"In this game, which is a race to zero for latency purposes, the less infrastructure you have to go through, the lower latency is going to be for the round-trip of that transaction," says Andrew Actman, chief strategy officer at Lightspeed Financial, holding company of Lightspeed Trading, explaining the attraction of sponsored access for trading firms. Lightspeed Trading is a direct-access brokerage firm that focuses on professional traders and small- to medium-size hedge funds but also caters to black-box, automated trading firms.

But industry sources contend that with high-frequency trading platforms firing off hundreds -- if not thousands -- of orders per second, a buy-side firm that has a sponsored-access arrangement with a broker could make a huge mistake. "With all these orders flying to the exchanges, with [broker-dealers] being on the hook, what if that [sponsored] firm doesn't have the money to settle the trade?" asks Laurie Berke, principal at TABB Group. "That is the arrangement that folks have concluded may pose a risk beyond what is arguably appropriate."

While sponsored access has been around for at least seven years, the practice is suddenly under the microscope behind closed doors at major prime brokers, where executives are worried about systemic risk in the event that an algorithm puts out erroneous trades, according to industry sources. Like many innovations on the Street, sponsored-access arrangements are a product of the high-speed arms race among capital markets firms.

Believing that traditional direct market access (DMA) trading, which is routed through a broker's compliance and risk checks, wasn't fast enough, proprietary trading firms began to work directly with the exchanges, which then developed sponsored-access programs with their member brokers. Under these programs the brokers are obligated to monitor the trading activity of their clients in accordance with compliance rules.

Undressing Sponsored Access

Now, however, concerns are being voiced that some brokers, in the interest of winning and maintaining business, have relaxed or even disabled pre-trade risk and compliance checks to allow their buy-side clients -- hedge funds and proprietary trading shops -- to gain direct access to the market with the lowest possible latency. Pre-trade risk controls, the argument goes, slow down the alpha-seeking strategies of the algorithmically driven high-frequency trading firms.

"There's no question that [for] every layer you strip out between your own platform and the actual market itself, the less latency you're going to have," comments Eric Pritchett, CEO of PhaseCapital, a Boston-based private investment adviser that utilizes high-frequency trading for one of the hedge funds that it advises. He notes that PhaseCapital colocates its strategies at Lime Brokerage's data center in New Jersey. (For more on PhaseCapital's high-frequency trading operations, see related sidebar.)

1 ||2 |  ||3 |  ||4 |  ||5 |  Next Page > >

	PRINT THIS ARTICLE
	E-MAIL THIS ARTICLE

Past Issues Subscribe Past Issues Subscribe Past Issues Subscribe