Nothing is more important to CME Group than the integrity of our markets. We use a variety of controls throughout the life of each trade, and those protections help to ensure customers have confidence in the market so they can manage their risk. We want to provide you with more information on how CME Group maintains the integrity of each market throughout the lifecycle of every trade.
CME Group has a system of risk controls that must be satisfied before a trader can enter a trade. These protections guard against a market participant entering unlimited quantities of orders or placing orders beyond their ability to execute and clear those orders.
CME Group and our clearing members use performance bonds, appropriate margin methodologies and additional risk management tools to protect our markets. These ensure that customers have the ability to execute the orders they place.
An order cannot be entered without passing pre-existing credit checks set by clearing firms. These ensure that, even for short-term traders who may exit their positions by the end of the trading session, financial requirements of the clearing member and the exchange are met. In addition, CME Group collects margin twice daily to ensure financial security. Both CME Group and the clearing member’s objective is to ensure that the customer is fully able to meet their financial obligations no matter what the conditions in the market.
Futures and options trading has transitioned from a mostly trading-pit-based system to a predominantly electronic market. Today, traders can enter their electronic orders manually – sometimes called “point and click” traders – or through automated systems such as auto-spreaders and defined algorithms. A subset of electronic trading is highfrequency trading. While there are a variety of different approaches to entering orders, it is important to remember that customers are prohibited by exchange rules from putting bids or offers in the book that they do not intend to execute or are unable to execute.
Regardless of how a trade is entered, there are controls on the actions that every trader can take. Credit controls and maximum order quantities are hard wired into the system to make the market function as efficiently as possible at all times. For example, credit controls ensure that a mandatory credit check is run before someone enters a trade on any CME Group exchange. Risk controls, another tool used by clearing firms, can block exposure at the executing firm or account level.
CME Group has a vested interest in preserving the integrity of its markets and accordingly employs substantial technological and human resources in its Market Regulation department to protect the market from anomalous, aberrant, abusive, and disruptive activity.
From the moment an order is placed, Market Regulation has a number of procedures and automated systems in place to monitor CME Group markets. These include staff oversight and engagement with market participants, automated systems that look for specific trading patterns, and established programs to perform complex data analysis. The Market Regulation team is also responsive to customer feedback and questions, and constantly monitors social media.
Over the years, Market Regulation has developed a highly granular and precise audit trail for electronic orders, trade, and market data information, which the company further enriches with outside reference data. Every order, modification, and cancellation, as well as every market data message is captured and maintained in this audit trail and is available for staff to monitor and analyze in real-time. At minimum, this audit trail information is time stamped at the millisecond level, with some systems capturing submillisecond increments.
Market Regulation analyzes the audit trail in conjunction with other pertinent data sources, such as records of position holders, using highly sophisticated tools, programs, and research methodologies. When anomalous activity or aberrations in market conditions are identified, comprehensive reviews are performed and documented. If a review concludes that disciplinary action is warranted, Market Regulation pursues those actions through an established enforcement program.
To ensure Market Regulation’s tools, techniques, programs other resources evolve with the market, CME Group continually invests in and develops these important facets of the company.
In addition to our Market Regulation team monitoring the markets and using automated trade data, a wide range of automated market protections are in place in the market to make it as efficient as possible. Credit controls, discussed earlier in this piece, are an example of pre-trade market protections. During the trading session, a number of other important tools are also at work in agricultural markets:
As orders are entered, bids and offers are disseminated through market data and in a central-limit order book for each market. For example, in agricultural products, this data is disseminated for 10 levels of the order book for grains and oilseeds and five levels of the order book for livestock and dairy products. In addition, in 2017, CME Group will begin publishing Market by Order data, which will provide greater detail on all orders at all levels of the book.
Customers can enter orders into Globex using a range of front ends and order-entry methodologies. Where speed of execution is a high priority, customers may use low-latency systems and possibly co-location. Others may find that calling their broker who then places the order meets their needs.
Customers have a range of options on the speed at which they place orders and how quickly they receive market data from the exchange. These alternatives impact both order entry and market data dissemination.
It is important to note that the order book locks when an order reaches the engine. Until that order is executed, no other order can change the composition of the book. Any unfilled bids or offers will be matched to the incoming order and the incoming order will be filled as fully as possible based on the composition of the order book.
In looking to execute large orders, it’s important to remember that while the book is locked during the execution of a given order, it unlocks between match events. This has implications for how customers place large orders. Let’s consider a customer who wants to execute a 500-contract buy order. If he places a single order for 500 contracts at a price which will sweep the 500 contracts that are offered in the book, the book will lock and he will get filled on his order. Alternatively, if the customer places five different 100-contract orders, it is a possibility that other orders may get between those orders and alter the book.
Suppose a 200-contract cancellation gets between the first and second of those five, 100-contract buy orders.
Orders flow sequentially through the match engine with no ability for one order to move ahead of another order. They are processed in the order received by the engine – whether they are new orders, modifications or cancellations. This means that once in the queue, one customer’s cancellation cannot get in front of another’s earlier buy or sell order to prevent that buyer or seller from lifting an existing order in the book.
In pit trading, the trader determined who would get filled on an order. In an electronic market, an allocation algorithm is used to determine who gets filled and in what amounts. CME Group constantly reviews how its algorithms are performing, and uses two different allocation algorithms in our agricultural products.
The FIFO algorithm uses price and time as the only criteria for filling an order. In this algorithm, all orders at the same price level are filled according to time priority; the first order at a price level is the first order matched. This gives an advantage to limit orders that have been in the order book at that price level the longest time. FIFO is currently used for livestock outright futures and EU Wheat futures.
The Split FIFO/Pro-Rata algorithm is a hybrid which integrates a percent-based allocation on both a FIFO and Pro-Rata formula to the resting order book. This algorithm has been developed with the flexibility to calibrate the level of tradable quantity that is allocated on a FIFO and Pro-Rata basis (A set percentage FIFO, and a set percentage Pro-Rata).
This algorithm ensures broader participation in the market. Currently set at 40% FIFO, this algorithm is used for grain futures (excluding EU Wheat) and spreads and livestock spreads.
Given that futures and options markets are now almost entirely electronic, speed and latency have become important issues for market participants of all kinds. For market makers, who are constantly adjusting bids and offers as the market moves, low latency can be a top priority so that stale bids and offers are removed from the order book as the market moves to different price levels. For others, who have longer term trading or risk management profiles, speed might be less of a priority than getting a set price.
Decisions such as what type of network connections, routing hardware, front-end order-entry and quote systems are being used all impact latency. Additionally, the physical proximity to the CME match engine impacts latency. A customer geographically further away, all else equal, will have greater latency than one close to the trading engine.
As part of its efforts to deliver access to low-cost connectivity services and support, CME Group allows every customer to rent equidistant connectivity to CME Globex through the exchange, major FCMs or third-party vendors. Costs are commensurate with the capacity needed (number of servers) and range from high-capacity multiple-rack installations to affordable virtual servers for cost-conscious customers.
The reasons for providing this service date back to when electronic markets started gaining significance, as CME Group observed customers buying and renting space as close to its match engine as possible to minimize latency. This gave an advantage to those who were first to obtain the closest real estate. In response, CME Group established a co-location facility so that each customer has a level playing field of access.
In recent years, CME Group adopted the CME Globex Messaging Efficiency Program to encourage responsible messaging practices – making sure there are not too many messages taking up bandwidth compared to the volume of trade in the market.
Each product has a benchmark message-to-fill ratio against which the total messages, weighted with the below factors for each message type, are compared. For example, in the case of Corn, the message-to-fill ratio it is 50:1, while in the case of Live Cattle it is 20:1. In the case of Live Cattle, this means that for every 20 messages, CME Group expects one fill. If an executing firm’s daily message-to-fill ratio exceeds the benchmark, CME Group levies a surcharge of $1,000 per product group, per day.
It is important that messaging programs provide guidelines without excessively constraining participants and therefore impacting liquidity – just as if pit traders had been told they could only bid or offer a set number of times before they had to buy or sell. For example, hedgers put in an order and expect it to be filled. They may need to move or modify their order if the market conditions change, but not that frequently. Their message-to-fill ratio is likely quite low. On the other hand, the messaging also has to work for the perspective of a market maker who typically will layer the book – that is have bids and offers at multiple levels above and below the market. As the market moves, market makers are constantly moving orders to frame the current market price and to manage the positions they are carrying. To do this effectively, their message-to-fill ratio can be much higher than that of the average hedger, and it is especially high in volatile markets.
Over the past decade, CME Group markets have evolved significantly as customers have shifted their business from the pits to the screen. This has created new market dynamics and challenges for both traders and exchanges. CME Group continues to evolve its platform and rules with the goal of ensuring its markets retain the highest integrity and are the most effective for meeting customers’ risk management needs.
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