Why Did The CFTC Suspend Their Visiting Academic Research Program?
Two of the best pieces of research on high frequency trading that we have read recently are Andrei Kirilenko’s “The Trading Profits of High Frequency Traders” and Adam Clark-Joseph’s ”Exploratory Trading” . These two pieces of research are special because they use actual transaction level data from the CME and traced back to the original source of the trade. Most of the rest of the HFT research reports out there rely on a sample set of data usually supplied by an exchange.
Yesterday, there was a very disturbing Bloomberg article which reported that the CFTC has “suspended a program of visiting academic researchers over concerns about the handling of confidential trading data.”
This is really unfortunate. The only way to find out what is really going on in the HFT world is to trace trades back to the original users. Of course, the CFTC staff will still have access to this data and can continue to perform their own research. However, when you consider their work load with Dodd Frank, they obviously must have capacity issues. Allowing the data to be analyzed by outside researchers allowed the CFTC to sub-contract out research work for no cost.
According to the Bloomberg article, the CFTC pulled the plug on the outside research program because:
“The management review, which is ongoing, has preliminarily discovered issues regarding the manner in which academic consultants and contractors were brought into the agency, their status with respect to the agency, their access to CFTC systems and information, and the adequacy of related documentation.”
There are a few troubling things about this story:
1- The CFTC waited for Andrei Kirilenko (their Chief Economist) to leave the agency for MIT before they pulled the plug on the program. Kirilenko was one of the few regulators who understood what has been going on in the HFT world. His research was groundbreaking and was starting to connect all the dots. You could say he was hot on the trail of some questionable behavior.
2- According to Bloomberg, “the commission’s concerns were initially triggered by an outside person who raised questions about academic research that referenced CFTC data.” Who was this outside person? Was it a high frequency trader? Or maybe it was an academic who has previously produced research saying that there was nothing wrong with HFT?
3- We couldn’t find the actual statement that the Bloomberg reporter quoted from in the article. We asked the reporter for a link to the statement and were abruptly told that we would have to contact the CFTC directly.
Was the research program suspended because the HFT community did not like the conclusions of Kirilenko and Clark-Joseph’s papers? Maybe they thought that any more noses poking around actual CME data were likely to draw even more damning conclusions and wanted to stifle any further research. Maybe the “outside person” told the CFTC that he was uncomfortable with user level data being given to non-regulators. Maybe he claimed that a proprietary HFT strategy that took millions of dollars to develop was at risk of being disclosed to their competitors. We think rather than the CFTC closing down a program which could be hugely beneficial to regulators and the investment community, they could have disguised the user identification codes so that the researchers didn’t know the actual firms involved.
We have previously reviewed both research papers and found them to be extremely detailed and filled with critical information. To reiterate, these two papers are powerful because they source actual trade data down to the user level. To put this into context, the SEC is about to spend billions of dollars on a Consolidated Audit Trail which will take years to develop and will finally give researchers the ability to get trade data down to the user level.
On the Kirilenko paper, we wrote :
“The Kirilenko paper shines a very bright light on the practice of aggressive HFT trading in the e-mini contract but we are still left to wonder how much money is being made and what is actually going on in all those other asset classes. Since Mr. Kirilenko is the Chief Economist at the CFTC, he was able to obtain very clean data down to the user level for the e-mini futures.”
On the Clark-Joseph paper, we wrote :
“The Harvard paper also strikes as just the opposite of the HFT claim that they “add liquidity”. Maybe HFT’s are defining “add liquidity” as layering the book with higher offers and then sending some exploratory aggressive bids out to the market in an attempt to have others jump ahead and lift those layered offers.”
Rather than closing up its outside research program, we think the CFTC should be welcoming in more researchers. They must know that the public does not trust the public markets. They must know that the public fears that nefarious behavior has been lurking in the high speed computers. You would think regulators would want to encourage more independent research to help calm the concerns of the public.