Reengineering Oversight: Regulating Algorithms in Financial Markets

• In Event: 2124 - Economic Sociology: Maintaining Markets

Abstract

Beginning in the late 2000s, U.S.-based financial markets that previously had been separate and independent became integrated into a single sociotechnical system in part because of the introduction of electronic algorithmic trading and in part because of the Securities and Exchange Commission(SEC)’s efforts to help regulate inequalities in trading. Algorithms replaced human actors as traders and market intermediaries to place orders and perform market intermediation. However, in the electronic market where algorithms dominate trading activities, the financial regulatory agencies—the SEC and Commodity Futures Trading Commission—significantly lagged in their infrastructure and skills to monitor and enforce algorithmic trading. In 2010, the SEC initiated the creation of a regulation that would require market participants to build a central data infrastructure called Consolidated Audit Trail (CAT) to track all market activities by algorithms. The tracking system in the initial proposal represented their ideal system for surveilling and regulating algorithms, but market participants expressed concerns about the burden—necessary changes in internal processes and entailed costs for the changes—of building a system that would demand technological capabilities sufficient for monitoring algorithms. The Final Rule for the CAT is the product of such contention and negotiation. To adapt to the technological capabilities of the market participants, the regulators took a two-pronged approach to implement the CAT in the Final Rule. They tightened the business clock synchronization requirements, but postponed real-time reporting of all market activities. The clock synchronization requirement transformed the time regime of market participants to that of algorithms in measuring and recording time. Furthermore, despite the postponement the real-time surveillance and intervention that the regulators are aiming toward initiate a corollary algorithmic shift in regulation. That is, regulating algorithmic trading can only be attained by adopting algorithms for regulatory activities. Thus, even the SEC will become governed by algorithms.

Author

• Bo Hee Min, Copenhagen Business School