IOSCO Produces Principles For Direct Electronic Access

by Robin Pilgrim, LawAndTax-News.com, London

19 August 2010

The International Organization of Securities Commissions (IOSCO) has published a final report containing principles designed to guide intermediaries, markets and regulators in relation to the areas of pre-conditions for direct electronic access (DEA), information flow and adequate systems and controls.

In February 2009, in a consultation paper, the technical committee of IOSCO identified and discussed the benefits, potential risks and concerns that are associated with the use of DEA arrangements, permitting customers of market members to enter orders into a market’s trade matching system for execution. It also addressed issues raised when a non-intermediary such as a hedge fund or proprietary trading group becomes a market member.

Although the technical committee recognized the market and regulatory benefits associated with the use of electronic execution systems, it also recognized that the increasing use of electronic access raised several regulatory challenges to markets, intermediaries and their regulators.

The final report is based on analyses of market and regulatory developments and of the responses received to the original DEA consultation paper.

IOSCO’s principles set out in the report are based on the recognition that all stakeholders must each play a role in addressing the potential risks posed by DEA. In addition, regulators should retain the power to allow or prohibit any form of DEA as well as to establish requirements in the DEA area, including pre-trade controls and risk limits. They should also exercise regulatory oversight over the decisions made by clients, intermediaries and exchanges.

A key aspect of the principles provide that neither the market nor an intermediary should offer DEA unless adequate pre-trade information (on a real-time basis) is provided, and both regulatory and financial controls, including automated pre-trade controls, are in place to enable intermediaries to implement appropriate risk limits.

The principles provide that intermediaries should require DEA customers to meet minimum standards, including that each has appropriate financial resources; appropriate procedures in place to assure that all relevant persons are both familiar, and comply, with the rules of the market; and have knowledge of and proficiency in the use of the order entry system. Market authorities should have rules in place that require intermediaries to have such minimum customer standards.

There should be a recorded, legally binding contract between the intermediary and the DEA customer, the nature and detail of which should be appropriate to the nature of the service provided. Each market should consider whether it is appropriate to have a legally binding contract or other relationship itself and the DEA customer.

It is emphasised that an intermediary retains ultimate responsibility for all orders under its authority, and for compliance of such orders with all regulatory requirements and market rules. Intermediaries should disclose to market authorities upon request and in a timely manner the identity of their DEA customers in order to facilitate market surveillance.

One of the key aspects of the principles is that a market should not permit DEA unless it can provide member firms with access to relevant pre and post-trade information (on a real time basis) to enable these firms to implement appropriate monitoring and risk management controls. There need to be in place effective systems and controls reasonably designed to enable the management of risk that enable intermediaries to implement appropriate trading limits.

Intermediaries (including, as appropriate, clearing firms) should use controls, including automated pre-trade controls, which can limit or prevent a DEA customer from placing an order that exceeds a relevant intermediary’s existing position or credit limits. Intermediaries (including clearing firms) should have adequate operational and technical capabilities to manage appropriately the risks posed by DEA.

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