When regulators reach too far

The Securities and Exchange Commission (SEC) has begun to receive the first responses to its proposed rules of exchange computer systems, dubbed Regulation Systems Compliance and Integrity (Reg SCI).

The general consensus seems to be that the SEC is overreaching, attempting to regulate technology that does not pose a threat to market integrity. Some even believe the regulation could inadvertently put markets at greater risk.

So wide-ranging is the potential impact of Reg SCI that a group of seventeen exchanges that are also self-regulatory organisations (SROs) have written a combined letter to the SEC highlighting their concerns.

Chief among them is the scope of the regulation, which extends to many systems and services that fall well outside of the core operation of their markets.

For example, systems disruptions rules include firms having to notify of cases where they switch to backups, or if their service level agreements with members are not met. The SROs believe the regulator has reached too far, and said: “The definition of the term ‘systems disruption’ should be limited to include only those events that have a material impact on the delivery of core services to members or participants, as opposed to routine issues.”

The SROs also complained that many aspects of the regulation are too vague and in need of clarification. They have called for greater guidance on mandatory testing and more discussion on the process by which markets should recover from wide-scale disruption.

Furthermore, the SEC risks creating further disruption by requiring live testing of failover systems. “[We] are concerned that live production testing could compromise the marketplace. [We] would not support including such a requirement in Regulation SCI,” the group of SROs said in a letter.

Lastly, there are concerns over the cost. The SROs believe the SEC’s cost benefit analysis has vastly underestimated the cost of the regulation. A recent trade body survey adds weight to this. The Futures Industry Association's Principal Traders Group found the average cost to a broker-dealer of complying would be around $4m per year.

Feedback on Reg SCI highlights a common problem for the industry when regulators attempt to overreach. While it is important to ensure that systems are robust enough to prevent market failures, which have irked many in recent years, by reaching too much into the fine detail of how exchanges run their systems and services, the SEC risks homogenising the market.

If regulators are too dictatorial about how systems outside of core operations are functioning, then there is little left for exchanges to differentiate themselves and this could cripple competitiveness. Unnecessary costs increases are also unwelcome at a time when markets are only just starting to get back on their feet.