[Federal Register Volume 86, Number 6 (Monday, January 11, 2021)]
[Rules and Regulations]
[Pages 2048-2077]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-27622]



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Vol. 86

Monday,

No. 6

January 11, 2021

Part II





 Commodity Futures Trading Commission





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17 CFR Part 38





Electronic Trading Risk Principles; Final Rule

  Federal Register / Vol. 86 , No. 6 / Monday, January 11, 2021 / Rules 
and Regulations  

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 38

RIN 3038-AF04


Electronic Trading Risk Principles

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or 
``CFTC'') is adopting final rules amending its part 38 regulations to 
address the potential risk of a designated contract market's (``DCM'') 
trading platform experiencing a market disruption or system anomaly due 
to electronic trading. The final rules set forth three principles 
applicable to DCMs concerning: The implementation of exchange rules 
applicable to market participants to prevent, detect, and mitigate 
market disruptions and system anomalies associated with electronic 
trading; the implementation of exchange-based pre-trade risk controls 
for all electronic orders; and the prompt notification of Commission 
staff by DCMs of any significant market disruptions on their electronic 
trading platforms. In addition, the final rules include acceptable 
practices (``Acceptable Practices''), which provide that a DCM can 
comply with these principles by adopting and implementing rules and 
risk controls reasonably designed to prevent, detect, and mitigate 
market disruptions and system anomalies associated with electronic 
trading.

DATES: 
    Effective date: The rules are effective on January 11, 2021.
    Compliance date: DCMs must be in full compliance with the 
requirements of this rule no later than July 12, 2021.

FOR FURTHER INFORMATION CONTACT: Marilee Dahlman, Special Counsel, 
[email protected] or 202-418-5264; Joseph Otchin, Special Counsel, 
[email protected] or 202-418-5623, Division of Market Oversight; Esen 
Onur, [email protected] or 202-418-6146, Office of the Chief Economist; in 
each case at the Commodity Futures Trading Commission, Three Lafayette 
Centre, 1155 21st Street NW, Washington, DC 20581.

SUPPLEMENTARY INFORMATION: 

Table of Contents

I. Background
    A. Purpose and Structure of the Risk Principles
    B. TAC Meeting
    C. Existing Part 38 Framework and the Risk Principles Proposal
    D. Framework of This Final Rulemaking
    1. Principles-Based Approach
    2. Issues Related to a DCM-Focused Approach
    3. Issues Related to Codification in Core Principle 4 and 
Overlap With Existing Commission Regulations
II. The Final Risk Principles
    A. Key Terms
    1. Electronic Trading
    2. Market Disruption and System Anomaly
    B. The Reasonableness Standard
    C. Risk Principle 1
    1. Proposal
    2. Rules Versus Controls and Other Procedures
    3. Scope of Electronic Trading Subject to DCM Rules
    D. Risk Principle 2--Risk Controls Listed in Part 38
    E. Risk Principle 3
    1. Proposal
    2. ``Significant'' Standard
    3. Notification Requirement
III. Related Matters
    A. Regulatory Flexibility Act
    B. Paperwork Reduction Act
    1. OMB Collection 3038-0093--Provisions Common to Registered 
Entities
    2. OMB Collection 3038-0052--Core Principles and Other 
Requirements for DCMs
    C. Cost-Benefit Considerations
    1. Introduction
    2. Costs
    3. Benefits
    4. 15(a) Factors
    D. Antitrust Considerations

I. Background

A. Purpose and Structure of the Risk Principles

    The Commission is adopting final rules establishing a set of 
principles (``Risk Principles'') and related Acceptable Practices 
applicable to DCMs for the purpose of preventing, detecting, and 
mitigating market disruptions and system anomalies associated with the 
entry of electronic orders and messages into DCMs' electronic trading 
platforms. Such market disruptions or anomalies originating at a market 
participant may negatively impact the proper functioning of a DCM's 
trading platform by limiting the ability of other market participants 
to trade, engage in price discovery, or manage risk.
    The Commission, DCMs, and market participants all have an interest 
in the effective prevention, detection, and mitigation of market 
disruptions and system anomalies associated with electronic trading. As 
discussed in the notice of proposed rulemaking for the Electronic 
Trading Risk Principles (``NPRM'') \1\ and noted by several NPRM 
commenters, the Commission believes that DCMs are addressing most, if 
not all, of the electronic trading risks currently presented to their 
trading platforms. DCMs and other market participants have worked 
together to better understand electronic trading risks and adapt risk 
control systems through the use of new technological tools and safety 
procedures, such as ``fat finger'' controls, dynamic price collars, 
kill switches, cancel-on-disconnect, drop copy feeds, self-match 
prevention, and granular pre-trade controls to manage limits within a 
product group.\2\ Since April 2010, FIA has published six papers 
proposing industry best practices and guidelines related to identifying 
risks and strengthening safeguards related to electronic trading in the 
futures markets.\3\
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    \1\ Electronic Trading Risk Principles, 85 FR 42761 (July 15, 
2020). NPRM commenters were as follows: Americans for Financial 
Reform Education Fund (``AFR''), Better Markets, Inc. (``Better 
Markets''), CBOE Futures Exchange, LLC (``CFE''), CME Group Inc. 
(``CME''), Commercial Energy Working Group (``CEWG''), Futures 
Industry Association and FIA Principal Traders Group (``FIA/FIA 
PTG''), Institute for Agriculture and Trade Policy (``IATP''), 
Intercontinental Exchange Inc. (``ICE''), International Swaps and 
Derivatives Association, Inc. and Securities Industry and Financial 
Markets Association (``ISDA/SIFMA''), Managed Funds Association 
(``MFA''), Minneapolis Grain Exchange, Inc. (``MGEX''), and Optiver 
US LLC (``Optiver''). In addition, the Commission received a 
thirteenth comment letter from Robert Rutkowski (``Rutkowski'') 
after the comment period closed.
    \2\ FIA/FIA PTG NPRM Letter, at 2; see also CME NPRM Letter, at 
1; ICE NPRM Letter, at 3. See also CME Group, Market Regulation 
Advisory Notice RA2006-5, ``Disruptive Trading Practices'' 
(effective Aug. 10, 2020), available at https://www.cmegroup.com/notices/market-regulation/2020/08/CME-Group-RA2006-5.html 
(prohibiting any market participant from intentionally or recklessly 
submitting or causing to be submitted an actionable or non-
actionable message(s) that has the potential to disrupt exchange 
systems).
    \3\ FIA/FIA PTG NPRM Letter, at 1.
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    The Risk Principles will require DCMs to continue to monitor these 
risks as they evolve along with the markets, and make reasonable 
modifications as appropriate. The Risk Principles reflect a flexible 
approach that complements industry-led initiatives and previous 
Commission measures to address market disruption risk. The Risk 
Principles provide further regulatory clarity to market participants 
while preserving the DCMs' ability to adapt to evolving technology and 
markets.

B. TAC Meeting

    At the Commission's Technology Advisory Committee (``TAC'') meeting 
on July 16, 2020, the TAC's Subcommittee on Automated and Modern 
Trading Markets (``Subcommittee'') presented the Subcommittee's 
position regarding the proposed Risk Principles.\4\ The

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Subcommittee stated that it broadly supports the rulemaking.\5\ The 
Subcommittee also indicated support for how the Commission 
characterized the concepts of ``electronic trading'' and ``market 
disruption.'' \6\ However, the Subcommittee described the second part 
of the definition of ``market disruption''--i.e., disruption of the 
ability of other market participants to trade on the DCM on which the 
market participant is trading--as ``amorphous.'' \7\ The Subcommittee 
noted that it is difficult to define in advance whether or not a trade 
halt is disruptive.\8\ The Subcommittee stated ``a positive part of the 
principles-based approach'' is that it allows the Commission and DCMs 
to define events in accordance with a principle as opposed to a 
list.\9\
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    \4\ Automated and Modern Trading Markets Subcommittee, 
``Discussion of the CFTC's Proposed Rule on Electronic Trading Risk 
Principles,'' (July 16, 2020) (``Subcommittee PowerPoint''), 
available at https://www.cftc.gov/About/CFTCCommittees/TechnologyAdvisory/tac_meetings.html.
    \5\ See July 16, 2020 TAC Meeting Transcript at 54:5.
    \6\ As discussed in further detail below, the NPRM described 
``electronic trading'' as all trading and order messages submitted 
by electronic means to the DCM's electronic trading platform, 
including both automated and manual order entry. The NPRM described 
``market disruption'' as generally including an event originating 
with a market participant that significantly disrupts the: (1) 
Operation of the DCM on which such participant is trading; or (2) 
ability of other market participants to trade on the DCM on which 
such participant is trading. See NPRM at 42765.
    See id. at 54:11-55:14, 56:6-16; Subcommittee PowerPoint at 3.
    \7\ See July 16, 2020 TAC Meeting Transcript at 55:21-56:10.
    \8\ See id. at 58:6-17.
    \9\ See id.
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    The Subcommittee anticipated that many procedures and rules adopted 
by DCMs would be similar, but it is nevertheless important to allow for 
flexibility, given that DCM trading systems have different 
architectures and features.\10\ The Subcommittee concluded that 
flexibility allows for market resilience and best practices that will 
improve over time.\11\
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    \10\ See id. at 6; July 16, 2020 TAC Meeting Transcript at 
62:13-63:15.
    \11\ See id.
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C. Existing Part 38 Framework and the Risk Principles Proposal

    As discussed in the NPRM, the Risk Principles supplement existing 
DCM Core Principle 4 regulations in part 38, namely Commission 
regulations Sec. Sec.  38.251 and 38.255.\12\ Existing Commission 
regulation Sec.  38.251(c) requires each DCM to demonstrate an 
effective program for conducting real-time monitoring of market 
conditions, price movements, and volumes, in order to detect 
abnormalities and, when necessary, to make a good-faith effort to 
resolve conditions that are, or threaten to be, disruptive to the 
market.\13\ In addition, existing Commission regulation Sec.  38.255 
requires each DCM to 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 DCM.\14\
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    \12\ See NPRM, supra note 1 at 42762.
    \13\ 17 CFR 38.251(c).
    \14\ 17 CFR 38.255.
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    Building on the requirements under existing Commission regulation 
Sec.  38.251 to conduct real-time monitoring and resolve conditions 
that are disruptive to the market, the Risk Principles, together with 
the Acceptable Practices, require DCMs to take reasonable steps to 
prevent, detect, and mitigate material market disruptions or system 
anomalies associated with electronic trading. Existing Commission 
regulations do not fully and explicitly address the risks of market 
disruptions or system anomalies associated with electronic trading, and 
the Risk Principles fill those gaps by establishing exchange rule and 
risk control requirements, as well as notification requirements, 
explicitly applicable to electronic trading. Additionally, while there 
may be some overlap between the Risk Principles and existing Commission 
regulation Sec.  38.255, the Commission believes the Risk Principles 
are distinguishable from existing Commission regulation Sec.  38.255 
because they focus on DCM rules, risk controls, and notification 
requirements, and are not limited to the application of risk controls 
as exists in regulation Sec.  38.255. The Commission also submits that 
the Risk Principles will provide greater certainty to DCMs regarding 
their obligations to address certain situations associated with 
electronic trading.

D. Framework of This Final Rulemaking

    The proposed rulemaking was subject to a 60-day comment period, 
which closed on August 24, 2020. As noted above, the Commission 
received 13 substantive comments and held one ex parte meeting.\15\ The 
following section addresses comments that generally apply to all three 
Risk Principles and Acceptable Practices. Comments that relate to 
individual Risk Principles and Acceptable Practices will be addressed 
in Section II.C-E.
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    \15\ See supra note 1.
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1. Principles-Based Approach
    In the NPRM, the Commission proposed a principles-based approach. 
The purpose of this approach was to provide DCMs with the flexibility 
to impose the most efficient and effective rules and pre-trade risk 
controls for market participants subject to the DCMs' respective 
jurisdictions. The Commission believes that a principles-based approach 
in connection with electronic trading requirements provides DCMs with 
flexibility to adapt and evolve with changing technologies and 
markets.\16\
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    \16\ See NPRM at 42762.
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a. Summary of Comments
    Most commenters, including CME, CFE, CEWG, FIA/FIA PTG, ICE, ISDA/
SIFMA, MFA, and Optiver supported a principles-based approach.\17\ In 
particular, FIA/FIA PTG, ISDA/SIFMA, and MFA noted that such an 
approach provides flexibility and takes into account future 
technological advances.\18\ Commenters also stated that the principles-
based approach is preferable to the prescriptive nature of prior 
proposals.\19\ ICE supported the Commission's view that each DCM should 
have discretion to identify market disruptions and system anomalies as 
they relate to the DCM's market and participants' trading activity.\20\ 
ICE stated that what constitutes a market disruption will not only vary 
from exchange to exchange, but also from market to market. Therefore, 
tolerance levels and thresholds must be set for each market.\21\
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    \17\ CME NPRM Letter, at 1, 12, 16; CFE NPRM Letter, at 1; CEWG 
NPRM Letter, at 2; FIA/FIA PTG NPRM Letter, at 2-4; ICE NPRM Letter, 
at 2, 9; ISDA/SIFMA NPRM Letter, at 1-2; MFA NPRM Letter, at 1-2; 
Optiver NPRM Letter, at 1.
    \18\ FIA/FIA PTG NPRM Letter, at 2-4; ISDA/SIFMA NPRM Letter, at 
1; MFA NPRM Letter, at 1-2.
    \19\ CME NPRM Letter, at 1, 12; CFE NPRM Letter, at 1; CEWG NPRM 
Letter, at 2.
    \20\ ICE NPRM Letter, at 2.
    \21\ See id.
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    In contrast, AFR, Better Markets, IATP, and Rutkowski disagreed 
with the Commission's principles-based approach, and asserted that the 
incentives of DCMs and public regulators are not fully aligned.\22\ 
Better Markets commented that the principles are too imprecise and 
unenforceable, and lack key definitions.\23\ IATP emphasized that 
principles-based rules

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must be enforceable.\24\ IATP also asserted principles-based rules that 
the Commission cannot effectively supervise and enforce would 
surrender, not delegate, the Commission's authority, and could legalize 
trading misconduct due to lack of resources.\25\ AFR, Better Markets, 
and Rutkowski further commented that the proposed regulations provide 
too much deference to DCMs and that the Commission failed to address 
conflicts of interest concerns that may impede DCM and self-regulatory 
organization (``SRO'') independence.\26\
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    \22\ AFR NPRM Letter, at 1-2; Better Markets NPRM Letter, at 2, 
6, 9, 10-12; IATP NPRM Letter, at 1, 4, 8; Rutkowski NPRM Letter, at 
1.
    \23\ Better Markets NPRM Letter, at 2, 9.
    \24\ IATP NPRM Letter, at 1.
    \25\ See id. at 8.
    \26\ AFR NPRM Letter, at 1-2; Better Markets NPRM Letter, at 2, 
6, 9, 10-12; Rutkowski NPRM Letter, at 1.
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    Finally, IATP made several comments addressing the potential for 
market disruption caused by ``idiosyncratic'' events, and suggested 
further study on the impact of electronic trading on intraday price 
volatility.\27\
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    \27\ See supra note 25 at 2-5, 8.
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b. Discussion
    The Commission considered the comments and is adopting the 
principles-based approach to the Risk Principles as discussed in the 
NPRM. The Commission believes that a principles-based approach provides 
appropriate flexibility to allow DCMs to adopt and implement effective 
and efficient measures reasonably designed to achieve the objectives of 
the Risk Principles. The Commission submits that prescriptive rules may 
not be sufficiently flexible to enable DCMs to adopt appropriate 
measures for their particular market, and therefore, would not be as 
effective in preventing market disruptions or system anomalies.
    The principles-based nature of the Risk Principles does not mean 
they are unenforceable. The Risk Principles will be enforceable 
regulations that allow the Commission to require all DCMs to implement 
appropriate, reasonable risk controls and rules to prevent, detect, and 
mitigate market disruptions. The Commission has brought enforcement 
actions relating to violations of Core Principles set forth in 
Commission regulations. Recently, in 2019, the Commission brought an 
action against Options Clearing Corporation (``OCC''), a derivatives 
clearing organization (``DCO''), for violations of DCO Core Principles 
under part 39.\28\ In particular, the Commission determined ``OCC 
failed to fully comply with the specified DCO Core Principles by 
failing to establish, implement, and enforce certain policies and 
procedures reasonably designed to (1) consider and produce margin 
levels commensurate with every potential risk and particular attribute 
of each relevant product cleared by OCC; (2) effectively measure, 
monitor and manage its credit exposure and liquidity risk; and (3) 
protect the security of certain of its information systems.'' \29\
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    \28\ See Order, CFTC Docket No. 19-19, at 3-5 (Sept. 4, 2019), 
available at https://www.cftc.gov/media/2396/enfoptionsclearingorder090419/download.
    \29\ Id. at 2. The order stated the Commission found OCC had 
failed to comply with Core Principles in Section 5b(c)(2)(B), (D), 
and (I) of the Commodity Exchange Act (``CEA'' or ``Act''), and 
Commission regulations Sec. Sec.  39.11(a) and (c), 39.13(a), (b), 
(f), and (g)(l) and (2), and 39.18(b)(l) and (e)(l). See id. at 3-5. 
The Commission issued a press release regarding the enforcement 
action stating: `` `As this case shows, principles-based regulation 
does not mean lax oversight,' said CFTC Chairman Heath P. Tarbert. 
`While clearing agencies have some discretion in crafting their risk 
management policies and procedures, those policies and procedures 
must be reasonable and take into consideration relevant risks.' '' 
See Press Release, ``SEC and CFTC Charge Options Clearing Corp. with 
Failing to Establish and Maintain Adequate Risk Management 
Policies'' (Sept. 4, 2019), available at https://www.cftc.gov/PressRoom/PressReleases/8000-19.
    Additionally, in 2015, the Commission brought an enforcement 
action against TeraExchange LLC, a provisionally registered swap 
execution facility (``SEF''), for violations of Core Principles 
requiring SEFs to enact and enforce rules prohibiting certain types 
of trade practices, including wash trading and prearranged trading. 
See Press Release, ``CFTC Settles with TeraExchange LLC for Failing 
to Enforce Prohibitions on Wash Trading and Prearranged Trading in 
Bitcoin Swap'' (Sept. 24, 2015), available at https://www.cftc.gov/PressRoom/PressReleases/7240-15.
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    While the final rules do not formally define terms such as ``market 
disruption'' or ``electronic trading'' in rule text, the Commission 
provided a general discussion of those terms in the NPRM. The 
Commission is providing additional clarity concerning relevant terms in 
this preamble, in order for DCMs and other market participants to have 
a sufficient understanding of how the Commission will interpret and 
enforce the Risk Principles.\30\ Further, by not defining the terms in 
a static way, the Commission intends to allow for DCMs' application of 
the Risk Principles to evolve over time alongside market 
developments.\31\
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    \30\ See Section II.A.
    \31\ See NPRM at 42765.
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    The Commission believes that DCMs are incentivized to have risk 
controls to promote the integrity of their markets, and existing risk 
controls in place across DCMs indicate that they have implemented such 
measures. As FIA/FIA PTG pointed out, ``[a]ll market participants have 
a shared interest in strengthening risk controls. The 
interconnectedness of the listed derivatives markets means that all 
market participants are vulnerable when risk controls fail. It is no 
surprise, then, that the industry has worked diligently to enhance and 
extend risk controls over the years.'' \32\
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    \32\ FIA/FIA PTG NPRM Letter, at 4. See also CME NPRM Letter, at 
1 (``. . . the integrity and reliability of our markets are 
cornerstones of our business model--market participants choose to 
manage their risk on the CME Group Exchanges because we offer fair, 
efficient, transparent, liquid, and dynamic markets that are 
conducted and operated in accordance with the highest standards.''; 
ICE NPRM Letter, at 2 (``DCMs have proactively developed a 
substantial suite of risk controls, as well as financial, 
operational and supervisory controls to protect their markets and 
comply with existing regulations.'').
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    The Risk Principles will require all DCMs to implement an 
appropriate standard for risk controls. DCMs are best positioned to 
determine what risk controls and rules are appropriate to prevent, 
detect, and mitigate disruptions on their respective markets. 
Permitting them to do so is consistent with Congressional intent to 
serve the public interests of the CEA ``through a system of effective 
self-regulation of trading facilities . . . under the oversight of the 
Commission.'' \33\ Any conflict of interest concerns, where DCMs might 
prioritize profitability over reasonable controls, will be addressed 
through regular Commission oversight of DCMs, including 
examinations.\34\ For example, in an examination, Commission staff may 
consider whether a DCM is allocating sufficient financial and staff 
resources to the compliance function, the background and qualifications 
of the DCM's regulatory oversight committee members and compliance 
officers, and any role non-compliance personnel might be taking in the 
DCM's market monitoring and investigations processes.\35\
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    \33\ Section 3(b) of the CEA. 7 U.S.C. 5(b).
    \34\ The Commission notes that DCMs are already subject to 
Commission regulation Sec.  38.850 (Core Principle 16, Conflicts of 
Interest), which requires DCMs to minimize conflicts of interest in 
the DCM's decision-making process and establish a process for 
resolving those conflicts of interest. 17 CFR 38.850.
    \35\ See Appendix B to Part 38--Guidance on, and Acceptable 
Practices in, Compliance with Core Principles, Core Principle 16 
(Subparagraph (b)) (``To comply with this Core Principle, contract 
markets should be particularly vigilant for such conflicts between 
and among any of their self-regulatory responsibilities, their 
commercial interests, and the several interests of their management, 
members, owners, customers and market participants, other industry 
participants, and other constituencies.'').
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    Regarding IATP's comments, the Commission acknowledges that market 
risks, like the markets themselves, are always evolving. The 
principles-based approach provides DCMs with flexibility to address 
risks to markets as they evolve, including any idiosyncratic events. 
Prescriptive regulations may

[[Page 2051]]

lack the flexibility to address such idiosyncratic events, while 
principles-based regulations would provide DCMs with a framework 
through which they can change their rules and risk controls to address 
such unforeseen events. The Commission or industry organizations may 
conduct studies relevant to electronic trading in the future, and the 
Commission expects that the results will inform regulatory oversight of 
DCMs and enforcement of the Risk Principles. The Commission notes that 
the Division of Market Oversight produced a report in 2019 examining 
trading functionality across markets and found a consistent increase in 
the percentage of trading that was identified as ``automated'' relative 
to ``manual.'' \36\ Further, the report also showed no general 
correlation (and in some instances an inverse correlation) between the 
increase in automated trading activity in these markets and daily 
volatility.\37\
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    \36\ Staff of the Market Intelligence Branch, ``Impact of 
Automated Orders in Futures Markets'' (Mar. 2019) at 4, 7, 13, 
available at https://www.cftc.gov/MarketReports/StaffReports/index.htm.
    \37\ See id.
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2. Issues Related to a DCM-Focused Approach
    The Commission proposed the Risk Principles should focus 
specifically on DCMs.\38\ The NPRM stated the Commission will continue 
to monitor whether Risk Principles of this nature may be appropriate 
for other markets such as SEFs or foreign boards of trade 
(``FBOTs'').\39\ The Commission also encouraged the National Futures 
Association to evaluate whether it should provide additional 
supervisory guidance to its members.\40\ As noted in the NPRM, each DCM 
may have a different risk management program based on its unique 
business model and market, and this may result in some degree of 
differences in DCM rules implementing the Risk Principles.\41\
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    \38\ See NPRM at 42763.
    \39\ See id. at 42763 n.6.
    \40\ See id. at 42764.
    \41\ See id. at 42765.
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a. Summary of Comments
    CEWG, FIA/FIA PTG, and Optiver supported the Risk Principles' focus 
on DCMs and addressed issues relating to DCM discretion in implementing 
the Risk Principles.\42\ FIA/FIA PTG stated that DCMs are the 
gatekeeper and overseer of electronic trading platforms and are 
therefore uniquely positioned to apply pre-trade controls uniformly to 
all participants and trading in their markets.\43\ Optiver similarly 
noted that each DCM has a unique technology stack on which its platform 
is built and must be afforded latitude to develop rules and risk 
controls.\44\ In contrast, AFR, Better Markets, IATP, and Rutkowski 
commented that the proposed regulations provide too much deference to 
DCMs, in allowing them to decide for themselves how to address 
prevention, detection, and mitigation of undefined market disruptions 
and system anomalies.\45\
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    \42\ CEWG NPRM Letter, at 3-4; FIA/FIA PTG NPRM Letter, at 3; 
Optiver NPRM Letter, at 1.
    \43\ FIA/FIA PTG NPRM Letter, at 3.
    \44\ Optiver NPRM Letter, at 1.
    \45\ AFR NPRM Letter, at 1-2; Better Markets NPRM Letter, at 2, 
6, 9, 10-12; IATP NPRM Letter, at 6-11; Rutkowski NPRM Letter, at 1.
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    CME stated the Risk Principles should apply to SEFs and FBOTs, in 
addition to DCMs.\46\ CFE stated any Commission assessments of DCM 
controls should be across all DCMs, and the Commission should not seek 
to hold all DCMs to what the larger DCMs may have in place.\47\ CME 
commented that each DCM may implement different rules and risk controls 
without harming market liquidity or integrity.\48\ In contrast, Better 
Markets commented that the Risk Principles ensure a lack of uniformity 
in DCM policies, procedures, and controls and potentially would punish 
responsible DCMs.\49\ Similarly, IATP asserted competition among DCMs 
for over-the-counter trading and for trading in new products, such as 
digital coins, could result in lax risk control design or updating 
under competitive pressures.\50\ IATP asked the Commission to explain 
why the lack of any uniform standard by which DCMs should develop rules 
and risk controls presents no risk of regulatory arbitrage or migration 
of market disruptions from one DCM to another.\51\
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    \46\ CME NPRM Letter, at 2, 13.
    \47\ CFE NPRM Letter, at 4.
    \48\ CME NPRM Letter, at 13.
    \49\ Better Markets NPRM Letter, at 9.
    \50\ IATP NPRM Letter, at 9.
    \51\ IATP NPRM Letter, at 11.
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    While the Risk Principles apply to DCMs, CEWG commented on their 
potential effect on market participants. In particular, CEWG requested 
the final rules clarify that market participants without access to 
source code used to operate trading systems would not be subject to 
DCM-imposed requirements to implement updates, test or monitor the 
operation of such software, or DCM-imposed requirements under Risk 
Principle 3 to implement remediation measures for software.\52\
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    \52\ CEWG NPRM Letter, at 7.
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    Finally, IATP commented that the Risk Principles indiscriminately 
apply to asset classes, financial speculators, and commercial 
hedgers.\53\ IATP further stated that the Commission should issue a 
term sheet for a study to investigate the feasibility of revising the 
demutualization rule to create tiers of DCMs with respect to physical 
and financial derivatives contracts, to which a rule on automated 
trading would apply.\54\ IATP also commented that the Commission should 
distinguish what additional pre-trade and post-trade risk controls the 
DCMs must maintain from what is required of futures commission 
merchants (``FCMs'') prescriptively.\55\
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    \53\ IATP NPRM Letter, at 4-5.
    \54\ See id.
    \55\ IATP NPRM Letter, at 13.
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b. Discussion
    The Commission believes that a regulatory approach focusing on Risk 
Principles applicable only to DCMs is the correct approach. All 
participants and intermediaries have a responsibility to address the 
risks of electronic trading. However, trading occurs on DCM platforms 
and DCM-implemented rules and risk controls will be most effective in 
preventing, detecting, and mitigating system anomalies and market 
disruptions. As noted above, conflict of interest concerns will be 
addressed through regular Commission oversight. DCMs are subject to 
Commission regulation Sec.  38.850 (Core Principle 16, Conflicts of 
Interest), which requires DCMs to minimize conflicts of interest in the 
DCM's decision-making process and establish a process for resolving 
those conflicts of interest.\56\ The Commission believes that DCMs, and 
other market participants, do have an interest in maintaining market 
integrity, and this is evidenced through existing measures. In its 
comment, FIA/FIA PTG addressed DCM tools and procedures adopted to 
address electronic trading risk, including basic ``fat finger'' 
controls, dynamic price collars, kill switches, cancel-on-disconnect, 
drop copy feeds, and self-match prevention, as well as granular pre-
trade controls to manage limits within a product group.\57\ FIA/FIA PTG 
noted that development of

[[Page 2052]]

risk control measures ``has been an evolving, iterative process, with 
market participants, FCMs, technology vendors and DCMs working together 
to build the safeguards needed to protect our markets. After all, it is 
in everyone's interest to have efficient, reliable markets.'' \58\
---------------------------------------------------------------------------

    \56\ 17 CFR 38.850. See also David Reiffen and Michel A. Robe, 
Demutualization and Customer Protection at Self-Regulatory Financial 
Exchanges, Journal of Futures Markets, Vol. 31, 126-164, Feb. 2011 
(in many circumstances, an exchange that maximizes shareholder 
(rather than member) income has a greater incentive to enforce 
aggressively regulations that protect participants from dishonest 
agents); and Kobana Abukari and Isaac Otchere, Has Stock Exchange 
Demutualization Improved Market Quality? International Evidence, 
Review of Quantitative Finance and Accounting, Dec 09, 2019, https://doi.org/10.1007/s11156-019-00863-y (demutualized exchanges have 
realized significant reductions in transaction costs in the post-
demutualization period).
    \57\ FIA/FIA PTG NPRM Letter, at 2.
    \58\ See id.
---------------------------------------------------------------------------

    The Commission acknowledges IATP's points concerning the 
possibility of creating different tiers of DCMs, and distinguishing 
controls required of DCMs from those required of FCMs. However, the 
Commission believes it is preferable to have the same regulations apply 
to all DCMs, and, in the enforcement of such regulations, recognize 
that each DCM has a unique market, technological infrastructure, and 
market participants. In addition, DCMs may require different controls 
from FCMs and the Commission will not specify particular required 
controls. This will serve the goal of ensuring that all DCMs, whatever 
their size or products, are subject to the same Commission regulations 
while allowing sufficient flexibility for each DCM to adopt risk 
controls and rules that are reasonably appropriate for its market.
    As noted in the NPRM, the Commission will continue to monitor 
whether Risk Principles of this nature may be appropriate for other 
markets such as SEFs or FBOTs.\59\ The Commission initially proposed 
the Risk Principles with a focus on DCMs due to their prominent nature 
in the futures market. Application of the Risk Principles to SEFs and 
FBOTs requires further study and consideration regarding the risks and 
unique attributes of those other markets, and the Commission expects to 
do so in the future to determine whether SEFs and/or FBOTs should be 
subject to the Risk Principles or similar regulations.
---------------------------------------------------------------------------

    \59\ See NPRM at 42763 n.6.
---------------------------------------------------------------------------

    The Commission acknowledges that DCMs might implement different 
rules and risk controls given differences in their respective markets. 
Ongoing Commission oversight is expected to identify differences in DCM 
policies, procedures, and controls. Differences between and among DCMs 
would be acceptable under the Risk Principles so long as their 
policies, procedures, and controls are objectively reasonable. The Risk 
Principles will require DCMs to establish rules and risk controls 
reasonably designed to prevent, detect, and mitigate market 
disruptions, and this should, in turn, help prevent the migration of 
market disruptions from one DCM to another.
    The Commission acknowledges CEWG's request that the final rules 
clarify that market participants without access to source code used to 
operate trading systems would not be subject to any DCM rules to 
implement updates, test or monitor the operation of such software, or 
DCM rules under Risk Principle 3 to implement remediation measures for 
software.\60\ While these points are reasonable, the Commission 
believes the extent to which market participants would be expected to 
implement software updates, tests, operation monitoring, or remediation 
measures should be left to individual DCM reasonable discretion. The 
Commission can envision unique arrangements involving market 
participant use of third-party software and therefore believes DCMs are 
the appropriate entity to adopt reasonable rules to govern those 
arrangements. The Commission notes that under existing Commission 
regulation Sec.  38.151, DCMs must provide their members, persons with 
trading privileges, and independent software vendors with impartial 
access to their markets and services, including access criteria that 
are impartial, transparent, and applied in a non-discriminatory 
manner.\61\
---------------------------------------------------------------------------

    \60\ CEWG NPRM Letter, at 7.
    \61\ 17 CFR 38.151.
---------------------------------------------------------------------------

3. Issues Related to Codification in Core Principle 4 and Overlap With 
Existing Commission Regulations
    The NPRM noted several areas where the Risk Principles may overlap 
with existing Commission regulations, including regulations related to 
the prevention of market disruptions and financial risk controls.\62\ 
The Commission explained that because DCMs have developed robust and 
effective processes for identifying and managing risks, both because of 
their incentives to maintain markets with integrity, as well as for 
purposes of compliance with existing Commission regulations, the Risk 
Principles may not necessitate the adoption of additional measures by 
DCMs.\63\ The Commission further stated that the proposed Risk 
Principles will result in DCMs continuing to monitor risks as they 
evolve along with the markets and make reasonable modifications as 
appropriate.\64\ Finally, the Commission proposed codifying the Risk 
Principles as part of Core Principle 4.\65\
---------------------------------------------------------------------------

    \62\ See NPRM 42762, 42764.
    \63\ See NPRM 42762.
    \64\ See id.
    \65\ See id.
---------------------------------------------------------------------------

a. Summary of Comments
    CME, ICE, and Better Markets asserted that the Risk Principles are 
redundant of existing regulations.\66\ In particular, CME commented 
that the Risk Principles overlap with existing regulations that require 
DCMs to have controls, tools, and rule sets to prevent and mitigate 
market and system disruptions.\67\ CME stated that its messaging 
controls, for example, are already arguably subject to Commission 
oversight pursuant to certain existing regulations under Core 
Principles 2 and 4.\68\ CME suggested the Commission take an 
alternative approach of simply relying on existing regulations rather 
than adopting new ones.\69\ CME also addressed where in the part 38 
regulations the Risk Principles should be codified if adopted. CME 
suggested the Risk Principles be codified as part of Core Principle 2, 
particularly Risk Principle 1, because that Core Principle requires a 
DCM to adopt and implement rules.\70\ CME also pointed out that Core 
Principle 4 addresses manipulation, price distortion, and disruptions 
of the delivery or cash-settlement process and that a ``market 
disruption'' or ``system anomaly'' does not fit within those 
elements.\71\
---------------------------------------------------------------------------

    \66\ CME NPRM Letter, at 12-13; ICE NPRM Letter, at 3; Better 
Markets NPRM Letter, at 4-9.
    \67\ CME NPRM Letter, at 12-13.
    \68\ See id. at 7.
    \69\ See id. at 12.
    \70\ See id. at 12-13.
    \71\ See id.
---------------------------------------------------------------------------

    ICE commented that the proposed risk principles largely duplicate 
existing Core Principle 4 guidance and acceptable practices.\72\ ICE 
suggested amending existing regulations, such as Commission regulation 
Sec.  38.255, to refer to electronic trading, rather than create a new 
set of principles that may unintentionally conflict with or create 
duplicative and overlapping standards.\73\ ICE stated this would track 
the Commission's approach to regulating financial risk controls in 
existing Commission regulation Sec.  38.607, which it believes has 
proven effective.\74\
---------------------------------------------------------------------------

    \72\ ICE NPRM Letter, at 3.
    \73\ See id.
    \74\ See id.
---------------------------------------------------------------------------

    Better Markets similarly commented that the proposed regulations 
are redundant of existing Commission regulations. Specifically, Better 
Markets pointed to Commission regulations Sec. Sec.  38.157, 38.251(a), 
38.255, 38.607, 38.1050, and 38.1051, as well as Core Principle 4 
guidance and acceptable practices.\75\ Better Markets stated the Risk 
Principles give the public the false

[[Page 2053]]

impression that the CFTC is taking meaningful regulatory action.\76\ 
Better Markets also considered the Commission's distinction that the 
new principles are ``anticipatory'' to be unclear and possibly 
inaccurate.\77\ Better Markets further commented that existing 
Commission regulation Sec.  38.255 squarely focuses on risk controls 
for the prevention and mitigation of market disruptions.\78\ Better 
Markets stated that existing Commission regulation Sec.  38.255 and the 
proposed Risk Principles are so similar that it is unreasonable, if not 
deceptive, to finalize them under the pretext that the Commission is 
setting forth a new and improved electronic trading framework.\79\
---------------------------------------------------------------------------

    \75\ Better Markets NPRM Letter, at 4-9.
    \76\ See id.
    \77\ See id.
    \78\ See id.
    \79\ See id.
---------------------------------------------------------------------------

    CME, CEWG, FIA/FIA PTG, ICE, and MFA commented that DCMs already 
implement controls and address risks to their platforms.\80\ MFA 
believes the Risk Principles will help encourage DCMs to continue to 
monitor risks as they evolve along with the markets, and to make 
reasonable modifications as appropriate.\81\ AFR and Rutkowski 
disagreed, commenting that the NPRM does not contain any systematic 
analysis demonstrating that current DCM practices are effective in 
controlling the risks of market disruptions due to electronic 
trading.\82\
---------------------------------------------------------------------------

    \80\ CME NPRM Letter, at 4-7; CEWG NPRM Letter, at 4; FIA/FIA 
PTG NPRM Letter, at 3; ICE NPRM Letter, at 1; MFA NPRM Letter, at 2.
    \81\ MFA NPRM Letter, at 2.
    \82\ AFR NPRM Letter, at 2; Rutkowski NPRM Letter, at 2.
---------------------------------------------------------------------------

b. Discussion
    As noted in the NPRM, the Risk Principles supplement existing 
Commission regulations governing DCMs by directly addressing certain 
risks associated with electronic trading in Core Principle 4 and its 
implementing regulations, namely Commission regulations Sec. Sec.  
38.251 and 38.255.\83\ Commission regulation Sec.  38.251(c) requires 
DCMs to conduct real-time monitoring and resolve conditions that are 
disruptive to the market. The Risk Principles supplement this 
regulation by specifically requiring actions by DCMs to prevent, 
detect, and mitigate market disruptions and systems anomalies. While 
the anticipatory nature of the Risk Principles (involving prevention, 
in addition to detection and mitigation) is not the only justification 
for these new rules, the Commission believes it is important to clarify 
that DCMs are obligated to do more than monitor and resolve disruptive 
conditions, as required by existing Commission regulation Sec.  38.251. 
In particular, Risk Principle 1 specifically requires the adoption of 
exchange-based ``rules'' that are reasonably designed to address 
electronic trading risk to the extent that such rules are not already 
in place.
---------------------------------------------------------------------------

    \83\ See NPRM at 42768.
---------------------------------------------------------------------------

    The NPRM further acknowledged that the Risk Principles largely 
overlap with Commission regulation Sec.  38.255, which requires DCMs to 
``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 DCM.\84\ Compared to 
existing Commission regulation Sec.  38.255, the Risk Principles 
specifically address material market disruptions and system anomalies 
associated with electronic trading (e.g., excessive messaging that may 
materially limit participant access), not only market disruptions 
involving market halts or price distortions.
---------------------------------------------------------------------------

    \84\ NPRM at 42768.
---------------------------------------------------------------------------

    The Commission disagrees with comments asserting the Risk 
Principles would be more appropriately implemented under Core Principle 
2 rather than Core Principle 4. Various regulations promulgated under 
Core Principle 4 already address market disruptions, including 
Commission regulations Sec. Sec.  38.251(c) and 38.255. The Commission 
believes that the Risk Principles, each dealing with market 
disruptions, should likewise be codified under Core Principle 4.
    The Commission believes that it must do more than rely on existing 
regulations or add the words ``electronic trading'' to existing 
regulations. For this reason, the Commission notes that the final Risk 
Principles specifically will apply to electronic trading, thereby 
requiring adoption of a DCM rule (if not already implemented) and risk 
control and notification requirements regarding market disruptions, 
that is expected to ensure the development and implementation of 
reasonable measures to address the threat of market disruptions caused 
by electronic trading. The Commission expects that these Risk 
Principles will enhance the Commission's ability to hold DCMs to a 
standard of reasonably-designed rules and appropriate risk controls, 
whether those rules and controls were already in place or are 
implemented pursuant to the Risk Principles.\85\
---------------------------------------------------------------------------

    \85\ The Commission notes that it does not intend or expect 
larger DCM pre-trade risk controls to be the standard for all DCMs, 
although there may be risk controls that are common to all DCMs.
---------------------------------------------------------------------------

    The NPRM noted several examples of exchange-based risk controls and 
several commenters elaborated further on these risk controls.\86\ The 
Commission continues to believe most DCMs already have effective 
controls in place to address electronic trading market disruptions. 
These Risk Principles will require DCMs to continue to implement such 
reasonable controls as markets and risks evolve.
---------------------------------------------------------------------------

    \86\ NPRM at 42768. CME commented it has a vested interest in 
preserving the integrity of its markets, and has done so through 
market integrity controls such as order messaging throttles, price 
limits, automated port closures, kill switches, velocity logic 
controls and dynamic circuit breakers, as well as trade practice, 
disciplinary and administrative rules. CME NPRM Letter, at 4. ICE 
pointed out that prior to giving a participant access to its trading 
platform, ICE requires the participant to undergo conformance 
testing, which is designed to and has been successful in detecting 
system anomalies. ICE NPRM Letter, at 2. ICE additionally stated it 
has developed pre-trade risk controls, such as messaging throttles, 
interval price limits (price velocity collars), individual maximum 
order quantities, and order reasonability limits. See id. CFE 
commented it has extensive rule provisions that provide for risk 
controls applicable to all orders. CFE NPRM Letter, at 2.
---------------------------------------------------------------------------

II. The Final Risk Principles

A. Key Terms

    The NPRM stated that the Risk Principles focus on market 
disruptions or system anomalies associated with electronic trading 
activities.\87\ While not defined in the regulation text, the preamble 
broadly discussed the goals of the Risk Principles through these terms. 
The NPRM further stated by not defining the terms in a static way, the 
Commission intends that the application of the Risk Principles by DCMs 
and the Commission will evolve over time along with market 
developments.\88\ The NPRM stated that a general discussion of those 
terms in the context of today's electronic markets would provide the 
public and, in particular, DCMs, guidance for applying the Risk 
Principles.\89\
---------------------------------------------------------------------------

    \87\ NPRM at 42765.
    \88\ See id.
    \89\ See id.
---------------------------------------------------------------------------

1. Electronic Trading
a. Proposal
    For purposes of this rulemaking, the Commission described 
electronic trading as encompassing a wide scope of trading activities, 
including all trading and order messages submitted by electronic means 
to a DCM's electronic trading platform.\90\ This includes both 
automated and manual order entry.\91\
---------------------------------------------------------------------------

    \90\ See id.
    \91\ See id.

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

[[Page 2054]]

b. Summary of Comments
    CME and ICE addressed whether the Commission should modify its 
description of the term electronic trading. CME believed that the term 
was sufficiently clear.\92\ In contrast, ICE commented that the term is 
used in Risk Principles 1 and 2 to ``include all trading and order 
messages submitted by electronic means to the DCM's electronic trading 
platform, including both automated and manual order entry.'' \93\ ICE 
stated that the inclusion of ``trading'' messages is unnecessary.\94\ 
Because participants only submit ``order'' messages to the central 
limit order book and not trades, ICE believes that the term 
``electronic trading'' captures off-facility transactions, such as 
exchange for related positions (``EFRPs'') and block transactions.\95\ 
ICE stated off-facility transactions are privately negotiated and have 
a low likelihood of disrupting the central limit order book.\96\
---------------------------------------------------------------------------

    \92\ CME NPRM Letter, at 10.
    \93\ ICE NPRM Letter, at 2, 3-4, 5.
    \94\ See id.
    \95\ See id.
    \96\ See id.
---------------------------------------------------------------------------

c. Discussion
    The Commission clarifies that the term ``electronic trading'' 
includes block and EFRP transactions, if such transactions are 
submitted electronically to the DCM's trading platform. The Commission 
believes that DCMs should have reasonable discretion to decide what 
rules and controls--if any--should be applied to off-exchange 
transactions such as block trades and EFRPs under Risk Principles 1 and 
2. The Commission expects DCMs to make such a determination based on: 
(a) The risk such off-exchange transactions will disrupt DCM platforms 
or markets; and (b) the rules and controls that would be most effective 
to address that risk. The Commission acknowledges that such trades are 
privately negotiated and currently may carry little risk of market 
disruption. However, it is unknown how much risk off-exchange trading 
will pose as markets evolve over time. In particular, off-exchange 
transactions could become increasingly electronic or automated, impact 
price formation and, consequently, pose greater risk to DCM markets. 
The Risk Principles allow DCM discretion in assessing this risk and how 
best to address it.
2. Market Disruption and System Anomaly
a. Proposal
    In the NPRM, the Commission stated it considers the term ``market 
disruption,'' for purposes of the Risk Principles, to generally mean an 
event originating with a market participant that significantly disrupts 
the: (1) Operation of the DCM on which such participant is trading; or 
(2) the ability of other market participants to trade on the DCM on 
which such participant is trading.\97\ For the purposes of the Risk 
Principles, ``system anomalies'' are unexpected conditions that occur 
in a market participant's functional system that cause a similar 
disruption to the operation of the DCM or the ability of market 
participants to trade on the DCM.\98\
---------------------------------------------------------------------------

    \97\ NPRM at 42765.
    \98\ See id.
---------------------------------------------------------------------------

b. Summary of Comments
    ICE, CME, CEWG, MFA, IATP, Better Markets, and MGEX addressed 
whether the Commission should modify its description of the terms 
market disruption and system anomaly.\99\
---------------------------------------------------------------------------

    \99\ ICE NPRM Letter, at 5-6; CME NPRM Letter, at 3-4, 10-11; 
CEWG NPRM Letter, at 4, 5; MFA NPRM Letter, at 3; IATP NPRM Letter, 
at 6; Better Markets NPRM Letter, at 9, 10; MGEX NPRM Letter, at 1-
2, 3.
---------------------------------------------------------------------------

    ICE requested clarification on whether the term ``significant'' 
qualifies ``market disruption.'' \100\ ICE also commented that the 
description of ``market disruption'' is overly broad, noting that the 
Commission uses the term to refer to an incident that disrupts the 
ability of other market participants to trade on the DCM.\101\ ICE 
asserted this could include a range of subjective interpretations and 
possibilities, including a disruption resulting in prices not 
reflective of market fundamentals.\102\ ICE commented that the term 
could also be interpreted to include entering orders in a disorderly 
manner, quote stuffing, causing illiquid markets where one would not 
occur otherwise, or causing the artificial widening of markets.\103\ 
ICE stated these scenarios could result from volatility but not a 
market disruption, and, because of the ambiguities in the Risk 
Principles, market participants may be reluctant to trade if pricing 
appears aberrant or erroneous.\104\ CEWG commented that the Commission 
should provide further high-level guidance with respect to events 
constituting ``market disruptions'' or ``system anomalies'' to minimize 
the potential for regulatory uncertainty.\105\
---------------------------------------------------------------------------

    \100\ ICE NPRM Letter, at 5.
    \101\ See id.
    \102\ See id.
    \103\ See id.
    \104\ See id.
    \105\ CEWG NPRM Letter, at 4.
---------------------------------------------------------------------------

    CME commented that the term ``market disruption'' is sufficiently 
clear.\106\ Similarly, MFA agreed with the Commission's approach to 
defining ``market disruption,'' which MFA believes focuses correctly on 
events impacting the operations of the DCM and/or the ability of other 
market participants to trade on the DCM, rather than the impact on 
trading of a single firm whose electronic trading was the source of the 
disruption.\107\ MFA also commented it supports that the Risk 
Principles allow a DCM to exercise discretion in identifying market 
disruptions and system anomalies as they relate to the DCM's particular 
market and the trading activities of participants in that market.\108\
---------------------------------------------------------------------------

    \106\ CME NPRM Letter, at 10-11.
    \107\ MFA NPRM Letter, at 3.
    \108\ See id.
---------------------------------------------------------------------------

    CME cautioned that no specific type of market halt should be 
considered a per se ``market disruption'' because some halts prevent 
and mitigate market disruptions.\109\ Similarly, ICE commented that an 
unscheduled trading halt caused by a market participant, which could 
not readily be attributed to market volatility or fundamental 
conditions in underlying or related markets, could constitute a market 
disruption.\110\ CME stated that the Commission should not characterize 
any specific period of latency as per se disruptive, because latency 
can occur due to bona fide market activity, or be based on a 
participant's own system.\111\ CME stated that a fact-specific inquiry 
is necessary to determine if there has been a market disruption.\112\ 
Similarly, ICE stated that latency incorporates many factors outside a 
DCM's processing of order messages.\113\ As such, the Commission should 
be cautious when interpreting latency as an indication of a market 
disruption.\114\ ICE stated it is more meaningful to quantify the 
impact on the market rather than to calculate a subjective impact to 
latency.\115\ CEWG commented that a disruptive event could have a 
significant impact on the market in one context, but not in 
another.\116\ For example, a one or two second delay in processing and 
execution may constitute a market disruption to automated trading firms 
but not to manual traders.\117\
---------------------------------------------------------------------------

    \109\ CME NPRM Letter, at 10-11.
    \110\ ICE NPRM Letter, at 5-6.
    \111\ CME NPRM Letter, at 10-11.
    \112\ See id.
    \113\ ICE NPRM Letter, at 6.
    \114\ See id.
    \115\ See id.
    \116\ CEWG NPRM Letter, at 5.
    \117\ See id.
---------------------------------------------------------------------------

    CME commented regarding the preamble's assertion that ``system 
anomalies'' are unexpected conditions

[[Page 2055]]

that occur in a participant's functional system ``which cause a similar 
disruption to the operation of the DCM or the ability of market 
participants to trade on the DCM.'' \118\ CME stated one could 
interpret the preamble language to mean the disruptions to the DCM must 
be similar to the disruptions to the originating participant.\119\ CME 
suggested if the phrase ``which cause a similar disruption'' is 
actually referring to the Commission's definition of ``market 
disruption'' described earlier in the NPRM preamble, then the 
Commission should clarify accordingly.\120\
---------------------------------------------------------------------------

    \118\ CME NPRM Letter, at 3.
    \119\ See id.
    \120\ See id.
---------------------------------------------------------------------------

    CME further commented that both definitions relate to the ability 
of other participants ``to trade.'' \121\ CME stated that sections of 
the preamble reference participants' inability to trade, engage in 
price discovery, or manage risk.\122\ CME asked the Commission to 
clarify whether it always means all three situations, or any of those 
situations.\123\ CME further commented that the Commission reconsider 
using the word ``ability.'' \124\ CME pointed out that not all the 
examples of market disruptions cited in the NPRM involved a disruption 
to the operation of the DCM and a participant being unable to trade, 
engage in price discovery, or manage risk.\125\ CME suggested that a 
clearer and more objective standard would be that the event ``must 
significantly disrupt other participants' access to the DCM.'' \126\ 
CME believes this standard captures the risks identified in the 
rulemaking and is something DCMs can typically identify on their 
own.\127\
---------------------------------------------------------------------------

    \121\ See id.
    \122\ See id.
    \123\ See id.
    \124\ CME NPRM Letter, at 3-4.
    \125\ See id. In particular, CME referenced 2011 disciplinary 
actions involving the same trading firm, where an automated trading 
system malfunction prompted selling e-mini Nasdaq 100 Index futures 
on the Chicago Mercantile Exchange, and another malfunction caused a 
rapid buying in oil futures on the New York Mercantile Exchange 
(``NYMEX'').
    \126\ See id. (emphasis added).
    \127\ See id.
---------------------------------------------------------------------------

    IATP commented that the Commission grants too much discretion to 
DCMs to interpret the terms of the NPRM and to determine what is or is 
not a ``market disruption'' or ``system anomaly'' and whether to 
mitigate it.\128\ Better Markets commented that terms such as 
``significant'' and ``disruption'' are ambiguous and will lead to 
divergent practices.\129\ Better Markets also commented that the Risk 
Principles provide essentially unfettered discretion to each DCM in 
terms of how to define market disruptions and system anomalies as they 
relate to their particular markets, and permitting differing 
definitions will undermine comparative analyses of market disruptions 
across exchanges.\130\
---------------------------------------------------------------------------

    \128\ IATP NPRM Letter, at 6.
    \129\ Better Markets NPRM Letter, at 9.
    \130\ See id. at 10. Better Markets cited ``the Flash Crash, 
recent WTI trading anomalies in the oil markets, and the Knight 
Capital meltdown'' as examples demonstrating that electronic trading 
presents ``varied, complex, and potentially extensive risks to 
market integrity, orderly trading, fair competition, and the price 
discovery process across the financial markets.'' See id. at 3.
---------------------------------------------------------------------------

    MGEX commented that the Commission should continue with its 
principles-based approach to broadly define ``market disruption'' and 
``system anomalies'' associated with electronic trading and ensure the 
reasonableness standard is approached with ample discretion.\131\ MGEX 
considered the general definitions of ``market disruption'' and 
``system anomalies'' stated in the NPRM to be acceptable, with the 
caveat that each DCM operates differently, and the Commission should 
recognize this during its rule enforcement reviews.\132\
---------------------------------------------------------------------------

    \131\ MGEX NPRM Letter, at 1-2.
    \132\ See id. at 3.
---------------------------------------------------------------------------

c. Discussion
    The NPRM described a market disruption as an event originating with 
a market participant that significantly disrupts the operation of the 
DCM on which such participant is trading. The proposed regulation text 
for Risk Principle 3 expressly included the term ``significant,'' while 
the regulation text for Risk Principles 1 and 2 did not. The Commission 
clarifies that the term ``market disruption,'' for DCMs' definitional 
and rule implementation purposes to satisfy Risk Principles 1 and 2, 
refers specifically to disruptions that materially impact the proper 
functioning of a DCM's trading platform. The term ``market disruption'' 
does not encompass disruptions that have only a de minimis effect on a 
DCM's trading platforms or the ability of other market participants to 
trade, engage in price discovery, or manage risk. For example, a 
technical malfunction at a market participant might cause excessive 
messaging in a product before a DCM's risk controls limit trading in 
that product. If the trading halt has a material impact on other market 
participants' ability to trade in that product, then that would 
constitute a market disruption. However, if trading is only halted for 
a de minimis amount of time, and market participants can quickly resume 
trading in that product, that may not rise to the level of a material 
``market disruption'' of the DCM's trading platform for purposes of the 
Risk Principles.
    CME indicated that a specific disruption cited in the NPRM (namely 
a malfunction that prompted the selling of e-mini Nasdaq 100 Index 
futures on the Chicago Mercantile Exchange, and another malfunction 
that caused a rapid buying of oil futures on NYMEX) was not necessarily 
a ``market disruption,'' because the event did not disrupt the 
operation of the DCM or limit market participants' ability to 
trade.\133\ The Commission acknowledges that DCMs will have some 
discretion to determine whether an event constitutes a market 
disruption for purposes of the Risk Principles. However, if the 
malfunctions described in the 2011 CME disciplinary actions were to 
cause a material change in price that deviated from prevailing market 
prices, and the DCMs were required to cancel numerous trades, the 
Commission would likely view such a scenario as a material market 
disruption that DCMs should have reasonable rules and risk controls in 
place to prevent, detect, and mitigate. The materiality of a market 
disruption would depend on, for example, in the context of trade 
errors, how quickly the DCM can correct erroneous prices, and how many 
contracts are affected. In the event of a market disruption involving a 
trading halt, materiality generally would depend on how quickly trading 
is able to resume.
---------------------------------------------------------------------------

    \133\ CME NPRM Letter, at 3.
---------------------------------------------------------------------------

    Under Risk Principle 3, DCMs only have to report market disruptions 
under Risk Principles 1 and 2 that are ``significant.'' All significant 
market disruptions under Risk Principle 3 are also market disruptions 
under Risk Principles 1 and 2, but the converse is not true: Some 
market disruptions under Risk Principles 1 and 2 will not be 
sufficiently significant to trigger the reporting requirement under 
Risk Principle 3. Thus, the standard for a significant market 
disruption under Risk Principle 3 is higher than the standard for a 
market disruption under Risk Principles 1 and 2. The Commission 
emphasizes that DCMs have reasonable discretion to determine whether a 
given market disruption had a ``significant'' impact on the trading 
platform, so as to trigger Risk Principle 3 reporting.\134\
---------------------------------------------------------------------------

    \134\ ``Reasonable discretion'' shall be interpreted in the same 
manner as it has been used elsewhere in the Commission's 
regulations. See, e.g., Part 38 Core Principle 1, which provides 
that unless otherwise determined by the Commission by rule or 
regulation, a board of trade described in paragraph (a) of this 
section shall have reasonable discretion in establishing the manner 
in which the board of trade complies with the core principles 
described in this subsection. 17 CFR 38.100 (emphasis added).

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

[[Page 2056]]

    Further, as to each Risk Principle, the Commission clarifies that 
the terms ``market disruption'' and ``system anomaly'' are intended to 
capture scenarios where a participant's ability to trade, engage in 
price discovery, or manage risk are materially impacted. All three 
scenarios do not have to occur for an event to be considered a market 
disruption or system anomaly. In addition, the Commission clarifies 
that ``system anomalies'' are unexpected conditions that occur in a 
market participant's functional system that cause a disruption to the 
operation of the DCM or the ability of market participants to trade on 
the DCM, engage in price discovery, or manage risk. The disruption on 
the DCM need not be similar in nature to the disruption in a 
participant's system.
    The Commission understands that many examples of a market 
participant's ability to trade on the DCM, engage in price discovery, 
or manage risk may involve the limitation of participant access to the 
DCM. However, the Commission declines to limit the definitions of 
``market disruption'' or ``system anomaly'' to a limitation of access, 
as there may be situations where market participants cannot engage in 
price discovery, regardless of whether they have access to the DCM. For 
example, a market participant may have access to trade in a particular 
product, but the product's price has been impacted by inadvertent rapid 
selling or buying.
    The Commission believes the term ``market disruption'' is not 
overly broad. While one commenter asserted that ``market disruption'' 
could include various events that involve prices not reflecting market 
fundamentals, such as entering orders in a disorderly manner, quote 
stuffing, causing illiquid markets where one would not occur otherwise, 
or causing the artificial widening of markets, the Commission clarifies 
that intentionally or recklessly disruptive trading behavior is not 
meant to be within the scope of the Risk Principles.\135\ Rather, the 
focus of the Risk Principles is to address unintentional technological 
malfunctions that disrupt the operation of the DCM or the ability of 
market participants to trade, engage in price discovery, or manage 
risk. A situation where prices do not reflect market fundamentals is 
not sufficient, on its own, to constitute a material market disruption 
for purposes of the Risk Principles.
---------------------------------------------------------------------------

    \135\ Intentional or reckless acts of price manipulation, fraud, 
disruptive trading, wash sales, or pre-arranged trading, among 
others, are addressed through existing provisions, including, but 
not limited to, Sections 4b, 4c(a)(2), 4c(a)(5), 4o, and 9 of the 
CEA and Commission regulations Sec. Sec.  1.38, 180.1, 180.2, 
38.152, and 38.250. See 7 U.S.C. 6b, 6c(a)(2), 6c(a)(5), 6o, 9; 17 
CFR 1.38, 180.1, 180.2, 38.152, 38.250.
---------------------------------------------------------------------------

    The Commission agrees that no specific market halt should be 
considered a per se ``market disruption,'' because certain halts 
effectively prevent and mitigate market disruptions. Further, the 
Commission will not characterize any specific period of latency as per 
se disruptive due to the various causes of latency, not all of them 
relating to market disruptive events. The Commission emphasizes that 
DCMs have discretion in determining whether a trading halt is 
disruptive.
    In response to comments relating to DCM discretion, the Commission 
reiterates DCMs are best-positioned to assess the material market 
disruption and system anomaly risks posed by their markets and market 
participant activity, and to design appropriate measures to address 
those risks. However, while DCMs may differ in what they consider to be 
a ``market disruption'' or ``system anomaly,'' and whether and how to 
mitigate such an event, this is not unlimited discretion. The 
Commission will oversee and enforce the Risk Principles in accordance 
with an objective reasonableness standard. In other words, while a DCM 
has discretion to determine what rules and risk controls are 
appropriate, the Commission as part of its oversight responsibility 
will consider the objective reasonableness of those measures in light 
of the DCM's products, volume, market participants and other factors, 
and how similarly positioned DCMs address similar risks.
    Due to differences among DCMs, the Commission acknowledges DCMs may 
have different determinations of what constitutes a ``market 
disruption'' or ``system anomaly.'' In response to the comment from 
Better Markets, the Commission does not believe this will hinder any 
``comparative'' analysis of market disruptions across exchanges. When 
assessing material market disruptions, the Commission will consider 
differences among DCM markets, technology, products, and market 
participants as part of its oversight.
    As to MGEX's comment that each DCM operates differently, the 
Commission acknowledges that each DCM operates unique markets, with 
unique market participants, products, and technology. The Commission 
already takes this into account with respect to its routine oversight, 
including examinations.

B. The Reasonableness Standard

1. Proposal
    The Commission proposed Acceptable Practices to Risk Principles 1 
and 2, which provide that a DCM can comply with those principles by 
adopting rules, and subjecting all electronic orders to exchange-based 
pre-trade risk controls, that are reasonably designed to prevent, 
detect, and mitigate market disruptions or system anomalies associated 
with electronic trading.\136\
---------------------------------------------------------------------------

    \136\ NPRM at 42777.
---------------------------------------------------------------------------

2. Summary of Comments
    ICE, MGEX, CME, Better Markets, and IATP commented on the 
reasonableness standard.\137\ ICE supported the Commission's approach 
to give DCMs reasonable discretion to adopt rules that prevent, detect, 
and mitigate market disruptions.\138\ ICE stated DCMs are best-
positioned to adopt the rules, procedures, and system controls that fit 
their market and technology.\139\ ICE further commented that the 
proposed Acceptable Practice for Commission regulation Sec.  38.251(e) 
provides DCMs with sufficient discretion to adopt the rules appropriate 
for their platform.\140\ ICE believes the supervisory obligations set 
out in exchange rules, along with requirements relating to disruptive 
trading practices, have been effective in preventing market 
disruptions.\141\ Similarly, MGEX commented that the Commission should 
accept that DCMs may differ in the rules they establish based on the 
unique and different markets and products, and DCMs must have 
discretion to ensure that the rules are ``objectively reasonable'' to 
address a market disruption or system anomaly.\142\
---------------------------------------------------------------------------

    \137\ ICE NPRM Letter, at 2; MGEX NPRM Letter, at 2-3; CME NPRM 
Letter, at 4-5, 6, 13; Better Markets NPRM Letter, at 8; IATP NPRM 
Letter, at 9.
    \138\ ICE NPRM Letter, at 2.
    \139\ See id.
    \140\ See id.
    \141\ See id.
    \142\ MGEX NPRM Letter, at 2-3.
---------------------------------------------------------------------------

    CME commented that the Commission should add ``reasonably 
designed'' to the regulation text, not just acceptable practices, just 
as it is in at least 40 other existing Commission regulations.\143\ CME 
believes this is especially important for Risk Principle 2, which 
requires controls to ``prevent'' system anomalies.\144\ CME stated that 
the word ``prevent'' creates an impossible

[[Page 2057]]

standard without a condition in the Risk Principle explicitly stating 
that the controls must be ``reasonably designed.'' \145\
---------------------------------------------------------------------------

    \143\ CME NPRM Letter, at 4-5.
    \144\ See id. at 6.
    \145\ See id. at 6-7.
---------------------------------------------------------------------------

    Better Markets commented that the Commission's emphasis on DCM 
flexibility suggests confusion as to whether reasonableness is an 
objective or subjective standard.\146\ Better Markets believed the 
preamble to the final rules should state that the Risk Principles may 
require DCMs to do things differently if their pre-trade risk controls 
do not objectively satisfy the regulations.\147\ Better Markets also 
commented that the NPRM's preamble set forth a ``near presumption of 
reasonableness.'' \148\ Similarly, IATP commented that the preamble 
indicates it is unlikely the Commission will take any enforcement 
action against DCMs.\149\ IATP disagreed with the Commission's 
statement that the Risk Principles will not result in enforcement 
actions based on strict liability.\150\ IATP stated that assuring DCMs 
that risk control failure will not result in enforcement action would 
signal to plaintiffs in a market disruption case that they would have 
to meet a high evidentiary standard.\151\
---------------------------------------------------------------------------

    \146\ Better Markets NPRM Letter, at 8.
    \147\ See id.
    \148\ See id.
    \149\ IATP NPRM Letter, at 9.
    \150\ See id.
    \151\ See id.
---------------------------------------------------------------------------

3. Discussion
    The Acceptable Practices will be adopted as proposed with the 
``reasonably designed'' standard. As stated in the NPRM, the Acceptable 
Practices for implementing the Risk Principles provide that DCMs shall 
have satisfied their requirements under the Risk Principles if they 
have established and implemented rules and pre-trade risk controls that 
are reasonably designed to prevent, detect, and mitigate market 
disruptions or system anomalies associated with electronic 
trading.\152\ ``Reasonably designed'' means that a DCM's rules and risk 
controls are objectively reasonable. As noted above, in assessing a 
DCM's rules and risk controls, the Commission as part of its oversight 
responsibility will consider the objective reasonableness of those 
measures in light of the DCM's products, volume, market participants 
and other factors, and how similarly positioned DCMs address similar 
risks.
---------------------------------------------------------------------------

    \152\ See NPRM at 42763.
---------------------------------------------------------------------------

    The Acceptable Practices are intended to provide DCMs with 
reasonable discretion to impose rules and risk controls to prevent, 
detect, and mitigate market disruption. Transferring the reasonableness 
standard to the regulation text is not necessary to allow DCM 
discretion to impose rules and controls appropriate to their own 
markets.
    In addition, the word ``prevent,'' when part of a reasonableness 
standard applicable through Acceptable Practices, does not create an 
impossible standard to achieve. Rules and controls implemented by DCMs 
need to be reasonable, as determined by an objective standard. Risk 
Principles 1 and 2 do not require DCMs to ``prevent'' market 
disruptions and system anomalies in all circumstances. A goal of these 
Risk Principles is to provide DCMs with appropriate flexibility to take 
reasonably designed measures relevant to individual markets, and 
improve those measures as markets evolve.
    The Commission confirms that the reasonableness standard is an 
objective one and there is no presumption of reasonableness. While 
there are differences among DCMs, what one DCM may implement in terms 
of rules and controls to address material market disruptions may be 
relevant to assessing another DCM's compliance. For example, if the 
Commission finds that a particular DCM is an outlier in terms of rules 
or controls, this may cause the Commission to inquire further whether 
there are legitimate reasons for the differences.
    The Commission confirms that DCMs may need to impose additional 
rules on their market participants, or implement additional controls, 
if their rules and controls do not objectively satisfy the Risk 
Principles. The Risk Principles are principles-based and allow for DCM 
discretion in compliance, but they are nevertheless enforceable 
regulations. Market participants should not interpret the Commission's 
statements in this preamble to articulate any particular evidentiary 
standard in an enforcement action.

C. Risk Principle 1

1. Proposal
    In Risk Principle 1, the Commission proposed that a DCM must adopt 
and implement ``rules'' governing market participants subject to its 
jurisdiction to prevent, detect, and mitigate market disruptions or 
system anomalies associated with electronic trading.\153\ The 
Commission proposed that Risk Principle 1 (and the other Risk 
Principles) apply to all electronic trading.
---------------------------------------------------------------------------

    \153\ NPRM at 42776.
---------------------------------------------------------------------------

2. Rules Versus Controls and Other Procedures
a. Summary of Comments
    Several commenters addressed Risk Principle 1's requirement that 
DCMs implement ``rules.'' CME suggested Risk Principle 1 should focus 
on rules on participants and their conduct that are enforced through 
administrative or disciplinary processes; an example is CME Group's 
Messaging Efficiency Policy.\154\ Other examples CME provided include 
trade practice and disciplinary rules and CME's disruptive trading 
practices rule (Rule 575), which CME amended in 2020 to provide that it 
is a violation ``for a participant to intentionally or recklessly 
engage in activity that has the potential to disrupt the systems of the 
Exchange.'' \155\
---------------------------------------------------------------------------

    \154\ CME NPRM Letter, at 5.
    \155\ Id. at 5-6 (emphasis in original).
---------------------------------------------------------------------------

    Better Markets and MGEX also commented on the term ``rule.'' \156\ 
Better Markets stated the Commission should clarify that ``rules'' 
include internal policies, procedures, controls, advisories, and 
trading protocols contemplated in the broad definition in 40.1.\157\ 
MGEX commented that the Commission should ensure ``rules,'' as 
described in the NPRM, include non-rules such as policies, procedures, 
protocols, and controls.\158\
---------------------------------------------------------------------------

    \156\ Better Markets NPRM Letter, at 10; MGEX NPRM Letter, at 2, 
4.
    \157\ Better Markets NPRM Letter, at 10.
    \158\ MGEX NPRM Letter, at 2, 4.
---------------------------------------------------------------------------

    CFE stated a DCM should be able to satisfy Risk Principle 1 through 
implementing internal systems, processes, and procedures, not just 
rules.\159\ For example, CFE commented a DCM may not want to publicly 
disclose how it monitors particular markets.\160\ CFE asserted 
requiring a DCM to describe in its rules how it monitors for market 
disruptions and system anomalies is administratively burdensome and may 
disincentivize a DCM from improving its systems.\161\
---------------------------------------------------------------------------

    \159\ CFE NPRM Letter, at 3.
    \160\ Id.
    \161\ Id.
---------------------------------------------------------------------------

    CEWG stated DCM rules adopted pursuant to Risk Principles 1 and 2 
should be subject to Commission approval under Commission regulation 
Sec.  40.5 or self-certification under Commission regulation Sec.  
40.6.\162\ CEWG asserted a transparent regulatory process would ensure 
that new DCM rules are appropriately tailored.\163\
---------------------------------------------------------------------------

    \162\ CEWG NPRM Letter, at 7.
    \163\ Id.

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

[[Page 2058]]

b. Discussion
    With respect to the comments addressing the scope of the term 
``rule'' in Risk Principle 1, the Commission emphasizes that the term 
is intended to have the meaning set forth in part 40 of the 
Commission's regulations. Specifically, the Commission clarifies that 
for purposes of Risk Principle 1 and the Acceptable Practices, the term 
``rule'' has the meaning set forth in existing Commission regulation 
Sec.  40.1(i), which provides that rule means any constitutional 
provision, article of incorporation, bylaw, rule, regulation, 
resolution, interpretation, stated policy, advisory, terms and 
conditions, trading protocol, 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.\164\ This definition of ``rule'' is broad and 
can include policies, procedures, protocols, and controls that are not 
public.\165\ DCM policies and other internal procedures addressing 
market disruption risk could also satisfy Risk Principle 1.
---------------------------------------------------------------------------

    \164\ 17 CFR 40.1(i).
    \165\ Under part 40, a DCM's filing of rules under Commission 
regulations Sec. Sec.  40.5 or 40.6 shall be treated as public 
information, unless accompanied by a request for confidential 
treatment. See 17 CFR 40.8(c).
---------------------------------------------------------------------------

    Commission regulation Sec.  40.1(i) would require rules to be 
approved or self-certified pursuant to part 40 regulations, though DCMs 
would be entitled to request confidential treatment pursuant to the 
procedures in Commission regulation Sec.  40.8(c) with respect to such 
filings.\166\ In particular, under Risk Principle 1, a DCM would be 
required to submit rules to the Commission in accordance with either: 
(a) Commission regulation Sec.  40.5, which provides procedures for the 
voluntary submission of rules for Commission review and approval; or 
(b) Commission regulation Sec.  40.6, which provides procedures for the 
self-certification of rules with the Commission.\167\
---------------------------------------------------------------------------

    \166\ 17 CFR 40.8(c).
    \167\ See 17 CFR 40.5, 40.6.
---------------------------------------------------------------------------

    The part 40 rule submission process will ensure that new rules that 
DCMs implement to address the risk of market disruption--including 
internal processes--will be subject to appropriate Commission review 
and oversight. With respect to self-certifications, the Commission 
stated in the preamble to the part 40 final rules that the explanation 
and analysis of certified rules or rule amendments should be a clear 
and informative--but not necessarily lengthy--discussion of the 
submission, the factors leading to the adoption of the rule or rule 
amendment, and the expected impact of the rule or rule amendment on the 
public and market participants.\168\
---------------------------------------------------------------------------

    \168\ Part 40 final rules, 75 FR 44776, 44782-83 (July 27, 
2011). The Commission further noted that it requires registered 
entities to provide a more detailed explanation and analysis of 
rules voluntarily submitted for Commission approval under the 
provisions of Sec.  40.5. Id. at 44782. See also 17 CFR 40.6(a)(7) 
(setting forth rule submission requirements).
---------------------------------------------------------------------------

3. Scope of Electronic Trading Subject to DCM Rules
a. Summary of Comments
    Several commenters addressed the scope of orders and trades subject 
to Risk Principle 1. ICE supported requiring DCMs to subject all 
electronic orders to exchange-based pre-trade risk controls, because 
all persons that trade electronically have the potential to disrupt 
markets.\169\ CFE asked the Commission to clarify that under Risk 
Principle 1, DCMs may have rules governing market participants subject 
to the DCM's jurisdiction that are applicable to a subset of market 
participants, as long as those rules apply to all electronic orders 
submitted to the DCM.\170\ IATP supported requiring DCMs to implement 
separate risk controls for cleared and uncleared trades.\171\ IATP 
asserted uncleared trades pose greater counterparty credit risks, so 
the Risk Principles should require post-trade risk controls to prevent 
post-trade contract defaults and other credit events.\172\
---------------------------------------------------------------------------

    \169\ ICE NPRM Letter, at 3.
    \170\ CFE NPRM Letter, at 1-2.
    \171\ IATP NPRM Letter, at 10.
    \172\ Id.
---------------------------------------------------------------------------

b. Discussion
    The Commission is adopting Risk Principle 1 as proposed, but 
clarifies that a DCM may have rules that apply to only a subset of 
market participants. The Commission understands that DCMs have markets 
with a broad range of market participants and trading patterns. The 
Commission believes that DCMs should have reasonable discretion to 
determine whether risk controls should be different for different types 
of trading activity. Indeed, it may not be advisable for a DCM to 
impose the same rules under Risk Principle 1 on all types of market 
participants and trading activity present on the DCM's platforms. The 
Commission's principles-based approach to the Risk Principles gives 
DCMs the flexibility to impose the most efficient and effective rules 
and pre-trade risk controls for their respective markets. The 
Commission believes Risk Principle 1 will help ensure DCMs continue to 
monitor risks as they evolve along with the markets, and make 
reasonable changes as appropriate to address those evolving risks.\173\
---------------------------------------------------------------------------

    \173\ NPRM at 42767.
---------------------------------------------------------------------------

    In response to IATP's comment supporting a separate set of risk 
controls on uncleared trades, the Commission notes that all 
transactions on or pursuant to the rules of a DCM must be cleared. As a 
result, any such separate set of risk controls would be on a null set 
of trades.\174\
---------------------------------------------------------------------------

    \174\ The Commission has explained that all transactions 
executed on or through a DCM must be cleared through a Commission-
registered DCO. See Core Principles and Other Requirements for 
Designated Contract Markets, 77 FR 36612, 36646 (June 19, 2012).
---------------------------------------------------------------------------

D. Risk Principle 2--Risk Controls Listed in Part 38

1. Proposal
    Risk Principle 2 requires DCMs to subject all electronic orders to 
exchange-based pre-trade risk controls to prevent, detect, and mitigate 
market disruptions or system anomalies associated with electronic 
trading.
    The Commission noted in the NPRM that certain existing provisions 
in part 38 list appropriate DCM-implemented risk controls.\175\ For 
example, existing Commission regulation Sec.  38.255 mandates exchange-
based risk controls to prevent and reduce the potential risk of market 
disruptions.\176\ In addition, existing Core Principle 4's Acceptable 
Practices \177\ list appropriate risk controls, and proposed Risk 
Principle 2 does not change those Acceptable Practices.
---------------------------------------------------------------------------

    \175\ See NPRM at 42767-68.
    \176\ See id. at 42768.
    \177\ See Appendix B to Part 38--Guidance on, and Acceptable 
Practices in, Compliance with Core Principles, Core Principle 4 
(Subparagraph (b)).
---------------------------------------------------------------------------

2. Summary of Comments
    CME, ICE, and MGEX agree with the Commission that the controls 
listed in existing acceptable practices are sufficient. CME stated the 
controls listed in the existing acceptable practices are effective at 
preventing or mitigating market disruptions, and the Commission should 
not list any others as part of proposed Commission regulation Sec.  
38.251(f).\178\ ICE commented there is not one set of risk controls 
that are most effective in preventing market disruptions.\179\ ICE

[[Page 2059]]

further asserted the proposed Acceptable Practices for proposed 
Commission regulation Sec.  38.251(f) and the guidance provided in 
existing Appendix B(b)(5) provide DCMs sufficient discretion to adopt 
appropriate risk controls.\180\ MGEX stated the controls outlined in 
existing Acceptable Practices for Core Principle 2 are sufficient.\181\
---------------------------------------------------------------------------

    \178\ CME NPRM Letter, at 14.
    \179\ ICE NPRM Letter, at 7.
    \180\ Id. at 8.
    \181\ MGEX NPRM Letter, at 2.
---------------------------------------------------------------------------

    In contrast, IATP commented that Risk Principle 2 should include 
post-trade risk controls to help protect market participants against 
credit events resulting from DCM negligence in the design, 
implementation and enforcement of its rules and risk controls.\182\ 
IATP stated this would follow the FIA recommendation on post-trade risk 
controls.\183\
---------------------------------------------------------------------------

    \182\ IATP NPRM Letter, at 10.
    \183\ Id.
---------------------------------------------------------------------------

3. Discussion
    The Commission is adopting Risk Principle 2 as proposed and is not 
adding specific controls to the regulation text or Acceptable 
Practices. As discussed in the NPRM, the purpose of Risk Principle 2 is 
to require DCMs to consider market participants' trading activities 
when designing and implementing exchange-based risk controls to address 
market disruptive events.\184\ Risk Principle 2 provides clarity to 
DCMs that their exchange-based risk controls must address market 
disruptions caused by electronic trading, including those related to 
price movements as well as other events that impair market 
participants' ability to trade.\185\
---------------------------------------------------------------------------

    \184\ NPRM at 42767.
    \185\ Id. at 42768.
---------------------------------------------------------------------------

    Consistent with the comments received from CME, ICE, and MGEX, the 
Commission believes the existing Acceptable Practices set forth in Core 
Principle 4 list appropriate risk controls. Specifically, the 
Acceptable Practices in existing Core Principle 4 list risk controls 
including pre-trade limits on order size, price collars or bands around 
the current price, message throttles, and daily price limits.\186\ The 
Commission declines to impose additional pre-trade or post-trade risk 
control requirements on DCMs. The Commission does not consider such 
requirements to be necessary or consistent with the Commission's 
principles-based approach to the Risk Principles.
---------------------------------------------------------------------------

    \186\ See Appendix B to Part 38--Guidance on, and Acceptable 
Practices in, Compliance with Core Principles, Core Principle 4 
(Subparagraph (b)).
---------------------------------------------------------------------------

E. Risk Principle 3

1. Proposal
    The Commission proposed in Risk Principle 3 that a DCM must 
promptly notify Commission staff of a ``significant'' disruption to its 
electronic trading platform(s) and provide timely information on the 
causes and remediation.
    In the NPRM, the Commission stated the required notification under 
Risk Principle 3 would take a form similar to current Commission 
regulation Sec.  38.1051(e) notification.\187\ Further, the Commission 
differentiated Risk Principle 3 from existing Commission regulation 
Sec.  38.1501(e) by noting that, rather than addressing a DCM's 
internal technological systems, Risk Principle 3 addresses malfunctions 
of the technological systems of trading firms and other non-DCM market 
participants that cause disruptions of the DCM's trading platform.
---------------------------------------------------------------------------

    \187\ NPRM at 42769.
---------------------------------------------------------------------------

    In addition, the Commission asked commenters to describe 
circumstances in which it would be appropriate for a DCM to notify 
other DCMs about a significant market disruption on its trading 
platform(s). The Commission asked whether proposed Risk Principle 3 
should include such a requirement.
2. ``Significant'' Standard
a. Summary of Comments
    Better Markets, CME, and ICE believed the term ``significant'' in 
Risk Principle 3 is unclear. Better Markets asserted that expectations 
regarding timing and substance of reporting ``significant market 
disruptions'' are imprecise and unenforceable.\188\ Better Markets 
stated DCMs must know what to report, where to report it, when to 
report it, and under what circumstances reporting is required.\189\ 
Better Markets further stated Risk Principle 3 fails to (i) provide a 
formal definition of market disruptions, (ii) indicate when disruptions 
cross the significance threshold, or (iii) identify the level of detail 
necessary to notify the CFTC sufficiently.\190\
---------------------------------------------------------------------------

    \188\ Better Markets NPRM Letter, at 2.
    \189\ Id. at 9.
    \190\ Id. at 10.
---------------------------------------------------------------------------

    CME stated that while Risk Principle 3 appears to require impact to 
both the operation of the DCM and market participants, Risk Principles 
1 and 2 seem to require impact to operation of the DCM or market 
participants.\191\ CME also commented that to be subject to the 
notification requirement, Risk Principle 3 provides a significant 
disruption must ``materially affect'' the DCM and market 
participants.\192\ CME supported clarifying the distinction between 
``significant'' and ``material.'' \193\
---------------------------------------------------------------------------

    \191\ CME NPRM Letter, at 8.
    \192\ Id.
    \193\ Id.
---------------------------------------------------------------------------

    MFA and MGEX supported the use of the term ``significant'' in Risk 
Principle 3. MFA believed the definition of ``significant'' establishes 
a threshold for when notification is required and will promote 
meaningful reporting and oversight.\194\ MFA agreed that an internal 
disruption in a market participant's own trading system ``should not be 
considered significant unless it causes a market disruption materially 
affecting the DCM's trading platform and other market participants.'' 
\195\ MGEX believed that ``significant disruption'' provides DCMs with 
discretion to interpret events in light of the unique nature of markets 
and products across DCMs and platforms.\196\
---------------------------------------------------------------------------

    \194\ MFA NPRM Letter, at 3.
    \195\ Id.
    \196\ Id. at 4.
---------------------------------------------------------------------------

b. Discussion
    The Commission acknowledges the term ``significant'' could be 
susceptible to varying degrees of application based on a particular 
DCM's business model and particular market. However, the Commission 
believes in practice Risk Principle 3 provides a workable standard for 
notifications.\197\ This has proven to be the case with respect to 
existing Commission regulation Sec.  38.1051(e), which requires DCMs to 
notify Commission staff of, among other things, ``significant'' system 
malfunctions.\198\ The Commission notes it originally proposed that 
DCMs must report to the Commission all system malfunctions under 
Commission regulation Sec.  38.1051(e).\199\ In response, CME commented 
that such a notification requirement would be overly broad.\200\ The 
Commission considered CME's comment and concluded that timely advance 
notice of all planned changes to address system malfunctions is not 
necessary and is revising the rule to provide that DCMs only need to 
promptly advise the Commission of all significant system

[[Page 2060]]

malfunctions.\201\ Thus, similar to the ``significant'' standard under 
Risk Principle 3, DCMs are already subject to a ``significant'' 
threshold for notification with respect to system safeguards rules. The 
Commission does not consider it appropriate or necessary to require 
DCMs to notify Commission staff of all market disruptions pursuant to 
Risk Principle 3, especially given that such a rule would be more 
burdensome on DCMs than a mandate that they report only ``significant'' 
market disruptions to the Commission.
---------------------------------------------------------------------------

    \197\ See Section II.A.2(c), discussing ``significant'' and 
``material.'' In addition, in response to CME's comment, a market 
disruption for purposes of all three Risk Principles requires impact 
to operation of the DCM or market participants.
    \198\ See 17 CFR 38.1051(e).
    \199\ See Core Principles and Other Requirements for Designated 
Contract Markets, supra note 174, at 36657-58.
    \200\ Id. at 36658.
    \201\ Id. (emphasis added).
---------------------------------------------------------------------------

3. Notification Requirement
a. Summary of Comments
    CME stated that it is unsure of the practical utility to the 
Commission of receiving notifications under Risk Principle 3, since the 
Commission already collects such information through other means.\202\ 
Better Markets asserted the CFTC should require part 40 filings, as 
opposed to email notifications.\203\
---------------------------------------------------------------------------

    \202\ CME NPRM Letter, at 16.
    \203\ Better Markets NPRM Letter, at 10.
---------------------------------------------------------------------------

    CME asserted the distinction from Commission regulation Sec.  
38.1051(e) is clear; an incident could disrupt the trading platform 
without there having been a system malfunction on the platform.\204\ 
CME gave as an example an incident originating with a participant that 
causes a match engine to failover to backup.\205\ CME further stated 
both notification provisions could be triggered by an incident arising 
with a participant that causes both a market disruption and a system 
malfunction.\206\
---------------------------------------------------------------------------

    \204\ CME NPRM Letter, at 14-15.
    \205\ Id.
    \206\ Id. at 15.
---------------------------------------------------------------------------

    CEWG stated Risk Principle 3 appears to apply a per se standard for 
reporting, which leaves market participants open to potential 
enforcement risk.\207\ CEWG asserted the Commission should revise Risk 
Principle 3 to require notifications only where disruptions result from 
grossly negligent or reckless conduct with respect to a market 
participant's obligations to implement and maintain pre-trade risk 
controls, conduct due diligence or testing, as well as appropriate risk 
mitigation measures consistent with applicable DCM rules or accepted 
industry practices related to electronic trading activity.\208\
---------------------------------------------------------------------------

    \207\ CEWG NPRM Letter, at 5.
    \208\ Id. at 6.
---------------------------------------------------------------------------

    ICE recommended the Commission define what constitutes a 
``significant disruption'' of a DCM trading platform and how it differs 
from a ``market disruption,'' e.g., whether a transient disruption, 
which temporarily results in prices not reflecting market fundamentals, 
would be reportable.\209\ ICE supported the Commission incorporating 
into Risk Principle 3 the requirement that a significant disruption be 
caused by a ``malfunction of a market participant's trading system.'' 
\210\ ICE asserted the addition of this language would help to 
differentiate the reporting obligations under Commission regulation 
Sec.  38.1051(e).\211\
---------------------------------------------------------------------------

    \209\ ICE NPRM Letter, at 4.
    \210\ Id.
    \211\ Id.
---------------------------------------------------------------------------

    In response to the question in the NPRM asking if Risk Principle 3 
should require a DCM to notify other DCMs of a significant market 
disruption, CME and ICE indicated Risk Principle 3 should not include 
such a requirement. ICE stated current Appendix B(b)(5) provides 
guidance on coordinating risk controls for linked or related 
contracts.\212\ ICE asserted in circumstances of a significant market 
disruption, it would be prudent for such coordination to include 
notification to impacted markets, at least though a market alert.\213\ 
CME noted there are already real-time data feeds and other public 
sources that provide information on whether a DCM is experiencing a 
significant market disruption.\214\ CME further noted if this proposal 
is adopted, all DCMs will be required to report to the Commission, 
negating the need for notice between DCMs.\215\
---------------------------------------------------------------------------

    \212\ CME NPRM Letter, at 15; ICE NPRM Letter, at 9.
    \213\ ICE NPRM Letter, at 9.
    \214\ CME NPRM Letter, at 15.
    \215\ Id.
---------------------------------------------------------------------------

b. Discussion
    The Commission is finalizing the notification requirement in Risk 
Principle 3 as proposed, with one clarification. In the NPRM, Risk 
Principle 3 referred to ``significant disruptions to'' a DCM's 
platform(s). Consistent with Risk Principles 1 and 2, which use the 
term ``market disruption,'' the Commission is revising Risk Principle 3 
to state a DCM must promptly notify Commission staff of any 
``significant market disruptions on'' its platform(s). The purpose of 
this revision is to clarify that the notification requirement in Risk 
Principle 3 applies to a subset of the market disruptions under Risk 
Principles 1 and 2, i.e., to those market disruptions that are 
``significant.'' Consistent with the comments received, the Commission 
is not including a requirement that a DCM notify other DCMs in the 
event of a significant market disruption.\216\
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    \216\ In response to ICE's comment, see discussion at Section 
II.A.2(c) addressing ``significant'' and ``material.''
---------------------------------------------------------------------------

    In response to comments questioning the utility of 
notifications,\217\ the Commission reiterates its view that the 
notification requirement under Risk Principle 3 will assist the 
Commission's oversight and its ability to monitor and assess market 
disruptions across all DCMs. The Commission expects notification under 
Risk Principle 3 to take a similar form to the current notification 
process for electronic trading halts, cybersecurity incidents, or 
activation of a DCM's business continuity-disaster recovery plan under 
Commission regulation Sec.  38.1051(e). Specifically, the Commission 
would expect such notification to consist of an email containing 
sufficient information to convey the nature of the market disruption, 
and if known, its cause, and the remediation.
---------------------------------------------------------------------------

    \217\ See CME NPRM Letter, at 16.
---------------------------------------------------------------------------

    In response to CEWG's comment, the Commission declines to limit the 
notification requirement in Risk Principle 3 to instances of ``grossly 
negligent'' or ``reckless'' conduct. The Commission considers such 
qualifiers to be overly limiting and unduly burdensome on DCMs that 
would be required to determine whether conduct constitutes gross 
negligence or recklessness. In addition, the Commission reiterates that 
an email notification is the appropriate form of Risk Principle 3 
notification. Requiring such notifications to be in the form of part 40 
filings would be overly burdensome to exchanges given the Commission's 
estimate of 0-25 notifications per year. Moreover, in the context of 
significant market disruptions, prompt email notification is preferable 
to the inherently slower process of part 40 filings.

III. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') requires federal agencies, 
in promulgating regulations, to consider the impact of those 
regulations on small entities, and to provide a regulatory flexibility 
analysis with respect to such impact. The regulations adopted in this 
final rulemaking will affect DCMs. The Commission previously determined 
that DCMs are not ``small entities'' for purposes of the RFA because 
DCMs are required to demonstrate compliance with a number of Core 
Principles, including principles concerning the expenditure of 
sufficient financial

[[Page 2061]]

resources to establish and maintain an adequate self-regulatory 
program.\218\ The Commission received no comments on the impact of the 
rules described in the NPRM on small entities. Therefore, the Chairman, 
on behalf of the Commission, hereby certifies, pursuant to 5 U.S.C. 
605(b), that the regulations adopted by this final rulemaking will not 
have a significant economic impact on a substantial number of small 
entities.
---------------------------------------------------------------------------

    \218\ See Policy Statement and Establishment of Definitions of 
``Small Entities'' for Purposes of the Regulatory Flexibility Act, 
47 FR 18618, 18619 (Apr. 30, 1982).
---------------------------------------------------------------------------

B. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (``PRA'') imposes certain 
requirements on federal agencies, including the Commission, in 
connection with conducting or sponsoring any ``collection of 
information,'' as defined by the PRA.\219\ Under the PRA, 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 from the Office of Management and Budget (``OMB''). The PRA is 
intended, in part, to minimize the paperwork burden created for 
individuals, businesses, and other persons as a result of the 
collection of information by federal agencies, and to ensure the 
greatest possible benefit and utility of information created, 
collected, maintained, used, shared, and disseminated by or for the 
federal government. The PRA applies to all information, regardless of 
form or format, whenever the federal government is obtaining, causing 
to be obtained, or soliciting information, and includes required 
disclosure to third parties or the public, of facts or opinions, when 
the information collection calls for answers to identical questions 
posed to, or identical reporting or recordkeeping requirements imposed 
on, ten or more persons.
---------------------------------------------------------------------------

    \219\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------

    The final rulemaking modifies the following existing collections of 
information previously approved by OMB and for which the Commission has 
received control numbers: (i) OMB control number 3038-0052, Core 
Principles and Other Requirements for DCMs (``OMB Collection 3038-
0052'') and OMB control number 3038-0093, Provisions Common to 
Registered Entities (``OMB Collection 3038-0093''). The Commission does 
not believe the Risk Principles as adopted impose any other new 
collections of information that require approval of OMB under the PRA.
    The Commission requests that OMB approve and revise OMB control 
numbers 3038-0052 and 3038-0093 in accordance with 44 U.S.C. 3507(d) 
and 5 CFR 1320.11.
1. OMB Collection 3038-0093--Provisions Common to Registered Entities
    Final Commission regulation Sec.  38.251(e) (``Risk Principle 1'') 
provides that DCMs must adopt and implement rules governing market 
participants subject to their respective jurisdictions to prevent, 
detect, and mitigate market disruptions or system anomalies associated 
with electronic trading. As provided in subparagraph (b)(6) of Appendix 
B to part 38, such rules must be reasonably designed to prevent, 
detect, and mitigate market disruptions or system anomalies associated 
with electronic trading. Any such rules a DCM adopts pursuant to 
Commission regulation Sec.  38.251(e) must be submitted to the 
Commission in accordance with part 40 of the Commission's regulations. 
Specifically, a DCM is required to submit such rules to the Commission 
in accordance with either: (a) Commission regulation Sec.  40.5, which 
provides procedures for the voluntary submission of rules for 
Commission review and approval; or (b) Commission regulation Sec.  
40.6, which provides procedures for the self-certification of rules 
with the Commission. This information collection is required for DCMs 
as needed, on a case-by-case basis. The Commission acknowledges that 
various DCM practices in place today may be consistent with Commission 
regulation Sec.  38.251(e), such as rules requiring market participants 
to use exchange-provided risk controls that address potential price 
distortions and related market anomalies. Accordingly, it is possible 
that some DCMs would not be required to file new or amended rules to 
satisfy Risk Principle 1.
    Commission regulation Sec.  38.251(e) amends OMB Collection 3038-
0093 by increasing the existing annual burden by an additional 48 hours 
\220\ for DCMs that would be required to comply with part 40 of the 
Commission's regulations. As a result, the revised total annual burden 
under this amended collection would increase by 816 hours.\221\ 
Although the Commission believes that operational and maintenance costs 
for DCMs in Commission regulation Sec.  38.251(e) will incrementally 
increase, these costs are expected to be de minimis.
---------------------------------------------------------------------------

    \220\ The Commission estimates that final Commission regulation 
Sec.  38.251(e) would require potentially 17 DCMs to make 2 filings 
with the Commission a year requiring approximately 24 hours each to 
prepare. Accordingly, the total burden hours for each DCM would be 
approximately 48 hours per year.
    \221\ The Commission estimates that the total additional 
aggregate annual burden hours for DCMs under final Commission 
regulation Sec.  38.251(e) would be 816 hours based on each DCM 
incurring 48 burden hours (17 x 48 = 816).
---------------------------------------------------------------------------

    The Commission has previously estimated the combined annual burden 
hours for both Commission regulations Sec. Sec.  40.5 and 40.6 to be 
7,000 hours. Upon implementation of final Commission regulation Sec.  
38.251(e), the Commission estimates that 17 exchanges may each make two 
rule filings under Commission regulations Sec.  40.5 or Sec.  40.6 per 
year for a total of 34 submissions for all DCMs.\222\ The Commission 
further estimates that the exchanges may employ a combination of in-
house and outside legal and compliance personnel to update existing 
rulebooks and it will take 24 hours to complete and file each rule 
submission for a total of 48 burden hours for each exchange and 816 
burden hours for all exchanges.
---------------------------------------------------------------------------

    \222\ The Commission revised the number of potential respondent-
DCMs to 17 in order to reflect the number of DCMs currently 
registered with the Commission.
---------------------------------------------------------------------------

    OMB Collection 3038-0093 was created to cover the Commission's part 
40 regulatory requirements for registered entities (including DCMs, 
SEFs, DCOs, and swap data repositories) to file new or amended rules 
and product terms and conditions with the Commission.\223\ OMB Control 
Number 3038-0093 covers all information collections in part 40, 
including Commission regulation Sec.  40.2 (Listing products by 
certification), Commission regulation Sec.  40.3 (Voluntary submission 
of new products for Commission review and approval), Commission 
regulation Sec.  40.5 (Voluntary submission of rules for Commission 
review and approval), and Commission regulation Sec.  40.6 (Self-
certification of rules). Commission regulation Sec.  38.251(e) adopted 
in this final rulemaking modifies the existing annual burden in OMB 
Collection 3038-0093, increasing the annual burden estimates in 
aggregate below:
---------------------------------------------------------------------------

    \223\ See 17 CFR part 40.
---------------------------------------------------------------------------

    Estimated number of respondents: 17.
    Estimated frequency/timing of responses: As needed.
    Estimated number of annual responses per respondent: 2.
    Estimated number of annual responses for all respondents: 34.
    Estimated annual burden hours per response: 24.
    Estimated total annual burden hours per respondent: 48.

[[Page 2062]]

    Estimated total annual burden hours for all respondents: 816.
2. OMB Collection 3038-0052--Core Principles and Other Requirements for 
DCMs
    Final Commission regulation Sec.  38.251(g) (``Risk Principle 3'') 
requires a DCM to promptly notify Commission staff of any significant 
market disruption on its electronic trading platform(s) and provide 
timely information on the cause and remediation of such 
disruption.\224\ Risk Principle 3 further requires that such 
notification contain sufficient information to convey the nature of the 
disruption, and if known, its causes, and remediation. The Commission 
recognizes that the specific cause of the market disruption and the 
attendant remediation may not be known at the time of the disruption 
and may have to be addressed in a follow-up email or report. This 
information collection will be required for DCMs as needed, on a case-
by-case basis.
---------------------------------------------------------------------------

    \224\ See supra Section II.E. (discussion of the Risk Principle 
3).
---------------------------------------------------------------------------

    The Commission received one comment regarding its PRA burden 
analysis in the preamble to the NPRM.\225\ CME in its comment letter 
asserted the operation of Risk Principle 3 is unclear, and the 
Commission's estimate of approximately 50 notifications per year is 
``so far from what we would have anticipated being required under this 
proposal that it merits discussion.'' \226\ CME also indicated it 
questions ``whether the Commission has an interpretation of 
`significant disruption' that is not reflected in its proposal'' based 
on the apparent differences in notification estimates by the Commission 
and CME.\227\
---------------------------------------------------------------------------

    \225\ See CME NPRM Letter, at 8.
    \226\ See id.
    \227\ See id.
---------------------------------------------------------------------------

    CME further described that since 2011, ``the CME Group DCMs have 
brought approximately 59 disciplinary actions for electronic trading 
activity that may have disrupted markets or other participants.'' \228\ 
However, based on CME's review of those disciplinary actions, the 
exchange only identified three cases that it believes could be 
considered to have caused a significant disruption to the operations of 
the DCM. CME did not in its comments explain how its estimate was 
determined or what criteria or standard was employed as part of this 
analysis.
---------------------------------------------------------------------------

    \228\ See id. at 9.
---------------------------------------------------------------------------

    As described above, CME is using the number of actual disciplinary 
actions brought against market participants for disruptions that could 
be detrimental to the exchange as a ``proxy'' for the ``substantial 
disruption'' standard set forth in Risk Principle 3. Without indicating 
what analysis it may have used or considered, CME asserted that only 
three disciplinary actions could be considered to have caused a 
significant disruption to the operations of CME.\229\ Although the 
Commission appreciates CME's comments regarding the potential number of 
reportable events in connection with final Commission regulation Sec.  
38.251(g), the Commission does not believe the number of actual 
disciplinary cases brought by an exchange is an appropriate proxy for 
reportable market disruption events.\230\ The Commission notes that in 
many instances, basing the reportable event on whether it is subject to 
a formal disciplinary action would be under-inclusive. In addition, 
what is a ``significant'' market disruption on one exchange may differ 
from another, based on market participant differences, the exchange's 
respective market structure, and the technology of the underlying 
exchange marketplace.
---------------------------------------------------------------------------

    \229\ The NPRM cited events at CME DCMs, including a 
disciplinary action from 2011, as examples of DCMs policing 
electronic trading activities that may be detrimental to the DCM.
    \230\ The Commission submits that a reportable event does not 
necessarily mean that a disciplinary case is required, but instead 
suggests that there has been a problem with the operation of the 
electronic trading platform that requires additional review and 
oversight. Accordingly, the notification of a significant market 
disruption would typically start a specific regulatory oversight 
process by the Commission--not establish the particular requirements 
that may or may not merit the bringing of a disciplinary action, as 
CME suggests.
---------------------------------------------------------------------------

    The Commission submits that its original estimate of the reportable 
events under Commission regulation Sec.  38.251(g) may be too high for 
some exchanges. However, the Commission does not believe an estimate of 
three reportable events since 2011, based on the number of disciplinary 
actions in the past, is a reasonable proxy. Therefore, the Commission 
asserts that a range of reportable events between 0-25 may better 
reflect the potential number of reportable significant market 
disruption events for each DCM. The Commission is accordingly revising 
collection 3038-0052 to reflect the range of potential annual 
reportable events by each DCM to be between 0 and 25, reflecting the 
differences in DCM structure and operations and the market participants 
accessing those DCMs.
    In connection with the request for comment in the NPRM regarding 
whether the proposed information collections are necessary for the 
proper performance of Commission functions, CME stated it is ``unsure 
of the practical utility to the Commission of receiving notifications 
from a DCM pursuant to draft Principle III. From a market oversight 
perspective, the Commission already (at least with the CME Group DCMs) 
collects information on these types of events through regular 
engagement and review of a DCM's compliance with core principles.'' 
\231\ The Commission does not agree with CME's assertion that the 
notification may serve no practical utility based on the assumption 
that the Commission collects this type of information from CME through 
regular engagement and review of CME's compliance with core principles. 
As described above in Section II.E, the purpose of the notification 
requirement adopted in Commission regulation Sec.  38.251(g) is for 
Commission staff to receive prompt notice of a market disruption 
impacting a DCM's trading platform(s). This notification is intended to 
assist the Commission in its oversight of the derivatives markets with 
the ability to monitor and assess market disruptions across DCMs on a 
near real-time basis. CME's argument that the current ``regular'' 
engagement and review of CME's compliance with core principles is 
sufficient for this purpose is not persuasive and would not provide the 
Commission with sufficient capability to address and monitor 
significant market disruptions on a near real-time basis.
---------------------------------------------------------------------------

    \231\ CME NPRM Letter, at 16.
---------------------------------------------------------------------------

    Additionally, CME further commented on the Commission's request in 
the NPRM relating to whether there are ways to minimize the burden of 
the proposed collections of information on DCMs, including through the 
use of appropriate automated, electronic, mechanical, or other 
technological information collection techniques. In its comment to this 
request, CME indicated that it ``currently provides CFTC staff near 
real-time notifications of velocity logic events. We separately provide 
the CFTC a daily file containing information related to events that 
occur on the match engine (e.g., velocity logic events, circuit 
breakers, etc.). These types of automated reports or notifications are 
highly efficient and effective means to provide CFTC staff pertinent 
information.'' \232\ Although the Commission finds the daily file that 
CME voluntarily provides relating to velocity logic events \233\ to be 
helpful in

[[Page 2063]]

certain circumstances, the Commission believes that a uniform standard 
across DCMs relating to ``reportable events'' for significant market 
disruption events is necessary for its oversight and regulatory 
responsibilities under the CEA. For this reason, the Commission notes 
that the notification requirement is a foundational requirement of the 
current rulemaking that is expected to provide greater transparency and 
awareness to the Commission regarding market disruptions associated 
with electronic trading.
---------------------------------------------------------------------------

    \232\ Id.
    \233\ ``Velocity Logic'' is addressed on CME's website. 
Generally, it is ``designed to detect market movement of a 
predefined number of ticks either up or down within a predefined 
time.'' Velocity Logic introduces a momentary suspension in matching 
by transitioning the futures instrument(s) and related options into 
the Pre-Open or Reserved/Pause State. See CME Velocity logic, 
available at https://www.cmegroup.com/confluence/display/EPICSANDBOX/Velocity+Logic.
---------------------------------------------------------------------------

    The Commission has previously estimated the combined annual burden 
hours for part 38 to be 7,357.5 hours. Upon implementation of final 
Commission regulation Sec.  38.251(g), the Commission estimates that 
OMB Collection 3038-0052 will be revised by increasing the number of 
annual responses by a range between 0 and 25 notifications to 
Commission staff per year for a total range of between 0 and 425 \234\ 
notifications for all DCMs. The Commission has also revised the number 
of potential respondent-DCMs to 17 in order to reflect the number of 
DCMs currently registered with the Commission. The Commission further 
estimates that the DCMs may employ a combination of in-house and 
outside legal and compliance personnel to review and prepare 
significant market disruption event notifications to Commission staff 
and it will take approximately 5 burden hours to prepare each 
notification resulting in a range of burden hours between 0 and 125 
\235\ for each event notification across DCMs and a total range of 
between 0 and 2,125 burden hours annually for all notifications to 
Commission staff required for all DCMs.\236\ Although the Commission 
believes that operational and maintenance costs for DCMs in Commission 
regulation Sec.  38.251(g) will incrementally increase, these costs are 
expected to be de minimis.
---------------------------------------------------------------------------

    \234\ Based on the annual aggregate range of potential 
notifications under final Commission regulation Sec.  38.251(g) from 
0 to 425 for all DCMs, the Commission estimates that the average 
annual aggregate notifications for all DCMs is 212.50 with the 
annual average number of notifications per DCM to be 13.28.
    \235\ The Commission estimates that final Commission regulation 
Sec.  38.251(g) would require potentially each DCM to make between 0 
and 25 reports with the Commission a year requiring approximately 5 
hours each to prepare. Accordingly, the total burden hour range for 
each DCM would be between approximately 0 and 125 hours per year (0 
x 5 = 0 and 25 x 5 = 125).
    \236\ The Commission estimates that the total aggregate annual 
burden hours for DCMs under final Commission regulation Sec.  
38.251(g) would be a range between 0 and 2,125 hours based on each 
DCM incurring between 0 hours (0 x 17 = 0 burden hours) and 2,125 
hours (125 x 17 = 2,125 burden hours). Based on these estimates, the 
Commission has determined the annual average aggregate burden hours 
for all DCMs to be 1,062.50 burden hours and the annual average 
burden hour for each DCM to be 66.406 burden hours.
---------------------------------------------------------------------------

    OMB Collection 3038-0052 was created to cover regulatory 
requirements for DCMs under part 38 of the Commission's 
regulations.\237\ OMB Control Number 3038-0052 covers all information 
collections in part 38, including Subpart A (General Provisions), 
Subparts B through X (the DCM core principles), as well as the related 
appendices thereto, including Appendix A (Form DCM), Appendix B 
(Guidance on, and Acceptable Practices in, Compliance with Core 
Principles), and Appendix C (Demonstration of Compliance That a 
Contract Is Not Readily Susceptible to Manipulation). Commission 
regulation Sec.  38.251(g) adopted in this final rulemaking modifies 
the existing annual burden in OMB Collection 3038-0052 for complying 
with certain requirements in Subpart E (Prevention of Market 
Disruption) of part 38, as estimated in aggregate below:
---------------------------------------------------------------------------

    \237\ See 17 CFR part 38.
---------------------------------------------------------------------------

    Estimated number of respondents: 17.
    Estimated frequency/timing of responses: As needed.
    Estimated number of annual responses per respondent: 0-25.
    Estimated number of annual responses for all respondents: 0-425.
    Estimated annual burden hours per response: 5.
    Estimated total annual burden hours per respondent: 0-125.
    Estimated total annual burden hours for all respondents: 0-2,125.
    Estimated aggregate annual recordkeeping burden hours: 0-850.\238\
---------------------------------------------------------------------------

    \238\ The Commission estimates that additional total aggregate 
annual recordkeeping burden hours for DCMs under Commission 
regulations Sec. Sec.  38.950 and 38.951 as a result of the final 
regulations under this rulemaking would be between 0 and 850 hours 
based on each DCM incurring between 0 and 50 burden hours (17 x 0 = 
0 and 17 x 50 = 850). These estimates are based on the range of 
notifications expected to be between 0-25 per DCM annually. The 
Commission estimates that each DCM would require 2 burden hours in 
connection with its recordkeeping obligations under Commission 
regulations Sec. Sec.  38.950 and 38.951. Based on these estimates, 
the Commission also calculates the annual average aggregate 
recordkeeping burden hours for all DCMs to be 400 burden hours and 
the annual average recordkeeping burden hour for each DCM to be 25 
burden hours.
---------------------------------------------------------------------------

C. Cost-Benefit Considerations

1. Introduction
    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.\239\ Section 15(a) further 
specifies that the costs and benefits shall be evaluated in light of 
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.
---------------------------------------------------------------------------

    \239\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------

    The baseline for the consideration of costs and benefits in this 
final rulemaking is the monitoring and mitigation capabilities of DCMs, 
as governed by rules in current part 38 of the CFTC's regulations. 
Under these rules, DCMs are required to conduct real-time monitoring of 
all trading activity on their electronic trading platforms and identify 
disorderly trading activity and any market or system anomalies.\240\
---------------------------------------------------------------------------

    \240\ See existing Commission regulations Sec. Sec.  38.250, 
38.251, 38.255 and Appendix B to Part 38--Guidance on, and 
Acceptable Practices in, Compliance with Core Principles, Core 
Principle 4 (Subparagraph (b)).
---------------------------------------------------------------------------

    The Commission recognizes that the final electronic trading risk 
principles rules may impose additional costs on DCMs and market 
participants. The Commission has endeavored to assess the expected 
costs and benefits of the final rulemaking in quantitative terms, 
including PRA-related costs, where possible. In situations where the 
Commission received quantitative data related to the cost-benefit 
estimates proposed in the NPRM, the Commission included them in the 
cost-benefit considerations of this final rulemaking. The Commission 
also acknowledges and took into consideration qualitative comments with 
regard to the cost-benefit estimates in the NPRM. When the Commission 
is unable to quantify the costs and benefits, the Commission identifies 
and considers the costs and benefits of the final rules in qualitative 
terms.
a. Summary of the Rule
    As discussed in more detail in the preamble above, after 
considering various comments submitted by the commenters, the 
Commission decided

[[Page 2064]]

on a principles-based approach and to give discretion to each DCM in 
terms of how to define precisely market disruptions and system 
anomalies as they relate to their particular markets. As a result, each 
DCM will have the flexibility to tailor the implementation of the rules 
to best prevent, detect, and mitigate market disruptions or system 
anomalies in their respective markets. This flexibility should mitigate 
the cost and burden associated with DCMs' implementation of the Risk 
Principles. Therefore, the Commission adopts the following specific 
Risk Principles and associated Acceptable Practices applicable to DCM 
electronic trading as proposed.\241\
---------------------------------------------------------------------------

    \241\ As discussed above, the Commission revised Risk Principle 
3 to change the phrase ``disruptions to'' to ``market disruptions 
on.'' See supra Section II.E.
---------------------------------------------------------------------------

i. Commission Regulation Sec.  38.251(e)--Risk Principle 1
    Commission regulation Sec.  38.251(e)--Risk Principle 1--provides 
that a DCM must adopt and implement rules governing market participants 
subject to its jurisdiction to prevent, detect, and mitigate market 
disruptions or system anomalies associated with electronic trading.
ii. Commission Regulation Sec.  38.251(f)--Risk Principle 2
    Commission regulation Sec.  38.251(f)--Risk Principle 2--provides 
that a DCM must subject all electronic orders to exchange-based pre-
trade risk controls to prevent, detect, and mitigate market disruptions 
or system anomalies associated with electronic trading.
iii. Commission Regulation Sec.  38.251(g)--Risk Principle 3
    Commission regulation Sec.  38.251(g)--Risk Principle 3--provides 
that a DCM must promptly notify Commission staff of a significant 
market disruption on its electronic trading platform(s) and provide 
timely information on the causes and remediation.
iv. Acceptable Practices for Commission Regulations Sec. Sec.  
38.251(e) and (f)
    The Acceptable Practices provide that, to comply with Commission 
regulation Sec.  38.251(e), a DCM must adopt and implement rules that 
are reasonably designed to prevent, detect, and mitigate market 
disruptions or system anomalies associated with electronic trading. To 
comply with Commission regulation Sec.  38.251(f), the Acceptable 
Practices provide that the DCM must subject all electronic orders to 
exchange-based pre-trade risk controls that are reasonably designed to 
prevent, detect, and mitigate market disruptions or system anomalies.
2. Costs
a. Costs of Adjustments to Existing Practices
i. Summary of Comments
    A number of commenters commented on the existing practices of DCMs. 
CME, ICE, and Better Markets asserted that the Risk Principles are 
redundant of existing regulations.\242\ In particular, CME commented 
that the Risk Principles overlap with existing Commission regulations, 
specifically regulations promulgated under Core Principles 2 and 
4.\243\ CME and ICE suggested relying on or amending existing 
regulations, specifically Commission regulation Sec.  38.255.\244\ ICE 
stated that this would track the Commission's approach to regulating 
financial risk controls in Commission regulation Sec.  38.607, which 
has proven effective.\245\ ICE also stated that the DCMs could face 
confusion and potential costs while determining an appropriate 
notification standard and updating existing regulations could help with 
these costs.\246\
---------------------------------------------------------------------------

    \242\ CME NPRM Letter, at 12-13; ICE NPRM Letter, at 3; Better 
Markets NPRM Letter, at 4-9.
    \243\ CME NPRM Letter, at 7, 12-13.
    \244\ See id. at 12; ICE NPRM Letter, at 3.
    \245\ See id.
    \246\ ICE NPRM Letter, at 9.
---------------------------------------------------------------------------

    CME, CEWG, FIA/FIA PTG, ICE, and MFA commented that DCMs already 
implement controls and address risks to their platforms.\247\ MFA 
believes the Risk Principles will help encourage DCMs to continue to 
monitor risks as they evolve along with the markets, and to make 
reasonable modifications as appropriate.\248\
---------------------------------------------------------------------------

    \247\ CME NPRM Letter, at 4-7; CEWG NPRM Letter, at 4; FIA/FIA 
PTG NPRM Letter, at 3; ICE NPRM Letter, at 1; MFA NPRM Letter, at 2.
    \248\ MFA NPRM Letter, at 2.
---------------------------------------------------------------------------

    AFR and Rutkowski disagreed with the assertion that current DCM 
practices are effective in achieving what the Risk Principles aim to 
achieve.\249\
---------------------------------------------------------------------------

    \249\ AFR NPRM Letter, at 2; Rutkowski NPRM Letter, at 2.
---------------------------------------------------------------------------

    CME had two direct comments regarding the cost estimates presented 
in the NPRM. First, CME commented that the Commission should identify 
the specific types of software enhancements and additional data fields 
associated with the 2,520 staff hours included in the proposed 
rulemaking.\250\ Second, CME commented that the Commission's estimate 
of 50 significant market disruptions described in the PRA section of 
the NPRM is too high, and added that CME determined it had only three 
significant market disruptions in the last decade across four DCMs 
based on the number of formal disciplinary cases brought by the DCM for 
electronic trading activity that may have disrupted markets or other 
participants.\251\
---------------------------------------------------------------------------

    \250\ CME NPRM Letter, at 17.
    \251\ See id.
---------------------------------------------------------------------------

    The Commission did not receive comments on other costs associated 
with adjusting existing practices, such as costs associated with 
recordkeeping or with the need for an additional compliance officer.
ii. Discussion
    The Commission acknowledges the Risk Principles supplement existing 
regulations, namely Commission regulations Sec. Sec.  38.251 and 
38.255, with some potential overlap. The Commission believes the 
intended goals of the Risk Principles cannot be solely achieved by 
adding the words ``electronic trading'' to existing regulations. To the 
extent that the Risk Principles are already covered by existing 
regulations as many commenters suggested, then the Commission does not 
expect much, if any, additional costs to be associated with the Risk 
Principles. While the Commission acknowledges that DCMs could face 
potential costs while determining an appropriate notification standard, 
the Commission expects DCMs to be already collecting most, if not all, 
required information to make such a determination. As a result, the 
Commission expects such costs to be minimal. Some commenters also 
disagreed with the assumption that existing DCM practices are effective 
in achieving what the Risk Principles aim to achieve. To the extent 
this might be the case, the Commission believes DCMs will accordingly 
experience some additional costs related to the regulations, but the 
risks associated with market disruptions or system anomalies associated 
with electronic trading will decrease in financial markets. The 
Commission expects the Risk Principles will minimize the risks 
associated with market disruptions or system anomalies associated with 
electronic trading to a greater degree than the existing regulations, 
while at the same time minimizing the additional cost burdens of 
implementation due to the existence of current DCM practices that are 
expected to be consistent with the Risk Principles.
    As to CME's comment on requiring more detail with regard to 
potential software enhancements that might be required, the Commission 
provides a

[[Page 2065]]

more detailed breakdown of the 2,520 staff hours below.
    In addressing CME's comment on the estimated annual number of 
significant market disruptions, the Commission believes that CME's use 
of the number of formal disciplinary cases brought in connection with 
electronic trading that may have disrupted markets or other market 
participants as a ``proxy'' for significant market disruptions may 
underestimate the actual number of significant market disruptions. More 
specifically, while CME states that it has brought approximately 59 
disciplinary actions for potential market disruptions involving 
electronic trading activity since 2011, CME identified just three of 
these cases to have potentially caused a significant market 
disruption.\252\ However, CME does not provide any information or 
analysis on how it arrived at its estimate of three significant market 
disruptions. The Commission notes that each DCM may interpret 
``significant'' disruption in a different manner based on differences 
in market structures, market participants, and the technology utilized 
by the DCM. As stated above, the Commission believes that the number of 
relevant disciplinary cases brought by a DCM could be under-inclusive 
of the number of potential reportable market disruption events and may 
not be an appropriate proxy for the number of market disruptions 
reportable under Commission regulation Sec.  38.251(g). However, the 
Commission also acknowledges that, based on CME's comment and further 
consideration, the Commission's original estimate of 50 annual 
significant market disruptions per DCM might be too high. Accordingly, 
the Commission has updated its estimate of the annual number of 
reportable market disruption events to be 25 or less (between 0-25) for 
each DCM as described below.\253\
---------------------------------------------------------------------------

    \252\ See id. at 9.
    \253\ See id.
---------------------------------------------------------------------------

iii. Costs
    Consistent with the NPRM and comments received, current risk 
management practices of some DCMs may be sufficient to comply with the 
requirements of Commission regulations Sec. Sec.  38.251(e) through 
38.251(g), in which case expected costs are expected to be 
minimal.\254\ However, some DCMs may have to adjust some of their 
existing practices to comply with the regulations.
---------------------------------------------------------------------------

    \254\ See NPRM at 42772; CME NPRM Letter, at 17; ICE NPRM 
Letter, at 9.
---------------------------------------------------------------------------

    The Commission believes that DCMs may have to update their software 
to enable them to capture more efficiently additional information 
regarding participants subject to their jurisdiction to implement rules 
adopted pursuant to Commission regulation Sec.  38.251(e). The 
Commission acknowledges that the additional information required to be 
collected may be different for each DCM because the specific rules each 
DCM might need to adopt and implement pursuant to Commission regulation 
Sec.  38.251(e) will be different, and also because the existing 
information collection protocols already in place at each DCM are not 
likely to be the same. The Commission expects, among other things, the 
required information to be collected include the trader identification 
for order entry, the means by which traders connect to the exchange's 
platform, or any required statistics of order message traffic 
attributable to an electronic trader.
    The Commission expects the design, development, testing, and 
production release of a required software update to take 2,520 staff 
hours in total. The Commission expects 360 hours of that total to be 
used for establishing requirements and design, 1,280 hours to be used 
for development, 720 hours for testing, and 160 hours for production 
release. To calculate the cost estimate for changes to DCM software, 
the Commission estimates the appropriate wage rate based on salary 
information for the securities industry compiled by the Department of 
Labor's Bureau of Labor Statistics (``BLS'').\255\ Commission staff 
arrived at an hourly rate of $70.76 using figures from a weighted 
average of salaries and bonuses across different professions contained 
in the most recent BLS Occupational Employment and Wages Report (May 
2019), multiplied by 1.3 to account for overhead and other 
benefits.\256\ Commission staff chose this methodology to account for 
the variance in skillsets that may be used to plan, implement, and 
manage the required changes to DCM software. Using these estimates, the 
Commission would expect the software update to cost $178,313 per DCM. 
The Commission acknowledges that this is an estimate and the actual 
cost of such a software update would depend on the current status of 
the specific DCM's information acquisition capabilities and the amount 
of additional information the DCM would have to collect as a result of 
Commission regulation Sec.  38.251(e). To the extent that a DCM 
currently or partially captures the required information and data 
through its systems and technology, these costs would be lower.
---------------------------------------------------------------------------

    \255\ May 2019 National Industry-Specific Occupational 
Employment and Wage Estimates, NAICS 523000--Securities, Commodity 
Contracts, and Other Financial Investments and Related Activities, 
available at https://www.bls.gov/oes/current/naics4_523000.htm.
    \256\ The Commission's estimated appropriate wage rate is a 
weighted national average of mean hourly wages for the following 
occupations (and their relative weight): ``computer programmer--
industry: securities, commodity contracts, and other financial 
investment and related activities'' (25 percent); ``project 
management specialists and business operations specialists--
industry: securities, commodity contracts, and other financial 
investment and related activities'' (25 percent); ``Software and Web 
Developers, Programmers, and Testers--industry: securities, 
commodity contracts, and other financial investment and related 
activities'' (25 percent); and ``Software Developers and Software 
Quality Assurance Analysts and Testers--industry: securities, 
commodity contracts, and other financial investment and related 
activities'' (25 percent).
---------------------------------------------------------------------------

    The Commission acknowledges that any additional rules resulting 
from Commission regulation Sec.  38.251(e) are required to be submitted 
pursuant to part 40. The Commission expects a DCM to take an additional 
48 hours annually (two submissions on average per year, 24 hours per 
submission) to submit these amendments to the Commission. In order to 
estimate the appropriate wage rate, the Commission used the salary 
information for the securities industry compiled by the BLS.\257\ 
Commission staff arrived at an hourly rate of $89.89 using figures from 
a weighted average of salaries and bonuses across different professions 
contained in the most recent BLS Occupational Employment and Wages 
Report (May 2019) multiplied by 1.3 to account for overhead and other 
benefits.\258\ The Commission estimates this indirect cost to each DCM 
to be $4,314.72 annually (48 x $89.89). To the extent a DCM currently 
has in place rules required under Commission regulation Sec.  
38.251(e), these costs would be incrementally lower.
---------------------------------------------------------------------------

    \257\ May 2019 National Industry-Specific Occupational 
Employment and Wage Estimates, NAICS 523000--Securities, Commodity 
Contracts, and Other Financial Investments and Related Activities, 
available at https://www.bls.gov/oes/current/naics4_523000.htm.
    \258\ The Commission's estimated appropriate wage rate is a 
weighted national average of mean hourly wages for the following 
occupations (and their relative weight): ``compliance officer--
industry: securities, commodity contracts, and other financial 
investment and related activities'' (50 percent); and ``lawyer--
legal services'' (50 percent). Commission staff chose this 
methodology to account for the variance in skill sets that may be 
used to accomplish the collection of information.
---------------------------------------------------------------------------

    The Commission can envision a scenario where a DCM might also need 
to update its trading systems to subject all electronic orders to 
exchange-based pre-trade risk controls to prevent, detect, and mitigate 
market disruptions or system anomalies as required by Commission 
regulation Sec.  38.251(f).

[[Page 2066]]

Depending on the extent of the update required, the Commission 
anticipates the design, development, testing, and production release of 
the new trading system to take 8,480 staff hours in total, which the 
Commission expects to be covered by more than one employee. To 
calculate the cost estimate for updating a DCM's trading systems, the 
Commission estimates the appropriate wage rate based on salary 
information for the securities industry compiled by the BLS.\259\ 
Commission staff arrived at an hourly rate of $70.76 using figures from 
a weighted average of salaries and bonuses across different professions 
contained in the most recent BLS Occupational Employment and Wages 
Report (May 2019) multiplied by 1.3 to account for overhead and other 
benefits.\260\ Commission staff chose this methodology to account for 
the variance in skill sets that may be used to plan, implement, and 
manage the required update to a DCM's trading system. Using these 
estimates, the Commission would expect the trading system update to 
cost $600,036 to a DCM. The Commission emphasizes that this is an 
estimate and the actual cost could be higher or lower. The cost may 
also vary across DCMs, as each DCM has the flexibility to apply the 
specific controls that the DCM deems reasonably designed to prevent, 
detect, and mitigate market disruptions or system anomalies. In 
addition, the Commission further notes that to the extent a DCM 
currently or partially has in place pre-trade risk controls consistent 
with proposed Commission regulation Sec.  38.251(f), these costs would 
be incrementally lower.
---------------------------------------------------------------------------

    \259\ May 2019 National Industry-Specific Occupational 
Employment and Wage Estimates, NAICS 523000--Securities, Commodity 
Contracts, and Other Financial Investments and Related Activities, 
available at https://www.bls.gov/oes/current/naics4_523000.htm.
    \260\ The Commission's estimated appropriate wage rate is a 
weighted national average of mean hourly wages for the following 
occupations (and their relative weight): ``computer programmer--
industry: securities, commodity contracts, and other financial 
investment and related activities'' (25 percent); ``project 
management specialists and business operations specialists--
industry: securities, commodity contracts, and other financial 
investment and related activities'' (25 percent); ``Software and Web 
Developers, Programmers, and Testers--industry: securities, 
commodity contracts, and other financial investment and related 
activities'' (25 percent); and ``Software Developers and Software 
Quality Assurance Analysts and Testers--industry: securities, 
commodity contracts, and other financial investment and related 
activities'' (25 percent).
---------------------------------------------------------------------------

    Commission regulation Sec.  38.251(g) requires a DCM promptly to 
notify Commission staff of a significant market disruption on its 
electronic trading platform(s) and provide timely information on the 
causes and remediation. The Commission expects that there may be 
incremental costs to DCMs from Commission regulation Sec.  38.251(g) in 
the form of analysis regarding which disruptions could be significant 
enough to report, maintain, and archive the relevant data, as well as 
the costs associated with the act of reporting the disruptions. The 
Commission currently expects every DCM to have the necessary means to 
communicate with the Commission promptly, and therefore, does not 
expect any additional communication costs. The Commission expects DCMs 
to incur a minimal cost in determining what a significant market 
disruption could be and preparing information on its causes and 
remediation. The Commission does not expect this cost to be 
significant, because the Commission believes DCMs should already have 
the means necessary to identify the causes of market disruptions and 
have plans for remediation. To the extent that complying with 
Commission regulation Sec.  38.251(g) requires a DCM to incur 
additional recordkeeping and reporting burdens, the Commission 
estimates these additional recordkeeping requirements to be no more 
than 50 hours per DCM per year, and the additional reporting 
requirements to require no more than 125 hours per DCM per year (five 
hours per report and an estimated 25 reports additionally per DCM).
    The Commission acknowledges CME's comment indicating that based on 
its review and analysis, CME believes to have had only three 
significant market disruptions in the past decade across its four DCMs. 
The Commission appreciates the information provided and recognizes that 
the number of times a DCM might have to identify and report significant 
market disruptions pursuant to Commission regulation Sec.  38.251(g) 
may vary greatly across DCMs. The Commission acknowledges that the 
frequency of such reporting could theoretically be less than one in any 
given year for an exchange.
    In calculating the cost estimates for recordkeeping and reporting, 
the Commission estimates the appropriate wage rate based on salary 
information for the securities industry compiled by the BLS.\261\ For 
the reporting cost, Commission staff arrived at an hourly rate of 
$76.44 using figures from a weighted average of salaries and bonuses 
across different professions contained in the most recent BLS 
Occupational Employment and Wages Report (May 2019) multiplied by 1.3 
to account for overhead and other benefits.\262\ In calculating the 
cost estimate for recordkeeping, the Commission staff arrived at an 
hourly rate of $71.019 using figures from the most recent BLS 
Occupational Employment and Wages Report (May 2019) multiplied by 1.3 
to account for overhead and other benefits.\263\ The Commission 
estimates the cost for additional recordkeeping to a DCM to be no more 
than $3,550.95 (50 x $71.019) annually and the cost for additional 
reporting to a DCM to be no more than $9,555.00 (125 x $76.44) 
annually. As discussed above, certain DCMs might have no additional 
relevant market disruptions to report some years, which would translate 
to a zero cost estimate of additional reporting and recordkeeping for 
those years for those DCMs.
---------------------------------------------------------------------------

    \261\ May 2019 National Industry-Specific Occupational 
Employment and Wage Estimates, NAICS 523000--Securities, Commodity 
Contracts, and Other Financial Investments and Related Activities, 
available at https://www.bls.gov/oes/current/naics4_523000.htm.
    \262\ The Commission's estimated appropriate wage rate is a 
weighted national average of mean hourly wages for the following 
occupations (and their relative weight): ``computer programmer--
industry: securities, commodity contracts, and other financial 
investment and related activities'' (25 percent); ``compliance 
officer--industry: securities, commodity contracts, and other 
financial investment and related activities'' (50 percent); and 
``lawyer--legal services'' (25 percent). Commission staff chose this 
methodology to account for the variance in skill sets that may be 
used to accomplish the required reporting.
    \263\ The Commission's estimated appropriate wage rate is the 
mean hourly wages for ``database administrators and architects.'' 
Commission staff chose this methodology to account for the variance 
in skill sets that may be used to accomplish the collection of 
information.
---------------------------------------------------------------------------

    To the extent that DCMs would need to update their rules and 
internal processes to comply with Commission regulations Sec. Sec.  
38.251(e) through 38.251(g) and the associated Acceptable Practices, 
the Commission expects some DCMs also may need to update or supplement 
their compliance programs, which would involve additional costs. 
However, the Commission does not expect these costs to be significant. 
The Commission believes some DCMs may need to hire an additional full-
time compliance staff member to address the additional compliance needs 
associated with the regulation. Assuming that the average annual salary 
of each compliance officer is $94,705, the Commission estimates the 
incremental annual compliance costs to a DCM that needs to hire an 
additional compliance officer to be $119,340.\264\ However, the

[[Page 2067]]

Commission notes that the exact compliance needs may vary across DCMs, 
and some DCMs may already have adequate compliance programs that can 
handle any rule updates and internal processes required to comply with 
Commission regulations Sec. Sec.  38.251(e) through 38.251(g), and 
therefore the actual compliance costs may be higher or lower than the 
Commission's estimates.
---------------------------------------------------------------------------

    \264\ In calculating this cost estimate for reporting, the 
Commission estimates the appropriate annual wage for a compliance 
officer based on salary information for the securities industry 
compiled by the BLS. Commission staff used the annual wage of 
$91,800, which reflects the average annual salary for a compliance 
officer contained in the most recent BLS Occupational Employment and 
Wages Report (May 2019), and multiplied it by 1.3 to account for 
overhead and other benefits.
---------------------------------------------------------------------------

b. Cost of Periodically Updating Risk Management Practices
i. Summary of Comments
    The Commission did not receive any comments associated with the 
need periodically to update risk management practices.
ii. Costs
    The Commission expects the trading methods and technologies of 
market participants to change over time, requiring DCMs to adjust their 
rules pursuant to Commission regulation Sec.  38.251(e) and adjust 
their exchange-based pre-trade risk controls pursuant to Commission 
regulation Sec.  38.251(f) accordingly. As trading methodologies and 
connectivity measures evolve, it is expected that new causes of 
potential market disruptions and system anomalies could surface. To 
that end, the Commission believes full compliance would require a DCM 
to implement periodic evaluation of its entire electronic trading 
marketplace and updates of the exchange-based pre-trade risk controls 
to prevent, detect, and mitigate market disruptions or system 
anomalies, as well as updates of the appropriate definitions of market 
disruptions and system anomalies. Therefore, rules imposed as a result 
of Commission regulations Sec. Sec.  38.251(e) through 38.251(g) would 
need to be flexible and fluid, and potentially updated as needed, which 
may involve additional costs. Moreover, such rule changes would result 
in a cost increase associated with the rise in the number of rule 
filings that DCMs would have to prepare and submit to the Commission.
c. Costs to Market Participants
i. Summary of Comments
    The Commission did not receive any comments associated with costs 
to market participants.
ii. Costs
    The Commission can envision a situation where the rules adopted by 
DCMs as a result of Commission regulation Sec.  38.251(e) change 
frequently, and market participants would need to adjust to new rules 
frequently. While these adjustments might carry some costs for market 
participants, such as potential added delays to their trading activity 
due to additional pre-trade controls, the Commission expects these 
changes to be communicated to the market participants by DCMs with 
enough implementation time so as to minimize the burden on market 
participants and their trading strategies. Moreover, to the extent a 
DCM's policies and procedures require market participants to report 
changes to their connection processes, trading strategies, or any other 
adjustments the DCM deems required, there could be some cost to the 
market participants. Finally, market participants may feel the need to 
upgrade their risk management practices as a response to DCMs' updated 
risk management practices driven by the Risk Principles. The Commission 
recognizes that part of the costs to market participants might also 
come from needing to update their systems and potentially adjust the 
software they use for risk management, trading, and reporting. These 
costs may be somewhat mitigated to the extent market participants 
currently comply with DCM rules and regulations regarding pre-trade 
risk controls and market disruption protocols.
d. Regulatory Arbitrage
i. Summary of Comments
    The Commission received a number of comments regarding the 
possibility of competition and regulatory arbitrage. CME commented that 
the greatest risk for regulatory arbitrage is between DCMs and SEFs or 
FBOTs.\265\ Also, IATP commented that the Commission should clarify why 
it considers regulatory arbitrage between DCMs unlikely to happen.\266\ 
IATP also noted that the competition among DCMs for over-the-counter 
trading and for trading in new products, such as digital coins, could 
result in lax risk control design or lax updating of controls under 
competitive pressures.\267\ IATP also mentioned the difference in 
competitive pressures for cleared and uncleared trades.\268\ Finally, 
CFE expressed concern that if the Commission compares all DCMs to a 
baseline of controls, which are prevalent across DCMs, there may be an 
expectation for smaller DCMs to adhere to the risk control standards of 
larger DCMs.\269\ This could become a barrier to entry for smaller 
DCMs.\270\
---------------------------------------------------------------------------

    \265\ CME NPRM Letter, at 13.
    \266\ IATP NPRM Letter, at 11.
    \267\ See id. at 9.
    \268\ See id. at 10.
    \269\ CFE NPRM Letter, at 4.
    \270\ See id.
---------------------------------------------------------------------------

ii. Discussion
    As outlined the in the NPRM and in the discussion of antitrust 
considerations below,\271\ the Commission acknowledges the theoretical 
possibility of regulatory arbitrage occurring as a result of the Risk 
Principles but does not expect it to materialize.\272\ As discussed in 
the NPRM and Section I.D.2 of this final rulemaking, the Commission 
will continue to monitor whether Risk Principles of this nature may be 
appropriate for other markets such as SEFs or FBOTs.\273\
---------------------------------------------------------------------------

    \271\ See Section III.D of this final rulemaking.
    \272\ See NPRM at 42763 n.6.
    \273\ See id. and Section I.D.2 of this final rulemaking.
---------------------------------------------------------------------------

    The Commission acknowledges there are differences in products and 
market participants across DCMs, and DCMs might implement different 
rules and risk controls given differences in their respective markets. 
It is important to note that ongoing Commission oversight will identify 
whether the differences in DCM rules and risk controls are due to 
differing contracts being offered for trading, competitive pressure, or 
regulatory arbitrage, and whether there are resulting issues that must 
be addressed.
iii. Costs
    The principles-based regulations offer DCMs the flexibility to 
address market disruptions and system anomalies as they relate to their 
particular markets and market participants' trading activities. 
Similarly, DCMs are also given the flexibility to decide how to apply 
the requirements associated with regulations in their respective 
markets. This flexibility could result in differences across DCMs, 
potentially contributing to regulatory arbitrage. For example, DCMs' 
practices could differ in the information collected from market 
participants; the rules applied to prevent, detect, and mitigate market 
disruptions or system anomalies; and the intensity of pre-trade 
controls. The parameters for establishing market disruptions or system 
anomalies could be defined differently by the various DCMs, which might 
lead to differing levels of exchange-based pre-trade risk controls.

[[Page 2068]]

    The Commission acknowledges that to the extent there is potential 
for market participants to choose between DCMs, those DCMs with lower 
information collection requirements and potentially less stringent pre-
trade risk controls could appear more attractive to certain market 
participants. All or some of these factors could create the potential 
for market participants to move their trading from DCMs with 
potentially more stringent risk controls to DCMs with less stringent 
controls, which could cost certain DCMs business. While the Commission 
recognizes that this kind of regulatory arbitrage could cause liquidity 
to move from one DCM to another, potentially impairing (or benefiting) 
the price discovery of the contract with reduced (or increased) 
liquidity, the Commission does not expect this to occur with any 
frequency. First, the Commission notes that liquidity for a given 
contract in futures markets tends to concentrate in one DCM. This means 
that futures markets are less susceptible to this type of regulatory 
arbitrage. Second, while an individual DCM decides the exchange-based 
pre-trade risk controls for its markets, those risk controls must be 
effective. The Commission does not believe that differences in the 
application of the Risk Principles across DCMs would be substantial 
enough to induce market participants to switch to trading at a 
different DCM, even if there were two DCMs trading similar enough 
contracts. For example, DCMs currently apply various pre-trade controls 
to comply with Commission regulation Sec.  38.255 requirements for risk 
controls for trading, but the Commission does not have any evidence 
that DCMs compete on pre-trade controls. The Commission expects DCMs to 
approach the setting of their rules and controls to comply with the 
Risk Principles in a similar manner.
3. Benefits
a. Minimize Disruptive Behaviors Associated With Electronic Trading and 
Ensure Sound Financial Markets
i. Summary of Comments
    While not a direct comment, AFR stated that the NPRM does not offer 
a systematic assessment of the current costs of the types of electronic 
disruptions addressed by the Risk Principles.\274\
---------------------------------------------------------------------------

    \274\ AFR NPRM Letter, at 2.
---------------------------------------------------------------------------

ii. Discussion
    The Commission acknowledges that no such costs were present in the 
NPRM and it considers such analysis not quantitatively feasible. 
However, the Commission considers market disruption costs to be 
substantial and the Commission expects that these regulations will 
minimize the frequency of market disruptions and their associated 
costs. The Commission believes this to be an important benefit to DCMs 
and market participants through ensuring a sound financial marketplace.
iii. Benefits
    The Commission believes that the Risk Principles are crucial for 
the integrity and resilience of financial markets, as they would ensure 
that DCMs have the ability to prevent, detect, and mitigate most, if 
not all, disruptive behaviors associated with electronic trading. 
Commission regulation Sec.  38.251(e) requires DCMs to adopt and 
implement rules governing market participants subject to their 
jurisdiction such that market disruptions or system anomalies 
associated with electronic trading can be minimized. This would allow 
markets to operate smoothly and to continue functioning as efficient 
platforms for risk transfer, as well as allowing for healthy price 
discovery.
    The Commission expects Commission regulation Sec.  38.251(f) to 
subject all electronic orders to a DCM's exchange-based pre-trade risk 
controls. The Commission expects this to benefit the markets as well as 
the market participants sending orders to the DCMs. First, by 
preventing orders that could cause market disruptions or system 
anomalies through exchange-based pre-trade risk controls, Commission 
regulation Sec.  38.251(f) allows the markets to operate orderly and 
efficiently. This benefits traders in the markets, market participants 
utilizing price discovery in the markets, as well as traders in related 
markets. Second, Commission regulation Sec.  38.251(f) provides market 
participants sending orders to a DCM with an additional layer of 
protection through the implementation of exchange-based pre-trade risk 
controls. If an unintentional set of messages were to breach the risk 
controls of FCMs and other market participants, Commission regulation 
Sec.  38.251(f) could prevent those messages from reaching a DCM and 
potentially resulting in unwanted transactions. This benefits the 
market participants, as well as their FCMs, by saving them from the 
obligation of unwanted and unintended transactions.
    Commission regulation Sec.  38.251(g) ensures that significant 
market disruptions will be communicated to the Commission staff 
promptly, as well as their causes and eventual remediation. The 
Commission believes Commission regulation Sec.  38.251(g) will benefit 
the markets and market participants by strengthening their financial 
soundness and promoting the resiliency of derivatives markets by 
allowing the Commission to stay informed of any potential market 
disruptions effectively and promptly. If needed, the Commission's 
timely action in the face of market disruptions could help markets 
recover faster and stronger.
    Finally, Commission regulations Sec. Sec.  38.251(e) through 
38.251(g) are likely to benefit the public by promoting sound risk 
management practices across market participants and preserving the 
financial integrity of markets so that markets can continue to fulfill 
their price discovery role.
b. Value of Flexibility Across DCMs
i. Summary of Comments
    Most commenters, including CME, CFE, CEWG, FIA/FIA PTG, ICE, ISDA/
SIFMA, MFA, and Optiver supported a principles-based approach, which 
allows flexibility in the implementation of the regulations across 
DCMs.\275\ Many commenters noted they prefer the principles-based 
approach to the prescriptive nature of prior proposals and that such an 
approach provides flexibility and takes into account future 
technological advances.\276\
---------------------------------------------------------------------------

    \275\ CME NPRM Letter, at 1, 12, 16; CFE NPRM Letter, at 1; CEWG 
NPRM Letter, at 2; FIA/FIA PTG NPRM Letter, at 2-4; ICE NPRM Letter, 
at 2, 9; ISDA/SIFMA NPRM Letter, at 1-2; MFA NPRM Letter, at 1-2; 
Optiver NPRM Letter, at 1.
    \276\ CME NPRM Letter, at 1, 12; CFE NPRM Letter, at 1; CEWG 
NPRM Letter, at 2; FIA/FIA PTG NPRM Letter, at 2-4; ISDA/SIFMA NPRM 
Letter, at 1; MFA NPRM Letter, at 1-2.
---------------------------------------------------------------------------

    In contrast, AFR, Better Markets, IATP, and Rutkowski disagreed 
with the principles-based approach, and asserted that the incentives of 
DCMs and public regulators are not fully aligned.\277\ AFR, Better 
Markets, and Rutkowski commented that the Risk Principles provide too 
much deference to DCMs and the Commission failed to address conflicts 
of interest concerns that may impede the independence of DCMs and 
SROs.\278\
---------------------------------------------------------------------------

    \277\ AFR NPRM Letter, at 1-2; Better Markets NPRM Letter, at 2, 
6, 9, 10-12; IATP NPRM Letter, at 1, 4, 8; Rutkowski NPRM Letter, at 
1.
    \278\ AFR NPRM Letter, at 1-2; Better Markets NPRM Letter, at 2, 
6, 9, 10-12; Rutkowski NPRM Letter, at 1.
---------------------------------------------------------------------------

ii. Discussion
    The Commission believes a principles-based approach of Risk 
Principles allows flexibility to DCMs. Through this flexible approach, 
DCMs can shape the adoption and

[[Page 2069]]

implementation of their rules to effectively prevent, detect, and 
mitigate risks associated with electronic trading in their markets. 
Additionally, this flexibility will also allow DCMs to adjust their 
rules accordingly to respond to future changes in their markets. 
Without such flexibility, DCMs would need to comply with prescriptive 
rules that may not be as effective in preventing, detecting, and 
mitigating market disruptions and system anomalies and that may involve 
higher costs to market participants as well as potential higher 
compliance costs.
    The Commission notes Core Principle 16 in part 38 requires DCMs to 
establish and enforce rules addressing potential conflicts of 
interest.\279\ Furthermore, as also mentioned in the preamble, any 
conflict of interest concerns, where DCMs might prioritize 
profitability over reasonable controls, will be addressed through 
regular Commission oversight of DCMs.\280\
---------------------------------------------------------------------------

    \279\ See 17 CFR 38.850-51.
    \280\ Conflicts of interest are also discussed in the antitrust 
considerations section of this final rule. See Section III.D below.
---------------------------------------------------------------------------

iii. Benefits
    The Commission believes that DCMs have markets with different 
trading structures and participants with varying trading patterns. It 
is possible that market participant behavior that one DCM considers a 
major risk of market disruptions could be of less concern to another 
DCM. The Commission's principles-based approach to Commission 
regulations Sec. Sec.  38.251(e) and 38.251(f) allows DCMs the 
flexibility to impose the most efficient and effective rules and pre-
trade risk controls for their respective markets. The Commission 
believes such flexibility, including through the Acceptable Practices, 
benefits DCMs by allowing them to adopt and implement effective and 
efficient measures reasonably designed to achieve the objectives of the 
Risk Principles. Without such flexibility, DCMs would need to comply 
with prescriptive rules that may not be as effective in preventing, 
detecting and mitigating market disruptions and system anomalies and 
that may potentially involve higher compliance costs.
c. Direct Benefits to Market Participants
i. Summary of Comments
    The Commission did not receive any comments associated with 
benefits to market participants.
ii. Benefits
    Commission regulation Sec.  38.251(e) requires DCMs to adopt and 
implement rules that are reasonably designed to prevent, detect, and 
mitigate market disruptions or system anomalies associated with 
electronic trading. In addition, Commission regulation Sec.  38.251(f) 
requires DCMs to subject all electronic orders to exchange-based pre-
trade risk controls that are reasonably designed to prevent, detect, 
and mitigate market disruptions or system anomalies associated with 
electronic trading. This approach will assist in preventing, detecting, 
and mitigating market disruptions and system anomalies and thus protect 
the effectiveness of financial markets to continue providing the 
services of risk transfer and price transparency to all market 
participants. Moreover, the Commission believes that requiring DCMs to 
implement these DCM-based rules and risk controls could incentivize 
market participants themselves to strengthen their own risk management 
practices.
d. Facilitate Commission Oversight
i. Summary of Comments
    The Commission did not receive any comments associated with 
benefits to Commission oversight.
ii. Benefits
    The Commission believes the implementation of the Risk Principles 
will facilitate the Commission's capability to monitor the markets 
effectively. Moreover, Commission regulation Sec.  38.251(g) will 
result in DCMs informing the Commission promptly of any significant 
market disruptions and remediation plans. The Commission believes this 
will allow it to take steps to contain a disruption and prevent the 
disruption from impacting other markets or market participants. Thus, 
the Risk Principles will facilitate the Commission's oversight and its 
ability to monitor and assess market disruptions across all DCMs.
    Finally, the Commission expects that the Risk Principles will 
better incentivize DCMs to recognize market disruptions and system 
anomalies and examine remediation plans in a timely fashion.
4. 15(a) Factors
a. Protection of Market Participants and the Public
    Commission regulations Sec. Sec.  38.251(e) through 38.251(g) are 
intended to protect market participants and the public from potential 
market disruptions due to electronic trading. The rules are expected to 
benefit market participants and the public by requiring DCMs to adopt 
and implement rules addressing the market disruptions and system 
anomalies associated with electronic trading, subject all electronic 
orders to specifically-designed exchange-based pre-trade risk controls, 
and promptly report the causes and remediation of significant market 
disruptions. All of these measures create a safer marketplace for 
market participants to continue trading without major interruptions and 
allow the public to benefit from the information generated through a 
well-functioning marketplace.
b. Efficiency, Competitiveness, and Financial Integrity of DCMs
    The Commission believes that Commission regulations Sec. Sec.  
38.251(e) through 38.251(g) will enhance the financial integrity of 
DCMs by requiring DCMs to implement rules and risk controls to address 
market disruptions and system anomalies associated with electronic 
trading. However, the Commission also acknowledges that market 
participants' efficiency of trading might be hindered due to potential 
latencies that may occur in the delivery and routing of orders to the 
matching engine as a result of additional pre-trade risk controls. In 
addition, the Commission can envision a scenario where the flexibility 
provided to DCMs in designing and implementing rules to prevent, 
detect, and mitigate market disruptions and system anomalies, and the 
differences between the updated pre-trade risk controls and existing 
DCM risk control rules, could potentially lead to regulatory arbitrage 
between DCMs. To the extent that there are significant differences in 
those practices set by competing DCMs, market participants might choose 
to trade in the DCM with the least stringent rules if competing DCMs 
offer the same or relatively similar products. The Commission 
acknowledges that competitiveness across DCMs might be hurt as a 
result. However, as discussed above, the Commission does not believe 
that differences in the application of the Risk Principles across DCMs 
would be substantial enough to induce market participants to switch to 
trading at a different DCM, even if there were two DCMs trading similar 
enough contracts.
c. Price Discovery
    The Commission expects price discovery to improve as a result of 
Commission regulations Sec. Sec.  38.251(e) through 38.251(g), 
especially due to improved market functioning through the 
implementation of targeted pre-trade risk controls and rules. The 
Commission

[[Page 2070]]

expects the new regulations to assist with the prevention and 
mitigation of market disruptions due to electronic trading, leading 
markets to provide more stable and consistent price discovery services. 
However, as noted above, adoption and implementation of rules pursuant 
to Commission regulation Sec.  38.251(e) and pre-trade risk controls 
implemented by DCMs pursuant to Commission regulation Sec.  38.251(f) 
could be different across DCMs. As a result, the improvements in price 
discovery across DCMs' markets are not likely to be uniform.
d. Sound Risk Management Practices
    The Commission expects Commission regulations Sec. Sec.  38.251(e) 
through 38.251(g) to help promote and ensure better risk management 
practices of both DCMs and their market participants. The Commission 
expects DCMs and market participants to focus on, and potentially 
update, their risk management practices. Additionally, the Commission 
believes that the requirement for DCMs to notify Commission staff 
regarding the cause of a significant market disruption to their 
respective electronic trading platforms would also provide reputational 
incentives for both DCMs and their market participants to focus on, and 
improve, risk management practices.
e. Other Public Interest Considerations
    The Commission does not expect Commission regulations Sec. Sec.  
38.251(e) through 38.251(g) to have any significant costs or benefits 
associated with any other public interests.

D. Antitrust Considerations

    Section 15(b) of the CEA requires the Commission to ``take into 
consideration the public interest to be protected by the antitrust laws 
and endeavor to take the least anticompetitive means of achieving the 
purposes of this Act, in issuing any order or adopting any Commission 
rule or regulation (including any exemption under section 4(c) or 
4c(b)), or in requiring or approving any bylaw, rule, or regulation of 
a contract market or registered futures association established 
pursuant to section 17 of this Act.'' \281\ The Commission believes 
that the public interest to be protected by the antitrust laws is 
generally to protect competition. In the NPRM, the Commission 
preliminarily determined that the Risk Principles proposal is not 
anticompetitive and has no anticompetitive effects. The Commission then 
requested comment on (i) whether the proposal is anticompetitive and, 
if so, what the anticompetitive effects are; (ii) whether any other 
specific public interest, other than the protection of competition, to 
be protected by the antitrust laws is implicated by the proposal; and 
(iii) whether there are less anticompetitive means of achieving the 
relevant purposes of the CEA that would otherwise be served by adopting 
the proposal.
---------------------------------------------------------------------------

    \281\ 7 U.S.C. 19(b).
---------------------------------------------------------------------------

    The Commission does not anticipate that the Risk Principles 
rulemaking will result in anticompetitive behavior, but instead, 
believes that the principles-based approach to DCM electronic trading 
does not establish a barrier to entry or a competitive restraint. As 
noted above, the Commission encouraged comments from the public on any 
aspect of the proposal that may have the potential to be inconsistent 
with the antitrust laws or anticompetitive in nature. The Commission 
received three comments asserting that the proposed rules may 
potentially impact competition through the existence of ``regulatory 
arbitrage'' and one comment regarding the competitive impact of 
potential risk control assessments to a baseline of risk controls that 
are prevalent and effective across DCMs.
    IATP commented that ``DCMs compete for market participant trades, 
so competitive pressures could reduce DCM verification of market 
participant compliance with DCM requirements for market participant 
risk control.'' \282\ IATP focused on the potential competitive 
pressures that could potentially occur with respect to non-cleared 
transactions, stating that these transactions should ``post higher 
initial margin and maintain higher variation margin than cleared 
trades.'' \283\ IATP disagreed with the Commission's belief in the NPRM 
that a lack of uniformity between DCMs' rules and risk controls does 
not render a particular DCM's rules or risk controls per se 
unreasonable.\284\
---------------------------------------------------------------------------

    \282\ IATP NPRM Letter, at 9. IATP noted, among other things, 
that ``trading in new products, such as digital coins, could result 
in lax risk control design or lax updating of controls under 
competitive pressures.''
    \283\ Id.
    \284\ See NPRM at 42765. IATP commented that ``If one DCM 
pursues competitive advantage by developing risk controls and rules 
that market participants perceive to be less costly to implement 
and/or to give them a competitive advantage in trading, the 
Commission believes the DCM seeking such a competitive advantage to 
comply with the Principles, provided that the DCM rules and risk 
controls are not inherently unreasonable.'' IATP NPRM Letter, at 11. 
IATP believes that, in connection with its comments regarding the 
potential competitive concerns of the Electronic Risk Principles 
Rule, the Commission should document and explain how ``allowing each 
DCM to develop and enforce its own rules and risk controls presents 
no possibility of regulatory arbitrage among DCMs.'' See id.
---------------------------------------------------------------------------

    AFR commented that the Commission's proposal rejected the more 
active regulatory approach to electronic trading taken in the now-
withdrawn Regulation AT and, instead, delegates the core elements of 
electronic trading oversight to for-profit exchanges under a 
principles-based approach.\285\ AFR criticized the Commission's 
principles-based approach regarding the regulation of electronic 
trading on DCMs, stating that it disagrees with the core assumption 
underlying the principles-based approach that the incentives of DCMs 
``are fully aligned with those of public regulators in limiting 
speculative and trading practices that could threaten market 
integrity.'' \286\ The basis of AFR's comment is that DCMs are 
``economically dependent on the order flow provided by large traders 
and are in direct competition with other venues to capture that order 
flow.'' \287\ As a result, AFR argues that this dependence on order 
flow creates a conflict of interest whereby DCMs may accommodate the 
interests of large brokers and traders even though there may be risks 
to market integrity. AFR further believes that conflict of interest 
requires significant public regulatory oversight of DCM market 
practices, stating that ``[p]ure self-regulation is not enough.'' \288\
---------------------------------------------------------------------------

    \285\ See AFR NPRM Letter, at 1. See also Rutkowski NPRM Letter, 
at 1. Mr. Rutkowski's comment largely adopts the arguments set forth 
in the AFR comment.
    \286\ See AFR NPRM Letter, at 1.
    \287\ Id.
    \288\ Id.
---------------------------------------------------------------------------

    Better Markets similarly commented that permitting DCMs to 
determine the types of risk controls to deter and/or prevent market 
disruptions is inherently conflicted due to competitive pressures.\289\ 
In commenting regarding the potential competitive issues in connection 
with the Risk Principles, Better Markets cited the Commission's 
statement in the NPRM that noted the potential for regulatory arbitrage 
due to

[[Page 2071]]

the principles-based nature of the requirements.\290\ With respect to 
this competitive issue, Better Markets noted that those DCMs with lower 
information collection requirements and less stringent pre-trade risk 
controls could appear more attractive to certain market participants 
and could facilitate certain market participants to move trading among 
DCMs, thereby costing certain DCMs business.\291\
---------------------------------------------------------------------------

    \289\ See Better Markets NPRM Letter, at 11. In particular, 
Better Markets noted that ``[e]xchanges face conflicts of interest 
between maximizing profit and shareholder value and diminishing 
trading volumes through meaningful limits on certain electronic 
trading practices. With competitive pressures and revenues at stake, 
one exchange is unlikely to be a first mover and absorb the costs 
and rancor of market participants in implementing risk controls and 
related measures that its competitors may, for market share reasons, 
postpone indefinitely. That is why a federal baseline set of 
controls and regulations--revisited as often as is necessary to 
ensure responsible innovation--must be applied to all DCMs.'' Id.
    \290\ Better Markets specifically stated that ``The CFTC 
acknowledges this regulatory arbitrage concern but minimizes such 
concerns due to a belief that ``differences in the application of 
the proposed regulation across DCMs would [not] be substantial 
enough to induce market participants to switch to trading at a 
different DCM, even if there were two DCMs trading similar enough 
contracts.'' Better Markets NPRM Letter, at 11. See also NPRM at 
42774.
    \291\ See id.
---------------------------------------------------------------------------

    As noted in the NPRM and the preamble of these final rules, the 
Commission is aware that DCMs may have conflicting and competing 
interests in connection with the oversight of electronic trading.\292\ 
However, the Commission does not believe that differences in the 
application of the Risk Principles across DCMs would be substantial 
enough to induce market participants to switch to trading at a 
different DCM.
---------------------------------------------------------------------------

    \292\ See NPRM at 42775 and Section III.C.4 of this final 
rulemaking.
---------------------------------------------------------------------------

    The commenters essentially argued that the more prescriptive 
regulatory approach to electronic trading taken in the withdrawn 
Regulation AT proposal is preferable to the Risk Principles approach 
that ``delegates'' elements of electronic trading oversight to for-
profit exchanges. As support for their argument, commenters focused on 
the inherent conflict of self-regulation whereby a for-profit entity is 
also tasked with performing a certain degree of regulatory oversight 
over its marketplace. The Commission notes the Congressional intent to 
serve the public interests of the CEA ``through a system of effective 
self-regulation of trading facilities . . . under the oversight of the 
Commission.'' \293\ DCMs have significant incentives and obligations to 
maintain well-functioning markets as self-regulatory organizations that 
are subject to specific regulatory requirements. Specifically, the DCM 
Core Principles require DCMs to, among other things, refrain from 
adopting any rule or taking any action that results in any unreasonable 
restraint of trade and imposing material anticompetitive burdens.\294\ 
In addition, DCM Core Principles also require DCMs to surveil trading 
on their markets to prevent market manipulation, price distortion, and 
disruptions of the delivery or cash-settlement process.\295\ Several 
academic studies, including one concerning futures exchanges and 
another concerning demutualized stock exchanges, also support the 
conclusion that exchanges are able both to satisfy shareholder 
interests and meet their self-regulatory organization 
responsibilities.\296\
---------------------------------------------------------------------------

    \293\ Section 3(b) of the CEA. 7 U.S.C. 5(b).
    \294\ CEA section 5(d)(19), 7 U.S.C. 7(d)(19) and 17 CFR 
38.1000.
    \295\ 17 CFR 38.200 and 17 CFR 38.250.
    \296\ See David Reiffen and Michel A. Robe, Demutualization and 
Customer Protection at Self-Regulatory Financial Exchanges, Journal 
of Futures Markets, supra note 56, at 126-164, Feb. 2011; Kobana 
Abukari and Isaac Otchere, Has Stock Exchange Demutualization 
Improved Market Quality? International Evidence, supra note 56.
---------------------------------------------------------------------------

    As noted above in Section III.C.3, CFE expressed concern that 
smaller DCMs could over time be expected to adopt and implement the 
same pre-trade risk controls in place at the larger DCMs which could, 
therefore, impact competition and diversity. CFE is specifically 
concerned about the statement in the NPRM regarding assessment of risk 
controls comparing ``all DCMs to a baseline of controls on electronic 
trading and electronic order entry that are prevalent and effective 
across DCMs.'' \297\ CFE further asserted that ``what is in place at 
the larger DCMs and DCM groups should not simply become the de facto 
standard for what all DCMs must employ.'' \298\
---------------------------------------------------------------------------

    \297\ NPRM at 42768.
    \298\ CFE NPRM Letter, at 4.
---------------------------------------------------------------------------

    The Commission reiterates that the Risk Principles are intended to 
provide DCMs with the flexibility to adopt those pre-trade risk 
controls reasonably designed to prevent, detect, and mitigate market 
disruptions or system anomalies associated with electronic trading. As 
a result, the Commission does not intend or expect larger DCM pre-trade 
risk controls to be the standard for all DCMs, although there may be 
risk controls that are common to all DCMs. As noted in the CFE 
comments, it is not the Commission's intent to effectively impose on 
all DCMs those risk controls that are in place at larger DCMs.
    The Commission also believes that these competitive concerns raised 
by commenters are mitigated because: (i) DCMs are required to submit 
any proposed rules under Commission regulation Sec.  38.251(e) to the 
Commission for review under part 40 of the Commission's regulations; 
and (ii) DCMs are required pursuant to the DCM Antitrust Core Principle 
to refrain from adopting any rule or taking any action that results in 
any unreasonable restraint of trade and imposing material 
anticompetitive burdens.\299\ Accordingly, the Commission has 
determined that the Risk Principles serve the regulatory purpose of the 
CEA to deter and prevent price manipulation or any other disruptions to 
market integrity.\300\ In addition, the Commission notes that the Risk 
Principles implement additional purposes and policies set forth in 
section 5(d)(4) of the CEA.\301\ The Commission has considered the 
final rules and related comments, to determine whether they are 
anticompetitive, and continues to believe that the Risk Principles will 
not result in any unreasonable restraint of trade, or impose any 
material anticompetitive burden on trading in the markets.
---------------------------------------------------------------------------

    \299\ See Commission regulation Sec.  38.1000 (Core Principle 
19, Antitrust Considerations).
    \300\ Section 3(b) of the CEA, 7 U.S.C. 5(b).
    \301\ 7 U.S.C. 5(d)(4). This DCM Core Principle focusing on the 
prevention of market disruption requires that the board of trade 
shall have the capacity and responsibility to prevent manipulation, 
price distortion, and disruptions of the delivery or cash-settlement 
process through market surveillance, compliance, and enforcement 
practices and procedures, including--(A) methods for conducting 
real-time monitoring of trading; and (B) comprehensive and accurate 
trade reconstructions.
---------------------------------------------------------------------------

List of Subjects in 17 CFR Part 38

    Commodity futures, Designated contract markets, Reporting and 
recordkeeping requirements.

PART 38--DESIGNATED CONTRACT MARKETS

0
1. 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
2. In Sec.  38.251, republish the introductory text and add paragraphs 
(e) through (g) to read as follows:


Sec.  38.251   General requirements.

    A designated contract market must:
* * * * *
    (e) Adopt and implement rules governing market participants subject 
to its jurisdiction to prevent, detect, and mitigate market disruptions 
or system anomalies associated with electronic trading;
    (f) Subject all electronic orders to exchange-based pre-trade risk 
controls to prevent, detect, and mitigate market disruptions or system 
anomalies associated with electronic trading; and
    (g) Promptly notify Commission staff of any significant market 
disruptions on

[[Page 2072]]

its electronic trading platform(s) and provide timely information on 
the causes and remediation.

0
3. In appendix B to part 38, under ``Core Principle 4 of section 5(d) 
of the Act: PREVENTION OF MARKET DISRUPTION,'' add paragraph (b)(6) 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) * * *
    (6) Market disruptions and system anomalies associated with 
electronic trading. To comply with Sec.  38.251(e), the contract 
market must adopt and implement rules that are reasonably designed 
to prevent, detect, and mitigate market disruptions or system 
anomalies associated with electronic trading. To comply with Sec.  
38.251(f), the contract market must subject all electronic orders to 
exchange-based pre-trade risk controls that are reasonably designed 
to prevent, detect, and mitigate market disruptions or system 
anomalies.
* * * * *

    Issued in Washington, DC, on December 10, 2020, by the 
Commission.
Robert Sidman
Deputy Secretary of the Commission.

    NOTE:  The following appendices will not appear in the Code of 
Federal Regulations.

Appendices to--Electronic Trading Risk Principles Voting Summary 
Chairman's and Commissioners' Statements

Appendix 1--Voting Summary

    On this matter, Chairman Tarbert and Commissioners Quintenz, 
Stump, and Berkovitz voted in the affirmative. Commissioner Behnam 
voted in the negative.

Appendix 2--Supporting Statement of Chairman Health P. Tarbert

    The mission of the CFTC is to promote the integrity, resilience, 
and vibrancy of U.S. derivatives markets through sound regulation. 
We cannot achieve this mission if we rest on our laurels--
particularly in relation to the ever-evolving technology that makes 
U.S. derivatives markets the envy of the world. What is sound 
regulation today may not be sound regulation tomorrow.
    I am reminded of the paradoxical observation of Giuseppe di 
Lampedusa in his prize-winning novel, The Leopard: ``If we want 
things to stay as they are, things will have to change.'' \1\
---------------------------------------------------------------------------

    \1\ Giuseppe Tomasi di Lampedusa, The Leopard (Everyman's 
Library Ed. 1991) at p. 22.
---------------------------------------------------------------------------

    While the novel focuses on the role of the aristocracy amid the 
social turbulence of 19th century Sicily, its central thesis--that 
achieving stability in changing times itself requires change--can be 
applied equally to the regulation of rapidly changing financial 
markets.
    Today we are voting to finalize a rule to address the risk of 
disruptions to the electronic markets operated by futures exchanges. 
The risks involved are significant; disruptions to electronic 
trading systems can prevent market participants from executing 
trades and managing their risk. But how we address those risks--and 
the implications for the relationship between the Commission and the 
exchanges we regulate--is equally significant.

The Evolution of Electronic Trading

    A floor trader from the 1980s and even the 1990s would scarcely 
recognize the typical futures exchange of the 21st Century. The 
screaming and shouting of buy and sell orders reminiscent of the 
film Trading Places has been replaced with silence, or perhaps the 
monotonous humming of large data centers. Over the past two decades, 
our markets have moved from open outcry trading pits to electronic 
platforms. Today, 96 percent of trading occurs through electronic 
systems, bringing with it the price discovery and hedging functions 
foundational to our markets.
    By and large, this shift to electronic trading has benefited 
market participants. Spreads have narrowed,\2\ liquidity has 
improved,\3\ and transaction costs have dropped.\4\ And the most 
unexpected benefit is that electronic markets have been able to stay 
open and function smoothly during the COVID-19 lockdowns. By 
comparison, traditional open outcry trading floors such as options 
pits and the floor of the New York Stock Exchange were forced to 
close for an extended time. Without the innovation of electronic 
trading, our financial markets would almost certainly have seized up 
and suffered even greater distress.
---------------------------------------------------------------------------

    \2\ Frank, Julieta and Philip Garcia, ``Bid-Ask Spreads, Volume, 
and Volatility: Evidence from Livestock Markets,'' American Journal 
of Agricultural Economics, Vol. 93, Issue 1, p. 209 (January 2011).
    \3\ Terrence Henderschott, Charles M. Jones, and Albert K. 
Menkveld, ``Does Algorithmic Trading Improve Liquidity?'' Journal of 
Finance, Volume 66, Issue 1, p. 1 (February 2011).
    \4\ Esen Onur and Eleni Gousgounis, ``The End of an Era: Who 
Pays the Price when the Livestock Futures Pits Close?'', Working 
Paper, Commodity Futures Trading Commission Office of the Chief 
Economist.
---------------------------------------------------------------------------

    But like any technological innovation, electronic trading also 
creates new and unique risks. Today's final rule is informed by 
examples of disruptions in electronic markets caused by both human 
error as well as malfunctions in automated systems--disruptions that 
would not have occurred in open outcry pits. For instance, ``fat 
finger'' orders mistakenly entered by people, or fully automated 
systems inadvertently flooding matching engines with messages, are 
two sources of market disruptions unique to electronic markets.

Past CFTC Attempts To Address Electronic Trading Risks

    The CFTC has considered the risks associated with electronic 
trading during much of the last decade. Seven years ago, a different 
set of Commissioners issued a concept release asking for public 
comment on what changes should be made to our regulations in light 
of the novel issues raised by electronic trading. Out of that 
concept release, the Commission later proposed Regulation AT. For 
all its faults, Regulation AT drove a very healthy discussion about 
the risks that should be addressed and the best way to do so.
    Regulation AT was based on the assumption that automated 
trading, a subset of electronic trading, was inherently riskier than 
other forms of trading. As a result, Regulation AT sought to require 
certain automated trading firms to register with the Commission 
notwithstanding that they did not hold customer funds or 
intermediate customer orders. Most problematically, Regulation AT 
also would have required those firms to produce their source code to 
the agency upon request and without subpoena.
    Regulation AT also took a prescriptive approach to the types of 
risk controls that exchanges, clearing members, and trading firms 
would be required to place on order messages. But this list was set 
in 2015. In effect, Regulation AT would have frozen in time a set of 
controls that all levels of market operators and market participants 
would have been required to place on trading. Since that list was 
proposed, financial markets have faced their highest volatility on 
record and futures market volumes have increased by over 50 
percent.\5\ Improvements in technology and computer power have been 
profound. Of course, I commend my predecessors for focusing on the 
risks that electronic trading can bring. But times change, and 
Regulation AT would not have changed with them. Consequently, our 
Commission formally withdrew Regulation AT this past summer.\6\
---------------------------------------------------------------------------

    \5\ Futures Industry Association, ``A record year for 
derivatives'' (March 5, 2019), available at https://www.fia.org/articles/record-year-derivatives.
    \6\ Regulation Automated Trading; Withdrawal, 85 FR 42755 (July 
15, 2020).
---------------------------------------------------------------------------

An Evolving CFTC for Evolving Markets

    In withdrawing Regulation AT, the CFTC has consciously moved 
away from registration requirements and source code production. But 
in voting to finalize the Risk Principles, the CFTC is committing to 
address risk posed by electronic trading while strengthening our 
longstanding principles-based approach to overseeing exchanges.
    The markets we regulate are changing. To maintain our regulatory 
functions, the CFTC must either halt that change or change our 
agency. Swimming against the tide of developments like electronic 
markets is not an option, nor should it be. The markets exist to 
serve the needs of market participants, not the regulator. If a 
technological change improves the functioning of the markets, we 
should embrace it. In fact, one of this agency's founding principles 
is that CFTC should ``foster responsible innovation.'' \7\ Applying 
this reasoning alongside the

[[Page 2073]]

overarching theme of The Leopard leads us to a single conclusion: As 
our markets evolve, the only real course of action is to ensure that 
the CFTC's regulatory framework evolves with it.
---------------------------------------------------------------------------

    \7\ Commodity Exchange Act, Section 3(b), 7 U.S.C. 3(b).
---------------------------------------------------------------------------

The Need for Principles-Based Regulation

    So then how do we as a regulator change with the times while 
still fulfilling our statutory role overseeing U.S. derivatives 
markets? I recently published an article setting out a framework for 
addressing situations such as this.\8\ I believe that principles-
based regulations can bring simplicity and flexibility while also 
promoting innovation when applied in the right situations. Such an 
approach can also create a better supervisory model for interaction 
between the regulator and its regulated firms--but only so long as 
that oversight is not toothless.
---------------------------------------------------------------------------

    \8\ Tarbert, Heath P., ``Rules for Principles and Principles for 
Rules: Tools for Crafting Sound Financial Regulation,'' Harv. Bus. 
L. Rev., Vol. 10 (June 15, 2020), available at https://www.hblr.org/volume-10-2019-2020/.
---------------------------------------------------------------------------

    There are a variety of circumstances in which I believe 
principles-based regulation would be most effective. Regulations on 
how exchanges manage the risks of electronic trading are a prime 
example. This is about risk management practices at sophisticated 
institutions subject to an established and ongoing supervisory 
relationship. But it is also an area where regulated entities have a 
better understanding than the regulator about the risks they face 
and greater knowledge about how to address those risks. As a result, 
exchanges need flexibility in how they manage risks as they 
constantly evolve.
    At the same time, principles-based regulation is not ``light 
touch'' regulation. Without the ability to monitor compliance and 
enforce the rules, principles-based regulation would be ineffective. 
Principles-based regulation of exchanges can work because the CFTC 
and the exchanges have constant interaction that engenders a degree 
of mutual trust. The CFTC--as overseen by our five-member 
Commission--has tools to monitor how the exchanges implement 
principles-based regulations through reviews of license applications 
and rule changes, as well as through periodic examinations and rule 
enforcement reviews.
    Monitoring compliance alone is not enough. The regulator also 
needs the ability to enforce against non-compliance. Principles-
based regimes ultimately give discretion to the regulated entity to 
find the best way to achieve a goal, so long as that method is 
objectively reasonable. To that end, the CFTC has a suite of tools 
to require changes through formal action, escalating from denial of 
rule change requests, to enforcement actions, to license 
revocations. The CFTC consistently needs to address the 
effectiveness and appropriateness of these levers to make sure the 
exchanges are meeting their regulatory objectives. And given that 
exchanges will be judged on a reasonableness standard, it must be 
the Commission itself--based on a recommendation from CFTC staff 
\9\--who ultimately decides whether an exchange has been objectively 
unreasonable in complying with our principles.
---------------------------------------------------------------------------

    \9\ CFTC Staff conduct regular examinations and reviews of our 
registered entities, including exchanges and clearinghouses. As part 
of those examinations and reviews, Staff may identify issues of 
material non-compliance with regulations as well as recommendations 
to bring an entity into compliance. Ultimately, however, the 
Commission itself must accept an examination report or rule 
enforcement review report before it can become final, including any 
findings of non-compliance. Likewise, Staff are asked to make 
recommendations regarding license applications, reviews of new 
products and rules, and a variety of other Commission actions, 
although ultimate authority lies with the Commission.
---------------------------------------------------------------------------

Final Rule on Risk Principles for Electronic Trading

    This brings us to today's finalization of the Risk Principles 
that were proposed in June of this year. The final rule, which we 
are adopting by-and-large as proposed, centers on a straightforward 
issue that I think we can all agree is important for our regulations 
to address. Namely, the Risk Principles require exchanges to take 
steps to prevent, detect, and mitigate market disruptions and system 
anomalies associated with electronic trading.
    The disruptions we are concerned about can come from any number 
of causes, including: (i) Excessive messages, (ii) fat finger 
orders, or (iii) the sudden shut off of order flow from a market 
maker. The key attribute of the disruptions addressed by the Risk 
Principles is that they arise because of electronic trading.
    To be sure, our current regulations do require exchanges to 
address market disruptions. But the focus of those rules has 
generally been on disruptions caused by sudden price swings and 
volatility. In effect, the Risk Principles expand the term ``market 
disruptions'' to cover instances where market participants' ability 
to access the market or manage their risks is negatively impacted by 
something other than price swings. This could include slowdowns or 
closures of gateways into the exchange's matching engine caused by 
excessive messages submitted by a market participant. It could also 
include instances when a market maker's systems shut down and the 
market maker stops offering quotes.
    As noted in the preamble to the final rule, exchanges have 
worked diligently to address emerging risks associated with 
electronic trading. Different exchanges have put in place rules such 
as messaging limits and penalties when messages exceed filled trades 
by too large a ratio. Exchanges also may conduct due diligence on 
participants using certain market access methods and may require 
systems testing ahead of trading through those methods.
    It is not surprising that exchanges have developed rules and 
risk controls that comport with our Risk Principles. The Commission, 
exchanges, and market participants have a common interest in 
ensuring that electronic markets function properly. Moreover, this 
is an area where exchanges are likely to possess the best 
understanding of the risks presented and have control over how their 
own systems operate. As a result, exchanges have the incentive and 
the ability to address the risks arising from electronic trading. 
Principles-based regulations in this area will ensure that exchanges 
have reasonable discretion to adjust their rules and risk controls 
as the situation dictates, not as the regulator dictates.
    The three Risk Principles encapsulate this approach. First, 
exchanges must have rules to prevent, detect, and mitigate market 
disruptions and system anomalies associated with electronic trading. 
In other words, an exchange should take a macro view when assessing 
potential market disruptions, which can include fashioning rules 
applicable to all traders governing items such as onboarding, 
systems testing, and messaging policies. Second, exchanges must have 
risk controls on all electronic orders to address those same 
concerns. Third, exchanges must notify the CFTC of any significant 
market disruptions and give information on mitigation efforts.
    Importantly, implementation of the Risk Principles will be 
subject to a reasonableness standard. The Acceptable Practices 
accompanying the Risk Principles clarify that an exchange would be 
in compliance if its rules and its risk controls are reasonably 
designed to meet the objectives of preventing, detecting, and 
mitigating market disruptions and system anomalies. The Commission 
will have the ability to monitor how the exchanges are complying 
with the Principles, and will have avenues to sanction non-
compliance.

Framework for Future Regulation

    I hope that the Risk Principles we are adopting today will serve 
as a framework for future CFTC regulations. Electronic trading 
presents a prime example of where principles-based regulation--as 
opposed to prescriptive rule sets--is more likely to result in sound 
regulation over time. Through thoughtful analysis of the regulatory 
objective we aim to achieve, the nature of the market and technology 
we are addressing, the sophistication of the parties involved, and 
the nature of the CFTC's relationship with the entity being 
regulated, we can identify what areas are best for a prescriptive 
regulation or a principles-based regulation.\10\ In the present 
context, a principles-based approach--setting forth concrete 
objectives while affording reasonable discretion to the exchanges--
provides flexibility as electronic trading practices evolve, while 
maintaining sound regulation. In sum, it recognizes that things will 
have to change if we want things to stay as they are.\11\
---------------------------------------------------------------------------

    \10\ Tarbert, at 11-17.
    \11\ Di Lampedusa, at 22.
---------------------------------------------------------------------------

Appendix 3--Supporting Statement of Commissioner Brian D. Quintenz

    I support today's final rule requiring designated contract 
markets (DCMs) to adopt rules that are reasonably designed to 
prevent, detect, and mitigate market disruptions or system anomalies 
associated with electronic trading. It also requires DCMs to subject 
all electronic orders to pre-trade risk controls that are reasonably 
designed to prevent, detect and mitigate market disruptions having a 
``material'' effect on its participants

[[Page 2074]]

and to provide prompt notice to the Commission in the event the 
platform experiences any material market disruptions that meet a 
higher threshold of being ``significant''.
    I believe all DCMs have already adopted regulations and pre-
trade risk controls designed to address the risks posed by 
electronic trading. As I have noted previously, many--if not all--of 
the risks posed by electronic trading are already being effectively 
addressed through the market's incentive structure, including 
exchanges' and firms' own self-interest: DCMs through their interest 
in operating markets with integrity, and firms through their 
interest in not exposing their or their customers' funds to huge 
losses in a matter of minutes through algorithmic operational error. 
Both exchanges and firms have been leaders in implementing best 
practices around electronic trading risk controls. Therefore, 
today's final rule merely codifies principles underlying existing 
market practice of DCMs to have reasonable controls in place to 
mitigate electronic trading risks.
    Significantly, the final rule puts forth a principles-based 
approach, allowing DCM trading and risk management controls to 
continue to evolve with the trading technology itself. As we have 
witnessed over the past decade, risk controls are constantly being 
updated and improved to respond to market developments. In my view, 
these continuous enhancements are made possible because exchanges 
and firms have the flexibility and incentives to evolve and hold 
themselves to an ever-higher set of standards, rather than being 
held to a set of prescriptive regulatory requirements which can 
quickly become obsolete. By adopting a principles-based approach, 
the final rule provides exchanges and market participants with the 
flexibility they need to innovate and evolve with technological 
developments. DCMs are well-positioned to determine and implement 
the rules and risk controls most effective for their markets. Under 
the rule, DCMs are required to adopt and implement rules and risk 
controls that are objectively reasonable. The Commission would 
monitor DCMs for compliance and take action if it determines that 
the DCM's rules and risk controls are objectively unreasonable. 
Importantly, the Appendix to the final rule points out that a DCM 
will be held to a standard of reasonableness and not to how other 
DCMs implement the rule. Any horizontal review across DCMs of rules 
or risk controls would only inform objectively unreasonable 
determinations, not create a baseline set of specific risk controls 
that become de-facto regulatory requirements.
    The Technology Advisory Committee (TAC), which I am honored to 
sponsor, has explored the risks posed by electronic trading at 
length. In each of those discussions, it has become obvious that 
both DCMs and market participants take the risks of electronic 
trading seriously and have expended enormous effort and resources to 
address those risks.
    For example, at one TAC meeting, we heard how the CME Group has 
implemented trading and volatility controls that complement, and in 
some cases exceed, eight recommendations published by the 
International Organization of Securities Commissions (IOSCO) 
regarding practices to manage volatility and preserve orderly 
trading.\1\ At another TAC meeting, the Futures Industry Association 
(FIA) presented on current best practices for electronic trading 
risk controls.\2\ FIA reported that through its surveys of 
exchanges, clearing firms, and trading firms, it has found 
widespread adoption of market integrity controls since 2010, 
including price banding and exchange market halts. FIA also 
previewed some of the next generation controls and best practices 
currently being developed by exchanges and firms to further refine 
and improve electronic trading systems. The Intercontinental 
Exchange (ICE) also presented on the risk controls ICE currently 
implements across all of its exchanges, noting how its 
implementation of controls was fully consistent with FIA's best 
practices.\3\ These presentations emphasize how critical it is for 
the Commission to adopt a principles-based approach that enables 
best practices to evolve over time.
---------------------------------------------------------------------------

    \1\ Meeting of the TAC on March 27, 2019, Automated and Modern 
Trading Markets Subcommittee Presentation, transcript and webcast 
available at, https://www.cftc.gov/PressRoom/Events/opaeventtac032719.
    \2\ Meeting of the TAC on Oct. 3, 2019, Automated and Modern 
Trading Markets Subcommittee Presentation, https://www.cftc.gov/PressRoom/Events/opaeventtac100319.
    \3\ Id.
---------------------------------------------------------------------------

    I believe the final rule issued today adopts such an approach 
and provides DCMs with the flexibility to continually improve their 
risk controls in response to technological and market advancements. 
Because this rule allows for flexible implementation and effectively 
places that burden on the market participants with the most aligned 
and motivated interests, I believe this rule will stand the test of 
time and serve as a paradigm of the CFTC's mission statement: Sound 
regulation that promotes the integrity, resilience, and vibrancy of 
the U.S. derivatives market.

Appendix 4--Dissenting Statement of Commissioner Rostin Behnam

    I would like to start by thanking DMO staff for their tireless 
work on this rule. While the Risk Principles are short, that is not 
reflective of the work that has been done by staff to produce them. 
This is the same DMO staff that worked on the much broader 
``Regulation AT'',\1\ and I appreciate all of their work over many 
years.
---------------------------------------------------------------------------

    \1\ Regulation Automated Trading, Proposed Rule, 80 FR 78824 
(Dec. 17, 2015); Supplemental Regulation AT NPRM, 81 FR 85334 (Nov. 
25, 2016).
---------------------------------------------------------------------------

    Last June, I stated in my dissent to the Electronic Trading Risk 
Principles proposal \2\ that I strongly support thoughtful and 
meaningful policy that addresses the ever-increasing use of 
automated systems in our markets.\3\ The proposal regarding 
Electronic Trading Risk Principles did not achieve this. Far from 
utilizing over a decade of experiences that should have profoundly 
shaped how we address operational risks that are consistently 
unpredictable and have wide-ranging impacts, today's final rule 
changes only a single word from the proposal aimed at codifying the 
status quo. Accordingly, I respectfully dissent.
---------------------------------------------------------------------------

    \2\ Rostin Behnam, Commissioner, CFTC, Dissenting Statement of 
Commissioner Rostin Behnam Regarding Electronic Trading Risk 
Principles (June 25, 2020), https://www.cftc.gov/PressRoom/SpeechesTestimony/behnamstatement062520b.
    \3\ The Commission's Office of the Chief Economist has found 
that over 96 percent of all on-exchange futures trading occurred on 
DCMs' electronic trading platforms. Haynes, Richard & Roberts, John 
S., ``Automated Trading in Futures Markets--Update #2'' at 8 (Mar. 
26, 2019), available at https://www.cftc.gov/sites/default/files/2019-04/ATS_2yr_Update_Final_2018_ada.pdf.
---------------------------------------------------------------------------

    A little over ten years ago, on May 6, 2010, the Flash Crash 
shook our markets.\4\ The prices of many U.S.-based equity products, 
including stock index futures, experienced an extraordinarily rapid 
decline and recovery. In 2012, Knight Capital, a securities trading 
firm, suffered losses of more than $460 million due to a trading 
software coding error.\5\ Other volatility events related to 
automated trading have followed with increasing regularity.\6\ In 
September and October 2019, the Eurodollar futures market 
experienced a significant increase in messaging.\7\ According to 
reports, the volume of data generated by activity in Eurodollar 
futures increased tenfold.\8\ A lesson of these events is that under 
stressed market conditions, automated execution of a large sell 
order can trigger extreme price movements, and the interplay between 
automated execution programs and algorithmic trading strategies can 
quickly result in disorderly markets.\9\
---------------------------------------------------------------------------

    \4\ See Findings Regarding the Market Events of May 6, 2010, 
Report of the Staffs of the CFTC and SEF to the Joint Advisory 
Committee on Emerging Regulatory Issues (Sept. 30, 2010), available 
at http://www.cftc.gov/ucm/groups/public/@otherif/documents/ifdocs/staff-findings050610.pdf.
    \5\ 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.
    \6\ For a list of volatility events between 2014 and 2017, see 
the International Organization of Securities Commissions (``IOSCO'') 
March 2018 Consultant Report on Mechanisms Used by Trading Venues to 
Manage Extreme Volatility and Preserve Orderly Trading (``IOSCO 
Report''), at 3, available at https://www.iosco.org/library/pubdocs/pdf/IOSCOPD607.pdf.
    \7\ See Osipovich, Alexander, ``Futures Exchange Reins in 
Runaway Trading Algorithms,'' Wall Street Journal (Oct. 29, 2019), 
available at https://www.wsj.com/articles/futures-exchange-reins-in-runaway-trading-algorithms-11572377375.
    \8\ Id.
    \9\ Id. at 6.
---------------------------------------------------------------------------

    Recent events further amplify that in increasingly 
interconnected markets, which are informed by growing access to 
real-time data and information, we do not always know how and where 
the next market stress event will materialize. This past April 20, 
the May contract for the West Texas Intermediate Light Sweet Crude 
Oil futures contract (the ``WTI Contract'') on the New York 
Mercantile Exchange settled at a price of -$37.63 per barrel. The 
May Contract's April 20 negative

[[Page 2075]]

settlement price was the first time the WTI Contract traded at a 
negative price since being listed for trading 37 years ago.
    While the unusual fact that the price went significantly 
negative grabbed the headlines, the precipitousness of the price 
move was every bit as significant. The price dropped more than $39 
between 2:10 and 2:30 p.m. on April 20. Overall, the price dropped 
$58.05 from the open of trading to its low on April 20, breaking its 
historical relationship with other petroleum-based contracts 
including the Brent Crude futures contract. The WTI price moved more 
in 20 minutes than it does most years. A contract that had never 
experienced a 10% move in a single day fell by more than 300% in a 
brief 20-minute period. All of the contributing factors have yet to 
be accounted for, but one thing is certain--these were stressed 
market conditions. An already oversupplied global crude oil market 
was hit with an unprecedented reduction in demand caused by the 
COVID-19 pandemic.\10\ Under stressed market conditions, automated 
trading has the potential to quickly make an already volatile 
situation even worse.
---------------------------------------------------------------------------

    \10\ Interim Staff Report, Trading in NYMEX WTI Crude Oil 
Futures Contract Leading Up to, on, and around April 20, 2020 (Nov. 
23, 2020), https://www.cftc.gov/PressRoom/PressReleases/8315-20.
---------------------------------------------------------------------------

    Technology glitches have continued to impact our markets. Just 
yesterday, a large retail broker that was significantly impacted by 
the events of April 20 suffered a significant failure in data 
storage.\11\ Recent technology glitches overseas have hampered our 
international colleagues as well, handcuffing markets for extended 
periods of time without clear explanation. In Japan this past 
September, the Tokyo Stock Exchange shut down for a day due to 
technical glitches in equities trading.\12\ Luckily, this glitch 
happened to coincide with all other Asian markets being closed and 
occurred the day after the first Presidential debate. But this only 
emphasizes the outsized impact that a technical issue could have 
during volatile market conditions. One can imagine what would have 
happened if the glitch had occurred the day before, during the 
leadup to the debate.\13\
---------------------------------------------------------------------------

    \11\ See Platt and Stafford, ``Trading Outages Strike Again for 
US Retail Brokers,'' Financial Times (Dec. 7, 2020), available at 
https://www.ft.com/content/cb99dc6f-a73e-41af-91fb-21a4aa606265.
    \12\ See Dooley, Ben, ``Tokyo Stock Market Halts Trading for a 
Day, Citing Glitch,'' The New York Times (Sep. 30, 2020), available 
at https://www.nytimes.com/2020/09/30/business/tokyo-stock-market-glitch.html.
    \13\ Id.
---------------------------------------------------------------------------

    Just last month, Australia's stock exchange lost an entire day 
of trading due to a software problem impacting trading of multiple 
securities in a single order.\14\ This discrete issue was enough to 
lead to inaccurate market data that necessitated shutting down the 
exchange for an entire trading day.\15\
---------------------------------------------------------------------------

    \14\ See ``Software Glitch Halts Trading on Australia's Stock 
Exchange, to Reopen Tuesday,'' Reuters (Nov. 15, 2020), available at 
https://www.reuters.com/article/us-asx-trading/software-glitch-halts-trading-on-australias-stock-exchange-to-reopen-tuesday-idUSKBN27W020.
    \15\ Id.
---------------------------------------------------------------------------

    As we consider today's final rule, there is a tendency to think 
that something is better than nothing, and that today's risk 
principles--if nothing else--demonstrate the Commission's belief 
that mitigating automated trading risk is important. However, I 
continue to question whether these Risk Principles improve upon the 
status quo, or even do anything of marginal substance relative to 
the status quo.\16\
---------------------------------------------------------------------------

    \16\ See Behnam, supra note 2.
---------------------------------------------------------------------------

    The preamble seems to go to great lengths to make it clear that 
the Commission is not asking DCMs to do anything. The preamble 
states at the very outset that the ``Commission believes that DCMs 
are addressing most, if not all, of the electronic trading risks 
currently presented to their trading platforms.'' \17\ The preamble 
presents each of the three Risk Principles as ``new'', but then goes 
on to describe all of the actions already taken by DCMs that meet 
the principles. If the appropriate structures are in place, and we 
have dutifully conducted our DCM rule enforcement reviews and have 
found neither deficiencies nor areas for improvement, then is the 
exercise before us today anything more than creating a box that will 
automatically be checked?
---------------------------------------------------------------------------

    \17\ Final Rule at 4.
---------------------------------------------------------------------------

    The only potentially new aspect of these Risk Principles is that 
the preamble suggests different application in the future, as 
circumstances change. As I said in regard to the proposal, the 
Commission seems to want it both ways: We want to reassure DCMs that 
what they do now is enough, but at the same time the new risk 
principles potentially provide a blank check for the Commission to 
apply them differently in the future.\18\
---------------------------------------------------------------------------

    \18\ See Behnam, supra note 2.
---------------------------------------------------------------------------

    We do not know what the next external event to stress market 
conditions will be, but one likely possibility is climate change. In 
establishing new rules for automated trading, I would have liked the 
Commission to have taken a more fulsome look at both the events of 
April 20, the COVID-19 pandemic more broadly, and the potential 
impacts of climate change on our automated markets. The recently 
published Interim Staff Report on the events of April 20 provides a 
stark example of what can happen to automated markets under times of 
economic stress.
    The April 20 price plummet triggered both dynamic circuit 
breakers and velocity logic--exactly the type of risk controls 
discussed in the proposal that preceded the Electronic Trading Risk 
Principles proposal, commonly referred to as ``Regulation AT.'' 
Regulation AT was formally withdrawn at the Chairman's direction and 
without my support. Further troubling, it was withdrawn before 
Commission staff had any meaningful opportunity to consider whether 
and how the risk controls in either Regulation AT or the Electronic 
Trading Risk Principles as proposed performed during trading around 
April 20. There was arguably no better test case, and yet we charged 
forward without looking back. If the risk controls were effective, 
we should consider whether more specific risk controls along these 
lines should be part of the Electronic Trading Risk Principles, in 
order to be certain that all DCMs are prepared to maintain orderly 
trading during such a confluence of events. If they are not, we 
should consider whether stronger risk controls are necessary.
    I also think the Risk Principles would be improved if they were 
informed by a consideration of the possible impacts of climate 
change. The preamble states ``The principles-based approach provides 
DCMs with flexibility to address risks to markets as they evolve, 
including any idiosyncratic events.'' Referring to events such as 
climate change as ``idiosyncratic'' downplays their impact and 
places regulators and DCMs in a purely reactive posture. While we 
cannot know for certain what the next external event that causes 
stressed market conditions will be, that does not mean that we 
should remain idle until it hits. As we will continue to experience 
unanticipated and unprecedented events that will impact our markets 
and the larger U.S. economy, I am concerned that a policy of simply 
checking a box will do nothing more than shield DCMs from public 
scrutiny and fault for the fallout.
    So often we hear that the markets have evolved from a 
technological and innovative standpoint at an exponential rate as 
compared to their regulators. Rulemakings like this provide our 
greatest opportunity to proactively close that gap. We need to be 
proactive. Being proactive means studying the incidents of the past, 
like the Flash Crash, Knight Capital, and most recently April 20 so 
that we can recognize the precursors of events to come. Instead of 
just reacting, we can predict, prepare for, and possibly prevent the 
next crisis event.
    Again, while there is a temptation to advance this rule under 
the theory that something is better than nothing, in this case I do 
not think that the final rules add anything at all beyond the 
opportunity to take a victory lap. In other words, the theme in this 
case is that nothing is better than something. I believe that we 
can, and should, do better. Therefore, I cannot support today's 
final rule.

Appendix 5--Supporting Statement of Commissioner Dawn D. Stump

    As I observed when we proposed these risk principles last 
summer, it is a simple fact that the markets we regulate have become 
increasingly electronic (much like everything else in our modern 
lives). The rulemaking that we are now adopting appropriately 
recognizes that market infrastructure providers have already 
implemented a host of measures pursuant to our existing regulations 
and their own self-regulatory responsibilities to account for the 
associated risks that inherently come with the development of 
electronic trading. I do not want our adoption of additional 
Commission risk principles regarding electronic trading on 
designated contract markets (``DCMs'') to be taken as an indication 
that adequate attention is not being paid--or that insufficient 
resources are being invested--by the exchanges to address the 
lessons that have already been learned and applied over many years 
as electronic trading has become more prevalent in these markets.
    I also want to stress the significance of the often-overlooked 
direction we have received from Congress in Section 3 of the 
Commodity

[[Page 2076]]

Exchange Act (``CEA'').\1\ Section 3(a) sets out Congress's finding 
that the transactions subject to the CEA are affected with a 
national public interest. Then, in Section 3(b), Congress stated 
that it is the purpose of the CEA to serve this public interest 
``through a system of effective self-regulation of trading 
facilities, clearing systems, market participants and market 
professionals under the oversight of the Commission.''
---------------------------------------------------------------------------

    \1\ CEA Section 3, 7 U.S.C. 5.
---------------------------------------------------------------------------

    I support adopting these electronic trading risk principles as 
an appropriate exercise of the Commission's oversight that Congress 
expects from us, as stated in Section 3(b) of the CEA. While, as 
noted, I do not question the exchanges' diligence in addressing the 
risks in electronic trading on their platforms, I am comfortable 
incorporating these principles into our existing rule set in order 
to make clear that DCMs must continue to monitor these risks as they 
evolve along with the markets, and make reasonable modifications as 
appropriate.
    Importantly, though, I also support the principles-based 
approach of these final rules. This approach recognizes that the 
front-line responsibility for preventing, detecting, and mitigating 
material risks posed by electronic trading rests with the exchanges 
themselves. The exchanges are best positioned to execute this 
responsibility because they have the best knowledge of the trading 
that occurs on their own markets. At the same time, this approach 
serves the public interest through a system of effective self-
regulation of trading facilities--precisely as Congress directed in 
its statement of purpose in Section 3(b) of the CEA.
    I thank and commend the Staff for the time and energy they have 
put into the preparation of this rulemaking, and for the thoughtful 
consideration they have given to these issues over the course of the 
past several years.

Appendix 6--Statement of Commissioner Dan M. Berkovitz

    I support today's final rule on Electronic Trading Risk 
Principles (``Final Rule''). The Final Rule addresses market 
disruptions associated with electronic trading through limited 
requirements applicable directly to designated contract markets 
(``DCMs'') and indirectly to DCM market participants. It is an 
incremental step that can enhance the safety and soundness of 
electronic trading on U.S. exchanges. I look forward to the 
continuing evolution of trading in our markets, and to the 
Commission's steady engagement with the technology and risk controls 
of modern trading to determine whether more may be needed in the 
future.
    I am able to support the Final Rule because it recognizes the 
role of both DCMs and market participants in preventing and 
mitigating market disruptions, as well as the ultimate 
responsibility and authority of the Commission to oversee the 
actions of our market infrastructures and market participants. The 
Final Rule codifies three ``Risk Principles,'' including new 
requirements in Risk Principle 1 that DCMs implement rules governing 
their market participants to prevent, detect, and mitigate market 
disruptions and system anomalies.\1\ This provision, codified in 
Commission regulation 38.251(e), speaks directly to new risk-
reducing practices and may be the most helpful of the three Risk 
Principles.
---------------------------------------------------------------------------

    \1\ In addition, Risk Principle 2 requires DCMs to subject all 
electronic orders to exchange-based pre-trade risk controls to 
prevent, detect, and mitigate market disruptions or system anomalies 
associated with electronic trading. Risk Principle 2 overlaps with 
existing Commission regulations, including Sec.  38.255, which 
requires DCMs to ``establish and maintain risk control mechanisms to 
prevent and reduce the potential risk of price distortions and 
market disruptions.'' DCMs should help drive an effective 
implementation of Risk Principle 2 by carefully examining their 
existing pre-trade risk controls and ensuring that such controls are 
fit for the types of market participants, technologies, and trading 
practices prevalent on their markets.
---------------------------------------------------------------------------

    Market participants originate, place, and manage orders on DCMs 
though an array of systems that vary in sophistication and 
automation. Experience teaches that errors in the design, testing, 
implementation, operation, or supervision of such systems by a 
single market participant can lead to cascading effects that disrupt 
an entire market and the ability of all market participants to 
engage in price discovery and risk mitigation. Accordingly, it is 
crucial that market participants, DCMs, and the Commission implement 
and enforce the Risk Principles in meaningful ways going forward.\2\
---------------------------------------------------------------------------

    \2\ I appreciate the concerns raised by some commenters that the 
Risk Principles may be imprecise, difficult to enforce, or provide 
too much deference to DCMs. As discussed below, the Final Rule helps 
mitigate some of these concerns by emphasizing that the Risk 
Principles are an objective standard and enforceable rules subject 
to Commission oversight. The Commission will be able to monitor 
DCMs' compliance with the Risk Principles through its DCM rule 
enforcement review program, as well as other oversight activities 
including review of new rule certifications, review of market 
disruption notifications received pursuant to Risk Principle 3, 
market surveillance, and other oversight tools.
---------------------------------------------------------------------------

    The Commission's efforts in this regard may be aided by Risk 
Principle 3, which requires DCMs to ``promptly notify Commission 
staff of any significant market disruptions'' and ``provide timely 
information on the causes and remediation.'' \3\ I support 
Commission efforts to remain up-to-date as technologies evolve, new 
potential sources of market disruptions arise, and best practices 
for safeguarding markets are developed. Information provided to the 
Commission through Risk Principle 3 will strengthen the Commission's 
daily oversight of DCMs, and help educate the Commission and its 
staff as to the most effective risk-reducing measures.
---------------------------------------------------------------------------

    \3\ Risk Principle 3 is codified in new Commission regulation 
38.251(g).
---------------------------------------------------------------------------

    I am also able to support the Final Rule because it recognizes 
and preserves the Commission's authority to interpret and enforce 
the standards in the Risk Principles, and because it clarifies that 
Risk Principles 1 and 2 are intended to address any type of market 
disruption arising from market participants or electronic orders 
that materially affects electronic trading. I thank the Chairman for 
working with my office to achieve these enhancements to the Final 
Rule.
    The Final Rule includes Acceptable Practices in Appendix B to 
part 38 providing that a DCM can comply with Risk Principles 1 and 2 
through rules and pre-trade risk controls that are ``reasonably 
designed'' to prevent, detect, and mitigate market disruptions and 
system anomalies. While legitimate concerns have been raised that 
these terms could lend themselves to excessive disputes over 
interpretation, the Final Rule makes clear that they are subject to 
an objective standard and Commission oversight. It notes 
specifically that ``[t]he Commission will oversee and enforce the 
Risk Principles in accordance with an objective reasonableness 
standard[,]'' and that the Risk Principles are ``enforceable 
regulations.'' \4\ I am pleased that the Final Rule clearly 
articulates the seriousness with which the Commission will monitor 
and enforce the Risk Principles.
---------------------------------------------------------------------------

    \4\ As I articulated in my statement when the Risk Principles 
were first proposed, the Dodd-Frank Act amended the Commodity 
Exchange Act to make clear that a DCM's discretion with respect to 
core principle compliance is circumscribed by any rule or regulation 
that the Commission might adopt pursuant to a core principle. In 
today's Final Rule, the Commission is requiring DCMs to adopt and 
implement rules and pre-trade risk controls that are ``reasonably 
designed to prevent, detect, and mitigate market disruptions or 
system anomalies associated with electronic trading.''
---------------------------------------------------------------------------

    The Final Rule also makes clear that while Risk Principle 3 
addresses ``significant'' market disruptions, Risk Principles 1 and 
2 include the broader set of ``material'' disruptions. As stated in 
the Final Rule, ``the standard for a significant market disruption 
under Risk Principle 3 is higher than the standard for a market 
disruption under Risk Principles 1 and 2.'' Markets and market 
participants will benefit from the Commission's decision to resolve 
this potential ambiguity in the proposed rule and to implement a 
rigorous standard for Risk Principles 1 and 2.
    Today's Final Rule addresses an issue that has remained open in 
the Commission's books for far too long. Electronic trading is no 
longer a new technology in Commission-regulated markets, and it has 
not been new for many years. The Risk Principles are a circumscribed 
but important first step in ensuring that the Commission's rules 
keep pace with technological changes underlying derivatives trading. 
The Commission must now proceed to full, effective implementation of 
the Risk Principles and to oversight of DCMs' own implementations. I 
support these efforts, combined with continued vigilance to 
determine whether additional steps may be needed in the future.
    In the preamble to the Final Rule, the Commission stresses the 
potential benefits of the principles-based approach embodied in the 
Risk Principles. My support for the principles-based approach in 
this particular rulemaking, however, should not be interpreted as an 
endorsement of such a broad principles-based approach in other 
circumstances, or foreclose my support for more prescriptive 
measures should they become necessary with respect to risk

[[Page 2077]]

controls. Although the markets overseen by the Commission have 
benefitted from the flexibility of a principles-based approach in a 
number of areas, in other circumstances a more prescriptive approach 
has provided the market with needed clarity and certainty. The 
appropriate choice or balance between prescriptive regulations and 
principles-based regulations will depend upon the circumstances 
being addressed by those regulations.
    Whether this rulemaking will fully accomplish its objectives 
will depend to a large extent upon the diligence and commitment to 
its implementation by DCMs and market participants. If DCMs and 
market participants comprehensively adopt and maintain industry best 
practices to prevent, detect, and mitigate market disruptions and 
system anomalies, as well as develop and implement measures to 
address emerging issues as they arise, then further prescriptive 
action by the Commission may not be necessary.
    I thank the staff of the Division of Market Oversight for their 
work to address a number of my concerns with the Final Rule, as well 
as their overall work on the Final Rule.

[FR Doc. 2020-27622 Filed 1-5-21; 11:15 am]
BILLING CODE 6351-01-P