The Securities and Exchange Commission (SEC) has confirmed that it will delay aspects of a new rule governing access to trading venues until 30 November, following requests from market participants for more preparation time.
The US securities market regulator will delay two parts of the rule originally due to come into force on 14 July. First, the SEC will postpone the implementation of controls and procedures that ensure orders sent through brokers' systems do not exceed pre-set credit or capital thresholds. Second, it will suspend the introduction of the naked access ban for fixed income securities.
“The Commission understands that, as broker-dealers with market access have worked to meet the July 14, 2011 compliance date, some have determined that additional time is needed to implement effective policies and procedures and complete the systems changes necessary to comply with certain requirements of Rule 15c3-5,” read the SEC statement.
Brokers will still be required to ensure that any orders they send to exchanges comply with other parts of the new rule, such as those designed to prevent erroneous or manipulative trading.
A separate request to delay some aspects of the market access rule was sent to the SEC by the four largest US stock exchanges last week. Exchanges have been reluctant to comment on the letter to the SEC, with some denying any involvement in a call for delay, but their request is believed to relate to the need for their broker-dealer subsidiaries – which route orders to other exchanges in accordance with Reg NMS – to implement risk controls in addition to those imposed by originating brokers.
“The exchanges feel there are unanswered questions relating to how the rule applies to affiliate broker-dealer,” said Jess Haberman, director of compliance for trading technology vendor Fidessa in the US. “The revenue they receive from this activity is limited and probably influences their ability to devote technology resources to address these requirements.”
The market access rule – originally proposed by the SEC in January 2010, but fast-tracked following the 6 May ”flash crash' – has been introduced to prevent broker-dealers from allowing clients to trade directly on equity markets without appropriate pre-trade risk controls. Brokers will be required to establish, document and maintain a system of risk management controls and supervisory procedures to manage the risks associated to market access. The market access rule has been seen as a key step toward avoiding a repetition of the US flash crash of 6 May 2010, in tandem with the introduction of a market-wide single-circuit breaker regime, due to be revised to include limit up/limit down functionality before the end of the year.
Circuit breaker support
The expected replacement of single-stock circuit breakers with limit up/limit down functionality has garnered broad support from the industry. US stock exchanges proposed a limit up/limit down system on 25 May, with the SEC inviting comments up until 22 June. It is expected to replace the current circuit breaker regime before August.
Limit up/limit down functionality would prevent trades in listed equity securities from being executed outside of a set percentage level above or below the average price of the security over the immediately preceding five-minute period. For stocks currently subject to the circuit breaker pilot – those in the Standard & Poor's 500 Index and Russell 1000 Index – the percentage would be 5%, and for those not subject to the pilot, the percentage would be 10%.
The percentage bands would be doubled during the opening and closing periods. Broader price bands would also apply to stocks priced below US$1.
In comments posted to the SEC website, market participants including broker Knight Capital, sell-side trade body SIFMA and investment manager Vanguard were all supportive of the new regime.
“A limit up/limit down structure is a better long-term solution to some of the issues that can arise in our increasingly automated and fragmented trading markets,” wrote George Sauter, chief investment officer, Vanguard Group, in his firm's response.
However, there were warnings on the implementation of some aspects of the rule. For instance, Knight Capital pointed out that the limit up/limit down threshold should not be applied during the first or last five minutes of trading to avoid disrupting price formation.
If the limit up/limit down mechanism does not resolve periods of extreme volatility, the existing single-stock circuit breaker regime will come into force. However, market participants may also have to take account of market-wide protocols and the individual circuit breakers used by each equity market such as NYSE Euronext's Liquidity Replenishment Points, which slow down trading during extremely volatile conditions.
“The complexity is not insurmountable and can be addressed separately from the debate on whether we need them at all. We have to understand that we need to sacrifice an element of market fluidity to protect against extreme volatility,” said Alison Crosthwait, managing director, global market structure at agency broker Instinet.
The current circuit breaker scheme – first introduced in June last year – halts trading in an individual stock for five minutes in the event of its value falling or rising by 10% or more in the previous five-minute period.