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August 1, 2011

Up for Grabs

Bulge Bracket Hungry for HFT Business in Wake of New SEC Market Access Rule

By James Armstrong

High-frequency traders' order flow is being wooed by the largest firms on Wall Street like never before. It all started last November when the Securities and Exchange Commission approved a new sponsored-access rule to rein in so-called "naked access," which regulators feared if left unchecked could cause a catastrophe similar to last year's "flash crash."

Under the SEC's new rule, high-frequency traders must submit their orders to risk checks before sending them into the market. Prior to the first part of the rule going into

effect last month, many HFTs paid brokers for direct access to the markets without compliance checks, a practice known as naked access.

John Goeller

The industry's biggest brokers largely shied away from this business because it was deemed too risky. They relinquished it to smaller, more aggressive firms that had less to lose from embarrassing mishaps. But now that every broker is required to run risk checks, the playing field has been leveled. And the bulge bracket wants in on the action.

"We always had pre-trade controls on our order flow," said John Goeller, managing director within global execution services at Bank of America Merrill Lynch. "Clients that may have not been leveraging broker pre-trade controls are, to a certain extent, up for grabs, and we're not alone in competing for that space."

Gaining Position

BofA Merrill, Deutsche Bank, Citi, UBS, Barclays Capital and other major players are all positioning themselves as access providers to HFTs. The bulge bracket firms now view high-frequency traders as highly valued customers.

Providing sponsored access to HFTs is not new for the bulge, but in the past it has been difficult for them to compete with firms offering naked access. That's because the risk checks they required to prevent mistakes-like fat-fingered trades or duplicated orders-slowed down trades. Regardless of how little the risk checks delayed an order, any latency at all can wreak havoc on high-frequency strategies.

According to Jose Marques, global head of electronic equity trading for Deutsche Bank, it is impossible to beat naked access in terms of speed, though he said his firm has been able to get latency down to about a microsecond. He predicted that competition among the bulge brackets will remain stiff, in spite of the fact that sponsored access is a low-margin business.

Firms providing sponsored access are loath to reveal how much they charge for the service, in part because pricing can vary significantly between clients. One source suggested fees can be as low as 10 to 25 mils per share. Clients who also use an access provider as a prime broker might even be able to negotiate charges down further. In the grand scheme of things, such fees might not be considered significant to bulge bracket firms.