FTEN Calls for SEC to Ban "Naked Access"
Traders Magazine Online News, May 27, 2009
A technology vendor in the sponsored-access arena is calling for the Securities and Exchange Commission to ban "naked access." The firm, New York-based FTEN, defines "naked access" as sponsored access to exchanges by non-broker-dealers with no pre-trade risk filters on that order flow.
Over the last half-year, sponsored access has gained prominence on the SEC's agenda. At an industry conference on market structure last week, James Brigagliano, co-acting director of the SEC's Division of Trading and Markets, noted that risks associated with sponsored access "could affect the integrity of the market structure itself." He stressed the "vital importance of dealing with these issues effectively," and said the Commission would address them in the coming months.
There is industry support for the SEC tackling the broad issue of sponsored access to the markets. But the complication, for some industry participants, is that too many forms of market access may currently be getting pushed under the sponsored-access umbrella, causing confusion and perhaps diluting regulatory focus on the type of access that is considered potentially dangerous to the marketplace.
Sponsored access refers to arrangements that allow firms to send orders directly to exchanges using the member firm's identifier. FTEN, a technology firm that provides risk management services, would like the SEC to prohibit a segment of that flow from reaching the market. "Sponsored access by non-broker-dealers with no pre-trade risk controls is a problem," said FTEN founder Ted Myerson. "It's a problem for the clearing firm, it's a problem for the firm's other clients, and it's a problem for the firm's counterparties."
The problem with this type of unfiltered flow is that a runaway algorithm operated by a non-broker-dealer, for example, could shoot thousands of orders into the market before it is caught and shut off. Other problems could also affect the prices of stocks in the market and expose clearing firms as well as exchanges to large financial and operational risks.
This type of sponsored access is the result of the need for speed by high-frequency trading firms. Firms whose orders do not run through pre-trade risk controls have an advantage over those that do, noted Gary LaFever, chief corporate development officer at FTEN. The pre-trade risk controls could take one-fifth of a millisecond, he said, but in the world of high-frequency trading, that's too long.
"This liquidity has taken the place of traditional market makers and is therefore valuable to the market," LaFever said. "But if we don't put governors around this liquidity, it gives unregulated entities benefits over those who want to do it right." He added that the availability of sponsored access without pre-trade risk filters also works as a disincentive for these trading firms becoming broker-dealers.
In an April letter to the SEC, FTEN suggested a series of "minimum pre-trade risk management best practices" around sponsored access provided to non-broker-dealers. These types of risk controls, the firm said, could be provided by FTEN, other third-party technology firms, prime brokers' internally developed systems, or, in some cases, exchanges. Exchanges, however, cannot provide the full panoply of services since they typically see only a portion of a customer's flow, LaFever told Traders Magazine.
John Jacobs, director of operations at Lime Brokerage, agrees with FTEN that naked access by non-broker-dealers should be banned. Many of Lime's customers are high-frequency trading firms, but Lime does not give them naked access to the markets. The broker argued to the SEC in February that sending order flow to exchanges without proper pre-trade risk controls is dangerous.
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