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Market Morphing

Commissioner Bart Chilton of the Commodity Futures Trading Commission Discusses the Need for Algorithm Oversight
Commissioner Bart Chilton, CFTCAs we all know, the world’s financial markets have changed dramatically in the last decade. Traders screaming at each other in trading pits have largely been replaced by computers screaming at each other as they look for micro-dollars in nanoseconds. Computer technology in trading is great for many reasons. It adds liquidity, it adds access and it adds an electronic data trail. As with most things, though, there are potentially dangerous ramifications of technology.
One such ramification gave us a wake-up call last May 6th. The financial markets came unwound the afternoon of the Flash Crash. You have heard the horror stories. The Dow lost nearly 1,000 points, and then recovered more than two thirds of it by the close of trading.
Mini-flash crashes occur frequently, too. They do not cause as much of a disruption as that of May 6, but more than once last year in the futures markets and stocks, runaway robotic programs disrupted markets and cost people money. One company lost a million dollars in the oil market in less than a second. Sometimes whole markets are affected and innocent people are hurt.
For regulators to keep up, we have to be nimble and quick because even if we get a better handle on how this breakneck speed trading, the methods, the machines and the markets will continue to change. Given our experience with the Flash Crash and mini-flash crashes, it is appropriate to consider if there should be limits on high frequency trading. For example, on position limits, let’s say that we allow ten percent of open interest in a market. Should high frequency traders be allowed to trade ten percent, ten times in ten seconds? What about five HFTs, each trading ten percent of the open interest in concert, and it moves a market?
Don’t get me wrong, HFT trading is here to stay but should it remain the same? Is this type of trading outside of the fundamental purposes of capital formation and risk management? Many commercial firms trying to hedge their risks complain about the inability to get into the markets due to the sheer number and speed of HFTs.
Another way to address some of these potential circumstances is to impose legal responsibility on high frequency and algo robot trading that roils markets. Should those who instigate runaway algos be held accountable when they hurt other market participants or injure consumers?
I believe there should be some standard definition of what high frequency trading is and maybe even a kind of “Good Housekeeping Seal of Approval.” As the markets and machines evolve, the definition may have to change, too. I would like to ensure that exchanges vet HFT programs before they go live to determine if they have the ability to roil markets. After it goes online, it needs to be monitored too.
The Commodity Futures Trading Commission began in 1975 to monitor human-to-human trades. In this relatively new world of computer-to-computer trades, we need the computer capability and the people power to keep up.
(The author, Commissioner Bart Chilton of the U.S. Commodity Futures Trading Commission, has worked in Washington D.C. for 25 years in the House of Representatives and the Senate, and as part of the Bush, Clinton and Obama Administrations).

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