While market participants are largely supportive of the US Securities and Exchange Commission’s proposed abolition of ‘naked’ sponsored access to trading venues, some have warned that the proposals could have an unintended impact on equity market liquidity if not amended.
On 19 January the SEC proposed a new rule, 15c3-5, which would require brokers offering clients the ability to trade directly on execution venues, including those providing sponsored access and direct market access, to implement pre-trade risk controls and supervisory procedures to manage the financial, regulatory and other risks associated with the access provision. The comment period for the proposals closed on Monday.
‘Naked’ sponsored access refers to a client accessing a venue using a broker’s market participant identifier (MPID) without first passing through the broker’s systems or being subject to any risk controls.
“BATS believes the proposal is too far-reaching in its scope and if implemented in its current form will have the unintended consequence of dramatically increasing trading friction and, hence, trading costs, which will in turn reduce available liquidity with little added benefit towards enhancing risk controls and preserving the integrity of the financial system,” wrote Eric Swanson, senior vice president and general counsel of US equities bourse BATS Exchange, in his firm’s submission to the proposal’s comment period.
In particular, BATS is concerned about the section of proposed rule 15c3-5 that would require the sponsoring broker-dealer to impose risk controls even if the entity it is granting access to is a broker-dealer itself, despite the fact that the broker-dealer obtaining the market access is already required under the US’s self-regulatory organisation rules to maintain written supervisory procedures related to its and its customers’ placement of orders into the marketplace.
“BATS does not support this aspect of the proposal and respectfully contends that the net result will be an unnecessary chain of redundant controls applied throughout the life of an order, which will have the effect of introducing trading friction not commensurate with any marginal and incremental risk control enhancement,” wrote Swanson.
BATS argues that the risk controls required by the SEC’s proposed rule should be imposed by the broker-dealer originating the order, as otherwise any broker that subsequently touched the order would have to impose its own risk controls.
However, the Financial Industry Regulatory Authority (FINRA), an independent US securities regulator, argues that the proposal to apply the new rule even to broker-dealers using sponsored access should stand. “The fact that a sponsored firm has independent regulatory obligations should not alter the fact that the sponsoring firm is responsible for monitoring all trading conducted using its MPID,” wrote Marcia Asquith, senior vice president and corporate secretary of FINRA, in her firm’s submission. “FINRA believes such obligations should continue to apply to both the sponsored and sponsoring firms under the SEC’s proposal.”
Others are concerned that US equity market liquidity could be compromised if the country acts alone in proposing stricter sponsored access controls. “To the extent the rules were imposed by the SEC in a unilateral or more onerous manner than other jurisdictions and had equivalent trading opportunities existed outside the US markets, it would be probable that a proportion of trading volume would be lost,” wrote Christopher Lee, global head of market access, and Paul Willis, global compliance officer at Fortis Clearing, which offers market access in addition to clearing services.
The two Fortis Clearing executives added that the most significant loss of trading would be among professional market participants and proprietary trading firms. “This will in turn also have a negative effect on the retail investor volume by reducing overall market liquidity and increased market spreads on price, increasing the overall cost-of-trade to the end retail client,” they wrote.
Having closed the comment period, the SEC will now digest the submissions before deciding if and how to enact proposed rule 15c3-5.
The sponsored access rule proposal is one of a series of initiatives announced by the SEC to enhance the US equities marketplace. The regulator adopted a new restriction on short-selling in February, which restricts short-selling in a stock if its value falls 10% compared to the previous day’s close. The commission has also proposed banning ‘flash’ orders, and increasing the disclosure requirements of dark pools of liquidity. The comment periods for these proposals closed in November 2009 and February 2010 respectively.
In addition the SEC has issued a ‘concept release’ seeking comment on the overall equity market structure and how it should be improved. Responses are due in by 21 April.