February 01, 2012

The Commodity Futures Trading Commission behaved like a "little child" in abandoning oversight of the futures market in order to focus on developing new rules governing how swaps are traded, commissioner Scott O'Malia said earlier this week.

Since 2010, the agency has been consumed with drafting new rules to regulate the $700 trillion over-the-counter derivatives market as required under the Dodd-Frank law. But with most of its manpower being used to help bring on the largest overhaul of the nation's financial system since the 1930s, O'Malia said the CFTC missed cracks in the system that have cost MF Global's clients hundreds of millions of dollars.

"Since the Dodd-Frank Act became law, the Commission has acted like a little child, abandoning the old toy and 'swapping' them out for the new," O'Malia said in a speech at New York Law School. "It has concentrated on swaps rulemaking while averting its gaze from the futures markets and their developments."

The agency is now focused on getting to the bottom of how customer funds went missing at MF Global, which failed in its duty as a broker to keep proprietary money segregated from what belonged to its futures clients, O'Malia said. MF Global customers are estimated to be missing anywhere from $600 million to $1.2 billion as a result of the stricken firm's demise.

"Every dollar that you deposit with the bank belongs to you right? Similarly every dollar that futures customers deposited with MF Global belonged to them," O'Malia said.

He also contended that the MF Global fiasco didn't happen because of a lack of regulation, adding that he's "puzzled" by the CFTC's attempt to regain the public's confidence with new rules.

DEFINING HIGH-FREQUENCY TRADING

In addition to his remarks on the futures market, O'Malia also argued that the agency has failed to keep pace with the rapid evolution of trading technology, which has limited its ability to provide effective oversight.

In the aftermath of the May 6, 2010 Flash Crash, the CFTC revived its technology advisory committee (TAC) to gain a better understand of the trading landscape. But shortly after the Flash Crash, O'Malia said he realized the group lacked a fundamental understanding of the new trading patterns being used in the markets.

"There was no consensus on what constituted automated trading, what constituted algorithmic trading, and what constituted HFT," O'Malia said. "There was no consensus on how each type of trading affected our markets. It was like having no consensus on what constitutes a broken window."

As a result, O'Malia said he's creating a new TAC subcommittee that will define and identify HFT in the swaps, futures and options markets. The comments also appear to indicate that the CFTC won't pursue any new regulation of HFT before coming up with a coherent definition of what it is.

"Regarding HFT, the Commission needs to enable the public to have a thoughtful and coherent debate," O'Malia said. "We should not be issuing new government dictates before properly identifying the problems and solutions."

ABOUT THE AUTHOR
As the Senior Editor of Advanced Trading, Justin Grant plays a key role in steering the magazine's coverage of the latest issues affecting the buy-side trading community. Since joining Advanced ...