[Senate Hearing 113-559]
[From the U.S. Government Publishing Office]
S. Hrg. 113-559
HIGH FREQUENCY AND AUTOMATED
TRADING IN FUTURES MARKETS
=======================================================================
HEARING
before the
COMMITTEE ON AGRICULTURE,
NUTRITION AND FORESTRY
UNITED STATES SENATE
ONE HUNDRED THIRTEENTH CONGRESS
SECOND SESSION
__________
MAY 13, 2014
__________
Printed for the use of the
Committee on Agriculture, Nutrition and Forestry
Available via the World Wide Web: http://www.fdsys.gov/
U.S. GOVERNMENT PUBLISHING OFFICE
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20402-0001
COMMITTEE ON AGRICULTURE, NUTRITION AND FORESTRY
DEBBIE STABENOW, Michigan, Chairwoman
PATRICK J. LEAHY, Vermont THAD COCHRAN, Mississippi
TOM HARKIN, Iowa MITCH McCONNELL, Kentucky
SHERROD BROWN, OHIO PAT ROBERTS, Kansas
AMY KLOBUCHAR, MINNESOTA SAXBY CHAMBLISS, Georgia
MICHAEL BENNET, COLORADO JOHN BOOZMAN, Arkansas
KIRSTEN GILLIBRAND, NEW YORK JOHN HOEVEN, North Dakota
JOE DONNELLY, INDIANA MIKE JOHANNS, Nebraska
HEIDI HEITKAMP, NORTH DAKOTA CHARLES E. GRASSLEY, Iowa
ROBERT P. CASEY, Jr., PENNSYLVANIA JOHN THUNE, South Dakota
JOHN WALSH, MONTANA
Christopher J. Adamo, Majority Staff Director
Jonathan J. Cordone, Majority Chief Counsel
Jessica L. Williams, Chief Clerk
Thomas Allen Hawks, Minority Staff Director
Anne C. Hazlett, Minority Chief Counsel and Senior Advisor
(ii)
C O N T E N T S
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Page
Hearing(s):
High Frequency and Automated Trading in Futures Markets.......... 1
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Tuesday May 13, 2014
STATEMENTS PRESENTED BY SENATORS
Stabenow, Hon. Debbie, U.S. Senator from the State of Michigan,
Chairwoman, Committee on Agriculture, Nutrition and Forestry... 1
Cochran, Hon. Thad, U.S. Senator from the State of Mississippi... 2
Panel I
McGonagle, Vince, Director of the Division of Market Oversight,
Commodity Futures Trading Commission, Washington, DC........... 3
Duffy, Terrence, Executive Chairman and President, CME Group,
Chicago, Illinois.............................................. 5
Kirilenko, Andrei, Ph.D., Professor of the Practice of Finance,
MIT Sloan School of Management, Cambridge, Massachusetts....... 6
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APPENDIX
Prepared Statements:
Thune, Hon. John............................................. 24
Duffy, Terrence.............................................. 27
Kirilenko, Andrei............................................ 31
McGonagle, Vince............................................. 38
Document(s) Submitted for the Record:
Duffy, Terrence:
CME Globex Risk and Volatility Mitigation Tools-Appendix A... 54
Question and Answer:
Duffy, Terrence:
Written response to questions from Hon. Charles Grassley..... 62
Written response to questions from Hon. John Thune........... 63
Kirilenko, Andrei:
Written response to questions from Hon. Charles Grassley..... 67
Written response to questions from Hon. John Thune........... 68
McGonagle, Vince:
Written response to questions from Hon. John Thune........... 70
HIGH FREQUENCY AND AUTOMATED
TRADING IN FUTURES MARKETS
----------
Tuesday May 13, 2014
United States Senate,
Committee on Agriculture, Nutrition and Forestry,
Washington, DC
The Committee met, pursuant to notice, at 10:03 a.m., room
328A, Russell Senate Office Building, Hon. Debbie Stabenow,
Chairwoman of the Committee, presiding.
Present or submitting a statement: Senators Stabenow,
Brown, Klobuchar, Gillibrand, Donnelly, Casey, Cochran,
Chambliss, and Thune.
STATEMENT OF HON. DEBBIE STABENOW, U.S. SENATOR FROM THE STATE
OF MICHIGAN, CHAIRWOMAN, COMMITTEE ON AGRICULTURE, NUTRITION
AND FORESTRY
Chairwoman Stabenow. Good morning. This Senate Agriculture,
Nutrition and Forestry Committee will come to order.
Thanks very much to our witnesses today for their
information, expertise. We thank all of our members being here
at this very, very important hearing.
For centuries, commodity markets have been about
connections between buyers and sellers. But those connections
have changed--the days of ``the pit'' as the main form of
trading are gone.
Today, the most important connections are fiber optic--
information can be transmitted at nearly the speed of light.
Powerful computers with complex programming have the ability to
execute many thousands of trades in the time it takes two
traders to use hand signals.
While advancements in technology have improved the markets
in many ways, we are also faced with new challenges, which we
are here today to discuss. As markets and trading change, so
must the oversight. To put it simply: the men and women who
have the public trust to oversee these markets must have the
tools and resources to keep up with the markets they are
overseeing.
With high-frequency trading in the news lately, it is
important to remember there are significant differences between
the securities and futures markets--both structural and
regulatory. While the markets are linked, as we saw during the
Flash Crash, some of the concerns raised about equities markets
are not applicable to the futures markets.
Today's hearing will focus on some of the changes brought
about by technology. Just as automated trading can take many
forms, including algorithmic trading and high frequency
trading--there are many different perspectives on the costs and
benefits of these strategies. We will hear some of those
perspectives today.
We will also ask some questions: Has automated trading
improved price discovery in futures markets? Does automated
trading make it easier to manage risk for our farmers, ranchers
and end users; or does it create risk? Are the regulators,
exchanges, and other market participants sufficiently managing
these new challenges?
These markets have changed dramatically over the years. For
a 21st Century market, we need a 21st Century regulator. That
means the CFTC needs the right authority and the right tools to
ensure that markets are working. That means they need enough
people, and it means they need up-to-date technology.
This hearing is not only a matter of oversight, but part of
the effort to reauthorize the Commodity Futures Trading
Commission, and affords us the opportunity to evaluate what
changes might be necessary to protect our markets.
Thank you to the witnesses who have come here today, who
represent an important cross-section of views. As we move
forward, we will continue to listen to the concerns of all
market participants, including farmers and ranchers; pension
funds and mutual funds; and proprietary firms and consumer
groups, to best ensure stability in today's futures markets.
Now, I will turn to my friend and the distinguished the
Ranking Member of the Committee, Senator Cochran.
STATEMENT OF HON. THAD COCHRAN, U.S. SENATOR FROM THE STATE OF
MISSISSIPPI
Senator Cochran. Madam Chairman, thank you for convening
the hearing.
The Committee continues to explore today reauthorization of
the Commodity Futures Trading Commission. It is an important
opportunity for us, therefore, to hear from industry users of
futures markets to get their suggestions, if there are needs
that we should know about, to help improve the integrity of the
process and the technology as well.
Over the years, we have seen commodity trading evolve from
a person-to-person transaction into sophisticated, complex
trades that span the globe and take only fractions of a second
to complete. Automated trading has allowed the marketplace to
grow and become more efficient.
But in light of these advances, it is important that we
ensure the CFTC is discharging its responsibility as the
primary regulator of futures markets.
There have not been reports of rampant abuses in the
futures markets relating to high frequency trading, but we need
to be sure that we have a framework of regulations and legal
provisions in the statutes that guards against abuses and
protects the integrity of this important marketplace.
Thank you.
Chairwoman Stabenow. Thank you, very, very much, Senator
Cochran.
I am pleased to introduce our panel of witnesses that we
have with us today. First, we have Vincent McGonagle, who is
the Director of the Division of Market Oversight at the
Commodity Futures Trading Commission where he oversees the
registration and oversight of trade execution facilities.
Since 1997, Mr. McGonagle has served as a variety of roles
at the CFTC, most recently as a Senior Deputy Director of
Enforcement in the Division of Enforcement. We thank you very
much for your work.
Our second witness is a familiar face to the Committee.
Welcome back. Mr. Terry Duffy is the Executive Chairman and
President of the CME Group. Mr. Duffy has been a member of CME
since 1981, the Executive Chairman since 2006 and took on the
Chairman's role in 2012, also served as Vice Chairman of the
CME Group Foundation in 2003.
Mr. Duffy was appointed by President Bush as a member of
the Federal Retirement Thrift Investment Board, a position that
he recently left. Welcome again. We are glad to have you.
Finally, we have Dr. Andrei Kirilenko, Professor of the
Practice of Finance at MIT's Sloan School of Management. Before
joining MIT, Dr. Kirilenko served as the Chief Economist at the
CFTC for four years until December 2012, and again, we were
much appreciate your expertise and willingness to be with us
today.
We will move ahead. I think all of you know we welcome any
written testimony. We will ask that your verbal testimony be
limited to five minutes so we have enough time for questions,
but we certainly welcome any additional written testimony you
would like to leave with the Committee.
Mr. McGonagle, your testimony please.
STATEMENT OF VINCE MCGONAGLE, DIRECTOR OF THE DIVISION OF
MARKET OVERSIGHT, COMMODITY FUTURES TRADING COMMISSION,
WASHINGTON, D.C.
Mr. McGonagle. Good morning, Chairwoman Stabenow, Ranking
Member Cochran and members on the Committee. Thank you for the
opportunity to appear before you today.
My name is Vincent McGonagle and I am the Director of the
Division of Market Oversight at the Commodity Futures Trading
Commission. I am pleased to appear before the Committee to
provide an overview of the Commission's Concept Release on Risk
Controls and System Safeguards for Automated Trading
Environments.
Together with a number of rules applicable to trading
platforms and market participants adopted since passage of the
Dodd-Frank fact, the Concept Release is a proactive effort to
evaluate technology driven changes in derivatives markets.
Over the past decade, automated order generating and trade
matching systems have been enhanced. There has been a growth of
interconnected automated markets and the role of humans and
markets has changed.
The Concept Release contains a range of best practices,
existing commission regulations, and potential concerns around
automated trading for comprehensive public discussion.
The Commission solicited public comment on 124 separate
questions what catalog existing industry practices.
Fundamentally, the Concept Release asked whether existing risk
controls are sufficient to match trading technologies of modern
markets. We focused on the automated trading environment
looking at the progression of orders generated by the automated
trading system or an ATS to the clearing firms that guarantee
customer orders and then on to execution by trading platforms.
The Concept Release also addresses the big ATSs themselves.
We sought comment concerning whether high frequency trading
should be defined or otherwise classified as a registrant.
The Concept Release grouped 23 potential risk controls and
other measures into four general categories. Pre-trade risk
controls, post-trade reports, design testing and supervision of
standards for the automated trading systems, and other measures
such as market structure.
Pre-trade with controls are designed to prevent and
minimize errors or disruptions from reaching trading platforms.
This category addresses message rates, execution throttles, and
maximum order sizes. Pre-trade risk controls could apply to
some or all trading firms, the ATSs, clearing firms or trading
platforms.
Post-trade reports will confirm receipt of an order or an
executed trade or otherwise report an error.
The third category, system safeguards. We looked at
safeguards for the design, testing, and supervision of
automated trading systems. We also asked about kill switches
effectively canceling all working orders that facilitate an
emergency intervention in the case of a malfunctioning ATS.
Turning to market function and structure, we asked whether
exchanges should publish market quality indicators describing
trading activity and other associated metrics.
For market structure, we asked whether exchanges should
amend their trade matching systems. An example listed includes
whether trading should take place in a batch auction rather
than the continuous trade matching system.
We received 43 comments to the Concept Release which raised
a range of opinions. Some commenters questioned whether certain
risk controls could slow creation or transmission of orders,
creating a competitive disadvantage for firms that adopt them
unilaterally.
Other commenters expressed concern about the speed of
trading, including within exchange order books and suggested
steps to reduce any potential advantages that come with speed.
Other commenters suggested, however, that further
regulation in this space would quickly become obsolete as
technologies evolve. Some pointed to industry-led best
practices and safeguards rather than Commission regulation as
an appropriate response.
The Commission has a responsibility to ensure preservation
of price integrity within these critical markets. The Concept
Release invited a public dialogue in order to make an informed
recommendation to the Commission as to whether and what further
role in the market, market participants, and the Commission
should take in automated trading.
I will be happy to answer any questions. Thank you.
[The prepared statement of Vince McGonagle can be found on
page 38 in the appendix.]
Chairwoman Stabenow. Thank you very much.
Mr. Duffy, welcome.
STATEMENT OF TERRENCE DUFFY, EXECUTIVE CHAIRMAN AND PRESIDENT,
CME GROUP, CHICAGO, ILLINOIS
Mr. Duffy. Thank you. Good morning, Chairwoman Stabenow,
Ranking Member Cochran, members of the Committee, thank you for
allowing me to express the views of the CME Group on a very
important topic, high frequency trading. High frequency trading
has been the focus of many negative comments, much of which has
been based on misinformation when it comes to futures markets.
First, let me say that I strongly agree with regulators, in
both the futures and the equities markets, that the futures
markets are not rigged. To the contrary, the futures markets
today are more open and accessible than ever before.
It is important to take a step back and discuss the market
as a whole. Futures markets have evolved from a floor-based
model to an electronic model at the demand of our customers who
sought immediate execution and confirmation.
CME Group responded to its diverse and global customer base
including our banks, hedge funds, farmers and ranchers,
commercial producers and merchandisers, and other constituents.
Our innovative implementation of electronic trading opened
the markets in a profound way. It increased liquidity and
tightened bid/ask spreads to the benefit of our customers. They
rely on deep liquid markets to achieve their risk management
and investment objectives.
Without doubt, the increased speed of electronic trading
has challenged us to ensure that our markets operate with
integrity and are fair and open to all customers.
CME Group has been focused on this task for years. We have
worked closely with this Congress, our regulators, and
customers to maintain a level playing field.
We use a central limit order book. The identity of traders
and firms is protected from disclosure on all their bids,
offers, and execution reports. No one can see an order prior to
them hitting our match engine and being made available on the
order book.
Our market data is sent to everyone at once. While
customers have several options in terms of how they can receive
data from us, we do not restrict access. We maintain a complete
and comprehensive audit trail of every message, every order,
and every trade.
Orders entered via automated systems and the traders who
operate them are identified in the audit trail. This allows us
to monitor our markets which we do through sophisticated
surveillance and the monitoring technology backed by
experienced investigators.
CME promotes market stability through industry leading risk
controls. These include pre-execution risk controls, price
banding, stop-logic functionality, velocity-logic
functionality, and messaging volume controls. These controls in
all instances automatically reject irregular orders caused, for
example, by an order entry or a malfunction of an algorithm.
I would like to talk a little bit about co-location. It is
a topic that has received a lot of attention lately. In many
cases, the coverage includes misinformation about how these
facilities actually operate.
Co-location in our market provides equal access. It used to
be that the benefit of speed from proximity was available only
to traders who could buy real estate near an exchange or where
he or she thought the server would be.
Because of co-location facilities, every trader has access
to co-location. This includes everyone from small retail
participants to the largest of Wall Street banks. Everyone in
our facility connects with the same length fiber, so there are
no unequal location advantages. This is one of the true
benefits of our co-location facilities.
Finally, something that this Committee is deeply aware of,
but has been largely ignored by the public, is that futures
markets are very different from equities markets. Many of the
complaints against high frequency trading in equity markets
simply do not apply to the U.S. futures markets which have a
completely different market structure.
The multilevel protections I described a few minutes ago
are specific to our markets at CME. We think this structure
strikes the right balance of regulating the market without
inhibiting true price discovery.
The balance of regulation and market surveillance, along
with deep pools of liquidity, give market participants the
confidence they have come to expect as they rely on our markets
to effectively manage their risk.
I look forward to answering your question this morning.
Thank you.
[The prepared statement of Mr. Duffy can be found on page
27 in the appendix.]
Chairwoman Stabenow. Thank you very much.
Dr. Kirilenko, welcome.
STATEMENT OF ANDREI KIRILENKO, PROFESSOR OF THE PRACTICE OF
FINANCE, MIT SLOAN SCHOOL OF MANAGEMENT, CAMBRIDGE,
MASSACHUSETTS
Mr. Kirilenko. Thank you good morning, Chairwoman Stabenow,
Ranking Member Cochran, Committee members. I am honored to
appear before you today at the hearing on high frequency and
automated trading in futures markets.
It is not so long ago that futures were traded by human
traders in face-to-face markets. An open outcry market was
visible to the human eye. Traders had names, served designated
functions, and occupied specific locations on the trading
floor.
It was in the last decade that trading floors have been
replaced by server farms and the traitors have been replaced by
anonymous algorithms. Automated markets came with the promise
of using faster and cheaper technology to drastically lower
execution costs and improved price discovery for fundamental
market participants, farmers, ranchers, manufacturers and
pension fund managers.
For investors who want to buy or sell 100 shares or a
couple of futures contracts, this process seems to have been
realized. They can do it at narrow bid-ask spreads, greater
market depths, and prices that can be discovered around the
clock.
Then on May 6, 2010 came the Flash Crash. The events of May
6, 2010 were blamed on high-frequency traders, a new breed of
secretive, hyperactive trading algorithms that take advantage
of anyone trying to trade on size.
Within hours after the Flash Crash, my colleagues at the
CFTC and I began looking into the trading activity in the mini-
futures market which provides price discovery for the broad
U.S. stock market.
We discover that on May 6, 2010 HFTs, as defined by us, did
not cause the Flash Crash but did contribute to the
extraordinary systemic market event which was triggered by a
large sell program in the mini-futures executed over a short
period of time.
Systemic implications of high-frequency trading in the
mini-futures prompted us to study the inner workings of the HFT
industry. We found that over a two-year period the HFT industry
remained dominated by a small number of fast and aggressive
incumbents.
These incumbents earned high and persistent returns while
taking little risk. For some reason, competitive market forces
did not seem to fully work and benefits of automated markets
may not have been fully realized for everyone.
Instead of competing to provide best execution to
customers, incumbent HFTs seemed to be engaged in a winner
takes all arms race for smaller reductions in latency.
This explains why many regulators and policymakers decided
to focus on latency type measures to slow things down, to put
in speed bumps, or to remove the speed advantage of HFTs.
The subject of today's hearing, high-frequency and
automated trading, lies at the intersection of four highly
specialized fields, regulation, finance, technology, and data
processing. I have specific recommendations for each of these
areas.
In terms of regulation, I recommend creating a broad
definition of automated brokers and traders, similar to what
used be called floor brokers and traders in human-based
markets. Regulators need to regain the ability to be on top of
all the active traders and their markets.
In terms of finance, I recommend that regulators closely
examine whether competitive market forces are eroding the high
concentration of the HFT industry. The competitive market
forces are not working among the black boxes. Regulators cannot
continue to rely on industry-suggested solutions and need to
step in.
In terms of technology, I recommend that automated
exchanges report latency measurements through the market feed.
Latency has become as important as prices and quantities.
In terms of data processing, I recommend that automated
futures exchanges continue to broaden the use of short trading
pauses and reopening auctions. This functionality is not
without a cost but the benefits to public confidence especially
for the slower public are worth it.
For the public to remain confident in automated futures
markets, federal regulators need to demonstrate that they have
upgraded their operations accordingly. This requires not only a
substantial investment in new technology but an equally, if not
greater, investment in human talent.
Regulators should also ask academia for help dealing with
the new challenges that they face. We are here to be of use.
Thank you very much for the opportunity to testify before
you today.
[The prepared statement of Mr. Kirilenko can be found on
page 31 in the appendix.]
Chairwoman Stabenow. Thank you very much to each of you.
Dr. Kirilenko, let me start with you. You mentioned that
some have said that we are now in an arms race as it relates to
technology. When we look at these markets, on the one hand we
do know it is different. It is not fragmented like the
securities markets.
On the other hand, we are talking about greater and greater
technology, and speed, and the whole question of whether or not
the risk associated with higher trading speeds outweigh the
benefits both in terms of managing risk and price discovery.
What would be your answer to that, looking broadly at the
issue of speed versus what we are doing in these particular
markets in allowing people to use these markets to manage their
risk and for price discovery?
Mr. Kirilenko. Senator, thank you very much for your
question. It is a critical question in these markets.
What we found empirically by looking at trading in
particular, very important futures contract is the HFT
industry, the HFT firms who operate in the industry is highly,
highly concentrated.
What happens when markets become concentrated like this is
that it creates an environment, a winner takes all type of
environment where instead of focusing on the needs of
customers, intermediates start focusing on how they out compete
their peers, if you will, because whoever is one nanosecond
late is not going to get the trade.
Therefore, what we might be witnessing is potentially
socially inefficient investment in technologies that do not
necessarily benefit the end users.
Chairwoman Stabenow. Thank you. Would the smaller retail
investor notice if the market slowed down the speed of trading
by milliseconds or nanoseconds?
Mr. Kirilenko. The thing that is very clear that automated
markets are bearing the fruit of Moore's law, if you will. The
technology, technological advances much, much faster and
cheaper computing power is bearing the fruit of making these
prices operate around the clock, of having the market quality
indicators really improving across the board.
The bid-ask spread is much tighter, the depth is deeper,
the volume is higher. For smaller investors, that may be what
it is, they may be able to reap the benefits of that.
However, the issue is that it is not--the small investors
when they execute a few contracts in futures may be benefitting
but their pension fund managers who are trying to execute in
the size to manage risks of their entire portfolio may be
paying the cost that empirically could be higher.
It is not necessarily clear how much higher. We need to do
at additional work on it. But on the whole the benefits may be
disproportionally sort of shifting towards smaller trades and
the few people who are inside the markets instead of a much,
much broader constituency.
Chairwoman Stabenow. Thank you.
Mr. Duffy, you have highlighted the importance of CME's
risk controls and I congratulate you on what you have been
doing, messaging controls to maintain market stability, and so
on.
Do you think the CFTC should require these standards for
all market participants?
Mr. Duffy. On the risk controls? For all market
participants, it would be a little difficult to do, Madam
Chairwoman. When you look at small participants trying to use
these markets to hedge their crops, if you are going to put the
same restrictions on them that you are going to do on a large
participant, the cost to them is going to be extraordinary.
That is why us as a good exchange, as a designated contract
market, we oversee those markets for those smaller
participants. That is why it is critically important.
When you look at what is going on today and let me just
counter to what the doctor said a little bit, futures markets
are about risk transfer, not about capital formation. There is
a complete difference in what they do.
Chairwoman Stabenow. Right.
Mr. Duffy. Risk transfer is critically important to keep
the spreads in line so the participants can execute at the
cheapest possible price including those that are using them for
risk transfer.
The people that are trading high-frequency which are
trading for the bid-offer are keeping the spreads very tight
does a service to the people that are doing the risk transfer.
High-frequency traders for the most part are there to try
to capture bid-offers. Risk transfers are buying bids and
selling offers. That is what they do and they do it at the most
cost-effective rates.
As far as the risk controls, it is critically important
that they are all in place. I agree with both the doctor here
on that. But what is more important here is the cost of
execution for the participants.
Chairwoman Stabenow. Dr. Kirilenko recommended that CME
build on its success and, quote, broaden the use of short
trading pauses and other risk controls. Would you agree with
his assessment on that?
Mr. Duffy. On our risk controls, we, I mean the doctor said
it in his testimony, the Flash Crash. He was correct that HFTs
did not create the Flash Crash, and I think there is a little
bit of miscommunication who actually did create the Flash
Crash.
As you know, there were major macro events going around
Europe at a particular time. There were big issues facing this
country. All of a sudden the market went down precipitously and
somebody was trying to do a large hedge and then the market
fell and that happens.
It came back, and the person who supposedly caused this
large Flash Crash actually sold on the way back up. I agree
with the doctor it was not HFTs and it was not a large asset
manager that caused it. It was factors from all over the world
but our technology with the stop logic functionality, we
stopped.
In the securities world, Senator, you may know that
Accenture went to a penny that day. We do not trade Accenture.
Because of stub quoting, the Flash Crash allowed markets like
that because of the market structure to go to a penny, we have
what is called stop logic functionality which, after so much,
the market stops were six seconds, replenishes liquidity.
We have velocity logic functionality. If there is too much
velocity at one time, we will stop the market. If there is a
big directional change in the market, we will also slow down
the market and pause it.
We have multiple controls in place to make sure these
things do not happen.
Chairwoman Stabenow. Thank you. I have additional
questions. I will wait for additional rounds.
Senator Cochran.
Senator Cochran. Madam Chair, thank you for convening this
hearing. Let me ask Mr. Duffy. Are there any changes in the
law, the underlying law, recommended by the Commission now to
try to address any kind of activity that should be disciplined
more tightly or supervised more closely to protect the
interests of the users of the markets?
Mr. Duffy. First, Senator, I am unaware of any particular
issues or laws that have been changed from what has already
been public recently that the Commission has put forth. But
what I will say is critically important, the most important
thing is that if somebody is acting nefariously in the market
to the detriment of the participants, they should be punished
to the degree, whatever the law will provide for.
Senator Cochran. Well, does the law provide sufficient
safeguards to achieve that goal?
Mr. Duffy. Yes. It does.
Senator Cochran. Thank you.
Chairwoman Stabenow. Thank you very much.
Senator Brown.
Senator Brown. Thank you, Madam Chair, and thanks to the
witnesses. Mr. McGonagle, nice to see you again. Thank you for
your testimony earlier in our commodities issue.
As we know, in the world of high-speed trading, time is
measured in microseconds, millionths of a second or
milliseconds, thousandths of a second. A significant portion of
Dr. Kirilenko's testimony focuses on latency, and I want to ask
Mr. Duffy a question on latency and recall some of your
statements and ask you to sort of explain.
The Wall Street Journal highlighted, quote-unquote, order
latency when trade information is routed to the parties to a
trade before they post to the rest of the market.
This informational advantage, if you will, allows high-
speed trading firms to see which way prices are heading, as you
know, and to trade ahead of the rest of the market on a
different futures exchange, exploiting arbitrage opportunities
in mere milliseconds.
Your testimony today says that CME's market data quota is
sent to everyone at once. On April 23, Mr. Duffy, you told
Bloomberg that, quote, latencies have been shrunk dramatically,
but I have heard they may remain important contracts like the
crude oil complex.
Has CME addressed latencies across all futures contracts or
are these delays just shorter or are they gone completely?
Mr. Duffy. All of our market data comes out of one pipe,
sir, and then the way you decide to acquire that is up to you.
There are multiple ways to receive market data. It does go out
all at once.
What you are referring to, sir, I believe in the Wall
Street Journal article that was written over a year and a half
ago is where a participant would receive his confirmation of
the trade but the market data did not hit the tape yet.
He knew he had the trade. He was the only one who knew he
had the trade. The rest of the world did not know he had the
trade yet. That was what the Wall Street Journal article cited.
We have shrunk that latency dramatically about market data
to market confirmation. You have to understand, sir, when you
have multiple messages coming from multiple participants coming
out at one price, it could slow that particular system down
quite, not quite a bit, a millisecond, and we have shrunk that
dramatically.
In most cases, sir, the time of market trade and market
data come out instantaneously. There are situations where there
could be a lag of a millisecond depending on what the scenario
of the market conditions are. But that is totally separate from
the way we distribute our market data. Everybody gets their
market data at the same, at one pipe. They decide how they
receive it. There is no differences.
Senator Brown. To clarify that, that microsecond or those
few microseconds or a millisecond of delay, does that advantage
one?
Mr. Duffy. No, sir, because the only person that knows that
he has gotten the trade is himself. Correct. In our world, if
he was--it is not like securities where he can go to an exact
market such as IBM stock being traded on 13 different venues
and potentially see a different price than what he received to
add to that benefit.
We do not have that in that world, sir. If you are trading
a Euro dollar futures contract on the CME Group, you get your
price confirmation but the market data had a millisecond lag,
yes, you could go to another market and execute. It does not
mean you are going to be right because it is not the same exact
market.
Senator Brown. You had said earlier that CME had said that
this issue would be addressed by the end of last year. You say
you have addressed it?
Mr. Duffy. Our issue with market confirmation and market
data for the participants is down to a millisecond. In most
situations, it actually comes out at the exact same time.
Senator Brown. Mr. McGonagle, if you would comment on this.
The CFTC was not in the process of examining this issue is my
understanding when it came to light last year. Do you have
comments on the back-and-forth of Mr. Duffy and me or CFTC's
role? Dr. Kirilenko, if you would weigh in too and your
thoughts about this.
Mr. McGonagle. Thank you, Senator. In evaluating the
concept or at least this conversation surrounding latency,
Commission consideration could focus on sort of the quality of
the information access, how much information about particular
trading in particular contracts are their latency issues on a
contract by contract, the Commission could certainly consider
that.
The Commission is also considering, as part of the Concept
Release, the idea, this concept and regulation about impartial
access. All market participants should have the same ability to
access the markets equally.
Whether or where the latency might cause some disruption in
that ability of market participants to get information, I think
could be something that the Commission could consider.
Mr. Duffy is talking about the ability to trade. That
information about the trade is important information and we
want to make sure that in evaluating these markets that the
information is readily available to all market participants
without disadvantage.
Senator Brown. Dr. Kirilenko, your thoughts.
Mr. Kirilenko. Thank you very much, Senator, for an
excellent question.
Your concerns and the public concerns about latency are
fully justified. That is why I recommend that instead of,
either the public deserves much greater transparency about what
is going on inside his market. I think the latency should be
reported in some form.
There are various types of latencies so that the automated
exchanges which, as we know, measure it with great precision
could be held accountable and the public could understand what
is actually going on.
It may or may not be an issue but at least the public would
know. We could also see whether different policy measures that
are being suggested and implemented actually do have an impact
as people think they do.
An automated exchange is a highly, highly complex automated
system. It has latencies because any automated complex system
has latencies in it. Latency is not a number. It is not a
millisecond. It is typically a distribution and not a bell-
shaped one. The public needs to understand that and also needs
to understand what to look for and how to measure what is being
going on.
Senator Brown. Thank you.
Thank you Madam Chair.
Chairwoman Stabenow. Thank you very much.
Senator Chambliss.
Senator Chambliss. Thank you very much, Madam Chair, and
let me just say off the top that with respect to your concern
about the difference in the risk that participants in the
market taken as well as Senator Cochran's question, there is a
major difference between one of our farmers and ranchers who is
driving from field to field and during the course of that
checks the market and wants to make a trade and the a major
integrated company who is going to be trading hundreds of
millions of dollars on contracts.
We thought we had made the right kind of changes in Dodd-
Frank but frankly we did not. I am going to be dropping a bill
today that we have worked with industry, with CFTC as well as
members of this Committee on--and I will be talking to the
chairman about it later--that seeks to correct the end-user
exemption that needs to be granted particularly to our farmers
and ranchers who they deal in a different world than a major
integrated company. So we will talk more about that later.
Mr. McGonagle, CFTC officials have stated in the past that
high frequency trading firms should be required to register so
that you know who they are. Now, what information specifically
could be gathered from a registration regime that is not
available to the Commission today?
Mr. McGonagle. Thank you, Senator. Currently market may be
registered to the extent that they are an automated trading
system or fall within some definition of what people have for
high-frequency trader but they might otherwise be registered
with the Commission in some other capacity.
In evaluating a new registration regime, we want to take
into consideration whether we have already captured the types
of traders that we are interested in terms of obligations that
they might have for information reporting, the level of
responsibility back to the agency.
One proposal or suggestion that we have in the Concept
Release is whether we should classify floor traders, use the
floor trader definition for high-frequency traders. That is
something we are considering at the staff level with respect to
a recommendation back to the Commission.
But if there is a registrant, they will have enhanced
reporting responsibilities to the agency. We will have a better
idea about who these entities are and the question is whether
we already have that information in a usable form and whether
this additional registration requirements, the benefits of
those requirements otherwise fit within a regulatory structure.
Senator Chambliss. Mr. Duffy, you just heard that answer
and you talked a little bit about the information that CME
Group collects on firm's identities. Would registration in and
of itself generate more information than what you receive on a
trader today?
Mr. Duffy. No, Senator, it would not. I mean, today we have
information on every market participant, every order; and every
person is identified with all of their activity in CME Group.
We tag traders in two different tags, basically what is
called Tag 50 for a regular trader, and then for an automatic
trading system we have another tag number for it. We have all
that information today that is accessible today to the CFTC.
Senator Chambliss. Okay. Again, Mr. Duffy, in your
testimony, you stay, and I quote, ``many of the recent
complaints against high-frequency trading and equity markets
simply do not apply to the U.S. futures markets''. Would you
elaborate a little bit on the differences.
Mr. Duffy. Thank you, Senator, I would be happy to.
As I said in my testimony, when you enter an order into the
CME system, no one knows you entered that order but yourself
until it hits our match engine, and then the order, the
transaction is complete.
In some of the allegations on 60 Minutes and in the book
about Flash Boys, if you recall, the allegation was there was
an order sent to a particular entity. Everybody could see it
and then they race to the 13 other exchanges that traded in
front of it and then offered a price a penny higher.
Well, that would be literally impossible in our world the
way the market structure handles it because no one knows about
that order but us. Also in a vertical silo which is what we
operate in the futures market, people do not have the ability
to go outside of our walls to go race customers to different
venues to beat them to that trade.
As I said, what is critically important, if, in fact, that
is going on in the securities world, that should be punished to
whatever the law would allow people to punish them for because
that is completely unacceptable.
But in our world, we do not see how that possibly can
happen. Now, someone says, could front running happen in your
business? It can happen in the way they described it in 60
Minutes. People can always act nefariously on behalf of a
client and do something that we obviously police for on that
activity.
Senator Chambliss. If that did happen, if you had a front
runner, if you do not pick it up on the front end, are you
going to pick it up eventually?
Mr. Duffy. We will pick it up through patterns. We will
pick it up through many different surveillance systems,
Senator, that we have put in place over the last several years.
We feel very comfortable that type of activity is not going on
in our marketplace.
Senator Chambliss. Thank you.
Chairwoman Stabenow. Thank you very much.
Senator Donnelly.
Senator Donnelly. Thank you Madam Chair, and thanks to all
the witnesses who are here today.
Mr. Kirilenko, are there latencies that continue today that
you see in the markets on a constant basis?
Mr. Kirilenko. Thank you very much, Senator, for this
question.
Again, I think that you are fully justified in thinking of
latency as an important indicator that really needs to be
measured and be made available to the public.
There is some reason preliminary work that indicates that
latency is not a number that it is a distribution of numbers,
and there is a significant degree of randomness in the way
latency accumulates within the system.
Therefore, when we think of time priority, we need to think
of it, this time priority being not as exact but somewhat
random depending on how a message hit the exchange, depending
on how long it took for risk safeguards to process it,
depending on where it hit the bus and so forth. It may be delay
even more or less. Latencies do accumulate within the system.
Senator Donnelly. Mr. Duffy, in your markets, do you keep
an eye out for latencies?
Mr. Duffy. We do, sir. As I said earlier, we are down two
microseconds on certain issues but there is also a speed of
light issue that there is not much anybody can control.
If your server is sitting in Chicago and you want to make a
trade from Los Angeles, there is a difference between Los
Angeles and Chicago as there is from New York to Chicago and
conversely both places.
There is a potential speed of light issue that I do not
think anybody could overcome unless they figure, I do not know
how they could figure that out. I think the doctor is right.
There are inherent latencies in all technologies.
Senator Donnelly. If you see a latency issue occur, is that
then made public that everybody knows it or how does that work?
Do you work to just fix it and keep it in effect within the
house or does that then become public that, hey, we found that
there is this latency here; this is what we are trying to do?
Mr. Duffy. I can tell you, Senator, that when we took our
systems from trading in minutes to seconds to milliseconds to
microseconds, I do not think we put out press releases or
anything else along the way. We just continued to make the
market more efficient.
You know, to tell you a quick story, when you look even at
the insurance business, there are commercials on television
today, you can get a quote from your insurance company for 15
minutes or less and then the next commercial a guy says you can
get it in two minutes or less.
Speed is something that the American public and the world
is very used to and wants more of it. There are certain
limitations to all speed and I do not think there is anything
you can do about it. We have narrowed it down to the smallest
of millisecond.
Senator Donnelly. Do those latencies that are there, does
that create an opportunity for any of the HFT firms to get a
market advantage?
Mr. Duffy. No, I do not believe it does because if they,
first of all, you have to be right a market regardless. You do
not have anywhere else to run where the price is different.
Where HFT's could potentially benefit, as I said earlier, is in
a fragmented marketplace where there are 13 different venues of
trade for the same product that might have an arbitrage
inherently built in them, well, that is where their speed could
actually have an advantage.
But when you have a product that is traded all under one
roof, it is very difficult to have an advantage.
Senator Donnelly. When we talk about the equities market
where it happened and you mentioned, hey, there are 13
different markets, they can see and then try to get ahead of
it. When the orders are placed in your markets, people from
other firms and such cannot see that is happening before hand?
Mr. Duffy. First, to be clear, I did not say that. 60
Minutes and Michael Lewis said that.
Senator Donnelly. All right. Understood.
Mr. Duffy. In our markets, what I had said is that when you
enter an order nobody knows who put that order in but yourself
until it hits our match engine.
Senator Donnelly. Okay. Mr. Kirilenko, when you look at
these markets, what is the biggest danger that you see still
now existing in his trading?
Mr. Kirilenko. I think these markets are incredibly
complex, interconnected, automated systems. Perhaps the biggest
danger lies in this interconnectedness where a trade executed
in one part of the market could be transmitted across the
entire universe very, very quickly by automated technologies,
by algorithms that police for a small price discrepancies and
the whole system becomes affected by that.
I think the interconnectedness and inter-linkages between
these markets I think is what is the biggest issue. I think
individually exchanges and regulators looking at them are aware
of some of the things that they are facing. But I think this
inter-linkage is something that requires a lot more attention.
Senator Donnelly. Okay. Madam Chair, thank you and thanks
to all the witnesses.
Chairwoman Stabenow. Thank you very much. I do believe we
have Senator Casey coming, but at this point, I am going to
proceed and if Senator Cochran has questions as well.
Mr. McGonagle, could you talk from the standpoint of the
CFTC and what is next at this point? Are you considering
proposing a rule on automated trading practices and how do you
think that the CFTC will proceed?
Mr. McGonagle. Thank you, Chairwoman. The Commission
currently has taken, we have taken the comments back at the
staff level. The staff is evaluating those comments in order to
come up with a recommendation.
While the Concept Release is not a rule writing, it can be
a precursor to a rule. Our expectation is that we will evaluate
each of these measures that we have put forward and become back
to the Commission with a recommendation.
But we need to do a thoughtful and diligent review of these
issues to see whether or where the Commission action is
warranted. A rule could be recommended but we are not at that
stage at this moment.
Chairwoman Stabenow. Mr. Duffy, interesting when you were
saying the public wants higher speeds. I do not know if that is
really true or not.
This whole thing is quite extraordinary in terms of speed,
and I do not know from a public standpoint if people really are
asking for more speed. I think they want confidence and they
want markets that they feel are stable and that they can use
appropriately.
But my question both to you and to Mr. McGonagle relates to
the ability of the CFTC to keep up. If we are going to see this
moving faster and faster at a time when the CFTC does not have
the technology that is comparable to what is happening in the
private sector. We have given tremendous responsibilities to
the CFTC without adding the additional staff necessary to help
with that.
If we are going to say that this should be a model where it
is not about direct regulation but more about working with the
industry in a self-regulating mode, there has to be some
capacity for oversight here that is equal to what is happening
in the marketplace.
I'm wondering, Mr. McGonagle, just from your standpoint,
what would the agency do from a technology standpoint, what
would you be able to do if you had additional funds?
Mr. McGonagle. Speaking specifically to the automated
trading system environment, additional technology funds could,
for example, be used. We need to supplement the staff that we
have. We have very well-qualified staff who are conducting
examinations and surveillance. But we would need to increase
those staff levels so they can perform the analytics on the
data that we receive.
We would increase the data that we do receive from the
exchanges. The exchanges have a wealth of information that is
available to them on a buy exchange basis. We pull in trade
order data on a T+1 the day after basis. But we would look for
messaging data, more discreet, nuanced information about these
particular trades that could inform us on our regulatory
obligations as well as how we conduct enforcement.
We would see multiple benefits just in increasing
technology in this one particular area. I mean, the
Commission's resource needs I think have been pretty well
documented. We do face substantial staff shortages within DMO
and within other divisions that I have worked at, Division of
Enforcement.
We do appreciate consideration of our resources but I defer
more to the Commission in terms of how we could allocate
resources, additional resources, if provided. But we certainly
have significant opportunities that we could address if we had
more people and we had more technology.
Chairwoman Stabenow. Mr. Duffy, you and I have talked about
this before, about user fees and so on. I am wondering, from
your standpoint, would you support using funds gathered from
enforcement cases to pay for agency expenses like technology
and staff?
Secondly, what if the agency funded itself with broader-
based fees, not only on transactions but looking at other
things, without harming the market?
Mr. Duffy. A couple of things if you do not mind. From an
enforcement issue, today I believe all of that money has to go
into the general Treasury of the United States and then gets
allocated through their appropriations process.
I think that is to keep away from the conflicts of interest
of any particular entity feeling that participants are only
being pressured or fined in order to fund an agency. But I do
believe that there could be a small portion of enforcement
findings to help fund an agency which would make sense.
Now, what that percentage is would be up for the government
to always decide. But if you looked at 10 to 20 percent, in
that neighborhood, you could probably fund the CFTC in full if
you were to use that portion of the enforcements to do so.
I am not suggesting it is a good idea or bad idea but I
think that should be at least looked at.
Second of all, on what Mr. McGonagle said, we do have a
wealth of information that we could share with the Commission,
which we do share with the Commission.
To give you an example, when the doctor referenced the
Flash Crash, I testified before a Committee here in the Senate
and we had every trade broken down in three hours and gave it
to the CFTC in the same night.
I testify two months later. The SEC still did not have
their information because they do not have a consolidated audit
trail. That is a big problem for that world.
We have done a lot to help with the enforcement and
protection of our marketplace. What is the most important thing
for us is to have the credibility and to have the public
confidence in the marketplace.
To give you an example why I think that not speed is
important but market efficiency is important, in the
agricultural community alone when you look at the marketplace
over the last year when the price of corn almost went in half,
we were able to provide deep, liquid pools of liquidity for
farmers and ranchers and others to use that as a hedge vehicle.
To protect that because their input costs are so high,
because of land, fees, and other things. That was a great
benefit these futures markets provide. I did not want to leave
without saying that.
I think that we do have a lot of the things in place to
help the agency. I cannot put their budget together for them.
You know, I think it is important for the CFTC to put forth a
budget like everybody else does to see where monies are going
to be appropriated, and then come to you to decide if you can
get Congress to agree to give some enforcement funding so they
do not have to rely on taxpayers alone.
Chairwoman Stabenow. You would agree we have dramatically
increased their responsibilities?
Mr. Duffy. Yes.
Chairwoman Stabenow. We have not dramatically increased
technology?
Mr. Duffy. Madam Chairwoman, as you know, I am a very big
proponent of the Commodity Futures Trading Commission. I do not
believe the CME has a credible business if we do not have
credible regulator. I want to make sure that they are the envy
of the world as far as regulation goes.
Chairwoman Stabenow. Thank you, Senator Cochran, did you
want to ask a follow-up? I know we have Senator Casey here.
Senator Cochran. No, Madam Chair, and I do not have any
other questions. Thank you very much for your cooperation with
our Committee.
Chairwoman Stabenow. Thank you, Senator Casey, welcome.
Senator Casey. Madam Chair, thank you very much. We
appreciate your testimony, sir. I am late for your individual
testimony but grateful for the time you give us with questions.
I guess I wanted to start with Mr. McGonagle. I want to ask
you in particular about the recommendations and suggestions you
would make for us. I know you may have already walked through
this.
What do you think we should be most concerned about with
regard to the oversight responsibility of this Committee?
Mr. McGonagle. Senator, particularly as it relates to the
automated trading system environment, I think that it would be
helpful to keep attention on CFTC as we evaluate these issues
and come forward with a recommendation.
Our responsibility is to ensure that our markets have
integrity, and the interaction with this Committee about how we
are fulfilling that responsibility I think is important. How we
come about with our recommendation on the Concept Release,
should we articulate that further rules are required, further
communication with this Committee on those points I think would
be helpful.
Senator Casey. With regard to rules that are prescriptive
in nature, would those kinds of rules leave some of these
entities or some of the practices out of regulation? What is
your sense of that?
Mr. McGonagle. The concern that we have heard at least in
comments is that prescriptive regulations in this area can be
quickly outstripped by changes in technology.
Proposals that have come back to the Commission are that we
should have more of a principle-based approach. I think the
challenge that we have is sort of flexibility versus clarity.
Principles give flexibility but they could be challenged or
subject to questions surrounding clarity.
We want to make sure that our market participants have a
level playing field and that they understand the rules on that
field. I think that is just a challenge always.
We have some prescriptive rules in our system of
regulations; and we have some principle space, particularly
supervision rules. I think evaluating how those applied in our
past history and going forward and looking at where in this
Concept Release recommendations would be helpful, would help
dictate whether we should go principles versus prescriptive.
Senator Casey. I know one of the things that we have to
focus on here are best practices but I wanted to ask you. Often
we have in our oversight responsibility, discharging that
responsibility, we have a lot of ideas about what an agency
should be doing and what we hoped they would be doing.
But we do sometimes engage in what folks at the state and
local level would say unfunded mandates, meaning thou shall do
the following and good luck getting it done without resources.
You may have already covered this and I just was not able to be
here.
But in order for you to do the job we would hope you could
do in this area, what, if any, resource means do you have?
Mr. McGonagle. Senator, if I can talk a little bit then
about resources just to give some perspective where the
Division of Market Oversight is, in 2011 the Division of Market
Oversight had a staff of about a 126 staff people, responsible
for registration obligations, enforcement of the rules, our
examinations staff as well as surveillance.
There were 16 designated contract markets within CFTC's
jurisdiction that DMO had control over. Currently, we have 40
registrants, 40 registered entities, a swap execution facility,
designated contract market, swap data repositories, and foreign
boards of trade that have some registration status.
Another 30 applicants are seeking registration status. DMO
could be responsible for upwards of 70 different registered
entities comprising a much broader jurisdictional swap than we
saw in 2011. My current staff load is about a 109.
In evaluating what our responsibilities are like any
agency, any business, we would look at our priorities, where do
we get the most benefit, where can we have the most leverage.
In looking at the Concept Release, I think of where there
are areas if we were to make a recommendation that we believe
would be the most impactful because again our goal here is
market integrity and we want to make sure that we are doing our
job and that the markets are doing their job.
Senator Casey. I know I am out of time but maybe I will
submit some questions for Mr. Duffy, for both witnesses because
one question I have was about how we get the balance right
between focusing on risky activities but also making sure that
we are not over regulating so that hedger's, bona fide hedgers
and end users are not adversely impacted. But I am out of time
but I will submit that.
Chairwoman Stabenow. Thank you. Important questions.
Senator Donnelly.
Senator Donnelly. Thank you, Madam Chair.
Dr. Kirilenko and this is a little bit off of the direct
topic--do you see the front running opportunity that has been
talked about a lot recently in the equities markets, do you see
that continuing in the equities market? What is the best way in
your mind to correct that?
Mr. Kirilenko. I think the equities market is really quite
different in terms of fragmentation.
Senator Donnelly. I understand I was just wondering if----
Mr. Kirilenko. Whether or not it is continuing is an
empirical question, Senator. I think it is a matter for the
regulators to really understand how their markets are working
to really get that consolidated audit trail to really get their
staff to understand how it works and find the evidence of that.
I have done little empirical work on securities markets. I
am familiar with them but I would like my remarks to be based
on experience and facts.
Senator Casey. Sure. Well then, Mr. Duffy or Mr. McGonagle,
both of you are extraordinarily experienced. Are there things
that you look at and you say, if in a perfect world if they
could change this or this it might make for more secure
equities market as well.
Mr. Duffy. You know, I will give you my opinion only
because I cannot help myself.
Senator Casey. That is why I asked you.
[Laughter.]
Mr. Duffy. I run a futures exchange.
Senator Casey. Right.
Mr. Duffy. I am 35 years running in the futures business. I
am not a securities expert. But what I do understand is price
discovery and how price discovery happens, what is the best way
to get price discovery.
When you have a fragmented marketplace and you have almost
half of the U.S. equity market dark in nature, it is really
difficult to find what is the actual value of it.
When you have multiple exchanges trading the exact same
product and you have Reg NMS requiring people to go to the best
bidder offer, it is really difficult to say who has the best
bidder offer at any given time, sir, because the markets are
moving so quickly.
One exchange could be showing IBM at a certain price plus a
penny, another exchange that is the best bid and offer, a half
a second later the other exchange is the best bid and offer,
you have not done working your order at the first exchange yet.
I think the system itself needs to be looked at,
streamlined, and more efficient. I do not think it is HFTs that
are the problem. I think market structure is the problem, sir.
Senator Casey. Have you detected, Mr. Duffy, in your
markets, you have indicated, look, it cannot happen or--I do
not want to paraphrase for you. But you do everything you can
to make sure it does not happen in your markets.
Have you detected, do you see at times in your systems that
some organizations have tried to figure out how to do that? I
mean can you see that?
Mr. Duffy. The only way it can happen, sir, and just to
make sure we are perfectly clear on this. The only way it could
happen is if someone is acting on your behalf. You have given
them the ability to act on your behalf to enter an order.
They decide to enter an order for themselves first, yours
second. That is the way it can happen in our world, and that is
against the law, and we rigorously police against that type of
activity.
But on an electronic system if you are to enter your order,
Senator Donnelly enters an order into the CME system, you are
the only person that knows about that order so it is impossible
to front-run something that nobody else knows about.
Senator Casey. Okay. Mr. McGonagle, in today's markets
where millions of dollars can change hands in milliseconds, we
have a system where if there are violations, the maximum
penalty is $1.4 million? Do you think that is enough to deter
manipulation?
Mr. McGonagle. Thank you, Senator. The enforcement penalty
standard looks at per violation and I think an evaluation of
how many violations have occurred is part of the rubric that
the Division of Enforcement has.
From our perspective, we enforce authority that we have,
and I would have to defer to others about whether more
penalties are appropriate for deterrence or there are other
mechanisms available. But looking at a penalty per violation
increased recently to 1 million per violation, that is our
current mandate.
Senator Casey. Okay. Well, I want to thank the witnesses
for being here.
Thank you, Madam Chair.
Chairwoman Stabenow. Thank you very much.
As we close, I do have one other question as a follow-up to
what Senator Donnelly was talking about, and this regards
disruptive trading practices.
Mr. McGonagle, if you could tell us as we are looking at
the Commodities Exchange Act, as we are looking at CFTC
reauthorization, we gave the CFTC more authority under Dodd-
Frank, to go after practices like spoofing and banging the
close and in some cases changed the criminal standard from
intent to reckless disregard.
Do you think we need to revisit that? Do you think the CFTC
has sufficient authority to go after market participants who
are knowingly or recklessly disrupting the market?
Mr. McGonagle. Thank you, Chairwoman. The CFTC recent
increase in authorities through substantial manipulation
authority as well as the new disruptive trading practices,
those investigations and associated litigation are now starting
to come on line.
We see the mandate that the Division of Enforcement has. We
take that very seriously and we think the markets do as well.
We are prepared to work within the jurisdiction that we have.
Further strengthening the manipulations standard would have
costs on market participants. I think for clarity that they
would have to be evaluated, and I am not in a position to sort
of offer another proposed recommendation. I think the authority
that we have is very useful to the agency and we are in the
process of effectively utilizing it.
Chairwoman Stabenow. Thank you.
Mr. Duffy, did you want to respond to that?
Mr. Duffy. No. I think that was well said.
Chairwoman Stabenow. Okay. Well, thank you very much we are
about to have a vote on the Senate floor. Let me thank each of
you for coming. This is an incredibly important topic.
As we consider all the benefits of technology, we have got
to make sure that market oversight is keeping up. That is our
job. We need to work together to ensure the markets are safe
for trading and that the regulators have the resources
necessary to keep them safe.
Any additional questions for the record should be submitted
to the Committee clerk five business days from today. That is
five p.m. on Wednesday, May 21, and the meeting is adjourned.
Thank you.
[Whereupon, at 11:11 a.m., the Committee was adjourned.]
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A P P E N D I X
MAY 13, 2014
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DOCUMENTS SUBMITTED FOR THE RECORD
MAY 13, 2014
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QUESTIONS AND ANSWERS
MAY 13, 2014
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