SPEECHES & TESTIMONY

Statement of Commissioner Brian Quintenz on the Certification of ICE Futures U.S., Inc. Submission No. 19-119

May 15, 2019

“The year was 2081, and everybody was finally equal. They weren’t only equal before God and the law.  They were equal every which way. Nobody was smarter than anybody else. Nobody was better looking than anybody else.  Nobody was stronger or quicker than anybody else. All the equality was due to the 211th, 212th, and 213th Amendments to the Constitution, and to the unceasing vigilance of agents of the United States Handicapper General.”

-Introduction to Harrison Bergeron, by Kurt Vonnegut, Jr.

The story of Harrison Bergeron is one of downward equality.  It is a story of penalizing advantages in order to equalize at the lowest level.  The strong slung multiple hundred pound sacks around their shoulders.  The beautiful wore hideous masks to disguise their features.  The smart had government-issued earpieces which delivered endless, piercing noises to scramble their thoughts.

The results were predictable.  Artistic performances became debacles.  Newscasts became unintelligible.  Family discussions became fishbowl dialogues. What was not described in the story was the state of the country’s economy or its markets.  One could only imagine.

The Commodity Futures Trading Commission (CFTC) is now confronted with a small, but precedent-setting exchange rule-filing that seeks to “equalize downward.”  Its potential ramifications on the perpetual forces of efficient market evolution are profound.

The Commodity Exchange Act (CEA) lists 23 “Core Principles” that Designated Contract Markets (DCMs, or exchanges) must follow. Each exchange, in adopting things like rules governing trading or the listing of new contracts, must certify that those rules meet all of the CEA’s core principles.  The CFTC, as a principles-based regulator, has given exchanges wide latitude in interpreting those core principles.  This process has worked well and for the benefit of markets – the potential political considerations of regulators are diminished and the exchanges are empowered to more freely and quickly respond to a dynamic marketplace.

However, there are, and need to be, limits to core principle interpretation.

A recent self-certified filing by an exchange seeks to implement a “speed bump” in its markets, but only for certain types of orders.[1]  The speed bump would halt an incoming order that would otherwise match with a resting order, thereby giving the resting order a small time window to be adjusted and avoid execution.  The speed bump’s effect would be to preclude a firm with faster networks from using its speed advantage to trade on market information by matching with resting orders.

The goal of financial markets is not to protect or shelter the less informed. Rather, the market incentivizes being informed and executing on that knowledge.  In other words, market efficiencies are earned - they are created through research, investment, and intellectual property.

Risk (and reward) move at the speed of information.  Those that invent, and invest in, faster information transmission technologies to capitalize on market dislocations reap the profits of their advantage.  That process enhances market efficiency – market prices more immediately reflect value-changing events, the advantaging inventions usually become more widespread after the robust early adoption by the sector where the rewards are the greatest, the gains available to further enhancing efficiency remain, and new rounds of innovation are undertaken.  The virtuous cycle of profit motivation, innovation, reward, and enhanced market efficiency have created the most liquid, technologically advanced, accessible, and instantaneously responsive markets in the world.

Profiting from innovations in the speed of information transmission has long been a driving force behind the communications revolution and market efficiency evolution.  In 1790, upon learning of Congress’ potential passage of Alexander Hamilton’s proposal in which the federal government would purchase the Revolutionary War debts issued by the states and the Continental Congress, traders chartered the fastest ships they could find to sail to ports and buy up the cheap debt before news of the law reached those cities.[2]  In the early 1800’s, carrier pigeons were employed to bring news from European ships docking in Nova Scotia back to Boston – stage coaches were then sent to New York to transmit that tradable intelligence.[3]  In the 1830s, William C. Bridges tried to cut out the pigeon, ship, horse, and stagecoach news transmission network all together.[4]  Instead, he operated a private signal network between New York and Philadelphia which consisted of a series of boards on poles mounted on hills which could be seen by telescope from each successive pole station.[5]  Bridges’ system transmitted stock market news between those cities within 10-30 minutes, cutting the normal two-day stagecoach news cycle by 99%.[6]

Yet, Bridges’ system was made obsolete a few years later by the telegraph, whose first customers were, unsurprisingly, stock brokers.[7]  Ultimately, the investments which Western Union made in expanding its telegraph network across the United States were funded through the profits from the financial community’s early adoption of its technology.[8]  In 1887, Western Union’s president claimed that 87% of its revenue came from stock and commodity traders.[9]

Imagine the lack of innovation of, and investment in, information transmission and distribution if the stock markets (with the backing of the government) imposed a two-day trading “speed bump” in the 1830s so that Bridges’ lucrative visual signal system was rendered ineffective.  How much of an incentive would have been removed from spurring the telegraph’s invention and adoption?  How long would it have delayed a country-wide communications network which was funded through profits from the trading community’s expenditures on that new technology?

Further, and more appropriate to this specific rule filing, had a two-day trading delay been implemented, what type of after-the-fact data analysis could have ever proved its negative impact on technological advancement?  I remain concerned that, even with the agency’s good intentions of a future data-driven analysis of this or additional speed bumps, the most important verdict for which we must answer – the potential negative impact or outright preclusion of technological advancement and corresponding market efficiency evolution – could never be conclusively stated. No amount or kind of data can ever prove a negative.

I have registered my objection to this self-certification with the Secretariat.  I also call on the Commission to develop and put forward regulations around Core Principle 9, which states, “[t]he board of trade shall provide a competitive, open, and efficient market and mechanism for executing transactions that protects the price discovery process of trading in the centralized market of the board of trade,”[10]  such that market efficiency concerns around speed bumps, asymmetric or two-sided, can be more clearly articulated.

The evolution of market efficiency elevates the status quo. It “equalizes up.” Shame on us if we advantage the opposite.

 

[1] Letter from Jason V. Fusco, Assistant Gen. Counsel, Mkt. Regulation, ICE Futures U.S., Inc., to Christopher J. Kirkpatrick, Sec’y of the Comm’n, CFTC (Feb. 1, 2019). Available at: https://www.cftc.gov/sites/default/files/2019-02/ICEFuturessPassiveOrder020119.pdf.

[2] See Bob Pisani,“Plundered by Harpies: An Early History of High Speed Trading,” Financial History, Fall 2014 at 20. Available at: https://www.moaf.org/publications-collections/financial-history-magazine/111/_res/id=Attachments/index=0/Plundered_by_Harpies.pdf

[3] Id.

[4] Id.

[5] Id.

[6] Id.

[7] Id.

[8] Id.

[9] Id.

[10] 7 U.S.C. § 7(d)(9)(A) (emphasis added).