U.S. derivatives regulators approved a proposal Friday that would expand their access to the computer code that drives automated trading strategies and would bring more high-frequency traders under their oversight.
The Commodity Futures Trading Commission voted 2-1 for the proposal, which has drawn a swell of opposition from firms that use complex mathematical models to drive trading decisions. But the measure also watered down an earlier plan that would have given the CFTC even more direct access to the source code by simply allowing its staff to request it.
Under the revised proposal, which will be issued for a 60-day public-comment period, a majority of the commission members would have to vote to issue an order seeking the code. CFTC Chairman Timothy Massad said the rules would modernize the oversight of futures markets by signaling that computerized records should be preserved and provided to regulators in the same way that paper trading records are.
“We should not have a regulatory regime where those who still trade at human speed are subject to effective surveillance, but those who use machines are not,” Mr. Massad said. “Our rules should not favor one method over another, and nobody should be able to hide behind their machines.”
The proposal divided the CFTC along partisan lines, with a Republican Commissioner, Christopher Giancarlo, arguing it symbolizes government creep toward peering into the computer code that drives everything from Uber’s dispatch formulas to Google’s search engine.
Mr. Giancarlo insisted the CFTC should only get the code through a subpoena, which any regulated firm can appeal to a court to either limit or quash. He warned that trading firms would probably sue if the rule is finalized because it grants the agency too much power to obtain their intellectual property.
High-speed trading firms including Virtu Financial Inc. have also argued that the CFTC should obtain a subpoena to get the records.
“They just have no choice if this rule is passed but to hand over their source code and basically shut up,” he said. “How’s that fair?”
Mr. Massad said the rules would respond to the concerns of operating companies such as agricultural businesses that use the futures markets to hedge their exposure to price swings. The CFTC chairman was clearly annoyed by Mr. Giancarlo’s pushback, arguing that source code isn’t different from traditional records that firms have used to implement trading decisions.
“So if you trade in our markets under the old-world ways, you are subject to surveillance,” he said. “But if you trade in our market under the new-world ways of algos, ‘Oh no, that’s a violation of the Constitution.'”
Mr. Massad and Mr. Giancarlo also clashed over whether the source code will be kept secure. The new approach would ensure the code isn’t disclosed publicly and that access is limited even among regulatory officials, Mr. Massad said. Mr. Giancarlo responded that source code is so valuable that “the CFTC will make itself a target for a broader group of cybercriminals, including those engaged in commercial espionage.”
The proposal approved Friday also would require about 50 additional trading firms to register with the CFTC and abide by its rules, including the need to implement pre-trade risk controls. That is fewer than would have registered under the CFTC’s original proposal issued in December.
The latest measure requires algorithmic trading firms to register with the CFTC if they trade on average 20,000 futures contracts a day over a six-month period. That would capture about 70 firms that are already under the CFTC’s oversight and about 50 firms that would have to newly register with the agency, CFTC officials said.