The CFTC approved a number of amendments to Part 38 ("Designated Contract Markets") of the CFTC Rules to include electronic trading risk principles ("Risk Principles").

As previously covered, the amendments consist of, among other things, three applicable Risk Principles for designated contract markets ("DCMs"):

  • the implementation of exchange rules intended to identify, alleviate and prevent market disruptions and electronic trading system anomalies;
  • the establishment of "exchange-based pre-trade risk controls" for all electronic orders; and
  • prompt notice to the CFTC by DCMs of "significant disruptions" to their electronic trading platforms.

The final rule goes into effect on the date of its publication in the Federal Register. DCMs are required to be in compliance with the final rule within 180 days of its publication in the Federal Register.

CFTC Commissioner Statements

CFTC Chair Heath Tarbert and CFTC Commissioner Brian Quintenz said that adoption of the final rule was a "prime example" of a principles-based approach to regulation that enables the evolution of electronic trading and related risk management controls as technological advancements occur. Mr. Tarbert and Mr. Quintenz noted that the exchanges have already established regulations and risk controls that are consistent with the Risk Principles, as it is in their best interests to ensure that electronic markets function with integrity. CFTC Commissioner Dawn Stump stated that exchanges "are best positioned to execute this responsibility because they have the best knowledge of the trading that occurs on their own markets." Ms. Stump also emphasized that the adoption of the Risk Principles is "an appropriate exercise of the Commission's oversight that Congress expects from [the CFTC], as stated in Section 3(b) of the CEA."

CFTC Commissioner Dan Berkovitz supported the final rule, stating that it is an "incremental step that can enhance the safety and soundness of electronic trading on U.S. exchanges." He noted that the extent to which the Risk Principles accomplish their goals will depend in large part on the "diligence and commitment to [their] implementation by DCMs and market participants." Mr. Berkovitz also highlighted (i) new requirements in Risk Principle 1 regarding DCMs' obligation to implement rules regulating the activities of their market participants in order to "prevent, detect, and mitigate market disruptions and system anomalies," and (ii) that Risk Principles 1 and 2 cover any type of market disruption resulting from market participants or electronic orders that "materially affects electronic trading" (emphasis added).

CFTC Commissioner Rostin Behnam dissented from the adoption of the final rule, stating that it effectively codifies the status quo. Mr. Behnam stated that recent market stresses have indicated the necessity for taking substantive steps toward addressing the risks associated with automated trading. Mr. Behnam pointed to the events of April 2020, in which a crude oil futures contract on the New York Mercantile Exchange traded at a negative price (see related coverage of the CFTC Interim Staff Report, "Trading in NYMEX WTI Crude Oil Futures Contract Leading up to, on, and around April 20, 2020"), as arguably the best test case that the CFTC could have used to consider if there were meaningful regulatory opportunities to improve risk controls. However, Mr. Behnam stated, the CFTC failed to adequately consider in this rulemaking the conditions leading to such a market event, as well as the impact of the COVID-19 pandemic, and the potential future impacts of climate change on market conditions. Mr. Benham said that he continues to question "whether these Risk Principles improve upon the status quo, or even do anything of marginal substance relative to the status quo."

Commentary

The debate as to whether regulators should govern through the establishment of general principle or specific requirements is an ongoing one, and will necessarily vary with the circumstances. For a good discussion of the issue, see CFTC Chair Heath Tarbert Compares Benefits of Principles- and Rules-Based Regulatory Approaches. In an area that is fast-changing and technology-driven, and where the regulated entities have a strong incentive to keep up with best practices, a principles-based framework seems the right approach.

Primary Sources

  1. CFTC Voting Draft: Electronic Trading Risk Principles
  2. CFTC Press Release: CFTC Approves Two Final Rules and Two Rules at December 8 Open Meeting
  3. CFTC Statement, Heath Tarbert: Statement in Support of the Final Rule on Electronic Trading Risk Principles
  4. CFTC Statement, Brian Quintenz: Statement regarding Final Rule on Electronic Trading Risk Principles
  5. CFTC Statement, Rostin Behnam: Dissenting Statement regarding Electronic Trading Risk Principles
  6. CFTC Statement, Dawn D. Stump: Statement in Support of Final Rules Related to Electronic Trading Risk Principles
  7. CFTC Statement, Dan Berkovitz: Statement regarding Risk Principles for Electronic Trading

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