UPDATE 2-U.S. derivatives watchdog hones in on speed traders

Mon Sep 9, 2013 2:56pm EDT

By Douwe Miedema

WASHINGTON, Sept 9 (Reuters) - The U.S. derivatives regulator put computerized trading in its sights on Monday in a long-awaited study that could be the first step to rein in a sector often blamed for market disruptions.

Citing a long series of recent glitches as evidence that its rules needed updating, the Commodity Futures Trading Commission (CFTC) asked for industry input on a long list of possible measures to make trading safer.

"Recent malfunctions ... in both derivatives and securities markets, illustrate the technological and operational vulnerabilities inherent to automated trading environments," the agency said in a so-called concept release.

Trading disruptions have plagued financial markets in the recent past, most notably when thousands of stocks listed on Nasdaq OMX Group's were paralyzed for three hours last month because of a technological problem.

The CFTC, which regulates swaps and futures markets, mentioned that outage, and other recent examples, to illustrate the importance of having robust trading systems.

High-frequency traders uses software to post orders in fractions of a second without human intervention, to be ahead of other and slower traders, and is a favored tool of hedge funds and trading desks at other investors.

It accounted for more than 60 percent of the entire volume of futures trading in 2012 on U.S. exchanges such as CME Group and IntercontinentalExchange, according to industry research group The Tabb Group.

In equity markets, the numbers are similar.

The May 6, 2010 "flash crash" - in which futures and securities indices fell more than 5 percent in minutes, before rapidly recovering - is the most prominent market lapse associated with high-frequency trading.

A panel of experts convened by the CFTC and the Securities Exchange Commission in 2011 already issued recommendations to reform automated trading after that event, but few of its ideas have made it into new regulation.

"This looks like a long-overdue first step by the financial regulators to stop abusive high speed computer-driven practices, which have caused havoc in our markets," said Dennis Kelleher, who heads financial reform group Better Markets.

In its concept release - a formal first step to possible rule-making - the CFTC asked companies and other stakeholders to answer more than 100 questions about possible proposals to adapt its rule-book to the new technologies.

One possible measure are limits on the number of orders that companies can send out to prevent them from flooding the markets with misleading information, and stop them from acting faster than their own risk control systems.

Maximum order sizes were another possible idea to prevent "fat finger" trades that can disrupt the market.

The CFTC has already issued rules for co-location, a process in hedge funds are allowed to place their computers within the buildings of a stock exchange, to shave a few more milliseconds off order times.

In a first step, the CFTC's Technology Advisory Committee, which groups together regulators and industry participants, will discuss the report at a meeting on Sept. 12.

The SEC, its sister agency, issued a concept release on market structure in 2010 and has since adopted new rules in a handful of areas, including risk controls for brokers and automated stops to prevent big market swings.

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