Risk Management Controls for Brokers or Dealers With Market Access
January 26th, 2010
SUMMARY: The Securities and Exchange Commission (“Commission” or “SEC”) is proposing for comment new Rule 15c3-5 under the Securities Exchange Act of 1934 (“Exchange Act”) that would require brokers or dealers with access to trading directly on an exchange or alternative trading system (“ATS”), including those providing sponsored or direct market access to customers or other persons, to implement risk management controls and supervisory procedures reasonably designed to manage the financial, regulatory, and other risks of this business activity. Given the increased speed and automation of trading on securities exchanges and ATSs today, and the growing popularity of sponsored or direct market access arrangements where broker-dealers allow customers to trade in those markets electronically using the broker-dealers’ market participant identifiers, the Commission is concerned that the various financial and regulatory risks that arise in connection with such access may not be appropriately and effectively controlled by all broker-dealers. The Commission believes it is critical that broker-dealers, which under the current regulatory structure are the only entities that may be members of exchanges and, as a practical matter, constitute the majority of subscribers to ATSs, appropriately control the risks associated with market access, so as not to jeopardize their own financial condition, that of other market participants, the integrity of trading on the securities markets, and the stability of the financial system.
DATES: Comments should be received on or before March 29, 2010.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
* Use the Commission’s Internet comment form (http://www.sec.gov/rules/proposed.shtml); or
* Send an e-mail to rule-comments@sec.gov. Please include File No. S7-03-10 on the subject line; or
* Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.
Paper Comments
* Send paper comments in triplicate to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090.
All submissions should refer to File No. S7-03-10. This file number should be included on the subject line if e-mail is used. To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments are also available for public inspection and copying in the Commission’s Public Reference Room, 100 F Street, NE., Washington, DC 20549 on official business days between the hours of 10 a.m. and 3 p.m. All comments received will be posted without change; we do not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly.
FOR FURTHER INFORMATION CONTACT: Marc F. McKayle, Special Counsel, at (202) 551-5633; Theodore S. Venuti, Special Counsel, at (202) 551-5658; and Daniel Gien, Attorney, at (202) 551-5747, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-7010.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
II. SRO Rules and Guidance
III. Proposed Rule 15c3-5
IV. Request for Comments
V. Paperwork Reduction Act
VI. Consideration of Costs and Benefits
VII. Consideration of Burden on Competition, and Promotion of Efficiency, Competition and Capital Formation
VIII. Consideration of Impact on the Economy
IX. Initial Regulatory Flexibility Analysis
X. Statutory Authority
XI. Text of Proposed Rule
Appendix
I. Introduction
The Commission has long recognized that beneficial innovations in trading and technology can significantly improve the efficiency and quality of our nation’s securities markets. At the same time, the Commission must ensure that the regulatory framework keeps pace with market developments and effectively addresses any emerging risks. In recent years, the development and growth of automated electronic trading has allowed ever increasing volumes of securities transactions across the multitude of trading systems that constitute the U.S. national market system. In fact, much of the order flow in today’s marketplace is typified by high-speed, high-volume, automated algorithmic trading, and orders are routed for execution in milliseconds or even microseconds.
Over the past decade, the proliferation of sophisticated, high-speed trading technology has changed the way broker-dealers trade for their own accounts and as agent for their customers. /1/ In addition, customers–particularly sophisticated institutions–have themselves begun using technological tools to place orders and trade on markets with little or no substantive intermediation by their broker-dealers. This, in turn, has given rise to the increased use and reliance on “direct market access” or “sponsored access” arrangements. /2/ Under these arrangements, the broker-dealer allows its customer–whether an institution such as a hedge fund, mutual fund, bank or insurance company, an individual, or another broker-dealer–to use the broker-dealer’s market participant identifier (“MPID”) or other mechanism for the purposes of electronically accessing the exchange or ATS. With “direct market access,” /3/ as commonly understood, the customer’s orders flow through the broker-dealer’s systems before passing into the markets, while with “sponsored access” /4/ the customer’s orders flow directly into the markets without first passing through the broker-dealer’s systems. In all cases, however, whether the broker-dealer is trading for its own account, is trading for customers through more traditionally intermediated brokerage arrangements, or is allowing customers direct market access or sponsored access, the broker-dealer with market access /5/ is legally responsible for all trading activity that occurs under its MPID. /6/
FOOTNOTE 1 The Commission notes that high frequency trading has been estimated to account for more than 60 percent of the U.S. equities market volume. See, e.g., Nina Mehta, Naked Access Bashed at Roundtable, Trader’s Magazine, August 6, 2009 (citing a report by Aite Group). END FOOTNOTE
FOOTNOTE 2 It has been reported that sponsored access trading volume accounts for 50 percent of overall average daily trading volume in the U.S. equities market. See, e.g., Carol E. Curtis, Aite: More Oversight Inevitable for Sponsored Access, Securities Industry News, December 14, 2009 (citing a report by Aite Group). In addition, sponsored access has been reported to account for 15 percent of Nasdaq volume. See, e.g., Nina Mehta, Sponsored Access Comes of Age, Traders Magazine, February 11, 2009 (quoting Brian Hyndman, Senior Vice President for Transaction Services, Nasdaq OMX Group, Inc. “[direct sponsored access to customers is] a small percentage of our overall customer base, but it could be in excess of 15 percent of our overall volume.”). END FOOTNOTE
FOOTNOTE 3 Generally, direct market access refers to an arrangement whereby a broker-dealer permits customers to enter orders into a trading center but such orders are filtered through the broker-dealer’s trading systems prior to reaching the trading center. See, e.g., Nasdaq Rule 4611(d)(1)(B). END FOOTNOTE
FOOTNOTE 4 Generally, sponsored access refers to an arrangement whereby a broker-dealer permits its customers to enter orders into a trading center that bypass the broker-dealer’s trading system and are routed directly to a trading market via a dedicated port, in some cases supported by a service bureau or other third party technology provider. See, e.g., Nasdaq Rule 4611(d)(1)(A). “Unfiltered” or “naked” access is generally understood to be a subset of sponsored access where pre-trade filters or controls are not applied to orders before such orders are submitted to an exchange or ATS. The Commission notes that the proposed rule would effectively prohibit any access to trading on an exchange or ATS, whether sponsored or otherwise, where pre-trade controls are not applied. END FOOTNOTE
FOOTNOTE 5 Under Proposed Rule 15c3-5(a)(1), the term “market access” is defined as access to trading in securities on an exchange or ATS as a result of being a member or subscriber of the exchange or ATS, respectively.See infra Section III.C. END FOOTNOTE
FOOTNOTE 6 See, e.g., NYSE IM-89-6 (January 25, 1989); and Securities Exchange Act Release No. 40354 (August 24, 1998), 63 FR 46264 (August 31, 1998) (NASD NTM-98-66). END FOOTNOTE
Certain market participants may find the wide range of access arrangements beneficial. For instance, facilitating electronic access to markets can provide broker-dealers, as well as exchanges and ATSs, opportunities to compete for greater volumes and a wider variety of order flow. For a broker-dealer’s customers, which could include hedge funds, institutional investors, individual investors, and other broker-dealers, such arrangements may reduce latencies and facilitate more rapid trading, help preserve the confidentiality of sophisticated, proprietary trading strategies, and reduce trading costs by lowering operational costs, /7/ commissions, and exchange fees. /8/
FOOTNOTE 7 For example, broker-dealers may receive market access from other broker-dealers to an exchange where they do not have a membership. END FOOTNOTE
FOOTNOTE 8 The Commission notes that exchanges offer various discounts on transaction fees that are based on the volume of transactions by a member firm. See, e.g., Nasdaq Rule 7018 and NYSE Arca, Inc. (“NYSE Arca”) Fee Schedule. Exchange members may use access arrangements as a means to aggregate order flow from multiple market participants under one MPID to achieve higher transaction volume and thereby qualify for more favorable pricing tiers. END FOOTNOTE
–This is a summary of a Federal Register article originally published on the page number listed below–
Proposed rule.
CFR Part: “17 CFR Part 240″
RIN Number: “RIN 3235-AK53″
Citation: “75 FR 4007″
Document Number: “Release No. 34-61379; File No. S7-03-10″
Federal Register Page Number: “4007″
“Proposed Rules”
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