In line with the regulatory framework for the securities market, the futures market will also see the introduction of administrative provisions to regulate program trading. On January 17, the China Securities Regulatory Commission (CSRC) sought public comments on the Administrative Provisions on Program Trading in the Futures Market (Trial) (Draft for Comments) (hereinafter referred to as the “Futures Program Trading Provisions” or the “Administrative Provisions”). These provisions align with the principles and spirit of the Administrative Provisions on Program Trading in the Securities Market (Trial) (the “Securities Program Trading Provisions”), which were issued by the CSRC on May 15, 2024, and took effect on October 8, 2024. The Administrative Provisions represent the first departmental regulation under the framework of the Futures and Derivatives Law to regulate program trading. They aim to enhance the regulation of program trading, standardize its development, and maintain order and fairness in futures trading. They also take into account the specific characteristics and current state of program trading in China’s futures market.
In terms of regulatory principles for program trading, there is no significant difference between the futures market and the securities market. Both emphasize the principles of “avoiding harm while seeking benefits, emphasizing fairness, implementing stringent regulation and developing businesses through regulation.” The principle of “implementing stringent regulation” mainly applies to high-frequency trading.
The CSRC’s drafting statement for the Futures Program Trading Provisions points out that, based on different trading frequencies, program trading in the futures market can be classified into high-frequency trading and medium or low-frequency trading. With the advancement of information technology, high-frequency trading has gained global popularity and developed rapidly in recent years.
This statement differs from the position taken by the CSRC in its drafting statement on the Securities Program Trading Provisions. In such drafting statement, the CSRC mentioned that program trading in the securities market, particularly high-frequency trading, has significant advantages in terms of technology, information, and speed over retail investors. It also pointed out issues such as strategy convergence and trading resonance at certain points in time, which exacerbate market volatility. This implies that the CSRC does not overlook the differences in the development of program trading between the futures market and the securities market. It emphasizes the need to differentiate between high-frequency and medium or low-frequency trading in the futures market, as well as acknowledging the rapid global development of high-frequency trading in recent years.
The key provisions of the Administrative Provisions are as follows:
1. Scope of Application
According to Article 2 of the Administrative Provisions, activities related to program trading in the futures market within the People’s Republic of China are subject to these regulations. Program trading on the Shanghai Futures Exchange, the Dalian Commodity Exchange, the Zhengzhou Commodity Exchange, the Guangzhou Futures Exchange, and the China Financial Futures Exchange must comply with the Administrative Provisions. Article 36 stipulates that program trading conducted on the Shanghai International Energy Exchange is also subject to the Administrative Provisions. Article 35 specifies that those engaging in market-making activities through program trading are subject to separate provisions established by the futures exchanges based on the principles of these regulations, thus constituting an exception to the application of these regulations. Current option products on securities exchanges, such as ETF options on the Shanghai Stock Exchange and Shenzhen Stock Exchange, are not subject to the Administrative Provisions.
2. Definition of High-Frequency Trading
Futures program trading refers to the act of conducting futures trading on a futures exchange through automatic generation or delivery of trading orders by computer programming. Futures high-frequency trading refers to futures program trading that possesses one or more of the following characteristics: (1) a high number or frequency of order placements and cancellations within a short period of time; (2) a high number of order placements and cancellations within a single day; or (3) other characteristics recognized by the CSRC. The specific standards for high-frequency trading are to be set by the relevant futures exchanges. This grants regulatory authorities discretionary power on one hand, and on the other hand establishes that these standards will be issued by the relevant futures exchanges, thereby maintaining regulatory adaptability and flexibility.
3. Program Trading Reporting System
The program trading reporting practice in the futures market predates that of the securities market. The Administrative Provisions are largely consistent with the Securities Program Trading Provisions. For example, futures brokers shall sign program trading entrustment agreements with clients; clients and futures brokers must report information as required; futures exchanges and futures brokers are to conduct regular or irregular checks on the information reported.
However, certain provisions are still noteworthy. For instance, Article 9 stipulates that non-futures company members who are allowed to directly enter the relevant futures exchange for trading must report relevant information to the futures exchange before engaging in program trading and they can only proceed with program trading after the futures exchange has confirmed the information, but such members who have direct access to the exchange are not allowed to engage in any high-frequency trading.
We also note that, unlike the securities market reporting system which requires all program traders to report their trading strategies and maximum frequencies, in the futures market, only high-frequency traders are obligated to report the type and main content of their trading strategies, the highest order placement and cancellation frequency, and the maximum number of order placement and cancellations per day. High-frequency traders are also required to report the location of their servers, technical system test reports, emergency plans, and risk control measures.
Similar to the Securities Program Trading Provisions, if a futures broker discovers that a client has not reported as required, it must urge the client to make corrections. If the client still does not comply, the futures broker must refuse to accept their opening orders in accordance with the futures exchange rules and the client entrustment agreement. This imposes stricter supervisory obligations on futures brokers. Furthermore, the relevant futures exchange should verify the information reported by program traders, with a focus on verifying the type of trading strategies, the highest order placement and cancellation frequency, and the maximum number of order cancellations per day reported by high-frequency traders. If any non-compliance of reporting is found, the futures exchange will take self-disciplinary measures against the relevant traders.
4. System Connectivity Management
The Administrative Provisions clarify the requirements for external system connectivity. Futures brokers should incorporate external system connectivity management into their compliance and risk control systems and establish comprehensive management mechanisms for connectivity testing, trading monitoring, and other processes. Futures brokers providing external connectivity to trading information systems and clients engaging in program trading that connect with these systems must comply with the relevant regulations of the CSRC, the relevant futures exchanges, and the China Futures Association. They must adhere to the principles of compliance, prudence, and controllable risk, ensuring that they do not compromise the security of the futures exchange systems or market fairness, nor infringe upon the legal rights of other traders.
The Administrative Provisions specify the requirements for system functionality and system testing. The technical systems used by program traders must comply with the rules of the futures exchanges and possess effective functions for anomaly monitoring, threshold management, error prevention, and emergency handling. The trading information systems used by futures brokers must comply with the rules and regulations of the CSRC and the relevant futures exchanges, and possess effective functions for authentication management, capital and position verification, permission control, anomaly monitoring, threshold management, error handling, and emergency handling. Futures brokers must test the technical systems used by program trading clients as well as their own trading information systems and retain the test records for no less than twenty years.
The Administrative Provisions prohibit futures brokers from deploying their trading information systems on the same physical equipment as the clients’ technical systems and prohibit futures brokers from granting clients an authorization to brokers’ own trading information systems. Program traders are prohibited from using system connectivity for any illegal futures business operations. Program traders are also prohibited from soliciting outside traders or handling third-party trading orders, and from transferring, lending their technology systems, or providing external system connectivity to third parties.
5. Server Co-location and Trading Seat Management
The Administrative Provisions stipulate that the relevant futures exchanges should establish an information reporting system for server co-location and a management system for trading seats. They should offer server co-location services and allocate trading seats following the principles of security, fairness, and reasonableness. The Administrative Provisions also require futures brokers to establish a server co-location resource management system and to use these resources reasonably. Futures exchanges should regularly check the usage of server co-location resources and trading seats by futures brokers and program traders. If any misuse is found, the relevant futures exchange may take self-disciplinary measures against the futures broker or client.
Futures brokers are prohibited from offering server co-location services to program trading clients who frequently display abnormal trading behavior or whose technical systems have significant faults.
6. Compliance and Risk Control Requirements for Program Trading Clients
Article 22 of the Administrative Provisions requires all entities, regardless of whether it has a legal person status, engaged in program trading to establish and effectively implement internal control, risk management, and compliance management systems for program trading. Executives responsible for compliance and risk management should supervise and inspect the legality and compliance of program trading and the effectiveness of risk management. They should not hold positions that have conflicts of interest with these responsibilities. It is recommended that program trading clients regularly verify the completeness and effectiveness of their internal systems. They should also strengthen performance of supervisory and inspection duties of their compliance and risk control executives and avoid any conflicts of interest arising from dual roles of such executives, thereby ensuring ongoing compliance.
In addition to the requirements on clients, the Administrative Provisions also specify compliance and risk control requirements for futures brokers and risk prevention requirements for futures exchanges. The relevant futures exchanges should monitor program trading in real-time and focus on abnormal trading behaviors such as high frequency or high order-to-trade ratio for order placement or cancellation. The specific standards for abnormal program trading behavior are set by the relevant futures exchanges. Futures exchanges should pay close attention to high-frequency trading and closely monitor changes in high-frequency trading behaviors and promptly assess market impacts. Similar to the Securities Program Trading Provisions, the relevant futures exchanges may establish systems for order placement and cancellation fees, trading limits, and adjust these standards as necessary, additionally, they may also implement differentiated fee management for high-frequency trading.
Our Observations
The drafting of the Administrative Regulations was based on a summary of the current regulatory practices. The CSRC’s drafting statement listed the measures already undertaken in the regulation of program trading in the futures market, including the establishment of a reporting system for program trading, the implementation of an order fee system, the establishment and improvement of monitoring and surveillance indicator systems, and the strengthening of the management of abnormal trading behaviors. The introduction of the Administrative Provisions fills the current gap in departmental regulations concerning program trading in the futures market. Current regulatory practices are already conducted within the principle framework. After the implementation of the Administrative Provisions, it is advisable to assess whether any implementation rules will have impact on the current futures market practice.
