U.S. securities regulators proposed rules on Wednesday that would require more supervision of unlicensed high-frequency traders who gain unfettered, or "naked," access to public markets.
The Securities and Exchange Commission voted for a proposal that would require brokerages that rent out their access to the markets to have rules in place to protect against potential mishaps from unlicensed traders.
The practice, known as "sponsored" access, is when brokerages that have been approved to trade on an exchange rent their access to traders who are then able to shave milliseconds from the time it takes to access the markets.
"Naked sponsored access," also called "unfiltered" access, is when the brokers do not screen orders en route to markets, making electronic trading even faster.
"We are concerned that order entry errors in this setting could suddenly and significantly make a broker dealer or other market participants financially vulnerable within mere minutes or seconds," said SEC Chairman Mary Schapiro.
The SEC said that the proposed rule would "effectively prohibit" brokerages from providing their clients with naked access to an exchange. The proposal is open for a 60-day comment period and will require another commission vote to adopt the rule.
Naked access is now monitored by a patchwork of rules maintained by the exchanges, brokers, and trading firms. Some 38 percent of all U.S. stock trading is estimated to be done through naked access, a portion of which is by high-frequency traders.
The proposal would require broker dealers to implement risk controls and supervisory procedures to manage various risks such as faulty orders.
Brokerages would have to, for example, implement controls to prevent the entry of orders that appear erroneous or exceed credit and capital thresholds.
The controls would have to be applied on a "pre-trade" basis or before orders are routed to an exchange, under the proposed rule.
Brokerages would not be allowed to outsource their supervisory procedures to third parties and would have to document and regularly review their risk management controls and procedures.
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