Direct Market Access (DMA) is a method of electronically trading securities on exchanges or other markets. It is typically used by investors and traders using systematic algorithmic strategies that require the minimum distance and systems between them and the exchange.
Historically this was a paid-for service supplied and operated by banks and brokers to their customers. However, in recent years, independent parties began to provide specialized services on behalf of banks and brokers directly to investors which are sometimes referred to as “Sponsored Market Access” or “SMA”.
A Direct Market Access Platform sits in between buy / sell-side applications and the exchange. The platform can be managed by multiple brokers on the same infrastructure.
Different financial markets may use different terms to identify the stakeholders in a Direct Market Access arrangement. To avoid potential ambiguities and misunderstandings here are the definitions of the terms used on this page
Investor, Trader or Client
|The individual or firm that decides to start a transaction to trade. The term ‘client’ is used to indicate the same type of stakeholder, as the investor or trader must be a client of the firm granting Direct Market Access|
|Broker||The authorized financial firm that is a member of an exchange and therefore is in a position to arrange Direct Market Access to that exchange for its clients.|
|Exchange (or Market)||
A venue where financial instruments are traded multilaterally. There are several types of exchanges. In Europe, they are now divided into four groups: Regulated Markets (RM), Multilateral Trading Facilities (MTF), Organized Trading Facilities (OTF), and Systematic internalisers (SI). In the US, Alternative Trading Systems (ATS) is more prevalent when describing a non-exchange activity.
As SIs and OTFs are operated by an authorized firm and can only be used by that firm’s clients, it is questionable whether it is relevant to discuss DMA to these types of venues, since their clients would have access to those markets anyway.
As an investment manager or a trader with a high volume of transactions with a specific exchange, you may find it convenient to access the exchange directly. A Direct Market Access arrangement will give you some of the same benefits of member direct access, but without the requirements associated with membership to an exchange.
Typically, when using DMA, you would only pay to access the broker’s technology rather than paying full transaction fees, therefore this type of agreement is financially convenient only if your volume of transactions with the exchange is very high. In any case, the main advantages of DMA are non-financial and vary depending on your type of use, for instance:
Control over execution – You decide when to execute and whether the investment decision is taken by a human or by an algorithm. Ultimately, it is not just a question of timing, but also of accuracy, in that there is no risk of instructions being misunderstood or not followed by an executing broker. DMA works better than any instruction on quotes, quantity, partial execution, etc.;
Minimal information leakage – there are no third parties involved in the transaction;
Speed - Low latency for algorithmic trading and high-frequency trading (HFT);
Auction Participation – A DMA arrangement allows you to participate in pre-market and post-market auctions.
Additionally, central limit order books (CLOBs) allow you as a DMA user to either submit aggressive orders that are priced across a narrow bid-offer spread or submit a passive order - at the price and size you wish to execute - to the Order Book, which is visible to all participants. In summary, if you are not a member of the exchange, DMA enables you to reap the benefits of an active trading strategy in a CLOB environment, since the evolution of the market during the trading day is directly accessible to you in a transparent way rather than mediated via a broker.
Direct Market Access is useful to sophisticated investors who do not want or do not feel the need to go via a broker. It is open to retail and professional investors whose brokers can arrange direct market access.
Typical DMA customers include buy-side firms, private investors, and proprietary trading firms. The DMA client can be in a different location from the Direct Market Access provider or the exchange, the only relevant question is whether the technology framework can be put in place.
Direct Market Access can be organized for any electronic exchange and any instrument traded on those exchanges can be traded via DMA. The most common instruments traded via DMA are Equities, Fixed Income, FX, Futures and Options. In any case, the type of instrument is not an indication whether Direct Market Access is or is not possible. Members of an electronic exchange based in a financial jurisdiction where the technology infrastructure enables a DMA framework can grant Direct Market Access without any problem.
The DMA technology relies on fast internet connections or direct point-to-point connectivity, and it could be implemented either via APIs (Application Program Interfaces) – a set of routines, protocols, and tools that specify how software components should interact – or other communication frameworks such as Microsoft .NET.
To set up DMA, you must either download the front end of a trading application from the broker or integrate your own trading application, either with the DMA provider’s system or directly with the exchange. The resulting networked framework must have a low level of latency to ensure that your orders are not unduly delayed before hitting the market.
In the past 20 years, the continuous development of technology has enabled constantly lower latency. The so-called ‘race to zero’ saw competing providers spend a lot of research and development time and money to guarantee a low level of latency for remote connections. This becomes vital when Direct Market Access is used for High-Frequency Trading because the algorithms behind HFT systems react to market movements in real time and rely on the ability to place – and cancel - frequent orders at a very fast pace.
Algorithmic trading could not exist without DMA. Any type of algorithmic trading – such as, for instance, Volume Weighed Average Price (VWAP), Time Weighed Average Price (TWAP), or Implementation Shortfall – relies on real-time access to data, high execution speed and Smart Order Routing (SOR). Some technology providers now claim that they enable the tick-to-trade flow to be measured in nanoseconds.
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Once you have been granted access to a market through a DMA arrangement, you operate in the same way as the trading desk of the broker that has granted you access. Therefore:
you are responsible for your own market data arrangements, so the choice whether to subscribe to Level 2 market data (or beyond) or to limit yourself to basic Level 1 market data is entirely yours,
you manage your own trading strategies. For instance, in the UK the FCA specifically excludes “operators of a collective investment scheme” (i.e., fund managers) from market making activities, but investors with a DMA arrangement could, at times, provide liquidity to the market in a way that would be similar to market makers but without the formal commitment. Other jurisdictions within the EU and elsewhere may not have the same restrictions as those imposed by the FCA; in any case, a DMA agreement would allow you to rapidly offset position risk through correlated instruments if that is required.
Although Direct Market Access disintermediates placing orders with the relevant exchange, certain pre-trade risk checks need to be put in place, which does not only monitor your activity as a DMA client but the broker as a whole.
The following are two examples of pre-trade risk checks that are specific to a DMA client:
Quantity limit on individual orders – If the quantity exceeds the limits specified by the exchange rules, or by the order type, the transaction would not be executed and should not be sent to the exchange, to begin with.
Pre-trade price collars – Orders where the price is too far from the current market would be rejected internally and never sent to the exchange.
On the other hand, there are other pre-trade risk checks that apply at the broker level. Key among these checks are:
Execution Throttle – If an algorithm or a group of algorithms receives too many fills in a specified period of time, the broker’s system should disable the algorithm(s) and prevent it (them) from placing new orders, until there is human intervention to reset it.
Message Throttle - If an algorithm or a group of algorithms sends too many messages in a specified period, the broker’s system should disable the algorithm(s) and prevent it (them) from placing new orders, until there is human intervention to reset it.
Kill Button – Every (broker) should have the capability to simultaneously cancel all existing orders and prevent the entire firm from placing new ones until there is human intervention to reset it.
The regulatory environment in which DMA operates varies between Europe and the US. In the EU, ESMA published regulatory guidelines to Electronic Trading in 2015 and later MiFID II, MiFID added a provision for ‘Direct Exchange Access (DEA)’ (the term used by ESMA to indicate DMA). In the US, DMA falls under rule 15c3-5 of reg-NMS. Broadly speaking the regulatory environment in both jurisdictions has many commonalities:
DMA (also known as DEA) providers must:
Perform due diligence on those who request DMA. Due diligence on their suitability must include: capabilities, the quality of their systems and controls, financial resources and trustworthiness.
In Europe, they have to notify their National Competent Authority (NCA) and the NCA of the trading venue. In the US, they have to notify their regulatory authority and the regulatory authority of the exchange.
Ensure that risk controls are imposed on the use of the service.
Prevent clients from exceeding appropriate pre-set trading and credit thresholds,
Monitor trading by clients using the firm’s MIC code. In particular, they have to make sure that they (the clients) do not engage in practices that are considered to be market abuse.
Establish processes and procedures to monitor trading by clients through the DMA arrangements to ensure that they do not represent a risk to the DMA provider, create a disorderly market or break the rules of the trading venue.
Carry out a review of the internal risk control systems of the DMA client.
Additionally, DMA (also known as DEA) in Europe is subject to additional regulations to ensure that:
DMA clients have suitable due diligence framework if they want to engage in sub-delegation, and only with the consent of the original DMA provider.
DMA clients accept the orders submitted via DMA is considered a direct order and therefore not subject to Best Execution provisions.
Trading Venues only permit DMA to be provided to EU authorized members which are investment firms/credit institutions.
Trading Venues set out and publish rules and conditions for their members to provide DMA to their own clients.
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