IOSCO report on Principles for Direct Electronic Access to Markets/ Direct Market Access and the SEBI regulations

What is Direct Electronic Access to Markets/ Direct Market Access?

Direct Market Access ("DMA") is a facility which allows brokers to offer clients direct access to the exchange trading system through the broker's infrastructure without manual intervention by the broker. In different markets, different terminologies are used for DMA. These include 'direct access', 'direct market access', 'pure direct market access', 'intermediated access', and 'sponsored access'. The International Organization for Securities Commission ("IOSCO") calls the DMA arrangement as 'Direct Electronic Access' ("DEA"), and defines it as the process by which a person transmits orders on their own (i.e., without any handling or re-entry by another person) directly into the market's trade matching system for execution.

IOSCO Report on Principles for Direct Electronic Access to Markets

On August 13, 2010, the technical committee of the IOSCO has published the report on the 'Principles for Direct Electronic Access to Markets' – containing principles designed to guide intermediaries, markets and regulators in relation to the areas of pre-conditions for DEA, information flow and adequate systems and controls. This final report is based on analyses of market and regulatory developments and of the responses received to the original consultation report. The report contains eight principles that should govern DEA to markets around the globe. They are as follows:

Principle 1 - Minimum Customer Standards: Intermediaries should require DEA customers to meet minimum standards, including that:

1. Each such DEA customer has appropriate financial resources;
2. Each such DEA customer has 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 used by the DEA customer.  

Principle 2 - Legally Binding Agreement: 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.

Principle 3 - Intermediary's Responsibility for Trades: An intermediary retains ultimate responsibility for all orders under its authority, and for compliance of such orders with all regulatory requirements and market rules.

Principle 4 - Customer Identification: 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.

Principle 5 - Pre and Post-Trade Transparency: Markets should 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.

Principle 6 - Markets: A market should not permit DEA unless there are in place effective systems and controls reasonably designed to enable the management of risk with regard to fair and orderly trading including, in particular, automated pre-trade controls that enable intermediaries to implement appropriate trading limits.

Principle 7 - Intermediaries: 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.

Principle 8 - Adequacy of Systems: Intermediaries (including clearing firms) should have adequate operational and technical capabilities to manage appropriately the risks posed by DEA.

SEBI regulations in relation to DMA in India

In India, SEBI vide circular MRD/ DoP/SE/Cir- 7 /2008 dated April 03, 2008 has allowed brokers to offer DMA to clients after obtaining permission from the respective stock exchanges. SEBI also stated that stock exchanges can specify from time to time the categories of investors to whom the DMA facility can be extendd. However, initially the permission was restricted to institutional clients.

An analysis of the current SEBI regulations in the light of the IOSCO report reveals that the current SEBI regulations do not fully address issues like minimum customer standards (principle 1 of IOSCO report), customer identification (principle 4 of IOSCO report), pre and post-trade transparency (principle 5 of IOSCO report) and the roles and capabilities of clearing houses (principles 7 and 8 of IOSCO report).