Thanks to advances in technology, securities trading has evolved well beyond the rules that are intended to ensure the basic fairness and safety of markets, and new risks have emerged as a result. However, slowly but surely, regulators are starting to tackle these challenges.

In early July, the key policy-making body for global securities regulators, the International Organization of Securities Commissions’ technical committee, published a report that examines the regulatory issues it sees arising from advances in trading technology. The report looks at the development of algorithmic trading, and of high-frequency trading in particular. The report also touches on the emergence of “dark” liquidity, direct electronic access and co-location — technological innovations that have affected who plays in the market, how the various players interact with one another and how markets operate. These innovations also are seriously challenging the regulators’ ability to supervise markets.

The IOSCO report indicates that these developments may have helped improve market efficiency and liquidity but may have had negative effects, too. Many of these concerns boil down to issues of access and fairness. Regulators are concerned that technology can give certain traders an advantage or empower predatory strategies — making some traditional market players reluctant to trade and undermining market integrity. In addition, regulators worry that market fragmentation has increased and that transparency may be suffering.

Notwithstanding these genuine concerns, regulators also appear to be far from certain about their ultimate significance; and what, if anything, the regulators should do about it. While the IOSCO report details a variety of possible risks due to developments in market technology, as well as a variety of possible regulatory responses, it concludes: “What is less clear is the extent of these risks in practice and what regulatory action should be prioritized.”

Rather than proposing a regulatory approach to these issues, IOSCO is seeking feedback from the securities industry to try to gauge how serious these risks are and what should be done about them. The goal is to have a final report ready in time for the G20 finance ministers meeting in October.

In the meantime, while global policy-makers try to get their heads around the implications of the overall market’s evolution, local authorities are already dealing with some of these issues in their home markets.

Late last year, the Canadian Securities Administrators and the Investment Industry Regulatory Organization of Canada published a joint concept paper setting out their proposed approach to regulating dark liquidity. And, in April, the CSA proposed a new rule to establish a regulatory framework for electronic trading generally, which aims to address some of its concerns about the proliferation of high-frequency trading and the risks accompanying the practice of allowing direct market access.

The comment period for the CSA proposal closed in mid-July, and most of the comments that have been submitted appear to support the CSA’s basic direction. Unlike many rules, which face outright resistance from the industry, there seems to be recognition from the industry that new rules are required in this area — although various parts of the industry have their quibbles with the details of the proposal.

The lack of pushback from the industry suggests that it sees the risks to be as real as the regulators do. All too often, regulators are accused of dreaming up solutions to problems that don’t exist; but, in this case, the industry appears prepared to embrace new rules. Perhaps that’s because memories of the turmoil created by the so-called “flash crash” in May 2010 (when the Dow Jones industrial average lost, then regained 900 points within minutes) are still fresh. Although many of the regulators’ concerns may be based on anecdotal evidence, the flash crash serves as a concrete example of how perceived weaknesses can turn into genuine market chaos and investor harm.@page_break@In general, regulators are worried that as trading gets ever faster, errors, failures or malicious acts can quickly transform into major market disruptions, and could even mushroom into systemic risks. Regulators are concerned that in a high-speed, highly inter-connected trading environment, potential problems such as systems failures, capacity shortages, programming errors, mistaken trades or intentional disruptions can soon spread through the market.

Other worries include uncontrolled credit risks, uncertain accountability for trading activity and the possibility of regulatory arbitrage.

To address these concerns, the CSA proposal would impose requirements on both market participants (dealers) and marketplaces to ensure that: all order flow is monitored to prevent problematic trades; credit and capital limits are enforced; and trading is being carried out in compliance with regulatory requirements.

The CSA proposal also imposes a specific framework on direct-access trading that would make the dealers that facilitate this sort of market access responsible for any trading that takes place under their name. The proposal also would require dealers to establish standards for clients using this capability (that is, standards regarding financial resources, proficiency requirements and compliance capabilities). And the proposed rules would restrict the roster of possible direct market access clients to IIROC dealers, portfolio managers and certain sophisticated individual inves-tors (such as former registered traders).

Although Canada’s industry seems to support the CSA proposal in principle, there are, naturally, objections to certain details. In particular, a few comments have protested the fact that dealers would be solely responsible for carrying out pre-trade credit and capital checks on their clients that are using direct market access.

New obligations to conduct such pre-trade checks have also run into resistance in the U.S., where the Securities and Exchange Commission had introduced its own rule governing market access last year, imposing requirements similar to those proposed by the CSA.

The SEC’s rule was to be implemented in mid-July; but, in response to industry lobbying, the SEC has deferred the date for compliance with the requirements relating to pre-trade credit, capital limits and fixed-income securities to Nov. 30. The SEC indicates that the extension was granted to give broker-dealers added time to develop, test and implement the necessary risk-management controls and supervisory procedures.

A number of comments on the CSA proposal also have stressed the need for a reasonable implementation period to give firms time to get in compliance.

Another element of the CSA proposal that has attracted plenty of feedback is that the proposal would effectively ban “exempt market dealers” from enjoying direct market access by restricting market access to dealers that belong to IIROC. This would subject all market participants to IIROC trading rules, so a firm couldn’t avoid complying with those rules by using an EMD registration.

However, a number of comments have pointed out that this measure could have unintended consequences. In particular, these comments argue, preventing EMDs from taking advantage of direct access could disrupt the market participation of foreign broker-dealers that also have an EMD registration. IE