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HFTs Fear SEC's 'Naked' Access Ban May Squeeze Profits

Although the move by U.S. regulators to ban "naked" access to public markets has been lauded as a necessary risk curb, a portion of the high-frequency trading community is awash in concern the new rules will damage time-sensitive strategies.

Although the move by U.S. regulators to ban "naked" access to public markets has been lauded as a necessary risk curb, a portion of the high-frequency trading community is awash in concern the new rules will damage time-sensitive strategies.

In an action widely seen as a way to level the playing field between retail investors and high-frequency traders, the Securities and Exchange Commission (SEC) unanimously voted last week to end the practice of brokerages renting out market access to unlicensed traders.

The rationale behind the move is to prevent errant trades from triggering a systemic event. SEC chairman Mary Schapiro once likened the dangers posed by unfiltered access to "giving your car keys to a friend who doesn't have a license and letting him drive unaccompanied." As part of the new rule, brokerages are now required to set up risk controls before allowing traders to access the market.

However those checks and balances are likely to add precious milliseconds to a high-frequency trader's executions, which will ultimately chip away at their profitability, argues Manoj Narang, the founder and chief executive of Tradeworx, a hedge fund and high-frequency trading firm based in Red Bank, N.J.

"The people who do sponsored access right now depend on the speed of direct access in order for their strategies to work," Narang explains.

He continues: "So they can't go to the brokerage platforms where they can't get that speed and continue to operate their strategies. The only choice is for people to accept a hit to their latency or top-tier rebates, which has real economic cost."

The other alternative for high-frequency trading firms is to become broker-dealers and exchange members themselves. But this option has drawbacks as well, Narang says, since most high-frequency trading firms will be unable to qualify for the top-tier rebates exchanges offer to high-volume brokerage firms.

"Because of that they're going to be entitled to a much lower rebate than what they currently get by trading through a broker-dealer that aggregates volume on their behalf," Narang notes. "Whether they choose to take the hit in terms of latency or rebates, either way it amounts to a competitive tax." As the Senior Editor of Advanced Trading, Justin Grant plays a key role in steering the magazine's coverage of the latest issues affecting the buy-side trading community. Since joining Advanced Trading in 2010, Grant's news analysis has touched on everything from the latest ... View Full Bio

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