US SEC seeks to curb “naked access,” expose fast trades

October 27, 2009

U.S. Securities and Exchange Commission Chairman Mary Schapiro testifies before the Senate Banking Committee on Capitol Hill in Washington, June 22, 2009.  (File Photo)  REUTERS/Jim Young    (UNITED STATES POLITICS BUSINESS)  By Elinor Comlay
NEW YORK, Oct 27 (Reuters) – The top U.S. securities regulator said she was looking for ways to crack down on “naked access,” the practice of brokers giving high-frequency traders unfettered access to public markets.

Securities and Exchange Commission Chairman Mary Schapiro said on Tuesday that she had concerns with sponsored naked access, where brokerages that have been approved to trade on an exchange rent their access to clients who are able to shave milliseconds from the time it takes to access the markets.

“I liken it to giving your car keys to a friend who doesn’t have a license and letting him drive unaccompanied,” Schapiro said at a Wall Street conference in New York.

Schapiro said she had directed SEC staff to come up with rule proposals that would address the risk naked access posed to exchanges, focusing on arrangements that enable unfiltered access by nonregulated entities.

“The reason this raises concerns is that broker-dealers perform vital gatekeeper functions, functions that are essential to maintaining the integrity of the markets,” she said at the Securities Industry and Financial Markets Association conference.

“We should not sacrifice the stability and fairness of the markets to give a trader a millisecond advantage.”

The SEC is examining changes to market structure and has already proposed ways to shed light on dark pools, which are private, anonymous, electronic trading venues that compete with exchanges for their largest, most profitable orders. It has also has proposed banning so-called flash orders, which give advance knowledge of stock orders to certain traders.

The SEC and some lawmakers have become increasingly concerned that recent market developments have created an uneven playing field that favors sophisticated traders and investors.

Schapiro said she had also directed her staff to craft a proposal to shed light on the activities of high-frequency traders.

High-frequency trading now accounts for an estimated 50 percent to 70 percent of all U.S. equity trading and is growing fast in other regions and asset classes. In it, banks, hedge funds, and independent shops use ultra-quick algorithms to make markets and capitalize on tiny spreads and market imbalances.

“We need a deeper understanding of the strategies and activities of high-frequency traders and the potential impact on our markets and investors of so many transactions occurring so quickly,” Schapiro said in prepared remarks.

She opened the door for Congress to give her agency more authority to police markets and said legislation might be needed to address new types of market professionals whose activities may not be sufficiently regulated.

On Wednesday, a congressional panel will examine high-frequency trading, naked access and other recent market developments.

Schapiro said legislation was needed to properly oversee asset-backed securities such as the ones linked to mortgages that contributed to the global financial crisis.

“Substantive protections beyond disclosure requirements” are needed for asset-backed securities, she said.

Policymakers are mulling legislation that would require banks to assume some of the risks of their loans or assets that are later securitized, or repackaged and then resold to investors.

Schapiro said new laws could have “substantive restrictions” or requirements for the trust that issues the securities and for related parties.

Requirements could include strong representations and warranties about the assets being securitized and procedures for ensuring those representations and warranties are followed, she said.

(Reporting by Elinor Comlay; Writing by Rachelle Younglai; Editing by Neil Stempleman and Lisa Von Ahn) (( + 1 202 898 8411))

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