Are the days of Direct Market Access numbered?
3 Jun 2010:
Even before Wall Street’s massive intraday free fall last month, the practice of Direct Market Access (DMA) was coming under scrutiny from regulators, particularly in the US. DMA is a practice which enables investment firms to execute equity trades “directly” using their broker’s infrastructure to access an exchange. Providing this service to its clients for the smaller and simpler deals has been a way of brokers attracting or retaining the more complex and profitable business from major investors. However, this is one of several current market practices disliked by the US Securities Exchange Commission (SEC).
The quote from SEC chairman, Mary Schapiro sums up her strong views on DMA, in particular, when brokers do not put any pre-trade checks or supervision in place. She said “Unfiltered [DMA] access is similar to giving your car keys to a friend who doesn’t have a license and letting him drive unaccompanied,” and continued to describe what the SEC plans are to address this “Today’s proposal would require that if a broker-dealer is going to loan his keys, he must not only remain in the car, but he must also see to it that the person driving observes the rules before the car is ever put into drive.”
This seems simple enough. However, regulators in equity markets face significant challenges as they try to span the range from the simplest equity investor to the most sophisticated broker, or “statistical-arbitrage” hedge fund. For example, I am reminded of a story about a UK junior rally driving champion who had proved himself very capable of throwing a car round private rally tracks, but was not able to drive on the public road simply because he was still under the age required by UK law. The correct level of control in many situations should be based on judgement, but this is hard to enshrine in rules and regulation. So given there are rumours that some particularly large DMA trades may have been responsible for precipitating the 1000 point drop in US stock prices last month. If the SEC does find evidence that DMA contributed to this fall, then I expect significant and potentially draconian controls being imposed on this practice – the time for being able to use judgement they may argue is over.
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