Tue. Oct 26th, 2021

Something Bots and the law: technology, automation and regulation of futures and other derivatives. 2020. Gregory Scopino. Cambridge University Press.

Derivative commercial technology has exploded in sophistication since the Great Financial Crisis, thanks to algorithms and electronic execution. The market for open cries about futures is becoming a distant memory, but it is unclear if we have a regulatory environment that can effectively cope with an execution-driven world. Technological improvements are increasingly affecting trading behavior, although the March 2020 pandemic market crisis generated a spending alert on market liquidity and plumbing issues and the set of regulations that traders navigate to take and provide liquidity. In a crisis, the nexus of technology, rules, and regulations may fail investors who need liquidity to minimize the cost of dealing with an adverse market environment.

In Something Bots and the law, Gregory Scopino, adjunct professor of law at Georgetown University and special advisor to the Market Participants Division of the Commodity Futures Trading Commission, seeks to make sense of this important intersection between regulation and enforcement technology.

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Artificial intelligence (AI) has advanced automated trading systems, or “something bots,” to the point that programs can react faster than any human trader and find relationships that the ground trader or market maker can only imagine. . Something Bots and the law reviews and discusses the implications for market surveillance of this fast-paced electronic environment. For those unfamiliar with the history and context of many futures and derivatives regulation issues, the first half of this book is a good introduction and addresses the key questions about what a futures market is and how to should regulate.

Futures regulation is different from securities regulation, with different goals and emphasis. Something Bots and the law it clearly explains a regulatory system full of arcane thoughts that may be in conflict between regulatory agencies and global jurisdictions. Regulation derived from swap markets is even more recent, so rules and jurisprudence are limited, somewhat murky, and contradictory. Regulatory clarity is especially needed in the case of fintech developments, such as cryptocurrencies.

Scopino’s descriptions serve as the basis for trade issues of some of the more complex and regulatory oversight issues addressed in the second half of the book. Today the regulation cannot be separated from the previous and previous regulations. Technology can advance markets, even if it is limited by the legal environment. However, the regulatory environment must adapt to the changing technology that facilitates transactions in our larger markets.

Critical legal issues such as fraud, manipulation, “counterfeiting,” and market integrity are described in detail in the context of advanced enforcement technology. These issues are of great public interest when associated with “rapid blockages” (i.e., short-term extreme declines in prices resulting from the disappearance of liquidity). Traders perform price discovery and obtain liquidity information from the market microstructure. The order book provides important information about the intentions of market players, although by placing and canceling orders, an automated trading system can create the emergence of liquidity and market demand that do not exist. Rapid addition and subtraction of orders can be seen as fraud and manipulation and can destroy the integrity of basic market functions.

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Seemingly simple problems can lead to regulatory complexity. Fraud and manipulation are based on the intent of traders, but can an algorithm that can obtain orders during a market decline, based on an AI reaction function or a feedback loop, have a detrimental legal intent? The author offers some answers and a solution that consists of regulating bots somewhat as a category of market participant, which is no different from flat traders. It also suggests the need for funds for market disruption and similar solutions to flash failure insurance.

Something Bots and the law provides a deeply detailed journey through the history of the regulation of futures and derivatives markets, from market definitions to how the legal precedent influences current thinking about the regulation of electronic markets. However, finance professionals who focus on market mechanics and how regulation affects their line of execution may be disappointed with the highly technical wording reminiscent of a law review article. Scopino does a good job of making this work accessible through clear prose and good examples, but he clearly has the legal audience for his book in mind. This is to the detriment of professionals who want to understand how enforcement services could adapt to the regulatory environment and potentially enhance liquidity.

In more than 470 pages, this work could have been condensed and focused on the future of regulation to create a more compelling story for a wider audience. Something Bots and the law
it would be more effective if one tried to relate legal issues to growing research on market microstructures and focus on the intersection of law and economics. While Scopino touches on many important issues, asset managers are likely to prefer a larger view of how regulation can shape the future of execution and prevent market crashes.

Execution technology is an arms race, with those trying to create a market advantage competing against those trying to minimize the cost of execution. The actions of one group that achieve a technological advantage invite the response of the other group. This conflict over different business objectives drives trends in liquidity and transaction costs. The resulting profits cannot be obtained if the integrity of the market is questioned or market collapses occur.

Journal of Financial Analysts

Markets are public goods, places where price discovery occurs through the transmission of order information. Therefore, regulation must look beyond competition and ensure the integrity of pricing information and adequate liquidity in a crisis. From my point of view as a professional and market economist, Scopino’s legal approach, while well presented, misses the opportunity to advance opinions on the structure of the market and potentially influence readers. and in regulatory thinking in a direction that will anticipate and address possible execution problems in a world. of fragile liquidity.

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All publications are the opinion of the author. As such, they should not be construed as investment advice, nor should the views expressed necessarily reflect the views of the CFA Institute or the author’s employer.

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