The four largest U.S. stock market operators asked the Securities and Exchange Commission to delay implementation of rules governing how brokers send orders to venues, which includes a ban on unsupervised market access given to some high-frequency traders.
NYSE Euronext, Nasdaq OMX Group Inc. (NDAQ), Bats Global Markets and Direct Edge Holdings Inc. asked the regulator for an extension until Nov. 30 from the current deadline of July 14, according to a letter dated yesterday obtained by Bloomberg News. The Securities Industry and Financial Markets Association, a trade organization for brokers, banks and asset managers, also asked for an extension for all securities firms in April.
Regulators are trying to prevent computer-driven trading strategies and erroneous orders from causing market routs and increasing risks to brokers and the financial system. The market-access rules will require brokers to implement financial and risk controls for all securities orders before those trading requests are sent to exchanges and other venues.
The exchanges said in the letter that a “number of interpretative issues” regarding the rule must be resolved and that they need time to “complete the development and implementation of the compliance controls.”
Their request would apply only to securities firms that route orders on behalf of other brokers, not those sending orders to markets directly, they said. Sifma asked for a delay for all securities firms.
John Jacobs, director of operations at Lime Brokerage LLC, a subsidiary of Wedbush Inc., said he agreed the SEC should extend the deadline to give brokers more time to comply with the rule. Many brokers use other securities firms to send orders to exchanges to get the benefit of better fees or rebates based on that firm’s trading volume. Exchanges such as Nasdaq Stock Market and NYSE Arca, run by NYSE Euronext (NYX), have different fees for brokers that send them a certain amount of shares per month.
“There’s still a fair amount of pushback from aggregators and those who benefit from the aggregation” of trading volume about some of the new rule’s requirements, Jacobs said.
Brokers that receive an order from a mutual or pension fund must run risk checks to make sure the request doesn’t exceed a client’s account limits, isn’t erroneous and doesn’t fall afoul of securities rules. Under the SEC proposal, if that broker sends the order to another broker for execution, the second firm must run its own set of checks, even if the original securities firm already performed a similar analysis. Some, but not all, checks can be delegated to the first firm.
The rule, which the SEC approved in November, includes a ban on unfiltered or “naked” access, in which brokers allow clients to make unsupervised trades on stock exchanges, using the securities firm’s identification number, a practice that Boston-based research firm Aite Group LLC said accounted for two of every five shares traded in 2009.
Richard Adamonis, a spokesman for New York-based NYSE Euronext, and Stacie Fleming of Lenexa, Kansas-based Bats declined to comment. Robert Madden of Nasdaq OMX in New York couldn’t immediately be reached for comment. Michael Boccio of Sloane & Co., which represents Jersey City, New Jersey-based Direct Edge, said the market operator co-signed the letter.
John Nester, an SEC spokesman, declined to comment on whether implementation would be delayed.
The SEC rule will force firms providing clients with direct access to exchanges to analyze customer credit thresholds, ensure that orders don’t violate short-sale rules, check for manipulative activity and prevent errant trades before those orders are sent to the market, Gerard Citera, an expert on regulation at Davis Polk & Wardwell LLP, said at a private panel at Nasdaq OMX in February. Chief executive officers at broker- dealers must certify their firms’ controls, he said.
Many brokers don’t want another broker to check orders they’ve already vetted, New York-based Jacobs said. Lime, which Los Angeles-based Wedbush agreed to buy on June 13, is ready for the new rules, he said.
While the four exchange operators said they’re making their request “on behalf of all routing broker-dealers,” they highlighted the “unique responsibilities and limitations” they face through the routing brokers they operate as subsidiaries. These brokers are run as facilities of an exchange and must receive regulatory approvals for all rules they institute.
The brokers are used to allow exchanges to comply with rules requiring them to avoid trading at a price inferior to the best available price on another market by sending orders to the other venue. While many larger brokers prefer making their own routing decisions, this service by exchanges offers an alternative and is used by many smaller and medium-size firms.
The exchanges told the SEC that their routing brokers currently have no discretion to reject orders they’re required to route elsewhere if the buy or sell requests are deemed erroneous or shouldn’t be allowed for another reason. They need to build the controls that would allow them to comply with the market-access rule, they said.
The exchanges also said the rules may cost more to implement than the SEC initially projected. They added that the regulator’s limitation on the products and services an exchange’s routing broker can offer “has had the effect of limiting the availability of sources of revenue to offset the costs of compliance with regulatory requirements,” including the market-access rule.
Exchanges could choose not to offer routing services. They aren’t obligated by the SEC to provide them.
A delay in the market-access rules would give brokers in equities, options and fixed-income products more time to prepare their trading and compliance systems, Jacobs said.
“One of the disconnects we’re seeing is that people don’t understand this also applies to internal order flow at a broker- dealer,” Jacobs said. “If the block sales trader is trading on behalf of a customer, that order flow must be programmatically risk managed. People erroneously think this is only about naked access and that’s not the case.”
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