Insider: Flash Ban Likely, but Volcker “Unworkable”

(February 24, 2010) — The US Congress and the Securities and Exchange Commission (SEC) could be close to passing legislation and rules that will, among other developments, eliminate flash trading and institute ‘circuit breakers’ for short-sellers, according to financial policy specialist Joseph Engelhard.

Engelhard – senior vice president at Washington-based Capital Alpha Partners, a provider of policy research for institutional investors – said in a speech on Monday at the TradeTech USA conference in New York City that such changes look “increasingly likely” to pass muster in the Senate by the August recess and with the SEC.

“They will very likely eliminate flash trading, and ‘circuit breaker’ rules – possibly after 10% declines – will be put into effect,” the speaker said. Such circuit-breaker rules would require a so-called passive-bid test, where short selling in falling stocks would only be allowed above a national best bid. This rule is seen by many as a compromise between no action and a reversion to the uptick rule, which was abolished in 2007.

The SEC proposed a revised uptick rule and a circuit breaker in April 2009, and followed this up with an alternative uptick rule proposal the following August, which it suggested could be combined with a circuit-breaker. The commission proposed a ban on flash trading in September.

Changes to high-frequency and dark pool trading, however, are being looked at with a “slower approach,” Engelhard said. The comment period for the SEC’s dark pool transparency rule proposals, first unveiled in October last year, closed on Monday. The SEC proposed a ban on offering sponsored access without risk controls, generally used by high-frequency traders, in January this year.

Proposals that seem unlikely to pass the Senate include the Volcker rule – which would prevent banks that take retail deposits from running proprietary trading desks and investing in hedge funds and private equity funds, and would be “unworkable”, according to Engelhard – and the Tobin tax, levied on individual financial transactions, which Engelhard claimed is “one of the few bad ideas that has little chance of passing”.

Instead, Engelhard believes that a so-called TARP Tax, which would bring in an estimated $90 billion from the largest US financial service firms, will successful work its way through Congress and onto President Obama’s desk within months. “Obama sees the TARP tax as sufficient to address the needs” of the country, Engelhard said.

Hedge funds also will come under further scrutiny, according to Engelhard. “The Securities and Exchange Commission is all but certain to require registration and limited reporting from all but the smallest funds,” he said, adding that “most of this information will not become public. They will collect assets under management, leverage, counterparty exposure – but only aggregate information will likely be available publicly.”

As expected by many, derivatives will also be affected by pending legislation, the speaker claimed. “Major swap dealers and market participants will likely have to register with the SEC,” Engelhard said. “Over-the-counter derivatives will see mandatory clearing by a central counterparty, because the CFTC (Commodity Futures Trading Commission) wants swaps put into clearing houses.”

TradeTech is a series of global conferences focusing on trade execution and technology.