Trading Platforms and Hedge Funds Object to Systems Regulation

Terry Flanagan

Electronic trading platforms and the asset management community are chafing at the Securities and Exchange Commission’s proposed rules that purport to strengthen the security of market infrastructure and address issues arising from operational risks, such as technology failures, natural disasters, and cyber-attacks.

LiquidPoint, the options business of Convergex Group, questioned whether it should be required to comply with proposed Regulation Systems Compliance and Integrity, or Reg SCI.

LiquidPoint operates a listed-option pairing facility called LiquidPoint NXP, which pairs options orders from LiquidPoint customers for submission the automated auction process on a register options exchange. If the liquidity providers’ trading interest can provide a contra order, it is paired with the originating customer order.

LiquidPoint then routes this contra order with the original order as a package to an exchange auction facility where there are additional opportunities for price improvement from other exchange members. If there is not a candidate for paring with the original order, then the original order is routed to exchanges based upon existing routing logic.

Because LiquidPoint has been required to register NXP as an autotimer trading system (ATS) with the SEC, the company is concerned that it could be subject to the requirements of Reg SCI.

“Those posing greater risks to the market as a whole, such as a market data distributor, primary listing exchange or a clearing agency, should have greater obligations than non-primary exchanges or a single ATS,” said Anthony Saliba, CEO of LiquidPoint, in a comment letter.

LiquidPoint believes that its NXP system is the only such pairing system that has been required by the SEC to register as an ATS. The additional burden that would be placed on it if NXP were to be considered an “SCI entity” at the very least warrant a review of the ATS designation, Saliba said.

The asset management community likewise believes that it might come under the SCI entity designation despite the fact that the regulation appears to be directed primarily at exchanges and broker-dealers.

“While the requirements under Reg SCI may be appropriate for market utilities given the role they play in the U.S. securities markets, an important distinction needs to be made between market utilities and general market participants,” said Stuart Kaswell, executive vice president and general counsel at the Managed Funds Association, in a comment letter.

The requirements under Reg SCI demand extensive resources and would not be feasible for investors who have an algorithmic or quantitative component in their investing, Kaswell noted.

Moreover, he said, the SEC’s rule 15c3-5, which requires broker-dealers to have systematic risk management controls to prevent trading errors and the entry of orders that exceed preset credit limits, already adequately addresses risks from customer orders.

Kaswell praised the SEC’s efforts to improve market structure over the past two decades, including the Order Handling Rules, Regulation ATS, decimalization and Regulation NMS.

“There advances have promoted greater completion among marketplaces, to the benefit of investors,” he said. “The electronic equity markets of the twenty-first century bring the benefits of greater completion, liquidity, transparency, and innovation, fostered in large measure by remarkable technological advances,” he said. “We believe that the Commission has wisely fostered and environment that has allowed such technological developments to flourish, which allows hedge funds and their investors to pursue different investment strategies.”

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