Sponsored access: New trading paradigm or upgraded DMA?
Europe’s sponsored access market has no shortage of suppliers, but demand for the service is being hampered by a lack of consistency on how it differs from standard direct market access and where responsibility lies for risk controls.
Trading technology firm SunGard can now route trades from buy- or sell-side clients directly to three European multilateral trading facilities (MTFs), and does so for at least one high-frequency trading client, according to David Mishoe, managing director, SunGard Trading. For two of the three MTFs, the trade is sent from the client through SunGard’s own high-speed pipes and across the firm’s risk management controls before being delivered to the venues’ matching engine.
For a third MTF, BATS Europe, the trade must pass through an additional risk management ‘layer’, managed by the venue, before being admitted for execution. In terms of pre-trade controls for sponsored access users, “You get a different answer from every different exchange,” admits Mishoe.
According to Mishoe, demand for sponsored access in Europe is highest among high-frequency trading firms that want to access multiple markets at low latency without having to invest in the underlying connections with individual exchanges, and tier-two banks and brokers that are less concerned about latency but do need managed access to exchanges across the region.
But the service SunGard offers in Europe is really “high-speed direct access” to exchanges, says Mishoe, rather than the sponsored access it offers to clients in the US. ‘True’ sponsored access removes any intermediary between the trading entity and the exchange. Rather than subjecting trades to pre-trade checks, US exchanges such as the CME or NYSE will share a FIX ‘drop copy’ of the client’s trades with the sponsoring broker, which serves as a near-real-time post-trade check that the client is not exceeding credit limits, for example.
Niki Beattie, managing director of UK consultancy The Market Structure Practice, says that a risk management layer will probably remain a permanent barrier between the sponsored client and the trading venue in Europe.
“Potentially, there is a reputational risk in offering sponsored access that many European banks aren’t prepared to take. For the foreseeable future, there is likely to be some kind of pre-trade risk management layer between the end-client and the trading venue,” she says.
Regardless of the existence or location of the pre-trade risk management layer in the sponsored access structure, responsibility for the client’s trades stays with the sponsoring broker.
In November 2008, The UK’s Financial Services Authority issued a Market Watch on sponsored access that reminded intermediaries that “full responsibility” for all client orders remained with them, even if pre- or post-trade controls and measures are carried out in conjunction with other parties. While warning that sponsored access increased the potential risk of error trades and abuse, the FSA said it did not object to UK platforms offering sponsored access “provided the additional risks are mitigated satisfactorily”.
Pan-European MTF Chi-X, which introduced sponsored access in Q4 2008, liaises with both the trading participant (i.e. member) and its client to facilitate the technological implementation of sponsored access and also checks the legal documentation, limits and controls between the trading participant and client. However, there is no contractual relationship between Chi-X and the trading participant’s client. “We provide the pre-trade risk management layer on behalf of the trading participant. This puts in place all the controls and limits that the broker would have in a DMA relationship. The trading participant sets the parameters and can change them on an intraday basis if they choose,” says Hirander Misra, chief operating officer at Chi-X. “The point of sponsored access is to minimise latency: our pre-trade layer adds just 8-10 microseconds.”
Exchanges are also gearing up to offer sponsored access. NYSE Euronext has been in discussions with the French financial regulator to launch the service in Paris, while the London Stock Exchange (LSE) announced plans for member authorised connectivity last December. In January this year, the exchange changed its rules to enable brokers to allow their clients to place an order directly onto the exchange’s order book. Under the scheme, the broker retains all financial liability for the clients’ trades and the exchange reserves the right to monitor and investigate member firms’ actions and to reject a client. To date, there are no live users of member authorised connectivity on the LSE, but a number of applications have been received.
Turquoise, the broker-owned MTF, has stood clear of the rush to offer sponsored access for now. However, the difference between Turquoise and other venues may be more a matter of semantics than speed. According to CEO Eli Lederman some of Turquoise’s members offer a service that they call sponsored access, but which he considers to be closer to traditional DMA as “we don’t have a direct relationship with the end-client”.
But Lederman believes the lack of definition of sponsored access is a matter that needs to be addressed before the service can develop. “We have a contractual relationship with our members and no direct relationship with clients. With sponsored access, it seems that responsibility for client behaviour is not well defined,” he asserts.
Beattie, however, suggests that sponsored access may find a wider audience than stat-arb traders in the longer term. “Sponsored access is mainly of interest to high-frequency players that need low-latency trading to deploy their strategies effectively. But it should also be seen as part of the continuum of using technology in trading to lower costs and empower the buy-side as a whole,” she says.