Three of the U.S. largest trade groups representing the derivatives industry have said to the Commodity Futures Trading Commission that it needs to be a lot more lenient on how it will monitor market manipulation when it implements its greater authority under the Dodd-Frank financial reform legislation.
In a joint letter issued December 28, the Futures Industry Association, the Securities Industry and Financial Markets Association and the International Swaps and Derivatives Association, said the CFTC must describe in proposed new rules how it will differentiate legitimate trading practices with those it has determined can lead to market manipulation.
The FIA represents 30 of the largest futures commission merchants in the U.S. responsible for processing exchange-based contracts. SIFMA ‘s membership includes a broader range of s banks, broker dealers and asset managers trading in both the derivatives and cash markets. Members of ISDA include over 800 of the world’s largest buy- and sell-side firms which trade over-the-counter derivatives.
“Failure to provide clear and straightforward guidance will only serve to add confusion to the markets and potentially chill legitimate trading activities in a competitive market where traders must make real-time trading decisions in dynamic markets without the benefit of hindsight,” wrote the three trade groups. “Market participants faced with overlapping and potentially inconsistent rules relating to the same activities are likely to reduce their participation because of the risk that activity permitted by one provision may be penalized under another."
The FIA, SIFMA and ISDA recommended that the CFTC should not implement new rules on market manipulation based upon Rule 10b-5 of the Securities Exchange Act of 1934 because they are “largely inapplicable and cannot be adapted to the futures and derivatives markets, due to the fundamental differences in the structures of the two market frameworks.” That rule governs the cash market.
Passed in July, the Dodd-Frank financial reform bill requires the CFTC to ban certain trading practices which include "banging the close,'' which is acquiring a big position and then offsetting it before trading ends, and "spoofing," where a trader makes bids or offers but cancels them before execution.
To comply with the new legislation, the CFTC has proposed a new rule on prohibition of market manipulation. If adopted, the new rule would require the CFTC to only show a trader acted in a manner that had the potential to disrupt the market, making it easier for the CFTC to prove its case.
Previously, the CFTC actually had to prove that a trader intended to manipulate prices by showing he or she had the market power to change the price of a commodity and that the trader caused a price change that would otherwise not have occurred.
The three trade groups said that the CFTC should clarify that nothing in its proposed new proposed rule will prevent market traders from taking positions and trading using material, nonpublic information that they have obtained legally. They also said that “extreme recklessness” rather than “recklessness alone” should be the criteria under which a trader is judged.
“Implementing a mere recklessness standard for the imposition of substantial civil penalties could have myriad unintended adverse consequences,” wrote the FIA, SIFMA and ISDA. “Traders may find it necessary to reduce their participation for fear that competitive trading strategies currently adopted may be misconstrued by the regulators with the benefit of hindsight. Similarly, potential entrants may decide that regulatory risks outweigh potential benefits and not enter the market at all, significantly reducing the liquidity and depth of markets.”