‘Naked Access’ Ban Unlikely to Spawn New Broker-Dealers

As reported by Traders Magazine’s James Armstrong, the Securities and Exchange Commission’s new market access rule takes effect Thursday, and some fear high-frequency traders could skirt the rule’s ban on so-called “naked access” by becoming broker-dealers. But experts say those fears are overblown.

The SEC passed the rule last year to end the practice of brokers offering unfiltered or “naked” access to exchanges. With “naked” access, brokers do not require any pre-trade monitoring systems for their clients. The first phase of the rule goes into effect tomorrow.

Already, the largest high-frequency firms don’t always need to go through a broker, as some of them have their own broker-dealer licenses and are members of exchanges. However, there has been some concern that the new regulation might simply get more HFTs to become broker-dealers.

Sang Lee, co-founder and managing partner at Aite Group, thinks few high-frequency traders will end up going that route.

“One of the downsides of having your own broker-dealer license and trying to get direct access yourself is there are increased regulatory requirements,” Lee said. “I don’t know that you’ll see a huge jump in the number of funds that register as a broker-dealer.”

There are other issues as well. Manoj Narang, founder and chief executive officer of the HFT firm Tradeworx who will speak at the High-Frequency Trading Leaders Forum 2011, points out that access to top tier exchange rebates—or at least to something close to them—is a crucial element of many high-frequency trading strategies.

Only a handful of players qualify for those top rebate tiers, which means HFT s looking for those big discounts have to trade with a big firm, he said.

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