By unanimous vote, the SEC adopted a new rule to require brokers and dealers to have risk controls in place before providing their customers with access to the market.  The new rule's focused on those B/D's that hand customer a special pass to access the markets, called a market participant identifier.  The customer then gains direct access to the applicable exchange or ATS, also known as “sponsored access.”  The rule becomes effective in 60 Days.

    The New Rule Prohibits ...  B/D's from providing customers with “unfiltered” or “naked” access to an exchange or ATS, and it requires brokers with market access - including those who sponsor customers’ access to an exchange or ATS - to put in place risk management controls and supervisory procedures to help prevent erroneous orders, ensure compliance with regulatory requirements, and enforce pre-set credit or capital thresholds.

    Customers Placing Orders Themselves.   Today, most orders are routed for execution in milliseconds through high-speed, high-volume, automated algorithmic trading.  High-frequency trading ("HFT") alone has been estimated to account for more than 50% of the U.S. equities market volume.  As a result, some sophisticated customers have begun using technological tools to place orders and execute high-speed trades themselves, essentially bypassing their broker-dealer, who provides the customer with the market participant identifier, or MPID.  In some of these arrangements, the customer is able to place an order that flows directly into the markets without first passing through the B/D's systems and without being pre-screened by the B/D in any manner - i.e., “unfiltered” or “naked” access.

Requirements, Going Forward.  A B/D has to establish, document and maintain a system of risk management controls and supervisory procedures reasonably designed to manage the financial, regulatory and other risks related to its market access, including access on behalf of sponsored customers.  In association with this requirement, B/D's have to:

• Create financial risk management controls reasonably designed to prevent the entry of orders that exceed appropriate pre-set credit or capital thresholds, or that appear to be erroneous.

• Create regulatory risk management controls reasonably designed to ensure compliance with all regulatory requirements applicable in connection with market access.

• Have certain financial and regulatory risk management controls applied automatically on a pre-trade basis before orders route to an exchange or ATS.

• Maintain risk mmgmt controls and supe procedures under the direct and exclusive control of the B/D with market access. There would however be limited exceptions, as specified in the rule, to permit a broker or dealer to reasonably allocate certain controls and procedures to another registered broker or dealer that, based on its position in the transaction and its relationship with the ultimate customer, can more effectively implement them.

• Establish, document and maintain a system for regularly reviewing the effectiveness of its risk mgmt controls and for promptly addressing any issues.

For further details, click onto:   [ SEC PR 10-210, 11/3 ]