Algos Needed to Surveill Algos, OMalia Says
June 19, 2012
There is one unavoidable avenue that has to be traversed by regulators if they hope to understand and deal with financial market where most instructions are issued by mathematical algorithms, instead of human traders.
"We need to use algorithms to surveill algorithms," Commodity Futures Trading Commission member Scott O’Malia said in extemporaneous remarks, a day before his Technology Advisory Committee meets to begin to define what constitutes high-frequency trading and how it should be dealt with.
The commission, he said, was still in the “plastics era” when it comes to bringing itself up to speed in using technology to manage technology-driven markets. When he arrived at the commission, he noted, compliance data was still coming in on fax machines, he said at the 2012 Technology Leaders Forum of the Securities Industry and Financial Markets Association.
The regulator of derivatives markets, which extend from futures and options to, soon, credit default swaps, needs “totally automated systems” to oversee markets, going forward, O’Malia said.
High-frequency trading now accounts for the majority of trades in equity markets, which are overseen by the Securities and Exchange Commission. But automated trading now is approaching 50 percent of trading in futures contracts, as well.
This automated trading has sliced and diced trades into average sizes of under 20 shares each and led to “massive volume increases” on a daily basis, he noted.
His committee on Wednesday will start work on how to address automated and high frequency trading (HFT); and the aggregation of liquidity across designated contract markets (“DCMs”) and swap execution facilities (“SEFs”).
The CFTC, in the aftermath of the credit crisis of 2008, is being charged with overseeing swap execution facilities by the 2010 Dodd-Frank Wall Street Reform Act.
One subcommittee will define high-frequency trading, another will categorize different flavors of it, a third will perform analysis of its economic effects and a fourth will look at its effect on market ‘’microstructure,’’ he said.
"The bottom line is we really need to develop a multiyear technology solution," for market oversight, O’Malia said. "Right now, we do not have that technology roadmap."
But the CFTC will create such a map and then follow it. “It’s the implementation, stupid, that we have to worry about,’’ he said, paraphrasing the 1992 campaign dictum of then-presidential candidate Bill Clinton.
He said a forthcoming study to appear in The Journal of Portfolio Management will argue that automated trading systems have created two markets.
One market, O’Malia said, is populated by low frequency traders that focus on “macro factors” like available supply, monetary policy and financial statements.