A proposed rule that would require high-frequency traders to code their tickets so their trading patterns can be tracked by regulators appears to have strong support among high-frequency traders themselves.
"It’s important for the regulators to have the information they need to understand the trading markets," said Chris Bartlett, a high-frequency trader at New York-based Nobilis Capital.
The rule in question is the so-called large trader rule, which would require high frequency and other large volume traders to code trade tickets with an identifier. And according to Bartlett, the rule would be a good thing because it would help the regulator better understand the industry.
The thinking behind the proposed rule is to examine the increasing role that large firms and traders are playing in the trading markets. According to market estimates, between 50 and 70 percent of total trading volume is done by large or high frequency traders, thus the interest.
"Normally when the SEC is trying to implement rules and regulations they are often extensive, expensive or disruptive," Bartlett said. "But in this case they have a good idea that can be implemented within the existing regulatory framework without any real undue burden."
The SEC defined "large trader" broadly as either a firm or individual whose transactions in exchange-listed securities equal or exceed two million shares or $20 million during any calendar day, or 20 million shares or $200 million during any calendar month.
If passed, the new Rule 13h-1 and Form 13H, would fall under Section 13(h) of the Securities Exchange Act of 1934. To register, a large trader must file Form 13H with the SEC, and update its Form 13H at least annually, and on a quarterly basis if necessary to correct information that becomes inaccurate. The large trader must also provide, on request, additional descriptive information that would allow the SEC to further identify the large trader and all accounts through which the large trader trades.
Once the SEC gets the 13H, it will issue the large trader a unique large trader identification number–LTID. The LTID would be used for all accounts over which the large trader directly or indirectly controls or exercises investment discretion, across broker-dealers, thereby providing the SEC with a full picture of each large trader’s activity in NMS securities.
Manoj Narang, chief executive officer and chief strategist at Tradeworx, said that despite the increased paperwork the large trader rule would bring, it won’t negatively impact his trading business, which is what he cares about most.
"I agree that the large trader rule could take pressure off high-frequency firms, which I feel exists for no good reason," Narang said. "This proposal doesn’t have any far reaching consequences in terms of equity market structure. Therefore, it’s a perfectly fine maneuver for the SEC to do."
So while the high-frequency crowd seem at ease with the new proposal, some sales traders are worried about too much information being disseminated and violating their clients’ right to privacy.
"There may be some unintended consequences from this rule, such as the ability to see the trading intentions of large institutional clients," said a sales trader at a bulge bracket firm. "Once you expose what a client is doing, it becomes a privacy issue. Even for a large institutional fund that is trading through multiple broker dealers, through this identifier you may be able to reverse engineer their trading strategy."
But according to the SEC proposal, all information gathered by the SEC would be confidential, subject to limited exceptions. Bartlett said arguments that large institutional clients’ privacy would be violated were moot since actual purchases or sales wouldn’t likely be included in the data requests, but rather whether or not an account simply was part of a trade.
Robert Colby, counsel at Davis Polk and former deputy director of the SEC’s Division of Trading and Markets, said this rule proposal, if passed, would not just target high-frequency traders. It would also target other entities, like corporate parents of capital market participants and hedge fund managers, who are exempt from registration as investment advisers.
"If a broker-dealer is itself a large trader, it must record the required information with respect to each account over which it exercises investment discretion," Colby said.
Broker-dealers could face broad recordkeeping, reporting and monitoring responsibilities for large traders who maintain accounts with them. The rule would require broker-dealers to provide trading data to the SEC the day after a request for such data is made.
"Brokers will need a system that can search for the large trader identification number and provide data to the Commission the next day," Colby said. "Some brokers might have to overhaul their whole data system, as they are not geared to produce all this. However, for some it could just be a matter of adding a data field to their systems."
The SEC has said broker-dealers have the infrastructure available to support the new system since they already provide the agency trading data through the Electronic Blue Sheets–EBS. But trade time is not a data point currently available via EBS, which the SEC wants to see. The SEC now attempts to re-create trading events based on price movements and not trade time.
"Time is a pretty critical factor to have when trying to reconstruct a trading scenario," Colby said.
