Preparing Financial Regulation for the Second Machine Age: The Need for Oversight of Digital Intermediaries in the Futures Markets

Humanity is entering the Second Machine Age, in which artificially intelligent computers and software programs (artificial agents) will become involved in almost every aspect of society. Computers and software programs now drive and park cars, fly drones, compose music, sell insurance, manage investments, and even write news stories. Indeed, computers and software programs are far better––and quicker––than humans at jobs that involve looking at numbers and drawing conclusions from them, which would include jobs such as investment advisors and futures traders. The rise of automated trading systems (“ATSs”) that use high-frequency trading strategies in the futures markets is but one example of how technology is fundamentally changing the nature of the financial markets. As a result, humans who are operating as futures market intermediaries (such as commodity trading advisors or introducing brokers) are likely to be displaced by digital intermediaries, that is, artificial agents that perform critical roles related to enabling customers to access the futures and derivatives markets. For example, commodity trading advisors are persons who are compensated to advise others about placing trades in futures and derivatives. Some commodity trading advisors receive authority to direct trades in client accounts. Existing technology has created computers and software programs that are fully capable of suggesting when a client should place trades in futures contracts or making the trading decisions in a client’s futures trading account. In other words, there are computers and software programs that could, as digital intermediaries, perform the role of commodity trading advisors.

The Commodity Exchange Act (“CEA”) governs the U.S. derivatives markets and requires specified categories of intermediaries––such as commodity trading advisors and their associated persons––to register with the Commodity Futures Trading Commission (“CFTC”). Compulsory registration has been called “the kingpin” of the CEA’s “statutory machinery” because it serves to identify the persons acting as market professionals, and provides a mechanism for such persons to undergo background ethics screenings for fitness to work in the industry, as well as proficiency testing and ethics training. The registration requirement only applies to humans and business entities that are considered “persons” under the law. Because the current laws and regulations focus on humans and legal “persons,” but not digital intermediaries (i.e., the computers and software programs operating as artificial agents), the existing laws and regulations may very well be failing to comprehensively oversee all entities whose activities otherwise would place them within the CFTC’s regulatory ambit. For example, the law and regulations require certain human (but not artificial) futures trading professionals to undergo mandatory competency testing and ethical screening. In the futures industry, ethical screening applies only to humans and operates under a statutory disqualification framework in which prior misconduct can cause a person to be barred from working as a futures (or derivative) trading professional. The current ethical screening process would ban a human with a history of engaging in disruptive trading practices from the industry but would not capture a digital intermediary (say, a misconduct-prone algorithmic trading program) with a similar track record. Because these requirements only apply to humans (and in some cases business entities that are legal persons), but not digital intermediaries, they fail to cover some of the entities that are actually making trading decisions for clients or otherwise operating as intermediaries in the derivative markets.

Because technological advances are enabling artificial agents to perform many of the intermediary roles that previously were done by humans, Congress and the CFTC should modify the CEA and CFTC Regulations (1) to expand the scope of persons who must register to include, among other things, persons who use ATSs and who have trading privileges on, or direct electronic access to, derivatives exchanges (or trading venues), and (2) to implement an identification program for ATSs and algorithms.

Lastly, Congress and the CFTC should look to research by academics in philosophy and law concerning (1) ways to ensure that digital intermediaries are built not just to be intelligent but also to be ethical, and (2) methods for allocating liability for wrongdoing by digital intermediaries.

The preceding post comes to us from Gregory Scopino, Adjunct Professor of Law at Cornell Law School and Special Counsel with the U.S. Commodity Futures Trading Commission (CFTC). It is based on his recent paper, “Preparing Financial Regulation for the Second Machine Age: The Need for Oversight of Digital Intermediaries in the Futures Markets,” which is forthcoming in The Columbia Business Law Review and available here. The positions expressed here and in Mr. Scopino’s paper are his own, and do not represent the views of the CFTC, its Commissioners, or other staff members.