The US Securities and Exchange Commission (SEC) has proposed a new rule that would prohibit brokers from providing their clients with direct access to exchanges or alternative trading systems without risk controls, known as ‘naked’ sponsored access.
The commission will also issue a ‘concept release’ seeking public comment on a wide range of issues relating to the structure of the US equities market, including high-frequency trading, co-location and non-displayed trading venues.
The SEC voted unanimously to take both actions at an open meeting yesterday.
The proposed sponsored access rule would require brokers with market access, including those who sponsor customers’ access to an exchange, to put in place risk management controls and supervisory controls. According to the SEC, such procedures would help prevent erroneous orders, ensure compliance with regulatory requirements and enforce predetermined credit or capital thresholds.
The SEC also approved a new rule on the Nasdaq stock exchange that requires brokers offering sponsored access to Nasdaq to establish certain controls that manage the financial and regulatory risks of the activity. The commission said its proposed rule would extend beyond the new Nasdaq rule in several respects – for example it would require the broker to automatically apply its controls on a pre-trade basis.
Separately, connectivity and trading solutions provider Ullink has annnounced that its UL NET+ high-frequency direct market access solution will enable brokers to address the SEC’s proposed restrictions on naked sponsored access.
Unlike direct market access, where client orders pass through the brokers’ systems on their way to trading venues, sponsored access allows clients to trade directly on the venues using their broker’s market participant identifier. If a broker does not pre-screen orders sent via sponsored access in any way, it is known as naked or unfiltered sponsored access.
The SEC contends sponsored access, particularly the naked type, creates the potential for financial, regulatory and other risks associated with the placement of orders to be inappropriately managed.
“Unfiltered access is similar to giving your car keys to a friend who doesn’t have a license and letting him drive unaccompanied,” said SEC chairman Mary Schapiro in a statement. “The proposal would require that if a broker-dealer is going to loan his keys, he must not only remain in the car, but he must also see to it that the person driving observes the rules before the car is ever put into drive.”
In its equity market structure concept release, the SEC is assessing how all types of individual investors and all sizes of institutional investors — small, medium, and large — are faring in the current market structure. It is also examining whether the current market structure promotes capital formation in companies with varying levels of market capitalisation.
The release requests comment on all matters related to market structure. It also asks specific questions about the current market structure relating to the best way of measuring market quality, the fairness of the market structure, whether high-frequency strategies are beneficial or harmful for investors and whether co-location gives proprietary trading firms an unfair advantage. It also asks whether the trading volume on non-displayed venues has reached such a level that it detracts from the quality of public price discovery.
The SEC has already proposed several new rules relating to US equity market structure as part of its continuing review, such as the banning of ‘flash’ orders and increasing the transparency in dark pools, but said the concept release is intended to help determine whether additional regulatory measures are needed to improve the current market structure.
Public comments on the proposed sponsored access rule must be received 60 days after the proposal’s publication in the Federal Register, and comments on the concept release must be received within 90 days.