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April 1, 2010

The Push for Faster Risk Checks

By Peter Chapman

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  • The Push for Faster Risk Checks

With the Securities and Exchange Commission expected to soon ban the practice of "naked access," vendors, exchanges and brokers are scrambling to speed up their risk management technology.

David Gilbert

Trading infrastructure vendors such as FTEN, Mantara and Bon Trade Solutions and exchanges like NYSE Euronext and BATS Exchange are in a race to develop and promote their risk-monitoring capabilities to potential clients--namely, broker-dealers and hedge funds involved in high-frequency trading.

Brokers themselves are either making their processes run faster and more efficiently or evaluating the offerings of the vendors.

It's all happening because the SEC wants the industry to check each and every order before it is sent out, to make sure none are erroneous or outsize.

"There needs to be more risk control than there has been," said David Gilbert, president and chief executive of Mantara. "The tools are there to do that."

On Jan. 13, the SEC proposed a new rule that would require broker-dealers who permit their customers to trade directly in the markets under their names to vet each order on a pre-trade basis. If approved, the rule would effectively bar unfiltered, or naked, access, which accounts for a considerable amount of volume.

The largest providers of naked access are expected to push the SEC to make an exception for the orders of their broker-dealer clients, arguing that they are already strictly regulated. Still, most trading officials expect the rule to pass without exceptions.

If that is the case, the ruling will open the sponsored-access business up to new players and require naked sponsors to incorporate risk checking. In either case, players will need a high-speed trading infrastructure coupled with risk-monitoring software.

"The big firms want the business, and they are trying to figure out how to get it," Gilbert said. "But they don't have the technology platforms themselves. We are in discussions with some of the major organizations who don't have the capability to do this."

Up until now, many high-frequency trading shops have opted for naked access because it was faster than going through myriad risk checks. Now they must resign themselves to the possibility of slightly slower trading speeds as their orders pass through possibly a dozen checkpoints.

That's why the efficiency or speed of the risk-checking software has become the highest priority and greatest concern in the high-frequency trading community. Because the quest for speed, or low latency, is as important as the quality of its trading strategy, a high-frequency trader who flies through the risk-checking process will have an advantage.

"As long as my tool is better than the FTEN equivalent, or something like that, then I am fine," Matthew Gray, chief executive and managing member of high-frequency shop Simplex Investments, said at last month's TradeTech conference. "A value-added tool will put me at a competitive advantage."