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Risk Management: In the Eye of the Storm

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Keep Out, At Your Own Risk

December 15, 2010
By Tom Steinert-Threlkeld

Until Nov. 3, saving time on managing risks was not an issue. Until then, broker-dealers who sponsored direct trading by their customers did not have to worry about any delays introduced in high-speed strategies from filtering orders in advance for the chance that something might go awry and leave the dealer holding the bag. The checks could be performed after the trade. But Nov. 3 changed that. That’s the day the Securities and Exchange Commission banned so-called “naked access,’’ adopting a rule that required brokers and dealers to put in place controls to help prevent erroneous orders, ensure compliance with regulations and enforce pre-set credit or capital requirements.

“I have previously likened unfiltered access to giving your car keys to a friend who doesn’t have a license and letting him drive unaccompanied,” said SEC Chairman Mary L. Schapiro pointedly, in enacting the rule. “This rule requires that broker-dealers not only remain in the car, but also maintain control of it so we can all be assured the rules of the road will be observed before the car is ever put into drive.”

This, in effect, creates a business opportunity for suppliers of exchange and trading technology, such as NYSE Euronext or its rival, Nasdaq OMX Group, as well as independent suppliers of risk-management software or services, such as SunGard Data Systems, Progress Software or FTEN. Brokers and dealers can roll their own risk filters, acquire or rent it or commit some kind of combination.

NYSE’s investment in its Risk Management Gateway “was a move towards making sure that whatever quote came into their venue was legit,’’ said Sang Lee, co-founder and managing partner of research firm Aite Group. But then came the rise of high-speed trading, the May 6 Flash Crash and the ban on naked access, over the last 12 to 18 months.

“In light of the heightened interest in e-trade risk, I think exchanges have realized they can actually make this into a profitable business,’’ he said.CHECKING FIRST With the Risk Management Gateway, brokers and dealers get access to risk controls that help them comply with the proposed SEC rules, notes Dan Romanelli, a former Merrill Lynch employee who is now the managing director at NYSE Technologies’ Transaction Solutions unit, in charge of developing the RMG business.

“What’s new is simply the clarification about who has to have the control over the flow, which is a sponsoring broker,” said Romanelli. “It boils back to a sponsoring broker having the responsibility” for any trades that get executed – and the responsibility to check for risks before orders are sent in to exchanges.

With the Risk Management Gateway, brokers get use of such controls at a remotely controlled site for what he and Tuskey believe are reasonable and competitive fees.

The pricing is based on per-channel or “session” rates. The cost is $3,000 a month for the first session, which caps out at 1,000 inbound messages a second. These can be new orders, cancellations or replacements. Each additional pipe costs $1,000 a month.

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