectiveness of the policies futures commission merchant reports and recordkeeping. each designated contract market on and procedures required by this which such AT Person engages in (a) AT Person Reports. Each AT paragraph (d), and take prompt action to Algorithmic Trading, books and records Person shall annually prepare a report document and remedy deficiencies in regarding such clearing member futures and submit such report by June 30 to such policies and procedures. commission merchant’s compliance each designated contract market on with all requirements pursuant to § 1.82. § 1.82 Clearing member futures which such AT Person engaged in commission merchant risk management. Algorithmic Trading. Together with the PART 38—DESIGNATED CONTRACT (a) For all AT Order Messages annual report, each AT Person shall MARKETS originating with an AT Person, the submit copies of the written policies futures commission merchant that is the and procedures developed to comply ■ 4. The authority citation for part 38 clearing member for such AT Person with § 1.81(a) and (c). Such report shall continues to read as follows: shall comply with the following cover the time period from May 1 of the Authority: 7 U.S.C. 1a, 2, 6, 6a, 6c, 6d, 6e, requirements: previous year to April 30 of the year 6f, 6g, 6i, 6j, 6k, 6l, 6m, 6n, 7, 7a–2, 7b, 7b– (1) Make use of pre-trade risk controls such report is submitted. The report 1, 7b–3, 8, 9, 15, and 21, as amended by the reasonably designed to prevent or shall include the following: Dodd-Frank Wall Street Reform and mitigate an Algorithmic Trading (1) A description of the pre-trade risk Consumer Protection Act, Pub. L. 111–203, Disruption, including at a minimum, controls required by § 1.80(a), including 124 Stat. 1376. those pre-trade risk controls described a description of each item enumerated ■ 5. Revise § 38.255 to read as follows: in § 1.80(a)(1). in § 1.80(a) and a description of all (2) Pre-trade risk controls must be set parameters and the specific quantitative § 38.255 Risk controls for trading. at the level of each AT Person, or such settings used by the AT Person for such (a) The designated contract market other more granular level as the clearing pre-trade risk controls; and must establish and maintain risk control futures commission merchant may (2) A certification by the chief mechanisms to prevent and reduce the determine, including but not limited to, executive officer or chief compliance potential risk of price distortions and by product, account number or officer of the AT Person that, to the best market disruptions, including, but not designation, or one or more identifiers of his or her knowledge and reasonable limited to, market restrictions that pause of natural persons associated with an belief, the information contained in the or halt trading in market conditions AT Order Message. report is accurate and complete. prescribed by the designated contract (3) The futures commission merchant (b) Clearing member futures market. shall have policies and procedures commission merchant reports. Each (b) For all AT Order Messages reasonably designed to ensure that futures commission merchant that is a originating with an AT Person that are natural person monitors at the clearing clearing member for one or more AT submitted to a designated contract futures commission merchant are Person(s) shall annually prepare and market through Direct Electronic Access promptly alerted when pre-trade risk submit a report by June 30 to each as defined in § 1.3(yyyy) of this chapter, control parameters established pursuant designated contract market on which the designated contract market shall to this section are breached. such AT Person(s) engaged in make available to the clearing member (4) Make use of the order cancellation Algorithmic Trading. Such report shall futures commission merchant for such systems described in § 1.80(b)(1). cover the time period from May 1 of the AT Person effective systems and (b) Direct Electronic Access orders. previous year to April 30 of the year controls, reasonably designed to For all AT Order Messages originating such report is submitted. The report facilitate the items enumerated below: with an AT Person submitted to a shall include the following: (1) The clearing member futures trading platform through Direct (1) A description of the clearing commission merchant’s management of Electronic Access as defined in member futures commission merchant’s the risks, pursuant to § 1.82(a)(1) and (2) § 1.3(yyyy), the futures commission program for establishing and of this chapter, that may arise from such merchant that is the clearing member for maintaining the pre-trade risk controls AT Person’s Algorithmic Trading using the AT Person shall comply with the required by § 1.82(a)(1) for its AT Direct Electronic Access. requirements of paragraphs (a)(1), (2), Persons at the designated contract (i) Such systems and controls shall and (4) of this section by implementing market; and include, at a minimum, the pre-trade

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risk controls described in § 1.80(a)(1) of the dissemination of real-time market the specific array of controls that are this chapter. data to market participants, including selected, the designated contract market also (ii) Such systems shall, at a minimum, but not limited to latencies or other must set the parameters for those controls, so enable the clearing member futures long as the types of controls and their variability in the electronic matching specific parameters are reasonably likely to commission merchant to set the pre- platform and the transmission of serve the purpose of preventing market trade risk controls at the level of each message acknowledgements, order disruptions and price distortions, or as they such AT Person, product, account confirmations, or trade confirmations, or are otherwise required to be designed number or designation, and one or more dissemination of market data. pursuant to Commission regulation. If a identifiers of natural persons associated (2) Through the procedures, contract is linked to, or is a substitute for, with an AT Order Message. Designated arrangements and resources required in other contracts, either listed on its market or contract market rules should permit paragraph (a) of this section, the on other trading venues, the designated contract market must, to the extent clearing member futures commission designated contract market must ensure practicable, coordinate its risk controls with merchants to choose the level at which public dissemination of information any similar controls placed on those other they place control, so long as clearing pertaining to new product listings, new contracts. If a contract is based on the price member futures commission merchants rules, rule amendments, rules pertaining of an equity security or the level of an equity use at least one of the levels. to the operation of the electronic index, such risk controls must, to the extent (2) The clearing member future matching platform or trade execution practicable, be coordinated with any similar commission merchant’s ability, facility, known attributes of its controls placed on national security pursuant to § 1.82(a)(4) of this chapter, electronic trading platform under exchanges. to make use of the order cancellation paragraph (a)(1)(iv) of this section, or * * * * * systems described in § 1.80(b)(1) of this other changes to previously-disclosed PART 40—PROVISIONS COMMON TO chapter. The designated contract market information, in accordance with the REGISTERED ENTITIES shall enable the clearing member future timeline provided in paragraph (c) of commission merchant to apply such this section. ■ 8. The authority citation for part 40 order cancellation systems to orders * * * * * continues to read as follows: from each such AT Person, product, (c) * * * Authority: 7 U.S.C. 1a, 2, 5, 6, 7, 7a, 8 and account number or designation, or one (3) A designated contract market, in 12, as amended by Titles VII and VIII of the or more identifiers of natural persons making available on its Web site Dodd-Frank Wall Street Reform and associated with an AT Order Message. information pursuant to paragraphs Consumer Protection Act, Pub. L. 111–203, (c) A designated contract market that (a)(1)(iii) and (iv) of this section, shall 124 Stat. 1376 (2010). permits Direct Electronic Access as place such information and submissions ■ 9. Revise § 40.1(i) to read as follows: defined in § 1.3(yyyy) of this chapter on its Web site within a reasonable time, shall also require clearing member but no later than 10 business days, § 40.1 Definitions. futures commission merchants to use following the identification of or * * * * * the systems and controls described in changes to such attributes. Such (i) Rule means any constitutional paragraph (b) of this section with information shall be disclosed provision, article of incorporation, respect to all AT Order Messages prominently and clearly in plain bylaw, rule, regulation, resolution, originating with an AT Person that are English. interpretation, stated policy, advisory, submitted through Direct Electronic * * * * * terms and conditions, market maker or Access. ■ 7. In Appendix B to part 38, in the trading incentive program, trading ■ 6. Amend § 38.401 as follows: paragraph with the subject heading Core protocol (including but not limited to ■ a. Revise paragraph (a)(1)(iii); Principle 4 of section 5(d) of the Act: any operation of an electronic matching ■ b. Add paragraph (a)(1)(iv); PREVENTION OF MARKET platform that materially affects the time, ■ c. Revise paragraph (a)(2); and DISRUPTION, revise paragraph (b)(5) to priority, price, or quantity of execution ■ d. Add paragraph (c)(3). read as follows: of market participant orders, the ability ■ The revisions and additions read as to cancel, modify, or limit display of follows: Appendix B to Part 38—Guidance on, market participant orders, or the and Acceptable Practices in, § 38.401 General requirements. dissemination of real-time market data Compliance With Core Principles to market participants), agreement or (a) * * * (1) * * * * * * * * instrument corresponding thereto, (iii) Rules and specifications including those that authorize a pertaining to the operation of the Core Principle 4 of section 5(d) of the Act: PREVENTION OF MARKET DISRUPTION response or establish standards for electronic matching platform or trade * * * * * responding to a specific emergency, and execution facility, including but not any amendment or addition thereto or limited to those pertaining to the (b) * * * (5) Risk controls for trading. An acceptable repeal thereof, made or issued by a operation of its electronic matching program for preventing market disruptions registered entity or by the governing platform that materially affect the time, must demonstrate appropriate trade risk board thereof or any committee thereof, priority, price, or quantity of execution, controls, in addition to pauses and halts. in whatever form adopted. or the ability to cancel, modify, or limit Such controls must be adapted to the unique display of market participant orders. characteristics of the markets to which they * * * * * (iv) Any known attributes of the apply and must be designed to avoid market §§ 40.13 through 40.19 [Reserved] disruptions without unduly interfering with electronic matching platform, other than ■ that market’s price discovery function. The 10. Add reserved §§ 40.13 through those already disclosed in rules or 40.19. specifications under paragraph (a)(1)(iii) designated contract market must employ the pre-trade risk controls specified in the ■ 11. Add §§ 40.20 through 40.23 to of this section, that materially affect the Commission’s regulations (including read as follows: time, priority, price, or quantity of applicable regulations contained in part 40 of execution of market participant orders, this chapter), and may employ additional § 40.20 Risk controls for trading. the ability to cancel, modify, or limit controls that the designated contract market A designated contract market shall display of market participant orders, or believes are appropriate to its market. Within implement pre-trade and other risk

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controls reasonably designed to prevent section for orders that do not originate with all requirements pursuant to § 1.82 an Algorithmic Trading Disruption (or, from Algorithmic Trading, after making of this chapter; and pursuant to paragraph (d) of this any adjustments to the mechanisms that (e) Review and evaluate, as necessary, section, similar disruption resulting the designated contract market books and records required to be kept from orders that originate from manual determines are appropriate for such pursuant to paragraph (d) of this order entry or other non-Algorithmic orders. section, and the measures described Trading) or an Algorithmic Trading (2) [Reserved] therein. An appropriate review shall Compliance Issue, including at a include measures by the designated § 40.21 DCM test environments. minimum all of the following: contract market reasonably designed to (a) Pre-trade risk controls. Pre-trade (a) A designated contract market shall identify and remediate any insufficient risk controls reasonably designed to provide a test environment that will mechanisms, policies, and procedures address the risks from Algorithmic enable AT Persons to simulate described in such books and records. Trading on a designated contract production trading. Such test § 40.23 Self-trade prevention tools. market. environment shall provide access to (1) The pre-trade risk controls to be historical transaction, order and (a) A designated contract market shall established and used by a designated message data and shall also enable AT implement rules reasonably designed to contract market shall include, at a Persons to conduct conformance testing prevent self-trading by market minimum, those described in of their Algorithmic Trading systems to participants, except as specified in § 1.80(a)(1) of this chapter. verify compliance with the paragraph (b) of this section. ‘‘Self- (2) At a minimum, the pre-trade risk requirements of §§ 1.80(a) through (c) trading’’ is defined for purposes of this controls established and used pursuant and 1.81(a)(1)(ii) through (iv) and (c)(1) section as the matching of orders for to this section shall be set at the level of this chapter. accounts that have common beneficial of each AT Person. Designated contract (b) [Reserved] ownership or are under common markets must also evaluate whether to control. A designated contract market § 40.22 DCM review of compliance reports; shall either apply, or provide and establish pre-trade risk controls at a maintenance of books and records. more granular level, including at a require the use of, self-trade prevention A designated contract market shall minimum, by product or one or more tools that are reasonably designed to comply with the following: identifiers of natural persons associated prevent self-trading and are applicable (a) Review of reports. Implement rules with an AT Order Message. Where to all orders on its electronic trade that require each AT Person that trades deemed appropriate by the designated matching platform. For purposes of on the designated contract market, and contract market, pre-trade risk controls complying with this requirement, a each futures commission merchant that should be set at such more granular designated contract market may either is a clearing member of a derivatives levels. determine for itself which accounts (3) A designated contract market shall clearing organization for such AT should be prohibited from trading with have policies and procedures reasonably Person, to submit the reports described each other, or require market designed to ensure that natural person in § 1.83(a) and (b), respectively, of this participants to identify to the designated monitors at such designated contract chapter; contract market which accounts should (b) Submission date. Require the market are promptly alerted when pre- be prohibited from trading with each submission of such reports by June 30th trade risk control parameters established other. of each year; pursuant to this section are breached. (b) Notwithstanding the foregoing, a (b) Order cancellation systems. (1) (c) Review program. Establish a designated contract market may, in its Order cancellation systems that have the program for effective periodic review discretion, implement rules that permit ability to: and evaluation of reports described in self-trading described in paragraphs (i) Perform the actions described in paragraph (a) of this section, and of the (b)(1) or (b)(2) of this section to occur, § 1.80(b)(1) of this chapter with respect measures described therein. An effective in each case subject to the requirements to orders from AT Persons; and program shall include measures by the of paragraph (c) of this section: (ii) Cancel or suspend all resting designated contract market reasonably (1) A self-trade resulting from the orders from AT Persons in the event of designed to identify and remediate any matching of orders for accounts with disconnect with the trading platform. insufficient mechanisms, policies and common beneficial ownership where (2) [Reserved] procedures described in such reports, such orders are initiated by independent (c) System connectivity. (1) Systems including identification and decision makers. A designated contract that enable the systems of an AT Person remediation of any inadequate market may through its rules further with Direct Electronic Access as defined quantitative settings or calibrations of define for its market participants in § 1.3(yyyy) of this chapter to indicate pre-trade risk controls required of AT ‘‘independent decision makers.’’ to the AT Person on an ongoing basis Persons pursuant to § 1.80(a) of this (2) A self-trade resulting from the whether the AT Person has proper chapter; matching of orders for accounts under connectivity with— (d) Maintenance of books and records. common control where such orders (i) The designated contract market’s Implement rules that require each AT comply with the designated contract trading platform, and Person to keep and provide to the market’s cross-trade, minimum (ii) Any systems used by the designated contract market books and exposure requirements or similar rules, designated contract market to provide records regarding such AT Person’s and are for accounts that are not under the AT Person with market data. compliance with all requirements common beneficial ownership. (2) [Reserved] pursuant to §§ 1.80 and 1.81 of this (c) A designated contract market may (d) Risk control mechanisms for chapter, and require each clearing permit self-trading described in manual order entry and other non- member futures commission merchant paragraph (b) of this section only if the Algorithmic Trading. (1) A designated to keep and provide to the designated designated contract market: contract market shall implement the risk contract market books and records (1) Requires market participants to control mechanisms described in regarding such clearing member futures request approval from the designated paragraphs (a) and (b)(1)(i) of this commission merchant’s compliance contract market that self-trade

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prevention tools not be applied with (3) A list of all products or services to § 40.26 Information requests from the respect to specific accounts under which the market maker or trading Commission or the Director of the Division common beneficial ownership or incentive program applies; of Market Oversight. control, on the basis that they meet the (4) A description of any eligibility (a) Upon request by the Commission criteria of paragraph (b) of this section. criteria or categories of market or the Director of the Division of Market The designated contract market must participants defining who may Oversight, a designated contract market require that such approval request be participate in the market maker or shall provide such information and data provided to it by a compliance officer or trading incentive program; as may be requested regarding senior officer of the market participant; (5) For any market maker or trading participation in market maker or trading and incentive program that is not open to all incentive programs offered by the (2) Requires market participants to market participants, an explanation of designated contract market, including withdraw or amend an approval request why such program is limited to the but not limited to, individual program if any change occurs that would cause chosen eligibility criteria or categories agreements, names of program the information provided in such of market participants, and an participants, benchmarks achieved by approval request to be no longer explanation of how such limitation program participants, and payments or accurate or complete. complies with the impartial access and other benefits conferred upon program (d) For each product and expiration comparable fee structure requirements participants. month traded on a designated contract of § 38.151(b) of this chapter for (b) [Reserved] market in the previous quarter, the designated contract markets; § 40.27 Payment for trades with no change designated contract market must (6) An explanation of how persons in ownership prohibited. prominently display on its Web site the eligible for the market maker or trading (a) A designated contract market shall following information: incentive program may apply to implement policies and procedures (1) The percentage of trades in such participate, and how eligibility will be reasonably designed to prevent the product including all expiration months evaluated by the designated contract payment of market maker or trading that represent self-trading approved market; incentive program benefits, including (pursuant to paragraph (c) of this (7) A description of any payments, but not limited to payments, discounts, section) by the designated contract incentives, discounts, considerations, or other considerations, for trades market, expressed as a percentage of all inducements or other benefits that between accounts that are: trades in such product and expiration market maker or trading incentive (1) Identified to such designated month; program participants may receive, contract market as under common (2) The percentage of volume of including any non-financial incentives; beneficial ownership pursuant to the trading in such product including all and approval process described in § 40.23(c); expiration months that represents self- (8) A description of the obligations, or trading approved (pursuant to paragraph benchmarks, or other measures that a (2) Otherwise known to the (c) of this section) by the designated participant in a market maker or trading designated contract market as under contract market, expressed as a incentive program must meet to receive common ownership. percentage of all volume in such the benefits described in paragraph (b) [Reserved] product and expiration month; and (a)(7) of this section. (3) The ratio of orders in such product § 40.28 Surveillance of market maker and (9) A description of any legal trading incentive programs. and expiration month whose matching affiliation between the designated was prevented by the self-trade contract market and any entity acting as (a) A designated contract market, prevention tools described in paragraph a market maker or participating in a consistent with its obligations pursuant (a) of this section, expressed as a ratio market maker program. to subpart C of part 38 of this chapter, shall review all benefits accorded to of all trades in such product and (b) In addition to any public notice participants in market maker and expiration month. required pursuant to this part (including trading incentive programs, including without limitation the requirements of § 40.24 [Reserved] but not limited to payments, discounts, §§ 40.5(a)(6) and 40.6(a)(2)) of this ■ 12. Add reserved § 40.24. or other considerations, to ensure that chapter a designated contract market ■ 13. Add §§ 40.25 through 40.28 to such benefits are not earned through shall ensure that the information read as follows: abusive practices. required by paragraphs (a)(1) through (b) [Reserved] § 40.25 Additional public information (a)(8) of this section is easily located on required for market maker and trading its public Web site from the time that PART 170—REGISTERED FUTURES incentive programs. such designated contract market begins ASSOCIATIONS (a) When submitting a Rule regarding accepting participants in the market a market maker or trading incentive maker or trading incentive program ■ 14. The authority citation for part 170 program pursuant to § 40.5 or § 40.6, a through the time that it ceases operation continues to read as follows: designated contract market shall, in of the market maker or trading incentive Authority: 7 U.S.C. 6d, 6m, 6p, 6s, 12a, and addition to information required by program. 21. such sections, include the following (c) A designated contract market shall ■ 15. Add § 170.18 to subpart C to read information in its public Rule filing: notify the Commission upon the as follows: (1) The name of the market maker termination of a market maker or trading program or trading incentive program, incentive program prior to the § 170.18 AT Persons. the date on which it is scheduled to termination date previously notified to Each registrant, as defined in begin, and the date on which it is the Commission; any extension or § 1.3(oooo) of this chapter, that is an AT scheduled to terminate (if applicable); renewal of a market maker or trading Person, as defined in § 1.3(xxxx) of this (2) An explanation of the specific incentive program beyond its original chapter, that is not otherwise required purpose for the market maker or trading termination date shall require a new to be a member of a futures association incentive program; Rule filing pursuant to this part. that is registered under Section 17 of the

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Act pursuant to §§ 170.15, 170.16, or Automated trading has brought many and I believe it is important to achieving a 170.17 of this chapter must become and benefits to market participants. These sound framework. But in doing so, we must remain a member of at least one futures include more efficient execution, lower seek efficiency, and avoid conflicting or association that is registered under spreads and greater transparency. But its unnecessary requirements at multiple levels. extensive use also raises important policy In order to make the multi-level approach Section 17 of the Act and that provides and supervisory questions and concerns. effective, we are proposing to require the for the membership therein of such The Commission has already taken a registration of proprietary traders who engage registrant, unless no such futures number of steps to respond to the in algorithmic trading on our regulated association is so registered. development of automated trading in our exchanges via ‘‘direct electronic access.’’ ■ 16. Add subpart D, consisting of markets. Following the 2010 ‘‘Flash Crash,’’ Today, our staff estimates that roughly 35 § 170.19, to read as follows: the CFTC worked with the SEC to establish percent of the futures trading in our markets certain controls to minimize the risk of is done by traders who use direct electronic Subpart D—Standards for Automated market disruptions. The Commission has also access and are not registered with us. A Trading and Algorithmic Trading required clearing members to implement registration requirement will ensure that all Systems policies and procedures governing the use of those with direct electronic access to our automated trading programs. We have also markets are complying with pre-trade risk § 170.19 RFA Standards for Automated required automatic screening of orders for controls, testing and other requirements. And Trading and Algorithmic Trading Systems. compliance with risk limits if they are it would enhance the Commission’s ability to (a) A registered futures association automatically executed. carry out its oversight responsibilities. But as markets continue to evolve, it is While we believe a registration must establish and maintain a program important to continue looking at this issue. requirement is appropriate, we have also for the prevention of fraudulent and Therefore, in September 2013, the invited market participants to comment on manipulative acts and practices, the Commission issued a Concept Release that whether there are alternatives that can protection of the public interest, and requested public comment on the necessity achieve the proposal’s underlying objectives. perfecting the mechanisms of trading on and operation of a variety of risk controls and We have also asked whether the registration designated contract markets by adopting measures. The Commission received many requirement should be limited to trading rules for each category of member, as written comments and also held a meeting of firms meeting certain volume, order or deemed appropriate by the registered its Technological Advisory to discuss the message levels—or be based on other futures association, requiring: issues raised. It served as a very useful way characteristics. Further, we are seeking (1) Pre-trade risk controls and other to understand existing industry practices and comment on whether all firms trading discuss what further actions might make through direct electronic access should be measures for algorithmic trading sense. required to register, even if they are not using systems; The proposal approved today addresses algorithmic trading. (2) Standards for the development, several areas discussed in the Concept We believe that many of the requirements testing, monitoring, and compliance of Release, and incorporates much of that we are proposing for trading firms represent algorithmic trading systems; public input. It focuses on minimizing the the best practices already followed by many (3) Designation and training of potential for disruptions and other larger firms. However, we know that a faulty algorithmic trading staff; and operational problems that may arise from the algorithm at a single firm, regardless of size, (4) Operational risk management automation of order origination, transmission can potentially cause a significant problem. standards for clearing member futures or execution. They may come about due to As a result, we have proposed standards that commission merchants with respect to malfunctioning algorithms, inadequate are applicable regardless of the size or similar customer orders originating with testing of algorithms, errors and similar attributes of a trading firm. We also are problems. cognizant of the importance of establishing algorithmic trading systems. No set of rules can prevent all such effective standards without creating barriers (b) [Reserved] problems. But that doesn’t discharge us from to entry for small firms. So we welcome Issued in Washington, DC, on November our duty to take reasonable measures to comment on whether these requirements 27, 2015, by the Commission. minimize these risks. It is our responsibility should vary in any way depending on the Christopher J. Kirkpatrick, as regulators to create a framework that size or activity level of the trading firm. Secretary of the Commission. promotes the integrity of these markets. And We have also proposed certain risk I believe this proposed rule helps do that. controls for clearing member futures Note: The following appendices will not Our futures market infrastructure is already commission merchants (FCMs) with respect appear in the Code of Federal Regulations. very strong. Our regulatory framework—and to their customers engaged in algorithmic the controls and measures that exist at the trading. FCMs play a critical role in overall Appendices to Regulation Automated exchange and clearing member level in risk management. As I noted earlier, they Trading—Commission Voting particular—have helped create the best have implemented measures already to Summary, Chairman’s Statement, and futures markets in the world. Our proposal require order limits and screening of orders. Commissioners’ Statements seeks to maintain that strength as our markets We believe the requirements we are evolve further. proposing today help achieve an effective Appendix 1—Commission Voting We have proposed a number of measures multi-layered approach. Summary that largely reflect what are industry best We have asked for public comment on practices to minimize the risk of disruptions whether there are any aspects of the required On this matter, Chairman Massad and and similar problems. We have tried to be controls that may pose an undue burden on Commissioners Bowen and Giancarlo voted principles-based. We have set forth clearing member FCMs or that are in the affirmative. No Commissioner voted in requirements for certain controls, but we unnecessary for reducing the risks associated the negative. have avoided prescribing the parameters or with algorithmic trading. We’ve also asked Appendix 2—Statement of Chairman levels at which they should be set. The about what technological development Timothy G. Massad proposed risk controls will apply regardless would be required by clearing members to of whether the automated trading is high- or comply with some requirements of this Today, the Commission has approved a low-frequency. The proposal does not define proposal. proposal that addresses the increased use of high frequency trading. I’ve said frequently that it’s very important automated trading in our markets. I strongly A key principal of this proposed rule is to that we have a robust clearing member support this important action. In the futures have risk controls at three levels—the industry and that all customers—particularly markets, today almost all trading is electronic exchange level, clearing member level and smaller ones—are able to access the markets in some form. And over the last few years, trading firm level. Market participants effectively and efficiently. We want to make more than 70 percent of all trading has generally supported this multi-level sure this proposal is consistent with become automated. approach in response to the Concept Release, achieving that objective.

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We have also included measures on some that is a risk that I believe we must not take. trading. I therefore hope we’ll get comments additional topics not covered in the Concept Recent events have raised important on this proposal from a wide swath of Release. These include provisions to increase questions about the impact and role of stakeholders, from industry experts, to end- transparency for exchanges’ electronic trade algorithmic trading in our markets. As I said users being impacted by this technology, to matching platforms, as well as for market earlier, this fall, ‘‘Even though the amount of even ordinary investors and consumers maker and trading incentive programs, which algorithmic trading and definitions of these concerned about the potential effects of have become more significant as automated various terms are not crystal clear, what is algorithmic trading on commodity prices. I trading has increased. clear is trades involving algorithms make up do not expect that everyone will have the There are concerns that have been raised a substantial portion of our markets, and same views on this subject or that there will with respect to automated trading that also go algorithms can and do malfunction at times, be unanimity of opinion on any part of this beyond the scope of this proposal. These with negative effects on the markets. As a rule. Even though I’ve only been in include whether our markets are best served result, I believe we are obligated to consider Washington for a year and a half, I’m by this speed, and what are its impacts on if it is prudent to establish some regulations experienced enough to know that people volatility and liquidity? These are important on algorithmic trading in our markets.’’ 5 have different opinions on high-visibility topics for market participants and the Today, we begin the process of potentially issues like this one. However, I do encourage Commission to continue to study and establishing those regulations. From what I people to comment so that we can get a full discuss. have seen, I believe we now owe it to market and fair read of popular opinion on both this This proposal provides some common- participants, investors, and ordinary proposal and the topic in general. And if sense risk controls that I believe embrace the consumers to ensure that a reasonable level people have concrete evidence that benefits that automated trading has brought of regulation exists over this new trading algorithmic trading is distorting markets and to our markets, while also protecting against technology. I have said such regulation needs to be curtailed, please submit it via a the increased possibility of breakdowns and should include requirements that entities comment. disruptions that come with it. We utilizing algorithms to trade must use risk There are a few sections of this rule on encourage—and welcome—public comment, management strategies, be required to which I think public comment would be which will carefully be taken into account disclose information to regulators, and have particularly helpful. First, the proposal’s before we take any final action. people who understand the Commodity sixth and seventh questions ask about the Exchange Act and our regulations involved nature of our proposed definition of Appendix 3—Concurring Statement of in the creation and maintenance of their algorithmic trading, including whether we Commissioner Sharon Y. Bowen algorithms. I think this proposed regulation should expand ‘‘the definition of Algorithmic I want to thank the Commission staff for meets that standard and does so in a way that Trading to encompass orders that are the time they have devoted to the proposed allows for innovation and continued generated using algorithmic methods . . . but rule on automated trading. It is a timely development of this nascent technology. are then manually entered into a front-end topic. Having said what I think lies at the core system by a natural person. . . .’’ The As I have previously said, our markets of this regulation, let me also be clear about definition of algorithmic trading is at the have seen immense technological change what this regulation is not. The rule before heart of this proposal, and we need over the last fifteen years.1 Futures trading us today should not substantially change comments on this point. If there is evidence used to involve ‘‘throngs of traders with how many firms utilize algorithms. If, as I that a form of algorithmic trading poses jackets and badges using hand-gestures’’ to hope, a firm already uses risk management systemic risks but is not captured by this purchase futures and options.2 That trading strategies, has various protections against definition, we should expand the definition structure has largely disappeared, with even malfunctions in place, and retains the to expand to cover that form of trading. CME closing the vast majority of its futures services of talented attorneys, this new Second, section 1.83(a) of the proposal pits this summer. Meanwhile, algorithmic regulation will not create significant new requires that persons engaged in algorithmic trading has substantially increased. Algo burdens for that firm. In effect, this trading and registered as such with the trading comprised less than 10% of futures rulemaking largely formalizes and mandates Commission must prepare and submit an volume at the turn of the millennium.3 Yet, firms involved in algorithmic trading to annual report to the Commission. These ‘‘per CFTC staff’s estimates, for the most engage in a variety of practices that they persons are required to include in their liquid U.S. futures contracts which account should already be doing for their own reports a description of the pre-trade risk for over 75% of total trading volume, more protection. controls in place, copies of policies crafted to than 90 percent of all trades make use of I expect that some observers will have comply with requirements regarding the algorithms or some other form of issues with this regulation for not doing more testing and development of algorithmic automation.’’ 4 Of course, these estimates are to constrain the growth and use of trading systems and how their algorithmic just that, estimates. We still do not have algorithmic trading, and I expect there will trading systems comply with the Commodity comprehensive, precise data on the be further debate. I do not regard this Exchange Act and our regulations, and a percentage of trades created or entered by regulation as the final word on regulation of certification by their chief executive officer algorithms in many product classes. Clearly, algorithmic trading. If there is clear evidence or chief compliance officer that the further research and work remain for all that more precise regulations are needed on information in the report is accurate and stakeholders, from regulators, to industry this technology to protect investors or ward complete. participants, to academics and advocates of off systemic risk, I would support further I think the current 1.83(a) does not ask financial reform. regulatory action. And I am sure that, given registrants for enough information. Now, we Yet, I do not believe this lack of the ferocious rate of change of this don’t want to require each registered information requires that regulators passively technology, we will need to update this algorithmic trader to submit a tome of several wait for this information to emerge. Simply regulation regularly to account for those thousand pages each year that lays out every waiting for that kind of data to materialize changes. In many ways, this regulation is arcane factoid about their trading systems. could allow problems to emerge in the merely the first step in a process, it’s a starter Such a requirement would bury our staff in interim that harm investors and the broader home rather than a two-story. But we have paper and create significant expense for financial system. Given the current state of to start somewhere, and starting with registrants. Yet, having already asked each our economy and a global financial system something that formalizes best practices and registered algorithmic trader to submit an still recovering from the 2008 financial crisis, increases disclosure is an excellent place to annual report, I believe we should ask for start. more information in the report. After all, at I have said numerous times that I support 1 Keynote Address by Commissioner Sharon Y. the point a company has to file an annual Bowen before ISDA North America Conference, smart regulation, regulation that works. That report, it should already be doing a CFTC (Sep. 17, 2015), http://www.cftc.gov/ goal is especially critical when it comes to comprehensive review of its policies. As a PressRoom/SpeechesTestimony/opabowen-6. regulation of such a nascent, significant, and result, asking for one or two more pieces of 2 Id. widespread technology as algorithmic information to be included in the annual 3 Id. report should not be a substantial additional 4 Id. 5 Id. cost to registrants. I therefore hope that

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commenters will let us know what additional misinterpretation by computerized analysis Regulation AT passes the SMART REG information registrants should be required to and mathematical models that increasingly standard. submit in their annual reports. For instance, replace human thought and deliberation. Nevertheless, I want to hear the views of should we require registrants to submit Legal scholars raise important questions market participants on this proposal. I will information about how they train and about the viability of traditional market evaluate any final rule based on the SMART monitor the staff responsible for handling regulation in automated trading markets. REG standard and thereafter determine algorithmic trading or about their order How markets and market regulators adjust whether to support or reject it. cancellation systems? to this change from human to automated I will explain my areas of concern. Finally, the proposal prohibits designated trading will be extremely important. It contract markets (DCMs) from paying market requires delicate balancing. To ensure I. Necessity of Regulation AT maker incentive program benefits for trades vibrant, accessible and durable markets, we It is hard to identify exactly what issue in between accounts under common ownership. must cultivate and embrace new technologies automated trading Regulation AT is designed I think that’s a good change and worthy of without harming innovation. Without a to address. The agency is basically playing being formalized in rule text. These programs doubt, there must be effective safeguards of catch-up to an industry that has already serve a critical purpose of encouraging market integrity and credibility, but those developed and implemented risk controls liquidity, but we don’t get increased liquidity safeguards should not bar promising and related testing standards for automated by increasing the amount of trades a person innovation and continuous market trading. Regulation AT describes the does with herself. development. extensive best practices and However, I wonder whether this In turning to Regulation Automated recommendations for automated trading prohibition should not go further. Perhaps Trading (‘‘Regulation AT’’), I acknowledge issued by industry organizations and notes we should also prohibit DCMs from paying that my staff and I had dozens of issues and these program benefits for trades in which concerns that we brought to the attention of that the majority of industry participants are the benefits are, on a per trade basis, greater the Division of Market Oversight. While they following such best practices. Regulation AT than the fees charged by the relevant DCM were responsive to a few small topics, many simply codifies industry best practices in and affiliated derivatives clearing other issues require much further attention many respects, but does not go as far as organization (DCO). Paying benefits for such and consideration that I will summarize in current industry efforts. As such, the trades seems tantamount to giving a subsidy this statement. Commission admits that many of the benefits to un-economic trades and thereby Still, after reading through the almost five of this proposal are already being realized in potentially risks distorting the overall hundred pages of this proposal, I am left with the marketplace. In reality, current industry market. I would therefore welcome one major question that I still cannot answer. standards on automated trading have well comments about whether this section is That question is: does this proposal surpassed Regulation AT in many areas. adequate as is or whether we should also sufficiently benefit the safety and soundness It is clear that the industry has long been prohibit DCMs from giving benefits to such of America’s futures markets so as to at the forefront of creating market solutions seemingly non-economic trades. outweigh its additional costs and burdens? for risk controls in automated trading well In closing, let me stress again that I want I wish the answer was clearer. before any regulatory mandate. As I recently this rule to be both effective and workable. I have three main concerns with Regulation stated, I favor this type of ongoing bottom-up No one benefits from rules that work in the AT. First, some of the requirements of the market-driven approach to risk controls for abstract but are confusing, impossible to proposal appear to be window dressing. That automated trading.3 Given the industry’s implement as written, or full of gaps that is especially the case in its requirement for leadership role and the fact that Regulation prompt stakeholders to engage in widespread development and implementation of risk AT simply codifies a small subset of industry regulatory arbitrage. I believe this automated controls and related testing standards that the best practices, while adding heavy trading proposal is a commonsense effort at industry has already widely adopted. compliance burdens, I question the necessity establishing reasonable regulation on a Second, I am concerned about the high and value-add of this proposal. nascent technology, but if there are flaws costs and burdens of this proposal, especially The staff partly justifies the proposal as with it, if it goes too far or not far enough, on small market participants. I am especially necessary to ensure market integrity given I want to know that now, before it is concerned about its requirement that the risks of automated trading. As support, finalized. Thank you. registrants hold their proprietary source code Regulation AT illustrates examples of recent Appendix 4—Statement of in data repositories available for inspection disruptive events in automated trading. by the Commission or the U.S. Department of However, the dearth of incidents in the Commissioner J. Christopher Giancarlo Justice at any time for any reason. futures market seems to indicate that current Introduction Third, I question the regulatory industry solutions are working well. The electronification of trading over the inconsistencies regarding the market Regulation AT only cites three U.S. past 30 to 40 years and the advent of participants that must comply with this disruptive automated trading events in the exponential digital technologies have rulemaking. past five and a half years and two of those transformed financial businesses, markets For these reasons and others, I have serious events occurred in the equities market, and entire economies, with dramatic doubts about today’s proposed rulemaking. obviously outside of our jurisdiction. In implications for capital formation and risk Last November, I delivered a speech at the addition, the equities market events occurred transfer. In U.S. futures markets, we see this U.S. Chamber of Commerce where I set forth despite the Securities and Exchange change most presently in the area of six principles that I would follow as I Commission (‘‘SEC’’) having implemented algorithmic or automated trading that now evaluate financial market regulations.1 As some reforms related to automated trading.4 constitutes up to seventy percent of regulated part of those principles, I proposed the Thus, I question whether Regulation AT will futures markets. Automated trading can ‘‘SMART REG’’ standard to help analyze whether CFTC rules actually solve for real lower transaction costs while increasing through flexible rules; R—Represent the best trader productivity through greater problems and promote the U.S. economy and approach among alternative courses of action; T— 2 transaction speed, precision and the American markets. I struggle to see how Take into account evidence, rather than sophistication. For many markets, automated assumptions; R—Realistically set compliance trading brings trading liquidity, broader 1 Remarks of CFTC Commissioner J. Christopher deadlines; E—Encourage employment of American market access, enhanced transparency and Giancarlo before the U.S. Chamber of Commerce, workers; and are G—Grounded in law. greater competition. Re-Balancing Reform: Principles for U.S. Financial 3 Keynote Address of CFTC Commissioner J. At the same time, automated trading Market Regulation In Service to the American Christopher Giancarlo before the 2015 ISDA Annual Economy, Nov. 20, 2014, http://www.cftc.gov/ Asia Pacific Conference, Top-Down Financial presents a host of potential new challenges. PressRoom/SpeechesTestimony/opagiancarlos-2. Market Regulation: Disease Mislabeled as Cure, Oct. They include increased risk of sudden spikes 2 Id. The ‘‘SMART REG’’ standard follows 26, 2015, http://www.cftc.gov/PressRoom/ in market volatility and ‘‘phantom’’ liquidity whether new CFTC regulations S—Solve for real SpeechesTestimony/opagiancarlo-10. arising from the sheer speed of execution, problems, not anecdotes of bad behavior; M— 4 See Regulation AT Preamble, Section II.C.1.: potentially flawed algorithms and position Measure success through a rigorous cost benefit ‘‘Background on Regulatory Responses to crowding. They also include the risk of data analysis; A—Advance innovation and competition Automated Trading.’’

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in fact reduce future disruptive events and concern and asks questions in this regard, at in that it requires AT Persons to register with enhance market integrity. the same time, the proposal dismisses the an RFA and, at the same time, to be subject As further support for market integrity, the possibility that it will capture many small to reviews by DCMs. The National Futures preamble asserts that the proposal may limit entities. I am not so sure that will be the case Association (‘‘NFA’’), the only RFA at this a ‘‘race to the bottom,’’ in which certain as the definition of Algorithmic Trading is time, will need to hire additional employees entities sacrifice effective risk controls in very broad and would appear to capture to establish and maintain a program for order to minimize costs or increase the speed market participants using off-the-shelf type Algorithmic Trading systems. The preamble of trading. In this, the proposal betrays a automated systems or simple excel to Regulation AT also contemplates that NFA naı¨ve misunderstanding of elementary micro- spreadsheets to automate trading.9 If that is would conduct routine examinations of its economics. Market participants have every the case, then this proposal could capture, for members to ensure that they are complying economic incentive to implement effective example, a small proprietary trading firm, a with NFA rules. This requirement translates risk controls to prevent the loss of their small commodity trading advisor (‘‘CTA’’) or into additional costs that will be passed capital and being forced out of business. That a rural grain elevator company that uses down to NFA’s members. Regulation AT is why the industry has been a leader in best simple automation. notes that NFA is the frontline regulator and practices for automated trading, including Regulation AT would add numerous costs is well-positioned to address rules and issues development of risk controls and related to small market participants and raise related to Algorithmic Trading as market testing standards. This ongoing bottom-up barriers to entry. Small market participants conditions and technology develops. market-driven approach to risk controls for may be less likely to employ risk controls However, it seems that DCMs have the automated trading has raised, not lowered, consistent with Regulation AT so they would most intimate knowledge of the markets and the standards. incur costs to develop or purchase such risk their participants trading in those markets. Several commenters cited in Regulation AT controls. They would also incur costs to hire DCMs have been at the forefront of creating supported a principles-based approach to additional employees to develop and market solutions for risk controls in regulation citing the need for flexibility implement policies and procedures for the automated trading, along with testing and because each market and the participants in development, testing, monitoring and certification of automated systems.11 In this those markets are different.5 These compliance of their Algorithmic Trading regard, Regulation AT requires AT Persons 12 commenters also noted that the Commission systems. Small market participants would and their clearing member futures already has robust regulations in place to have to hire additional employees to commission merchants (‘‘FCMs’’) to submit address the risks of automated trading.6 continuously monitor their Algorithmic annual reports and policies and procedures Tweaking the Commission’s existing Trading systems on a real-time basis. They regarding their Algorithmic Trading to all regulations 7 in line with a principles-based would incur costs to annually prepare and DCMs on which they trade. DCMs must approach may be a better way to build upon submit a pre-trade risk control compliance establish a program to review these reports ongoing industry efforts regarding automated report to each DCM on which they trade. and procedures and provide feedback, trading, while reducing the compliance Furthermore, the proposal would add costs to including any deficiencies in participants’ burdens of Regulation AT. small market participants given the required pre-trade risk control settings or I invite comment on the necessity of registration with the Commission and an calibrations.13 AT Persons and their clearing Regulation AT and on other approaches to RFA. That sounds like a whole lot of extra member FCMs must also keep, and provide automated trading that support—rather than costs to me for a ‘‘principles-based’’ non- upon request to DCMs, books and records burden—ongoing industry efforts. prescriptive rule. regarding compliance with the proposed The proposed rule admits that the rules. DCMs must review these books and II. Costs of Regulation AT Versus the Commission does not know how many small records as necessary. Benefits entities this proposal will affect— Although the preamble states that the NFA I am concerned about the costs of unfortunately, a common theme for CFTC and DCM requirements are not intended to Regulation AT, especially on small market rules when discussing costs and burdens on create conflicting obligations, I am afraid that participants. The Commission tries to the marketplace. I am disappointed that the the lack of clarity provides a potential to downplay the costs of this proposal because Commission did not get a better sense of the subject AT Persons to some duplication. As in many respects it simply codifies industry potential universe of small market noted above, DCMs already have standards best practices and many market participants participants that may be impacted by for risk controls, testing and certification of are already following such practices.8 The Regulation AT. To this point, I am very automated systems, but Regulation AT proposal also repeatedly asserts that the rules interested to hear estimates of costs requires NFA to address these topics in its are flexible seemingly in an effort to highlight Regulation AT will impose on smaller market program. Regulation AT also discusses its low burdens. However, in reality, participants and how it will impact their reviews for both NFA and DCMs. Duplicative Regulation AT adds compliance, reporting ability to conduct business. requirements would add unnecessary costs and registration requirements, and Interestingly, the proposed rule also asserts that would be especially harmful to small establishes designated contract market that a technological malfunction or error in market participants. (‘‘DCM’’) and registered futures association a very small proprietary trading firm’s I am interested to hear from market (‘‘RFA’’) review programs. These additional algorithm could have a significant, participants if Regulation AT provides requirements will certainly increase costs to detrimental impact on the market despite enough clarity on this issue or if the all market participants engaged in providing no evidence to support this Commission should provide further detail. I claim.10 Algorithmic Trading that are subject to this I invite commenters to weigh in on am particularly interested to hear comments this issue. I am also interested to hear proposal. on the requirement for market participants to comments on whether the proposed rules register with NFA and to be subject to NFA’s A. Small Market Participants make sense for those market participants program for Algorithmic Trading systems. In The costs of this proposal may using off-the-shelf type automated systems or light of DCMs’ existing efforts on risk disproportionately impact small market simple excel spreadsheets to automate controls and testing, is such a requirement participants. While Regulation AT raises this trading, especially the rules around necessary or are DCMs already serving as the development, testing, monitoring and frontline regulator? Would NFA serve a compliance of Algorithmic Trading systems. 5 ICE Comment Letter at 1–3 (Jan. 17, 2014); Katten Muchin Rosenmann Comment Letter on B. Overlapping Requirements and 11 E.g., CME Comment Letter at 25–26 (Dec. 11, behalf of Gelber Group at 5, 20 and 22–24 (Dec. 9, Duplicative Costs 2013) (discussing CME’s two testing environments 2013). for its users and its certification requirement). Regulation AT contains a potential overlap 6 Id. 12 AT Person is defined in proposed Commission 7 See e.g., Commission regulations 1.11(e)(3)(ii), in some requirements and duplicative costs regulation 1.3(xxxx) and captures the persons 1.73, 23.600(d)(9), 23.609, 38.255 and 38.607. subject to Regulation AT, including existing 8 I also note that the Commission uses old 9 See definition of Algorithmic Trading in Commission registrants engaged in Algorithmic compensation data from 2012 in calculating the proposed Commission regulation 1.3(zzzz). Trading and the newly expanded definition of floor costs of Regulation AT, which underreports these 10 See Regulatory Flexibility Act section of trader. costs estimates. Regulation AT. 13 Proposed Commission regulation 40.22(c).

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useful role in setting consistent standards belligerents were able to get their hands on commenters to provide feedback on the across all markets or do DCMs need this technology the same way some of the intersection of Regulation AT and Rule 1.35. flexibility in setting rules because each U.S.’ most important industrial, military and market and the participants in those markets other sensitive data have been hacked. I D. Other Costs are different?14 I also invite comment on question the need for this new requirement I would also like to obtain industry input alternatives to the requirement that AT and request commenter feedback on this on the following costs of Regulation AT: Persons and their clearing member FCMs issue. 1. The costs on FCMs under proposed prepare and submit annual reports to DCMs In addition to my concerns above, I Rules 1.82 and 1.83, especially the and DCM reviews of those reports. One previously expressed reservations about requirement that an FCM prevent or mitigate possibility is to require AT Persons and their Commission regulation 1.31 in the proposed an Algorithmic Trading Disruption for its AT clearing member FCMs to conduct self- rulemaking on Records of Commodity Persons.22 I have previously expressed assessments (like FINRA requires) and only Interest and Related Cash or Forward concerns about the harm caused to the FCM require submission to DCMs upon request. Transactions.16 Commenters to that proposed industry by the heightened cost of regulation, C. Source Code Repository and Commission rulemaking stated that Commission so I am especially interested to hear 23 Regulation 1.31 regulation 1.31 is technologically outdated comments in this regard. and compliance with the rule is overly 2. The costs to DCMs to establish and Source code is the intellectual property of burdensome, infeasible and costly.17 maintain a program for the review and AT Persons representing their current and Managed Funds Association, the Investment evaluation of compliance reports and books future trading strategies. Source code of AT Adviser Association and the Alternative and records of each AT Person and their firms is unlike traditional trading firm Investment Management Association even clearing member FCMs trading on the DCMs, information in that it reveals not what petitioned the Commission to amend Rule as required under proposed Rule 40.22. positions are held in the past or present, but 1.31 back on July 21, 2014.18 Unfortunately, 3. The ease and costs for DCMs to generate what positions the firm intends to buy or sell the Commission has not acted on this and publish self-trading statistics, as required in the future upon specified market events. request. under proposed Rule 40.23(d). I am particularly concerned that Regulation Regulation AT’s requirement that source AT requires that each market participant code repositories must be kept and made E. Costs Versus Benefits keep a source code repository for algorithms available for inspection pursuant to Based on all the costs described above, and make it available for inspection to any Commission regulation 1.31 will impose Regulation AT does not seem to be a non- representative of the Commission or the U.S. unnecessary costs and burdens on AT prescriptive, low-burden rule that simply Department of Justice for any reason.15 Persons. Given the voluminous comments codifies industry best practices as the Currently, the federal government may only that the staff has received on the proposal asserts. It goes much further and, I obtain such sensitive information through a unworkability of Rule 1.31, I am surprised fear, does greater harm. While Regulation AT subpoena. Regulation AT dramatically lowers that Regulation AT would subject source the bar for the federal government to obtain does recognize industry best practices with codes to this rule. As an alternative, the this information. respect to several risk controls, it adds Commission should consider allowing AT I am unaware of any other industry where prescriptive compliance, reporting and Persons to keep source code repositories in the federal government has such easy access registration requirements and establishes accordance with their own reasonable and to a firm’s intellectual property and future overlapping and duplicative DCM and RFA secure internal recordkeeping procedures. I business strategies. Other than possibly in review programs of questionable value. Given welcome comments on the costs of the area of national defense and security, I the industry’s extensive efforts to date, I Commission regulation 1.31 in this regard. question whether the federal government has question whether the costs of Regulation AT Finally, I would like to note that currently similarly unfettered access to the future actually justify the benefits. The principles- business strategy of any American industrial unregistered market participants who will based approach that I discussed above may sector. Does the SEC require such access from now be required to register under the revised be as effective and less costly than Regulation its registrants? Do other agencies in the floor trader definition may be subject to AT’s approach. I invite commenters to heighted record keeping requirements under provide feedback regarding the costs and federal government have ready access to 19 businesses’ intellectual property and proposed Commission regulation 1.35. benefits of Regulation AT and the specific business strategies? Proposed Rule 1.35 states that a member of points I raised above. I am unclear why either the Commission or a DCM that is not registered or required to be registered with the Commission in any III. Regulatory Inconsistency of Regulation the U.S. Department of Justice needs access AT to source code information without a capacity would not have to keep (i) records subpoena, especially the Justice Department, of transactions in a manner that is searchable I would like to note three regulatory whose only use for such information would or allows for identification of a particular inconsistencies in Regulation AT. The staff 20 be in criminal proceedings. Does today’s rule transaction and (ii) text messages related to proposes to amend the definition of floor 21 24 proposal presume that the use of automated those transactions. If the Commission trader in order to register currently trading technology makes a trading firm more finalizes Rule 1.35 as proposed, Regulation unregistered persons using direct electronic likely to engage in criminal behavior than a AT’s registration requirement would increase access for algorithmic trading on DCMs.25 manual trading operation? the burdens under that rule. I invite The preamble to Regulation AT states that in There is strong reason for concern about 1993, when the Commission finalized rules maintaining the confidentiality of this source 16 Records of Commodity Interest and Related regarding the definition and registration of code. As we all know, the federal government Cash or Forward Transactions, 79 FR 68140, 68148 floor traders, the Commission decided to has a poor track record of keeping sensitive (proposed Nov. 14, 2014). include as floor traders only those traders information secure from cyberattacks and 17 Managed Funds Association Comment Letter at operating on the trading floor of an exchange. other data breaches. Any data breach of this 4–7 (Jan. 13, 2015); Commodity Markets Council However, in that 1993 rulemaking, the information would be devastating for such Comment Letter at 5 (Jan. 13, 2015); SIFMA AMG Commission stated that certain traders using Comment Letter 5–6 (Jan. 13, 2015). electronic trading systems come within the entities and, potentially, for the safety and 18 Managed Funds Association, the Investment floor trader definition. Back then, the orderly operation of U.S. markets. Imagine Adviser Association and the Alternative Investment the harm that could be caused to U.S. Management Association, Petition for Rulemaking financial markets, if cyber terrorists or other to Amend CFTC Regulations 1.31, 4.7(b) and (c), 22 Proposed Commission regulation 1.82(a)(1). 4.23 and 4.33 (Jul. 21, 2014). 23 Statement of Commissioner J. Christopher 14 See supra note 5. 19 Records of Commodity Interest and Related Giancarlo for the Market Risk Advisory Committee 15 Under Regulation AT, in accordance with Cash or Forward Transactions, 79 FR 68140 Meeting, Jun. 1, 2015; http://www.cftc.gov/ Commission Regulation 1.31 (17 CFR 1.31), AT (proposed Nov. 14, 2014). PressRoom/SpeechesTestimony/ Persons would have to make their source code 20 Id. at 68146, Proposed Commission regulation giancarlostatement060115. repository available for inspection to any 1.35(a)(3)(i). 24 17 CFR 1.3(x). representative of the CFTC, in addition to the U.S. 21 79 FR at 68146, Proposed Commission 25 Another requirement is that the person must be Department of Justice. regulation 1.35(a)(3)(ii). trading for their own account.

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Commission took a technological approach to comments on this competitive disadvantage, rules? Will this periodic review become a the definition of floor trader. including whether Regulation AT should continuous review in order to avoid liability? Today, Regulation AT is taking that same exclude from its scope swaps listed on approach and is proposing to register persons DCMs. Conclusion using direct electronic access for algorithmic While I am pleased that Regulation AT IV. Other Comments on Regulation AT trading, but not those using manual means. provides flexibility in setting risk control I am not clear on the rationale for this I also invite industry comment on the parameters and does not require the pre- technology driven distinction to registration following issues: approval or pre-testing of algorithms, the (as the preamble does not articulate one) 1. Whether the Algorithmic Trading proposal appears to add many burdensome when the proposal acknowledges that Compliance Issue definition in proposed compliance costs and does not adequately manual trading also poses risks. Several Commission regulation 1.3(tttt) is necessary. take into account small market participants commenters cited in Regulation AT also If a major reason for Regulation AT is market or the work of the industry in developing noted the importance of risk controls for integrity then it seems the Algorithmic algorithmic trading risk controls and related manual and automated trading systems.26 I Trading Disruption definition is sufficient. testing requirements. Rather than duplicating invite industry comments on this issue, Furthermore, if an AT Person violates a rule their efforts and adding additional burdens, or regulation it will be liable so the notwithstanding my above concerns about the Commission should look to support and Algorithmic Trading Compliance Issue the registration requirement. enhance ongoing industry progress. On the definition appears unnecessary. Another regulatory inconsistency is that other hand, I am highly concerned about Regulation AT only captures floor traders 2. Whether the definition of Direct Electronic Access in proposed Commission Regulation AT’s several significant who use direct electronic access for inconsistencies and its extraordinary algorithmic trading, but it captures all regulation 1.3(yyyy) should be harmonized 27 requirement that AT source codes be placed existing registrants, such as FCMs, swap with the definition in Rule 38.607. 3. Whether several of the proposed rules in government accessible repositories. dealers and CTAs regardless of whether they Overall, I have a great many concerns with use direct electronic access for algorithmic that require periodic review of compliance measures or regular testing of Algorithmic Regulation AT. Most principally, I struggle to trading. Again, Regulation AT does not figure out if it will benefit the safety and articulate a reason for this inconsistency and Trading systems open up AT Persons to liability risk. For example, proposed soundness of America’s futures markets I question its logic. I invite comment on this Commission regulation 1.80(f) 28 requires enough to outweigh its additional costs and issue, including whether, for existing each AT Person to periodically review its burdens. Its purpose must not be to allow a registrants, the proposal should only capture compliance with the pre-trade risk control Federal regulator to say that it has ‘‘done those using direct electronic access. requirements to determine whether it has something’’ about computerized trading in Finally, Regulation AT only applies to effectively implemented sufficient measures response to media headlines, best-selling trading on DCMs and not on SEFs. reasonably designed to prevent an books or political campaign agendas. The Regulation AT justifies this distinction by Algorithmic Trading Event. What happens if development of automated trading is too stating that compared to DCMs, SEFs and market conditions change rapidly between complicated and too important to be SEF markets are newer and less liquid and periodic reviews and the AT Person’s risk addressed with such superficiality. have less automated trading. However, DCMs controls are no longer sufficient to prevent an For my part, I will carefully review can also list swaps and Regulation AT Algorithmic Trading Event? Is the AT Person thoughtful comments from market applies to that trading. In this regard, now liable for a violation of Commission participants and the public. I will measure Regulation AT may disadvantage DCMs who my support for any final rule against the list swaps as compared to SEFs. I welcome 27 17 CFR 38.607. SMART REG standard. 28 See also proposed Commission regulations 26 E.g., CME Comment Letter at 43, 44 (Dec. 11, 1.81(a)(1)(iii), (a)(1)(iv), (a)(2) and (c)(2)(i) for [FR Doc. 2015–30533 Filed 12–16–15; 8:45 am] 2013). further examples. BILLING CODE 6351–01–P

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