The Securities and Exchange Commission’s new market access rule, set to go into effect on July 14, has brokers scrambling to comply with a set of regulations many feel are too confusing, and are also apt to be more expensive than originally anticipated.
New regulations associated with SEC Rule 15c3-5 will end the practice of brokers offering unfiltered or "naked" access to exchanges and alternative trading systems. Currently, brokers providing naked access will only monitor their clients’ trades after the fact, or sometimes not at all.
Both the Financial Information Forum and the Securities Industry and Financial Markets Association have asked the SEC to consider a phased-in implementation of the rule, delaying certain portions until November 30, though other key parts would still go into effect on July 14. The Commission is currently considering the request.
When the SEC adopted the rule in November, the agency said the costs associated with compliance would be justified by new protections on market integrity and efficiency. It estimated the industry would have to spend about $22 million, or an average of $16,000 per firm, on hardware and software to implement the rule. Ongoing compliance costs would be somewhat more, about $28.2 million, or $20,500 per broker dealer, annually, the SEC said.
But John Jacobs, director of operations for Lime Brokerage, said for firms used to providing naked access the costs could be quite higher than those predicted averages.
"Going from a post-trade environment to a pre-trade environment requires some pretty substantial investment," Jacobs said.
Lime is one of the brokerages that pushed for the new rule, so it already had controls in place, according to Jacobs. Firms offering naked access, however, tend to cater to high-frequency traders, and providing pre-trade controls while also maintaining low latency won’t be cheap, he said.
(Lime was recently acquired by Wedbush, a competitor in the business of servicing HFTs. In the past, Wedbush has been cited as one of the major firms offering naked access.)
Chris Lees, a vice president at SunGard Global Trading, said the adjustments required of brokers are probably some of the most costly technical changes brokers have had to make in the past few years.
In addition to making sure that sponsored access clients are following procedures to prevent accidental or improper trades, under the new regulation brokers will also have to make sure clients comply with exchange rules.
If a sponsored access client violates a rule of one of the exchanges, the sponsoring broker would not only be liable for a fine from the exchange, it could also face enforcement action from the SEC, Lees said.
According to Michael O’Conor, director of management consulting for Jordan & Jordan, most everyone agrees that controlling access is important. However, it is still unclear how far brokers will have to go to comply with the new rule.
"There have been some questions as to interpretation of what the Commission is asking them to do and how they are going to approach doing it," O’Conor said.
Under the new rule, brokers will still be allowed to offer sponsored access, in which a client uses the broker’s MPID to go directly to an exchange or ATS, often with a separate prime broker clearing and settling their trades. However, this access would have to be accompanied by certain limits imposed by the broker.
The process of creating, implementing and monitoring these limits is well underway by brokerage firms, but many questions remain, according to O’Conor. For instance, firms are supposed to have controls designed to prevent duplicative orders, but detecting duplication can be difficult with some algorithmic trading systems used by clients.
"Some algos are designed to create many orders that are similar," O’Conor said. "There are multiple approaches that brokers can take to that."
The variety of tactics being taken by brokerages is proving to be a challenge to the software vendors trying to help them comply with the rule, according to SunGard’s Lees.
"There are very different interpretations of what you would typically expect to be standardized checks," said Lees. "Brokers are interpreting the rule as they consider it to apply to their particular client base, but it’s very inconsistent."
Michael Lynch, head of execution services for the Americas at Bank of America Merrill Lynch, said while he would support a phased-in approach to the rule as the FIF and SIFMA have proposed, BofA Merrill will be ready for the July 14 deadline regardless.
Because the firm already had pre-trade controls on its order flow, it was largely able to adapt its existing technology to address the requirements of the new rule, Lynch said.
