I disagree with the self-certification of ICE’s new Rule 4.26(c), and its associated passive order protection (“POP”) functionality for the Exchange’s Gold Daily and Silver Daily futures markets.[2] POP is an issue of first impression in Commission-regulated markets: an asymmetric speed bump specifically designed to alter the competitive balance between market participants and trading strategies. Asymmetric speed bumps, such as POP, that purposely disadvantage particular trading entities, strategies, or technologies, are discriminatory, anti-competitive, and facially inconsistent with the fundamental objectives of the Commodity Exchange Act (“Act”) to promote “responsible innovation and fair competition . . . among market participants.” In these circumstances a compelling “explanation and analysis” of the proposed rule’s compliance with applicable provisions of the Act and the Commission’s regulations must be provided for the Commission not to find the rule inconsistent with the Act.[3] As discussed below, no such compelling explanation and analysis has been provided with respect to the POP rule.
Under Section 5c of the Act, the Commission shall approve a rule submitted for approval by a registered entity, including a designated contract market (“DCM”), “unless the Commission finds that the new rule, or rule amendment, is inconsistent with [the Act or the Commission’s regulations].”[4] Significantly, the Commission’s review is not limited to determining whether the rule is inconsistent with only the core principles for a registered entity, but rather the review encompasses consistency with the entirety of the Act. The broad scope of review that the Commission must undertake is made clear by Regulation 40.6, which governs the submission and review of rule self-certifications. Under Regulation 40.6(a)(7)(v), a rule submitted by a registered entity for approval must include a “concise explanation and analysis” of the proposed rule’s “compliance with the Act, including core principles, and the Commission’s regulations thereunder.”[5] Regulation 40.6 thus requires the submission to include information regarding compliance with the entire Act, not just the core principles for the registered entity.
In this context, Section 15(b) of the Act also governs the Commission’s review of rule submissions by a DCM. Section 15(b) states:
The Commission shall take into consideration the public interest to be protected by the antitrust laws and endeavor to take the least anticompetitive means of achieving the objectives of the Act, as well as the policies and purposes of this Act, in issuing any order or adopting any Commission rule or regulation . . . , or in requiring or approving any bylaw, rule, or regulation of a contract market . . . .[6]
Accordingly, in reviewing a rule submission, the Commission must take into account the protection of competition under the antitrust laws, and endeavor to take the least anticompetitive means to achieve the policies and purposes of the Act. Under Section 3 of the Act, these purposes include promoting “responsible innovation and fair competition among boards of trade, other markets, and market participants.”[7] When conducting the review mandated by Section 15(b), the Commission may “exercis[e] its independent judgment” in considering the issues presented.[8]
The Act and Commission regulations evidence a clear preference for open, transparent, and competitive derivatives markets where participants can bring and fully utilize their expertise and resources. Congress enunciated strong principles of fair-trading[9] in Section 3 of the Act, and specifically identified “responsible innovation and fair competition” in derivatives markets as fundamental purposes underlying the entire statutory regime.[10] In Sections 5(d)(19) and 5h(11) of the Act,[11] Congress also instructed DCMs and swap execution facilities (“SEFs”), respectively, to not “impose any material anticompetitive burden on trading [on the DCM or SEF]” unless “necessary or appropriate to” achieve the purposes of the Act. As noted, the record before the Commission includes no compelling explanation and analysis as to why an asymmetric speed bump such as POP—clearly a “material anticompetitive burden” for some market participants—is necessary or appropriate to achieve the purposes of the Act. Conclusory assertions that the asymmetric speed bump will reduce latency arbitrage and “attract additional participants and liquidity to the screen” are not sufficient to justify such material anticompetitive burdens.[12]
The Commission has implemented Congress’s competition directives through, for example, regulations that codify Sections 5(d)(19) and 5h(11) into Commission rules.[13] The Commission has also adopted impartial access rules that require DCMs to provide their market participants with impartial access to the DCMs’ “markets and services,” including “[a]ccess criteria that are impartial, transparent, and applied in a non-discriminatory manner.”[14] DCMs are also required under the Act and the Commission’s regulation to “promote fair and equitable trading” on their facilities.[15]
Practices that serve to preclude legitimate methods of competition or protect incumbents from challenges by new entrants are facially incompatible with the principle of fair competition embodied in the Act and Commission regulations.
In the case of POP, the Commission is faced with an asymmetric speed bump that penalizes certain order types (aggressing orders) and trading strategies (cross-market arbitrage), while also discriminating against market participants that have developed the skill and invested in the technology to thrive in modern markets. ICE’s public comments in support of POP express the Exchange’s aim of “reducing the importance of latency advantages which are only available to a small subset of the fastest firms engaged in arbitrage . . . .”[16] When presented with a proposed rule such as an asymmetric speed bump that is discriminatory by design, the Commission must be provided with sufficient explanation and analysis to enable it to conclude that the proposed rule is not inconsistent with the purpose of promoting fair competition and doing so using the “least anti-competitive means” as specified in the Act and the Commission’s regulations.
The record before the Commission does not provide sufficient explanation and analysis to conclude that the proposed rule is not inconsistent with the Act and Commission regulations. Although I agree with the staff’s interpretation that “notwithstanding the broad language of the ICE Rule, the future implementation of the POP functionality for any ICE contract other than the Gold Daily and Silver Daily contracts, or a change to the three millisecond delay period, among other changes to the POP functionality, would require ICE to file a new rule submission in accordance with CEA Section 5c(c) and part 40 of the Commission’s regulations,” the fact is, as the staff noted, the Rule submitted by ICE is not limited.[17] By its terms, the ICE rule applies to any futures contract traded on the ICE DCM, as ICE determines “in its discretion.” Although the ICE rule as drafted is not limited to Gold Daily and Silver Daily contracts, and it does not appear that ICE intended for the rule to be so limited, no justification was provided regarding the rationale for the application of the rule to any contract other than the Gold Daily and Silver Daily contracts. Based on the record before it, the Commission should have determined that the broad rule is inconsistent with the Act and Commission regulations.
However, even if the submission were limited to Gold Daily and Silver Daily contracts, I do not find the proffered rationale for the application of this asymmetric speed bump sufficiently compelling to justify the anticompetitive burden it places on classes of market participants. In my view, the promotion of liquidity does not justify the imposition of a material anti-competitive discriminatory burden on a particular segment of the market. The Commission should not ignore a fundamental purpose of the CEA—to promote fair competition—in a speculative attempt to generate liquidity.
Today’s statement by staff of the Division of Market Oversight (“DMO”) notes that this is the first instance of an asymmetric speed bump being proposed for a CFTC-regulated market and there is no data as to the effectiveness of this type of rule in our markets. In the event that the CFTC may be requested to consider additional rules imposing speed bumps or other measures to discriminate against particular classes of market participants, I urge the Commission to gather additional information and data about speed bumps, for example by examining the effectiveness and fairness of speed bumps in non-CFTC markets, requesting the Office of Chief Economist to assist in the review of this issue, and seeking input from other outside experts, through, for example, a CFTC Advisory Committee. Additionally, I urge the Commission to develop some criteria for measuring the effectiveness of speed bumps.
I agree with the statement by DMO staff that today’s non-action by the Commission sets no legal or policy precedent. DMO staff also correctly states that ICE must submit a new rule filing pursuant to Part 40 of the Commission’s regulations if it in any way intends to modify its current POP functionality, expand it to new products, or adjust the time delay period.
I thank the staff of DMO for being responsive to questions from my office during the consideration of this matter.
[1] Hereinafter “ICE” or “Exchange.”
[2] See Letter from Jason V. Fusco, Assistant General Counsel, Market Regulation, ICE, to Christopher J. Kirkpatrick, Secretary of the Commission, Submission No. 19-119 (“ICE Filing Letter”) (Feb. 1, 2019), available at https://www.cftc.gov/sites/default/files/filings/orgrules/19/02/rule022019iceusdcm001.pdf.
ICE codified its POP functionality in new Exchange Rule 4.26(c). As the Exchange explained in its rule filing, POP functionality "works by creating a very short . . . delay for incoming orders that would otherwise transact immediately opposite resting . . . orders.” ICE asserts that “[t]his short delay helps level the playing field by giving all traders who have placed a resting order additional time to react to price changes in related markets.” ICE also stated that POP functionality is "designed to reduce latency advantages between traders engaged in arbitrage strategies against related markets." ICE’s rule filing states that the POP delay will be three milliseconds.
[3] See 17 C.F.R. § 40.6(a)(7)(v).
[4] See 7 U.S.C. § 7a-2. The Commission’s regulations similarly provide that a rule submitted for certification shall become effective unless, prior to the expiration of the review period, the Commission “objects to the proposed certification on the grounds that the proposed rule or rule amendment is inconsistent with the Act or the Commission’s regulations.” 17 C.F.R. § 40.6(c)(3).
[5] See 17 C.F.R. § 40.6(a)(7)(v) (emphasis added).
[6] See 7 U.S.C. § 19(b) (emphasis added).
[7] See 7 U.S.C. § 5.
[8] U.S. Futures Exchange, LLC v. Board of Trade of City of Chicago, 346 F.Supp.3d 1230, 1261 (N.D. Ill. 2018). In U.S. Futures Exchange, the district court found that the CFTC had in fact exercised such independent judgment in its Section 15(b) review. The court noted that the CFTC “had been considering ‘the policy and legal issues involved for the past year’” and that the “CFTC staff acknowledged and weighed the antitrust and competition objections raised and concluded that there were no viable alternatives to the ‘single dedicated clearinghouse’ model.” Id. at 1259, 1261. See also American Agriculture Movement, Inc. v. Board of Trade of City of Chicago, 977 F.2d 1147, 1167 (7th Cir. 1992) (question of implied antitrust immunity depends on whether agency antitrust review is “active, intrusive and appropriately deliberative . . . . We do not deny that the CEA and its enabling regulations lay in place a regulatory framework under which the Commission can exercise the requisite degree of supervision.”)
[9] See 7 U.S.C. § 5(a).
[10] See 7 U.S.C. § 5(b).
[11] See 7 U.S.C. § 7(d)(19) and 7 U.S.C. § 7b-3(11).
[12] See ICE Comment Letter, dated March 15, 2019, from Trabue Bland, President, ICE, at 1, available at https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=62080&SearchText
[13] See 17 C.F.R. § 37.1100 for SEFs and 17 C.F.R. § 38.1000 for DCMs.
[14] See 17 C.F.R. § 38.151(b). The impartial access requirements for SEFs are similar. See17 C.F.R. § 37.202(a).
[15] See 17 C.F.R. § 38.651.
[16] See ICE Comment Letter at 1.
[17] The Rule states that “Passive Order Protection may be activated for those Exchange Futures Contracts and contract months as determined by the Exchange from time to time in its discretion . . . .” See ICE Filing Letter at Exhibit A. In its Filing Letter, ICE stated, “The Exchange will initially enable POP functionality with a 3 millisecond delay period in Gold Daily and Silver Daily futures markets.” (emphasis added).
