High-Frequency Trading Needs New Rules:  Official

A malfunctioning algorithm that caused a $1 surge in oil prices earlier this year shows the need for regulators to zero in on the risks posed by high-speed trading, an official from the U.S. Commodity Futures Trading Commission said on Thursday.


The trading program, owned by Infinium Capital Management, was shut down after five seconds, but CFTC Commissioner Scott O'Malia said the incident should be treated seriously.

"The market was tainted and prices plunged as a result," O'Malia said in a statement, responding to a Reuters story describing how the algorithm ran amok on Feb. 3, incurring a million-dollar loss in about a second.

"It is examples like this that confirm to me the importance of continuing the discussion of implementing more robust risk functionality on exchanges and traders," said O'Malia, who recently revived a CFTC advisory committee on technology to examine how the regulator should adapt its rules, first developed to police traders working in open outcry pits.

The chief executive of Infinium is a member of the CFTC committee.

A source told Reuters that the CFTC is investigating the incident but O'Malia did not provide comment on the agency's involvement.

"We need to develop rules and regulations that are more appropriate to policing the high-speed nature of today's computer-aided trading styles, where computers can have a significant impact on the market in a matter of seconds, rather than trying to conform pit trading enforcement methods to today's markets," O'Malia said.

CFTC Commissioner Bart Chilton said he also believes the CFTC needs to get a better handle on high-frequency trading, which uses computer-driven algorithms to rapidly create and execute trades, and accounts for a growing share of U.S. futures trade.

Chilton declined to comment specifically on the Infinium incident.

Chilton said he questions whether some high-frequency traders, who rapidly enter and exit markets, provide liquidity.

"Are these types of traders truly contributing to risk management and price discovery functions, or are they 'sideline' trading, on the edges of the real market?" Chilton told Reuters.

"Parasitical trading doesn't truly contribute to fundamental market functions," he said, noting that not all high-frequency trading (HFT) is negative.

"There are some HFT cowboys out there, and they may be giving respectable HFT a bad name and not contributing much to these markets," he said.

The new Wall Street reform law gives the CFTC power to write regulations to prevent disruptive trading practices, O'Malia noted.

"Whatever we do, the risks posed by high speed and algorithmic trading must be handled with great care because when things go wrong, five seconds can generate a lifetime's worth of trading, not to mention a toxic trail," he said.