While the US Securities and Exchange Commission’s (SEC) ‘concept release’ on the US equity market structure has a strong focus on the effects of high-frequency trading, firms conducting such activities may escape relatively unscathed by any new rules arising from the regulator’s review, according to a senior broker.
“While the focus is on high-frequency trading and there are a couple of particular areas of concern, I don’t think high-frequency trading is going to be hit very hard by what comes out of Washington,” said Joe Gawronski, president and chief operating officer of US boutique broker Rosenblatt Securities, speaking on a high-frequency trading webinar hosted by research firm TABB Group and financial software provider ULLINK. “I think they will fare pretty well compared with brokers.”
One of the areas being examined by the SEC is whether access to co-location facilities, where trading firms host their servers in the same data centres as exchange matching engines to minimise latency, is fair and does not give advantages to certain participants. High-frequency trading strategies are generally heavily dependent on co-location. However, Gawronski feels there will be little change. “The exchanges have been proactive in saying that they will be transparent with pricing and offer fair access, and the SEC is just likely to codify the rules,” he said. “I think it is going to be a non-event.”
As part of its overall review of US equity market structure, the SEC has proposed mandating brokers to impose pre-trade risk controls when granting clients sponsored access to trading venues. Access without the risk controls, known as ‘naked’ sponsored access, is typically used by high-frequency traders to cut out the additional latency that pre-trade checks would impose.
While he acknowledges that a new sponsored access rule could change firms’ business models and introduce additional latency, Gawronski said, “People will adjust and they are going to have time to adjust. I don’t view things like that as terribly disruptive.”
There are also some elements of the SEC’s concept release that could actively benefit high-frequency traders, argued Gawronski. For example, the release asks participants for comment on whether the minimum tick size of for stocks trading over $1 should be lowered, pointing out that the current one-cent increment makes up a high proportion of the value of low-priced stocks, which may provide a greater incentive for broker internalisation of trades in these stocks.
“I think the SEC is going to give a very serious hearing to sub-penny quoting by exchanges,” said Gawronski. “High-frequency traders would like it and exchanges would certainly like it from a volume perspective.”
However, brokers’ operations could face bigger disruptions from the SEC’s equity market review. One area of discussion is the apparent opacity of brokers’ routing practices. For example, in its response to the concept release, agency broker and crossing network operator Liquidnet proposed mandating disclosure of specific order handling practices by institutional brokers.
“I think there is a general feeling by the SEC that broker routing practices aren’t very transparent,” said Gawronski. “While we live in a world in which it seems that buy-side traders have much more control, I’m not sure they are aware of how their order flow is being handled in terms of what dark pools it is going to, who is getting rebates for what and where it is being sent out using indications of interest. I think there may be some action on broker routing practices and also some anti-internalisation measures.”
One potential change proposed by the concept release is a ‘trade-at’ rule, which would seek to prohibit any trading venue from executing at the national best bid and offer (NBBO) unless it was displaying the NBBO at the time it received the incoming contra-side order. “I think the people in Washington are going to give this a serious hearing and that would be a negative for any broker that internalises,” said Gawronski.
The SEC issued its concept release on US equity market structure on 13 January. The deadline for comments is 21 April.