Land of Sponsored Access
After much anticipation, the SEC finally released the long-awaited proposed rules on market access in late January 2010. While there are many details behind the proposed rules, in essence the SEC is looking to require sponsoring brokers to“establish, document, and maintain”direct and exclusive risk management and supervisory controls of sponsored entities. However, the proposed rules state that a certain level of flexibility would have to be built in to ensure that the controls and procedures fit the business models of broker-dealers and type of customer base.
While certain parts of the industry may resist some impending changes, most of the major market participants — including high frequency trading firms, sponsoring brokers and exchanges — agree that something should be done in terms of standardizing the overall sponsored access arrangements. The idea here is to level the playing field so that no single segment of the market has a clear advantage caused due to lack of industry uniformity in risk checks.
Still, it would be a mistake to think that increasing regulatory oversight on the activities of non-broker-dealers in sponsored access arrangements will eliminate all systemic risk from the institutional trading market. Recent history has shown that financial debacles caused by rogue traders or lack of risk controls can certainly occur within the regulated banks or brokerage operations. Indeed, some would strongly argue that most of the financial debacles of recent memory have occurred within heavily regulated broker-dealers, typically dealing with over-the-counter (OTC) instruments.
One danger here is that additional regulation in sponsored access may lead to a false sense of security. Uniformity and standardization in requisite pre- and post-trade risk checks should go a long way in paving the way for fair competition. That said additional regulation does not equal elimination of systemic risk. All major market participants must continue with their due diligence and scheduled audits to ensure that sponsored access arrangements remain a beneficial force in market structure evolution.
What do other experts say?
“Buy-sides continue to move beyond equities and into options, futures and fixed income. Trading these asset classes is converging, however risk management is not. In the equity space, Reg NMS has radically changed equity market making into an HFT model – creating greater intraday risk. Exchanges responded by creating pre-trade risk management controls for the brokers. The SEC is proposing to strengthen this by forcing brokers to take a pre-trade view of their risk across asset classes. The broker must estimate their risk based on their exposure to this client. It does not appear that the SEC is attempting to regulate the buy-side’s risk – only the broker’s risk if their buy-sides fail; so this isn’t part of the awkward multi-prime model. This regulation places a technical burden on each broker as they must create or purchase tools to monitor risk for each of their desks. A less burdensome approach may be to leverage a national institution to summarize this risk in real-time rather than charging each broker to implement these tools.”