Objective 1.1
| Ensure that markets are structured to reflect the forces of supply and demand for the underlying commodity and are free from manipulation, disruptive activity, and abusive trading practices. |
Derivatives markets serve an important function in the U.S. economy by providing a mechanism for price discovery and a means of offsetting price risk. It is critical that the markets and contracts traded on them are structured such that prices accurately reflect the economic forces of supply and demand and that trading is free from manipulation or other disruptive activity. The Commission’s market and product review programs have the primary responsibility for reviewing exchange rules and contract terms and conditions to ensure that they are specified in such a way that the markets achieve their intended purpose.
A key factor in the Commission’s effort to effectively oversee the markets under its jurisdiction is its ability to collect information and communications from market participants and stakeholders. With respect to market surveillance, for example, the Commission collects various reports from large traders that provide analysts with important background information on traders. The Commission also relies on public comments as part of its rulemaking efforts and to guide its oversight of the exchanges and registrants. To ensure that its communications with the public and registrants is efficient, the Commission is committed to updating its rules and procedures to receive forms and other information electronically. The Commission is also enhancing the process for public comment submissions to enable submitters and Commission staff to search and locate information more efficiently, increase information integrity, and streamline the submission and information management processes.
Although the structure of the markets and contracts must be overseen to ensure they are serving as the basis for sound price discovery and effective risk management, it also is necessary to actively monitor the behavior of market participants to identify specific situations that could cause distortions in the market. The Commission’s surveillance program closely monitors the futures, options, and swaps market activity of all traders whose positions are large enough to potentially impact the orderly operation of the market. Where conditions warrant, Commission staff contact traders and work with exchange surveillance staff to defuse potentially disruptive situations.
Another key objective of the Commission is to assure that participants within the market are protected against fraudulent or abusive trading practices. To detect these types of abuses, the Commission staff routinely review trading activity of individuals at each domestic exchange and, when they come into existence, swaps execution facilities. Staff look for patterns of activity that may indicate possible violations of the CEA by one or more individuals. When such patterns are observed, staff engage in additional efforts to collect supporting documents and other evidence of violations. Where appropriate, matters are referred to the appropriate exchange for continued investigation, disciplinary action, or enforcement action. In addition, Commission staff routinely consult with surveillance staff at exchanges as a means to collect addition information and intelligence on surveillance matters as well as to coordinate actions involving traders when appropriate.
Strategy 1.1.1 Develop automated surveillance systems to monitor market conditions and trader activity, and develop an alert and case management system to identify and track potential trading violations.
The Commission constantly monitors prices and traders’ positions to identify unusual price changes and price relationships in the futures and options markets. As information on swap positions becomes available, a similar effort to monitor swap market activity will also be incorporated into the surveillance systems. Staff follow up to determine whether the cause of such unusual changes and relationships may be the result of inappropriate activity by traders in the market. Staff also routinely monitor the composition of traders’ positions, in particular when a trader’s position has risen to a high level of concentration due to the trader actively increasing a position or by the attrition of other traders’ positions in the market.
The Commission is developing automated systems that will identify and alert staff to unusual market conditions and trader activity. Four market alerts currently being developed will automatically notify staff economists to the existence of unusual situations related to price changes, trader position changes, trading activity around scheduled economic data releases, and unusual option trading around futures last trading days. Staff are also developing a fifth flexible market profile alert system that could be used to identify traders trading in concert, and situations or conditions in or between markets that fall outside the “normal” market profile, such as a normal spread between related commodities, record high volumes or open interest, large price inversions, etc. In addition, as staff receive data for swaps market transactions, this data will be integrated into existing alerts and new alerts will be developed that are relevant to that market.
Staff currently monitor trader positions to identify position limit violations for nine DCM-listed agricultural commodities for which Federal position limits exist. Under the Dodd-Frank Act, the Commission’s responsibilities will expand to positions in not only the futures markets, but to positions in non-financial-based swaps markets as well. In addition, Federal speculative position limits may expand to cover about 30 agricultural and exempt commodity markets. To ensure that Commission staff and exchanges are properly monitoring and enforcing their position limits, staff will develop automated systems to identify potential position limit violations by traders in commodities with Federal position limits. As swaps transactions are added to the mix of commodities to which Federal position limits may apply, staff will integrate those transactions into the alert systems, first relying on large trader reports submitted by swap dealers and ultimately transitioning to swap data that has been submitted to SDRs.
Commission surveillance staff closely review the intraday trading activity of market participants. DCMs submit daily trade data to the Commission on the day following the day on which trades are executed. The data is maintained in a database and is the backbone of the CFTC’s Trade Surveillance System (TSS). The transaction data is used by trade practice analysts, economists, attorneys, and other market analysts to examine market activity to ensure against fraud, abusive trading practices, and manipulation. In addition, Commission staff analyze trade data to determine whether markets regulated by the Commission are operating in an efficient and orderly manner.
A key strategy used to detect abusive trading practices is to establish normal patterns of trading activity, using available data from DCMs, which can serve to identify trading activity that deviate from the norms and is indicative of potential trading violations.1 When such trading is observed, TSS alerts analysts to conduct further investigation to ascertain whether a trading violation has occurred. Alerts have been developed and implemented for trading violations such as wash trading, trading ahead of customer orders, and marking the close, and staff continue to work to develop and implement additional trade practice alerts as well as a profiling model that will include profiling alerts. Alerts also will be developed for the swaps markets and to conduct cross-market surveillance.
The Commission is developing an electronic case management system to assure appropriate review and documentation of alerts to note whether continued monitoring is needed, referral to enforcement is appropriate, or other action is necessary. This case management system will also be used to monitor manipulation concerns, complaints, tips, and referrals that come from within and outside the Commission.
The implementation of automated surveillance systems is expected to enhance the surveillance program in several respects. First, it will allow staff to allocate more time to data analysis and focus analysis on the participants, issues, and trends having the biggest impact on markets. This technology transformation will accompany and result in increasingly innovative approaches to identifying key information and collaborating with other staff. Second, it will expand the breadth of surveillance by using computerized algorithms to routinely scan data for potential trading violations or market conditions that may previously have been overlooked. Third, the use of a case management system to document staff analyses and examinations can itself be used as a source to identify additional surveillance concerns, such as to identify trends or patterns in particular types of activity. Finally, the use of an integrated automated alert and case management system will ensure that identified trading violations and market surveillance concerns are routinely scrutinized and documented.
| FY 2011 | Implement automated position limit monitoring for all additional commodities under CFTC position limits for futures and options traded on DCMs. |
|---|---|
| FY 2012 | Implement automated position limit monitoring for all commodities under CFTC position limits for the swaps market using large trader reporting data. |
| FY 2013 | N/A |
| FY 2014 | Implement automated position limit monitoring for all commodities under CFTC position limits using integrated data from reporting firms and swaps data repositories. |
| FY 2015 | N/A |
| FY 2011 | Implement four automated market alerts. |
|---|---|
| FY 2012 | Implement automated market profile alerts. Integrate swaps market data into two automated market alerts. |
| FY 2013 | Implement automated market profile alerts for swaps market. |
| FY 2014 | N/A |
| FY 2015 | N/A |
| 1 Staff have identified a total of five market alerts to be developed and implemented during the period of this Strategic Plan. Development of additional alerts and enhancements to alerts may occur to the extent that staff become aware of other types of trading abuses or better means to detect known types of trading violations. The ability to fully integrate swaps data into the alert systems developed for futures and option positions will depend on the nature of the data eventually reported to swaps data repositories. (back to text) | |
| FY 2011 | Implement five automated trading violation alerts. |
|---|---|
| FY 2012 | Implement five automated trading violation alerts. |
| FY 2013 | Implement four automated trading violation alerts. |
| FY 2014 | Implement two automated trading violation alerts. |
| FY 2015 | Develop and implement additional automated alerts as identified. |
| 1 Staff have identified a total of 16 trading violation alerts to be developed and implemented during the period of this Strategic Plan. Development of additional alerts and enhancements to alerts may occur to the extent that staff become aware of other types of trading abuses or better means to detect known types of trading violations. Also, alerts to be implemented in FY 2013 and FY 2014 assume that staff will have access to additional information regarding order book data and ownership and control data, respectively. (back to text) | |
Strategy 1.1.2 Review and update the content requirements of currently used trader reporting forms and identify potential new reporting forms or methods.
In conducting surveillance, it is important that staff have background information regarding those holding positions in futures, options, and swaps. Information currently collected by the Commission through CFTC Forms 40, 102, 204, and 304 permits Commission staff to carry out a variety of surveillance functions that would not be possible or as effective without the availability of this information. Data submitted on these forms allows for a more complete aggregation of positions where, for example, a trader holds positions in multiple accounts, potentially at different reporting firms. It also provides information on the types of activity in which a trader or business is operating. Such information is used to assess the applicability of position limits or to evaluate the potential motivations of a trader. Basic contact information is included in these forms should there be the need to contract traders. Information provided in these reports allows the Commission to generate the Commitments of Traders reports, which help to promote market transparency. In addition, requirements of the Dodd-Frank Act will also necessitate additional information collection regarding traders in the swaps market.
Many of the forms used to collect information on traders have been in use for many years. To assure that information being collected in these forms remains relevant, staff will undertake a review of current forms to evaluate the need for potential changes, including consolidation. In addition, staff will undertake, in collaboration with the futures and swaps industry, an effort to develop the best means to collect certain ownership, control, and related information for all trading accounts active on all U.S. futures exchanges and other reporting entities. The objective of such a proposal is to enable the Commission to more readily form a complete picture of an individual’s position within and across markets, both with respect to a trader’s open positions as well as his or her intraday trading activity.
| FY 2011 | Conduct internal review and update current reporting forms. Collaborate with industry committee to develop recommendations for ownership and control information related to exchange-traded futures and options. |
|---|---|
| FY 2012 | Implement ownership and control reporting standards for futures and option markets. Implement reportable trader standards for swaps traders. |
| FY 2013 | N/A |
| FY 2014 | N/A |
| FY 2015 | N/A |
Strategy 1.1.3 Increase efficiency and reduce errors through the adoption of electronic filing of CFTC reporting forms.
In addition to updating information requirements, Commission staff will also begin efforts to automate the collection of data through the electronic filing of forms. Currently such information is filed though paper documents and entered by staff into the Commission’s computerized databases. Electronic filing will reduce transcription errors when information is entered into the Commission’s computer systems, allow for automated checks of data entered by filers, allow tagging that will facilitate aggregation and system integration, and support automated downstream processing and dissemination of public information. Such efforts will enhance the efficiency of the Commission by reducing the time staff need to spend checking for and correcting errors so that their efforts can be redirected to other tasks.
| FY 2011 | Transmit information requirements to OITS for revised trader reporting forms. |
|---|---|
| FY 2012 | Fully deploy electronic filing of trader reporting forms. |
| FY 2013 | Fully deploy information systems for ownership and control reporting. Fully deploy information systems for reportable trader standards for swap traders. |
| FY 2014 | N/A |
| FY 2015 | N/A |
Strategy 1.1.4 Review all contracts that have significant market impact for compliance with core principles in a timely manner.
A key strategy to ensure that contracts listed on futures and option exchanges serve their intended purposes of providing effective risk shifting and price discovery functions is to review the terms and conditions of contracts with significant trading to assure that they meet the core principles of the CEA. To best support the integrity and structure of the markets, Commission staff will regularly examine each new contract for market significance and will prioritize timely review of contracts that meet a certain threshold of significance. Contracts will be found to have market significance if they have reached a monthly trading volume of 20,000 contracts and a month-end open interest of 10,000 contracts. Contracts that reach these volume and open interest benchmarks can be reasonably considered to have achieved at least a minimal degree of market acceptance, and thus could be viewed as having market significance. Efficient use of Commission resources requires prioritization of due diligence reviews of new contracts in order to efficiently employ Commission resources. The use of market significance, as indicated by market acceptance, appears to be a reasonable standard. Contracts also will be found to have market significance if they present issues that are novel, particularly complex, or otherwise notable. As the CFTC begins to collect information on swaps contracts, staff will also develop measures to identify what levels of activity are indicative of market significance in that market.
| FY 2011 | 100% |
|---|---|
| FY 2012 | 100% |
| FY 2013 | 100% |
| FY 2014 | 100% |
| FY 2015 | 100% |
Strategy 1.1.5 Timely review of new rules and rule changes for compliance with core principles.
Along with the review of terms and conditions of contracts for compliance with core principles, a review of the rules and rule changes proposed by exchanges and SEFs for compliance with core principles serves as a means to assure that exchanges are operating in a fashion that protects the markets and market users from abuse and price distortions. It is also important to promptly conduct review of rules and rule changes in order to ensure that the rules under which the exchanges are operating are effective. Where they are not, prompt review allows quick referral back to the exchanges for correction.
| FY 2011 | 100% |
|---|---|
| FY 2012 | 100% |
| FY 2013 | 100% |
| FY 2014 | 100% |
| FY 2015 | 100% |
Strategy 1.1.6 Ensure that new exchanges adopt rules that comply with core principles.
A key element in assuring that derivatives exchanges operate in a transparent, competitive, and fair manner is that they have a set of rules in place that govern the operation of markets and the rights and obligations of market participants. Before an exchange may begin operation, staff conduct a thorough review of the exchange’s proposed rules to assure that the rules comply with core principles. Staff also make an assessment of the ability of the exchange to enforce its rules on an ongoing basis.
| FY 2011 | 100% |
|---|---|
| FY 2012 | 100% |
| FY 2013 | 100% |
| FY 2014 | 100% |
| FY 2015 | 100% |
1 When in the future SEFs begin operating, this strategy will be expanded to cover those operations. (back to text)