Electronic Trading Risk Principles

2048

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

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.

4

Automated and Modern Trading Markets

Subcommittee, ‘‘Discussion of the CFTC’s Proposed

COMMODITY FUTURES TRADING

COMMISSION

17 CFR Part 38

RIN 3038–AF04

Electronic Trading Risk Principles

AGENCY

: Commodity Futures Trading

Commission.

ACTION

: Final rule.

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,

mdahlman@cftc.gov or 202–418–5264;

Joseph Otchin, Special Counsel,

jotchin@cftc.gov or 202–418–5623,

Division of Market Oversight; Esen

Onur, eonur@cftc.gov 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

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

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.

10

See id. at 6; July 16, 2020 TAC Meeting

Transcript at 62:13–63:15.

11

See id.

12

See NPRM, supra note 1 at 42762.

13

17 CFR 38.251(c).

14

17 CFR 38.255.

15

See supra note 1.

16

See NPRM at 42762.

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.

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.

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

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

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

§§ 38.251 and 38.255.

12

Existing

Commission regulation § 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 § 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

Building on the requirements under

existing Commission regulation § 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

§ 38.255, the Commission believes the

Risk Principles are distinguishable from

existing Commission regulation § 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

§ 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.

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

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

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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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.

27

See supra note 25 at 2–5, 8.

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 §§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.

30

See Section II.A.

31

See NPRM at 42765.

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.’’).

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 §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.’’).

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

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

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

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

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

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

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

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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.

38

See NPRM at 42763.

39

See id. at 42763 n.6.

40

See id. at 42764.

41

See id. at 42765.

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.

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.

52

CEWG NPRM Letter, at 7.

53

IATP NPRM Letter, at 4–5.

54

See id.

55

IATP NPRM Letter, at 13.

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.

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

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

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

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

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

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

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 § 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

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58

See id.

59

See NPRM at 42763 n.6.

60

CEWG NPRM Letter, at 7.

61

17 CFR 38.151.

62

See NPRM 42762, 42764.

63

See NPRM 42762.

64

See id.

65

See id.

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.

72

ICE NPRM Letter, at 3.

73

See id.

74

See id.

75

Better Markets NPRM Letter, at 4–9.

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

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.

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 § 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

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

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

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 § 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

§ 38.607, which it believes has proven

effective.

74

Better Markets similarly commented

that the proposed regulations are

redundant of existing Commission

regulations. Specifically, Better Markets

pointed to Commission regulations

§§ 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

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76

See id.

77

See id.

78

See id.

79

See id.

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.

83

See NPRM at 42768.

84

NPRM at 42768.

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.

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.

87

NPRM at 42765.

88

See id.

89

See id.

90

See id.

91

See id.

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 § 38.255

squarely focuses on risk controls for the

prevention and mitigation of market

disruptions.

78

Better Markets stated that

existing Commission regulation § 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

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

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 §§ 38.251 and

38.255.

83

Commission regulation

§ 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 § 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.

The NPRM further acknowledged that

the Risk Principles largely overlap with

Commission regulation § 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

§ 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.

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 §§ 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

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.

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

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

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92

CME NPRM Letter, at 10.

93

ICE NPRM Letter, at 2, 3–4, 5.

94

See id.

95

See id.

96

See id.

97

NPRM at 42765.

98

See id.

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.

100

ICE NPRM Letter, at 5.

101

See id.

102

See id.

103

See id.

104

See id.

105

CEWG NPRM Letter, at 4.

106

CME NPRM Letter, at 10–11.

107

MFA NPRM Letter, at 3.

108

See id.

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.

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

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

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

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

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

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

CME commented regarding the

preamble’s assertion that ‘‘system

anomalies’’ are unexpected conditions

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CME NPRM Letter, at 3.

119

See id.

120

See id.

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.

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.

131

MGEX NPRM Letter, at 1–2.

132

See id. at 3.

133

CME NPRM Letter, at 3.

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

Continued

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

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

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

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

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.

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

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(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).

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

§§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.

136

NPRM at 42777.

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.

143

CME NPRM Letter, at 4–5.

144

See id. at 6.

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.

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

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 § 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

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

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145

See id. at 6–7.

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.

152

See NPRM at 42763.

153

NPRM at 42776.

154

CME NPRM Letter, at 5.

155

Id. at 5–6 (emphasis in original).

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.

159

CFE NPRM Letter, at 3.

160

Id.

161

Id.

162

CEWG NPRM Letter, at 7.

163

Id.

standard without a condition in the Risk

Principle explicitly stating that the

controls must be ‘‘reasonably

designed.’’

145

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

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.

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.

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

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

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

CEWG stated DCM rules adopted

pursuant to Risk Principles 1 and 2

should be subject to Commission

approval under Commission regulation

§ 40.5 or self-certification under

Commission regulation § 40.6.

162

CEWG

asserted a transparent regulatory process

would ensure that new DCM rules are

appropriately tailored.

163

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164

17 CFR 40.1(i).

165

Under part 40, a DCM’s filing of rules under

Commission regulations §§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).

166

17 CFR 40.8(c).

167

See 17 CFR 40.5, 40.6.

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 §40.5. Id. at 44782. See also

17 CFR 40.6(a)(7) (setting forth rule submission

requirements).

169

ICE NPRM Letter, at 3.

170

CFE NPRM Letter, at 1–2.

171

IATP NPRM Letter, at 10.

172

Id.

173

NPRM at 42767.

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).

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)).

178

CME NPRM Letter, at 14.

179

ICE NPRM Letter, at 7.

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

§ 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.

Commission regulation § 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 § 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 § 40.5, which

provides procedures for the voluntary

submission of rules for Commission

review and approval; or (b) Commission

regulation § 40.6, which provides

procedures for the self-certification of

rules with the Commission.

167

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

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

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

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

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 § 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.

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 § 38.251(f).

178

ICE

commented there is not one set of risk

controls that are most effective in

preventing market disruptions.

179

ICE

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180

Id. at 8.

181

MGEX NPRM Letter, at 2.

182

IATP NPRM Letter, at 10.

183

Id.

184

NPRM at 42767.

185

Id. at 42768.

186

See Appendix B to Part 38—Guidance on, and

Acceptable Practices in, Compliance with Core

Principles, Core Principle 4 (Subparagraph (b)).

187

NPRM at 42769.

188

Better Markets NPRM Letter, at 2.

189

Id. at 9.

190

Id. at 10.

191

CME NPRM Letter, at 8.

192

Id.

193

Id.

194

MFA NPRM Letter, at 3.

195

Id.

196

Id. at 4.

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.

further asserted the proposed

Acceptable Practices for proposed

Commission regulation § 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

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

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

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.

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

§ 38.1051(e) notification.

187

Further, the

Commission differentiated Risk

Principle 3 from existing Commission

regulation § 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.

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

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

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

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

§ 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 § 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

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201

Id. (emphasis added).

202

CME NPRM Letter, at 16.

203

Better Markets NPRM Letter, at 10.

204

CME NPRM Letter, at 14–15.

205

Id.

206

Id. at 15.

207

CEWG NPRM Letter, at 5.

208

Id. at 6.

209

ICE NPRM Letter, at 4.

210

Id.

211

Id.

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.

216

In response to ICE’s comment, see discussion

at Section II.A.2(c) addressing ‘‘significant’’ and

‘‘material.’’

217

See CME NPRM Letter, at 16.

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.

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

CME asserted the distinction from

Commission regulation § 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

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

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 § 38.1051(e).

211

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

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

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 § 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.

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

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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).

219

44 U.S.C. 3501 et seq.

220

The Commission estimates that final

Commission regulation §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 §38.251(e)

would be 816 hours based on each DCM incurring

48 burden hours (17 × 48 = 816).

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.

223

See 17 CFR part 40.

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.

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.

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

§ 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 § 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 § 40.5, which provides

procedures for the voluntary submission

of rules for Commission review and

approval; or (b) Commission regulation

§ 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

§ 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 § 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

§ 38.251(e) will incrementally increase,

these costs are expected to be de

minimis.

The Commission has previously

estimated the combined annual burden

hours for both Commission regulations

§§ 40.5 and 40.6 to be 7,000 hours.

Upon implementation of final

Commission regulation § 38.251(e), the

Commission estimates that 17

exchanges may each make two rule

filings under Commission regulations

§ 40.5 or §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.

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 § 40.2 (Listing

products by certification), Commission

regulation § 40.3 (Voluntary submission

of new products for Commission review

and approval), Commission regulation

§ 40.5 (Voluntary submission of rules for

Commission review and approval), and

Commission regulation § 40.6 (Self-

certification of rules). Commission

regulation § 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:

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.

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224

See supra Section II.E. (discussion of the Risk

Principle 3).

225

See CME NPRM Letter, at 8.

226

See id.

227

See id.

228

See id. at 9.

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.

231

CME NPRM Letter, at 16.

232

Id.

233

‘‘Velocity Logic’’ is addressed on CME’s

website. Generally, it is ‘‘designed to detect market

Estimated total annual burden hours

for all respondents: 816.

2. OMB Collection 3038–0052—Core

Principles and Other Requirements for

DCMs

Final Commission regulation

§ 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.

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

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.

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 § 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.

The Commission submits that its

original estimate of the reportable

events under Commission regulation

§ 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 § 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.

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

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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.

234

Based on the annual aggregate range of

potential notifications under final Commission

regulation §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 §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 × 5 = 0 and 25 × 5 = 125).

236

The Commission estimates that the total

aggregate annual burden hours for DCMs under

final Commission regulation §38.251(g) would be a

range between 0 and 2,125 hours based on each

DCM incurring between 0 hours (0 × 17 = 0 burden

hours) and 2,125 hours (125 × 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.

237

See 17 CFR part 38.

238

The Commission estimates that additional

total aggregate annual recordkeeping burden hours

for DCMs under Commission regulations §§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 × 0 = 0 and 17 × 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 §§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.

239

7 U.S.C. 19(a).

240

See existing Commission regulations

§§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)).

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.

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 § 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 § 38.251(g) will

incrementally increase, these costs are

expected to be de minimis.

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 § 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:

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

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.

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

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

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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.

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.

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.

249

AFR NPRM Letter, at 2; Rutkowski NPRM

Letter, at 2.

250

CME NPRM Letter, at 17.

251

See id.

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

i. Commission Regulation § 38.251(e)—

Risk Principle 1

Commission regulation § 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 § 38.251(f)—

Risk Principle 2

Commission regulation § 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

§ 38.251(g)—Risk Principle 3

Commission regulation § 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 §§ 38.251(e) and (f)

The Acceptable Practices provide

that, to comply with Commission

regulation § 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 § 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 § 38.255.

244

ICE

stated that this would track the

Commission’s approach to regulating

financial risk controls in Commission

regulation § 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

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

AFR and Rutkowski disagreed with

the assertion that current DCM practices

are effective in achieving what the Risk

Principles aim to achieve.

249

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

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 §§ 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

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See id. at 9.

253

See id.

254

See NPRM at 42772; CME NPRM Letter, at 17;

ICE NPRM Letter, at 9.

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).

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.

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 § 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

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

§§ 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.

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 § 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

§ 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 § 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.

The Commission acknowledges that

any additional rules resulting from

Commission regulation § 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 × $89.89). To the

extent a DCM currently has in place

rules required under Commission

regulation § 38.251(e), these costs would

be incrementally lower.

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 § 38.251(f).

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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).

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.

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

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 § 38.251(f), these costs would

be incrementally lower.

Commission regulation § 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

§ 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

§ 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 § 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 × $71.019)

annually and the cost for additional

reporting to a DCM to be no more than

$9,555.00 (125 × $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.

To the extent that DCMs would need

to update their rules and internal

processes to comply with Commission

regulations §§ 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

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$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.

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.

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.

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

§§ 38.251(e) through 38.251(g), and

therefore the actual compliance costs

may be higher or lower than the

Commission’s estimates.

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

§ 38.251(e) and adjust their exchange-

based pre-trade risk controls pursuant to

Commission regulation § 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 §§ 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 § 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

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

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.

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AFR NPRM Letter, at 2.

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.

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.

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

§ 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

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 § 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 § 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 § 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

§ 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 § 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 § 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 § 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

§§ 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

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

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

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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.

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

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 §§ 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 § 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

§ 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 § 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 §§ 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 §§ 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 §§ 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

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281

7 U.S.C. 19(b).

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.

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.

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.

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 § 38.251(e) and pre-trade risk

controls implemented by DCMs

pursuant to Commission regulation

§ 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 §§ 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 §§ 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.

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

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

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

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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.

292

See NPRM at 42775 and Section III.C.4 of this

final rulemaking.

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.

297

NPRM at 42768.

298

CFE NPRM Letter, at 4.

299

See Commission regulation §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.

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

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.

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

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

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 § 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.

List of Subjects in 17 CFR Part 38

Commodity futures, Designated

contract markets, Reporting and

recordkeeping requirements.

PART 38—DESIGNATED CONTRACT

MARKETS

■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.

■2. In § 38.251, republish the

introductory text and add paragraphs (e)

through (g) to read as follows:

§ 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

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1

Giuseppe Tomasi di Lampedusa, The Leopard

(Everyman’s Library Ed. 1991) at p. 22.

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.

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).

7

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

3(b).

its electronic trading platform(s) and

provide timely information on the

causes and remediation.

■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 § 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 § 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

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.

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

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

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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/.

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.

10

Tarbert, at 11–17.

11

Di Lampedusa, at 22.

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.

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.

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.

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

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

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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.

1

Regulation Automated Trading, Proposed Rule,

80 FR 78824 (Dec. 17, 2015); Supplemental

Regulation AT NPRM, 81 FR 85334 (Nov. 25, 2016).

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.

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.

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.

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.

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.

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

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

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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.

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.

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.

16

See Behnam, supra note 2.

17

Final Rule at 4.

18

See Behnam, supra note 2.

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.

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

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

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

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?

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

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

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1

CEA Section 3, 7 U.S.C. 5.

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

§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.

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.

3

Risk Principle 3 is codified in new Commission

regulation 38.251(g).

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.’’

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.’’

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.

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

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.

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.

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

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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

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Published date	11 January 2021
Citation	86 FR 2048
Record Number	2020-27622
Section	Rules and Regulations
Court	Commodity Futures Trading Commission

Electronic Trading Risk Principles

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