(Kitco News) - A deeply liquid market is considered a sign of a healthy market with lots of participants, but a Commodity Futures Trading Commission official said all liquidity may not be the same and could be distorting markets.
The CFTC is concerned that some of the liquidity that may be provided by high-frequency traders could be “fantasy liquidity created by ‘wash’ sales,” which is prohibited under both the Commodity Exchange Act and exchange rules, said Bart Chilton, commissioner of the Commodity Futures Trading Commission, on Monday.
High-frequency traders enter and exit the market quickly and can do so multiple times a day, helping to create a more liquid market. But they’re a relatively new addition to the trading world and Chilton said how they operate needs closer scrutiny, especially since at times they can be 30% to 50% of a market.
Chilton, who spoke at The Trading Show Chicago 2013, calls these high-frequency traders “cheetahs” to describe the speed at which they trade.
“I don’t have a problem with cheetahs making money,” Chilton said, but added that the changes to the trading landscape create new policy, oversight and enforcement issues for the agency.
The concern is over “wash” trades, which happens a trader trades with himself, in other words puts out a bid price and matches it. “If you’re trading with yourself, you have nothing to lose, you’re not taking a risk. If this was occurring a little bit, it would be no harm, no foul,” Chilton said.
However, he said, this is happening more than a little bit, calling the wash trades “voluminous,” but said he was not allowed by legal counsel cite a specific amount.
Chilton said there may be two reasons why these wash trades are happening. One is to make it look like there is deep volume to entice other people to trade those markets. Second, these traders may be part of legitimate market-maker programs, which is when an exchange pays a market-maker to provide liquidity.
“But it’s dangerous if you’re trading with yourself and taking no risk. It can also affect price discovery and hurts consumers,” he said.
Chilton said there are existing exchange rules against wash sales and the CME Group is proposing additional rules against wash sales, “wash blocker guidance,” he called it.
He said the CME Group proposed the new rules a week ago and if the CFTC does not seek further review, the new plan would go into effect on July 1, but he said he would like to see this proposal go up for public comment.
“Unless we act by Thursday, to tell the CME to take a chill pill, it will go into effect on July 1,” he said.
He said that the CFTC staff could decide to put the CME proposal up to public comment. That would give the public 30 days to comment and afterward allow the CFTC up to 90 days to give their interpretation of the proposal.
“It may be totally fine…. But I want to make sure it’s ok,” Chilton said.
The IntercontinentalExchange may also propose wash trade guidance, he said, but so far they have not.
He gave an example to explain using CFTC data that shows how often and how quickly high-frequency traders are in markets. This was a separate discussion from the concerns over wash trades.
Chilton said in a December study, the CFTC looked at 20 million trading seconds, and of those 20 million, the agency pinpointed 189,000 seconds, mostly around the open and close of the markets. They looked at one 5,000-contract commodity market. During that time, high-frequency traders as a group traded at rates of 100 to 500 trades per second, he said.
In another, separate study the CFTC did, it looked at the impact high-frequency traders have on other market participants. “When cheetahs trade among themselves, they don’t make as much money. But when they trade with fundamental traders, a cheetah makes $1.92 on a $50,000 trade. But if that same trade is done with a small traders, they make $3.49,” Chilton said.
He further explained to the media that fundamental traders are usually large commercial end-users, while small traders could be anyone from a retail trader to even a grain elevator or cooperative.
He added that he is not against high-frequency traders, but he said people should know this. “We just want to put it out there,” he said.
When asked on the sidelines of the Chicago speech about any further progress over the CFTC’s investigation over possible silver market manipulation, which was started over four years ago, Chilton said he had nothing new to say, citing enforcement rules prohibiting public comment.
“I’d like the public to know what we’ve done, but I don’t want to characterize it in any way,” he said.
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By Debbie Carlson of Kitco News; dcarlson@kitco.com,
