Section 747 and HFT
Have you ever heard of Section 747? No, it’s not where the government is hiding the aliens. And it’s not the secret area where The Bernank prints all the money. Section 747 is a small paragraph buried deep in the 3000 page monstrosity known as the Dodd-Frank Act. And Section 747 is causing a lot of folks in the HFT world to be very concerned. Yesterday, the CFTC held a roundtable meeting on disruptive trading practices. This meeting was in response to an advance notice of proposed rulemaking (ANOPR) that the the CFTC issued on October 26 which dealt with section 747 of the Dodd-Frank Act (http://www.cftc.gov/ucm/groups/public/@lrfederalregister/documents/file/2010-27547a.pdf):
SEC. 747. ANTIDISRUPTIVE PRACTICES AUTHORITY.
Section 4c(a) of the Commodity Exchange Act (7 U.S.C. 6c(a)) is amended by adding at the end the following:
ANTIDISRUPTIVE PRACTICES.—It shall be unlawful for any person to engage in any trading, practice, or conduct on or subject to the rules of a registered entity that—
(A) violates bids or offers;
(B) demonstrates intentional or reckless disregard for the orderly execution of transactions during the closing period; or
(C) is, is of the character of, or is commonly known to the trade as, spoofing’ (bidding or offering with the intent to cancel the bid or offer before execution).
Dodd-Frank section 747 also gives the CFTC the authority to make rules and regulations as, in the judgment of the Commission, are reasonably necessary to prohibit the trading practices in section 747 and any other trading practice that is disruptive of fair and equitable trading.
In the ANOPR, the CFTC also asks for comments on 19 questions. We won’t list them all here (you can find them in the above link) but question #9 is of particular interest:
“Should the Commission separately specify and prohibit the following practices as distinct from spoofing as articulated in paragraph (C)? Or should these practices be considered a form of spoofing that is prohibited by paragraph (C)?
a. Submitting or cancelling bids or offers to overload the quotation system of a registered entity, or delay another person’s execution of trades
b. Submitting or cancelling multiple bids or offers to cause a material price movement
c. Submitting or cancelling multiple bids or offers to create an appearance of market depth that is false.”
The participants at yesterday’s meeting were a who’s who of the HFT world including representatives from Hudson River Trading Group, Quantlab Financial, Allston Trading and DRW Trading Group and of course one of their lobbying firms, Patton Boggs. And they weren’t very happy about the new power that Dodd-Frank has bestowed on the CFTC. In fact, here is how a Bloomberg reporter summarized their responses (http://noir.bloomberg.com/apps/news?pid=newsarchive&sid=ahNsO33J7kZw):
“The top U.S. commodity regulator may hamper markets if it writes rules to stop disruptive trading practices without considering the intent behind a transaction, representatives of high-frequency trading firms said. The firms said that without a better sense of the purpose of a trade, regulators could restrict practices that move markets but are not disruptive. “What really needs to be there, in my mind, are some notions of intent,” said Cameron Smith, general counsel of Quantlab Financial…Donald Wilson, founder and chief executive officer of DRW Trading Group, said at the meeting that markets could be “significantly harmed” if the rules lack specifics about the intent of the trades.
So there you have it. A new front has been opened up by the CFTC on the battle against HFT. No doubt all the HFT lobbyists have been busy coming up with ways to defeat Section 747. They appear not to be using the standard HFT defense that “we add liquidity and shrink spreads” . This time they are going with intent – “you need to know the intent” of what is clearly disruptive trading practices. They are basically saying that even if we cancel 99,000 out of 100,000 orders, that shouldn’t be considered spoofing because you don’t know the intent of those cancellations. C’mon guys, you have to do better than that. We all know what your intent is.