Some clarity, please.
The Securities and Exchange Commission may have effectively banned the practice of "naked" sponsored access with its recent rule. But some industry sources say the regulator left somewhat vague the matter of whether brokers granting sponsored access to other brokers must provide an additional layer of risk checks.
Brokers such as Penson Financial Services and Wedbush Securities do not provide pre-trade risk checks for broker-dealer clients. This, they said, is because their broker-dealer clients are already required to provide them, and because the clearing firms monitor risks on a real-time basis immediately post-trade.
The language in the SEC rule is somewhat unclear about whether orders coming through broker-dealer sponsors of broker-dealer clients are excluded from the requirement, said Jeff Bell, executive vice president of the clearing and technology group at Wedbush. The industry hopes the SEC will clarify the matter soon through a Frequently Asked Question, or FAQ, Bell added.
"That’s an area that needs a little more clarity, through an FAQ, to understand what [the SEC’s] expectation was," Bell said.
Regardless of the exemption, Wedbush and Penson are hedging their bets. Both said they are signing up a third-party vendor’s pre-trade risk-check technology.
"It’s possible we still need to have an additional risk control for the broker-dealer clients we sponsor," Bell said. "That’s the lack of clarity at this point. We think there’s an exemption, but we’re not positive about it."
The SEC rule requires broker-dealers who permit their non-broker-dealer clients to trade directly in the markets under their names to scrutinize each order on a pre-trade basis. The rule therefore effectively bans unfiltered, or naked, access.
Sponsored access involves a large portion of the markets’ volume. By one industry estimate, about half of all order flow reaches the markets through sponsored-access arrangements.
The SEC rule became effective on Jan. 14, or 60 days after it was published in the Federal Register–which was on Nov. 15. Firms have six months after that date, or until July 14, to comply with the rule.
Penson and Wedbush said their broker-dealer clients do their own risk checks already, to protect themselves. These firms prefer to rely on their own technology to protect orders that involve their own money, Bell said.
And firms such as Penson monitor those checks, said Sean Malloy, a senior vice president and director of global sales and marketing there. Penson either has access to customers’ systems, or it runs real-time "echo" risk checks, which occur as the trade happens. Either way, Penson said it certifies, examines and documents the pre-trade risk controls its broker customers have in place.
"The question is: Can brokers continue to sponsor brokers as long as we have access to their risk control screens and access to kill switches?" Malloy asked. "Or will an additional layer of pre-trade checks on top of what’s in place now be required? If additional checks are required, they should be performed by the market centers, which can create standards to ensure the application of risk metrics are uniform and the playing field is level for all. This needs to be clarified."
Pre-trade checks, according to the SEC, help prevent erroneous orders and enforce preset credit or capital thresholds. The SEC has said that pre-trade risk checks on orders protect the integrity of the markets. But such checks increase latency, which is detrimental to many sponsored-access customers’ high-frequency-trading strategies.
"An additional risk check is additional time," Bell said. "And latency is everything in this space. So, even if all you’re adding is 10 to 20 microseconds, it’s pretty meaningful."
