The Commodity Futures Trading Commission determined not to stand in the way of a rule amendment by ICE Futures U.S. to impose speed bumps on certain orders entered in two futures contracts traded on the exchange. Two commissioners raised concerns that the rule amendment might be anticompetitive. Separately, the futures industry’s Joint Audit Committee reiterated prior guidance that a futures commission merchant may not guarantee customers against losses, or pay out funds from any individual account of a customer, where the payout would leave the aggregate of accounts of the customer at the FCM undermargined. Moreover, JAC strongly suggested FCMs take certain immediate actions to comply with its guidance with the implicit suggestion “or else.” As a result, the following matters are covered in this week’s edition of Bridging the Week:
Because of the US Memorial Day holiday on May 27, the next regularly scheduled edition of Bridging the Week will be June 10, 2019.
The rule amendment was self-certified by IFUS with a representation that its so-called “passive order protection” or “POP” functionality would initially be applied solely in the exchange’s Gold Daily and Silver Daily futures contracts and involve speed bumps of three milliseconds. However, the language of the actual rule amendment does not reference any specific futures contracts or speed bump time periods.
Notwithstanding, in recommending non-objection of IFUS’s amended rule by the CFTC, the Commission’s Division of Market Oversight indicated that its views were limited to IFUS’s implementation of POP functionality only for gold and silver contracts and using a three-millisecond speed bump. According to DMO, “staff does not view the certification of the ICE Rule as establishing a precedent with respect to the legal and policy merits of speed bump functionalities generally.” DMO expects potential application of POP functionality to any other IFUS-listed futures contracts to be preceded by separate self-certifications.
Under POP, a trader entering an order (e.g., an offer) and letting it rest in IFUS’s central limit order book could cancel the order if another order was entered into the marketplace that otherwise would match against the resting order (e.g., a bid). The trader with the resting order would have up to the time of the speed bump to assess the new order (e.g., a last look) and pull the resting order prior to execution against the new order. If the resting order was pulled, the new order would remain in the marketplace. Pursuant to the amended relevant rule, the POP functionality could be activated at any time in IFUS’s sole discretion. (Click here to access IFUS February 1, 2019 self-certification of amendments to its Rule 4.56)
According to IFUS, the purpose of its new POP functionality is “to encourage additional market participants, who may not otherwise trade certain Exchange markets due to a latency disadvantage, to participate in trading such products.” The exchange claimed that attracting more market participants would increase liquidity “particularly in those markets where price discovery takes place in a related market rather than, or in addition to, the Exchange futures contracts and latency arbitrage is common.” IFUS indicated that its speed bumps were solely intended for futures contracts with de minimis liquidity.
When it was proposed, many commentators objected to IFUS’s amended rule. In one comment letter, for example, FIA PTG argued that IFUS’s proposed speed bumps effectively gave liquidity providers an unfair opportunity to review pending orders and cancel or widen their quotes in response. FIA PTG expressed concern that “[a]llowing market participants that post resting quotes … to pull their quotes allow certain participants to display quotes that they do not intend to execute whil[e] also fostering a misleading impression of liquidity in the product.” (Click here to access the FIA PTG letter; click here to access all commentators’ responses.)
Two CFTC commissioners also expressed reservations regarding IFUS’s amended rule – Brian Quintenz and Dan Berkovitz. Mr. Quintenz questioned how penalizing those who have innovated by introducing higher speeds into marketplaces promotes the objective of CFTC Core Principle 9 for designated contract markets. This provision requires a board of trade seeking DCM status to provide “a competitive, open and efficient market and mechanism for executing transactions.” (Click here to access the full text of Core Principle 9.) Mr. Berkovitz likewise questioned how speed bumps – which he claimed were a “material anticompetitive burden” for at least some market participants – helped promote “responsible innovation and fair competition” among market participants which he claimed was an obligation of the CFTC to consider in evaluating new DCM rules.
Contrariwise, Commissioner Dawn Stump spoke in support of IFUS’s self-certification of its amended rule, saying that under the Commission’s self-certification regime, IFUS, in the first instance, must determine that its proposal complies with applicable law. Because no “reliable data or empirical analysis” supports a contrary conclusion, she believed it was appropriate for the CFTC not to object to IFUS’s self-certification.
In recommending non-objection of IFUS’s amended rule, DMO acknowledged that speed bump functionalities might impact marketplaces both negatively and positively. As a result, it indicated that staff would monitor the impact of the use of POP functionality on liquidity, price discovery, competition and the potential for manipulation and disruptive trading. IFUS has not announced when it will implement its POP functionality.
In June 2016, the Securities and Exchange Commission approved the Investors’ Exchange LLC as a national securities exchange. In announcing its approval, the SEC noted that an automated quotation system like IEX would satisfy the SEC’s requirement that it provide an immediate response to an immediate or cancel order if it implements “an intentional access delay that is de minimis.” At the time, IEX contemplated a one-millisecond speed bump.(Click here for further details in the article “IEX Approved as a National Securities Exchange” in the June 19, 2016 edition of Bridging the Week.)
Memory Lane: Shortly after its designation as a DCM in May 2009 to trade US Treasury Futures contracts, ELX Futures filed a request with the CFTC for approval of a rule authorizing participants on the exchange to transact exchange of futures for futures transactions. Although the proposed rule was drafted in generic terms, the purpose was to enable ELX market participants to establish US Treasury Futures positions on ELX while simultaneously liquidating functionally equivalent futures positions on the Chicago Board of Trade, or similarly, to establish positions on CBOT while concurrently liquidating functionally equivalent positions on ELX. (The US Treasury Futures contracts on both ELX and CBOT were materially the same, except those at ELX cleared through the Options Clearing Corporation while those at CBOT cleared through the CME Clearinghouse.)
Although the CFTC did not agree with CBOT’s claim that ELX’s EFF transactions constituted impermissible wash trades (because each exchange’s contract cleared through a different clearinghouse), it did uphold the legitimacy of CBOT’s prohibition against use of EFF’s, claiming that it was not “an unreasonable restraint of trade or a material anticompetitive burden on trading.” ELX became a dormant DCM as of July 1, 2017, with its last trade occurring in June 2016. (Click here for details on ELX’s EFF rule in the June 16, 2011 letter from the CFTC to the CME Group, Inc.)
Arts and Science: Two weeks ago, in expressing her skepticism regarding the Securities and Exchange Commission’s recently issued framework regarding when cryptoassets may constitute investment contracts (and thus securities), Hester Peirce, an SEC commissioner, lamented that the SEC’s “Jackson Pollock approach to splashing lots of factors on the canvas without any clear message leaves something to be desired.” (Click here for background in the article, "SEC Crypto Guidance Employing Jackson Pollock Techniques Too Cryptic Says Commissioner Hester Peirce" in the May 12, 2019 edition of Bridging the Week.) In response, last week, when I was in Chicago at an event at the Art Institute, I made it a point to view Mr. Pollock's painting The Key that is on exhibit there. This painting reflects a more deliberate painting style than some of Mr. Pollock's more spontaneously inspired creations, but viewing it nevertheless made me reflect more on Ms. Peirce's warning.
Last week, Brian Quintenz, a CFTC commissioner, invoked the introduction to Kurt Vonnegut, Jr.'s satirical science fiction fantasy, Harrison Bergeron, in criticizing IFUS's amended new rule that would permit speed bumps for the first time for US-traded futures contracts. He feared that the exchange's passive order protection functionality would negate speed innovation by certain traders and thus, going forward, might discourage innovation in futures markets generally. He paralleled this to Mr. Vonnegut's vision of a dystopian make-believe America of 2081, where in the interest of equality, those with natural advantages of any kind (e.g., intelligence, beauty, physical strength) are artificially handicapped with techniques and physical impediments (e.g., techniques to scramble thoughts, mandatory masks, mandatory weights) to neutralize their superiority. Mr. Quintenz's allusion to Harrison Bergeron was witty and helped emphasize his concerns. It left me thinking for sure and searching to find my copy of Welcome to the Monkey House where the Harrison Bergeron short story is found.
In school we likely all began an essay at one point or another, "in literature as in life..." I guess as adults, we now recognize we should have written, "In life as in literature and art..."
Specifically, JAC indicated that an FCM would not comply with the CFTC’s prohibition of guaranteeing a customer against loss if it included a limited or nonrecourse clause in a customer or non-customer agreement. JAC indicated that an FCM must have the “absolute right” at all times “to look to funds in all accounts of [a] beneficial owner, including accounts that are under different control, as well as the right to call [a] beneficial owner for funds.” This requirement, said JAC, would preclude an FCM from restricting its ability to look for funds in different accounts of a beneficial owner that might be under different discretionary control or from agreeing not to call a beneficial owner for more funds in an account than the owner may have allocated to a manager for that account.
Additionally, JAC noted that all accounts of a single beneficial owner for the same account classification must be viewed together when considering margin funds available for distribution to any individual account. JAC indicated that an FCM may determine to call individual accounts of a beneficial owner managed by different account controllers separately. However, when paying out individual accounts, FCMs must ensure that such payments would not cause a beneficial owner for all its accounts of the same account classification to be undermargined.
JAC is a committee of CFTC-authorized US derivatives exchanges and the National Futures Association.
It’s important that FCMs take steps to follow JAC’s guidance timely.
In other legal and regulatory developments regarding cryptoassets:
For further information:
Another Day, Another Bitcoin ETF Review Delayed:
CFTC DSIO Head Suggests Revision of Permitted Investments for FCMs and Clarification of Exemption for Floor Traders From Swap Dealer Definition Under Consideration:
CFTC Staff Declines to Halt Rollout of ICE Futures U.S. Speed Bumps; Two Commissioners Raise Concerns:
European Commission Slaps Five Banks With Almost 1.2 Billion Euros Fine for Purported FX Spot Trading Cartel:
First Person Convicted and Sentenced for Spoofing Under Dodd-Frank Law Loses Bid for Retrial:
Futures Industry Self-Regulators Warn FCMs Against Limiting Losses of Customers and Not Combining Accounts for Aggregate Margin Call Calculations:
NY Court Upholds Restriction on Stablecoin Transferring Tethered Funds to Affiliated International Exchange but Limits Time Period of Prohibition:
The information in this article is for informational purposes only and is derived from sources believed to be reliable as of May 18, 2019. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP may represent one or more entities mentioned in this article. Quotations attributable to speeches are from published remarks and may not reflect statements actually made. Views of the author may not necessarily reflect views of Katten Muchin or any of its partners or employees.