Second, by indicating that some risk controls should reside at the exchange level in addition to the market participant and clearing firm levels, the Commission is responding to competitive and "race to the bottom" concerns raised by several observers.
FOOTNOTE 71 See FIA Market Access Recommendations, supra note 23, at 8. See also TAC Pre-Trade Functionality Subcommittee DMA Recommendations, supra note 26, at 2. The TAC Pre-Trade Functionality Subcommittee called for a "realistic view" of the incentives under which market participants, clearing firms, and exchanges operate. The Subcommittee identified these incentives as follows:
* "Trading firms are competing with one another to have the smallest time delays (lowest latency) in getting their orders into the exchange's matching engine, and are thus negotiating with brokers to reduce latency. At the same time they are trying to protect their capital from rogue trading, technological deficiencies or other adverse, unintended events.
* Brokers (clearing FCMs) are competing with one another to attract the business of these high-volume, speed-seeking trading firms, and are thus trying to reduce latency. At the same time, they are trying to protect themselves from loss due to unauthorized trading by their trading firm clients or other adverse, unintended events.
* Exchanges (Designated Contract Markets, or DCMs, and Foreign Boards of Trade, or FBOTs) are competing with one another to provide low latency execution, and will soon be competing with Swaps Execution Facilities (SEFs), to attract the business of these trading firms."
The Subcommittee expressed its concern that risk controls should ensure fairness so that one trading firm is not disadvantaged relative to another "because its clearing firm chose to act more responsibly." END FOOTNOTE
Third, the risk controls listed below acknowledge a variety of industry practices with respect to order generation, such as whether the order passes through intermediaries prior to execution. The Commission seeks to understand how increased standardization in risk controls at the level of exchanges or exchange members could provide strengthened protection for the markets and the public. /72/ Notably, if the Commission were to require the placement of credit controls, maximum order size limits, and maximum message rate limits at both exchanges and clearing members, it could address both traditional means of order flow (i.e., through a clearing firm) and newer DMA practices, which require controls at the exchange set by the relevant clearing firm. In combination, these reasons demonstrate the strength, in certain cases, of putting into practice standardized risk controls, with similar goals, at multiple entity types. /73/
FOOTNOTE 72 For example, trading platforms provide a range of risk controls, but there is limited standardization in the types of risk controls available to customers from one exchange to the next. The Commission seeks to understand whether diverse risk management tools and policies at various exchanges complicate risk management for intermediaries and traders. END FOOTNOTE
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