Good Data Bad Data Part II – CFTC

Yesterday our note to you discussed the challenges the SEC faces in collecting the right data, so that they can understand our equity markets and assess their quality. We stressed the importance of data down to the user level. This type of data is most important, because with such data we can really understand and properly identify “HFT”, as opposed to lumping in so many trading styles into the same bucket. This type of data is crucial to the work of researchers, be they within the SEC or in academia.

Today we want to switch gears and discuss challenges the CFTC faces. You may recall a note we sent out to you over one year ago titled Why Did the CFTC Suspend Their Visiting Academic Research Program. That program was responsible for helping visiting CFTC academia study the nature of our modern markets. Two significant research papers came from that program: Andrei Kirilenko’s  The Trading Profits of High Frequency Traders and Adam Clark-Joseph’s Exploratory Trading. Both papers used transaction data from the CME and traced them back to the source of the trade. They were both critical of HFT. These papers also prompted the CFTC to end, or severely limit, its outside research program, at the request of an “outside person who raised questions about academic research that referenced CFTC data.”

In our note a year ago we asked who was that person? Was it a high frequency trader? Was it was an academic who has previously produced research saying that there was nothing wrong with HFT? It since came out that the “outside person” was the CME, and you can surmise who their largest customer base includes.

The shattered CFTC Visiting Academic Research Program subsequently went from 39 economists in December 2012 to just 11 in January 2014. In addition, the precedent set also affected research at the SEC. One professor we spoke with on condition of anonymity told us how similar research stalled at the SEC as well, and that some young professors could not get their research published as a result. It even affected their ability to secure employment.

This week we got good news.

The Office of the Inspector General (OIG) examined the CFTC’s conduct last year. And they released a report that analyzed the CME’s allegations, and the CFTC’s subsequent handling of their request. This Reuters story does a great job of summarizing the 134 page OIG report, complete with redactions.

The OIG report has concluded that the CME’s confidentiality allegations were unsubstantiated and that no laws governing the protection of sensitive market data were broken. It was also critical of how the CFTC shut down the research program, and went so far as to say that the CFTC may have even violated law that required them to maintain that program. The OIG did not stop there. They also found that the CFTC began to operate at somewhat of a stall, and was concerned that a special CFTC internal committee formed to review academic papers started taking far too long to issue approvals. Of 24 papers identified by CFTC in February 2013, three papers took eight months to approve, four papers took about a year to approve, and the remaining 17 papers had not been approved when CFTC OIG published its report.

The CFTC has so many great and passionate employees, whom we have no doubt want to get facts and processes right. While they took issue with some of the OIG’s findings (they insist they did not violate any free speech issues, and the program was never actually shut down; it just was focused on issuing news releases – specifically related to the SWAPS markets), they also have, to their credit, begun the process of hiring back academic researchers since December of last year.

This is a great story, and we believe finally it is ending well. All of you understand how important unconflicted research is, especially where big industries and their effects are involved. Perhaps now the CFTC will continue to make user-level data available to outside associated researchers, who can help all of us understand the strengths and weaknesses of our modern markets, without the pressure of industry business models.

(By the way – most of you know that my Twitter handle is The Smoking Kid. It is a nod to the old tobacco studies funded by that tobacco industry that for years insisted there was no definitive proof that smoking was harmful to one’s health.)