CME, HFT, Capitalism, Low Volume, and New Rule 575

“The U.S. equity market is sitting at all-time highs and nobody is in it.” – Terry Duffy

Photo Credit Chicago Tribune…


CME CEO Terry Duffy was featured in a Chicago Tribune article over the weekend, titled CME’s Duffy Talks Shop. He talks straight about a few issues, such as HFT, colocation, and Flash Boys:


–          HFT is 35% of CME volume.

–          Flash Boys does highlight problems in equity markets – TRUE. Just don’t call it rigged.

–          There is nothing wrong with colocation- this is capitalism. There are different prices and speeds, depending on what one wants to pay, just like anything else in life.


The article is a good eleven question Q&A with Duffy, and it does highlight some of the pressure he and the CME are under currently. The CME has seen a trading slump along with other exchanges and asset classes. According to the article the CME has raised transaction fees this year to help mitigate the effects of lower volume.

However, the article doesn’t go into what else the CME has done in this low volume environment – beef up incentive programs. While the CME does not employ a maker-taker pricing model in futures, it does use incentive programs to add liquidity. The incentive programs are geared towards a great variety of participants such as central banks, new proprietary traders, and existing market makers. Especially recently, there has been a slew of new programs – like this one. The programs encourage quoting and trading in high volumes and speeds. But the high frequency trading that does it not as benign as you might think.

Ove the past few years we have received many “tips”, and requests to peek under the hood in the futures markets. We haven’t written much about activities there; it is not the primary market our business operates in. Our clients do operate there, however, as well as in equity markets, and you might be surprised by the similarity of many issues in both asset classes:

–          We have glitches in equity markets, so does the CME.

–          We have “spoofing”, so does the CME.

–          We have quote stuffing, so does the CME.

–          We have manipulation where bids and offers are entered with no intention of execution, specifically designed to trick other humans or algos, so does the CME.

This may not surprise you, but what does surprise us is the candor with which the CME describes such bad behavior; we are not accustomed to that straight talk coming from stock exchanges. The CME tells you, and even describes the activities in detail in its new Rule 575 filing with the CFTC. The rule filing is here for you to read, and the rule lays out Prohibited Disruptive Practices.

Frankly, the rule reads much more plainly than similar rules in the equities markets, and it is refreshing to see it so. More importantly – the rule specifically talks about activities that have gone on at the CME presumably over a long period of time. We find that fascinating; the CME lays it all out for you; from Rule 575:

Examples of Prohibited Activity – The following is a non-exhaustive list of various examples of conduct that may be found to violate Rule 575:

Single asset class manipulation: The market participant places orders  to induce or trick other market participants.

  Cross Asset Manipulation: A market participant enters one or more orders in a particular market (Market A) to identify algorithmic activity in a related market (Market B). Knowing how the algorithm will react to order activity in Market A, the participant first enters an order or orders in Market B that he anticipates would be filled opposite the algorithm when ignited. The participant then enters an order or orders in Market A for the purpose of igniting the algorithm and creating momentum in Market B.

 Price manipulation at the open: During the pre-opening period on CME Globex, a market participant enters a large order priced through the IOP (a bid higher than the existing best bid or an offer lower than the existing best offer) and continues to systematically enter successive orders priced further through the IOP until he causes a movement in the IOP, which prompts him to cancel all of his orders.

 More tricking around closing and opening prices: A market participant places large quantity orders at the beginning of the pre-opening period in an effort to artificially increase or decrease the IOP with the intent to attract other market participants. Once others join the market participant’s bid or offer, the market participant cancels his orders shortly before the no-cancel period.

 Arbitrage on demand: A market participant enters a large number of orders and/or cancellations/updates for the purpose of overloading the quotation systems of other market participants with excessive market data messages to create “information arbitrage.”

 Quote Stuffing: A market participant enters order(s) or other messages for the purpose of creating latencies in the market or in information dissemination by the Exchanges for the purpose of disrupting the orderly functioning of the market.

 Using Self Match Prevention mechanisms to aid in price manipulation: A market participant enters a large aggressor buy (sell) order at the best offer (bid) price, trading opposite the resting sell (buy) orders in the book, which results in the remainder of the original aggressor order resting first in the queue at the new best bid (offer). As the market participant anticipated and intended, other participants join his best bid (offer) behind him in the queue. The market participant then enters a large aggressor sell (buy) order into his now resting buy (sell) order at the top of the book. The market participant’s use of CME Group’s Self-Match Prevention functionality or other wash blocking functionality cancels the market participant’s resting buy (sell) order, such that market participant’s aggressor sell (buy) order then trades opposite the orders that joined and were behind the market participant’s best bid (offer) in the book.

 We are quite pleased that the CME has looked into, found, and acknowledged unfairness and issues in their market silo. I mean they have to have found evidence of it, lest they wouldn’t make a rule prohibiting these very specific activities. After all, the police do not make anti-speeding laws unless they find that people speed, and the government doesn’t write anti-money-laundering laws unless the find evidence of money-laundering. Right?

Wouldn’t it be great if our stock exchanges did the same thing that the CME just did? When was the last time you saw a stock exchange acknowledge participants using exchange self-match prevention mechanisms (that the exchanges created for these HFTs) to manipulate? Instead we see stock exchanges provide simple sensible ways that price-sliding order types may be used, instead of the real juice – the queue-jumping ways in which they actually are used in real life.

We suppose kudos are in order to the CME; it is nice to see bad behavior laid out in simple language, even if one has to dig through rule filings to see the text.