[Federal Register Volume 80, Number 242 (Thursday, December 17, 2015)]
[Proposed Rules]
[Pages 78824-78948]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-30533]



[[Page 78823]]

Vol. 80

Thursday,

No. 242

December 17, 2015

Part II





Commodity Futures Trading Commission





-----------------------------------------------------------------------





17 CFR Parts 1, 38, 40, et al.





Regulation Automated Trading; Proposed Rule

  Federal Register / Vol. 80 , No. 242 / Thursday, December 17, 2015 / 
Proposed Rules  

[[Page 78824]]


-----------------------------------------------------------------------

COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1, 38, 40, and 170

RIN 3038-AD52


Regulation Automated Trading

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of proposed rulemaking.

-----------------------------------------------------------------------

SUMMARY: The Commodity Futures Trading Commission (``CFTC'' or 
``Commission'') is proposing a series of risk controls, transparency 
measures, and other safeguards to enhance the regulatory regime for 
automated trading on U.S. designated contract markets (``DCMs'') 
(collectively, ``Regulation AT''). The Commission's proposals build on 
efforts by numerous entities in recent years to promote best practices 
and regulatory standards for automated trading, including standards and 
best practices for algorithmic trading systems (``ATSs''), electronic 
trade matching engines, and new connectivity methods that characterize 
modern financial markets. In 2012 the Commission adopted rules 
requiring futures commission merchants (``FCMs''), swap dealers 
(``SDs''), and major swap participants (``MSPs'') to use automated 
means to screen orders for compliance with certain risk-based limits. 
It also adopted rules requiring certain financial risk control 
requirements for DCMs offering direct market access to their customers. 
In 2013 the Commission published an extensive Concept Release on Risk 
Controls and System Safeguards for Automated Trading Environments 
(``Concept Release''), compiling in one document a comprehensive 
discussion of industry practices, Commission regulations, and evolving 
concerns in automated trading.\1\ Now, through this notice of proposed 
rulemaking (``NPRM'') for Regulation AT, the Commission seeks to update 
Commission rules in response to the evolution from pit trading to 
electronic trading. In particular, the Commission is proposing to adopt 
a comprehensive approach to reducing risk and increasing transparency 
in automated trading. Proposed Regulation AT is designed to consolidate 
previous work by industry participants, the Commission, and fellow 
regulators into a unified body of law addressing automation in order 
placement and execution in U.S. derivatives markets. The Commission 
welcomes all public comments.
---------------------------------------------------------------------------

    \1\ Concept Release on Risk Controls and System Safeguards for 
Automated Trading Environments, 78 FR 56542 (Sept. 12, 2013).

---------------------------------------------------------------------------
DATES: Comments must be received on or before March 16, 2016.

ADDRESSES: You may submit comments, identified by RIN 3038-AD52, by any 
of the following methods:
     CFTC Web site: http://comments.cftc.gov. Follow the 
instructions for submitting comments through the Comments Online 
process on the Web site.
     Mail: Send to Christopher Kirkpatrick, Secretary of the 
Commission, Commodity Futures Trading Commission, Three Lafayette 
Centre, 1155 21st Street, NW., Washington, DC 20581.
     Hand Delivery/Courier: Same as Mail, above.
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
    Please submit comments by only one method. All comments should be 
submitted in English or accompanied by an English translation. Comments 
will be posted as received to http://www.cftc.gov. You should submit 
only information that you wish to make available publicly. If you wish 
the Commission to consider information that may be exempt from 
disclosure under the Freedom of Information Act (``FOIA''), a petition 
for confidential treatment of the exempt information may be submitted 
according to the procedures established in 17 CFR 145.9. The Commission 
reserves the right, but shall have no obligation, to review, prescreen, 
filter, redact, refuse, or remove any or all of your submission from 
http://www.cftc.gov that it may deem to be inappropriate for 
publication, such as obscene language. All submissions that have been 
so treated that contain comments on the merits of the rulemaking will 
be retained in the public comment file and will be considered as 
required under the Administrative Procedure Act and other applicable 
laws, and may be accessible under FOIA.

FOR FURTHER INFORMATION CONTACT: Sebastian Pujol Schott, Associate 
Director, Division of Market Oversight, [email protected] or 202-418-5641; 
Marilee Dahlman, Special Counsel, Division of Market Oversight, 
[email protected] or 202-418-5264; Mark Schlegel, Special Counsel, 
Division of Market Oversight, [email protected] or 202-418-5055; 
Michael Penick, Economist, Office of the Chief Economist, 
[email protected] or 202-418-5279; Richard Haynes, Economist, Office of 
the Chief Economist, [email protected] or 202-418-5063; Andrew Ridenour, 
Senior Trial Attorney, Division of Enforcement, [email protected] or 
202-418-5438; or John Dunfee, Assistant General Counsel, Office of 
General Counsel, [email protected] or 202-418-5396.

SUPPLEMENTARY INFORMATION: 

Table of Contents

I. Introduction
    A. Overview--Development of Automated Trading Environment
    B. Risks and Potential Benefits Associated With Automated 
Trading
    C. The Proposed Regulations
    1. Overview of NPRM
    2. The Proposed Regulations Under Parts 1, 38, 40, and 170
II. Background on Regulatory Responses to Automated Trading
    A. The Commission's Regulatory Response to Date
    B. The Commission's 2013 Concept Release
    C. Other Recent Regulatory Responses
    1. SEC Regulatory Initiatives
    2. FINRA Initiatives
    3. European and Other Regulatory Initiatives
    D. Industry and Regulatory Best Practices and Recommendations
    1. NFA Compliance Rule 2-9: Supervision
    2. FIA Reports on Automated Trading
    3. IOSCO Reports on Electronic Trading
    4. CFTC TAC Subcommittee
    5. FIX Risk Management Working Group
    6. Senior Supervisors Group (SSG) Briefing Note
    7. Treasury Market Practices Group Best Practices
III. Recent Disruptive Events in Automated Trading Environments
IV. Overview of Regulation AT
    A. Concept Release/Regulation AT Terminology
    B. Commenter Preference for Principles-Based Regulations
    C. Multi-Layered Approach to Pre-Trade Risk Controls and Other 
Measures
    D. Codification of Defined Terms Used Throughout Regulation AT
    1. ``Algorithmic Trading''--Sec.  1.3(zzzz)
    2. ``Algorithmic Trading Compliance Issue''--Sec.  1.3(tttt)
    3. ``Algorithmic Trading Disruption''--Sec.  1.3(uuuu)
    4. ``Algorithmic Trading Event''--Sec.  1.3(vvvv)
    5. ``AT Order Message''--Sec.  1.3(wwww)
    6. ``AT Person''--Sec.  1.3(xxxx)
    7. ``Direct Electronic Access''--Sec.  1.3(yyyy)
    E. Registration of Certain Persons Not Otherwise Registered With 
Commission--Sec.  1.3(x)
    1. Concept Release Comments
    2. Description of Regulation
    3. Policy Discussion
    4. Request for Comments
    F. RFA Standards for Automated Trading and Algorithmic Trading 
Systems--Sec.  170.19
    1. Policy Discussion
    2. Description of Regulation
    3. Request for Comments
    G. AT Persons Must Become Members of an RFA--Sec.  170.18

[[Page 78825]]

    1. Policy Discussion
    2. Description of Regulation
    3. Request for Comments
    H. Pre-Trade and Other Risk Controls for AT Persons--Sec.  1.80
    1. Concept Release Comments on Pre-Trade and Other Risk Controls
    2. Description of Regulation
    3. Policy Discussion
    4. Request for Comments
    I. Standards for Development, Testing, Monitoring, and 
Compliance of Algorithmic Trading Systems--Sec.  1.81
    1. Concept Release Comments
    2. Description of Regulation
    3. Policy Discussion
    4. Request for Comments
    J. Risk Management by Clearing Member FCMs--Sec.  1.82
    1. Concept Release Comments
    2. Description of Regulation
    3. Policy Discussion
    4. Discussion of Persons Subject to Proposed Sec. Sec.  1.80 and 
1.82
    5. Request for Comments
    K. Compliance Reports Submitted by AT Persons and Clearing FCMs 
to DCMs; Related Recordkeeping Requirements--Sec.  1.83
    1. Concept Release Comments
    2. Description of Regulation
    3. Policy Discussion
    4. Request for Comments
    L. Risk Controls for Trading: Direct Electronic Access Provided 
by DCMs--Sec.  38.255(b) and (c)
    1. Concept Release Comments
    2. Description of Regulation
    3. Policy Discussion
    4. Request for Comments
    M. Disclosure and Transparency in DCM Trade Matching Systems--
Sec.  38.401(a)
    1. Concept Release Comments
    2. Description of Regulation
    3. Policy Discussion
    4. Request for Comments
    N. Pre-Trade and Other Risk Controls at DCMs--Sec.  40.20
    1. Concept Release Comments
    2. Description of Regulation
    3. Policy Discussion
    4. Request for Comments
    O. DCM Test Environments for AT Persons--Sec.  40.21
    1. Concept Release Comments
    2. Description of Regulation
    3. Request for Comments
    P. DCM Review of Compliance Reports by AT Persons and Clearing 
FCMs; DCM Rules Requiring Certain Books and Records; and DCM Review 
of Such Books and Records as Necessary--Sec.  40.22
    1. Concept Release Comments
    2. Description of Regulation
    3. Policy Discussion
    4. Request for Comments
    Q. Self-Trade Prevention Tools--Sec.  40.23
    1. Concept Release Comments
    2. Commission Analysis of Amount of Self-Trading in the 
Marketplace
    3. Description of Regulation
    4. Policy Discussion
    5. Request for Comments
    R. DCM Market Maker and Trading Incentive Programs--Sec. Sec.  
40.25-40.28
    1. Policy Discussion
    2. Description of Regulations
    3. Request for Comments
V. Related Matters
    A. Calculation of Number of Persons Subject to Regulations
    1. Request for Comments
    B. Calculation of Hourly Wage Rates Used in Related Matters
    C. Regulatory Flexibility Act
    1. FCMs and DCMs
    2. AT Persons
    3. Request for Comments
    D. Paperwork Reduction Act
    1. Information Provided by Reporting Entities/Persons
    a. Sec.  1.3(x)(3)--Submissions by newly registered floor 
traders
    b. Sec.  1.83(a)--Compliance reports submitted by AT Persons to 
DCMs
    c. Sec.  1.83(b)--Compliance reports submitted by clearing 
member FCMs to DCMs
    d. Sec.  1.83(c)--AT Person retention and production of books 
and records
    e. Sec.  1.83(d)--Clearing member FCM retention and production 
of books and records
    f. Sec.  38.401(a) and (c)--Public dissemination of information 
by DCMs pertaining to electronic matching platforms
    g. Sec.  40.23--Information publicly disseminated by DCMs 
regarding self-trade prevention
    h. Sec.  40.25--Information in public rule filings provided by 
DCMs regarding Market Maker and Trading Incentive Programs
    i. Sec.  40.26--Information provided by DCMs to the Division of 
Market Oversight upon request regarding Market Maker and Trading 
Incentive Programs
    2. Information Collection Comments
    E. Cost Benefit Considerations
    1. The Statutory Requirement for the Commission to Consider the 
Costs and Benefits of its Actions
    2. Concept Release Comments Regarding Costs and Benefits
    3. The Commission's Cost-Benefit Consideration of Regulation 
AT--Baseline Point
    4. The Commission's Cost-Benefit Consideration of Regulation 
AT--Cross-Border Effects
    5. General Request for Comment
    6. The Commission's Cost-Benefit Consideration of Regulation 
AT--Proposed Definitions
    7. Pre-Trade Risk Controls, Testing and Supervision of Automated 
Systems, Requirement to Submit Compliance Reports, and Other Related 
Algorithmic Trading Requirements
    8. Requirements for Certain Entities to Register as Floor 
Traders
    9. Transparency in Exchange Trade Matching Systems
    10. Self-Trade Prevention
    11. Market-Maker and Trading Incentive Programs
VI. Aggregate Estimated Cost of Regulation AT
VII. List of All Questions in the NPRM

I. Introduction

A. Overview--Development of Automated Trading Environment

    U.S. derivatives markets have historically relied on manual 
processes for the origination of orders, transmission of information, 
and execution of trades. Trading decisions were typically initiated by 
natural persons, and transmitted through intermediaries via 
comparatively simple communications networks. Execution occurred in 
open-outcry trading pits operated by DCMs. Access to these pits was 
limited to brokers and traders granted trading privileges by the 
exchange. A range of other processing and risk management services were 
equally reliant on manual processes, and the complete trading system 
could move only as fast as its human decision-makers. Trading 
information was often recorded on paper order tickets and trading 
cards, and time-stamps were recorded only to the nearest minute. The 
physical element of trading was reflected in exchange or Commission 
rules governing diverse matters such as the types of trading permitted 
from the top step of a futures pit,\2\ as well as requirements that 
certain orders for execution in a trading pit be recorded in ``non-
erasable ink.'' This basic structure remained constant for decades, and 
produced a parallel regulatory framework also premised on natural 
persons and human decision-making speeds.
---------------------------------------------------------------------------

    \2\ For example, press reports surrounding the initiation of 
CME's ``top step'' rule in the S&P 500 stock-index pit in 1987 
indicated that brokers preferred the top step to ``get a panoramic 
view of the trading activity and quickly grab customer order sheets 
being relayed by nearby clerks.'' They described a trading pit where 
``[s]ome 400 traders are jammed shoulder-to-shoulder in the 
amphitheater-like pit, which accounts for three-fourths of the 
nation's stock-index futures trading.'' See Jouzaitis, Carol, ``Merc 
Launches `Top-step' Reform,'' Chicago Tribune (June 22, 1987) 
available at http://articles.chicagotribune.com/1987-06-22/business/8702160155_1_dual-trading-stock-index-futures-market-chicago-mercantile-exchange.
---------------------------------------------------------------------------

    Today, derivatives markets have transitioned from the manual 
processes described above to highly automated trading and trade 
matching systems. Modern DCMs and DCM market participants, in 
particular, are characterized by a wide array of algorithmic and 
electronic systems for the generation, transmission, management, and 
execution of orders, as well as systems used to confirm transactions, 
communicate market data, and link markets and market participants 
through high-speed networks. Collectively, such DCM and market 
participant trading systems constitute the ``automated trading

[[Page 78826]]

environment'' at the center of Regulation AT. Automated trading 
environments often make use of automated systems for either the 
generation or the execution of orders (in many cases, both). Such 
automated systems are based on sets of rules or instructions (commonly 
referred to as algorithms) and related computer systems used to 
automate the execution of a trading strategy.\3\ In futures markets, 
orders generated by automated trading systems are ultimately 
transmitted to DCMs that accept, manage and match orders by automated 
means.
---------------------------------------------------------------------------

    \3\ See IOSCO Report on Regulatory Issues Raised by 
Technological Changes, infra note 103 at 10.
---------------------------------------------------------------------------

    While technologies have evolved, the underlying functions of 
derivatives markets remain the same, as do the Commission's 
responsibilities under the Commodity Exchange Act (the ``CEA'' or 
``Act''). Such markets, typically operated by DCMs, provide valuable 
risk mitigation and price discovery services for numerous financial and 
physical commodities businesses, including producers and consumers of 
energy, foodstuff, metals, and other raw materials, as well as natural 
person investors. The Commission is committed to the safety and 
integrity of U.S. markets as they continue their rapid technological 
change. Through proposed Regulation AT, the Commission is taking its 
next steps in ensuring that its regulatory standards and industry 
practices properly address current and foreseeable risks arising from 
automated trading, and promote responsible innovation and fair 
competition among markets and market participants.\4\
---------------------------------------------------------------------------

    \4\ See CEA Section 3, ``Findings and Purposes,'' noting in 
Section 3(a) that transactions subject to the CEA are ``affected 
with a national public interest'' and in Section 3(b) that ``[t]o 
foster these public interests, it is further the purpose of this Act 
to deter . . . any other disruptions to market integrity; to ensure 
the financial integrity of all transactions subject to the Act and 
the avoidance of systemic risk; . . . and to promote responsible 
innovation and fair competition among boards of trade . . . and 
market participants.''
---------------------------------------------------------------------------

    Within U.S. derivatives markets, DCMs represent a significant 
catalyst in the transition to automated trading. From its beginnings 
with CME Globex in 1992, DCM on-exchange trading now occurs almost 
exclusively on electronic matching platforms, using internal algorithms 
to rapidly match incoming orders from an array of market 
participants.\5\ Data available to Commission staff indicates that in 
an approximately two-year period through October 2014, over 95 percent 
of all on-exchange futures trading occurred on DCMs' electronic trade 
matching platforms.\6\ In this regard, the Commission notes that CME 
Group, the largest U.S. exchange operator, announced in February 2015 
its intention to close all but one of its open-outcry trading floors 
for futures.\7\ IntercontinentalExchange, the second largest DCM 
operator, ended all futures open-outcry trading in March 2008, and 
ended all options open-outcry trading in October 2012. On-exchange 
trading on DCMs other than the CME Group exchanges and 
IntercontinentalExchange now occurs exclusively on electronic matching 
platforms. Concurrent with their transition to electronic trade 
matching platforms, DCMs have taken steps to increase the speed of 
trading in their markets. These include offering co-location and 
proximity hosting services to reduce latencies between the DCM and 
market participants, as well as measures taken by DCMs to reduce 
processing times within their electronic trade matching platform. The 
two largest DCMs, for example, have for several years indicated in 
their public materials average or median order entry round trip times 
of less than one millisecond.\8\
---------------------------------------------------------------------------

    \5\ Trading on CME Globex was initially limited to ``after-
hours'' periods when the Exchange's open-outcry pits were closed. 
The first products offered on Globex in 1992 included German mark 
and Japanese yen futures and options on futures contracts, followed 
by other FX and currency products. In 1997, CME launched the E-mini 
S&P 500 futures contract, the first CME product available 
exclusively on Globex, including during regular (open-outcry) 
trading hours in other CME products. Globex monthly volume exceeded 
100,000 contracts for the first time in 1997. In 1999, CME for the 
first time began offering ``side-by-side'' trading, allowing its 
Eurodollar contract to be traded both on Globex and in open-outcry 
during regular trading hours. Side-by-side trading was expanded in 
the ensuing years, including for example to FX products in 2001. 
Globex average daily volume exceeded 1,000,000 contracts for the 
first time in 2002. By 2004, Globex trading volume began exceeding 
open-outcry volume for the first time. Through agreements or 
mergers, CME began listing NYMEX products (2006) and CBOT products 
(2007) on Globex as well. See Aldinger, Lori, and Labuszewski, John 
W., ``ELECTRONIC TRADING Twenty Years of CME Globex'' (2012), 
available at http://www.cmegroup.com/education/files/globex-retrospective-2012-06-12.pdf.
    \6\ Haynes, Richard & Roberts, John S., ``Automated Trading in 
Futures Markets,'' CFTC Office of Chief Economist (Mar. 13, 2015), 
available at http://www.cftc.gov/ucm/groups/public/@economicanalysis/documents/file/oce_automatedtrading.pdf.
    \7\ See CME Press Release, ``CME Group to Close Most Open Outcry 
Futures Trading in Chicago and New York by July; Most Options 
Markets to Remain Open,'' (Feb. 4, 2014) available at http://cmegroup.mediaroom.com/2015-02-04-CME-Group-to-Close-Most-Open-Outcry-Futures-Trading-in-Chicago-and-New-York-by-July-Most-Options-Markets-to-Remain-Open?pagetemplate=article.
    \8\ See CME Group, ``The World's Leading Electronic Platform: 
CME Globex,'' (2014) at 3, available at http://www.cmegroup.com/globex/files/globexbrochure.pdf; IntercontinentalExchange, 2010 
Annual Report, (2011) at 26, available at http://ir.theice.com/~/
media/Files/I/Ice-IR/annual-reports/2010/ice-2010ar.pdf.
---------------------------------------------------------------------------

    The largely complete transition of DCMs to electronic trade 
matching platforms has occurred alongside an equally important shift in 
the technologies used by market participants to place and manage 
orders. Market participants have applied a range of sophisticated 
technological tools to their trading. For example, market participants 
are increasingly using ATSs, often coupled with high-speed 
communication networks. Market participants are also increasingly 
relying on electronic market and other data feeds to inform trading 
decisions, and on multiple computer algorithms to generate, manage, or 
route orders to DCMs. Market participants may also make use of direct 
electronic access and/or co-location services to minimize latencies 
between an ATS, market data systems, and a DCM's electronic trading 
matching platform.
    Data available to the Commission highlights the importance of ATS 
trading on DCMs today. The Commission's analysis of data covering the 
same approximately two-year period addressed above (through October 
2014) indicates that ATSs were present on at least one side in almost 
80 percent of foreign exchange futures volume, 67 percent of interest 
rate futures volume, and 62 percent of equity futures volume analyzed. 
They were also present on at least one side in approximately 47 percent 
of metals and energy product volumes. Even in agricultural products, a 
category not typically associated with automation in recent years, ATSs 
were present in at least 38 percent of futures volume analyzed. 
Finally, in the aggregate, ATSs were present in over 60 percent of all 
futures volume traded across all products in the nearly two-year period 
that the Commission examined. In highly liquid product categories, ATSs 
represented both sides of the transaction over 50 percent of the 
time.\9\
---------------------------------------------------------------------------

    \9\ See Haynes & Roberts, supra note 6 at 4.
---------------------------------------------------------------------------

    Market participants using ATSs may transact on DCMs through 
registered intermediaries, including their clearing members. Such 
intermediaries themselves often rely on extensive automation, using 
ATSs for functions ranging from simple order routing to the generation 
of independent trading decisions. These registered intermediaries 
include FCMs, commodity pool operators (``CPOs''), commodity trading 
advisors (``CTAs''), introducing brokers (``IBs''), and floor brokers 
(``FBs''). In addition, Commission-registered SDs and MSPs

[[Page 78827]]

may use ATSs to conduct trading on DCMs. As discussed in more detail 
below, each of these categories of Commission registrants may be 
subject to Regulation AT in the event that they conduct algorithmic 
trading on a DCM.

B. Risks and Potential Benefits Associated With Automated Trading

    Regulation AT proposes a series of pre-trade risk controls and 
other measures intended to address the risks related to automated 
trading on DCMs. The proposed rules primarily address operational risk 
issues, as well as related issues such as self-trading and market maker 
and trading incentive programs.
    The potential risks of automated trading were recently described in 
a report discussing the events of October 15, 2014, when the market for 
U.S. Treasury securities, futures, and other closely related financial 
markets experienced an unusually high level of volatility and a very 
rapid round-trip in prices. On July 13, 2015, five regulatory agencies 
issued a joint staff report on the unusual market events of October 15, 
2014 (the ``October 15 Joint Staff Report'').\10\ In addition to 
discussing the events of October 15, the report includes an Appendix C 
that summarizes many of the risks of automated trading. These risks 
include the following: Operational risks (ranging from malfunctioning 
and incorrectly deployed algorithms to algorithms reacting to 
inaccurate or unexpected data); market liquidity risks (arising from 
abrupt changes in trading strategies even when a firm executes its 
strategy perfectly); market integrity risks (automated trading can 
provide new tools to engage in unlawful conduct); transmission risks 
(shocks based on erroneous orders impacting multiple markets); clearing 
and settlement risks (as more firms gain access to trading platforms, 
trades may not be subject to sufficient settlement risk mitigation 
techniques); and risks to effective risk management (the speed of trade 
execution may make critical risk mitigation devices less effective).
---------------------------------------------------------------------------

    \10\ See Joint Staff Report: The U.S. Treasury Market on October 
15, 2014 (July 13, 2015) [hereinafter ``October 15 Joint Staff 
Report''], prepared by the U.S. Department of Treasury, Board of 
Governors of the Federal Reserve System, Federal Reserve Bank of New 
York, U.S. Securities and Exchange Commission, and U.S. Commodity 
Futures Trading Commission, available at http://cftc.wss/OCE/conceptrelease/documentlibrary/Regulation%20AT/Reg%20AT%20--%20DRAFT%20PREAMBLE/October%2015%20report/treasury-market-volatility-10-14-2014-joint-report.pdf. The report discusses the 
preliminary findings regarding the conditions that may have 
contributed to the October 15 volatility, particularly in the 
``event window'' that began at 9:33 a.m. ET. Among other potential 
causes of this volatility, the October 15 Joint Staff Report states 
that several large transactions occurred between the release of 
certain U.S. retail sales data and the start of the event window; 
that there was a significant reduction in market depth following the 
retail sales data release, which appears to have resulted from a 
high volume of transactions and bank-dealers and principal trading 
firms changing their participation in the cash and futures order 
books; that latency associated with a significant increase in 
message traffic due to order cancellations increased just before the 
event window; and there was a higher incidence of ``self-trading'' 
during the event window. Id. at 4-6.
---------------------------------------------------------------------------

    Notwithstanding the risks described above, several commentators 
have argued that algorithmic trading results in a more efficient 
marketplace. A recent study of the equities market concluded that 
algorithmic trading narrows spreads, reduces adverse selection, and 
reduces trade-related price discovery.\11\ The study also suggested 
that algorithmic trading improves liquidity and enhances the 
information provided in quotes. Another recent study of low latency 
activity in the equities market (typically associated with high 
frequency trading) concluded that ``an increase in low-latency activity 
reduces quoted spreads and the total price impact of trades, increases 
depth in the limit order book, and lowers short-term volatility.'' \12\
---------------------------------------------------------------------------

    \11\ See, e.g., Hendershott, Jones and Menkveld, ``Does 
Algorithmic Trading Improve Liquidity?,'' The Journal of Finance, 
Vol. LXVI, No. 1 (Feb. 2011), available at http://faculty.haas.berkeley.edu/hender/algo.pdf.
    \12\ See Hasbrouck and Saar, ``Low-latency trading,'' Journal of 
Financial Markets 16 (2013) at 646-679, available at http://people.stern.nyu.edu/jhasbrou/Research/LowLatencyTradingJFM.pdf.
---------------------------------------------------------------------------

C. The Proposed Regulations

1. Overview of NPRM
    The Commission is pursuing a number of goals in proposed Regulation 
AT. As an overarching goal, the Commission seeks to update Commission 
rules in response to the evolution from pit trading to electronic 
trading. The risk controls and other rules proposed in this NPRM are 
focused on algorithmic order origination or routing by market 
participants, and electronic order execution by DCMs. In addition to 
mitigating risks arising from algorithmic trading activity, the 
proposed rules are intended to increase transparency around DCM 
electronic trade matching platforms and the use of self-trade 
prevention tools on DCMs.\13\ Furthermore, the proposed rules are 
intended to foster transparency with respect to DCM programs and 
activities, including market maker and trading incentive programs, that 
have become more prominent as automated trading becomes the dominant 
market model.
---------------------------------------------------------------------------

    \13\ See section IV(Q) below for a discussion of the term 
``self-trade'' and proposed regulations with respect to self-trade 
prevention.
---------------------------------------------------------------------------

    The Commission notes that Regulation AT generally does not address 
trading activity on swap execution facilities (``SEFs''). The 
Commission believes that neither execution nor order entry on SEF 
markets are sufficiently automated at this time to require the degree 
of automated safeguards proposed herein.\14\ In addition, Regulation AT 
is not proposing a number of measures discussed in the Concept Release, 
such as the following: Proposals to implement various post-trade 
reports (post-order drop copies, post-trade drop copies, and post-
clearing drop copies), ``reasonability checks'' on incoming market data 
used by firms operating automated systems, policies and procedures for 
identifying ``related'' contracts, and proposals to standardize and 
simplify order types, each of which was discussed in the Concept 
Release.\15\
---------------------------------------------------------------------------

    \14\ The requirements on DCMs arising out of Regulation AT may 
ultimately be imposed on SEFs. However, an important consideration 
for the Commission is that SEFs and SEF markets are much newer and 
less liquid than the more established and liquid DCMs and DCM 
markets. While SEFs and SEF markets are still in this nascent stage, 
the Commission does not want to impose additional requirements that 
may have the effect of decreasing the number of SEFs or decreasing 
liquidity. For these reasons, and in light of the lesser degree of 
automation in SEF markets, the policy considerations underlying 
Regulation AT are not as critical, at least at this time, in the SEF 
context.
    \15\ See Concept Release, 78 FR at 56569-73 for a summary of 
measures discussed in the Concept Release.
---------------------------------------------------------------------------

    Market participants using automated trading include an important 
population of proprietary traders that, while responsible for 
significant trading volumes and liquidity in key futures products, are 
not registered with the Commission. These unregistered proprietary 
traders include a number of traders engaged in high-frequency trading 
(``HFT''). The Commission notes, however, that the risk control 
requirements under proposed Regulation AT do not vary in response to a 
market participant's algorithmic trading strategies; the same risk 
controls would be required in connection with high-frequency and low-
frequency algorithmic trading. In particular, HFT is not specifically 
identified under the proposed regulations, and is not regulated in a 
different fashion from other types of algorithmic trading under 
proposed Regulation AT. Instead, the proposed regulations focus on 
automation of order origination, transmission and execution, and the 
risks that may arise from such activity. As discussed above, nearly 
universal electronic order matching at DCMs is

[[Page 78828]]

increasingly complemented by algorithmic order origination among market 
participants. Against this backdrop, the Commission believes that 
appropriate pre-trade and other risk controls are necessary at the 
level of market participants, clearing FCMs, and DCMs, in order to 
ensure the integrity of Commission-regulated markets and provide market 
participants with greater confidence that intentional, bona fide 
transactions are being executed.
    Principal elements of Regulation AT for market participants and 
clearing FCMs include: (i) Codification of defined terms used 
throughout Regulation AT; (ii) registration of certain entities not 
otherwise registered with the Commission; (iii) new algorithmic trading 
procedures for trading firms and clearing firms, including pre-trade 
and other risk controls; (iv) testing, monitoring, and supervision 
requirements for ATSs; and (v) requirements that certain persons submit 
compliance reports to DCMs regarding their ATSs. Principal elements for 
DCMs include: (i) New risk controls for Direct Electronic Access 
(``DEA'') provided by DCMs; (ii) transparency in DCM electronic trade 
matching platforms; and (iii) new risk control procedures, including 
pre-trade risk controls, compliance report review standards, self-trade 
prevention tool requirements, and market-maker and trading incentive 
program disclosure and related requirements.
    As mentioned above, Regulation AT is not intended to discriminate 
across registration categories, connectivity methods, or even ``high-
frequency'' or slower trading strategies. Rather, Regulation AT is 
focused on reducing risk, increasing transparency and disclosure, and 
related DCM procedures.\16\ In developing Regulation AT, the Commission 
built on the Concept Release and relevant comments received, which are 
discussed further in section II(B) below. However, interested parties 
will observe that the Commission has chosen not to pursue certain 
measures discussed in the Concept Release (as discussed above), while 
also proposing a small number of new measures not addressed in the 
Concept Release. In addition, Regulation AT in certain cases seeks only 
to clarify the scope of existing Commission regulations that may be 
impacted by the growth of automated trading environments.
---------------------------------------------------------------------------

    \16\ See, e.g., the compliance reports required to be submitted 
by AT Persons and clearing member firms of AT Persons under Sec.  
1.83, the statistics required to be reported by DCMs regarding self-
trading that they have both authorized and prevented on their 
platforms under Sec.  40.23, and the disclosure required of DCMs 
with respect to market maker and trading incentive programs under 
Sec.  40.25.
---------------------------------------------------------------------------

    In preparing this NPRM, the Commission has reviewed relevant 
industry practices, measures taken by other U.S. and foreign 
regulators, and best practices or guidance set forth by other informed 
parties. In these sources and comments received in response to the 
Concept Release, the Commission has identified an emerging consensus 
around pre-trade risk controls for automated trading and supervision 
standards for ATSs. The Commission also notes comments received in 
response to the Concept Release that are supportive of risk controls 
placed in multiple stages across the life-cycle of order generation, 
transmission, management and execution (i.e., similar risk controls 
placed at the levels of market participants, clearing member FCMs, and 
DCMs). Proposed Regulation AT attempts to balance flexibility in a 
rapidly changing technological landscape with the need for a regulatory 
baseline that provides a robust and sufficiently clear standard for 
pre-trade risk controls, supervision standards, and other safeguards 
for automated trading environments. The specific regulations and 
amendments proposed by Regulation AT are discussed in greater detail 
below.
2. The Proposed Regulations Under Parts 1, 38, 40, and 170
    Regulation AT proposes new regulations or amendments to existing 
regulations in parts 1, 38, 40, and 170 of the Commission's 
regulations. It proposes to amend part 1 by inserting the following 
defined terms: Sec.  1.3(tttt)--Algorithmic Trading Compliance Issue; 
Sec.  1.3(uuuu)--Algorithmic Trading Disruption; Sec.  1.3(vvvv)--
Algorithmic Trading Event; Sec.  1.3(wwww)--AT Order Message; Sec.  
1.3(xxxx)--AT Person; Sec.  1.3(yyyy)--Direct Electronic Access; and 
Sec.  1.3(zzzz)--Algorithmic Trading. Regulation AT also proposes to 
amend existing Sec.  1.3(x), which defines Floor Trader.
    In addition, Regulation AT would create a new subpart A in part 1 
that includes the following new regulations applicable to AT Persons 
and their clearing FCMs: Sec.  1.80--requiring AT Persons to implement 
pre-trade risk controls and other related measures; Sec.  1.81--
requiring AT Persons to implement standards for the development, 
testing, monitoring, and compliance of their ATSs; Sec.  1.82--
requiring clearing member FCMs to implement pre-trade risk controls and 
other related measures for orders from their AT Person customers; and 
Sec.  1.83--requiring AT Persons and their clearing member FCMs to 
provide to DCMs annual compliance reports, and to keep and provide upon 
request to DCMs certain related books and records.
    Regulation AT also proposes to amend part 38 of the Commission's 
regulations. Specifically, it would amend existing Sec.  38.255--Risk 
controls for trading, to require DCMs to have in place systems 
reasonably designed to facilitate the FCM's management of the risks 
that may arise from their customers' Algorithmic Trading using Direct 
Electronic Access. Regulation AT would also make corresponding changes 
to the discussion of risk controls in Appendix B--Guidance on, and 
Acceptable Practices in, Compliance with Core Principles (Subsection 
(b)(5)--Acceptable Practices for Risk controls for trading). Finally in 
part 38, Regulation AT would amend existing Sec.  38.401(a) to require 
DCMs to provide additional public disclosure regarding their electronic 
matching platforms.
    Regulation AT would also amend part 40 of the Commission's 
regulations. It would create the following new regulations: Sec.  
40.20--requiring DCMs to implement pre-trade risk controls and other 
related measures; Sec.  40.21--requiring DCMs to provide a test 
environment to AT Persons; Sec.  40.22--requiring DCMs to implement a 
review program for compliance reports regarding Algorithmic Trading 
submitted by AT Persons and clearing member FCMs, require that certain 
books and records be maintained by such persons, and review such books 
and records as necessary; Sec.  40.23--requiring DCMs to implement 
self-trade prevention tools, mandate their use, and publish statistics 
concerning self-trading; and Sec. Sec.  40.25-40.28--requiring DCMs to 
provide disclosure and implement other controls regarding their market 
maker and trading incentive programs. Finally, Regulation AT would make 
changes to the definition of Rule in Sec.  40.1(i) in response to 
certain of the changes proposed above.
    Finally, Regulation AT proposes to amend part 170 of the 
Commission's regulations. It would require in new Sec.  170.18 that all 
AT Persons become members of at least one registered futures 
association (``RFA''). Regulation AT would create a new subpart D in 
part 170, and require in proposed Sec.  170.19 that RFAs adopt 
membership rules, as deemed appropriate by the RFA, requiring pre-trade 
risk controls and other measures for ATSs; standards for the 
development, testing, monitoring, and compliance of ATSs; designation 
and training of algorithmic

[[Page 78829]]

trading staff; and clearing FCM risk management standards.

II. Background on Regulatory Responses to Automated Trading

A. The Commission's Regulatory Response to Date

    The Commission has responded to the development of automated 
trading environments through a number of regulatory measures that 
address risk controls within both new and existing categories of 
registrants, including DCMs, SEFs, FCMs, SDs, MSPs and others.\17\ 
While focused to a degree on financial and related risks, these 
provisions reflect the Commission's ongoing commitment to maintaining 
the safety and soundness of automated trading in modern derivatives 
markets. The Commission has adopted regulations with respect to DCMs 
and SEFs that require exchanges to establish risk control mechanisms to 
prevent market disruptions, including mechanisms that pause or halt 
trading.\18\ The guidance and acceptable practices to the SEF and DCM 
rules in part 37 and 38, respectively, provide examples of acceptable 
risk controls.\19\ In addition, in the DCM final rules, the Commission 
adopted new risk control requirements for exchanges that provide DEA to 
clients. Regulation 38.607 requires DCMs that permit DEA to have 
effective systems and controls reasonably designed to facilitate an 
FCM's management of financial risk.\20\
---------------------------------------------------------------------------

    \17\ These measures are discussed in more detail in the Concept 
Release. See Concept Release, 78 FR at 56548.
    \18\ See Core Principles and Other Requirements for Designated 
Contract Markets, 77 FR 36612, 36703 (June 19, 2012) [hereinafter 
``DCM Final Rules'']; Core Principles and Other Requirements for 
Swap Execution Facilities, 78 FR 33476, 33590 (June 4, 2013) 
[hereinafter ``SEF Final Rules''].
    \19\ See DCM Final Rules, 77 FR at 36718; SEF Final Rules, 78 FR 
at 33601.
    \20\ See 17 CFR 38.607.
---------------------------------------------------------------------------

    The Commission also adopted relevant regulations for FCMs, SDs, and 
MSPs. Such firms that are clearing members must establish risk-based 
limits based on position size, order size, margin requirements, or 
similar factors for all proprietary accounts and customer accounts.\21\ 
The regulations, codified in Sec. Sec.  1.73 and 23.609, also require 
these entities to ``use automated means to screen orders for compliance 
with the [risk] limits'' when such orders are subject to automated 
execution.\22\ In addition, Sec.  1.11 requires FCMs to have 
``automated financial risk management controls reasonably designed to 
prevent the placing of erroneous orders'' and ``policies and procedures 
governing the use, supervision, maintenance, testing, and inspection'' 
of automated trading programs.\23\ The Commission also adopted 
regulations requiring SDs and MSPs that are clearing members to ensure 
that their ``use of trading programs is subject to policies and 
procedures governing the use, supervision, maintenance, testing, and 
inspection of the program.'' \24\
---------------------------------------------------------------------------

    \21\ 17 CFR 1.73(a)(1) and 23.609(a)(1).
    \22\ 17 CFR 1.73(a)(2)(i) and 23.609(a)(2)(i).
    \23\ 17 CFR 1.11(e)(3)(ii). The Commission notes that the 
requirements of Sec.  1.11(e)(3)(ii) fall within an FCM's broader 
obligation in Sec.  1.11 to establish and maintain a formal ``Risk 
Management Program.'' Such program must include a risk management 
unit independent of the business unit; quarterly risk exposure 
reports to senior management and the governing body of the FCM, with 
copies to the Commission; and other substantive requirements. 
Proposed Regulation AT would not require FCMs to subsume applicable 
requirements into their Sec.  1.11 Risk Management Programs. 
However, the Commission is seeking public comment in the questions 
below regarding whether, in any final rules arising from this NPRM, 
FCMs should in fact be required to incorporate elements of 
Regulation AT proposed in Sec. Sec.  1.80, 1.81, 1.83(a), and 
1.83(c) into their Sec.  1.11 Risk Management Programs. Such 
incorporation could help improve the interaction between an FCM's 
operational risk efforts pursuant to Sec.  1.11(e)(3)(ii) and its 
pre-trade risk controls and development, monitoring, and compliance 
efforts pursuant to Sec. Sec.  1.80, 1.81, 1.83(a), and 1.83(c). It 
could also help ensure that an FCM's Sec. Sec.  1.80, 1.81, 1.83(a), 
and 1.83(c) processes benefit from the same internal rigor and 
independence required by Sec.  1.11.
    \24\ 17 CFR 23.600(d)(9).
---------------------------------------------------------------------------

    Finally, the Commission adopted final rules implementing new 
authority under the CEA to, among other things, broadly prohibit 
manipulative and deceptive devices and price manipulation.\25\ The 
Commission also provided guidance on the scope and application of CEA 
Section 4c(a)(5), which makes it unlawful for any person to engage in 
any trading, practice, or conduct on or subject to the rules of a 
registered entity that violates bids or offers, demonstrates 
intentional or reckless disregard for the orderly execution of 
transactions during the closing period, or is, is of the character of, 
or is commonly known to the trade as, ``spoofing.'' \26\
---------------------------------------------------------------------------

    \25\ See 17 CFR 180.1 and 180.2.
    \26\ See Antidisruptive Practices Authority, 78 FR 31890 (May 
28, 2013).
---------------------------------------------------------------------------

B. The Commission's 2013 Concept Release

    Overview of Concept Release. As noted above, in 2013 the Commission 
issued a ``Concept Release on Risk Controls and System Safeguards for 
Automated Trading Environments,'' which provided an overview of the 
automated trading environment and discussed a series of pre-trade risk 
controls, post-trade reports and other measures, system safeguards, and 
additional protections that could be implemented by Commission 
registrants or other market participants. The Concept Release reflects 
the Commission's ongoing commitment to the safety and soundness of U.S. 
derivatives markets in times of technological change, including the 
growth of automated trading.
    The Concept Release was published in the Federal Register on 
September 12, 2013.\27\ The initial 90-day comment period closed on 
December 11, 2013, but was reopened from January 21 through February 
14, 2014, in conjunction with a meeting of the CFTC's Technology 
Advisory Committee (``TAC''). The Concept Release requested public 
comment on 124 separate questions regarding the necessity and operation 
of potential pre-trade risk controls, post-trade reports and other 
measures, system safeguards and additional protections (such as 
proposals to identify ``related'' contracts on trading platforms, and 
proposals to standardize and simplify order types). The Concept Release 
served as a vehicle to catalogue existing industry practices, determine 
their efficacy and implementation to date, and evaluate the need for 
additional measures. The Concept Release was not a proposed rule, but 
rather a prior step designed to facilitate a public dialogue and 
educate the Commission so that it may make an informed determination as 
to whether rulemaking is necessary and, if so, the substantive 
requirements of such a rulemaking.
---------------------------------------------------------------------------

    \27\ Concept Release, 78 FR 56542.
---------------------------------------------------------------------------

    Topics Discussed in Concept Release. The Concept Release 
highlighted data on the increased importance of electronic and 
algorithmic trading across a number of U.S. markets (including 
equities, futures and fixed income markets). The Concept Release also 
noted that the infrastructure of automated trading environments has 
progressively decreased the time necessary to process orders and 
execute trades, reducing the communication times between market 
participants and trading venues.\28\ One exchange group now indicates 
that its ``median inbound latency for order entry'' on its trading 
platform is fifty-two (52) microseconds within its ``four walls.'' \29\ 
As discussed in the Concept Release, advances in trading speeds are 
partly due to the development of dedicated fiber-optic and microwave 
communications networks that have dramatically reduced transmission 
times across large

[[Page 78830]]

distances.\30\ On a smaller scale, co-location and proximity hosting 
are two common methods for reducing the distance, and thus latency, 
between market participants and the exchanges. Co-location services are 
now provided by most large electronic trading platforms within the 
United States.
---------------------------------------------------------------------------

    \28\ See id. at 56546-47.
    \29\ See CME Group, ``The World's Leading Electronic Platform. 
CME Globex,'' (2014) at 3, available at http://www.cmegroup.com/globex/files/globexbrochure.pdf.
    \30\ See Concept Release, 78 FR at 56546.
---------------------------------------------------------------------------

    Another important latency-reducing advance in connectivity 
discussed in the Concept Release is Direct Market Access (``DMA''). For 
purposes of the Concept Release, the Commission defined DMA as a 
connection method that enables a market participant to transmit orders 
to a trading platform without reentry or prior review by systems 
belonging to the market participant's clearing firm.\31\ DMA can be 
provided directly by an exchange or through the infrastructure of a 
third-party provider, but in all cases, DMA implies that an order is 
not routed through a clearing firm prior to reaching the trading 
platform.\32\ For purposes of Regulation AT, as discussed in section 
IV(D)(7) below, the Commission proposes to define a slightly modified 
term: ``Direct Electronic Access'' (``DEA''), as opposed to Direct 
Market Access. Despite the slightly modified name, the Commission 
intends that the term ``Direct Electronic Access'' has a meaning 
similar to ``Direct Market Access,'' as such term was used in the 
Concept Release.\33\
---------------------------------------------------------------------------

    \31\ See id.
    \32\ See id.
    \33\ The Commission notes that the term ``direct electronic 
access'' is also used in existing Commission regulation 38.607. 
Regulation AT does not modify Sec.  38.607, and the term ``direct 
electronic access'' in Sec.  38.607 will continue to have the 
meaning specified in that section.
---------------------------------------------------------------------------

    The Concept Release discussed a set of risk controls that would be 
intended to operate at the same rapid speed at which trading occurs in 
the automated trading environment. As the industry reduces latency 
through improvements in technologies for the generation, transmission 
and execution of orders or management of other data, there is concern 
that the drive for ever lower latencies may lead to a competitive race 
toward progressively less stringent risk controls.\34\ A separate, but 
related, concern is that market participants may simply engage in 
trading at speeds beyond the abilities of their risk management 
systems, or those tasked with monitoring their activity. Risk 
management systems operating at these misaligned speeds could allow an 
active algorithm to breach its prescribed risk controls and disrupt one 
or more markets.
---------------------------------------------------------------------------

    \34\ As noted by the Futures Industry Association's Market 
Access Working Group, for example: ``[p]re-trade risk controls have 
become a point of negotiation between trading firms and clearing 
members because they can add latency to a trade.'' See FIA Market 
Access Risk Management Recommendations, infra note 97 at 8. 
Similarly, the TAC's Pre-Trade Functionality Subcommittee noted that 
latency is a key area where trading firms and brokers are competing 
to gain an advantage. See TAC Pre-Trade Functionality Subcommittee, 
``Recommendations on Pre-Trade Practices for Trading Firms, Clearing 
Firms, and Exchanges Involved in Direct Market Access'' (Mar. 1, 
2011) at 2 [hereinafter ``CFTC TAC Recommendations''], available at 
http://www.cftc.gov/ucm/groups/public/@swaps/documents/dfsubmission/tacpresentation030111_ptfs2.pdf.
---------------------------------------------------------------------------

    In light of the potential for disruptive trading events related to 
such high-speed algorithmic trading, the Concept Release addressed 23 
potential risk controls and other measures broadly grouped into four 
categories. The first includes ``pre-trade risk controls,'' such as 
controls designed to prevent potential errors or disruptions from 
reaching trading platforms, or to minimize their impact once they have. 
A second category of safeguards includes ``post-trade reports'' and 
``other post-trade measures.'' Examples in this category include 
reports that promote the flow of order, trade and position information; 
uniform trade adjustment or cancellation policies; and standardized 
error trade reporting obligations. The third category of risk controls 
discussed in the Concept Release is termed ``system safeguards,'' 
including safeguards for the design, testing and supervision of ATSs, 
as well as measures such as ``kill switches'' that facilitate emergency 
intervention in the case of malfunctioning ATSs.\35\ Finally, the 
Concept Release presented a fourth category of measures focusing on 
various options for improving market functioning or structure.
---------------------------------------------------------------------------

    \35\ As explained in section IV(A) below, the Concept Release 
used the term ``ATS'' or ``automated trading system'' to refer to 
the algorithms used to automate the generation and execution of a 
trading strategy. For purposes of this NPRM, the Commission has 
determined to use the term ``Algorithmic Trading'' or ``algorithmic 
trading system'' (abbreviated as ATS), as opposed to the term 
``automated trading system.'' For purposes of discussing comments to 
the Concept Release, the Commission may use the terms ATS and 
automated trading system as such terms were used in the Concept 
Release.
---------------------------------------------------------------------------

    Comments Received on Concept Release and Commission Response. The 
Commission received a total of 43 public comments on the Concept 
Release, including comments from DCMs, an array of trading firms, trade 
associations, public interest groups, members of academia, and 
consulting, technology and information service providers in the 
financial industry. All comments are available on www.cftc.gov. Many of 
the comments received are detailed and thorough, and the Futures 
Industry Association (``FIA'') conducted surveys to gauge existing 
risk-management practices. Other commenters provided academic papers in 
support of their points of view.
    Staff reviewed all comments received and made recommendations to 
the Commission. This NPRM reflects the Commission's decision to propose 
regulations in certain areas addressed by the Concept Release, 
including: Registration of certain entities not otherwise registered 
with the Commission; enhanced identification of orders placed on 
exchanges; pre-trade risk controls at exchanges, trading firms and 
clearing firms; standards for development, testing and supervision of 
algorithmic systems; trading firm and clearing member FCM compliance 
reports regarding algorithmic trading; and self-trade prevention tools. 
Regulation AT also addresses several areas not covered in the Concept 
Release, including transparency in exchange trade matching systems and 
market-maker protections, and in certain cases seeks to clarify the 
scope of existing Commission regulations that may be impacted by the 
growth of automated trading environments.

C. Other Recent Regulatory Responses

1. SEC Regulatory Initiatives
    The SEC has recently taken regulatory steps related to automated 
trading, aimed at preventing instability in the equities markets. Most 
significantly, the SEC adopted the Market Access Rule and Regulation 
SCI.
    The Securities Exchange Act Rule 15c3-5--Risk Management Controls 
for Brokers or Dealers with Market Access (the ``Market Access Rule''), 
adopted in November 2010, requires brokers and dealers to have risk 
controls in place before providing their customers with access to the 
market.\36\ Specifically, the Market Access Rule requires risk controls 
that prevent entry of (i) orders exceeding appropriate pre-set credit 
or capital thresholds in the aggregate for each customer and the 
broker-dealer; and (ii) erroneous orders, by rejecting orders that 
exceed appropriate price or size parameters, on an order-by-order basis 
or over a short period of time, or those that indicate duplicative 
orders.\37\

[[Page 78831]]

These risk controls must be under the direct and exclusive control of 
the broker-dealer (subject to certain exceptions) and regularly 
reviewed for effectiveness.\38\ In October 2013, the SEC brought its 
first enforcement action under the Market Access Rule, securing a $12 
million settlement with Knight Capital in connection with the firm's 
August 2012 trading incident that disrupted the markets.\39\
---------------------------------------------------------------------------

    \36\ See Market Access Rule, 75 FR 69792 (Nov. 15, 2010); see 
also SEC Press Release No. 2010-210, ``SEC Adopts New Rule 
Preventing Unfiltered Market Access'' (Nov. 3, 2010), available at 
http://www.sec.gov/news/press/2010/2010-210.htm.
    \37\ See Market Access Rule, supra note 36 at 69825-26; see also 
SEC, Responses to Frequently Asked Questions Concerning Risk 
Management Controls for Brokers or Dealers with Market Access (Apr. 
15, 2014), available at https://www.sec.gov/divisions/marketreg/faq-15c-5-risk-management-controls-bd.htm.
    \38\ See Market Access Rule, supra note 36 at 69826.
    \39\ See SEC Press Release No. 2013-222, ``SEC Charges Knight 
Capital With Violations of Market Access Rule'' (Oct. 16, 2013), 
available at http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370539879795 [hereinafter ``SEC Knight Capital 
Release''].
---------------------------------------------------------------------------

    On November 19, 2014, the SEC adopted Regulation Systems Compliance 
and Integrity (``Reg SCI'').\40\ Reg SCI applies to alternative trading 
systems, certain self-regulatory organizations (including registered 
clearing agencies), plan processors, and exempt clearing agencies 
(collectively, ``SCI entities''). Under Reg SCI, SCI entities are 
required to have comprehensive policies and procedures in place for 
their technological systems. The SCI entities must, among other things, 
take appropriate corrective action when systems issues occur; provide 
notifications and reports to the SEC regarding systems problems and 
systems changes; inform members and participants about systems issues; 
conduct business continuity testing; implement standards that result in 
SCI systems being designed, developed, tested, maintained, operated, 
and surveilled in a manner that facilitates the successful collection, 
processing, and dissemination of market data; and conduct annual 
reviews of their automated systems, which must be summarized in a 
report that is provided to the SEC.\41\
---------------------------------------------------------------------------

    \40\ See Reg SCI, 79 FR 72252 (Dec. 5, 2014); see also SEC Press 
Release No. 2014-260, ``SEC Adopts Rules to Improve Systems 
Compliance and Integrity'' (Nov. 19, 2014), available at http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370543496356#.VKQS2qxOlaQ.
    \41\ See Reg SCI, supra note 40 at 72437-39.
---------------------------------------------------------------------------

    The SEC has also taken action in the area of enhancing oversight of 
proprietary trading firms. In March 2015, the SEC proposed a rule that 
would narrow an exemption that currently exempts certain broker-dealers 
from membership in a national securities association.\42\ The exemption 
was originally designed to accommodate exchange specialists and other 
floor members that might need to conduct limited hedging or other off-
exchange activities ancillary to their business.\43\ Over time, 
proprietary trading firms were able to take advantage of this 
exemption.\44\ The SEC's proposed rules would amend the exemption to 
target those broker-dealers for which it was originally designed, and 
require broker-dealers trading in off-exchange venues to become members 
of a national securities association. In the securities markets, this 
association is the Financial Industry Regulatory Authority 
(``FINRA'').\45\
---------------------------------------------------------------------------

    \42\ See SEC, Press Release No. 2015-48, ``SEC Proposes Rule to 
Require Broker-Dealers Active in Off-Exchange Market to Become 
Members of National Securities Association'' (Mar. 25, 2015) 
[hereinafter ``SEC Press Release on Broker-Dealer Registration''], 
available at http://www.sec.gov/news/pressrelease/2015-48.html#.VSbd9KwpBaQ; Exemption for Certain Exchange Members, 80 FR 
18036, 18042-43 (Apr. 2, 2015) [hereinafter ``SEC Proposed Rule on 
Exemption for Certain Exchange Members''].
    \43\ See SEC Press Release on Broker-Dealer Registration, supra 
note 42.
    \44\ See id. The SEC estimates that there are approximately 125 
firms exempt from association membership, which includes some of the 
most active cross-market proprietary trading firms. See SEC Proposed 
Rule on Exemption for Certain Exchange Members, 80 FR at 18042.
    \45\ See SEC Press Release on Broker-Dealer Registration, supra 
note 42.
---------------------------------------------------------------------------

    The SEC's Chair explained that the proposed rule ``embodies a 
simple but powerful principle of the federal securities laws--the 
protection of investors and the stability of our markets require that 
trading is overseen by both the Commission and a strong self-regulatory 
organization.'' \46\ In its preamble to the proposed rule, the SEC 
explained that, in the event that a broker-dealer trades electronically 
across a range of exchange and off-exchange venues, an individual 
exchange of which the broker-dealer is a member may be unable to 
effectively regulate the off-exchange activity of the broker-dealer, 
because the exchange may lack the resources or expertise to oversee 
such off-exchange activity.\47\ The SEC viewed FINRA, the self-
regulatory organization (``SRO'') to which off-exchange trades are 
reported, as being in the best position to regulate cross-market 
activity by broker-dealers.\48\
---------------------------------------------------------------------------

    \46\ See id.
    \47\ SEC Proposed Rule on Exemption for Certain Exchange 
Members, 80 FR at 18042-43.
    \48\ See id. at 18041-45.
---------------------------------------------------------------------------

    The SEC has taken additional regulatory initiatives in this area. 
On July 11, 2012, the SEC adopted Rule 613 under Regulation NMS, 
requiring SROs to submit a plan to the SEC to create, implement, and 
maintain a consolidated audit trail (``CAT''). This audit trail is 
intended to increase the data available to regulators investigating 
illegal activities such as insider trading and market manipulation, and 
improve the ability to reconstruct broad-based market events in an 
accurate and timely manner.\49\ The SROs submitted the plan on 
September 30, 2014.\50\ In addition, in response to policy 
recommendations resulting from the Flash Crash events of May 6, 2010, 
the SEC and the securities industry implemented market-wide circuit 
breakers as well as a ``limit up-limit down'' mechanism in order to 
moderate price volatility in individual securities.\51\ The SEC is also 
working to update its regulatory regime to improve firms' risk 
management of trading algorithms and to enhance regulatory oversight 
over their use.\52\ The SEC is also developing an anti-disruptive 
trading rule to address the use of aggressive, potentially 
destabilizing trading strategies during vulnerable market periods.\53\
---------------------------------------------------------------------------

    \49\ See SEC Press Release No. 2012-134, ``SEC Approves New Rule 
Requiring Consolidated Audit Trail to Monitor and Analyze Trading 
Activity'' (July 11, 2012), available at http://www.sec.gov/News/PressRelease/Detail/PressRelease/1365171483188#.VKQkAqxOlaQ.
    \50\ See SEC, ``Rule 613 (Consolidated Audit Trail),'' available 
at http://www.sec.gov/divisions/marketreg/rule613-info.htm.
    \51\ See Mary Jo White, Chairman, Securities and Exchange 
Commission, Enhancing Our Equity Market Structure (June 5, 2014), 
available at http://www.sec.gov/News/Speech/Detail/Speech/1370542004312#.VKP_o6xOlaS.
    \52\ See id.
    \53\ See id.
---------------------------------------------------------------------------

    Finally, while not directly relevant to Commission-regulated 
markets, the SEC is working with equities exchanges and FINRA to 
minimize latency between different market feeds. Specifically, 
exchanges must not transmit data directly to customers any sooner than 
they transmit data to a securities information processor (``SIP''), the 
system that consolidates market feeds from all platforms and publishes 
the public price ticker. In addition, the technology used for 
transmitting data to the SIP must be on a par with what is used for 
transmitting data to direct feeds.\54\ Finally, the SEC is working to 
address concerns associated with the fragmentation of trading venues, 
dark trading venues, and broker conflicts.\55\
---------------------------------------------------------------------------

    \54\ See id.
    \55\ See id.
---------------------------------------------------------------------------

2. FINRA Initiatives
    In addition to the SEC, FINRA is developing rules focused on 
automated trading and transparency in the equities markets. In March 
2015, FINRA published a Request for Comment proposing to require 
registration (as a ``Limited Representative--Equity Trader'') persons 
that are (1) primarily responsible for the design, development

[[Page 78832]]

or significant modification of an algorithmic strategy; or (2) 
responsible for supervising such functions.\56\ FINRA explained that 
given today's highly automated environment (according to FINRA, where 
firms trade using automated systems that initiate pre-programmed 
trading instructions based on specified variables, referred to as 
algorithmic trading strategies), it is concerned that persons involved 
in preparing or supervising algorithmic trading may lack adequate 
knowledge of securities rules and regulations, which could result in 
algorithms that do not comply with applicable rules.\57\ Accordingly, 
FINRA believes such persons should meet the same minimum competency 
standards for knowledge of securities regulations that apply to 
individual traders.\58\
---------------------------------------------------------------------------

    \56\ See FINRA, Regulatory Notice 15-06, ``Registration of 
Associated Persons Who Develop Algorithmic Trading Strategies'' 
(Mar. 2015), available at http://www.finra.org/sites/default/files/notice_doc_file_ref/Notice_Regulatory_15-06.pdf.
    \57\ See id. at 3.
    \58\ See id.
---------------------------------------------------------------------------

    In March 2015, FINRA published a regulatory notice (15-09) 
providing guidance on supervision and control practices for algorithmic 
trading strategies in the equities markets.\59\ The notice offered 
guidance on practices in five general areas: General risk assessment 
and response; software/code development and implementation; software 
testing and system validation; trading systems; and compliance. Among 
other practices, the notice recommended that firms should consider: 
Implementing a development and change management process that tracks 
the development of new trading code or material changes to existing 
code; implementing a basic summary description of algorithmic trading 
strategies that enables supervisory and compliance staff to understand 
the intended function of an algorithm; conducting testing to confirm 
that core code components operate as intended and do not produce 
unintended consequences; implementing controls, monitors, alerts and 
reconciliation processes that enable the firm to quickly identify 
whether an algorithmic is experiencing unexpected results; and 
providing for adequate communication between supervisory and compliance 
staff related to the function and control of algorithms such that the 
firm meets its regulatory obligations.\60\
---------------------------------------------------------------------------

    \59\ See FINRA, Regulatory Notice 15-09, ``Equity Trading 
Initiatives: Supervision and Control Practices for Algorithmic 
Trading Strategies'' (Mar. 2015) [hereinafter ``FINRA Notice 15-
09''], available at https://www.finra.org/industry/notices/15-09.
    \60\ See id.
---------------------------------------------------------------------------

3. European and Other Regulatory Initiatives
a. ESMA
    The European Securities and Markets Authority (``ESMA'') is an 
independent EU Authority established in January 2011. ESMA published 
guidelines on automated trading in February 2012, which became 
effective across the European Union on May 1, 2012.\61\ The ESMA 
guidelines addressed the operation of an electronic trading system by a 
regulated market or a multilateral trading facility; the use of an 
electronic trading system, including a trading algorithm, by an 
investment firm for dealing on its own account or for the execution of 
orders on behalf of clients; and the provision of direct market access 
or sponsored access by an investment firm as part of the service of the 
execution of orders on behalf of clients.\62\
---------------------------------------------------------------------------

    \61\ See ESMA, ``Systems and controls in an automated trading 
environment for trading platforms, investment firms and competent 
authorities'' (Feb. 24, 2012) [hereinafter ``ESMA Guidelines''], 
available at http://www.esma.europa.eu/system/files/esma_2012_122_en.pdf and accompanying public statement, available at 
http://www.esma.europa.eu/system/files/2012-128.pdf.
    \62\ See id. at 3.
---------------------------------------------------------------------------

    Among other elements, the ESMA guidelines recommended that trading 
platforms should have: Arrangements to prevent the excessive flooding 
of the order book; arrangements (such as throttling) to prevent 
capacity limits on messaging from being breached; and arrangements (for 
example, volatility interruptions or automatic rejection of orders 
which are outside of certain set volume and price thresholds) to 
constrain trading or to halt trading in individual or multiple 
financial instruments when necessary.\63\ The ESMA guidelines also 
recommended that trading platforms should have procedures in place to 
identify potential market abuse in an automated trading environment, 
such as ping orders, quote stuffing, momentum ignition, and layering 
and spoofing.\64\
---------------------------------------------------------------------------

    \63\ See id. at 13.
    \64\ See id. at 16-17.
---------------------------------------------------------------------------

    In addition, the ESMA guidelines recommended that investment firms 
should make use of clearly delineated development and testing 
methodologies prior to deploying an electronic trading system or a 
trading algorithm, and should monitor their electronic trading systems, 
including trading algorithms, in real-time.\65\ ESMA also recommended 
that investment firms implement price and size parameters, systems that 
control messaging traffic to individual trading platforms, financial 
risk controls, and controls that block a trader's orders if they are 
for a financial instrument that the trader does not have permission to 
trade.\66\ As to orders submitted via direct market access and 
sponsored access, ESMA recommended, among other things, that such 
orders be submitted to the same pre-trade risk controls that it 
recommends for investment firms (including, for example, price and size 
parameters).\67\
---------------------------------------------------------------------------

    \65\ See id. at 10.
    \66\ See id. at 14-15.
    \67\ See id. at 21-23.
---------------------------------------------------------------------------

    On March 18, 2015, ESMA released a report finding that all 30 
participating European Economic Area members have incorporated the 
Guidelines into their legal framework, and all except three have 
incorporated it into their supervisory framework.\68\ The report went 
on to identify challenges to further enhancing compliance including: 
Market complexity, IT-knowledge, additional on-site inspections of 
markets, testing of trading halts, and setting up ring-defense against 
cyber-attacks.\69\
---------------------------------------------------------------------------

    \68\ ESMA, Automated Trading Guidelines: ESMA Peer Review Among 
National Competent Authorities (Mar. 18, 2015), available at http://www.esma.europa.eu/system/files/esma-2015-592-automated_trading_peer_review_report_publication.final_.pdf.
    \69\ See id. at 9-10.
---------------------------------------------------------------------------

    As discussed below, ESMA has performed additional work in the area 
of automated trading, such as developing technical standards for the 
requirements of MiFID II.
b. MiFID II
    The European Commission published a new Directive on markets in 
financial instruments (``MiFID II'') on June 12, 2014.\70\ The 
Directive contains a definition of both `algorithmic trading' and 
`high-frequency algorithmic trading technique,' which is defined as a 
specific type of algorithmic trading. Among other requirements, the 
Directive requires that an investment firm engaged in algorithmic 
trading must have effective systems and risk controls to ensure that 
its trading systems are resilient and have sufficient capacity, are 
subject to appropriate trading thresholds and limits, and prevent the 
sending of erroneous orders or other system activity that may create or 
contribute to a disorderly market.\71\ Such a firm must also have 
effective business continuity arrangements to deal with any failure of 
its trading

[[Page 78833]]

systems and must ensure its systems are fully tested and properly 
monitored.\72\ Furthermore, an investment firm that engages in a high-
frequency algorithmic trading technique must store in an approved form 
accurate and time sequenced records of all its placed orders, including 
cancellations of orders, executed orders and quotations on trading 
venues and make them available to the competent authority upon 
request.\73\
---------------------------------------------------------------------------

    \70\ See European Commission, ``Updated rules for markets in 
financial instruments: MiFID 2'' (June 12, 2014) [hereinafter 
``MiFID II''], available at http://ec.europa.eu/finance/securities/isd/mifid2/index_en.htm.
    \71\ See id. at Article 17(1).
    \72\ See id.
    \73\ See id. at Article 17(2).
---------------------------------------------------------------------------

    The MiFID II Directive also requires a regulated market to be able 
to temporarily halt or constrain trading if there is a significant 
price movement in a financial instrument on that market or a related 
market during a short period. In exceptional cases, a regulated market 
must be able to cancel, vary or correct any transaction.\74\ In 
addition, the Directive requires a regulated market to have in place 
effective systems, procedures and arrangements, including requiring 
members or participants to carry out appropriate testing of algorithms. 
A regulated market must also provide environments to facilitate such 
testing, to ensure that algorithmic trading systems cannot create or 
contribute to disorderly trading conditions on the market. The 
Directive requires a regulated market to implement systems to limit the 
ratio of unexecuted orders to transactions that may be entered into the 
system by a member or participant, to be able to slow down the flow of 
orders if there is a risk of its system capacity being reached, and to 
limit and enforce the minimum tick size that may be executed on the 
market.\75\
---------------------------------------------------------------------------

    \74\ See id. at Article 48(5).
    \75\ See id. at Article 48(6).
---------------------------------------------------------------------------

    The European Commission requested that ESMA develop technical and 
implementing standards for MiFID II. On May 22, 2014, ESMA published a 
consultation paper seeking comments on certain topics in connection 
with MiFID II, including ``micro-structural issues'' such as testing 
and risk control requirements for investment firms engaged in 
algorithmic trading and trading venues.\76\ ESMA published another 
consultation paper on December 19, 2014, seeking further comments on 
technical and implementing standards in connection with the 
implementation of MiFID II and summarizing comments received in 
response to ESMA's May 2014 paper.\77\ The comment period for the 
December 19, 2014 consultation paper closed in March 2015. In late 
2014, ESMA released a final report covering technical advice in certain 
areas, including the definition of algorithmic trading, HFT, and direct 
electronic access.\78\ In July 2015, ESMA released final technical 
advice relating to investor protection topics, including procedures for 
financial services firms to apply for authorized status, information 
required of firms applying to passport into other jurisdictions, and 
co-operation between regulatory authorities.\79\ On September 28, 2015, 
ESMA released a final report on draft regulatory and implementing 
technical standards for MiFID II (``2015 Final Draft Regulatory 
Standards'').\80\ This report provides regulatory standards for 
investment firms engaged in algorithmic trading as well as for trading 
venues that allow algorithmic trading. Details regarding ESMA's 
standards are discussed below as relevant to the Commission's proposed 
regulations relating to risk controls and other measures that AT 
Persons, clearing member FCMs and DCMs must implement.
---------------------------------------------------------------------------

    \76\ ESMA, ``Consultation Paper,'' (May 22, 2014), available at 
http://www.esma.europa.eu/system/files/2014-549_-_consultation_paper_mifid_ii_-_mifir.pdf.
    \77\ ESMA, ``Consultation Paper,'' (Dec. 19, 2014) and 
accompanying Annexes A and B, available at http://www.esma.europa.eu/system/files/2014-1570_cp_mifid_ii.pdf.
    \78\ ESMA, ``ESMA's Technical Advice to the Commission on MiFID 
II and MiFIR,'' (Dec. 19, 2014) [hereinafter ``ESMA Technical Advice 
Final Report''], available at http://www.esma.europa.eu/system/files/2014-1569_final_report_-_esmas_technical_advice_to_the_commission_on_mifid_ii_and_mifir.pdf.
    \79\ ESMA, Final Report: MiFID II/MiFIR draft Technical 
Standards on authorization, passporting, registration of third 
country firms and cooperation between competent authorities, Art. 
6(g) (June 29, 2015), available at http://www.esma.europa.eu/system/files/2015-esma-1006_-_mifid_ii_final_report_on_mifid_ip_technical_standards.pdf.
    \80\ ESMA, Final Report: Draft Regulatory and Implementing 
Technical Standards MiFID II/MiFIR (Sept. 28, 2015) [hereinafter, 
the ``ESMA September 2015 Final Draft Standards Report''], available 
at https://www.esma.europa.eu/system/files/2015-esma-1464_-_final_report_-_draft_rts_and_its_on_mifid_ii_and_mifir.pdf; ESMA, 
Regulatory technical and implementing standards--Annex 1 (Sept. 28, 
2015) [hereinafter, the ``ESMA September 2015 Final Draft Standards 
Report Annex 1''], available at https://www.esma.europa.eu/system/files/2015-esma-1464_annex_i_-_draft_rts_and_its_on_mifid_ii_and_mifir.pdf; ESMA, Cost-Benefit 
Analysis--Annex II, Draft Regulatory and Implementing Technical 
Standards MiFID II/MiFIR (Sept. 28, 2015), [hereinafter, the ``ESMA 
September 2015 Cost-Benefit Annex II''], available at https://www.esma.europa.eu/system/files/2015-esma-1464_annex_ii_-_cba_-_draft_rts_and_its_on_mifid_ii_and_mifir.pdf.
---------------------------------------------------------------------------

c. Other European Regulatory Initiatives
    In May 2013, Germany enacted the Act on the Prevention of Risks and 
Abuse in High-frequency Trading (the ``High-frequency Trading Act''). 
\81\ The High-frequency Trading Act requires that firms engaged in 
high-frequency trading must be licensed.\82\ In summary, high-frequency 
trading is defined to include each of the following four elements: (i) 
Trading for one's own account, or by proprietary trading firms; (ii) 
trading algorithmically without human intervention; (iii) trading using 
low-latency infrastructures; and (iv) trading that generates a high 
intraday message rate.\83\ In addition, exchanges must impose, on a 
product-by-product basis, an excessive system usage fee and an order-
to-trade ratio limit intended to prevent unnecessary messaging.\84\ 
Finally, the High-frequency Trading Act requires identification of 
algorithmically generated orders and trading algorithms, which is 
intended to enhance monitoring of manipulative activity.\85\
---------------------------------------------------------------------------

    \81\ See online summaries of High-frequency Trading Act (2013), 
available at http://www.bafin.de/SharedDocs/Veranstaltungen/EN/WA11_20130430_hft_workshop_en.html.
    \82\ See id.; see also Morgan, Megan, Tabb Forum, ``Decoding the 
German HFT Act: A Guide to Regulating Electronic Markets'' (Oct. 17, 
2014), available at http://tabbforum.com/opinions/decoding-the-german-hft-act-how-to-regulate-electronic-markets.
    \83\ See id.
    \84\ See id.
    \85\ See id.
---------------------------------------------------------------------------

    In May 2015, the Bank of England's Prudential Regulation Authority 
(``PRA''), the United Kingdom's prudential supervisor of major trading 
firms, announced that it would assess the adequacy of existing risk 
measurement and management practices with respect to trading 
algorithms, including whether controls around algorithmic trading are 
``fit for purpose.'' \86\ The PRA discussed the growth of automated 
trading in financial markets, which has included incidents of extreme 
volatility. For example, volatility seen in the Swiss Franc exchange 
rate on January 15, 2015, following the Swiss central bank's decision 
to remove a floor to the exchange rate, may have been exacerbated by 
high-frequency trading.\87\
---------------------------------------------------------------------------

    \86\ See Bailey, Andrew, Bank of England, ``Financial Markets: 
Identifying risks and appropriate responses,'' at 9 (May 15, 2015), 
available at http://www.bankofengland.co.uk/publications/Documents/speeches/2015/speech814.pdf.
    \87\ See id. at 5-6; Binham, Caroline, ``High-frequency trading 
faces tougher Bank of England scrutiny,'' Financial Times (May 15, 
2015), available at http://www.ft.com/intl/cms/s/0/f7d4e438-fb20-11e4-9aed-00144feab7de.html#axzz3aUzgwb2N.
---------------------------------------------------------------------------

    Finally, in July 2015, the United Kingdom's Financial Conduct 
Authority issued a consultation paper addressing strengthening 
accountability in

[[Page 78834]]

banking.\88\ The proposed rule specifically set out to capture 
individuals responsible for the deployment of trading algorithms in its 
Certification Regime.\89\ Pursuant to the proposal, individuals 
responsible for: (1) Approving the deployment of a trading algorithm or 
a material part of one; (2) approving the deployment of a material 
amendment to a trading algorithm or a material part of one, or the 
combination of trading algorithms; and (3) monitoring or deciding 
whether or not the use or deployment of a trading algorithm is or 
remains compliant with the firm's obligations would be captured and 
subject to the Certification Regime.\90\
---------------------------------------------------------------------------

    \88\ Financial Conduct Authority (``FCA''), CP15/22 
Strengthening accountability in banking: Final rules (including 
feedback on CP14/31 and CP15/5) and consultation on extending the 
Certification Regime to wholesale market activities, at 46 (July 
2015), available at https://www.fca.org.uk/your-fca/documents/consultation-papers/cp15-22.
    \89\ Id.
    \90\ Id.
---------------------------------------------------------------------------

d. The October 15 Joint Staff Report
    As discussed above in section I(B), on July 13, 2015, five 
regulatory agencies issued the October 15 Joint Staff Report on the 
unusually high level of volatility and rapid round-trip in prices that 
occurred on October 15, 2014 in the market for U.S. Treasury 
securities, futures and other closely related financial markets.\91\ In 
addition to discussing the events of October 15, the report includes an 
Appendix C that summarizes many of the risks of automated trading. 
These risks include the following: Operational risks (ranging from 
malfunctioning and incorrectly deployed algorithms to algorithms 
reacting to inaccurate or unexpected data); market liquidity risks 
(arising from abrupt changes in trading strategies even when a firm 
executes its strategy perfectly); market integrity risks (automated 
trading can provide new tools to engage in unlawful conduct); 
transmission risks (shocks based on erroneous orders impacting multiple 
markets); clearing and settlement risks (as more firms gain access to 
trading platforms, trades may not be subject to sufficient settlement 
risk mitigation techniques); and risks to effective risk management 
(the speed of trade execution may make critical risk mitigation devices 
less effective).
---------------------------------------------------------------------------

    \91\ See October 15 Joint Staff Report, supra note 10.
---------------------------------------------------------------------------

D. Industry and Regulatory Best Practices and Recommendations

    Widely recognized organizations and governmental entities or 
agencies have issued ``best practices'' for automated trading, 
including the National Futures Association (``NFA''), the FIA, ESMA, 
and the International Organization of Securities Commissions 
(``IOSCO''), among others.
1. NFA Compliance Rule 2-9: Supervision
    NFA, a registered futures association under Section 17 of the Act, 
has provided guidance regarding ATSs to industry participants since 
2002. Specifically, NFA Interpretive Notice 9046 addresses the 
``Supervision of the Use of Automated Order-Routing Systems'' in the 
context of NFA's overarching supervision requirements in Compliance 
Rule 2-9 (Supervision).\92\ The Commission believes that Compliance 
Rule 2-9 and Interpretive Notice 9046 are especially relevant because 
of their wide applicability as NFA membership rules, binding on FCMs, 
IBs, CPOs, CTAs, and other NFA members. In addition, these provisions 
and interpretations have been in place since at least 2006, such that 
NFA members--and by extension many AT Persons--will have been subject 
to regulatory requirements concerning algorithmic trading for many 
years.
---------------------------------------------------------------------------

    \92\ NFA, ``9046--Compliance Rule 2-9: Supervision of the Use of 
Automated Order-Routing Systems,'' (Dec. 12, 2006), available at 
https://www.nfa.futures.org/nfamanual/NFAManual.aspx?RuleID=9046&Section=9.
---------------------------------------------------------------------------

    Compliance Rule 2-9 requires each NFA member to ``diligently 
supervise its employees and agents in the conduct of their commodity 
futures activities for or on behalf of the Member.'' Interpretive 
Notice 9046, first issued in 2002 and revised in 2006, states that 
NFA's board of directors ``firmly believes that supervisory standards 
do not change with the medium used. How those standards are applied, 
however, may be affected by technology.'' To fulfill their supervisory 
responsibilities, NFA members ``must adopt and enforce written 
procedures to examine the security, capacity, and credit and risk-
management controls provided by the firm's automated order-routing 
systems (AORSs).'' Interpretive Notice 9046 applies to systems ``that 
are within a Member's control, including AORSs that are provided to the 
Member by an application service provider or an independent software 
vendor.'' NFA acknowledges that NFA members will not control an AORS 
chosen by an NFA customer, such as direct access systems provided by 
exchanges. In such circumstances, the NFA member must nevertheless 
adopt procedures ``reasonably expected to address the trading, 
clearing, and other risks attendant to [their] customer 
relationship[s].''
    Among other requirements, Interpretive Notice 9046 addresses the 
following standards for automated systems:
     Pre-Execution Controls (including both credit and ``fat-
finger'' protections): ``An AORS should allow the Member to set limits 
for each customer based on commodity, quantity, and type of order or 
based on margin requirements. It should allow the Member to impose 
limits pre-execution and to automatically block any orders that exceed 
those limits.'' \93\
---------------------------------------------------------------------------

    \93\ Interpretive Notice 9046 does not require NFA members to 
``impose pre-execution controls on all customers, however. The 
Member should review the customer's sophistication, credit-
worthiness, objectives, and trading practices and strategies when 
determining whether to impose controls pre-execution or post-
execution and deciding what levels to use when setting limits.''
---------------------------------------------------------------------------

     Post-Execution Controls: ``For customers subject to post-
execution controls, the Member should have the ability to monitor 
trading promptly. The AORS should generate alerts when limits are 
exceeded through that system. The system should also allow the Member 
to block subsequent orders, either in their entirety or by kind (e.g., 
to block orders that create a new position or increase an existing 
position but not orders that liquidate some or all of an existing 
position).'' \94\
---------------------------------------------------------------------------

    \94\ The Interpretive Notice adds that ``[t]his ability can be 
provided by the AORS or through other risk-management systems.''
---------------------------------------------------------------------------

     Direct Access Systems: ``When authorizing [customer] use 
of a direct access system that does not allow the Member to monitor 
trading promptly, the Member should utilize pre-execution controls, if 
available, to set pre-execution limits for each customer, regardless of 
the nature of the customer.''
     Review: ``Members should use AORSs in conjunction with 
their credit-review/risk-management systems and should evaluate the 
controls imposed on each customer as part of their regular credit and 
risk-control procedures.''
    A number of the controls summarized above are in keeping with the 
Commission's proposed requirements for AT Persons, including proposed 
Sec.  1.80, which requires pre-trade risk controls and other measures 
reasonably designed to prevent an Algorithmic Trading Event, including 
but not limited to maximum order message and execution frequencies per 
unit time; order price parameters and maximum order sizes; and certain 
order cancellation capabilities. The Commission notes once again its 
intent in much of Regulation AT to build on

[[Page 78835]]

existing regulatory requirements and industry practices so that its 
proposed regulations facilitate an ongoing transition to effective risk 
controls in algorithmic trading. The Commission believes that the 
existence of related regulatory standards enforced by NFA since 2002 
and updated in 2006 would help minimize any potential disruptions or 
burdens that would otherwise be associated with a number of the 
Commission's proposed rules for AT Persons. The Commission also 
believes that NFA's prior experience in this area will assist in 
complying with the requirements of proposed Sec.  170.19, discussed in 
detail in section IV(F) below.
2. FIA Reports on Automated Trading
    On March 23, 2015, FIA released the ``FIA Guide to the Development 
and Operation of Automated Trading Systems'' (the ``FIA Guide''), which 
provides recommendations concerning appropriate risk controls at the 
trader, broker and exchange levels.\95\ Risk controls recommended by 
FIA include maximum order size limits, maximum intraday position 
limits, market data reasonability checks, price tolerance limits, 
repeated automated execution limits, exchange dynamic price collars, 
exchange market pauses, exchange message programs, message throttles, 
self-trade prevention tools, kill switches, cancel-on-disconnect 
service and exchange-provided order management tools. FIA also 
recommended audit trail procedures that identify automated trading 
system operators; certain post-trade measures to monitor for potential 
credit events or unintended trading; measures related to co-location 
services; and disaster recovery and business continuity procedures. 
Finally, FIA recommended measures related to automated trading system 
development and support, including general principles related to 
testing; policies and procedures related to security; systems 
monitoring procedures; and documentation procedures. Consistent with 
the approach the Commission intends to pursue in Regulation AT, the FIA 
Guide states that, ``[c]are should be taken to avoid implementing 
overly prescriptive standards or rules that impose a one-size-fits-all 
approach to all entities.'' \96\
---------------------------------------------------------------------------

    \95\ FIA, ``FIA Guide to the Development and Operation of 
Automated Trade Systems'' (Mar. 23, 2015) [hereinafter ``FIA 
Guide''], available at https://fia.org/sites/default/files/FIA%20Guide%20to%20the%20Development%20and%20Operation%20of%20Automated%20Trading%20Systems.pdf.
    \96\ Id. at 6.
---------------------------------------------------------------------------

    The Commission encourages industry participants to consider FIA's 
recommendations. In the event that the FIA Guide recommends best 
practices that are not proposed in Regulation AT, the Commission 
encourages industry participants to consider implementing the FIA best 
practices if they are appropriate to their business and are reasonably 
designed to prevent an Algorithmic Trading Event. FIA's recommendations 
may also serve as a useful starting point for an RFA considering 
potential measures in response to proposed Sec.  170.19, discussed in 
section IV(F) below.
    FIA has issued several additional reports related to the 
appropriate best practices that should be implemented with respect to 
automated trading. In April 2010, FIA issued a report addressing the 
risks of direct market access and providing recommendations for risk 
controls to be implemented by exchanges and applied across all trading 
firms.\97\ In November 2010, FIA's Principal Traders Group (``FIA 
PTG'') released a report setting out recommended risk controls for 
trading firms that have direct access to exchange matching engines,\98\ 
as well as a global survey of futures exchanges to determine what 
controls were in place to manage the risks in providing trading firms 
with direct market access.\99\ In March 2012, FIA PTG and FIA European 
Principal Traders Association issued recommendations to assist trading 
firms in establishing internal procedures, processes and controls for 
the development, testing and deployment of trading software.\100\ 
Finally, in September 2013, FIA released recommendations for increasing 
the usefulness of drop copy systems in exchange-traded markets.\101\
---------------------------------------------------------------------------

    \97\ FIA, ``Market Access Risk Management Recommendations,'' 
(Apr. 2010), available at http://www.futuresindustry.org/downloads/Market_Access-6.pdf.
    \98\ FIA PTG, ``Recommendations for Risk Controls for Trading 
Firms,'' (Nov. 2010), available at http://www.futuresindustry.org/downloads/Trading_Best_Pratices.pdf.
    \99\ Sutphen, Leslie, ``Exchange Survey Finds Wide Range of Risk 
Controls in Place,'' (Jan. 2011), available at http://www.futuresindustry.org/downloads/RC-survey.pdf.
    \100\ FIA PTG & EPTA, ``Software Development and Change 
Management Recommendations,'' (Mar. 14, 2012), available at http://www.futuresindustry.org/downloads/Software_Change_Management.pdf.
    \101\ FIA, ``Drop Copy Recommendations,'' (Sept. 2013), 
available at http://www.futuresindustry.org/downloads/FIA-Drop_Copy(FINAL).pdf.
---------------------------------------------------------------------------

3. IOSCO Reports on Electronic Trading
    IOSCO is an international body of securities regulators. IOSCO 
develops, implements and promotes adherence to internationally 
recognized standards for securities regulation. Its membership 
regulates more than 95% of the world's securities markets in more than 
115 jurisdictions.\102\ In October 2011, IOSCO released recommendations 
to promote the integrity and efficiency of markets in order to mitigate 
risks posed by the latest technological developments.\103\ Among other 
things, IOSCO recommended that regulators ensure that trading venues 
have in place suitable trading control mechanisms such as trading 
halts, volatility interruptions, and limit-up/limit-down controls to 
deal with volatile market conditions, as well as trading systems that 
have the ability to adjust to changes in message traffic (including 
sudden increases).\104\ In addition, IOSCO recommended that all order 
flow of trading participants, regardless of whether they access the 
market directly, be subject to appropriate controls, including 
automated pre-trade controls. IOSCO also recommended that regulators 
should identify any risks arising from currently unregulated direct 
participants of trading venues and take steps to address them.\105\
---------------------------------------------------------------------------

    \102\ See IOSCO's public Web site, available at https://www.iosco.org/about/?subsection=about_iosco.
    \103\ Technical Committee of the IOSCO, ``Regulatory Issues 
Raised by the Impact of Technological Changes on Market Integrity 
and Efficiency: Final Report,'' (Oct. 2011), available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD361.pdf.
    \104\ See id.
    \105\ See id.
---------------------------------------------------------------------------

    More recently, in April 2015, IOSCO released a consultation report 
entitled ``Mechanisms for Trading Venues to Effectively Manage 
Electronic Trading Risks and Plans for Business Continuity.'' \106\ The 
report compiles the results of a survey that IOSCO sent to trading 
venues across more than 30 different jurisdictions. Based on the 
information compiled, the report proposes best practices that should be 
considered by trading venues when developing and implementing risk 
mitigation mechanisms. These practices are intended to promote the 
integrity, resiliency and reliability of trading systems and business 
continuity plans. With respect to managing risks originating from 
market participant technology, the report explains that most trading 
venues have policies, procedures and tools to detect and address the 
operational risks associated with electronic trading. These tools

[[Page 78836]]

include, among others, pre-trade risk controls (such as price and 
volume controls or filters and order entry controls), the ability to 
block, suspend or disconnect a user (e.g., a kill switch), measures to 
halt trading in the event of sudden price movements, and throttles that 
constrain the number or frequency of messages from any given 
participant.\107\ IOSCO also explained that many trading venue 
participants use pre-trade risk controls such as order volume, price 
per security, credit, notional value of order, order value, capital, 
position checks, price deviation thresholds, and regulatory integrity 
checks.\108\ Finally, IOSCO addressed direct market access by referring 
to a previous report it issued in 2010, called ``Principles for Direct 
Electronic Access to Markets.'' In that report, IOSCO recommended that 
intermediaries (including clearing firms) have adequate operational and 
technical capability to appropriately manage the risks posed by 
DEA.\109\
---------------------------------------------------------------------------

    \106\ IOSCO, ``Mechanisms for Trading Venues to Effectively 
Manage Electronic Trading Risks and Plans for Business Continuity: 
Consultation Report,'' (Apr. 2015) [hereinafter ``IOSCO 2015 
Consultation Report''], available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD483.pdf.
    \107\ See id. at 20-21.
    \108\ See id.
    \109\ See id. at 22-23. IOSCO uses the term DEA or ``direct 
electronic access'' to mean an arrangement where a client of an 
intermediary obtains access to the market through the intermediary's 
infrastructure or access without using the intermediary's systems. 
See id. at 20 n.56.
---------------------------------------------------------------------------

4. CFTC TAC Subcommittee
    In 2011, the Pre-Trade Functionality Subcommittee (``TAC 
Subcommittee'') of the CFTC's TAC issued recommendations for pre-trade 
controls for trading firms, clearing firms and exchanges which use, or 
provide, direct market access.\110\ The TAC Subcommittee recommended 
the following risk controls for trading firms: Quantity limits on 
individual orders; price collars; execution throttles; message 
throttles; and a kill switch that would cancel all existing orders and 
prevent the firm from placing new orders. The TAC Subcommittee further 
recommended that clearing firms trading on their own behalf should 
comply with those risk controls. In addition, clearing firms should 
confirm that their client firms are implementing such controls, approve 
the parameters used by the trading firm, and have access to the kill 
switch. Exchanges should implement, and require trading firms to use, 
pre-trade quantity limits on individual orders; intra-day position 
limits; price collars; and message throttles. The TAC Subcommittee also 
recommended that exchanges implement clear and consistent error trade 
policies, order cancellation policies that allow for automatic 
cancellation of orders on disconnect, and the ability for clearing 
firms to view their firm's orders and to cancel working orders.
---------------------------------------------------------------------------

    \110\ See CFTC TAC Recommendations, supra note 34.
---------------------------------------------------------------------------

5. FIX Risk Management Working Group
    Additional organizations have released best practices documents, 
including FIX Protocol Ltd.'s (``FIX'') Americas Risk Management 
Working Group. FIX is a non-profit, industry standards association that 
owns, maintains and continuously develops the Financial Information 
eXchange (FIX) Protocol in response to market requirements. In 2012, 
FIX released risk control guidelines for algorithmic trading orders and 
direct market access orders.\111\ FIX identified typical order 
scenarios that brokers attempt to detect, which include the following: 
An order for an exceedingly large quantity; an order that will 
adversely impact the market for a given security; an order with 
incomplete or conflicting instructions; an order that is potentially 
duplicative or unintentionally repeating; an order where adverse or 
favorable price moves impact the order while it is working; and an 
order that may be stale or may have been replaced by the client or a 
system.\112\ FIX explained that the absence of appropriate risk 
controls can result in market dislocation, failure to settle/deliver, 
conflict between the client's intent and order execution, and trading 
the wrong product.\113\ FIX provides a recommended matrix of risk 
controls, which includes maximum order quantity, average daily volume 
checks, price limit checks, favorable/adverse price move checks, 
position limits, credit checks, and stale, runaway, and duplicate order 
checks.\114\
---------------------------------------------------------------------------

    \111\ See FPL Americas Risk Management Working Group, 
``Recommended Risk Control Guidelines,'' (2012), available at http://www.fixtradingcommunity.org/mod/file/view.php?file_guid=32127.
    \112\ See id. at 5. Other scenarios include an order where the 
symbology cannot be resolved to a single security and large accrued 
long or short positions that may result in settlement and/or 
delivery risk if the client cannot settle the trade.
    \113\ See id.
    \114\ See id. at 22.
---------------------------------------------------------------------------

6. Senior Supervisors Group (SSG) Briefing Note
    In April 2015, the Senior Supervisors Group (``SSG''), composed of 
the staff of banking and other financial regulatory agencies from ten 
countries and the European Union, issued an ``Algorithmic Trading 
Briefing Note.'' \115\ The Note focused on how large financial 
institutions currently monitor and control for the risks associated 
with algorithmic trading during the trading day. The Note identified 
several risks that SSG believes are common to algorithmic trading 
across jurisdiction and asset class: (i) Systemic risk may be 
amplified; (ii) algorithmic trading desks may face a significant amount 
of risk intraday without transparency and robust controls; (iii) 
internal controls may not have kept pace with speed and market 
complexity; and (iv) without adequate controls, losses can accumulate 
and spread rapidly.\116\ The Note provided a list of principles for 
supervisors to consider when evaluating controls over algorithmic 
trading at banks: (a) Controls must keep pace with technological 
complexity and trading speeds; (b) governance and management oversight 
can limit exposure to losses and improve transparency; (c) testing 
needs to be conducted during all phases of a trading product's 
lifespan, namely during development, rollout to production, and ongoing 
maintenance; and (d) when assessing control depth and suitability, 
management should ensure sufficient involvement of control functions 
(including compliance, technology, legal, and controllers), as well as 
business-unit management.\117\
---------------------------------------------------------------------------

    \115\ See Senior Supervisors Group, ``Algorithmic Trading 
Briefing Note,'' (Apr. 2015) [hereinafter ``SSG 2015 Note''], 
available at http://www.newyorkfed.org/newsevents/news/banking/2015/SSG-algorithmic-trading-2015.pdf. The SSG includes staff from the 
following organizations: Canadian Office of the Superintendent of 
Financial Institutions, the European Central Bank Banking 
Supervision, the French Prudential Control and Resolution Authority, 
the German Federal Financial Supervisory Authority, the Bank of 
Italy, the Japanese Financial Services Agency, the Netherlands Bank, 
the Bank of Spain, the Swiss Financial Market Supervisory Authority, 
the United Kingdom's Prudential Regulatory Authority, and, in the 
United States, the Office of the Comptroller of the Currency, the 
Securities and Exchange Commission, and the Federal Reserve.
    \116\ See id. at 2-3.
    \117\ See id. at 3-4.
---------------------------------------------------------------------------

7. Treasury Market Practices Group Best Practices
    In June 2015, the Treasury Market Practices Group, a group 
sponsored by the Federal Reserve Bank of New York, and comprised of 
legal, compliance and business representatives from institutions 
related to U.S. Treasury market primary and secondary trading, released 
a white paper on Automated Trading \118\ and an updated Best Practices 
document for trading in U.S. cash Treasury securities markets.\119\ The

[[Page 78837]]

Best Practice updates, among other things, expanded the scope of 
recommended risk controls that address the risks of automated trading 
(automated trading, for purposes of the Best Practices document, means 
the subset of electronic trading that relies on computer algorithms for 
decision-making and execution of order submissions), including the 
documentation of internal policies and procedures, additional 
transparency in exchange or trading platform market data, error trade 
rules and exchange provided services, expanded design and testing 
environments at firms and exchanges, and updated risk controls that 
align with the speed of trading technology. The white paper notes that 
these updates were issued in a period when cash Treasury securities 
markets, like many other asset classes, have experienced a strong 
increase in automated trading on electronic platforms.
---------------------------------------------------------------------------

    \118\ See Treasury Market Practices Group, ``Automatic Trading 
in Treasury Markets,'' (June 2015), available at http://www.newyorkfed.org/tmpg/TPMG_June%202015_automated%20trading_white%20paper.pdf.
    \119\ See Treasury Market Practices Group, ``Best Practices for 
Treasury, Agency Debt, and Agency Mortgage-Backed Securities 
Markets,'' (June 2015), available at http://www.newyorkfed.org/tmpg/TPMG_June%202015_Best%20Practices.pdf.
---------------------------------------------------------------------------

III. Recent Disruptive Events in Automated Trading Environments

    The Concept Release discussed malfunctions in automated trading 
systems, in both derivatives and securities markets, that illustrate 
the technological and operational vulnerabilities inherent to automated 
trading environments.\120\ As an example, the Flash Crash of May 2010 
involved an automated trading system with a design flaw that impacted 
both the derivatives and securities markets. According to the CFTC/SEC 
joint report on the Flash Crash, an automated execution algorithm did 
not take price or time variables into account. Given the parameters of 
the program, the algorithm continued to send orders even as prices 
moved far beyond traditional daily ranges.\121\ In another example, in 
2012 a securities trading firm, Knight Capital Group, made a coding 
error in an automated equity router, and then incorrectly deployed new 
code in the same router.\122\ Because of these coding errors, the 
firm's automated trading system inadvertently built up unintended 
positions in the equity market, eventually resulting in losses of more 
than $460 million for the firm.\123\ The malfunction impacted the 
broader market, creating swings in the share prices of almost 150 
companies; these price swings were high enough to trigger pauses in the 
trading of five stocks.\124\
---------------------------------------------------------------------------

    \120\ See Concept Release, 78 FR at 56548-49.
    \121\ See U.S. Commodity Futures Trading Commission and U.S. 
Securities and Exchange Commission, ``Findings Regarding the Market 
Events of May 6, 2010,'' (September 30, 2010) [hereinafter, the 
``Flash Crash Report''], available at http://www.cftc.gov/ucm/groups/public/@otherif/documents/ifdocs/staff-findings050610.pdf.
    \122\ See SEC Knight Capital Release, supra note 39.
    \123\ See id.
    \124\ See Strasburg, Jenny and Bunge, Jacob, ``Loss Swamps 
Trading Firm,'' Wall St. J. (Aug. 2, 2012), available at http://online.wsj.com/article/SB10000872396390443866404577564772083961412.html and Valetkevitch, 
Caroline and Mikolajczak, Chuck, ``Error by Knight Rips Through 
Stock Market,'' Reuters (Aug. 1, 2012), available at http://www.reuters.com/article/2012/08/01/us-usa-nyse-tradinghalts-idUSBRE8701BN20120801.
---------------------------------------------------------------------------

    Foreign markets have also experienced disruptive events in recent 
years. For example, in May 2012 in Mexico, a ``fat finger'' error by a 
market participant resulted in the execution of 1.13 million shares 
(representing U.S. $3.78 billion).\125\ In February 2015, there was a 
five minute delay in opening futures and options on the Eurex exchange 
in Germany because a market participant's system was transmitting 
duplicate orders.\126\ In February 2014, trading in three-year Korean 
treasury bonds was halted for almost two hours at the Korea Exchange 
due to a system malfunction resulting from an improper order from a 
brokerage house.\127\ On October 26, 2011, the Bombay Stock Exchange 
had to cancel all derivatives trading due to unusually high volumes and 
price volatility as a result of a flawed algorithm used by a member 
firm.\128\
---------------------------------------------------------------------------

    \125\ See IOSCO 2015 Consultation Report, supra note 106 at 1 
n.6.
    \126\ See id. and ``Technical Failure Delays Eurex Trading in 
Futures, Options,'' Bloomberg (Feb. 17, 2015), available at http://www.bloomberg.com/news/articles/2015-02-17/eurex-futures-options-opening-delayed-after-technical-problem.
    \127\ See ``Treasuries trading system disrupted,'' Korea Times 
(Feb. 14, 2014), available at https://www.koreatimes.co.kr/www/news/biz/2014/09/488_151619.html.
    \128\ See ``Sebi probes Muhurat trading mishap on BSE,'' 
Business Standard (Nov. 12, 2011), available at http://www.business-standard.com/article/markets/sebi-probes-muhurat-trading-mishap-on-bse-111111200083_1.html.
---------------------------------------------------------------------------

    Goldman Sachs was recently fined $7 million by the SEC for 
violating its Market Access Rule and causing a disruptive trading 
event.\129\ On August 20, 2013, a configuration error in one of 
Goldman's options order routers erroneously sent thousands of limit 
orders to the options exchanges prior to the start of regular market 
trading.\130\ By the time the creation of additional orders was 
disabled, and efforts to cancel unintended orders were taken, 
approximately 1.5 million unintended orders (representing 150 million 
underlying shares) had been executed on the market.\131\ The existing 
risk management controls and supervisory procedures in place at Goldman 
failed to stop the erroneous orders, and human error and failure to 
follow best practices exacerbated the errors.\132\ While some erroneous 
orders were able to be cancelled, Goldman's loss ultimately totaled $38 
million.\133\
---------------------------------------------------------------------------

    \129\ See In re Goldman, Sachs & Co., No. 3-16665 (SEC June 30, 
2014) (order instituting administrative and cease-and-desist 
proceedings).
    \130\ Id. at 2.
    \131\ Id.
    \132\ Id. at 3.
    \133\ Id. at 2.
---------------------------------------------------------------------------

    Disruptive events illustrate the importance of effective risk 
controls. The risk controls contemplated in Regulation AT are intended 
to limit the extent of market disruption caused by ATSs or trading 
platform malfunctions. For example, a pre-trade risk control such as a 
message throttle will prevent submission of orders that exceed a 
predetermined frequency per unit time. Such a control could be operated 
by the market participant generating orders, the clearing firm 
guaranteeing its trades, or the trading platform on which orders would 
be executed, and would limit the impact of an algorithmic trading 
system not operating as intended. As another example, monitoring and 
supervision standards for algorithmic trading may help ensure that 
human supervisors intervene quickly when automated systems experience 
unexpected or degraded performance, and that supervision staff have the 
both the authority and knowledge to take appropriate steps in this 
scenario.

IV. Overview of Regulation AT

A. Concept Release/Regulation AT Terminology

    The Concept Release used the term ``automated trading system'' 
(abbreviated ``ATS'') to refer to the algorithms used to automate the 
generation and execution of a trading strategy.\134\ In discussing 
comments to the Concept Release, the Commission will continue to use 
the term automated trading system. However, for greater precision, the 
proposed rules and preamble for Regulation AT instead refer to 
``algorithmic trading system'' (also abbreviated ``ATS''). This change 
is intended only as a change in in nomenclature. ATSs as described 
herein should not be confused with alternative trading systems in 
equities markets.
---------------------------------------------------------------------------

    \134\ Concept Release, 78 FR 56542, 56544.
---------------------------------------------------------------------------

B. Commenter Preference for Principles-Based Regulations

    As an initial matter, the Commission notes a preference expressed 
in comments to the Concept Release for principles-based, as opposed to 
prescriptive, regulations. Fifteen

[[Page 78838]]

commenters advocated a limited or ``principles-based'' approach to any 
regulation arising from the Concept Release.\135\ Commenters indicated 
that prescriptive requirements will become obsolete, stifle innovation, 
discourage self-reporting of technological failures, may not account 
for the unique characteristics of market participants, and would result 
in participants designing around such measures.\136\
---------------------------------------------------------------------------

    \135\ The Futures Industry Association (``FIA'') Comment Letter 
(Dec. 11, 2013) at 2, 12; CME Group (``CME'') Comment Letter (Dec. 
11, 2013) at 3, 41-42; Gelber Group, LLC (``Gelber'') Comment Letter 
(Dec. 9, 2013) at 1-2; KCG Holdings, Inc. (``KCG'') Comment Letter 
(Dec. 11, 2013) at 3; The Alternative Investment Management 
Association (``AIMA'') Comment Letter (Dec. 11, 2013) at 1; The 
Minneapolis Grain Exchange (``MGEX'') Comment Letter (Dec. 11, 2013) 
at 1; CBOE Futures Exchange, LLC (``CFE'') Comment Letter (Dec. 11, 
2013) at 2; Managed Funds Association (``MFA'') Comment Letter (Dec. 
11, 2013) at 2; Holly Bell (Bell'') Comment Letter (Dec. 11, 2013) 
at 3; Virtu Financial LLC (``VFL'') Comment Letter (Jan. 10, 2014) 
at 2-3; Chris Barnard Comment Letter (Jan. 29, 2014) at 2; 
Susquehanna International Group (``SIG'') Comment Letter at 2; 
IntercontinentalExchange Group, Inc. (``ICE'') Comment Letter (Feb. 
14, 2014) at 1-2; 3Red Trading LLC (``3Red'') Comment Letter (Feb. 
14, 2014) at 2; OneChicago, LLC (``OneChicago'') Comment Letter 
(Feb. 14, 2015) at 5.
    \136\ FIA at 2, 12; CME at 3-4, 7; Gelber at 1-2; Tellefsen and 
Company, L.L.C. (``TCL'') Comment Letter (Oct. 31, 2013) at 5, 18; 
AIMA at 1, 2; CFE at 2; VFL at 3; Bell at 3.
---------------------------------------------------------------------------

    More specifically, FIA \137\ and CME Group, Inc. (``CME'') 
suggested that the best way to achieve standardization of risk controls 
is through implementing ``best practices'' developed through working 
groups of DCMs, FCMs, and other market participants.\138\ Similarly, 
IntercontinentalExchange, Inc. (``ICE'') indicated that ``exchanges are 
able to better implement and update risk controls on a market-by-market 
basis than through a Commission rulemaking,'' and should be allowed 
flexibility in designing exchange risk controls.\139\ Susquehanna 
International Group (``SIG'') stated that the Commission should ``allow 
the exchanges to work with firms on tailoring the rules for 
implementation in ways that best consider the technical intricacies 
between firms and exchanges.'' \140\ Virtu Financial LLC (``VFL'') 
suggested that ``mandating risk controls and supervisory systems that 
are `reasonably designed' or `provide reasonable assurance' of 
protection would allow participants to tailor these controls to the 
specific risks associated with their business.'' \141\
---------------------------------------------------------------------------

    \137\ The Commission notes that six entities submitted letters 
in support of FIA's comment letter: RGM Advisors, LLC, Allston 
Trading LLC, Geneva Trading USA, LLC, Tibra Trading America LLC, DRW 
Trading Group and IMC Financial Markets.
    \138\ FIA at 63; CME at 41.
    \139\ ICE at 1-2.
    \140\ SIG at 2.
    \141\ VFL at 3.
---------------------------------------------------------------------------

    In addition, five commenters indicated that the Commission already 
has robust regulations in place to address the risks of automated 
trading.\142\ Such comments cited the DCM and SEF Core Principles; 
\143\ Commission regulations 1.73, 23.609, 38.255, and 38.607; \144\ 
and CEA and Commission market manipulation and disruptive trading 
practices rules.\145\
---------------------------------------------------------------------------

    \142\ CME at 3; FIA at 5; MFA at 6; Gelber at 2, 5, 20; Bell at 
2, 4.
    \143\ Gelber at 21; CFE at 1; MFA at 6.
    \144\ MFA at 4; CFE at 1.
    \145\ Gelber at 2, 5, 20; CFE at 3; CME at 3; MFA at 6; Bell at 
2.
---------------------------------------------------------------------------

    In contrast to a limited or principles-based approach to 
regulation, several commenters supported a more prescriptive approach 
to a rulemaking addressing the risks of automated trading.\146\ These 
commenters include the Institute for Agriculture and Trade Policy 
(``IATP''), Better Markets, and Americans for Financial Reform 
(``AFR''). For example, IATP stated that unless the Commission receives 
documentation that the risk controls of firms and exchanges are 
consistent and effective, the Commission should assume that regulatory 
standardization will be beneficial for each risk control and at each 
phase of the trade lifecycle.\147\ In addition, several academic 
commenters discussed concerns with automated, high speed trading and 
advocated specific changes to the trade matching or order submission 
process to increase market liquidity and efficiency.\148\
---------------------------------------------------------------------------

    \146\ The Institute for Agriculture and Trade Policy (``IATP'') 
Comment Letter (Dec. 11, 2013) at 4; Better Markets Inc. (``Better 
Markets'') Comment Letter (Dec. 11, 2013) at 1; Americans for 
Financial Reform (``AFR'') Comment Letter (Dec. 11, 2013) at 6.
    \147\ IATP at 4.
    \148\ Eric Budish et al. Comment Letter (Feb. 14, 2014) at 1; 
Brian F. Mannix Comment Letter (Dec.10, 2013) at 2; Elaine Wah et 
al. Comment Letter (Dec. 11, 2013) at 2.
---------------------------------------------------------------------------

    As discussed below, consistent with comments received, the 
Commission has taken a balanced approach to the regulations it believes 
are necessary to manage the risks of algorithmic trading. For example, 
the Commission proposes a principles-based approach to its risk 
controls requirements, in that it would require particular controls but 
allow the relevant entity--a trading firm, clearing member FCM, or 
DCM--discretion in the design of such control and the parameters that 
would be used.

C. Multi-Layered Approach to Pre-Trade Risk Controls and Other Measures

    In response to the Commission's questions in the Concept Release 
about the appropriate location for risk controls and other measures, 
commenters generally supported a multi-layered approach to risk 
controls, with each level--trading firm, clearing firm, and exchange--
implementing risk controls that are adjusted depending on 
circumstance.\149\
---------------------------------------------------------------------------

    \149\ CME at 8-9; FIA at 61; Federal Reserve Bank of Chicago 
(``Chicago Fed'') Comment Letter (Dec. 11, 2013) at 2; AIMA at 7; 
KCG at 2; VFL at 2.
---------------------------------------------------------------------------

    For example, FIA commented that ``[i]ntroducing redundant risk 
controls at more than one focal point in the trading lifecycle may 
increase the integrity of the marketplace when careful consideration is 
given to their differences in roles, implementations and 
configurations.'' \150\ However, FIA also stated that ``we caution 
against a mandated proliferation of redundant risk controls because the 
existence of similar but not identically implemented risk controls may 
do more harm than good. Each new implementation of a control will 
increase complexity and may cause misunderstanding between traders and 
risk managers as a consequence of conflicting risk limits.'' \151\ As 
an example of a control that may be appropriately implemented at 
multiple levels, FIA stated that maximum order size limits may be 
implemented at both market participant and FCM levels without 
redundancy because they reflect the different responsibilities of each 
participant.\152\ FIA further explained that if an FCM has implemented 
customer-specific controls within its infrastructure, it would be 
redundant to use the same controls at the DCM level, though as an 
additional protection, it is permissible to set higher limits at the 
DCM that apply across all customers.\153\
---------------------------------------------------------------------------

    \150\ FIA at 61.
    \151\ See id.
    \152\ FIA at 62.
    \153\ See id.
---------------------------------------------------------------------------

    CME cited the TAC Subcommittee's ``Recommendations on Pre-Trade 
Practices for Trading Firms, Clearing Firms and Exchanges involved in 
Direct Market Access,'' and commented that ``each level of the 
`electronic trading `supply chain' (trading firms, clearing firms, and 
exchanges) must share in the effort to preserve market integrity 
through the implementation of effective risk controls, no matter if 
that participant has direct market access or is routing to the exchange 
via its clearing member firm''.\154\ Specifically

[[Page 78839]]

with respect to kill switch functionality, CME indicated that kill 
switch functionality deployed at multiple levels should not be 
considered redundant.\155\ CME further suggested that while multi-
layered kill switch functionality is not necessary for effective risk 
control, it is nevertheless beneficial as it adds additional measures 
of protection.\156\ CME made a general point that registrants should 
establish controls appropriate to the nature of their business that are 
reasonably designed to control access, effectively monitor trading, and 
prevent errors as well as other inappropriate activity.\157\ CME 
indicated that, regardless of whether orders are entered manually 
through an electronic system or entered through an automated trading 
system, such principles are equally important, because the method of 
order entry does not lessen the impact of a particular order on the 
market.\158\
---------------------------------------------------------------------------

    \154\ CME at 7-8.
    \155\ CME at 22.
    \156\ See id.
    \157\ CME at 43-44.
    \158\ See id.
---------------------------------------------------------------------------

    Other commenters supported a multi-layered approach to risk 
controls. AIMA indicated that risk controls should be ``broadly 
similar'' and applied at the trading firm, clearing firm, and exchange 
levels.\159\ KCG stated that ``risk management is most effective when 
it is multi-layered and overlapping.'' \160\ VFL stated that a 
``multilayered system of risk controls is a key ingredient to protect 
the market from disruptive events.'' \161\
---------------------------------------------------------------------------

    \159\ AIMA at 7.
    \160\ KCG at 2.
    \161\ VFL at 2.
---------------------------------------------------------------------------

    The Commission agrees with the comments above that it should adopt 
a multi-layered approach to regulations intended to mitigate the risks 
of automated trading. As explained below, the Commission proposes to 
impose requirements at multiple stages of the lifecycle of an order. 
The Commission acknowledges FIA's comment that the different role of 
entities at various stages in the trade lifecycle must be carefully 
evaluated. While Regulation AT requires the same types of pre-trade and 
other risk controls to be implemented by different entities, the 
Commission notes that the proposed regulations allow for discretion in 
the appropriate design and parameters of each risk control. 
Accordingly, a trading firm, clearing member FCM, and DCM may each 
choose to design and calibrate the same control in different ways, 
depending on how the control is used by each entity to manage risks.
    The Commission notes that ESMA's 2015 Final Draft Regulatory 
Standards require pre-trade risk controls at both investment firms and 
trading venues.\162\ ESMA acknowledged commenter disagreement with such 
redundancy and stated, ``ESMA believes that at least two lines of 
defence are appropriate in this complex business and thus continues to 
require the pre-trade risk controls conducted by both investment firms 
and trading venues.'' \163\ ESMA's regulatory standards further provide 
that where a client is granted market access either through an 
intermediary's systems, or directly without using the intermediary's 
systems, the direct electronic access provider must apply the required 
pre-trade risk controls.\164\ Regulation AT requires pre-trade and 
other risk controls at both the AT Person and clearing member FCM level 
(as well as the DCM level) based on its understanding that the risks--
and the resulting calibration levels of the controls--may be different 
given those entities' distinct priorities and understanding of the 
risks to themselves and their customers.
---------------------------------------------------------------------------

    \162\ ESMA September 2015 Final Draft Standards Report, supra 
note 80 at 201.
    \163\ See id.
    \164\ ESMA September 2015 Final Draft Standards Report Annex 1, 
supra note 80 at 218.
---------------------------------------------------------------------------

    Below is a summary of each element of Regulation AT. For each 
element, the Commission addresses relevant Concept Release comments, 
summarizes the proposed regulation, and asks questions concerning the 
proposed regulation.

D. Codification of Defined Terms Used Throughout Regulation AT

1. ``Algorithmic Trading''--Sec.  1.3(zzzz)
a. Concept Release Comments
    The Concept Release requested comment concerning whether the 
Commission should define ATS or algorithm for purposes of any ATS 
identification system. Commenters disagreed on whether the Commission 
should adopt a definition of ``ATS.'' FIA and CME opposed a regulatory 
definition, arguing that industry already has a definition of automated 
trading system.\165\ FIA and CME indicated that the definition of ATS 
is self-evident and has been in use for a long time, and that ATS, or 
automated orders, are orders that are generated and/or routed without 
human intervention. This includes orders generated by a computer system 
as well as orders that are routed using functionality that manages 
order submission by automated means (i.e., execution algorithms).\166\ 
Another commenter, Gelber Group, LLC (``Gelber''), stated that the 
Commission should adopt a ``strong but appropriately flexible 
definition'' of ATS aligned with existing exchange definitions.\167\
---------------------------------------------------------------------------

    \165\ FIA at 41-42; CME at 29. CME defines ``ATS'' as ``a 
trading method in which a computer makes decisions and enters orders 
without a person entering those orders. This is a programmatic way 
of representing the trader.'' See CME Glossary, available at http://www.cmegroup.com/education/glossary.html. ICE defines ``ATS'' as 
``any system that automates the generation and submission of orders 
to ICE.'' See ICE Notice, Revision to Authorized Trader Requirements 
(Jan. 4, 2011) at 3, available at https://www.theice.com/publicdocs/otc/advisory_notices/ICE%20Advisory%20Notice%20for%20Authorized%20Trader%20Registration%20010411.pdf.
    \166\ FIA at 41; CME at 29.
    \167\ Gelber at 2-3.
---------------------------------------------------------------------------

    The Commission's evaluation of this issue is also informed by the 
work of the TAC Subcommittee. In particular, the TAC Subcommittee 
described ``automated trading'' as follows: ``[Automated trading] 
covers systems employed in the decision-making, routing and/or 
execution of an investment or trading decision, which utilizes a range 
of technologies including software, hardware, and network components to 
facilitate efficient access to the financial markets via electronic 
trading platforms.'' \168\
---------------------------------------------------------------------------

    \168\ CFTC Technology Advisory Committee Subcommittee on 
Automated and High-Frequency Trading, Presentation to the TAC (Oct. 
12, 2012), available at http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/tac103012_wg1.pdf.
---------------------------------------------------------------------------

b. Description of Regulation
    While the Commission does not define the term ``ATS'' in this NPRM, 
the Commission does propose a new Sec.  1.3(zzzz) that defines the 
related activity of ``Algorithmic Trading.'' This proposed term means 
trading in any commodity interest as defined in Regulation 1.3(yy) 
\169\ on or subject to the rules of a DCM, where: (1) One or more 
computer algorithms or systems determines whether to initiate, modify, 
or cancel an order, or otherwise makes determinations with respect to 
an order, including but not limited to: the product to be traded; the 
venue where the order will be placed; the type of order to be placed; 
the timing of the order; whether to place the order; the sequencing of 
the order in relation to other orders; the price of the order; the 
quantity of the

[[Page 78840]]

order; the partition of the order into smaller components for 
submission; the number of orders to be placed; or how to manage the 
order after submission; and (2) such order, modification or order 
cancellation is electronically submitted for processing on or subject 
to the rules of a DCM; provided, however, that Algorithmic Trading does 
not include an order, modification, or order cancellation whose every 
parameter or attribute is manually entered into a front-end system 
\170\ by a natural person, with no further discretion by any computer 
system or algorithm, prior to its electronic submission for processing 
on or subject to the rules of a DCM.\171\
---------------------------------------------------------------------------

    \169\ Regulation 1.3(yy) provides that the term ``commodity 
interest'' means (1) any contract for the purchase or sale of a 
commodity for future delivery; (2) any contract, agreement or 
transaction subject to a Commission regulation under section 4c or 
19 of the Act; and (3) Any contract, agreement or transaction 
subject to Commission jurisdiction under section 2(c)(2) of the Act; 
and (4) Any swap as defined in the Act, by the Commission, or 
jointly by the Commission and the Securities and Exchange 
Commission. See 17 CFR 1.3(yy).
    \170\ The reference to a ``front-end system'' may include a 
system provided by an independent software vendor (``ISV''), a 
broker or an exchange, or developed internally.
    \171\ The Commission notes that if a customer submits an order 
to its clearing FCM, which then submits the order to a DCM, such 
order would still be considered ``electronically submitted for 
processing on or subject to the rules of a designated contract 
market,'' notwithstanding the fact that the order is routed through 
the intervening clearing FCM.
---------------------------------------------------------------------------

    The term ``Algorithmic Trading'' is a critical underpinning of 
other elements of this NPRM. Specifically, the Commission proposes a 
number of requirements related to Algorithmic Trading, including that 
trading firms (i.e., AT Persons, as defined in section IV(D) below), 
clearing member FCMs, and DCMs implement certain pre-trade risk 
controls for Algorithmic Trading; that trading firms implement certain 
standards for the development, testing, monitoring, and compliance of 
ATSs; and that trading firms and clearing members FCMs submit 
compliance reports describing the new pre-trade risk controls. In 
addition, the term ``Algorithmic Trading'' is employed in the proposed 
definition of ``AT Person,'' a term that identifies those persons or 
entities subject to the Commission's proposed new pre-trade risk 
control requirements, among other requirements.
    The Commission notes that its definition of Algorithmic Trading is 
similar to the definition of algorithmic trading adopted by the 
European Commission under MiFID II.\172\ However, the definition of 
algorithmic trading under MiFID II does not include systems that only 
make decisions as to the routing of orders to one or more trading 
venues.\173\ Similarly, for purposes of a proposal relating to 
registration of persons who develop algorithmic trading strategies, 
FINRA's definition of ``algorithmic trading strategy'' does not include 
an order router alone.\174\ In contrast to MiFID II and FINRA, the 
Commission intends that the definition of Algorithmic Trading includes 
systems that make determinations regarding any aspect of the routing of 
an order, i.e., systems that only make decisions as to the routing of 
orders to one or more trading venues. The Commission believes that 
automated order routers have the potential to disrupt the market to a 
similar extent as other types of automated systems, and therefore 
should not be treated differently under the proposed regulations. For 
example, the SEC determined that Knight Capital made errors related to 
the coding and testing of an automated equity router, which caused the 
firm to acquire several billion dollars in unwanted positions and 
sustain a loss of more than $460 million, in addition to causing 
substantial market disruption.\175\
---------------------------------------------------------------------------

    \172\ See ESMA Technical Advice Final Report, supra note 78 at 
318. Article 4(1)(39) of MiFID II defines algorithmic trading as 
``trading in financial instruments where a computer algorithm 
automatically determines individual parameters of orders such as 
whether to initiate the order, the timing, price or quantity of the 
order or how to manage the order after its submission, with limited 
or no human intervention, and does not include any system that is 
only used for the purpose of routing orders to one or more trading 
venues or for the processing of orders involving no determination of 
any trading parameters or for the confirmation of orders or the 
post-trade processing of executed transactions.'' See MiFID II, 
supra note 70. The ESMA Technical Advice Final Report states at 323, 
``There is limited or no human intervention (and therefore 
algorithmic trading) when the system at least makes independent 
decisions at any stage of order-execution processes, either on 
initiating, routing or executing orders. It is noted that the 
reference to `orders' encompasses `quotes' as well.''
    \173\ See ESMA Technical Advice Final Report, supra note 78 at 
324.
    \174\ See FINRA, Regulation Notice 15-06, ``Registration of 
Associated Persons Who Develop Algorithmic Trading Strategies,'' 
(Mar. 2015), available at http://www.finra.org/sites/default/files/notice_doc_file_ref/Notice_Regulatory_15-06.pdf. In the Notice, 
FINRA defines an ``algorithmic trading strategy'' as ``any program 
that generates and routes (or sends for routing) orders (and order-
related messages, such as cancellations) in securities on an 
automated basis.'' Id. at 3.
    \175\ See SEC Knight Capital Release, supra note 39.
---------------------------------------------------------------------------

    The Commission has taken this approach to automated order routers 
after considering existing industry definitions of ``automated trading 
systems.'' For example, CME defines ``ATS'' as ``a trading method in 
which a computer makes decisions and enters orders without a person 
entering those orders. This is a programmatic way of representing the 
trader.'' \176\ Similarly, ICE defines ``ATS'' as ``any system that 
automates the generation and submission of orders to ICE.'' \177\ The 
Commission anticipates that entities using automated order routers will 
be using similar or related automated technology to determine other 
parameters of an order. In addition to the consideration that order 
routing systems have the potential to disrupt the market, the 
Commission believes that, given the interconnectedness of trading firm 
systems, carving out a particular subset of automated systems from the 
definition of Algorithmic Trading, e.g., order routing systems, would 
introduce unnecessary complexity and reduce the effectiveness of the 
safeguards provided in its proposed regulations.\178\
---------------------------------------------------------------------------

    \176\ See CME Glossary, available at http://www.cmegroup.com/education/glossary.html.
    \177\ See ICE Notice, Revision to Authorized Trader Requirements 
(Jan. 4, 2011) at 3, available at https://www.theice.com/publicdocs/otc/advisory_notices/ICE%20Advisory%20Notice%20for%20Authorized%20Trader%20Registration%20010411.pdf.
    \178\ The Commission notes that Forex Capital Markets, LLC 
(``FXCM'') commented in response to the Concept Release that 
automatic order routing systems be excluded from any definition of 
``high-frequency trading,'' arguing that such systems are already 
subject to extensive regulatory oversight and control. See FXCM 1-2. 
For the reasons stated above, the Commission determined to include 
such systems within the definition of Algorithmic Trading.
---------------------------------------------------------------------------

    The Commission notes that even if a computer algorithm or system 
makes one or more determinations with respect to an order (such as 
product, timing, price or quantity), the submission of the order would 
not constitute Algorithmic Trading if every parameter or attribute of 
the order is manually entered into a front-end system by a natural 
person, with no further discretion by any computer system or algorithm, 
prior to its electronic submission for processing on or subject to the 
rules of a DCM. However, if a natural person does not manually enter an 
order as described in the preceding sentence, but nonetheless 
intervenes in the order in some other and more limited manner, the 
submission of the order would still represent Algorithmic Trading if 
the other elements of the definition are met. The Commission believes 
that the risks of Algorithmic Trading continue to exist in trading 
where there is some limited natural person intervention at particular 
stages of order submission or execution, and Regulation AT requirements 
should apply to such trading to the same extent that it does to trading 
that is entirely automated. In sum, the only circumstance in which 
natural person intervention by definition would cause trading to not 
represent Algorithmic Trading is if the proviso in clause (2) of the 
definition of Algorithmic Trading were met.
    Finally, the Commission clarifies that there are certain automated 
functions that do not fall within the proposed definition of 
Algorithmic Trading. For example, the use of automated programs that 
incorporate electronic indicators or

[[Page 78841]]

other technical analysis features to notify a trader regarding 
specified market activity (e.g., a product reaches a particular price) 
would not in itself represent Algorithmic Trading, unless the same 
program makes the determinations described in clause (1) of the 
definition, and clause (2) is also met. Similarly, if an entity (such 
as an introducing broker) uses certain electronic systems as part of 
its business practices, but does not submit orders to a trading 
platform, that entity's use of electronic systems would not of itself 
be considered Algorithmic Trading. Finally, the application of risk 
filters to an order that is otherwise entered through entirely manual 
means (i.e., an order whose every parameter or attribute is manually 
entered into a front-end system by a natural person, with no further 
discretion by any computer system or algorithm) \179\ would not be 
considered Algorithmic Trading solely due to the use of risk filters. 
For example, existing Sec. Sec.  1.11 and 1.73 require FCMs and 
clearing member FCMs, respectively, to establish certain automated 
financial or risk-based controls, including limits based on position 
size, order size and margin requirements or capital, credit or volume 
thresholds. The application of such automated controls would not, on 
their own, cause an order to fall within the definition of Algorithmic 
Trading.
---------------------------------------------------------------------------

    \179\ See the discussion of front-end systems supra note 170.
---------------------------------------------------------------------------

    The Commission notes that ESMA's 2015 Final Draft Regulatory 
Standards address the distinction between ``investment decision 
algorithms'' (which make automated trading decisions by determining 
which assets to purchase or sell) and ``order execution algorithms'' 
(which optimize order execution processes by automatic generation and 
submission of orders or quotes to one or several trading venues once 
the investment decision is made). ESMA's standards provide that pure 
investment decision algorithms which generate orders that are only to 
be executed by non-automated means and with human intervention are 
excluded from ESMA testing requirements.\180\
---------------------------------------------------------------------------

    \180\ See ESMA September 2015 Final Draft Standards Report Annex 
1, supra note 80 at 201-02.
---------------------------------------------------------------------------

c. Request for Comments
    1. Is the Commission's definition of ``Algorithmic Trading'' 
generally consistent with what algorithmic trading is understood to 
mean in the industry? If not, please explain how it is inconsistent and 
how the definition should be modified. In your answer, please explain 
whether the definition inappropriately includes or excludes a 
particular type or aspect of trading.
    2. Should the Commission adopt a definition of ``Algorithmic 
Trading'' that is more closely aligned with any definition used by 
another regulatory organization?
    3. For purposes of the Commission's definition of Algorithmic 
Trading, is it necessary for the Commission to define ``computer 
algorithms or systems''? If so, please explain what should be included 
in such a definition.
    4. Should the Commission's definition of ``Algorithmic Trading'' 
include systems that only make determinations as to the routing of 
orders to different venues (which is contemplated in the proposed 
definition)? With respect to the definition of ``Algorithmic Trading,'' 
should the Commission differentiate between different types of 
algorithms, such as alpha-generating algorithms and order routing 
algorithms?
    5. Is the Commission's understanding correct that most entities 
using automated order routers will be using similar or related 
automated technology to determine other parameters of an order?
    6. The Commission posits a scenario in which an AT Person submits 
orders through Algorithmic Trading, and a non-clearing FCM or other 
entity acts only as a conduit for these AT Person orders. If the non-
clearing FCM or other entity does not make any determinations with 
respect to such orders, the conduit entity would not be engaged in 
Algorithmic Trading, as that definition is currently proposed. Should 
the definition of Algorithmic Trading be modified to capture a conduit 
entity such as a non-clearing FCM in this scenario, thereby making the 
entity an AT Person subject to Regulation AT? In other words, should 
non-clearing FCMs be required to manage the risks of AT Person 
customers? How would non-clearing FCMs do so if the non-clearing FCMs 
do not have risk controls comparable to the risk controls specified in 
proposed Sec.  1.82?
    7. The Commission, recognizing that natural person traders who 
manually enter orders also have the potential to cause market 
disruptions, is considering expanding the definition of Algorithmic 
Trading to encompass orders that are generated using algorithmic 
methods (e.g., an algorithm generates a buy or sell signal at a 
particular time), but are then manually entered into a front-end system 
by a natural person, who determines all aspects of the routing of the 
orders. Such order entry would not represent Algorithmic Trading under 
the currently proposed definition. The Commission requests comment on 
this proposed expansion of the definition of Algorithmic Trading, which 
the Commission may implement in the final rulemaking for Regulation AT. 
The Commission requests comment on the costs and benefits of this 
proposal, in addition to any other comments regarding the effectiveness 
of this proposal in terms of risk reduction.
2. ``Algorithmic Trading Compliance Issue''--Sec.  1.3(tttt)
a. Description of Regulation
    The Commission proposes to define three new, related terms: 
``Algorithmic Trading Compliance Issue,'' ``Algorithmic Trading 
Disruption,'' and ``Algorithmic Trading Event'' (which encompasses 
Algorithmic Trading Compliance Issues or Algorithmic Trading 
Disruptions). As a general matter, the proposed regulations contained 
in Regulation AT are intended to address the risks of automated 
trading. Malfunctioning or incorrectly deployed algorithms deploying 
erroneous messages to trading venues can significantly impact markets 
and market participants. The speed at which trading occurs can magnify 
the harm caused by a malfunctioning system, for example, in driving 
unwarranted price changes. The proposed definitions work in conjunction 
with proposed regulations requiring certain risk controls and other 
measures and are intended to describe the types of market disruptions, 
regulatory violations, or other events that Regulation AT is designed 
to prevent or mitigate.
    The three proposed terms Algorithmic Trading Compliance Issue, 
Algorithmic Trading Disruption, and Algorithmic Trading Event have 
analogues under Reg SCI's definitions of ``Systems compliance issue,'' 
``Systems disruption,'' and ``SCI event.'' \181\ The term ``SCI 
event,'' under Reg SCI, encompasses systems compliance issues and 
systems disruptions. Similar to Regulation AT, Reg SCI requires that an 
SCI entity's policies and procedures must include monitoring of systems 
to identify potential SCI events, and that SCI entities must establish 
escalation procedures to quickly inform responsible SCI personnel of 
potential SCI events.\182\
---------------------------------------------------------------------------

    \181\ See Reg SCI, supra note 40 at 72437.
    \182\ Id. at 72437.
---------------------------------------------------------------------------

    The term ``Algorithmic Trading Compliance Issue'' is defined in 
proposed Sec.  1.3(tttt), and means ``an event at an AT Person that has 
caused any Algorithmic Trading of such entity to operate in a manner 
that does not

[[Page 78842]]

comply with the CEA or the rules and regulations thereunder, the rules 
of any designated contract market to which such AT Person submits 
orders through Algorithmic Trading, the rules of any registered futures 
association of which such AT Person is a member, the AT Person's own 
internal requirements, or the requirements of the AT Person's clearing 
member, in each case as applicable.''
    The term is relevant to Regulation AT's pre-trade risk and other 
control requirements for AT Persons as provided in proposed Sec.  1.80, 
which requires the specified controls and measures to be reasonably 
designed to prevent or mitigate an ``Algorithmic Trading Event.'' The 
term Algorithmic Trading Event, as discussed below, means either an 
Algorithmic Trading Compliance Issue or an Algorithmic Trading 
Disruption. The defined term Algorithmic Trading Compliance Issue is 
also relevant to Regulation AT's proposed testing requirements on AT 
Persons. Specifically, proposed Sec.  1.81(c) requires each AT Person 
to establish procedures requiring its staff to review Algorithmic 
Trading systems in order to detect potential Algorithmic Trading 
Compliance Issues. Regulation Sec.  1.81(c) also would require a plan 
of internal coordination and communication between compliance staff of 
the AT Person and staff of the AT Person responsible for Algorithmic 
Trading designed to detect and prevent Algorithmic Trading Compliance 
Issues. Finally, proposed Sec.  40.20 requires a DCM to establish and 
maintain pre-trade and other risk controls reasonably designed to 
prevent the occurrence of an Algorithmic Trading Disruption (or similar 
disruption) or an Algorithmic Trading Compliance Issue. The proposed 
definition of Algorithmic Trading Compliance Issue was not discussed in 
the Concept Release.
b. Request for Comments
    8. Should the definition of Algorithmic Trading Compliance Issue be 
modified to include other potential compliance failures involving an AT 
Person that may have a significant detrimental impact on such AT 
Person, the relevant DCM, or other market participants?
3. ``Algorithmic Trading Disruption''--Sec.  1.3(uuuu)
a. Description of Regulation
    Regulation AT proposes a defined term ``Algorithmic Trading 
Disruption.'' The term is defined in new Sec.  1.3(uuuu), and means 
``an event originating with an AT Person that disrupts, or materially 
degrades, (1) the Algorithmic Trading of such AT Person, (2) the 
operation of the designated contract market on which such AT Person is 
trading or (3) the ability of other market participants to trade on the 
designated contract market on which such AT Person is trading.'' \183\ 
The Commission notes that it interprets clause (3) of the definition 
broadly (``an event originating with an AT Person that disrupts, or 
materially degrades . . . the ability of other market participants to 
trade on the designated contract market on which such AT Person is 
trading.'') Among other events that would meet the Commission's 
understanding of ``disrupts, or materially degrades,'' the Commission 
interprets clause (3) as including an event originating with an AT 
Person that prohibits other market participants from trading on the 
designated contract market on which such AT Person is trading.
---------------------------------------------------------------------------

    \183\ The Commission notes that, under this definition, an 
Algorithmic Trading Disruption may be the result of intentional or 
unintentional acts by an AT Person.
---------------------------------------------------------------------------

    The term Algorithmic Trading Disruption is relevant to Regulation 
AT's pre-trade risk and other control requirements for AT Persons and 
FCMs that are clearing members for a DCO, as provided in proposed 
Sec. Sec.  1.80 and 1.82(a), respectively. The controls and measures 
required by proposed Sec.  1.80 must be reasonably designed to prevent 
or mitigate an ``Algorithmic Trading Event,'' The term ``Algorithmic 
Trading Event,'' as discussed below, means either an ``Algorithmic 
Trading Compliance Issue'' or an ``Algorithmic Trading Disruption.'' 
The controls and measures required of clearing member FCMs in proposed 
Sec.  1.82(a), in contrast to those required of AT Persons in proposed 
Sec.  1.80, must be reasonably designed to prevent or mitigate only the 
narrower Algorithmic Trading Disruption. Finally, proposed Sec.  40.20 
requires a designated contract market to establish and maintain pre-
trade and other risk controls reasonably designed to prevent an 
Algorithmic Trading Disruption. The proposed definition of Algorithmic 
Trading Disruption was not discussed in the Concept Release.
b. Request for Comments
    9. Should the definition of Algorithmic Trading Disruption be 
modified to include other types of disruptive events that may originate 
with an AT Person?
    10. Should the definition be expanded to include other types of 
disruptive downstream consequences that may result from an Algorithmic 
Trading Disruption originating with an AT Person, and which may 
negatively impact the relevant designated contract market, other market 
participants, or other persons? Alternatively, should the scope of the 
definition be reduced, and if so, why?
    11. In addition, should the reference to ``materially degrades'' in 
the definition of Algorithmic Trading Disruption be expanded or 
otherwise modified to encompass other types of disruptions that may 
impact the relevant designated contract market, other market 
participants, or other persons? Please provide examples of real-world 
events originating with AT Persons (as defined under Regulation AT) 
that resulted in disruptions that may not be captured by the reference 
to ``materially degrades'' in the definition.
4. ``Algorithmic Trading Event''--Sec.  1.3(vvvv)
    Regulation AT proposes a new definition in Sec.  1.3(vvvv) 
(Algorithmic Trading Event) that means either an Algorithmic Trading 
Compliance Issue or an Algorithmic Trading Disruption. As noted above, 
the term Algorithmic Trading Event is used in proposed Sec.  1.80 
requiring AT Persons to implement risk controls that are reasonably 
designed to prevent or mitigate an ``Algorithmic Trading Event.'' The 
proposed definition is also used in rules under proposed Sec.  1.81(a) 
that require AT Persons to conduct regular back-testing of Algorithmic 
Trading using historical transaction, order, and message data to 
identify circumstances that may contribute to future Algorithmic 
Trading Events. The definition is also used in rules under proposed 
Sec.  1.81(b) that require AT Persons to conduct continuous real-time 
monitoring of Algorithmic Trading to identify potential Algorithmic 
Trading Events, and in rules under proposed Sec.  1.81(d) that require 
AT Persons to establish training procedures for communicating and 
escalating instances of Algorithmic Trading Events to the appropriate 
personnel. The proposed definition was not discussed in the Concept 
Release.
5. ``AT Order Message''--Sec.  1.3(wwww)
a. Description of Regulation
    The Commission is proposing to define an ``AT Order Message'' (new 
Sec.  1.3(wwww)) as each new order or quote submitted through 
Algorithmic Trading to a DCM by an AT Person and each change or 
deletion submitted through Algorithmic Trading by an AT

[[Page 78843]]

Person \184\ with respect to such an order or quote. This term is used 
in the proposed regulations requiring AT Persons, clearing member FCMs 
and DCMs to implement pre-trade risk controls and other measures with 
respect to AT Order Messages. The proposed controls include a maximum 
AT Order Message frequency per unit time, which is also known as a 
message throttle requirement.\185\ The Commission notes that its 
definition of AT Order Message is consistent with ESMA's definition of 
message in its HFT analysis.\186\ The proposed language does not impose 
specific requirements concerning the design of the AT Order Message 
throttle or the particular thresholds that must be used.
---------------------------------------------------------------------------

    \184\ The definition of AT Person is discussed in section 
IV.D.6.
    \185\ The regulation are proposed Sec. Sec.  1.80 (for AT 
Persons), 1.82 (for FCMs), 38.255(b) and (c) (for DCMs permitting 
direct electronic access), and 40.20 (for DCMs).
    \186\ Specifically, ESMA considered one message to mean ``each 
content that needs independent processing,'' and further explained 
that ``messages to be counted for these purposes are each new order 
or quote, each successful change to an order or quote and each 
successful deletion of an order or quote.'' See ESMA Technical 
Advice Final Report, supra note 78 at 320.
---------------------------------------------------------------------------

    The Commission believes that defining AT Order Message is necessary 
in proposed Sec. Sec.  1.80, 1.82, 38.255(b) and (c), and 40.20(a)(1) 
to specify the type of messages that should be subject to frequency 
controls. The Commission intends that required maximum message 
frequency controls would apply to new orders, order cancellations, and 
changes to important order terms that have the potential to impact the 
market.\187\ Notwithstanding the foregoing, while the definition of AT 
Order Message would only apply to order-related messages, the 
Commission recognizes that certain message types outside of the 
definition of AT Order Message may cause market disruptions by 
affecting the operation of a DCM's electronic matching platform. A DCM 
has the discretion to implement controls throttling excessive heartbeat 
\188\ or administrative-type messages if it believes that such controls 
are necessary to prevent fraud or manipulation or otherwise ensure the 
proper functioning of its electronic matching platform and market.
---------------------------------------------------------------------------

    \187\ Order terms that have the potential to impact the market 
might include, but are not limited to, changes to price, quantity, 
and order type.
    \188\ By ``heartbeat'' messages, the Commission means signals 
sent at regular intervals to ensure that the connection between the 
trading firm and the DCM's electronic matching platform is in a 
normal state.
---------------------------------------------------------------------------

    As discussed below, the Commission believes that requiring maximum 
order message frequencies at the trading firm, clearing member FCM and 
DCM levels serves important policy goals. Order entry frequencies that 
are much larger than intended could result in an accumulation or 
reduction of positions at speeds that outpace or overload associated 
risk management systems. Large quantities of unintended orders could 
also impact the market by increasing engine matching times or order 
submission latencies.
b. Request for Comments
    12. Please comment on the proposed scope of the Commission's 
definition of AT Order Message. Is the proposed definition too 
expansive, in that it would limit the submission of messages that do 
not have the potential to disrupt the market? Alternatively, is the 
scope of the AT Order Message too limited, in that it could allow 
messages not related to orders (i.e., heartbeat messages or requests 
for mass quotes) to intentionally or unintentionally flood the DCM's 
systems and slow down the matching engine? Please explain how this 
definition would be more appropriately limited or expanded.
6. ``AT Person''--Sec.  1.3(xxxx)
a. Description of Regulation
    The Concept Release did not specifically address whether 
regulations in the area of algorithmic trading should include a defined 
term ``AT Person.'' However, the Commission determined that such a 
defined term is necessary in order to identify which entities are 
subject to the proposed regulations addressing trading firms' 
management of the risks of algorithmic trading. These regulations 
include, for example, pre-trade and other risk controls on the orders 
initiated by the trading firm; development, testing and supervision 
standards; and the requirement to submit compliance reports regarding 
the new risk controls.
    The proposed definition under new Sec.  1.3(xxxx) lists those 
particular persons or entities that may be considered an AT Person: 
Persons registered or required to be registered as FCMs, floor brokers, 
SDs, MSPs, CPOs, CTAs, or IBs that engage in Algorithmic Trading on or 
subject to the rules of a DCM, or persons registered or required to be 
registered as floor traders as defined in Sec.  1.3(x)(3).\189\ 
Regulation Sec.  1.3(x)(3) is a proposed revision to the Commission's 
existing definition of floor trader, and is discussed in detail below 
(see section IV(E) below on Registration of Certain Persons Not 
Otherwise Registered with the Commission). Such persons or entities 
would be AT Persons if they engage in Algorithmic Trading on or subject 
to the rules of a DCM. See section IV(H) below for a more detailed 
discussion of which persons would be designated as AT Persons for 
purposes of proposed Sec.  1.80 and other regulations, and which 
persons would not be AT Persons, but would nonetheless be subject to 
proposed Sec.  1.82.
---------------------------------------------------------------------------

    \189\ As a result, any person who is required to be registered 
as one of these registration categories and who is engaged in 
Algorithmic Trading will be subject to all requirements of an AT 
Person under this regulation, regardless of whether such person has 
actually registered with the Commission.
---------------------------------------------------------------------------

b. Request for Comments
    13. The Commission notes that the FIA Guide recommends certain pre-
trade risk controls and contemplates three levels at which these 
controls can be placed: Automated trader, broker, and exchange. FIA 
defines ``automated trader'' as any trading entity that uses an 
automated system, including hedge funds, buy-side firms, trading firms, 
and brokers who deploy automated algorithms, and defines ``broker'' as 
FCMs, other clearing firms, executing brokers and other financial 
intermediaries that provide access to an exchange.
    a. Should the Commission's definition of ``AT Person'' explicitly 
include or exclude any of the classes of parties included in FIA's term 
``automated trader''? Please explain. Are there any types of entities 
not present in this list that should be included in the ``AT Person'' 
definition?
    b. Should Regulation AT use the term ``broker,'' as understood by 
FIA? If so, please explain. Is there another term that would be more 
appropriate in defining the scope of AT Persons?
    14. Algorithmic Trading carries technological and personnel costs, 
and the Commission expects that such trading will be performed by 
entities, not natural persons. Is this a reasonable assumption? For 
purposes of quantifying the number of AT Persons that will be subject 
to the regulations, do you believe that any AT Person (a definition 
that encompasses the following persons if engaged in Algorithmic 
Trading: FCMs, floor brokers, swap dealers, major swap participants, 
commodity pool operators, commodity trading advisors, introducing 
brokers, and newly registered floor traders using Direct Electronic 
Access) will be a natural person or a sole proprietorship with no 
employees other than the sole proprietor?
    15. The Commission recognizes that a CPO could use Algorithmic 
Trading to enter orders on behalf of a commodity pool which it 
operates. In these

[[Page 78844]]

circumstances, should the Commission consider the CPO that operates the 
commodity pool or the underlying commodity pool itself as ``engaged in 
Algorithmic Trading'' pursuant to the definition of AT Person? \190\
---------------------------------------------------------------------------

    \190\ The Commission notes that CPOs are separate legal entities 
from the underlying commodity pools which they operate.
---------------------------------------------------------------------------

    16. The Commission notes that pursuant to Sec.  1.57(b) of the 
Commission's regulations IBs may not carry proprietary accounts. 
However, certain customer relationships may cause an IB to fall under 
the definition of AT Person. The Commission requests comment on the 
types of IB customer relationships that could cause IBs to fall under 
the definition of AT Persons. What activities are currently being 
conducted by IBs that could cause an IB to be considered engaging in 
Algorithmic Trading on or subject to the rules of a DCM and would 
therefore cause the IB to be considered an AT Person?
    17. Should the definition of AT Person be limited to persons using 
DEA? In other words, should the definition capture persons registered 
or required to be registered as FCMs, floor brokers, SDs, MSPs, CPOs, 
CTAs, or IBs that engage in Algorithmic Trading on or subject to the 
rules of a DCM, or persons registered or required to be registered as 
floor traders as defined in Sec.  1.3(x)(3), in each case if such 
persons are using DEA? The Commission requests comment on the costs and 
benefits of this approach, including comments on whether this more 
limited definition of AT Persons would adequately mitigate the risks 
associated with algorithmic trading.
7. ``Direct Electronic Access''--Sec.  1.3(yyyy)
a. Concept Release Comments
    The Concept Release asked whether there are specific risk controls 
that should apply in the context of direct market access, and whether 
the implementation of risk controls should be modified in the context 
of direct market access.\191\
---------------------------------------------------------------------------

    \191\ See section II(B) above for a discussion of direct market 
access in the Concept Release.
---------------------------------------------------------------------------

    Several commenters agreed that any potential risk controls should 
also apply to those with direct access to the market.\192\ For example, 
FIA described market participants' access to markets as consisting of 
two broad categories: ``Direct ATS Participants,'' characterized by use 
of an ATS directly connected to a DCM without using an FCM's 
infrastructure to route orders, and ``Indirect ATS Participants,'' 
characterized by use of an ATS that routes orders through an FCM's 
infrastructure.\193\ FIA stated that all types of market access create 
risks; therefore, the same principles should apply to all types of 
market access.\194\ FIA also explained that since market participants 
may now access a DCM directly without passing through an FCM's 
infrastructure, ``the only consistent opportunity for risk control is 
at the DCM and the market participant.'' \195\
---------------------------------------------------------------------------

    \192\ FIA at 12, 15; KCG at 2; CME at 7-8; VFL at 2; AIMA at 1.
    \193\ FIA at 8-9.
    \194\ FIA at 12, 15.
    \195\ FIA at 8-9; 61-62.
---------------------------------------------------------------------------

    Additional commenters made similar points. CME stated that all 
entities--whether they have direct market access or not--must ``share 
in the effort to preserve market integrity.'' \196\ ICE explained that 
it treats every order and trade equally regardless of connection method 
or participant type.\197\ KCG Holdings, Inc. (``KCG'') commented that 
``any pre-trade risk control requirements [must] be applied so as to 
not permit market participants to avoid their application based on the 
manner in which the participant accesses the market.'' \198\ VFL 
commented that ``the privilege of direct exchange access should bring 
with it the obligation to deploy a system designed to protect the 
integrity of the marketplace.'' \199\ VFL explained that all exchange 
members should be required to employ pre- and post-trade risk controls, 
and all non-members should be required to access exchanges only through 
a member's risk control layer.\200\
---------------------------------------------------------------------------

    \196\ CME at 7-8.
    \197\ ICE at 2.
    \198\ KCG at 2.
    \199\ VFL at 2.
    \200\ See id.
---------------------------------------------------------------------------

b. Description of Regulation
    Consistent with the comments discussed above, the Commission 
proposes a new Sec.  1.3(yyyy) that defines ``Direct Electronic 
Access'' (``DEA'') and, through other proposed rules, requires that AT 
Order Messages originating with an AT Person and submitted by AT 
Persons through such DEA be subjected to the same types of pre-trade 
and other risk controls that such orders would pass through if they 
flowed through the infrastructure of an FCM before entering the market.
    The Commission notes that the Concept Release used the term 
``direct market access,'' or ``DMA,'' and such term is commonly used in 
industry. The Commission intends that ``Direct Electronic Access'' be 
consistent with the term ``direct market access'' as it is used in 
Commission-regulated markets. The Commission determined to employ the 
term Direct Electronic Access, as opposed to direct market access, in 
the interest of regulatory consistency. The term ``Direct Electronic 
Access'' by FCM customers is used in existing Regulation 38.607, where 
it is described as ``allowing customers of futures commission merchants 
to enter orders directly into a designated contract market's trade 
matching system for execution.'' \201\
---------------------------------------------------------------------------

    \201\ In addition, in the context of foreign boards of trade, 
Section 4(b)(1)(A) of the CEA defines ``direct access'' as ``an 
explicit grant of authority by a foreign board of trade to an 
identified member or other participant located in the United States 
to enter trades directly into the trade matching system of the 
foreign board of trade.''
---------------------------------------------------------------------------

    The Commission proposes that the term ``Direct Electronic Access'' 
means an arrangement where a person electronically transmits an order 
to a DCM, without the order first being routed through a separate 
person who is a member of a DCO to which the DCM submits transactions 
for clearing. By ``routed,'' the Commission means the process by which 
an order physically goes from a customer to a designated contract 
market.\202\ As indicated below, the Commission requests comment on its 
definition of DEA and whether there are particular scenarios where it 
would be unclear whether a customer is trading through DEA.
---------------------------------------------------------------------------

    \202\ The Commission notes that the operative element of DEA is 
submission of an order to a DCM without the order first being routed 
through a separate person who is a member of a DCO to which the DCM 
submits transactions for clearing. Other factors, such as co-
location, or use of FCM-provided software, are not on their own 
determinative of whether a customer is submitting orders through 
DEA.
---------------------------------------------------------------------------

    DEA is relevant to several of the proposed regulations. As 
explained below, DEA is used as a filter to help define a new category 
of market participants required to register as floor traders and be 
subject to the requirements of Regulation AT (see proposed Sec.  
1.3(x)(3), discussed below). In addition, the term DEA is relevant to 
revised Sec.  38.255, which would require DCMs to have in place systems 
and controls reasonably designed to facilitate FCM's management of the 
risks that may arise from Algorithmic Trading, and proposed Sec.  1.82, 
which requires FCMs to implement such DCM-provided controls for DEA 
orders. This approach recognizes that when DEA is used, clearing FCMs 
do not have the ability to apply market risk controls to orders they 
receive for clearing before these orders reach the DCM. This approach 
of enabling clearing FCMs to implement DCM-based controls is

[[Page 78845]]

similar to how the Commission addresses financial risk management by 
FCMs, as reflected in existing DCM regulation Sec.  38.607.
    The Commission's proposed definition of DEA differs from SEC, ESMA 
and IOSCO terminology. The SEC characterizes ``direct market access'' 
as an arrangement whereby a broker-dealer permits customers to enter 
orders into a trading center but such orders flow through the broker-
dealer's trading systems prior to reaching the trading center.\203\ 
``Sponsored access'' generally refers to an arrangement whereby a 
broker-dealer permits customers to enter orders into a trading center 
that bypass the broker-dealer's trading system and are routed directly 
to a trading center, in some cases supported by a service bureau or 
other third-party technology provider.\204\ ``Unfiltered'' or ``naked'' 
access is a subset of sponsored access, where pre-trade filters or 
controls are not applied to orders before such orders are submitted to 
an exchange or ATS.\205\ Similarly, ESMA and IOSCO refer to ``direct 
electronic access'' as including direct market access and sponsored 
access; ``direct market access,'' as an arrangement where a member of a 
trading venue provides a connecting system to a person to transmit 
orders; and ``sponsored access'' as an arrangement where such an 
infrastructure is not used by a person.\206\ While the Commission's 
proposed terminology differs from that used by other regulatory 
organizations, the Commission believes that its defined term DEA is 
consistent with existing Commission regulations. References to ``DEA'' 
and ``Direct Electronic Access'' throughout this preamble shall refer 
to the term proposed in Sec.  1.3(yyyy).
---------------------------------------------------------------------------

    \203\ See Risk Management Controls for Brokers or Dealers With 
Market Access, 75 FR 69792, 69793 (Nov. 15, 2010).
    \204\ See id.
    \205\ See id.
    \206\ ESMA Technical Advice Final Report supra note 78 at 340; 
IOSCO 2015 Consultation Report, supra note 106 at 20 n.56.
---------------------------------------------------------------------------

c. Request for Comments
    18. Please explain whether the Commission's proposed definition of 
DEA will encompass all types of access commonly understood in 
Commission-regulated markets as ``direct market access.'' In light of 
the proposed regulations concerning pre-trade and other risk controls 
and standards for the development, testing and supervision of 
algorithmic trading systems, do you believe that the proposed 
definition of Direct Electronic Access is too limited (or, 
alternatively, too expansive)? If so, please explain why and how the 
definition should be revised.
    19. Should the Commission define ``routed'' in its definition of 
DEA? If so, how? Are there specific examples of trading or routing 
arrangements where it would be unclear whether trading was performed 
through DEA?
    20. Should the Commission use the term ``direct market access'' 
instead of DEA, and if so why?
    21. Should the Commission define sub-categories of DEA, such as 
sponsored market access?
    22. The Commission's proposed definition of DEA in Sec.  1.3(yyyy) 
differs from definitions of direct electronic access in Sec.  38.607 
and direct access for FBOTs in Sec.  48.2(c). The Commission believes 
that the more technical definition in proposed 1.3(yyyy) is appropriate 
for Regulation AT. The Commission solicits comment regarding proposed 
1.3(yyyy), whether all definitions of ``direct'' access should be 
harmonized across the Commission's rules, and if so how. Do you believe 
that two definitions would create confusion with respect to Commission 
requirements as to direct electronic access? With respect to Sec. Sec.  
1.80, 1.82 and 38.255(b) and (c) provisions imposing risk control 
requirements on AT Persons, FCM and DCMs, should the Commission use the 
existing definition of direct electronic access provided in Sec.  
38.607?

E. Registration of Certain Persons Not Otherwise Registered With 
Commission--Sec.  1.3(x)

    The Commission proposes to amend the definition of ``Floor trader'' 
in Commission regulation 1.3(x), in order to facilitate the 
registration of proprietary traders using DEA for Algorithmic Trading 
on a DCM. Such persons would be required to register as Floor traders 
pursuant to proposed Sec.  1.3(x)(3), assuming that they were not 
already registered or required to register with the Commission in 
another capacity. The remainder of this section presents Concept 
Release comments on this topic, a description of the proposed 
regulation, a discussion of the policy justification for the proposal, 
and a request for comments on the proposal.
1. Concept Release Comments
    The Concept Release requested comment on whether all firms 
operating ATSs to trade solely for their own account should be required 
to register with the Commission. As discussed in greater detail below, 
a registration requirement for firms operating ATSs and not otherwise 
registered with the Commission would enhance the Commission's oversight 
capabilities and allow for wider implementation of some or all of the 
pre-trade controls and risk management tools discussed in this NPRM and 
currently used in the market today. In particular, registration will 
help ensure that all market participants that actively trade on 
Commission-regulated markets implement appropriate controls, including 
those trading firms that access the market directly and use algorithmic 
trading systems that could malfunction and create systemic risk to all 
market participants.
    In the Concept Release, the Commission requested specific comment 
on whether firms operating ATSs to trade solely for their own account 
would meet the definition of ``floor trader'' in Section 1a(23) of the 
Act, and whether registering such firms as floor traders would 
effectuate the purposes of the Act. The ``floor trader'' definition in 
CEA 1a(23) states that, in general, the term ``floor trader'' means any 
person who, in or surrounding any pit, ring, post or other place 
provided by a contract market for the meeting of persons similarly 
engaged, purchases, or sells solely for such person's own account.\207\ 
Given the evolution of futures trading over recent years, electronic 
trading platforms have now become a primary ``other place'' in which 
proprietary market making and trading generally, takes place.
---------------------------------------------------------------------------

    \207\ CEA Section 1a(23)(A) provides that the term ``floor 
trader,'' in general, means any person (i) who, in or surrounding 
any pit, ring, post, or other place provided by a contract market 
for the meeting of persons similarly engaged, purchases, or sells 
solely for such person's own account (I) any commodity for future 
delivery, security futures product, or swap; or (II) any commodity 
option authorized under section 4c; or (ii) who is registered with 
the Commission as a floor trader. A further definition of the term 
``floor trader'' is provided for by Section 1a(23)(B), which states 
that the Commission, by rule or regulation, may include within, or 
exclude from, the term ``floor trader'' any person in or surrounding 
any pit, ring, post, or other place provided by a contract market 
for the meeting of persons similarly engaged who trades solely for 
such person's own account if the Commission determines that the rule 
or regulation will effectuate the purposes of the Act. 7 U.S.C. 
1a(23).
---------------------------------------------------------------------------

    Seven commenters (including FIA, CME, MFA and the Chicago Fed) 
opposed registration for reasons including: DCMs already use Operator 
IDs; the DCM audit trail already satisfies the goals of registration; 
implementing the Commission's final rule on ownership and control 
reporting (``OCR'') will provide additional information on trading 
identities; and the Commission already has access to trade data (i.e., 
Regulation 1.40 and part 38's mandate that DCMs require market 
participants to submit to a DCM's

[[Page 78846]]

jurisdiction).\208\ In response to the Concept Release question seeking 
information concerning whether firms operating ATSs would meet the 
definition of ``floor trader'' under the CEA, CME and Gelber stated 
that the term floor trader is an anachronism that is irrelevant to 
automated trading environments.\209\
---------------------------------------------------------------------------

    \208\ FIA at 43-46; CME at 32-34; Gelber at 22-24; KCG at 18; 
MFA at 3; AIMA at 2, 24; Chicago Fed at 3.
    \209\ CME at 34; Gelber at 22-24.
---------------------------------------------------------------------------

    In contrast, Better Markets, AFR, and TCL supported ATS 
registration.\210\ AFR stated that ``[t]he enhancement of investigative 
authority is extraordinarily important given that the Commission staff 
would often need to involve itself in the workings of the ATSs to 
anticipate problems and to detect and investigate problems that have 
occurred. HFT firms should have the highest priority.'' \211\
---------------------------------------------------------------------------

    \210\ Better Markets at 13; AFR at 8-9; TCL at 17.
    \211\ AFR at 8-9.
---------------------------------------------------------------------------

    Finally, AIMA and VFL supported registration for participants with 
direct market access.\212\ VFL commented that if an exchange provides a 
participant the ability to connect directly, then that participant 
enjoys all of the rights of a member and should be regulated at the 
federal and exchange level.\213\ Finally, while Chicago Fed opposed a 
requirement that ATSs register with the Commission, it suggested that 
participants with direct market access must register with the 
exchange.\214\
---------------------------------------------------------------------------

    \212\ AIMA at 24; VFL at 3.
    \213\ VFL at 3.
    \214\ Chicago Fed at 4.
---------------------------------------------------------------------------

2. Description of Regulation
    The Commission proposes to require the registration of proprietary 
traders using DEA for Algorithmic Trading on a DCM. As discussed in 
greater detail in section 3 below, registration of entities with DEA as 
floor traders would mean that such firms must implement the pre-trade 
controls and risk management tools that Regulation AT requires of AT 
Persons. If the Commission were to only require those firms that are 
already registered with the Commission to implement such controls, some 
market participants conducting Algorithmic Trading on Commission-
regulated markets would not be subject to the Commission's risk control 
requirements.
    In order to achieve registration of proprietary traders using DEA 
for Algorithmic Trading on a DCM, the Commission proposes amending the 
definition of ``Floor trader'' in Commission regulation 1.3(x). The 
amended definition would expressly include any person who purchases or 
sells futures or swaps solely for such person's own account in a place 
provided by a contract market for the meeting of persons similarly 
engaged, where such place is accessed by such person in whole or in 
part through DEA (as defined in proposed Sec.  1.3(yyyy)) for 
Algorithmic Trading, and such person is not otherwise registered with 
the Commission as a futures commission merchant, swap dealer, floor 
broker, major swap participant, commodity pool operator, commodity 
trading advisor, or introducing broker. The Commission notes, however, 
that persons otherwise registered or required to register with the 
Commission in another capacity (e.g., as a swap dealer) would not be 
exempt from such registration simply by registering as a Floor trader 
pursuant to proposed Sec.  1.3(x)(3).
    CEA 1a(23) states that the term ``floor trader'' means any person 
who, in or surrounding any pit, ring, post or other place provided by a 
contract market for the meeting of persons similarly engaged, 
purchases, or sells solely for such person's own account.\215\ The term 
was added to the Act in the Futures Trading Practice Act of 1992 (the 
``1992 Act'').\216\ The 1992 Act also amended Section 4e of the Act to 
require registration of floor traders, and tasked the Commission with 
issuing rules to implement the requirement within 180 days of the date 
of enactment.
---------------------------------------------------------------------------

    \215\ See supra note 207.
    \216\ Futures Trading Practices Act of 1992, Pub. L. 102-546, 
106 Stat. 3590, 3625-28 (1992).
---------------------------------------------------------------------------

    In 1993, pursuant to the 1992 Act, the Commission finalized rules 
regarding registration of floor traders.\217\ The Commission 
established a definition for the term ``floor trader'' in Regulation 
1.3(x). The Commission noted in the preamble to that final rule that 
``certain persons trading through electronic systems come within the 
[floor trader] definition.'' \218\ Given the prevalence of pit trading 
in 1992 and the short time frame to implement floor trader 
registration, the Commission determined to require registration for 
floor traders operating ``on the trading floor of an exchange'' and 
``to defer consideration of the application of floor trader 
registration requirements to persons using electronic trading systems 
and to reconsider the subject at a later date.'' \219\ The Commission 
expressly stated that, ``[i]n order to preserve flexibility in this 
area, the definition of floor trader in Rule 1.3(x) states that it 
shall include any person required to register as [a floor trader] by 
rule or regulation of the Commission pertaining to the operation of an 
electronic trading system.'' \220\
---------------------------------------------------------------------------

    \217\ Registration of Floor Traders; Mandatory Ethics Training 
for Registrants; Suspension of Registrants Charged with Felonies, 58 
FR 19575 (1993) (hereinafter ``Registration of Floor Traders 
Rule'').
    \218\ Id. at 19576.
    \219\ Id.
    \220\ Id.
---------------------------------------------------------------------------

    On July 21, 2010, President Obama signed the Dodd-Frank Wall Street 
Reform and Consumer Protection Act (``Dodd-Frank Act'').\221\ Title VII 
of the Dodd-Frank Act amended the CEA definition of ``floor trader.'' 
\222\ This amendment maintained the language from the 1992 Act defining 
a floor trader as a person ``who, in or surrounding any pit, ring, 
post, or other place provided by a contract market . . . for the 
meeting of persons similarly engaged, purchases, or sells solely for 
such person's own account'' any commodity for future delivery. However, 
the amended definition also applied to trading in swaps, and provided 
that the definition includes ``anyone who is registered with the 
Commission as a floor trader.'' Finally, the amendment allows for the 
Commission by regulation to include within the definition or exclude 
from the definition anyone who meets the statutory definition. 
Subsequently, the Commission amended the definition of floor trader in 
Rule 1.3(x) to precisely mirror the language contained in section 
1a(23)(A) of the Act.\223\
---------------------------------------------------------------------------

    \221\ Dodd-Frank Wall Street Reform and Consumer Protection Act, 
Pub. L. 111-203, 124 Stat. 1376 (2010).
    \222\ See supra note 207.
    \223\ See Final Rule, Adaptation of Regulations to Incorporate 
Swaps, 77 FR 66288, 66317 (Nov. 2, 2012).
---------------------------------------------------------------------------

3. Policy Discussion
    In order to enhance the Commission's oversight capabilities as they 
relate to entities with DEA and allow for wider implementation of some 
or all of the pre-trade controls and risk management tools discussed in 
this NPRM and currently used in the market today, the Commission 
proposes amending Regulation 1.3(x) to expressly include such firms 
within the definition of ``floor trader.'' The Commission emphasizes 
that the ``floor trader'' definition is not being expanded to capture 
all proprietary traders engaged in Algorithmic Trading; rather, the 
revised floor trader definition is limited to firms using DEA to engage 
in Algorithmic Trading. Historically, pursuant to the Commission's 
preamble discussion in the Registration of Floor Traders Rule and the 
original formulation of Regulation 1.3(x) discussed above, the 
Commission has

[[Page 78847]]

only required registration of floor traders conducting business on the 
physical trading floor of an exchange. However, the Act contemplates 
floor traders in ``other places'' besides the trading floor, and the 
Commission has previously noted that the Act's definition applies to 
persons using electronic trading systems.\224\
---------------------------------------------------------------------------

    \224\ Registration of Floor Traders Rule, 58 FR at 19576. 
Further, the Commission notes that it is not the first to observe 
the degree to which the tangible technological infrastructure 
provided by DCMs for trading, including for example electronic trade 
matching platforms or co-location or proximity hosting facilities, 
can constitute a ``place.'' Futures Industry magazine, a publication 
of FIA, noted the following in a 2007 article describing co-location 
and proximity hosting: ``[t]he pit is back. Just a few years since 
the concept of a commodity exchange as a tangible `place' had begun 
to seem hopelessly old-fashioned, many traders now want to be at the 
heart of the action once more. At Eurex, customers that until 
recently were scattered all over the globe are moving closer to the 
exchange, `forming a physical community like a pit again,' says 
Matthias Kluber, head of networks and infrastructure operations at 
Deutsche B[ouml]rse Systems, which builds and operates the Eurex 
trading and clearing systems.'' See Bennet Voyles, Co-Location 
Catches On, Futures Industry (July/Aug. 2007) at 28, available at: 
https://secure.fia.org/downloads/Jul-Aug_Colocatiion.pdf.
---------------------------------------------------------------------------

    Registration of entities with DEA as floor traders would enhance 
the pre-trade controls and risk management tools discussed elsewhere in 
this NPRM by making such entities subject to the various regulations 
governing AT Persons under the NPRM. For example, the pre-trade risk 
controls listed in proposed Sec.  1.80--maximum AT Order Message 
frequencies per unit time, maximum execution frequencies per unit time, 
order price parameters and maximum order size limits--must be 
established and used by all AT Persons. If the Commission were to only 
require those firms that are already registered with the Commission to 
implement such controls, it would be ignoring a significant number of 
market participants that actively trade on Commission-regulated 
markets, each of which has ATSs that could malfunction and create 
systemic risk to all market participants. Registration as floor traders 
would also require entities using DEA, as AT Persons, to maintain 
certain books and records, thus enhancing the Commission's ability to 
gather information.
    The Commission estimates that there are approximately one hundred 
proprietary trading firms engaged in Algorithmic Trading in Commission-
regulated markets. Some of these firms may already be registered with 
the Commission in some capacity. In the event that one of these firms 
engaged in Algorithmic Trading is already registered with the 
Commission, the firm would be considered an AT Person under clause (1) 
of the proposed definition of AT Person, and would not be required to 
also register as a floor trader. The proposed requirement under revised 
Sec.  1.3(x) is intended to require firms not otherwise registered to 
become registered with the Commission. Given that a technological 
malfunction in a single trading firm's systems can significantly impact 
other markets and market participants, the proposed registration 
requirement is critical to ensuring that all such firms are subject to 
appropriate risk control, testing, and other requirements of Regulation 
AT.
4. Request for Comments
    23. Should firms operating Algorithmic Trading systems in CFTC-
regulated markets, but not otherwise registered with the Commission, be 
required to register with the CFTC? If not, what alternatives are 
available to fully effectuate the purpose and design of Regulation AT?
    24. Should all firms deploying Algorithmic Trading systems be 
required to register with the Commission? Are there additional 
characteristics of AT Persons that should be taken into consideration 
for registration purposes? For example, should the Commission limit 
registration to trading firms meeting certain trading volume, order or 
message levels? In other words, should there be a minimum volume, order 
or message test in order to meet the definition of ``floor trader,'' or 
otherwise to meet the definition of AT Person? If so, what should be 
measured and what specific thresholds should be used?
    25. In the alternative, should the Commission broaden the 
registration requirements in proposed Sec.  1.3(x)(3)(ii) so that all 
persons trading on a contract market through DEA are required to 
register, instead of only those who are engaged in Algorithmic Trading?
    26. Please supply any information or data that would help the 
Commission in deciding whether firms may or may not meet the definition 
of ``floor trader'' in Section 1a(23) of the Act.
    27. Do you believe that the registration of such firms as ``floor 
traders'' would help effectuate the purposes of the CEA to deter and 
detect price manipulation or any other disruptions to market integrity? 
If you believe that registration of such firms will not help effectuate 
the purposes of the CEA, or that the same purposes can be achieved by 
other means, please explain.

F. RFA Standards for Automated Trading and Algorithmic Trading 
Systems--Sec.  170.19

    To fully effectuate the design and intent of Regulation AT, the 
Commission is proposing a new Sec.  170.19 requiring RFAs to adopt 
certain membership rules--as deemed appropriate by the RFA--relevant to 
algorithmic trading for each category of member in the RFA. RFAs would 
have discretion as to the rules they issue and the categories of 
members to which their rules apply. Further, to ensure that all AT 
Persons are subject to rules of an RFA regarding algorithmic trading, 
the Commission is also proposing a new Sec.  170.18 requiring AT 
Persons to become members of at least one RFA. Proposed Sec.  170.18 is 
discussed in detail in section G below. Taken together, Sec. Sec.  
170.18 and 170.19 would allow RFAs to supplement elements of Regulation 
AT as markets and trading technologies evolve over time, and allow 
frontline regulators to drive future incremental enhancements to the 
Commission's basic regulatory structure for algorithmic trading by AT 
Persons.
1. Policy Discussion
    In developing Regulation AT, the Commission sought to balance 
meaningful regulatory baselines against the need for standards 
sufficiently flexible to keep pace with changing industry practices and 
technologies. The Commission's determination to balance both interests 
is particularly reflected in its treatment of AT Persons and in 
proposed Sec. Sec.  1.80, 1.81, and 1.82, which address: (1) Pre-trade 
risk controls and other measures for ATSs; (2) standards for the 
development, testing, monitoring, and compliance of ATSs; (3) 
designation and training of algorithmic trading staff; and (4) clearing 
FCM risk management. A number of the proposed sections and subsections 
in these rules include well-established risk control and other 
practices among market participants. The proposed pre-trade risk 
controls in Sec.  1.80(a), for example, are generally limited to risk 
controls identified as best practices by FIA in 2015, and the text of 
the rules is intentionally flexible so that AT Persons may determine 
for themselves how required pre-trade risk controls and other measures 
should be designed and calibrated. Other proposed rules addressing AT 
Persons offer flexibility in that they require AT Persons to implement 
specific programs, but provide latitude regarding how such programs are 
to be designed. Thus, proposed Sec.  1.81(a)(1)(vi) requires AT Persons 
to maintain a source code

[[Page 78848]]

repository to manage source code access, persistence, copies of 
production code, and changes to production code, but does not impose a 
prescriptive standard for how the source code repository must be 
structured or maintained. Similarly, proposed Sec. Sec.  
1.81(a)(1)(iii) and (a)(1)(iv) require regular back testing of 
Algorithmic Trading and stress testing of ATSs, but impose no specific 
testing protocols and do not specify a minimum testing frequency. The 
Commission also notes the existence of numerous other pre and post-
trade risk controls and measures available to AT Persons but not 
incorporated as requirements in Regulation AT. Some, such as drop-copy 
reporting, were raised in the Concept Release, and others were 
addressed in responsive public comments.
    The Commission has determined to focus in Regulation AT on areas 
where the safety and soundness of derivatives markets would benefit 
from a core set of pre-trade risk controls and other measures 
applicable to all AT Persons. As noted above, the Commission believes 
that effective rules for AT Persons are best structured as clear 
regulatory requirements combined with embedded flexibility to adapt to 
changing markets and technologies. Accordingly, the Commission's 
proposed rules in Sec. Sec.  1.80, 1.81, and 1.82 address only a subset 
of potentially responsive risk controls and other measures. Each AT 
Person shall also determine what additional safeguards would be 
reasonably designed to prevent an Algorithmic Trading Event given its 
trading strategies, technologies, or the markets in which it 
participates. The proposed rules also provide a degree of flexibility 
regarding the design, implementation, or calibration of those pre-trade 
risk control or other measures that are specifically required in 
Sec. Sec.  1.80, 1.81, and 1.82, again allowing each AT Person to adapt 
the rules to its own trading and technology.
    Given the structure of proposed Sec. Sec.  1.80, 1.81, and 1.82 as 
regulatory baselines with a degree of embedded flexibility, the 
Commission has determined to provide RFAs with a discretionary role in 
augmenting the requirements of Regulation AT for AT Persons.\225\ RFAs 
serve a vital regulatory function as frontline regulators of their 
members, which would include all AT Persons pursuant to proposed Sec.  
170.18. RFAs promulgate binding membership rules and can supplement 
Commission rules as appropriate. RFAs can also operate examination 
programs to monitor members' compliance with association rules, and can 
sanction members for non-compliance. The Commission believes that RFAs 
are well-positioned to address rules in areas experiencing rapid 
evolution in market practices and technologies, including particularly 
Sec. Sec.  1.80, 1.81, and 1.82. Proposed Sec.  170.19 is described 
below.
---------------------------------------------------------------------------

    \225\ The Commission notes an exception in proposed Sec.  1.83, 
which requires the submission of annual reports from AT Persons and 
their clearing FCMs to DCMs.
---------------------------------------------------------------------------

2. Description of Regulation
    Proposed Sec.  170.19 would require RFAs to (1) establish and 
maintain a program (2) for the prevention of fraudulent and 
manipulative acts and practices, the protection of the public interest, 
and perfecting the mechanisms of trading on DCMs (3) by adopting rules 
for each category of member, as deemed appropriate by the RFA, 
requiring: (i) Pre-trade risk controls and other measures for ATSs 
(Sec.  170.19(a)(1)); (ii) standards for the development, testing, 
monitoring, and compliance of ATSs (Sec.  170.19(a)(2)); (iii) 
designation and training of algorithmic trading staff (Sec.  
170.19(a)(3)); and (iv) operational risk management standards for 
clearing member FCMs with respect to customer orders originating with 
ATSs (Sec.  170.19(a)(4)). With respect to rules (prong 3 above), the 
areas RFAs must address pursuant to proposed Sec.  170.19 are similar 
to those that AT Persons and clearing FCMs must address in proposed 
Sec. Sec.  1.80, 1.81, and 1.82. RFAs, however, would be required in 
Sec.  170.19 to consider whether additional rules or granularity are 
appropriate as baseline SRO requirements and binding membership rules 
for one or more categories of RFA members.\226\ The Commission notes 
that Sec.  170.19 would require that RFAs consider the need for 
additional rules, and issue such rules where appropriate. However, 
Sec.  170.19 would not require RFAs to issue any rules pursuant to 
Sec.  170.19 where the RFA believes they are unnecessary. Rather, the 
proposed regulation leaves discretion to the RFAs to determine what 
rules would prevent fraudulent and manipulative acts and practices, 
protect the public interest, and perfect the mechanisms of trading on 
DCMs.
---------------------------------------------------------------------------

    \226\ In this regard, the Commission distinguishes an RFA's 
obligation to establish memberships rules--i.e., mandatory 
requirements for all persons in the relevant membership category--
from steps that a single AT Person or clearing member FCM may 
voluntary take to augment its pre-trade risk controls or other 
measures based on its unique trading or technology and its 
obligations pursuant to proposed Sec. Sec.  1.80, 1.81, and 1.82.
---------------------------------------------------------------------------

    When evaluating potential membership rules regarding algorithmic 
trading, proposed Sec.  170.19 would also require RFAs to consider how 
such rules could help prevent fraudulent and manipulative acts, protect 
the public interest, and perfect the mechanisms of trading on DCMs 
(prong 2 above). The Commission believes that these are important 
elements in the requirements proposed to be codified in Sec.  170.19. 
RFAs should be cognizant, for example, of the overarching requirement 
in proposed Sec.  1.80 that AT Persons take steps reasonably designed 
to prevent an Algorithmic Trading Event, defined in proposed Sec.  
1.3(vvvv) to include both Algorithmic Trading Compliance Issues and 
Algorithmic Trading Disruptions. Algorithmic Trading Compliance Issues 
include events at an AT Person that cause its algorithmic trading to 
operate in a manner that does not comply with the CEA, Commission 
regulations, or the rules of a DCM. Algorithmic Trading Disruptions 
include events originating with an AT Person that disrupt or materially 
degrade the operation of a DCM or the ability of other market 
participants to trade on the DCM. In short, an AT Person's algorithmic 
trading should neither disrupt the market nor violate law. RFAs should 
consider these factors when determining whether and what further rules 
they may promulgate over time pursuant to Sec.  170.19.
    Proposed Sec.  170.19 would require an RFA to ``establish and 
maintain a program'' (prong 1 above) for the prevention of fraud and 
manipulation, protection of the public interest, and perfecting the 
mechanisms of trading on DCMs. The Commission anticipates that an RFA 
would include in its routine examinations of members pursuant to such 
program a verification that such members are complying with any rules 
that the RFA may determine to issue pursuant to proposed Sec.  170.19. 
The Commission intends for proposed Sec.  170.19 to provide RFAs with a 
wide measure of latitude in both the rules they may elect to adopt and 
in the members to whom they apply such rules. It is the Commission's 
further intent that RFAs consider the need for rules pursuant to 
proposed Sec.  170.19, and that they adopt such rules where the RFA 
considers it necessary. However, the determination as to both the 
necessity of rules and their application to specific categories of 
members remains with the RFA.
    Finally, the Commission notes that while proposed Sec.  170.19 
would require RFAs to issue rules as they deem appropriate, RFAs would 
remain free to take other steps when potential rules regarding 
algorithmic trading are not yet ripe. As both membership and self-

[[Page 78849]]

regulatory organizations, RFAs are uniquely positioned to gain insights 
from members through examination programs and coordination with other 
self-regulatory or standard-setting bodies. In addition to rulemaking 
when necessary, RFAs could leverage these resources to issue guidance 
or best practices, hold periodic discussions with relevant 
stakeholders, and otherwise provide leadership as risks, risk control 
technologies, market practices evolve over time. The Commission also 
affirms that proposed Sec.  170.19 is not intended to create 
conflicting obligations between an RFA's role in establishing 
algorithmic trading standards for its members and a DCM's role as a 
self-regulatory organization. Accordingly, the requirements of proposed 
Sec.  170.19 specifically address pre-trade risk controls for ATSs, 
standards for the designing, testing, monitoring, and supervision of 
ATSs, and the designation and training of algorithmic trading staff. 
The Commission believes that these areas are appropriate for potential 
future standards issued by an RFA in an evolving technological and 
market environment, and that such standards will be best implemented as 
uniform requirements of an RFA for its relevant members as opposed to 
potentially varying approaches by individual DCMs.
3. Request for Comments
    28. The Commission requests comment on the scope of 
responsibilities assigned to RFAs under proposed Sec.  170.19. Should 
RFAs be responsible for fewer or additional areas regarding AT Persons, 
ATSs, and algorithmic trading than specified in proposed Sec.  170.19, 
prongs (1), (2), (3), and (4) (Sec.  170.19(a)(1)-(a)(4))? Regulation 
170.19 requires RFAs to consider the need for rules in the areas listed 
in prongs (1)-(4) (Sec.  170.19(a)(1)-(a)(4)). Should RFAs be 
responsible for considering whether to adopt rules in fewer or 
additional areas?
    29. The Commission requests comment on the latitude afforded to 
RFAs in proposed Sec.  170.19. Should RFAs have more or less latitude 
to issue rules than specified in proposed Sec.  170.19?
    30. The Commission requests comment on RFAs' obligation in proposed 
Sec.  170.19 to establish and maintain a program for the prevention of 
fraud and manipulation, protection of the public interest, and 
perfecting the mechanisms of trading, including through rules it may 
determine to adopt pursuant to Sec.  170.19. The proposed rules 
anticipate that an RFA's program will include examination and 
enforcement components. Is this the appropriate approach?
    31. The Commission requests comment on whether proposed Sec.  
170.19 may result in duplicative obligations on AT Persons or any other 
market participant. In particular, please comment on potential 
duplication, if any, between algorithmic trading requirements that an 
RFA may impose upon its members pursuant to Sec.  170.19, and similar 
requirements that may be imposed by a DCM in its role as a self-
regulatory organization. What amendments would be appropriate in any 
final rules arising from this NPRM to clarify that unintended overlap 
between the role of an RFA and a DCM in this context?

G. AT Persons Must Become Members of an RFA--Sec.  170.18

1. Policy Discussion
    An RFA is an association of persons registered with the Commission 
as such pursuant to section 17 of the CEA.\227\ Subject to Commission 
oversight, RFAs serve a vital self-regulatory role by functioning as 
frontline regulators of their members, including in large measure most 
Commission registrants who will qualify as AT Persons pursuant to 
proposed Sec.  1.3(xxxx).\228\ Entities that are not members of an RFA, 
however, are not bound by the rules of the RFA.\229\ As such, the 
Commission previously adopted Sec. Sec.  170.15 and 170.16 to require 
each registered FCM, and each registered SD and MSP, respectively, to 
be an RFA member, subject to an exception for certain notice registered 
securities brokers or dealers.\230\ The Commission also recently 
adopted Sec.  170.17 to require that all registered IBs and CPOs, and 
most registered CTAs, to become RFA members.\231\
---------------------------------------------------------------------------

    \227\ 7 U.S.C. 21.
    \228\ RFA members also remain subject to oversight by the 
Commission.
    \229\ Those Commission registrants that are not RFA members are 
nevertheless subject to the rules and regulations of the Commission. 
See 7 U.S.C 21(e), which specifies that any person registered under 
the CEA, who is not an RFA member, ``in addition to the other 
requirements and obligations of [the CEA] and the regulations 
thereunder shall be subject to such other rules and regulations as 
the Commission may find necessary to protect the public interest and 
promote just and equitable principles of trade.''
    \230\ 17 CFR 170.15 and 170.16.
    \231\ See Membership in a Registered Futures Association, 80 FR 
55022 (Sept. 14, 2015).
---------------------------------------------------------------------------

    Together Sec. Sec.  170.15, 170.16, and 170.17 require many, but 
not all, Commission registrants who may be considered AT Persons 
pursuant to proposed Sec.  1.3(xxxx) to become RFA members. In 
particular, floor brokers and floor traders, who have historically been 
overseen by the DCMs on which they operate, are not required by 
Sec. Sec.  170.15, 170.16, or 170.17 to become members of an RFA. In 
order to ensure that all AT Persons will be subject to any rules 
promulgated by an RFA pursuant to proposed Sec.  170.19, including 
floor brokers and floor traders, the Commission is proposing a new 
Sec.  170.18. This provision would require that all AT Persons that are 
not otherwise required to be a member of a RFA pursuant to Sec. Sec.  
170.15, 170.16, or 170.17 be a member of an RFA.
2. Description of Regulation
    The Commission is proposing a new Sec.  170.18 to require all 
Commission registrants that are AT Persons to be members of an RFA. The 
membership requirements proposed by Sec.  170.18 will ensure that all 
AT Persons would be subject to membership rules promulgated by an RFA, 
including those membership rules promulgated pursuant to proposed Sec.  
170.19 to address algorithmic trading. Specifically, proposed Sec.  
170.18 requires that each registrant that is an AT Person that is not 
otherwise required to be a member of an RFA pursuant to Sec. Sec.  
170.15, 170.16, or 170.17 must become and remain a member of at least 
one RFA that provides for the membership of such registrant, unless no 
such futures association is so registered.
3. Request for Comments
    32. The Commission requests comment on whether the regulatory 
framework established by Regulation AT would require all AT Persons to 
be members of an RFA in order to be effective. Alternatively, could the 
goals of Regulation AT be realized without requiring all AT Persons to 
be members of an RFA?

H. Pre-Trade and Other Risk Controls for AT Persons--Sec.  1.80

    The Commission proposes as a fundamental element of Regulation AT a 
new Sec.  1.80 of its regulations, requiring AT Persons to implement 
pre-trade risk controls, order cancellation systems, and other measures 
reasonably designed to prevent an Algorithmic Trading Event. Such 
controls include, but are not limited to, maximum AT Order Message 
frequency and maximum execution frequency per unit time; order price 
parameters and maximum order size limits; order cancellation and 
Algorithmic Trading disconnect systems; and connectivity monitoring 
systems for AT Persons with DEA. In

[[Page 78850]]

addition, proposed Sec.  1.80 requires AT Persons to: Notify applicable 
clearing member FCMs and DCMs that the AT Person will engage in 
Algorithmic Trading; and calibrate or otherwise implement DCM-provided 
self-trade prevention tools.\232\ It would also require AT Persons to 
periodically review the sufficiency and effectiveness of their 
compliance with Sec.  1.80. The remainder of this section presents 
Concept Release comments on this topic, a description of the proposed 
regulation, a discussion of the policy justification for the proposal, 
and a request for comments on the proposal.
---------------------------------------------------------------------------

    \232\ See section IV(Q) below for a discussion of the term 
``self-trade'' and proposed regulations with respect to self-trade 
prevention.
---------------------------------------------------------------------------

1. Concept Release Comments on Pre-Trade and Other Risk Controls
    The Concept Release requested comment on various pre-trade and 
other types of risk controls, including message and execution 
throttles, maximum order sizes, price collars, and order management 
controls, such as connectivity monitoring services, automatic 
cancellation of orders on disconnect and kill switches. The Concept 
Release contemplated that such controls would apply at the trading 
firm, clearing member and trading platform levels. As discussed below, 
the Commission has determined to require that AT Persons, FCMs, and 
DCMs \233\ implement such pre-trade and other risk controls. Relevant 
comments to the Concept Release are discussed below.
---------------------------------------------------------------------------

    \233\ The pre-trade and other risk controls for DCMs in proposed 
Sec.  40.20 are discussed below in a separate section.
---------------------------------------------------------------------------

a. Message and Execution Throttles
    The Concept Release described message throttles as establishing 
maximum message rates per unit in time and execution throttles as 
establishing limits on the maximum number of orders that an ATS can 
execute in a given direction per unit in time. The Concept Release also 
sought comment on a particular form of execution throttle, the repeated 
automated execution throttle, which would disable a trading system 
after a configurable number of repeated executions until a human re-
enables the system.\234\ The Concept Release stated that the throttles 
would be calibrated to address the potential for unintended message 
flow or executions from a malfunctioning ATS.\235\
---------------------------------------------------------------------------

    \234\ Concept Release, 78 FR at 56571.
    \235\ Concept Release, 78 FR at 56569.
---------------------------------------------------------------------------

    Commenters indicated that message and execution throttles are 
widely used in the industry. FIA PTG surveyed its members and found 
that almost all firms that responded used message and execution 
throttles.\236\ Commenters noted certain benefits to messaging and 
execution throttles, including that they may mitigate the risk and 
impact of disruptive events, alert market participants to potential 
problems with their automated order entry systems, and help ensure a 
level playing field for all market participants.\237\ Commenters also 
noted that message or execution limits have potential negative effects 
because they can block risk-reducing orders.\238\
---------------------------------------------------------------------------

    \236\ FIA at 59-60.
    \237\ FIA at 12, 15-17, 65; CME at 8-9; Gelber 7; AFR at 6-7; 
KCG at 3-5; Better Markets at 6-7.
    \238\ KCG at 3-5; MFA at 7, 13. See also Bell at 3-4.
---------------------------------------------------------------------------

    Commenters addressing this topic did not support regulations 
mandating throttle thresholds because appropriate limits will vary per 
market participant, depending on each participant's unique systems and 
trading strategy.\239\ MFA strongly advised against required use of the 
repeated automated execution throttle, stating that it is best for 
market participants to determine which controls are most appropriate 
for their ATSs.\240\ IATP commented on the difficulty in setting 
standardized throttle thresholds, and alternatively suggested 
standardizing a graduated levy on order cancellations.\241\ Finally, 
Chicago Fed commented that regulators should assess the methodology 
that trading firms use to set throttle limits, the reasonableness of 
those limits, and the procedures followed when they are breached.\242\
---------------------------------------------------------------------------

    \239\ FIA at 12; CME at 8-9; MFA at 7, 13; Gelber at 5-7; AIMA 
at 8; KCG at 3-4.
    \240\ MFA at 7, 13.
    \241\ IATP at 3-5.
    \242\ Chicago Fed at 2.
---------------------------------------------------------------------------

    As to the appropriate design of throttles, CME and AIMA commented 
that throttles implemented by market participants should be based on 
the specific attributes of an entity or account, including the nature 
of a firm's trading strategies, the market it trades in, and the speed 
of its systems.\243\ AIMA indicated that applying throttles on a per-
algorithm basis would distort the output of the ATS because an 
algorithm interacts with many other algorithms within the same 
ATS.\244\ In contrast, AFR indicated that in order to detect a 
malfunctioning algorithm, the threshold should be based on the 
algorithm's trading strategy.\245\
---------------------------------------------------------------------------

    \243\ CME at 8-9; AIMA at 8.
    \244\ AIMA at 9.
    \245\ AFR at 6-7.
---------------------------------------------------------------------------

b. Maximum Order Sizes
    Commenters indicated that maximum order size controls are already 
used in the industry. According to FIA PTG's survey, all responding 
trading firms use maximum order size limits.\246\ AIMA indicated that 
many market participants use maximum order sizes limits,\247\ and 
Gelber, a trading firm, stated that it uses this risk control.\248\ 
KCG, Gelber and 3Red commented that market participants should use 
exchange-provided maximum order size controls.\249\
---------------------------------------------------------------------------

    \246\ FIA at 59-60.
    \247\ AIMA at 13.
    \248\ Gelber at 10.
    \249\ KCG at 8; Gelber at 10; 3Red at 2.
---------------------------------------------------------------------------

    With respect to implementing maximum order size limits, FIA and CME 
indicated that this control should be applied per product or 
contract.\250\ KCG suggested that exchange-provided maximum order size 
controls should provide flexibility to the market participant in 
setting different levels for users within a firm, for example, based on 
trader ID or customer.\251\ Alternatively, the market participant 
should rely on tighter internal controls.\252\ CME and KCG opposed 
standardization of maximum order size protections, stating that 
implementation of this control depends on individual customers and the 
market,\253\ while FIX and IATP supported uniformity with respect to 
these controls.\254\
---------------------------------------------------------------------------

    \250\ FIA at 18-19; CME at 15.
    \251\ KCG at 8.
    \252\ See id.
    \253\ CME at 15-16; KCG at 8.
    \254\ FIX at 3; IATP at 5.
---------------------------------------------------------------------------

c. Price Collars
    The Concept Release requested comment on price collars, a control 
in which trading platforms would assign a range of acceptable order and 
execution prices for each product and all market participants would 
establish similar limits to ensure that orders outside of a particular 
price range are not transmitted to the trading platform. While most 
comments addressing this topic focused on price collars implemented by 
exchanges, FIA indicated that its FIA PTG survey reflected that almost 
all responding trading firms used either price collars or trading 
pauses.\255\
---------------------------------------------------------------------------

    \255\ FIA at 60.
---------------------------------------------------------------------------

d. Connectivity Indications and Cancel on Disconnect
    The Concept Release requested comment regarding ``system 
heartbeats'' that would indicate proper connectivity between a trading 
firm's automated

[[Page 78851]]

trading system and the trading platform, and ``auto-cancel on 
disconnect,'' an exchange tool allowing trading firms to determine 
whether their orders will be left in the market upon disconnection. Two 
exchanges stated that they provide an optional cancel-on-disconnect 
functionality.\256\ FIA characterized cancel-on-disconnect as a 
``widely adopted DCM-hosted pre-trade risk control'' and indicated that 
it is increasingly common for FCMs to employ cancel-on-disconnect for 
their connections to the DCM.\257\ Several commenters indicated that 
they support exchanges offering system heartbeats and/or cancel-on-
disconnect to their market participants.\258\
---------------------------------------------------------------------------

    \256\ CME at Appendix A-4; CFE at 9-10.
    \257\ FIA at 14.
    \258\ FIA at 14; KCG at 12; MFA at 12; Chicago Fed at 2.
---------------------------------------------------------------------------

e. Order Cancellation Systems
    The Concept Release also addressed selective working order 
cancellation, a tool that enables an exchange to immediately cancel 
one, multiple, or all resting orders from a market participant as 
necessary in an emergency situation. Such a tool will mitigate impact 
to the market of a malfunctioning Algorithmic Trading system because it 
will limit additional erroneous orders from being submitted to a 
trading platform and executed. The Concept Release also considered 
order cancellation mechanisms that would immediately cancel all working 
orders and prevent submission (by the market participant), transmittal 
(by the clearing member), or acceptance (by the trading platform) of 
any new orders from a market participant or a particular trader or ATS 
of such market participant.
    In response to the Concept Release, numerous commenters addressed 
kill switches, discussing industry use; opposition to prescriptive 
requirements; the importance of flexibility in design; potential 
triggers; and content of kill switch procedures. For purposes of this 
discussion, the term ``kill switch'' means generally any order 
cancellation tools that cancels or prevents submission of orders. 
Commenters generally indicated that kill switches could be beneficial, 
but also stressed the complexity involved in their design and use.
    Several commenters described order cancellation mechanisms 
currently employed in the industry. One exchange commented that it has 
two kill switch tools: A kill switch used by the exchange, clearing 
firm, or trading firm to remove an entity from the market completely; 
and an order management tool that enables clearing firms and end-users 
to cancel orders at a more granular level.\259\ Another exchange 
explained that it can cancel orders and quotes in an emergency and it 
also provides a kill switch to clearing members that cancels all orders 
and quotes from a market participant.\260\ While commenters noted the 
importance of placing kill switches at the DCM level,\261\ several 
commenters stated that kill switches should be implemented by market 
participants and clearing firms in addition to exchanges.\262\
---------------------------------------------------------------------------

    \259\ CME at 23-24.
    \260\ CFE at 11.
    \261\ FIA at 29-33; Citadel LLC (``Citadel'') Comment Letter 
(December 11, 2013) at 3; AIMA at 3, 18; MFA at 12-13; KCG at 13.
    \262\ FIA at 30; Citadel at 3; CME at 22; Chicago Fed at 2; MFA 
at 12-13; Gelber at 14.
---------------------------------------------------------------------------

    Commenters stressed the importance of flexibility in the design of 
kill switches \263\ and generally opposed prescriptive requirements 
regarding their design and implementation.\264\ Reasons included 
challenges concerning setting the correct level of granularity (i.e., 
whether the control should apply to one participant and not others at 
the same firm); the possibility that kill switches may prevent a firm 
from being able to enter risk-reducing orders; prescriptive 
requirements will become outdated; that time is of the essence, and 
therefore exchanges and firms need to be free from time-consuming 
processes concerning the use of the kill switch; the standardization of 
kill switches, if poorly calibrated or too widely applied, could result 
in increased costs and disruption of legitimate trading operations; and 
a concern over adding more layers of complexity into an already complex 
market.\265\
---------------------------------------------------------------------------

    \263\ FIA at 29-33; TCL at 8; AIMA at 18; MFA at 12; KCG at 13-
14.
    \264\ FIA at 29-33; CME at 23; Gelber at 14-15; AIMA at 19.
    \265\ FIA at 29-33; CME at 23; Gelber at 14-15; AIMA at 19; TCL 
at 8.
---------------------------------------------------------------------------

    A critical concern raised by commenters was how order cancellation 
mechanisms should address risk-reducing activity.\266\ Gelber and KCG 
suggested that kill switches enable a firm to mitigate risk through 
manual order entry, and that allowing the market participant to set 
trigger thresholds will help ensure that orders entered for the purpose 
of reducing risk are not cancelled.\267\ In contrast, CME stated that a 
kill switch should exist solely to completely remove an entity from the 
market, and that other tools can be used to enter risk reducing orders. 
CME argued that allowing entry of risk reducing orders as an exception 
to the kill switch process introduces too much uncertainty and 
complexity.\268\
---------------------------------------------------------------------------

    \266\ FIA at 29-33; TCL at 8; Gelber at 14-15; CME at 24; KCG at 
13; SIG at 8.
    \267\ Gelber at 14-15; KCG at 13.
    \268\ CME at 24.
---------------------------------------------------------------------------

    Finally, commenters discussed procedures concerning activation of a 
kill switch. For example, FIA and Gelber suggested that a kill switch 
have both automated and manual triggers.\269\ KCG suggested that if the 
total risk of a portfolio exceeds certain thresholds, firm systems 
should automatically send only risk reducing orders and supervisors 
should be able to stop trading entirely.\270\ TCL commented that an 
exchange or ATS operator will not implement a system that abdicates 
control to an automated kill switch. TCL suggested that monitoring 
systems identify irregular market activity and alert staff that have 
access to a kill switch.\271\ Similarly, Chicago Fed recommended that a 
human decide whether to use a kill switch based on internal and market 
conditions.\272\
---------------------------------------------------------------------------

    \269\ FIA at 29-33; Gelber at 14-15.
    \270\ KCG at 14.
    \271\ TCL at 8.
    \272\ Chicago Fed at 2.
---------------------------------------------------------------------------

    Additional Concept Release comments, including comments on kill 
switch functionality, are discussed below with respect to Regulation AT 
pre-trade risk and other control requirements on FCMs and DCMs.
2. Description of Regulation
    The Commission proposes a new Sec.  1.80 of its regulations to 
require that AT Persons implement pre-trade risk controls and other 
measures for all AT Order Messages that are reasonably designed to 
prevent an Algorithmic Trading Event. Relevant controls and measures 
required by Sec.  1.80 include, but are not limited to: Maximum AT 
Order Message frequency and maximum execution frequency per unit time; 
order price parameters and maximum order size limits; order 
cancellation and ATS disconnect systems; and connectivity monitoring 
systems. They also include several other specific requirements, such as 
notification by AT Persons to applicable DCMs and clearing member FCMs 
that they will engage in Algorithmic Trading; calibrating or otherwise 
implementing DCM-provided self-trade prevention tools; and periodic 
consideration of the sufficiency and effectiveness of the controls that 
an AT Person has implemented. Consistent with comments received in 
response to the Concept Release, proposed Sec.  1.80 provides market 
participants latitude in the design and implementation of required 
controls, and in fact requires

[[Page 78852]]

only a small number of specific controls that the Commission 
understands are already widely implemented by likely AT Persons (e.g., 
proposed Sec. Sec.  1.80(a), 1.80(b) and 1.80(c)). In this regard, 
proposed Sec.  1.80 provides each AT Person with the flexibility to 
identify and implement any additional controls that such AT Person 
believes are appropriate for its Algorithmic Trading. The Commission is 
cognizant that prescriptive regulations in this area may fail to take 
into account the unique characteristics of market participants and 
trading strategies, or may become obsolete as technology evolves. The 
Commission has attempted to provide appropriate flexibility to 
accommodate such variety and evolution, while also establishing a 
regulatory floor that reflects its evaluation of basic requirements for 
all AT Persons.\273\
---------------------------------------------------------------------------

    \273\ See section IV(H) below for a more detailed discussion of 
which persons will be designated as AT Persons for purposes of 
proposed Sec.  1.80 and other regulations, and which persons will 
not be AT Persons, but will nonetheless be subject to proposed Sec.  
1.82.
---------------------------------------------------------------------------

3. Policy Discussion
    Proposed Sec.  1.80 requires AT Persons to implement pre-trade risk 
controls and other measures reasonably designed to prevent an 
Algorithmic Trading Event. This requirement is central to the purposes 
of Sec.  1.80. As discussed below, the Commission believes that 
proposed Sec.  1.80 would reduce the potential for market disruptions 
arising from system malfunctions, other errors, or intentional 
disruptive conduct. The Commission notes that the risks of such 
disruptions are heightened by the increased use of high-speed 
algorithmic trading, which makes the implementation of pre-trade risk 
controls and other measures even more necessary. Without effective risk 
controls, erroneous orders can significantly impact many market 
participants in a short amount of time. The prevention of Algorithmic 
Trading Events pursuant to Sec.  1.80 would help ensure the integrity 
of Commission-regulated markets and provide market participants with 
greater confidence that intentional, bona fide transactions are being 
executed.
    The pre-trade risk controls and other measures required by proposed 
Sec.  1.80 include, but are not limited to, those described in clauses 
(a)-(e) of Sec.  1.80. The Commission believes that each of these 
enumerated controls and other measures will promote the goals of Sec.  
1.80, as described above. Proposed Sec.  1.80(f) also promotes the 
goals of Sec.  1.80, by requiring each AT Person to periodically review 
its compliance with Sec.  1.80 to determine whether it has effectively 
implemented sufficient measures reasonably designed to prevent an 
Algorithmic Trading Event. Each AT Person must take prompt action to 
remedy any deficiencies it identifies.
a. Maximum AT Order Message and Execution Frequencies
    Proposed Sec.  1.80(a)(1)(i) requires AT Persons to set pre-trade 
risk controls that establish maximum AT Order Message and execution 
frequencies per unit time. These controls are commonly referred to in 
industry as message and execution throttles. These controls are 
designed to prevent excessive messaging or trading which could disrupt, 
slow down, or impede normal market activity. The Commission's proposed 
regulation on maximum order message and execution frequencies is aimed 
at preventing market disruptions caused by either inadvertent or 
intentional submission of AT Order Messages. This proposed regulation 
should not prevent DCMs from maintaining any and all additional 
safeguards intended to prevent intentional activity such as quote 
stuffing, or to apply such safeguards to message or data flows that are 
broader than the proposed definition of AT Order Messages. As indicated 
above, commenters to the Concept Release indicated that message and 
execution throttles are already widely used in the industry.\274\ 
Commenters indicated that the benefits of these risk controls include 
mitigating the risk and impact of disruptive events, alerting market 
participants to potential problems with their automated trading 
systems, helping to ensure a level playing field for all market 
participants, and deterring predatory and disruptive activities.\275\ 
In light of these benefits, and the already extensive use of this risk 
control, the Commission includes maximum AT Order Message and execution 
frequencies in its proposed rule.
---------------------------------------------------------------------------

    \274\ See FIA at 59-60 (FIA's surveys of member firms and FCMs) 
and comment indicating that exchanges already use throttles (CME at 
8-9; CFE at 5-6; TCL at 6; KCG at 4; MFA at 7; and AIMA at 8).
    \275\ See FIA at 12, 15-17, 65; MFA at 7; CME at 8; Gelber at 5-
7; AFR at 6-7.
---------------------------------------------------------------------------

    The Commission notes that ESMA's 2015 Final Draft Regulatory 
Standards require investment firms to establish a maximum messages 
limit and repeated automated execution throttle.\276\ The execution 
throttle should limit the number of times a strategy is applied only 
where appropriate to the specific trading venue, strategy or 
product.\277\ ESMA requires that the controls be calibrated as 
appropriate for the investment firm's capital base, clearing 
arrangements, trading strategy, risk tolerance and experience.\278\ 
ESMA further requires that firms take into account variables such as 
length of time since engaged in algorithmic trading and reliance on 
third-party vendors, and firms must re-calibrate in order to account 
for the changing impact of the orders on the relevant market due to 
different price and liquidity levels.\279\ In addition, the 
calculations supporting each control should take into account all 
orders sent to a trading venue.\280\ FIA has recently recommended that 
automated traders implement message throttles and repeated automated 
execution limits.\281\
---------------------------------------------------------------------------

    \276\ ESMA September 2015 Final Draft Standards Report Annex 1, 
supra note 80 at 214-15.
    \277\ See id.; ESMA September 2015 Final Draft Standards Report, 
supra note 80 at 200.
    \278\ See id.
    \279\ See id.
    \280\ See id.
    \281\ FIA Guide, supra note 95 at 10, 12.
---------------------------------------------------------------------------

    As to the appropriate thresholds of these controls, the Commission 
agrees with Concept Release comments indicating that regulations should 
not mandate specific thresholds because, among other things, 
flexibility is necessary to respond to the dynamics of the market, and 
appropriate limits will vary by participant.\282\ For example, 
commenters suggested that message and execution throttles should be 
based on the specific attributes of the trading firm or account, 
including the nature of the firm's trading strategies, the market it 
trades in, and the speed of its systems.\283\ Therefore, the proposed 
rules do not prescribe particular limits or thresholds, aside from the 
overarching requirement that the controls be reasonably designed to 
prevent an Algorithmic Trading Event, and Sec.  1.80(a)(2)'s 
requirement that the controls be set at the level of each AT Person, or 
such other more granular level as the AT Person may determine, 
including but not limited to, by product, account number or 
designation, or one or more identifiers of natural persons associated 
with an AT Order Message. While several commenters supported greater 
Commission involvement in setting risk control parameters, the 
Commission believes that it is not in the best position to determine 
the appropriate message or execution rate for each trading firm, 
trading strategy, product, and every other potentially relevant factor 
that should be taken into account when establishing thresholds.

[[Page 78853]]

As discussed below, DCMs would receive information as to the specific 
quantitative settings used by each AT Person as part of Commission-
required compliance reports pursuant to proposed Sec.  1.83. Pursuant 
to this reporting process, DCMs would be able to identify AT Persons 
that have message or execution throttle thresholds that appear 
insufficient.
---------------------------------------------------------------------------

    \282\ See FIA at 12; CME at 9; Gelber at 5-7; AIMA at 8; KCG at 
3-4; OneChicago at 5.
    \283\ CME at 8-9; AIMA at 8.
---------------------------------------------------------------------------

    The Commission notes that several commenters cited potential 
negative effects of controls establishing message or execution limits 
(e.g., they can block risk-reducing orders and decrease liquidity). The 
Commission believes that the overall benefits to maximum order message 
and execution frequencies, as noted above, outweigh potential negative 
effects. In addition, allowing market participants discretion in the 
design and implementation of message and execution throttles, as well 
as in establishing appropriate thresholds, would enable market 
participants to address and limit the potential negative effects of 
this risk control.
    Finally, as noted above, proposed Sec.  1.80(a)(2) requires the 
controls to be implemented at the AT Person-level. Consistent with 
Sec.  1.80's overarching requirement that an AT Person shall implement 
pre-trade risk controls and other measures reasonably designed to 
prevent an Algorithmic Trading Event, each AT Person must evaluate 
whether the controls should be set at a more granular level--for 
example, by product, account number or designation, or one or more 
identifiers of natural persons associated with an AT Order Message. 
Where deemed appropriate by the AT Person, the controls should be set 
at such more granular levels. In addition, proposed Sec.  1.80(a)(3) 
requires that natural person monitors at the AT Person be promptly 
alerted when the controls are breached. The purpose of this requirement 
is to ensure that the AT Person would take any further action that is 
necessary to prevent or mitigate an Algorithmic Trading Event.
b. Order Price Parameters and Maximum Order Size Limits
    Proposed Sec.  1.80(a)(1)(ii) requires pre-trade risk controls that 
limit the prices and quantities associated with individual order 
messages. By requiring ``order price parameters,'' the Commission means 
that AT Persons must establish price limits intended to prevent orders 
with prices far from the prevailing market from entering the market. At 
the trading firm or clearing member level, such controls may be called 
``price tolerance limits'' that define a maximum amount that an order 
price may deviate from a pre-determined price, such as the last trade 
price, or the market open price.\284\ By requiring ``maximum order size 
limits,'' the Commission means the risk control generally understood in 
industry as ``fat-finger'' limits. Commenters to the Concept Release 
indicated that maximum order size controls are already widely used by 
trading firms and that this control is effective at reducing the 
likelihood that an exchange would need to make use of its error trade 
policy.\285\
---------------------------------------------------------------------------

    \284\ See FIA Guide, supra note 95 at 10.
    \285\ FIA at 18-19, 23; CME at 15; Gelber at 10; KCG at 8; 3Red 
at 2.
---------------------------------------------------------------------------

    The Commission notes that ESMA's 2015 Final Draft Regulatory 
Standards require investment firms to establish price collars, maximum 
order value limits and maximum order volume limits, appropriately 
calibrated for their capital base, clearing arrangements, trading 
strategy, risk tolerance and experience.\286\ IOSCO has also indicated 
that many market participants already employ order price and volume 
limits.\287\ In addition, FIA has recently recommended that automated 
traders employ maximum order size and price tolerance limits.\288\ 
Finally, the Commission also notes that the SEC's Market Access Rule 
requires controls that prevent entry of erroneous orders, by rejecting 
orders that exceed appropriate price or size parameters, on an order-
by-order basis or over a short period of time, or that indicate 
duplicative orders.\289\
---------------------------------------------------------------------------

    \286\ See ESMA September 2015 Final Draft Standards Report Annex 
1, supra note 80 at 214-15.
    \287\ See IOSCO 2015 Consultation Report, supra note 106 at 21.
    \288\ See FIA Guide, supra note 95 at 8, 10.
    \289\ See SEC, Responses to Frequently Asked Questions 
Concerning Risk Management Controls for Brokers or Dealers with 
Market Access, supra note 37.
---------------------------------------------------------------------------

    Given the usefulness of price and order size parameters in 
preventing the execution of erroneous trades, the Commission determined 
to require that AT Persons establish such controls on all orders 
submitted through Algorithmic Trading. The proposed regulations are 
intended to be sufficiently flexible so that as required controls 
improve or new types controls emerge, they may be incorporated into an 
AT Person's pre-trade risk control program and satisfy the requirements 
of proposed Sec.  1.80(a). Similarly, this regulation is intended to be 
sufficiently flexible that exchanges, AT Persons, and clearing member 
FCMs may set the specific thresholds that will be most effective in 
preventing an Algorithmic Trading Event.
    Accordingly, the Commission proposes to require that each order 
pass through price parameter and maximum order size limit checks in 
order to protect the natural price discovery process from disruptive 
behavior such as unintentionally large orders. Consistent with the 
Commission's approach to the other pre-trade risk controls, the 
Commission will not impose thresholds, but will leave design of the 
control and specific thresholds to the discretion of market 
participants. Finally, the Commission notes that market participants 
could comply with the pre-trade and other risk controls required by 
Regulation AT in multiple ways: By internally developing such controls 
from scratch, upgrading existing systems, or purchasing a risk 
management solution from an outside vendor. The Commission understands 
that market participants may also be able to purchase some risk 
management solutions from DCMs. The Commission notes that 
implementation of exchange-provided controls, such as a maximum order 
size limit, would comply with Regulation AT's requirement that AT 
Persons use that control. However, an AT Person's use of a DCM-provided 
maximum order size limit would not constitute DCM compliance with 
proposed regulations requiring that DCMs implement maximum order sizes 
limits at the exchange level.
c. Order Management Controls
    Proposed Sec.  1.80(b) requires that AT Persons implement certain 
order management controls. The required controls must have the ability 
to: (i) Immediately disengage Algorithmic Trading; (ii) cancel selected 
or up to all resting orders when system or market conditions require 
it; and (iii) prevent submission of any new AT Order Messages (i.e., a 
``kill switch''). The parameters for the order cancellation systems 
must be reasonably designed to prevent an Algorithmic Trading Event. In 
addition, proposed Sec.  1.80(c) requires that AT Persons with Direct 
Electronic Access (as defined in proposed Sec.  1.3(yyyy)) must 
implement systems to indicate on an ongoing basis whether they have 
proper connectivity with the trading platform and any systems used by a 
DCM to provide the AT Person with market data. Proposed Sec.  
1.80(b)(2) requires that prior to an AT Person's initial use of 
Algorithmic Trading to submit a message or order to a DCM's trading 
platform, such AT Person must notify the applicable DCM whether all of 
its resting orders should be cancelled or suspended in the event of 
disconnect with the trading platform.

[[Page 78854]]

    The order cancellation systems requirements provided in proposed 
Sec.  1.80(b) and (c) are intended to protect against erroneous trading 
activity caused by an algorithmic trading system malfunction. As to 
connectivity monitoring and cancel-on-disconnect, several commenters 
supported exchanges offering such functionality to trading firms.\290\ 
Given the possibility of a technology failure that causes a market 
participant's orders to be left in the market upon disconnect, leaving 
the trader or trading firm unable to manage the orders, the Commission 
believes that systems indicating proper connectivity and cancel-on-
disconnect are important risk management tools that should be required. 
The Commission notes that commenters to the Concept Release indicated 
cancel-on-disconnect functionality should be a flexible tool, allowing 
market participants to determine whether orders should be left in the 
market upon disconnection.\291\ FIA has explained that automated 
traders must decide whether cancellation upon disconnect mitigates or 
increases risk.\292\ Accordingly, the Commission does not require 
cancellation or suspension of orders upon disconnect. Rather, it 
requires AT Persons, prior to engaging in Algorithmic Trading, to 
notify the DCM as to what action it should take in the event of 
disconnect, which may depend on the facts and circumstances.
---------------------------------------------------------------------------

    \290\ FIA at 14; KCG at 12; MFA at 12; Chicago Fed at 2.
    \291\ CME at Appendix A-4; CFE at 9-10; MFA at 12.
    \292\ FIA Guide, supra note 95 at 15.
---------------------------------------------------------------------------

    As to ``kill switch'' functionality, comments to the Concept 
Release indicated that exchanges already provide kill switch 
functionality for use by market participants or clearing members, and 
additional commenters suggested that such functionality should be 
implemented by market participants and clearing firms in addition to 
exchanges.\293\ The Commission notes the challenges identified by 
commenters around setting the correct level of granularity of an order 
cancellation tool, and of the potential need for trading firms to 
submit risk-reducing orders. The Commission believes that requiring 
that order cancellation tools allow for submission of risk-reducing 
orders may introduce too much uncertainty or complexity into the 
market, or may be technically infeasible at this time. In light of such 
considerations, the Commission's proposed regulations do not mandate 
specific elements of kill switch design, such as the parameters or 
procedures concerning when the control must be triggered, or require 
that the functionality must allow for submission of risk-reducing 
orders. Rather, Sec.  1.80(b)(1) would require that AT Persons have the 
ability and authority to disengage Algorithmic Trading, cancel selected 
resting orders, and prevent submission of new AT Order Messages, but 
does not specify when such functionality should be triggered. The 
Commission allows flexibility for AT Persons to design and implement 
appropriate parameters and procedures that are appropriate for their 
trading strategy or markets.
---------------------------------------------------------------------------

    \293\ FIA at 30; Citadel at 3; CME at 22-24; Chicago Fed at 2; 
MFA at 12-13; Gelber at 14; CFE at 11.
---------------------------------------------------------------------------

    The Commission's approach to order cancellation systems is 
consistent with current recommendations in the European regulatory 
context. ESMA's 2015 Final Draft Regulatory Standards require that 
investment firms know which algorithm and which trader, trading desk 
or, where applicable, client is responsible for each order, and have 
the ability, as an emergency measure, to cancel unexecuted orders 
submitted to individual trading venues originated by individual 
traders, trading desks, or where applicable, clients. Investment firms 
must also have the ability, as an emergency measure, to immediately 
cancel all the firm's outstanding orders at all trading venues to which 
it is connected.\294\ The Commission also notes that FIA recently 
recommended that automated traders build their own kill switch 
functionality into their trading systems where it is possible to 
implement it on a sufficiently granular level to identify individual 
trading systems.\295\ FIA also recommended that where an exchange 
provides a kill switch, there should be a registration process and 
entitlement system that requires automated traders or brokers to 
specify which staff are authorized to use the functionality.\296\ The 
Commission believes that FIA (in its recent Guide to the Development 
and Operation of Automated Trading Systems), other industry 
organizations, and commenters to the Concept Release provided 
reasonable recommendations as to the design and implementation of order 
cancellation systems. The Commission urges AT Persons and other market 
participants to consider such recommendations in the implementation of 
order cancellation and connectivity systems.
---------------------------------------------------------------------------

    \294\ See ESMA September 2015 Final Draft Standards Report Annex 
1, supra note 80 at 211-12.
    \295\ See FIA Guide, supra note 95 at 14.
    \296\ See id. at 14.
---------------------------------------------------------------------------

d. Notification of Algorithmic Trading
    Proposed Sec.  1.80(d) requires that, prior to an AT Person's 
initial use of Algorithmic Trading to submit a message or order to a 
DCM, such AT Person must notify its clearing member FCM, as well as the 
DCM on which the AT Person is trading, that it will engage in 
Algorithmic Trading. The Commission intends that this requirement 
ensure that clearing member FCMs and exchanges have sufficient advance 
notice to implement and calibrate pre-trade and other risk controls to 
manage risks arising from the AT Person's trading.
e. Self-Trade Prevention Tools
    Proposed Sec.  1.80(e) requires that, to the extent that 
implementation of a DCM's self-trade prevention tools requires 
calibration or other action by an AT Person, such AT Person must 
calibrate or take such other action as is necessary to apply such 
tools. This proposed regulation is designed to operate in conjunction 
with proposed Sec.  40.23, which requires DCMs to either apply, or 
provide and require the use of, self-trade prevention tools.\297\
---------------------------------------------------------------------------

    \297\ See section IV(Q) below for a discussion of proposed Sec.  
40.23 and requests for comment in connection with the proposed 
regulations.
---------------------------------------------------------------------------

f. Periodic Review for Sufficiency and Effectiveness
    Finally, proposed Sec.  1.80(f) requires that each AT Person shall 
periodically review its compliance with Sec.  1.80 to determine whether 
it has effectively implemented sufficient measures reasonably designed 
to prevent an Algorithmic Trading Event. Proposed Sec.  1.80(f) would 
also require that an AT Person take prompt action to remedy any 
deficiencies it identifies. The Commission recognizes through proposed 
Sec.  1.80(f) that trading practices, technologies for algorithmic 
trading, and best practices in risk controls will necessarily evolve 
over time. It believes that periodic review by AT Persons of their own 
pre-trade risk controls and other measures will help to ensure 
compliance with proposed Sec.  1.80 in an engaged and proactive manner.
g. Certain Measures Not Adopted in This NPRM
    The Commission determined not to address in this NPRM some measures 
that were discussed in the Concept Release and supported by Concept 
Release commenters. For example, various commenters favored 
standardization around drop copies and error trade policies. FIA 
commented that drop copies should be available for

[[Page 78855]]

all trading venues and products whenever technologically practicable 
and that trade reports and other information provided by drop copy 
should be disseminated to the consumer in real-time or as near real-
time as practicable.\298\ As to error trade policies, FIA suggested 
that they be clear and deterministic enough for all participants to 
understand, promote a marketplace where all trades stand as executed, 
protect participants who are counterparties to error trades, and not be 
subject to discretion.\299\ KCG, MFA, Citadel and SIG also made similar 
comments.\300\ The Commission believes that standardization of drop 
copy reports and error trade policies, as well as other measures 
addressed in the Concept Release, merit further consideration within 
the Commission as well as in industry. However, the Commission 
determined to include particular risk controls in Regulation AT, and 
not others, based on its understanding of the critical importance of 
controls required in proposed Sec.  1.80 in preventing and mitigating 
market disruptions, as well as their current widespread industry use.
---------------------------------------------------------------------------

    \298\ FIA at 13.
    \299\ See id.
    \300\ KCG at 10-11; MFA at 2, 10-12; Citadel at 3, 4-5; SIG at 
8-9.
---------------------------------------------------------------------------

    In addition, as noted above, the Commission has taken a principles-
based approach to its requirements relating to risk controls and other 
measures. Proposed Sec.  1.80 provides market participants discretion 
in the design and implementation of controls, and requires only a small 
number of specific controls that the Commission understands are already 
widely implemented. Proposed Sec.  1.80 provides AT Persons with 
flexibility to identify and implement any additional controls 
appropriate for their Algorithmic Trading. The Commission is aware that 
prescriptive regulations in this area may not take into account the 
unique characteristics of each market participant, and may become 
obsolete. The proposed regulation reflects the Commission's intent to 
accommodate the diverse and evolving nature of market participants' 
businesses and technology, while establishing basic regulatory 
requirements of essential risk controls and related measures that each 
market participant engaged in Algorithmic Trading should have.
4. Request for Comments
    33. Are any pre-trade and other risk controls required by Sec.  
1.80 ineffective, not already widely used by AT Persons, or likely to 
become obsolete?
    34. Are there additional pre-trade or other risk controls that 
should be specifically enumerated in proposed Sec.  1.80?
    35. Do you believe that the pre-trade and other risk controls 
required in Sec.  1.80 sufficiently address the possibility of 
technological advances in trading, and the development of new, more 
effective controls that should be implemented by AT Persons?
    36. The Commission welcomes comment on whether the regulation's 
requirements relating to the design of controls and the levels at which 
the controls should be set are appropriate and sufficiently granular.
    37. The Commission notes that Sec.  1.80(d) requires that prior to 
initial use of Algorithmic Trading, an AT Person must notify its 
clearing member FCM and the DCM that it will engage in Algorithmic 
Trading. The Commission welcomes comment on whether the content of that 
notification requirement is sufficient, or whether clearing member FCMs 
and DCMs should also be notified of additional information. For 
example, should AT Persons be required to notify their clearing member 
FCMs of particular changes to their Algorithmic Trading systems that 
would affect the risk controls applied by the clearing member FCM?
    38. Is Sec.  1.80(f)'s requirement that each AT Person periodically 
review its compliance with Sec.  1.80 appropriate? Should there be more 
prescriptive and granular requirements to ensure that each AT Person 
periodically reviews its pre-trade and other risk controls and takes 
appropriate steps to update or recalibrate them in order to prevent an 
Algorithmic Trading Event? Alternatively, is Sec.  1.80(f) necessary? 
Does the Commission need to explicitly require AT Persons to conduct a 
periodic review of their compliance with Sec.  1.80?
    39. AT Persons that are registered FCMs are required by existing 
Commission regulation 1.11 to have formal ``Risk Management Programs,'' 
including, pursuant to Sec.  1.11(e)(3)(ii), ``automated financial risk 
management controls reasonably designed to prevent the placing of 
erroneous orders'' and ``policies and procedures governing the use, 
supervision, maintenance, testing, and inspection of automated trading 
programs.'' As described in Sec.  1.11, an FCM's Risk Management 
Program must include a risk management unit independent of the business 
unit; quarterly risk exposure reports to senior management and the 
governing body of the FCM, with copies to the Commission; and other 
substantive requirements. The Commission requests public comment 
regarding whether one or more of the proposed requirements applicable 
to FCMs in Sec. Sec.  1.80, 1.81, 1.83(a), and 1.83(c) (as described 
below) should be incorporated within an FCM's Risk Management Program 
and be subject to the requirements of such program as described in 
Sec.  1.11. In this regard, any final rules arising from this NPRM 
could place all requirements applicable to FCMs in Sec. Sec.  1.80, 
1.81, 1.83(a), and 1.83(c) within the operational risk measures 
required in Sec.  1.11(e)(3)(ii). Such incorporation could help improve 
the interaction between an FCM's operational risk efforts and its pre-
trade risk controls; development, monitoring, and compliance efforts; 
and reporting and recordkeeping requirements, pursuant to Sec. Sec.  
1.80, 1.81, 1.83(a), and 1.83(c). It could also help ensure that an 
FCM's Sec. Sec.  1.80, 1.81, 1.83(a), and 1.83(c) processes benefit 
from the same internal rigor and independence required by the Risk 
Management Program in Sec.  1.11.
    40. The Commission proposes to adopt a multi-layered approach to 
regulations intended to mitigate the risks of automated trading, 
including pre-trade risk controls and other procedures applicable to AT 
Persons, clearing member FCMs and DCMs. Please comment on whether an 
alternative approach, for example one which does not impose 
requirements at each of these three levels, would more effectively 
mitigate the risks of automated trading and promote the other 
regulatory goals of Regulation AT.

I. Standards for Development, Testing, Monitoring, and Compliance of 
Algorithmic Trading Systems--Sec.  1.81

    The Commission proposes regulations under Sec.  1.81 requiring AT 
Persons to establish policies and procedures that accomplish a number 
of objectives with respect to the development, testing, monitoring, and 
compliance of Algorithmic Trading. The proposed regulations are 
intended to standardize a set of principles in order to reduce the 
operational risk of such systems. The remainder of this section 
presents Concept Release comments on this topic, a description of the 
proposed regulation, a discussion of the policy justification for the 
proposal, and a request for comments on the proposal.
1. Concept Release Comments
    The Concept Release requested comment on testing procedures for 
ATSs. The Concept Release contemplated, among other things, that market 
participants operating ATSs must test each ATS internally and on each 
trading platform on which it will

[[Page 78856]]

operate, and trading platforms must provide test environments that 
simulate the production environment. In particular, the Concept Release 
asked for comment on when it is most beneficial for firms to test an 
ATS after it has been modified, and how the Commission and market 
participants should distinguish between major modifications and minor 
modifications.
    Commenters support ATS testing and discussed current and best 
practices, but disagreed as to whether regulatory measures are 
appropriate to standardize these practices. Most commenters (including 
FIA, CME, CFE, and MFA) oppose standardized ATS testing 
procedures.\301\ FIA indicated that it is impractical to implement 
prescriptive standardized procedures for development, testing and 
change management given the diversity of technologies and business 
operations at DCMs. FIA pointed to the testing recommendations outlined 
in its March 2012 ``Software Development and Change Management 
Recommendations'' as best practices for trading firms, which could also 
apply to all participants. FIA described different types of testing and 
supports DCMs providing robust test environments and market 
participants using such environments.\302\ CME cited the FIA PTG's 
``Recommendations for Risk Controls for Trading Firms'' as an 
appropriate principles-based approach to management, oversight, and 
testing of electronic trading systems.\303\ CME noted that exchange 
systems vary widely, and each exchange should develop and test in a 
manner that comports with industry best practices.\304\
---------------------------------------------------------------------------

    \301\ FIA at 34-38; CME at 26; CFE at 2-3; AIMA at 3, 20-21; TCL 
at 15; KCG at 15-16; MFA at 2, 12-13; OneChicago at 2-3.
    \302\ FIA at 34-38.
    \303\ CME at 25.
    \304\ CME at 26.
---------------------------------------------------------------------------

    SIG indicated that DCMs should provide test environments and stated 
that ATS testing procedures should be standardized ``where possible.'' 
\305\ Gelber stated that standardizing development, testing and change 
management might be helpful, but it is more important that these 
procedures are clear and comprehensive at each exchange than that they 
are standardized.\306\
---------------------------------------------------------------------------

    \305\ SIG at 9.
    \306\ Gelber at 15-16.
---------------------------------------------------------------------------

    Both FIA and CME noted the difficulty of establishing objective 
criteria to determine what constitutes a ``major'' or ``minor'' 
modification of an ATS.\307\ CFE noted that DCMs are already subject to 
DCM Core Principle 20 and Commission regulation 38.1051(h), which 
require DCMs to conduct periodic, objective testing and review of their 
automated systems to ensure that they are reliable, secure, and have 
adequate scalable capacity.\308\ In addition, KCG argued that a 
``testing process that creates too many frictions can discourage making 
changes that improve a system.'' \309\ Similarly, TCL stated that the 
testing procedures suggested in the Concept Release are overly broad 
and could force ATS operators to take a narrow view of what constitutes 
a change.\310\
---------------------------------------------------------------------------

    \307\ FIA at 34-38; CME at 25-26.
    \308\ CFE at 2-3.
    \309\ KCG at 15-16.
    \310\ TCL at 15.
---------------------------------------------------------------------------

    In contrast, several commenters support regulatory involvement in 
this area. Chicago Fed noted that many industries have standards-
setting bodies, but because there is no corollary for the development 
of ATSs within an ``HFT environment,'' market participants and the TAC 
should work together to formulate such standards and guidelines that 
will help mitigate the impact of operational risks.\311\ IATP stated 
that out of all of the safeguards addressed in the Concept Release, ATS 
testing has the greatest potential to reduce market disruptions. IATP 
recommended that the Commission review and select from current best 
practices.\312\ MFA recommended that industry engage in more robust 
testing, and that trading platforms should offer testing where a firm's 
software interacts with other types of software.\313\
---------------------------------------------------------------------------

    \311\ Chicago Fed at 3.
    \312\ IATP at 7.
    \313\ MFA, Presentation Before the CFTC Technology Advisory 
Committee Meeting on Risk Controls and System Safeguards for 
Automated Trading Environments (Feb. 10, 2014) at 13, available at: 
http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/tac021014_mfa.pdf.
---------------------------------------------------------------------------

    AIMA opposes standardization, and suggested alternatively that 
``CFTC principles'' create a legal requirement for a certain standard 
of testing and change management. AIMA cited as an example the 
Department of Energy Software Engineering Methodology.\314\ While MFA 
also opposes standardization, it stated that ``rules or industry 
practice should encourage more robust and more routine testing at the 
trading platform level.'' \315\
---------------------------------------------------------------------------

    \314\ AIMA at 3, 20-21.
    \315\ MFA at 13.
---------------------------------------------------------------------------

    Finally, as to current ATS testing practices, MFA indicated that 
``many, if not all, exchanges provide market participants a test 
facility to test trading software and algorithms, as well as offer test 
symbols to trade.'' \316\ CME and CFE described their own testing 
practices. CME indicated that market participants routinely test in 
their own testing environments using historical data to test trading 
strategies against a range of market conditions, and that exchanges 
commonly make their own historical data available for testing purposes. 
CME explained that it requires all systems interfacing with CME Globex 
to be certified on the order entry and/or market data interfaces prior 
to deployment.\317\ CFE provides a user testing environment that 
simulates the production environment.\318\ TCL described FIA industry-
wide testing of backup systems.\319\
---------------------------------------------------------------------------

    \316\ MFA at 13.
    \317\ CME at 25-26.
    \318\ CFE at 12.
    \319\ TCL at 11-14.
---------------------------------------------------------------------------

    FIX stated that it has a working group that is developing best 
practices related to testing and is working to increase the 
availability of test financial instruments.\320\ Similarly, IIT 
commented that a working group named AT 9000, which is affiliated with 
the International Organization for Standardization, is developing a 
quality management system for automated trading. The goals of AT 9000 
are to help automated trading industry organizations satisfy their 
responsibility for trading safety, to satisfy regulatory requirements, 
and to improve the efficiency and effectiveness of automated 
trading.\321\
---------------------------------------------------------------------------

    \320\ FIX Trading Community (``FIX'') Comment Letter (December 
11, 2013) at 4-5.
    \321\ Illinois Institute of Technology (``IIT'') Comment Letter 
(February 11, 2014) at 1-2.
---------------------------------------------------------------------------

    The Concept Release also requested comment on ATS development and 
change development. Among other things, the Concept Release 
contemplated that trading platforms and market participants operating 
ATSs must maintain a development environment that is adequately 
isolated from the production trading environment, and that market 
participants must have policies and procedures concerning approval and 
verification of changes to their trading systems. In particular, the 
Concept Release asked for comment on what challenges or benefits may 
result from the implementation of standardized development and change 
management procedures.
    FIA described the core components of a change management as 
including authorization (effective pre-deployment review of the 
proposed change) and auditability (procedures for communicating 
requirements, changes and functionality related to proprietary software 
and technical infrastructure). FIA indicated that prescriptive

[[Page 78857]]

development and change management standards are impractical given the 
diversity of market participants, but principles such as authorization 
and auditability can serve as ``building blocks'' that market 
participants can use to tailor a change management process to fit their 
needs.\322\
---------------------------------------------------------------------------

    \322\ FIA at 4, 36-37.
---------------------------------------------------------------------------

    Similarly, TCL indicated that exchanges and ATSs should have formal 
processes for change management, which include a production 
installation authorization process in which no one may change the 
production systems after it has been submitted for authorization, 
followed by a formal signoff.\323\ KCG recommended that policies for 
deploying new software include staged deployment (deploying new 
software in phases, with explicit rollback procedures), and validation 
(manual and automated evaluation of whether a change is 
successful).\324\
---------------------------------------------------------------------------

    \323\ TCL at 15.
    \324\ KCG at 17.
---------------------------------------------------------------------------

    In addition, the Concept Release requested comment on ATS 
monitoring and supervision. In particular, the Concept Release 
requested comment on the extent to which human monitors have been 
trained in how to respond to unexpected problems, and been given the 
requisite authority to intervene at these times. The Concept Release 
suggested that market participants operating ATSs must ensure that 
their ATSs are subject to continuous real-time monitoring and 
supervision by trained and qualified staff at all times while engaged 
in trading. Two commenters addressed ATS monitoring and supervision, 
but did not specifically express support or opposition to regulatory 
action. KCG recommended that a monitoring process identify ``smoke 
signals'' (unusual or abnormal behaviors), investigate the cause of the 
smoke signals, and, if the smoke signal is an error, the monitoring 
alerts should be adjusted to take that information into account.\325\ 
MFA commented that there should be at least one designated individual 
who is available and authorized to suspend a firm's trading program. 
MFA also suggested that FCMs should have ``plan-of-action'' protocols 
that include scenarios where trading is suspended based on specific 
types of events.\326\
---------------------------------------------------------------------------

    \325\ KCG at 17-18.
    \326\ MFA at 14.
---------------------------------------------------------------------------

2. Description of Regulation
    The Commission proposes regulations requiring AT Persons to 
establish policies and procedures that accomplish a number of 
objectives with respect to the design, testing, and supervision of 
Algorithmic Trading. The proposed regulations are intended to 
standardize a set of principles in order to reduce the operational risk 
of such systems. The proposed regulations require each AT Person to: 
Implement written policies and procedures for the development and 
testing of ATSs (Sec.  1.81(a)); implement written policies and 
procedures reasonably designed to ensure that each of its ATSs is 
subject to continuous real-time monitoring and supervision by 
knowledgeable and qualified staff while such ATS is engaged in trading 
(Sec.  1.81(b)); implement written policies and procedures reasonably 
designed to ensure that ATSs operate in a manner that complies with the 
CEA and the rules and regulations thereunder, and ensure that staff are 
familiar with the CEA and the rules and regulations thereunder, the 
rules of any DCM to which such AT Person submits orders through 
Algorithmic Trading, the rules of any RFA of which such AT Person is a 
member, the AT Person's own internal requirements, and the requirements 
of the AT Person's clearing member FCM, in each case as applicable 
(Sec.  1.81(c)); and implement written policies and procedures to 
designate and train staff responsible for Algorithmic Trading (Sec.  
1.81(d)). The proposed rules are described in greater detail below.
    As a complement to the proposed design and testing requirements, 
Regulation AT proposes a new requirement that DCMs (under proposed 
Sec.  40.21, discussed in section IV(O) below) provide a test 
environment that will enable market participants to simulate production 
trading and conduct exchange-based conformance testing of their 
Algorithmic Trading systems.
    Development and Testing of Algorithmic Trading Systems. Regulation 
AT proposes a new requirement (Sec.  1.81(a)(1)) that each AT Person 
must implement written policies and procedures for the development and 
testing of its Algorithmic Trading systems. Such policies and 
procedures must at a minimum include the following: (i) Maintaining a 
development environment that is adequately isolated from the production 
trading environment (the development environment may include computers, 
networks, and databases, and should be used by software engineers while 
developing, modifying, and testing source code); (ii) testing of all 
Algorithmic Trading code and related systems and any changes to such 
code and systems prior to their implementation, including testing to 
identify circumstances that may contribute to future Algorithmic 
Trading Events (such testing must be conducted both internally with the 
AT Person and on each designated contract market on which Algorithmic 
Trading will occur); (iii) regular back-testing of Algorithmic Trading 
using historical transaction, order, and message data to identify 
circumstances that may contribute to future Algorithmic Trading Events; 
(iv) regular stress tests of Algorithmic Trading systems to verify 
their ability to operate in the manner intended under a variety of 
market conditions; (v) procedures for documenting the strategy and 
design of proprietary Algorithmic Trading software used by an AT 
Person, as well as any changes to such software if such changes are 
implemented in a production environment; and (vi) maintaining a source 
code repository to manage source code access, persistence, copies of 
all code used in the production environment, and changes to such code 
(such source code repository must include an audit trail of material 
changes to source code that would allow AT Persons to determine, for 
each such material change: Who made it; when they made it; and the 
coding purpose of the change. The source code must also be maintained 
in accordance with Commission regulation Sec.  1.31).
    Monitoring of Algorithmic Trading Systems. Regulation AT proposes a 
new requirement (Sec.  1.81(b)) that each AT Person must implement 
written policies and procedures reasonably designed to ensure that each 
of its ATSs is subject to continuous real-time monitoring by 
knowledgeable and qualified staff while such ATS is engaged in trading. 
Such policies and procedures must at a minimum include the following: 
(i) Continuous real-time monitoring of Algorithmic Trading to identify 
potential Algorithmic Trading Events; (ii) automated alerts when an 
ATS's AT Order Message behavior breaches design parameters, upon loss 
of network connectivity or data feeds, or when market conditions 
approach the boundaries within which an ATS is intended to operate, to 
the extent applicable; \327\ (iii) monitoring staff of the AT Person 
shall have the ability and authority to disengage an Algorithmic 
Trading system and to cancel resting orders when system or market 
conditions require it, including the ability to contact staff of the 
applicable designated contract market and clearing firm, as applicable, 
to seek information

[[Page 78858]]

and cancel orders; and (iv) procedures that will enable AT Persons to 
track which monitoring staff is responsible for an Algorithmic Trading 
system during trading hours. The Commission believes that staff persons 
who are responsible for monitoring the trading of other AT Person staff 
should typically not be actively engaged in trading at the same time, 
because it would be difficult to adequately and consistently monitor 
trading of other AT Person staff while engaged in trading 
activities.\328\
---------------------------------------------------------------------------

    \327\ For example, if an ATS is designed to operate within 
certain ranges of volatility, liquidity, or order or trade prices, 
automated alerts may be triggered when volatility or a moving 
average approaches the pre-determined ranges.
    \328\ The Commission notes that the supervision requirement of 
proposed Sec.  1.81(b) is analogous to the supervision requirements 
for Commission registrants under the customer protection rules of 
Commission regulation 166.3. The Commission further notes that 
ESMA's draft regulatory standards for MiFID II provide that real-
time monitoring should be performed by a risk function that is 
independent from the trader, to ensure an appropriate segregation 
between the trading desk and supporting functions. See ESMA 
September 2015 Final Draft Standards Report, supra note 80 at 201.
---------------------------------------------------------------------------

    Compliance of Algorithmic Trading Systems. Regulation AT proposes a 
new requirement (Sec.  1.81(c)) that each AT Person shall implement 
written policies and procedures reasonably designed to ensure that each 
of its Algorithmic Trading systems operates in a manner that complies 
with the CEA and the rules and regulations thereunder. AT Persons must 
also implement procedures requiring staff of the AT Person to review 
Algorithmic Trading systems in order to detect potential Algorithmic 
Trading Compliance Issues. Such staff must include staff of the AT 
Person familiar with the CEA and the rules and regulations thereunder, 
the rules of any DCM to which such AT Person submits orders through 
Algorithmic Trading, the rules of any RFA of which such AT Person is a 
member, the AT Person's own internal requirements, and the requirements 
of the AT Person's clearing member FCM, in each case as applicable. The 
procedures should also include a plan of internal coordination and 
communication between compliance staff of the AT Person and staff of 
the AT Person responsible for Algorithmic Trading regarding Algorithmic 
Trading design, changes, testing, and controls, which plan should be 
designed to detect and prevent Algorithmic Trading Compliance Issues.
    Designation and Training of Algorithmic Trading Staff. Regulation 
AT proposes a new requirement (Sec.  1.81(d)) that each AT Person must 
implement written policies and procedures to designate and train its 
staff responsible for Algorithmic Trading. Such policies and procedures 
must at a minimum include the following: (i) Procedures for designating 
and training all staff involved in designing, testing and monitoring 
Algorithmic Trading, and documenting training events (training must, at 
a minimum, cover design and testing standards, Algorithmic Trading 
Event communication procedures, and requirements for notifying staff of 
the applicable designated contract market when Algorithmic Trading 
Events occur); (ii) training policies reasonably designed to ensure 
that natural person monitors are adequately trained for each 
Algorithmic Trading system or strategy (or material change to such 
system or strategy) for which such monitors are responsible; and (iii) 
escalation procedures to inform senior staff as soon as Algorithmic 
Trading Events are identified. The training described in clause (ii) 
above must include, at a minimum, the trading strategy for the 
Algorithmic Trading system, as well as the automated and non-automated 
risk controls that are applicable to the Algorithmic Trading system or 
strategy. Adequate training should ensure that monitors are effectively 
educated regarding the typical behavior of each Algorithmic Trading 
system or strategy (or material change to such system or strategy) that 
they are responsible for overseeing in production. It should also allow 
monitors to understand when risk controls may be triggered, and how to 
respond once they are. As result of the training they receive, monitors 
should be capable of making rapid, appropriate decisions in real time 
to help contain or mitigate ATS issues.
3. Policy Discussion
    Consistent with the comments received, the Commission is taking a 
principles-based approach in this area, which is intended to provide 
discretion to AT Persons, particularly with respect to the development 
and testing of Algorithmic Trading systems. The Commission acknowledges 
that prescriptive regulations in this area may fail to take into 
account the unique characteristics of various market participants' 
trading strategies, and may become obsolete as technology and 
development standards evolve. For example, the Commission recognizes 
that software development practices continue to evolve, and therefore 
is not imposing very granular coding or testing requirements. The 
Commission believes that this principles-based approach is consistent 
with other regulatory initiatives and best practice guides issued in 
this area, as further discussed below.
Guidelines, Best Practices and Regulatory Standards on Testing and 
Development
    As noted above, the ESMA guidelines recommended that investment 
firms should make use of clearly delineated development and testing 
methodologies prior to deploying an electronic trading system or a 
trading algorithm, and should monitor their electronic trading systems, 
including trading algorithms, in real-time.\329\ The MiFID II Directive 
requires a regulated market to have in place effective systems, 
procedures and arrangements, including requiring members or 
participants to carry out appropriate testing of algorithms and 
providing environments to facilitate such testing. The Directive seeks 
to reduce the likelihood that algorithmic trading systems may create or 
contribute to disorderly trading conditions, and to promote effective 
resolution of any disorderly trading conditions that do arise from 
algorithmic trading systems.\330\ With respect to MiFID II, ESMA's 2015 
Final Draft Regulatory Standards include requirements relating to the 
role of compliance and monitoring staff, testing (including conformance 
testing, stress testing, and testing environments), annual review and 
validation of systems, change management procedures, and real-time 
market monitoring procedures.\331\ These standards include, among other 
things, that a firm must have clear lines of accountability for the 
development, deployment and updates of algorithms, and effective 
procedures for communication of information; compliance staff must have 
a general understanding of how trading systems and algorithms operate, 
and be in continuous contact with persons with detailed technical 
knowledge of trading systems and algorithms; testing must ensure that 
systems conform with the rules and systems of the trading venue, risk 
controls work as intended, and systems will not contribute to 
disorderly trading and can continue to work effectively in stressed 
market conditions; firms must run an annual validation process, which 
includes preparation of a validation report; firms must keep records of 
material changes made to software, including when a change was made, 
who made it, who approved it, and the nature of the change; and 
monitoring systems must have real-time alerts that assist staff in 
identifying when an algorithm is not behaving as expected, and firms 
must

[[Page 78859]]

have a process for remedial action when alerts occur, including a 
process for an orderly withdrawal from the market.\332\
---------------------------------------------------------------------------

    \329\ See ESMA Guidelines, supra note 61 at 10.
    \330\ See MiFID II, Article 48(6).
    \331\ ESMA September 2015 Final Draft Standards Report Annex 1, 
supra note 80 at 205-16.
    \332\ See id.
---------------------------------------------------------------------------

    With respect to the U.S. securities markets, the SEC's Reg SCI 
requires SCI entities to implement a program to review and keep current 
systems development and testing methodology for SCI systems, and to 
implement standards that result in SCI systems being designed, 
developed, tested, maintained, operated, and surveilled in a manner 
that facilitates the successful collection, processing, and 
dissemination of market data.\333\ In addition, FINRA Notice 15-09, 
published in March 2015, offered guidance on effective supervision and 
control practices for market participants that use algorithmic trading 
strategies in the equities market. The FINRA notice provided guidance 
in five general areas: General risk assessment and response; software/
code development and implementation; software testing and system 
validation; trading systems; and compliance.\334\
---------------------------------------------------------------------------

    \333\ See Reg SCI, supra note 40 at 72437.
    \334\ See FINRA Notice 15-09, supra note 59 at 1.
---------------------------------------------------------------------------

    The Commission further notes that the FIA Guide provides an 
overview of development and testing procedures, including software 
development, source code management and implementation, exchange-based 
conformance testing, and post-deployment verification, while noting 
that ``market participants and exchanges should have the flexibility 
necessary to establish procedures that are appropriate and proportional 
to their operations.'' \335\ The IOSCO 2015 Consultation Report notes 
that ``many regulatory authorities have introduced specific 
requirements and guidelines regarding the introduction of new systems 
and changes to existing systems,'' and recommends that trading venues 
should consider establishing policies and procedures related to the 
development, modification, testing and implementation of critical 
systems, and establishing a governance model for the management of 
critical systems.\336\ The IOSCO report also notes that most trading 
venues have procedures and tools designed to address the operational 
risk associated with electronic trading, including monitoring of 
trading in real-time (or near real-time), and monitoring of the trading 
venue's system performance in real-time.\337\ Finally, the Senior 
Supervisors Group Algorithmic Trading Briefing Note, published in April 
2015, recommended that market participants using algorithmic trading 
conduct testing during all phases of a trading product's lifestyle, 
namely during development, rollout to production, and ongoing 
maintenance.\338\
---------------------------------------------------------------------------

    \335\ See FIA Guide, supra note 95 at 23-30.
    \336\ See IOSCO 2015 Consultation Report, supra note 106 at 14, 
19.
    \337\ Id. at 21.
    \338\ See SSG 2015 Note, supra note 115 at 3.
---------------------------------------------------------------------------

    The rules proposed under Sec.  1.81 are intended to be consistent 
with these regulatory initiatives and best practices. The Commission 
believes that most market participants and DCMs have implemented 
controls regarding the design, testing, and supervision of Algorithmic 
Trading systems, in light of the numerous best practices and regulatory 
requirements promulgated in this area. The proposed regulations are 
intended to standardize a set of principles relating to the design, 
testing, and supervision of Algorithmic Trading systems in order to 
reduce the operational risk of such systems. In their response to the 
Concept Release, IATP noted that, out of all the safeguards discussing 
in the Release, they believed ATS testing had the greatest potential to 
reduce market disruptions.\339\ By standardizing principles in this 
area, Regulation AT is intended to reduce the risk of disorderly 
trading, including the risk that orders will be unintentionally sent 
into the marketplace by a poorly designed or insufficiently supervised 
algorithm.
---------------------------------------------------------------------------

    \339\ IATP at 7.
---------------------------------------------------------------------------

    For example, the regulations proposed under Sec.  1.81 may reduce 
the risk of market disruptions such as the 2012 incident involving 
Knight Capital. The SEC later concluded that, among other failures, 
Knight Capital did not have adequate controls and procedures for code 
deployment and testing for its order router, did not have sufficient 
controls and written procedures to guide employees' responses to 
significant technological and compliance incidents, and did not have an 
adequate written description of its risk management controls.\340\ As 
discussed above, proposed Sec.  1.81 requires written policies and 
procedures relating to the following: Testing of all Algorithmic 
Trading code and relates systems and any changes to such code and 
systems prior to their implementation; regular stress tests of 
Algorithmic Trading systems to verify their ability to operate in the 
manner intended under a variety of market conditions; a plan of 
internal coordination and communication between compliance staff of the 
AT Person and staff of the AT Person responsible for Algorithmic 
Trading regarding Algorithmic Trading design, changes, testing, and 
controls; and procedures for documenting the strategy and design of 
proprietary Algorithmic Trading software used by an AT Person, among 
other controls. The standardization of such written policies and 
procedures may make disruptive events like the Knight Capital incident 
less likely in the future.
---------------------------------------------------------------------------

    \340\ See SEC Knight Capital Release, supra note 39.
---------------------------------------------------------------------------

4. Request for Comments
    41. The Commission understands that the requirements for 
developing, testing, and supervising algorithmic systems proposed in 
Sec.  1.81(a)-(d) are already widely used throughout the industry. Are 
any specific requirements proposed in this section not widely used by 
persons that would be designated as AT Persons under Regulation AT, and 
if not, why not? If any requirements described in Sec.  1.81(a)-(d) are 
not widely used, please provide an estimate of the cost that would be 
incurred by an AT Person to implement such requirements.
    42. Are there any aspects of Sec.  1.81(a)-(d) that are unnecessary 
for purposes of reducing the risks from Algorithmic Trading, and should 
not be mandated by regulation? If so, please explain.
    43. Are the procedures described above for the development and 
testing of Algorithmic Trading sufficient to ensure that algorithmic 
systems are thoroughly tested before being used in production, and will 
operate in the manner intended in the production environment?
    44. Are there any additional procedures for the development and 
testing of Algorithmic Trading that should be required under Regulation 
AT?
    45. Are any of the required procedures for the development and 
testing of Algorithmic Trading likely to become obsolete in the near 
future as development and testing standards evolve?
    46. Are the procedures for designating and training Algorithmic 
Trading staff of AT Persons sufficient to ensure that such staff will 
be knowledgeable in the strategy and operation of Algorithmic Trading, 
and capable of identifying Algorithmic Trading Events and promptly 
escalating them to appropriate staff members?
    47. Is it typical that persons responsible for monitoring 
algorithmic trading do not simultaneously engage in trading activity?
    48. Proposed Sec. Sec.  1.80, 1.81, and 1.83 would impose certain 
requirements on all AT Persons regardless of the size, sophistication, 
or other attributes of their business. The Commission requests public 
comment regarding

[[Page 78860]]

whether these requirements should vary in some manner depending on the 
AT Person. If commenters believe proposed Sec. Sec.  1.80, 1.81, and 
1.83 should vary, please describe how and according to what criteria.

J. Risk Management by Clearing Member FCMs--Sec.  1.82

    The Commission proposes a new Sec.  1.82 to require clearing member 
FCMs to implement pre-trade risk and order management controls with 
respect to AT Order Messages originating with an AT Person. 
Specifically, such clearing member FCMs must make use of pre-trade risk 
controls reasonably designed to prevent or mitigate an Algorithmic 
Trading Disruption, including at a minimum, those pre-trade risk 
controls described in Sec.  1.80(a)(1). The remainder of this section 
presents Concept Release comments on this topic, a description of the 
proposed regulation, a discussion of the policy justification for the 
proposal, and a request for comments on the proposal.
1. Concept Release Comments
    The Concept Release inquired about clearing members' use of the 
same pre-trade and other risk controls discussed above in section IV(H) 
with respect to AT Persons.
a. Message and Execution Throttles
    FIA indicated that message and execution throttles are already 
widely used by clearing members. FIA PTG surveyed its members and found 
that all responding FCMs used message and execution throttles, either 
internally or at the exchange level.\341\ FIA also indicated that most 
DCMs provide tools to allow FCMs to set pre-trade controls for their 
customers, which are a prerequisite for an FCM to provide direct access 
to a market participant without routing orders through the FCM's 
infrastructure.\342\ FIA explained that FCMs encourage DCMs to provide 
pre-trade risk controls that can be set at various levels, whether at 
session level, customer level or account level.\343\ CFE commented that 
it provides an execution throttle to clearing members.\344\
---------------------------------------------------------------------------

    \341\ FIA at 59-60.
    \342\ FIA at 13.
    \343\ FIA at 13.
    \344\ CFE at 7.
---------------------------------------------------------------------------

    FIA stated that DCM message rate limits should be supplemented at 
the market participant or FCM level.\345\ FIA explained that where an 
FCM facilitates market access, it has the ability to impose the FCM's 
own message rate limits. These limits should be documented and 
discussed with market participants to ensure that they are appropriate 
for the participants' type of activity.\346\ FIA further stated that 
FCMs that choose to implement message rate limits within their 
infrastructure should be transparent to their customers regarding the 
reason for the control and the maximum message rate that can be 
supported by the FCM.\347\ In the case of direct access, FIA explained 
that the FCM should rely on DCM-provided message rate limits and any 
controls implemented by the market participants themselves.\348\
---------------------------------------------------------------------------

    \345\ FIA at 12, 16.
    \346\ FIA at 16.
    \347\ FIA at 12.
    \348\ FIA at 16.
---------------------------------------------------------------------------

    Additional commenters indicated that FCMs should implement 
messaging or execution limits.\349\ For example, Gelber stated that 
``in many cases, FCMs receive fills from the exchanges and have no 
control over the amount of messaging coming from a customer controlled-
and-run applications. Therefore, FCMs need to have the ability to 
coordinate throttle rates through the account identifier at the 
exchange.'' \350\ Gelber indicated that such limits should take into 
account financial risk and FCMs' understanding of their clients' 
business.\351\ MFA stated that clearing members, as the gateways to the 
markets, should have financial and regulatory risk management controls 
to reduce risks associated with market access.\352\ Similarly, CME 
supported allowing clearing members to provide direct market access to 
their customers as long as the clearing member has appropriately vetted 
the client and implemented appropriate risk management controls.\353\ 
CME stated that clearing firms should decide the exact nature of the 
throttles to impose across their customer base, taking into 
consideration financial risk to the extent possible and their 
understanding of their clients' businesses.\354\ Finally, SIG commented 
that clearing firms should have the ability to throttle orders at the 
exchange level in connection with credit limits set by the clearing 
firm, and that exchanges should make this same protection available to 
executing brokers executing for customers for whom they do not 
clear.\355\
---------------------------------------------------------------------------

    \349\ KCG at 3; Gelber at 6; MFA at 4-5; CME at 7-9; AIMA at 7; 
Chicago Fed at 2; SIG at 3. The Commission notes that the same 
concern discussed in the AT Person context that message or execution 
limits have potential negative effects because they can block risk-
reducing orders would also apply to message or execution limits 
applied by an FCM. To that end, the Commission notes that FIA 
commented that a FCM should never reject an order cancellation 
request due to message rate limits. See FIA at 16.
    \350\ Gelber at 6.
    \351\ Gelber at 5-7.
    \352\ MFA at 4-5.
    \353\ CME at 7.
    \354\ CME at 9.
    \355\ See id.
---------------------------------------------------------------------------

b. Maximum Order Sizes
    Commenters indicated that clearing members already use maximum 
order sizes. FIA explained that FIA PTG conducted a survey and all 
responding FCMs used this control.\356\ CME commented that it allows 
clearing members to use its technology to set maximum order sizes for 
specific customers or accounts.\357\ CFE stated that it allows clearing 
members to set maximum order size limits by product, and then set 
maximum order and quote size limits by the ``log-in'' of trading 
privilege holders.\358\ FIX indicated that it is becoming increasingly 
common for futures and equities exchanges to provide tools that allow 
an FCM the ability to set checks for each client that accesses the 
exchange directly.\359\ AIMA suggested that many market participants 
already use maximum order sizes when trading through their brokers, but 
may have less access to this control in the case of direct market 
access.\360\ MFA commented that some FCMs already offer their customers 
this control, which can be set at the following levels: Each direct 
market access order, each individual algorithmic order, net sell and 
buy order limits, and total contract limits.\361\ MFA suggested that 
all FCMs offer this maximum order size control at the trader-
level.\362\ Similarly, KCG believes that exchange-provided maximum 
order size controls should allow the market participant flexibility in 
setting different maximum order size levels for different users within 
a firm, such as based on trader ID or customer.\363\ Chicago Fed 
supports a requirement that clearing firms must use this control at the 
account level.\364\
---------------------------------------------------------------------------

    \356\ FIA at 59-60.
    \357\ CME at 15.
    \358\ CFE at 7.
    \359\ FIX at 3.
    \360\ AIMA at 13.
    \361\ MFA at 9.
    \362\ See id.
    \363\ KCG at 8.
    \364\ Chicago Fed at 2.
---------------------------------------------------------------------------

c. Price Collars
    Most comments addressing this control focused on price collars 
implemented by exchanges. However, the FIA FCM Survey reflected that 
almost all responding FCMs used price collars, administered either 
internally or at the exchange level.\365\
---------------------------------------------------------------------------

    \365\ FIA at 60.

---------------------------------------------------------------------------

[[Page 78861]]

d. Order Management Controls
    As noted above, the Concept Release requested comment regarding 
``system heartbeats'' and ``auto-cancel on disconnect,'' and commenters 
that addressed this topic indicated that exchanges provide these tools. 
In addition, FIA indicated that it is increasingly common for FCMs to 
employ cancel-on-disconnect for their connections to the DCM.\366\
---------------------------------------------------------------------------

    \366\ FIA at 14.
---------------------------------------------------------------------------

    Some commenters addressed the implementation of ``kill switch'' 
functionality by FCMs. Two exchanges commented that their kill switch 
functionality allows clearing firms to cancel orders \367\ and several 
commenters stated that kill switches should be implemented by market 
participants and clearing firms in addition to exchanges.\368\ Barclays 
commented that if a kill switch is located at the FCM level, then the 
Commission should provide ``clear regulatory guidance'' about when the 
FCM should alter or cancel orders, given that altering or cancelling 
orders could expose the FCM to significant financial or legal 
liability.\369\
---------------------------------------------------------------------------

    \367\ CME at 23-24; CFE at 11.
    \368\ Citadel at 3; CME at 22; Chicago Fed at 2.
    \369\ Barclays Capital Inc. (``Barclays'') Comment Letter 
(December 10, 2013) at 1. Similarly, FIA commented that where FCMs 
rely on DCM-provided controls, and such controls fail to operate 
according to the instructions of the FCM, FCMs should be deemed to 
have met their regulatory obligations. FIA at 19-20.
---------------------------------------------------------------------------

    FIA explained that if a DCM cannot provide the appropriate level of 
granularity in the function of its kill switch, the focus of this 
functionality should be at the FCM level.\370\ FIA recommended that a 
kill switch implemented by an FCM should be able to be invoked ``at the 
finest resolution possible'' and should include both manual and 
automated methods for triggering the kill switch.\371\ FIA stressed 
that a kill switch should be used as a ``final measure'' only when 
other processes have not been successful, and that policies and 
procedures for when an FCM will invoke a kill switch should be clearly 
communicated to the market participant.\372\
---------------------------------------------------------------------------

    \370\ FIA at 30.
    \371\ Id. at 31.
    \372\ Id.
---------------------------------------------------------------------------

2. Description of Regulation
    The Commission proposes a new Sec.  1.82 to require clearing member 
FCMs to implement pre-trade risk controls and order management controls 
with respect to AT Order Messages originating with an AT Person. 
Specifically, such clearing member FCMs must make use of pre-trade risk 
controls reasonably designed to prevent or mitigate an Algorithmic 
Trading Disruption, including at a minimum, those pre-trade risk 
controls described in Sec.  1.80(a)(1). (Proposed Sec.  1.80(a)(1) 
requires AT Persons to implement, at a minimum, maximum AT Order 
Message frequency per unit time and maximum execution frequency per 
unit time, order price parameters and maximum order size limits.) The 
Commission notes that proposed Sec.  1.82 requires clearing member FCMs 
to address ``Algorithmic Trading Disruptions,'' rather than the broader 
``Algorithmic Trading Events'' that AT Persons are required to address 
under proposed Sec.  1.80. As discussed in section IV(D) above, an 
Algorithmic Trading Disruption is defined in proposed Sec.  1.3(uuuu) 
as an event originating with an AT Person that disrupts, or materially 
degrades, (1) the Algorithmic Trading of such AT Person, (2) the 
operation of the DCM on which such AT Person is trading or (3) the 
ability of other market participants to trade on the DCM on which such 
AT Person is trading. In contrast to an Algorithmic Trading Event 
(defined in proposed Sec.  1.3(vvvv)), an Algorithmic Trading 
Disruption does not specifically incorporate violations of the CEA or 
the rules thereunder. The Commission anticipates that some Algorithmic 
Trading Disruptions may be the result of violations of the CEA or 
Commission regulations, and some Algorithmic Trading Disruptions may 
not. Proposed Sec.  1.82 requires clearing member FCMs to make use of 
pre-trade risk controls reasonably designed to prevent or mitigate an 
Algorithmic Trading Disruption, regardless of whether such disruptions 
were the result of a violation of the CEA or Commission regulations. It 
otherwise does not require clearing member FCMs to ensure that their 
customers' order flow does not violate the CEA or Commission 
regulations. However, nothing in proposed Sec.  1.82 relieves FCMs of 
their obligations under all other applicable Commission regulations.
    Proposed Sec.  1.82 also requires that pre-trade risk controls must 
be set at the level of each AT Person, or such other more granular 
level as the clearing FCM may determine, including but not limited to: 
By product, account number or designation, or one or more identifiers 
of natural persons associated with an AT Order Message. In addition, 
Sec.  1.82 would require the clearing member FCM to have policies and 
procedures reasonably designed to ensure that natural person monitors 
at the FCM are promptly alerted when pre-trade risk control parameters 
established pursuant to this section are breached, and make use of the 
order cancellation systems described in Sec.  1.80(b)(1). (The order 
cancellation systems are the same controls that proposed Sec.  
1.80(b)(1) requires AT Persons to implement, i.e., systems that have 
the ability to immediately disengage Algorithmic Trading, cancel 
selected or up to all resting orders when system or market conditions 
require it, and prevent the submission of new orders.)
    Pursuant to proposed Sec.  1.82(b) and (c), the location of the 
pre-trade and other risk controls calibrated by the clearing member FCM 
varies, according to whether an AT Person's orders are placed through 
DEA or intermediated by its clearing FCM.
    DEA Orders--Controls Reside at DCM. Proposed Sec.  1.82(b) 
addresses AT Order Messages originating with an AT Person and submitted 
through DEA. In the case of DEA, pre-trade and other risk controls 
would be established by and located at the DCM, and be controlled or 
calibrated by the clearing FCM. This approach recognizes that clearing 
FCMs do not have the ability to apply market risk controls to 
customers' DEA orders before they reach a DCM. With respect to 
financial risk, existing Sec.  38.607 requires DCMs to establish 
controls facilitating FCMs' management of financial risk, and existing 
Sec.  1.73 provides requirements with respect to clearing FCMs' 
implementation of such controls.\373\ Consistent with that structure, 
proposed amendments to Sec.  38.255 establish a similar structure in 
which DCMs must establish pre-trade and other risk controls addressing 
the risks of Algorithmic Trading for use by FCMs. Proposed Sec.  
1.82(b), accordingly, requires FCMs to implement such controls residing 
at the DCM.
---------------------------------------------------------------------------

    \373\ The Commission notes that Sec.  23.609 imposes the same 
risk-based limit requirements on SDs and MSPs as Sec.  1.73 does on 
clearing FCMs. SDs and MSPs do not carry customer accounts; 
accordingly, any firm that has customer accounts must be a 
registered FCM and implement the controls required by new Sec.  
1.82. Furthermore, any SD or MSP that engages in Algorithmic Trading 
for its own account will have to comply with the AT Person 
requirements of proposed Sec.  1.80.
---------------------------------------------------------------------------

    Non-DEA Orders--FCM Implements and Calibrates Controls. Proposed 
Sec.  1.82(c) addresses the scenario in which AT Order Messages 
originating with an AT Person are not submitted to a trading platform 
through DEA, but instead are routed through a clearing member FCM. In 
the case of such intermediated orders, the controls would not reside at 
the DCM. Instead, the clearing member FCM itself would have the 
obligation to implement and

[[Page 78862]]

calibrate pre-trade risk and other controls with respect to such 
orders.
    The Commission notes that while the controls implemented by the FCM 
are the same types of controls that would be implemented by AT Persons 
pursuant to Sec.  1.80 (and by DCMs pursuant to Sec.  40.20, discussed 
below), each entity would be responsible for ensuring the appropriate 
calibration of the control. Accordingly, an FCM's setting of a maximum 
order size limit, for example, may be different from the setting used 
by an AT Person, depending on each entity's assessment of the potential 
for an Algorithmic Trading Event or an Algorithmic Trading Disruption, 
as applicable. The Commission will not mandate exactly when 
intervention by an FCM to modify or cancel orders is necessary; rather, 
the Commission believes that each FCM is best positioned to determine 
appropriate parameters that will prevent or mitigate an Algorithmic 
Trading Disruption. Furthermore, the Commission will not specify a 
mandate which, if complied with by an FCM, would absolve the FCM of 
liability (as requested by Barclays).\374\
---------------------------------------------------------------------------

    \374\ See Barclays at 1.
---------------------------------------------------------------------------

3. Policy Discussion
    The Commission agrees with comments to the Concept Release that 
suggested that all types of market access create risks; therefore, the 
same principles should apply to all types of market access. When an 
order does not pass through a clearing member FCM's infrastructure 
before entering the market, it is critical that DCMs provide clearing 
member FCMs with the ability to subject such orders to controls that 
prevent or mitigate the impact of unintended or disruptive trading. In 
addition, where orders pass through a clearing member FCM's 
infrastructure before entering the market, that clearing member FCMs 
should subject such orders to similar controls. The Commission believes 
that an order should pass through the same pre-trade risk controls 
regardless of trading strategy or means of market access, and that all 
market participants have a responsibility to implement risk controls 
appropriate to their role in the lifecycle of an order.
    As discussed above, commenters indicated that the required controls 
(i.e., message and execution throttles and price and size parameters) 
are already widely used by clearing members, either internally or as 
provided by the DCM. The Commission also notes that IOSCO and ESMA have 
stressed the importance of adequate risk controls where a user is 
granted access to the market via an intermediary's systems or directly, 
without using the intermediary's systems. IOSCO has recommended that 
intermediaries (including clearing firms) have adequate operational and 
technical capabilities to manage appropriately the risks posed by such 
access.\375\ ESMA's 2015 Final Draft Regulatory Standards require that 
the intermediary providing access apply pre-trade risk controls on the 
order flow of their clients.\376\ ESMA's regulatory standards provide 
that the direct electronic access provider may use its own proprietary 
controls, controls purchased from a third-party, or controls offered by 
a trading venue, but in each of those circumstances the provider 
remains responsible for the effectiveness of those controls and is 
solely entitled to set or modify any parameters and limits.\377\
---------------------------------------------------------------------------

    \375\ IOSCO 2015 Consultation Report, supra note 106 at 22-23.
    \376\ See ESMA September 2015 Final Draft Standards Report Annex 
1, supra note 80 at 218. ESMA's 2015 Final Draft Regulatory 
Standards further require, among other things, that direct 
electronic access providers have the ability to stop order flow of 
their clients, carry out a review of the internal risk controls 
systems of the client, and have the ability to identify the 
different trading desks and traders of its clients. The direct 
electronic access provider must also perform due diligence on its 
clients covering, among other things, the type of strategies the 
client will use, the operational set-up, systems and controls of the 
client, its historical trading pattern and behavior, an assessment 
of the level of expected trading and order volume, and the ability 
of the client to meet its financial obligations. See id. at 219-20.
    \377\ See id.
---------------------------------------------------------------------------

4. Discussion of Persons Subject to Proposed Sec. Sec.  1.80 and 1.82
    The following discussion is intended to provide detailed examples 
of which persons will be subject to proposed Sec. Sec.  1.80 
(applicable to all AT Persons when acting as such) and 1.82 (applicable 
only to clearing FCMs). Proposed Sec.  1.80 would apply to AT Persons--
i.e., any FCM, floor broker, SD, MSP, CPO, CTA, IB or floor trader as 
defined in proposed Sec.  1.3(x)(3) when engaged in Algorithmic Trading 
on or subject to the rules of a DCM. In contrast, proposed Sec.  1.82 
would apply to clearing FCMs when acting as clearing members for their 
customers with respect to an AT Order Message.
    An entity could be subject to both Sec.  1.80 and Sec.  1.82 in 
certain circumstances. For example, in the event that a clearing FCM 
engages in both Algorithmic Trading for its own account and acts a 
clearing member with respect to its customers' AT Order Messages, such 
clearing FCM would be subject to both proposed Sec.  1.80 (as an AT 
Person with respect to its own Algorithmic Trading) and to proposed 
Sec.  1.82 (as a clearing member). The Commission is providing further 
clarity regarding who would be AT Persons for purposes of Sec.  1.80 
and other regulations, including some detailed order flow scenarios 
that demonstrate the application of Sec. Sec.  1.80 and 1.82, below.
    Question One: In the scenario in which a non-clearing FCM trading 
for a proprietary account submits orders to a separate clearing FCM, 
could the clearing FCM ever engage in Algorithmic Trading and be an AT 
Person?
    If an FCM trading for a proprietary account submits an order to a 
separate clearing FCM, the separate clearing FCM could be an AT Person 
if it uses computer algorithms or systems to determine any of the 
elements of the definition of Algorithmic Trading (e.g., determinations 
regarding order routing). If the clearing FCM is not making any of 
these determinations, the clearing FCM is not an AT Person.
    If an FCM trading for a proprietary account submits an order to a 
separate non-clearing FCM who then submits it to an additional separate 
clearing FCM, the clearing FCM is not engaged in Algorithmic Trading, 
provided that it is not determining any of the elements of the 
definition of Algorithmic Trading.
    Question Two: Is it correct to say that all FCMs using Algorithmic 
Trading to engage in proprietary trading are AT Persons?
    Yes. A non-clearing or clearing FCM that uses Algorithmic Trading 
to engage in proprietary trading is an AT Person.
    Question Three: Is it correct to say that an FCM accepting orders 
from its customer may be an AT Person, if its computer algorithms or 
systems determine any of the elements of the definition of Algorithmic 
Trading?
    Yes. A non-clearing or clearing FCM that accepts customer orders, 
and that uses computer algorithms or systems to determine any of the 
elements of the definition of Algorithmic Trading (e.g., determinations 
regarding order routing), would be an AT Person with respect to the 
customer's orders.
    Below are some detailed order flow scenarios that demonstrate the 
application of Sec. Sec.  1.80 (which applies to AT Persons) and 1.82.

    Example 1: Order flow prior to execution by DCM: (i) Customer to 
(ii) non-clearing FCM to (iii) separate clearing FCM. Customer is 
not registered with the Commission; uses algorithms but not DEA. 
Neither the non-clearing FCM nor the clearing FCM make any of the 
determinations regarding the order described in the definition of 
Algorithmic Trading.

    Who is an AT Person?

[[Page 78863]]

    (i) The customer is not an AT Person, because it is not registered 
and does not use DEA.
    (ii) The non-clearing FCM is not an AT Person, because it doesn't 
make any determinations regarding the order and therefore doesn't 
engage in Algorithmic Trading.
    (iii) The clearing FCM is not an AT Person, for the same reason as 
(ii). The clearing member FCM is also not subject to 1.82, because the 
customer in (i) originating orders isn't an AT Person.

    Example 2: Order flow prior to execution by DCM: (i) Customer to 
(ii) non-clearing FCM to (iii) separate clearing FCM. Customer is 
not registered with the Commission; uses algorithms but not DEA. 
Non-clearing FCM's computer algorithms or systems make some of the 
determinations regarding the order described in the definition of 
Algorithmic Trading.

    Who is an AT Person?
    (i) The customer is not an AT Person, because it is not registered 
and does not use DEA.
    (ii) The non-clearing FCM is an AT Person, because it engages in 
Algorithmic Trading regarding the customer's order.
    (iii) The clearing FCM is not an AT Person, assuming it doesn't 
make any determinations regarding order and therefore doesn't engage in 
Algorithmic Trading. The clearing FCM is also not subject to 1.82, 
because the customer originating orders isn't an AT Person (even though 
the non-clearing FCM in the order flow is an AT Person).

    Example 3:  Order flow prior to execution by DCM: (i) Customer 
to (ii) a clearing FCM. Customer is not registered with the 
Commission; uses algorithms but not DEA. Clearing FCM just clears 
trades, and does not make any of the determinations regarding the 
order described in the definition of Algorithmic Trading.

    Who is an AT Person?
    (i) The customer is not an AT Person, because it is not registered 
and does not use DEA.
    (ii) The clearing FCM is not an AT Person, because it doesn't make 
any determinations regarding the order and therefore doesn't engage in 
Algorithmic Trading. The clearing FCM is also not subject to 1.82, 
because the customer originating orders isn't an AT Person.

    Example 4: Order flow prior to execution by DCM: (i) FCM trading 
for its proprietary account to (ii) a separate clearing FCM. The FCM 
trading for a proprietary account uses Algorithmic Trading; clearing 
member FCM does not make any of the determinations described in the 
definition of Algorithmic Trading.

    Who is an AT Person?
    (i) The FCM trading for the proprietary account is an AT Person, 
because it engages in Algorithmic Trading.
    (ii) The clearing FCM is not an AT Person, because it doesn't make 
any determinations regarding the order and therefore doesn't engage in 
Algorithmic Trading. But the clearing FCM is subject to Sec.  1.82, 
because the FCM originating the orders is an AT Person.
5. Request for Comments
    49. Are any pre-trade or other risk controls required by Sec.  1.82 
ineffective, not already widely used by clearing member FCMs, or likely 
to become obsolete?
    50. Are there any aspects of proposed Sec.  1.82 that pose an undue 
burden for clearing member FCMs and are unnecessary for purposes of 
reducing the risks associated with Algorithmic Trading? If so, please 
explain (1) the burden; (2) why it is not necessary to reduce the risks 
associated with Algorithmic Trading, particularly in the case of DEA. 
What alternatives are available consistent with the purposes of 
Regulation AT?
    51. Please describe the technological development that would be 
required by clearing member FCMs to comply with the requirement to 
implement and calibrate the pre-trade and other risk controls required 
by Sec.  1.82(c) for non-DEA orders. To what extent have clearing 
member FCMs already developed the technology required by this 
provision, for example in connection with existing requirements under 
Sec.  1.11, and Sec. Sec.  1.73 and 38.607 for clearing FCMs to manage 
financial risks?
    52. Are there additional pre-trade or other risk controls that 
should be specifically required pursuant to proposed Sec.  1.82?
    53. Do you believe that the pre-trade and other risk controls 
required in Sec.  1.82 sufficiently address the possibility of 
technological advances in trading and development of new, more 
effective controls that should be implemented by FCMs?
    54. The Commission welcomes comment on whether the requirements of 
Sec.  1.82 relating to the design of controls and the levels at which 
the controls should be set are appropriate and sufficiently granular.
    55. Proposed Sec.  1.82 does not require FCMs to have connectivity 
monitoring such as ``system heartbeats'' or automatic cancel-on-
disconnect functions. Do you believe that Sec.  1.82 should require 
FCMs to have such functionality?
    56. Proposed Sec.  1.82 requires clearing FCMs to implement 
controls with respect to AT Order Messages originating with an AT 
Person. The Commission is considering modifying proposed Sec.  1.82 to 
require clearing FCMs to implement controls with respect to all orders, 
including orders that are manually submitted or are entered through 
algorithmic methods that nonetheless do not meet the definition of 
Algorithmic Trading. Such a requirement would correspond to the 
requirement under proposed Sec.  40.20(d) that DCMs implement risk 
controls for orders that do not originate from Algorithmic Trading. If 
the Commission were to incorporate such amendments in any final rules 
arising from this NPRM, its intent would be to further reduce risk by 
ensuring that all orders, regardless of source, are screened for risk 
at both the clearing member FCM and the DCM level. Risk controls at the 
point of order origination would continue to be limited to AT Persons. 
The Commission requests comment on this proposed amendment to Sec.  
1.82, which the Commission may implement in the final rulemaking for 
Regulation AT. The Commission requests comment on the costs and 
benefits to clearing FCMs of this proposal, in addition to any other 
comments regarding the effectiveness of this proposal in terms of risk 
reduction.

K. Compliance Reports Submitted by AT Persons and Clearing FCMs to 
DCMs; Related Recordkeeping Requirements--Sec.  1.83

    The Commission is proposing new Sec.  1.83(a) and (b) of its 
regulations to require that AT Persons and clearing member FCMs provide 
the DCMs on which they operate with information regarding their 
compliance with Sec. Sec.  1.80(a) and 1.82(a)(1). Specifically, the 
proposed rules would require AT Persons prepare, certify, and submit 
annual reports regarding their controls for: (1) Maximum AT Order 
Message frequency; (2) maximum execution frequency; (3) order price 
parameters; and (4) maximum order sizes. The proposed rules would 
require each FCM that is a clearing member for an AT Person to prepare, 
certify, and submit annual reports regarding its program for 
establishing and maintaining those same controls for its AT Persons (in 
the aggregate). As described in section IV(H) and (J) above, the use of 
such pre-trade risk controls would be mandatory for both AT Persons and 
clearing member FCMs pursuant to Sec. Sec.  1.80(a)(1) and 1.82(a)(1), 
respectively.
    The reports proposed by Sec.  1.83, together with the DCM review 
program proposed by Sec.  40.22, will enable DCMs to have a clearer 
understanding of the pre-trade risk controls of all AT Persons

[[Page 78864]]

that are engaged in Algorithmic Trading on such DCM. Furthermore, 
because AT Persons and clearing member FCMs will have great flexibility 
in how they implement their pre-trade risk controls pursuant to 
proposed Sec. Sec.  1.80(a)(1) and 1.82(a)(1), the annual reporting 
obligations in proposed Sec.  1.83 and DCM review provisions in Sec.  
40.22 will help ensure that such controls are being implemented and are 
reasonably designed and calibrated.
    As a complement to the compliance report program described above, 
proposed Sec.  1.83(c) and (d) would require AT Persons and clearing 
member FCMs for AT Persons to keep and provide upon request to DCMs 
books and records regarding their compliance with Sec. Sec.  1.80 and 
1.81 (for AT Persons) and Sec.  1.82 (for clearing member FCMs).
    The remainder of this section presents Concept Release comments on 
this topic, a description of the proposed regulation, a discussion of 
the policy justification for the proposal, and a request for comments 
on the proposal.
1. Concept Release Comments
    The Concept Release requested comment on whether it would be 
appropriate to require periodic self-certifications by all market 
participants operating ATSs and by clearing firms that provide clearing 
services to those market participants.\378\ In the Concept Release, the 
Commission set forth potential areas that a self-certification for 
market participants might cover. The Commission stated that a 
certification might attest that: ``(1) The ATS contains structural 
safeguards to provide reasonable assurance that the trading system will 
not be disruptive to fair and equitable trading; (2) the market 
participant's ATSs have been designed to avoid violations of the CEA, 
Commission regulations, or exchange rules related to fraud, disruptive 
trading practices, manipulation and trade practice violations; and (3) 
such systems have been sufficiently tested and documented in a manner 
that is appropriate to the intended design and use of that system.'' 
\379\ The Concept Release also requested comment on a number of 
different aspects of a self-certification program. These included: (1) 
Whether the chief executive officer or chief compliance officer, or 
similar ranking official of each market participant should attest to 
the certification; (2) how often should a market participant make the 
self-certification; (3) which entities should receive the 
certification; and (4) should DCMs, SEFs, or clearing member FCMs be 
required to audit the certifications of market participants.\380\
---------------------------------------------------------------------------

    \378\ Concept Release, 78 FR 56559.
    \379\ Id.
    \380\ Id.
---------------------------------------------------------------------------

    Commenters were mixed in their support of a certification 
requirement for market participants operating ATSs and for clearing 
firms that provide clearing services to those market participants. Some 
commenters, such as AFR, supported certifications.\381\ Others, such as 
AIMA, FIA, and CME, oppose a certification requirement set by the 
Commission.\382\ AIMA argued that a certification requirement ``could 
merely create extra administrative costs for firms and the CFTC.'' 
\383\ FIA and CME stated that it should be left to individual DCMs to 
define certification policies for their market participants.\384\ FIA 
commented that instead of formal certification, market access should 
depend on attestation that the highest quality standards are maintained 
and appropriate risk controls and escalation procedures are in 
place.\385\ CME argued that ``[g]iven the breadth of risk profiles 
across the spectrum of clients, it would be unduly burdensome and cost-
prohibitive for the exchanges or the Commission to mandate specific 
risk management parameters and the continuous auditing or formal 
certification thereof.'' \386\
---------------------------------------------------------------------------

    \381\ AFR at 8.
    \382\ AIMA at 21; FIA at 4; CME at 27.
    \383\ AIMA at 21.
    \384\ FIA at 4; CME at 27.
    \385\ FIA at 40.
    \386\ CME at 28.
---------------------------------------------------------------------------

    With respect to what information might be included in the 
certifications, Gelber argued that ``[a] market participant should 
certify that each of its ATS employs pre-trade risk controls, post-
trade reports and system safeguards.'' \387\ FIA and CME also commented 
that if the Commission were to impose a certification requirement, the 
standards for such requirement should be principles-based.\388\
---------------------------------------------------------------------------

    \387\ Gelber at 17.
    \388\ FIA at 4; CME at 27.
---------------------------------------------------------------------------

    Most commenters support requiring senior management to make the 
certification. FIA argued that if a certification requirement is 
imposed, this certification should be the responsibility of senior 
management at the market participant, DCM or FCM.\389\ Gelber commented 
that the certification should be from a chief technology officer or 
equivalent, and attested to by another c-level executive officer.\390\ 
AFR commented that certifications ``should be made by the CEO, as well 
as both the CCO and CRO to make certain that responsibility for the 
underlying systems and algorithms is taken by those officers having 
direct responsibility.'' \391\ CME commented that any attestation 
should lie with the supervisors with business line responsibility for, 
and knowledge of, the systems at issue. CME also stated that the 
certifications ``should be tendered to each level of the supply chain 
with supervisory authority.'' \392\
---------------------------------------------------------------------------

    \389\ FIA at 39.
    \390\ Gelber at 17.
    \391\ AFR at 8.
    \392\ CME at 28.
---------------------------------------------------------------------------

    With respect to the frequency of the certifications, Gelber 
commented that market participants should certify twice per year and 
whenever there has been a material change to a program that they 
employ.\393\ TCL stated that ATSs should be required to make the 
certification annually, or whenever a major functional change to their 
business environment is implemented.\394\ With respect to the auditing 
of the certifications, FIA argued that audit responsibilities should 
only be determined after standards are in place.\395\ Alternatively, 
Gelber argued that exchanges should require firms to maintain 
certifications and produce them upon request. Gelber stated that it 
should be at the exchanges' discretion as to whether they audit such 
certifications.\396\
---------------------------------------------------------------------------

    \393\ Gelber at 17.
    \394\ TLC at 15.
    \395\ FIA at 40.
    \396\ Gelber at 17.
---------------------------------------------------------------------------

2. Description of Regulation
    Compliance Report Program. Proposed Sec.  1.83(a) and (b) would 
require that AT Persons and clearing member FCMs, respectively, provide 
the DCMs on which they operate with information regarding their 
compliance with Sec. Sec.  1.80(a) and 1.82(a)(1). Specifically, the 
proposed rules would to require AT Persons to prepare, certify, and 
submit annual reports regarding their controls for: (1) Maximum AT 
Order Message frequency; (2) maximum execution frequency; (3) order 
price parameters; and (4) maximum order sizes. The proposed rules would 
require each FCM that is a clearing member for one or more AT Persons 
to prepare, certify, and submit annual reports regarding its program 
for establishing and maintaining those same controls for its AT Persons 
in the aggregate. As described in section IV(H) and (J) above, the use 
of such pre-trade risk controls would be mandatory for AT Persons 
pursuant to Sec.  1.80(a)(1), and mandatory for clearing member FCMs 
pursuant to Sec.  1.82(a)(1).

[[Page 78865]]

    The Commission is also proposing a new Sec.  40.22 (discussed in 
more detail below) to require that each DCM that receives a report 
described in Sec.  1.83 establish a program for effective review and 
evaluation of the reports. The reports proposed by Sec.  1.83 and the 
review program proposed by Sec.  40.22 would enable DCMs to have a 
clearer understanding of the pre-trade risk controls and compliance 
procedures of all AT Persons that are engaged in Algorithmic Trading on 
such DCM. The proposed reports and review program will also give DCMs a 
better understanding of the program for establishing and maintaining 
the pre-trade risk controls used by any FCM of an AT Person that is 
engaged in Algorithmic Trading on such DCM.
    The Commission notes that the SEC's Market Access Rule, as 
discussed in greater detail above, has a similar certification 
requirement for certain broker-dealers.\397\ The Market Access Rule 
requires that certain broker-dealers maintain a system for regularly 
reviewing the effectiveness of the risk management controls and 
supervisory procedures required by the Market Access Rule. It also 
requires that the Chief Executive Officer (or equivalent officer) of a 
broker-dealer subject to the Market Access Rule certify, on an annual 
basis, that the risk management controls and supervisory procedures 
established by the broker-dealer comply with the Market Access Rule, 
and that the broker-dealer conducted the required review of the risk 
management controls and supervisory procedures. The certification 
required by the Market Access Rule must be preserved by the broker-
dealer as part of its books and records.
---------------------------------------------------------------------------

    \397\ 17 CFR 240.15c3-5(e).
---------------------------------------------------------------------------

    The Commission also notes that ESMA's 2015 Final Draft Regulatory 
Standards require an annual self-assessment and validation process in 
which investment firms must review their algorithmic trading systems 
and trading algorithms, and overall compliance with Article 17 of 
Directive 2014/65/EU (MiFID II's requirements on firms that engage in 
Algorithmic Trading).\398\ ESMA sets out elements that investment firms 
should consider in its self-assessment, which include elements relating 
to the nature of its business (e.g., level of automation, types of 
strategies it employs, latency sensitivity), the scale of its business 
(e.g., number of algorithms, number of trading desks, messaging volume 
capabilities), and the complexity of its business (e.g., diversity of 
trading systems and connectivity methods, and the speed of trading). 
The validation report must be approved by the firm's senior management 
and the firm must remedy any deficiencies identified.
---------------------------------------------------------------------------

    \398\ ESMA September 2015 Final Draft Standards Report Annex 1, 
supra note 80 at 210, 224-26.
---------------------------------------------------------------------------

    While not identical to the certification required of broker-dealers 
in the Market Access Rule or ESMA's annual self-assessment process for 
investment firms, the compliance report program proposed by Sec.  1.83 
and Sec.  40.22 is similarly designed to ensure that market 
participants have effective risk controls in place and that these risk 
controls are regularly reviewed. Specifically, proposed Sec.  1.83(a) 
would require each AT Person to annually prepare a report, and submit 
such report by June 30 to each DCM on which such AT Person engaged in 
Algorithmic Trading, that covers from May 1 of the previous year to 
April 30 of the year such report is submitted. Together with the annual 
report, each AT Person would be required to submit copies of the 
written policies and procedures developed to comply with Sec.  1.81(a) 
and (c). The report must include descriptions of the AT Person's pre-
trade risk controls required by proposed Sec.  1.80(a)(1), and the 
parameters and specific quantitative settings used for the risk 
controls. The report would also be required to include a certification 
by the chief executive officer or chief compliance officer of the AT 
Person that, to the best of his or her knowledge and reasonable belief, 
the information contained in the report is accurate and complete.
    Proposed Sec.  1.83(b) would require each FCM that is a clearing 
member for an AT Person to annually prepare a report, and submit such 
report by June 30 to each DCM on which such AT Person engaged in 
Algorithmic Trading, that covers from May 1 of the previous year to 
April 30 of the year such report is submitted. The report must include 
a description of the FCM's program for establishing and maintaining the 
pre-trade controls required by proposed Sec.  1.82(a)(1) for its AT 
Persons (in the aggregate) at the DCM. The requirements of proposed 
Sec.  1.83(b) apply to the pre-trade risk controls implemented by the 
FCM for AT Persons using DEA, as well as for AT Persons that do not use 
DEA. The report would also be required to include a certification by 
the chief executive officer or chief compliance officer of the FCM 
that, to the best of his or her knowledge and reasonable belief, the 
information contained in the report is accurate and complete. Related 
to these reporting requirements in proposed Sec.  1.80(a) and (b), 
proposed Sec.  40.22(c) \399\ would require DCMs to establish a program 
for effective periodic review and evaluation of AT Person and clearing 
member FCM reports.
---------------------------------------------------------------------------

    \399\ See section IV(P) below for a discussion of DCMs' 
obligations under proposed Sec.  40.22.
---------------------------------------------------------------------------

    Recordkeeping Requirements. As a complement to the compliance 
report review program, proposed Sec.  1.83(c) and (d) would require AT 
Persons and clearing member FCMs for AT Persons to keep and provide 
upon request to DCMs books and records regarding their compliance with 
proposed Sec. Sec.  1.80 and 1.81 (for AT Persons) and Sec.  1.82 (for 
clearing member FCMs). Related to these provisions, the Commission is 
also proposing a new Sec.  40.22(d) (discussed in more detail below) to 
require DCMs to implement rules that require each AT Person to keep and 
provide to the DCM books and records regarding such AT Person's 
compliance with all requirements pursuant to Sec.  1.80 and Sec.  1.81, 
and require each clearing member FCM to keep and provide to the DCM 
books and records regarding such clearing member FCM's compliance with 
all requirements pursuant to Sec.  1.82. Finally, proposed Sec.  
40.22(e) would require DCMs to review and evaluate, as necessary, books 
and records maintained by AT Persons and clearing member FCMs regarding 
their compliance with Sec. Sec.  1.80 and 1.81 (for AT Persons) and 
Sec.  1.82 (for clearing member FCMs).
3. Policy Discussion
    The Commission is proposing Sec.  1.83 because it believes that 
Regulation AT must include a mechanism to ensure that AT Persons and 
clearing member FCMs are complying with the requirement to implement 
certain pre-trade risk controls. Moreover, an assessment of such 
compliance requires an adequate level of expertise and knowledge of 
markets and market participants' technological systems and trading 
strategies. In this regard, the Commission notes that reports proposed 
by Sec.  1.83 will enable DCMs to have a better understanding of the 
pre-trade risk controls of all AT Persons engaged in Algorithmic 
Trading. Furthermore, because the Commission's pre-trade risk control 
requirements in proposed Sec. Sec.  1.80(a)(1) and 1.82(a)(1) offer 
substantial flexibility, the annual reporting obligations in proposed 
Sec.  1.83 will help ensure that such controls are reasonably designed 
and calibrated. The Commission believes that a review program requiring 
AT Persons and clearing member FCMs to provide information concerning 
compliance

[[Page 78866]]

with Sec. Sec.  1.80(a) and 1.82(a)(1), and requiring DCMs to review 
such information, is the most effective method to ensure that all 
market participants are implementing measures that are reasonably 
designed to prevent an Algorithmic Trading Event or Algorithmic Trading 
Disruption.
    The recordkeeping requirements proposed under Sec.  1.83(c) and (d) 
and Sec.  40.22(d) and (e) complement the compliance report program. 
These provisions will enable DCMs to review the compliance of AT 
Persons and clearing member FCMs with their various obligations under 
Sec. Sec.  1.80, 1.81, and 1.82, by inspecting the books and records of 
AT Persons and clearing member FCMs as necessary. For example, a DCM 
may find it necessary to conduct such a review if: It becomes aware if 
an AT Person's kill switch is frequently activated, or otherwise 
performs in an unusual manner; if a DCM becomes aware that an AT 
Person's algorithm frequently performs in a manner inconsistent with 
its design, which may raise questions about the design or monitoring of 
the AT Person's algorithms; if a DCM identifies frequent trade practice 
violations at an AT Person, which are related to an algorithm of the AT 
Person; or if an AT Person represents significant volume in a 
particular product, thereby requiring heightened scrutiny, among other 
reasons.
4. Request for Comments
    57. The Commission welcomes comment on the type of information that 
should be included in the reports required by proposed Sec.  1.83. 
Should different or additional descriptions be included in the reports, 
which will be evaluated by DCMs under proposed Sec.  40.22?
    58. How often should the reports required by proposed Sec.  1.83 be 
submitted to the relevant DCMs? Should the report be submitted more or 
less frequently than annually?
    59. When should the reports required by proposed Sec.  1.83 be 
submitted to the relevant DCMs? Should the reports be submitted on a 
date other than June 30 of each year?
    60. Should a representative of the AT Person or clearing member FCM 
other than the chief executive officer or the chief compliance officer 
be responsible for certifying the reports required by proposed Sec.  
1.83? Should only the chief executive officer be permitted to certify 
the report? Alternatively, should only the chief compliance officer be 
permitted to certify the report?
    61. Are there any aspects of proposed Sec.  1.83(b) that pose an 
undue burden for clearing member FCMs and are unnecessary for purposes 
of reducing the risks associated with Algorithmic Trading? If so, 
please explain (1) the burden; (2) why it is not necessary to reduce 
the risks associated with Algorithmic Trading, particularly in the case 
of DEA. What alternatives are available consistent with the purposes of 
Regulation AT, including in particular Regulation AT's intent that 
Sec.  1.83 reports benefit from the third-party SRO review performed by 
DCMs with respect to such reports?
    62. Should the reports required by proposed Sec.  1.83 be sent to 
any entity other than each DCM on which the AT Person operates, such as 
the Commission or an RFA? For example, should the Commission require 
that AT Persons that are members of a RFA send compliance reports to 
RFA upon NFA's request?
    63. Proposed Sec.  1.83(c) includes recordkeeping requirements 
imposed on AT Persons, and proposed Sec.  1.83(d) includes 
recordkeeping requirements imposed on clearing member FCMs. Should the 
recordkeeping requirements of Sec.  1.83(c) be distributed throughout 
the sections of the Commission's regulations that contain recordkeeping 
requirements for various categories of Commission registrants that will 
be classified as AT Persons? Should Sec.  1.83(d) be transferred to 
section 1.35 of the Commission's regulations, which contains 
recordkeeping requirements for clearing member FCMs?

L. Risk Controls for Trading: Direct Electronic Access Provided by 
DCMs--Sec.  38.255(b) and (c)

    The Commission proposes to amend Sec.  38.255 (Risk controls for 
trading) by adding new Sec.  38.255(b) requiring DCMs to implement 
systems and controls reasonably designed to facilitate a clearing FCM's 
management of Algorithmic Trading risks arising from its DEA customers. 
The Commission also proposes to amend Sec.  38.255 by adding new 
paragraph (c), which would require that DCMs who permit DEA also 
mandate the use of Sec.  38.255(b) risk controls by all clearing member 
FCMs with respect to the Algorithmic Trading of their DEA customers. 
The Commission notes that the risk controls and requirements described 
in proposed Sec.  38.255(b) and (c), while provided by and residing at 
the DCM, are fundamentally intended to facilitate a clearing member 
FCM's management of the risks posed by the clearing member FCM's DEA 
customers. In this regard, proposed Sec.  38.255(b) and (c) should be 
read in conjunction with proposed Sec.  1.82(b), which would require 
clearing member FCMs to make use of the systems provided by DCMs 
pursuant to Sec.  38.255(b). The remainder of this section presents 
Concept Release comments on this topic, a description of the proposed 
regulation, a discussion of the policy justification for the proposal, 
and a request for comments on the proposal.\400\
---------------------------------------------------------------------------

    \400\ The proposed amendments would also re-designate the 
existing requirements in Sec.  38.255 as Sec.  38.255(a).
---------------------------------------------------------------------------

1. Concept Release Comments
    As noted above in section IV(D)(7), in the Commission's discussion 
of its proposed definition of Direct Electronic Access, several 
commenters agreed that any potential risk controls should also apply to 
those with direct access to the markets.\401\ FIA stated, for example, 
that all types of market access create risks.\402\ Similarly, CME 
stated that all entities--whether they have direct market access or 
not--must ``share in the effort to preserve market integrity.'' \403\ 
In addition, commenters indicated that exchanges already provide 
certain pre-trade risk controls for use by clearing firms. Please see 
the discussion at section IV(H)(1) above for a discussion of Concept 
Release comments with respect to clearing firms' use of exchange-
provided pre-trade and other risk controls.
---------------------------------------------------------------------------

    \401\ FIA at 12, 15; KCG at 2; CME at 7-8; VFL at 2; AIMA at 1.
    \402\ FIA at 12, 15.
    \403\ CME at 7-8.
---------------------------------------------------------------------------

2. Description of Regulation
    The Commission proposes to amend Sec.  38.255 (Risk controls for 
trading) to require DCMs to have in place systems and controls designed 
to facilitate a clearing member FCM's management of the risks that may 
arise from Algorithmic Trading by its AT Person customers using DEA (as 
defined in proposed Sec.  1.3(yyyy)). The DCM regulations already 
address financial risk using a similar structure. Existing Sec.  38.607 
provides that, in the context of direct electronic access, a DCM must 
have in place systems and controls designed to facilitate an FCM's 
management of ``financial risk.'' The DCM must also require FCMs to use 
such controls.
    The pre-trade risk controls and order cancellation systems that 
DCMs must provide to clearing member FCMs are the same as those that 
proposed Sec.  1.80(a) requires AT Persons to implement, i.e., maximum 
AT Order Message frequency per unit time and maximum execution 
frequency per unit time, and order price parameters and maximum order 
size limits. The order

[[Page 78867]]

cancellation systems that DCMs must establish for implementation by the 
clearing member FCM are the same controls that proposed Sec.  
1.80(b)(1) requires AT Persons to implement, i.e., systems that have 
the ability to immediately disengage Algorithmic Trading, cancel 
selected or up to all resting orders when system or market conditions 
require it, and prevent the submission of new orders.
    The proposed regulation text is articulated broadly enough to allow 
DCMs the flexibility to design controls for use by clearing member FCMs 
that are appropriate to their markets and market participants. Proposed 
Sec.  38.255(b)(1)(ii) provides that the pre-trade risk controls 
established by the DCMs must enable the clearing member FCM to set the 
controls at the level of each AT Person, product, account number or 
designation, and one or more identifiers of natural persons associated 
with an AT Order Message. DCM rules should permit clearing member FCMs 
to choose the level at which they place the control, as long as 
clearing member FCMs use at least one of the levels. Similarly, 
proposed Sec.  38.255(b)(2) provides that the DCM-provided order 
cancellation systems should enable the clearing member FCM to apply 
such systems to orders from each AT Person, product, account number or 
designation, or one or more identifiers of natural persons associated 
with an AT Order Message. A DCM that permits DEA must require FCMs to 
use the Sec.  38.255(b) controls with respect to all AT Order Messages 
originating with an AT Person that are submitted through DEA.
3. Policy Discussion
    The Commission believes that its proposed amendments to Sec.  
38.255, and corresponding proposed Sec.  1.82 applicable to clearing 
member FCMs, is consistent with those comments to the Concept Release 
that suggested that pre-trade risk controls should apply to those with 
direct market access.\404\ As FIA explained, all types of market access 
create risks; therefore, the same principles should apply to all types 
of market access.\405\ In addition, the Commission's approach to 
controls that should exist in the context of DEA is consistent with 
recommendations of or steps taken by other regulatory organizations. 
For example, IOSCO has recommended that intermediaries (including 
clearing firms) should have adequate operational and technical 
capabilities to manage appropriately the risks posed by direct 
electronic access.\406\ In addition, as discussed above, ESMA's 2015 
Final Draft Regulatory Standards require direct electronic access 
providers to apply pre-trade controls on the order flow of their 
clients consistent with the controls that ESMA requires for investment 
firms.\407\ ESMA's standards further provide, among other things, that 
trading venues must have public rules pursuant to which direct 
electronic access providers provide their service, and in the case of 
sponsored access (where a client transmits orders directly to a trading 
platform without such orders passing through an intermediary's 
infrastructure), the trading venue must require such firms to implement 
the same pre-trade risk controls as the trading venue's members.\408\ 
The Commission believes that requiring DCMs to establish pre-trade risk 
controls and order management controls for use by clearing member FCMs 
with respect to their direct access customers will ensure that all 
orders, regardless of access method, are subjected to the same tools 
that mitigate the risks posed by Algorithmic Trading.
---------------------------------------------------------------------------

    \404\ FIA at 12, 15; KCG at 2; CME at 7-8; VFL at 2; AIMA at 1.
    \405\ FIA at 12, 15.
    \406\ IOSCO 2015 Consultation Report, supra note 106 at 22-23.
    \407\ See ESMA September 2015 Final Draft Standards Report Annex 
1, supra note 80 at 218.
    \408\ See id. at 269-70.
---------------------------------------------------------------------------

4. Request for Comments
    64. Are there any pre-trade and other risk controls required by 
Sec.  38.255(b) and (c) that will be ineffective, not already widely 
provided by DCMs for use by FCMs, or likely to become obsolete?
    65. Are there additional pre-trade or other risk controls that DCMs 
should be specifically required to provide to FCMs pursuant to proposed 
Sec.  38.255(b) and (c)?
    66. Do you believe that the pre-trade and other risk controls 
required pursuant to Sec.  38.255(b) sufficiently address the 
possibility of technological advances in trading? For example, do they 
appropriately address the potential for the future development of 
additional effective controls that should be provided by DCMs and 
implemented by FCMs?
    67. The Commission welcomes comment on whether Sec.  38.255(b)'s 
requirements relating to the design of controls and the levels at which 
the controls should be set are appropriate and sufficiently granular.
    68. Proposed Sec.  38.255(b) and (c) do not require DCMs to provide 
to FCMs connectivity monitoring systems such as ``system heartbeats'' 
or automatic cancel-on-disconnect functions. Should Sec.  38.255 
require such functionality?

M. Disclosure and Transparency in DCM Trade Matching Systems--Sec.  
38.401(a)

    Regulation AT proposes to amend Sec.  38.401(a) of the Commission's 
regulations to enhance public transparency regarding the design and 
operation of a DCM's electronic matching platform. Currently, Sec.  
38.401(a) requires DCMs to have procedures, arrangements, and resources 
for disclosing to the Commission, market participants, and the public 
accurate information on the rules and specifications of their 
electronic matching platforms or trade execution facilities. The 
proposed amendments to Sec.  38.401(a) would clarify that such existing 
obligations include disclosure of any attributes of an electronic 
matching platform or trade execution facility that materially impact 
market participant orders, but which are not readily apparent to a 
market participant. The proposed amendments recognize that the 
structure, architecture, mechanics, characteristics, attributes, or 
other elements of an electronic matching platform or trade execution 
facility--elements that are under the design control of the DCM--may 
affect how market participant orders are received or executed. The 
Commission believes that each market participant should have ready 
access to information that explains the existence and operation of any 
attribute within an electronic matching platform or trade execution 
facility that will impact how a market participant experiences the 
market. The remainder of this section presents Concept Release comments 
on this topic, a description of the proposed regulation, a discussion 
of the policy justification for the proposal, and a request for 
comments on the proposal.
1. Concept Release Comments
    As noted above, the proposed amendments to Sec.  38.401(a) focus in 
large measure on attributes of an electronic matching platform or trade 
execution facility that impact the timing and sequencing of specific 
events on the exchange. While the Concept Release did not directly 
address proposed Sec.  38.401(a), it did ask for public comment on 
latencies in the transmission of various types of messages between 
exchanges, firms and vendors wherein differences in latency could 
provide opportunities for informational advantage.\409\ It pointed to 
press reports that one exchange sent confirmations to the traders 
involved in

[[Page 78868]]

an executed transaction before the DCM posted the transaction on its 
market data feed to the marketplace as a whole.\410\ The Commission 
asked for comments on: (a) Whether the extent of latency in message 
transmission can have an adverse impact on market quality or fairness; 
and (b) whether exchanges, vendors and firms should be required to 
audit their systems and processes on a periodic basis to identify and 
resolve such latencies.\411\
---------------------------------------------------------------------------

    \409\ Concept Release, 78 FR 56546.
    \410\ Scott Patterson, Jenny Strasburg, & Liam Pleven, ``High-
Speed Traders Exploit Loophole,'' Wall St. J. (May 1, 2013), 
available at http://www.wsj.com/articles/SB10001424127887323798104578455032466082920.
    \411\ Concept Release, 78 FR 56546.
---------------------------------------------------------------------------

    The Concept Release also asked for public comment on the 
advisability of requiring each trading platform to provide market 
quality indicators on a periodic basis for each product traded on its 
platform.\412\ The Concept Release also asked for comments on what 
types of market quality data would be helpful to market participants 
and promote market efficiency through transparency and market 
competition.
---------------------------------------------------------------------------

    \412\ Id. at 56561.
---------------------------------------------------------------------------

    Several commenters supported increased transparency by the 
exchanges in the operation of their electronic matching platforms. 
AIMA, for example, would welcome new requirements for transparency by 
exchanges on issues of latency, noting that market participants without 
DMA are currently not able to calculate many measures of latency and 
market quality that are available to those with DMA.\413\ Bell noted 
that the disclosure of latencies in CME's electronic matching platform 
removed the informational advantage held by those market participants 
who knew of the latency compared to those who did not.\414\ However, 
Bell also cautioned that the threat of sanctions against an exchange 
for the existence of a latency arbitrage opportunity in an electronic 
matching platform could discourage that exchange from publicly 
disclosing such information. FIA noted that real-time access to 
additional information regarding the order book creates a more 
transparent marketplace, which ultimately breeds confidence among 
market participants.\415\
---------------------------------------------------------------------------

    \413\ AIMA at 7.
    \414\ Bell at 3.
    \415\ FIA at 51.
---------------------------------------------------------------------------

    CME and FIA noted that latency is a natural component of market 
structure because of the time it takes computer systems to process 
information as well as the communications systems involved in 
transmitting order message information.\416\ Even if no latencies 
existed within an exchange's infrastructure, market participants may 
still face latencies in clearing and executing firms' systems.\417\
---------------------------------------------------------------------------

    \416\ CME at 6-7; FIA at 47-48.
    \417\ CME at 48.
---------------------------------------------------------------------------

    Several commenters addressed the specific issue of whether 
participants in a trade should receive confirmations of that trade 
before, or at least not after, the trade is reflected in market data 
sent to all market participants (``confirmation-first latency'').\418\ 
FIA commented that the confirmation-first latency on one exchange was 
not hidden, and that it could be measured and understood by anyone with 
the proper market access.\419\ FIA stated that it is imperative that 
the market data broadcast to all market participants not be sent before 
the participants to a trade know that the trade was executed (``market 
data-first latency'').\420\ FIA also stated that market data-first 
latency would cause liquidity providing participants to be unaware of 
their positions and therefore hamper their ability to hedge risk 
effectively. The commenter believed that this would cause market makers 
to widen the spreads they offer. OneChicago suggested that 
confirmation-first latency should not be considered an unfair 
advantage.\421\ SIG suggested that confirmation-first latency would 
encourage liquidity by allowing an executing trader to hedge a position 
before quickly responding momentum traders exhausted available 
liquidity in the market.\422\
---------------------------------------------------------------------------

    \418\ FIA at 47-48; SIG at 2; OneChicago at 1. The Commission is 
using the term ``confirmation-first latency'' for ease of reference; 
it was not used in the comment letters.
    \419\ FIA at 48.
    \420\ Id. The Commission is using the term ``market data-first 
latency'' for ease of reference; it was not used in the comment 
letters.
    \421\ OneChicago at 1.
    \422\ SIG at 2.
---------------------------------------------------------------------------

2. Description of Regulation
    Current Sec.  38.401(a) requires DCMs to have procedures, 
arrangements, and resources for disclosing to the Commission, market 
participants, and the public accurate information on, inter alia, the 
rules and specifications concerning the operation of the DCM's 
electronic matching platform or trade execution facility. Current Sec.  
38.401(b) requires DCMs to provide such information that ``it believes, 
to the best of its knowledge, is accurate and complete, and must not 
omit material information.'' Current Sec.  38.401(c) requires DCMs to 
make publicly available on their Web sites any new product listings, 
rules, rule amendments, or other changes to previously-disclosed 
information, concurrent with filing such submissions with the 
Commission. The proposed amendments to Sec.  38.401 build on these 
disclosure, accuracy, and timing requirements, and extend the 
disclosure requirements to cover certain attributes of the operation of 
electronic matching platforms.
    The Commission proposes to amend Sec.  38.401(a)(1)(iii) to require 
DCMs to disclose to the Commission, market participants and the public 
accurate information pertaining to rules or specifications pertaining 
to the operation of the electronic matching platform or trade execution 
facility, including but not limited to those pertaining to the 
operation of its electronic matching platform that materially affect 
the time, priority, price, or quantity of execution, or the ability to 
cancel, modify, or limit display of market participant orders.
    The Commission also proposes to amend Sec.  38.401(a)(1) by adding 
a new requirement (Sec.  38.401(a)(1)(iv)) that DCMs must disclose to 
all market participants any known attributes of the electronic matching 
platform, other than those already disclosed in rules or specifications 
under section (a)(1)(iii), that materially affect the time, priority, 
price, or quantity of execution of market participant orders, the 
ability to cancel, modify, or limit display of market participant 
orders, or the dissemination of real-time market data to market 
participants, including but not limited to latencies or other 
variability in the electronic matching platform and the transmission of 
message acknowledgements, order confirmations, or trade confirmations, 
or dissemination of market data. The Commission notes, however, that 
proposed Sec.  38.401(a)(1)(iii) and (iv) are not intended to require 
the disclosure of trade secrets by any DCM.
    Finally, the Commission also proposes to amend Sec.  38.401(c) by 
adding a new requirement (Sec.  38.401(c)(3)) that a DCM, in making 
available on its Web site information pursuant to paragraphs 
(a)(1)(iii) and (iv) of Sec.  38.401(c), must place such information 
and submissions on its Web site within a reasonable time, but no later 
than 10 business days, following the identification of or changes to 
such attributes. Such information shall be disclosed prominently and 
clearly in plain English. The Commission emphasizes that the disclosure 
of information prominently and clearly by a DCM precludes such DCM from 
placing information required by this

[[Page 78869]]

rule behind registration, log in, user name, password or other walls on 
the DCM's Web site.
a. What Must Be Disclosed Under the Proposed Regulations
    The proposed Sec.  38.401(a)(1)(iii) and (iv) would apply to all 
known attributes of an electronic matching platform that materially 
affect the time, priority, price, or quantity of execution of market 
participant order messages, or the ability to cancel, modify, or limit 
display of, market participant order messages. The Commission proposes 
a ``materiality'' threshold to such obligations so that the disclosure 
requirements would not capture aspects of exchange systems that do not 
have a discernible effect on how orders are entered or executed.\423\
---------------------------------------------------------------------------

    \423\ In evaluating what attributes of a platform would be 
material, the Commission would look to the substantial case law on 
the issue of materiality. See, e.g., R&W Tech. Servs., Ltd. v. CFTC, 
205 F.3d 165, 169 (5th Cir. 2000) (``A statement or omitted fact is 
`material' if there is a substantial likelihood that a reasonable 
investor would consider the information important in making a 
decision to invest.''); see also CFTC v. R.J. Fitzgerald & Co., 310 
F.3d 1321, 1332 (11th Cir. 2002) (finding misrepresentations 
material where ``an objectively reasonable investor's decision-
making process would be substantially affected'' by them and the 
misrepresentations would ``as a matter of law, alter the total mix 
of relevant information available to the potential . . . 
investor.''). Materiality in the context of attributes of an 
electronic matching platform would include those attributes whose 
existence or degree a reasonable market participant would consider 
when making a decision on whether, when or how to place orders on an 
exchange's platform.
---------------------------------------------------------------------------

    An ``attribute'' for purposes of proposed Sec.  38.401(a)(1)(iv) 
would mean any aspect of the structure, architecture, mechanics, 
characteristics, or other elements of the design or operation of an 
electronic matching platform that materially affects how market 
participant orders are received and executed, and how information on 
such orders and executed trades are communicated to other market 
participants. ``Attributes'' would include, but are not limited to, 
aspects of the platform that may provide an advantage or disadvantage 
to a category of market participants.\424\ ``Attributes'' would also 
include aspects of the platform that affect orders from all market 
participants regardless of access method or membership status, such as 
latencies within the matching engine and any data feeds.\425\
---------------------------------------------------------------------------

    \424\ For purposes of this discussion, ``categories of market 
participants'' may be based on access method, colocation, 
involvement in a market maker incentive program, or membership 
status, among other things. DCMs are currently required to submit as 
rule changes under Part 40 any changes to these programs. As 
discussed more fully below, the proposed transparency requirement 
would only require disclosure of attributes not already disclosed 
through submissions under Part 40, 17 CFR 40.1, et seq. (2014).
    \425\ As an illustration of attributes that should be disclosed 
to market participants (and acknowledging the more complex order 
types and modes of execution in the equities market), the Commission 
notes two recent SEC enforcement actions against the operators of 
alternative trading systems for selective disclosure or non-
disclosure regarding how certain order types operate under different 
market conditions. See In the Matter of UBS Securities LLC., No. 3-
16338 (SEC, Jan. 15, 2015); In the Matter of EDGA Exchange, Inc., 
No. 3-16332 (SEC, Jan. 12, 2015).
---------------------------------------------------------------------------

    The Commission's proposals under Sec.  38.401(a)(1)(iii) and (iv) 
apply to ``electronic matching platforms,'' which comprise all systems 
under the control or operation of the DCM that interact with market 
participant order messages and are involved in market data 
dissemination. Such systems are not limited to matching engines, but 
would apply more broadly to the network architecture that accepts and 
processes order messages, and disseminates market data and messages to 
market participants. To the extent that they impact order entry and 
execution, the electronic matching platform would also include pre-
trade risk management systems and controls such as self-trade 
prevention tools.\426\
---------------------------------------------------------------------------

    \426\ The Commission notes that the proposed disclosure 
requirements in large part would address IOSCO's recommendation 
relating to sound practices on controls surrounding the development 
of new or changes to critical systems at trading venues. IOSCO, 
after reviewing current member state regulations, recommended 
``[e]stablishing and implementing communication protocols that 
govern the sharing of information regarding the introduction of new, 
or changes to, critical systems[,]'' including information on the 
timing of such new systems or changes to provide market participants 
sufficient lead time to make changes or adjustments to their own 
systems. See IOSCO 2015 Consultation Report, supra note 106 at 13-
20.
---------------------------------------------------------------------------

    The Commission's proposals under Sec.  38.401(a)(1)(iii) and (iv) 
are intended to apply to various aspects of how an electronic platform 
operates, beyond the technical process of how any order is actually 
matched. The proposed regulations explicitly require the disclosure of 
information relating to latencies in the matching of orders and 
transmission of that information to market participants. In addition, 
if they have a material impact on market participants, exchanges must 
disclose information on exchange functions such as self-trade 
prevention, implied spread markets, and priority assignment of orders 
in a central limit order book, where applicable. Exchanges also must 
disclose how available order types would be executed (or not) under 
different market conditions, where applicable. The Commission is 
mindful that DCMs should only be required to describe attributes of 
their own systems. However, such systems would include platform systems 
or components that are monitored, leased from, or otherwise operated by 
an affiliate or third party.\427\
---------------------------------------------------------------------------

    \427\ The Commission is mindful that some DCMs use electronic 
matching platforms leased from or otherwise provided by other DCMs 
or non-DCM entities. However, each DCM would be required under this 
provision to provide information on any electronic matching platform 
it uses, regardless of whether that platform is owned or leased by 
the DCM.
---------------------------------------------------------------------------

    The Commission has also proposed under amended Sec.  38.401(a)(2) 
that a DCM must provide a description of known attributes of its 
electronic trading platform under paragraph (a)(1)(iv). However, this 
may not relieve an exchange of the obligation to disclose information 
if the exchange should have known of an attribute. The Commission notes 
that DCMs must regularly test and review their automated systems,\428\ 
monitor trading on their facilities, and identify any market or system 
anomalies.\429\ The Commission cautions, however, that compliance with 
Regulation AT's disclosure requirements may not absolve a DCM of other 
statutory or regulatory obligations. For instance, DCMs must promote 
fair and equitable trading and protect markets and market participants 
from abusive practices.\430\
---------------------------------------------------------------------------

    \428\ Both DCMs and SEFs are obligated to ``conduct regular, 
periodic, objective testing and review of their automated systems to 
ensure that they are reliable, secure, and have adequate scalable 
capacity.'' Regulations Sec. Sec.  37.1401(g) and 38.1051(h), 17 CFR 
37.1401(g) and 38.1051(h) (2014).
    \429\ See regulation 37.203(e), 17 CFR 37.203(e) (2014), for 
real-time market monitoring obligations of SEFs. See regulation 
38.157, 17 CFR 38.157 (2014), for real-time monitoring obligations 
of DCMs.
    \430\ DCM Core Principle 12, Section 5(d)(12) of the Act, 7 
U.S.C. 7(d)(12) (2012).
---------------------------------------------------------------------------

b. How Information Should Be Disclosed
    The Commission proposes under Sec.  38.401(a)(1)(iv) that DCMs be 
required to disclose any known attributes of their electronic matching 
platform, other than those already disclosed pursuant to Sec.  
38.401(a)(1)(iii). This description should, at a minimum, identify what 
the attribute is and how it may affect market participant orders. To 
the extent such information is necessary for market participants to 
understand the significance of an attribute, the description may need 
to provide statistics or examples. As with all information provided to 
market participants under current regulation 38.401, the description 
must include information that the DCM believes, to the best of its 
knowledge, to be accurate and complete, and not omit material

[[Page 78870]]

information.\431\ Cost estimates for the Commission amendments to Sec.  
38.401 are provided in this NPRM's cost-benefit considerations below.
---------------------------------------------------------------------------

    \431\ See regulation 38.401(b), 17 CFR 38.401(b) (2014).
---------------------------------------------------------------------------

    The Commission proposes under Sec.  38.401(c)(3) that DCMs be 
required to disclose information on the attributes of their platforms 
``prominently and clearly'' on their Web sites. The Commission also 
proposes under Sec.  38.401(c)(3) that information regarding attributes 
of the electronic matching platforms be provided in ``plain English.'' 
Because market participants may have different degrees of technical 
understanding, the Commission aims to make information on the 
electronic matching platforms accessible to market participants 
regardless of their technical proficiency or sophistication. Providing 
highly complex information on the platforms may allow more technically-
proficient market participants to understand the operations of the 
platform, but may be inaccessible to other market participants.
c. When Information Should Be Disclosed
    The Commission's proposals on DCM transparency are intended to 
account for two situations: (1) Where the DCM makes a change to the 
platform, resulting in an impact on the execution of market participant 
orders, and (2) where the DCM becomes aware of an existing attribute 
within the platform that affects the execution of such orders. Under 
the first situation, as clarified in the proposed amendment to the 
definition of ``rule'' under Sec.  40.1(i), information submitted to 
the Commission under Sec. Sec.  40.5(a) or 40.6(a) would be public 
information, except to the extent that confidential treatment is 
granted pursuant to Sec.  40.8. Furthermore, a DCM would be required to 
post the relevant submission on its Web site concurrent with the 
provision of such submission to the Commission pursuant to current 
Sec.  38.401(c). Under the second situation, the Commission's proposals 
would require the DCM to make the relevant information available 
``within a reasonable time, but no later than 10 days'' following the 
identification or change to the attribute. DCMs must also ensure that 
information can be accessed by visitors to the Web site without the 
need to register, log in, provide a user name, or obtain a password.
d. Changes in Definition of ``Rule''
    The Commission also proposes amending the definition of ``rule'' 
under Sec.  40.1(i), which is relevant to regulations common to all 
registered entities.\432\ The proposed change to the definition of 
``rule'' would track language in the transparency requirements under 
proposed Sec.  38.401(a)(1)(iv) (which applies only to DCMs). The 
proposed change to the definition would make clear that ``trading 
protocols'' includes ``any operation of an electronic matching platform 
that materially affects the time, priority, price, or quantity of 
execution of market participant orders, the ability to cancel, modify, 
or limit display of market participant orders, or the dissemination of 
real-time market data to market participants.'' As with any other rule 
change, changes to a registered entity's trading protocols must be 
submitted to the Commission pursuant to existing Sec. Sec.  40.5 or 
40.6.
---------------------------------------------------------------------------

    \432\ Part 40 of the Regulations applies to all registered 
entities, which include DCMs, SEFs, derivative clearing 
organizations (``DCOs''), swap data repositories (``SDRs''), and 
certain electronic trading facilities and boards of trade registered 
under Section 5c of the Act. As discussed below in the cost benefit 
consideration section (sections V(E)(9) and (11)), none of the 
proposed amendments to Sec.  40.1(i) should create new costs for any 
registered entity, because the amendments merely clarify and codify 
the Commission's interpretation of the definition of ``rule.'' See, 
e.g., the Final Rule for Provisions Common to Registered Entities, 
published in the Federal Register in 2011, in which the Commission 
stated with respect to market maker and trading incentive programs, 
``The Commission continues to view such programs as `agreements * * 
* corresponding' to a `trading protocol' within the Sec.  40.1 
definition of `rule' and, as such, all market maker and trading 
incentive programs must be submitted to the Commission in accordance 
with procedures established in part 40.'' Final Rule, Provisions 
Common to Registered Entities, 76 FR 44776, 44778 (July 27, 2011).
---------------------------------------------------------------------------

    The Commission notes that this proposed amendment to the definition 
of ``rule'' also adds a reference to market maker and trading incentive 
programs. This change clarifies and codifies the Commission's current 
interpretation of the definition of ``rule'' under Sec.  40.1(i), in 
which registered entities are required to submit new rules and rule 
amendments to the Commission when changes are made to, among other 
things, matching algorithms, market maker or trading incentive program 
agreements, and available order types. This proposed change to Sec.  
40.1(i), which reflects the Commission's understanding of ``rule'', 
should be distinguished from the proposed regulations regarding market 
maker and trading incentive programs under Sec. Sec.  40.25-40.28, 
which represent new requirements that apply only to DCMs.
3. Policy Discussion
    With the proposed transparency requirements, the Commission aims to 
increase the relevant information available to market participants that 
may influence their choice of trading venue. The Commission believes 
that such will foster competition among exchanges by incentivizing them 
to provide the most efficient and fairest venue for trading. Should an 
exchange intentionally or unintentionally structure its trading systems 
to potentially or actually advantage one category of market participant 
over others, the potentially disadvantaged market participants may opt 
to trade on another venue.
    One Concept Release commenter noted that market participants, if 
they have direct market access, could calculate market quality metrics 
including latencies and therefore would be aware of many of the 
attributes of a platform that affect order execution. The requirements 
proposed under Sec.  38.401(a)(1)(iii) and (iv) give all market 
participants an equal footing in terms of understanding how the 
platform operates independent of access methods and services such as 
colocation.
4. Request for Comments
    69. The Commission has proposed that certain components of an 
exchange's market architecture should be considered part of the 
``electronic matching platform'' for purposes of the DCM transparency 
provision. Are there any additional systems that should fall within the 
meaning of ``electronic matching platforms'' for purposes of proposed 
Sec.  38.401(a)?
    70. The Commission has specifically identified, as ``attributes'' 
that must be disclosed, latencies within a platform and how a self-
trade prevention tool determines whether to cancel an order. Are there 
any other attributes that would materially affect the execution of 
market participant orders and therefore should be made known to all 
market participants? Should the Commission revise the final rule so 
that it only applies to latencies within a platform and how a self-
trade prevention tool determines whether to cancel an order?
    71. What information should be disclosed as part of the description 
of relevant attributes of the platform? For instance, with latencies 
within a platform, should statistics on latencies be required? If so, 
what statistics would help market participants assess any impact on 
their orders? Would a narrative description of attributes be 
preferable, including a description of how the attributes might affect 
market participant orders under different market conditions, such as 
during times of increased messaging activity?

[[Page 78871]]

    72. The Commission notes that proposed Sec.  38.401(a)(1)(iii) and 
(iv) are not intended to require the disclosure of a DCM's trade 
secrets. The Commission requests comments on whether the proposed rules 
might inadvertently require such disclosure, and if so, how they might 
be amended to address this concern. Furthermore, the Commission 
anticipates that the mechanisms and standards for requesting 
confidential treatment already codified in existing Sec.  40.8 could be 
used by DCMs to identify and request confidential treatment for 
information otherwise required to be disclosed pursuant to proposed 
Sec.  38.401(a)(1)(iii) and (iv), for example by incorporating Sec.  
40.8's mechanisms and standards into any final rules arising from this 
NPRM. If commenters believe that the mechanisms and standards in Sec.  
40.8 are inappropriate for this purpose, please describe any other 
mechanism that should be included in any final rules to facilitate DCM 
requests for confidential treatment of information otherwise required 
to be disclosed pursuant to proposed Sec.  38.401(a)(1)(iii) and (iv).
    73. The Commission notes that DCMs are required, as part of 
voluntary submissions of new rules or rule amendments under Sec.  
40.5(a) and self-certification of rules and rule amendment under Sec.  
40.6(a), to provide inter alia an explanation and analysis of the 
operation, purpose and effect of the proposed rule or rule amendment. 
Would the information required under Sec. Sec.  40.5(a) or 40.6(a) 
provide market participants and the public with sufficient information 
regarding material attributes of an electronic matching platform?
    74. The Commission recognizes that DCMs are required to have system 
safeguards to ensure information security, business continuity and 
disaster recovery under DCM Core Principle 20. The Commission 
understands that some attributes of an electronic matching platform 
designed to implement those safeguards should be maintained as 
confidential to prevent cybersecurity or other threats. Does existing 
Sec.  40.8, 17 CFR 40.8 (2014) provide sufficient basis for DCMs to 
publicly disclose the relevant attributes of their platforms while 
maintaining as confidential information concerning system safeguards?
    75. With respect to material attributes affecting market 
participant orders caused by temporary or emergency situations, such as 
network outages or the temporary suspension of certain market 
functionality, what is the best way for DCMs to alert market 
participants? How are DCMs currently handling these situations?
    76. The Commission proposes that DCMs provide a description of the 
relevant material attributes in a single document ``disclosed 
prominently and clearly'' on the exchange's Web site. The Commission 
also proposes that this document be written in ``plain English'' to 
allow market participants, even those not technically proficient, to 
understand the attributes described. Would these requirements be 
practical and help market participants locate and understand the 
information provided?
    77. The Commission proposes requiring DCMs to disclose information 
on the relevant attributes: (a) When filing a rule change submission 
with the Commission for changes to the electronic matching platform; or 
(b) within a ``reasonable time, but no later than ten days'' following 
the identification of such attribute. Do the proposed timeframes 
provide sufficient time for DCMs to disclose the relevant information? 
Do the proposed timeframes offer sufficient notice of changes or 
discovered attributes to market participants to allow them to adjust 
any systems or strategies, including any algorithmic trading systems?
    78. The Commission proposes requiring disclosure of newly 
identified attributes within 10 days of discovery. Does this provide 
DCMs sufficient time to analyze the attribute and provide a 
description? Should DCMs be required to provide notice of the existence 
of the attribute and supplement as further analysis is performed?

N. Pre-Trade and Other Risk Controls at DCMs--Sec.  40.20

    The Commission proposes a new Sec.  40.20 to require DCMs to 
establish pre-trade and other risk controls specifically designed to 
address the risks that may arise from Algorithmic Trading. The 
Commission is also proposing to codify in Sec.  40.20 basic pre-trade 
risk control requirements and order cancellation capabilities for 
orders that do not originate from Algorithmic Trading. In this regard, 
the Commission recognizes that natural person traders manually entering 
orders also have the potential to cause market disruptions. While the 
majority of the pre-trade and other risk controls in Regulation AT 
address Algorithmic Trading, the Commission believes it is also 
important to promote a basic degree of risk control for all trading 
regardless of source.
    The pre-trade and other risk controls required of DCMs pursuant to 
proposed Sec.  40.20 reflect Regulation AT's layered approach to risk 
mitigation in automated trading. In particular, the measures required 
of DCMs in Sec.  40.20 are similar to those required of AT Persons in 
proposed Sec.  1.80(a)(1) and (b)(1), and also similar to those 
required of clearing member FCMs in Sec.  1.82(a). The Commission 
intends to offer AT Persons, clearing member FCMs and DCMs the 
flexibility to design and calibrate such controls according to their 
own distinct priorities and understanding of the risks to themselves, 
their customers, and the broader market. In this regard, while certain 
proposed rules may appear duplicative on their face, Regulation AT is 
designed to address the diverse needs of market participants trading 
across multiple markets, by spreading the requirement to impose risk 
controls across AT Persons, clearing member FCMs and DCMs and 
encouraging them to each independently calibrate such controls.
    The remainder of this section presents Concept Release comments on 
this topic, a description of the proposed regulation, a discussion of 
the policy justification for the proposal, and a request for comments 
on the proposal.
1. Concept Release Comments
    The Concept Release requested comment on various pre-trade and 
other types of risk controls, including message and execution 
throttles, maximum order sizes, price collars, and order management 
controls, such as connectivity monitoring services, automatic 
cancellation of orders on disconnect and kill switches. The Concept 
Release contemplated that such controls would apply at the trading 
firm, clearing member and trading platform levels. As explained above, 
proposed Sec.  1.80 requires AT Persons to implement certain pre-trade 
risk controls and order management controls. By reference to the 
proposed Sec.  1.80 regulations, proposed Sec.  40.20 will require DCMs 
to establish similar pre-trade and other risk controls specifically 
designed to address the risks that may arise from Algorithmic Trading, 
and to establish similar controls for orders entered manually. Relevant 
comments to the Concept Release addressing pre-trade and other risk 
controls for DCMs are discussed below.
a. Message and Execution Throttles
    As discussed above, the Concept Release described message throttles 
as establishing maximum message rates per unit of time and execution 
throttles as establishing limits on the maximum number of orders that 
an ATS can execute in a given direction per unit in time. The Concept 
Release also sought

[[Page 78872]]

comment on a particular form of execution throttle, the repeated 
automated execution throttle, which would disable a trading system 
after a configurable number of repeated executions until a human re-
enables the system.\433\ The Concept Release stated that the throttles 
would be calibrated to address the potential for unintended message 
flow or executions from a malfunctioning ATS.\434\
---------------------------------------------------------------------------

    \433\ Concept Release, 78 FR 56571.
    \434\ Concept Release, 78 FR 56569.
---------------------------------------------------------------------------

    Commenters indicated that DCMs are already implementing messaging 
rate limits. Two exchanges described their own message rate limits 
\435\ and four commenters stated generally that many exchanges have 
messaging rate limits in place.\436\ Commenters generally discussed 
throttles at the exchange as being ``messaging'' limits. KCG explained 
that many participants' trading strategies include trading activity on 
multiple markets, and thus the responsibility for establishing limits 
on executions must reside with the market participant and its clearing 
firm.\437\ Benefits of exchange-based messaging limits noted by 
commenters include identifying potentially malfunctioning ATSs, 
preventing a platform overload that would impact the processing of 
messages across all market participants, ensuring a level playing field 
for all market participants, mitigating risk to the DCO, and deterring 
predatory and disruptive activities that require high message 
traffic.\438\ SIG cautioned that exchanges should not impose ``speed-
bump'' throttles on order messaging as a means to ``slow down trading 
for its own sake.'' \439\ FIA suggested that a DCM should never reject 
an order cancellation request due to message rate limits.\440\
---------------------------------------------------------------------------

    \435\ CME at 8-9; CME at Appendix A, 3-4, 6; CFE at 5-6.
    \436\ TCL at 6; KCG at 4; MFA at 7; AIMA at 8.
    \437\ KCG at 5.
    \438\ FIA at 12, 15-17, 65; MFA at 7; CME at 8; Gelber at 5-7; 
AFR at 6-7; SIG at 3.
    \439\ SIG at 3.
    \440\ FIA at 16.
---------------------------------------------------------------------------

    Commenters indicated that exchanges should have flexibility in 
setting messaging limits because exchanges are in the best position to 
respond to the dynamics of the market, monitor the activity of all 
participants, and determine the impact of messaging.\441\ Commenters 
indicated that throttle limits implemented by DCMs should be based on 
the unique characteristics of each product; the capacity and 
performance of a DCM's network and matching engine and the matching 
algorithm; and the market participant's role (i.e., liquidity providers 
may be excluded from limits).\442\ FIA noted that a DCM's message rate 
limit should not adjust to market conditions because participants must 
always know what the limit is.\443\ Chicago Fed commented that 
regulators should assess the methodology that trading venues use to set 
throttle limits, the reasonableness of those limits, and the procedures 
followed when they are breached.\444\ Finally, IATP commented on the 
difficulty in setting standardized throttle thresholds, and 
alternatively suggested standardizing a graduated levy on order 
cancellations.\445\
---------------------------------------------------------------------------

    \441\ FIA at 12, 15-17; CME at 8-9; MFA at 13; Gelber at 5-7; 
KCG at 3-4; AIMA at 8; OneChicago at 5.
    \442\ FIA at 15; CME at 8-9; Gelber at 5-7; KCG at 4; AIMA at 8.
    \443\ FIA at 12, 16.
    \444\ Chicago Fed at 2.
    \445\ IATP at 3-5.
---------------------------------------------------------------------------

b. Maximum Order Sizes
    Commenters indicated that exchanges already implement maximum order 
size limits. Two exchanges, CME and CFE, stated that they apply order 
size limits on each of their products.\446\ AIMA also stated that 
maximum order sizes are normally applied per product at the DCM or FCM 
level to all customers.\447\ Chicago Fed commented that exchanges 
should implement maximum order size limits.\448\ MFA also recommended 
that maximum order size controls be implemented at the FCM and/or 
exchange level, and apply to both manual and automated traders.\449\ 
FIA commented that while it ``has been a proponent of standardization 
of pre-trade risk controls across DCMs we understand that each DCM 
needs to have discretion on how these controls are implemented.'' \450\
---------------------------------------------------------------------------

    \446\ CME at 15, Appendix A-1; CFE at 7.
    \447\ AIMA at 13.
    \448\ Chicago Fed at 2; MFA at 2, 9; Gelber at 10; KCG at 8.
    \449\ MFA at 9.
    \450\ FIA at 18-19.
---------------------------------------------------------------------------

c. Price Collars
    The Concept Release requested comment on price collars, a control 
in which trading platforms would assign a range of acceptable order and 
execution prices for each product and all market participants would 
establish similar limits to ensure that orders outside of a particular 
price range are not transmitted to the trading platform. Commenters 
indicated that exchanges already implement price collars. CME and CFE 
described their own price collar mechanisms.\451\
---------------------------------------------------------------------------

    \451\ CME at 13-14; 16-17, CME at Appendix A-6; CFE at 6-8.
---------------------------------------------------------------------------

    FIA indicated that price collars are a ``widely adopted'' DCM-
hosted risk control and are effective at preventing orders from 
disrupting the market and affecting the price discovery process.\452\ 
FIA further explained that they have been proven to minimize erroneous 
trading by controlling the range of execution prices and can ensure the 
integrity of trades cleared through the DCO by dramatically reducing 
the chance that a trade may be deemed erroneous and subsequently 
adjusted or busted.\453\ FIA recommended that price collars be used on 
all contracts, set by the DCM based on estimates of volatility and 
market conditions.\454\ FIA cautioned that price collars should not be 
mandated at the same levels across all products.\455\
---------------------------------------------------------------------------

    \452\ FIA at 18.
    \453\ FIA at 18.
    \454\ Id. at 13-14.
    \455\ Id. at 18.
---------------------------------------------------------------------------

    Other commenters made similar points. KCG stated that ``the futures 
markets' price collars work well,'' and reduce the potential for 
erroneous trades.\456\ KCG supports requiring exchanges to establish 
price collars on all contracts, but believes that exchanges should have 
discretion in setting the price collars.\457\ Gelber stated that 
exchanges should establish price collars and that this control protects 
DCOs and market participants from volatile markets.\458\ MFA stated 
that price collars in the futures markets have been effective in 
maintaining fair and orderly markets, and have fewer unintended 
consequences than trading pauses.\459\ SIG also stated that the markets 
benefit from price collars.\460\ Finally, Chicago Fed and AFR 
recommended that trading venues implement price collars.\461\
---------------------------------------------------------------------------

    \456\ KCG at 7-8.
    \457\ See id.
    \458\ Gelber at 9.
    \459\ MFA at 8-9.
    \460\ SIG at 8-9.
    \461\ Chicago Fed at 3; AFR at 7.
---------------------------------------------------------------------------

    In contrast to the above comments, AIMA acknowledged that price 
collars may be beneficial, but explained that price collars have 
potentially negative consequences in that they may impede the efficient 
price discovery process.\462\ In particular, AIMA suggested that market 
participants should be encouraged to place bids and offers far above or 
below the current market price.\463\ Among other things, AIMA

[[Page 78873]]

suggested that brief trading pauses were preferable to price collars, 
and that if a collar or pause is activated, market participants should 
be notified as soon as possible.\464\
---------------------------------------------------------------------------

    \462\ AIMA at 12-13.
    \463\ See id.
    \464\ See id.
---------------------------------------------------------------------------

d. Connectivity Indications and Cancel on Disconnect
    As noted above, the Concept Release requested comment regarding 
``system heartbeats'' that would indicate proper connectivity between a 
trading firm's automated trading system and the trading platform, and 
``auto-cancel on disconnect,'' an exchange tool that allows trading 
firms to determine whether their orders will be left in the market upon 
disconnection. Two exchanges stated that they provide an optional 
cancel-on-disconnect functionality \465\ and FIA characterized cancel-
on-disconnect as a ``widely adopted DCM-hosted pre-trade risk 
control.'' \466\ Several commenters indicated that they support 
exchanges offering system heartbeats and/or cancel-on-disconnect to 
their market participants.\467\
---------------------------------------------------------------------------

    \465\ CME at Appendix A-4; CFE at 9-10.
    \466\ FIA at 14.
    \467\ FIA at 14; KCG at 12; MFA at 12; Chicago Fed at 2.
---------------------------------------------------------------------------

e. Order Cancellation Systems
    As discussed above, the Concept Release addressed selective working 
order cancellation, a tool in which an exchange can immediately cancel 
one, multiple, or all resting orders from a market participant as 
necessary in an emergency situation and well as order cancellation 
mechanisms that would immediately cancel all working orders and prevent 
submission (by the market participant), transmittal (by the clearing 
member), or acceptance (by the trading platform) of any new orders from 
a market participant or a particular trader or ATS of such market 
participant. The Commission notes that comments to the Concept Release 
generally discussing the design and implementation of kill switches are 
addressed above with respect to order cancellation systems requirements 
on AT Persons.
    Specifically as to exchanges, the Commission notes that one 
exchange indicated that it has two kill switch tools: A kill switch 
used by the exchange, clearing firm, or trading firm to remove an 
entity from the market completely; and an order management tool that 
enables clearing firms and end-users to cancel orders at a more 
granular level.\468\ Another exchange explained that it can cancel 
orders and quotes in an emergency and also provides a kill switch to 
clearing members that cancels all orders and quotes from a market 
participant.\469\
---------------------------------------------------------------------------

    \468\ CME at 23-24.
    \469\ CFE at 11.
---------------------------------------------------------------------------

    Some commenters noted the importance of placing kill switches at 
the DCM level.\470\ For example, Citadel noted that ``kill switches can 
operate at a number of levels--at the market participant, at the 
clearing firm, or at the trading platform. While all are advisable, 
their use at the trading platform level is of paramount importance. 
Trading platforms sit at the center of trading and are therefore best 
positioned to efficiently and consistently monitor activity across a 
wide variety of market participants.'' \471\ While commenters generally 
opposed prescriptive kill switch requirements and indicated the 
challenges of standardization, several noted that there could be some 
benefits to standardized kill switch processes across exchanges.\472\
---------------------------------------------------------------------------

    \470\ FIA at 29-33; Citadel at 3; AIMA at 3, 18; MFA at 12-13; 
KCG at 13.
    \471\ Citadel at 3.
    \472\ FIA at 29-33; CME at 23; AIMA at 18; SIG at 8; Gelber at 
14-15.
---------------------------------------------------------------------------

    Commenters also stressed the importance of clear, transparent 
procedures governing use of the kill switch.\473\ FIA stated that ``a 
failure to communicate policies that govern the use of kill switches, 
any potential changes to such policies, or the utilization of a kill 
switch in a live trading environment without prior notification can 
introduce significant risk to a market participant's trading operation 
as well as the wider marketplace.'' \474\ MFA commented that trading 
platforms should have clear and objective policies detailing the 
circumstances that warrant use of a kill switch.\475\ In contrast, CME 
stressed that the kill switch tool must be free of restrictive policies 
and procedures, because time is of the essence in use of the kill 
switch. However, CME stated that if policies do govern an exchange's 
use of a kill switch, such policies should define a hierarchy of 
authority for who can send kill instructions.\476\
---------------------------------------------------------------------------

    \473\ FIA at 29; MFA at 12; Citadel at 3.
    \474\ FIA at 29.
    \475\ MFA at 12.
    \476\ CME at 23.
---------------------------------------------------------------------------

    Regarding activation of the kill switch, FIA cautioned that this 
tool should only be used as a ``final safeguard'' that should be a 
redundant control as long as appropriate risk controls are implemented 
at the FCM and DCM levels.\477\ FIA suggested that a kill switch have 
both automated and manual triggers, but a DCM should contact the market 
participant before activating the kill switch.\478\ FIA also suggested 
that a DCM be allowed to terminate market access without contacting the 
participant if necessary to protect market integrity or the financial 
integrity of participants.\479\ Citadel commented that exchange systems 
should employ robust and reliable systems that automatically identify 
potentially erroneous activity, and this activity could trigger 
automatic notifications to the participant; review by exchange staff; 
automatic blocks of further activity; and, under appropriate 
circumstances, a confidential notification to other trading platforms 
that a firm's trading is halted.\480\ KCG stressed that market 
participants should establish thresholds for kill switches,\481\ and 
Gelber cautioned that exchanges should apply kill switches on an ATS, 
not firm-wide, level.\482\ SIG suggested that exchanges set kill 
switches at the gateway level, firm level, or an account level.\483\
---------------------------------------------------------------------------

    \477\ FIA at 29-33; Gelber at 14-15.
    \478\ FIA at 29-33.
    \479\ FIA at 29-33.
    \480\ Citadel at 3-4.
    \481\ KCG at 13.
    \482\ Gelber at 14.
    \483\ SIG at 8.
---------------------------------------------------------------------------

    An issue related to pre-trade and other risk controls implemented 
by DCMs is the testing of exchange systems. The Concept Release did not 
directly explore the testing of DCM automated systems. Moreover, 
commenters did not raise the issue. Nevertheless, the Commission notes 
that there have been incidents following automated system changes that 
might have been prevented or mitigated by additional testing. For 
example, in early 2015, certain European futures exchanges experienced 
outages in their trading platforms following updates to their automated 
systems.\484\ In September 2010, 30,000 test orders were accidentally 
submitted to the CME Globex system (due to human error), resulting in 
numerous executed trades.\485\ In April 2014, the Globex system halted, 
forcing traders to execute futures trades on the trading floor.\486\

[[Page 78874]]

The Commission further notes that IOSCO published in April 2015 a 
consultation report recommending that exchanges consider ``establishing 
policies and procedures related to the development, modification, 
testing and implementation of new, or changes to, critical systems.'' 
\487\ Existing Sec.  38.1051(h) requires DCMs to ``conduct regular, 
periodic, and objective testing of its automated systems to ensure that 
they are reliable, secure, and have adequate scalable capacity'' and 
Sec.  38.1051(a)(5) requires exchanges to address risk analysis and 
oversight for ``systems development and quality assurance.'' While the 
Commission is not proposing any amendments to Sec.  38.1051 in this 
NPRM, the Commission requests comment on whether the existing rule 
provides the Commission with adequate authority to require DCMs to 
adequately test planned changes to their matching engines and other 
automated systems.
---------------------------------------------------------------------------

    \484\ See ``Euronext Derivatives Trading Resumes Following One-
Hour Halt,'' Bloomberg (March 30, 2015), available at http://www.bloomberg.com/news/articles/2015-03-30/euronext-derivatives-trading-halted-because-of-technical-issue.
    \485\ See ``CME Test Orders Went Live,'' Wall St. J. (September 
15, 2010), available at http://www.wsj.com/articles/SB10001424052748703376504575491971336921954.
    \486\ See ``Technical Glitch Hits CME Trading,'' Wall St. J. 
(April 8, 2014), available at http://www.wsj.com/articles/SB10001424052702304819004579489683245107384. The Commission notes 
that moving to the floor will no longer be available as a backup as 
the CME was planning to close most futures trading pits in July 
2015.
    \487\ See IOSCO 2015 Consultation Report, supra note 106 at 19.
---------------------------------------------------------------------------

2. Description of Regulation
    Existing Sec.  38.255 requires DCMs to establish risk control 
mechanisms to prevent and reduce the potential risk of price 
distortions and market disruptions, including market restrictions that 
pause or halt trading. The Commission proposes a new Sec.  40.20 to 
require DCMs to establish pre-trade and other risk controls 
specifically designed to address the risks that may arise from 
Algorithmic Trading, and to establish similar controls for orders 
entered manually.
    The controls required by Sec.  40.20 are consistent with the 
controls that Regulation AT would require AT Persons and clearing 
member FCMs to implement. By reference to the pre-trade and other risk 
controls required of AT Persons pursuant to Sec.  1.80(a)(1), proposed 
Sec.  40.20 would require message and execution throttles and controls 
establishing price and size parameters. Proposed Sec.  40.20 would also 
require DCMs to implement the above risk controls for orders that do 
not originate from Algorithmic Trading.
    The proposed regulation, by reference to Sec.  1.80(b) and (c), 
would also require DCMs to establish certain order cancellation and 
connectivity monitoring systems. The cancellation systems must have the 
ability to: (i) Immediately disengage Algorithmic Trading; (ii) cancel 
selected or up to all resting orders when system or market conditions 
require it; (iii) prevent acceptance or submission of any new orders; 
and (iv) cancel or suspend all resting orders from AT Persons in the 
event of disconnect with the trading platform. The connectivity 
monitoring systems established by the DCM must enable the systems of AT 
Persons with DEA to indicate to the AT Persons on an intermittent or 
continuous basis whether they have proper connectivity with the trading 
platform, including any systems used by a DCM to provide the AT Person 
with market data.
    Finally, the Commission is amending the Acceptable Practices for 
Core Principle 4 in part 38 of the DCM regulations. The existing 
Acceptable Practices provide that the DCM may choose from risk 
controls, including pre-trade limits on order size, price collars or 
bands around the current price, message throttles and daily price 
limits, to comply with Core Principle 4. Such controls are now 
required. Accordingly, the Acceptable Practices will be revised to 
correspond to the new requirements set forth in Sec.  40.20.
3. Policy Discussion
    Consistent with its multi-layered approach to regulations intended 
to mitigate the risks of automated trading, the Commission proposes in 
Sec.  40.20 to require that DCMs establish and implement certain pre-
trade risk controls and order management controls that are broadly 
similar to those that would be required of AT Persons and clearing 
member FCMs. The Commission's determination to require DCM-implemented 
controls is consistent with several Concept Release comments that 
indicated that pre-trade risk and order management controls should be 
placed at the exchange level, with one commenter explaining that 
exchanges sit at the center of trading, and are therefore best 
positioned to monitor activity across a wide variety of 
participants.\488\ The Commission notes that its approach is consistent 
with ESMA's 2015 Final Draft Regulatory Standards, in that ESMA 
requires pre-trade risk controls at both the investment firm and 
trading venue level.\489\ In addition, with respect to kill switch 
functionality, ESMA's 2015 Final Draft Regulatory Standards set out two 
different obligations: Trading venues must have their own kill 
functionality, and separately, investment firms must have the ability 
to cancel unexecuted orders.\490\
---------------------------------------------------------------------------

    \488\ FIA at 29-33; Citadel at 3; AIMA at 3, 18; MFA at 12-13; 
KCG at 13.
    \489\ ESMA September 2015 Final Draft Standards Report, supra 
note 80 at 201-02.
    \490\ See id.
---------------------------------------------------------------------------

    The Commission believes that the controls required in proposed 
Sec.  40.20 are in many cases largely consistent with controls already 
used by DCMs. As discussed above, commenters to the Concept Release 
addressing this topic generally indicated that exchanges already use 
message rate limits, maximum order size limits, and price limits. 
Comments to the Concept Release indicated that order cancellation 
systems and connectivity monitoring systems are already used by DCMs as 
well. Although some commenters did indicate that execution throttles 
are more appropriate for trading firms than for DCMs, the Commission 
believes that pre-trade risk controls and other measures serve 
different functions and may be designed or calibrated distinctly at 
each entity in the life-cycle of an AT Order Message. As noted above, 
proposed Sec.  40.20 and other elements of Regulation AT reflect the 
proposed rules' layered approach to risk mitigation in automated 
trading. In this regard, Regulation AT is designed to address the 
diverse needs of market participants trading across multiple markets, 
by spreading the requirement to impose risk controls across AT Persons, 
clearing member FCMs and DCMs and encouraging them to each make 
independent use of such controls.
    The Commission notes that IOSCO has recently explained that most 
trading venues have tools used to mitigate the operational risks of 
electronic trading, and such tools include price and volume controls, 
messaging throttles, and kill switches.\491\ In addition, ESMA's 2015 
Final Draft Regulatory Standards require that trading venues have price 
collars that automatically block or cancel orders that do not meet set 
price parameters with respect to different financial instruments, on an 
order-by-order basis; and maximum order value and maximum order volume 
limits.\492\ ESMA's regulatory standards also require throttles 
limiting the number of orders each member may submit per second.\493\ 
Trading venues must also determine a maximum ratio of unexecuted orders 
to transactions at a level they deem appropriate, consistent with a 
calculation methodology provided by ESMA.\494\ ESMA standards further 
require a kill functionality to cancel unexecuted orders upon request 
of a market participant that is technically unable to delete its own

[[Page 78875]]

orders, when the order book is corrupted by erroneous duplicated 
orders, or following a suspension initiated by the market operator or 
the competent authority.\495\
---------------------------------------------------------------------------

    \491\ IOSCO 2015 Consultation Report, supra note 106 at 21.
    \492\ See ESMA September 2015 Final Draft Standards Report Annex 
1 at 269.
    \493\ See id. at 266.
    \494\ See id. at 285-88.
    \495\ See id. at 266-67.
---------------------------------------------------------------------------

    The Commission's proposed rules do not impose a ``one-size-fits-
all'' standard on DCMs for compliance. Rather, the DCM's pre-trade risk 
controls must be set at the level of each AT Person, and exchanges must 
evaluate whether the controls should be set at a more granular level, 
including by product or one or more identifiers of natural persons 
associated with an AT Order Message, and then take appropriate action 
to set the controls at that more granular level. The Commission expects 
that it will often be beneficial to set controls at a more granular 
level. As noted above, while some commenters to the Concept Release 
indicated that Commission involvement in setting thresholds for these 
controls might be useful, the Commission agrees with those commenters 
indicating that exchanges need discretion to determine how these 
controls are implemented. The Commission believes that it is not in the 
best position to determine the appropriate control parameters for each 
trading strategy, product, capacity of exchange matching engine, and 
every other potentially relevant factor that should be taken into 
account by a DCM when establishing thresholds. The proposed rules do 
not prescribe particular limits or thresholds. Rather, they require 
that the DCM set the controls at levels intended to prevent an 
Algorithmic Trading Event.
    The Commission believes that allowing DCMs discretion in the design 
and implementation of risk controls is particularly important in the 
area of order cancellation functions. FIA has stated that 
``[a]ctivation of a kill switch is based on a decision that such action 
protects market integrity or the financial integrity of the 
counterparties involved,'' and should ``only be invoked based on a 
qualitative decision taken as a last resort when other actions have 
failed or may not be feasible.'' \496\ Furthermore, FIA has explained 
that the conditions under which a kill switch may be used by an 
exchange should be clearly communicated to the counterparties.\497\ 
Similarly, MFA commented that trading platforms should have clear and 
objective policies detailing when a kill switch will be used.\498\ CME 
indicated that restrictive policies governing use of a kill switch 
could be detrimental, given the speed with which a kill switch may need 
to be implemented.\499\ The Commission believes that exchanges should 
have clear and public policies governing use of a kill switch, but 
understands that the specifics of such policies may different depending 
on the nature of an exchange's market and market participants. 
Therefore, the Commission has determined that its proposed rules in 
this area should provide exchanges with the discretion to design 
policies and procedures appropriate to their market. The Commission 
stresses that exchanges should clearly communicate such policies and 
procedures to market participants.
---------------------------------------------------------------------------

    \496\ See FIA Guide, supra note 95 at 14.
    \497\ See id.
    \498\ MFA at 12.
    \499\ CME at 23.
---------------------------------------------------------------------------

    The Commission notes that Sec.  40.20(d) would require a DCM to 
implement the pre-trade and other risk control mechanisms described in 
Sec.  40.20(a) and (b)(1)(i) (meaning, message and execution throttles 
and order and price parameters and order cancellation systems) for 
orders that do not originate from Algorithmic Trading, after making any 
adjustments to such controls that the DCM determines are appropriate 
for such orders. The Commission recognizes that certain activity that 
such controls are designed to address can be caused by manual order 
entry in addition to Algorithmic Trading. For example, fat-finger 
errors are a commonly-cited example of an unintentional error that can 
have a significant disruptive effect, which can be caused by, and may 
even be more likely to occur in the context of, manual order entry.
4. Request for Comments
    79. The Commission proposes to require DCMs to set pre-trade risk 
controls at the level of the AT Person, and allows discretion to set 
controls at a more granular level. Should the Commission eliminate this 
discretion, and require that the controls be set at a specific, more 
granular, level? If so, please explain the more appropriate level at 
which pre-trade risk controls should be set by a DCM.
    80. The Commission requests public comment on the pre-trade and 
other risk controls required of DCMs in proposed Sec.  40.20. Are any 
of the risk controls required in the proposed rules unhelpful to 
operational or other risk mitigation, or to market stability, when 
implemented at the DCM level?
    81. Are there additional pre-trade or other risk controls that 
should be specifically enumerated in proposed Sec.  40.20?
    82. The Commission proposes, with respect to its kill switch 
requirements, to allow DCMs the discretion to design a kill switch that 
allows a market participant to submit risk-reducing orders. The 
Commission also does not mandate particular procedures for alerts or 
notifications concerning kill switch triggers. Does the proposed rule 
allow for sufficient flexibility in the design of kill switch 
mechanisms and the policies and procedures concerning their 
implementation? Should the Commission consider more prescriptive rules 
in this area?
    83. Does existing Sec.  38.1051 provide the Commission with 
adequate authority to require DCMs to adequately test planned changes 
to their matching engines and other automated systems?

O. DCM Test Environments for AT Persons--Sec.  40.21

    The Commission proposes a new Sec.  40.21 to require DCMs to 
provide a test environment that will enable AT Persons to simulate 
production trading.
1. Concept Release Comments
    The Concept Release contemplated that trading platforms must 
provide to their market participants test environments that simulate 
the production environment. FIA supports DCMs providing robust test 
environments and market participants using such environments.\500\ SIG 
also indicated that DCMs should provide test environments.\501\ MFA 
indicated that many, if not all, exchanges currently provide market 
participants a test facility to test trading software and 
algorithms.\502\
---------------------------------------------------------------------------

    \500\ FIA at 34-38.
    \501\ SIG at 9.
    \502\ MFA at 13.
---------------------------------------------------------------------------

2. Description of Regulation
    Regulation AT proposes a new requirement that DCMs (under proposed 
Sec.  40.21) provide a test environment that will enable AT Persons to 
simulate production trading. The required test environment should 
provide access to historical transaction, order and message data. The 
test environment should also enable AT Persons to conduct conformance 
testing of their Algorithmic Trading systems to verify compliance with 
the requirements of proposed Sec.  1.80(a)-(c) (which address pre-trade 
risk controls and other measures), Sec.  1.81(a)(1)(ii)-(iv) and Sec.  
1.81(c)(1) (which address the testing and compliance of algorithmic 
trading systems). The Commission anticipates that AT Persons would use 
the DCM test environment in connection with the

[[Page 78876]]

testing of their Algorithmic Trading systems, to identify issues that 
may arise in a production environment that may not have been identified 
through testing in the AT Person's development environment.
3. Request for Comments
    84. Should the test environment provided by DCMs under proposed 
Sec.  40.21 offer any other functionality or data inputs that will 
promote the effective design and testing of Algorithmic Trading by AT 
Persons?

P. DCM Review of Compliance Reports by AT Persons and Clearing FCMs; 
DCM Rules Requiring Certain Books and Records; and DCM Review of Such 
Books and Records as Necessary--Sec.  40.22

    The Commission proposes a new Sec.  40.22 that complements the 
requirement under Sec.  1.83 for AT Persons and clearing member FCMs to 
submit compliance reports to DCMs. Sections 40.22(a) and (b) would 
require a DCM to require each AT Person that trades on the DCM, and 
each FCM that is a clearing member for such AT Person, to submit the 
reports described in Sec.  1.83(a) and (b) annually. Further, Sec.  
40.22(c) would require each DCM to establish a program for effective 
review of such reports and remediation of any deficiencies found. DCMs 
would have considerable latitude, however, in the design of their 
review programs. Proposed Sec.  40.22(d) would require DCMs to 
implement rules that require each AT Person to keep and provide to the 
DCM books and records regarding such AT Person's compliance with all 
requirements pursuant to Sec.  1.80 and Sec.  1.81, and require each 
clearing member FCM to keep and provide to the DCM books and records 
regarding such clearing member FCM's compliance with all requirements 
pursuant to Sec.  1.82. Finally, proposed Sec.  40.22(e) would require 
DCMs to review and evaluate, as necessary, books and records maintained 
by AT Persons and clearing member FCMs regarding their compliance with 
Sec. Sec.  1.80 and 1.81 (for AT Persons) and Sec.  1.82 (for clearing 
member FCMs). This proposed provision also provides DCMs with 
considerable latitude in the implementation of their review function. 
The remainder of this section presents Concept Release comments on this 
topic, a description of the proposed regulation, a discussion of the 
policy justification for the proposal, and a request for comments on 
the proposal.
1. Concept Release Comments
    As noted in the discussion of proposed Sec.  1.83 above, the 
Concept Release requested comment on whether it would be appropriate to 
require periodic self-certifications by all market participants 
operating ATSs and by clearing firms that provide clearing services to 
those market participants.\503\ Comments addressing this topic are 
addressed in section IV(I)(1) above.
---------------------------------------------------------------------------

    \503\ Concept Release, 78 FR at 56559.
---------------------------------------------------------------------------

2. Description of Regulation
    Proposed Sec.  40.22 complements the requirement under Sec.  1.83 
for AT Persons and clearing member FCMs to submit compliance reports to 
DCMs. Proposed Sec.  40.22(a) requires a DCM to implement rules that 
require each AT Person that trades on the DCM, and each FCM that is a 
clearing member of a DCO for such AT Person, to submit the reports 
described in Sec.  1.83(a) and (b), respectively. Under proposed Sec.  
40.22(b), a DCM must require the submission of such reports by June 
30th of each year. Proposed Sec.  40.22(c) requires a DCM to establish 
a program for effective periodic review and evaluation of reports 
described in paragraph (a) of Sec.  40.22, and of the measures 
described therein. An effective program must include measures by the 
DCM reasonably designed to identify and remediate any insufficient 
mechanisms, policies and procedures described in such reports, 
including identification and remediation of any inadequate quantitative 
settings or calibrations of pre-trade risk controls required of AT 
Persons pursuant to Sec.  1.80(a).
    In addition, as an additional complement to the compliance report 
review program described above, proposed Sec.  40.22(d) requires DCMs 
to implement rules requiring each AT Person to keep and provide to the 
DCM books and records regarding their compliance with all requirements 
pursuant to Sec.  1.80 and Sec.  1.81, and requires each clearing 
member FCM to keep and provide to the DCM market books and records 
regarding their compliance with all requirements pursuant to Sec.  
1.82. Finally, proposed Sec.  40.22(e) requires DCMs to review and 
evaluate, as necessary, books and records required to be kept pursuant 
to proposed Sec.  40.22(d), and the measures described therein. A DCM 
could find it necessary to conduct such a review if: It becomes aware 
if an AT Person's kill switch is frequently activated, or otherwise 
performs in an unusual manner; if a DCM becomes aware that an AT 
Person's algorithm frequently performs in a manner inconsistent with 
its design, which may raise questions about the design or monitoring of 
the AT Person's algorithms; if a DCM identifies frequent trade practice 
violations at an AT Person, which are related to an algorithm of the AT 
Person; or if an AT Person represents significant volume in a 
particular product, thereby requiring heightened scrutiny, among other 
reasons. An appropriate review pursuant to Sec.  40.22(e) should 
include measures by the DCM reasonably designed to identify and 
remediate any insufficient mechanisms, policies, and procedures 
described in such books and records.
3. Policy Discussion
    In proposing this regulation, the Commission disagrees with 
comments to the Concept Release opposing such a review requirement and 
suggesting that it would merely create extra administrative costs.\504\ 
The Commission acknowledges that the review program required by Sec.  
40.22 would impose costs on DCMs, but believes that Regulation AT must 
include a mechanism to ensure that AT Persons and clearing member FCMs 
are complying with the requirement to implement certain pre-trade and 
other risk controls. Moreover, an assessment of such compliance 
requires an adequate level of expertise and knowledge of markets and 
market participants' technological systems and trading strategies. The 
Commission believes that a review program requiring AT Persons to 
describe the pre-trade risk controls required by Sec.  1.80(a) and 
clearing member FCMs to describe their program for establishing and 
maintaining the pre-trade risk controls required by 1.82(a)(1), and 
requiring DCMs to review such information, is the most effective method 
to ensure that all market participants are implementing measures that 
are reasonably designed to prevent an Algorithmic Trading Event or 
Algorithmic Trading Disruption. The requirements of proposed Sec.  
40.22(d) and (e) will enable DCMs to perform a more intensive review, 
as necessary, of AT Persons' compliance with Sec. Sec.  1.80 and 1.81, 
and clearing member FCMs' compliance with Sec.  1.82, by among other 
factors, helping to ensure that necessary books and records are 
maintained and available to a DCM.
---------------------------------------------------------------------------

    \504\ See, e.g., AIMA at 21; FIA at 4; CME at 47.
---------------------------------------------------------------------------

    The Commission notes, in particular, that DCMs are best positioned 
to assess the measures taken by market participants on their exchange, 
and identify outliers that may not have implemented adequate measures 
or

[[Page 78877]]

particular parameters as compared to other market participants. The 
Commission believes that it is in the interest of the DCM, as well as 
all market participants trading on the DCM, to ensure that no market 
participants are conducting Algorithmic Trading without adequate 
protections in place.
    Some commenters indicated that any certification requirements 
should be principles-based.\505\ The Commission agrees that a DCM 
should have discretion in the design and implementation of its review 
program. Accordingly, proposed Sec.  40.22 provides a general framework 
for the DCM's review program: e.g., a DCM must require the submission 
of reports by June 30 of each year; and the DCM must establish a 
program for effective periodic review and evaluation of the reports, 
including measures by the DCM reasonably designed to identify and 
remediate any insufficient mechanisms, policies and procedures 
described in such reports. Beyond the specific requirements set forth 
in proposed Sec.  40.22, however, each DCM may tailor its review 
program in the manner it believes will be most effective to understand 
the measures its market participants have taken to address the risks of 
Algorithmic Trading, and evaluate whether they are sufficient.
---------------------------------------------------------------------------

    \505\ See, e.g., FIA at 4, CME at 27.
---------------------------------------------------------------------------

4. Request for Comments
    85. In lieu of a DCM's affirmative obligation in proposed Sec.  
40.22 to review AT Person and clearing member FCM compliance reports, 
should DCMs instead be permitted to rely on the CEO or CCO 
representations required by proposed Sec.  1.83(a)(2)? If so, what 
events in the Algorithmic Trading of an AT Person should trigger review 
obligations by the DCM?
    86. Should Sec.  40.22(c) provide more specific requirements 
regarding a DCM's establishment of a program for effective periodic 
review and evaluation of AT Person and clearing member FCM reports? For 
example, Sec.  40.22(c) could require review at specific intervals 
(e.g., once every two years). Alternatively, Sec.  40.22(c) could 
provide greater discretion to DCMs in establishing their programs for 
the review of reports. Please comment on the appropriateness of these 
alternative approaches.
    87. Should Sec.  40.22(e) provide more specific requirements 
regarding the triggers for a DCM to review and evaluate the books and 
records of AT Persons and clearing member FCMs required to be kept 
pursuant to Sec.  40.22(d)? For example, Sec.  40.22(e) could require 
review at specific intervals (e.g., once every two years), or it could 
require review in response to specific events related to the 
Algorithmic Trading of AT Persons. Please comment on the 
appropriateness of these alternative approaches.
    88. Does Sec.  40.22 leave enough discretion to the DCM in 
determining how to design and implement an effective compliance review 
program regarding Algorithmic Trading? Alternatively, is there any 
aspect of this regulation that should be more specific or prescriptive?
    89. Should Sec.  40.22 specifically authorize a DCM to establish 
further standards for the organization, method of submission, or other 
attributes of the reports described in Sec.  40.22(a)?

Q. Self-Trade Prevention Tools--Sec.  40.23

    The Commission understands that self-trade activity has grown as 
trading has migrated to an electronic trading environment. The 
Commission has determined to propose rules in this area, which would 
address both intentional and unintentional self-trading activity, with 
the goal of benefiting market participants and enhancing the price 
discovery process. Specifically, the Commission is proposing Sec.  
40.23(a) to require DCMs to implement rules reasonably designed to 
prevent self-trading, excluding certain ``permitted self-trades'' 
described below. Proposed Sec.  40.23(a) defines self-trading as the 
matching of orders for accounts that have common beneficial ownership 
\506\ or are under common control. As discussed below, a trade that 
results from the matching of opposing orders both generated by a firm 
or a single or commonly owned account does not shift risk between 
different market participants. There is a possibility that such trades 
may inaccurately signal the level of liquidity in the market and may 
result in a non-bona fide price. Risk controls that identify and limit 
self-trading may result in more accurate indications of the level of 
market interest on both sides of the market and help ensure arms-length 
transactions that promote effective price discovery.
---------------------------------------------------------------------------

    \506\ The Commission is requesting public comment in the 
questions below regarding whether it should define ``common 
beneficial ownership'' in any final rules arising from this NPRM, 
and if so, how the term should be defined. The Commission notes in 
its request for public comment that its aggregation rules in Sec.  
150.4 are a potential model for defining common beneficial ownership 
in any final rules. The Commission is also requesting public comment 
regarding whether the definition of common beneficial ownership for 
purposes of Sec.  40.23 should be left to the individual discretion 
of each DCM.
---------------------------------------------------------------------------

    The Commission recognizes that there could be legitimate reasons 
for self-trades, and hence is proposing to provide DCMs and market 
participants the appropriate flexibility in implementation of the self-
trade prevention tools. DCMs have begun offering self-trade prevention 
tools to market participants in recent years, and a large fraction of 
market participants have started using these tools. Analysis of self-
match use at DCMs has found that the majority of orders in many liquid 
contracts already make use of this tool. While acknowledging the 
growing use of such tools, the Commission is interested in 
strengthening regulatory standards to increase transparency and ensure 
more effective limitation of unintentional self-trades. By 
standardizing self-trade prevention use across firms, it should be 
easier for the marketplace as a whole to differentiate permitted self-
trading. The Commission's proposed rules on self-trade prevention are 
also intended as a complement to the prohibition under the CEA 
regulations regarding wash trades.\507\ Wash trading has been defined 
as ``entering into, or purporting to enter into, transactions to give 
the appearance that purchases and sales have been made, without 
incurring market risk or changing the trader's market position.'' \508\ 
Therefore, intentional self-trades could constitute wash trades.
---------------------------------------------------------------------------

    \507\ See Section 4c(a) of the CEA, 7 U.S.C. 6c(a)(2)(A), and 
Commission regulation 1.38(a).
    \508\ See CFTC Glossary, available at: http://www.cftc.gov/ConsumerProtection/EducationCenter/CFTCGlossary/index.htm#W.
---------------------------------------------------------------------------

    The remainder of this section presents Concept Release comments on 
this topic, a Commission analysis of the amount of self-trading in the 
marketplace, a description of the proposed regulation, a discussion of 
the policy justification for the proposal, and a request for comments 
on the proposal.
1. Concept Release Comments
    The Concept Release requested comment on self-trading controls. The 
Concept Release considered whether trading platforms should provide, 
and market participants apply, technologies to identify and limit the 
transmission of orders from their systems to a trading platform that 
would result in self-trades. Numerous commenters addressed self-trading 
controls, including the extent of their use by industry; the types of 
trades that self-trade controls should prevent; and the appropriate 
design of self-trade controls. Commenters disagreed as to whether there 
should be regulation in this area, but most either oppose regulation or 
express concern about how it would be implemented, for reasons similar 
to those stated by FIA: ``To

[[Page 78878]]

require the adoption of DCM-based self-match prevention as a `one-size-
fits-all' approach may result in unnecessary financial exposure caused 
by the inherent blocking of legitimate transactions. . . . The options 
for this type of functionality must be flexible enough so that market 
participants can choose the method that best suits their business and 
preserves legitimate trading.'' \509\
---------------------------------------------------------------------------

    \509\ FIA at 27-28.
---------------------------------------------------------------------------

    Commenters indicated that exchange-provided self-trading controls 
are widely used by market participants.\510\ The FIA PTG Survey 
reflected that 25 of 26 responding firms use such controls.\511\ Both 
CME and ICE provide self-trade prevention controls, a capability which 
was introduced, and refined, in recent years.\512\ CME's self-trade 
control is optional rather than required. It allows market participants 
to prevent buy and sell orders for the same account, or accounts with 
common beneficial ownership, from matching with each other. CME noted 
that its self-trade control can be applied by market participants at 
the executing firm level or at more granular levels, including at an 
individual user level.\513\ CME stated that more than 100 firms have 
registered for this control since it was launched in June 2013.\514\ 
ICE noted that its self-trade prevention tool is mandatory for 
proprietary traders with DEA.\515\ Another exchange, CFE, commented 
that it will be employing self-trade prevention functionality in the 
near future.\516\
---------------------------------------------------------------------------

    \510\ FIA at 26; Gelber at 7-9.
    \511\ FIA at 26, 59-60.
    \512\ FIA at 25-27; MFA at 8; Gelber at 7-9; FAIMA at 10; IATP 
at 5.
    \513\ CME at 12.
    \514\ Id. at 11-12.
    \515\ ICE at 2.
    \516\ CFE at 6.
---------------------------------------------------------------------------

    While FIA believes that DCMs should offer self-trading controls, 
FIA and four other commenters (including CME) oppose self-trading 
regulation at this time.\517\ Reasons articulated by FIA and other 
commenters included: The technology supporting this risk control is not 
sufficiently developed, although industry is already working to improve 
it and is in the best position to do so; regulating self-trading 
controls would lock in standards or technology that will become 
obsolete; self-trade controls may cause an accumulation of either 
resting orders or new orders, depending on how the controls are 
calibrated, which does not advance the regulatory goal of protecting 
the marketplace; and there are ways to prevent self-trades without 
using a self-trade prevention tool (i.e., trading firms may choose to 
simply modify their trading strategies).\518\ OneChicago commented that 
self-trading controls should be implemented and calibrated at the 
clearing firm level, not at the DCM level.\519\
---------------------------------------------------------------------------

    \517\ FIA at 25-27; CME at 10-12; Gelber at 7-9; MFA 5, 8; AIMA 
at 11-12.
    \518\ FIA at 25-27; CME at 11-12; AIMA at 11-12; Gelber at 7.
    \519\ OneChicago at 2.
---------------------------------------------------------------------------

    In contrast, IATP and AFR support the Commission requiring 
exchanges and market participants to use self-trading controls.\520\ 
SIG believes that exchanges should offer self-trade prevention 
functionality, with parameters set by firms.\521\
---------------------------------------------------------------------------

    \520\ IATP at 5; AFR at 7.
    \521\ SIG at 9.
---------------------------------------------------------------------------

    As to cost considerations, CME stated that self-trade controls 
require significant investments in technology and resources by 
exchanges and trading firms.\522\ MFA noted that it is more cost-
effective for exchanges, rather than market participants, to develop 
self-trade controls.\523\
---------------------------------------------------------------------------

    \522\ CME at 10.
    \523\ MFA at 8.
---------------------------------------------------------------------------

    Finally, comments addressed the specific functionality of self-
trade controls currently used by exchanges and firms. For example, five 
comments addressed the type of trades that such controls should 
prevent.\524\ FIA explained that self-trading controls should only 
address trades submitted by the same trading desk that are matched 
despite best efforts to avoid self-trading. This is different from wash 
trades, which are intentional self-trades that Commission and DCM rules 
already effectively address, and bona fide self-trades, which are buy 
and sell orders for accounts with common beneficial ownership that are 
independently initiated for legitimate business purposes, but which 
coincidentally cross.\525\ FIA and Gelber stated that CME's November 
19, 2013 advisory notice on wash trades \526\ provides an accurate 
description of when self-matching is acceptable.\527\ SIG stated that 
exchanges should focus on trades that would create material, not 
immaterial, market misperceptions.\528\ Finally, KCG stated that it 
does not believe the CFTC needs to prohibit all self-trading, but that 
``market participants must be able to demonstrate, through information 
barriers or other effective policies and procedures, that any self-
trading is between unrelated strategies and not designed with a 
manipulative intent.'' \529\
---------------------------------------------------------------------------

    \524\ FIA at 25; Gelber at 9; KCG at 7; AIMA at 11; SIG at 9.
    \525\ FIA at 25.
    \526\ See the CME Group Advisory Notice RA 1308-5 (Nov. 19, 
2013), available at http://www.cmegroup.com/rulebook/files/cme-group-ra1308-5.pdf. The FAQ in the Advisory Notice discusses various 
types of acceptable self-matching that would not violate CME Rule 
534 (``Wash Trades Prohibited'').
    \527\ FIA at 25; Gelber at 9.
    \528\ SIG at 9.
    \529\ KCG at 7.
---------------------------------------------------------------------------

    Commenters also addressed the appropriate level at which self-trade 
controls should be calibrated.\530\ Several stressed that DCMs should 
allow market participants to tailor this control to their own 
needs.\531\ FIA commented that self-trade controls should be offered at 
varying levels of granularity (i.e., firm level, group level, trader ID 
level, customer account level and strategy level), and certain levels 
can be combined.\532\ AIMA stated that self-trade controls set at the 
firm trader ID level could be ``gamed'' by traders creating a shell 
company under a different ID.\533\ SIG suggested that the controls be 
customizable at the ``aggregation unit level'' and ``user-defined tag 
level.'' \534\
---------------------------------------------------------------------------

    \530\ FIA at 25-27; Gelber at 7-9; CME at 12; AIMA at 10-12; SIG 
at 9.
    \531\ FIA 25-27; Gelber at 7-9; CME at 12; SIG at 9.
    \532\ FIA at 27.
    \533\ AIMA at 10-12.
    \534\ SIG at 9.
---------------------------------------------------------------------------

    Six comments addressed whether exchanges should require market 
participants to use the exchanges' self-trading controls.\535\ CME 
noted that it is optional for market participants to use its self-trade 
tools, and FIA supported this approach.\536\ In contrast, AIMA 
suggested mandatory confidential flagging of self-trades to the market 
participant, but only optional cancellations of orders.\537\ Gelber and 
KCG support mandatory use at the ``trader ID'' level.\538\ Gelber noted 
that ICE's controls are mandatory for some market participants.\539\ 
Finally, IATP suggested requiring exchanges to provide self-trading 
controls and apply them to all participants and all products, arguing 
that requiring such controls for some but not others creates arbitrage 
opportunities.\540\
---------------------------------------------------------------------------

    \535\ FIA at 25-27; CME at 13, Appendix A-4; Gelber at 7-9; KCG 
at 7; AIMA at 2, 10-11; IATP at 5.
    \536\ CME at 13, Appendix A-4; FIA at 25-27.
    \537\ AIMA at 2, 10-11.
    \538\ Gelber at 7-9; KCG at 7.
    \539\ Gelber at 7-9.
    \540\ IATP at 5.
---------------------------------------------------------------------------

    Comments also addressed order cancellation options in order to 
prevent self-trading, which can include cancel resting, cancel new, 
cancel both, and decrement order quantity (canceling the smaller order 
and reducing the larger

[[Page 78879]]

order by the size of the smaller order).\541\ As described below, the 
Commission's proposed self-trade prevention requirements do not mandate 
a particular technological approach, nor do they specify which order or 
set of orders should be canceled in order to prevent a self-trade.
---------------------------------------------------------------------------

    \541\ FIA at 26; CME at 11. FIA, Gelber and SIG support the DCM 
offering cancellation options to the market participant. FIA at 26; 
Gelber at 7-9; SIG at 9. In its comment letter, CME stated that its 
self-match prevention system was, at the time of the comment letter, 
structured to cancel the resting order, retaining orders based on 
more current market information. (CME has more recently expanded the 
number of cancellation choices.) The benefit of the opposite 
approach, canceling the taking order, is that it favors the priority 
of orders resting in the order book. CME at 11. Similarly, MFA 
stated that it disagrees with the approach of canceling the resting 
order, because it causes a participant to lose its resting orders 
even if the orders have been working in the queue. MFA noted that 
other exchanges, such as NYSE Euronext, offer options such as 
cancelling the taking order and decrementing order quantity. MFA at 
8. AFR supports cancellation of the taking order, reasoning that the 
taking order is more likely to be the erroneous order. AFR at 7. 
Finally, AIMA favors rejection of both the resting order and the 
taking order. AIMA at 11.
---------------------------------------------------------------------------

2. Commission Analysis of Amount of Self-Trading in the Marketplace
    The pervasive growth of algorithmic trading by firms deploying 
large numbers of strategies has likely increased the incidence of self-
trading activity. In order to estimate the percentage of self-trading 
in the marketplace, the Commission recently reviewed twelve months of 
trade data received from several large DCMs, focusing primarily on the 
most active products. Among other findings, the Commission learned that 
intra-firm self-trades, including both proprietary and customer trades, 
can comprise a meaningful percentage of daily trading activity in 
individual futures contracts.\542\ For example, in February 2015 intra-
firm self-trades in one examined futures contract were almost 10 
percent of all trades in that contract, increasing to almost 15 percent 
on individual days. Self-trade rates for a few other contracts were 
around 5 percent of total activity. The Commission found similar 
patterns at individual firm levels, with cumulative self-trade volumes 
at times in the millions of contracts for some market participants over 
the course of the 12-month sample period. The average size of a firm's 
self-trades ranged from approximately two contracts per trade to over 
two thousand contracts per trade.
---------------------------------------------------------------------------

    \542\ Self-trading identified in the Commission's analysis could 
include trading between accounts controlled by separate independent 
decision makers.
---------------------------------------------------------------------------

3. Description of Regulation
    The Commission is proposing new requirements under Sec.  40.23 that 
would require DCMs to apply, or provide and require the use of, tools 
reasonably designed to prevent self-trading. Proposed Sec.  40.23 
defines self-trading for purposes of this regulation as the matching of 
orders for accounts that have common beneficial ownership or are under 
common control. These requirements are intended to prevent self-
trading, while still allowing what FIA has characterized as ``bona fide 
and desirable self-match trades,'' i.e. buy and sell orders for 
accounts with common beneficial ownership that are independently 
initiated for legitimate business purposes, but which coincidentally 
cross.\543\ While the proposed rules contain exceptions for bona fide 
self-match trades (described in Sec.  40.23(b)), they are intended to 
address all unintentional self-trading, and do not include a de minimis 
exception for a certain percentage of unintentional self-trading. In 
addition, the proposed rules would provide for an important new element 
of transparency around bona fide self-match trades to furnish all 
market participants with greater information regarding the markets on 
which they trade.
---------------------------------------------------------------------------

    \543\ FIA at 25. See also FIA Guide, supra note 95 at 13, which 
describes bona fide and allowable self-match trades as ``buy and 
sell orders for accounts with common beneficial ownership that are 
independently initiated for legitimate and separate business 
purposes by independent decision makers and which coincidentally 
cross with each other in the competitive market.''
---------------------------------------------------------------------------

    Description of Sec.  40.23(a). Regulation 40.23(a) would require a 
DCM to implement rules reasonably designed to prevent self-trading by 
market participants, except as specified in paragraph (b). The 
regulation defines ``self-trading,'' for purposes of Sec.  40.23, as 
the matching of orders for accounts that have common beneficial 
ownership or are under common control. Regulation 40.23(a) would 
require that a DCM shall either apply, or provide and require the use 
of, self-trade prevention tools that are reasonably designed to prevent 
self-trading and are applicable to all orders on its electronic trade 
matching platform. If a DCM does not implement and apply self-trade 
prevention tools, then it must provide such tools to its market 
participants and require all market participants to use the tools. For 
purposes of complying with the requirements of proposed Sec.  40.23, a 
DCM could either determine for itself which accounts should be 
prohibited from trading with each other, or require market participants 
to identify to the DCM which accounts should be prohibited from trading 
with each other. The proposed regulations allow DCMs to exercise 
discretion in the design and implementation of self-trade prevention 
tools, in response to Concept Release commenter concerns that the 
technology supporting this control is still being developed, and overly 
prescriptive regulations in this area may lock in standards or 
technology that will become obsolete.
    Description of Sec.  40.23(b). The requirements of proposed Sec.  
40.23(a) are subject to the proviso in Sec.  40.23(b) that a DCM may, 
in its discretion, implement rules that permit a self-trade resulting 
from the matching of orders for accounts with common beneficial 
ownership where such orders are initiated by independent decision 
makers. A DCM could, through its rules, further define for its market 
participants ``independent decision makers.'' This exception is closely 
based on FIA's comment letter description of how a bona fide self-trade 
that should be permitted to occur.\544\ The Commission considered FIA's 
concept of permissible self-trading to be a reasonable one, which would 
be easily understood by exchanges and market participants. In addition 
to the foregoing exception relating to common beneficial ownership, 
Sec.  40.23(b) allows a DCM to permit a self-trade resulting from the 
matching of orders for accounts under common control where such orders 
comply with the DCM's cross-trade, minimum exposure requirements or 
similar rules, and are for accounts that are not under common 
beneficial ownership.
---------------------------------------------------------------------------

    \544\ See FIA at 25.
---------------------------------------------------------------------------

    Description of Sec.  40.23(c). Under proposed Sec.  40.23(c), a DCM 
must require market participants to receive approval from the DCM to 
forego self-trade prevention tools with respect to specific accounts 
under common beneficial ownership or control, on the basis that they 
meet the criteria of paragraph (b). The DCM must require that such 
approval request be provided to it by a compliance officer or senior 
officer of the market participant. The Commission emphasizes that the 
approval request to not apply self-trade prevention tools to certain 
orders should not be made by an individual trader or other non-
management or more junior employee of the trading firm. Market 
participants must withdraw or amend an approval request if any change 
occurs that would cause the information provided in such approval 
request to be no longer accurate or complete. The Commission notes that 
any approval request submitted to the DCM would be subject to section 
9(a)(4)

[[Page 78880]]

of the Act, 7 U.S.C. 13(a)(4) (2012), which prohibits, inter alia, 
making false, fictitious, or fraudulent statements to a registered 
entity.
    Description of Sec.  40.23(d). Finally, proposed Sec.  40.23(d) 
would require that for each product and expiration month traded on a 
DCM in the previous quarter, the DCM must prominently display on its 
Web site the following information: (i) The percentage of trades in 
such product including all expiration months that represent self-
trading approved (pursuant to paragraph (c) of Sec.  40.23) by the DCM, 
expressed as a percentage of all trades in such product and expiration 
month; (ii) the percentage of volume of trading in such product 
including all expiration months that represents self-trading approved 
(pursuant to paragraph (c) of Sec.  40.23) by the DCM, expressed as a 
percentage of all volume in such product and expiration month; and 
(iii) the ratio of orders in such product and expiration month whose 
matching was prevented by the self-trade prevention tools described in 
paragraph (a) of Sec.  40.23, expressed as a ratio of all trades in 
such product and expiration month. The Commission emphasizes that the 
``prominent display'' of information by a DCM precludes such DCM from 
placing information required by this rule behind registration, log in, 
user name, password or other walls on the DCM's Web site.
4. Policy Discussion
    The Commission understands that for various reasons, firms might 
operate multiple algorithms, each following a different trading 
strategy, but transacting in the same instrument/futures contract. This 
can cause buy and sell orders for the same instrument to be generated 
at the same instant by different algorithms, which in turn can get 
matched with each other as self-trades. Certain firms might choose to 
prevent these self-trades from occurring, or limit the extent of self-
trades. They could choose to do this by building tools that scan all 
orders being generated from within the firm and stop those that could 
potentially result in self-trades. But there are challenges in building 
efficient firm-level solutions, especially in modern low latency 
markets. In response, DCMs have implemented self-trade prevention tools 
to help firms manage and limit the extent of self-trades that would 
otherwise be generated by these algorithms. These trading system-level 
solutions appear to be more efficient in helping firms manage their 
self-trade activity.
    The Commission has included self-trade prevention requirements in 
Regulation AT to ensure that there are regulatory standards to more 
effectively and fairly limit unintentional self-trading across 
Commission-regulated markets, aiding in the risk management and trading 
efficiency of individual firms.
    In addition, while existing Commission regulations address market 
manipulation and wash sales, these types of violative behavior require 
some level of intent. Therefore, the Commission has determined to 
propose regulations in the area of self-trading that address both 
matching of orders for accounts that have common beneficial ownership 
or are under common control, independent of intent.
    The proposed regulations are intended to take into account Concept 
Release comments advising that the Commission should not be overly 
prescriptive in requiring specific types of self-trade prevention 
tools, or specific settings or controls in connection with such tools, 
because such tools are still technologically evolving. Furthermore, the 
Commission agrees with comments stating that exchanges are in the 
position, from a technology standpoint, to develop these types of 
controls. Accordingly, the Commission proposes to require the use of 
self-trade prevention tools in proposed Sec.  40.23, but allow 
exchanges and market participants the discretion to tailor the design 
of such tools and how to most effectively calibrate them in order to 
prevent unintentional self-matching. The Commission believes that the 
requirements of proposed Sec.  40.23 are generally consistent with how 
exchange-provided self-trade prevention tools currently operate, as 
indicated by comment letters.\545\ The proposed regulations would also 
require DCMs to publish statistics on their Web site regarding self-
trading that they have both authorized and prevented on their platform. 
The Commission is proposing this Web site reporting requirement because 
it understands that the design of self-trade prevention tools may vary 
among DCMs. These statistics will serve a critical purpose in 
disclosing to market participants the extent of self-trading that 
occurs in each product. The Commission believes that such transparency 
is a key element of the proposed rules as it will help furnish all 
market participants with better information regarding the markets in 
which they trade.
---------------------------------------------------------------------------

    \545\ See, e.g., CME at 11-12; ICE at 2.
---------------------------------------------------------------------------

    While some commenters to the Concept Release were not supportive of 
Commission action in this area, the commenters also indicated that 
self-trade prevention tools are already widely implemented in 
industry.\546\ Moreover, FINRA Rules already address self-trade 
prevention. In June 2014, FINRA published a regulatory notice stating 
that the SEC had approved new supplementary material to FINRA Rule 5210 
(Publications of Transactions and Quotations) to address transactions 
in a security resulting from the unintentional interaction of orders 
originating from the same firm that involve no change in the beneficial 
ownership of the security (self-trades).\547\ Effective August 25, 
2014, firms must have policies and procedures in place that are 
reasonably designed to review their trading activity for, and prevent, 
a pattern or practice of self-trades resulting from orders originating 
from a single algorithm or trading desk, or related algorithms or 
trading desks.
---------------------------------------------------------------------------

    \546\ See, e.g., FIA at 26; Gelber at 7-9; CME at 11-12; ICE at 
2.
    \547\ See FINRA, ``Regulatory Notice 14-28: Self Trades; SEC 
Approves FINRA Rule Concerning Self-Trades '' (June 2014), available 
at http://www.finra.org/sites/default/files/NoticeDocument/p540972.pdf.
---------------------------------------------------------------------------

    In addition, the FIA Guide sets forth guidelines for self-trade 
prevention, and recommends that exchanges should offer participants a 
selection of self-trade tools to allow market participants to tailor 
self-trade prevention to their individual needs by offering various 
options (e.g., cancel resting, cancel new, cancel both, and decrement 
order size) and various levels of granularity (e.g., firm level, group 
level, trader ID level, customer account level and strategy 
level).\548\ The FIA Guide recommends that the use of such self-trade 
tools by market participants should remain optional.\549\ The new 
Regulation AT requirements, by contrast, would make use of exchange-
provided self-trade prevention tools mandatory by market participants.
---------------------------------------------------------------------------

    \548\ See FIA Guide, supra note 95 at 13.
    \549\ Id.
---------------------------------------------------------------------------

5. Request for Comments
    90. The Commission seeks to require self-trade prevention tools 
that screen out unintentional self-trading, while permitting bona-fide 
self-matched trades that are undertaken for legitimate business 
purposes. Under the regulations proposed above, DCMs shall implement 
rules reasonably designed to prevent self-trading (``the matching of 
orders for accounts that have common beneficial ownership or are under 
common control''), but DCMs may in their discretion implement rules 
that permit ``the matching of orders for

[[Page 78881]]

accounts with common beneficial ownership where such orders are 
initiated by independent decision makers.''
    a. Do these standards accomplish the goal of preventing only 
unintentional self-trading, or would other standards be more effective 
in accomplishing this goal? For example, should the Commission consider 
adopting in any final rules arising from this NPRM an alternative 
requirement modeled on FINRA Rule 5210 and require market participants 
to implement policies and procedures to review their trading activity 
for, and a prevent a pattern of, self-trades?
    b. While the regulations contain exceptions for bona fide self-
match trades (described in Sec.  40.23(b)), the regulations are 
intended to prevent all unintentional self-trading, and do not include 
a de minimis exception for a certain percentage of unintentional self-
trading. Should the regulations permit a certain de minimis amount of 
unintentional self-trading, and if so, what amount should be permitted 
(e.g., as a percentage of monthly trading volume)?
    c. The following terms are used in proposed Sec.  40.23(a) and (b): 
(1) Self-trading, (2) common beneficial ownership, (3) independent 
decision makers, and (4) common control. Do any of these terms require 
further definition? If so, how should they be defined? Should any 
alternatives be used and, if so, how should such substitute terms be 
defined?
    d. With respect to ``common beneficial ownership,'' the Commission 
requests comment on the minimum degree of ownership in an account that 
should trigger a determination that such account is under common 
beneficial ownership. For example, should an account be deemed to be 
under common beneficial ownership between two unrelated persons if each 
person directly or indirectly has a 10% or more ownership or equity 
interest in such account? The Commission refers commenters to the 
aggregation rules in part 150 of its regulations, including 
specifically Sec.  150.4, and requests comment on a potential 
Commission definition of common beneficial ownership that is modeled on 
Sec.  150.4.
    e. The Commission also requests comment on whether ``common 
beneficial ownership'' should be defined in any final rules arising 
from this NPRM, or whether such definition should be left to each DCM 
with respect to its program for implementing proposed Sec.  40.23.
    91. Are there any other types of self-trading that should be 
permitted in addition to the exceptions permitted in Sec.  40.23(b)(1) 
and (2)? If so, please describe such other types of acceptable self-
trading and explain why they should be permitted.
    92. Proposed Sec.  40.23 provides that DCMs may comply with the 
requirement to apply, or provide and require the use of, self-trade 
prevention tools by requiring market participants to identify to the 
DCM which accounts should be prohibited from trading with each other. 
With respect to this account identification process, the Commission's 
principal goal is to prevent unintentional self-trading; the Commission 
does not have a specific interest in regulating the manner by which 
market participants identify to DCMs the account that should be 
prohibited from trading from each other, so long as this goal is met. 
Should any other identification methods be permitted in Sec.  40.23? 
For example, please comment on whether the opposite approach is 
preferable: market participants would identify to DCMs the accounts 
that should be permitted to trade with each other (as opposed to those 
accounts that should be prevented from trading with each other).
    93. The Commission believes that its requirements concerning self-
trade prevention tools must strike the appropriate balance between 
flexibility (allowing market participants with diverse trading 
operations and strategies the discretion in implementation so as 
effectively prevent only unintentional self-trades) and simplicity (a 
variety of design and implementation options may render this control 
too complex to be effective).\550\ Does the Commission allow sufficient 
discretion to exchanges and market participants in the design and 
implementation of self-trade prevention tools? Is there any area where 
the Commission should be more prescriptive? The Commission is 
particularly interested in whether there is a particular level at which 
it should require implementation of self-trade prevention tools, i.e., 
if the tools must prevent matching of orders from the same trading 
firm, the same trader, the same trading algorithm, or some other level.
---------------------------------------------------------------------------

    \550\ See FIA Guide, supra note 95 at 13 (discussing balance 
between flexibility and complexity with respect to self-trade 
prevention tools).
---------------------------------------------------------------------------

    94. Proposed Sec.  40.23(a) would require DCMs to either apply, or 
provide and require the use of, self-trade prevention tools. Please 
comment whether Sec.  40.23(a) should, in addition, permit market 
participants to use their own self-trade prevention tools to meet the 
requirements of proposed Sec.  40.23(a), and if so, what additional 
regulations would ensure that DCMs are able to: Ensure that such tools 
are comparable to DCM-provided tools; monitor the performance of such 
tools; and otherwise review such tools and ensure that they are 
sufficiently rigorous to meet the requirements of Sec.  40.23.
    95. Is it appropriate to require implementation of self-trade 
prevention tools with respect to all orders? Should such controls be 
mandatory for only a particular subset of orders, i.e., orders from AT 
Persons or orders submitted through DEA?
    96. Please comment on the requirement that DCMs disclose self-trade 
statistics. Is the data required to be disclosed appropriate? Is there 
any other category of self-trade data that DCMs should be required to 
disclose?
    97. Should DCMs be required to disclose the amount of unintentional 
self-trading that occurs each month, alongside the self-trade 
statistics required to be published under proposed Sec.  40.23(d)?
    98. As noted above, the Commission understands that there is some 
potential for self-trade prevention tools to be used for wrongful 
activity that may include disruptive trading or other violations of the 
Act or Commission regulations on DCMs. Are there ways to design self-
trade prevention tools so that they do not facilitate disruptive 
trading (such as spoofing) or other violations of the Act or Commission 
regulations on DCMs? Are additional regulations warranted to ensure 
that such tools are not used to facilitate such activities?

R. DCM Market Maker and Trading Incentive Programs--Sec. Sec.  40.25-
40.28

    Proposed Sec. Sec.  40.25-40.28 would require DCMs to provide 
additional public information regarding their market maker and trading 
incentive programs, restrict certain types of payments by DCMs in 
connection with such programs, and require DCMs to perform surveillance 
of such programs to prevent abusive practices. The remainder of this 
section presents a description of the proposed regulation, a discussion 
of the policy justification for the proposal, and a request for 
comments on the proposal.
1. Policy Discussion
    Although not discussed in the Concept Release, the Commission has 
determined to address in Regulation AT certain aspects of DCM market 
maker and trading incentive programs that it believes are particularly 
relevant in the

[[Page 78882]]

context of automated trading.\551\ Formal market making and incentive 
programs were not common in the days of pit trading. In the modern 
trading environment, DCM trading incentive programs (which may also be 
called a liquidity provider program) typically compensate one or more 
market participants with financial or non-financial incentives or 
benefits for meeting certain volume thresholds or providing liquidity. 
A market maker program (which may also be called, for example, a market 
specialist, designated market maker, lead market maker, or liquidity 
provider program) is a more focused offering that involves a 
contractual agreement between the DCM and a market participant. It 
typically compensates one or more market participants with financial or 
non-financial incentives or benefits for fulfilling certain affirmative 
obligations in a particular product or products, such as maintaining 
two way prices and volumes or a pre-determined minimum bid/ask spread 
for a specified period of the trading day.
---------------------------------------------------------------------------

    \551\ The Commission notes that ESMA's 2015 Final Draft 
Regulatory Standards address market maker schemes. The standards 
address the circumstances under which an investment firm must enter 
into a market making agreement with a trading venue, and the content 
that should be included in such an agreement. See ESMA September 
2015 Final Draft Standards Report Annex 1, supra note 80 at 279-80.
---------------------------------------------------------------------------

    The number of such programs self-certified to the Commission has 
risen sharply in recent years, as has the complexity of the programs 
and size of the incentives. In 2010, 56 market maker and incentive 
programs were self-certified by DCMs; in 2013, DCMs had self-certified 
341 programs, an increase by over 600 percent compared to the number of 
programs self-certified by DCMs in 2010. In 2012, nearly every contract 
at one DCM was part of a market maker or incentive program, including 
highly liquid contracts.
    The Commission understands that DCMs have launched market making 
and other incentive programs to encourage liquidity provisioning and 
order flow to their electronic trading platforms. While the Commission 
does not object to such goals, the Commission's proposed regulations in 
Sec. Sec.  40.25-40.28 reflect its concern that market maker and 
trading incentive programs could have the potential to spur market 
participants to trade in ways designed to collect program benefits, 
independently of any contribution they may be making to liquidity or 
price discovery. Such practices may potentially also lead to abusive 
trading practices in violation of DCM and Commission rules. Notably for 
purposes of Regulation AT, market participants using ATSs can magnify 
these concerns in several respects. First, the automation and speed of 
ATSs can allow market participants to quickly reach market-maker or 
trading incentive program thresholds, depending on the liquidity of a 
market and threshold levels. Second, the trading strategies pursued 
through ATSs can sometimes result in a large number of trades between 
the same ATS or between two or more ATSs owned or controlled by the 
same market participants. In this regard, the Commission is also 
proposing new Sec.  40.23 to help prevent self-trading on DCMs, and 
provide market participants with greater transparency around DCM depth 
and liquidity when self-trading does occur.\552\
---------------------------------------------------------------------------

    \552\ See Section IV(Q) above for a discussion of self-trading 
and proposed Sec.  40.23.
---------------------------------------------------------------------------

    Proposed Sec. Sec.  40.25-40.28 will further the Commission's 
policy objectives in three key areas: (1) Transparency; (2) market 
integrity; and (3) effective self-regulation by all DCMs. The proposed 
regulations would further transparency through proposed Sec. Sec.  
40.25 and 40.26, which would require greater disclosure of information 
to the public and to the Commission regarding market maker and trading 
incentive programs. Together with proposed amendments to the definition 
of ``rule'' in Sec.  40.1(i) to explicitly include market maker and 
trading incentive programs, the proposed regulations would also help 
eliminate any potential ambiguity that may exist regarding the 
Commission's authority over such programs.\553\ Proposed Sec.  40.25 
will enhance the types of information that DCMs should expect to 
provide the Commission when requesting approval or self-certifying 
market-maker or trading incentive programs, and will also require that 
information regarding market-maker and trading incentive programs be 
easily located on a DCM's Web site.
---------------------------------------------------------------------------

    \553\ In the Final Rule for Provisions Common to Registered 
Entities, the Commission stated with respect to market maker and 
trading incentive programs, ``The Commission continues to view such 
programs as ``agreements * * * corresponding'' to a ``trading 
protocol'' within the Sec.  40.1 definition of ``rule'' and, as 
such, all market maker and trading incentive programs must be 
submitted to the Commission in accordance with procedures 
established in part 40.'' In this Final Rule, the Commission also 
stated, specifically with respect to DCMs, that ``[a] DCM's rules 
implementing market maker and trading incentive programs fall within 
the Commission's oversight authority. Indeed, a number of core 
principles touch upon trading issues that may be implicated by the 
design of such programs. Core Principle 9, for example, establishes 
the Commission's framework for regulating the execution of 
transactions, requiring DCMs . . . to provide a competitive, open, 
and efficient market and mechanism for execution. The newly-amended 
Core Principle 12 also requires DCMs to establish and enforce rules 
to protect markets and market participants from abusive practices 
and to promote fair and equitable trading on designated contract 
markets. In addition, market maker and trading incentive programs 
frequently touch upon Core Principle 19, which requires that DCMs 
avoid adopting any rules or taking any actions that result in 
unreasonable restraints of trade.'' Final Rule, Provisions Common to 
Registered Entities, 76 FR 44776, 44777-8 (July 27, 2011).
---------------------------------------------------------------------------

    The Commission notes that in June 2012 it adopted core principles 
and final rules modernizing the regulatory regime applicable to all 
DCMs (``DCM Final Rules''). The DCM Final Rules emphasized DCMs' 
obligations as the front-line regulators of their markets, including 
extensive trade practice and market surveillance responsibilities. In 
addition, the Commission codified new requirements that a DCM offer its 
``members [and] persons with trading privileges . . . with impartial 
access to its markets and services,'' including: (1) ``Access criteria 
that are impartial, transparent and applied in a non-discriminatory 
manner'' and (2) ``comparable fee structures . . . for equal access to, 
or services from'' the DCM. Taken together, proposed Sec. Sec.  40.25-
40.28 will facilitate the Commission's oversight of DCMs' market maker 
and trading incentive programs, and will also help the Commission 
ensure that market maker and trading incentive programs are in 
compliance with Commission rules regarding trade practice and market 
surveillance and impartial access requirements.
    Importantly, the proposed regulations would promote market 
integrity by requiring in proposed Sec.  40.27(a) that DCMs implement 
policies and procedures reasonably designed to prevent payment of 
market maker or trading incentive program benefits for self-trades. In 
this regard, the proposed regulations are designed to ensure that 
market maker or trading incentive programs do not incentivize abusive, 
manipulative, or disruptive trading practices, and also do not 
encourage or facilitate behavior that distorts markets and give the 
appearance of false market depth. Proposed Sec.  40.28 clarifies DCMs' 
surveillance obligations regarding market maker or trading incentive 
programs and their participants. Separately, the Commission believes 
that proposed Sec. Sec.  40.25-40.28 will also provide DCMs and market 
participants with greater certainty as to what types of trading 
incentive and market maker programs are inappropriate. The proposed 
regulations are described in detail below. The proposed rules will

[[Page 78883]]

work in conjunction with the proposed amendments to the definition of 
``rule'' in proposed Sec.  40.1(i) to explicitly include market maker 
and trading incentive programs.
    In sum, the Commission's proposed amendments to Sec.  40.1(i) and 
new Sec. Sec.  40.25-40.28 will increase transparency around DCM 
market-maker and trading incentive programs, underline existing 
regulatory expectations, and introduce basic safeguards in the conduct 
of such programs. The proposed regulations would make clear that 
market-maker and trading incentive programs are ``rules'' for purposes 
of part 40, and establish information and disclosure requirements when 
DCMs request Commission approval or self-certify new rules pursuant to 
part 40. They would also make clear that DCMs' existing surveillance 
responsibilities in part 38 apply equally to market-maker and trading 
incentive programs. Finally, the proposed regulations would codify the 
Commission's expectation that DCM market-maker and trading incentive 
programs should not provide payments or incentives for market-maker or 
trading activity between accounts under common ownership.
2. Description of Regulations
    Proposed Sec. Sec.  40.25-40.28 would require DCMs to provide 
additional public information regarding their market maker and trading 
incentive programs. Proposed Sec.  40.25(a) would require that, when 
submitting a rule regarding a market maker or trading incentive program 
pursuant to Sec.  40.5 or Sec.  40.6, a DCM must, in addition to 
information required by such sections, include specific additional 
information in its public rule filing.\554\ Additional information to 
be provided would include: (1) The name of the market maker program or 
trading incentive program, the date on which it will begin, and the 
date on which it will terminate (if applicable); (2) an explanation of 
the specific purpose for the program; (3) a list of the product(s) the 
trading of which is eligible for benefits under the market maker or 
trading incentive program, and list of the potential service(s) 
rendered by a market participant to which the market maker or trading 
incentive program applies (e.g., trading at certain hours; trading 
originating from certain geographic zones; trading originating with 
certain types or categories or market participants; or the bid/ask 
spread to be maintained by a market participant); (4) a description of 
any eligibility criteria or categories of market participants defining 
who may participate in the program; (5) for any market maker or trading 
incentive program that is not open to all market participants, an 
explanation of why the program is limited to the chosen eligibility 
criteria or categories of market participants, and an explanation of 
how such limitation complies with the impartial access and comparable 
fee structure requirements of Sec.  38.151(b) for DCMs; (6) an 
explanation of how persons eligible for the market maker or trading 
incentive program may apply to participate, and how eligibility will be 
evaluated by the DCM; (7) a description of any payments, incentives, 
discounts, considerations, inducements or other benefits that program 
participants may receive, including any non-financial incentives (non-
financial incentives may include, for example, enhanced trading 
priorities or preferential access to market data, including order and 
trade data); (8) a description of the obligations, benchmarks, or other 
measures that a participant in a market maker or trading incentive 
program must meet to receive the benefits described in paragraph (a)(7) 
of this section; and (9) a description of any legal affiliation between 
the DCM and any entity acting as a market maker or participating in a 
market maker or trading incentive program.\555\ Proposed Sec.  40.25(b) 
would require that, in addition to any public notice required pursuant 
to part 40 (including without limitation the requirements of Sec.  
40.5(a)(6) and Sec.  40.6(a)(2)), a DCM must ensure that the 
information required by Sec.  40.25(a)(1)-(8) is easily located on its 
public Web site during the lifetime of the market maker or trading 
incentive program, that is, from the time that the DCM begins accepting 
participants in the program through the time the program ceases 
operation.
---------------------------------------------------------------------------

    \554\ The Commission is cognizant that a DCM may consider 
certain information required by proposed Sec.  40.25(a) to be non-
public. In this regard, the Commission notes that Sec.  40.8 of its 
existing regulations provides a mechanism for registered entities to 
request confidential treatment when submitting rule filings pursuant 
to Sec. Sec.  40.5 or 40.6. Among other requirements, a registered 
entity must file a ``detailed written justification'' for its 
confidential treatment request. Regulation 40.8 remains available to 
DCMs for any Sec.  40.25(a) filings that may be required in the 
future. See 17 CFR 40.8; see also 17 CFR 145.9.
    \555\ Commission staff has historically required enhanced DCM 
surveillance procedures when a DCM market maker is operated by an 
affiliate of the DCM. Proposed Sec.  40.25(a)(9) will assist the 
Commission in identifying potential conflicts of interest between a 
DCM, its market makers, and participants in market maker or trading 
incentive programs, and also assist the Commission in promoting 
appropriate surveillance in such circumstances.
---------------------------------------------------------------------------

    Proposed Sec.  40.25(c) would require a DCM to notify the 
Commission upon the termination of a market maker or trading incentive 
program when such program terminates prior to the date previously 
notified the Commission. Any extension or renewal of a market maker or 
trading incentive program beyond its original termination date would 
require a new rule filing pursuant to this part.
    Proposed Sec.  40.26 would require that, upon request by the 
Commission or the Director of the Division of Market Oversight, a DCM 
must provide such information and data as may be requested regarding 
participation in market maker or trading incentive programs offered by 
the DCM, including but not limited to, individual program agreements, 
names of program participants, benchmarks achieved by program 
participants, and payments or other benefits conferred upon program 
participants.
    Proposed Sec.  40.27(a) would require a DCM to implement policies 
and procedures reasonably designed to prevent payment of market maker 
or trading incentive program benefits, including but not limited to 
payments, discounts, or other considerations, for trades between 
accounts that are: (1) Identified to the DCM as under common beneficial 
ownership pursuant to the approval process described in Sec.  40.23(c); 
or (2) otherwise known to the DCM as under common ownership.\556\
---------------------------------------------------------------------------

    \556\ The Commission notes that proposed Sec.  40.27(a) 
prohibits payments for trades between accounts (i) identified to the 
DCM as under common beneficial ownership or (ii) known to the DCM as 
under common ownership. This distinction reflects that the 
Commission's belief that DCMs may not always have beneficial 
ownership information unless it has been provided to them, pursuant 
for example to proposed Sec.  40.23.
---------------------------------------------------------------------------

    Finally, proposed Sec.  40.28 would require that a DCM, consistent 
with its obligations pursuant to subpart C of part 38, must review all 
benefits accorded to participants in market maker and trading incentive 
programs, including but not limited to payments, discounts, or other 
considerations, to ensure that such benefits are not earned through 
abusive practices. The Commission notes that such determination is not 
intended as a substitute for DCMs' trade practice surveillance, market 
surveillance, and other surveillance obligations with respect to all 
trading.
3. Request for Comments
    99. To what extent do market participants currently trade in ways 
designed primarily to collect market maker or trading incentive program 
benefits, rather than for risk management purposes?

[[Page 78884]]

    100. To what extent do that market maker and trading incentive 
programs currently provide benefits for self-trades? To what extent do 
market participants collect such benefits for self-trades?
    101. The Commission requests comment regarding whether the 
information proposed to be collected in Sec.  40.25 would be sufficient 
for it to determine whether a DCM's market-maker or trading incentive 
program complies with the impartial access requirements of Sec.  
38.151(b). If additional or different information would be helpful, 
please identify such information.
    102. The Commission requests comment regarding whether DCMs should 
be required to maintain on their public Web sites the information 
required by proposed Sec.  40.25(a) and (b) for an additional period 
beyond the end of the market maker or trading incentive program. The 
Commission may determine to include in any final rules arising from 
this NPRM a requirement that such information remain publicly available 
pursuant to proposed Sec.  40.25(b) for an additional period up to six 
months following the end of a market maker or trading incentive 
program.
    103. The Commission requests comment regarding whether the text of 
proposed Sec.  40.27(a) identifies with sufficient particularity the 
types of trades that are not eligible for payments or benefits pursuant 
to a DCM market-maker or trading incentive program. What amendments, if 
any, are necessary to clearly identify trades that are not eligible?
    104. Section 40.27(a) provides that DCMs shall implement policies 
and procedures that are reasonably designed to prevent the payment of 
market-maker or trading incentive program benefits for trades between 
accounts under common ownership. Are there any other types of trades or 
circumstances under which the Commission should also prohibit or limit 
DCM market-maker or trading incentive program benefits?
    105. The Commission is proposing in Sec.  40.27(a) certain 
requirements regarding DCM payments associated with market maker and 
trading incentive programs. Please address whether the proposed rules 
will diminish DCMs' ability to compete or build liquidity by using 
market maker or trading incentive programs. Does any DCM consider it 
appropriate to provide market maker or trading incentive program 
benefits for trades between accounts known to be under common 
beneficial ownership?
    106. In any final rules arising from this NPRM, should the 
Commission also prohibit DCMs from providing trading incentive program 
benefits where such benefits on a per-trade basis are greater than the 
fees charged per trade by such DCMs and its affiliated DCO (if 
applicable)? The Commission also specifically requests comment on the 
extent, if any, to which one or more DCMs engage in this practice.
    107. Proposed Sec.  40.25(b) imposes certain transparency 
requirements with respect to both market maker and trading incentive 
programs. The Commission requests public comment regarding:
    a. The most appropriate place or manner for a DCM to disclose the 
information required by proposed Sec.  40.25(b);
    b. The benefits or any harm that may result from such transparency, 
including any anti-competitive effect or pro-competitive effect among 
DCMs or market participants;
    c. Whether transparency as proposed in Sec.  40.25(b) is equally 
appropriate for both market maker programs and trading incentive 
programs, or are the proposed requirements more or less appropriate for 
one type of program over the other?
    d. Whether any of the enumerated items required to be posted on a 
DCM's public Web site pursuant to proposed Sec.  40.25(b) could 
reasonably be considered confidential information that should not be 
available to the public, and if so, what process should be available 
for a DCM to request from the Commission an exemption from the 
requirements of proposed Sec.  40.25(b) for that specific enumerated 
item?

V. Related Matters

A. Calculation of Number of Persons Subject to Regulations

    AT Persons. The Related Matters discussion below includes a number 
of hourly burden estimates and cost estimates for persons subject to 
new or revised regulations under Regulation AT. In order to estimate 
the number of AT Persons, the Commission used a sample of orders sent 
to DCMs. This data includes new orders, modifications to orders, and 
cancellations of the same. Of those available to the Commission, this 
data set is the one most closely related to the requirements included 
in the proposed rules. It includes the data elements potentially 
generated by an algorithm, often routed through a clearing member, and 
accepted by the matching engine for execution. The data set includes 
identifiers for the firm that generated and/or routed the order to the 
exchange, and indicators of whether the order is associated to an 
automated system. Using this participant-identified data, the 
Commission estimated the number of unique firms actively sending in 
algorithmic orders to the DCMs, making them potentially subject to 
requirements of AT Persons.
    Some of the firms included in this count, although they use 
automated systems, may not fully satisfy the requirements for an AT 
Person, possibly making the current estimate higher than the actual 
number of AT Persons. For example, firms identified in the data set as 
submitting algorithmic orders may not be required to register with the 
Commission under current or proposed rules and thus would not be AT 
Persons (e.g., registration triggers under proposed Sec.  1.3(x)(3)(ii) 
include a DEA component in addition to an Algorithmic Trading 
component). However, because the Commission does not historically 
receive the complete order book audit trail, the estimate by necessity 
only used a subset of all orders sent into the DCMs. To generate an 
accurate estimate of automated order activity, the estimate included 
many of the most active products on the DCMs, where participant 
diversity would be greatest. This analysis resulted in approximately 
350 potential AT Persons. To further address AT Persons that may not be 
identified in its data set, the Commission increased its finding of 
approximately 350 potential AT Persons by 20 percent, yielding a total 
of 420 potential AT Persons subject to the rules proposed herein. The 
Commission understands and acknowledges that this could lead to 
estimates which are incomplete, and welcomes any comments which might 
provide a more complete and/or more accurate count of AT Persons. This 
estimate of 420 AT Persons is used for purposes of the calculations in 
the Related Matters discussion below.
    Floor Traders (A Component of AT Persons). As noted in section 
IV(E) above, the Commission proposes to require the registration of 
proprietary traders using DEA for Algorithmic Trading on a DCM. In 
order to achieve registration, the Commission proposes amending the 
definition of ``Floor trader'' in Commission Regulation 1.3(x). Newly 
registered floor traders would be included in the definition of AT 
Persons. In order to estimate the number of these firms, the Commission 
made use of reference information for the connection methods used by 
active futures trading firms. These data files include information 
about the characteristics of the connection, including the location 
where orders are

[[Page 78885]]

generated. In order to identify direct connections, the Commission 
isolated those connections associated with co-location or other 
services likely related to DEA. These filters generated an estimate of 
approximately 100 potential firms that may need to register under 
proposed Sec.  1.3(x)(3). This calculation did not exclude those firms 
which may already be registered with the Commission in some capacity. 
As a result, the 100 estimate is potentially higher than the actual 
number of floor traders that would register under the new provision.
    Clearing member FCMs and DCMs. Finally, the Commission estimated 
the number of clearing member FCMs and DCMs that would be subject to 
proposed Regulation AT. The Commission arrived at an estimate of 57 
clearing member FCMs, based on the financial data for FCMs reported on 
the CFTC Web site. This data states that there were 57 FCMs in March 
2015 that required ``Customer's Segregation of Funds.'' \557\ The 
Commission arrived at an estimate of 15 DCMs, based on the list of 
designated DCMs as of the date of this NPRM, as reported on the CFTC 
Web site.\558\ This number does not include dormant or pending DCMs.
---------------------------------------------------------------------------

    \557\ See CFTC, Financial Data for FCMs, available at http://www.cftc.gov/MarketReports/FinancialDataforFCMs/index.htm.
    \558\ See CFTC, DCM Industry Filings, available at http://sirt.cftc.gov/SIRT/SIRT.aspx?Topic=TradingOrganizations&implicit=true&type=DCM&CustomColumnDisplay=TTTTTTTT.
---------------------------------------------------------------------------

1. Request for Comments
    108. The Commission requests comment on its calculation of the 
number of AT Persons, newly registered floor traders, clearing member 
FCMs, and DCMs that will be subject to Regulation AT.

B. Calculation of Hourly Wage Rates Used in Related Matters

    The Related Matters discussion below estimates the cost of various 
regulations proposed under Regulation AT. These costs incorporate 
hourly wage rates derived from salary information compiled by the 
Securities Industry and Financial Markets Association (``SIFMA''). 
Specifically, the hourly wage rates are based on salaries and bonuses 
across different professions that are listed in the SIFMA Report on 
Management & Professional Earnings in the Securities Industry 2013, 
modified to account for an 1800-hour work-year and multiplied by 1.3 to 
account for overhead and other benefits.\559\ The following professions 
and hourly wages are referenced throughout the Related Matters:
---------------------------------------------------------------------------

    \559\ The SIFMA Report on Management & Professional Earnings in 
the Securities Industry (2013) (``2013 SIFMA Report''), available at 
http://www.sifma.org/research/item.aspx?id=8589940603.
    \560\ The hourly wage rate represents the total mean 2012 
compensation with bonus divided by 1800 hours and multiplied by 1.3 
to account for overhead and other benefits.
    \561\ See 2013 SIFMA Report, supra note 559 at 273.
    \562\ See id.at 136.
    \563\ Id.
    \564\ See id.at 395.
    \565\ See id.at 113.
    \566\ See id. at 104.
    \567\ See id. at 119.
    \568\ See id. at 279.

----------------------------------------------------------------------------------------------------------------
                                                                             Total mean 2012
                                                 Description of role in     compensation with   Hourly wage rate
   2013 SIFMA report profession and code            related matters         bonus--2013 SIFMA   (rounded) \560\
                                                                                  report
----------------------------------------------------------------------------------------------------------------
Project Manager (1030).....................  Project Manager..............       \561\ 97,138                $70
Business Analyst (Intermediate) (602)......  Business Analyst.............       \562\ 72,650                 52
Business Analyst (Intermediate) (602)......  Tester.......................       \563\ 72,650                 52
Programmer Analyst (Senior) (1607).........  Developer....................      \564\ 103,851                 75
Compliance Examiner (Senior) (409).........  Senior Compliance Examiner...       \565\ 79,992                 58
Compliance Specialist (Senior) (406).......  Senior Compliance Specialist.       \566\ 78,250                 57
Chief Compliance Officer (Mutual Funds/      Chief Compliance Officer.....      \567\ 192,367                139
 Investment Advisory Services) (413).
Compliance Attorney (1103).................  Compliance Attorney..........      \568\ 133,059                 96
----------------------------------------------------------------------------------------------------------------

C. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') requires that agencies 
consider whether the rules they propose will have a significant 
economic impact on a substantial number of small entities and, if so, 
provide a regulatory flexibility analysis regarding the impact.\569\ A 
regulatory flexibility analysis or certification is typically required 
for ``any rule for which the agency publishes a general notice of 
proposed rulemaking'' pursuant to the notice-and-comment provisions of 
the Administrative Procedure Act, 5 U.S.C. 553(b).\570\
---------------------------------------------------------------------------

    \569\ 5 U.S.C. 601 et seq.
    \570\ 5 U.S.C. 601(2), 603, 604 and 605.
---------------------------------------------------------------------------

1. FCMs and DCMs
    The Commission has previously determined that FCMs and clearing 
members are not small entities for purposes of the RFA.\571\ The 
Commission has also previously determined that DCMs are not small 
entities for purposes of the RFA.\572\ Accordingly, the Chairman, on 
behalf of the Commission, hereby certifies pursuant to 5 U.S.C. 605(b) 
that the rules proposed in Regulation AT imposing requirements on FCMs 
and DCMs would not have a significant economic impact on a substantial 
number of small entities. The Commission invites public comment on this 
determination.
---------------------------------------------------------------------------

    \571\ See 47 FR 18618 (April 30, 1982) (FCMs); and 76 FR 71626 
at 71680 (November 18, 2011) and 76 FR 43851 at 43860 (July 22, 
2011) (clearing members).
    \572\ 76 FR 44776, 44789 (July 27, 2011) (``Provisions Common to 
Registered Entities''); see 66 FR 45064, 45609 (Aug. 29, 2001); 47 
FR 18618, 18619 (Apr. 30, 1982).
---------------------------------------------------------------------------

2. AT Persons
    Regulation AT would also impose requirements on ``AT Persons,'' a 
definition that includes: FCMs, floor brokers, SDs, MSPs, CPOs, CTAs or 
IBs, as well as ``floor traders'' as defined in proposed Sec.  
1.3(x)(3), that engage in Algorithmic Trading.
    The Commission has previously determined that FCMs, foreign 
brokers, SDs, MSPs, CPOs, and natural persons are not small entities 
for purposes of the RFA.\573\ As indicated above, the Commission 
believes that it is likely that no natural persons will be AT

[[Page 78886]]

Persons, given the technological and personnel costs associated with 
Algorithmic Trading. The Commission, pursuant to question #106 below, 
asks whether this assumption is correct.
---------------------------------------------------------------------------

    \573\ See respectively and as indicated: 47 FR 18618, 18619 
(April 30, 1982) (FCMs, CPOs); 72 FR 34417 at 34418 (June 22, 2007) 
(foreign brokers); 76 FR 71626 at 71680 (November 18, 2011) (SDs); 
77 FR 2613, 2620 (Jan. 19, 2012) (SDs and MSPs). See also 5 U.S.C. 
601(6) (natural persons are not entities for purposes of the RFA).
---------------------------------------------------------------------------

    The Commission has previously decided to evaluate, within the 
context of a particular rule proposal, whether all or some floor 
brokers, floor traders, CTAs, and IBs should be considered to be small 
entities, and if so, to analyze the economic impact on them of any such 
rule.\574\ In 2012, the Commission stated that it has not made a 
determination regarding floor traders, since all registered traders at 
the time were individuals, and individuals are not subject to the small 
entity analysis under the RFA.\575\
---------------------------------------------------------------------------

    \574\ See 47 FR 18618, 18620 (Apr. 30, 1982) (floor brokers); 
and 58 FR 19575, 19588 (Apr. 15, 1993) (floor traders); 47 FR at 
18619 (CTAs); 48 FR 35248, 35276-77 (Aug. 3, 1983) (IBs).
    \575\ See Commission, Final Rule: Registration of 
Intermediaries, 77 FR 51898, 51901 (Aug. 28, 2012).
---------------------------------------------------------------------------

    Accordingly, the Commission must address whether, in the context of 
Regulation AT, floor brokers, floor traders, CTAs, and IBs that engage 
in Algorithmic Trading should be considered small entities for purposes 
of the RFA. As discussed below, the Commission believes that the 
proposed rules regarding pre-trade and other risk controls, as well as 
standards relating to the design, testing, and supervision of 
Algorithmic Trading, are already being widely implemented in industry. 
Accordingly, while Regulation AT would have a significant economic 
impact on entities that are not currently implementing such measures, 
based on its best understanding, the Commission believes that it would 
not have a significant economic impact on a substantial number of small 
entities. However, the Commission is not in a position to determine how 
many of such entities would be affected, or the extent of such impact, 
given the varying sizes, technological systems, and business strategies 
of such entities. Therefore, pursuant to 5 U.S.C. 603, the Commission 
offers for public comment this initial regulatory flexibility analysis 
addressing the impact of Regulation AT on small entities:
i. A Description of the Reasons Why Action Is Being Considered
    The Commission is taking action because the increased use of 
algorithmic trading and increasingly interconnected nature of markets 
means that a technological malfunction or error can have widespread, 
significant impact on many market participants. In this time of 
technological change, the Commission believes that it is necessary to 
enact new and amended regulations requiring risk controls, testing 
standards and other measures that will safeguard the integrity of 
markets.
ii. A Succinct Statement of the Objectives of, and Legal Basis for, the 
Proposals
    The objective of Regulation AT is to address the risks of 
algorithmic trading through a series of pre-trade risk controls and 
other measures that AT Persons, clearing member FCMs and DCMs must 
implement. The legal authority for the proposed rules is Sections 
4c(a)(6), 4s(b)(4) 1a(23), 3(b) and 8a(5) of the CEA.\576\
---------------------------------------------------------------------------

    \576\ 7 U.S.C. 6c(a)(6) (rulemaking authority with respect to 
disruptive trading practices); 7 U.S.C. 6s(b)(4) (rulemaking 
authority with respect to swap dealers and major swap participants); 
7 U.S.C. 1a(23) (Definitions); 7 U.S.C. 5(b) (Findings and purpose); 
7 U.S.C. 12a(5) (Rules and Regulations).
---------------------------------------------------------------------------

iii. A Description of and, Where Feasible, an Estimate of the Number of 
Small Entities to Which the Proposed Rules Will Apply
    The small entities to which the proposed amendments may apply are 
those floor brokers, floor traders (as defined in proposed Sec.  
1.3(x)(3)), CTAs and IBs that engage in Algorithmic Trading and fall 
within the definition of a ``small entity'' under the RFA, including 
size standards established by the Small Business Administration.\577\ 
Each of the categories of persons discussed below would fall within the 
definition of ``AT Persons.'' As discussed in section V(A) above, the 
Commission estimates that approximately 420 persons will be AT Persons.
---------------------------------------------------------------------------

    \577\ 15 U.S.C. 601(3) (defining ``small business'' to have the 
same meaning as the term ``small business concern'' in the Small 
Business Act); 15 U.S.C. 632(a)(1) (defining ``small business 
concern'' to include an agricultural enterprise with annual receipts 
not in excess of $750,000); 13 CFR 121.201 (establishing size 
standards for small business concerns).
---------------------------------------------------------------------------

     Floor brokers. The Commission's best understanding is that 
at this time, all floor brokers are natural persons. Given the 
technological and personnel costs associated with Algorithmic Trading, 
the Commission's expectation is that only entities, not natural 
persons, will meet the definition of ``AT Person.'' Accordingly, the 
Commission estimates that no floor brokers will be ``small entities'' 
for purposes of the RFA.
     Floor traders. The Commission estimates that there is a 
maximum of 100 proprietary firms engaged in Algorithmic Trading that 
will be considered ``floor traders'' under proposed Sec.  1.3(x)(3) of 
Regulation AT. See section V(A) above for a discussion of how the 
Commission generated this estimate.
     CTAs. Based on NFA's registration directory, the 
Commission estimates that there are approximately 2,464 CTAs.\578\ The 
Commission notes that some registered CTAs are individuals, and not all 
CTAs will be engaged in Algorithmic Trading. It is not feasible for the 
Commission to estimate what portion of the 420 AT Persons will be CTAs.
---------------------------------------------------------------------------

    \578\ See NFA Directories, available at: http://www.nfa.futures.org/NFA-registration/NFA-directories.HTML.
---------------------------------------------------------------------------

     IBs. Based on NFA's registration directory, the Commission 
estimates that there are approximately 1,375 IBs.\579\ The Commission 
notes that some registered IBs are individuals, and not all IBs will be 
engaged in Algorithmic Trading. It is not feasible for the Commission 
to estimate what portion of the 420 AT Persons will be IBs.
---------------------------------------------------------------------------

    \579\ See id.
---------------------------------------------------------------------------

    Beyond the above estimates of the maximum number of floor brokers, 
floor traders (as defined in proposed Sec.  1.3(x)(3)), CTAs and IBs, 
it is not feasible for the Commission to provide a more exact estimate 
of the number of small entities to which Regulation AT will apply. The 
Commission estimates that no floor brokers will be ``small entities'' 
for purposes of the RFA, and that a maximum of 100 proprietary firms 
engaged in Algorithmic Trading will be considered ``floor traders'' 
under Sec.  1.3(x)(3) of the proposed rulemaking. The Commission 
estimates that the information collection will apply to no more than a 
total of 320 CTAs and IBs, and likely significantly less than 320. 
Based on the numbers described above, the Commission does not believe 
that a substantial number of small entities will be impacted by the 
information collection. Further, the definition of AT Person is limited 
to entities that conduct Algorithmic Trading and, the definition of new 
floor traders under proposed Sec.  1.3(x)(3) is further limited to 
those entities with Direct Electronic Access. The Commission believes 
that entities with such capabilities are generally not small entities. 
This NPRM asks specific questions on the issue of how the proposed 
regulations may affect small entities, in particular, whether sole 
proprietorships would be considered AT Persons and whether Regulation 
AT requirements should vary depending on the size, sophistication or 
other attributes of the AT Person.

[[Page 78887]]

iv. A Description of the Projected Reporting, Recordkeeping, and Other 
Compliance Requirements of the Rules, Including an Estimate of the 
Classes of Small Entities Which Will Be Subject to the Requirements and 
the Type of Professional Skills Necessary for Preparation of the Report 
or Record
    The following section discusses the projected reporting, 
recordkeeping, and other compliance requirements that will be imposed 
upon AT Persons under the proposed rules.
 Sec.  1.3(x)(3)--New Registration of Floor Traders
    Regulation AT would impose new registration requirements on certain 
entities with Direct Electronic Access as a result of the proposed 
amendment to the definition of ``Floor trader'' in Commission 
Regulation 1.3(x). The Commission provides detailed estimates of the 
costs associated with registration as a floor trader in section E 
below. As discussed more fully below, the Commission estimates that new 
registrants will incur a one-time cost of approximately $2,106 per 
registrant ($1,050 in application fees plus $1,056 in preparation 
costs). Accordingly, assuming (as discussed above) that there are 100 
new registrants as Floor traders, the total one-time cost of 
registration would be approximately $210,600.\580\
---------------------------------------------------------------------------

    \580\ Pursuant to part 3 of its regulations, the Commission has 
delegated its registration functions to the National Futures 
Association (NFA). Non-natural person floor trader entities register 
with the Commission and apply for membership in NFA via CFTC Form 7-
R. Principals of non-natural person floor trader entities register 
via Form 8-R. Based on a review of the principals associated with 
registered FCMs, the Commission estimates that each non-natural 
person floor trader entity will have approximately 10 principals and 
therefore need to file approximately 10 Forms 8-R. In the event that 
a natural person meets the definition of Floor Trader in proposed 
Sec.  1.3(x)(3), and is therefore required to register with the 
Commission and become a member of NFA, such person would only be 
required to complete Form 8-R and would face substantially lower 
costs than those estimated here. Because registration with the 
Commission and membership in NFA make use of the same forms and 
process, the Commission anticipates that the costs associated with 
proposed Sec.  1.3(x)(3) and proposed Sec.  170.18 will be one and 
the same.
---------------------------------------------------------------------------

 Sec.  170.18--AT Persons Must Become Members of an RFA
    Regulation AT would require all registrants that are AT Persons 
that are not otherwise required to become members of an RFA pursuant to 
Sec. Sec.  170.15, 170.16, or 170.17 to become members of an RFA. Taken 
together, Sec. Sec.  170.15, 170.16, and 170.17 require most 
registrants who may be considered AT Persons to become RFA members. The 
Commission estimates that the requirements of proposed Sec.  170.18 
will result in requiring the 100 new floor traders that will be 
registered pursuant Sec.  1.3(x)(3) to become members of an RFA. The 
Commission estimates that the floor trader registrants will incur 
initial and annual RFA membership dues of $5,625.\581\ Accordingly, 
assuming (as discussed above) that there are 100 new floor trader 
members, the total initial cost of RFA membership would be 
approximately $562,500 and the annual cost would be approximately 
$562,500.
---------------------------------------------------------------------------

    \581\ The Commission notes that NFA is currently the only entity 
registered as an RFA. The Commission estimates for RFA membership 
dues are based on its analysis of NFA dues.
---------------------------------------------------------------------------

 Sec.  1.80--Pre-Trade Risk Controls
    Based on Concept Release comments, best practices documents issued 
by industry or regulatory organizations, as well as existing 
regulations, the Commission believes that a significant number of 
trading firms already implement the specifically-enumerated pre-trade 
and other risk controls required pursuant to proposed Sec.  1.80. For 
example, in its survey of member firms, PTG found the following: (i) 25 
out of 26 responding firms use message and execution throttles; (ii) 
all 26 responding firms use maximum order size limits, either using 
their own technology, the exchange's technology, or some combination; 
\582\ and (iii) 24 out of 26 responding firms use either price collars 
or trading pauses.\583\ As to order management controls, two comments 
to the Concept Release from exchanges stated that they provide an 
optional cancel-on-disconnect functionality.\584\ Those exchanges also 
indicated that they provide kill switch functionality to market 
participants.\585\ In addition, the types of controls required by 
proposed Sec.  1.80 have been included in best practices documents for 
years, such those best practices documents issued by FIA PTG,\586\ 
ESMA,\587\ the CFTC TAC \588\ and the TMPG.\589\ Finally, many trading 
firms that do securities trading in addition to futures trading may 
already have these systems in place in order to comply with the SEC's 
Market Access Rule, which requires brokers and dealers to have risk 
controls that prevent the entry of erroneous orders, by rejecting 
orders that exceed appropriate price or size parameters, on an order-
by-order basis or over a short period of time, or that indicate 
duplicative orders.\590\
---------------------------------------------------------------------------

    \582\ AIMA indicated that many market participants use maximum 
order size limits, and Gelber, a trading firm, stated that it uses 
this risk control. See AIMA at 13; Gelber at 10.
    \583\ FIA at 59-60.
    \584\ CME at Appendix A-4; CFE at 9-10. In addition, FIA 
characterized cancel-on-disconnect as a ``widely adopted DCM-hosted 
pre-trade risk control.'' See FIA at 14.
    \585\ CME at 23-24; CFE at 11.
    \586\ FIA PTG, ``Recommendations for Risk Controls for Trading 
Firms,'' (Nov. 2010) at 4-5.
    \587\ ESMA Guidelines, supra note 61 at 14-15.
    \588\ CFTC TAC Recommendations, supra note 34 at 2-3.
    \589\ TMPG, ``Best Practices for Treasury, Agency Debt, and 
Agency Mortgage-Backed Securities Markets'' (June 2015).
    \590\ See SEC, Responses to Frequently Asked Questions 
Concerning Risk Management Controls for Brokers or Dealers with 
Market Access, supra note 37.
---------------------------------------------------------------------------

    Nevertheless, the Commission recognizes that there may be some 
trading firms within a given registration category that do not yet 
implement the risk controls required by Regulation AT, or that may need 
to upgrade their systems in order to comply with Regulation AT. 
Accordingly, Regulation AT would impose technology and personnel costs 
on this subset of trading firms; these costs would likely include both 
initial risk control creation costs and ongoing maintenance costs.
    The Commission provides detailed estimates of the implementation 
costs of risk controls in section E below.\591\ The Commission 
considered the possibility that a trading firm already implements the 
controls required by proposed Sec.  1.80, but the controls may not 
comply with every aspect of the regulation. In such a case, as 
discussed in greater detail below, the Commission estimates that it 
will cost an AT Person approximately $79,680 to upgrade its controls 
(i.e., evaluate current systems, modify or create new code, and test 
systems) in order to comply with Sec.  1.80. Accordingly, assuming (as 
discussed above) that there are 420 AT Persons, the Commission 
estimates that the total industry cost to implement Sec.  1.80 would be 
approximately $33,465,600.
---------------------------------------------------------------------------

    \591\ The Commission notes that trading firms can choose not to 
develop these controls internally, but rather may purchase a 
solution from an outside vendor (or DCM or clearing member) in order 
to comply with Sec.  1.80. The Commission has requested comments 
providing estimates of such costs.
---------------------------------------------------------------------------

 Sec.  1.81--Standards for Development, Testing and Monitoring 
of Algorithmic Trading Systems
    The Commission believes that most market participants and DCMs have 
implemented controls regarding the design, testing, and supervision of 
ATSs, in light of the numerous best practices and regulatory 
requirements promulgated in this area. These efforts include the FIA 
PTG's November 2010 ``Recommendations for Risk Controls for Trading 
Firms,'' FIA's March 2012 ``Software Development and Change Management 
Recommendations,'' ESMA and MiFID II guidelines and

[[Page 78888]]

directives on the development and testing of algorithmic systems, Reg 
SCI requirements on the development, testing, and monitoring of SCI 
systems, FINRA's March 2015 Notice 15-09 on effective supervision and 
control practices for market participants that use algorithmic trading 
strategies in the equities market, IOSCO's April 2015 Consultation 
Report, summarizing best practices that should be considered by trading 
venues when developing and implementing risk mitigation mechanisms, and 
the Senior Supervisors Group (SSG) April 2015 Algorithmic Trading 
Briefing Note, which described how large financial institutions 
currently monitor and control for the risks associated with algorithmic 
trading during the trading day.
    Notwithstanding the standards described above, the Commission has 
calculated a maximum cost to an AT Person that has not implemented any 
of the design, testing, and supervision standards required by proposed 
Sec.  1.81.
    Development and Testing. The Commission estimates that an AT Person 
that has not implemented any of the requirements of proposed Sec.  
1.81(a) (development and testing of Algorithmic Trading Systems) would 
incur a total cost of $349,865 to implement these requirements. This 
cost is broken down as follows: 1 Project Manager, working for 1,707 
hours (1,707 x $70 = $119,490); 2 Business Analysts, working for 853 
hours (853 x $52 = $44,356); 3 Testers, working for a combined 2,347 
hours (2,347 x $52 = $122,044); and 2 Developers, working for a 
combined 853 hours (853 x $75 = $63,975).\592\
---------------------------------------------------------------------------

    \592\ See section V(B) above for the calculation of hourly wage 
rates used in this analysis.
---------------------------------------------------------------------------

    Monitoring. The Commission estimates that an AT Person that has not 
implemented any of the requirements of Sec.  1.81(b) (monitoring of 
Algorithmic Trading Systems) would incur a total cost of $196,560 to 
implement these requirements. This cost is broken down as follows: 1 
Senior Compliance Specialist, working for 2,080 hours (2,080 x $57 = 
$118,560); and 1 Business Analyst, working for 1,500 hours (1,500 x $52 
= $78,000).
    Compliance. The Commission estimates that an AT Person that has not 
implemented any of the requirements of Sec.  1.81(c) (compliance of 
Algorithmic Trading Systems) would incur a total cost of $174,935 to 
implement these requirements. This cost is broken down as follows: 1 
Project Manager, working for 853 hours (853 x $70 = $59,710); 2 
Business Analysts, working for a combined 427 hours (427 x $52 = 
$22,204); 3 Testers, working for a combined 1,173 hours (1,173 x $52 = 
$60,996); and 2 Developers, working for a combined 427 hours (427 x $75 
= $32,025).
    Designation and Training of Staff. The Commission estimates that an 
AT Person that has not implemented any of the requirements of proposed 
Sec.  1.81(d) (designation and training of Algorithmic Trading staff) 
would incur a total cost of $101,600 to implement these requirements. 
This cost is broken down as follows: 1 Senior Compliance Specialist, 
working for 500 hours (500 x $57 = $28,500); 1 Project Manager, working 
for 500 hours (500 x $70 = $35,000); 1 Developer, working for 300 hours 
(300 x $75 = $22,500); and 1 Business Analyst, working for 300 hours 
(300 x $52 = $15,600).
    Notwithstanding these estimates, the Commission believes that 
proposed Sec.  1.81 standardizes existing industry practices in this 
area, but does not impose additional requirements that are not already 
followed by the majority of market participants. As a result, the 
Commission does not believe that Sec.  1.81 would impose additional 
costs on AT Persons.
 Sec.  1.83(a)--Compliance Reports Submitted by AT Persons
    Proposed Sec.  1.83 would require AT Persons and FCMs that are 
clearing members for AT Persons to annually submit reports regarding 
their compliance with Sec.  1.80(a) and pursuant to Sec.  1.82(a)(1), 
respectively, to each DCM on which they operate. The report prepared by 
an AT Person pursuant to Sec.  1.83(a) would include a description of 
the AT Person's pre-trade risk controls and the parameters and specific 
quantitative settings used for such pre-trade risk controls. Together 
with the annual report, each AT Person would be required to submit 
copies of the written policies and procedures developed to comply with 
Sec.  1.81(a) and (c). The report would also be required to include a 
certification by the chief executive officer or chief compliance 
officer of the AT Person that, to the best of his or her knowledge and 
reasonable belief, the information contained in the report is accurate 
and complete.
    AT Person Compliance Reports. AT Persons will incur the cost of 
annually preparing and submitting the reports to their DCMs. The 
Commission estimates that an AT Person will incur a total annual cost 
of $4,240 to draft the report required by proposed Sec.  1.83(a). This 
cost is broken down as follows: 1 Senior Compliance Specialist, working 
for 50 hours (50 x $57 per hour = $2,850) and 1 Chief Compliance 
Officer, working for 10 hours (10 x $139 per hour = $1,390) for a total 
cost of $4,240 per year. The approximately 420 AT Persons to which 
Sec.  1.83(a) would apply would therefore incur a total annual cost of 
$1,780,800 (420 x $4,240) to prepare and submit the report required by 
Sec.  1.83(a).
 Sec.  1.83(c)--AT Person Recordkeeping Requirements
    Proposed Sec.  1.83(c) would require each AT Person to keep, and 
provide upon request to each DCM on which such AT Person engages in 
Algorithmic Trading, books and records regarding such AT Person's 
compliance with all requirements pursuant to proposed Sec. Sec.  1.80 
and 1.81.
    The Commission estimates that, on an initial basis, an AT Person 
will incur a cost of $5,130 to draft and update recordkeeping policies 
and procedures and make technology improvements to recordkeeping 
infrastructure. This cost is broken down as follows: 1 Compliance 
Attorney, working for 30 hours (30 x $96 = $2,880); and 1 Developer, 
working for 30 hours (30 x $75 = $2,250). The 420 AT Persons would 
therefore incur a total initial cost of $2,154,600 (420 x $5,130).
    The Commission estimates that, on an annual basis, an AT Person 
will incur a cost of $2,670 to ensure continued compliance with DCM 
recordkeeping rules relating to Sec.  1.82 compliance, including the 
updating of policies and procedures and technology infrastructure, and 
in respond to DCM record requests. This cost is broken down as follows: 
1 Compliance Attorney, working for 20 hours (20 x $96 = $1,920); and 1 
Developer, working for 10 hours (10 x $75 = $750). The 420 AT Persons 
would therefore incur a total annual cost of $1,121,400 (420 x $2,670).
 Sec.  40.23(c)--Approval Requests Submitted by Market 
Participants re: Self-Trading Controls
    Market participants will incur costs in the event that they prepare 
and submit the self-trading approval requests contemplated by proposed 
Sec.  40.23(c). This provision, which is discussed in more detail in 
section IV(Q) above, requires market participants to request approval 
from the DCM that self-trade prevention tools not be applied with 
respect to specific accounts under common beneficial ownership or 
control. The Commission estimates that, on an annual basis, a market 
participant will incur a cost of $3,810 to prepare and submit these 
approval requests. This cost is broken down as follows: 1 Business 
Analyst, working for 30 hours (30 x $52 per hour = $1,560); and 1

[[Page 78889]]

Developer, working for 30 hours (30 x $75 per hour = $2,250).\593\
---------------------------------------------------------------------------

    \593\ See section V(B) above for the calculation of hourly wage 
rates used in this analysis.
---------------------------------------------------------------------------

    The Commission cannot predict how many market participants would 
likely submit the approval requests contemplated by proposed Sec.  
40.23(c) on an annual basis. The Commission believes that not all 
market participants trading on a DCM would submit such requests. In the 
view of the Commission, for example, a limited subset of market 
participants will own two or more accounts, but operate them through 
``independent decision makers,'' as contemplated by proposed Sec.  
40.23(b). Similarly, a limited subset of market participants will find 
it advantageous to incur the costs associated with the self-trading 
described by Sec.  40.23(b), such as trading costs and clearing fees. 
In addition, the Commission believes that market participants 
submitting orders through Algorithmic Trading are more likely than 
traders submitting orders manually to inadvertently self-trade through 
independent decision-makers. The Commission estimates that, 
notwithstanding the fact that the DCM rules described in Sec.  40.23(c) 
are directed to all market participants, the number of market 
participants that will submit the approval requests described therein 
are equivalent to the number of AT Persons calculated above (420).\594\ 
On this basis, the Commission estimates that market participants will 
incur a total annual cost of $1,600,200 to submit the approval requests 
contemplated by Sec.  40.23(c) ($3,810 per market participant x 420 
market participants).
---------------------------------------------------------------------------

    \594\ See section V(A) above for the calculation of the number 
of person subject to Regulation AT.
---------------------------------------------------------------------------

v. An Identification, to the Extent Practicable, of All Relevant 
Federal Rules Which May Duplicate, Overlap or Conflict With the Rules
    The Commission is unaware of any Federal rules that could 
duplicate, overlap, or conflict with the proposal.
vi. A description of any significant alternatives to the proposed rule 
which accomplish the stated objectives of applicable statutes and which 
minimize any significant impact of the proposed rule on small entities. 
These may include, for example, (1) the establishment of differing 
compliance or reporting requirements or timetables that take into 
account the resources available to small entities; (2) the 
clarification, consolidation, or simplification of compliance and 
reporting requirements under the rule for such small entities; (3) the 
use of performance rather than design standards; and (4) an exemption 
from coverage of the rule, or any part thereof, for such small 
entities.
    A potential alternative to Regulation AT that would minimize any 
significant impact on small entities would be to amend or propose new 
rules requiring trading firms implement pre-trade and other risk 
controls, but limit application of such requirements to entities that 
would not be considered ``small entities'' for purposes of the RFA. 
However, the Commission does not believe that this is a viable 
alternative. A principal basis for Regulation AT's risk control 
requirements is that a technological malfunction or error can have a 
significant, detrimental impact on other market participants across 
Commission-regulated markets. Importantly, such a technological 
malfunction or error can arise from any size of firm, including a very 
small proprietary trading firm with few employees. In today's 
interconnected markets, where a small error can cause a severe 
disruption in minutes, it is equally important that small firms have 
risk controls as large firms. The Commission believes that the risk 
controls required by Regulation AT will help ensure that all entities--
not just large entities with the most technological and financial 
resources--will have effective risk controls. The Commission is aware 
that smaller firms may have different trading strategies and technology 
than larger firms; accordingly, the proposed regulations allow all 
trading firms, including small entities, the discretion to design 
controls appropriate to their own business and to implement them in the 
most cost-effective manner.
    The Commission is also considering alternatives with respect to 
proposed Sec.  1.83, which would require AT Persons to submit 
compliance reports to DCMs on an annual basis. Such reports would need 
to be submitted and certified annually by the chief executive officer 
or the chief compliance officer of the AT Person. Proposed Sec.  40.22 
would require DCMs to establish a program for effective periodic review 
and evaluation of these reports. The Commission has proposed these 
regulations, using the deadlines described above, because it believes 
they represent an appropriate balancing of the transparency and risk 
reduction provided by the reports against the burden placed on AT 
Persons and DCMs of providing and reviewing the reports. The Commission 
is considering the alternative of requiring AT Persons to submit such 
reports more or less frequently than annually. The Commission is also 
considering the alternatives of placing the responsibility for 
certifying the reports required by proposed Sec.  1.83 only on the 
chief executive officer, only on the chief compliance officer, or 
permitting certification from other officers of the AT Person. The 
Commission notes that it considered the alternative of requiring 
additional information to be included in the Sec.  1.83 reports, such 
as descriptions of how AT Persons comply with Sec.  1.81 requirements 
and how clearing member FCMs comply with all Sec.  1.82 requirements. 
In the interest of minimizing costs to AT Persons and clearing member 
FCMs, the Commission determined at this time to require, pursuant to 
proposed Sec.  1.83(c) and (d), that AT Persons and clearing member 
FCMs instead retain and provide to DCMs books and records regarding 
their compliance with Sec. Sec.  1.80, 1.81 and 1.82 requirements. 
Proposed Sec.  40.22(d) includes a corresponding requirement that DCMs 
implement rules requiring AT Persons and clearing member FCMs to keep 
and provide such books and records.
    Finally, the Commission is considering alternatives with respect to 
proposed Sec.  40.23. This proposed regulation provides that DCMs may 
comply with the requirement to apply, or provide and require the use 
of, self-trade prevention tools by requiring market participants to 
identify to the DCM which accounts should be prohibited from trading 
with each other. With respect to this account identification process, 
the Commission's principal goal is to prevent unintentional self-
trading; the Commission does not have a specific interest in regulating 
the manner by which market participants identify to DCMs the account 
that should be prohibited from trading from each other, so long as this 
goal is met. The Commission has considered whether other identification 
methods should be made available to market participants

[[Page 78890]]

when submitting the approval requests described in Sec.  40.23. For 
example, the Commission has requested comment on whether the opposite 
approach is preferable: Market participants would identify to DCMs the 
accounts that should be permitted to trade with each other (as opposed 
to those accounts that should be prevented from trading with each 
other).
3. Request for Comments
    109. The Commission requests comment on each element of its RFA 
analysis. In particular, the Commission specifically invites comment on 
the accuracy of its estimates of potential firms that could be 
considered ``small entities'' for RFA purposes.
    110. The Commission also requests comment on whether any natural 
persons will be designated as AT Persons under the proposed definition 
of that term.

D. Paperwork Reduction Act

    The Paperwork Reduction Act (``PRA'') \595\ imposes certain 
requirements on Federal agencies in connection with their conducting or 
sponsoring any collection of information as defined by the PRA. This 
proposed rulemaking would result in new collection of information 
requirements within the meaning of the PRA. The Commission therefore is 
submitting this proposal to the Office of Management (OMB) for review 
in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. The following 
requirements of this rulemaking will result in new collection of 
information requirements within the meaning of the PRA: Sec.  1.83(a) 
would require AT Persons to submit reports to DCMs concerning 
compliance with Sec.  1.80(a), as well as copies of the written 
policies and procedures developed to comply with Sec.  1.81(a) and (c); 
Sec.  1.83(b) would require clearing member FCMs to submit reports to 
DCMs concerning compliance with Sec.  1.82(a)(1); Sec.  1.83(c) and (d) 
would require AT Persons and clearing member FCMs, respectively, to 
keep and provide upon request to DCMs books and records regarding their 
compliance with Sec. Sec.  1.80 and 1.81 (for AT Persons) and Sec.  
1.82 (for clearing member FCMs); Sec.  40.23(c) states that a DCM must 
require market participants to request approval from the DCM that self-
trade prevention tools not be applied with respect to certain types of 
accounts; Sec.  40.23(d) would require that DCMs display information 
about percentage and ratio of self-trading. The title for this 
collection of information is Regulation Automated Trading. An agency 
may not conduct or sponsor, and a person is not required to respond to, 
a collection of information unless it displays a currently valid 
control number. The OMB has not yet assigned this collection a control 
number. As used below, ``burden'' means the total time, effort, or 
financial resources expended by persons to generate, maintain, retain, 
disclose or provide information to or for a federal agency.
---------------------------------------------------------------------------

    \595\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------

    Additional Regulation AT requirements will amend existing 
collections of information. Proposed Sec.  1.3(x)(3) (requiring certain 
persons with DEA to prepare and submit forms to register with the 
Commission) would amend existing collection of information 
``Registration Under the Commodity Exchange Act,'' OMB Control Number 
3038-0023. Proposed Sec.  38.401(a) and (c) (requiring DCMs to publicly 
post information regarding certain aspects of their electronic matching 
platforms) and Sec.  40.26 (permitting the Commission or the director 
of DMO to require certain information from DCMs regarding their market-
maker or trading incentive programs) would amend existing collection of 
information ``Core Principles and Other Requirements for DCMs,'' OMB 
Control Number 3038-0052. Finally, proposed Sec.  40.25 (requiring DCMs 
to provide the Commission with certain information regarding their 
market-maker and trading incentive programs when submitting such 
programs as rules pursuant to part 40) would amend existing collection 
of information ``Part 40, Provisions Common to Registered Entities,'' 
OMB Control Number 3038-0093.
    The collections of information under these proposed regulations are 
necessary to implement certain provisions of the CEA, as amended by the 
Dodd-Frank Act. Section 8a(5) of the CEA provides the Commission with 
authority to promulgate rules as reasonably necessary to effectuate any 
of the provisions or to accomplish any of the purposes of the Act, and 
Section 4c(a)(6) of the CEA provides rulemaking authority to prohibit 
disruptive trading practices. As provided in Section 3(b) of the CEA, 
it is the purpose of the CEA to deter and prevent price manipulation or 
any other disruptions to market integrity; to ensure the financial 
integrity of all transactions subject to this chapter and the avoidance 
of systemic risk; to protect all market participants from fraudulent or 
other abusive sales practices and misuses of customer assets; and to 
promote responsible innovation and fair competition among boards of 
trade, other markets and market participants.\596\ Proposed regulations 
requiring registration with the Commission, submission of compliance 
reports to DCMs, implementation of self-trade prevention tools and 
increased disclosure of certain aspects of electronic matching 
platforms and market maker and trading incentive programs, will help 
prevent or mitigate technological malfunctions that will disrupt market 
integrity, protect market participants from fraudulent or disruptive 
practices, and promote fair competition among boards of trade, other 
markets and market participants.
---------------------------------------------------------------------------

    \596\ 7 U.S.C. 5.
---------------------------------------------------------------------------

    If the proposed regulations are adopted, responses to the 
collections of information would be mandatory. The Commission will 
protect proprietary information according to the Freedom of Information 
Act and 17 CFR part 145, ``Commission Records and Information.'' In 
addition, Section 8(a)(1) of the CEA strictly prohibits the Commission, 
unless specifically authorized by the CEA, from making public ``data 
and information that would separately disclose the business 
transactions or market positions of any person and trade secrets or 
names of customers.'' The Commission is also required to protect 
certain information contained in a government system of records 
according to the Privacy Act of 1974, 5 U.S.C. 552a.
1. Information Provided by Reporting Entities/Persons
    The following is a brief description of the PRA responsibilities of 
various entities under Regulation AT. In summary, Sec.  1.3(x)(3) would 
require certain floor traders with DEA to prepare and submit forms to 
register with the Commission; Sec.  1.83(a) and (b) would require AT 
Persons and clearing member FCMs to submit reports to DCMs concerning 
compliance with Sec.  1.80(a) and Sec.  1.82(a)(1), respectively; Sec.  
1.83(c) and (d) would require AT Persons and clearing member FCMs, 
respectively, to keep and provide upon request to DCMs books and 
records regarding their compliance with Sec. Sec.  1.80 and 1.81 (for 
AT Persons) and Sec.  1.82 (for clearing member FCMs); Sec.  38.401(a) 
and (c) would require DCMs to publicly post information regarding 
certain aspects of their electronic matching platforms; Sec.  40.23(c) 
states that a DCM must require market participants to request approval 
from the DCM that self-trade prevention tools not be applied with 
respect to certain types of accounts; Sec.  40.23(d) would require that 
DCMs

[[Page 78891]]

display information about percentage and ratio of self-trading; Sec.  
40.25 would require DCMs to provide the Commission with certain 
information regarding their market-maker and trading incentive programs 
when submitting such programs as rules pursuant to part 40; and Sec.  
40.26 would permit the Commission or the director of DMO to require 
certain information from DCMs regarding their market-maker or trading 
incentive programs.
    a. Sec.  1.3(x)(3)--Submissions by Newly Registered Floor Traders
    The Commission estimates that the proposed rules requiring certain 
floor traders with Direct Electronic Access to register will result in 
11 hours of burden per affected entity, and 1100 burden hours in total. 
The Commission estimates that each affected entity will require 1 hour 
to prepare and submit one Form 7-R (for the entity) and 10 hours to 
prepare and submit 10 Forms 8-R (one form for each principal of the 
entity).\597\ The estimated burden was calculated as follows:
---------------------------------------------------------------------------

    \597\ CFTC Form 7-R is used to apply for registration with the 
Commission as a non-natural person floor trader, and is also used 
for such entities to apply for membership in NFA. Form 8-R is used 
to identify principals of non-natural person floor trader entities. 
As noted previously, the Commission estimates that each non-natural 
person floor trader entity will have approximately 10 principals and 
therefore need to file approximately 10 Forms 8-R. In the event that 
a natural person meets the definition of Floor Trader in proposed 
Sec.  1.3(x)(3) and is therefore required to register with the 
Commission and become a member of NFA, such person would only be 
required to complete Form 8-R and would face substantially lower 
costs than those estimated here. Because registration with the 
Commission and membership in NFA make use of the same forms and 
process, the Commission anticipates that the costs associated with 
proposed Sec.  1.3(x)(3) and proposed Sec.  170.18 will be one and 
the same.
---------------------------------------------------------------------------

    Burden: Complete Form 7-R and 8-R to register as a floor trader.
    Respondents/Affected Entities: 100 new floor traders.
    Estimated number of responses: 100.
    Estimated total burden on each respondent: 11 hours.
    Frequency of collection: One-time initial registration fee.
    Burden statement-all respondents: 100 respondents x 1 hour = 100 
Burden Hours.
    The Commission estimates that a new registrant will incur a one-
time cost of $96 to complete one Form 7-R and a one-time cost of $960 
to complete 10 Forms 8-R. These costs represent the work of 1 
Compliance Attorney per affected entity, working for 1 hour per form (a 
total of 11 hours x $96 = $1,056).\598\ The 100 entities that will be 
subject to the registration requirement under Sec.  1.3(x)(3) would 
therefore incur a total one-time cost of $105,600 (100 x $1,506).\599\
---------------------------------------------------------------------------

    \598\ See section V(B) above for the calculation of hourly wage 
rates used in this analysis.
    \599\ See section V(A) above for the calculation of the number 
of persons subject to Regulation AT.
---------------------------------------------------------------------------

b. Sec.  1.83(a)--Compliance Reports Submitted by AT Persons to DCMs
    The Commission estimates that the proposed rules requiring AT 
Persons to submit annual reports regarding their pre-trade risk 
controls required pursuant to proposed Sec.  1.80(a) (as well as copies 
of the written policies and procedures developed to comply with Sec.  
1.81(a) and (c)) to each DCM on which they operate will result (on an 
annual basis) in 60 hours of burden per AT Person, and 25,200 burden 
hours in total. The estimated burden was calculated as follows:
    Burden: Compliance reports submitted by AT Persons to DCMs.
    Respondents/Affected Entities: 420 AT Persons.
    Estimated number of responses: 420.
    Estimated total burden on each respondent: 60 hours.
    Frequency of collection: Annual.
    Burden statement-all respondents: 420 respondents x 60 hours = 
25,200 Burden Hours per year.
    The Commission estimates that, on an annual basis, an AT Person 
will incur a cost of $4,240 to submit the compliance reports required 
by proposed Sec.  1.83(a). This cost is broken down as follows: 1 
Senior Compliance Specialist, working for 50 hours (50 x $57 = $2,850); 
and 1 Chief Compliance Officer, working for 10 hours (10 x $139 = 
$1,390).\600\ The 420 AT Persons that will be subject to Sec.  1.83(a) 
would therefore incur a total annual cost of $1,780,800 (420 
x$4,240).\601\
---------------------------------------------------------------------------

    \600\ See section V(B) above for the calculation of hourly wage 
rates used in this analysis.
    \601\ See section V(A) above for the calculation of the number 
of persons subject to Regulation AT.
---------------------------------------------------------------------------

c. Sec.  1.83(b)--Compliance Reports Submitted by Clearing Member FCMs 
to DCMs
    The Commission estimates that the proposed rules requiring clearing 
member FCMs to submit annual reports (describing the clearing member 
FCM's program for establishing and maintaining the pre-trade risk 
controls required by proposed Sec.  1.82(a)(1) for its AT Person 
customers in the aggregate) to each DCM on which they operate will 
result (on an annual basis) in 110 hours of burden per clearing member, 
and 6,270 burden hours in total. The estimated burden was calculated as 
follows:
    Burden: Compliance reports submitted by clearing member FCMs to 
DCMs.
    Respondents/Affected Entities: 57 clearing member FCMs.
    Estimated number of responses: 57.
    Estimated total burden on each respondent: 110 hours.
    Frequency of collection: Annual.
    Burden statement-all respondents: 57 respondents x 110 hours = 
6,270 Burden Hours per year.
    The Commission estimates that, on an annual basis, a clearing 
member FCM will incur a cost of $7,090 to submit the compliance reports 
required by Sec.  1.83(b). This cost is broken down as follows: 1 
Senior Compliance Specialist, working for 100 hours (100 x $57 = 
$5,700); and 1 Chief Compliance Officer, working for 10 hours (10 x 
$139 = $1,390).\602\ The 57 clearing member FCMs that will be subject 
to Sec.  1.83(b) would therefore incur a total annual cost of $404,130 
(57 x$7,090).\603\
---------------------------------------------------------------------------

    \602\ See section V(B) above for the calculation of hourly wage 
rates used in this analysis.
    \603\ See section V(A) above for the calculation of the number 
of persons subject to Regulation AT.
---------------------------------------------------------------------------

d. Sec.  1.83(c)--AT Person Retention and Production of Books and 
Records
    Initial Costs. The Commission estimates that rules pursuant to 
proposed Sec.  1.83(c) requiring AT Persons to keep and provide books 
and records relating to Sec. Sec.  1.80 and 1.81 compliance will result 
in initial costs of 60 hours of burden per AT Person, and 25,200 burden 
hours in total. The estimated burden was calculated as follows:
    Burden: Rule requiring AT Persons to keep and produce records 
relating to Sec. Sec.  1.80 and 1.81 compliance.
    Respondents/Affected Entities: 420 AT Persons.
    Estimated total burden on each respondent: 60 hours.
    Burden statement&all respondents: 420 respondents x 60 hours = 
25,200 Burden Hours initial year.
    The Commission estimates that, on an initial basis, an AT Person 
will incur a cost of $5,130 to draft and update recordkeeping policies 
and procedures and make technology improvements to recordkeeping 
infrastructure. This cost is broken down as follows: 1 Compliance 
Attorney, working for 30 hours (30 x $96 = $2,880); and 1 Developer, 
working for 30 hours (30 x $75 = $2,250). The 420 AT Persons would 
therefore incur a total initial cost of $2,154,600 (420 x $5,130).
    Annual Costs. The Commission estimates that rules pursuant to 
proposed Sec.  1.83(c) requiring AT Persons to keep and provide books 
and records

[[Page 78892]]

relating to Sec. Sec.  1.80 and 1.81 compliance will result in annual 
costs of 30 hours of burden per AT Person, and 12,600 burden hours in 
total. The estimated burden was calculated as follows:
    Burden: Rules requiring AT Persons to keep and produce records 
relating to Sec. Sec.  1.80 and 1.81 compliance.
    Respondents/Affected Entities: 420 AT Persons.
    Estimated number of responses: 420.
    Estimated total burden on each respondent: 30 hours.
    Frequency of collection: Intermittent.Burden statement-all 
respondents: 420 respondents x 30 hours = 12,600 Burden Hours per year.
    The Commission estimates that, on an annual basis, an AT Person 
will incur a cost of $2,670 to ensure continued compliance with the 
Sec.  1.83(c) recordkeeping rules relating to Sec.  1.82 compliance, 
including the updating of policies and procedures and technology 
infrastructure, and to respond to DCM record requests. This cost is 
broken down as follows: 1 Compliance Attorney, working for 20 hours (20 
x $96 = $1,920); and 1 Developer, working for 10 hours (10 x $75 = 
$750). The 420 AT Persons would therefore incur a total annual cost of 
$1,121,400 (420 x $2,670).
e. Sec.  1.83(d)--Clearing Member FCM Retention and Production of Books 
and Records
    Initial Costs. The Commission estimates that rules pursuant to 
proposed Sec.  1.83(d) requiring clearing member FCMs to keep and 
provide books and records relating to Sec.  1.82 compliance will result 
in initial costs of 60 hours of burden per clearing member FCM, and 
3,420 burden hours in total. The estimated burden was calculated as 
follows:
    Burden: Rules requiring clearing member FCMs to keep and produce 
records relating to Sec.  1.82 compliance.
    Respondents/Affected Entities: 57 clearing member FCMs.
    Estimated total burden on each respondent: 60 hours.
    Burden statement-all respondents: 57 respondents x 60 hours = 3,420 
Burden Hours initial year.
    The Commission estimates that, on an initial basis, a clearing 
member FCM will incur a cost of $5,130 to draft and update 
recordkeeping policies and procedures and make technology improvements 
to recordkeeping infrastructure. This cost is broken down as follows: 1 
Compliance Attorney, working for 30 hours (30 x $96 = $2,880); and 1 
Developer, working for 30 hours (30 x $75 = $2,250). The 57 clearing 
member FCMs would therefore incur a total initial cost of $292,410 (57 
x $5,130).
    Annual Costs. The Commission estimates that that DCM rules pursuant 
to proposed Sec.  1.83(d) requiring clearing member FCMs to keep and 
provide books and records relating to Sec.  1.82 compliance will result 
in annual costs of 30 hours of burden per clearing member FCM, and 
1,710 burden hours in total. The estimated burden was calculated as 
follows:
    Burden: Rules requiring clearing member FCMs to keep and produce 
records relating to Sec.  1.82 compliance.
    Respondents/Affected Entities: 57 clearing member FCMs.
    Estimated number of responses: 57.
    Estimated total burden on each respondent: 30 hours.
    Frequency of collection: Intermittent.
    Burden statement-all respondents: 57 respondents x 30 hours = 1,710 
Burden Hours per year.
    The Commission estimates that, on an annual basis, a clearing 
member FCM will incur a cost of $2,670 to ensure continued compliance 
with the Sec.  1.83(d) recordkeeping rules relating to Sec.  1.82 
compliance, including the updating of policies and procedures and 
technology infrastructure, and to respond to DCM record requests. This 
cost is broken down as follows: 1 Compliance Attorney, working for 20 
hours (20 x $96 = $1,920); and 1 Developer, working for 10 hours (10 x 
$75 = $750). The 57 clearing member FCMs would therefore incur a total 
annual cost of $152,190 (57 x $2,670).
f. Sec.  38.401(a) and (c)--Public Dissemination of Information by DCMs 
Pertaining to Electronic Matching Platforms
    The proposed amendments to regulations 38.401(a) and 38.401(c) 
require DCMs to publicly post information regarding certain aspects of 
their electronic matching platforms. DCMs should already be performing 
tests on their electronic matching platforms that would identify such 
attributes; therefore the added burden under the proposed amendments 
would be limited to drafting the description of such attributes and 
making the description available on the DCM's Web site. The Commission 
estimates that the proposed rules will result (on an annual basis) in 
200 hours of burden per DCM, and 3,200 burden hours in total. This 
estimate assumes that DCMs are already compliant with the requirements 
to post the specifications of their electronic matching platform under 
current regulation 38.401(a).
    Burden: Public Dissemination of Information by DCMs--Electronic 
Matching Platforms.
    Respondents/Affected Entities: 15 DCMs.
    Estimated total burden on each respondent: 200 hours per year.
    Frequency of collection: Intermittent.
    Burden statement-all affected entities: 15 affected entities x 200 
hours = 3,000 Burden Hours per year.
    The Commission estimates that, on an annual basis, a DCM will incur 
a cost of $19,200 to comply with amended Sec.  38.401(a) and (c). This 
cost represents the work of 1 Compliance Attorney, working for 200 
hours (200 x $96 = $19,200).\604\ The 15 DCMs that will be subject to 
amended Sec. Sec.  38.401(a) and (c) would therefore incur a total 
annual cost of $288,000 (15 x $19,200).\605\ The Commission anticipates 
that this figure would decrease in subsequent years as the descriptions 
provided would only need to be amended to reflect changes to the 
electronic matching platform or the discovery of previously unknown 
attributes.
---------------------------------------------------------------------------

    \604\ See section V(B) above for the calculation of hourly wage 
rates used in this analysis.
    \605\ See section V(A) above for the calculation of the number 
of persons subject to Regulation AT.
---------------------------------------------------------------------------

g. Sec.  40.23--Information Publicly Disseminated by DCMs Regarding 
Self-Trade Prevention
    Regulation AT proposes a new requirement (Sec.  40.23) that a DCM 
shall implement rules reasonably designed to prevent self-trading by 
market participants, except as specified in paragraph (b) of Sec.  
40.23. Section 40.23(b) states that a DCM may, in its discretion, 
implement rules that permit the matching of orders for accounts with 
common beneficial ownership where such orders are initiated by 
independent decision makers. A DCM may also permit under Sec.  40.23(b) 
the matching of orders for accounts under common control where such 
orders comply with the DCM's cross-trade, minimum exposure requirements 
or similar rules, and are for accounts that are not under common 
beneficial ownership. Section 40.23(c) states that a DCM must require 
market participants to request approval from the DCM that self-trade 
prevention tools not be applied with respect to specific accounts under 
common beneficial ownership or control, on the basis that they meet the 
criteria of paragraph (b).
    Proposed Sec.  40.23(d) would require that for each product and 
expiration month traded on a DCM in the previous quarter, the DCM must 
prominently display on its Web site the following

[[Page 78893]]

information: (1) The percentage of trades in such product including all 
expiration months that represent self-trading approved (pursuant to 
paragraph (c)(2) of Sec.  40.23) by the DCM, expressed as a percentage 
of all trades in such product and expiration month; (2) the percentage 
of volume of trading in such product including all expiration months 
that represents self-trading approved (pursuant to paragraph (c)(2) of 
Sec.  40.23) by the DCM, expressed as a percentage of all volume in 
such product and expiration month; and (3) the ratio of orders in such 
product and expiration month whose matching was prevented by the self-
trade prevention tools described in paragraph (a) of Sec.  40.23, 
expressed as a ratio of all trades in such product and expiration 
month.
    Market Participant Approval Requests. Market participants will 
incur costs in the event that they prepare and submit the approval 
requests contemplated by proposed Sec.  40.23(c). This provision 
requires market participants to request approval from the DCM that 
self-trade prevention tools not be applied with respect to specific 
accounts under common beneficial ownership or control. The Commission 
estimates that Sec.  40.23(c) will result (on an annual basis) in 60 
hours of burden per market participant, and 185,340 burden hours in 
total. The estimated burden was calculated as follows:
    Burden: Market Participant Submission of Self-Trade Approval 
Requests.
    Respondents/Affected Entities: 420.\606\
---------------------------------------------------------------------------

    \606\ See section V(E)(8)(b) below for a discussion of how this 
estimate of affected entities was performed.
---------------------------------------------------------------------------

    Estimated number of responses: 1 per respondent per year. Market 
participants may choose to submit approval requests more frequently, 
but regardless of how frequently market participants submit approval 
requests, the Commission estimates a total burden of 60 hours per 
market participant per year.
    Estimated total burden on each respondent: 60 hours per year.
    Burden statement--all respondents: 420 respondents x 60 hours per 
year = 25,200 Burden Hours per year.
    The Commission estimates that, on an annual basis, a market 
participant will incur a cost of $3,810 to prepare and submit the 
approval requests contemplated by 40.23(c). This cost is broken down as 
follows: 1 Business Analyst, working for 30 hours (30 x $52 per hour = 
$1,560); and 1 Developer, working for 30 hours (30 x $75 per hour = 
$2,250).\607\ The estimated 420 market participants that will be 
subject to Sec.  40.23(c) would therefore incur a total annual cost of 
$1,600,200 (420 x $3,810).\608\
---------------------------------------------------------------------------

    \607\ See section V(B) above for the calculation of hourly wage 
rates used in this analysis.
    \608\ See section V(A) above for the calculation of the number 
of persons subject to Regulation AT.
---------------------------------------------------------------------------

    DCM Publication of Statistics Regarding Self-Trade Prevention. The 
Commission estimates that the requirement under proposed Sec.  40.23(d) 
that DCMs publish statistics regarding self-trade prevention will 
result (on an annual basis) in 100 hours of burden per DCM, and 1,500 
burden hours in total for all 15 DCMs. The estimated burden was 
calculated as follows:
    Burden: DCM Publication of Statistics Regarding Self-Trade 
Prevention.
    Respondents/Affected Entities: 15 DCMs.
    Estimated total burden on each affected entity: 100 hours per year 
for DCMs to generate and publish statistics.
    Frequency of collection: 4 DCM Web site updates per year (one per 
quarter).
    Burden statement-all affected entities: 15 respondents x 100 hours 
of DCM time per year = 1,500 Burden Hours per year.
    The Commission estimates that, on an annual basis, a DCM will incur 
a cost of $6,650 to publish the statistics required by proposed Sec.  
40.23(d). This cost is broken down as follows: 1 Senior Compliance 
Examiner, working for 50 hours (50 x $58 per hour = $2,900); and 1 
Developer, working for 50 hours (50 x $75 per hour =$3,750).\609\ The 
15 DCMs that will be subject to Sec.  40.23(d) would therefore incur a 
total annual cost of $99,750 (15 x $6,650).\610\
---------------------------------------------------------------------------

    \609\ See section V(B) above for the calculation of hourly wage 
rates used in this analysis.
    \610\ See section V(A) above for the calculation of the number 
of persons subject to Regulation AT.
---------------------------------------------------------------------------

h. Sec.  40.25--Information in Public Rule Filings Provided by DCMs 
Regarding Market Maker and Trading Incentive Programs
    Proposed Sec.  40.25 would require DCMs to provide the Commission 
with certain information regarding their market-maker and trading 
incentive programs when submitting such programs as rules pursuant to 
part 40. Among other information, DCMs would be required to provide a 
description of any categories of market participants or eligibility 
criteria limiting who may participate in the program. They would also 
be required to provide an explanation of the specific purpose for a 
market-maker or trading incentive program; a list of all products or 
services to which the program applies; a description of any payments, 
incentives, discounts, considerations, inducements or other benefits 
that program participants may receive; and other requirements. To 
ensure public transparency in market-maker and trading incentive 
programs, proposed Sec.  40.25 would require DCMs to ensure that the 
information described above is easily located on their public Web 
sites.
    While proposed Sec.  40.25 may appear on its face to require 
substantial new information from DCMs regarding their market-maker or 
trading incentive programs, the proposed rule is largely similar to 
existing rule filing requirements in part 40. For example, existing 
Sec. Sec.  40.5 and 40.6 each require a DCM requesting approval or 
self-certifying rules to provide the Commission with the rule text; the 
proposed effective date or date of intended implementation; and an 
``explanation and analysis of the operation, purpose, and effect'' of 
the proposed rule. Existing Sec. Sec.  40.5 and 40.6 also require each 
DCM to provide the Commission with an assessment of the rule's 
``compliance with applicable provisions of the Act, including core 
principles, and the Commission's regulations thereunder;'' and ``a 
brief explanation of any substantive opposing views expressed to [the 
DCM] by governing board or committee members, members of the entity or 
market participants that were not incorporated into the rule . . . .'' 
Further, these existing provisions each require a DCM to certify that 
the DCM posted on its public Web site a notice of pending rule or 
certification and to also post a copy of the DCM's submission to the 
Commission on the DCM's Web site.
    The Commission believes proposed Sec.  40.25 adds important clarity 
to existing rule filing requirements in part 40 when such filings 
pertain to market-maker or trading incentive programs. However, the 
Commission also believes that there is significant overlap between 
proposed Sec.  40.25 and existing requirements for DCMs in Sec. Sec.  
40.5 and 40.6. Proposed Sec.  40.25 does not create a new category of 
rule filings, nor does it or require more frequent filings. For these 
reasons, the Commission believes that any additional Paperwork 
Reduction Act obligations in proposed Sec.  40.25 will be minor per 
DCM.
    Burden: Information regarding market maker and trading incentive 
program rule filings pursuant to part 40.
    Respondents/Affected Entities: 15 DCMs.
    Estimated total burden on each affected entity: 156 hours of DCM 
time per year.
    Frequency of collection: Intermittent.

[[Page 78894]]

    Burden statement-all affected entities: 15 respondents x 156 hours 
of DCM time per year = 2,340 Burden Hours per year.
i. Sec.  40.26--Information Provided by DCMs to the Division of Market 
Oversight Upon Request Regarding Market Maker and Trading Incentive 
Programs
    Proposed Sec.  40.26 would permit the Commission or the director of 
DMO to require certain information from DCMs regarding their market-
maker or trading incentive programs. The Commission believes that 
proposed Sec.  40.26 will impose no additional Paperwork Reduction Act 
burdens on DCMs. The proposed regulation permits the Commission or the 
director of DMO to require information from a DCM regarding the DCM's 
market-maker or trading incentive programs. It is a more targeted 
iteration of existing Sec.  38.5, which requires a DCM to file with the 
Commission such ``information related to its business as a designated 
contract market'' as the Commission may require. Section 38.5 also 
requires a DCM upon request by the Commission or the director of DMO to 
file ``a written demonstration'' that the DCM ``is in compliance with 
one or more core principles as specified in the request'' or 
``satisfies its obligations under the Act,'' including ``supporting 
data, information and documents.'' Proposed Sec.  40.26 does not alter 
a DCM's existing obligations under Sec.  38.5, but rather makes clear 
that Commission and DMO information requests may pertain specifically 
to market-maker and trading incentive programs. It imposes no new 
obligation to provide information, and does not increase the frequency 
which information must be provided.
    Burden: Information requests from the Commission or the Director of 
the Division of Market Oversight.
    Respondents/Affected Entities: 15 DCMs.
    Estimated total burden on each affected entity: 0 hours of DCM time 
per year.
    Frequency of collection: Intermittent.
    Burden statement-all affected entities: 15 respondents x 0 hours of 
DCM time per year = 0 Burden Hours per year.
2. Information Collection Comments
    The Commission invites the public to comment on any aspect of the 
paperwork burdens discussed herein. Copies of the supporting statements 
for the collections of information from the Commission to OMB are 
available by visiting RegInfo.gov. Pursuant to 44 U.S.C. 3506(c)(2)(B), 
the Commission solicits comments in order to: (i) Evaluate whether the 
proposed collections of information are necessary for the proper 
performance of the functions of the Commission, including whether the 
information will have practical utility; (ii) evaluate the accuracy of 
the Commission's estimate of the burden of the proposed collections of 
information; (iii) determine whether there are ways to enhance the 
quality, utility, and clarity of the information proposed to be 
collected; and (vi) minimize the burden of the proposed collections of 
information on those who are to respond, including through the use of 
appropriate automated collection techniques or other forms of 
information technology.
    Those desiring to submit comments on the proposed information 
collection requirements should submit them directly to the Office of 
Information and Regulatory Affairs, OMB, by fax at (202) 395-6566, or 
by email at [email protected]. Please provide the Commission 
with a copy of submitted comments so that all comments can be 
summarized and addressed in the final rule preamble. Refer to the 
Addresses section of this notice of proposed rulemaking for comment 
submission instructions to the Commission.

E. Cost Benefit Considerations

1. The Statutory Requirement for the Commission To Consider the Costs 
and Benefits of Its Actions
    Section 15(a) of the CEA requires the Commission to ``consider the 
costs and benefits'' of its actions before promulgating a regulation 
under the CEA or issuing certain orders.\611\ Section 15(a) further 
specifies that the costs and benefits must be evaluated in light of the 
following five broad areas of market and public concern: (1) Protection 
of market participants and the public; (2) efficiency, competitiveness, 
and financial integrity of futures markets; (3) price discovery; (4) 
sound risk management practices; and (5) other public interest 
considerations. The Commission considers the costs and benefits 
resulting from its discretionary determinations with respect to the 
section 15(a) factors below. As a general matter, the Commission 
considers the incremental costs and benefits of these proposed rules, 
taking into account what it believes is industry practice given the 
Commission's existing regulations and industry best practices, as 
described below. Where reasonably feasible, the Commission has 
endeavored to estimate quantifiable costs and benefits. The Commission 
also identifies and describes costs and benefits qualitatively.
---------------------------------------------------------------------------

    \611\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------

2. Concept Release Comments Regarding Costs and Benefits
    In the Concept Release, the Commission sought comments on most of 
the measures now addressed by Regulation AT. Six commenters made 
general points on cost-benefit considerations. Specifically, FIA and 
CME noted that the cost of implementing risk controls varies 
widely.\612\ FIA stated that many of the risk controls addressed in the 
Concept Release are already used in the futures industry and their 
benefit is clearly understood.\613\ FIA further stated that the 
implementation cost to individual firms varies widely based on the 
systems they have and the market and products they trade.\614\ 
Similarly, CME indicated that as to risk controls, specific costs as to 
development, implementation and ongoing operational figures will vary 
widely across the futures industry supply chain.\615\ CME declined to 
provide detailed analysis as to its own expenditures.\616\
---------------------------------------------------------------------------

    \612\ FIA at 60; CME at 41.
    \613\ FIA at 60.
    \614\ See id.
    \615\ CME at 41.
    \616\ See id.
---------------------------------------------------------------------------

    CFE commented that if the Commission proposes risk control 
requirements, it should perform a careful cost-benefit analysis and 
allow DCMs at least two years to implement the controls.\617\ TCL 
stated that most entities have the technology to address the ``spirit'' 
of the controls described in the Concept Release.\618\ AFR noted that 
cost-benefit analysis should be based on costs and benefits to the 
public as a whole, not on private benefits to individual actors.\619\ 
Finally, IATP stated that the Concept Release asked more frequently 
about costs of risk controls as compared to benefits of increased 
market stability, which can be more difficult to quantify.\620\
---------------------------------------------------------------------------

    \617\ CFE at 2.
    \618\ TCL at 18.
    \619\ AFR at 2.
    \620\ IATP at 3.
---------------------------------------------------------------------------

3. The Commission's Cost-Benefit Consideration of Regulation AT--
Baseline Point
    As a preliminary matter, the Commission notes that certain aspects 
of Regulation AT, as discussed below, codify existing norms and best 
practices of trading firms, clearing member FCMs

[[Page 78895]]

and DCMs. In that regard, in 2013, FIA surveyed FCMs and FIA PTG member 
firms regarding their use of risk controls and self-trade controls and 
found that all or most respondents currently use such controls.\621\ 
Comment letters to the Concept Release indicated that implementation of 
pre-trade and other risk controls was already widespread. Moreover, 
existing statutory schemes (e.g., the SEC's Market Access Rule and the 
CFTC's requirements relating to financial risk) means that many 
entities will already have systems in place relevant to the controls 
proposed in Regulation AT. Accordingly, as discussed below, the 
existing norms or best practices serve as the Commission's guide for 
determining the status quo baseline against which to measure the 
incremental costs and benefits of the proposed regulations. The 
Commission recognizes, however, that some individual firms currently 
may not be operating at industry best practice levels; for such firms 
costs and benefits attributable to the proposed regulations will be 
incremental to a lower status quo baseline. In many cases, the 
Commission assumes that compliance with regulations will require an 
upgrade to existing systems, rather than building risk control systems 
from scratch.
---------------------------------------------------------------------------

    \621\ FIA at 3, 59-60.
---------------------------------------------------------------------------

    To assist the Commission and the public in assessing and 
understanding the economic costs and benefits of the proposed rule, the 
Commission has analyzed the costs of the proposed regulations that 
impose additional requirements on trading firms, clearing member FCMs 
and DCMs above and beyond the baseline. In many instances, full 
quantification of the costs is not reasonably feasible because costs 
depend on the size, structure, and practices of trading firms, clearing 
member FCMs and DCMs. Within each category of entity, the size, 
structure and practices of such entities will vary markedly. In 
addition, the quantification may require information or data that the 
Commission does not have or was not provided in response to the Concept 
Release or other requests. The Commission notes that to the extent that 
the regulations proposed in this rulemaking results in additional 
costs, those costs will be realized by trading firms, clearing member 
FCMs and exchanges in order to protect market participants and the 
public. Finally, in general, full quantification of the benefits of the 
proposed rule is also not reasonably feasible, due to the difficulty in 
quantifying the benefits of a reduction in market disruptions and other 
significant market events due to the risk controls and other measures 
proposed in Regulation AT.
4. The Commission's Cost-Benefit Consideration of Regulation AT--Cross-
Border Effects
    The Commission notes that the consideration of costs and benefits 
below is based on the understanding that the markets function 
internationally, with many transactions involving U.S. firms taking 
place across international boundaries; with some Commission registrants 
being organized outside of the United States; with leading industry 
members typically conducting operations both within and outside the 
United States; and with industry members commonly following 
substantially similar business practices wherever located. Where the 
Commission does not specifically refer to matters of location, the 
below discussion of costs and benefits refers to the effects of the 
proposed rules on all activity subject to the proposed and amended 
regulations, whether by virtue of the activity's physical location in 
the United States or by virtue of the activity's connection with or 
effect on U.S. commerce under CEA Section 2(i).\622\ In particular, the 
Commission notes that some AT Persons are located outside of the United 
States.
---------------------------------------------------------------------------

    \622\ 7 U.S.C. 2(i).
---------------------------------------------------------------------------

5. General Request for Comment
    111. Beyond specific questions interspersed throughout its 
discussion, the Commission generally requests comment on all aspects of 
its consideration of costs and benefits, including: (a) Identification, 
quantification, and assessment of any costs and benefits not discussed 
therein; (b) whether any of the proposed regulations may cause FCMs or 
DCMs to raise their fees for their customers, or otherwise result in 
increased costs for market participants and, if so, to what extent; (c) 
whether any category of Commission registrants will be 
disproportionately impacted by the proposed regulations, and if so 
whether the burden of any regulations should be appropriately shifted 
to other Commission registrants; (d) what, if any, costs would likely 
arise from market participants engaging in regulatory arbitrage by 
restructuring their trading activities to trade on platforms not 
subject to the proposed regulations, or taking other steps to avoid 
costs associated with the proposed regulations; (e) quantitative 
estimates of the impact on transaction costs and liquidity of the 
proposals contained herein; (f) the potential costs and benefits of the 
alternatives that the Commission discussed in this release, and any 
other alternatives appropriate under the CEA that commenters believe 
would provide superior benefits relative to costs; (g) data and any 
other information to assist or otherwise inform the Commission's 
ability to quantify or qualitatively describe the benefits and costs of 
the proposed rules; and (h) substantiating data, statistics, and any 
other information to support positions posited by commenters with 
respect to the Commission's consideration of costs and benefits.
6. The Commission's Cost-Benefit Consideration of Regulation AT--
Proposed Definitions
    The Commission notes that Regulation AT proposes certain defined 
terms, including ``AT Person,'' ``Algorithmic Trading,'' and ``Direct 
Electronic Access'' (as an element of the revised definition of the 
term ``Floor Trader''). While the defined terms themselves do not 
impose costs, the Commission recognizes that the scope of such 
definitions will impact the potential costs of other regulations. For 
example, proposed Sec.  1.80 imposes risk control requirements on ``AT 
Persons,'' and the defined term ``Algorithmic Trading'' is an element 
of the term AT Person. The broader the definition of AT Person and 
Algorithmic Trading, the greater the number of firms that would be 
required to meet the requirements of Sec.  1.80.
    The Commission believes its definition of AT Person is appropriate 
and its inclusion of ``floor traders,'' consistent with the proposed 
changes to Sec.  1.3(x), will mean that certain currently unregistered 
market participants who actively trade on Commission-regulated markets 
will be subject to risk control requirements that will prevent or 
mitigate the risks of malfunctioning algorithmic trading systems. 
Similarly, the proposed definition of Algorithmic Trading captures such 
trading activity that has the potential, when there is a technological 
malfunction, to harm market participants and disrupt markets at a speed 
that is difficult to mitigate. The Commission asks questions concerning 
the scope of the definition of Algorithmic Trading, for example whether 
order routing systems should be included within such definition. The 
Commission acknowledges that any change made to scope of AT Person and 
Algorithmic Trading made in accordance with any comments received will 
impact the cost of regulations that use those definitions.

[[Page 78896]]

7. Pre-Trade Risk Controls, Testing and Supervision of Automated 
Systems, Requirement To Submit Compliance Reports, and Other Related 
Algorithmic Trading Requirements
a. Summary of Proposed Rules
    This section addresses the following proposed regulations: (i) The 
requirement that AT Persons implement pre-trade risk controls and other 
related measures (Sec.  1.80); (ii) standards for the development, 
testing, and monitoring of Algorithmic Trading systems by AT Persons 
(Sec.  1.81); (iii) registered futures association (``RFA'') standards 
for algorithmic trading systems (``ATSs'') operated by their members 
and clearing member FCMs with respect to customer orders originating 
with ATSs (Sec.  170.19); (iv) the requirement that AT Persons must 
become a member of a futures association (Sec.  170.18); (v) the 
requirement that clearing member FCMs implement pre-trade risk controls 
and other related measures (Sec.  1.82); (vi) the requirements of Sec.  
1.83, including that: AT Persons submit compliance reports to DCMs 
regarding their Sec.  1.80(a)-required risk controls, as well as copies 
of the written policies and procedures developed to comply with Sec.  
1.81(a) and (c) (Sec.  1.83(a)); clearing member FCMs submit compliance 
reports to DCMs regarding their program for establishing and 
maintaining the pre-trade risk controls required by Sec.  1.82(a)(1) 
for AT Person customers (Sec.  1.83(b)); AT Persons keep and provide 
upon request to DCMs books and records regarding their compliance with 
Sec. Sec.  1.80 and 1.81 (Sec.  1.83(c)); and clearing member FCMs keep 
and provide upon request to DCMs books and records regarding their 
compliance with Sec.  1.82 (Sec.  1.83(d)); (vii) the requirement that 
DCMs implement pre-trade risk controls and other related measures 
(Sec. Sec.  38.255 and 40.20); (viii) the requirement that DCMs provide 
test environments where AT Persons may test their ATSs (Sec.  40.21); 
and (ix) the requirements of Sec.  40.22, including that DCMs: 
implement rules requiring AT Persons and clearing member FCMs to submit 
compliance reports each year (Sec.  40.22(a) and (b)), establish a 
program for effective periodic review and evaluation of the reports 
(Sec.  40.22(c)), implement rules that require each AT Person to keep 
and provide to the DCM books and records regarding their compliance 
with all requirements pursuant to Sec.  1.80 and Sec.  1.81, and 
require each clearing member FCM to keep and provide to the DCM market 
books and records regarding their compliance with all requirements 
pursuant to Sec.  1.82 (Sec.  40.22(d)), and require DCMs to review and 
evaluate, as necessary, books and records required to be kept pursuant 
to Sec.  40.22(d), and the measures described therein (Sec.  40.22(e)).
    The pre-trade risk controls and other measures required by 
Sec. Sec.  1.80, 1.82, 38.255, and 40.20 would require the following 
enumerated pre-trade risk controls: Maximum AT Order Message and 
execution frequencies, price parameters, and maximum order size limits. 
The regulations would also require certain order management controls, 
including kill switch and cancel-on-disconnect functionalities. 
Proposed Sec.  170.19 would require an RFA to adopt certain membership 
rules--as deemed appropriate by the RFA--relevant to ATSs and 
algorithmic trading for each category of member in the RFA. Proposed 
Sec.  170.18 would require all AT Persons to be registered as a member 
of an RFA.
    Proposed Sec.  1.81 would require AT Persons to establish policies 
and procedures that accomplish a number of objectives relating to the 
design, testing, and supervision of Algorithmic Trading. More 
specifically, proposed Sec.  1.81 would require each AT Person to: 
Implement written policies and procedures for the development and 
testing of ATSs (Sec.  1.81(a)); implement written policies and 
procedures reasonably designed to ensure that each of its ATSs is 
subject to continuous real-time monitoring and supervision by 
knowledgeable and qualified staff while such ATS is engaged in trading 
(Sec.  1.81(b)); implement written policies and procedures reasonably 
designed to ensure that ATSs operate in a manner that complies with the 
CEA and the rules and regulations thereunder, and ensure that staff are 
familiar with the CEA and the rules and regulations thereunder, the 
rules of any DCM to which such AT Person submits orders through 
Algorithmic Trading, the rules of any RFA of which such AT Person is a 
member, the AT Person's own internal requirements, and the requirements 
of the AT Person's clearing member FCM, in each case as applicable 
(Sec.  1.81(c)); and implement written policies and procedures to 
designate and train staff responsible for Algorithmic Trading (Sec.  
1.81(d)). As a complement to the proposed design and testing 
requirements, proposed Sec.  40.21 would require DCMs to provide a test 
environment that will enable market participants to simulate production 
trading and conduct exchange-based conformance testing of their 
Algorithmic Trading systems.
    Proposed Sec.  1.83(a) would require AT Persons to submit annual 
reports to each DCM on which they operate regarding their pre-trade 
risk controls as required by Sec.  1.80(a). Together with such annual 
reports, each AT Person would also be required to submit copies of the 
written policies and procedures developed to comply with Sec.  1.81(a) 
and (c). Proposed Sec.  1.83(b) would require clearing member FCMs for 
AT Persons to submit reports to DCMs describing their program for 
establishing and maintaining the pre-trade risk controls required by 
Sec.  1.82(a)(1). The Commission is also proposing a new Sec.  40.22(c) 
to require that each DCM that receives a report described in Sec.  1.83 
establishes a program for effective periodic review and evaluation of 
the reports. In addition, proposed Sec.  1.83(c) and (d) would require 
AT Persons and clearing member FCMs for AT Persons to keep and provide 
upon request to DCMs books and records regarding their compliance with 
Sec. Sec.  1.80 and 1.81 (for AT Persons) and Sec.  1.82 (for clearing 
member FCMs). The Commission is also proposing a new Sec.  40.22(d) and 
(e) to require that DCMs implement rules requiring AT Persons and 
clearing member FCMs to keep and provide such books and records, and to 
require DCMs to review and evaluate such books and records, and 
identify and remediate any insufficient mechanisms, policies and 
procedures therein.
b. Costs and Benefits
i. Sec.  1.80 Costs--Pre-Trade and Other Risk Controls (AT Persons)
    Based on Concept Release comments, best practices documents issued 
by industry or regulatory organizations, as well as existing 
regulations, the Commission believes that a significant number of AT 
Persons already implement the specifically-enumerated pre-trade and 
other risk controls required pursuant to proposed Sec.  1.80. 
Specifically, in its survey of member firms, PTG found the following: 
(i) 25 out of 26 responding firms use message and execution throttles; 
(ii) all 26 responding firms use maximum order size limits, either 
using their own technology, the exchange's technology, or some 
combination; \623\ and (iii) 24 out of 26 responding firms use either 
price collars or trading pauses.\624\ As to order management controls, 
two comments to the Concept Release from exchanges stated that they 
provide an optional cancel-on-disconnect functionality.\625\

[[Page 78897]]

Those exchanges also indicated that they provide kill switch 
functionality to market participants.\626\
---------------------------------------------------------------------------

    \623\ AIMA indicated that many market participants use maximum 
order size limits, and Gelber, a trading firm, stated that it uses 
this risk control. See AIMA at 13; Gelber at 10.
    \624\ FIA at 59-60.
    \625\ CME Appendix at A-4; CFE at 9-10. In addition, FIA 
characterized cancel-on-disconnect as a ``widely adopted DCM-hosted 
pre-trade risk control.'' See FIA at 14.
    \626\ CME at 23-24; CFE at 11.
---------------------------------------------------------------------------

    The Commission notes that these types of controls have been 
included in industry best practices for years. For example, FIA PTG 
recommended, among other things, that trading firms implement message 
limits, a repeated automated execution throttle, fat-finger limits and 
price collars, as well as ``heartbeats'' with the exchange, use of 
exchange-provided cancel-on-disconnect functionality, and a kill button 
that disables the system's ability to trade and cancels all resting 
orders.\627\ In addition, ESMA guidelines from 2012 recommended, among 
other things, that investment firms implement messaging traffic 
controls and price or size parameters.\628\ The Commission also notes 
that the SEC's Market Access Rule, adopted in November 2010, requires 
brokers and dealers to have risk controls that prevent entry of 
erroneous orders, by rejecting orders that exceed appropriate price or 
size parameters, on an order-by-order basis or over a short period of 
time, or that indicate duplicative orders.\629\ Given that many firms 
are registered both with the SEC and the CFTC, it is likely that there 
is overlap between the set of firms covered under the SEC's Market 
Access Rule and this Proposed Rule. Finally, in 2011, the CFTC TAC 
recommended, among other things, that trading firms implement message 
and execution throttles, maximum quantity limits, price collars, and a 
kill button.\630\
---------------------------------------------------------------------------

    \627\ FIA PTG, ``Recommendations for Risk Controls for Trading 
Firms,'' (Nov. 2010) at 4-5.
    \628\ ESMA Guidelines, supra note 61 at 14-15.
    \629\ See 17 CFR 240.15c3-5(e); SEC, Responses to Frequently 
Asked Questions Concerning Risk Management Controls for Brokers or 
Dealers with Market Access (Apr. 15, 2014), supra note 37.
    \630\ CFTC TAC Recommendations, supra note 34 at 2-3.
---------------------------------------------------------------------------

    The Commission also notes that, as discussed in detail above in 
section II.E.1, NFA has provided guidance regarding ATSs to industry 
participants since 2002. Such guidance includes NFA Interpretive Notice 
9046, which addresses the ``Supervision of the Use of Automated Order-
Routing Systems'' in the context of NFA's overarching supervision 
requirements in Compliance Rule 2-9 (Supervision). This rule and 
interpretive notice are widely applicable to almost all registered 
futures market participants and therefore apply to many AT Persons. In 
particular, Compliance Rule 2-9 requires each NFA member to 
``diligently supervise its employees and agents in the conduct of their 
commodity futures activities for or on behalf of the Member.'' 
Interpretive Notice 9046, first issued in 2002 and revised in 2006, 
provided, among other things, that an AORS should allow the Member to 
set limits for each customer based on commodity, quantity, and type of 
order or based on margin requirements, and should allow the Member to 
impose limits pre-execution and to automatically block any orders that 
exceed those limits. In addition, the interpretive notice provided that 
when authorizing use of a direct access system, the Member should 
utilize pre-execution controls, if available, to set pre-execution 
limits for each customer, regardless of the nature of the customer.
    Although proposed Sec.  1.80 is consistent with accepted industry 
best practices of long standing and existing Commission and SEC 
regulations to which many AT Persons now comply, Regulation AT's risk 
control requirements will impose technology and personnel costs on AT 
Persons. These costs include initial risk control creation costs and 
possibly ongoing maintenance costs. Many AT Persons already have the 
controls required by Regulation AT in place, and will only need to 
upgrade such controls to ensure compliance. To the extent some AT 
Persons may be outliers that do not currently implement risk controls 
consistent with industry best practice--a number the Commission lacks 
data to accurately identify and quantify--these firms would incur costs 
greater than ``upgrade'' costs. The costs to any such outlier firms 
would vary based on each firm's unique size, business model, technology 
and existing risk controls. The Commission recognizes that some firms 
will already have entirely compliant systems requiring no upgrade and, 
at the other end of the spectrum, some firms may not be currently 
implementing the Sec.  1.80 required risk controls at all. Accordingly, 
the Commission estimates the ``upgrade'' costs for AT Persons to comply 
with Regulation AT risk control requirements, and welcomes comment on 
the accuracy of such estimates.
    Aside from costs to individual AT Persons in creating and 
maintaining the controls required by Regulation AT, in quantifying 
costs of Sec.  1.80, the Commission considered that this regulation may 
impose general costs to the marketplace as a whole. For example, while 
the Commission expects that most AT Persons will only need to upgrade 
systems in order to comply with Regulation AT, it is possible that 
costs related to the implementation of new risk controls could lead to 
adverse effects. For example, compliance costs may cause some AT 
Persons to reduce, or cease, their activities in certain markets. This 
may result in a decrease in market liquidity, which may cause the costs 
of trading to increase. In order to mitigate these potential concerns, 
the Commission has (as discussed further in the consideration of 
alternatives) limited the compliance requirements to what it 
preliminarily believes is the minimum level needed to protect market 
participants and the public. In addition, as discussed in section (ii) 
below, the Commission believes that the standardization of risk 
controls may result in the provision of additional liquidity.
    Other potential costs related to risk controls are similarly hard 
to quantify. Kill switches aim to cease unintended message behavior, 
and the potential losses and disruption associated with such behavior. 
However, the mandatory triggering of a kill switch when not appropriate 
to a particular firm could also prevent the firm's legitimate, risk-
reducing activity, and instead result in increased costs for such firm. 
This distinction emphasizes the need to appropriately calibrate risk 
controls on an individual basis, and the Commission has proposed rules 
that accommodate that need. While the Commission attempts to quantify 
costs to individual firms, the Commission is also aware of the broader 
impact of the proposed rules on markets once firms apply the proposed 
risk controls, including potential effects on liquidity. The Commission 
welcomes comments on these and other potential market-wide effects of 
the proposed regulations.
    In addition to the potential costs to the market as a whole 
discussed above, individual AT Persons may incur costs of risk control 
implementation, in particular the cost of upgrading systems in order to 
comply with the proposed regulations. Specifically, if a particular AT 
Person's systems are not already compliant with Sec.  1.80, it will 
need to comply with the pre-trade and other risk controls in one of 
several ways: By internally developing such controls from scratch, 
upgrading existing systems, or through purchasing a risk management 
solution from an outside vendor. Each approach potentially has initial 
costs and annual ongoing costs. Based on responses to the FIA survey, 
industry best practice standards, and existing regulations both in 
Commission-regulated markets as well as SEC-regulated markets, the 
Commission believes that many AT Persons will be able to substantially 
satisfy the risk control requirements of Regulation AT with their 
existing systems and controls. For others, the

[[Page 78898]]

costs of upgrading and introducing the required systems would vary 
considerably based on current controls and procedures, as well as 
particular business models.\631\
---------------------------------------------------------------------------

    \631\ For example, the needs of a particular AT Person will vary 
based on its current systems and controls in place, the 
comprehensiveness of its controls and procedures, the types of 
trading strategies it uses, and the volume and speed of its trading 
activity.
---------------------------------------------------------------------------

    Rather than develop or upgrade its own systems, AT Persons may 
choose to purchase a risk management solution from a third-party 
vendor, a DCM, or a clearing member FCM. These costs could similarly 
vary, depending on the AT Persons' current systems and controls in 
place, the types of trading strategies it uses, the volume and speed of 
its trading activity, and the pricing model utilized by the software 
vendor. As one example, the Commission notes that CME provides a number 
of risk management tools to its market participants and clearing firms. 
These tools include: Cancel-on-disconnect, CME Globex credit controls, 
a Risk Management Interface (RMI) (which allows clearing members to 
manage risk), drop copy, FirmSoft (the ability to view and cancel 
orders), a kill switch (a single step shutdown of trading activity) and 
self-trade prevention.\632\ As another example, NASDAQ OMX Group, Inc. 
offers risk management tools that include fat finger price checks, 
maximum order quantity checks, daily accumulated quantity checks, 
maximum order rate per second checks, disconnect safeguards, email 
notifications when limits or warning levels are breached, and an 
administration interface that allows emergency actions.\633\ Many of 
these mirror, or complement, risk controls included within this 
proposed rule.
---------------------------------------------------------------------------

    \632\ CME Group, ``Risk Management Tools Introduction,'' 
available at: http://www.cmegroup.com/globex/trading-cme-group-products/risk-management-tools.html.
    \633\ NASDAQ OMX Group, Inc., ``Pre-Trade Risk Management--
Genium INET,'' available at: http://www.nasdaqomx.com/nordicprm/geniuminet.
---------------------------------------------------------------------------

    The Commission estimated the costs for AT Persons to comply with 
proposed Sec.  1.80. In making its estimates, the Commission made 
several assumptions. The Commission assumes that the effort to adjust 
any one control (by ``control,'' in this context, the Commission means 
the pre-trade risk controls, order cancellation systems, and 
connectivity systems required by Sec.  1.80) would require assessment 
and possible modifications to all controls.\634\ The required 
programming changes could be applied using flexible and generalizable 
methods and leveraged across all algorithms. The Commission recognizes 
that execution speed is considered to be a significant factor in 
algorithmic trading, and understands that controls have the potential 
to impact execution speed; however, the Commission believes that 
requiring a base set of risk controls will, rather than further 
increasing speed disadvantages across market participants, partially 
reduce them by ensuring that no firm avoids the use of a given control 
to gain an advantage. Because each AT Person is unique and 
technological systems across AT Persons will vary, the following 
estimates reflect staff's best efforts, and the Commission welcomes 
comments on their accuracy.
---------------------------------------------------------------------------

    \634\ The Commission also assumes that the most difficult 
control to implement will be message and execution throttles because 
such throttles will need to be coordinated among many complex 
algorithms running simultaneously.
---------------------------------------------------------------------------

    Estimate--Upgrade of Controls. The Commission considered the 
scenario where an AT Person already implements controls as required by 
proposed Sec.  1.80, but the controls may not comply with every aspect 
of the regulation. In such instance, an AT Person will need to evaluate 
its current risk control systems to determine whether it is compliant 
with new regulatory requirements; modify existing code or creating new 
code to address any gaps between current risk control systems and new 
regulatory requirements; and test current systems and new code to 
verify correct operation and compliance. The Commission assumes that AT 
Persons will generally already have some code in place for the basic 
controls required by Sec.  1.80, or for something similar that can be 
added to or modified, rather than need to build entire pre-trade 
systems from scratch. For example, an AT Person may have an existing 
library of ``code blocks,'' with a block being useful for multiple 
related purposes.
    Accordingly, the Commission estimates that an AT Person would incur 
a one-time cost of $79,680 to upgrade its systems to comply with 
proposed Sec.  1.80. This cost is broken down as follows: 1 Project 
Manager, working for 320 hours (320 x $70 per hour = $22,400); 1 
Business Analyst, working for 320 hours (320 x $52 per hour = $16,640); 
1 Tester, working for 320 hours (320 x $52 per hour = $16,640); and 1 
Developer, working for 320 hours (320 x $75 per hour = $24,000). The 
Commission estimates that if an AT Person already has at least some of 
the controls required by Sec.  1.80, there will be no additional annual 
costs to maintain the modifications required to bring the systems into 
compliance with Sec.  1.80. Assuming (as discussed above) that there 
are 420 AT Persons, the Commission estimates that the total one-time 
industry cost to implement Sec.  1.80 would be approximately 
$33,465,600.
    The Commission notes that AT Persons could choose not to develop 
these controls internally, but rather may purchase a solution from an 
outside vendor (or DCM or clearing member FCM) in order to comply with 
Sec.  1.80. The Commission welcomes comments providing estimates 
concerning the cost for an AT Person to use an outside vendor to comply 
with this proposed regulation.
    SEC Estimates. The proposing release for the SEC's Market Access 
Rule, which requires brokers and dealers to have risk controls in place 
before providing their customers with access to the market, provided 
compliance costs estimates.\635\ The Commission's upgrade estimates are 
generally consistent with the cost estimates provided by the SEC. For 
example, the SEC estimated that it would cost a broker-dealer 
approximately $270,404 ($167,904 in technology personnel costs and 
$102,500 in hardware and software costs) to build a risk control 
management system from scratch and that it would cost a broker-dealer 
$39,401 ($27,984 for technology personnel and $11,517 for hardware and 
software) to substantially upgrade an existing risk control 
system.\636\ The SEC estimated that the total annual ongoing cost to 
maintain an in-house risk control management system would be $47,300 
per broker-dealer ($26,800 for technology personnel and $20,500 for 
hardware and software).\637\ Finally, with respect to outsourcing such 
controls, the SEC estimated that a broker-dealer would pay 
approximately $8,000 per month ($96,000 annually) for a startup 
contract.\638\ To be conservative, the SEC estimated the same amount 
for an annual ongoing cost.\639\
---------------------------------------------------------------------------

    \635\ See Securities Exchange Act Release No. 61379 (January 19, 
2010), 75 FR 4007 (January 26, 2010) (File No. S7-03-10).
    \636\ See id. at 4022.
    \637\ See id.
    \638\ See id.
    \639\ See id.
---------------------------------------------------------------------------

    The Commission notes that in addition to the general requirements 
of proposed Sec.  1.80 to implement pre-trade risk controls, order 
cancellation systems and connectivity systems, Sec.  1.80 imposes 
additional requirements relating to such controls. Regulation Sec.  
1.80(a)(2) provides requirements as to the level at which pre-trade 
risk controls should be set and Sec.  1.80(a)(3) requires that natural 
person monitors be promptly alerted when such parameters are breached. 
The Commission assumes

[[Page 78899]]

that such requirements impose no additional costs or are part of the 
costs described above. Establishing particular parameters of controls 
is a necessary part of establishing and implementing any control. In 
addition, as discussed below, the Commission assumes that it is already 
industry practice to employ a natural person to test and monitor a 
firm's algorithmic trading systems. Accordingly, requiring that natural 
person monitors at the AT Person be alerted with pre-trade risk control 
parameters are breached should not impose additional costs on AT 
Persons.
    Proposed Sec.  1.80(d) requires each AT Person, prior to its 
initial use of Algorithmic Trading, to submit a message or order to a 
DCM's trading platform, must notify its clearing member FCM and the DCM 
on which it will be trading that it will engage in Algorithmic Trading. 
Subject to consideration of relevant comments, the Commission 
preliminarily believes that this requirement of this initial 
notification to clearing firms and DCMs will impose minimal or no costs 
on AT Persons. The Commission welcomes comment on the costs, if any, of 
this notification requirement.
    Proposed Sec.  1.80(e) requires AT Persons to implement a DCM's 
self-trade prevention tools. The Commission's self-trade prevention 
requirements are principally directed toward DCMs, in that Sec.  40.23 
would require DCMs to apply, or provide and require the use of, self-
trade prevention tools. The Commission believes that DCMs would incur 
the costs of developing or upgrading such tools as necessary to comply 
with Sec.  40.23. To the extent that AT Persons are not already 
complying with DCM-provided self-trade prevention tools already used in 
industry, the Commission believes that the cost to an AT Person in 
calibrating or otherwise applying such a tool would be a minimal, 
involving provision of the relevant account or other necessary 
information in the DCM in order to apply the tool. The Commission 
welcomes comment on the costs, if any, to an AT Person in complying 
with Sec.  1.80(e).
    Finally, proposed Sec.  1.80(f) requires that each AT Person shall 
periodically review its compliance with Sec.  1.80 to determine whether 
it has effectively implemented sufficient measures reasonably designed 
to prevent an Algorithmic Trading Event. AT Persons must take prompt 
action to document and remedy deficiencies in such policies and 
procedures. The Commission believes that this periodic review is 
necessary to comply with Sec.  1.83(a), which, as discussed below, 
requires AT Persons to annually submit reports regarding their pre-
trade risk controls required pursuant to proposed Sec.  1.80(a) and 
copies of the written policies and procedures developed to comply with 
Sec.  1.81(a) and (c) to each DCM on which they operate. Accordingly, 
the Commission believes that articulating such requirement explicitly 
in the final subsection of this rule will not engender costs separate 
from those previously discussed and considered.
    The Commission emphasizes that costs for each AT Person will vary. 
Finally, the Commission notes that, as indicated above, these estimates 
may overstate the actual costs to the industry. Based on Concept 
Release comments, best practices issued by industry and regulatory 
organizations, as well as existing regulations, the Commission believes 
that all or most AT Persons are already using the pre-trade and other 
risk controls required by proposed Sec.  1.80. The Commission welcomes 
public comment on the above analysis and estimates.
ii. Sec.  1.80 Benefits--Pre-Trade and Other Risk Controls (AT Persons)
    Proposed Sec.  1.80 should benefit market participants by 
mitigating credit, market, and operational risks faced by trading 
firms. Standardization of pre-trade and other risk controls is 
particularly critical in the context of potential outlier trading firms 
that have chosen not to implement appropriate risk controls in the 
absence of regulation. As noted above (for example, with respect to the 
Knight Capital incident), a technological malfunction at such a single 
firm can have far-reaching impact across markets and market 
participants. Credit, market and operational risks are mitigated 
through ensuring that each order accurately reflects the intentions of 
the participant and does not otherwise violate the CEA or Commission 
regulations. The pre-trade and other risk controls required by proposed 
Sec.  1.80 should improve both price efficiency and price transparency 
in Commission-regulated markets by reducing the chances of large, 
unintended orders moving prices away from appropriate market values. 
Absent protections, unintended and erroneous trades resulting from a 
malfunctioning trading system could potentially expose not just the 
original market participant, but any participant exposed to the given 
market, to unexpected financial burdens as a result of price moves. 
These burdens may include the financial impact on market participants 
with open positions impacted by price moves, or market participants 
with market orders in the order book. In addition to these losses, and 
potentially uncertain trading positions, sudden, large unintentional 
market activity can disrupt the efficiency, competitiveness and 
financial integrity of the futures markets. Because much of the impact 
of such unintended trades is independent of connection method, it is in 
the individual trading firm's interest, and the interest of Commission-
regulated markets as a whole, to have all types of algorithmic trading 
orders, regardless of access method, be subjected to sound risk 
controls.
    As noted, the Commission believes that proposed regulation Sec.  
1.80 standardizes existing industry practices in this area, and does 
not impose additional requirements beyond existing best practices that 
most market participants satisfy. Accordingly, the Commission notes 
that many of the benefits of Sec.  1.80 are already being realized. 
This proposed rule, however, may serve to limit a ``race to the 
bottom'' in which certain entities sacrifice effective risk controls in 
order to minimize costs or increase the speed of trading. The proposed 
rules, by standardizing the risk controls required to be used by firms, 
would help ensure that the benefits of these risk controls are more 
evenly distributed across a wide set of market participants, and reduce 
the likelihood that an outlier firm without sufficient risk controls 
causes significant market disruption.
    Incidents like the one involving Knight Capital highlight the 
importance of using pre-trade and other risk control protections. 
Specifically, an SEC investigation found that Knight Capital did not 
have adequate safeguards in place to limit the risks posed by its 
access to the markets, and, as a result, failed to prevent the entry of 
millions of erroneous orders.\640\ Knight Capital also failed to 
conduct adequate reviews of control effectiveness.\641\ The SEC charged 
Knight Capital with multiple violations of the SEC's Market Access 
Rule, which included failure to have adequate controls at a point 
immediately prior to its submission of orders to the market, such as a 
control to compare orders leaving the router with those entered.\642\ 
Knight also failed to adequately review its business activity in 
connection with its market access to ensure the overall effectiveness 
of its risk management controls and supervisory procedures.\643\

[[Page 78900]]

As a result of these failures, the SEC found that Knight put not only 
themselves, but the markets in general, at risk. The Commission views 
prevention of disruptive events like that involving Knight Capital as 
an important benefit of Sec.  1.80 that impacts all market participants 
and the public.
---------------------------------------------------------------------------

    \640\ See SEC Knight Capital Release, supra note 39.
    \641\ See id.
    \642\ See id.
    \643\ See id.
---------------------------------------------------------------------------

    By requiring, and standardizing, certain risk controls implemented 
by traders and trading firms, the Commission intends to foster a level 
playing field across market participants, and avoid a situation where 
firms with stronger risk control systems face speed disadvantages. The 
Commission also recognizes that in the absence of a rule requiring 
implementation of certain risk controls, some market participants may 
be compelled by competitive and economic pressures to submit orders, or 
allow the submission of orders, without appropriate controls to 
safeguard against the risks of a malfunctioning algorithm. The race for 
speed may reduce the incentive to add risk controls, and the absence of 
risk controls can magnify the effect, and cost, of errors in the high 
speed trading environment. In addition, the mitigation of significant 
system risks should help ensure market integrity and provide the 
investing public with greater confidence that all transactions, along 
with the resulting price movements, are intentional and bona fide. 
Regulation AT should promote investor confidence as well as enhance the 
fair and efficient operation of the markets.
    The Commission believes that market participants, in particular 
those currently using risk controls, may face a number of disadvantages 
due to the fact that risk controls for algorithmic trading are not 
standardized, and that these disadvantages may discourage market 
participants from providing liquidity. Market participants may be 
concerned about their exposure to potential losses due to Algorithmic 
Trading events and various market abuses in the absence of standardized 
risk controls and other measures. Market participants may also be 
concerned whether market orders and trades in fact reflect the intent 
of the market participants submitting them. The Commission thus 
expects, subject to consideration of comments, that standardization of 
risk control requirements for all AT Persons via Regulation AT will 
reduce such costs and trading disincentives for market participants 
arising from Algorithmic Trading events and market abuses. The 
Commission also expects, subject to consideration of comments, that 
standardization will reduce unexpected costs that market participants 
currently experience when unfavorable price movements occur due to the 
behavior of another market participant's faulty algorithm. As a result, 
the Commission, subject to consideration of comments, views the 
proposed standardized risk controls as a tool likely to encourage AT 
Persons and other market participants to provide additional liquidity, 
mitigating the potential negative impact on market liquidity from 
certain costs associated with Regulation AT, as previously discussed in 
section (i) above.
iii. Sec.  1.81 Costs--Development, Testing and Supervision of 
Algorithmic Systems (AT Persons)
    The Commission believes that most market participants and DCMs have 
implemented controls regarding the design, testing, and supervision of 
Algorithmic Trading systems, in light of the numerous best practices 
and regulatory requirements promulgated in this area. For this fully 
compliant majority, the codification of such standards in proposed 
Sec.  1.81 should not engender additional costs. For any market 
participants that are not fully compliant, some additional costs may be 
expected. These efforts include the FIA PTG's November 2010 
``Recommendations for Risk Controls for Trading Firms,'' FIA's March 
2012 ``Software Development and Change Management Recommendations,'' 
ESMA and MiFID II guidelines and directives on the development and 
testing of algorithmic systems, SEC Regulation SCI requirements on the 
development, testing, and monitoring of SCI systems, FINRA's March 2015 
Notice 15-09 on effective supervision and control practices for market 
participants that use algorithmic trading strategies in the equities 
market, IOSCO's April 2015 Consultation Report, summarizing best 
practices that should be considered by trading venues when developing 
and implementing risk mitigation mechanisms, and the Senior Supervisors 
Group (SSG) April 2015 Algorithmic Trading Briefing Note, which 
described how large financial institutions currently monitor and 
control for the risks associated with algorithmic trading during the 
trading day.
    The Commission has calculated an estimated maximum cost to an AT 
Person that has not implemented any of the design, testing, and 
supervision standards required by proposed Sec.  1.81 as further 
described below. To the extent an AT Person is already in partial 
compliance with Sec.  1.81, as the Commission believes many are likely 
to be, their costs should be less than the maximum described.
    Development and Testing. The Commission estimates that an AT Person 
that has not implemented any of the requirements of proposed Sec.  
1.81(a) (development and testing of Algorithmic Trading Systems) would 
incur a total cost of $349,865 to implement these requirements. This 
cost is broken down as follows: 1 Project Manager, working for 1,707 
hours (1,707 x $70 = $119,490); 2 Business Analysts, working for a 
combined 853 hours (853 x $52 = $44,356); 3 Testers, working for a 
combined 2,347 hours (2,347 x $52 = $122,044); and 2 Developers, 
working for a combined 853 hours (853 x $75 = $63,975).\644\
---------------------------------------------------------------------------

    \644\ See section V(B) above for the calculation of hourly wage 
rates used in this analysis.
---------------------------------------------------------------------------

    Monitoring. The Commission estimates that an AT Person that has not 
implemented any of the requirements of proposed Sec.  1.81(b) 
(monitoring of Algorithmic Trading Systems) would incur a total cost of 
$196,560 to implement these requirements. This cost is broken down as 
follows: 1 Senior Compliance Specialist, working for 2,080 hours (2,080 
x $57 = $118,560); and 1 Business Analyst, working for 1,500 hours 
(1,500 x $52 = $78,000).\645\
---------------------------------------------------------------------------

    \645\ As discussed above, the Commission notes that staff 
persons who are responsible for monitoring the trading of other AT 
Person staff should not simultaneously be actively engaged in 
trading. The Commission believes that it would not be possible to 
adequately and consistently monitor trading of other AT Person staff 
while engaged in trading activities.
---------------------------------------------------------------------------

    Compliance. The Commission estimates that an AT Person that has not 
implemented any of the requirements of proposed Sec.  1.81(c) 
(compliance of Algorithmic Trading Systems) would incur a total cost of 
$174,935 to implement these requirements. This cost is broken down as 
follows: 1 Project Manager, working for 853 hours (853 x $70 = 
$59,710); 2 Business Analysts, working for a combined 427 hours (427 x 
$52 = $22,204); 3 Testers, working for a combined 1,173 hours (1,173 x 
$52 = $60,996); and 2 Developers, working for a combined 427 hours (427 
x $75 = $32,025).
    Designation and Training of Staff. The Commission estimates that an 
AT Person that has not implemented any of the requirements of proposed 
Sec.  1.81(d) (designation and training of Algorithmic Trading staff) 
would incur a total cost of $101,600 to implement these requirements. 
This cost is broken down as follows: 1 Senior Compliance Specialist, 
working for 500 hours (500 x $57 = $28,500); 1 Project Manager, working 
for 500 hours (500 x $70 = $35,000); 1 Developer, working for 300 hours 
(300 x $75 = $22,500); and 1

[[Page 78901]]

Business Analyst, working for 300 hours (300 x $52 = $15,600).
    Notwithstanding these estimates, the Commission believes that 
proposed Sec.  1.81 standardizes existing industry practices in this 
area, but does not impose additional requirements that are not already 
followed by the majority of market participants. As a result, subject 
to consideration of relevant comments, the Commission preliminarily 
believes that regulation Sec.  1.81 would not impose additional costs 
on the majority of AT Persons and that the costs imposed on AT Persons 
that are in partial compliance with Sec.  1.81 will be less than the 
amounts described above.
iv. Sec.  1.81 Benefits--Development, Testing and Supervision of 
Algorithmic Systems (AT Persons)
    The rules proposed with respect to the design, testing, and 
supervision of Algorithmic Trading systems are intended to further 
mitigate the risk of Algorithmic Trading. In their response to the 
Concept Release, IATP noted that, out of all the safeguards discussing 
in the Release, they believed ATS testing had the greatest potential to 
reduce market disruptions.\646\ By standardizing principles in this 
area, Regulation AT is intended to reduce the risk of disorderly 
trading, including the risk that orders will be unintentionally sent 
into the marketplace by a poorly designed or insufficiently supervised 
algorithm.
---------------------------------------------------------------------------

    \646\ IATP at 7.
---------------------------------------------------------------------------

    For example, the regulations proposed under Sec.  1.81 may reduce 
the risk of market disruptions such as the 2012 incident involving 
Knight Capital. The SEC later concluded that, among other failures, 
Knight Capital did not have adequate controls and procedures for code 
deployment and testing for its order router, did not have sufficient 
controls and written procedures to guide employees' responses to 
significant technological and compliance incidents, and did not have an 
adequate written description of its risk management controls.\647\ 
Proposed Sec.  1.81 requires written policies and procedures relating 
to the following: Testing of all Algorithmic Trading code and relates 
systems and any changes to such code and systems prior to their 
implementation; regular stress tests of ATSs to verify their ability to 
operate in the manner intended under a variety of market conditions; a 
plan of internal coordination and communication between compliance 
staff of the AT Person and staff of the AT Person responsible for 
Algorithmic Trading regarding Algorithmic Trading design, changes, 
testing, and controls; and procedures for documenting the strategy and 
design of proprietary Algorithmic Trading software used by an AT 
Person, among other controls. The standardization of such written 
policies and procedures may make disruptive events like the Knight 
Capital incident less likely in the future.
---------------------------------------------------------------------------

    \647\ See SEC Knight Capital Release, supra note 39.
---------------------------------------------------------------------------

    As noted, the Commission believes that proposed regulation Sec.  
1.81 standardizes existing industry practices in this area, and does 
not impose additional requirements that are not already followed by the 
majority of market participants. Accordingly, the Commission notes that 
many of the benefits of Sec.  1.81 are already being realized. The 
proposed rule would help ensure that the benefits of the required 
testing and supervision will be fully realized and sustained into the 
future.
v. Sec.  170.19 Costs--RFA Standards for Automated Trading and 
Algorithmic Trading Systems (RFAs)
    Proposed Sec.  170.19 requires an RFA to establish and maintain a 
program for the prevention of fraudulent and manipulative acts and 
practices, the protection of the public interest, and perfecting the 
mechanisms of trading on designated contract markets through membership 
rules, as deemed appropriate by the RFA, requiring: (1) Pre-trade risk 
controls and other measures for ATSs; (2) standards for the 
development, testing, monitoring, and compliance of ATSs; (3) 
designation and training of algorithmic trading staff; and (4) 
operational risk management standards for clearing member FCMs with 
respect to customer orders originating with algorithmic trading 
systems.
    Proposed Sec.  170.19 will impose costs on an RFA to establish and 
maintain a program as described in the rule. However, RFAs would only 
be required to adopt rules as they deem appropriate; any rulemaking 
pursuant to proposed Sec.  170.19 would be entirely at the discretion 
of the RFA. The Commission believes that the costs to an RFA of 
proposed Sec.  170.19 cannot reasonably be quantified given RFAs' 
complete discretion to adopt many, several, or no rules in the 
foreseeable future pursuant to Sec.  170.19. In addition, relevant 
rulemaking by an RFA is likely to be episodic, as circumstances 
warranting rulemaking will typically not arise on an annual basis. With 
those caveats, however, for purposes of this analysis and as a basis 
for comment, the Commission is using its own experience to quantify the 
potential costs of proposed Sec.  170.19 to an RFA on those occasions 
when it determines to adopt rules. For purposes of this exercise, the 
Commission anticipates that an RFA could potentially seek to codify 
industry best practices in order to establish a baseline of regulatory 
standardization around such practices.
    The Commission believes that the work of adopting these rules would 
fall primarily to legal, information technology, and compliance staff 
within an RFA. It estimates 450 hours of burden for an RFA to adopt 
rules. This includes analysis of existing industry best practices, 
consultation with market participants, drafting rules, further 
consultations, including potentially with Commission staff, and 
adoption of final rules. The Commission estimates a total cost of 
$34,200 for these efforts. This cost is broken down as follows: 2 
Compliance Attorneys, working for a combined 150 hours (150 hours x $96 
per hour = $14,400); 2 Developers, working for a combined 150 hours 
(150 hours x $75 per hour = $11,250); and 2 Senior Compliance 
Specialists, working for a combined 150 hours (150 hours x $57 per hour 
= $8,550), for a total cost of $34,200.\648\
---------------------------------------------------------------------------

    \648\ See section V(B) above for the calculation of hourly wage 
rates used in this analysis.
---------------------------------------------------------------------------

    The Commission notes that an RFA, after familiarizing itself with 
relevant best practices, may determine that additional membership rules 
pursuant to proposed Sec.  170.19 are unnecessary. Under those 
circumstances, elements of the work described above would not be 
required, and the total estimated cost of $34,200 would not be 
incurred. The Commission believes, for example, that Compliance 
Attorneys, Developers, and Senior Compliance Specialists could analyze 
best practices and determine that additional membership rules are not 
required after a combined 150 hours of work (50 hours of work for each 
professional role). The Commission estimates a total cost of $11,400 
for these efforts. This cost is broken down as follows: 2 Compliance 
Attorneys, working for a combined 50 hours (50 hours x $96 per hour = 
$4,800); 2 Developers, working for a combined 40 hours (50 hours x $75 
per hour = $3,750); and 2 Senior Compliance Specialists, working for a 
combined 50 hours (50 hours x $57 per hour = $2,850), for a total cost 
of $11,400.\649\
---------------------------------------------------------------------------

    \649\ In this regard, the Commission estimates that total costs 
for an RFA could range between $11,400 and $34,200 based on the 
amount of work invested before the RFA determined not to pursue 
additional membership rules pursuant to proposed Sec.  170.19.

---------------------------------------------------------------------------

[[Page 78902]]

vi. Sec.  170.19 Benefits--RFA Standards for Automated Trading and 
Algorithmic Trading Systems (RFAs)
    The Commission believes that proposed Sec.  170.19, by requiring 
RFAs to establish and maintain a program addressing the automated 
trading and algorithmic trading systems of its members, will help to 
advance the goals described in Sec.  170.19: Prevention of fraudulent 
and manipulative acts and practices, the protection of the public 
interest, and perfecting the mechanisms of trading on designated 
contract markets.
    RFAs serve a vital regulatory function as frontline regulators of 
their members, which would include all AT Persons pursuant to proposed 
Sec.  170.18. RFAs promulgate binding membership rules and can 
supplement Commission rules as appropriate. RFAs can also operate 
examination programs to monitor members' compliance with association 
rules, and can sanction members for non-compliance. The Commission 
believes that because RFAs have these and other tools at their 
disposal, RFAs are well-positioned to address rules in areas 
experiencing rapid evolution in market practices and technologies, 
including particularly Sec. Sec.  1.80, 1.81, and 1.82.
    The Commission believes that the structure of proposed Sec. Sec.  
1.80, 1.81, and 1.82 makes it particularly appropriate to give RFAs a 
discretionary role in augmenting the requirements of Regulation AT for 
AT Persons. Proposed Sec. Sec.  1.80, 1.81, and 1.82 address only a 
subset of potentially responsive risk controls and other measures. Each 
AT Person remains free to adopt additional safeguards reasonably 
designed to prevent an Algorithmic Trading Event given its trading 
strategies, technologies, or the markets in which it participates. The 
proposed rules also provide a degree of flexibility regarding the 
design, implementation, or calibration of those pre-trade risk control 
or other measures that are specifically required in Sec. Sec.  1.80, 
1.81, and 1.82, again allowing each AT Person to adapt the rules to its 
own trading and technology. Given the degree of flexibility embedded in 
these rules, RFAs will be well positioned to work with their member AT 
Persons to develop standards that are appropriate to each AT Person's 
specific trading approach and technology, and that best serve to 
promote the goals described in Sec.  170.19.
vii. Sec.  170.18 Costs--AT Person Membership in a Registered Futures 
Association (AT Persons)
    Proposed Sec.  170.18 requires each registrant that is an AT Person 
that is not otherwise required to be a member of an RFA pursuant to 
Sec. Sec.  170.15, 170.16, or 170.17 to become and remain a member of 
at least one RFA that provides for the membership of such registrant, 
unless no such futures association is so registered. Proposed Sec.  
170.18 would only affect those entities that are not required to become 
members of an RFA pursuant to Sec. Sec.  170.15, 170.16, or 170.17. 
Floor brokers and floor traders, who have historically been overseen by 
the DCMs on which they operate, are not required by Sec. Sec.  170.15, 
170.16, or 170.17 to become members of an RFA and would likely be the 
entities impacted by proposed regulation 170.18. The new membership 
requirements would require affected entities to pay initial and annual 
NFA membership dues.
    NFA charges each FCM registrant $5,625 in initial membership dues 
and $5,625 per year for continuing NFA membership where NFA is the SRO. 
The Commission estimates that membership dues for AT Person floor 
traders or floor brokers may also be $5,625, but that actual dues may 
be different than this. This is because while NFA will generally have 
more limited oversight responsibilities for AT Person floor traders and 
floor brokers, it may pass on the costs of proposed Sec.  170.19 to AT 
Person members in the form of higher dues.\650\ The Commission 
estimates that there will be approximately 100 entities that are AT 
Persons and will register as floor traders under the new registration 
requirements of Sec.  1.3(x)(3). It is likely that these 100 entities 
will be the only entities that will be required to become members of an 
RFA pursuant to proposed regulation 170.18. Accordingly, the Commission 
estimates that entities affected by proposed regulation 170.18 will 
incur a total initial cost of about $562,500 for NFA membership dues 
(about $5,625 in annual membership dues per registrant, paid each year 
by 100 registrants) and a total annual cost of about $562,500.
---------------------------------------------------------------------------

    \650\ Currently, while floor traders and floor brokers register 
with the NFA, they do not become NFA members, and, thus, do not pay 
membership dues.
---------------------------------------------------------------------------

    The Commission also preliminarily believes that the rule may impose 
certain compliance costs on affected entities. However, such costs 
should not be substantially different from or significantly exceed the 
costs associated with current Commission regulations and proposed 
Regulation AT generally. As discussed above, proposed Sec.  170.18 will 
likely only affect those floor traders that were required to register 
with the Commission pursuant to Sec.  1.3(x)(3). NFA, as the only 
currently registered RFA, has not to date promulgated any rules 
specific to floor traders or AT Persons. As a result, the only current 
NFA membership rules that these entities would be required to follow 
are those rules that are generally applicable to all NFA members. Many 
of these rules are general in nature and mirror current Commission 
regulations or those proposed in Regulation AT. Accordingly, these 
entities would not incur any additional general, ongoing compliance 
costs as a result of NFA membership.
viii. Sec.  170.18 Benefits--AT Person Membership in a Registered 
Futures Association (AT Persons)
    Because entities that are not members of an RFA are not bound by 
the rules of the RFA, the Commission is proposing Sec.  170.18 to 
ensure that all AT Persons (including newly registered floor traders) 
would become members of an RFA and would therefore be subject to any 
membership rules promulgated by such RFA. Regulation AT proposes to 
establish a role for RFAs in setting the framework in which AT Persons 
operate. Proposed Sec.  170.19, which is described in greater detail 
above, requires an RFA to adopt rules, as deemed appropriate by the 
RFA, requiring (i) pre-trade risk controls for ATSs; (ii) standards for 
the development, testing, monitoring and compliance of ATSs; (iii) 
designation and training of algorithmic trading staff; and (iv) 
operational risk management standards for clearing member FCMs with 
respect to customer orders originating with ATSs. The benefits of these 
risk controls and other measures are described in more detail 
throughout this section.\651\
---------------------------------------------------------------------------

    \651\ See, e.g., the discussion of benefits related to proposed 
Sec. Sec.  1.80, 1.81, and 1.82.
---------------------------------------------------------------------------

ix. Sec.  1.82 Costs--Pre-Trade and Other Risk Controls (FCMs)
    Based on Concept Release comments, best practices documents issued 
by industry or regulatory organizations, as well as existing 
regulations, the Commission believes that clearing member FCMs already 
implement the specifically-enumerated pre-trade and other risk controls 
required pursuant to proposed Sec.  1.82. Specifically, in its survey 
of FCMs, FIA found that all responding firms used message and execution 
throttles, maximum order sizes, price collars, and order

[[Page 78903]]

cancellation capabilities, including a kill switch, either administered 
internally or at the exchange level.\652\ FIA also indicated that most 
DCMs provide tools to allow the FCM to set pre-trade controls for their 
customers, which are a prerequisite for an FCM to provide direct access 
to a market participant without routing orders through the FCM's 
infrastructure.\653\ Two exchanges commented that their kill switch 
functionality allows clearing firms to cancel orders.\654\
---------------------------------------------------------------------------

    \652\ FIA at 60.
    \653\ FIA at 13. Two exchanges commented that they provide 
technology allowing clearing members to set maximum order size 
limits. See CME at 23-24; CFE at 11.
    \654\ CME at 23-24; CFE 11.
---------------------------------------------------------------------------

    The Commission notes that these types of controls have been subject 
of industry best practices for years. For example, FIA's Market Access 
Risk Management Recommendations from 2010 recommended, among other 
things, that a clearing firm providing direct access to a market should 
implement maximum quantity limits, price banding or dynamic price 
limits and exchange-provided order cancellation capabilities.\655\ The 
ESMA Guidelines from 2012 recommended that firms providing direct 
market access or sponsored access (as such terms are defined by ESMA) 
\656\ must, among other things, implement controls that limit messaging 
traffic and establish price and size parameters.\657\
---------------------------------------------------------------------------

    \655\ FIA Market Access Working Group, ``Market Access Risk 
Management Recommendations,'' (April 2010) at 8-10.
    \656\ ESMA defines direct market access as an investment firm's 
client transmitting orders to a trading platform using the 
investment firm's infrastructure, and sponsored access as a client 
transmitting orders directly to a trading platform without such 
orders passing through the investment firm's infrastructure. See 
ESMA Guidelines, supra note 61 at 4-5.
    \657\ See id. at 14-15, 21-23.
---------------------------------------------------------------------------

    Nevertheless, the Commission recognizes that there could be costs 
associated with implementation of the risk controls in Sec.  1.82. 
Specifically, for purposes of Direct Electronic Access (DEA), defined 
in proposed Sec.  1.3(yyyy), if clearing members do not already use 
DCM-provided systems, they will need to implement additional DCM-
provided systems. For non-DEA orders, clearing firms will need to 
internally develop such controls from scratch, upgrade existing 
systems, or purchase a risk management solution from an outside vendor. 
Each approach potentially has initial costs and annual ongoing costs, 
although the costs of upgrading and implementing the required systems 
would vary considerably based on current controls and procedures, as 
well as particular business models. For example, the needs of a 
clearing member will vary based on its current systems and controls in 
place, the comprehensiveness of its controls and procedures, the types 
of trading strategies its customers use, and the volume and speed of 
its customers' trading activity.
    Estimate-DEA Orders, Update to Controls. The Commission also 
estimated costs to a clearing member that already uses DCM-provided 
controls with respect to DEA orders and only needs to assess and update 
its implementation in order to ensure it fully complies with Sec.  
1.82. The Commission assumed that message handling already exists and 
little is needed to update the clearing member's systems in order to 
comply with Sec.  1.82. As noted above with respect to AT Persons and 
compliance with Sec.  1.80, the Commission believes that upgrading 
existing systems to comply with Sec.  1.82 would involve evaluating 
current risk control systems to determine compliance with new 
regulatory requirements; modifying existing code or creating new code 
to address gaps between current risk control systems and new regulatory 
requirements; and testing current systems and new code to verify 
correct operation and compliance. The Commission estimates that the 
cost for a clearing member to assess and update its implementation of 
controls required by Sec.  1.82 is $49,800. This cost is broken down as 
follows: 1 Project Manager, working for 200 hours (200 x $70 per hour = 
$14,000); 1 Business Analyst, working for 200 hours (200 x $52 per hour 
= $10,400); 1 Tester, working for 200 hours (200 x $52 per hour = 
$10,400); and 1 Developer, working for 200 hours (200 x $75 per hour = 
$15,000). The 57 clearing members that will be subject to Sec.  1.82 
would therefore incur a total one-time cost of $2,838,600 (57 x 
$49,800) to update their controls.\658\ The Commission estimates that 
if a clearing member already implements at least some of the DCM-
provided controls required by Sec.  1.82, there will be no additional 
annual costs to maintain the modifications required to bring the 
clearing member's systems into compliance with Sec.  1.82.
---------------------------------------------------------------------------

    \658\ See section V(A) above for the calculation of the number 
of persons subject to Regulation AT.
---------------------------------------------------------------------------

    Estimate-Non-DEA Orders, Update to Controls. The Commission also 
estimated costs to clearing members to comply with Sec.  1.82's 
requirements with respect to non-DEA orders assuming that the clearing 
member already has the pre-trade and other risk controls in place, and 
must only update the controls to ensure that they comply with the 
regulation. The Commission estimates that the cost for a clearing 
member to assess and update its implementation of such controls is 
$159,360. This cost is broken down as follows: 1 Project Manager, 
working for 640 hours (640 x $70 per hour = $44,800); 1 Business 
Analyst, working for 640 hours (640 x $52 per hour = $33,280); 1 
Tester, working for 640 hours (640 x $52 per hour = $33,280); and 1 
Developer, working for 640 hours (640 x $75 per hour = $48,000). The 57 
clearing members that will be subject to Sec.  1.82 would therefore 
incur a total one-time cost of $9,083,520 (57 x $159,360) to update 
their controls.\659\ The Commission estimates that if a clearing member 
already implements at least some of the DCM-provided controls required 
by Sec.  1.82, there will be no additional annual costs to maintain the 
modifications required to bring the clearing member's systems into 
compliance with Sec.  1.82.
---------------------------------------------------------------------------

    \659\ See section V(A) above for the calculation of the number 
of persons subject to Regulation AT.
---------------------------------------------------------------------------

    The Commission emphasizes that costs listed above are estimates, 
and it welcomes comment on their accuracy. The Commission further 
emphasizes that the costs for each clearing member will vary. Finally, 
the Commission notes that, as indicated above, these estimates may 
overstate the actual costs to the industry. Based on Concept Release 
comments, best practices issued by industry and regulatory 
organizations, as well as existing regulations, the Commission believes 
that clearing members are largely already using the pre-trade and other 
risk controls required by Sec.  1.82.
x. Sec.  1.82 Benefits--Pre-Trade and Other Risk Controls (FCMs)
    The Commission notes that many of the benefits discussed above with 
respect to pre-trade and other risk controls required of trading firms 
pursuant to Sec.  1.80 also apply with respect to the benefits of 
controls that FCMs must implement pursuant to proposed Sec.  1.82. 
Specifically, requiring such controls contributes to orderly markets by 
preventing orders that are outside of pre-determined parameters and 
ensuring a level-playing field among clearing members. The benefits 
also include allowing clearing members to have control over the trading 
flow of their customers, regardless of their customers' method of 
access--DEA or non-DEA.
    In addition, given that different entities have differing 
information about the trading activities of their customers/

[[Page 78904]]

users, identification of unintended market behavior may be easier for 
certain entity types, such as trading firms. For example, with respect 
to trading firms that mostly trade through a single clearing member, 
but across a disparate set of products, these metrics may be more 
easily calculated at the FCM than at the DCM. To protect against the 
broadest set of errors, there are benefits to implementing risk 
controls at multiple points in the order chain, including the FCM.
    As noted, the Commission believes that proposed Sec.  1.82 
standardizes existing industry practices in this area, and some of the 
requirements are already followed by the majority of clearing members. 
Accordingly, the Commission notes that many of the benefits of Sec.  
1.82 are already being realized. This proposed rule may serve to limit 
a ``race to the bottom'' in which some entities sacrifice effective 
risk controls in order to minimize costs or increase the speed of 
trading. Thus, the proposed rule would help ensure that the benefits of 
the required risk controls will be fully realized.
xi. Sec.  1.83 Costs--AT Persons and FCM Clearing Members Must Submit 
Compliance Reports and Maintain Certain Books and Records
    Proposed Sec.  1.83 would require AT Persons and FCMs that are 
clearing members for AT Persons to annually submit reports regarding 
compliance with Sec.  1.80(a) and Sec.  1.82(a)(1), respectively, to 
each DCM on which they operate. The reports prepared by AT Persons 
would have descriptions of the AT Person's pre-trade risk controls as 
required by proposed Sec.  1.80(a). The reports prepared by FCMs that 
are clearing members for AT Persons would have a description of the 
FCM's program for establishing and maintaining the pre-trade risk 
controls required by proposed Sec.  1.82(a)(1) for its AT Persons at 
the DCM. The reports would also be required to include a certification 
by the chief executive officer or chief compliance officer of the AT 
Person or clearing member FCM, as applicable, that, to the best of his 
or her knowledge and reasonable belief, the information contained in 
the report is accurate and complete.
    In addition, proposed Sec.  1.83(c) and (d) would require AT 
Persons and clearing member FCMs for AT Persons to keep and provide 
upon request to DCMs books and records regarding their compliance with 
Sec. Sec.  1.80 and 1.81 (for AT Persons) and Sec.  1.82 (for clearing 
member FCMs). The Commission is also proposing pursuant to Sec.  
40.22(d) that DCMs must require each AT Person to keep and provide to 
the DCM books and records regarding the AT Person's compliance with all 
Sec. Sec.  1.80 and 1.81 requirements, and each clearing member FCM to 
keep and provide to the DCM books and records regarding such clearing 
member FCM's compliance with all Sec.  1.82 requirements. The proposed 
recordkeeping requirements will cause AT Persons and clearing member 
FCMs to incur costs, as discussed below.
    AT Person Compliance Reports. AT Persons and FCMs that are clearing 
members of AT Persons will incur the cost of annually preparing and 
submitting the reports to their DCMs, as well as the written policies 
and procedures developed to comply with Sec.  1.81(a) and (c). The 
Commission estimates that an AT Person will incur a total annual cost 
of $4,240 to draft the report and submit the policies and procedures as 
required by Sec.  1.83(a). This cost is broken down as follows: 1 
Senior Compliance Specialist, working for 50 hours (50 x $57 per hour = 
$2,850) and 1 Chief Compliance Officer, working for 10 hours (10 x $139 
per hour = $1,390) for a total cost of $4,240 per year. The 
approximately 420 AT Persons to which Sec.  1.83(a) would apply would 
therefore incur a total annual cost of $1,780,800 (420 x $4,240) to 
prepare and submit the report and written policies and procedures 
required by Sec.  1.83(a).
    Clearing Member FCM Compliance Reports. The Commission further 
estimates that an FCM will incur a total cost annually of $7,090 to 
draft the report required by Sec.  1.83(b). This cost is broken down as 
follows: 1 Senior Compliance Specialist, working for 100 hours (100 x 
$57 per hour = $5,700) and 1 Chief Compliance Officer, working for 10 
hours (10 x $139 per hour = $1,390), for a total cost of $7,090 per 
year. The 57 FCMs to which Sec.  1.83(b) would apply would therefore 
incur a total annual cost of $404,130 (57 x $7,090) to prepare and 
submit the report required by Sec.  1.83(b).
    AT Person and Clearing Member FCM Retention of Books and Records. 
As discussed above, the Commission believes that AT Persons and 
clearing member FCMs already implement the risk controls, testing 
standards and other measures that would be required pursuant to 
Sec. Sec.  1.80, 1.81, and 1.82. Retention of records relating to such 
measures is prudent business practice and the Commission anticipates 
that many AT Persons and clearing member FCMs already maintain some 
form of these records in the ordinary course of their business. 
Accordingly, the Commission believes that AT Persons and clearing 
member FCMs will adapt their current infrastructure to accommodate new 
DCM rules relating to recordkeeping, and AT Persons and clearing member 
FCMs will not have substantial expenditures related to new 
recordkeeping technology or re-programming existing recordkeeping 
technology. The Commission expects that additional expenditure related 
to Sec.  1.83(c) and (d) recordkeeping requirements would be limited to 
the drafting and maintenance of recordkeeping policies and procedures 
by in-house counsel and programmer burden hours associated with 
recordkeeping technology improvements, as well as annual costs in 
ensuring that recordkeeping policies and procedures and related 
technology comply with DCM rules. As noted below, with respect to Sec.  
40.22(e), the Commission estimates that a DCM would find it necessary 
to review the books and records of approximately 10% of AT Persons and 
clearing member FCMs on an annual basis. The production of such records 
would result in additional burden hours by AT Person and clearing 
member FCM in-house counsel, a consideration which the Commission 
included in its annual cost estimates below.
    AT Person Recordkeeping Costs. The Commission estimates that, on an 
initial basis, an AT Person will incur a cost of $5,130 to draft and 
update recordkeeping policies and procedures and make technology 
improvements to recordkeeping infrastructure. This cost is broken down 
as follows: 1 Compliance Attorney, working for 30 hours (30 x $96 = 
$2,880); and 1 Developer, working for 30 hours (30 x $75 = $2,250). The 
420 AT Persons would therefore incur a total initial cost of $2,154,600 
(420 x $5,130).
    The Commission estimates that, on an annual basis, an AT Person 
will incur a cost of $2,670 to ensure continued compliance with DCM 
recordkeeping rules relating to Sec.  1.82 compliance, including the 
updating of policies and procedures and technology infrastructure, and 
in respond to DCM record requests. This cost is broken down as follows: 
1 Compliance Attorney, working for 20 hours (20 x $96 = $1,920); and 1 
Developer, working for 10 hours (10 x $75 = $750). The 420 AT Persons 
would therefore incur a total annual cost of $1,121,400 (420 x $2,670).
    Clearing Member FCM Recordkeeping Costs. The Commission estimates 
that, on an initial basis, a clearing member FCM will incur a cost of 
$5,130 to draft and update recordkeeping policies and procedures and 
make technology improvements to recordkeeping

[[Page 78905]]

infrastructure. This cost is broken down as follows: 1 Compliance 
Attorney, working for 30 hours (30 x $96 = $2,880); and 1 Developer, 
working for 30 hours (30 x $75 = $2,250). The 57 clearing member FCMs 
would therefore incur a total initial cost of $292,410 (57 x $5,130).
    The Commission estimates that that DCM rules pursuant to proposed 
Sec.  40.22(d) requiring clearing member FCMs to keep and provide books 
and records relating to Sec.  1.82 compliance will result in annual 
costs of 30 hours of burden per clearing member FCM, and 1,710 burden 
hours in total. The estimated burden was calculated as follows:
    The Commission estimates that, on an annual basis, a clearing 
member FCM will incur a cost of $2,670 to ensure continued compliance 
with DCM recordkeeping rules relating to Sec.  1.82 compliance, 
including the updating of policies and procedures and technology 
infrastructure, and in respond to DCM record requests. This cost is 
broken down as follows: 1 Compliance Attorney, working for 20 hours (20 
x $96 = $1,920); and 1 Developer, working for 10 hours (10 x $75 = 
$750). The 57 clearing member FCMs would therefore incur a total annual 
cost of $152,190 (57 x $2,670).
    As discussed further in the consideration of Sec.  15(a) factors 
below, the Commission also acknowledges that the compliance 
requirements of Regulation AT could have adverse effects on small 
clearing firms. Any compliance costs that go beyond existing industry 
practice could potentially cause some FCMs to scale back operation. 
Thus the rule has some potential to contribute to increased 
concentration among clearing firms, i.e., fewer competing clearing 
firms.
    The Commission emphasizes that costs listed above are estimates, 
and it welcomes comment on their accuracy. The Commission further 
emphasizes that the costs for each AT Person and each FCM will vary.
xii. Sec.  1.83 Benefits--AT Persons and FCM Clearing Members Must 
Submit Compliance Reports and Maintain Certain Books and Records
    Proposed Sec.  1.83 would require AT Persons and FCMs that are 
clearing members for AT Persons to annually submit reports regarding 
compliance with Sec.  1.80(a) and Sec.  1.82(a)(1), respectively, to 
each DCM on which they operate. Proposed Sec.  1.83(c) and (d) would 
require AT Persons and clearing member FCMs, respectively, to keep and 
provide upon request to DCMs books and records regarding their 
compliance with Sec. Sec.  1.80 and 1.81 (for AT Persons) and Sec.  
1.82 (for clearing member FCMs). The reports and recordkeeping proposed 
by Sec.  1.83, and the review program proposed by Sec.  40.22, will 
enable DCMs to have a clearer understanding of the pre-trade risk 
controls of all AT Persons that are engaged in Algorithmic Trading on 
such DCM. The proposed reports will also enable DCMs to set up the 
review program required by Sec.  40.22. The review program would 
improve the standardization of market participants' pre-trade risk 
controls. The standardization of such systems and procedures should 
further reduce the risk that a market participant will engage in 
disorderly trading due to inadequate pre-trade risk controls.
xiii. Sec.  38.255(b) and (c) Costs--DCMs Must Provide Controls to FCMs
    As noted above with respect to proposed Sec.  1.82, based on 
Concept Release comments, best practices documents issued by industry 
or regulatory organizations, as well as existing regulations, the 
Commission believes that most DCMs already have established the 
specifically-enumerated pre-trade and other risk controls for use by 
clearing members that would be required pursuant to revised Sec.  
38.255. The Commission also notes that existing Sec.  38.607 requires 
that DCMs that permit direct electronic access must have in place 
effective systems and controls reasonably designed to facilitate an 
FCM's management of financial risk, such as automated pre-trade 
controls that enable member FCMs to implement appropriate financial 
risk limits. Accordingly, even if DCMs do not currently and voluntarily 
implement the specific controls addressing the risks of Algorithmic 
Trading proposed under Sec.  38.255(b), they should already have in 
place similar systems addressing FCMs' management of financial risk 
pursuant to existing Sec.  38.607.
    Estimate-Upgrade of Controls. With respect to a DCM that already 
has the controls required by Sec.  38.255(b) in place, and only needs 
to update them to meet regulatory requirements (i.e., evaluate current 
systems, modify or create new code, and test systems), the Commission 
estimates that the cost to the DCM would be $155,520. This cost is 
broken down as follows: 1 Project Manager, working for 480 hours (480 x 
$70 per hour = $33,600); 1 Business Analyst, working for 480 hours (480 
x $52 per hour = $24,960); 1 Tester, working for 480 hours (480 x $52 
per hour = $24,960); and 2 Developers, working for a combined 960 hours 
(960 x $75 per hour = $72,000). Commission staff estimates that if a 
DCM already has at least some of the controls required by Sec.  
38.255(b), there will be no additional annual costs to maintain the 
modifications required to bring the systems into compliance with this 
regulation.
    Accordingly, the Commission estimates that the 15 DCMs that will be 
subject to Sec.  38.255(b) would therefore incur a total one-time cost 
of $2,332,800 (15 x $155,520) to update their controls.
    The Commission believes that the above estimates would change if a 
DCM must upgrade its systems in order to comply with Sec.  40.20 
(discussed below). Under such circumstances, where the DCM is already 
upgrading controls for its own implementation pursuant to Sec.  40.20, 
total cost to upgrade controls for use by FCMs pursuant to Sec.  38.255 
should decrease. The controls required by Sec.  40.20 should include 
interfaces to support external interactions and expanding them to 
support FCMs should not have additional costs.
    The Commission emphasizes that costs listed above are estimates, 
and it welcomes comment on their accuracy. The Commission further 
emphasizes that the costs for each DCM will vary. Finally, the 
Commission notes that, as indicated above, these estimates may 
overstate the actual costs to DCMs. Based on Concept Release comments, 
best practices issued by industry and regulatory organizations, as well 
as existing regulations, the Commission believes that DCMs have largely 
already established and are providing to FCMs the pre-trade and other 
risk controls required by Sec.  38.255(b).
xiv. Sec.  38.255(b) and (c) Benefits--DCMs Must Provide Controls in 
DEA Context
    An additional benefit to Regulation AT is the reduction of system 
risk in the context of Direct Electronic Access. As noted above, the 
Commission believes that Algorithmic Trading creates risks regardless 
of the method of access. Because of this, the Commission seeks to 
ensure that all types of trading, including through DEA, is subject to 
pre-trade and other risk controls. The requirements of proposed Sec.  
38.255(b) specifically address the structure of DEA, in which orders 
submitted by an AT Person do not flow through the clearing member FCM's 
infrastructure prior to submission to the DCM. Currently, credit risk 
in the DEA context is addressed through clearing member FCM-implemented 
controls provided by the DCM, as required pursuant to existing 
regulations Sec. Sec.  38.607 and 1.73. Proposed Sec.  38.255(b) and 
(c) follow a similar approach that would allow clearing members to have 
control over the trading flow of their DEA customers

[[Page 78906]]

for purposes of addressing the operational risks of Algorithmic 
Trading. Accordingly, Sec.  38.255(b) would contribute to orderly 
markets by preventing orders that are outside of pre-determined 
parameters and ensuring a level-playing field among clearing members.
    As noted, the Commission believes that proposed regulations Sec.  
38.255(b) and (c) standardize existing industry practices in this area, 
and that many of the requirements are already followed by the majority 
of DCMs. Accordingly, the Commission notes that many of the benefits of 
Sec.  38.255(b) and (c) are already being realized. The proposed rule 
would help ensure that the benefits of the required risk controls will 
be fully realized across all DEA active participants and sustained in 
the future.
xv. Sec.  40.20 Costs--Pre-Trade and Other Risk Controls (DCMs)
    Based on Concept Release comments, best practices documents issued 
by industry or regulatory organizations, as well as existing 
regulations, the Commission believes that most DCMs already implement 
the specifically-enumerated pre-trade and other risk controls required 
pursuant to proposed Sec.  40.20. In response to the Concept Release, 
CME and CFE indicated that they implement message rate limits,\660\ 
order size limits, and price collar mechanisms.\661\ In addition, they 
indicated that they provide an optional cancel-on-disconnect 
functionality \662\ and kill switch tools.\663\ The Commission notes 
that these types of controls have been subject of industry best 
practices for years. For example, ESMA guidelines from 2012 recommended 
that trading platforms implement, among other things, throttling limits 
and controls filtering order price and quantity.\664\ In addition, the 
CFTC TAC recommended in 2011 that exchanges implement, among other 
things, message throttles, order quantity limits, price collars, and 
order cancellation policies that allow clearing firms and clients to 
opt for automatic cancellation of order upon disconnect and provide 
clearing firms with a tool that allows them to view and cancel 
orders.\665\
---------------------------------------------------------------------------

    \660\ In addition, four commenters stated generally that many 
exchanges have messaging rate limits in place. See TCL at 6; KCG at 
4; MFA at 7; AIMA at 8.
    \661\ CME at 8-9, 13-17; CME Appendix A-1, 3-4, 6; CFE at 5-8.
    \662\ CME at 23-24, Appendix A-4; CFE at 9-10.
    \663\ CME at 23-24.
    \664\ ESMA Guidelines, supra note 61 at 12-13.
    \665\ CFTC TAC Recommendations, supra note 34 at 4-5.
---------------------------------------------------------------------------

    While the Commission believes that most DCMs already implement the 
controls required by Sec.  40.20, it acknowledges that there may be 
DCMs that do not currently implement such controls, and those DCMs 
would incur some costs to comply with this regulation. An initial 
investment would be required to develop and implement processes 
necessary for compliance, and ongoing costs would be incurred to 
maintain such controls. The costs for each DCM will vary depending on 
the degree to which its current practices are or are not in compliance, 
as well as the procedures it selects and implements in order to comply. 
In addition, as noted above with respect to Sec.  38.255(b) and (c), 
the Commission acknowledges that Regulation AT could have adverse 
effects on smaller DCMs. Any compliance costs that go beyond existing 
industry practice could potentially cause some DCMs to cease or scale 
back operation, and could potentially impact the entry of new DCMs.
    Estimate--Upgrade of Controls. With respect to a DCM that already 
has the controls required by proposed Sec.  40.20 in place, and only 
needs to update them to meet regulatory requirements (i.e., evaluate 
current systems, modify or create new code, and test systems), the 
Commission estimates that the cost to the DCM would be $155,520. This 
cost is broken down as follows: 1 Project Manager, working for 480 
hours (480 x $70 per hour = $33,600); 1 Business Analyst, working for 
480 hours (480 x $52 per hour = $24,960); 1 Tester, working for 480 
hours (480 x $52 per hour = $24,960); and 2 Developers, working for a 
combined 960 hours (960 x $75 per hour = $72,000). The Commission 
estimates that if a DCM already has at least some of the controls 
required by Sec.  40.20, there will be no additional annual costs to 
maintain the modifications required to bring the systems into 
compliance with this regulation.
    Accordingly, the Commission estimates that the 15 DCMs that will be 
subject to Sec.  40.20 would therefore incur a total one-time cost of 
$2,332,800 (15 x $155,520) to update their controls.
    The Commission notes that a DCM can choose not to develop these 
controls internally, but rather may purchase a solution from an outside 
vendor (or another DCM) in order to comply with Sec.  40.20. The 
Commission welcomes comments providing estimates concerning the cost 
for a DCM to use technology solution from an outside party to comply 
with this proposed regulation. In addition, as discussed above, the 
Commission believes that the above estimates for Sec.  40.20 would 
change if a DCM is simultaneously upgrading its systems in order to 
comply with Sec.  38.255. Where the DCM is already upgrading controls 
for FCM implementation pursuant to Sec.  38.255, the cost of upgrading 
controls for its own implementation pursuant to Sec.  40.20 should 
decrease.
    The Commission emphasizes that costs listed above are estimates, 
and it welcomes comment on their accuracy. The Commission further 
emphasizes that the costs for each DCM will vary. Finally, the 
Commission notes that, as indicated above, these estimates may 
overstate the actual costs to DCMs. Based on Concept Release comments, 
best practices issued by industry and regulatory organizations, as well 
as existing regulations, the Commission believes that DCMs are largely 
already using the pre-trade and other risk controls required by Sec.  
40.20.
xvi. Sec.  40.20 Benefits--Pre-Trade and Other Risk Controls (DCMs)
    The Commission believes that the pre-trade risk and order 
management control requirements that DCMs must implement pursuant to 
proposed Sec.  40.20, inasmuch as they are not currently implemented, 
will contribute to a system-wide reduction in operational risk, and 
will help standardize risk management practices across exchanges. These 
enhanced risk management practices should help reduce unintended market 
volatility and mitigate and prevent significant disruptive activity 
caused by algorithmic trading malfunctions.
    In addition, given that FCMs may have differing information about 
the trading activities of their customers/users, a DCM may be better 
able to identify unintended market behavior. For example, with respect 
to a trading firm active in a single product and using multiple 
clearing firms, identifying total order frequencies or inventory levels 
may be more easily done at the market venue. To protect against the 
broadest set of errors, there are benefits to implementing risk 
controls at multiple points in the order chain, including the DCM.
    As noted, the Commission believes that proposed Sec.  40.20 
standardizes existing industry practices in this area, and that many of 
the requirements are already followed by the majority of DCMs. 
Accordingly, the Commission notes that many of the benefits of Sec.  
40.20 are already being realized. The proposed rule would help ensure 
that the benefits of the required risk controls will be fully realized 
and sustained in the future.

[[Page 78907]]

xvii. Sec.  40.21 Costs--DCM Test Environments for AT Persons (DCMs)
    The Commission believes that the majority of DCMs have implemented 
test environments in which market participants may test their 
algorithmic systems. The Commission received comments in response to 
the Concept Release that ``many, if not all, exchanges provide market 
participants a test facility to test trading software and algorithms, 
as well as offer test symbols to trade.'' \666\ The Commission believes 
that most if not all DCM's already provide test environments that would 
comply with proposed Sec.  40.21. As a result, subject to consideration 
of relevant comments, the Commission preliminarily believes that DCMs 
will not incur any material additional costs to comply with the 
proposed regulation. The Commission is therefore not estimating any 
costs for DCMs in connection with the proposed regulation in this 
discussion.
---------------------------------------------------------------------------

    \666\ MFA at 13.
---------------------------------------------------------------------------

xviii. Sec.  40.21 Benefits--DCM Test Environments for AT Persons 
(DCMs)
    As noted, the Commission believes that proposed Sec.  40.21 
standardizes existing industry practices in this area, and that the 
requirements are already followed by the majority of DCMs. Accordingly, 
the Commission notes that many of the benefits of Sec.  40.21 are 
already being realized. The proposed rule will help ensure that the 
benefits are being realized at all DCMs and sustained in the future. 
Proposed Sec.  40.21 requires DCMs to provide test environments in 
which market participants may test their algorithmic systems. This 
regulation is designed to promote testing of algorithmic systems using 
data and market conditions that approximate as closely as possible 
those of a live trading environment. Such testing should enable market 
participants to discover potential issues in the design of their 
algorithmic systems that were not discovered in their own test 
environment, thereby mitigating the risk that algorithmic systems cause 
market disruptions by failing to operate as intended in the production 
environment. Comments received in response to the Concept Release 
indicate that DCMs recognize the benefit of providing such test 
environments to their market participants. For example, CME indicated 
that market participants routinely test in their own testing 
environments using historical data to test trading strategies against a 
range of market conditions, and that exchanges commonly make their own 
historical data available for testing purposes. CME stated that it 
requires all systems interfacing with CME Globex to be certified on the 
order entry and/or market data interfaces prior to deployment.\667\ FIA 
also recommended the use of DCM test environments, noting in its 
comment letter, ``We encourage DCMs to develop more robust test 
environments that more closely simulate trading in the production 
environment, and market participants to thoroughly test new and 
modified software in these DCM provided simulators when necessary.'' 
\668\
---------------------------------------------------------------------------

    \667\ CME at 25-26.
    \668\ FIA at 35.
---------------------------------------------------------------------------

xix. Sec.  40.22 Costs--DCM Review of Compliance Reports (DCMs)
    Proposed Sec.  40.22 complements the requirement under Sec.  1.83 
for AT Persons and clearing member FCMs to submit compliance reports to 
DCMs. Proposed 40.22(a) requires a DCM to implement rules that require 
each AT Person that trades on the DCM, and each FCM that is a clearing 
member of a DCO for such AT Person, to submit the reports described in 
Sec.  1.83(a) and (b), respectively. Under proposed Sec.  40.22(b), a 
DCM must require the submission of such reports by June 30th of each 
year. Proposed Sec.  40.22(c) requires a DCM to establish a program for 
effective periodic review and evaluation of reports described in 
paragraph (a) of Sec.  40.22, and of the measures described therein. An 
effective program must include measures by the DCM reasonably designed 
to identify and remediate any insufficient mechanisms, policies and 
procedures described in such reports, including identification and 
remediation of any inadequate quantitative settings or calibrations of 
pre-trade risk controls required of AT Persons pursuant to Sec.  
1.80(a).
    In addition, as a complement to the compliance report review 
program described above, proposed Sec.  40.22(d) requires each AT 
Person to keep and provide to the DCM books and records regarding their 
compliance with all requirements pursuant to Sec.  1.80 and Sec.  1.81, 
and requires each clearing member FCM to keep and provide to the DCM 
market books and records regarding their compliance with all 
requirements pursuant to Sec.  1.82. Finally, proposed Sec.  40.22(e) 
requires DCMs to review and evaluate, as necessary, books and records 
required to be kept pursuant to Sec.  40.22(d), and the measures 
described therein. An appropriate review pursuant to Sec.  40.22(e) 
should include measures by the DCM reasonably designed to identify and 
remediate any insufficient mechanisms, policies, and procedures 
described in such books and records.
    DCM Establishment of Review Program. The Commission estimates that 
a DCM will incur a total one-time cost of $37,000 to establish the 
review program required by proposed Sec.  40.22. This cost is broken 
down as follows: 1 Tester, working for 200 hours (200 x $52 per hour = 
$10,400); 1 Developer, working for 200 hours (200 x $75 per hour = 
$15,000); and 1 Senior Compliance Examiner, working for 200 hours (200 
x $58 per hour = $11,600).\669\ The 15 DCMs to which Sec.  40.22 would 
apply would therefore incur a total one-time cost of $555,000 (15 x 
37,000) to establish the review program required by Sec.  40.22.\670\
---------------------------------------------------------------------------

    \669\ See section V(B) above for the calculation of hourly wage 
rates used in this analysis.
    \670\ See section V(A) above for the calculation of the number 
of persons subject to Regulation AT.
---------------------------------------------------------------------------

    DCM Review of Compliance Reports (Sec.  40.22(c)). Proposed Sec.  
40.22(a) and (b) would require DCMs to implement rules that require AT 
Persons, and FCMs that are clearing members for AT Persons, to submit 
the reports required of AT Persons and clearing member FCMs by proposed 
Sec.  1.83. Proposed Sec.  40.22(c) requires a DCM to establish a 
program for effective periodic review and evaluation of reports 
described in paragraph (a) of Sec.  40.22, and of the measures 
described therein. As discussed in section V(D)(e) above, Commission 
staff estimates that each DCM will review 120 reports per year pursuant 
to Sec.  40.22(c). The Commission estimates that a DCM will incur a 
total cost of $925 to review each report required by Sec.  40.22. This 
cost is broken down as follows: 1 Tester, working for 5 hours (5 x $52 
per hour = $260); 1 Developer, working for 5 hours (5 x $75 per hour = 
$375); and 1 Senior Compliance Examiner, working for 5 hours (5 x $58 
per hour = $290), for a total review cost of $925 per report. If a DCM 
reviews an average of 120 reports per year, a DCM would require 1,800 
hours per year to review the 120 reports (15 hours x 120 reports), and 
would incur a cost of $111,000 per year. The 15 DCMs to which Sec.  
40.22 would apply would incur a total annual cost of $1,665,000 (15 x 
$111,000) to conduct such a review.
    DCM Communication of Remediation Instructions (Sec.  40.22(c)). 
Proposed Sec.  40.22(c) states that an effective review program must 
include measures by the DCM reasonably designed to identify and 
remediate any insufficient mechanisms, policies and procedures

[[Page 78908]]

described in such reports, including identification and remediation of 
any inadequate quantitative settings or calibrations of pre-trade risk 
controls required of AT Persons pursuant to proposed Sec.  1.80(a). The 
Commission estimates that a DCM will communicate remediation 
instructions in connection with approximately 20% of the reports 
reviewed on an annual basis (or 24 reports, which is 20% of 120 
reports). The Commission estimates that a DCM will incur a total cost 
of $925 to communicate remediation instructions for a report required 
by Sec.  40.22. This cost is broken down as follows: 1 Tester, working 
for 5 hours (5 x $52 per hour = $260); 1 Developer, working for 5 hours 
(5 x $75 per hour = $375); and 1 Senior Compliance Examiner, working 
for 5 hours (5 x $58 per hour = $290), for a total review cost of $925 
per report giving rise to remediation instructions. If a DCM provides 
remediation instructions in connection with 24 reports per year, a DCM 
would require 360 hours per year to review the 24 reports (15 hours x 
24 reports), and would incur a cost of $22,200 per year. The 15 DCMs to 
which Sec.  40.22(c) would apply would incur a total annual cost of 
$333,000 (15 x $22,200) to conduct such a review.
    DCM Review of Books and Records (Sec.  40.22(e)). Proposed Sec.  
40.22(d) requires each AT Person to keep and provide to the DCM books 
and records regarding their compliance with all requirements pursuant 
to Sec. Sec.  1.80 and 1.81, and requires each clearing member FCM to 
keep and provide to the DCM market books and records regarding their 
compliance with all requirements pursuant to Sec.  1.82. The cost of 
these obligations to AT Persons and clearing member FCMs under Sec.  
40.22(d) is discussed above in this section.
    Proposed Sec.  40.22(e) requires DCMs to review and evaluate, as 
necessary, books and records required to be kept pursuant to Sec.  
40.22(d), and the measures described therein. The Commission notes that 
Sec.  40.22(e) does not prescribe how frequently DCMs should perform 
this review, or how many AT Persons and clearing member FCMs should be 
evaluated on an annual basis. For purposes of generating a cost 
estimate, the Commission anticipates that a DCM will find it necessary 
to review the books and records of approximately 10% of AT Persons and 
clearing member FCMs on an annual basis. For example, a DCM may find it 
necessary to conduct such a review if: it becomes aware if an AT 
Person's kill switch is frequently activated, or otherwise performs in 
an unusual manner; if a DCM becomes aware that an AT Person's algorithm 
frequently performs in a manner inconsistent with its design, which may 
raise questions about the design or monitoring of the AT Person's 
algorithms; if a DCM identifies frequent trade practice violations at 
an AT Person, which are related to an algorithm of the AT Person; or if 
an AT Person represents significant volume in a particular product, 
thereby requiring heightened scrutiny, among other reasons. DCMs may 
find it appropriate to review the books and records of AT Persons and 
clearing member FCMs on a more or less frequent basis, depending on 
other relevant considerations.
    The Commission estimates that AT Persons will generally be active 
on half of the 15 DCMs. If a DCM reviews the books and records of 10% 
of AT Persons and clearing member FCMs on an annual basis, a DCM will 
review 24 entities on an annual basis (420 AT Persons + 57 clearing 
member FCMs = 477. 477/2 = 239 entities. 239 x .1 = 24). The Commission 
estimates that a DCM will incur a total cost of $4,620 to review the 
books and records of an entity pursuant to Sec.  40.22(e). This cost is 
broken down as follows: 1 Senior Compliance Examiner, working for 30 
hours (30 x $58 per hour = $1,740); and 1 Compliance Attorney, working 
for 30 hours (5 x $96 per hour = $2,880), for a total review cost of 
$4,620 per entity reviewed by a DCM. If a DCM reviews the books and 
records of 24 entities per year, a DCM would require 1,440 hours per 
year to review the 24 entities (60 hours x 24 entities), and would 
incur a cost of $110,880 per year. The 15 DCMs to which Sec.  40.22(e) 
would apply would incur a total annual cost of $1,663,200 (15 x 
$110,880) to review such books and records.
    Total Cost to DCMs for Proposed Sec.  40.22 Requirements. A DCM 
will therefore incur $133,200 ($111,000 + $22,200) on an annual basis 
to review all reports received at least once every two years, 
communicate instructions to persons whose controls the DCM has 
determined are insufficient, and will incur $110,880 on an annual basis 
to review the books and records of 24 AT Persons and clearing member 
FCMs. The 15 DCMs to which Sec.  40.22 would apply would therefore 
incur a total annual cost of $3,661,200 ($1,665,000 + $333,000 + 
$1,663,200) to maintain the review program required by Sec.  40.22.
    The Commission also acknowledges that the compliance requirements 
on DCMs in Regulation AT could have adverse effects on smaller DCMs. 
Any compliance costs that go beyond existing industry practice could 
potentially cause some DCMs to cease or scale back operation, and 
impact the entry of new DCMs.
xx. Sec.  40.22 Benefits--DCM Review of Compliance Reports (DCMs)
    Proposed Sec.  40.22 is a complement to proposed Sec.  1.83, which 
would require AT Persons, and FCMs that are clearing members for AT 
Persons, to submit reports regarding compliance with Sec.  1.80(a) and 
pursuant to Sec.  1.82(a)(1), respectively, to each DCM on which they 
operate, and to keep and provide upon request to DCMs books and records 
regarding their compliance with all Sec. Sec.  1.80 and 1.81 (for AT 
Persons) and Sec.  1.82 (for clearing member FCMs) requirements. New 
Sec.  40.22 would require each DCM that receives a report described in 
Sec.  1.83 to establish a program for effective review and evaluation 
of the reports. By requiring DCMs to review the reports, identify 
outliers, and communicate instructions to outliers in order to 
remediate their pre-trade risk controls, proposed Sec.  40.22 will 
standardize market participants' pre-trade risk controls required 
pursuant to proposed Sec.  1.80(a). Further, DCM review of compliance 
reports is an important safeguard to prevent trading firms, the 
``outliers'' described above, from operating without sufficient 
controls. Proposed Sec.  40.22(e) will complement the review of 
compliance reports, by requiring DCMs to review and evaluate, as 
necessary, the books and records kept by AT Persons to demonstrate 
their compliance with Sec. Sec.  1.80 and 1.81, and the books and 
records kept by clearing member FCMs to demonstrate their compliance 
with Sec.  1.82. A single Algorithmic Trading malfunction at a single 
market participant can significantly impact markets and market 
participants. Accordingly, all DCMs and market participants benefit 
from a review program that ensures that market participants conducting 
Algorithmic Trading have adequate pre-trade risk controls in place.
c. Section 15(a) Factors
    This section discusses the CEA section 15(a) factors for the 
following proposed regulations: (i) The requirement that AT Persons 
implement pre-trade risk controls and other related measures (Sec.  
1.80); (ii) standards for the development, testing, and monitoring of 
Algorithmic Trading systems by AT Persons (Sec.  1.81); (iii) RFA 
standards for automated trading and algorithmic trading systems of 
their members (Sec.  170.19); (iv) the requirement that AT Persons must 
become a member of a futures association (Sec.  170.18); (v) the 
requirement that clearing member FCMs

[[Page 78909]]

implement pre-trade risk controls and other related measures (Sec.  
1.82); (vi) the requirement that AT Persons submit compliance reports 
to DCMs regarding their risk controls and Algorithmic Trading 
procedures and clearing member FCMs submit compliance reports to DCMs 
regarding their risk control program for AT Person customers, and that 
AT Persons and clearing member FCMs keep and provide upon request to 
DCMs certain related books and records (Sec.  1.83); (vii) the 
requirement that DCMs implement pre-trade risk controls and other 
related measures (Sec. Sec.  38.255 and 40.20); (viii) the requirement 
that DCMs provide test environments where AT Persons may test their 
Algorithmic Trading systems (Sec.  40.21); and (ix) the requirements of 
Sec.  40.22, including that DCMs: implement rules requiring AT Persons 
and clearing member FCMs to submit compliance reports each year (Sec.  
40.22(a) and (b)); establish a program for effective periodic review 
and evaluation of the reports (Sec.  40.22(c)); require each AT Person 
to keep and provide to the DCM books and records regarding their 
compliance with all requirements pursuant to Sec. Sec.  1.80 and 1.81, 
and require each clearing member FCM to keep and provide to the DCM 
market books and records regarding their compliance with all 
requirements pursuant to Sec.  1.82 (Sec.  40.22(d)); and require DCMs 
to review and evaluate, as necessary, books and records required to be 
kept pursuant to Sec.  40.22(d), and the measures described therein 
(Sec.  40.22(e)).
i. Protection of Market Participants and the Public
    The Commission preliminarily believes that Regulation AT would 
protect market participants and the public by limiting a ``race to the 
bottom,'' in which certain entities sacrifice effective risk controls 
in order to minimize costs or increase the speed of trading. The 
proposed rules, by standardizing the risk controls required to be used 
by firms, would help ensure that the benefits of these risk controls 
are more evenly distributed across a wide set of market participants, 
and reduce the likelihood that an outlier firm without sufficient risk 
controls causes significant market disruption. The requirements under 
proposed Sec. Sec.  170.18 and 170.19 that all AT Persons be registered 
as a member of a futures association, and subject to an RFA program 
promulgating standards for automated trading and algorithmic trading 
systems, further promotes the standardization of risk controls. 
Moreover, the proposed rules, to the extent that they increase the 
usage of effective risk and order management controls, may reduce the 
likelihood that market participants execute trades at terms they do not 
intend. This is particularly important as to price, as market 
participants and members of the public rely on the prices of trades 
executed on DCMs, often for products not directly traded on the DCM. 
The requirements of proposed Sec.  40.22, which requires DCMs to review 
the compliance reports and the books and records of AT Persons and 
clearing member FCMs, may promote protection of market participants and 
the public by helping to ensure that the risk control rules are 
followed in a consistent manner and may further reduce the likelihood 
of Algorithmic Trading Events and Algorithmic Trading Disruptions. 
Applying Regulation AT to all market levels--the trading firm, the 
clearing member, and the exchange--may further protect market 
participants and the public by providing multiple layers of protection 
against market disruptions. In addition, including automated order 
routers in the Algorithmic Trading definition may protect market 
participants and the public by providing these protections to a wider 
set of automated systems that may have the potential to disrupt the 
markets.
    Finally, the absence of pre-trade risk and order management 
controls at automated firms increases the chances for unintended 
trading behavior, including algorithms acting beyond their parameters 
or risk levels, resulting in unexpected market volatility or market 
disruptions (potentially across multiple market venues), distorted 
prices, and risks that could harm the economy and the public.
ii. Efficiency, Competitiveness, and Financial Integrity of Futures 
Markets
    The Commission preliminarily believes that by addressing pre-trade 
risk controls, testing, and order management controls at all market 
levels--the trading firm, the clearing member, and the exchange--
Regulation AT provides standards that can be interpreted and enforced 
in a uniform manner. Implementation of Regulation AT would help 
mitigate instabilities in the markets and ensure market efficiency and 
integrity. Regulation AT may serve to limit a ``race to the bottom,'' 
in which certain entities sacrifice effective risk controls in order to 
minimize costs or increase the speed of trading. The proposed rules, by 
standardizing the risk controls required to be used by firms, would 
help ensure that the benefits of these risk controls are more evenly 
distributed across a wide set of market participants, and reduce the 
likelihood that an outlier firm without sufficient risk controls causes 
significant market disruption.
    In particular, the implementation of such controls and systems 
would help prevent the occurrence of unintended and erroneous trades, 
and therefore contribute to market efficiency and integrity. For 
example, Regulation AT requires that trading firms, clearing members 
and exchanges implement maximum order size limits. That control is 
intended to prevent unintentionally large orders from entering the 
market and causing unintended executions. The Commission believes that 
a positive trading intention behind an execution is integral to the 
operations of an efficient market and to market integrity. By limiting 
the potential for erroneous executions, Regulation AT should enhance 
market efficiency and integrity by minimizing the number of trades that 
are subsequently broken and ensuring that publicly reported transaction 
prices are valid. Similarly, Regulation AT requires message and 
execution throttles, which mitigate the risks of executing large 
numbers of unintended orders, potentially harming market efficiency and 
integrity. Ensuring that only bona fide and intentional orders are 
entered into the market may also help promote market competitiveness by 
helping to ensure that a single entity does not inadvertently dominate 
the market due to unintended excessive orders.
    The Commission acknowledges that certain aspects of Regulation AT, 
such as the compliance reports, could have adverse effects on some 
trading firms due to the cost of creating and submitting the compliance 
reports, and to the extent that firms do not already do so, 
implementing and maintaining the proposed regulation's required pre-
trade risk and order management controls. In order to mitigate costs to 
trading firms, the Commission is restricting the need for trading firm 
level risk controls and the associated compliance reports to those 
entities that are registered with the Commission in some capacity. For 
those who are not required to register, pre-trade risk controls will be 
executed by the entity's clearing firm and the contract market the 
entity trades on and compliance reports will be submitted by the 
clearing FCM.
    According to a study by the Commission's Division of Swap Dealer 
and Intermediary Oversight that was presented to the Commission's 
Agricultural Advisory Committee on

[[Page 78910]]

September 22, 2015,\671\ the number of active FCMs has declined in 
recent years from 180 in 2005 to 76 in December 2014. The decline over 
this period in the number of FCMs holding customer assets was not as 
large as the overall decline in the number of FCMs: from 85 to 60. The 
decline in the number of FCMs can be attributed to a number of factors, 
including low interest rates (which can reduce FCM profitability by 
lowering the rate of return on the investment of customer funds) and 
the changing regulatory environment. The compliance and other costs on 
clearing FCMs that go beyond existing industry practice could, in 
conjunction with existing factors that are pressuring FCMs, potentially 
cause some additional FCMs to scale back operations, or make it less 
likely that new FCMs will enter the market. The Commission also notes 
the possibility that if clearing FCMs are required to establish and 
maintain pre-trade risk controls and order cancellation systems 
pursuant to Sec.  1.82(c) with respect to AT Order Messages originating 
with AT Persons that do not use DEA and to submit compliance reports 
regarding their risk controls, they may refuse to serve such firms in 
light of the additional costs or may raise trading fees to cover these 
costs. Such potential increased costs may make it more difficult for 
new trading firms to enter the market and for certain existing trading 
firms to remain in the market. This could happen if FCMs determines to 
cease serving firms that, in light of the increased costs, are no 
longer profitable for the FCM. However, it is possible that the rule 
will create a market opportunity for certain FCMs to specialize in 
monitoring the operation of Algorithmic Trading systems used by trading 
firms that do not use DEA. This may mitigate the impact of other FCMs 
exiting the market or new FCMs choosing not to enter the market and may 
mitigate the impact on trading firms.
---------------------------------------------------------------------------

    \671\ The presentation is available at http://www.cftc.gov/idc/groups/public/@aboutcftc/documents/file/aac092215presentations_dsio.pdf.
---------------------------------------------------------------------------

    The potential reduction in the number of clearing FCMs and market 
participants due to increased costs could reduce liquidity and increase 
transaction costs in futures markets. The proposed rules also impose 
costs on DCMs that, to the extent they go beyond existing industry 
practice (including the costs of reviewing submissions from AT Persons 
and FCMs pursuant to proposed Sec.  40.22), may significantly affect 
small or start-up DCMs. However, the Commission emphasizes the general 
benefits that Regulation AT provides to the market, such as the 
protection of market integrity and efficiency, which were impacted by 
previous disruptive market events. As noted in section III above, for 
example, the events at Knight Capital significantly impacted the 
equities market. Due to coding errors in Knight's systems, the firm's 
automated trading system inadvertently built up unintended positions in 
the equity market, eventually resulting in losses of more than $460 
million for the firm.\672\ In addition, the Flash Crash in 2010 
impacted market efficiency in several respects; for example, due to the 
extreme price movement, the exchanges and FINRA made a determination to 
cancel a significant number of trades that were executed during the 
crash.\673\
---------------------------------------------------------------------------

    \672\ See SEC Knight Capital Release, supra note 39.
    \673\ As noted in the Flash Crash Report, ``during the 20 minute 
period between 2:40 p.m. and 3:00 p.m., over 20,000 trades (many 
based on retail-customer orders) across more than 300 separate 
securities, including many ETFs, were executed at prices 60% or more 
away from their 2:40 p.m. prices. After the market closed, the 
exchanges and FINRA met and jointly agreed to cancel (or break) all 
such trades under their respective `clearly erroneous' trade 
rules.'' See the Flash Crash Report, supra note 121 at 6.
---------------------------------------------------------------------------

    The Commission has preliminarily determined that burdens placed on 
market participants, FCMs, and DCMs imposed by Regulation AT is 
justified by the benefits in ensuring that all orders submitted through 
Algorithmic Trading pass through effective controls and systems that 
mitigate the risks of malfunctioning automated trading systems. The 
Commission has endeavored to minimize the compliance burden in 
Regulation AT to the minimum level necessary to protect market 
participants and the public.
    The proposed rules may promote the financial integrity of futures 
markets by reducing the likelihood of flash crashes and other automated 
trading disruptions. Such disruptions can place financial strain on 
market participants, intermediaries, and DCOs.
iii. Price Discovery
    Requiring trading firms, clearing members and exchanges to 
implement pre-trade risk controls, testing, and order management 
control requirements in order to mitigate the risk of a malfunctioning 
trading algorithm or automated trading disruption promotes the price 
discovery process by reducing the likelihood of transactions at prices 
that do not accurately reflect market forces.
iv. Sound Risk Management Practices
    The Commission believes that the pre-trade risk and order 
management control requirements contained in Regulation AT will 
contribute to a system-wide reduction in operational risk, and will 
help standardize risk management practices across similar entities 
within the marketplace. The reduction in operational risk may simplify 
the tasks associated with sound risk management practices. These 
enhanced risk management practices should help reduce unintended market 
volatility, which will aid in efficient market making, and reduce 
overall transaction costs as they relate to price movements, which 
should encourage market participants to trade in Commission-regulated 
markets. Market participants and those who rely on prices as determined 
within regulated markets should benefit from markets that behave in an 
orderly and expected fashion.
v. Other Public Interest Considerations
    The Commission has not identified any effects that these proposed 
rules would have on other public interest considerations other than 
those addressed above.
d. Consideration of Alternatives
i. Pre-Trade and Other Risk Controls
    In proposing these regulations, the Commission considered 
alternatives suggested by comments to the Concept Release. The 
Commission notes that the Concept Release raised numerous potential 
measures and controls, not all of which are proposed in Regulation AT. 
Accordingly, comments supporting or opposing regulation in the area of 
automated trading were made without the benefit of knowing specifically 
what regulations would be proposed. Some commenters indicated that 
there was already sufficient regulation in the area of risk controls. 
For example, FIA suggested that ``the best approach to achieve 
standardization is to reflect industry best practices through working 
groups of DCMs, FCMs and market participants.'' \674\ CFE stated that 
there is already sufficient regulation of DCMs in relation to risk 
controls and that exchange risk control practices should evolve as 
technology and markets evolve.\675\ MFA indicated that current CFTC 
regulations and existing best practices require entities to have 
sufficient and effective pre-trade risk controls.\676\ ICE commented 
that exchanges are better able to implement and update risk controls on 
a market-by-market basis than through a

[[Page 78911]]

Commission rulemaking.\677\ OneChicago indicated that ``additional 
mandates'' as to exchange risk controls will increase costs and 
complexity.\678\
---------------------------------------------------------------------------

    \674\ FIA at 63.
    \675\ CFE at 1-2.
    \676\ MFA at 5.
    \677\ ICE at 1.
    \678\ OneChicago at 4-5.
---------------------------------------------------------------------------

    As noted above, the Concept Release addresses a number of potential 
measures that are not proposed as part of Regulation AT. With respect 
to the pre-trade risk and other controls proposed in this NPRM, the 
Commission acknowledges that many best practices as to risk controls 
have been developed without a regulatory mandate, and that trading 
firms, clearing member FCMs, and DCMs are in the best position to 
determine the most effective design of their own particular risk 
controls and innovate new forms of controls. However, the Commission 
believes that regulation in this area will better foster 
standardization of controls across all entities, including smaller 
firms or exchanges that may, without regulation, implement some but not 
all of the controls required by Regulation AT. This rulemaking may 
serve to limit a ``race to the bottom'' in which some entities 
sacrifice effective risk controls in order to minimize costs or 
increase the speed of trading. In the context of automated trading, a 
technological malfunction at a single firm can have a significant 
impact across markets and market participants.\679\ Given that reality, 
it is insufficient that some, but not all, industry participants have 
the appropriate risk controls. Requiring the implementation of certain 
risk controls through regulation will help ensure that all industry 
participants have the appropriate risk controls, thus fostering trade 
certainty and market integrity for all market participants. In 
determining which risk controls discussed in the Concept Release should 
be proposed in this NPRM, the Commission has attempted to propose those 
core risk controls that it believes are currently implemented by the 
majority of market participants, foregoing certain risk controls that 
are implemented by relatively few market participants and may be of 
less value in mitigating risk.
---------------------------------------------------------------------------

    \679\ See, e.g., the discussion of Knight Capital in section III 
above.
---------------------------------------------------------------------------

    In addition, some commenters to the Concept Release explained the 
appropriate implementation or design of particular pre-trade risk 
controls, which are discussed above as relevant to each control. Also 
as discussed above, the Commission determined that, while it believes 
that these comments are reasonable and merit further consideration by 
market participants as they implement risk controls, the specific 
design and operation of risk controls should not be mandated by 
regulation. Rather, given the wide variety of trading firms, 
technology, trading strategies, markets, and products, the relevant 
entities--trading firms, clearing firms, and DCMs--should have the 
discretion to determine the appropriate design of the specific controls 
required by Regulation AT.
    The remainder of this discussion focuses on various alternative 
measures that the Commission considered in proposing these regulations, 
some of which were discussed in the Concept Release, and some of which 
are contained in other regulatory systems. The Commission evaluated 
various regulatory definitions of algorithmic trading when considering 
how to draft a definition for purposes of this NPRM. The Commission has 
proposed that the definition of Algorithmic Trading will include 
systems that make determinations regarding any aspect of the routing of 
an order, i.e., systems that only make decisions as to the routing of 
orders to one or more trading venues. The Commission notes analogous 
definitions adopted by the European Commission under MiFID II and by 
FINRA do not include automated systems that only route orders as 
algorithmic trading. Excluding automated order routers would reduce the 
number of automated systems captured by Regulation AT relative to the 
Commission's proposal and may reduce the number of AT Persons subject 
to the costs of the regulation. Nevertheless, the Commission believes 
that automated order routers have the potential to disrupt the market 
to a similar extent as other types of automated systems, and that there 
are significant benefits to including automated order routers in the 
proposed regulations.
    The Commission is also considering expanding the definition of 
Algorithmic Trading to encompass orders that are generated using 
algorithmic methods (e.g., an algorithm generates a buy or sell signal 
at a particular time), but are then manually entered into a front-end 
system by a natural person, who determines all aspects of the routing 
of the orders. Such an alternative would increase the number of 
automated systems captured by Regulation AT relative to the 
Commission's proposal and may increase the number of AT Persons subject 
to the costs of the regulation. The Commission preliminarily believes 
that such manually entered orders present less risk than fully 
automated orders and that the benefits of including them in the 
definition of Algorithmic Trading would therefore be limited.
    In the event that a non-clearing FCM or other entity acts only as a 
conduit for orders, and does not make any determinations with respect 
to such orders, the conduit entity would not be engaged in Algorithmic 
Trading, as that definition is currently proposed. The Commission 
preliminarily believes that expanding the definition to include conduit 
entities would not sufficiently enhance the benefits associated with 
Regulation AT relative to the additional costs.
    The Commission determined not to extend Regulation AT to SEFs, a 
proposal that was supported by one Concept Release commenter. CFE 
stated that any risk control requirements should apply to SEFs, in 
addition to DCMs. CFE explained that there must be a level playing 
field between both DCMs and SEFs and that there be no regulatory 
disparities that would make it more advantageous to list a swap on a 
SEF as opposed to a DCM.\680\ The Commission believes in fostering a 
level playing field in its markets, and as a result any requirements on 
DCMs arising out of Regulation AT may ultimately be imposed on SEFs at 
a later date. However, as noted in section (C)(1) above, an important 
consideration for the Commission is that SEFs and SEF markets are much 
newer and less liquid than the more established and liquid DCMs and DCM 
markets. While SEFs and SEF markets are still in this nascent stage, 
the Commission does not want to impose additional requirements that may 
have the effect of decreasing the number of SEFs or decreasing 
liquidity. Moreover, the Commission, based on its present knowledge, 
believes that automated trading is not as prevalent in SEF markets as 
compared to DCM markets. Therefore, the policy considerations 
underlying Regulation AT are not as critical, at least at this time, in 
the SEF context.
---------------------------------------------------------------------------

    \680\ CFE at 2.
---------------------------------------------------------------------------

    Proposed Sec.  1.82 requires clearing FCMs to implement controls 
with respect to AT Order Messages originating with an AT Person. The 
Commission is considering modifying proposed Sec.  1.82 to require 
clearing FCMs to implement controls with respect to all orders, 
including orders that are manually submitted. Such a requirement would 
correspond to the requirement under proposed Sec.  40.20(d) that DCMs 
implement risk controls for orders that do not originate from 
Algorithmic Trading. The Commission is considering this modification 
because it recognizes that manually entered

[[Page 78912]]

orders also have the potential to cause significant market disruption. 
The Commission requests comment on this proposed alternative 
formulation of Sec.  1.82, which the Commission may implement in the 
final rulemaking for Regulation AT. The Commission acknowledges that 
this proposed alternative formulation would impose additional costs on 
clearing FCMs relative to the currently proposed Sec.  1.82. The 
Commission requests comment on the potential benefits of this proposal 
relative to the increased costs to clearing FCMs, in addition to any 
other comments regarding the effectiveness of this proposal in terms of 
risk reduction.
ii. Compliance Reports
    Proposed Sec.  1.83 would require AT Persons and clearing FCMs to 
submit compliance reports to DCMs on an annual basis. Such reports 
would need to be submitted and certified annually by the chief 
executive officer or the chief compliance officer of the AT Person or 
FCM. Proposed Sec.  40.22 would require DCMs to establish a program for 
effective periodic review and evaluation of the reports. The Commission 
has proposed these regulations, using the deadlines described above, 
because it believes they represent an appropriate balancing of the 
transparency and risk reduction provided by the reports against the 
burden placed on AT Persons, clearing FCMs, and DCMs of providing and 
reviewing the reports.
    The Commission is considering the alternatives of requiring AT 
Persons and clearing FCMs to submit such reports more or less 
frequently than annually. The Commission is also considering the 
alternatives of placing the responsibility for certifying the reports 
required by proposed Sec.  1.83 only on the chief executive officer, 
only on the chief compliance officer, or permitting certification from 
other officers of the AT Person or FCM. While proposed Sec.  40.22 
would require DCMs to establish a program for effective periodic review 
and evaluation of the reports, the Commission is considering the 
alternative of requiring DCMs to review the reports at more specific 
intervals.
    The Commission considered the alternative of requiring additional 
information in the reports by AT Persons to DCMs under proposed Sec.  
1.83, including (1) descriptions of order cancellation systems; (2) 
policies and procedures for the development, testing, and monitoring of 
Algorithmic Trading systems; and (3) policies and procedures for the 
training of Algorithmic Trading staff. The Commission determined not to 
propose these additional requirements in order to limit costs both to 
AT Persons and to the DCMs that will be required to review the reports 
under proposed Sec.  40.22, while retaining the benefits of protecting 
market participants and the public from disruptions and other adverse 
events associated with automated trading.
    Requirements related to RFAs. The Commission is considering making 
adjustments to the scope of RFA responsibility under proposed Sec.  
170.19. For example, RFAs could be responsible for fewer or additional 
areas regarding AT Persons, ATSs, and algorithmic trading than 
specified in proposed Sec.  170.19 and could have more or less latitude 
to issue rules than under the proposal.
e. Request for Comments
Pre-Trade and Other Risk Controls
    112. How would an alternative definition of Algorithmic Trading 
that excludes automated order routers affect the costs and benefits of 
the pre-trade and other risk controls in comparison to the costs and 
benefits of the proposed definition that includes automated order 
routers? Would such an alternative definition reduce the number of AT 
Persons captured by Regulation AT?
    113. Would the benefits of Regulation AT be enhanced significantly 
if the definition of Algorithmic Trading were modified to capture a 
conduit entity such as a non-clearing FCM, thereby making the entity an 
AT Person subject to Regulation AT? How would such a modification 
affect costs?
    114. Would the benefits of Regulation AT be enhanced significantly 
if the definition of Algorithmic Trading were expanded to encompass 
orders that are generated using algorithmic methods (e.g., an algorithm 
generates a buy or sell signal at a particular time), but are then 
manually entered into a front-end system by a natural person? How would 
such a modification affect costs? Please comment on the costs and 
benefits of an alternative whereby the Commission would implement 
specific rules regarding the appropriate design of the specific 
controls required by Regulation AT and compare them to the costs and 
benefits of the Commission's proposal whereby the relevant entities--
trading firms, clearing firms, and DCMs--would have the discretion to 
determine the appropriate design of those controls.
    115. Does one particular segment of trading firms, clearing member 
FCMs or DCMs (e.g., smaller entities) currently implement fewer of the 
pre-trade and other risk controls required by Regulation AT than some 
other segment of trading firms, clearing member FCMs or DCMs? If so, 
please describe any unique or additional costs that will be imposed on 
such persons to develop the technology and systems necessary to 
implement the pre-trade and other risk controls required by Regulation 
AT.
    116. In question 14, the Commission asks whether there are any AT 
Persons who are natural persons. Would AT Persons who are natural 
persons (or sole proprietorships with no employees other than the sole 
proprietor) be required to hire staff to comply with the risk control, 
testing and monitoring, or compliance requirements of Regulation AT?
    117. Do you agree with the accuracy of cost estimates provided by 
the Commission as to how much it will cost a trading firm, clearing 
member FCM or DCM to internally develop the technology and systems 
necessary to implement the pre-trade and other risk controls required 
by Regulation AT? If you disagree with the Commission's analysis, 
please provide your own quantitative estimates, as well as data or 
other information in support. Please specify in your answer the type of 
entity and which specific pre-trade risk or order management controls 
for which you are providing estimates.
    In addition, please differentiate between the situations where an 
entity (i) already has partially compliant controls in place, and only 
needs to upgrade such technology and systems to bring it into 
compliance with the regulations; and (ii) needs to build such 
technology and systems from scratch. Please include, as applicable, 
hardware and software costs as well as the hourly wage information of 
the employee(s) necessary to develop such risk controls (i.e., 
technology personnel such as programmer analysts, senior programmers 
and senior systems analysts).
    118. The Commission has assumed that the effort to adjust any one 
risk control (by ``control,'' in this context, the Commission means the 
pre-trade risk controls, order cancellation systems, and connectivity 
systems required by Sec.  1.80) will require assessment and possible 
modifications to all controls. Is this assumption correct, and if not, 
why not?
    119. As indicated above, the Commission lacks sufficient 
information to provide full estimates of costs that a trading firm, 
clearing member FCM or DCM will incur if it chooses not to internally 
develop such controls, and instead purchases the solutions of an 
outside vendor in order to comply with Regulation AT's pre-trade and 
other risk controls requirements. Please provide quantitative estimates 
of such costs, including supporting data or other

[[Page 78913]]

information. In addition, please specify in your answer the type of 
entity and which specific pre-trade risk or order management control 
for which you are providing estimates.
    In addition, please differentiate between the situations where an 
entity (i) already uses an outside vendor to at least some extent to 
implement the controls; and (ii) does not currently implement the 
controls and must obtain all applicable technology and systems from an 
outside vendor necessary to comply with Regulation AT. Please include, 
if applicable, hardware and software costs as well as the hourly wage 
information of the employee(s) necessary to effectuate the 
implementation of such controls from an outside vendor.
    120. Do you agree with the Commission's estimates of how much it 
will cost a trading firm, clearing member FCM or DCM to annually 
maintain the technology and systems for the pre-trade and other risk 
controls required by Regulation AT, if it uses internally developed 
technology and systems? If not please provide quantitative estimates 
and supporting data or other information with respect to how much it 
will cost a trading firm, clearing member FCM or DCM to annually 
maintain the technology and systems for pre-trade and other risk 
controls required by Regulation AT, if it uses an outside vendor's 
technology and systems.
    121. Is it correct to assume that many of the trading firms subject 
to Sec.  1.80 are also subject to the SEC's Market Access Rule, and, 
accordingly, already implement many of the systems required by 
Regulation AT for purposes of their securities trading?
    Please specify in your answer the type of entity and which specific 
pre-trade risk or order management control is already required pursuant 
to the Market Access Rule, and the extent of the overlap.
    122. Please comment on the costs and benefits (including 
quantitative estimates with supporting data or other information) to 
clearing FCMs of an alternative to proposed Sec.  1.82 that would 
require clearing FCMs to implement controls with respect to all orders, 
including orders that are manually submitted or are entered through 
algorithmic methods that nonetheless do not meet the definition of 
Algorithmic Trading and compare those costs and benefits to those costs 
and benefits of proposed Sec.  1.82.
    123. Please comment on the additional costs (including quantitative 
estimates with supporting data or other information) to AT Persons of 
complying with each of the following specific requirements of Sec.  
1.80:
    a. Sec.  1.80(a)(2) (pre-trade risk control threshold 
requirements);
    b. Sec.  1.80(a)(3) (natural person monitors must be alerted when 
thresholds are breached)
    c. Sec.  1.80(d) (notification to DCM and clearing member FCM that 
AT Person will use Algorithmic Trading);
    d. Sec.  1.80(e) (self-trade prevention tools); and
    e. Sec.  1.80(f) (periodic review of pre-trade risk controls and 
other measures for sufficiency and effectiveness).
    124. The Commission welcomes comment on the estimated costs of the 
pre-trade risk controls proposed in Sec.  1.80 as compared to the 
annual industry expenditure on technology, risk mitigation and/or 
technology compliance systems.
    125. Please comment on the costs to AT Persons and clearing member 
FCMs of complying with DCM rules requiring retention and production of 
records relating to Sec. Sec.  1.80, 1.81, and 1.82 compliance, 
pursuant to Sec.  40.22(d), including without limitation on the extent 
to which AT Persons and clearing member FCMs already have policies, 
procedures, staffing and technological infrastructure in place to 
retain such records and produce them upon DCM request.
    126. The Commission anticipates that Regulation AT may promote 
confidence among market participants and reduce market risk, 
consequently reducing transaction costs, but has not estimated this 
reduction in transaction costs. The Commission welcomes comment on the 
extent to which Regulation AT may impact transaction costs and effects 
on liquidity provision more generally.
AT Person Membership in RFA; RFA Standards for Automated Trading and 
Algorithmic Trading Systems
    127. The Commission estimates that the costs of membership in an 
RFA associated with proposed Sec.  170.18 will encompass certain costs, 
such as those associated with NFA membership dues. Has the Commission 
correctly identified the costs associated with membership in an RFA?
    128. The Commission expects that entities that will be required to 
become members of an RFA would not incur any additional compliance 
costs as a result of their membership in an RFA. The Commission 
requests comment on the accuracy of this expectation. What additional 
compliance costs, if any, would a registrant face as a result of being 
required to become a member of an RFA pursuant to proposed Sec.  
170.18?
    129. Has the Commission accurately estimated that approximately 100 
entities will be affected by the membership requirements of Sec.  
170.18?
    130. The Commission invites estimates on the cost to an RFA to 
establish and maintain the program required by Sec.  170.19, and the 
amount of that cost that will be passed along to individual categories 
of AT Person members in the RFA.
Development, Testing, and Supervision of Algorithmic Systems
    131. Proposed Sec.  1.81(a) establishes principles-based standards 
for the development and testing of Algorithmic Trading systems and 
procedures, including requirements for AT Persons to test all 
Algorithmic Trading code and related systems and any changes to such 
code and systems prior to their implementation. AT Persons would also 
be required to maintain a source code repository to manage source code 
access, persistence, copies of all code used in the production 
environment, and changes to such code, among other requirements. Are 
any of the requirements of Sec.  1.81(a) not already followed by the 
majority of market participants that would be subject to Sec.  1.81(a) 
(or some particular segment of market participants), and if so, how 
much will it cost for a market participant to comply with such 
requirement(s)?
    132. Proposed Sec.  1.81(b) requires that an AT Person's 
Algorithmic Trading is subject to continuous real-time monitoring and 
supervision by knowledgeable and qualified staff at all times while 
Algorithmic Trading is occurring. Proposed Sec.  1.81(b) also requires 
automated alerts when an Algorithmic Trading system's AT Order Message 
behavior breaches design parameters, upon loss of network connectivity 
or data feeds, or when market conditions approach the boundaries within 
which the ATS is intended to operate, to the extent applicable, among 
other monitoring requirements. Are any of the requirements of Sec.  
1.81(b) not already followed by the majority of market participants 
that would be subject to Sec.  1.81(b), and if so, how much will it 
cost for a market participant to comply with such requirement(s)?
    133. Proposed Sec.  1.81(c) requires that AT Persons implement 
policies designed to ensure that Algorithmic Trading operates in a 
manner that complies with the CEA and the rules and regulations 
thereunder. Among other controls, the policies should include a plan of 
internal coordination and communication between

[[Page 78914]]

compliance staff of the AT Person and staff of the AT Person 
responsible for Algorithmic Trading regarding Algorithmic Trading 
design, changes, testing, and controls. Are any of the requirements of 
Sec.  1.81(c) not already followed by the majority of market 
participants that would be subject to Sec.  1.81(c), and if so, how 
much will it cost for a market participant to comply with such 
requirement(s)?
    134. Proposed Sec.  1.81(d) requires that AT Persons implement 
policies to designate and train their staff responsible for Algorithmic 
Trading, which policies should include procedures for designating and 
training all staff involved in designing, testing and monitoring 
Algorithmic Trading. Are any of the requirements of Sec.  1.81(d) not 
already followed by the majority of market participants that would be 
subject to Sec.  1.81(d), and if so, how much will it cost for a market 
participant to comply with such requirement(s)?
AT Person and FCM Compliance Reports
    135. Please comment on whether any of the alternatives discussed 
above regarding compliance reports would provide a superior cost-
benefit profile relative to the Commission's proposal.
DCM Test Environments
    136. Do any DCMs not currently offer a test environment that 
simulates production trading to their market participants, as would be 
required by proposed Sec.  40.21? If so, how much would it cost a DCM 
to implement a test environment that would comply with the requirements 
of Sec.  40.21?
DCM Review of Compliance Reports
    137. Please comment on the cost estimates provided above with 
respect to DCMs' review of compliance reports provided under Sec.  
40.22 and related review requirements, including the estimated cost for 
DCMs to: Establish the review program required by Sec.  40.22; review 
the reports provided by AT Persons and clearing member FCMs; 
communicate remediation instructions to a subset of AT Persons and 
clearing member FCMs; and review and evaluate, as necessary, books and 
records of AT Persons and clearing member FCMs as contemplated by 
proposed Sec.  40.22(e).
Section 15(a) Considerations
    138. The Commission requests comment on its discussion of the 
effects of the proposed rules on the considerations in Sec.  15(a) of 
the CEA.
    139. Are the compliance costs associated with the proposed rules of 
sufficient magnitude to potentially cause smaller market participants, 
FCMs, or DCMs to cease or scale back operations? Do these costs create 
significant barriers to entry?
8. Requirements for Certain Entities To Register as Floor Traders
a. Background
    The Commission proposes to require registration for certain market 
participants with Direct Electronic Access. To achieve registration, 
the Commission proposes amending the definition of ``Floor trader'' in 
Commission regulation 1.3(x). The amended definition would include any 
person who purchases or sells futures or swaps solely for such person's 
own account in any other place provided by a contract market for the 
meeting of persons similarly engaged where such place is accessed for 
Algorithmic Trading by such person in whole or in part through Direct 
Electronic Access (as defined in proposed Sec.  1.3(yyyy)).
b. Costs
    Registration and Membership Fees. The new registration requirements 
imposed on certain entities with Direct Electronic Access would require 
these entities to pay certain one-time registration charges. NFA 
currently charges non-natural persons applying for registration as 
floor traders $200 per application (on Form 7-R), and charges 
individuals $85 per application (on Form 8-R). The Commission estimates 
that there will be approximately 100 entities with Direct Electronic 
Access that will register as Floor Traders under the new registration 
requirements. The Commission further estimates that each entity will be 
required to file 10 Forms 8-R in relation to its principals. 
Accordingly, the Commission estimates that new registrants will incur 
one-time registration costs of $105,500 for Form 7-R and 8-R fees 
combined (Form 7-Rs submitted by 100 new registrants, at $200 per Form 
7-R plus 10 Forms 8-R submitted by each of 100 new registrants, at $85 
per Form 8-R).\681\
---------------------------------------------------------------------------

    \681\ As noted previously, the Commission has delegated its 
registration functions to NFA. Non-natural person floor trader 
entities register with the Commission and apply for membership in 
NFA via CFTC Form 7-R. Principals of non-natural person floor trader 
entities register via Form 8-R. The Commission estimates that each 
non-natural person floor trader entity will have approximately 10 
principals and therefore need to file approximately 10 Forms 8-R. In 
the event that a natural person meets the definition of Floor Trader 
in proposed Sec.  1.3(x)(3), and is therefore required to register 
with the Commission and become a member of NFA, such person would 
only be required to complete Form 8-R and would face substantially 
lower costs than those estimated here. The Form 7-R and 8-R fees 
estimated here are based on NFA's current fees.
---------------------------------------------------------------------------

    Costs for Submitting Applications. In addition, the Commission 
estimates that new registrants will incur a total one-time cost of 
$105,600 to prepare and submit Forms 7-R and 8-R. This cost represents 
the work of 1 Compliance Attorney per registrant, working for 11 hours 
(11 x $96 = $1,056 per registrant).\682\ The 100 new registrants will 
therefore incur a total one-time cost of $105,600.
---------------------------------------------------------------------------

    \682\ See section V(B) above for the calculation of hourly wage 
rates used in this analysis.
---------------------------------------------------------------------------

    Other Indirect Costs. The Commission preliminarily believes that 
there are additional indirect costs, beyond the cost of registration, 
to new registrants resulting from the new registration requirement. New 
floor traders required to register under proposed Sec.  1.3(x)(3) will 
be included in the definition of ``AT Person.'' These proposed rules 
establish various requirements for AT Persons, including the 
implementation of risk controls for algorithmic systems (proposed Sec.  
1.80), the implementation of standards for development, testing, and 
supervision of algorithmic systems (proposed Sec.  1.81), and the 
submission to DCMs of compliance reports regarding risk controls and, 
upon request, certain related books and records (proposed Sec.  1.83). 
Because these provisions apply to AT Persons, new floor traders under 
Proposed Sec.  1.3(x)(3) will only be required to follow these 
provisions as a result of their status as a floor trader. Thus, any 
costs associated with these rules are also indirect costs of 
registration itself.\683\
---------------------------------------------------------------------------

    \683\ See Section V(E)(7)(b) above for a discussion of costs 
associated with Proposed Sec. Sec.  1.80, 1.81, and 1.83.
---------------------------------------------------------------------------

c. Benefits
    The Commission preliminarily believes that registration of certain 
entities with Direct Electronic Access would enhance the pre-trade 
controls and risk management tools discussed elsewhere in this NPRM. 
For example, the pre-trade risk controls listed in proposed Sec.  
1.80(a)--maximum AT Order Message frequencies per unit time, maximum 
execution frequencies per unit time, order price parameters and maximum 
order size limits--must be established and used by all AT Persons. If 
the Commission were to only require those trading firms or clearing 
member FCMs that are already registered with the Commission to 
implement such controls, it would be ignoring a significant number of 
market participants that actively trade on Commission-regulated 
markets, each of which has algorithmic trading systems

[[Page 78915]]

that could malfunction and create systemic risk to all market 
participants. The Commission estimates that there are approximately one 
hundred proprietary trading firms engaged in Algorithmic Trading in 
Commission-regulated markets. However, a technological malfunction in a 
single trading firm's systems can significantly impact other markets 
and market participants. Accordingly, the proposed registration 
requirement accomplished through revised Sec.  1.3(x) is critical to 
ensuring that all such firms are registered and subject to appropriate 
risk control, testing, and other requirements of Regulation AT.
    A number of commenters to the Concept Release pointed out benefits 
of additional registration.\684\ AFR stated that ``[t]he enhancement of 
investigative authority is extraordinarily important given that the 
Commission would often need to involve itself in the workings of the 
ATSs to anticipate problems and to detect and investigate problems that 
have occurred. HFT firms should have the highest priority.'' \685\
---------------------------------------------------------------------------

    \684\ Better Markets 13; AFR 8-9; TCL 17.
    \685\ AFR 8-9.
---------------------------------------------------------------------------

    AIMA and VFL specifically emphasized benefits of registration for 
participants with direct market access.\686\ VFL commented that if an 
exchange provides a participant the ability to connect directly, then 
that participant enjoys all of the rights of a member and should be 
regulated at the federal and exchange level.\687\
---------------------------------------------------------------------------

    \686\ AIMA 24; VFL 3.
    \687\ VFL 3.
---------------------------------------------------------------------------

d. Section 15(a) Factors
    This section discusses the section 15(a) factors for the proposed 
amendment of the definition of ``Floor trader'' in Commission 
Regulation 1.3(x), for purposes of registering participants with Direct 
Electronic Access.
i. Protection of Market Participants and the Public
    The Commission preliminarily believes that requiring market 
participants with Direct Electronic Access to register with the 
Commission will further the protection of market participants and the 
public by enhancing the Commission's ability to seek information from 
such firms and allow for wider implementation of many of the pre-trade 
risk controls and other tools discussed in this release. Broader use of 
these tools will reduce the likelihood of market disruptions that 
adversely impact market participants and the public. Regulation AT may 
serve to limit a ``race to the bottom,'' in which certain entities 
sacrifice effective risk controls in order to minimize costs or 
increase the speed of trading. The proposed rules, by standardizing the 
risk controls required to be used by firms, would help ensure that the 
benefits of these risk controls are more evenly distributed across a 
wide set of market participants, and reduce the likelihood that an 
outlier firm without sufficient risk controls causes significant market 
disruption. Thus, the proposed registration requirement may help ensure 
the protections of market participants and the public that these tools 
provide as discussed above.
ii. Efficiency, Competitiveness, and Financial Integrity of Futures 
Markets
    The Commission preliminarily believes that requiring market 
participants with Direct Electronic Access to register with the 
Commission will further the efficiency, competitiveness, and financial 
integrity of futures markets by enhancing the Commission's ability to 
seek information from such firms and allow for wider implementation of 
many of the pre-trade risk controls and other tools discussed in this 
release. Broader use of these tools will reduce the likelihood of 
market disruptions that may adversely impact the efficiency and 
integrity of the futures markets. Consistent use of these tools may 
also even the playing field within groups of automated firms, such as 
market-makers, or across firms with differing strategies. This 
consistency can improve firm competitiveness and reduce disadvantages 
experienced by those firms who would employ more comprehensive risk 
control and order management programs even absent a rule requiring use 
of such tools. Thus, the proposed registration requirement may help 
ensure the furtherance of efficiency, competitiveness, and financial 
integrity that these tools provide as discussed above.
iii. Price Discovery
    The Commission preliminarily believes that requiring market 
participants with direct market access to register with the Commission 
will also further price discovery by enhancing the Commission's ability 
to seek information from such firms and allow for wider implementation 
of many of the pre-trade controls and risk management tools discussed 
in this release. Broader use of these tools will reduce the likelihood 
of market disruptions that may interfere with the price discovery 
process. Thus, the proposed registration requirement may help ensure 
the furtherance of price discovery protections that these tools provide 
as discussed above.
iv. Sound Risk Management Practices
    The Commission preliminarily believes that requiring market 
participants with direct market access to register with the Commission 
will also further sound risk management practices by enhancing the 
Commission's ability to seek information from such firms and allow for 
wider implementation of many of the pre-trade controls and risk 
management tools discussed in this release. Broader use of these tools 
will reduce the likelihood of market disruptions that may interfere 
with sound risk management practices. Thus, the proposed registration 
requirement may help ensure the furtherance of sound risk management 
practices that these tools provide as discussed above.
v. Other Public Interest Considerations
    The Commission has not identified any effects that these proposed 
rules would have on other public interest considerations other than 
those addressed above.
e. Consideration of Alternatives
    The Commission considered a number of alternatives to the proposed 
approach of requiring registration for entities with Direct Electronic 
Access. In the Concept Release, the Commission sought comments 
regarding broader registration of proprietary traders generally. Based 
upon the comments received, many of which did not support registration, 
the Commission is not proposing broad registration of proprietary 
traders at this time.
    As an alternative to requiring the registration of entities engaged 
in proprietary Algorithmic Trading through DEA, the Commission 
considered reaching such entities indirectly through the DCMs on which 
they trade. This approach would have necessitated that DCMs implement 
rules requiring relevant entities to meet the substantive standards of 
Regulation AT. These DCM rules would have needed to require, for 
example, that relevant entities implement pre-trade risk controls, 
establish policies and procedures for testing and monitoring of ATSs, 
and provide compliance reports regarding their algorithmic trading to 
DCMs (which are currently proposed as direct obligations upon AT 
Persons under Sec. Sec.  1.80, 1.81, and 1.83, respectively). This 
alternative would have reduced the costs for such entities, since they 
would not be required to register with the Commission. However,

[[Page 78916]]

such costs would instead have been borne by DCMs, and potentially 
passed back on to relevant entities. The Commission did not pursue this 
approach for a number of other reasons as well. In particular, the 
Commission wanted to ensure that such entities are directly subject to 
Commission regulations, rather than impose obligations indirectly 
through DCMs. In addition, the Commission wanted to ensure a uniform 
baseline of regulatory expectations which might not arise where 
numerous DCMs are independently producing their own self-regulatory 
standards in lieu of the Commission's standards. Furthermore, the 
Commission also wanted to combine the requirement to register with the 
Commission with the requirement under Sec.  170.18 that all AT Persons 
must become a member of a registered futures association, so that the 
RFA can consider adopting standards for automated trading and ATSs 
applicable to AT Persons. These standards are described under Sec.  
170.19. As discussed above, the Commission believes that Sec. Sec.  
170.18 and 170.19 would allow RFAs to supplement elements of Regulation 
AT as markets and trading technologies evolve over time, and do so in a 
uniform manner that would not be available through separate initiatives 
by individual DCMs.
    The Commission also considered not requiring currently unregistered 
entities to register with the Commission as floor traders. A number of 
commenters supported such an approach, including FIA, which suggested 
``[r]ather than creating a new registration framework, expanding the 
information required in [the DCM's] audit trail may be a more direct 
and efficient way to address the Commission's concerns.'' \688\ Other 
commenters also focused on whether the Commission already had access to 
the information that registration would ostensibly enable it to 
acquire. Commenters pointed out that: DCMs already use Operator IDs; 
the DCM audit trail already satisfies the goals of registration; 
implementing the Commission's final rule on ownership and control 
reporting (OCR) will provide additional information on trading 
identities; and the Commission already has access to trade data (i.e., 
Regulation 1.40 and part 38's mandate that DCMs require market 
participants to submit to jurisdiction).\689\ The Commission notes that 
obtaining information from proprietary traders is not the primary 
purpose of the proposed registration requirement, and therefore 
believes that the goals of Regulation AT can only be realized by 
requiring currently unregistered entities to register with the 
Commission as floor traders.
---------------------------------------------------------------------------

    \688\ FIA at 44.
    \689\ FIA 43-46; CME at 32-34; Gelber at 22-24; KCG at 18; MFA 
at 3; AIMA at 2, 24; Chicago Fed at 3.
---------------------------------------------------------------------------

    As discussed more fully in section IV(E)(3) above, the ``floor 
trader'' definition is not being expanded to capture all proprietary 
traders engaged in Algorithmic Trading; rather, the revised floor 
trader definition is limited to firms using DEA to engage in 
Algorithmic Trading. Registration of entities with DEA as floor traders 
would enhance the pre-trade controls and risk management tools 
discussed elsewhere in this NPRM by making such entities subject to the 
various regulations governing AT Persons under the NPRM. For example, 
the pre-trade risk controls listed in proposed Sec.  1.80--maximum AT 
Order Message frequencies per unit time, maximum execution frequencies 
per unit time, order price parameters and maximum order size limits--
must be established and used by all AT Persons. The Commission is also 
considering whether it is appropriate to further limit the registration 
requirement by adding a de minimis exception, whereby only those 
persons with DEA who also meet certain trading volume or message volume 
thresholds would be required to register.
f. Request for Comments
    140. The Commission estimates that the costs of registration will 
encompass direct costs (those associated with NFA membership, and 
reporting and recordkeeping with the Commission), and indirect costs 
(e.g. those associated to risk control requirements placed on all 
registered entities). Has the Commission correctly identified the costs 
associated with the new registration category? What firm 
characteristics would change the level of direct and indirect costs 
associated with the registration?
    141. Has the Commission accurately estimated that approximately 100 
currently unregistered entities will be captured by the new 
registration requirement in proposed Sec.  1.3(x)(3).
    142. Has the Commission accurately estimated that each currently 
unregistered entity captured by the new registration requirement in 
proposed Sec.  1.3(x)(3) will have approximately 10 persons required to 
file Form 8-R?
    143. As defined, the new floor trader category restricts the 
registration requirement to those who make use of Direct Electronic 
Access. Is this requirement overly restrictive or unduly broad from a 
cost-benefit perspective? Are there alternate, or additional, 
characteristics of trading activity to determine registration status 
that would be preferable from a cost-benefit standpoint? For example, 
should persons with trading volume or message volume below a specified 
threshold be exempted from registration?
    144. Will any currently unregistered entities change their business 
model or exit the market in order to avoid the proposed registration 
requirement?
    145. The Commission believes that the risk control protocols 
required of registered entities, specifically those under the new 
registration category, will provide a general benefit to the safety and 
soundness of market activity and price formation. Has the Commission 
correctly identified the type and level of benefits which arise from 
placing these requirements on a new set of significant market 
participants?
    146. The Commission requests comment on its discussion of the 
effects of the proposed rules on the considerations in Section 15(a) of 
the CEA.
9. Transparency in Exchange Trade Matching Systems
a. Background
    The proposed regulations concerning additional disclosure by DCMs 
regarding their trade matching systems (amendments to Sec. Sec.  
38.401(a) and 40.1(i)) provide that DCMs publicly disclose certain 
information prominently and clearly. These proposed regulations would 
require DCMs to provide a description of attributes of trade matching 
systems that materially affect the entry and execution of orders and 
requests for quotes, including any changes to trade matching systems 
that would cause such effects.
b. Costs
    The Commission notes that DCMs are currently obligated under DCM 
core principles and existing regulations to make available certain 
types of information concerning the operation of their electronic 
matching platforms through publication of rulebooks and through the 
required posting of specifications of platforms on their Web site. DCMs 
are also obligated under DCM core principles and existing regulations 
to establish and maintain a program of risk analysis and oversight to 
identify and minimize sources of operation risk, which should identify 
and remediate aspects of an electronic matching platform that could 
negatively affect market participants' orders. Therefore, to a large 
extent, the Commission believes that the disclosure

[[Page 78917]]

requirements under proposed Sec.  38.401(a) would not materially impact 
a DCM's operations costs.
    The Commission anticipates that additional costs under proposed 
Sec.  38.401(a) would be staff hours associated with drafting 
descriptions of such attributes that the DCMs should already be 
determining as part of their systems testing and disclosure of platform 
specifications. Such drafting may also require additional 
determinations as to the materiality of attributes and, where 
applicable, additional testing of systems to ensure an accurate 
description of those attributes in public documents. This may also 
involve attorneys' fees associated with reviewing any disclosures.
    The proposed amendments to Sec.  38.401(a) and (c) require DCMs to 
publicly post information regarding certain aspects of their electronic 
matching platforms. The Commission anticipates that DCMs are likely to 
be aware of these aspects of their platforms based on their daily work 
in operating their matching engines, monitoring performance, and 
receiving customer feedback, among other internal monitoring 
activities. As a result, the added burden under the proposed amendments 
would be limited to drafting the description of such attributes and 
making the description available on the DCM's Web site.
    The Commission estimates that a DCM would incur an annual cost of 
$19,200 to comply with amended Sec.  38.401(a)-(c), assuming the DCM is 
already compliant with the requirements to post the specifications of 
its electronic matching platform under current Sec.  38.401(a). This 
cost represents the work of 1 Compliance Attorney, working for 200 
hours (200 x $96 per hour = $19,200).\690\ The 15 DCMs that would be 
subject to amended Sec.  38.401(a)-(c) would therefore incur a total 
annual cost of $288,000 (15 x $19,200).\691\ The Commission anticipates 
that this figure would decrease in subsequent years as the descriptions 
provided would only need to be amended to reflect changes to the 
electronic matching platform or the discovery of previously unknown 
attributes.
---------------------------------------------------------------------------

    \690\ See section V(B) above for the calculation of hourly wage 
rates used in this analysis.
    \691\ See section V(A) above for the calculation of the number 
of persons subject to Regulation AT.
---------------------------------------------------------------------------

    The proposed amendment to Regulation 40.1(i) that adds the language 
``(including but not limited to any operation of an electronic matching 
platform that materially affects the time, priority, price, or quantity 
of execution of market participant orders, the ability to cancel, 
modify, or limit display of market participant orders, or the 
dissemination of real-time market data to market participants)'' would 
not result in any additional costs for DCMs. The Commission notes that 
the proposed change to Regulation 40.1(i) clarifies and codifies the 
Commission's existing interpretation of the term ``rule.'' Moreover, 
the proposal is consistent with industry practice, whereby DCMs have 
submitted as rule changes information regarding proposed changes to 
electronic trade matching platform that affect the entry and execution 
of market participant orders and quotes. Therefore, the Commission does 
not anticipate that DCMs will be required to file submissions relating 
to any changes to the platform that should not already be filed under 
current Commission interpretation and industry practice.
c. Benefits
    The Commission believes that the additional disclosure by DCMs 
regarding their trade matching systems, pursuant to the proposed 
amendments to Sec. Sec.  38.401(a) and 40.1(i), would have substantial 
benefits for market participants. With a better understanding of how 
their order messages interact with an electronic matching platform, 
market participants can more efficiently use the electronic markets to 
hedge risks. Moreover, the disclosure required by the proposed rule 
would foster greater transparency in the operation of electronic 
markets. This enhanced transparency would foster confidence in the 
markets and ensure the availability of efficient markets to hedge 
risks. Finally, this increased transparency would encourage competition 
among DCMs to provide the best platforms for market participants, as 
market participants would be able to evaluate better the relative 
benefits of trading on individual exchanges. The Commission believes 
that, to the extent that DCMs are currently in compliance with the 
proposed amendments to Sec. Sec.  38.401(a) and 40.1(i), many of the 
benefits of the proposed amendments are already being realized. The 
proposed rule will ensure that the benefits are being realized by 
market participants at all DCMs.
d. Section 15(a) Factors
    This section discusses the Section 15(a) factors for the proposed 
regulations requiring additional disclosure by DCMs regarding their 
trade matching systems (amendments to Sec. Sec.  38.401(a) and 
40.1(i)).
i. Protection of Market Participants and the Public
    The Commission preliminarily believes that the proposed disclosure 
requirement and the enhanced transparency that it would foster will 
protect market participants by providing them with a better 
understanding of how their order messages interact with an electronic 
matching platform, thus facilitating their ability to tailor their 
orders to their understanding of the matching engine and reducing the 
likelihood of unpleasant surprises regarding order fills.
ii. Efficiency, Competitiveness, and Financial Integrity of Futures 
Markets
    Requiring submissions for changes to available order types and 
platform functionalities also ensures transparency on the operation of 
such platforms, further encouraging competition among DCMs and 
enhancing market integrity. The increased transparency may increase 
investor confidence and expand participation in the futures markets.
iii. Price Discovery
    The proposed rule may protect and enhance the price discovery 
process by providing market participants and the public with a better 
understanding of how buy and sell orders interact on the trading 
platform, thus making the price discovery process more transparent.
iv. Sound Risk Management Practices
    The proposal may promote sound risk management practices by 
providing market participants with more detailed information regarding 
how their order messages will be processed once they reach the trading 
platform, and how their messages will interact with messages from other 
market participants, including the priority with which they will be 
executed. This information will enable market participants to calibrate 
their risk controls more effectively.
v. Other Public Interest Considerations
    The Commission has not identified any effects that these proposed 
rules would have on other public interest considerations other than 
those addressed above.
vi. Consideration of Alternatives
    The Commission is considering the alternative of applying the 
transparency requirement only with respect to latencies within a 
platform and how a self-trade prevention tool determines whether to 
cancel an order. The Commission preliminarily believes that the broader 
language that it is proposing

[[Page 78918]]

would better ensure that DCMs disclose any additional attributes of an 
electronic matching platform that may materially impact market 
participant orders and any material attributes that may arise in the 
future as the structures of matching engines continue to evolve. This 
additional information may enable market participants to make better 
and more informed decisions about their trading decisions.
e. Request for Comments
    147. The Commission anticipates that costs associated with the 
transparency requirement would come from some additional testing of 
platform systems and from drafting and publishing descriptions of any 
relevant attributes of the platform. What new costs would be associated 
with providing descriptions of attributes of electronic matching 
platforms that affect market participant orders and quotes?
    148. Please compare the costs and benefits of the alternative of 
applying the transparency requirement only with respect to latencies 
within a platform and how a self-trade prevention tool determines 
whether to cancel an order with the costs and benefits of the proposed 
rule.
    149. What benefits might market participants receive through 
increased transparency into the operation of electronic matching 
platforms, particularly for those market participants without direct 
electronic access who may not be able to accurately measure latencies 
or other metrics of market efficiency?
    150. The Commission requests comment on its discussion of the 
effects of the proposed rules on the considerations in Section 15(a) of 
the CEA.
10. Self-Trade Prevention
a. Background
    Regulation AT proposes a new requirement (Sec.  40.23) that a DCM 
shall implement rules reasonably designed to prevent self-trading by 
market participants, except as specified in paragraph (b) of Sec.  
40.23. ``Self-trading'' is defined for purposes of Sec.  40.23 as the 
matching of orders between accounts that have common beneficial 
ownership or are under common control. A DCM must either apply, or 
provide and require the use of, self-trade prevention tools that are 
reasonably designed to prevent self-trading and are applicable to all 
orders on its electronic trade matching platform. This requirement is 
subject to the proviso in proposed Sec.  40.23(b) that a DCM may, in 
its discretion, implement rules that permit the matching of orders for 
accounts with common beneficial ownership where such orders are 
initiated by independent decision makers. Under Sec.  40.23(b), a DCM 
could also permit the matching of orders for accounts under common 
control where such orders comply with the DCM's cross-trade, minimum 
exposure requirements or similar rules, and are for accounts that are 
not under common beneficial ownership.
    Proposed Sec.  40.23(c) states that a DCM may only permit the self-
trading described in Sec.  40.23(b) if the DCM complies with certain 
requirements, including the requirement under Sec.  40.23(c) that the 
DCM requires market participants to request approval from the DCM that 
self-trade prevention tools not be applied with respect to specific 
accounts under common beneficial ownership or control, on the basis 
that they meet the criteria of Sec.  40.23(b). Finally, proposed Sec.  
40.23(d) would require DCMs to publish statistics on their Web site 
with respect to self-trading activity on their platform. For example, 
each DCM would be required to describe the amount of trading on its 
platform that represents permitted self-trading approved pursuant to 
Sec.  40.23(b).
b. Costs
    The Commission assumes that most, if not all, DCMs currently offer 
self-trade prevention controls or plan to implement them and provide 
them for use by market participants in the near future. FIA recommends 
that DCMs offer such controls,\692\ and several DCMs provide the 
controls, a capability which was introduced, and refined, in recent 
years.\693\ As a result, subject to consideration of relevant comments, 
the Commission preliminarily believes that DCMs would not incur 
additional costs to develop and offer self-trade prevention controls as 
required by Sec.  40.23(a). The Commission has, nonetheless, estimated 
the cost to a DCM that does not currently offer self-trade prevention 
tools to develop and implement such tools for purposes of complying 
with Sec.  40.23(a).
---------------------------------------------------------------------------

    \692\ FIA at 25-27.
    \693\ FIA at 25-27; MFA at 8; Gelber 7-9; AIMA at 10; IATP at 5.
---------------------------------------------------------------------------

    Cost to DCMs to Implement Self-Trade Prevention Tools. The 
Commission estimates that a DCM would incur a total one-time cost of 
$155,520 to implement these Sec.  40.23(a) requirements, in the absence 
of any existing controls. This cost is broken down as follows: 1 
Project Manager, working for 480 hours (480 x $70 = $33,600); 1 
Business Analyst, working for 480 hours (480 x $52 = $24,960); 1 
Tester, working for 480 hours (480 x $52 = $24,960); and 2 Developers, 
working for a combined 960 hours (960 x $75 = $72,000).\694\ 
Notwithstanding these estimates, the Commission believes that the 
requirement under proposed Sec.  40.23(a) that DCMs either apply self-
trade prevention tools, or provide such tools to market participants, 
standardizes existing industry practice. As a result, subject to 
consideration of relevant comments, the Commission preliminarily 
believes that this requirement under Sec.  40.23(a) will not impose 
additional costs on DCMs.
---------------------------------------------------------------------------

    \694\ See section V(B) above for the calculation of hourly wage 
rates used in this analysis.
---------------------------------------------------------------------------

    DCM Review of Approval Requests. DCMs will, however, incur 
additional costs in connection with proposed Sec.  40.23(c). This 
provision requires market participants to request approval from the DCM 
that self-trade prevention tools not be applied with respect to 
specific accounts under common beneficial ownership or control, on the 
basis that they meet the criteria of Sec.  40.23(b). DCMs will incur 
costs to review these Sec.  40.23(c) approval requests. These costs may 
vary significantly depending on the number of approval requests a DCM 
receives. The Commission has therefore estimated the average annual 
costs that a DCM will incur, while acknowledging that DCMs may incur 
lower or higher costs depending on the number of requests received. On 
average, the Commission estimates that, on an annual basis, a DCM will 
incur a cost of $22,000 to review these approval requests. This cost is 
broken down as follows: 1 Senior Compliance Examiner, working for 200 
hours (200 x $58 per hour = $11,600); and 1 Business Analyst, working 
for 200 hours (200 x $52 per hour = $10,400).\695\ The 15 DCMs that 
will be subject to Sec.  40.23(c) would therefore incur a total annual 
cost of $330,000 (15 x 22,000).\696\
---------------------------------------------------------------------------

    \695\ See section V(B) above for the calculation of hourly wage 
rates used in this analysis.
    \696\ See section V(A) above for the calculation of the number 
of persons subject to Regulation AT.
---------------------------------------------------------------------------

    DCM Publication of Statistics Regarding Self-Trade Prevention. In 
addition, DCMs will incur costs to generate and publish the self-trade 
statistics on their Web site required by Sec.  40.23(d). The Commission 
estimates that, on an annual basis, a DCM will incur a cost of $6,650 
to generate and publish these statistics. This cost is broken down as 
follows: 1 Developer, working for 50 hours (50 x $75 per hour = 
$3,750); and 1 Senior Compliance Examiner, working for 50 hours (50 x

[[Page 78919]]

$58 per hour = $2,900).\697\ The 15 DCMs that will be subject to Sec.  
40.23(c) and (d) would therefore incur a total annual cost of $99,750 
(15 x 6,650).\698\ These costs may vary significantly depending on the 
size of a DCM and the number of products it lists for trading.
---------------------------------------------------------------------------

    \697\ See section V(B) above for the calculation of hourly wage 
rates used in this analysis.
    \698\ See section V(A) above for the calculation of the number 
of persons subject to Regulation AT.
---------------------------------------------------------------------------

    As noted above, proposed Sec.  40.23 requires DCMs to apply, or 
provide and require the use of, self-trade prevention tools that are 
reasonably designed to prevent self-trading and are applicable to all 
orders on its electronic trade matching platform. To the extent that a 
DCM offers self-trade prevention tools to market participants, in lieu 
of the DCM internalizing and directly applying these tools, then market 
participants will be required to use these tools. Commenters indicated 
that exchange-provided self-trading controls are widely used by market 
participants.\699\ The FIA PTG Survey indicated that 25 of 26 
responding firms use such controls.\700\ In the event that a market 
participant is required to use self-trade prevention tools in the 
scenario described above, and was not previously using such tools, the 
Commission estimates that the market participant will not incur any 
additional costs beyond those costs already incurred to implement the 
pre-trade risk controls required by Regulation AT.
---------------------------------------------------------------------------

    \699\ FIA at 26; Gelber at 7-9.
    \700\ FIA at 26, 59-60.
---------------------------------------------------------------------------

    Market Participant Approval Requests. Market participants will, 
however, incur additional costs in the event that they prepare and 
submit the approval requests contemplated by Sec.  40.23(c). This 
provision requires market participants to request approval from DCMs on 
which they are active that self-trade prevention tools not be applied 
with respect to specific accounts under common beneficial ownership or 
control. The Commission estimates that, on an annual basis, a market 
participant will incur a total cost of $3,810 to prepare and submit 
these approval requests to the DCMs on which the market participant is 
active. This cost is broken down as follows: 1 Business Analyst, 
working for 30 hours (30 x $52 per hour = $1,560); and 1 Developer, 
working for 30 hours (30 x $75 per hour = $2,250).\701\
---------------------------------------------------------------------------

    \701\ See section V(B) above for the calculation of hourly wage 
rates used in this analysis.
---------------------------------------------------------------------------

    The Commission cannot predict how many market participants would 
likely submit the approval requests contemplated by Sec.  40.23(c) on 
an annual basis. The Commission believes that not all market 
participants trading on a DCM would submit such requests. In the view 
of the Commission, for example, a limited subset of market participants 
will own two or more accounts, but operate them through ``independent 
decision makers'' that initiate orders for ``separate business 
purposes,'' as contemplated by Sec.  40.23(b). Similarly, a limited 
subset of market participants will find it advantageous to incur the 
costs associated with the self-trading described by Sec.  40.23(b), 
such as trading costs and clearing fees. In addition, the Commission 
believes that market participants submitting orders through Algorithmic 
Trading are more likely than traders submitting orders manually to 
inadvertently self-trade through independent decision-makers. The 
Commission estimates that, notwithstanding the fact that the DCM rules 
described in Sec.  40.23(c) are directed to all market participants, 
the number of market participants that will submit the approval 
requests described therein are equivalent to the number of AT Persons 
calculated above (420).\702\ On this basis, the Commission estimates 
that market participants will incur a total annual cost of $1,600,200 
to submit the approval requests contemplated by Sec.  40.23(c) ($3,810 
per market participant x 420 market participants).
---------------------------------------------------------------------------

    \702\ See section V(A) above for the calculation of the number 
of person subject to Regulation AT.
---------------------------------------------------------------------------

c. Benefits
    The Commission notes that, to the extent that DCMs are offering 
self-trade prevention tools and market participants are using them, 
many of the benefits of the proposed rules are already being realized. 
Nonetheless, the Commission has determined to propose rules in the area 
of self-trading that address both intentional and unintentional 
matching of orders for accounts that have common beneficial ownership 
or are under common control, with the goal of benefiting markets and 
market participants. In particular, the proposed rules would codify a 
regulatory baseline for self-trade prevention across DCMs, and provide 
all market participants with enhanced transparency regarding the 
products in which they trade.
    Regulation AT addresses certain self-trading as provided in Sec.  
40.23(a) and (b) (trades between accounts that have common beneficial 
ownership or are under common control, with certain exceptions). At 
their extreme, intentional self-trades, or wash sales, may indicate an 
intent to manipulate a market by creating a false impression of supply 
or demand or distortions in prices. While Section 4c of the CEA 
prohibits wash sales, unintentional self-trades are not specifically 
prohibited under the statute. While existing Commission rules address 
market manipulation, including wash sales, the use of self-trade tools 
(as compared to an electronic market without such controls) can improve 
market functioning, aid firm and market efficiency, and minimize 
unintentional, and often unnecessary, trading by firms that may be 
difficult for firms to track on their own. Absent self-trade controls, 
it has become even more difficult for firms to avoid unintentional 
self-matches due to their use of automated strategies, which make 
trading decisions in isolation from the rest of the firm at very high 
speeds. The Commission preliminarily believes that the proposed rule, 
by standardizing the use of self-trade controls, will ensure that these 
benefits of self-trade controls will be available to all market 
participants. The Commission believes that DCMs are best situated to 
promulgate rules designed to limit the frequency of self-trading on 
their platforms, and to provide disclosure to the marketplace regarding 
the frequency of self-trade activity on their platform.
    Proposed Sec.  40.23(c) requires market participants to request 
approval from DCMs on which they are active that self-trade prevention 
tools not be applied with respect to specific accounts under common 
beneficial ownership or control. The Commission preliminarily believes 
that this rule will benefit the market by providing, to the DCMs, 
additional transparency on the relationships between accounts and 
trading strategies within a firm. In addition, the rule will better 
ensure that firms will apply self-trade prevention tools in a 
consistent manner.
    The Commission preliminarily believes that publication of self-
trade statistics by DCMs (proposed Sec.  40.23(d)) will benefit market 
participants by providing transparency about the frequency of certain 
categories of self-trades on each DCM, which can aid in a better 
understanding of the sources, and characteristics, of liquidity demand 
and supply across futures products.
d. Section 15(a) Factors
    This section discusses the Section 15(a) factors for the new 
proposed requirement (Sec.  40.23) that a DCM shall implement rules 
reasonably designed to prevent self-trading by market participants, 
except as specified in paragraph (b) of Sec.  40.23.

[[Page 78920]]

i. Protection of Market Participants and the Public
    The Commission preliminarily believes that the proposed rule would 
protect market participants and the public by codifying the use of 
self-trade controls and increasing transparency around self-trading as 
required by proposed Sec.  40.23(d). It may also incentivize practices 
that help to reduce the likelihood of wash trades and self-trades.
ii. Efficiency, Competitiveness, and Financial Integrity of Futures 
Markets
    The Commission preliminarily believes that the proposed rule 
standardizing the use of self-trade controls and increasing 
transparency around self-trading would promote the efficiency of the 
markets. The use of self-trade controls may promote financial integrity 
by helping to limit self-trades (including intentional and potentially 
manipulative self-trades). Moreover, requiring that DCMs provide self-
trade controls and that market participants use them may enhance 
competitiveness by preventing a race to the bottom; that is, 
eliminating the possibility that a DCM or market participant could 
elect not to require or implement self-trade prevention in order to 
gain competitive advantage.
iii. Price Discovery
    The proposed rule may protect and enhance the price discovery 
process by standardizing the use of self-trade controls and increasing 
transparency around self-trading.
iv. Sound Risk Management Practices
    The proposed rule may promote sound risk management practices since 
self-trade controls (which the rule codifies) give market participants 
greater ability to avoid unintentional self-trading that could expose 
them to various financial risks.
v. Other Public Interest Considerations
    The Commission has not identified any effects that these proposed 
rules would have on other public interest considerations other than 
those addressed above.
e. Consideration of Alternatives
    Proposed Sec.  40.23 provides that DCMs may comply with the 
requirement to apply, or provide and require the use of, self-trade 
prevention tools by requiring market participants to identify to the 
DCM which accounts should be prohibited from trading with each other. 
With respect to this account identification process, the Commission's 
principal goal is to address unintentional self-trading; the Commission 
does not have a specific interest in regulating the manner by which 
market participants identify to DCMs the accounts that should not trade 
with each other, so long as this goal is met. The Commission has 
requested comment on whether other identification methods should be 
permitted in Sec.  40.23. For example, the Commission has requested 
comment on whether the opposite approach is preferable: market 
participants would identify to DCMs the accounts that should be 
permitted to trade with each other (as opposed to those accounts that 
should be prevented from trading with each other). The Commission has 
also asked for comment on whether other identification methods would 
reduce costs for market participants or be easier for both market 
participants and DCMs to administer. Upon consideration of comments, 
the Commission may choose to adopt these other methods in lieu of what 
is now proposed.
f. Request for Comments
    151. Please comment on the cost estimates described above for DCMs 
and market participants to comply with the requirements of Sec.  40.23. 
The Commission is interested in commenter opinion on all aspects of its 
analysis, including its estimate of the number of entities impacted by 
the proposed regulation and the amount of costs such entities may incur 
to comply with the regulation.
    152. Please comment on the benefits described above. Do you agree 
with the Commission's position that self-trade prevention requirements 
will result in more accurate indications of the level of market 
interest on both sides of the market and help ensure arms-length 
transactions that promote effective price discovery? Are there 
additional benefits to regulatory self-trade prevention requirements 
not articulated above?
    153. Are there any DCMs that neither internalize and apply self-
trade prevention tools, nor provide self-trade prevention tools to 
their market participants? If so, please provide an estimate of the 
cost to such a DCM to comply with the requirement under Sec.  40.23(a) 
to apply, or provide and require the use of, self-trade prevention 
tools.
    154. Would any DCMs that currently offer self-trade prevention 
tools need to update their tools to meet the requirements of Sec.  
40.23? If so, please provide an estimate of the cost to such a DCM to 
comply with the requirements of Sec.  40.23.
    155. What percentage of market participants do not currently make 
use of exchange-provided self-trade prevention tools, when active on a 
DCM that provides, but does not require such tools? Please provide an 
estimate of the cost to such a market participant to initially 
calibrate and use exchange-provided self-trade prevention tools, in 
accordance with Sec.  40.23. Please also comment on any other direct or 
indirect costs to a market participant that does not currently use 
self-trade prevention tools arising from the proposed requirement to 
implement such tools.
    156. The Commission estimates above that the number of market 
participants that will submit the approval requests described by Sec.  
40.23(c) is approximately equivalent to the number of AT Persons. 
Please comment on whether the estimate of the number of market 
participants submitting such approval requests should be higher or 
lower. For example, should the estimate be raised to account for 
proprietary algorithmic traders that will not be AT Persons, because 
they do not use Direct Electronic Access and therefore will not be 
required to register as floor traders?
    157. Proposed Sec.  40.23 provides that DCMs may comply with the 
requirement to apply, or provide and require the use of, self-trade 
prevention tools by requiring market participants to identify to the 
DCM which accounts should be prohibited from trading with each other. 
With respect to this account identification process, the Commission's 
principal goal is to prevent unintentional self-trading; the Commission 
does not have a specific interest in regulating the manner by which 
market participants identify to DCMs the account that should be 
prohibited from trading from each other, so long as this goal is met. 
Should any other identification methods be permitted in Sec.  40.23? 
For example, please comment on whether the opposite approach is 
preferable: market participants would identify to DCMs the accounts 
that should be permitted to trade with each other (as opposed to those 
accounts that should be prevented from trading with each other). In 
particular, please comment on whether this approach or other 
identification methods would reduce costs for market participants or be 
easier for both market participants and DCMs to administer.
    158. The Commission requests comment on its discussion of the 
effects of the proposed rules on the considerations in Section 15(a) of 
the CEA.

[[Page 78921]]

11. Market-Maker and Trading Incentive Programs
a. Summary of Proposed Rules
    The Commission is proposing new regulations in part 40 to increase 
transparency around DCM market-maker and trading incentive programs, 
underline existing regulatory expectations, and introduce basic 
safeguards in the conduct of such programs. The proposed regulations 
would amend existing Sec.  40.1(i), which applies to all registered 
entities, to make clear that market-maker and trading incentive 
programs are ``rules'' for purposes of part 40, and therefore subject 
to part 40's rule filing requirements. They would also establish 
information requirements when DCMs file rules for Commission approval 
pursuant to existing Sec.  40.5 or self-certify rules pursuant to 
existing Sec.  40.6. Information requirements would be codified in 
proposed Sec.  40.25, including Sec.  40.25(a) for information to be 
provided to the Commission and Sec.  40.25(b) specifying information 
that must be available on a DCM's public Web site. Relatedly, proposed 
Sec.  40.26 would permit the Commission or the director of DMO to 
require certain information from DCMs regarding their market-maker or 
trading incentive programs, including but not limited to copies of 
program agreements, names of program participants, and payments or 
other benefits conferred pursuant to a program.
    The most substantive provisions of the Commission's proposed rules 
for market-maker and trading incentive programs are in new Sec.  
40.27(a). Proposed Sec.  40.27(a) would codify DMO's long-standing 
guidance to DCMs that market-maker and trading incentive programs 
should not provide payments or incentives for trades between accounts 
under common ownership. Finally, the proposed regulations would also 
make clear in Sec.  40.28 that DCMs' existing trade practice and market 
surveillance responsibilities in subparts C and E of part 38 apply 
equally to market-maker and trading incentive programs.
b. Costs
i. Rule 40.1(i)--Definition of ``Rule''; and Rule 40.26--Information 
Requests From the Commission or the Director of the Division of Market 
Oversight
    Proposed amendments to Sec.  40.1 and new Sec.  40.26 serve in 
large part to emphasize existing regulatory requirements and Commission 
or staff authorities. As such, they are not expected to impose 
meaningful costs on DCMs. While they may in some cases impose minor 
incremental costs, they should not require entirely new programs, 
systems, or categories of employees for DCMs that are already compliant 
with parts 38 and 40 of the Commission's regulations.
    The Commission proposes to amend Sec.  40.1(i) to make clear that 
market-maker and trading incentive programs are ``rules'' for purposes 
of part 40. This codification of a previously articulated Commission 
standard with broad industry-wide acceptance should not give rise to 
new costs for market participants. The Commission has previously stated 
its view, in a Final Rule regarding Provisions Common to Registered 
Entities, that a market-maker or trading incentive program is an 
``agreement'' corresponding to ``trading protocol'' as such terms are 
used within Sec.  40.1(i)'s existing definition of ``rule.'' \703\ In 
the same Final Rule, the Commission stated that ``all market maker and 
trading incentive programs must be submitted to the Commission in 
accordance with the procedures established in part 40.'' \704\ DCMs, 
for example, certify numerous market-maker and trading incentive 
programs to the Commission annually, including 341 such self-
certifications in 2013. For these and other rule filings, DCMs already 
employ corresponding staff and other resources to comply with their 
part 40 obligations. The proposed amendments to Sec.  40.1(i) do not 
create a new category of rule filings, nor do they require more 
frequent filings. Furthermore, the proposed amendments would require no 
additional staff or other resources beyond those already in place to 
meet existing rule filing requirements in part 40. Accordingly, the 
Commission believes that the proposed amendments to Sec.  40.1(i) will 
impose no additional costs on the registered entities to which it 
applies.
---------------------------------------------------------------------------

    \703\ See Final Rule, Provisions Common to Registered Entities, 
76 FR 44776, 44778 (July 27, 2011), where the Commission stated, 
specifically with respect to DCMs, that ``[a] DCM's rules 
implementing market maker and trading incentive programs fall within 
the Commission's oversight authority.''
    \704\ See id.
---------------------------------------------------------------------------

    Proposed Sec.  40.26 is a new regulatory provision that would 
permit the Commission or the director of DMO to require certain 
information from DCMs regarding their market-maker or trading incentive 
programs. As with Sec.  40.1(i), the Commission believes that proposed 
Sec.  40.26 will impose no additional costs on DCMs. The proposed 
regulation is a more targeted iteration of existing Sec.  38.5, which 
requires a DCM to file with the Commission such ``information related 
to its business as a designated contract market'' as the Commission may 
require. Section 38.5 also requires a DCM upon request by the 
Commission or the director of DMO to file ``a written demonstration'' 
that the DCM ``is in compliance with one or more core principles as 
specified in the request'' or ``satisfies its obligations under the 
Act,'' including ``supporting data, information and documents.''
    Proposed Sec.  40.26 does not alter a DCM's existing obligations 
under Sec.  38.5, but rather makes clear that Commission and DMO 
information requests may pertain specifically to market-maker and 
trading incentive programs. It also provides a non-exhaustive list of 
the types of ``supporting data, information and documents'' that the 
Commission or the director of DMO may request that is particularly 
appropriate to market-maker and trading incentive programs. Proposed 
Sec.  40.26 imposes no new obligation to provide information, and does 
not increase the frequency which information must be provided. The 
Commission is aware that DCMs already employ legal, business, 
technology, and other staff and resources necessary to respond to Sec.  
38.5 information requests. The Commission believes that the same staff 
will be appropriate for any Sec.  40.26 information request that it may 
issue to focus specifically on market-maker or trading incentive 
programs. Accordingly, the Commission believes that proposed Sec.  
40.26 will impose no additional costs on DCMs.
ii. Rule 40.25--Additional Public Information Required for Market Maker 
and Trading Incentive Programs; and Rule 40.28--Surveillance of Market 
Maker and Trading Incentive Programs
    Proposed Sec.  40.25(a) would require DCMs to provide the 
Commission with certain information regarding their market-maker and 
trading incentive programs when submitting such programs as rules 
pursuant to part 40. Specifically, when requesting approval of a new 
program pursuant to Sec.  40.5, or self-certifying a program pursuant 
to Sec.  40.6, DCMs would be required to provide the name of the 
program, the date on which it begins, and the date on which it 
terminates (if applicable). DCMs would also be required to provide a 
description of any categories of market participants or eligibility 
criteria limiting who may participate in the program. For any market-
maker or trading incentive program open to only some market 
participants, proposed Sec.  40.25(a) would require DCMs to explain why 
the program was limited to the chosen participants or criteria. 
Proposed Sec.  40.25(a) would also require DCMs to include in their 
rule filings an

[[Page 78922]]

explanation of how persons eligible for a market-maker or trading 
incentive program would apply to participate, and how eligibility would 
be evaluated by the DCM.
    Separately, proposed Sec.  40.25(a) would require DCMs to provide 
an explanation of the specific purpose for a market-maker or trading 
incentive program, and a list of all products or services to which the 
program applies. It would also require a description of any payments, 
incentives, discounts, considerations, inducements or other benefits 
that program participants may receive, including any non-financial 
incentives. Finally, proposed Sec.  40.25(a) would require a 
description of the obligations, benchmarks, or other measures that 
participants in a market-maker or trading incentive program must meet 
to receive benefits.
    To ensure public transparency in market-maker and trading incentive 
programs, proposed Sec.  40.25(b) would enlarge upon DCMs' existing 
obligations in part 40 to provide public notice and other information 
regarding their rule filings. Specifically, proposed Sec.  40.25(b) 
would require DCMs to ensure that the information described above in 
Sec.  40.25(a) is easily located on their public Web sites. Lastly, 
proposed Sec.  40.25(c) would require DCMs to notify the Commission 
upon the termination of a market maker or trading incentive program.
    While proposed Sec.  40.25 would require information from DCMs 
regarding their market-maker or trading incentive programs, the 
Commission believes it largely incorporates existing rule filing 
requirements in part 40. For example, existing Sec. Sec.  40.5 and 40.6 
each require a DCM requesting approval or self-certifying rules to 
provide the Commission with the rule text; the proposed effective date 
or date of intended implementation; and an ``explanation and analysis 
of the operation, purpose, and effect'' of the proposed rule. Existing 
Sec. Sec.  40.5 and 40.6 also require each DCM to provide the 
Commission with an assessment of the rule's ``compliance with 
applicable provisions of the Act, including core principles, and the 
Commission's regulations thereunder;'' and ``a brief explanation of any 
substantive opposing views expressed to [the DCM] by governing board or 
committee members, members of the entity or market participants that 
were not incorporated into the rule. . . . '' Furthermore, these 
existing provisions each require a DCM to certify that the DCM posted 
on its public Web site a notice of pending rule or certification and to 
also post a copy of the DCM's submission to the Commission on the DCM's 
Web site.
    The Commission believes proposed Sec.  40.25 adds important clarity 
to existing rule filing requirements in part 40 when such filings 
pertain to market-maker or trading incentive programs. However, it also 
recognizes important overlaps between proposed Sec.  40.25 and existing 
regulations in Sec. Sec.  40.5 and 40.6. Furthermore, proposed Sec.  
40.25 does not create a new category of rule filings, nor does it or 
require more frequent filings. For these reasons, the Commission 
believes that additional costs to DCMs attributable to Sec.  40.25 will 
not be significant. As an example of such costs, DCMs will need to 
evaluate Sec.  40.25 and assess whether and what filings must be made 
to comply with the regulation. In addition, the more explicit 
requirements of proposed Sec.  40.25, as compared to existing 
regulations, may prompt DCMs to make filings that they otherwise may 
not have made. The Commission estimates the costs of proposed Sec.  
40.25 per DCM as described below.
    The Commission believes that the work of proposed Sec.  40.25 will 
fall primarily upon DCM Compliance Attorneys already employed in 
completing part 40 rule filings. The Commission estimates that a DCM 
(through its Compliance Attorneys) will incur a total annual cost of 
$14,976 to comply with proposed Sec.  40.25. This cost is broken down 
as follows: 1 Compliance Attorney, working for 156 hours \705\ (156 x 
$96 per hour = $14,976).\706\ On average, the 15 DCMs to which proposed 
Sec.  40.25 would apply would therefore incur a total annual cost of 
$224,640 (15 x $14,976) to comply with proposed Sec.  40.25. The 
Commission notes, however, that actual costs per DCM may vary depending 
on the number of market-maker and trading incentive program rule 
filings submitted by an individual DCM on an annual basis.
---------------------------------------------------------------------------

    \705\ The Commission estimates that a Compliance Attorney will 
be required to spend an additional three hours per week over the 
course of a 52 week year to comply with proposed Sec.  40.25. Such 
hours are additional because DCMs are already required to provide 
substantial information regarding market-maker and trading incentive 
program rule filings pursuant to existing requirements in Sec. Sec.  
40.5 and 40.6 as discussed above. Three additional hours per week 
across a 52 week year yields approximately 156 additional hours per 
year per DCM to comply with proposed Sec.  40.25.
    \706\ See section V(B) above for the calculation of hourly wage 
rates used in this analysis.
---------------------------------------------------------------------------

    Finally, proposed Sec.  40.28 requires that a DCM, ``consistent 
with its obligations pursuant to subparts C and E of part 38 . . . 
review all benefits accorded to participants in market maker and 
trading incentive programs . . . to ensure that such benefits are not 
earned through abusive practices.'' Notably, the proposed regulation 
points to preexisting requirements in the Commission's rules--and to 
costs that DCMs must already assume independently of proposed Sec.  
40.28. Subpart C of part 38, entitled ``Compliance with Rules,'' 
requires DCMs to prohibit abusive trading practices on its markets by 
all members and market participants, including but not limited to a 
series of enumerated trade practice violations. It also requires DCMs 
to have the capacity to detect and investigate rule violations, 
including sufficient compliance staff and resources, automated trade 
surveillance systems, and real-time market monitoring. Subpart E, 
``Prevention of Market Disruptions,'' requires DCMs to ``collect and 
evaluate data on individual traders' market activity on an ongoing 
basis in order to detect and prevent manipulation, [and] price 
distortions.'' In addition, subpart E requires a DCM to have the 
ability to ``comprehensively and accurately'' reconstruct trading on 
its markets, obtain information from its market participants, and 
implement additional requirements for cash-settled and physically-
settled contracts.
    Proposed Sec.  40.28 does not add to the oversight responsibilities 
outlined above, but rather makes clear that a DCM's existing 
obligations in subparts C and E of part 38 apply equally in the context 
of market-maker and trading incentive programs. The Commission believes 
that proposed Sec.  40.28 will impose no significant new costs on DCMs, 
but acknowledges that it may result in minor administrative costs. 
Specifically, a DCM not already doing so will be required to ensure 
appropriate communication between its compliance staff tasked with 
detecting abusive practices and its business staff that may administer 
the DCM's market-maker or trading incentive programs. For example, in 
the case of an incentive program based on a market participant's gross 
trading volume, compliance staff would be required to inform business 
staff of trades that should not be credited towards the incentive 
program because they were conducted in violation of an exchange rule. 
The Commission believes that the costs associated with proposed Sec.  
40.28 are not significant due in part to DCMs' existing surveillance 
capabilities, which are typically highly automated.
    The Commission estimated the costs of complying with proposed Sec.  
40.28. In making its estimates, the Commission determined that the 
primary costs associated with the regulation will be communication 
between a DCM's

[[Page 78923]]

compliance and business staffs. The Commission estimates that a DCM 
will incur a total annual cost of $12,710 to comply with proposed Sec.  
40.28. This cost is broken down as follows: 1 Compliance Attorney, 
working for 62 hours (62 x $96 per hour = $5,952); 1 Senior Compliance 
Specialist, working for 62 hours (62 x $57 per hour = $3,534); and 1 
Business Analyst, working for 62 hours (62 x $52 per hour = 
$3,224).\707\ In the event that no DCM is currently in compliance with 
proposed Sec.  40.28, the 15 DCMs to which proposed Sec.  40.28 would 
apply would therefore incur a total annual cost of $190,650 (15 x 
$12,710) to comply with proposed Sec.  40.28.\708\
---------------------------------------------------------------------------

    \707\ See section V(B) above for the calculation of hourly wage 
rates used in this analysis.
    \708\ The Commission estimates that each such staff person will 
be required to dedicate approximately 1 hour per week over the 
course of a 52 week year, yielding approximately 52 hours per year. 
The Commission is increasing these estimates by an additional 20 
percent to account for more complicated circumstances that may 
arise. This yields a total of approximately 62 hours per year for 
each relevant staff role.
---------------------------------------------------------------------------

iii. Rule Sec.  40.27--Payment for Trades With No Change in Ownership 
Prohibited
    The Commission is also proposing new Sec.  40.27(a) to require that 
DCMs implement policies and procedures reasonably designed to prevent 
the payment of market-maker or trading incentive payments for trades 
between accounts identified to the DCM as under common beneficial 
common ownership or known to the DCM as under common ownership. 
Proposed Sec.  40.27(a) is consistent with guidance provided to DCMs by 
the Commission that incentive payments should not be made for ``self-
trades.'' In this regard, the proposed regulation ratifies staff's 
previous guidance \709\ and further develops the Commission's 
expectations regarding appropriate uses of market-maker and trading 
incentive programs. However, because the subject matter of proposed 
Sec.  40.27(a) is not explicitly addressed in existing regulations, the 
Commission is analyzing it as an entirely new cost to DCMs for this 
purpose.
---------------------------------------------------------------------------

    \709\ See Final Rule, Provisions Common to Registered Entities, 
76 FR 44776, 44778.
---------------------------------------------------------------------------

    The Commission believes that the costs associated with proposed 
Sec.  40.27(a) will be administrative in nature. DCMs will be required 
to implement policies and procedures reasonably designed to ensure that 
self-trades permitted pursuant to Sec.  40.23 nonetheless do not 
receive market-maker or trading incentives payments, discounts or other 
considerations. DCMs will also be required to implement policies and 
procedures reasonably designed to ensure that any other self-trades 
known to the DCM do not receive market-maker or trading incentive 
payments, discounts or other considerations.
    The Commission believes a DCM could efficiently implement proposed 
Sec.  40.27(a) by requiring the DCM's compliance staff (Senior 
Compliance Specialist) to periodically provide its business staff 
(Business Analyst) with summary statistics regarding self-trades by 
market participants. Business Analysts responsible for administering a 
market-maker or trading incentive program could then discount such 
trades from any payments, benefits, or other considerations made 
pursuant to a program. Reports regarding self-trades could be automated 
at the DCM's discretion. When necessary, Senior Compliance Specialists 
could collaborate with the DCM's legal staff (Compliance Attorney) to 
address instances in which the existence of a self-trade is unclear. 
Similarly, Business Analysts could collaborate with legal or compliance 
counterparts where a market participant challenges the DCM's 
determinations or payments. The Commission believes that a similar 
process of information flow to Business Analysts administering 
payments, benefits, or other considerations pursuant to a market-maker 
or trading incentive program would also be appropriate to implement 
proposed Sec.  40.27(a). The Commission estimates the costs of 
compliance as described below.
    The Commission estimates that a DCM will incur a total annual cost 
of $30,108 to comply with proposed Sec.  40.27(a). This cost is broken 
down as follows: 1 Compliance Attorney, working for 52 hours (52 x $96 
per hour = $4,992); 1 Senior Compliance Specialist, working for 156 
hours (156 x $57 per hour = $8,892); and 1 Business Analyst, working 
for 312 hours (312 x $52 per hour = $16,224).\710\ The 15 DCMs to which 
proposed Sec.  40.27(a) would apply would therefore incur a total 
annual cost of $451,620 (15 x $16,224) to comply with proposed Sec.  
40.27(a).\711\
---------------------------------------------------------------------------

    \710\ See section V(B) above for the calculation of hourly wage 
rates used in this analysis.
    \711\ The Commission estimates that a Compliance Attorney will 
require 1 hour per week, a Senior Compliance Specialist will require 
3 hours per week, and a Business Analyst will require 6 hours per 
week, in each case over the course of a 52 week year.
---------------------------------------------------------------------------

c. Benefits
    The Commission anticipates that the proposed amendments to Sec.  
40.1(i) and new Sec. Sec.  40.25-40.28 will facilitate Commission 
oversight; increase public transparency; and help ensure market-maker 
and trading incentive programs that are compliant with the Act and 
Commission regulations. The proposed rules are consistent with existing 
regulatory expectations. To the extent that they impose requirements 
beyond those of existing Commission regulations and to the extent that 
DCMs are currently not in compliance with the proposed rules, the 
Commission expects the rules to increase transparency around DCM 
market-maker and trading incentive programs, and introduce basic 
safeguards in the conduct of such programs. Building on the Dodd-Frank 
Act, the Commission adopted in June 2012 core principles and final 
rules modernizing the regulatory regime applicable to all DCMs (``DCM 
Final Rules''). Among other areas, the DCM Final Rules emphasized DCMs' 
obligations as the front-line regulators of their markets. These 
include extensive trade practice responsibilities pursuant to subpart C 
of part 38, and market surveillance responsibilities pursuant to 
subpart E. In addition, the Commission codified new requirements that a 
DCM offer its ``members [and] persons with trading privileges . . . 
with impartial access to its markets and services,'' including: (1) 
``Access criteria that are impartial, transparent and applied in a non-
discriminatory manner'' and (2) ``comparable fee structures . . . for 
equal access to, or services from'' the DCM.
    Substantively, the Commission believes that the proposed 
regulations for market-maker and trading incentive programs will help 
facilitate Commission oversight by eliminating any potential ambiguity 
that may exist regarding its authority over such programs. Proposed 
amendments to the definition of ``rule'' in Sec.  40.1(i), in 
particular, will codify previous statements by the Commission regarding 
the treatment of market-maker and trading incentive programs as 
``rules'' pursuant to part 40, which statements however were not 
explicitly reflected in existing Sec.  40.1(i). Proposed Sec.  40.25 
will enhance the types of information that DCMs should expect to 
provide the Commission when requesting approval or self-certifying 
market-maker or trading incentive programs. Such information will 
include a description of any eligibility criteria for participation in 
a market-maker or trading incentive program, and an explanation for 
programs with limited eligibility. Proposed Sec.  40.25 will also 
require that information regarding

[[Page 78924]]

market-maker and trading incentive programs be easily located on a 
DCM's Web site. Taken together, these measures will for example 
facilitate the Commission's oversight of DCMs' compliance with 
impartial access and comparable fee structure requirements in Sec.  
38.151(b) adopted by the Commission in 2012.
    Proposed Sec.  40.27(a) is designed to promote market integrity and 
to discourage abusive trading practices. The Commission believes it is 
imperative that market participants are not incentivized to trade 
solely for the purpose of collecting market-maker or trading incentive 
program benefits. Trading for the sake of collecting such benefits may, 
for example, inaccurately signal the level of liquidity in the market 
and may result in a non-bona fide price. Key public statistics 
published by DCMs regarding trades, orders, and other measures of 
liquidity on their markets must not be inflated through trading 
strategies that may be violative of DCM or Commission rules and that 
are designed solely to collect incentives or to meet market-maker 
program requirements. For example, the Commission seeks to eliminate 
incentives that may encourage market participants to engage in illegal 
behavior such as wash trading, which is prohibited under the CEA and 
Commission regulations.\712\
---------------------------------------------------------------------------

    \712\ See Section 4c(a) of the CEA, 7 U.S.C. 6c(a)(2)(A), and 
Commission regulation 1.38(a).
---------------------------------------------------------------------------

d. Section 15(a) Factors
    This section discusses the Section 15(a) factors for the proposed 
new regulations in part 40 to increase transparency around DCM market-
maker and trading incentive programs, underline existing regulatory 
expectations, and introduce basic safeguards in the conduct of such 
programs. The proposed regulations would amend existing Sec.  40.1(i) 
and create new Sec. Sec.  40.25- 40.28.
i. Protection of Market Participants and the Public
    The Commission preliminarily believes that the proposed rule would 
protect market participants and the public by eliminating potential 
ambiguity that may exist regarding the Commission's expectations and 
requirements with respect to market-maker and trading incentive 
programs and by guarding against such programs incentivizing self-
trading. By so doing, the proposed rules would help ensure that volume 
reports accurately reflect levels of bona fide risk shifting 
transactions activity rather than self-trades. It may also reduce the 
frequency of self-trades, and eliminate incentives that may encourage 
market participants to engage in illegal behavior such as wash trading, 
by prohibiting market-maker or trading incentive program payments for 
transactions involving accounts under common ownership.
ii. Efficiency, Competitiveness, and Financial Integrity of Futures 
Markets
    The Commission preliminarily believes that the proposed rule would 
promote the efficiency, competitiveness and financial integrity of 
futures markets by clarifying Commission requirements and expectations 
regarding market-maker and trading incentive programs. The proposed 
rule regarding payments to accounts with common ownership may reduce 
incentives to self-trade and thus may also help further ensure (beyond 
the rules related to self-trades also being proposed in this release) 
that market volumes reflect only trades that shift risk between 
different counterparties and thus accurately reflect supply and demand 
in the market and true market liquidity. The proposed rule regarding 
payments to accounts with common ownership may promote financial 
integrity by helping to prevent intentional self-trades (wash trades) 
that could lead to price distortions.
iii. Price Discovery
    The Commission expects that the proposed rule regarding payments to 
accounts with common ownership to protect and enhance the price 
discovery process by helping to prevent intentional self-trades (wash 
trades) that could lead to price distortions. The proposed rules also 
would make clear Commission requirements designed to prevent market-
maker and trading incentive programs from interfering with or doing 
harm to the price discovery process.
iv. Sound Risk Management Practices
    The proposed rule regarding payments to accounts with common 
ownership may promote sound risk management practices by helping to 
ensure that market-maker and trading incentive programs do not 
incentivize self-trades or wash trades. The proposed rules also would 
make clear Commission requirements designed to prevent market-maker and 
trading incentive programs from deterring sound risk management 
considerations.
v. Other Public Interest Considerations
    The Commission has not identified any effects that these proposed 
rules would have on other public interest considerations other than 
those addressed above.
e. Consideration of Alternatives
    As discussed, the proposed rules regarding market-maker and trading 
incentive programs largely refer to and clarify the Commission's 
existing rules and guidance and make Commission expectations more clear 
to new and existing DCMs. The Commission considered not proposing these 
rules. Absent these rules, the Commission could still realize many of 
the benefits by enforcing the existing regulations, but it would be 
more difficult to ensure that DCMs provide information regarding 
market-maker and trading incentive programs prominently on their Web 
sites. Moreover, absent the proposed rule, there would only be guidance 
rather than a rule regarding payments for self-trades. The Commission 
has determined to propose these rules to provide increased regulatory 
certainty to DCMs and market participants regarding market-maker and 
trading incentive programs and to ensure that such programs do not 
permit self-trade payments.
f. Request for Comments
    159. The Commission requests comment on the accuracy of its cost 
estimates.
    160. To what extent are the costs imposed on the DCMs by the 
proposed rule already incurred pursuant to existing rules?
    161. To what extent are the benefits of the proposed rule currently 
being realized?
    162. Do DCM Web sites currently provide adequate information 
regarding market-maker and trading incentive programs, and is such 
information easily located?
    163. To what extent do DCMs currently make payments for self-trades 
pursuant to market-maker and trading incentive programs?
    164. The Commission requests comment on its discussion of the 
effects of the proposed rules on the considerations in Section 15(a) of 
the CEA.

VI. Aggregate Estimated Cost of Regulation AT

    Summarizing the cost estimates presented above, the Commission 
estimates that Regulation AT will impose the following costs on persons 
subject to its rules. These costs are broken into one-time costs for 
initial compliance, and annual costs following thereafter. As discussed 
in section V above, the Commission calculated costs for certain risk 
mitigation procedures,

[[Page 78925]]

but determined that they generally will not be imposed upon market 
participants because, among other reasons, they relate to procedures or 
controls that are already widely used in the industry.\713\ The two 
charts below do not include such costs.
---------------------------------------------------------------------------

    \713\ See, e.g., the calculation of costs for procedures related 
to the testing, monitoring and supervision of Algorithmic Trading 
systems, which are discussed in section V(E)(7) above. These costs 
are not included in the charts in this section VI.
---------------------------------------------------------------------------

    In addition, as noted above, the Commission believes that the risk 
controls and other measures required by Sec. Sec.  1.80 and 1.82 are 
already widely used by market participants. Upgrading such systems to 
come into full compliance with the proposed regulations will impose 
initial one-time costs, which are included in the one-time costs chart 
below. However, the Commission believes that because market 
participants already have these systems in place, the proposed 
regulations will generally not result in increased annual costs to 
maintain such systems.
---------------------------------------------------------------------------

    \714\ See supra note 597.
---------------------------------------------------------------------------

    One-time costs:

----------------------------------------------------------------------------------------------------------------
                                                                                     Cost per      Cost for all
                 Regulation                              Description                  entity         entities
----------------------------------------------------------------------------------------------------------------
                                        New Floor Traders (100 Entities)
----------------------------------------------------------------------------------------------------------------
1.3(x)/170.18 \714\........................  Registration of new floor traders              $200         $20,000
                                              with CFTC and as members of RFA--
                                              Form 7-R Fee.
1.3(x)/170.18..............................  Registration of new floor traders                96           9,600
                                              with CFTC and as members of RFA--
                                              preparation of Form 7-R.
1.3(x)/170.18..............................  Registration of new floor traders               850          85,000
                                              with CFTC and as members of RFA--
                                              Form 8-R Fee for 10 principals.
1.3(x)/170.18..............................  Registration of new floor traders               960          96,000
                                              with CFTC and as members of RFA--
                                              preparation of Form 8-R for 10
                                              principals.
                                                                                 -------------------------------
    Total New Floor Traders................  ...................................           2,106         210,600
----------------------------------------------------------------------------------------------------------------
                                            AT Persons (420 Entities)
----------------------------------------------------------------------------------------------------------------
1.80.......................................  Risk controls......................          79,680      33,465,600
1.83(c)....................................  Recordkeeping......................           5,130       2,154,600
                                                                                 -------------------------------
    Total AT Persons.......................  ...................................          84,810      35,620,200
----------------------------------------------------------------------------------------------------------------
                                       Clearing Member FCMs (57 Entities)
----------------------------------------------------------------------------------------------------------------
1.82.......................................  Risk controls--DEA orders..........          49,800       2,838,600
1.82.......................................  Risk controls--non-DEA orders......         159,360       9,083,520
1.83(d)....................................  Recordkeeping......................           5,130         292,410
                                                                                 -------------------------------
    Total Clearing Member FCMs.............  ...................................         214,290      12,214,530
----------------------------------------------------------------------------------------------------------------
                                               DCMs (15 Entities)
----------------------------------------------------------------------------------------------------------------
38.255(b)..................................  Provide controls to FCMs...........         155,520       2,332,800
40.20......................................  Risk controls......................         155,520       2,332,800
40.22(c)...................................  Establish compliance report review           37,000         555,000
                                              program.
                                                                                 -------------------------------
    Total DCMs.............................  ...................................         348,040       5,220,600
                                                                                 -------------------------------
    Total All Entities.....................  ...................................  ..............      53,265,930
----------------------------------------------------------------------------------------------------------------

    Annual costs:

----------------------------------------------------------------------------------------------------------------
                                                                                     Cost per      Cost for all
                 Regulation                              Description                  entity         entities
----------------------------------------------------------------------------------------------------------------
                                        New Floor Traders (100 Entities)
----------------------------------------------------------------------------------------------------------------
170.18.....................................  RFA annual membership dues (payable          $5,625        $562,500
                                              first year of membership and each
                                              year after).
                                                                                 -------------------------------
    Total New Floor Traders................  ...................................           5,625         562,500
----------------------------------------------------------------------------------------------------------------
                                            AT Persons (420 Entities)
----------------------------------------------------------------------------------------------------------------
1.83(a)....................................  Submit compliance reports/written             4,240       1,780,800
                                              policies.
1.83(c)....................................  Recordkeeping......................           2,670       1,121,400
40.23......................................  Submit approval requests to DCMs to           3,810       1,600,200
                                              forego self-trade controls.
                                                                                 -------------------------------
    Total AT Persons.......................  ...................................          10,720       4,502,400
----------------------------------------------------------------------------------------------------------------

[[Page 78926]]

 
                                       Clearing Member FCMs (57 Entities)
----------------------------------------------------------------------------------------------------------------
1.83(b)....................................  Submit compliance reports..........           7,090         404,130
1.83(d)....................................  Recordkeeping......................           2,670         152,190
                                                                                 -------------------------------
    Total Clearing Member FCMs.............  ...................................           9,760         556,320
----------------------------------------------------------------------------------------------------------------
                                               DCMs (15 Entities)
----------------------------------------------------------------------------------------------------------------
38.401.....................................  Disclosure of trade matching                 19,200         288,000
                                              programs.
40.22(c)...................................  Review of compliance reports.......         111,000       1,665,000
40.22(c)...................................  Remediation of compliance reports..          22,200         333,000
40.22(e)...................................  Review books and records...........         110,880       1,663,200
40.23(c)...................................  Review approval requests from                22,000         330,000
                                              market participants re self-
                                              trading.
40.23(d)...................................  Publish statistics on self-trading.           6,650          99,750
40.25......................................  Provide information on market maker          14,976         224,640
                                              programs in rule filings.
40.27......................................  Restrictions on payments under               30,108         451,620
                                              marker maker programs.
40.28......................................  Surveillance of market maker                 12,710         190,650
                                              programs for abusive practices.
                                                                                 -------------------------------
    Total DCMs.............................  ...................................         349,724       5,245,860
                                                                                 -------------------------------
    Total All Entities.....................  ...................................  ..............      10,867,080
----------------------------------------------------------------------------------------------------------------

    The Commission is also presenting the following costs applicable to 
an RFA pursuant to proposed Sec.  170.19. The Commission anticipates 
that an RFA will incur these costs on an episodic basis in connection 
with Sec.  170.19.
    Episodic costs:

----------------------------------------------------------------------------------------------------------------
                                                                                     Cost per      Cost for all
                 Regulation                              Description                  entity         entities
----------------------------------------------------------------------------------------------------------------
                                                 RFAs (1 Entity)
----------------------------------------------------------------------------------------------------------------
170.19.....................................  RFA Standards......................         $34,200         $34,200
                                                                                 -------------------------------
    Total RFAs.............................  ...................................          34,200          34,200
----------------------------------------------------------------------------------------------------------------

VII. List of All Questions in the NPRM

    Listed below are all questions raised in the preceding sections of 
this NPRM, organized according to the section of the NPRM in which the 
question appears. The Commission welcomes any and all comments on any 
aspect of Regulation AT regardless of whether it is addressed by a 
particular question. If responding to a specific question enumerated in 
this NPRM, the Commission requests that commenters in their comment 
letters refer to that question being answered.

IV(D) Codification of Defined Terms

``Algorithmic Trading''--Sec.  1.3(zzzz)
    1. Is the Commission's definition of ``Algorithmic Trading'' 
generally consistent with what algorithmic trading is understood to 
mean in the industry? If not, please explain how it is inconsistent and 
how the definition should be modified. In your answer, please explain 
whether the definition inappropriately includes or excludes a 
particular type or aspect of trading.
    2. Should the Commission adopt a definition of ``Algorithmic 
Trading'' that is more closely aligned with any definition used by 
another regulatory organization?
    3. For purposes of the Commission's definition of Algorithmic 
Trading, is it necessary for the Commission to define ``computer 
algorithms or systems''? If so, please explain what should be included 
in such a definition.
    4. Should the Commission's definition of ``Algorithmic Trading'' 
include systems that only make determinations as to the routing of 
orders to different venues (which is contemplated in the proposed 
definition)? With respect to the definition of ``Algorithmic Trading,'' 
should the Commission differentiate between different types of 
algorithms, such as alpha-generating algorithms and order routing 
algorithms?
    5. Is the Commission's understanding correct that most entities 
using automated order routers will be using similar or related 
automated technology to determine other parameters of an order?
    6. The Commission posits a scenario in which an AT Person submits 
orders through Algorithmic Trading, and a non-clearing FCM or other 
entity acts only as a conduit for these AT Person orders. If the non-
clearing FCM or other entity does not make any determinations with 
respect to such orders, the conduit entity would not be engaged in 
Algorithmic Trading, as that definition is currently proposed. Should 
the definition of Algorithmic Trading be modified to capture a conduit 
entity such as a non-clearing FCM in this scenario, thereby making the 
entity an AT Person subject to Regulation AT? In other words, should 
non-clearing FCMs be required to manage the risks of AT Person 
customers? How would non-clearing FCMs do so if the non-clearing FCMs 
do not have risk controls comparable to the risk controls specified in 
proposed Sec.  1.82?
    7. The Commission, recognizing that natural person traders who 
manually enter orders also have the potential to cause market 
disruptions, is considering expanding the definition of Algorithmic 
Trading to encompass orders that are generated using algorithmic 
methods (e.g., an algorithm generates a buy or sell signal at a 
particular time), but are then manually entered into a front-end system 
by a natural person, who

[[Page 78927]]

determines all aspects of the routing of the orders. Such order entry 
would not represent Algorithmic Trading under the currently proposed 
definition. The Commission requests comment on this proposed expansion 
of the definition of Algorithmic Trading, which the Commission may 
implement in the final rulemaking for Regulation AT. The Commission 
requests comment on the costs and benefits of this proposal, in 
addition to any other comments regarding the effectiveness of this 
proposal in terms of risk reduction.
``Algorithmic Trading Compliance Issue''--Sec.  1.3(tttt)
    8. Should the definition of Algorithmic Trading Compliance Issue be 
modified to include other potential compliance failures involving an AT 
Person that may have a significant detrimental impact on such AT 
Person, the relevant DCM, or other market participants?
``Algorithmic Trading Disruption''--Sec.  1.3(uuuu)
    9. Should the definition of Algorithmic Trading Disruption be 
modified to include other types of disruptive events that may originate 
with an AT Person?
    10. Should the definition be expanded to include other types of 
disruptive downstream consequences that may result from an Algorithmic 
Trading Disruption originating with an AT Person, and which may 
negatively impact the relevant designated contract market, other market 
participants, or other persons? Alternatively, should the scope of the 
definition be reduced, and if so, why?
    11. In addition, should the reference to ``materially degrades'' in 
the definition of Algorithmic Trading Disruption be expanded or 
otherwise modified to encompass other types of disruptions that may 
impact the relevant designated contract market, other market 
participants, or other persons? Please provide examples of real-world 
events originating with AT Persons (as defined under Regulation AT) 
that resulted in disruptions that may not be captured by the reference 
to ``materially degrades'' in the definition.
``AT Order Message''--Sec.  1.3(wwww)
    12. Please comment on the proposed scope of the Commission's 
definition of AT Order Message. Is the proposed definition too 
expansive, in that it would limit the submission of messages that do 
not have the potential to disrupt the market? Alternatively, is the 
scope of the AT Order Message too limited, in that it could allow 
messages not related to orders (i.e., heartbeat messages or requests 
for mass quotes) to intentionally or unintentionally flood the DCM's 
systems and slow down the matching engine? Please explain how this 
definition would be more appropriately limited or expanded.
``AT Person''--Sec.  1.3(xxxx)
    13. The Commission notes that the FIA Guide recommends certain pre-
trade risk controls and contemplates three levels at which these 
controls can be placed: Automated trader, broker, and exchange. FIA 
defines ``automated trader'' as any trading entity that uses an 
automated system, including hedge funds, buy-side firms, trading firms, 
and brokers who deploy automated algorithms, and defines ``broker'' as 
FCMs, other clearing firms, executing brokers and other financial 
intermediaries that provide access to an exchange.
    a. Should the Commission's definition of ``AT Person'' explicitly 
include or exclude any of the classes of parties included in FIA's term 
``automated trader''? Please explain. Are there any types of entities 
not present in this list that should be included in the ``AT Person'' 
definition?
    b. Should Regulation AT use the term ``broker,'' as understood by 
FIA? If so, please explain. Is there another term that would be more 
appropriate in defining the scope of AT Persons?
    14. Algorithmic Trading carries technological and personnel costs, 
and the Commission expects that such trading will be performed by 
entities, not natural persons. Is this a reasonable assumption? For 
purposes of quantifying the number of AT Persons that will be subject 
to the regulations, do you believe that any AT Person (a definition 
that encompasses the following persons if engaged in Algorithmic 
Trading: FCMs, floor brokers, swap dealers, major swap participants, 
commodity pool operators, commodity trading advisors, introducing 
brokers, and newly registered floor traders using Direct Electronic 
Access) will be a natural person or a sole proprietorship with no 
employees other than the sole proprietor?
    15. The Commission recognizes that a CPO could use Algorithmic 
Trading to enter orders on behalf of a commodity pool which it 
operates. In these circumstances, should the Commission consider the 
CPO that operates the commodity pool or the underlying commodity pool 
itself as ``engaged in Algorithmic Trading'' pursuant to the definition 
of AT Person? \715\
---------------------------------------------------------------------------

    \715\ The Commission notes that CPOs are separate legal entities 
from the underlying commodity pools which they operate.
---------------------------------------------------------------------------

    16. The Commission notes that pursuant to Sec.  1.57(b) of the 
Commission's regulations IBs may not carry proprietary accounts. 
However, certain customer relationships may cause an IB to fall under 
the definition of AT Person. The Commission requests comment on the 
types of IB customer relationships that could cause IBs to fall under 
the definition of AT Persons. What activities are currently being 
conducted by IBs that could cause an IB to be considered engaging in 
Algorithmic Trading on or subject to the rules of a DCM and would 
therefore cause the IB to be considered an AT Person?
    17. Should the definition of AT Person be limited to persons using 
DEA? In other words, should the definition capture persons registered 
or required to be registered as FCMs, floor brokers, SDs, MSPs, CPOs, 
CTAs, or IBs that engage in Algorithmic Trading on or subject to the 
rules of a DCM, or persons registered or required to be registered as 
floor traders as defined in Sec.  1.3(x)(3), in each case if such 
persons are using DEA? The Commission requests comment on the costs and 
benefits of this approach, including comments on whether this more 
limited definition of AT Persons would adequately mitigate the risks 
associated with algorithmic trading.
``Direct Electronic Access''--Sec.  1.3(yyyy)
    18. Please explain whether the Commission's proposed definition of 
DEA will encompass all types of access commonly understood in 
Commission-regulated markets as ``direct market access.'' In light of 
the proposed regulations concerning pre-trade and other risk controls 
and standards for the development, testing and supervision of 
algorithmic trading systems, do you believe that the proposed 
definition of Direct Electronic Access is too limited (or, 
alternatively, too expansive)? If so, please explain why and how the 
definition should be revised.
    19. Should the Commission define ``routed'' in its definition of 
DEA? If so, how? Are there specific examples of trading or routing 
arrangements where it would be unclear whether trading was performed 
through DEA?
    20. Should the Commission use the term ``direct market access'' 
instead of DEA, and if so why?

[[Page 78928]]

    21. Should the Commission define sub-categories of DEA, such as 
sponsored market access?
    22. The Commission's proposed definition of DEA in Sec.  1.3(yyyy) 
differs from definitions of direct electronic access in Sec.  38.607 
and direct access for FBOTs in Sec.  48.2(c). The Commission believes 
that the more technical definition in proposed 1.3(yyyy) is appropriate 
for Regulation AT. The Commission solicits comment regarding proposed 
1.3(yyyy), whether all definitions of ``direct'' access should be 
harmonized across the Commission's rules, and if so how. Do you believe 
that two definitions would create confusion with respect to Commission 
requirements as to direct electronic access? With respect to Sec. Sec.  
1.80, 1.82, and 38.255(b) and (c) provisions imposing risk control 
requirements on AT Persons, FCM and DCMs, should the Commission use the 
existing definition of direct electronic access provided in Sec.  
38.607?

IV(E) Registration of Certain Persons Not Otherwise Registered With 
Commission--Sec.  1.3(x)

    23. Should firms operating Algorithmic Trading systems in CFTC-
regulated markets, but not otherwise registered with the Commission, be 
required to register with the CFTC? If not, what alternatives are 
available to fully effectuate the purpose and design of Regulation AT?
    24. Should all firms deploying Algorithmic Trading systems be 
required to register with the Commission? Are there additional 
characteristics of AT Persons that should be taken into consideration 
for registration purposes? For example, should the Commission limit 
registration to trading firms meeting certain trading volume, order or 
message levels? In other words, should there be a minimum volume, order 
or message test in order to meet the definition of ``floor trader,'' or 
otherwise to meet the definition of AT Person? If so, what should be 
measured and what specific thresholds should be used?
    25. In the alternative, should the Commission broaden the 
registration requirements in proposed Sec.  1.3(x)(3)(ii) so that all 
persons trading on a contract market through DEA are required to 
register, instead of only those who are engaged in Algorithmic Trading?
    26. Please supply any information or data that would help the 
Commission in deciding whether firms may or may not meet the definition 
of ``floor trader'' in Section 1a(23) of the Act.
    27. Do you believe that the registration of such firms as ``floor 
traders'' would help effectuate the purposes of the CEA to deter and 
detect price manipulation or any other disruptions to market integrity? 
If you believe that registration of such firms will not help effectuate 
the purposes of the CEA, or that the same purposes can be achieved by 
other means, please explain.

IV(F) RFA Standards for Automated Trading and Algorithmic Trading 
Systems--Sec.  170.19

    28. The Commission requests comment on the scope of 
responsibilities assigned to RFAs under proposed Sec.  170.19. Should 
RFAs be responsible for fewer or additional areas regarding AT Persons, 
ATSs, and algorithmic trading than specified in proposed Sec.  170.19, 
prongs (1), (2), (3), and (4) (Sec.  170.19(a)(1)-(a)(4))? Regulation 
170.19 requires RFAs to consider the need for rules in the areas listed 
in prongs (1)-(4) (Sec.  170.19(a)(1)-(a)(4)). Should RFAs be 
responsible for considering whether to adopt rules in fewer or 
additional areas?
    29. The Commission requests comment on the latitude afforded to 
RFAs in proposed Sec.  170.19. Should RFAs have more or less latitude 
to issue rules than specified in proposed Sec.  170.19?
    30. The Commission requests comment on RFAs' obligation in proposed 
Sec.  170.19 to establish and maintain a program for the prevention of 
fraud and manipulation, protection of the public interest, and 
perfecting the mechanisms of trading, including through rules it may 
determine to adopt pursuant to Sec.  170.19. The proposed rules 
anticipate that an RFA's program will include examination and 
enforcement components. Is this the appropriate approach?
    31. The Commission requests comment on whether proposed Sec.  
170.19 may result in duplicative obligations on AT Persons or any other 
market participant. In particular, please comment on potential 
duplication, if any, between algorithmic trading requirements that an 
RFA may impose upon its members pursuant to Sec.  170.19, and similar 
requirements that may be imposed by a DCM in its role as a self-
regulatory organization. What amendments would be appropriate in any 
final rules arising from this NPRM to clarify that unintended overlap 
between the role of an RFA and a DCM in this context?

IV(G) AT Persons Must Become Members of an RFA--Sec.  170.18

    32. The Commission requests comment on whether the regulatory 
framework established by Regulation AT would require all AT Persons to 
be members of an RFA in order to be effective. Alternatively, could the 
goals of Regulation AT be realized without requiring all AT Persons to 
be members of an RFA?

IV(H) Pre-Trade and Other Risk Controls for AT Persons--Sec.  1.80

    33. Are any pre-trade and other risk controls required by Sec.  
1.80 ineffective, not already widely used by AT Persons, or likely to 
become obsolete?
    34. Are there additional pre-trade or other risk controls that 
should be specifically enumerated in proposed Sec.  1.80?
    35. Do you believe that the pre-trade and other risk controls 
required in Sec.  1.80 sufficiently address the possibility of 
technological advances in trading, and the development of new, more 
effective controls that should be implemented by AT Persons?
    36. The Commission welcomes comment on whether the regulation's 
requirements relating to the design of controls and the levels at which 
the controls should be set are appropriate and sufficiently granular.
    37. The Commission notes that Sec.  1.80(d) requires that prior to 
initial use of Algorithmic Trading, an AT Person must notify its 
clearing member FCM and the DCM that it will engage in Algorithmic 
Trading. The Commission welcomes comment on whether the content of that 
notification requirement is sufficient, or whether clearing member FCMs 
and DCMs should also be notified of additional information. For 
example, should AT Persons be required to notify their clearing member 
FCMs of particular changes to their Algorithmic Trading systems that 
would affect the risk controls applied by the clearing member FCM?
    38. Is Sec.  1.80(f)'s requirement that each AT Person periodically 
review its compliance with Sec.  1.80 appropriate? Should there be more 
prescriptive and granular requirements to ensure that each AT Person 
periodically reviews its pre-trade and other risk controls and takes 
appropriate steps to update or recalibrate them in order to prevent an 
Algorithmic Trading Event? Alternatively, is Sec.  1.80(f) necessary? 
Does the Commission need to explicitly require AT Persons to conduct a 
periodic review of their compliance with Sec.  1.80?
    39. AT Persons that are registered FCMs are required by existing 
Commission regulation 1.11 to have formal ``Risk Management Programs,'' 
including, pursuant to Sec.  1.11(e)(3)(ii), ``automated financial risk 
management

[[Page 78929]]

controls reasonably designed to prevent the placing of erroneous 
orders'' and ``policies and procedures governing the use, supervision, 
maintenance, testing, and inspection of automated trading programs.'' 
As described in Sec.  1.11, an FCM's Risk Management Program must 
include a risk management unit independent of the business unit; 
quarterly risk exposure reports to senior management and the governing 
body of the FCM, with copies to the Commission; and other substantive 
requirements. The Commission requests public comment regarding whether 
one or more of the proposed requirements applicable to FCMs in 
Sec. Sec.  1.80, 1.81, 1.83(a), and 1.83(c) should be incorporated 
within an FCM's Risk Management Program and be subject to the 
requirements of such program as described in Sec.  1.11. In this 
regard, any final rules arising from this NPRM could place all 
requirements applicable to FCMs in Sec. Sec.  1.80, 1.81, 1.83(a), and 
1.83(c) within the operational risk measures required in Sec.  
1.11(e)(3)(ii). Such incorporation could help improve the interaction 
between an FCM's operational risk efforts and its pre-trade risk 
controls; development, monitoring, and compliance efforts; and 
reporting and recordkeeping requirements, pursuant to Sec. Sec.  1.80, 
1.81, 1.83(a), and 1.83(c). It could also help ensure that an FCM's 
Sec. Sec.  1.80, 1.81, 1.83(a), and 1.83(c) processes benefit from the 
same internal rigor and independence required by the Risk Management 
Program in Sec.  1.11.
    40. The Commission proposes to adopt a multi-layered approach to 
regulations intended to mitigate the risks of automated trading, 
including pre-trade risk controls and other procedures applicable to AT 
Persons, clearing member FCMs and DCMs. Please comment on whether an 
alternative approach, for example one which does not impose 
requirements at each of these three levels, would more effectively 
mitigate the risks of automated trading and promote the other 
regulatory goals of Regulation AT.

IV(I) Standards for Development, Testing, Monitoring, and Compliance of 
Algorithmic Trading Systems--Sec.  1.81

    41. The Commission understands that the requirements for 
developing, testing, and supervising algorithmic systems proposed in 
Sec.  1.81(a)-(d) are already widely used throughout the industry. Are 
any specific requirements proposed in this section not widely used by 
persons that would be designated as AT Persons under Regulation AT, and 
if not, why not? If any requirements described in Sec.  1.81(a)-(d) are 
not widely used, please provide an estimate of the cost that would be 
incurred by an AT Person to implement such requirements.
    42. Are there any aspects of Sec.  1.81(a)-(d) that are unnecessary 
for purposes of reducing the risks from Algorithmic Trading, and should 
not be mandated by regulation? If so, please explain.
    43. Are the procedures described above for the development and 
testing of Algorithmic Trading sufficient to ensure that algorithmic 
systems are thoroughly tested before being used in production, and will 
operate in the manner intended in the production environment?
    44. Are there any additional procedures for the development and 
testing of Algorithmic Trading that should be required under Regulation 
AT?
    45. Are any of the required procedures for the development and 
testing of Algorithmic Trading likely to become obsolete in the near 
future as development and testing standards evolve?
    46. Are the procedures for designating and training Algorithmic 
Trading staff of AT Persons sufficient to ensure that such staff will 
be knowledgeable in the strategy and operation of Algorithmic Trading, 
and capable of identifying Algorithmic Trading Events and promptly 
escalating them to appropriate staff members?
    47. Is it typical that persons responsible for monitoring 
algorithmic trading do not simultaneously engage in trading activity?
    48. Proposed Sec. Sec.  1.80, 1.81, and 1.83 would impose certain 
requirements on all AT Persons regardless of the size, sophistication, 
or other attributes of their business. The Commission requests public 
comment regarding whether these requirements should vary in some manner 
depending on the AT Person. If commenters believe proposed Sec. Sec.  
1.80, 1.81, and 1.83 should vary, please describe how and according to 
what criteria.

IV(J) Risk Management by Clearing Member FCMs--Sec.  1.82

    49. Are any pre-trade or other risk controls required by Sec.  1.82 
ineffective, not already widely used by clearing member FCMs, or likely 
to become obsolete?
    50. Are there any aspects of proposed Sec.  1.82 that pose an undue 
burden for clearing member FCMs and are unnecessary for purposes of 
reducing the risks associated with Algorithmic Trading? If so, please 
explain (1) the burden; (2) why it is not necessary to reduce the risks 
associated with Algorithmic Trading, particularly in the case of DEA. 
What alternatives are available consistent with the purposes of 
Regulation AT?
    51. Please describe the technological development that would be 
required by clearing member FCMs to comply with the requirement to 
implement and calibrate the pre-trade and other risk controls required 
by Sec.  1.82(c) for non-DEA orders. To what extent have clearing 
member FCMs already developed the technology required by this 
provision, for example in connection with existing requirements under 
Sec.  1.11, and Sec. Sec.  1.73 and 38.607 for clearing FCMs to manage 
financial risks?
    52. Are there additional pre-trade or other risk controls that 
should be specifically required pursuant to proposed Sec.  1.82?
    53. Do you believe that the pre-trade and other risk controls 
required in Sec.  1.82 sufficiently address the possibility of 
technological advances in trading and development of new, more 
effective controls that should be implemented by FCMs?
    54. The Commission welcomes comment on whether the requirements of 
Sec.  1.82 relating to the design of controls and the levels at which 
the controls should be set are appropriate and sufficiently granular.
    55. Proposed Sec.  1.82 does not require FCMs to have connectivity 
monitoring such as ``system heartbeats'' or automatic cancel-on-
disconnect functions. Do you believe that Sec.  1.82 should require 
FCMs to have such functionality?
    56. Proposed Sec.  1.82 requires clearing FCMs to implement 
controls with respect to AT Order Messages originating with an AT 
Person. The Commission is considering modifying proposed Sec.  1.82 to 
require clearing FCMs to implement controls with respect to all orders, 
including orders that are manually submitted or are entered through 
algorithmic methods that nonetheless do not meet the definition of 
Algorithmic Trading. Such a requirement would correspond to the 
requirement under proposed Sec.  40.20(d) that DCMs implement risk 
controls for orders that do not originate from Algorithmic Trading. If 
the Commission were to incorporate such amendments in any final rules 
arising from this NPRM, its intent would be to further reduce risk by 
ensuring that all orders, regardless of source, are screened for risk 
at both the clearing member FCM and the DCM level. Risk controls at the 
point of order origination would continue to be limited to AT Persons. 
The Commission requests comment on this proposed amendment to Sec.  
1.82, which the Commission may implement

[[Page 78930]]

in the final rulemaking for Regulation AT. The Commission requests 
comment on the costs and benefits to clearing FCMs of this proposal, in 
addition to any other comments regarding the effectiveness of this 
proposal in terms of risk reduction.

IV(K) Compliance Reports Submitted by AT Persons and Clearing FCMs to 
DCMs; Related Recordkeeping Requirements--Sec.  1.83

    57. The Commission welcomes comment on the type of information that 
should be included in the reports required by proposed Sec.  1.83. 
Should different or additional descriptions be included in the reports, 
which will be evaluated by DCMs under proposed Sec.  40.22?
    58. How often should the reports required by proposed Sec.  1.83 be 
submitted to the relevant DCMs? Should the report be submitted more or 
less frequently than annually?
    59. When should the reports required by proposed Sec.  1.83 be 
submitted to the relevant DCMs? Should the reports be submitted on a 
date other than June 30 of each year?
    60. Should a representative of the AT Person or clearing member FCM 
other than the chief executive officer or the chief compliance officer 
be responsible for certifying the reports required by proposed Sec.  
1.83? Should only the chief executive officer be permitted to certify 
the report? Alternatively, should only the chief compliance officer be 
permitted to certify the report?
    61. Are there any aspects of proposed Sec.  1.83(b) that pose an 
undue burden for clearing member FCMs and are unnecessary for purposes 
of reducing the risks associated with Algorithmic Trading? If so, 
please explain (1) the burden; (2) why it is not necessary to reduce 
the risks associated with Algorithmic Trading, particularly in the case 
of DEA. What alternatives are available consistent with the purposes of 
Regulation AT, including in particular Regulation AT's intent that 
Sec.  1.83 reports benefit from the third-party SRO review performed by 
DCMs with respect to such reports?
    62. Should the reports required by proposed Sec.  1.83 be sent to 
any entity other than each DCM on which the AT Person operates, such as 
the Commission or an RFA? For example, should the Commission require 
that AT Persons that are members of a RFA send compliance reports to 
RFA upon NFA's request?
    63. Proposed Sec.  1.83(c) includes recordkeeping requirements 
imposed on AT Persons, and proposed Sec.  1.83(d) includes 
recordkeeping requirements imposed on clearing member FCMs. Should the 
recordkeeping requirements of Sec.  1.83(c) be distributed throughout 
the sections of the Commission's regulations that contain recordkeeping 
requirements for various categories of Commission registrants that will 
be classified as AT Persons? Should Sec.  1.83(d) be transferred to 
Sec.  1.35 of the Commission's regulations, which contains 
recordkeeping requirements for clearing member FCMs?

IV(L) Direct Electronic Access Provided by DCMs--Sec.  38.255(b) and 
(c)

    64. Are there any pre-trade and other risk controls required by 
Sec.  38.255(b) and (c) that will be ineffective, not already widely 
provided by DCMs for use by FCMs, or likely to become obsolete?
    65. Are there additional pre-trade or other risk controls that DCMs 
should be specifically required to provide to FCMs pursuant to proposed 
Sec.  38.255(b) and (c)?
    66. Do you believe that the pre-trade and other risk controls 
required pursuant to Sec.  38.255(b) sufficiently address the 
possibility of technological advances in trading? For example, do they 
appropriately address the potential for the future development of 
additional effective controls that should be provided by DCMs and 
implemented by FCMs?
    67. The Commission welcomes comment on whether Sec.  38.255(b)'s 
requirements relating to the design of controls and the levels at which 
the controls should be set are appropriate and sufficiently granular.
    68. Proposed Sec.  38.255(b) and (c) do not require DCMs to provide 
to FCMs connectivity monitoring systems such as ``system heartbeats'' 
or automatic cancel-on-disconnect functions. Should Sec.  38.255 
require such functionality?

IV(M) Disclosure and Transparency in DCM Trade Matching Systems--Sec.  
38.401(a)

    69. The Commission has proposed that certain components of an 
exchange's market architecture should be considered part of the 
``electronic matching platform'' for purposes of the DCM transparency 
provision. Are there any additional systems that should fall within the 
meaning of ``electronic matching platforms'' for purposes of proposed 
Sec.  38.401(a)?
    70. The Commission has specifically identified, as ``attributes'' 
that must be disclosed, latencies within a platform and how a self-
trade prevention tool determines whether to cancel an order. Are there 
any other attributes that would materially affect the execution of 
market participant orders and therefore should be made known to all 
market participants? Should the Commission revise the final rule so 
that it only applies to latencies within a platform and how a self-
trade prevention tool determines whether to cancel an order?
    71. What information should be disclosed as part of the description 
of relevant attributes of the platform? For instance, with latencies 
within a platform, should statistics on latencies be required? If so, 
what statistics would help market participants assess any impact on 
their orders? Would a narrative description of attributes be 
preferable, including a description of how the attributes might affect 
market participant orders under different market conditions, such as 
during times of increased messaging activity?
    72. The Commission notes that proposed Sec.  38.401(a)(1)(iii) and 
(iv) are not intended to require the disclosure of a DCM's trade 
secrets. The Commission requests comments on whether the proposed rules 
might inadvertently require such disclosure, and if so, how they might 
be amended to address this concern. Furthermore, the Commission 
anticipates that the mechanisms and standards for requesting 
confidential treatment already codified in existing Sec.  40.8 could be 
used by DCMs to identify and request confidential treatment for 
information otherwise required to be disclosed pursuant to proposed 
Sec.  38.401(a)(1)(iii) and (iv), for example by incorporating Sec.  
40.8's mechanisms and standards into any final rules arising from this 
NPRM. If commenters believe that the mechanisms and standards in Sec.  
40.8 are inappropriate for this purpose, please describe any other 
mechanism that should be included in any final rules to facilitate DCM 
requests for confidential treatment of information otherwise required 
to be disclosed pursuant to proposed Sec.  38.401(a)(1)(iii) and (iv).
    73. The Commission notes that DCMs are required, as part of 
voluntary submissions of new rules or rule amendments under Sec.  
40.5(a) and self-certification of rules and rule amendment under Sec.  
40.6(a), to provide inter alia an explanation and analysis of the 
operation, purpose and effect of the proposed rule or rule amendment. 
Would the information required under Sec. Sec.  40.5(a) or 40.6(a) 
provide market participants and the public with sufficient information 
regarding material attributes of an electronic matching platform?
    74. The Commission recognizes that DCMs are required to have system 
safeguards to ensure information security, business continuity and 
disaster recovery under DCM Core

[[Page 78931]]

Principle 20. The Commission understands that some attributes of an 
electronic matching platform designed to implement those safeguards 
should be maintained as confidential to prevent cybersecurity or other 
threats. Does existing Sec.  40.8, 17 CFR 40.8 (2014) provide 
sufficient basis for DCMs to publicly disclose the relevant attributes 
of their platforms while maintaining as confidential information 
concerning system safeguards?
    75. With respect to material attributes affecting market 
participant orders caused by temporary or emergency situations, such as 
network outages or the temporary suspension of certain market 
functionality, what is the best way for DCMs to alert market 
participants? How are DCMs currently handling these situations?
    76. The Commission proposes that DCMs provide a description of the 
relevant material attributes in a single document ``disclosed 
prominently and clearly'' on the exchange's Web site. The Commission 
also proposes that this document be written in ``plain English'' to 
allow market participants, even those not technically proficient, to 
understand the attributes described. Would these requirements be 
practical and help market participants locate and understand the 
information provided?
    77. The Commission proposes requiring DCMs to disclose information 
on the relevant attributes: (a) When filing a rule change submission 
with the Commission for changes to the electronic matching platform; or 
(b) within a ``reasonable time, but no later than ten days'' following 
the identification of such attribute. Do the proposed timeframes 
provide sufficient time for DCMs to disclose the relevant information? 
Do the proposed timeframes offer sufficient notice of changes or 
discovered attributes to market participants to allow them to adjust 
any systems or strategies, including any algorithmic trading systems?
    78. The Commission proposes requiring disclosure of newly 
identified attributes within 10 days of discovery. Does this provide 
DCMs sufficient time to analyze the attribute and provide a 
description? Should DCMs be required to provide notice of the existence 
of the attribute and supplement as further analysis is performed?

IV(N) Pre-Trade and Other Risk Controls at DCMs--Sec.  40.20

    79. The Commission proposes to require DCMs to set pre-trade risk 
controls at the level of the AT Person, and allows discretion to set 
controls at a more granular level. Should the Commission eliminate this 
discretion, and require that the controls be set at a specific, more 
granular, level? If so, please explain the more appropriate level at 
which pre-trade risk controls should be set by a DCM.
    80. The Commission requests public comment on the pre-trade and 
other risk controls required of DCMs in proposed Sec.  40.20. Are any 
of the risk controls required in the proposed rules unhelpful to 
operational or other risk mitigation, or to market stability, when 
implemented at the DCM level?
    81. Are there additional pre-trade or other risk controls that 
should be specifically enumerated in proposed Sec.  40.20?
    82. The Commission proposes, with respect to its kill switch 
requirements, to allow DCMs the discretion to design a kill switch that 
allows a market participant to submit risk-reducing orders. The 
Commission also does not mandate particular procedures for alerts or 
notifications concerning kill switch triggers. Does the proposed rule 
allow for sufficient flexibility in the design of kill switch 
mechanisms and the policies and procedures concerning their 
implementation? Should the Commission consider more prescriptive rules 
in this area?
    83. Does existing Sec.  38.1051 provide the Commission with 
adequate authority to require DCMs to adequately test planned changes 
to their matching engines and other automated systems?

IV(O) DCM Test Environments for AT Persons--Sec.  40.21

    84. Should the test environment provided by DCMs under proposed 
Sec.  40.21 offer any other functionality or data inputs that will 
promote the effective design and testing of Algorithmic Trading by AT 
Persons?

IV(P) DCM Review of Compliance Reports by AT Persons and Clearing 
FCMs--Sec.  40.22

    85. In lieu of a DCM's affirmative obligation in proposed Sec.  
40.22 to review AT Person and clearing member FCM compliance reports, 
should DCMs instead be permitted to rely on the CEO or CCO 
representations required by proposed Sec.  1.83(a)(2)? If so, what 
events in the Algorithmic Trading of an AT Person should trigger review 
obligations by the DCM?
    86. Should Sec.  40.22(c) provide more specific requirements 
regarding a DCM's establishment of a program for effective periodic 
review and evaluation of AT Person and clearing member FCM reports? For 
example, Sec.  40.22(c) could require review at specific intervals 
(e.g., once every two years). Alternatively, Sec.  40.22(c) could 
provide greater discretion to DCMs in establishing their programs for 
the review of reports. Please comment on the appropriateness of these 
alternative approaches.
    87. Should Sec.  40.22(e) provide more specific requirements 
regarding the triggers for a DCM to review and evaluate the books and 
records of AT Persons and clearing member FCMs required to be kept 
pursuant to Sec.  40.22(d)? For example, Sec.  40.22(e) could require 
review at specific intervals (e.g., once every two years), or it could 
require review in response to specific events related to the 
Algorithmic Trading of AT Persons. Please comment on the 
appropriateness of these alternative approaches.
    88. Does Sec.  40.22 leave enough discretion to the DCM in 
determining how to design and implement an effective compliance review 
program regarding Algorithmic Trading? Alternatively, is there any 
aspect of this regulation that should be more specific or prescriptive?
    89. Should Sec.  40.22 specifically authorize a DCM to establish 
further standards for the organization, method of submission, or other 
attributes of the reports described in Sec.  40.22(a)?

IV(Q) Self-Trade Prevention Tools--Sec.  40.23

    90. The Commission seeks to require self-trade prevention tools 
that screen out unintentional self-trading, while permitting bona-fide 
self-matched trades that are undertaken for legitimate business 
purposes. Under the regulations proposed above, DCMs shall implement 
rules reasonably designed to prevent self-trading (``the matching of 
orders for accounts that have common beneficial ownership or are under 
common control''), but DCMs may in their discretion implement rules 
that permit ``the matching of orders for accounts with common 
beneficial ownership where such orders are initiated by independent 
decision makers.''
    a. Do these standards accomplish the goal of preventing only 
unintentional self-trading, or would other standards be more effective 
in accomplishing this goal? For example, should the Commission consider 
adopting in any final rules arising from this NPRM an alternative 
requirement modeled on FINRA Rule 5210 and require market participants 
to implement policies and procedures to review their trading activity 
for, and a prevent a pattern of, self-trades?
    b. While the regulations contain exceptions for bona fide self-
match trades (described in Sec.  40.23(b)), the

[[Page 78932]]

regulations are intended to prevent all unintentional self-trading, and 
do not include a de minimis exception for a certain percentage of 
unintentional self-trading. Should the regulations permit a certain de 
minimis amount of unintentional self-trading, and if so, what amount 
should be permitted (e.g., as a percentage of monthly trading volume)?
    c. The following terms are used in proposed Sec.  40.23(a) and (b): 
(1) Self-trading, (2) common beneficial ownership, (3) independent 
decision makers, and (4) common control. Do any of these terms require 
further definition? If so, how should they be defined? Should any 
alternatives be used and, if so, how should such substitute terms be 
defined?
    d. With respect to ``common beneficial ownership,'' the Commission 
requests comment on the minimum degree of ownership in an account that 
should trigger a determination that such account is under common 
beneficial ownership. For example, should an account be deemed to be 
under common beneficial ownership between two unrelated persons if each 
person directly or indirectly has a 10% or more ownership or equity 
interest in such account? The Commission refers commenters to the 
aggregation rules in part 150 of its regulations, including 
specifically Sec.  150.4, and requests comment on a potential 
Commission definition of common beneficial ownership that is modeled on 
Sec.  150.4.
    e. The Commission also requests comment on whether ``common 
beneficial ownership'' should be defined in any final rules arising 
from this NPRM, or whether such definition should be left to each DCM 
with respect to its program for implementing proposed Sec.  40.23.
    91. Are there any other types of self-trading that should be 
permitted in addition to the exceptions permitted in Sec.  40.23(b)(1) 
and (2)? If so, please describe such other types of acceptable self-
trading and explain why they should be permitted.
    92. Proposed Sec.  40.23 provides that DCMs may comply with the 
requirement to apply, or provide and require the use of, self-trade 
prevention tools by requiring market participants to identify to the 
DCM which accounts should be prohibited from trading with each other. 
With respect to this account identification process, the Commission's 
principal goal is to prevent unintentional self-trading; the Commission 
does not have a specific interest in regulating the manner by which 
market participants identify to DCMs the account that should be 
prohibited from trading from each other, so long as this goal is met. 
Should any other identification methods be permitted in Sec.  40.23? 
For example, please comment on whether the opposite approach is 
preferable: market participants would identify to DCMs the accounts 
that should be permitted to trade with each other (as opposed to those 
accounts that should be prevented from trading with each other).
    93. The Commission believes that its requirements concerning self-
trade prevention tools must strike the appropriate balance between 
flexibility (allowing market participants with diverse trading 
operations and strategies the discretion in implementation so as 
effectively prevent only unintentional self-trades) and simplicity (a 
variety of design and implementation options may render this control 
too complex to be effective).\716\ Does the Commission allow sufficient 
discretion to exchanges and market participants in the design and 
implementation of self-trade prevention tools? Is there any area where 
the Commission should be more prescriptive? The Commission is 
particularly interested in whether there is a particular level at which 
it should require implementation of self-trade prevention tools, i.e., 
if the tools must prevent matching of orders from the same trading 
firm, the same trader, the same trading algorithm, or some other level.
---------------------------------------------------------------------------

    \716\ See FIA Guide, supra note 95 at 13 (discussing balance 
between flexibility and complexity with respect to self-trade 
prevention tools).
---------------------------------------------------------------------------

    94. Proposed Sec.  40.23(a) would require DCMs to either apply, or 
provide and require the use of, self-trade prevention tools. Please 
comment whether Sec.  40.23(a) should, in addition, permit market 
participants to use their own self-trade prevention tools to meet the 
requirements of proposed Sec.  40.23(a), and if so, what additional 
regulations would ensure that DCMs are able to: ensure that such tools 
are comparable to DCM-provided tools; monitor the performance of such 
tools; and otherwise review such tools and ensure that they are 
sufficiently rigorous to meet the requirements of Sec.  40.23.
    95. Is it appropriate to require implementation of self-trade 
prevention tools with respect to all orders? Should such controls be 
mandatory for only a particular subset of orders, i.e., orders from AT 
Persons or orders submitted through DEA?
    96. Please comment on the requirement that DCMs disclose self-trade 
statistics. Is the data required to be disclosed appropriate? Is there 
any other category of self-trade data that DCMs should be required to 
disclose?
    97. Should DCMs be required to disclose the amount of unintentional 
self-trading that occurs each month, alongside the self-trade 
statistics required to be published under proposed Sec.  40.23(d)?
    98. As noted above, the Commission understands that there is some 
potential for self-trade prevention tools to be used for wrongful 
activity that may include disruptive trading or other violations of the 
Act or Commission regulations on DCMs. Are there ways to design self-
trade prevention tools so that they do not facilitate disruptive 
trading (such as spoofing) or other violations of the Act or Commission 
regulations on DCMs? Are additional regulations warranted to ensure 
that such tools are not used to facilitate such activities?

IV(R) DCM Market Maker and Trading Incentive Programs--Sec. Sec.  
40.25-40.28

    99. To what extent do market participants currently trade in ways 
designed primarily to collect market maker or trading incentive program 
benefits, rather than for risk management purposes?
    100. To what extent do that market maker and trading incentive 
programs currently provide benefits for self-trades? To what extent do 
market participants collect such benefits for self-trades?
    101. The Commission requests comment regarding whether the 
information proposed to be collected in Sec.  40.25 would be sufficient 
for it to determine whether a DCM's market-maker or trading incentive 
program complies with the impartial access requirements of Sec.  
38.151(b). If additional or different information would be helpful, 
please identify such information.
    102. The Commission requests comment regarding whether DCMs should 
be required to maintain on their public Web sites the information 
required by proposed Sec.  40.25(a) and (b) for an additional period 
beyond the end of the market maker or trading incentive program. The 
Commission may determine to include in any final rules arising from 
this NPRM a requirement that such information remain publicly available 
pursuant to proposed Sec.  40.25(b) for an additional period up to six 
months following the end of a market maker or trading incentive 
program.
    103. The Commission requests comment regarding whether the text of 
proposed Sec.  40.27(a) identifies with sufficient particularity the 
types of trades that are not eligible for payments

[[Page 78933]]

or benefits pursuant to a DCM market-maker or trading incentive 
program. What amendments, if any, are necessary to clearly identify 
trades that are not eligible?
    104. Section 40.27(a) provides that DCMs shall implement policies 
and procedures that are reasonably designed to prevent the payment of 
market-maker or trading incentive program benefits for trades between 
accounts under common ownership. Are there any other types of trades or 
circumstances under which the Commission should also prohibit or limit 
DCM market-maker or trading incentive program benefits?
    105. The Commission is proposing in Sec.  40.27(a) certain 
requirements regarding DCM payments associated with market maker and 
trading incentive programs. Please address whether the proposed rules 
will diminish DCMs' ability to compete or build liquidity by using 
market maker or trading incentive programs. Does any DCM consider it 
appropriate to provide market maker or trading incentive program 
benefits for trades between accounts known to be under common 
beneficial ownership?
    106. In any final rules arising from this NPRM, should the 
Commission also prohibit DCMs from providing trading incentive program 
benefits where such benefits on a per-trade basis are greater than the 
fees charged per trade by such DCMs and its affiliated DCO (if 
applicable)? The Commission also specifically requests comment on the 
extent, if any, to which one or more DCMs engage in this practice.
    107. Proposed Sec.  40.25(b) imposes certain transparency 
requirements with respect to both market maker and trading incentive 
programs. The Commission requests public comment regarding:
    a. The most appropriate place or manner for a DCM to disclose the 
information required by proposed Sec.  40.25(b);
    b. The benefits or any harm that may result from such transparency, 
including any anti-competitive effect or pro-competitive effect among 
DCMs or market participants;
    c. Whether transparency as proposed in Sec.  40.25(b) is equally 
appropriate for both market maker programs and trading incentive 
programs, or are the proposed requirements more or less appropriate for 
one type of program over the other?
    d. Whether any of the enumerated items required to be posted on a 
DCM's public Web site pursuant to proposed Sec.  40.25(b) could 
reasonably be considered confidential information that should not be 
available to the public, and if so, what process should be available 
for a DCM to request from the Commission an exemption from the 
requirements of proposed Sec.  40.25(b) for that specific enumerated 
item?

Related Matters--A. Calculation of Number of Persons Subject to 
Regulations

    108. The Commission requests comment on its calculation of the 
number of AT Persons, newly registered floor traders, clearing member 
FCMs, and DCMs that will be subject to Regulation AT.

Related Matters--C. Regulatory Flexibility Act Analysis

    109. The Commission requests comment on each element of its RFA 
analysis. In particular, the Commission specifically invites comment on 
the accuracy of its estimates of potential firms that could be 
considered ``small entities'' for RFA purposes.
    110. The Commission also requests comment on whether any natural 
persons will be designated as AT Persons under the proposed definition 
of that term.

Related Matters--E. Cost Benefit Considerations

    111. Beyond specific questions interspersed throughout its 
discussion, the Commission generally requests comment on all aspects of 
its consideration of costs and benefits, including: (a) Identification, 
quantification, and assessment of any costs and benefits not discussed 
therein; (b) whether any of the proposed regulations may cause FCMs or 
DCMs to raise their fees for their customers, or otherwise result in 
increased costs for market participants and, if so, to what extent; (c) 
whether any category of Commission registrants will be 
disproportionately impacted by the proposed regulations, and if so 
whether the burden of any regulations should be appropriately shifted 
to other Commission registrants; (d) what, if any, costs would likely 
arise from market participants engaging in regulatory arbitrage by 
restructuring their trading activities to trade on platforms not 
subject to the proposed regulations, or taking other steps to avoid 
costs associated with the proposed regulations; (e) quantitative 
estimates of the impact on transaction costs and liquidity of the 
proposals contained herein; (f) the potential costs and benefits of the 
alternatives that the Commission discussed in this release, and any 
other alternatives appropriate under the CEA that commenters believe 
would provide superior benefits relative to costs; (g) data and any 
other information to assist or otherwise inform the Commission's 
ability to quantify or qualitatively describe the benefits and costs of 
the proposed rules; and (h) substantiating data, statistics, and any 
other information to support positions posited by commenters with 
respect to the Commission's consideration of costs and benefits.

Sec.  1.80 Pre-Trade and Other Risk Controls

    112. How would an alternative definition of Algorithmic Trading 
that excludes automated order routers affect the costs and benefits of 
the pre-trade and other risk controls in comparison to the costs and 
benefits of the proposed definition that includes automated order 
routers? Would such an alternative definition reduce the number of AT 
Persons captured by Regulation AT?
    113. Would the benefits of Regulation AT be enhanced significantly 
if the definition of Algorithmic Trading were modified to capture a 
conduit entity such as a non-clearing FCM, thereby making the entity an 
AT Person subject to Regulation AT? How would such a modification 
affect costs?
    114. Would the benefits of Regulation AT be enhanced significantly 
if the definition of Algorithmic Trading were expanded to encompass 
orders that are generated using algorithmic methods (e.g., an algorithm 
generates a buy or sell signal at a particular time), but are then 
manually entered into a front-end system by a natural person? How would 
such a modification affect costs? Please comment on the costs and 
benefits of an alternative whereby the Commission would implement 
specific rules regarding the appropriate design of the specific 
controls required by Regulation AT and compare them to the costs and 
benefits of the Commission's proposal whereby the relevant entities--
trading firms, clearing firms, and DCMs--would have the discretion to 
determine the appropriate design of those controls.
    115. Does one particular segment of trading firms, clearing member 
FCMs or DCMs (e.g., smaller entities) currently implement fewer of the 
pre-trade and other risk controls required by Regulation AT than some 
other segment of trading firms, clearing member FCMs or DCMs? If so, 
please describe any unique or additional costs that will be imposed on 
such persons to develop the technology and systems necessary to 
implement the pre-trade and other risk controls required by Regulation 
AT.
    116. In question 14, the Commission asks whether there are any AT 
Persons who are natural persons. Would AT Persons who are natural 
persons (or sole

[[Page 78934]]

proprietorships with no employees other than the sole proprietor) be 
required to hire staff to comply with the risk control, testing and 
monitoring, or compliance requirements of Regulation AT?
    117. Do you agree with the accuracy of cost estimates provided by 
the Commission as to how much it will cost a trading firm, clearing 
member FCM or DCM to internally develop the technology and systems 
necessary to implement the pre-trade and other risk controls required 
by Regulation AT? If you disagree with the Commission's analysis, 
please provide your own quantitative estimates, as well as data or 
other information in support. Please specify in your answer the type of 
entity and which specific pre-trade risk or order management controls 
for which you are providing estimates.
    In addition, please differentiate between the situations where an 
entity (i) already has partially compliant controls in place, and only 
needs to upgrade such technology and systems to bring it into 
compliance with the regulations; and (ii) needs to build such 
technology and systems from scratch. Please include, as applicable, 
hardware and software costs as well as the hourly wage information of 
the employee(s) necessary to develop such risk controls (i.e., 
technology personnel such as programmer analysts, senior programmers 
and senior systems analysts).
    118. The Commission has assumed that the effort to adjust any one 
risk control (by ``control,'' in this context, the Commission means the 
pre-trade risk controls, order cancellation systems, and connectivity 
systems required by Sec.  1.80) will require assessment and possible 
modifications to all controls. Is this assumption correct, and if not, 
why not?
    119. As indicated above, the Commission lacks sufficient 
information to provide full estimates of costs that a trading firm, 
clearing member FCM or DCM will incur if it chooses not to internally 
develop such controls, and instead purchases the solutions of an 
outside vendor in order to comply with Regulation AT's pre-trade and 
other risk controls requirements. Please provide quantitative estimates 
of such costs, including supporting data or other information. In 
addition, please specify in your answer the type of entity and which 
specific pre-trade risk or order management control for which you are 
providing estimates. In addition, please differentiate between the 
situations where an entity (i) already uses an outside vendor to at 
least some extent to implement the controls; and (ii) does not 
currently implement the controls and must obtain all applicable 
technology and systems from an outside vendor necessary to comply with 
Regulation AT. Please include, if applicable, hardware and software 
costs as well as the hourly wage information of the employee(s) 
necessary to effectuate the implementation of such controls from an 
outside vendor.
    120. Do you agree with the Commission's estimates of how much it 
will cost a trading firm, clearing member FCM or DCM to annually 
maintain the technology and systems for the pre-trade and other risk 
controls required by Regulation AT, if it uses internally developed 
technology and systems? If not please provide quantitative estimates 
and supporting data or other information with respect to how much it 
will cost a trading firm, clearing member FCM or DCM to annually 
maintain the technology and systems for pre-trade and other risk 
controls required by Regulation AT, if it uses an outside vendor's 
technology and systems.
    121. Is it correct to assume that many of the trading firms subject 
to Sec.  1.80 are also subject to the SEC's Market Access Rule, and, 
accordingly, already implement many of the systems required by 
Regulation AT for purposes of their securities trading? Please specify 
in your answer the type of entity and which specific pre-trade risk or 
order management control is already required pursuant to the Market 
Access Rule, and the extent of the overlap.
    122. Please comment on the costs and benefits (including 
quantitative estimates with supporting data or other information) to 
clearing FCMs of an alternative to proposed Sec.  1.82 that would 
require clearing FCMs to implement controls with respect to all orders, 
including orders that are manually submitted or are entered through 
algorithmic methods that nonetheless do not meet the definition of 
Algorithmic Trading and compare those costs and benefits to those costs 
and benefits of proposed Sec.  1.82.
    123. Please comment on the additional costs (including quantitative 
estimates with supporting data or other information) to AT Persons of 
complying with each of the following specific requirements of Sec.  
1.80:
    a. Sec.  1.80(a)(2) (pre-trade risk control threshold 
requirements);
    b. Sec.  1.80(a)(3) (natural person monitors must be alerted when 
thresholds are breached);
    c. Sec.  1.80(d) (notification to DCM and clearing member FCM that 
AT Person will use Algorithmic Trading);
    d. Sec.  1.80(e) (self-trade prevention tools); and
    e. Sec.  1.80(f) (periodic review of pre-trade risk controls and 
other measures for sufficiency and effectiveness).
    124. The Commission welcomes comment on the estimated costs of the 
pre-trade risk controls proposed in Sec.  1.80 as compared to the 
annual industry expenditure on technology, risk mitigation and/or 
technology compliance systems.
    125. Please comment on the costs to AT Persons and clearing member 
FCMs of complying with DCM rules requiring retention and production of 
records relating to Sec. Sec.  1.80, 1.81, and 1.82 compliance, 
pursuant to Sec.  40.22(d), including without limitation on the extent 
to which AT Persons and clearing member FCMs already have policies, 
procedures, staffing and technological infrastructure in place to 
retain such records and produce them upon DCM request.
    126. The Commission anticipates that Regulation AT may promote 
confidence among market participants and reduce market risk, 
consequently reducing transaction costs, but has not estimated this 
reduction in transaction costs. The Commission welcomes comment on the 
extent to which Regulation AT may impact transaction costs and effects 
on liquidity provision more generally.

AT Person Membership in RFA; RFA Standards for Automated Trading and 
Algorithmic Trading Systems

    127. The Commission estimates that the costs of membership in an 
RFA associated with proposed Sec.  170.18 will encompass certain costs, 
such as those associated with NFA membership dues. Has the Commission 
correctly identified the costs associated with membership in an RFA?
    128. The Commission expects that entities that will be required to 
become members of an RFA would not incur any additional compliance 
costs as a result of their membership in an RFA. The Commission 
requests comment on the accuracy of this expectation. What additional 
compliance costs, if any, would a registrant face as a result of being 
required to become a member of an RFA pursuant to proposed Sec.  
170.18?
    129. Has the Commission accurately estimated that approximately 100 
entities will be affected by the membership requirements of Sec.  
170.18?
    130. The Commission invites estimates on the cost to an RFA to 
establish and maintain the program required by Sec.  170.19, and the 
amount of that cost that will be passed along to individual categories 
of AT Person members in the RFA.

[[Page 78935]]

Development, Testing, and Supervision of Algorithmic Systems

    131. Proposed Sec.  1.81(a) establishes principles-based standards 
for the development and testing of Algorithmic Trading systems and 
procedures, including requirements for AT Persons to test all 
Algorithmic Trading code and related systems and any changes to such 
code and systems prior to their implementation. AT Persons would also 
be required to maintain a source code repository to manage source code 
access, persistence, copies of all code used in the production 
environment, and changes to such code, among other requirements. Are 
any of the requirements of Sec.  1.81(a) not already followed by the 
majority of market participants that would be subject to Sec.  1.81(a) 
(or some particular segment of market participants), and if so, how 
much will it cost for a market participant to comply with such 
requirement(s)?
    132. Proposed Sec.  1.81(b) requires that an AT Person's 
Algorithmic Trading is subject to continuous real-time monitoring and 
supervision by knowledgeable and qualified staff at all times while 
Algorithmic Trading is occurring. Proposed Sec.  1.81(b) also requires 
automated alerts when an Algorithmic Trading system's AT Order Message 
behavior breaches design parameters, upon loss of network connectivity 
or data feeds, or when market conditions approach the boundaries within 
which the ATS is intended to operate, to the extent applicable, among 
other monitoring requirements. Are any of the requirements of Sec.  
1.81(b) not already followed by the majority of market participants 
that would be subject to Sec.  1.81(b), and if so, how much will it 
cost for a market participant to comply with such requirement(s)?
    133. Proposed Sec.  1.81(c) requires that AT Persons implement 
policies designed to ensure that Algorithmic Trading operates in a 
manner that complies with the CEA and the rules and regulations 
thereunder. Among other controls, the policies should include a plan of 
internal coordination and communication between compliance staff of the 
AT Person and staff of the AT Person responsible for Algorithmic 
Trading regarding Algorithmic Trading design, changes, testing, and 
controls. Are any of the requirements of Sec.  1.81(c) not already 
followed by the majority of market participants that would be subject 
to Sec.  1.81(c), and if so, how much will it cost for a market 
participant to comply with such requirement(s)?
    134. Proposed Sec.  1.81(d) requires that AT Persons implement 
policies to designate and train their staff responsible for Algorithmic 
Trading, which policies should include procedures for designating and 
training all staff involved in designing, testing and monitoring 
Algorithmic Trading. Are any of the requirements of Sec.  1.81(d) not 
already followed by the majority of market participants that would be 
subject to Sec.  1.81(d), and if so, how much will it cost for a market 
participant to comply with such requirement(s)?

AT Person and FCM Compliance Reports

    135. Please comment on whether any of the alternatives discussed 
above regarding compliance reports would provide a superior cost-
benefit profile relative to the Commission's proposal.

DCM Test Environments

    136. Do any DCMs not currently offer a test environment that 
simulates production trading to their market participants, as would be 
required by proposed Sec.  40.21? If so, how much would it cost a DCM 
to implement a test environment that would comply with the requirements 
of Sec.  40.21?

DCM Review of Compliance Reports

    137. Please comment on the cost estimates provided above with 
respect to DCMs' review of compliance reports provided under Sec.  
40.22 and related review requirements, including the estimated cost for 
DCMs to: Establish the review program required by Sec.  40.22; review 
the reports provided by AT Persons and clearing member FCMs; 
communicate remediation instructions to a subset of AT Persons and 
clearing member FCMs; and review and evaluate, as necessary, books and 
records of AT Persons and clearing member FCMs as contemplated by 
proposed Sec.  40.22(e).

Section 15(a) Considerations

    138. The Commission requests comment on its discussion of the 
effects of the proposed rules on the considerations in Section 15(a) of 
the CEA.
    139. Are the compliance costs associated with the proposed rules of 
sufficient magnitude to potentially cause smaller market participants, 
FCMs, or DCMs to cease or scale back operations? Do these costs create 
significant barriers to entry?

Registration--Sec.  1.3(x)(3)

    140. The Commission estimates that the costs of registration will 
encompass direct costs (those associated with NFA membership, and 
reporting and recordkeeping with the Commission), and indirect costs 
(e.g. those associated to risk control requirements placed on all 
registered entities). Has the Commission correctly identified the costs 
associated with the new registration category? What firm 
characteristics would change the level of direct and indirect costs 
associated with the registration?
    141. Has the Commission accurately estimated that approximately 100 
currently unregistered entities will be captured by the new 
registration requirement in proposed Sec.  1.3(x)(3).
    142. Has the Commission accurately estimated that each currently 
unregistered entity captured by the new registration requirement in 
proposed Sec.  1.3(x)(3) will have approximately 10 persons required to 
file Form 8-R?
    143. As defined, the new floor trader category restricts the 
registration requirement to those who make use of Direct Electronic 
Access. Is this requirement overly restrictive or unduly broad from a 
cost-benefit perspective? Are there alternate, or additional, 
characteristics of trading activity to determine registration status 
that would be preferable from a cost-benefit standpoint? For example, 
should persons with trading volume or message volume below a specified 
threshold be exempted from registration?
    144. Will any currently unregistered entities change their business 
model or exit the market in order to avoid the proposed registration 
requirement?
    145. The Commission believes that the risk control protocols 
required of registered entities, specifically those under the new 
registration category, will provide a general benefit to the safety and 
soundness of market activity and price formation. Has the Commission 
correctly identified the type and level of benefits which arise from 
placing these requirements on a new set of significant market 
participants?
    146. The Commission requests comment on its discussion of the 
effects of the proposed rules on the considerations in Section 15(a) of 
the CEA.

Transparency in Exchange Trade Matching Systems

    147. The Commission anticipates that costs associated with the 
transparency requirement would come from some additional testing of 
platform systems and from drafting and publishing descriptions of any 
relevant attributes of the platform. What new costs would be associated 
with providing descriptions of attributes of electronic matching

[[Page 78936]]

platforms that affect market participant orders and quotes?
    148. Please compare the costs and benefits of the alternative of 
applying the transparency requirement only with respect to latencies 
within a platform and how a self-trade prevention tool determines 
whether to cancel an order with the costs and benefits of the proposed 
rule.
    149. What benefits might market participants receive through 
increased transparency into the operation of electronic matching 
platforms, particularly for those market participants without direct 
electronic access who may not be able to accurately measure latencies 
or other metrics of market efficiency?
    150. The Commission requests comment on its discussion of the 
effects of the proposed rules on the considerations in Section 15(a) of 
the CEA.

Self-Trade Prevention

    151. Please comment on the cost estimates described above for DCMs 
and market participants to comply with the requirements of Sec.  40.23. 
The Commission is interested in commenter opinion on all aspects of its 
analysis, including its estimate of the number of entities impacted by 
the proposed regulation and the amount of costs such entities may incur 
to comply with the regulation.
    152. Please comment on the benefits described above. Do you agree 
with the Commission's position that self-trade prevention requirements 
will result in more accurate indications of the level of market 
interest on both sides of the market and help ensure arms-length 
transactions that promote effective price discovery? Are there 
additional benefits to regulatory self-trade prevention requirements 
not articulated above?
    153. Are there any DCMs that neither internalize and apply self-
trade prevention tools, nor provide self-trade prevention tools to 
their market participants? If so, please provide an estimate of the 
cost to such a DCM to comply with the requirement under Sec.  40.23(a) 
to apply, or provide and require the use of, self-trade prevention 
tools.
    154. Would any DCMs that currently offer self-trade prevention 
tools need to update their tools to meet the requirements of Sec.  
40.23? If so, please provide an estimate of the cost to such a DCM to 
comply with the requirements of Sec.  40.23.
    155. What percentage of market participants do not currently make 
use of exchange-provided self-trade prevention tools, when active on a 
DCM that provides, but does not require such tools? Please provide an 
estimate of the cost to such a market participant to initially 
calibrate and use exchange-provided self-trade prevention tools, in 
accordance with Sec.  40.23. Please also comment on any other direct or 
indirect costs to a market participant that does not currently use 
self-trade prevention tools arising from the proposed requirement to 
implement such tools.
    156. The Commission estimates above that the number of market 
participants that will submit the approval requests described by Sec.  
40.23(c) is approximately equivalent to the number of AT Persons. 
Please comment on whether the estimate of the number of market 
participants submitting such approval requests should be higher or 
lower. For example, should the estimate be raised to account for 
proprietary algorithmic traders that will not be AT Persons, because 
they do not use Direct Electronic Access and therefore will not be 
required to register as floor traders?
    157. Proposed Sec.  40.23 provides that DCMs may comply with the 
requirement to apply, or provide and require the use of, self-trade 
prevention tools by requiring market participants to identify to the 
DCM which accounts should be prohibited from trading with each other. 
With respect to this account identification process, the Commission's 
principal goal is to prevent unintentional self-trading; the Commission 
does not have a specific interest in regulating the manner by which 
market participants identify to DCMs the account that should be 
prohibited from trading from each other, so long as this goal is met. 
Should any other identification methods be permitted in Sec.  40.23? 
For example, please comment on whether the opposite approach is 
preferable: Market participants would identify to DCMs the accounts 
that should be permitted to trade with each other (as opposed to those 
accounts that should be prevented from trading with each other). In 
particular, please comment on whether this approach or other 
identification methods would reduce costs for market participants or be 
easier for both market participants and DCMs to administer.
    158. The Commission requests comment on its discussion of the 
effects of the proposed rules on the considerations in Section 15(a) of 
the CEA.

Market-Maker and Trading Incentive Programs

    159. The Commission requests comment on the accuracy of its cost 
estimates.
    160. To what extent are the costs imposed on the DCMs by the 
proposed rule already incurred pursuant to existing rules?
    161. To what extent are the benefits of the proposed rule currently 
being realized?
    162. Do DCM Web sites currently provide adequate information 
regarding market-maker and trading incentive programs, and is such 
information easily located?
    163. To what extent do DCMs currently make payments for self-trades 
pursuant to market-maker and trading incentive programs?
    164. The Commission requests comment on its discussion of the 
effects of the proposed rules on the considerations in Section 15(a) of 
the CEA.

List of Subjects

17 CFR Part 1

    Commodity futures, Commodity pool operators, Commodity trading 
advisors, Definitions, Designated contract markets, Floor brokers, 
Futures commission merchants, Introducing brokers, Major swap 
participants, Reporting and recordkeeping requirements, Swap dealers.

17 CFR Part 38

    Commodity futures, Designated contract markets, Reporting and 
recordkeeping requirements.

17 CFR Part 40

    Commodity futures, Definitions, Designated contract markets, 
Reporting and recordkeeping requirements.

17 CFR Part 170

    Commodity futures, Commodity pool operators, Commodity trading 
advisors, Floor brokers, Futures commission merchants, Introducing 
brokers, Major swap participants, Reporting and recordkeeping 
requirements, Swap dealers.

    For the reasons stated in the preamble, the Commodity Futures 
Trading Commission proposes to amend 17 CFR chapter I as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

0
1. The authority citation for part 1 continues to read as follows:

    Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h, 
6i, 6k, 6l, 6m, 6n, 6o, 6p, 6r, 6s, 7, 7a-1, 7a-2, 7b, 7b-3, 8, 9, 
10a, 12, 12a, 12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24 (2012).


[[Page 78937]]


0
2. In Sec.  1.3, add paragraphs (x)(3), (tttt), (uuuu), (vvvv), (wwww), 
(xxxx), (yyyy), and (zzzz) to read as follows:


Sec.  1.3  Definitions.

* * * * *
    (x) * * *
    (3)(i) Who, in or surrounding any other place provided by a 
contract market for the meeting of persons similarly engaged purchases 
or sells solely for such person's own account--
    (A) Any commodity for future delivery, security futures product, or 
swap; or
    (B) Any commodity option authorized under section 4c of the Act; 
and
    (ii) Who uses Direct Electronic Access as defined in paragraph 
(yyyy) of this section, in whole or in part, to access such other place 
for Algorithmic Trading; and
    (iii) Who is not registered with the Commission as a futures 
commission merchant, floor broker, swap dealer, major swap participant, 
commodity pool operator, commodity trading advisor, or introducing 
broker.
* * * * *
    (tttt) Algorithmic Trading Compliance Issue. This term means an 
event at an AT Person that has caused any Algorithmic Trading of such 
entity to operate in a manner that does not comply with the Commodity 
Exchange Act or the rules and regulations thereunder, the rules of any 
designated contract market to which such AT Person submits orders 
through Algorithmic Trading, the rules of any registered futures 
association of which such AT Person is a member, the AT Person's own 
internal requirements, or the requirements of the AT Person's clearing 
member, in each case as applicable.
    (uuuu) Algorithmic Trading Disruption. This term means an event 
originating with an AT Person that disrupts, or materially degrades--
    (1) The Algorithmic Trading of such AT Person,
    (2) The operation of the designated contract market on which such 
AT Person is trading, or
    (3) The ability of other market participants to trade on the 
designated contract market on which such AT Person is trading.
    (vvvv) Algorithmic Trading Event. This term means an event at an AT 
Person that constitutes--
    (1) An Algorithmic Trading Compliance Issue; or
    (2) An Algorithmic Trading Disruption.
    (wwww) AT Order Message. This term means each new order or quote 
submitted through Algorithmic Trading to a designated contract market 
by an AT Person and each change or deletion submitted through 
Algorithmic Trading by an AT Person with respect to such an order or 
quote.
    (xxxx) AT Person. This term means any person registered or required 
to be registered as a--
    (1) Futures commission merchant, floor broker, swap dealer, major 
swap participant, commodity pool operator, commodity trading advisor, 
or introducing broker that engages in Algorithmic Trading on or subject 
to the rules of a designated contract market; or
    (2) Floor trader as defined in paragraph (x)(3) of this section.
    (yyyy) Direct Electronic Access. This term means an arrangement 
where a person electronically transmits an order to a designated 
contract market, without the order first being routed through a 
separate person who is a member of a derivatives clearing organization 
to which the designated contract market submits transactions for 
clearing.
    (zzzz) Algorithmic Trading. This term means trading in any 
commodity interest as defined in paragraph (yy) of this section on or 
subject to the rules of a designated contract market, where:
    (1) One or more computer algorithms or systems determines whether 
to initiate, modify, or cancel an order, or otherwise makes 
determinations with respect to an order, including but not limited to: 
The product to be traded; the venue where the order will be placed; the 
type of order to be placed; the timing of the order; whether to place 
the order; the sequencing of the order in relation to other orders; the 
price of the order; the quantity of the order; the partition of the 
order into smaller components for submission; the number of orders to 
be placed; or how to manage the order after submission; and
    (2) Such order, modification or order cancellation is 
electronically submitted for processing on or subject to the rules of a 
designated contract market; provided, however, that Algorithmic Trading 
does not include an order, modification, or order cancellation whose 
every parameter or attribute is manually entered into a front-end 
system by a natural person, with no further discretion by any computer 
system or algorithm, prior to its electronic submission for processing 
on or subject to the rules of a designated contract market.
0
3. Add subpart A to read as follows:
Subpart A--Requirements for Algorithmic Trading
Sec.
1.80 Pre-trade risk controls for AT Persons.
1.81 Standards for the development, monitoring, and compliance of 
Algorithmic Trading systems.
1.82 Clearing futures commission merchant risk management.
1.83 AT Person and clearing member futures commission merchant 
reports and recordkeeping.

Subpart A--Requirements for Algorithmic Trading


Sec.  1.80  Pre-trade risk controls for AT Persons.

    For all AT Order Messages, an AT Person shall implement pre-trade 
risk controls and other measures reasonably designed to prevent an 
Algorithmic Trading Event, including but not limited to:
    (a) Pre-Trade Risk Controls. (1) The pre-trade risk controls shall 
include, at a minimum, the following:
    (i) Maximum AT Order Message frequency per unit time and maximum 
execution frequency per unit time; and
    (ii) Order price parameters and maximum order size limits.
    (2) Pre-trade risk controls shall be set at the level of each AT 
Person, or such other more granular level as the AT Person may 
determine, including but not limited to, by product, account number or 
designation, or one or more identifiers of natural persons associated 
with an AT Order Message.
    (3) Natural person monitors at the AT Person shall be promptly 
alerted when pre-trade risk control parameters established pursuant to 
this section are breached.
    (b) Order Cancellation Systems. (1) Systems that have the ability 
to:
    (i) Immediately disengage Algorithmic Trading;
    (ii) Cancel selected or up to all resting orders when system or 
market conditions require it; and
    (iii) Prevent submission of new AT Order Messages.
    (2) Prior to an AT Person's initial use of Algorithmic Trading to 
submit a message or order to a designated contract market's trading 
platform, such AT Person must notify the designated contract market on 
which it conducts Algorithmic Trading whether all of its resting orders 
should be cancelled or suspended in the event that the AT Person's 
Algorithmic Trading system disconnects with the trading platform.
    (c) System Connectivity. AT Persons with Direct Electronic Access 
as defined in Sec.  1.3(yyyy) shall implement systems to indicate on an 
ongoing basis whether they have proper connectivity with the trading 
platform and any systems used by a designated contract market to 
provide the AT Person with market data.

[[Page 78938]]

    (d) Notification of Algorithmic Trading. Prior to an AT Person's 
initial use of Algorithmic Trading to submit a message or order to a 
designated contract market's trading platform, such AT Person shall 
notify its clearing member and the designated contract market on which 
it will be trading that it will engage in Algorithmic Trading.
    (e) Self-Trade Prevention Tools. To the extent that implementation 
of a designated contract market's self-trade prevention tools requires 
calibration or other action by an AT Person, such AT Person shall 
calibrate or take such other action as is necessary to apply such 
tools.
    (f) Periodic Review for Sufficiency and Effectiveness. Each AT 
Person shall periodically review its compliance with this section to 
determine whether it has effectively implemented sufficient measures 
reasonably designed to prevent an Algorithmic Trading Event. Each AT 
Person shall take prompt action to remedy any deficiencies it 
identifies.


Sec.  1.81  Standards for the development, monitoring, and compliance 
of Algorithmic Trading systems.

    (a) Development and testing of Algorithmic Trading Systems. (1) 
Each AT Person shall implement written policies and procedures for the 
development and testing of its Algorithmic Trading systems. Such 
policies and procedures shall at a minimum include the following:
    (i) Maintaining a development environment that is adequately 
isolated from the production trading environment. The development 
environment may include computers, networks, and databases, and should 
be used by software engineers while developing, modifying, and testing 
source code.
    (ii) Testing of all Algorithmic Trading code and related systems 
and any changes to such code and systems prior to their implementation, 
including testing to identify circumstances that may contribute to 
future Algorithmic Trading Events. Such testing must be conducted both 
internally within the AT Person and on each designated contract market 
on which Algorithmic Trading will occur.
    (iii) Regular back-testing of Algorithmic Trading using historical 
transaction, order, and message data to identify circumstances that may 
contribute to future Algorithmic Trading Events.
    (iv) Regular stress tests of Algorithmic Trading systems to verify 
their ability to operate in the manner intended under a variety of 
market conditions.
    (v) Procedures for documenting the strategy and design of 
proprietary Algorithmic Trading software used by an AT Person, as well 
as any changes to such software if such changes are implemented in a 
production environment.
    (vi) Maintaining a source code repository to manage source code 
access, persistence, copies of all code used in the production 
environment, and changes to such code. Such source code repository must 
include an audit trail of material changes to source code that would 
allow the AT Person to determine, for each such material change: who 
made it; when they made it; and the coding purpose of the change. Each 
AT Person shall keep such source code repository, and make it available 
for inspection, in accordance with Sec.  1.31.
    (2) Each AT Person shall periodically review the effectiveness of 
the policies and procedures required by this paragraph (a), and take 
prompt action to document and remedy deficiencies in such policies and 
procedures.
    (b) Monitoring of Algorithmic Trading Systems. (1) Each AT Person 
shall implement written policies and procedures reasonably designed to 
ensure that each of its Algorithmic Trading systems is subject to 
continuous real-time monitoring by knowledgeable and qualified staff 
while such Algorithmic Trading system is engaged in trading. Such 
policies and procedures shall at a minimum include the following:
    (i) Continuous real-time monitoring of Algorithmic Trading to 
identify potential Algorithmic Trading Events.
    (ii) Automated alerts when an Algorithmic Trading system's AT Order 
Message behavior breaches design parameters, upon loss of network 
connectivity or data feeds, or when market conditions approach the 
boundaries within which the Algorithmic Trading system is intended to 
operate, to the extent applicable.
    (iii) Monitoring staff of the AT Person shall have the ability and 
authority to disengage an Algorithmic Trading system and to cancel 
resting orders when system or market conditions require it, including 
the ability to contact staff of the applicable designated contract 
market and clearing firm, as applicable, to seek information and cancel 
orders. Such monitoring staff must also have dashboards and control 
panels to monitor and interact with the Algorithmic Trading systems for 
which they are responsible.
    (iv) Procedures that will enable AT Persons to track which 
monitoring staff is responsible for an Algorithmic Trading system 
during trading hours.
    (2) Each AT Person shall periodically review the effectiveness of 
the policies and procedures required by this paragraph (b), and take 
prompt action to document and remedy deficiencies in such policies and 
procedures.
    (c) Compliance of Algorithmic Trading Systems. (1) Each AT Person 
shall implement written policies and procedures reasonably designed to 
ensure that each of its Algorithmic Trading systems operates in a 
manner that complies with the Commodity Exchange Act and the rules and 
regulations thereunder.
    (2) Each AT Person shall implement written policies and procedures 
requiring:
    (i) Staff of the AT Person to review Algorithmic Trading systems in 
order to detect potential Algorithmic Trading Compliance Issues. 
Procedures shall indicate that such staff shall include staff of the AT 
Person familiar with the Commodity Exchange Act and the rules and 
regulations thereunder, the rules of any designated contract market to 
which such AT Person submits AT Order Messages, the rules of any 
registered futures association of which such AT Person is a member, the 
AT Person's own internal requirements, and the requirements of the AT 
Person's clearing member, in each case as applicable.
    (ii) A plan of internal coordination and communication between 
compliance staff of the AT Person and staff of the AT Person 
responsible for Algorithmic Trading regarding Algorithmic Trading 
design, changes, testing, and controls, which plan should be designed 
to detect and prevent Algorithmic Trading Compliance Issues.
    (3) Each AT Person shall periodically review the effectiveness of 
the policies and procedures required by this paragraph (c), and take 
prompt action to document and remedy deficiencies in such policies and 
procedures.
    (d) Designation and training of Algorithmic Trading staff. (1) Each 
AT Person shall implement written policies and procedures to designate 
and train its staff responsible for Algorithmic Trading. Such policies 
and procedures shall at a minimum include the following:
    (i) Procedures for designating and training all staff involved in 
designing, testing and monitoring Algorithmic Trading, and documenting 
training events. Training must, at a minimum, cover design and testing 
standards, Algorithmic Trading Event communication procedures, and 
requirements for notifying staff of the

[[Page 78939]]

applicable designated contract market when Algorithmic Trading Events 
occur.
    (ii) Training policies reasonably designed to ensure that natural 
person monitors are adequately trained for each Algorithmic Trading 
system or strategy (or material change to such system or strategy) for 
which such monitors are responsible. Training must include, at a 
minimum, the trading strategy for the Algorithmic Trading as well as 
the automated and non-automated risk controls that are applicable to 
the Algorithmic Trading.
    (iii) Escalation procedures to inform senior staff of the AT Person 
as soon as Algorithmic Trading Events are identified.
    (2) Each AT Person shall periodically review the effectiveness of 
the policies and procedures required by this paragraph (d), and take 
prompt action to document and remedy deficiencies in such policies and 
procedures.


Sec.  1.82  Clearing member futures commission merchant risk 
management.

    (a) For all AT Order Messages originating with an AT Person, the 
futures commission merchant that is the clearing member for such AT 
Person shall comply with the following requirements:
    (1) Make use of pre-trade risk controls reasonably designed to 
prevent or mitigate an Algorithmic Trading Disruption, including at a 
minimum, those pre-trade risk controls described in Sec.  1.80(a)(1).
    (2) Pre-trade risk controls must be set at the level of each AT 
Person, or such other more granular level as the clearing futures 
commission merchant may determine, including but not limited to, by 
product, account number or designation, or one or more identifiers of 
natural persons associated with an AT Order Message.
    (3) The futures commission merchant shall have policies and 
procedures reasonably designed to ensure that natural person monitors 
at the clearing futures commission merchant are promptly alerted when 
pre-trade risk control parameters established pursuant to this section 
are breached.
    (4) Make use of the order cancellation systems described in Sec.  
1.80(b)(1).
    (b) Direct Electronic Access orders. For all AT Order Messages 
originating with an AT Person submitted to a trading platform through 
Direct Electronic Access as defined in Sec.  1.3(yyyy), the futures 
commission merchant that is the clearing member for the AT Person shall 
comply with the requirements of paragraphs (a)(1), (2), and (4) of this 
section by implementing the pre-trade risk controls and order 
cancellation systems provided by designated contract markets pursuant 
to Sec.  38.255(b) and (c) of this chapter.
    (c) Non-Direct Electronic Access orders. For all AT Order Messages 
originating with an AT Person that are not submitted to a trading 
platform through Direct Electronic Access as defined in Sec.  
1.3(yyyy), the futures commission merchant that is the clearing member 
for the AT Person shall comply with the requirements of paragraphs 
(a)(1), (2), and (4) of this section by itself establishing and 
maintaining the pre-trade risk controls and order cancellation systems 
described therein.


Sec.  1.83  AT Person and clearing member futures commission merchant 
reports and recordkeeping.

    (a) AT Person Reports. Each AT Person shall annually prepare a 
report and submit such report by June 30 to each designated contract 
market on which such AT Person engaged in Algorithmic Trading. Together 
with the annual report, each AT Person shall submit copies of the 
written policies and procedures developed to comply with Sec.  1.81(a) 
and (c). Such report shall cover the time period from May 1 of the 
previous year to April 30 of the year such report is submitted. The 
report shall include the following:
    (1) A description of the pre-trade risk controls required by Sec.  
1.80(a), including a description of each item enumerated in Sec.  
1.80(a) and a description of all parameters and the specific 
quantitative settings used by the AT Person for such pre-trade risk 
controls; and
    (2) A certification by the chief executive officer or chief 
compliance officer of the AT Person that, to the best of his or her 
knowledge and reasonable belief, the information contained in the 
report is accurate and complete.
    (b) Clearing member futures commission merchant reports. Each 
futures commission merchant that is a clearing member for one or more 
AT Person(s) shall annually prepare and submit a report by June 30 to 
each designated contract market on which such AT Person(s) engaged in 
Algorithmic Trading. Such report shall cover the time period from May 1 
of the previous year to April 30 of the year such report is submitted. 
The report shall include the following:
    (1) A description of the clearing member futures commission 
merchant's program for establishing and maintaining the pre-trade risk 
controls required by Sec.  1.82(a)(1) for its AT Persons at the 
designated contract market; and
    (2) A certification by the chief executive officer or chief 
compliance officer of the futures commission merchant that, to the best 
of his or her knowledge and reasonable belief, the information 
contained in the report is accurate and complete.
    (c) AT Person recordkeeping. Each AT Person shall keep, and provide 
upon request to each designated contract market on which such AT Person 
engages in Algorithmic Trading, books and records regarding such AT 
Person's compliance with all requirements pursuant to Sec. Sec.  1.80 
and 1.81.
    (d) Clearing member futures commission merchant recordkeeping. Each 
futures commission merchant that is a clearing member for an AT Person 
shall keep, and provide upon request to each designated contract market 
on which such AT Person engages in Algorithmic Trading, books and 
records regarding such clearing member futures commission merchant's 
compliance with all requirements pursuant to Sec.  1.82.

PART 38--DESIGNATED CONTRACT MARKETS

0
4. The authority citation for part 38 continues to read as follows:

    Authority: 7 U.S.C. 1a, 2, 6, 6a, 6c, 6d, 6e, 6f, 6g, 6i, 6j, 
6k, 6l, 6m, 6n, 7, 7a-2, 7b, 7b-1, 7b-3, 8, 9, 15, and 21, as 
amended by the Dodd-Frank Wall Street Reform and Consumer Protection 
Act, Pub. L. 111-203, 124 Stat. 1376.

0
5. Revise Sec.  38.255 to read as follows:


Sec.  38.255  Risk controls for trading.

    (a) The designated contract market must establish and maintain risk 
control mechanisms to prevent and reduce the potential risk of price 
distortions and market disruptions, including, but not limited to, 
market restrictions that pause or halt trading in market conditions 
prescribed by the designated contract market.
    (b) For all AT Order Messages originating with an AT Person that 
are submitted to a designated contract market through Direct Electronic 
Access as defined in Sec.  1.3(yyyy) of this chapter, the designated 
contract market shall make available to the clearing member futures 
commission merchant for such AT Person effective systems and controls, 
reasonably designed to facilitate the items enumerated below:
    (1) The clearing member futures commission merchant's management of 
the risks, pursuant to Sec.  1.82(a)(1) and (2) of this chapter, that 
may arise from such AT Person's Algorithmic Trading using Direct 
Electronic Access.
    (i) Such systems and controls shall include, at a minimum, the pre-
trade

[[Page 78940]]

risk controls described in Sec.  1.80(a)(1) of this chapter.
    (ii) Such systems shall, at a minimum, enable the clearing member 
futures commission merchant to set the pre-trade risk controls at the 
level of each such AT Person, product, account number or designation, 
and one or more identifiers of natural persons associated with an AT 
Order Message. Designated contract market rules should permit clearing 
member futures commission merchants to choose the level at which they 
place control, so long as clearing member futures commission merchants 
use at least one of the levels.
    (2) The clearing member future commission merchant's ability, 
pursuant to Sec.  1.82(a)(4) of this chapter, to make use of the order 
cancellation systems described in Sec.  1.80(b)(1) of this chapter. The 
designated contract market shall enable the clearing member future 
commission merchant to apply such order cancellation systems to orders 
from each such AT Person, product, account number or designation, or 
one or more identifiers of natural persons associated with an AT Order 
Message.
    (c) A designated contract market that permits Direct Electronic 
Access as defined in Sec.  1.3(yyyy) of this chapter shall also require 
clearing member futures commission merchants to use the systems and 
controls described in paragraph (b) of this section with respect to all 
AT Order Messages originating with an AT Person that are submitted 
through Direct Electronic Access.
0
6. Amend Sec.  38.401 as follows:
0
a. Revise paragraph (a)(1)(iii);
0
b. Add paragraph (a)(1)(iv);
0
c. Revise paragraph (a)(2); and
0
d. Add paragraph (c)(3).
0
The revisions and additions read as follows:


Sec.  38.401  General requirements.

    (a) * * * (1) * * *
    (iii) Rules and specifications pertaining to the operation of the 
electronic matching platform or trade execution facility, including but 
not limited to those pertaining to the operation of its electronic 
matching platform that materially affect the time, priority, price, or 
quantity of execution, or the ability to cancel, modify, or limit 
display of market participant orders.
    (iv) Any known attributes of the electronic matching platform, 
other than those already disclosed in rules or specifications under 
paragraph (a)(1)(iii) of this section, that materially affect the time, 
priority, price, or quantity of execution of market participant orders, 
the ability to cancel, modify, or limit display of market participant 
orders, or the dissemination of real-time market data to market 
participants, including but not limited to latencies or other 
variability in the electronic matching platform and the transmission of 
message acknowledgements, order confirmations, or trade confirmations, 
or dissemination of market data.
    (2) Through the procedures, arrangements and resources required in 
paragraph (a) of this section, the designated contract market must 
ensure public dissemination of information pertaining to new product 
listings, new rules, rule amendments, rules pertaining to the operation 
of the electronic matching platform or trade execution facility, known 
attributes of its electronic trading platform under paragraph 
(a)(1)(iv) of this section, or other changes to previously-disclosed 
information, in accordance with the timeline provided in paragraph (c) 
of this section.
* * * * *
    (c) * * *
    (3) A designated contract market, in making available on its Web 
site information pursuant to paragraphs (a)(1)(iii) and (iv) of this 
section, shall place such information and submissions on its Web site 
within a reasonable time, but no later than 10 business days, following 
the identification of or changes to such attributes. Such information 
shall be disclosed prominently and clearly in plain English.
* * * * *
0
7. In Appendix B to part 38, in the paragraph with the subject heading 
Core Principle 4 of section 5(d) of the Act: PREVENTION OF MARKET 
DISRUPTION, revise paragraph (b)(5) to read as follows:

Appendix B to Part 38--Guidance on, and Acceptable Practices in, 
Compliance With Core Principles

* * * * *
    Core Principle 4 of section 5(d) of the Act: PREVENTION OF 
MARKET DISRUPTION
* * * * *
    (b) * * *
    (5) Risk controls for trading. An acceptable program for 
preventing market disruptions must demonstrate appropriate trade 
risk controls, in addition to pauses and halts. Such controls must 
be adapted to the unique characteristics of the markets to which 
they apply and must be designed to avoid market disruptions without 
unduly interfering with that market's price discovery function. The 
designated contract market must employ the pre-trade risk controls 
specified in the Commission's regulations (including applicable 
regulations contained in part 40 of this chapter), and may employ 
additional controls that the designated contract market believes are 
appropriate to its market. Within the specific array of controls 
that are selected, the designated contract market also must set the 
parameters for those controls, so long as the types of controls and 
their specific parameters are reasonably likely to serve the purpose 
of preventing market disruptions and price distortions, or as they 
are otherwise required to be designed pursuant to Commission 
regulation. If a contract is linked to, or is a substitute for, 
other contracts, either listed on its market or on other trading 
venues, the designated contract market must, to the extent 
practicable, coordinate its risk controls with any similar controls 
placed on those other contracts. If a contract is based on the price 
of an equity security or the level of an equity index, such risk 
controls must, to the extent practicable, be coordinated with any 
similar controls placed on national security exchanges.
* * * * *

PART 40--PROVISIONS COMMON TO REGISTERED ENTITIES

0
8. The authority citation for part 40 continues to read as follows:

    Authority: 7 U.S.C. 1a, 2, 5, 6, 7, 7a, 8 and 12, as amended by 
Titles VII and VIII of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).

0
9. Revise Sec.  40.1(i) to read as follows:


Sec.  40.1  Definitions.

* * * * *
    (i) Rule means any constitutional provision, article of 
incorporation, bylaw, rule, regulation, resolution, interpretation, 
stated policy, advisory, terms and conditions, market maker or trading 
incentive program, trading protocol (including but not limited to any 
operation of an electronic matching platform that materially affects 
the time, priority, price, or quantity of execution of market 
participant orders, the ability to cancel, modify, or limit display of 
market participant orders, or the dissemination of real-time market 
data to market participants), agreement or instrument corresponding 
thereto, including those that authorize a response or establish 
standards for responding to a specific emergency, and any amendment or 
addition thereto or repeal thereof, made or issued by a registered 
entity or by the governing board thereof or any committee thereof, in 
whatever form adopted.
* * * * *


Sec. Sec.  40.13 through 40.19  [Reserved]

0
10. Add reserved Sec. Sec.  40.13 through 40.19.
0
11. Add Sec. Sec.  40.20 through 40.23 to read as follows:


Sec.  40.20  Risk controls for trading.

    A designated contract market shall implement pre-trade and other 
risk

[[Page 78941]]

controls reasonably designed to prevent an Algorithmic Trading 
Disruption (or, pursuant to paragraph (d) of this section, similar 
disruption resulting from orders that originate from manual order entry 
or other non-Algorithmic Trading) or an Algorithmic Trading Compliance 
Issue, including at a minimum all of the following:
    (a) Pre-trade risk controls. Pre-trade risk controls reasonably 
designed to address the risks from Algorithmic Trading on a designated 
contract market.
    (1) The pre-trade risk controls to be established and used by a 
designated contract market shall include, at a minimum, those described 
in Sec.  1.80(a)(1) of this chapter.
    (2) At a minimum, the pre-trade risk controls established and used 
pursuant to this section shall be set at the level of each AT Person. 
Designated contract markets must also evaluate whether to establish 
pre-trade risk controls at a more granular level, including at a 
minimum, by product or one or more identifiers of natural persons 
associated with an AT Order Message. Where deemed appropriate by the 
designated contract market, pre-trade risk controls should be set at 
such more granular levels.
    (3) A designated contract market shall have policies and procedures 
reasonably designed to ensure that natural person monitors at such 
designated contract market are promptly alerted when pre-trade risk 
control parameters established pursuant to this section are breached.
    (b) Order cancellation systems. (1) Order cancellation systems that 
have the ability to:
    (i) Perform the actions described in Sec.  1.80(b)(1) of this 
chapter with respect to orders from AT Persons; and
    (ii) Cancel or suspend all resting orders from AT Persons in the 
event of disconnect with the trading platform.
    (2) [Reserved]
    (c) System connectivity. (1) Systems that enable the systems of an 
AT Person with Direct Electronic Access as defined in Sec.  1.3(yyyy) 
of this chapter to indicate to the AT Person on an ongoing basis 
whether the AT Person has proper connectivity with--
    (i) The designated contract market's trading platform, and
    (ii) Any systems used by the designated contract market to provide 
the AT Person with market data.
    (2) [Reserved]
    (d) Risk control mechanisms for manual order entry and other non-
Algorithmic Trading. (1) A designated contract market shall implement 
the risk control mechanisms described in paragraphs (a) and (b)(1)(i) 
of this section for orders that do not originate from Algorithmic 
Trading, after making any adjustments to the mechanisms that the 
designated contract market determines are appropriate for such orders.
    (2) [Reserved]


Sec.  40.21  DCM test environments.

    (a) A designated contract market shall provide a test environment 
that will enable AT Persons to simulate production trading. Such test 
environment shall provide access to historical transaction, order and 
message data and shall also enable AT Persons to conduct conformance 
testing of their Algorithmic Trading systems to verify compliance with 
the requirements of Sec. Sec.  1.80(a) through (c) and 1.81(a)(1)(ii) 
through (iv) and (c)(1) of this chapter.
    (b) [Reserved]


Sec.  40.22  DCM review of compliance reports; maintenance of books and 
records.

    A designated contract market shall comply with the following:
    (a) Review of reports. Implement rules that require each AT Person 
that trades on the designated contract market, and each futures 
commission merchant that is a clearing member of a derivatives clearing 
organization for such AT Person, to submit the reports described in 
Sec.  1.83(a) and (b), respectively, of this chapter;
    (b) Submission date. Require the submission of such reports by June 
30th of each year;
    (c) Review program. Establish a program for effective periodic 
review and evaluation of reports described in paragraph (a) of this 
section, and of the measures described therein. An effective program 
shall include measures by the designated contract market reasonably 
designed to identify and remediate any insufficient mechanisms, 
policies and procedures described in such reports, including 
identification and remediation of any inadequate quantitative settings 
or calibrations of pre-trade risk controls required of AT Persons 
pursuant to Sec.  1.80(a) of this chapter;
    (d) Maintenance of books and records. Implement rules that require 
each AT Person to keep and provide to the designated contract market 
books and records regarding such AT Person's compliance with all 
requirements pursuant to Sec. Sec.  1.80 and 1.81 of this chapter, and 
require each clearing member futures commission merchant to keep and 
provide to the designated contract market books and records regarding 
such clearing member futures commission merchant's compliance with all 
requirements pursuant to Sec.  1.82 of this chapter; and
    (e) Review and evaluate, as necessary, books and records required 
to be kept pursuant to paragraph (d) of this section, and the measures 
described therein. An appropriate review shall include measures by the 
designated contract market reasonably designed to identify and 
remediate any insufficient mechanisms, policies, and procedures 
described in such books and records.


Sec.  40.23  Self-trade prevention tools.

    (a) A designated contract market shall implement rules reasonably 
designed to prevent self-trading by market participants, except as 
specified in paragraph (b) of this section. ``Self-trading'' is defined 
for purposes of this section as the matching of orders for accounts 
that have common beneficial ownership or are under common control. A 
designated contract market shall either apply, or provide and require 
the use of, self-trade prevention tools that are reasonably designed to 
prevent self-trading and are applicable to all orders on its electronic 
trade matching platform. For purposes of complying with this 
requirement, a designated contract market may either determine for 
itself which accounts should be prohibited from trading with each 
other, or require market participants to identify to the designated 
contract market which accounts should be prohibited from trading with 
each other.
    (b) Notwithstanding the foregoing, a designated contract market 
may, in its discretion, implement rules that permit self-trading 
described in paragraphs (b)(1) or (b)(2) of this section to occur, in 
each case subject to the requirements of paragraph (c) of this section:
    (1) A self-trade resulting from the matching of orders for accounts 
with common beneficial ownership where such orders are initiated by 
independent decision makers. A designated contract market may through 
its rules further define for its market participants ``independent 
decision makers.''
    (2) A self-trade resulting from the matching of orders for accounts 
under common control where such orders comply with the designated 
contract market's cross-trade, minimum exposure requirements or similar 
rules, and are for accounts that are not under common beneficial 
ownership.
    (c) A designated contract market may permit self-trading described 
in paragraph (b) of this section only if the designated contract 
market:
    (1) Requires market participants to request approval from the 
designated contract market that self-trade

[[Page 78942]]

prevention tools not be applied with respect to specific accounts under 
common beneficial ownership or control, on the basis that they meet the 
criteria of paragraph (b) of this section. The designated contract 
market must require that such approval request be provided to it by a 
compliance officer or senior officer of the market participant; and
    (2) Requires market participants to withdraw or amend an approval 
request if any change occurs that would cause the information provided 
in such approval request to be no longer accurate or complete.
    (d) For each product and expiration month traded on a designated 
contract market in the previous quarter, the designated contract market 
must prominently display on its Web site the following information:
    (1) The percentage of trades in such product including all 
expiration months that represent self-trading approved (pursuant to 
paragraph (c) of this section) by the designated contract market, 
expressed as a percentage of all trades in such product and expiration 
month;
    (2) The percentage of volume of trading in such product including 
all expiration months that represents self-trading approved (pursuant 
to paragraph (c) of this section) by the designated contract market, 
expressed as a percentage of all volume in such product and expiration 
month; and
    (3) The ratio of orders in such product and expiration month whose 
matching was prevented by the self-trade prevention tools described in 
paragraph (a) of this section, expressed as a ratio of all trades in 
such product and expiration month.


Sec.  40.24  [Reserved]

0
12. Add reserved Sec.  40.24.
0
13. Add Sec. Sec.  40.25 through 40.28 to read as follows:


Sec.  40.25  Additional public information required for market maker 
and trading incentive programs.

    (a) When submitting a Rule regarding a market maker or trading 
incentive program pursuant to Sec.  40.5 or Sec.  40.6, a designated 
contract market shall, in addition to information required by such 
sections, include the following information in its public Rule filing:
    (1) The name of the market maker program or trading incentive 
program, the date on which it is scheduled to begin, and the date on 
which it is scheduled to terminate (if applicable);
    (2) An explanation of the specific purpose for the market maker or 
trading incentive program;
    (3) A list of all products or services to which the market maker or 
trading incentive program applies;
    (4) A description of any eligibility criteria or categories of 
market participants defining who may participate in the market maker or 
trading incentive program;
    (5) For any market maker or trading incentive program that is not 
open to all market participants, an explanation of why such program is 
limited to the chosen eligibility criteria or categories of market 
participants, and an explanation of how such limitation complies with 
the impartial access and comparable fee structure requirements of Sec.  
38.151(b) of this chapter for designated contract markets;
    (6) An explanation of how persons eligible for the market maker or 
trading incentive program may apply to participate, and how eligibility 
will be evaluated by the designated contract market;
    (7) A description of any payments, incentives, discounts, 
considerations, inducements or other benefits that market maker or 
trading incentive program participants may receive, including any non-
financial incentives; and
    (8) A description of the obligations, benchmarks, or other measures 
that a participant in a market maker or trading incentive program must 
meet to receive the benefits described in paragraph (a)(7) of this 
section.
    (9) A description of any legal affiliation between the designated 
contract market and any entity acting as a market maker or 
participating in a market maker program.
    (b) In addition to any public notice required pursuant to this part 
(including without limitation the requirements of Sec. Sec.  40.5(a)(6) 
and 40.6(a)(2)) of this chapter a designated contract market shall 
ensure that the information required by paragraphs (a)(1) through 
(a)(8) of this section is easily located on its public Web site from 
the time that such designated contract market begins accepting 
participants in the market maker or trading incentive program through 
the time that it ceases operation of the market maker or trading 
incentive program.
    (c) A designated contract market shall notify the Commission upon 
the termination of a market maker or trading incentive program prior to 
the termination date previously notified to the Commission; any 
extension or renewal of a market maker or trading incentive program 
beyond its original termination date shall require a new Rule filing 
pursuant to this part.


Sec.  40.26  Information requests from the Commission or the Director 
of the Division of Market Oversight.

    (a) Upon request by the Commission or the Director of the Division 
of Market Oversight, a designated contract market shall provide such 
information and data as may be requested regarding participation in 
market maker or trading incentive programs offered by the designated 
contract market, including but not limited to, individual program 
agreements, names of program participants, benchmarks achieved by 
program participants, and payments or other benefits conferred upon 
program participants.
    (b) [Reserved]


Sec.  40.27  Payment for trades with no change in ownership prohibited.

    (a) A designated contract market shall implement policies and 
procedures reasonably designed to prevent the payment of market maker 
or trading incentive program benefits, including but not limited to 
payments, discounts, or other considerations, for trades between 
accounts that are:
    (1) Identified to such designated contract market as under common 
beneficial ownership pursuant to the approval process described in 
Sec.  40.23(c); or
    (2) Otherwise known to the designated contract market as under 
common ownership.
    (b) [Reserved]


Sec.  40.28  Surveillance of market maker and trading incentive 
programs.

    (a) A designated contract market, consistent with its obligations 
pursuant to subpart C of part 38 of this chapter, shall review all 
benefits accorded to participants in market maker and trading incentive 
programs, including but not limited to payments, discounts, or other 
considerations, to ensure that such benefits are not earned through 
abusive practices.
    (b) [Reserved]

PART 170--REGISTERED FUTURES ASSOCIATIONS

0
14. The authority citation for part 170 continues to read as follows:

    Authority: 7 U.S.C. 6d, 6m, 6p, 6s, 12a, and 21.

0
15. Add Sec.  170.18 to subpart C to read as follows:


Sec.  170.18  AT Persons.

    Each registrant, as defined in Sec.  1.3(oooo) of this chapter, 
that is an AT Person, as defined in Sec.  1.3(xxxx) of this chapter, 
that is not otherwise required to be a member of a futures association 
that is registered under Section 17 of the

[[Page 78943]]

Act pursuant to Sec. Sec.  170.15, 170.16, or 170.17 of this chapter 
must become and remain a member of at least one futures association 
that is registered under Section 17 of the Act and that provides for 
the membership therein of such registrant, unless no such futures 
association is so registered.
0
16. Add subpart D, consisting of Sec.  170.19, to read as follows:

Subpart D--Standards for Automated Trading and Algorithmic Trading 
Systems


Sec.  170.19  RFA Standards for Automated Trading and Algorithmic 
Trading Systems.

    (a) A registered futures association must establish and maintain a 
program for the prevention of fraudulent and manipulative acts and 
practices, the protection of the public interest, and perfecting the 
mechanisms of trading on designated contract markets by adopting rules 
for each category of member, as deemed appropriate by the registered 
futures association, requiring:
    (1) Pre-trade risk controls and other measures for algorithmic 
trading systems;
    (2) Standards for the development, testing, monitoring, and 
compliance of algorithmic trading systems;
    (3) Designation and training of algorithmic trading staff; and
    (4) Operational risk management standards for clearing member 
futures commission merchants with respect to customer orders 
originating with algorithmic trading systems.
    (b) [Reserved]

     Issued in Washington, DC, on November 27, 2015, by the 
Commission.
Christopher J. Kirkpatrick,
Secretary of the Commission.

    Note: The following appendices will not appear in the Code of 
Federal Regulations.

Appendices to Regulation Automated Trading--Commission Voting Summary, 
Chairman's Statement, and Commissioners' Statements

Appendix 1--Commission Voting Summary

    On this matter, Chairman Massad and Commissioners Bowen and 
Giancarlo voted in the affirmative. No Commissioner voted in the 
negative.

Appendix 2--Statement of Chairman Timothy G. Massad

    Today, the Commission has approved a proposal that addresses the 
increased use of automated trading in our markets. I strongly 
support this important action. In the futures markets, today almost 
all trading is electronic in some form. And over the last few years, 
more than 70 percent of all trading has become automated.
    Automated trading has brought many benefits to market 
participants. These include more efficient execution, lower spreads 
and greater transparency. But its extensive use also raises 
important policy and supervisory questions and concerns.
    The Commission has already taken a number of steps to respond to 
the development of automated trading in our markets. Following the 
2010 ``Flash Crash,'' the CFTC worked with the SEC to establish 
certain controls to minimize the risk of market disruptions. The 
Commission has also required clearing members to implement policies 
and procedures governing the use of automated trading programs. We 
have also required automatic screening of orders for compliance with 
risk limits if they are automatically executed.
    But as markets continue to evolve, it is important to continue 
looking at this issue. Therefore, in September 2013, the Commission 
issued a Concept Release that requested public comment on the 
necessity and operation of a variety of risk controls and measures. 
The Commission received many written comments and also held a 
meeting of its Technological Advisory to discuss the issues raised. 
It served as a very useful way to understand existing industry 
practices and discuss what further actions might make sense.
    The proposal approved today addresses several areas discussed in 
the Concept Release, and incorporates much of that public input. It 
focuses on minimizing the potential for disruptions and other 
operational problems that may arise from the automation of order 
origination, transmission or execution. They may come about due to 
malfunctioning algorithms, inadequate testing of algorithms, errors 
and similar problems.
    No set of rules can prevent all such problems. But that doesn't 
discharge us from our duty to take reasonable measures to minimize 
these risks. It is our responsibility as regulators to create a 
framework that promotes the integrity of these markets. And I 
believe this proposed rule helps do that.
    Our futures market infrastructure is already very strong. Our 
regulatory framework--and the controls and measures that exist at 
the exchange and clearing member level in particular--have helped 
create the best futures markets in the world. Our proposal seeks to 
maintain that strength as our markets evolve further.
    We have proposed a number of measures that largely reflect what 
are industry best practices to minimize the risk of disruptions and 
similar problems. We have tried to be principles-based. We have set 
forth requirements for certain controls, but we have avoided 
prescribing the parameters or levels at which they should be set. 
The proposed risk controls will apply regardless of whether the 
automated trading is high- or low-frequency. The proposal does not 
define high frequency trading.
    A key principal of this proposed rule is to have risk controls 
at three levels--the exchange level, clearing member level and 
trading firm level. Market participants generally supported this 
multi-level approach in response to the Concept Release, and I 
believe it is important to achieving a sound framework. But in doing 
so, we must seek efficiency, and avoid conflicting or unnecessary 
requirements at multiple levels.
    In order to make the multi-level approach effective, we are 
proposing to require the registration of proprietary traders who 
engage in algorithmic trading on our regulated exchanges via 
``direct electronic access.'' Today, our staff estimates that 
roughly 35 percent of the futures trading in our markets is done by 
traders who use direct electronic access and are not registered with 
us. A registration requirement will ensure that all those with 
direct electronic access to our markets are complying with pre-trade 
risk controls, testing and other requirements. And it would enhance 
the Commission's ability to carry out its oversight 
responsibilities.
    While we believe a registration requirement is appropriate, we 
have also invited market participants to comment on whether there 
are alternatives that can achieve the proposal's underlying 
objectives. We have also asked whether the registration requirement 
should be limited to trading firms meeting certain volume, order or 
message levels--or be based on other characteristics. Further, we 
are seeking comment on whether all firms trading through direct 
electronic access should be required to register, even if they are 
not using algorithmic trading.
    We believe that many of the requirements we are proposing for 
trading firms represent the best practices already followed by many 
larger firms. However, we know that a faulty algorithm at a single 
firm, regardless of size, can potentially cause a significant 
problem. As a result, we have proposed standards that are applicable 
regardless of the size or similar attributes of a trading firm. We 
also are cognizant of the importance of establishing effective 
standards without creating barriers to entry for small firms. So we 
welcome comment on whether these requirements should vary in any way 
depending on the size or activity level of the trading firm.
    We have also proposed certain risk controls for clearing member 
futures commission merchants (FCMs) with respect to their customers 
engaged in algorithmic trading. FCMs play a critical role in overall 
risk management. As I noted earlier, they have implemented measures 
already to require order limits and screening of orders. We believe 
the requirements we are proposing today help achieve an effective 
multi-layered approach.
    We have asked for public comment on whether there are any 
aspects of the required controls that may pose an undue burden on 
clearing member FCMs or that are unnecessary for reducing the risks 
associated with algorithmic trading. We've also asked about what 
technological development would be required by clearing members to 
comply with some requirements of this proposal.
    I've said frequently that it's very important that we have a 
robust clearing member industry and that all customers--particularly 
smaller ones--are able to access the markets effectively and 
efficiently. We want to make sure this proposal is consistent with 
achieving that objective.

[[Page 78944]]

    We have also included measures on some additional topics not 
covered in the Concept Release. These include provisions to increase 
transparency for exchanges' electronic trade matching platforms, as 
well as for market maker and trading incentive programs, which have 
become more significant as automated trading has increased.
    There are concerns that have been raised with respect to 
automated trading that also go beyond the scope of this proposal. 
These include whether our markets are best served by this speed, and 
what are its impacts on volatility and liquidity? These are 
important topics for market participants and the Commission to 
continue to study and discuss.
    This proposal provides some common-sense risk controls that I 
believe embrace the benefits that automated trading has brought to 
our markets, while also protecting against the increased possibility 
of breakdowns and disruptions that come with it. We encourage--and 
welcome--public comment, which will carefully be taken into account 
before we take any final action.

Appendix 3--Concurring Statement of Commissioner Sharon Y. Bowen

    I want to thank the Commission staff for the time they have 
devoted to the proposed rule on automated trading. It is a timely 
topic.
    As I have previously said, our markets have seen immense 
technological change over the last fifteen years.\1\ Futures trading 
used to involve ``throngs of traders with jackets and badges using 
hand-gestures'' to purchase futures and options.\2\ That trading 
structure has largely disappeared, with even CME closing the vast 
majority of its futures pits this summer. Meanwhile, algorithmic 
trading has substantially increased. Algo trading comprised less 
than 10% of futures volume at the turn of the millennium.\3\ Yet, 
``per CFTC staff's estimates, for the most liquid U.S. futures 
contracts which account for over 75% of total trading volume, more 
than 90 percent of all trades make use of algorithms or some other 
form of automation.'' \4\ Of course, these estimates are just that, 
estimates. We still do not have comprehensive, precise data on the 
percentage of trades created or entered by algorithms in many 
product classes. Clearly, further research and work remain for all 
stakeholders, from regulators, to industry participants, to 
academics and advocates of financial reform.
---------------------------------------------------------------------------

    \1\ Keynote Address by Commissioner Sharon Y. Bowen before ISDA 
North America Conference, CFTC (Sep. 17, 2015), http://www.cftc.gov/PressRoom/SpeechesTestimony/opabowen-6.
    \2\ Id.
    \3\ Id.
    \4\ Id.
---------------------------------------------------------------------------

    Yet, I do not believe this lack of information requires that 
regulators passively wait for this information to emerge. Simply 
waiting for that kind of data to materialize could allow problems to 
emerge in the interim that harm investors and the broader financial 
system. Given the current state of our economy and a global 
financial system still recovering from the 2008 financial crisis, 
that is a risk that I believe we must not take. Recent events have 
raised important questions about the impact and role of algorithmic 
trading in our markets. As I said earlier, this fall, ``Even though 
the amount of algorithmic trading and definitions of these various 
terms are not crystal clear, what is clear is trades involving 
algorithms make up a substantial portion of our markets, and 
algorithms can and do malfunction at times, with negative effects on 
the markets. As a result, I believe we are obligated to consider if 
it is prudent to establish some regulations on algorithmic trading 
in our markets.'' \5\
---------------------------------------------------------------------------

    \5\ Id.
---------------------------------------------------------------------------

    Today, we begin the process of potentially establishing those 
regulations. From what I have seen, I believe we now owe it to 
market participants, investors, and ordinary consumers to ensure 
that a reasonable level of regulation exists over this new trading 
technology. I have said such regulation should include requirements 
that entities utilizing algorithms to trade must use risk management 
strategies, be required to disclose information to regulators, and 
have people who understand the Commodity Exchange Act and our 
regulations involved in the creation and maintenance of their 
algorithms. I think this proposed regulation meets that standard and 
does so in a way that allows for innovation and continued 
development of this nascent technology.
    Having said what I think lies at the core of this regulation, 
let me also be clear about what this regulation is not. The rule 
before us today should not substantially change how many firms 
utilize algorithms. If, as I hope, a firm already uses risk 
management strategies, has various protections against malfunctions 
in place, and retains the services of talented attorneys, this new 
regulation will not create significant new burdens for that firm. In 
effect, this rulemaking largely formalizes and mandates firms 
involved in algorithmic trading to engage in a variety of practices 
that they should already be doing for their own protection.
    I expect that some observers will have issues with this 
regulation for not doing more to constrain the growth and use of 
algorithmic trading, and I expect there will be further debate. I do 
not regard this regulation as the final word on regulation of 
algorithmic trading. If there is clear evidence that more precise 
regulations are needed on this technology to protect investors or 
ward off systemic risk, I would support further regulatory action. 
And I am sure that, given the ferocious rate of change of this 
technology, we will need to update this regulation regularly to 
account for those changes. In many ways, this regulation is merely 
the first step in a process, it's a starter home rather than a two-
story. But we have to start somewhere, and starting with something 
that formalizes best practices and increases disclosure is an 
excellent place to start.
    I have said numerous times that I support smart regulation, 
regulation that works. That goal is especially critical when it 
comes to regulation of such a nascent, significant, and widespread 
technology as algorithmic trading. I therefore hope we'll get 
comments on this proposal from a wide swath of stakeholders, from 
industry experts, to end-users being impacted by this technology, to 
even ordinary investors and consumers concerned about the potential 
effects of algorithmic trading on commodity prices. I do not expect 
that everyone will have the same views on this subject or that there 
will be unanimity of opinion on any part of this rule. Even though 
I've only been in Washington for a year and a half, I'm experienced 
enough to know that people have different opinions on high-
visibility issues like this one. However, I do encourage people to 
comment so that we can get a full and fair read of popular opinion 
on both this proposal and the topic in general. And if people have 
concrete evidence that algorithmic trading is distorting markets and 
needs to be curtailed, please submit it via a comment.
    There are a few sections of this rule on which I think public 
comment would be particularly helpful. First, the proposal's sixth 
and seventh questions ask about the nature of our proposed 
definition of algorithmic trading, including whether we should 
expand ``the definition of Algorithmic Trading to encompass orders 
that are generated using algorithmic methods . . . but are then 
manually entered into a front-end system by a natural person. . . 
.'' The definition of algorithmic trading is at the heart of this 
proposal, and we need comments on this point. If there is evidence 
that a form of algorithmic trading poses systemic risks but is not 
captured by this definition, we should expand the definition to 
expand to cover that form of trading.
    Second, section 1.83(a) of the proposal requires that persons 
engaged in algorithmic trading and registered as such with the 
Commission must prepare and submit an annual report to the 
Commission. These persons are required to include in their reports a 
description of the pre-trade risk controls in place, copies of 
policies crafted to comply with requirements regarding the testing 
and development of algorithmic trading systems and how their 
algorithmic trading systems comply with the Commodity Exchange Act 
and our regulations, and a certification by their chief executive 
officer or chief compliance officer that the information in the 
report is accurate and complete.
    I think the current 1.83(a) does not ask registrants for enough 
information. Now, we don't want to require each registered 
algorithmic trader to submit a tome of several thousand pages each 
year that lays out every arcane factoid about their trading systems. 
Such a requirement would bury our staff in paper and create 
significant expense for registrants. Yet, having already asked each 
registered algorithmic trader to submit an annual report, I believe 
we should ask for more information in the report. After all, at the 
point a company has to file an annual report, it should already be 
doing a comprehensive review of its policies. As a result, asking 
for one or two more pieces of information to be included in the 
annual report should not be a substantial additional cost to 
registrants. I therefore hope that

[[Page 78945]]

commenters will let us know what additional information registrants 
should be required to submit in their annual reports. For instance, 
should we require registrants to submit information about how they 
train and monitor the staff responsible for handling algorithmic 
trading or about their order cancellation systems?
    Finally, the proposal prohibits designated contract markets 
(DCMs) from paying market maker incentive program benefits for 
trades between accounts under common ownership. I think that's a 
good change and worthy of being formalized in rule text. These 
programs serve a critical purpose of encouraging liquidity, but we 
don't get increased liquidity by increasing the amount of trades a 
person does with herself.
    However, I wonder whether this prohibition should not go 
further. Perhaps we should also prohibit DCMs from paying these 
program benefits for trades in which the benefits are, on a per 
trade basis, greater than the fees charged by the relevant DCM and 
affiliated derivatives clearing organization (DCO). Paying benefits 
for such trades seems tantamount to giving a subsidy to un-economic 
trades and thereby potentially risks distorting the overall market. 
I would therefore welcome comments about whether this section is 
adequate as is or whether we should also prohibit DCMs from giving 
benefits to such seemingly non-economic trades.
    In closing, let me stress again that I want this rule to be both 
effective and workable. No one benefits from rules that work in the 
abstract but are confusing, impossible to implement as written, or 
full of gaps that prompt stakeholders to engage in widespread 
regulatory arbitrage. I believe this automated trading proposal is a 
commonsense effort at establishing reasonable regulation on a 
nascent technology, but if there are flaws with it, if it goes too 
far or not far enough, I want to know that now, before it is 
finalized. Thank you.

Appendix 4--Statement of Commissioner J. Christopher Giancarlo

Introduction

    The electronification of trading over the past 30 to 40 years 
and the advent of exponential digital technologies have transformed 
financial businesses, markets and entire economies, with dramatic 
implications for capital formation and risk transfer. In U.S. 
futures markets, we see this change most presently in the area of 
algorithmic or automated trading that now constitutes up to seventy 
percent of regulated futures markets. Automated trading can lower 
transaction costs while increasing trader productivity through 
greater transaction speed, precision and sophistication. For many 
markets, automated trading brings trading liquidity, broader market 
access, enhanced transparency and greater competition.
    At the same time, automated trading presents a host of potential 
new challenges. They include increased risk of sudden spikes in 
market volatility and ``phantom'' liquidity arising from the sheer 
speed of execution, potentially flawed algorithms and position 
crowding. They also include the risk of data misinterpretation by 
computerized analysis and mathematical models that increasingly 
replace human thought and deliberation. Legal scholars raise 
important questions about the viability of traditional market 
regulation in automated trading markets.
    How markets and market regulators adjust to this change from 
human to automated trading will be extremely important. It requires 
delicate balancing. To ensure vibrant, accessible and durable 
markets, we must cultivate and embrace new technologies without 
harming innovation. Without a doubt, there must be effective 
safeguards of market integrity and credibility, but those safeguards 
should not bar promising innovation and continuous market 
development.
    In turning to Regulation Automated Trading (``Regulation AT''), 
I acknowledge that my staff and I had dozens of issues and concerns 
that we brought to the attention of the Division of Market 
Oversight. While they were responsive to a few small topics, many 
other issues require much further attention and consideration that I 
will summarize in this statement.
    Still, after reading through the almost five hundred pages of 
this proposal, I am left with one major question that I still cannot 
answer.
    That question is: does this proposal sufficiently benefit the 
safety and soundness of America's futures markets so as to outweigh 
its additional costs and burdens?
    I wish the answer was clearer.
    I have three main concerns with Regulation AT. First, some of 
the requirements of the proposal appear to be window dressing. That 
is especially the case in its requirement for development and 
implementation of risk controls and related testing standards that 
the industry has already widely adopted.
    Second, I am concerned about the high costs and burdens of this 
proposal, especially on small market participants. I am especially 
concerned about its requirement that registrants hold their 
proprietary source code in data repositories available for 
inspection by the Commission or the U.S. Department of Justice at 
any time for any reason.
    Third, I question the regulatory inconsistencies regarding the 
market participants that must comply with this rulemaking.
    For these reasons and others, I have serious doubts about 
today's proposed rulemaking.
    Last November, I delivered a speech at the U.S. Chamber of 
Commerce where I set forth six principles that I would follow as I 
evaluate financial market regulations.\1\ As part of those 
principles, I proposed the ``SMART REG'' standard to help analyze 
whether CFTC rules actually solve for real problems and promote the 
U.S. economy and the American markets.\2\ I struggle to see how 
Regulation AT passes the SMART REG standard.
---------------------------------------------------------------------------

    \1\ Remarks of CFTC Commissioner J. Christopher Giancarlo before 
the U.S. Chamber of Commerce, Re-Balancing Reform: Principles for 
U.S. Financial Market Regulation In Service to the American Economy, 
Nov. 20, 2014, http://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlos-2.
    \2\ Id. The ``SMART REG'' standard follows whether new CFTC 
regulations S--Solve for real problems, not anecdotes of bad 
behavior; M--Measure success through a rigorous cost benefit 
analysis; A--Advance innovation and competition through flexible 
rules; R--Represent the best approach among alternative courses of 
action; T--Take into account evidence, rather than assumptions; R--
Realistically set compliance deadlines; E--Encourage employment of 
American workers; and are G--Grounded in law.
---------------------------------------------------------------------------

    Nevertheless, I want to hear the views of market participants on 
this proposal. I will evaluate any final rule based on the SMART REG 
standard and thereafter determine whether to support or reject it.
    I will explain my areas of concern.

I. Necessity of Regulation AT

    It is hard to identify exactly what issue in automated trading 
Regulation AT is designed to address. The agency is basically 
playing catch-up to an industry that has already developed and 
implemented risk controls and related testing standards for 
automated trading. Regulation AT describes the extensive best 
practices and recommendations for automated trading issued by 
industry organizations and notes that the majority of industry 
participants are following such best practices. Regulation AT simply 
codifies industry best practices in many respects, but does not go 
as far as current industry efforts. As such, the Commission admits 
that many of the benefits of this proposal are already being 
realized in the marketplace. In reality, current industry standards 
on automated trading have well surpassed Regulation AT in many 
areas.
    It is clear that the industry has long been at the forefront of 
creating market solutions for risk controls in automated trading 
well before any regulatory mandate. As I recently stated, I favor 
this type of ongoing bottom-up market-driven approach to risk 
controls for automated trading.\3\ Given the industry's leadership 
role and the fact that Regulation AT simply codifies a small subset 
of industry best practices, while adding heavy compliance burdens, I 
question the necessity and value-add of this proposal.
---------------------------------------------------------------------------

    \3\ Keynote Address of CFTC Commissioner J. Christopher 
Giancarlo before the 2015 ISDA Annual Asia Pacific Conference, Top-
Down Financial Market Regulation: Disease Mislabeled as Cure, Oct. 
26, 2015, http://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo-10.
---------------------------------------------------------------------------

    The staff partly justifies the proposal as necessary to ensure 
market integrity given the risks of automated trading. As support, 
Regulation AT illustrates examples of recent disruptive events in 
automated trading. However, the dearth of incidents in the futures 
market seems to indicate that current industry solutions are working 
well. Regulation AT only cites three U.S. disruptive automated 
trading events in the past five and a half years and two of those 
events occurred in the equities market, obviously outside of our 
jurisdiction. In addition, the equities market events occurred 
despite the Securities and Exchange Commission (``SEC'') having 
implemented some reforms related to automated trading.\4\ Thus, I 
question whether Regulation AT will

[[Page 78946]]

in fact reduce future disruptive events and enhance market 
integrity.
---------------------------------------------------------------------------

    \4\ See Regulation AT Preamble, Section II.C.1.: ``Background on 
Regulatory Responses to Automated Trading.''
---------------------------------------------------------------------------

    As further support for market integrity, the preamble asserts 
that the proposal may limit a ``race to the bottom,'' in which 
certain entities sacrifice effective risk controls in order to 
minimize costs or increase the speed of trading. In this, the 
proposal betrays a na[iuml]ve misunderstanding of elementary micro-
economics. Market participants have every economic incentive to 
implement effective risk controls to prevent the loss of their 
capital and being forced out of business. That is why the industry 
has been a leader in best practices for automated trading, including 
development of risk controls and related testing standards. This 
ongoing bottom-up market-driven approach to risk controls for 
automated trading has raised, not lowered, the standards.
    Several commenters cited in Regulation AT supported a 
principles-based approach to regulation citing the need for 
flexibility because each market and the participants in those 
markets are different.\5\ These commenters also noted that the 
Commission already has robust regulations in place to address the 
risks of automated trading.\6\ Tweaking the Commission's existing 
regulations \7\ in line with a principles-based approach may be a 
better way to build upon ongoing industry efforts regarding 
automated trading, while reducing the compliance burdens of 
Regulation AT.
---------------------------------------------------------------------------

    \5\ ICE Comment Letter at 1-3 (Jan. 17, 2014); Katten Muchin 
Rosenmann Comment Letter on behalf of Gelber Group at 5, 20 and 22-
24 (Dec. 9, 2013).
    \6\ Id.
    \7\ See e.g., Commission regulations 1.11(e)(3)(ii), 1.73, 
23.600(d)(9), 23.609, 38.255 and 38.607.
---------------------------------------------------------------------------

    I invite comment on the necessity of Regulation AT and on other 
approaches to automated trading that support--rather than burden--
ongoing industry efforts.

II. Costs of Regulation AT Versus the Benefits

    I am concerned about the costs of Regulation AT, especially on 
small market participants. The Commission tries to downplay the 
costs of this proposal because in many respects it simply codifies 
industry best practices and many market participants are already 
following such practices.\8\ The proposal also repeatedly asserts 
that the rules are flexible seemingly in an effort to highlight its 
low burdens. However, in reality, Regulation AT adds compliance, 
reporting and registration requirements, and establishes designated 
contract market (``DCM'') and registered futures association 
(``RFA'') review programs. These additional requirements will 
certainly increase costs to all market participants engaged in 
Algorithmic Trading that are subject to this proposal.
---------------------------------------------------------------------------

    \8\ I also note that the Commission uses old compensation data 
from 2012 in calculating the costs of Regulation AT, which 
underreports these costs estimates.
---------------------------------------------------------------------------

A. Small Market Participants

    The costs of this proposal may disproportionately impact small 
market participants. While Regulation AT raises this concern and 
asks questions in this regard, at the same time, the proposal 
dismisses the possibility that it will capture many small entities. 
I am not so sure that will be the case as the definition of 
Algorithmic Trading is very broad and would appear to capture market 
participants using off-the-shelf type automated systems or simple 
excel spreadsheets to automate trading.\9\ If that is the case, then 
this proposal could capture, for example, a small proprietary 
trading firm, a small commodity trading advisor (``CTA'') or a rural 
grain elevator company that uses simple automation.
---------------------------------------------------------------------------

    \9\ See definition of Algorithmic Trading in proposed Commission 
regulation 1.3(zzzz).
---------------------------------------------------------------------------

    Regulation AT would add numerous costs to small market 
participants and raise barriers to entry. Small market participants 
may be less likely to employ risk controls consistent with 
Regulation AT so they would incur costs to develop or purchase such 
risk controls. They would also incur costs to hire additional 
employees to develop and implement policies and procedures for the 
development, testing, monitoring and compliance of their Algorithmic 
Trading systems. Small market participants would have to hire 
additional employees to continuously monitor their Algorithmic 
Trading systems on a real-time basis. They would incur costs to 
annually prepare and submit a pre-trade risk control compliance 
report to each DCM on which they trade. Furthermore, the proposal 
would add costs to small market participants given the required 
registration with the Commission and an RFA. That sounds like a 
whole lot of extra costs to me for a ``principles-based'' non-
prescriptive rule.
    The proposed rule admits that the Commission does not know how 
many small entities this proposal will affect--unfortunately, a 
common theme for CFTC rules when discussing costs and burdens on the 
marketplace. I am disappointed that the Commission did not get a 
better sense of the potential universe of small market participants 
that may be impacted by Regulation AT. To this point, I am very 
interested to hear estimates of costs Regulation AT will impose on 
smaller market participants and how it will impact their ability to 
conduct business.
    Interestingly, the proposed rule also asserts that a 
technological malfunction or error in a very small proprietary 
trading firm's algorithm could have a significant, detrimental 
impact on the market despite providing no evidence to support this 
claim.\10\ I invite commenters to weigh in on this issue. I am also 
interested to hear comments on whether the proposed rules make sense 
for those market participants using off-the-shelf type automated 
systems or simple excel spreadsheets to automate trading, especially 
the rules around development, testing, monitoring and compliance of 
Algorithmic Trading systems.
---------------------------------------------------------------------------

    \10\ See Regulatory Flexibility Act section of Regulation AT.
---------------------------------------------------------------------------

B. Overlapping Requirements and Duplicative Costs

    Regulation AT contains a potential overlap in some requirements 
and duplicative costs in that it requires AT Persons to register 
with an RFA and, at the same time, to be subject to reviews by DCMs. 
The National Futures Association (``NFA''), the only RFA at this 
time, will need to hire additional employees to establish and 
maintain a program for Algorithmic Trading systems. The preamble to 
Regulation AT also contemplates that NFA would conduct routine 
examinations of its members to ensure that they are complying with 
NFA rules. This requirement translates into additional costs that 
will be passed down to NFA's members. Regulation AT notes that NFA 
is the frontline regulator and is well-positioned to address rules 
and issues related to Algorithmic Trading as market conditions and 
technology develops.
    However, it seems that DCMs have the most intimate knowledge of 
the markets and their participants trading in those markets. DCMs 
have been at the forefront of creating market solutions for risk 
controls in automated trading, along with testing and certification 
of automated systems.\11\ In this regard, Regulation AT requires AT 
Persons \12\ and their clearing member futures commission merchants 
(``FCMs'') to submit annual reports and policies and procedures 
regarding their Algorithmic Trading to all DCMs on which they trade. 
DCMs must establish a program to review these reports and procedures 
and provide feedback, including any deficiencies in participants' 
pre-trade risk control settings or calibrations.\13\ AT Persons and 
their clearing member FCMs must also keep, and provide upon request 
to DCMs, books and records regarding compliance with the proposed 
rules. DCMs must review these books and records as necessary.
---------------------------------------------------------------------------

    \11\ E.g., CME Comment Letter at 25-26 (Dec. 11, 2013) 
(discussing CME's two testing environments for its users and its 
certification requirement).
    \12\ AT Person is defined in proposed Commission regulation 
1.3(xxxx) and captures the persons subject to Regulation AT, 
including existing Commission registrants engaged in Algorithmic 
Trading and the newly expanded definition of floor trader.
    \13\ Proposed Commission regulation 40.22(c).
---------------------------------------------------------------------------

    Although the preamble states that the NFA and DCM requirements 
are not intended to create conflicting obligations, I am afraid that 
the lack of clarity provides a potential to subject AT Persons to 
some duplication. As noted above, DCMs already have standards for 
risk controls, testing and certification of automated systems, but 
Regulation AT requires NFA to address these topics in its program. 
Regulation AT also discusses reviews for both NFA and DCMs. 
Duplicative requirements would add unnecessary costs that would be 
especially harmful to small market participants.
    I am interested to hear from market participants if Regulation 
AT provides enough clarity on this issue or if the Commission should 
provide further detail. I am particularly interested to hear 
comments on the requirement for market participants to register with 
NFA and to be subject to NFA's program for Algorithmic Trading 
systems. In light of DCMs' existing efforts on risk controls and 
testing, is such a requirement necessary or are DCMs already serving 
as the frontline regulator? Would NFA serve a

[[Page 78947]]

useful role in setting consistent standards across all markets or do 
DCMs need flexibility in setting rules because each market and the 
participants in those markets are different?\14\ I also invite 
comment on alternatives to the requirement that AT Persons and their 
clearing member FCMs prepare and submit annual reports to DCMs and 
DCM reviews of those reports. One possibility is to require AT 
Persons and their clearing member FCMs to conduct self-assessments 
(like FINRA requires) and only require submission to DCMs upon 
request.
---------------------------------------------------------------------------

    \14\ See supra note 5.
---------------------------------------------------------------------------

C. Source Code Repository and Commission Regulation 1.31

    Source code is the intellectual property of AT Persons 
representing their current and future trading strategies. Source 
code of AT firms is unlike traditional trading firm information in 
that it reveals not what positions are held in the past or present, 
but what positions the firm intends to buy or sell in the future 
upon specified market events.
    I am particularly concerned that Regulation AT requires that 
each market participant keep a source code repository for algorithms 
and make it available for inspection to any representative of the 
Commission or the U.S. Department of Justice for any reason.\15\ 
Currently, the federal government may only obtain such sensitive 
information through a subpoena. Regulation AT dramatically lowers 
the bar for the federal government to obtain this information.
---------------------------------------------------------------------------

    \15\ Under Regulation AT, in accordance with Commission 
Regulation 1.31 (17 CFR 1.31), AT Persons would have to make their 
source code repository available for inspection to any 
representative of the CFTC, in addition to the U.S. Department of 
Justice.
---------------------------------------------------------------------------

    I am unaware of any other industry where the federal government 
has such easy access to a firm's intellectual property and future 
business strategies. Other than possibly in the area of national 
defense and security, I question whether the federal government has 
similarly unfettered access to the future business strategy of any 
American industrial sector. Does the SEC require such access from 
its registrants? Do other agencies in the federal government have 
ready access to businesses' intellectual property and business 
strategies?
    I am unclear why either the Commission or the U.S. Department of 
Justice needs access to source code information without a subpoena, 
especially the Justice Department, whose only use for such 
information would be in criminal proceedings. Does today's rule 
proposal presume that the use of automated trading technology makes 
a trading firm more likely to engage in criminal behavior than a 
manual trading operation?
    There is strong reason for concern about maintaining the 
confidentiality of this source code. As we all know, the federal 
government has a poor track record of keeping sensitive information 
secure from cyberattacks and other data breaches. Any data breach of 
this information would be devastating for such entities and, 
potentially, for the safety and orderly operation of U.S. markets. 
Imagine the harm that could be caused to U.S. financial markets, if 
cyber terrorists or other belligerents were able to get their hands 
on this technology the same way some of the U.S.' most important 
industrial, military and other sensitive data have been hacked. I 
question the need for this new requirement and request commenter 
feedback on this issue.
    In addition to my concerns above, I previously expressed 
reservations about Commission regulation 1.31 in the proposed 
rulemaking on Records of Commodity Interest and Related Cash or 
Forward Transactions.\16\ Commenters to that proposed rulemaking 
stated that Commission regulation 1.31 is technologically outdated 
and compliance with the rule is overly burdensome, infeasible and 
costly.\17\ Managed Funds Association, the Investment Adviser 
Association and the Alternative Investment Management Association 
even petitioned the Commission to amend Rule 1.31 back on July 21, 
2014.\18\ Unfortunately, the Commission has not acted on this 
request.
---------------------------------------------------------------------------

    \16\ Records of Commodity Interest and Related Cash or Forward 
Transactions, 79 FR 68140, 68148 (proposed Nov. 14, 2014).
    \17\ Managed Funds Association Comment Letter at 4-7 (Jan. 13, 
2015); Commodity Markets Council Comment Letter at 5 (Jan. 13, 
2015); SIFMA AMG Comment Letter 5-6 (Jan. 13, 2015).
    \18\ Managed Funds Association, the Investment Adviser 
Association and the Alternative Investment Management Association, 
Petition for Rulemaking to Amend CFTC Regulations 1.31, 4.7(b) and 
(c), 4.23 and 4.33 (Jul. 21, 2014).
---------------------------------------------------------------------------

    Regulation AT's requirement that source code repositories must 
be kept and made available for inspection pursuant to Commission 
regulation 1.31 will impose unnecessary costs and burdens on AT 
Persons. Given the voluminous comments that the staff has received 
on the unworkability of Rule 1.31, I am surprised that Regulation AT 
would subject source codes to this rule. As an alternative, the 
Commission should consider allowing AT Persons to keep source code 
repositories in accordance with their own reasonable and secure 
internal recordkeeping procedures. I welcome comments on the costs 
of Commission regulation 1.31 in this regard.
    Finally, I would like to note that currently unregistered market 
participants who will now be required to register under the revised 
floor trader definition may be subject to heighted record keeping 
requirements under proposed Commission regulation 1.35.\19\ Proposed 
Rule 1.35 states that a member of a DCM that is not registered or 
required to be registered with the Commission in any capacity would 
not have to keep (i) records of transactions in a manner that is 
searchable or allows for identification of a particular transaction 
\20\ and (ii) text messages related to those transactions.\21\ If 
the Commission finalizes Rule 1.35 as proposed, Regulation AT's 
registration requirement would increase the burdens under that rule. 
I invite commenters to provide feedback on the intersection of 
Regulation AT and Rule 1.35.
---------------------------------------------------------------------------

    \19\ Records of Commodity Interest and Related Cash or Forward 
Transactions, 79 FR 68140 (proposed Nov. 14, 2014).
    \20\ Id. at 68146, Proposed Commission regulation 1.35(a)(3)(i).
    \21\ 79 FR at 68146, Proposed Commission regulation 
1.35(a)(3)(ii).
---------------------------------------------------------------------------

D. Other Costs

    I would also like to obtain industry input on the following 
costs of Regulation AT:
    1. The costs on FCMs under proposed Rules 1.82 and 1.83, 
especially the requirement that an FCM prevent or mitigate an 
Algorithmic Trading Disruption for its AT Persons.\22\ I have 
previously expressed concerns about the harm caused to the FCM 
industry by the heightened cost of regulation, so I am especially 
interested to hear comments in this regard.\23\
---------------------------------------------------------------------------

    \22\ Proposed Commission regulation 1.82(a)(1).
    \23\ Statement of Commissioner J. Christopher Giancarlo for the 
Market Risk Advisory Committee Meeting, Jun. 1, 2015; http://www.cftc.gov/PressRoom/SpeechesTestimony/giancarlostatement060115.
---------------------------------------------------------------------------

    2. The costs to DCMs to establish and maintain a program for the 
review and evaluation of compliance reports and books and records of 
each AT Person and their clearing member FCMs trading on the DCMs, 
as required under proposed Rule 40.22.
    3. The ease and costs for DCMs to generate and publish self-
trading statistics, as required under proposed Rule 40.23(d).

E. Costs Versus Benefits

    Based on all the costs described above, Regulation AT does not 
seem to be a non-prescriptive, low-burden rule that simply codifies 
industry best practices as the proposal asserts. It goes much 
further and, I fear, does greater harm. While Regulation AT does 
recognize industry best practices with respect to several risk 
controls, it adds prescriptive compliance, reporting and 
registration requirements and establishes overlapping and 
duplicative DCM and RFA review programs of questionable value. Given 
the industry's extensive efforts to date, I question whether the 
costs of Regulation AT actually justify the benefits. The 
principles-based approach that I discussed above may be as effective 
and less costly than Regulation AT's approach. I invite commenters 
to provide feedback regarding the costs and benefits of Regulation 
AT and the specific points I raised above.

III. Regulatory Inconsistency of Regulation AT

    I would like to note three regulatory inconsistencies in 
Regulation AT. The staff proposes to amend the definition of floor 
trader \24\ in order to register currently unregistered persons 
using direct electronic access for algorithmic trading on DCMs.\25\ 
The preamble to Regulation AT states that in 1993, when the 
Commission finalized rules regarding the definition and registration 
of floor traders, the Commission decided to include as floor traders 
only those traders operating on the trading floor of an exchange. 
However, in that 1993 rulemaking, the Commission stated that certain 
traders using electronic trading systems come within the floor 
trader definition. Back then, the

[[Page 78948]]

Commission took a technological approach to the definition of floor 
trader.
---------------------------------------------------------------------------

    \24\ 17 CFR 1.3(x).
    \25\ Another requirement is that the person must be trading for 
their own account.
---------------------------------------------------------------------------

    Today, Regulation AT is taking that same approach and is 
proposing to register persons using direct electronic access for 
algorithmic trading, but not those using manual means. I am not 
clear on the rationale for this technology driven distinction to 
registration (as the preamble does not articulate one) when the 
proposal acknowledges that manual trading also poses risks. Several 
commenters cited in Regulation AT also noted the importance of risk 
controls for manual and automated trading systems.\26\ I invite 
industry comments on this issue, notwithstanding my above concerns 
about the registration requirement.
---------------------------------------------------------------------------

    \26\ E.g., CME Comment Letter at 43, 44 (Dec. 11, 2013).
---------------------------------------------------------------------------

    Another regulatory inconsistency is that Regulation AT only 
captures floor traders who use direct electronic access for 
algorithmic trading, but it captures all existing registrants, such 
as FCMs, swap dealers and CTAs regardless of whether they use direct 
electronic access for algorithmic trading. Again, Regulation AT does 
not articulate a reason for this inconsistency and I question its 
logic. I invite comment on this issue, including whether, for 
existing registrants, the proposal should only capture those using 
direct electronic access.
    Finally, Regulation AT only applies to trading on DCMs and not 
on SEFs. Regulation AT justifies this distinction by stating that 
compared to DCMs, SEFs and SEF markets are newer and less liquid and 
have less automated trading. However, DCMs can also list swaps and 
Regulation AT applies to that trading. In this regard, Regulation AT 
may disadvantage DCMs who list swaps as compared to SEFs. I welcome 
comments on this competitive disadvantage, including whether 
Regulation AT should exclude from its scope swaps listed on DCMs.

IV. Other Comments on Regulation AT

    I also invite industry comment on the following issues:
    1. Whether the Algorithmic Trading Compliance Issue definition 
in proposed Commission regulation 1.3(tttt) is necessary. If a major 
reason for Regulation AT is market integrity then it seems the 
Algorithmic Trading Disruption definition is sufficient. 
Furthermore, if an AT Person violates a rule or regulation it will 
be liable so the Algorithmic Trading Compliance Issue definition 
appears unnecessary.
    2. Whether the definition of Direct Electronic Access in 
proposed Commission regulation 1.3(yyyy) should be harmonized with 
the definition in Rule 38.607.\27\
---------------------------------------------------------------------------

    \27\ 17 CFR 38.607.
---------------------------------------------------------------------------

    3. Whether several of the proposed rules that require periodic 
review of compliance measures or regular testing of Algorithmic 
Trading systems open up AT Persons to liability risk. For example, 
proposed Commission regulation 1.80(f) \28\ requires each AT Person 
to periodically review its compliance with the pre-trade risk 
control requirements to determine whether it has effectively 
implemented sufficient measures reasonably designed to prevent an 
Algorithmic Trading Event. What happens if market conditions change 
rapidly between periodic reviews and the AT Person's risk controls 
are no longer sufficient to prevent an Algorithmic Trading Event? Is 
the AT Person now liable for a violation of Commission rules? Will 
this periodic review become a continuous review in order to avoid 
liability?
---------------------------------------------------------------------------

    \28\ See also proposed Commission regulations 1.81(a)(1)(iii), 
(a)(1)(iv), (a)(2) and (c)(2)(i) for further examples.
---------------------------------------------------------------------------

Conclusion

    While I am pleased that Regulation AT provides flexibility in 
setting risk control parameters and does not require the pre-
approval or pre-testing of algorithms, the proposal appears to add 
many burdensome compliance costs and does not adequately take into 
account small market participants or the work of the industry in 
developing algorithmic trading risk controls and related testing 
requirements. Rather than duplicating their efforts and adding 
additional burdens, the Commission should look to support and 
enhance ongoing industry progress. On the other hand, I am highly 
concerned about Regulation AT's several significant inconsistencies 
and its extraordinary requirement that AT source codes be placed in 
government accessible repositories.
    Overall, I have a great many concerns with Regulation AT. Most 
principally, I struggle to figure out if it will benefit the safety 
and soundness of America's futures markets enough to outweigh its 
additional costs and burdens. Its purpose must not be to allow a 
Federal regulator to say that it has ``done something'' about 
computerized trading in response to media headlines, best-selling 
books or political campaign agendas. The development of automated 
trading is too complicated and too important to be addressed with 
such superficiality.
    For my part, I will carefully review thoughtful comments from 
market participants and the public. I will measure my support for 
any final rule against the SMART REG standard.

[FR Doc. 2015-30533 Filed 12-16-15; 8:45 am]
BILLING CODE 6351-01-P