CFTC Denies Asking Renaissance For Code

CFTC Denies Asking Renaissance For Code

When the New York Post first reported that Renaissance Technologies was asked by the CFTC to provide access to their trading algorithms, it sent shivers up the collective spines of trading lobbying groups as well as the broader technology development world. For a regulator to demand a review what amounts to the secret formula to a business innovation was “precedent-setting,” with concerns for the source code leaking a very real possibility.  But does the CFTC even have the authority to investigate methods of placing orders on an electronic exchange? And what about the issue if it were to involve a market destabilizing flash crash with potential national security implications? The lines are murky at best – meet Regulation AT.

Regulation AT Source Code CFTC
By Gert-Martin Greuel [CC BY-SA 2.0 de], via Wikimedia Commons

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Renaissance Technologies is the very secret $65 billion Long Island, NY-based hedge fund whose founders were also major supporters of Donald Trump. It is now a Trump led CFTC that is in the middle of reports it requested access to confidential algorithms that drive performance of one of the world’s most noncorrealted hedge funds.

The issue of regulators sizing what amounts to “the secret formula to Coca-Cola” from a quantitative investment firm has been opposed by industry lobbyists such as the Modern Markets Initiative, Managed Funds Association, and the Futures Industry Association.

The recent case of a SEC staffer leaking confidential code to private parties is only one of several concerns industry participants have, all of which resurfaced recently.

Code can be written to be just average or “very elegant,” noted David Downey, CEO of the single stock futures exchange OneChicago.  “Anyone with a simple background in coding would recognize the elegance that makes a particular piece of code works better than another.”

Often times the first step in understanding sophisticated code is to break it down into understandable performance drivers, a task typically accomplished in the development and testing of trading code. Certain industry professionals can look at code and assess core performance drivers, which might damage a company’s competitiveness, raising concerns. “It’s intellectual property and letting the regulatory staff get a peek at it is wrong,” Downey said.

Computer code is often categorized based on performance drivers and in identifying repeating market patterns. When analyzing such algorithms, there is a specific process that some practitioners follow that detangles complexity and explains how an algorithm operates through market environments. With such high-level documentation, a strategy could be replicated, is one concern.

The current rue surfaced again when Renaissance Technologies Chief Operating Officer James Rowan was reported to have said at a private hedge fund conference this week that the CFTC requested a review of their computer code, a charge later denied by the CFTC.

“The CFTC has not made any inquiries or requests related to the source code of Renaissance Technologies,” Erica Elliott Richardson, a CFTC spokesperson, told ValueWalk.

Regardless of the issue status, the potential for regulators to demand access to private intellectual property sent chills up several spines.

Regulation AT for access to source code is the larger touchstone issue

For trading industry sources, the issue over this incident reflects the broader argument over what is known as Regulation AT, a topic previously addressed in ValueWalk.

Such a change in policy would set a dangerous precedent, according to Modern Markets Imitative Washington DC-based analyst Kristen Wegner. “There are only a few rare occasions when the government attacks private property,” she said.

Regulation of computer code that has the potential to destabilize global markets through potential flash crashes is a multi-fascinated issue that touches on core property rights and the ability of government to demand access to confidential business secrets. Such private industry rights have been juxtaposed to national security issues on several occasions.

The recent CFTC issue over the Regulation AT dispute brings to a boil a hot topic closely monitored in Silicon Valley and among trading firms around the world: Can a regulatory body, without a subpoena, gain access to confidential computer code? Even with a subpoena, the issue isn’t always clear, a situation was the most apparent in the FBI attempts to access the Apple iPhone of San Bernardino terrorists during March of 2016.

It is not only a question of property rights, but of regulatory authority as well, according to one exchange official.

Regulation AT Aside, Does the CFTC have the authority to investigate how orders are placed on electronic markets?

Specific methodologies mandated in CFTC rules guide how the regulatory organization interacts interact with their Designated-Self Regulatory Organizations (DSRO) and Designated Contact Markets (DCM) regulators. OneChicago, for instance, is a single stock futures exchange that offers listed clearing of individual name futures contracts, much of which is conducted in large block transactions. It is the duty of the exchange to police participants operating under their umbrella.

“The issue is how orders are placed in the electronic markets that affect the marketplace generally than that is the responsibility of the DCM/Exchange/ATS,” Downey said, pointing to a process with specific procedures. The DCM or in the case of derivatives the DSRO is charged with initial policing and investigations, “as designated in the rulebooks and the enforcement of the rules by the DCM.”

“If the CFTC/SEC are needed then they will become engaged,” Downey said, pointing to a referral process “per the rules.”

The legal tenants upon which these relationships are based can be murky. The CFTC has overruled its DSRO over investigations, such as what occurred in MF Global, documented in December 2011 Congressional testimony. There have also been conflicts over how high frequency trading rules are enforced, as evidenced by a lawsuit filed by former National Futures Association Chairman Chris Hehmeyer.

While the issue remains murky, what is clear is the sensitivity to regulator demands into access to private industry intellectual secrets.

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