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Speaker 1: a Bloombird business flash. You're listening to taking stock with
Speaker 1: pim Box and Kathleen Hayes on Bloombird Radio. Algoes algorithmic trading.
Speaker 1: This has become more and more controversial as many Wall
Speaker 1: Street professionals worry that high frequency trading firms are using
Speaker 1: these algos to speed up their trades but perhaps destabilize
Speaker 1: the markets. In fact, now algorithmic traders in US derivatives
Speaker 1: markets may be subjected to heightened regulation, as the Commodity
Speaker 1: Futures Trading Commission ways a proposal that would set registration requirements,
Speaker 1: among other things. We're joining now by Nathan Dean, government
Speaker 1: analyst for Bloomberg Intelligence in Washington. So Nathan, first of all,
Speaker 1: what is an issue here. Let's start with what is
Speaker 1: going on in the derivatives trading that is being done
Speaker 1: by algorithms and what is the extent of it. So
Speaker 1: this rule is a proposal from the CFTC, and this
Speaker 1: really stems from UH several flash crashes or in the
Speaker 1: derivative markets over the last couple of years and UH
Speaker 1: several occurrences in which algorithms have run amuck UH and
Speaker 1: the exchanges have had to essentially shut those algorithms off.
Speaker 1: So the CFTC proposed rule. UH. This rule does not
Speaker 1: slow down high frequency trading. But really what it does
Speaker 1: is that it puts restrictions on algorithms in terms of
Speaker 1: pre trade post trade risk controls a lot of things
Speaker 1: that the exchanges already do. But there's there's two controversial
Speaker 1: elements here. One is source code provisions. UH. This rule
Speaker 1: would require algorithmic traders to hand over their source code
Speaker 1: to the CFTC, to the Justice Department upon request. Obviously
Speaker 1: they're not hal be about that. And the second thing
Speaker 1: is registration requirements. A lot of these algorithmic traders, these
Speaker 1: are five ten person firms and they they just don't
Speaker 1: have the compliance and UH risk departments that can handle
Speaker 1: this proposal. Nathan, can you tell us about kill switches?
Speaker 1: What would they do? So it kill switches essentially like
Speaker 1: pulling the key out of your ignition. Uh. You know,
Speaker 1: it stops the algorithm. Uh. And a lot of the
Speaker 1: hyperquincy traders already have this, The exchanges already have this. Uh.
Speaker 1: And so this would allow the exchange to go in
Speaker 1: and essentially just press a button and block the all
Speaker 1: go from its market. Uh. You know, this is one
Speaker 1: of the provisions that we think that the CEEFTC is
Speaker 1: going to try and finalize this year. Uh. You know,
Speaker 1: this rule is a very large rule, and so just
Speaker 1: recently the chair decided that or at least announced that
Speaker 1: he was planning to split this rule off and kill
Speaker 1: switches we think is going to be part of the
Speaker 1: finalized rule this year. Well, kill switches source code? How
Speaker 1: does that play in? And you have to be a
Speaker 1: computer geek to understand how this all works. So the
Speaker 1: source code is, uh, you know, it's the brains of
Speaker 1: the algo. You know, it's it's the computer programming. And
Speaker 1: a lot of the high frequency traders out there will
Speaker 1: say that the source code contains the prietary and the
Speaker 1: business strategy and everything that's crucial to their success. And
Speaker 1: what happens here is that under the proposal to see
Speaker 1: IFDC or the Justice department will notice that an algorithm
Speaker 1: runs a muck and they call the high frequency trader
Speaker 1: over and say you have to provide it without a subpoena.
Speaker 1: You just have to provide it. And obviously from a
Speaker 1: cybersecurity perspective, from a privacy perspective, Uh, these small firms
Speaker 1: are not happy with this provision and so uh uh
Speaker 1: you know, if this world to be finalized, it wouldn't
Speaker 1: be surprising the sea and legal challenges come out of it. Nathan,
Speaker 1: What effect would this have, if any, on high frequency trading?
Speaker 1: So it's gonna make so it won't slow down the
Speaker 1: high frequency traders. And this is only in the derivatives market.
Speaker 1: The equity high frequency traders are under your different program. Uh,
Speaker 1: it won't slow them down, but it will increase their
Speaker 1: compliance costs. Uh. The CFTC estimates that there's about four
Speaker 1: hundred and twenty hyperquency trading firms out there, uh, and
Speaker 1: only estimates thirty five million dollars for them to implement this.
Speaker 1: We think that figure is very low, that it's going
Speaker 1: to be much more costly, but it's gonna be a
Speaker 1: regulatory headache. And like I said before, a lot of
Speaker 1: these firms are five, ten, fifteen people firms, and uh,
Speaker 1: they're gonna have to have a compliance person really dig
Speaker 1: through and to see how they can comply with this role.
Speaker 1: Is this a way to slow something down, to perhaps
Speaker 1: put a curb on high frequency trading by adding these
Speaker 1: excess steps, adding more or I shouldn't sayccess but adding
Speaker 1: additional steps, adding more regulation, rather than facing head on
Speaker 1: this question of whether or not algorithmic trading is something
Speaker 1: that has gotten a lot of control or really is
Speaker 1: creating more volatility and destabilizing markets. You know, I think
Speaker 1: it's the first step in the process. You know, the
Speaker 1: CFTC has said that the hyperquency trading isn't an issue,
Speaker 1: or at least that's what they've alluded to, So they
Speaker 1: don't want to slow it down, but they need to
Speaker 1: do something. Uh. And so this proposal was a broad,
Speaker 1: broad sweep here of trying to bring in many, many
Speaker 1: aspects of algorithmic training under regulations. And UH, I think
Speaker 1: what they're gonna face with is, UH, you know, they're
Speaker 1: going to have to start picking off what they expect
Speaker 1: they can actually get done this year. And UH, at
Speaker 1: the end of the day, if I don't think a
Speaker 1: high food. See trading firm has to worry much that
Speaker 1: their their algorals are going to be slowed by this.
Speaker 1: Is there an issue having to do with market makers statistics? Yes,
Speaker 1: that's so, that's one part of the proposal. And so
Speaker 1: this proposal would require market makers and it would require
Speaker 1: the exchanges UH to release more details about their market
Speaker 1: making and their incentive programs, you know, the compensation paid
Speaker 1: to market makers, benefits received, etcetera. And what the goal
Speaker 1: here is to increase transparency in those market making programs
Speaker 1: so they can ensure that there's no false liquid out there.
Speaker 1: You know, there's some because some claims out there that
Speaker 1: you know, high frequency traders are essentially just making whatever
Speaker 1: they need to make as per their compensation program and
Speaker 1: then the liquidity disappears. UH. You know, this portion of
Speaker 1: the rule was something that we think is going to
Speaker 1: get pushed off in the two thousand seventeen. Thank you
Speaker 1: very much for joining us and giving us that insight.
Speaker 1: Nathan Dean is government analysts for Bloomberg Intelligence. He's based
Speaker 1: in Washington, d C. Home of course to Bloomberg FM
Speaker 1: and one oh five point seven FM h D two.
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