Category: Regulation

The SEC has announced:

The Securities and Exchange Commission today adopted rule changes to shorten the standard settlement cycle for most broker-dealer transactions in securities from two business days after the trade date (T+2) to one (T+1). The final rule is designed to benefit investors and reduce the credit, market, and liquidity risks in securities transactions faced by market participants.

“I support this rulemaking because it will reduce latency, lower risk, and promote efficiency as well as greater liquidity in the markets,” said SEC Chair Gary Gensler. “Today’s adoption addresses one of the four areas the staff recommended the Commission address in response to the meme stock events of 2021. Taken together, these amendments will make our market plumbing more resilient, timely, orderly, and efficient.”

In addition to shortening the standard settlement cycle, the final rules will improve the processing of institutional trades. Specifically, the final rules will require a broker-dealer to either enter into written agreements or establish, maintain, and enforce written policies and procedures reasonably designed to ensure the completion of allocations, confirmations, and affirmations as soon as technologically practicable and no later than the end of trade date. The final rules also require registered investment advisers to make and keep records of the allocations, confirmations, and affirmations for certain securities transactions.

Further, the final rules add a new requirement to facilitate straight-through processing, which applies to certain types of clearing agencies that provide central matching services. The final rules will require central matching service providers to establish, implement, maintain, and enforce new policies and procedures reasonably designed to facilitate straight-through processing and require them to submit an annual report to the Commission that describes and quantifies progress with respect to straight-through processing.

The adopting release is published on SEC.gov and will be published in the Federal Register. The final rules will become effective 60 days after publication in the Federal Register. The compliance date for the final rules is May 28, 2024.

This is wonderful news, albeit of more interest to institutional investors and their fund managers than to retail. Back in my Canada bond trading days, it was unusual, but not unknown, for clients of the firm to have trades totalling 100-million per side (buy and sell) with a single dealer. Say the market has moved by a buck after trade time but before settlement. Then one side has a loss of 1-million odd, and the other side has a gain of about the same amount. Now say the dealer goes bust before the trade gets settled. The losing side of the trade would settle, but the winning side … maybe. When Confederation Life went bust in the nineties, if you had an outstanding FX trade that you were losing money on, it settled. If you were winning … get in line, buddy! So this is a risk that is reduced by faster settlement.

There are implications for retail, though … everybody remembers the Robin Hood / Meme Stock problem, when Robin Hood suddenly started getting very fussy about what orders they would accept … and although you’ll find lots of vitriol on the web directed at them by newbie retails, you’ll also learn that few of these guys understood the problem: the problem was that clearing corporations demand collateral to mitigate the settlement risk described above:

New York markets had just fired up, and the investing world was tuning in for Thursday’s episode of the continuing drama: Legions of Robinhood Markets investors versus hedge-fund Goliaths.

But within minutes, a shock wave invisible to the outside world rattled the mechanics of Wall Street — sending Robinhood rushing for more than $1 billion of additional cash. The stock market’s central clearing hub had demanded large sums of collateral from brokerages including Robinhood that for weeks had facilitated spectacular jumps in shares such as GameStop Corp.

The Silicon Valley venture with the wildly popular no-fee trading app came to a crossroads. It reined in the risk to itself by banning certain trades and unwinding client bets — igniting an outcry from customers and even U.S. political leaders. By that night, word was emerging that Robinhood had raised more than $1 billion from existing investors and drawn hundreds of millions more from bank credit lines to weather the storm.
…
The question is whether such critics will dig into the industry’s inner workings, where pressure mounted on Robinhood and other firms to limit certain trades. That would put a rare spotlight on arcane parts of the market designed to prevent catastrophe, such as the Depository Trust & Clearing Corp.

One key consideration for brokers, particularly around high-flying and volatile stocks like GameStop, is in the money they must put up with the DTCC while waiting a few days for stock transactions to settle. Those outlays, which behave like margin in a brokerage account, can create a cash crunch on volatile days, say when GameStop falls from $483 to $112 like it did at one point during Thursday’s session.
…
The trouble on Thursday began around 10 a.m., when after days of turbulence, the DTCC demanded significantly more collateral from member brokers, according to two people familiar with the matter.

A spokesman for the DTCC wouldn’t specify how much it required from specific firms but said that by the end of the day industrywide collateral requirements jumped to $33.5 billion, up from $26 billion.

Brokerage executives rushed to figure out how to come up with the funds. Robinhood’s reaction drew the most public attention, but the firm wasn’t alone in limiting trading of stocks such as GameStop and AMC Entertainment Holdings Inc.

In fact, Charles Schwab Corp.’s TD Ameritrade curbed transactions in both of those companies on Wednesday. Interactive Brokers Group Inc. and Morgan Stanley’s E*Trade took similar action Thursday.

So, faster settlement will alleviate, to a large degree, the amount of settlement risk there is in the system and, hopefully, reduce the chance of serious volatility freezing the markets.

There was a lot of self-congratulation. Chair Gary Gensler stated:

First, the amendments will shorten the standard settlement cycle by half, from two business days (“T+2”) to one business day (“T+1”). The amendments also will halve the settlement cycle for trades relating to initial public offerings, from T+4 to T+2. As they say, time is money. Halving these settlement cycles will reduce the amount of margin that counterparties need to place with the clearinghouse. This lowers risk in the system and frees up liquidity elsewhere in the market.

Now, that’s not to say this change will be new; in fact, this change simply brings us back to the T+1 settlement cycle our markets used up until the 1920s. It also aligns with the T+1 cycle used in the $24 trillion Treasury market.
…
Today’s adoption addresses one of the four areas the staff recommended the Commission address in response to the meme stock events of 2021. Further, the implementation for these amendments will be set to after Memorial Day weekend (May 28, 2024). This implementation comes more than three years after key industry members first proposed shortening the settlement cycle, and a year and a quarter from now, providing sufficient time in my view for the transition. Further easing the transition, the implementation date will occur during a three-day holiday weekend.

Commissioner Jaime Lizárraga stated:

Why does this matter to the investing public? Because buyers and sellers of securities will receive their cash and securities a day earlier under T+1 than they do currently. And because market participants can allocate their capital more quickly and efficiently. Based on the public comments to the proposal, these benefits accrue to retail investors in particular.

Reducing the current settlement time in half will alleviate some of the downsides of the current T+2 cycle, such as counterparty, market, liquidity, credit, and other risks. A longer settlement time also requires risk management tools, such as margin requirements, that carry significant costs. Shortening the settlement cycle not only helps reduce these risks and costs but lowers volatility and makes our markets more fair and efficient.

The risks of longer settlement times are not just theoretical. In January 2021, unprecedented price volatility in so-called “meme stocks” challenged many retail investors’ faith in our in financial markets. Clearing agencies in equities and options experienced record volumes cleared. In the face of high volume and volatility, market utilities had to issue significant margin calls. In reaction to these margin calls, certain brokers restricted trading in some, or all, of the meme stocks. According to media reports, at least one broker’s decisions to halt trading came at the peak of the market and infuriated many retail investors. Investors have filed approximately 50 class action lawsuits claiming substantial harm from this broker’s trading halt.

Commissioner Caroline A. Crenshaw stated (with lots of valuable footnotes):

Specifically, a shorter settlement cycle should reduce the number of outstanding unsettled trades, reduce clearing agency margin requirements, and allow investors quicker access to their securities and funds. Longer settlement periods, on the other hand, are associated with increased counterparty default risk, market risk, liquidity risk, credit risk, and overall systemic risk.[7]

Commenters were overwhelmingly in favor of shortening the settlement cycle.[8] We received supportive comments from a broad range of stakeholders, including individual investors, investor advocates, clearing agencies, and broker-dealers.[9] Some commenters raised concerns regarding the proposed changes related to the processing of institutional trades,[10] firm commitment offerings,[11] and security-based swaps,[12] and the final rule reflects certain changes from the proposal in response to those comments. A number of commenters also raised concerns about the implementation timeline, which has been extended by several months from the proposed date to facilitate a smooth transition.[13] The new compliance date would provide market participants more than fifteen months to prepare for the transition.[14]

The proposal also included a request for comment on the possibility of settling trades by the end of the trade date, or what we call “T+0.” Some commenters highlighted challenges relating to multi-lateral netting, securities lending practices, and other issues.[15] However, many others expressed support for an eventual move to T+0.[16] While it is clear that T+0 will entail greater operational and technological challenges than the move to T+1, I agree with commenters that such a move may be both desirable and feasible in the future, and I look forward to working with my colleagues and stakeholders toward that important goal.[17]

Commissioner Mark T. Uyeda was a little bitter (bolding added):

While the net benefits of a shorter settlement cycle are clear, T + 1 can potentially increase some operational risks. There will be less time to address errors within the process and, in some circumstances, less time to deal with trading entities that are suddenly confronting massive and unexpected trading losses within the settlement cycle timeframe. There is also less time for regulators to identify and freeze the potential proceeds from potential frauds, such as, insider trading and market manipulation, before those proceeds exit our jurisdiction. These arguments and considerations, however, do not ultimately weigh against shortening the settlement cycle, but they provide reason for ensuring readiness among market participants. This speaks to the implementation date.

Ensuring a smooth transition will take significant investment and systems changes as well as operational and computational testing among broker-dealers, clearing firms, investment advisers, custodians, payment systems, and so on. Detailed planning is required, as is process adjustment, organizational change, and changes in the relationships among market participants. There is asymmetry in terms of costs and benefits—a smooth transition would provide net benefits for investors and U.S. markets to be accrued over the long-term in the future. On the other hand, the downside of a rough, turbulent transition could be steep, and could induce substantial harm in the short-run. That asymmetry cautions us to provide sufficient time to ensure a smooth transition.

Many comment letters have emphasized the need for more time than the Commission proposed.[5] Many have pointed to the 2024 Labor Day weekend as the implementation date. It would have the added advantage that Canada is also moving forward with T + 1 around the same time. Instead, the Commission appears to be ready to adopt May 28, 2024 as the implementation date.[6] In my view, we are in an imprudent rush away from a sensible transition date and, for that reason, I am unable to support the final rule.

Commissioner Hester M. Peirce also complained about implementation (bolding added):

I support the plan to move to T+1, but do not support the proposed timeline for making this change. Shortening the settlement cycle is a way to remove some risk from our markets. Mandating that the change occur in May 2024, however, could pose risks of its own by forcing the transition before market participants are ready. I propose instead a September 3, 2024 implementation date. Let me explain why:

• Although preferable to the proposed March 31, 2024 implementation date, the May 28, 2024 date is still too early. Shortening the settlement cycle by one business day is a big change with implications all across the market. We cannot afford a cavalier approach.
• Many commenters called for a September 3, 2024 date to ensure that the transition would happen with minimal disruption to the markets.
• Tuesday, September 3, 2024 is the first business day after the 3-day Labor Day weekend, and Canada, the only jurisdiction currently planning on moving with us to T+1, shares this 3-day weekend. The transition from T+3 to T+2 occurred successfully over Labor Day weekend in 2017.
• This later date would give other foreign market participants the time to work out some of the challenges they will face from our transition to a shorter settlement cycle than they have in their markets.
• The additional three months will allow more time for firm-specific and coordinated, industry-wide testing, which will make a smoother transition more likely.
• The transition from T+2 to T+1 is likely to present numerous operational challenges—some of them more difficult than in the last transition—related to, among other things, pre- and post-trade processes, securities lending, foreign exchange transactions, and processing corporate actions.
• The transition is happening at the same time the market is processing many other regulatory changes.

I do not have any questions for the staff, but do want to make one final plea to Chair Gensler. Why not adopt a September 3, 2024 compliance date? I will vote for the rule if you make this change.

The Canadian Securities Administrators have announced that they have:

published for comment CSA Staff Notice 21-315 Next Steps in Regulation and Transparency of the Fixed Income Market, which describes the CSA’s plan to enhance fixed income regulation.

The Notice sets out the steps CSA staff are taking to improve market integrity, evaluate access to the fixed income market and facilitate more informed decision making among market participants.
…
The CSA Staff Notice can be found on CSA members’ websites. The 45-day comment period will close on November 1, 2015.

Naturally the CSA can’t put actual links on the press release announcing their existence. That would be too simple, but after some poking around we find on the OSC website CSA Staff Notice and Request for Comment 21-315 Next Steps in Regulation and Transparency of the Fixed Income Market:

On April 23, 2015, staff of the Ontario Securities Commission (OSC) published a report titled The Canadian Fixed Income Market 2014 (the Report).{2} The Report presented a fact-based snapshot of the $2 trillion fixed income market in Canada, with particular emphasis on the $500 billion in corporate debt outstanding.{3} The Report also highlighted the following:

1. fixed income data available is limited and fragmented across a number of sources, which makes it difficult to conduct a comprehensive assessment of the fixed income market;

2. the secondary fixed income market is a decentralized, over-the-counter market where large investors have significantly more bargaining power than small investors;

3. there is limited adoption of electronic trading and alternative trading systems, especially for corporate bonds; and

4. direct retail participation in the primary and secondary fixed income market is low and retail investors typically access the fixed income market by purchasing investment funds.

The purpose of this notice is to set out the CSA staff’s plan to enhance fixed income regulation to:

1. facilitate more informed decision-making among all market participants, regardless of their size;

2. improve market integrity; and

3. evaluate whether access to the fixed income market is fair and equitable for all investors.

Each of these steps is discussed in the sections below.

The report was discussed on PrefBlog in the post The Canadian Fixed Income Market: 2014.

It is noteworthy that not one of the objectives involves answering the question “What is the corporate bond market for?”. If this question was ever asked and it was decided that the purpose of the corporate bond market was to give Granny a good place to invest her $5,000 in a single particular bond at a good price then the other objectives make sense. If, however, the purpose of the market is to give corporations access to debt funding that is less constraining and cheaper than bank funding, so they can invest money, help the economy grow and create jobs, then other conclusions might be drawn.

However, CSA staff already has jobs, currently on the public payroll and quite often with the banks afterwards, so job creation by other corporations is hardly a meaningful concern.

As they are on the public payroll, they have very prudently not commenced crippling the government bond market:

NI 21-101 sets out transparency requirements for government debt securities. Specifically, marketplaces and inter-dealer bond brokers are required to report order or trade information, or both, to an information processor. However, an exemption from these transparency requirements is in place and was recently extended until January 1, 2018, through amendments to NI 21-101. As indicated in the notice published with the amendments,{9} no other jurisdiction has mandated transparency for government debt securities. The extension was granted in order to allow CSA staff to monitor international developments, including the expected implementation of the transparency regime that will be established across the European Union by the new Markets in Financial Instruments Directive (MiFID II) and the Markets in Financial Instrument Regulation (MiFIR) adopted by the European Commission,{10} and to determine whether the NI 21-101 transparency requirements for government debt securities should be implemented or whether changes are appropriate.

It is laughable that CSA staff boasts about the wonders of public dissemination of information via SEDAR without permitting direct links to these public documents, but the funniest part of this diktat is their lip service to liquidity:

As noted above, it is CSA staff’s goal to achieve transparency for trades in all corporate debt securities by the end of 2017. We have considered how to achieve this goal in light of:

• the fact that IIROC will be implementing the IIROC Debt Reporting Rule in two phases (described below); and

• concerns that have been raised globally about a decrease in the liquidity in corporate debt markets, and the potential impact of additional transparency on liquidity.{19}

It is intended that transparency for all corporate debt securities will be phased in over the next two years in two phases, as follows:

• in Phase I (expected to occur in mid-2016), IIROC, as an information processor, will disseminate post-trade information for all trades in the Designated Corporate Debt Securities and for retail trades{20} for all other corporate debt securities reported to IIROC; and

• in Phase II (expected to occur in mid-2017), IIROC will disseminate information for all trades in all corporate debt securities and for new issues of corporate debt.

Footnote 19 reads: Specifically, concerns have been raised globally about a potential decrease in the liquidity of the fixed income markets due to a number of factors, including an increase in corporate bond issuances coupled with, some believe, decreases in dealers’ inventories resulting from changes in regulation. We have also heard these concerns raised by Canadian buy-side and sell-side firms during our discussions regarding liquidity and transparency.

Oh, isn’t that just the sweetest thing you can imagine! They’ve “heard these concerns” and, of course, having heard them we can rely on our Wise Masters to have made the correct decision. Just what these concerns were and just why certain decisions were made is none of your business – not only are you mere investor scum but you’re not even government employees, so dry up and blow away, vermin.

I have written about liquidity ant transparency many times on this blog and provided some of the links in my review of the OSC literature survey that is being used as cover for the CSA’s shenanigans. The short version is: increasing transparency leads to markets with a narrower bid-ask spread, but less depth. This has been shown time and time again by academics studying all sorts of markets. Naturally, the regulators are focussing on a definition of liquidity that emphasizes the bid-ask spread; Granny will be able to trade her $5,000 worth of bonds much more cheaply. Investors who trade corporates in $1-million+ sized chunks, however, experience a sharp decline in liquidity. This, naturally, increases the risk of flash-crashes and ‘crowded-trades’ as retail dumps ETFs … but who cares? That will merely give the regulators another excuse for some crocodile tears and another expensive study.

Institutional level liquidity is not a joke and it’s not trivial. When investments are more volatile and less liquid, you want to get paid more for holding them. That is to say, you demand more yield. It is the issuers who are paying that yield and increases in this yield increase their costs, and make building that new factory just that much less attractive.

But nobody cares and the regulators can’t even be bothered to ask ‘What is the corporate bond market for?’.

I’ve had it with this sham. However, for those who are interested, there was a story in the Globe about this issue titled Canadian regulators unveil new system to report corporate bond trading data. The plan has been greeted with rapturous applause from non-investors.

Coming up next: industry regulators take on the Ontario Food Terminal. It is disgusting that purchase of food at wholesale prices is restricted! Let’s see some FAIRNESS!!!

Update, 2015-9-19: Other press mentions have been Canada to Boost Corporate Bond Market Transparency by 2017 and CSA seeks comments on enhancing fixed-income transparency. The former article is notable for the paragraph:

“The steps we have set out to enhance regulation in the fixed income market will improve market transparency and better protect investor interests,” Tracey Stern, head of market regulation at the Ontario Securities Commission, said in an e- mailed statement. “With increased transparency, investors will be in a better position to assess the quality of their executions.”

Do I really need to point out that the concept of judging “quality of their executions” is a concept that applies only to brokered trades, while virtually all bond transactions are done on a principal basis? It would appear that I do.

Assiduous Readers will remember the highly politicized SEC Flash Crash Report. It’s taken five years, but they’ve finally isolated a scapegoat who spends his spare time rubbing his hands together and cackling about the triumph of evil:

NAVINDER SINGH SARAO was a futures trader
who operated from his residence in the United Kingdom and who traded primarily through his company, Nav Sarao Futures Limited.
…
“Layering” (a type of “spoofing”) was a form of manipulative, high speed activity in the financial markets. In a layering scheme, a trader places multiple, bogus orders that the trader does not intend to have executed-for example, multiple orders to sell a financial product at different price points-and then quickly modifies or cancels those orders before they are executed. The purpose of these bogus orders is to trick other market participants and manipulate the product’s market price (in the foregoing example of bogus sell orders, by creating a false appearance of increased supply in the product and thereby depressing its market price). The trader seeks to mislead and deceive investors by communicating false pricing signals to the market, to create a false impression of how market participants value a financial product, and thus to prevent legitimate forces of supply and demand from operating properly. The trader does so by creating a false appearance of market depth, with intent to create artificial price movements. The trader could then exploit this layering activity by simultaneously executing other, real trades that the trader does intend to have executed, in an attempt to profit from the artificial price movements that the trader had created. Such layering and trading activity occurs over the course of seconds, in multiple cycles that the trader repeats throughout the trading day. Given the speed and near simultaneity of market activity in a successful layering scheme, such schemes are aided by custom programmed, automated trading software.
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Beginning in or about June 2009, SARAO sought to enrich himself through manipulation of the market for E-Minis. By placing multiple large-volume orders on the CME at different price points, SARAO created the false appearance of substantial supply in order to fraudulently induce other market participants to react to his deceptive market information. SARAO thus artificially depressed EMini prices. With the aid of an automated trading program, SARAO was able to all but eliminate his risk of unintentionally executing these orders by modifying and ultimately canceling them before execution. Meanwhile, he exploited his manipulation to reap large trading profits by executing other, real orders.

Matt Levine of Bloomberg – who I respect greatly as a reporter who really puts a lot of intelligence and sweat to work when writing his columns – writes a wonderful column regarding the indictment:

So straightforward that one of the biggest puzzles here is why it took so long — and the help of a whistleblower — for regulators to figure it out. They came tantalizingly close:

As reflected in correspondence with both SARAO and an FCM he used, the CME observed that, between September 2008 and October 2009, SARAO had engaged in pre-opening activity — specifically, entering orders and then canceling them — that “appeared to have a significant impact on the Indicative Opening Price.” The CME contacted SARAO about this activity in March 2009 and notified him, via correspondence dated May 6, 2010, that “all orders entered on Globex during the pre-opening are expected to be entered in good faith for the purpose of executing bona fide transactions.” The CME provided a copy of the latter correspondence to SARAO’s FCM, which suggested to SARAO in an email that he call the FCM’s compliance department if he had any questions. In a responsive email dated May 25, 2010, SARAO wrote to his FCM that he had “just called” the CME “and told em to kiss my ass.”

Emphasis added because come on: The futures exchange wrote to Sarao on the day of the flash crash, telling him to stop spoofing, and he called them back “and told em to kiss my ass.” And then regulators pondered that reply for five years before deciding that they’d prefer to have him arrested in London and extradited to face criminal spoofing charges. One conclusion here might be that rudeness to regulators really works.

It’s a tempting idea!

The CFTC claims that Sarao basically started his spoofing career by causing the flash crash, and then went ahead and kept spoofing for another five years without much interruption. I guess he got more subtle at it? Not very subtle though; he was a consistently large trader, “placing, repeatedly modifying, and ultimately canceling multiple 200-, 250-, 300-, 400-, 500-, 550-, 600-, and 900-lot sell orders,” versus an average order size of seven contracts. He also seems to have had some patterns (like putting in orders for exactly 188 or 289 contracts that never executed) that you’d think would make him easier for regulators or exchanges to spot.6 If regulators think that Sarao’s behavior on May 6, 2010, caused the flash crash, and if they think he continued that behavior for much of the subsequent five years, and if that behavior was screamingly obvious, maybe they should have stopped him a little earlier?

Also, I mean, if his behavior on May 6, 2010, caused the flash crash, and if he continued it for much of the subsequent five years, why didn’t he cause, you know, a dozen flash crashes?

And Mr. Levine closes with the key point:

I have always been impressed and puzzled that low-tech spoofers have much success ripping off whomever they rip off. It’s such a minimal fraud; it’s just saying that you want to sell when you don’t want to sell.10 It’s always surprising that that could have a major effect on markets. John Arnold has argued here at Bloomberg View that spoofing only hurts front-running high-frequency traders, while others point out that “algorithmic trading tools are used by a wide class of traders,” including long-term investors like Waddell & Reed who use algorithms to try to avoid the front-running HFTs. But the FBI’s and CFTC’s theory here is far more troubling: It suggests that existing algorithms are not just dumb enough to give spoofers some of their money, but dumb enough to give spoofers so much of their money that they destabilize the financial markets. It’s not especially confidence-inspiring to read that a guy with a spreadsheet can trick everyone into thinking that the market is crashing, and thereby cause the market to crash.

Well, if the extremely well-paid hard-nosed deep-thinking portfolio managers at Waddell & Reed have their naivety and incompetence exploited by someone who plays the game a little better than they do, you won’t find any tears here.

I hadn’t read the argument linked with “others point out” before, but it doesn’t impress me:

Even if we exclude cases such as this one and legalize the submission of spoofed orders with the proviso that they stay live for less than 100ms, there are plenty of unsophisticated market participants who would still be harmed. These days, algorithmic trading tools are used by a wide class of traders. There is an entire industry, possibly larger than that of vanilla HFT, focused on creating and marketing these tools. Tremendous volume is executed via algorithms on behalf of traditional long-term traders.[2] I’m not an expert on such algorithms, but my impression is that they tend to be much less sophisticated than a lot of vanilla HFT, and thus more likely to be tricked by spoofing. A basic example of one such execution algorithm would be a peg order, which is priced in a very simple fashion somewhere in between the best bid and ask. If a spoofer alters the best bid then a peg order will change its price in response, leaving the user open to losses.

The open question here is: why should anybody in his right mind care about unsophisticated market participants? If they show up at a gunfight with a boxing glove, that’s their problem; the sooner they go bankrupt and go on welfare, the better, as far as I’m concerned. If they are placing orders with no other thought than ‘Golly, I guess I’ll do whatever the rest of the market is doing’ then they are contributing to market inefficiency and harming the market’s price discovery function. So screw ’em; give a medal to the guys who punish ’em. Markets and market regulation should concentrate on the best interests of fundamental traders; any help, succor or encouragement given to techno-weenies is misplaced.

The other major argument in the linked objection is:

Say that you wanted to change this definition to allow spoofing with the intention of damaging order-anticipation strategies. Could you do so in a fashion that didn’t also allow other kinds of nasty manipulation? I don’t see how. Manipulation via self-trading is probably a behavior that everybody agrees should be prohibited. When a manipulator trades with themselves, they can do so risk-free at an arbitrary price, giving other traders a false sense of the market price.[3] Self-trading can be extremely damaging to market integrity. But which group, I wonder, is most hurt by self-trading? One could argue that so-called “front-runners” are. For example, say Apple stock is currently trading at $100, and a manipulator trades 10 million shares with themselves at $90. There could be order-anticipation algorithms, ‘predicting’ selling to come, that react to this and sell Apple stock.[4] There could also be strategies that take this as a signal that there will soon be selling across the entire sector, and sell stocks in related companies. These algorithms fall under Arnold’s definition of “front-running,” and would be expected to lose money when the manipulator decides it’s time to push Apple stock back to $100. Does that mean we should celebrate the manipulator? No.[5]

That’s a big leap of logic in the last word there! I will certainly celebrate the manipulator: he’s punished a few stupid rat-turds who aren’t trading on fundamentals. Good for him!

To his credit, the guy at Mechanical Markets does address my view in his footnote:

[5] If you’re a long-term investor, this scenario seems great, right? You can buy Apple stock at a $10 discount. So, if you thought the stock had an intrinsic value of $105, you’re getting a real bargain. In practice though, I’d imagine that you would hesitate to start buying stock in such a scenario. At least until you had confirmed that the price wasn’t plummeting because of some news that you hadn’t heard yet. By the time you could rule out any news, the manipulator would have pushed the price back to $100.

He who hesitates is lost! Many limit orders entered by fundamental traders during the manipulation phase will be executed prices more attractive than would otherwise be the case. In the long run, fundamental traders who pursue incredibly sophisticated strategies like “paying what they consider a fair price for their purchases” will scoop up all kinds of money from the empty-headed game-players.

But, of course, the Boo-Hoo-Hoo Brigade is in full cry:

“It’s incumbent upon regulators not to be asleep at the switches,” said Donald Selkin, who helps manage about $3 billion as chief market strategist at National Securities Corp. in New York. “They have been, time and time again.”
…
“Things like this don’t build a lot of confidence,” said Timothy Ghriskey, the chief investment officer at Solaris Asset Management LLC in New York, who helps manage about $1.5 billion. “It’s a risk that regulators are always going to be a step behind. That’s why they should be more aggressive.”
…
“It’s ridiculous, it’s the government at its best — inept,” Rick Fier, director of equity trading at Conifer Securities LLC in New York, said in a phone interview. “It really is just another one of many things to deal with, it’s extremely frustrating. We’ve seen flash crashes and we’ll see them again and it’s definitely disconcerting.”
…
“The [high-frequency trading] term’s just become meaningless at this point; it’s just a boogie-man,” said Dave Lauer, president of Kor Group, a market structure lobbying and research firm.

“There are high-frequency market-makers, there are high-speed proprietary traders who don’t care about making markets and I do think there are predatory high-speed traders and manipulative high-speed traders,” Lauer said. “What this guy was doing was using computers in a manipulative, high-order-volume manner.”
…
no more than 20 trading days when volatility was high.

“On the surface, the headline isn’t comforting, but perhaps it provides the avenue to prevent something of this nature from happening again,” said Walter Todd, who oversees about $1 billion as chief investment officer for Greenwood, South Carolina-based Greenwood Capital. “I’m glad we know definitively how it happened, but at the same time, the headline isn’t a great thing.”

Go have lunch with a client, guys, if that’s all you’re good for.

Update: Here’s more argument in favour of ditching the completely artificial spoofing and layering rules – look at just just who Navinder Singh Sarao is and how he did it:

Sarao, 36, has no record of having worked at a major financial firm in the U.S. or the U.K. At the time of the flash crash, Sarao was renting space from a proprietary-trading firm in the City of London and clearing his transactions through MF Global Holdings Ltd., the now-defunct firm headed by Jon Corzine, said a person with knowledge of the matter.
…
That picture, according to U.S. authorities, belies a years-long history of lightening-quick computer trading that netted Sarao $40 million in illicit profits.
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By all accounts, the flash crash was more than a mere technical glitch. It raised fundamental questions about how vulnerable today’s complex financial markets are to the high-speed, computer-driven trading that has come to dominate the marketplace.
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Sarao’s computer screen almost always flashed futures data tied to the Standard & Poor’s 500 Index and his interactions were typically limited to workers installing new trading algorithms, said the person, who spoke on the condition of anonymity.

When he started his allegedly manipulative trading in 2009, Sarao used off-the-shelf software that he later asked to be modified so he could rapidly place and cancel orders automatically. At one point, he asked the software developer for the code, explaining that he wanted to play around with creating new versions, according to regulators.

So he wasn’t an expert trader, using his years of industry experience to exploit infinitesimal little bugs in standardized software, or his deep knowledge of trade-matching and clearing to exploit some bizarre mismatch in the interface between various systems.

He was one guy, using slightly modified off-the-shelf software, who broke one rule. And a rule, by the way that I feel is probably bent many, many times per day despite a very expensive army of regulators devoted to enforcing the silly thing.

If the US financial system is so vulnerable to one guy breaking one silly rule then we’ve got a problem that will not be fixed by doubling the number of regulators who check out trade cancellations and try to decide just what the intent was when each order was originally placed. If the rule is so vulnerable to exploitation and so unenforceable: get rid of it. Unleash the real players in the industry to detect and enforce a level playing field, with spoofing algorithms, spoofing detection and counter-exploitation algorithms, spoofing cloaking algorithms, anti-spoofing-cloaking algorithms … the whole nine yards. And bring some sanity back to the world.

Update, 2015-4-22: Zero Hedge is irritated:

While we eagerly await for the SEC to retract its official 104 page report summarizing the “Findings regarding the market events of May 6, 2010” in light of “recent developments”, and as we follow the shift in the official narrative to the outright bizarre, in which the entire Flash Crash is now blamed on just one man (as opposed to just Waddell & Reed as per the previous narrative), we learn that the latest scapegoat for a broken, fragmented and manipulated market, Navinder Sarao, is not quite so eager to go to minimum security prison in the US for doing what leads to a slap on the wrist when someone like Citadel or Virtu does it, and will challenge the CFTC’s attempt to pin everything on him.
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As previoisly reported, Sarao engaged in what every other HFT firms on a daily basis: namely spoofing. However, because he is a foreigner, he was easy prey for the US “justice” system, and as a result it is he that has been picked as a scapegoat (perhaps because the official investigation into Virtu, Citadel and the other HFT firms revealed something so dramatic it needed an easy and available cover up).

Eric Scott Hunsader of Nanex, whose work has been quoted admiringly on PrefBlog in the past, has posted a series of tweets:

If this futures trader *was* spoofing during Flash Crash, it means the CFTC completely missed what should have been easy to spot
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Flash Crash Brit was just one of many #HFT ass-hats in the market on 5/6 contributing to a fragile system
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We spotted the Flash Crash Brit years ago – red/yellow on this eMini chart is from his algo on 5/6
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What Singh Sarao is being accused of is as common as Oxygen. I can’t stress this enough.
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It is wrong to say Sarao caused flash crash. He contributed to causing it, yes, but it was Barclay’s leak that sent it down
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Why didn’t the CME say anything about Sarao for what.. 5 years now?
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How did Andrei Kirilenko (CFTC) miss Sara’s spoofing while analyzing a week’s worth of AUDIT TRAIL DATA??
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Why is Sarao (DOJ flash crash spoofer) being singled out from so many other #HFT spoofing algos?
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When I 1st saw Sarao’s algo in Summer 2010, I thought it was Tradebot because it stopped when Cummings said they pulled the plug
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“Exploratory Trading” – another #HFT strategy used by top firms to manipulate eMini’s $ES_F http://www.nanex.net/aqck2/4136.html
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What really caused Flash Crash: Someone LEAKED that a mutual fund was selling 75K eMini’s via participation algo. Wall St pounced
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Sarao turned off his algo at 14:40:12. The market flash crash began 2 minutes 32 seconds later at 14:42:44 – an eon in market time
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Detailed forensic evidence on the flash crash: http://www.nanex.net/aqck2/4650.html

FT Alphaville has some harsh words:

In a series of moves variously known as “layering” or “spoofing,” Sarao allegedly created the appearance of substantial supply in the market which didn’t actually exist — sparking a short-lived 600 point fall over in the Dow Jones Industrial Average in the space of five minutes.

Except you know, instinctively, that this is nonsense. It’s pure financial keystone cop-ery. This is a laughable piece of regulatory grand-standing from the Americans, which the British authorities look like fools for going along with.

The S&P futures market, across its various guises, is colossal. It is dominated by robot traders and other, highly capitalised professionals. The simple idea that a chap in West London, playing around at home with an off-the-shelf algo programme on his PC while his parents are off at the gurdwara, can up-end the entire US equity market is comical.

Or rather, if there’s any truth here at all, the guys under arrest should be those at the top of the CME and other key pieces of US market infrastructure.