The Futures Industry Association’s Principle Traders Group (PTG) has slammed the decision by the Commodity Futures Trading Commission (CFTC) to allow ICE to self-certify its Passive Order Protection mechanism, more commonly known as a speed bump. The PTG was joined in its criticism of the decision, which has already caused significant controversy in futures circles, by three CFTC commissioners.
In a statement, the CFTC’s Division of Market Oversight (DMO) says, “On February 1, 2019, ICE Futures US self-certified an amendment to ICE Rule 4.26 (Order Execution) that would allow ICE to implement a new functionality, named Passive Order Protection. The POP functionality creates a delay or “speed bump” in the processing of incoming “aggressive” orders that would otherwise execute against “resting” or “passive” orders, but does not delay the processing of passive orders or their cancellations or modifications. The POP functionality is designed to reduce the impact of latency (or speed) advantages among a segment of higher speed traders through the asymmetric delay as described above.
“The Submission (but not ICE Rule 4.26) provides that the POP functionality will initially be implemented for ICE’s Gold Daily and Silver Daily futures markets, and the delay period will be set at three milliseconds,” the statement continues. “ICE Rule 4.26 states that “Passive Order Protection may be activated for those Exchange Futures Contracts and contract months as determined by the Exchange from time to time in its discretion.”
The FIA’s PTG was quick to voice its concern following the news, saying in its own statement, “The Passive Order Protection functionality raises significant concerns for our members, as well as the marketplace.”
The statement does praise CFTC staff for their reasoning behind the decision, which “demonstrated an understanding of the complexity of this issue” as well as the “responsible” decision reached in the search to reconcile the interest of the exchange in continuing to innovate and the interest of the marketplace in fair competition, it adds that as active liquidity providers, FIA PTG members remain concerned about the potential impact that artificial latency mechanisms, including asymmetric speed bumps such as the ICE POP, will have on market quality, including execution quality, price discovery, and liquidity.
“The ICE POP is specifically designed to impact competition between firms with different business models, advantaging some while disadvantaging others,” the statement argues. “FIA PTG believes that any mechanism designed intentionally to put certain segments of the market at a disadvantage to others, undermines the level playing field and highly competitive environment of today’s futures markets.
“Although FIA PTG supports innovation, we believe that speed bumps present a threat to the function, fairness and stability of markets,” it continues. “While the ICE POP will seemingly only affect one small and obscure corner of the market to start, the broad language in the rule change made us very concerned that this could be like opening a Pandora’s Box of changes to market structure. For this reason, the statement’s requirements for additional filings and processes around future speed bumps have helped alleviate our concerns.”
The statement concludes, “FIA PTG is a strong supporter of data-driven decision making, and we are pleased to see the Commission staff intends to monitor and analyse the impact of the ICE POP functionality on an ongoing basis. We look forward to this analysis.”
It was not only traders who disagreed with the decision, however, for two CFTC commissioners issued statements deploring it.
Noting that she “strongly supports the Commission’s self-certification process”, and that his is the first time that a futures exchange has self-certified speed bump functionality, Commissioner Dawn Stump says, “Commenters, including IFUS, have presented competing predictions of the anticipated effects of implementing this functionality. Yet, no reliable data or empirical analysis actually exists. I am unable to conclude within the bounds of the self-certification standard prescribed by the Commodity Exchange Act (CEA) that, notwithstanding IFUS’ certification of compliance, this speed bump for the IFUS Gold Daily and Silver Daily futures markets is inconsistent with the CEA or the Commission’s regulations.
“That determination, however, must always be based on the specific facts and circumstances of a given market (e.g., the product, number of participants, and market depth or liquidity), and the particular attributes of the proposed speed bump (e.g., three milliseconds in this case),” she continues. “IFUS, in the first instance, is responsible for determining that its trading functionality for a particular market complies with the CEA and the Commission’s regulations. It is my expectation that if IFUS seeks to implement a speed bump in any other market, and/or on any other terms, it will self-certify that determination to the Commission pursuant to the self-certification process.”
Meanwhile, in a lengthy statement, commissioner Dan Berkovitz, says, “I disagree with the self-certification of ICE’s new Rule 4.26(c), and its associated passive order protection functionality for the Exchange’s Gold Daily and Silver Daily futures markets. POP is an issue of first impression in Commission-regulated markets: an asymmetric speed bump specifically designed to alter the competitive balance between market participants and trading strategies.
“Asymmetric speed bumps, such as POP, that purposely disadvantage particular trading entities, strategies, or technologies, are discriminatory, anti-competitive, and facially inconsistent with the fundamental objectives of the CEA to promote ‘responsible innovation and fair competition . . . among market participants.’ In these circumstances a compelling ‘explanation and analysis’ of the proposed rule’s compliance with applicable provisions of the Act and the Commission’s regulations must be provided for the Commission not to find the rule inconsistent with the Act,” he continues, adding, “no such compelling explanation and analysis has been provided with respect to the POP rule”.
Berkovitz also argues that, “Practices that serve to preclude legitimate methods of competition or protect incumbents from challenges by new entrants are facially incompatible with the principle of fair competition embodied in the Act and Commission regulations.
“In the case of POP, the Commission is faced with an asymmetric speed bump that penalizes certain order types (aggressing orders) and trading strategies (cross-market arbitrage), while also discriminating against market participants that have developed the skill and invested in the technology to thrive in modern markets,” he says. “ICE’s public comments in support of POP express the Exchange’s aim of “reducing the importance of latency advantages which are only available to a small subset of the fastest firms engaged in arbitrage…” When presented with a proposed rule such as an asymmetric speed bump that is discriminatory by design, the Commission must be provided with sufficient explanation and analysis to enable it to conclude that the proposed rule is not inconsistent with the purpose of promoting fair competition and doing so using the ‘least anti-competitive means’ as specified in the Act and the Commission’s regulations.
“The record before the Commission does not provide sufficient explanation and analysis to conclude that the proposed rule is not inconsistent with the Act and Commission regulations,” he continues. “Although I agree with the staff’s interpretation that ‘notwithstanding the broad language of the ICE Rule, the future implementation of the POP functionality for any ICE contract other than the Gold Daily and Silver Daily contracts, or a change to the three millisecond delay period, among other changes to the POP functionality, would require ICE to file a new rule submission in accordance with CEA Section 5c(c) and part 40 of the Commission’s regulations,’ the fact is, as the staff noted, the Rule submitted by ICE is not limited. By its terms, the ICE rule applies to any futures contract traded on the ICE DCM, as ICE determines ‘in its discretion.’ Although the ICE rule as drafted is not limited to Gold Daily and Silver Daily contracts, and it does not appear that ICE intended for the rule to be so limited, no justification was provided regarding the rationale for the application of the rule to any contract other than the Gold Daily and Silver Daily contracts.
“Based on the record before it, the Commission should have determined that the broad rule is inconsistent with the Act and Commission regulations,” Berkovitz further states. “However, even if the submission were limited to Gold Daily and Silver Daily contracts, I do not find the proffered rationale for the application of this asymmetric speed bump sufficiently compelling to justify the anticompetitive burden it places on classes of market participants. In my view, the promotion of liquidity does not justify the imposition of a material anti-competitive discriminatory burden on a particular segment of the market. The Commission should not ignore a fundamental purpose of the CEA—to promote fair competition—in a speculative attempt to generate liquidity.”
Berkovitz also observes that this being a first, “there is no data as to the effectiveness of this type of rule in our markets”, adding that in the event that the CFTC may be requested to consider additional rules imposing speed bumps or other measures to discriminate against particular classes of market participants, “I urge the Commission to gather additional information and data about speed bumps, for example by examining the effectiveness and fairness of speed bumps in non-CFTC markets, requesting the Office of Chief Economist to assist in the review of this issue, and seeking input from other outside experts, through, for example, a CFTC Advisory Committee. Additionally, I urge the Commission to develop some criteria for measuring the effectiveness of speed bumps.”
Meanwhile, CFTC Commissioner Brian Quintenz says, “The CFTC is now confronted with a small, but precedent-setting exchange rule-filing that seeks to “equalize downward.” Its potential ramifications on the perpetual forces of efficient market evolution are profound.”
Quintenz adds, “The goal of financial markets is not to protect or shelter the less informed. Rather, the market incentivises being informed and executing on that knowledge. In other words, market efficiencies are earned – they are created through research, investment, and intellectual property.
“Risk (and reward) move at the speed of information,” he continues. “Those that invent, and invest in, faster information transmission technologies to capitalize on market dislocations reap the profits of their advantage. That process enhances market efficiency – market prices more immediately reflect value-changing events, the advantaging inventions usually become more widespread after the robust early adoption by the sector where the rewards are the greatest, the gains available to further enhancing efficiency remain, and new rounds of innovation are undertaken. The virtuous cycle of profit motivation, innovation, reward, and enhanced market efficiency have created the most liquid, technologically advanced, accessible, and instantaneously responsive markets in the world.”
Quintenz closes his statement by making clear his objection to this self-certificatio, stating, “I also call on the Commission to develop and put forward regulations around Core Principle 9, which states, ‘[t]he board of trade shall provide a competitive, open, and efficient market and mechanism for executing transactions that protects the price discovery process of trading in the centralized market of the board of trade,’ such that market efficiency concerns around speed bumps, asymmetric or two-sided, can be more clearly articulated.
“The evolution of market efficiency elevates the status quo,” he concludes. “It ‘equalizes up.’ Shame on us if we advantage the opposite.”