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March 11, 2009

Sponsored Access Comes of Age

By Nina Mehta

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  • Sponsored Access Comes of Age
  • Page 2

Securities and Exchange Commission concern over high-frequency traders accessing the markets under their brokers' names, but not through the trading systems of those brokers, will soon be addressed through a new "sponsored access" regime. The goal is to ensure that broker-dealers have financial and regulatory controls in place to fulfill their regulatory responsibilities.

In response to the Commission's desire to create a framework around sponsored access, Nasdaq recently filed a proposal that lays out a series of requirements for member firms that provide sponsored access to customers. Those customers can include institutions as well as other broker-dealers. The exchange's proposed rule fleshes out Nasdaq's existing rule set around sponsored access.

"The definition of sponsored access is something the SEC is focused on: direct market access vs. direct sponsored access vs. third-party access," said Brian Hyndman, senior vice president for transaction services at Nasdaq OMX Group. "There will be financial, regulatory and risk management controls put in place in the new sponsored access rules."

James Draddy, chief regulatory officer at NYSE Arca, said Nasdaq's filing "makes a lot of sense." Last month, he said his exchange would submit it to its ownrule proposal to the SEC.

Sponsored access refers generally to a broker-dealer member of an exchange providing other market participants with access to that market center. This type of access has existed for several years through brokers' DMA platforms as well as through more-direct access into exchanges, but the requirements around sponsored access have been amorphous and the rules have been different across market centers.

Another concern with sponsored access is that competition for flow from high-frequency trading firms and other customers bent on low-latency access to the markets could be driving some brokers to relax their supervisory controls. This regulatory worry is compounded by the lack of clear definition for sponsored access and the variety of arrangements now in place.

According to Nasdaq's Hyndman, a number of Nasdaq broker-dealer members currently provide direct sponsored access to customers. "It's a small percentage of our overall customer base, but it could be in excess of 15 percent of our overall volume," he said.

The new rules impose more definition around the types of sponsored access arrangements that currently exist. Nasdaq's new rules and contractual requirements will apply to direct sponsored access, in which a sponsoring broker provides the sponsored participant with technology to reach the exchange directly, and third-party sponsored access, in which a service bureau or third party, such as Lava Trading, FTEN or FlexTrade Systems, provides the technology to access exchanges via an arrangement with the sponsoring broker. DMA is considered different from the two other forms of sponsored access since a customer's DMA flow first passes through the sponsoring broker's systems and is therefore already subject to financial and regulatory controls and checks.

Among other requirements, the new rules obligate the sponsored firm to abide by the sponsoring member's credit and financial limits. In addition, the sponsoring broker must maintain controls to ensure compliance with rules related to short selling, trading halts and prohibitions against manipulative trading practices.

See Nasdaq's Proposed Rules