The Commodity Futures Trading Commission’s (CFTC’s) final interpretative guidance and policy statement on disruptive trading clarifies various aspects of, but does not deviate significantly from, its proposed interpretive order in 2011. Like the proposed order, the final statement addresses three areas: (i) violating bids or offers, (ii) orderly execution of transactions during the closing period, and (iii) spoofing. In response to comments filed, the CFTC clarified its proposal, both generally and in certain specific areas discussed below, but did not deviate significantly from the proposed rule.
On a general level, the CFTC refused to prohibit the three disruptive trading practices only on platforms or venues that have “order book” functionality. Rather, the prohibition on such practices will apply to any trading, practices or conduct on a registered entity, such as a designated contract market or swap execution facility. The Commission said, however, that it would not apply these prohibitions to either block trades (privately negotiated transactions executed apart and away from the trading facilities) or exchanges for related positions (exchanges of futures contracts for related cash or over-the-counter derivative positions, such as options or swaps).
More specifically, the CFTC reiterated that the prohibition on violating bids or offers prohibits a person, on a registered entity, from buying a contract at a price that is higher than the lowest available price offered for such contract or selling a contract at a price that is lower than the highest available price bid for such contract. The Commission said such conduct would be a per se offense – the CFTC would not have to show intent.
The Commission, however, clarified that the prohibition would not apply in several situations. First, the CFTC clarified that it does not intend to exercise its discretion to bring an enforcement action against an individual who, by accident, makes a one-off trade in violation of the prohibition. Second, the Commission does not interpret the prohibition as applying to non-cleared swap transactions, even if they are transacted on or through a registered entity, or to bids or offers on swaps that would be cleared at different clearing houses, since in such circumstances parties may take credit and other non-price factors into consideration. Third, the CFTC did not create a “best execution standard” across multiple registered entities — a person’s obligation to not violate bids or offers applies only to the specific registered entity being utilized at a particular time. Fourth, the CFTC will not apply the prohibition where an individual is “buying the board,” i.e., executing a sequence of trades to buy all available offers or sell to all available bids on an order book, in accordance with the rules of the facility.
Regarding the intentional or reckless disregard for the orderly execution of transactions during the closing period, the CFTC clarified that physical products priced using indices or benchmarks have a closing period, i.e., during the window of time when the price reporting agencies calculate price indexes. Further, the CFTC clarified that conduct outside the closing period could violate this section if a market participant accumulates a large position in a product or contract in the period immediately preceding the closing period with the intent (or reckless disregard) to disrupt the orderly execution of transactions during the product’s, or a similar product’s, defined closing period.
On “spoofing,” at the CFTC’s open meeting regarding the final statement, CFTC Enforcement Director, David Meister clarified that “strobing” would be considered a “spoof.” “Strobing” is high frequency trading strategy in which the same order is sent and cancelled many times to create the appearance of liquidity. Mr. Miester said such trades would be considered “spoofing” because the orders were placed with the intent to cancel prior to execution. Mr. Miester added that “strobing” would be considered “spoofing”– even if orders were executed — because the orders were placed with the intent to cancel. In other words, that the orders were executed would not be a defense to a “strobing spoofing” violation. Finally, Mr. Meister said that a “strobing spoofing” violation does not require any intent to create the appearance of liquidity – simply placing the orders with the intent to cancel would result in a “strobing spoofing” violation.