Now that the first phase of the market access rule has gone into effect, brokers are looking ahead to the next stage of the rule, when they will need to perform aggregate credit and capital checks for their clients and themselves.
Originally, the Securities and Exchange Commission planned to implement the entire rule on July 14, but after receiving requests from the industry, it delayed key aspects of the rule until Nov. 30.
Starting at the end of November, a broker-dealer will be required to set credit limits for each customer for which it provides market access and capital thresholds for its own proprietary trading.
The SEC passed the market access rule last year, banning the practice of brokers offering so-called "naked" access to exchanges and alternative trading systems. Under naked access, brokers required only post-trade monitoring systems for their clients, or sometimes no monitoring systems at all.
While the ban on completely naked access goes into effect today, regulations effective at the end of November go beyond simple pre-trade controls designed to prevent erroneous trades.
Those regulations require risk management controls and supervisory procedures designed to limit the financial exposure of the broker-dealer and its sponsored-access clients.
The second set of requirements is much broader in terms of how brokers will have to look at clients and aggregate information, forcing them to go beyond current trade-by-trade risk checks.
"While you might be checking each order, you will now need to know across all the orders where the client is," said Gary LaFever, chief corporate development officer at FTEN, which is owned by Nasdaq and provides HFT services. "That’s a huge issue."
The requirements slated for November will introduce another latency hop in addition to the one created by the regulations that went into effect today, according to Nick Pratt, associate director of technology consulting firm Lab49.
Perhaps more importantly, the aggregate checks could raise concerns among the high-frequency traders using sponsored access that their brokers might gain unwelcome insights into their strategies.
"I’m not sure that some HFT shops will be comfortable with that, no matter how well the Chinese walls are in place," Pratt said. "The HFT shops are very protective of their IP."
Pratt suggested some high-frequency traders might just avoid the rule by moving their trading to exchanges outside the U.S. If that happens, there will definitely be a loss of liquidity in U.S. equities markets, he said.
According to LaFever, regulators are increasingly looking at high-frequency traders as they formulate new rules.
"HFT represents an area of great opportunity, promise, liquidity and volume to the industry, which are all very real positives," LaFever said. "It also represents a source of potential issues if not managed correctly."
Miranda Mizen, principal and director of equities research at Tabb Group, said additional regulations will likely hold brokers responsible for even more in the future. That will undoubtedly drive up their costs of doing business.
If future regulation improves the integrity of the market and brings back investor confidence, however, it will end up being a good thing, she added.
