The SEC's Concept Release on Market Structure, Proposes Risk Management Rules for Sponsored Access


On January 14, 2010, the Securities and Exchange Commission (SEC") voted to issue a concept release intended to elicit public comment on a broad range of questions relating to the efficiency and fairness of the public equity markets (the "Concept Release"). The Concept Release revisited issues that the SEC raised and addressed nearly five years ago in a comprehensive set of market, trading and reporting rules codified in Regulation NMS. Shortly after publishing the Concept Release, the SEC also published a release proposing a new risk management rule requiring firms that sponsor trading access to exchanges and alternative trading systems (ATSs) to establish (and periodically evaluate) a system of controls intended to limit potential financial exposure and to ensure compliance with relevant regulatory requirements (the "Sponsored Access Release"). These recent market-structure initiatives form part of the SEC's ongoing review of the equity markets and follow two discrete SEC rule-making initiatives from 2009 currently under consideration.

SEC Market Structure Review

The Concept Release conveyed the SEC's concerns that current regulations intended to support and promote a competitive and an efficient national market system (an "NMS") are not keeping pace with significant changes in trading technologies and trading practices. The SEC focused on current structural elements of the equity markets that generally speaking could (i) give regulatory and competitive advantages to professional market participants at the expense of other participants; (ii) lead to greater market fragmentation; and (iii) detract from goals of public price transparency. In particular, the SEC highlighted recent technological advances that are driving equity trading from trading on the floors of stock exchanges to computer screens and matching engines whose highly automated functions are decreasing order transmission and execution times to milliseconds, or even microseconds.

In light of new technologies and related trading strategies, long-term (and especially institutional) investors have been compelled to engage in a technological arms race in order to minimize the market impact and possible front-running of their trades. They have increasingly turned to their own trading algorithms or those of their market intermediaries, which divide large (or "parent") orders and send the constituent smaller (or "child") orders to a variety of market centers, both transparent and dark. These market forces, aided by changes in technology, have created a more complex and dispersed market ecosystem of high frequency traders, dark pools, server co-location and sponsored market access, all of which are designed to handle and capitalize on structural changes in the equity markets and the increased speed and volume capabilities of automated market centers. [footnotes omitted]

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