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SEC to Tackle Sponsored Access in Coming Months
Traders Magazine Online News, May 21, 2009
The Securities and Exchange Commission is likely to address significant concerns associated with sponsored access in the next few months, according to a top trading official at the Commission.
James Brigagliano, co-acting director of the SEC's Division of Trading and Markets, noted that a variety of risks exist when trading firms have "unfiltered access" to the markets. "These risks can affect many participants in the market structure, including the trader's broker, the exchanges and the clearing entities," he said. "Ultimately, the risks can affect the integrity of the market structure itself."
Brigagliano said the SEC would probably address concerns about certain ways that market participants send orders to market centers "in the coming months." He spoke at a conference on market structure sponsored by the Securities Industry and Financial Markets Association.
The SEC exec pointed out that the Commission staff has been "gathering facts and reviewing issues" related to sponsored access for some time. He defined sponsored access as an exchange member "providing its customers with electronic access to the exchange using the member's identifier."
Nasdaq in January submitted a proposal to the SEC, overhauling requirements around sponsored-access arrangements for its market. The requirements outlined in the proposal were based on guidance from the SEC. The proposal, Brigagliano said, "sparked a very useful public debate on sponsored access." The expectation is that any new rules approved would be replicated by the other exchanges.
The Nasdaq proposal ropes three types of market access into its sponsored-access program. These are direct-market access through the exchange member's systems, access through a third party such as an execution management system, and direct access by the exchange member's customer to the exchange without that flow first passing through the broker's systems.
It is this latter type of access that is considered controversial by many in the industry. FTEN, a technology company that provides risk-related services to brokers and trading firms engaged in sponsored access, believes that a large portion of the industry's high-frequency trading flow goes to the market unchecked by brokers. Research firm TABB Group estimates that about 66 percent of equities volume comes from high-frequency firms. FTEN says about half of that flow is not subjected to pre-trade risk filters.
The SEC has expressed concerned about sponsored access for at least two years, based on public comments by SEC officials, but that concern has only recently gained greater prominence. "This type of [direct] access to exchange execution systems, which often is unfiltered, has increased significantly," Brigagliano said yesterday.
Lauren Mullen, assistant general counsel in global equities at Bank of America/Merill Lynch, noted that Nasdaq's proposal has led to some confusion in the industry about what type of sponsored-access trading should and shouldn't be allowed. She said some pre-trade risk controls are "completely at odds with the fundamental nature of the sponsored-access product because these trades do not pass through the broker-dealer's pipes." She described direct sponsored access to the markets, in which flow isn't sent through the broker's pipes, as more akin to a counterparty relationship, in which due diligence plays a big role.
In Mullen's view, sponsored access should not be what she referred to as the Wild West. If the broker conducts good due diligence of customers directly accessing exchanges and has adequate contractual arrangements in place, then "we [can] take this system and legitimize it" in a way that's manageable, she said. Mullen spoke at yesterday's SIFMA conference in a panel discussion.
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