United States: Regulation AT – An Update

Last Updated: February 9 2017
Article by Derivatives In Review

From the time Regulation AT was initially proposed by the Commodity Futures Trading Commission ("CFTC") over a year ago, the CFTC has solicited and considered numerous comment letters, held a public roundtable, supplemented the proposed regulation, and, on January 23, 2017, extended the comment period for that supplemental proposal. However, although the substance of the regulation has evolved in certain respects, its future remains uncertain.

In November 2015, the CFTC first proposed Regulation AT, which would regulate automated trading on U.S. designated contract markets ("DCMs") and was primarily designed to reduce the likelihood of market disruptions caused by automated trading. As originally proposed, Regulation AT would impose risk control and other requirements at three levels: (i) on certain market participants (known as "AT Persons") using algorithmic trading systems ("ATSs"); (ii) on clearing member futures commission merchants ("FCMs") with respect to their customers that are AT Persons; and (iii) on DCMs executing the orders of AT Persons.  The proposed rule also would impose registration requirements on proprietary traders that electronically submit orders directly to a DCM, without those orders being routed through a separate person that is a member of the derivatives clearing organization to which the DCM submits transactions for clearing (known as "direct electronic access" or "DEA").1  A 90-day comment period followed during which the CFTC received almost 100 comment letters.

After the conclusion of this comment period, the CFTC held a public roundtable in June 2016 to discuss the proposed regulation. The roundtable focused largely on: (i) narrowing the definition of "AT Person" (with panelists exploring both quantitative and principles-based approaches); (ii) amending the definition of "DEA" to take a more principles-based approach; (iii) avoiding duplicative risk control requirements; and (iv) persisting concerns regarding the requirement that AT Persons maintain and provide to regulators access to "source code" information.  The CFTC Commissioners generally have indicated a willingness for flexibility on the proposed regulation, including at the roundtable.2

On November 4, 2016, the CFTC supplemented its proposed rulemaking based on the comments it had received from market participants and further consideration of its initially proposed Regulation AT.3  Under the Supplemental Rulemaking, the CFTC proposed the following amendments to proposed Regulation AT, among others:

  • Setting risk controls at two, instead of three, levels.  Specifically, risk controls would be set at the levels of (i) the AT Person or its FCM (the AT Person would have the ability to delegate its pre-trade risk control requirements to an FCM (with the agreement of that FCM) instead of implementing its own controls) and (ii) the DCM, as opposed to the levels of the AT Person, the FCM and the DCM.
  • Imposing risk controls on electronic trading at the AT Person, FCM, and DCM levels, as opposed to just algorithmic trading of AT Persons.
  • Providing AT Persons, FCMs and DCMs with greater flexibility regarding the level at which pre-trade controls must be set.
  • Eliminating the annual compliance report requirement for AT Persons and providing for a streamlined annual certification requirement from AT Persons to DCMs (based on comments that the proposed reporting requirements were overly-burdensome and would provide little benefit in mitigating algorithmic trading risks).
  • In response to concerns expressed by market participants over confidentiality and proprietary value of their algorithmic trading source code information, extensively modifying the source code preservation, recordkeeping and access provisions (including providing that the CFTC would have access to such source code and related records only through a subpoena or a special call approved by the CFTC itself, and not by its staff).

During the recent campaign and afterwards, President Donald Trump and some of his representatives suggested that certain restrictions imposed by the Dodd-Frank Wall Street Reform and Consumer Protection Act be eased or repealed.4  President Trump and his representatives have not focused their attention on fundamental derivatives reform that has already been implemented (e.g., mandatory clearing of standardized swap contracts, reporting of swap data to registered swap data repositories, basic recordkeeping requirements for swaps).5  However, derivatives regulations that remain in proposed form—including position limit rules and Regulation AT—ultimately may not survive intact, and could be withdrawn entirely.

In the case of Regulation AT, CFTC Acting Chairman Giancarlo has repeatedly expressed his concern over several aspects of the proposed regulation. In his strong dissent to the Supplemental Rulemaking, Commissioner Giancarlo highlighted, among other things, that the proposed "special call" process "would strip owners of intellectual property of due process of law" by allowing the government the ability to seize property (in this case, source code information) without first obtaining a subpoena.6  He further noted that the CFTC's effort to oversee modern digital markets was being "squandered by its gigantic stumble backwards" through proposed Regulation AT.  On January 23, the CFTC extended the closing of the comment period for the Supplemental Rulemaking from January 24, 2017 to May 1, 2017,7 consistent with the desire expressed by Commissioner Giancarlo just days earlier.8  The concerns of the Acting Chairman regarding the current focus of proposed Regulation AT may provide some insight into the future of this proposed regulation.

We will continue to monitor developments regarding proposed Regulation AT.

Footnotes

1 For additional information on the initial proposal for Regulation AT, see the previous posting in Derivatives in Review (available here) and Nikiforos Mathews and Jonas Robison, Regulating Automated Trading in Derivatives: An Overview of the CFTC's Proposed Regulation AT, 29 Journal of Taxation and Regulation of Financial Regulations 31 (May/June 2016).

2 For example, Commissioner J. Christopher Giancarlo expressed his concern that the proposed regulation was "a 20th Century analog response to the 21st Century digital revolution in trading markets."  Opening Statement of Commissioner J. Christopher Giancarlo before the CFTC Staff Roundtable on Regulation Automated Trading (June 10, 2016) (available at: http://www.cftc.gov/PressRoom/SpeechesTestimony/giancarlostatement061016).  See also Concurring Statement of Commissioner Sharon Y. Bowen on Supplemental Notice of Proposed Rulemaking for Regulation AT (November 4, 2016) (available at: http://www.cftc.gov/PressRoom/SpeechesTestimony/bowenstatement110416) (acknowledged that the supplemental proposed regulation was a "first cut" that could require modification).  Commissioners Giancarlo and Bowen are currently the only CFTC Commissioners (three vacancies exist) following the resignation of CFTC Chairman Timothy Massad, effective January 20, 2017.

3 See Regulation Automated Trading, 81 Fed. Reg. 85,334 (Nov. 25, 2016) (the "Supplemental Rulemaking").

4 See, e.g., Jesse Hamilton & Elizabeth Dexhelmer, Trump's Transition Team Pledges to Dismantle Dodd-Frank Act, Bloomberg, Nov. 10, 2016 (quoting a statement posted on then-candidate Trump's official transition website that "[t]he Financial Services Policy Implementation team will be working to dismantle the Dodd-Frank Act and replace it with new policies to encourage economic growth and job creation.").

5 Note, however, that certain aspects of finalized regulations may be affected. For example, the March 1, 2017 implementation deadline for new margin requirements on uncleared swaps may be delayed. See, e.g., Keynote Address of CFTC Commissioner J. Christopher Giancarlo Before SEFCON VII (January 18, 2017) ("Giancarlo Keynote Address") (available at: http://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo-19) ("I am aware that market participants continue to face hard challenges in meeting this deadline. I am especially concerned that smaller firms, including American pension and retirement funds, may not be able to get their documentation done in time.").

Also, the CFTC could establish the $8 billion de minimis exception from the requirement to register as a swap dealer, which is scheduled to automatically decrease to $3 billion on December 31, 2018, may become permanent (or even increase).  For additional information on the de minimis exception, including the details of its calculation, see previous postings in Derivatives in Review (available here and here).

6 Supplemental Rulemaking at 85,396.

7 Regulation Automated Trading, 82 Fed. Reg. 8,502 (January 26, 2017).

8 See Giancarlo Keynote Address.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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