CFTC Chair Massad Examines Market Structure and Risk

CFTC Chair Timothy Massad discussed aspects of the Treasury market that he said are important to include in the conversation about the general oversight of that market.

Chair Massad began by reviewing the findings in a joint staff report by U.S. financial regulators. The findings indicated a high correlation between prices and activity in the Treasury futures and cash markets. In response, Chair Massad suggested that the market fluctuations of October 15, 2014 – when a sudden large price movement in U.S. Treasuries was reversed within minutes – are happening to other products. He reported that the CFTC measured the frequency of “flash events” in Treasury futures and five of the most active contracts. It found that “movements of a magnitude similar to Treasuries on October 15th were not uncommon.”

Discussing the automation of trading, Chair Massad took a position that was largely positive. He acknowledged the tremendous significance of automated trading to the market and noted that, for some products, automated trading “accounts” for almost two-thirds of trading volume. He also reported that “[e]lectronic trading has contributed to a substantial improvement in transparency in the markets.” Before electronic trading, he said, traders often were unable to “maintain tight and deep spreads during volatile conditions. They likely took long coffee breaks.” However, he indicated that the CFTC probably would propose a number of measures to reduce the likelihood of technological glitches or other unfortunate reactions caused by automated trading.

Chair Massad delivered his remarks before the Conference on the Evolving Structure of the U.S. Treasury Markets at the New York Fed.

Lofchie Comment: Overall, Chair Massad’s assessment seemed fairly realistic; i.e., that electronic trading is not going away, and that markets sometimes move for reasons that cannot be easily explained. He also advanced what seemed to be limited and reasonable proposals for rule changes that could diminish the likelihood (though nothing could eliminate it) of future flash crashes.

All of that good stuff aside, the CFTC issued a number of press releases several months ago that a singled out a U.K. trader by the name of Sarao (who may have engaged in illegal trading activity) as the likely cause of the flash crash. The CFTC also published an academic study to support this allegation. On its face, the notion that the CFTC could trace the cause of the flash crash to the activities of a single trader acting in a completely routine, if illegal, manner seemed completely absurd. See, e.g., Finance Professor Calls CFTC Allegations That Nav Sarao Caused Flash Crash ”Outrageous” (with Lofchie Comment and Video Selection) (Apr. 24, 2015); CFTC Charges UK Trader Company with Spoofing Scheme That Contributed (Allegedly) to ”Flash Crash” Day in 2010 (with Lofchie Comment) (Apr. 21, 2015); Article Casts Doubt on Significance and Causes of Flash Crash (Apr. 23, 2015).

Chair Massad’s remarks make clear that the CFTC’s claims about Mr. Sarao were not justified. For starters, Chair Massad reported that flash events are relatively routine and in fact occur in many different markets. He also conceded that markets move for a number of different reasons and, sometimes, for no reason at all. In other words, (i) Sarao’s behavior, even if bad, was extremely common, (ii) flash events are likewise quite common in many different types of markets and (iii) it’s often difficult to know why markets move. Given Chair Massad’s contextualization of the crash, the CFTC should apologize to Mr. Sarao for trying to blame the flash crash on him. Even if Mr. Sarao were guilty of the trading violations of which he is accused, it is simply not right for a government agency to tarnish an individual’s name as the CFTC did Mr. Sarao’s.