6351-01-P COMMODITY FUTURES TRADING COMMISSION 17 CFR Parts 1, 38, 40, and 170 RIN 3038-AD52 Regulation Automated Trading AGENCY: Commodity Futures Trading Commission. ACTION: Notice of proposed rulemaking. SUMMARY: The Commodity Futures Trading Commission (“CFTC” or “Commission”) is proposing a series of risk controls, transparency measures, and other safeguards to enhance the regulatory regime for automated trading on U.S. designated contract markets (“DCMs”) (collectively, “Regulation AT”). The Commission’s proposals build on efforts by numerous entities in recent years to promote best practices and regulatory standards for automated trading, including standards and best practices for algorithmic trading systems (“ATSs”), electronic trade matching engines, and new connectivity methods that characterize modern financial markets. In 2012 the Commission adopted rules requiring futures commission merchants (“FCMs”), swap dealers (“SDs”), and major swap participants (“MSPs”) to use automated means to screen orders for compliance with certain risk-based limits. It also adopted rules requiring certain financial risk control requirements for DCMs offering direct market access to their customers. In 2013 the Commission published an extensive Concept Release on Risk Controls and System Safeguards for Automated Trading Environments (“Concept Release”), compiling in one document a comprehensive discussion of industry practices, 1 Commission regulations, and evolving concerns in automated trading.1 Now, through this notice of proposed rulemaking (“NPRM”) for Regulation AT, the Commission seeks to update Commission rules in response to the evolution from pit trading to electronic trading. In particular, the Commission is proposing to adopt a comprehensive approach to reducing risk and increasing transparency in automated trading. Proposed Regulation AT is designed to consolidate previous work by industry participants, the Commission, and fellow regulators into a unified body of law addressing automation in order placement and execution in U.S. derivatives markets. The Commission welcomes all public comments. DATES: Comments must be received on or before [INSERT DATE 90 DAYS AFTER DATE OF PUBLICATION IN THE FEDERAL REGISTER]. ADDRESSES: You may submit comments, identified by RIN 3038-AD52, by any of the following methods: • CFTC website: http://comments.cftc.gov. Follow the instructions for submitting comments through the Comments Online process on the website. • Mail: Send to Christopher Kirkpatrick, Secretary of the Commission, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street, NW, Washington, DC 20581. • Hand Delivery/Courier: Same as Mail, above. • Federal eRulemaking Portal: http://www.regulations.gov. Follow the instructions for submitting comments. 1 Concept Release on Risk Controls and System Safeguards for Automated Trading Environments, 78 FR 56542 (Sept. 12, 2013). 2 Please submit comments by only one method. All comments should be submitted in English or accompanied by an English translation. Comments will be posted as received to http://www.cftc.gov. You should submit only information that you wish to make available publicly. If you wish the Commission to consider information that may be exempt from disclosure under the Freedom of Information Act (“FOIA”), a petition for confidential treatment of the exempt information may be submitted according to the procedures established in 17 CFR 145.9. The Commission reserves the right, but shall have no obligation, to review, prescreen, filter, redact, refuse, or remove any or all of your submission from http://www.cftc.gov that it may deem to be inappropriate for publication, such as obscene language. All submissions that have been so treated that contain comments on the merits of the rulemaking will be retained in the public comment file and will be considered as required under the Administrative Procedure Act and other applicable laws, and may be accessible under FOIA. FOR FURTHER INFORMATION CONTACT: Sebastian Pujol Schott, Associate Director, Division of Market Oversight, [email protected] or 202-418-5641; Marilee Dahlman, Special Counsel, Division of Market Oversight, [email protected] or 202-418-5264; Mark Schlegel, Special Counsel, Division of Market Oversight, [email protected] or 202-418-5055; Michael Penick, Economist, Office of the Chief Economist, [email protected] or 202-418-5279; Richard Haynes, Economist, Office of the Chief Economist, [email protected] or 202-418-5063; Andrew Ridenour, Senior Trial Attorney, Division of Enforcement, [email protected] or 202-418-5438; or John Dunfee, Assistant General Counsel, Office of General Counsel, [email protected] or 202- 418-5396. 3 SUPPLEMENTARY INFORMATION: Table of Contents I. Introduction A. Overview -- Development of Automated Trading Environment B. Risks and Potential Benefits Associated With Automated Trading C. The Proposed Regulations 1. Overview of NPRM 2. The Proposed Regulations Under Parts 1, 38, 40, and 170 II. Background on Regulatory Responses to Automated Trading A. The Commission’s Regulatory Response to Date B. The Commission’s 2013 Concept Release C. Other Recent Regulatory Responses 1. SEC Regulatory Initiatives 2. FINRA Initiatives 3. European and Other Regulatory Initiatives D. Industry and Regulatory Best Practices and Recommendations 1. NFA Compliance Rule 2-9: Supervision 2. FIA Reports on Automated Trading 3. IOSCO Reports on Electronic Trading 4. CFTC TAC Subcommittee 5. FIX Risk Management Working Group 6. Senior Supervisors Group (SSG) Briefing Note 7. Treasury Market Practices Group Best Practices III. Recent Disruptive Events in Automated Trading Environments IV. Overview of Regulation AT A. Concept Release / Regulation AT Terminology B. Commenter Preference for Principles-Based Regulations C. Multi-Layered Approach to Pre-Trade Risk Controls and Other Measures D. Codification of Defined Terms Used Throughout Regulation AT 1. “Algorithmic Trading” -- § 1.3(ssss) 2. “Algorithmic Trading Compliance Issue” -- § 1.3(tttt) 3. “Algorithmic Trading Disruption” -- § 1.3(uuuu) 4. “Algorithmic Trading Event” -- § 1.3(vvvv) 5. “AT Order Message” -- § 1.3(wwww) 6. “AT Person” -- § 1.3(xxxx) 7. “Direct Electronic Access” -- § 1.3(yyyy) E. Registration of Certain Persons Not Otherwise Registered with Commission -- § 1.3(x) 1. Concept Release Comments 2. Description of Regulation 3. Policy Discussion 4. Request for Comments F. RFA Standards for Automated Trading and Algorithmic Trading Systems -- § 170.19 4 1. Policy Discussion 2. Description of Regulation 3. Request for Comments G. AT Persons Must Become Members of an RFA -- § 170.18 1. Policy Discussion 2. Description of Regulation 3. Request for Comments H. Pre-Trade and Other Risk Controls for AT Persons -- § 1.80 1. Concept Release Comments on Pre-Trade and Other Risk Controls 2. Description of Regulation 3. Policy Discussion 4. Request for Comments I. Standards for Development, Testing, Monitoring, and Compliance of Algorithmic Trading Systems -- § 1.81 1. Concept Release Comments 2. Description of Regulation 3. Policy Discussion 4. Request for Comments J. Risk Management by Clearing Member FCMs – § 1.82 1. Concept Release Comments 2. Description of Regulation 3. Policy Discussion 4. Discussion of Persons Subject to Proposed §§ 1.80 and 1.82 5. Request for Comments K. Compliance Reports Submitted by AT Persons and Clearing FCMs to DCMs; Related Recordkeeping Requirements -- § 1.83 1. Concept Release Comments 2. Description of Regulation 3. Policy Discussion 4. Request for Comments L. Risk Controls for Trading: Direct Electronic Access Provided by DCMs - - § 38.255(b) and (c) 1. Concept Release Comments 2. Description of Regulation 3. Policy Discussion 4. Request for Comments M. Disclosure and Transparency in DCM Trade Matching Systems -- § 38.401(a) 1. Concept Release Comments 2. Description of Regulation 3. Policy Discussion 4. Request for Comments N. Pre-Trade and Other Risk Controls at DCMs -- § 40.20 1. Concept Release Comments 2. Description of Regulation 3. Policy Discussion 5 4. Request for Comments O. DCM Test Environments for AT Persons -- § 40.21 1. Concept Release Comments 2. Description of Regulation 3. Request for Comments P. DCM Review of Compliance Reports by AT Persons and Clearing FCMs; DCM Rules Requiring Certain Books and Records; and DCM Review of Such Books and Records as Necessary -- § 40.22 1. Concept Release Comments 2. Description of Regulation 3. Policy Discussion 4. Request for Comments Q. Self-Trade Prevention Tools -- § 40.23 1. Concept Release Comments 2. Commission Analysis of Amount of Self-Trading in the Marketplace 3. Description of Regulation 4. Policy Discussion 5. Request for Comments R. DCM Market Maker and Trading Incentive Programs -- §§ 40.25–40.28 1. Policy Discussion 2. Description of Regulations 3. Request for Comments V. Related Matters A. Calculation of Number of Persons Subject to Regulations 1. Request for Comments B. Calculation of Hourly Wage Rates Used in Related Matters C. Regulatory Flexibility Act 1. FCMs and DCMs 2. AT Persons 3. Request for Comments D. Paperwork Reduction Act 1. Information Provided by Reporting Entities/Persons a. § 1.3(x)(3) – Submissions by newly registered floor traders b. § 1.83(a) – Compliance reports submitted by AT Persons to DCMs c. § 1.83(b) – Compliance reports submitted by clearing member FCMs to DCMs d. § 1.83(c) – AT Person retention and production of books and records e. § 1.83(d) – Clearing member FCM retention and production of books and