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August 6, 2009

Naked Access Bashed at Roundtable

By Nina Mehta

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  • Naked Access Bashed at Roundtable

Brokers, vendors and exchanges took turns criticizing a controversial form of "sponsored access" at a June roundtable convened by the New York chapter of the Security Traders Association. The practice under the microscope is access to markets by a broker-dealer's customers with no pre-trade intermediation, supervision or risk management checks performed by the broker.

Goldman Sachs said it is no fan of this type of access. Dariush Nazem, vice president and head of business development for low-latency solutions at Goldman, said brokers providing access to the markets should observe internal risk protocols to ensure that their clients are not taking undue risks that the broker is not comfortable with.

When it comes to sponsored-access arrangements, Nazem said, the industry should "make sure it's a product offering that protects not only the client but the broker-dealer involved." Forms of sponsored access in which the broker is aware of what the client is doing on a pre-trade, during-trade and post-trade basis, and can control those risks, are part of an acceptable product offering in Goldman's view.

Sponsored access with no pre-trade risk controls is called "naked access" by some firms. Other firms refer to this as "unfiltered access." Ted Myerson, founder and president of FTEN Inc., a vendor that facilitates sponsored access and that sponsored the roundtable, said regulators should ban naked access.

In Myerson's view, the stakes are high. Sponsored firms can trade a lot of volume very quickly. Errors can rapidly propagate through the system, leading to systemic risk. He noted that proprietary trading firms engaging in high-frequency trading, including those getting sponsored access, may also take large positions. Myerson added that these firms rely on "sub-millisecond speed to seize momentary price fluctuations."

In addition to conducting fast, sub-second trading, these firms have holding periods of very short duration and massive computing power, said Jamil Nazarali, a managing director and head of electronic trading at Knight Capital Group. There's little human intervention in the trading business of these firms.

If there's a bug in a firm's software or a computing problem, "everything it does can be amplified millions of times over," Nazarali said. This is a particular worry for firms whose order flow gets skimpy or no risk checks before it hits the market.

Research firm Aite Group estimates that about 60 percent of equities market volume comes from high-frequency trading firms. A small subset of that is from non-broker-dealers getting direct sponsored access to the markets.

The Securities and Exchange Commission is considering a set of new rules that may be imposed around sponsored-access relationships. Nasdaq earlier this year recommended new requirements around three types of sponsored access. The three types are traditional direct-market access, in which the customer routes orders to the market through a broker-dealer; access to the markets via a technology vendor, based on a contractual relationship between the vendor and the firm's broker; and direct access whereby the trading house sends flow directly to the markets via its own pipes. In all these cases, the broker whose mnemonic or market participant ID is used is responsible for the trades.