Continuing Up The HFT Flagpole, Sponsored Access Next In The Regulatory And Public Spotlight
Three months ago Zero Hedge, amidst a whole lot of hyperventilating, schizo-paranoid ramblings, managed to discuss sponsored, or naked access, as a key concern in the ongoing debate against HFT. Once again, we feel humbled that the WSJ (SEC) has decided to read between our disjointed commentary and make a prominent article (regulatory issue) of this critical topic.
Here is WSJ's take on the topic.
Called sponsored or "naked" access, the setup allows high-speed
firms and other outfits to trade directly on exchanges using powerful
computers without the exchanges or regulators knowing who is making the
"We understand that some firms are offering so-called naked access
without effective controls over financial regulatory risk," said David
Shillman, associate director of the Securities and Exchange
Commission's division of trading and markets, which is stepping up its
scrutiny of the issue.
The practice is one of several involving high-frequency trading that is
troubling regulators amid a broader look at making securities markets
more transparent and stable. High-frequency firms collectively trade
billions of shares a day using computer algorithms to capture fleeting
changes in prices. The strategy recently has been one of the most
lucrative in the markets and now accounts for more than half of
stock-trading volume, according to industry estimates.
Sponsored access is akin to members of an exclusive club charging
others to use their pass. The members in this case are registered
brokerage firms that are approved and pay to trade on exchanges.
High-frequency firms or other traders such as hedge funds cut deals
with these regulated brokerage firms that let them use their computer
access codes -- known as a "market participant ID" -- to trade directly
on exchange computers that match buy and sell orders.
And here are the simplified threats:
One concern, regulators say, is that a trading outfit could suffer a
massive loss through a computer glitch that threatens the financial
stability of the sponsoring broker, or triggers a sudden and
unexplained decline in the broader market. Brokers that provide
sponsored access are on the hook for client losses that exceed the
"The risk is that neither the broker nor the exchange have any
obligation to implement technology that would allow them to act" if a
cascade of rapid-fire orders went awry, potentially destabilizing
markets, said Laurie Berke, a principal with Tabb Group, which tracks
Defenders of sponsored access note that so far there has been scant
evidence that the arrangements pose risk to markets. They say brokerage
firms employ rapid posttrade checks that can quickly shut down an
operation if orders run amok. They also say high-speed traders are
sophisticated enough to avoid problems. For now, a patchwork of loose
rules among exchanges and brokers governs the practice.
The SEC says naked access poses threats to stability, whereas "flash
orders," a type of high-speed trading that recently has caught the
attention of politicians, raise concerns of fairness. Flash involves
some traders getting a sneak peek at market orders before other
investors. The SEC has recently sought to ban flash orders.
And here is why Goldman would not be happy to lose a major revenue stream if naked access was banned outright, and is likely negotiating behind the scenes to get its way: another issue Zero Hedge has speculated upon previously.
Goldman Sachs Group Inc. and Credit Suisse Group
AG provide a variant of sponsored access, according to representatives
at the firms. But, unlike Wedbush, they require the firms to route
orders through their computer systems before the orders go the
exchange; this step creates a more-immediate way to monitor trades.
Also, it appears that the only reason the SEC has finally decided to move its ass on this issue is that even though it has been considering this issue for a long time, only recently have HFT users realized what a bonanza it is to nickel and dime retail investors and dinosaur money (pension funds) to the tune of millions of times each and every second.
Though sponsored access has been on the SEC's radar for more than a
year, the agency's concerns lately have mounted as more firms jump into
the field of high-frequency trading, according to a person familiar
with the agency's thinking.
The SEC is concerned the exchanges haven't enacted new rules quickly
enough, according to a person familiar with the matter. Another concern
is that the exchanges could face conflicts of interest, since they
benefit from the huge volumes high-speed traders bring to the market.
If the exchanges don't act soon, the SEC may impose its own rules,
the person says. Though the SEC isn't expected to impose a ban, it
could require that users of sponsored access submit to pre-trade order
checks monitored by the brokerage firm. The rule would undercut the
practice by curbing the speed advantages firms get from sponsored
The WSJ also presents a wonderful example of just what represents your traditional momo quant group outfit: a 4 person group with $10 million in capital. Somehow we have gotten to a point where these kinds of jokers can push the market one way or another on oddlot trades due to a plunge in overall volumes as nobody trusts the underlying mechanics of equity markets anymore, and thus trades exclusively in liquid instruments such as, ironically, CDS.
One recent Wedbush sponsored-access client is Quadeye Trading LLC, a
New York high-frequency-trading firm with $10 million in capital.
Quadeye is run by four traders with a background in computer-driven
mathematical investment strategies, including Sudeep Gupta, who has
more than a decade of experience running quantitative trading desks at
Morgan Stanley and Merrill Lynch, now part of Bank of America Corp. Mr.
Gupta says the firm has "multiple layers of risk control."
Wedbush, which declines to share revenue figures or a
sponsored-access fee schedule, says firms using sponsored access and
brokerage firms that offer it are motivated to manage their risk, since
even small glitches can result in big losses that the brokerage firm
ultimately could have to bear.
"We think the risk decisions should be left to the people with the
capital on the line," said Jeff Bell, an executive vice president at
Wedbush. Mr. Bell says Wedbush hasn't incurred any losses from
Bottom line - let's not forget: what Goldman wants, Goldman gets. In its recent presentation to the SEC, the squid noted that "naked sponsored access introduces the potential for significant systemic risk due to the lack of appropriate risk controls." Furthermore, previously Greg Tusar had said this of sponsored access, and specifically why Goldman is all for pre-trade checks:
"In the case of high-frequency trading, in particular guarding against
technology failures, oversized orders and other situations where
there's potentially systemic market impact, we believe strongly that
pre-trade checks are a prerequisite. We don't believe that's strong enough or what the regulators
want now, because of the potentially dire consequences, and because
we-as broker-dealers-bear much of that risk."
How convenient that the SEC moves only on issues that Goldman is happy to see the SEC move on. And would we be so bold as to wager that the SEC will ultimately decide for...pre-trade access monitoring for naked access, along the lines of what Mr. Tusar subliminally recommends? Why, would that perchance benefit Spear Leeds Kellogg's GSETConnect/REDIPlus/REDIPlus FX/Sonar/DMA/SIGMA/OptimIS/PortX current multi-billion infrastructure? We would be so bold as to say why "Yes, Virginia." What better way to front run everyone on the planet than to reroute every single HFT order from a common shared pre-trade clearance router that commingles flow and prop trades (of Goldman Sachs, natch) which is endorsed and in fact, encouraged by "regulators", thus effectively monopolizing front running not only on an Octavian but Galactic scale.
We can't wait to see the results of our wager.