Seeking better-defined trading rules

From Bloomberg:

The U.S. Commodity Futures Trading Commission proposed derivatives market guidelines designed to help define trading practices such as “spoofing” and “banging the close” that are prohibited under the Dodd-Frank Act.

CFTC commissioners voted 4-1 today to seek comment on measures they say would provide greater detail about practices that violate bids or offers, or show “intentional or reckless disregard” for orderly transactions during a closing period.

The Dodd-Frank Act, the regulatory overhaul enacted in July, bans spoofing, in which a trader enters a bid or offer with the intent of canceling the transaction before it is carried out. The law also targets “banging the close,” in which traders attempt to affect a settlement price by buying or selling large volumes just before the day’s end of business.

The CFTC proposal takes a “middle ground” approach by neither letting Dodd-Frank stand without additional definition nor proposing a rule that would “bind us all to concepts that we may not yet appreciate,” Commissioner Scott O’Malia, one of two Republicans on the panel, said in a statement before the vote. The measure was opposed by the other Republican, Jill Sommers, who said it “raises more questions than it answers.”

The proposal will be opened for 60 days of public comment before commissioners take a final vote on the guidance.

Separately, the CFTC’s staff is working on a proposal for testing and supervision of algorithmic trading, CFTC Chairman Gary Gensler said at the meeting. The agency’s proposal will be based in part on recommendations from a task force set up by the CFTC and Securities and Exchange Commission in response to last year’s May 6 stock-market plunge.

Commissioner Bart Chilton, a Democrat, said in a statement that the market needs explicit rules for high-frequency and algorithmic trading that “do more than merely this order” of guidelines released today.

Representatives for high-frequency trading firms told the CFTC at a Dec. 2 hearing that without a better sense of the intent behind transactions, regulators could hamper liquidity by restricting market-moving practices that aren’t disruptive.

“What really needs to be there, in my mind, are some notions of intent,” Cameron Smith, general counsel of Quantlab Financial LLC, said at the CFTC hearing in Washington.

The Securities Industry and Financial Markets Association and International Swaps and Derivatives Association Inc. said in a Jan. 3 letter to the CFTC that the practices prohibited under Dodd-Frank aren’t commonly understood in the swaps market.

“These terms lack definition, which makes them susceptible to being interpreted to sweep in a range of completely appropriate conduct,” the associations wrote.

The guidance would provide examples of banned spoofing practices, such as when traders submit or cancel orders with the intent of overloading a price-quotation system, said Robert Pease, attorney in the CFTC’s enforcement division.

The CFTC also voted to issue a separate proposal for when swaps must be reported to and processed by clearinghouses. The law aims to reduce risk in the swaps market by having most deals guaranteed by central clearinghouses that stand between buyers and sellers.

Derivatives, including swaps, are financial contracts tied to stocks, bonds, interest rates or events, such as the default of a company.


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