Mary Schapiro, chairman of US regulator the Securities and Exchange Commission (SEC), has suggested that compliance with automation review policies (ARPs) could be made obligatory.
Speaking at the industry body SIFMA's Compliance and Legal Society Annual Seminar, she explained that ARPs, which were issued by the SEC after ”Black Monday' the global stock market crash in 1987, in which “investors overwhelmed Wall Street's existing automated systems.” The ARPs set out expectations that market participants would acquire and test the systems necessary to run their operations and that these would be reviewed annually. They also told that the SEC should be alerted to any problems or changes. As these were policy statements, not rules, compliance was not a binding requirement.
“Today, with risks including algorithm-generated volume surges and malevolent hackers still very much with us, I believe the SEC should consider making ARP compliance mandatory,” said Schapiro. “In my view, these rules should reinforce the current expectation that registrants report systems changes, malfunctions and intrusions to the SEC and disclose material problems to the public.”
Trading venues, clearing houses, securities depositories and information processors would all be subject to compliance with the policies.
Concern on the effect that automated trading poses to the market was heightened by the ”flash crash' on 6 May last year, which demonstrated the effect that automated trades could have if they lacked certain controls.
“It is not okay for firms to simply allow algorithms to continue to operate without evaluating their results and their impact, without completely understanding how they work in periods of excessive volatility,” said Richard Ketchum, chairman and chief executive officer of sell-side industry body FINRA, speaking at the same event, “I think the new SEC rule is absolutely critical to ensuring market integrity both with regard to market volatility and disruptions, and also with regard to concerns about manipulation.”
Schapiro's comments added to the ”Recommendations regarding regulatory responses to the market events of May 6 2010' issued on 18 February by the Joint Commodity and Futures Trading Commission (CFTC) – SEC Advisory Committee on Emerging Regulatory Issues, which proposed 14 changes that the CFTC and SEC should consider making to market rules in order to strengthen market infrastructure.
Among these was the trade-at rule, which would require a venue not displaying the national best-bid-offer price (NBBO) to either execute an order with ”substantial' price improvement to the NBBO or to route it to a market that does display the NBBO. The rule is intended to prevent orders from being executed in dark pools that could otherwise be executed in lit venues and contribute to price formation.
On Monday 21 March, responding to the report, Ann Vlcek, associate general counsel at SIFMA, issued a letter that took issue with the proposed rule, citing increased market impact and the potential damage it could do to best execution.
“Routing under a trade-at rule may well increase the likelihood of information leakage, signalling to other market participants the possibility of additional order flow at a non-displaying trading venue, for example, thereby disrupting attempts of investors to reduce implicit costs associated with larger orders,” wrote Vlcek.
“It is the discretion afforded to broker-dealers in determining how best to execute orders that has put exchanges in healthy competition with alternative trading systems and over-the-counter market makers over the last decade,” she continued, adding that the rule preferenced “investors who display orders over investors who decide it is in their best interest not to display some or any of their orders – even if they may be willing to execute at the same price as the displayed markets”.
SIFMA also argued against the proposal for material price improvement for internalised or preferenced orders, or a requirement for such internalising or preferencing firms to execute some portion of their order flow during volatile market periods, saying that it would harm internalisation benefits “investors of all sizes, both large and small, and has not adversely impacted the quality of the markets.”