Brokers See Challenges Ahead To Meet Sponsored Access Mandates
Traders Magazine Online News, July 19, 2011
The industry got some needed breathing room. The Securities and Exchange Commission decided in late June to postpone compliance with a cornerstone of its sponsored-access rule for four months. That gives broker-dealers time to figure out how to build credit checks into their businesses that serve high-frequency traders.
Broker-dealers engaged in a sponsored-access business now have until Nov. 30 to comply with the section of SEC Rule 15c3-5 that requires them to establish credit thresholds for their customers. All other parts of the rule dealing with the trading of equities, ETFs, options and swaps went into effect on July 14.
On that date, brokers became responsible for policing their customers' activities on an order-by-order basis. Come November, they must be able to set overarching trading limits on a customer-by-customer basis. They must also be able to manage their aggregate customer exposure across the firm.
As of July, brokers have to check each order to make sure it complies with the SEC's rules and those of the self-regulatory organizations. They also have to make sure the orders are not "erroneous." Erroneous orders are those with incorrect quantities or prices or those that are "duplicative," or entered twice.
Checking for duplicative orders has proved challenging, but for the most part brokers have had little trouble instituting risk checks to guard against regulatory breaches or simple erroneous trades. Most have been running these checks for years.
Michael O'Conor
The requirement that sponsoring brokers establish credit, or trading, limits for their customers, on the other hand, has proved taxing for many. Although some have always incorporated trading limits into their electronic platforms, many have not.
Traditionally, brokers have relied on assurances from their customers that they would not exceed certain limits. Plus, industry rules give customers three (previously seven) days to settle their trades. Any problems get dealt with during the settlement process.
"Some firms were able to deal with the issue of trading limits on a customer-by-customer basis," said Michael O'Conor, a consultant with Jordan & Jordan. "Others were only prepared to deal with it on a firmwide basis. "Now everyone must do it on a customer-by-customer basis."
Behind the new rule are SEC concerns over brokers offering "naked," or unfiltered, sponsored access to high-frequency traders. The practice of "renting" a broker's name to an HFT unencumbered by risk checks previously constituted the majority of sponsored access.
Behind the credit checks are SEC concerns over the ability of high-frequency traders to build up outsize positions in seconds. Assuming an HFT is able to trade 1,000 orders per second, the SEC estimated a high-frequency shop could build up a position of $720 million in only two minutes. "Financial exposure through rapid order entry can occur very quickly," the regulator intoned in its final ruling, issued last November. The regulator's stated aim is to protect the sponsoring broker and any trade counterparties from financial harm, and to prevent disruptive market behavior.
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