Eighth Annual Markets Infrastructure Group
Seminar: How will MiFID change the way we
trade?
Imogen Garner | Partner
8 July 2015
2017
2016
2015
2014
Timing: MiFID II / MiFIR
2 July
MiFID II and MiFIR entered into force
1 August
Level 2 Consultation on advice on delegated acts and Discussion Paper on technical standards closed 19 December Level 2 Consultation on technical standards commenced. ESMA provided final report on technical advice to the Commission on delegated acts 2 March Level 2 Consultation on technical standards closed End of September Level 2 regulatory technical standards to be submitted to Commission (delayed from 3 July) 3 January Level 2 implementing technical standards to be submitted to Commission 3 July Member States to adopt and publish measures transposing MiFID II into national law
3 January
MiFID II and MiFIR Level 1 and Level 2 implementation date Consultation period Consultation period Autumn FCA MiFID II conference December FCA to publish consultation paper on proposed Handbook changes to implement MiFID II and MiFIR
June
FCA to publish policy statement and final rules
EU implementation
A brief history in time
● MiFID II and MiFIR were published in the OJ on 12 June 2014 and entered into force on the twentieth day following publication – i.e. 2 July 2014
● On 3 January 2017: MiFID II and MiFIR apply
● MiFID II and MiFIR supplemented by implementing measures (Level 2 legislation) consisting of delegated acts and technical standards: ESMA has a key role in producing these
● On 19 December 2014 ESMA published: (1) Final report on technical advice to the Commission on the delegated acts (2) CP on the technical standards - deadline for comments is 2 March 2015
● On 18 February 2015 ESMA published a consultation paper which complemented the transparency section of the December 2014 consultation paper
Delegated acts
● The Commission will prepare the delegated acts on the basis of ESMA’s technical advice – although it may elect to depart from it
● The power to adopt a delegated act is conferred on the Commission for an indeterminate period of time
although it may be revoked at any time by the EP or Council
● FCA MiFID II implementation roundtable states that the Commission is expected to adopt delegated acts in July or September 2015
● As soon as it adopts a delegated act the Commission will notify the EP and Council
● EP and Council will consider the delegated acts adopted by the Commission and have the power to object, provided they do so within 3 months (which can be extended by a further 3 months)
● Once a delegated act is adopted it is published as a Commission delegated Regulation in the OJ. Delegated acts should be adopted by the Commission so that they enter into application by 3 January 2017
Technical standards
● Deadlines which ESMA is working to:
– Must submit draft RTS to the Commission for adoption by 3 July 2015 (delayed until end of September)
– Must submit draft ITS to the Commission for adoption by 3 January 2016
● Key difference between RTS and ITS: EP and Council have no power of objection over ITS once adopted by Commission
● On receiving the ITS the Commission has three months to determine adoption (can be extended by one month)
● Within three months of receiving the RTS the Commission must determine adoption:
– If the Commission adopts the RTS without
amendment the EP and Council may object within one month (extended by another month)
– If the Commission adopts the RTS with amendment the EP and Council may object within three months (which can be extended by another three months)
● Once adopted the RTS and ITS are published in the OJ as an implementing Regulation or implementing
Decision
UK transposition
MiFID II implementation
● Article 93 MiFID II: Member States shall adopt and publish, by 3 July 2016, the laws,
regulations and administrative provisions necessary to implement this Directive
● HM Treasury will represent UK at Commission organised MiFID II transposition workshops
● FCA states that the biggest practical challenges will be around issues such as transaction reporting, commodities position reporting and the provision of information to ESMA for various purposes
● But a significant part of its work will be about communication so that firms can get to grips with the new legislation and deal with the various notifications, authorisations and variations of permissions
● How to keep informed: FCA MiFID review page -
http://www.fca.org.uk/firms/markets/internation al-markets/mifid-ii/mifid-review
FCA Handbook changes
● March 2015: Discussion paper on developing the FCA’s approach to implementing MiFID II conduct of business and organisational
requirements
● Autumn 2015:
Second MiFID II annual
conference
● December 2015:
Publication of the main
consultation paper on the FCA’s proposed
Handbook changes to implement MiFID II /
MiFIR
● June 2016:
FCA feedback and policy
statement confirming final changes to its
Handbook
HM Treasury
● March 2015: Published consultation paper on transposition of MiFID II
● Consultation closed 18 June 2015.
Government expects
that the draft legislation
will be made in 2016
Timetable
9:00
Opening remarks
9:10 – 10:10
The trading environment of the future
10:10 – 10:25
Refreshments
10:25 – 10:55
Choice of break-out sessions:
1. The US story
2. Algorithmic trading and direct
electronic access
11:00 – 11:30
How will the post-trade world look?
11:30 – 12:00
Panel session
Where to go?
The trading environment of the
future
Auds 1-3
Break-out sessions
– The US story
and Algorithmic trading and direct
electronic access
The US story: K1
Algorithmic trading and direct electronic
access: Auds 1-3
How will the post-trade world
look?
Auds 1-3
Panel session
Auds 1-3
Refreshments and networking
session
CPD accreditation
•
This MIG seminar attracts 2.25 accredited CPD points
•
Course reference is: L140305
•
Norton Rose Fulbright’s Law Society code is 080-NROS
•
Pass this code to your Training Department who will be able to
credit your point bank
Safety notice
Should you hear the fire alarm please listen for instructions and
exit the building via the front entrance
The trading environment of the future
Jonathan Herbst | Partner
Hannah Meakin | Partner
Tara Mokijewski | Of Counsel
8 July 2015
The crystal ball: what will it mean?
Restructuring/ consolidation?
•
Will you need to restructure any
business lines?
•
Will cost of compliance necessitate
consolidation?
•
Who will you be competing with? How
will you differentiate?
End of OTC?
•
How much will be mandated for
platform trading and how quickly?
•
What choices does the OTC world
have?
•
Might OTC exist but in a different
form?
More or less global markets?
•
How quickly will equivalence
decisions be made?
•
To what extent will same standards
apply to EU and non-EU firms and
venues?
•
Does it make global trading structures
any easier?
More data and definitions
than we can cope with?
•
What will firms do with best execution
and transparency data?
•
How will it change trading patterns?
•
Increased granularity and overlapping
of categorisations – does this present
opportunities?
Where will you be able to trade equities and
derivatives?
What should I be thinking about?
Z
?
Asset manager
Introducing broker
Agency broker
Executing broker
Trading obligations
Best execution
Transparency
Shares
• What? Shares admitted to trading on a regulated market or traded on an MTF
• Where?
– Regulated Market, MTF, Systematic Internaliser
– Equivalent third country trading venue
• Who?
– Investment Firms
– Only investment firms can be direct members of trading venues
• Trading obligation does not apply to trades that
are:
– Non-systematic, ad hoc, irregular and infrequent;
– Carried out between eligible and/or professional counterparties and do not contribute to price discovery;
– In shares or equity instruments not admitted to trading on a regulated market or traded on an MTF; or
– By non-Investment Firms (only)
These parties / instruments can trade OTC
Derivatives
• What? Derivatives that are traded on a trading venue that are sufficiently liquid and declared subject to the trading obligation
• Where?
– Regulated Market, MTF, OTF
– Equivalent third country trading venue
• Who? Transactions between:
– An FC and another FC
– An FC and an NFC+
– An NFC+ and another NFC+
(and third country entities that would be subject to clearing obligation in certain cases)
• Trading obligation does not apply to: – Non-equity instruments that have not been
declared subject to the trading obligation
– Any trade with an NFC- (including if it trades with an FC or NFC+)
These parties / instruments can trade OTC or on an SI
BOTTOM UP
TOP DOWN
How will they decide which derivatives to mandate?
To determine whether there is sufficient liquidity:
ESMA must consider these criteria:
– Average frequency and size of trades
– Number and type of active market participants
– Average size of spreads
– Anticipated impact on liquidity
– Impact on commercial activities of non-financial end users
ESMA proposes to:
– Apply the factors based on different weightings as appropriate to each class or sub-class
– Not close down possibility of assessing additional relevant criteria
ESMA suggests it will follow a similar approach to determining whether there is a liquid market as for transparency but the thresholds may not be the same
ESMA will keep a register
Commission adopts RTS designating class of derivatives for clearing under EMIR ESMA consults the public and
third country authorities ESMA has 6 months to recommend it for trading obligation with effective date, phase ins and counterparties Commission decides
ESMA identifies class of derivatives which should be mandated for trading even though: − there is no CCP that
clears them or
− they are not traded on a TV ESMA notifies Commission Public consultation
ESMA may call for development for proposals for trading
Trading venues – new concepts and boundaries
Multilateral systems “Multiple third party trading
interests interact in the system in a way that
results in the formation of contracts” Multilateral Trading Facilities (MTFs) Non-discretionary execution
Market operator or IF managed Operating is an investment service Few conduct of business rules apply
Organised Trading Facilities (OTFs)
Discretionary execution
Market operator or IF managed Operating is an investment service
Investor protection, conduct of business and best execution apply
Regulated Markets (RMs)
Non-discretionary execution
Managed by market operator Operating is not an investment
MTFs and trading protocols (discretion)
MTF:
"a multilateral system, operated by an investment firm or a market operator, which brings
together multiple third-party buying and selling interests in financial instruments
– in the system
and in accordance with non-discretionary rules – in a way that results in a contract"
Scenario #1: A trading platform has multiple participants. These submit orders to an order book. Orders
are matched (usually on a price-time basis) automatically by the platform. Neither the participant nor the
platform operator can do anything after submission of the order that would affect whether or how orders
are matched. Such a platform would quite clearly be an MTF. This is because:
1)
by having multiple participants able to interact in the order book it is "multilateral";
2)
orders are "brought together" by being able to interact directly in the order book;
3)
orders fall within "buying and selling interests";
4)
the operator has no ability to force / prevent trades to occur so the rules are "non-discretionary"; and
5)
because the participant cannot make a choice after submitting an order whether or not to trade, the
MTFs and trading protocols (RFQ and RFS)
Scenario #2: RFQ / RFS permit quotes to be requested from discrete parties and sent directly to the
requestor. Requestor must then choose which (if any) provider's quote to accept. The operator has no
discretion (so it cannot be an OTF). This is arguably not an MTF:
1)
Likely (although not certain) that it is “multilateral” as multiple parties are involved
Counter-argument: The requestor interacts with each responder bilaterally (this bilateral argument
is more likely to hold if the requestor must accept / reject each quote individually rather than
accepting one being sufficient to automatically reject the others)
2)
Possible that buying & selling interests are “brought together” when quotes arrive at the requestor
Counter-argument: Quotes from multiple parties are not "brought together" as in a CLOB
– the
requestor's indication of interest is brought together individually with separate quotes (i.e. there is no
mass interaction of multiple requests with multiple responses)
3)
Arguable that the trade might not have occurred otherwise so the system “results in a contract”
Counter-argument: The requestor elects for a trade to occur. There is no certainty that a trade will
occur on the basis of the quotes. Therefore it is not the system that "results in a contract" but instead
the system enables the requestor to take an action that will "result in a contract"
MTF:
"a multilateral system, operated by an investment firm or a market operator, which brings
together multiple third-party buying and selling interests in financial instruments
– in the system
MTFs and trading protocols (RFQ and RFS)
Regulators across Europe differ
in
their
acceptance
of
the
counter-arguments
Reasons for rejecting the
counter-arguments also vary
FCA's
approach:
inconsistent
(expressed by the FCA in the
context of Trayport):
if requestors are authorised (i.e.
brokers) then this is not an MTF
if requestors are not authorised
then this is an MTF
Policy
argument:
authorised
entities can make final choice on an
unregulated platform because these
will be professionals
Concern
is
to
protect
unauthorised / retail entities
Not (as yet) possible to give a
single definition of an MTF
This will likely explain market
participants’ previous experiences
with regulators taking inconsistent
approaches to RFQ on MTFs
OTFs and trading protocols (discretion)
Scenario #3: Exactly the same situation as Scenario 1, however, now the platform operator has
discretion as to
a)
if / when orders should be placed on the platform; and / or
b)
what orders to match against each other (i.e. follows best execution requirements - these do not
necessarily equate to a price-time matching algo).
Such a platform would quite clearly be an OTF under MiFID II. This is because of the reasons below
except that reason (4) is now that the operator has the requisite type of discretion for the platform to be
"discretionary"
1)
by having multiple participants able to interact in the order book it is "multilateral";
2)
orders are "brought together" by being able to interact directly in the system;
3)
orders fall within "buying and selling interests";
4)
the operator has the requisite type of discretion for the platform to be "discretionary"; and
5)
because the participant cannot make a choice after submitting an order whether or not to trade, the
system "results in a contract".
OTF:
"a multilateral system which is not a regulated market or an MTF and in which multiple
third-party buying and selling interests in bonds, structured finance products, emission
allowances or derivatives are able to interact in the system in a way that results in a contract"
The OTF debate
There is considerable confusion in the market on the position of physically settled trades executed
using trading functionality; this is a purely MiFID I issue
The threshold question is whether these trades are deemed to be executed on an MTF (i.e.,
whether the way an individual broker is using the system means that it is operating an MTF). The
result would be that all the trades will be treated as MiFID instruments and within the EMIR
threshold calculation for non-financial counterparties
The FCA expects the market to separate physically delivered from financially delivered
instruments (as the latter will always be regulated instruments)
As an example, the Trayport system is, according to the FCA, a segregated system, since it
effectively works as two markets: physicals and financials
This type of segregated system may also be considered a hybrid system – e.g. a broker using the
system can use both the electronic system and / or voice broking to create the transaction.
Contracts can be made based on bids and offers put into the system without the parties using the
electronic functionality of the system itself
A system employing both discretionary and non-discretionary execution techniques (i.e. hybrid) is
still an MTF
Advantages of MTFs
Market operators can capture the increased shift in trade flow with the mandatory trading obligation
Increased competition resulting from more flexible approach to capture this increased trade flow
Difference in regulatory approach to RMs despite legal convergence
From a cost perspective, lighter touch regulation than RMs
Disadvantages of MTFs
Implication: is it a one-way journey towards becoming RMs?
New obligations for operators: new regulations regarding algorithmic trading, high frequency trading (HFT), direct electronic access (DEA) and market making
Lack of uniform definition throughout the EU and cross-border
Liquidity fragmentation with third country venues
Not clear whether non-CLOB functionality may be considered an MTF
Reputational issues – does not have gold stamp of an RM
OTFs: advantages and disadvantages
Advantages of OTFs
Trading venue operators can concentrate on the percentage of the market which will trade on an RM / MTF and, for non-equities, also cater for those who would use an OTF
Broadly, for non-commodity derivatives, members of MTFs or RMs must be regulated, whereas unregulated participants can use an OTF
For commodities derivatives, the position is more nuanced; it appears that prop traders, e.g., locals, may be unregulated members of MTFs or RMs provided they (a) do not execute client orders or (b) perform HFT
An OTF has a greater level of flexibility as it has discretion on order flow but has to be non-discriminatory
Physically settled gas and power forwards traded on an OTF but not an MTF or RM will be outside MiFID II and the EMIR threshold calculation
Disadvantages of OTFs
Equities are not tradeable on an OTF
Counts towards EMIR threshold (if outside narrow exception for gas / power forwards) unlike contracts on a RM
Increased bureaucracy (particularly as a “detailed explanation” may be needed on why a RM or MTF has not been used)
Full conduct of business rules apply to operator, including best execution – as well as most requirements for RMs and MTFs
Issues over whether an OTF can connect with another OTF
Reputational issues – does not have gold stamp of an RM (or possibly same reputation as an MTF)
Does best execution mean best execution on your venue or best execution on venues in general?
Structural considerations
If you operate an MTF
•
You can’t execute client orders against
proprietary capital –– you can’t therefore
have an SI in the same entity
•
You can’t engage in matched principal
trading in the same entity
•
It looks like you can operate an OTF as
well
•
If you’re the operator of a regulated
market, you can operate an MTF and an
OTF
•
There are examples in the market of firms
operating an MTF and a non-regulated
platform side by side in the same legal
entity
•
It looks like you can order route to other
MTFs, OTFs and SIs, although query
whether this is part of the MTF
functionality
If you operate an OTF
•
You can’t execute client orders against
proprietary capital –– you can’t therefore
have a SI in the same legal entity
•
But you can deal on own account in
non-liquid sovereign bonds
•
You can’t engage in matched principal
trading in the same entity save for
instruments other than mandatory traded
derivatives but only with the client’s
consent
•
You can’t execute client orders against
the proprietary capital of another member
of the group – ie. other members of the
group can’t act as market makers
•
Orders cannot connect to or interact with
orders in an SI or another OTF – so you
cannot order route to SIs and OTFs
•
It looks like you can operate a MTF as
well (and if you’re the operator of a
regulated market, you can operate an
MTF and OTF)
Systematic Internalisers
Definition:
“An investment firm which, on an organised,
frequent, systematic and substantial basis
deals on own account by executing client
orders outside a RM, MTF or OTF
”
Quantitative tests and opt in:
• Firms exceeding both thresholds are
caught but others can opt into the regime
• Must notify competent authority
• NB. applies per instrument/ ISIN
Equities Bonds Structured Finance Products Derivatives Emission allowances Frequent and systematic basis threshold (liquid instruments) OR Number of transactions executed by the investment firm on own account OTC / total number of transaction in the same financial instrument in the EU Equal to or more than 0.4% and daily 2 to 3% and at least once a week 3 to 5% and at least once a week 2 to 3% and at least once a week 3 to 5% and at least once a week Frequent and systematic basis threshold (illiquid instruments) AND
Minimum trading frequency (average during last 6 months)
Daily At least once a week At least once a week At least once a week At least once a week
Substantial basis threshold criteria 1 OR
Size of OTC trading by investment firm in a financial instrument on own account / total volume in the same financial instrument executed by the investment firm
15% 25% 30% 25% 30%
Substantial basis threshold criteria 2
Size of OTC trading by investment firm in a financial instrument on own account / total volume in the same financial instrument in the European Union
The future for equities broker crossing networks
•
3 choices for an equities broker crossing network?
– MTF
: must be an MTF if operated on a multilateral basis
– SI
: must be an SI if not multilateral and exceeds SI thresholds
– Neither?
: if multilateral but exercise discretion or if deal on own account but
below thresholds and don’t opt in to SI regime – for use by exempt persons
•
An investment firm that operates an internal matching system on a
multilateral basis should be authorised as an MTF
•
Single dealer platform (where trading is always against one firm) v
multi-dealer platform, with multiple multi-dealers interacting for same financial
instrument
•
How bilateral do SIs need to be?
–
Dealing on own account when executing client orders includes matching on a
matched principal basis
–
Does this mean that a SI for non-equities (other than derivatives subject to
mandatory trading) could look very similar to an OTF?
•
SIs may have more control over access to flow and fewer markets
obligations (inc. transparency) but quoting obligations are onerous
What would this bond arrangement be?
Client A
Client B
Client C
Indicative
prices
Client X
FIRM
Firm streams indicative prices to market 1Client asks for price
2
Firm accepts order and enters trades with clients X and B
6
Firm gives price to client, which places order
5
If firm can’t satisfy from its own stock it looks for other side of trade 3 Client B agrees to trade 4 Could it be an SI?
• Are orders executed outside a trading venue? • Does firm deal on own account when
executing client orders?
• Is it bilateral / a single dealer platform?
• Is it on an organised, frequent, systematic and substantial basis?
Could it be an OTF?
• Is it multilateral?
• Does it bring together multiple buying and selling interests / is a multi-dealer platform? • Is there a system?
• Do they interact in a system in a way that results in a contract?
Mapping out the brokerage world
Systematic internaliser
OTF for non-liquid sovereign debt possible
OTF with consent (save for mandatory traded derivatives) possible OTF MTF Dealing on own account (Dealing on own account when executing client orders) (Matched principal trading) Execution of orders on behalf of clients Reception and transmission Dealing as principal Dealing as principal with Article 29(2) CRD restriction Dealing as agent Art 25(1) RAO arranging T R A D IN G P LA T FORMS U K R E GI ME M IFID II A C T IV IT IE S /S E R V IC E S
Pre-trade transparency, dark pools and best
execution
Pre-trade transparency on trading venues
Make public bid and offer prices and depth of trading interest
Extended to actionable indications of interest
Competent authorities permitted to grant waivers including orders that are large in scale but ESMA will opine on use of waivers before their use and has powers to oppose them
Volume cap limit on use of referential price and (for liquid shares) negotiated transaction waivers: 4% per trading venue and 8% across all trading venues of overall EU trading in instrument
Existing waivers to be reviewed against new requirements by January 2019
Make public bid and offer prices and depth of trading interest
Extended to actionable indications of interest
Potential waivers for:
– large in scale orders: by reference to class of financial instrument
– orders held in an order management facility –
minimum tradable quantity
– actionable indications of interest above a specific size that would expose liquidity providers to undue risk: 50% of large in scale (RFQ and voice only)
– Derivatives not subject to clearing obligation and other instruments for which no liquid market: threshold per class of financial instrument
Competent authority can temporarily suspend disclosure where liquidity falls
Equity instruments:
– shares
– depositary receipts
– ETFs
– certificates
– similar financial instruments that are traded on a trading venue
Non-equity instruments:
– bonds
– structured finance products
– emission allowances
– derivatives
that are traded on a trading venue
Equity
Instruments
Non-Equity
Instruments
Pre-trade transparency for trading in equities
• Large in scale (LIS)
: ESMA has set restrictive thresholds for block trades - set against a
scale measured in average daily turnover in the EU
• Order management facility
: orders for order management facility may not be smaller than
the minimum tradable quantity (as set in the trading venue’s rules) and reserve orders may
not be smaller than €10,000 at any stage during their lifetime
• Price reference
: either the price for that instrument from the trading venue where the
instrument was first admitted to trading, or the
‘most relevant market in terms of liquidity’
(market with the highest turnover in the EU in the preceding calendar year (excluding
transactions concluded under a pre-trade transparency waiver))
• Negotiated transactions
: ESMA has prescribed the scope of transactions falling within this
waiver by merit of being subject to conditions other than market price (which are partially
aligned with the transactions that do not contribute to price discovery, such as give-ups or
give-ins)
Exception Type Instruments Covered Pre-trade Waiver Post-trade DeferralLarge-in-scale All Yes Yes
Order management facility All Yes No
Price reference Equities & equity-like Yes No
Negotiated transactions Equities & equity-like Yes No
Size specific to instrument Non-equities RFQ & voice trading systems only
Yes
(all trading systems)
Pre-trade transparency for trading in non-equities
32
• Large in scale (LIS)
: ESMA has set restrictive thresholds for block trades - set against a
scale measured in average daily turnover in the EU
• Order management facility
: orders for order management facility may not be smaller than
the minimum tradable quantity (as set in the trading venue’s rules) and reserve orders may
not be smaller than €10,000 at any stage during their lifetime
• Size-specific-to-instrument (SSTI)
: applicable only to actionable IOIs in RFQ and voice
operated trading systems that are at or above a set threshold, where publication would
expose liquidity providers to undue risk. The threshold which must be met is set at half the
size of the LIS thresholds and the same issues as arise there, albeit the lower threshold is
less restrictive on block trades
• Illiquid instruments
: encompasses all derivatives which are not subject to
MiFIR’s trading
obligation; also applies to other instruments (including derivatives that are subject to the
trading obligation) that ESMA has deemed at Level 2 are not sufficiently liquid to be subject
to pre-trade transparency
Exception Type Instruments Covered Pre-trade Waiver Post-trade DeferralLarge-in-scale All Yes Yes
Order management facility All Yes No
Price reference Equities & equity-like Yes No
Negotiated transactions Equities & equity-like Yes No
Size specific to instrument Non-equities RFQ & voice trading systems only
Yes
(all trading systems)
Issues from the Level 2 consultations
Liquid market
definition
• Same themes in the December and February consultations
• ESMA’s assessments of liquidity for the illiquid instruments waiver have been conducted using COFIA (as opposed to an instrument-by-instrument approach)
• Some instruments have been classified as liquid despite common
understanding in the market to the contrary • The effect, particularly for
certain derivatives, has been to apply a single assessment to diverse instruments with different trading volume or
liquidity profiles
Data
• Debate about the data used and if this could be made available
• Confidentiality
agreement – could not put the data in public domain
• Challenge to dispute and comment on proposals
COFIA approach
• General agreement with relative simplicity and certainty of approach • Argue for more granular
in relation to certain financial instruments e.g. commodities
• Issue: regulators keen in not allowing too much being illiquid – G20 mandate concerns but thresholds might be too low and wide
Cross border
convergence
• ‘Large in Scale’ v ‘Block’ regimes; LIS thresholds generally lower
• Divergence of
approaches between EU and US
• Systems and monitoring convergence / updates required
• Deferral regime and NCA discretion under Article 11 MiFIR may lead to regulatory arbitrage • Trading obligation;
‘sufficiently liquid test’ should be applied at a more granular level • BUT alignment with EMIR is welcomed
What does this all mean for dark pool trading?
Shares
• Dark pools continue in theory but volume caps will make unlit trading unpredictable in practice for all but block trades
• Moving to another dark pool could result in a market wide suspension
• Scope for trading elsewhere is limited by trading obligation but could SIs be an alternative?
• Venues and firms will need to be ready to “light up” – will they be expected to have arrangements in place?
Other equity instruments
• Subject to transparency for first time and waivers are subject to volume caps
• Volume caps do not apply to negotiated
transactions in these instruments for which there is no liquid market in certain cases
Derivatives that are mandated for
trading and other liquid non-equities
• Subject to transparency for first time
• Dark pools can exist if trading venues get waivers
• No volume cap
• If transparency drops, competent authorities can suspend pre-trade transparency obligations for up to 3 months but extendable
Other derivatives and non-liquid
financial instruments
• Waiver from pre-trade transparency so this can remain dark
• Competent authorities can withdraw waivers where they think they are being abused
Whenever instruments are executed on trading
Pre-trade transparency for systematic internalisers
Equity like instruments
Non-equity like instruments
Make public quotes for
liquid instruments
On a regular and continuous basis
during normal trading hours
- When prompted by client
- When agree to provide a quote
Quotes requirements
Must achieve best execution and reflect prevailing market conditions
Update / withdraw
Can update any time but can only withdraw in exceptional conditions
Access to quotes
Must make available to other clients but can have commercial policy on access
provided objective and non-discriminatory
Obligation
Execute at quoted price in sizes up
to standard market size – minimum
quote size
Enter transactions under published
conditions if at or below size specific to
instrument
Acceptable limits
Number of trades with same client
and total trades at same time
provided non-discriminatory and
transparent
Number of trades at any quote provided
non-discriminatory and transparent
Price improvement
Same but carve out for professional
clients where several securities in
one trade
Only in justified cases if it falls within
public range close to market conditions
Firms still need to be able to comply with best execution:
•
Must take all sufficient (not just reasonable) steps to achieve best possible result
•
Must not receive a benefit for routing client orders to a particular venue that would constitute a conflict or
inducement
•
Execution venues and SIs to publish information about their execution quality
•
Firms to publish annually their top 5 execution venues and their quality of execution
•
Order execution policies to be clear, easily comprehensible and sufficiently detailed
Technical advice:
•
Policies must be customised to class of financial instrument and service provided and should explain
•
Policies should list execution venues for class of financial instrument and explain how venues are
selected
•
Factors used to select venues should be consistent with controls to demonstrate best execution
•
For OTC products, firm should be able to check fairness of price through market data used to determine
price and by comparing to other products
•
Where firm charges different fees for executing on different venues, firm must explain pros and cons in a
fair, clear and non-misleading way
•
If firm is permitted to receive any inducement from an execution venue, they must be disclosed
Enhanced best execution
How do you achieve best execution?
BEST EXECUTION
(take all sufficient steps to
achieve best possible result)
Trading venues and SIs
to publish information
about execution
Access to the EU by third country firms: the UK view
Retail & Opt Up
Professional
Professional &
Eligible Counterparties
Authorised
branch
•
Harmonises
rules across
the EU
•
Inter-regulator
MOU
•
No passport
National
regime
•
Maintains
current
position
•
Rules likely
to differ
across EU
•
No passport
National
regime
•
Maintains
current
position
•
Rules likely
to differ
across EU
•
No passport
Authorised
branch
•
Harmonises
rules across
the EU
•
Inter-regulator
MOU
•
Passport
ESMA
Register
•
No branch
•
Equivalence
•
Reciprocity
•
Submit to
jurisdiction
•
Passport
Member States can elect to
use either MiFID authorised
branch or a national regime
Member States must permit use of the
ESMA
Register
unless
no
positive
equivalence decision is in effect
Unpacking the issues for firms
•
MiFID II marks a significant change for firms in the markets space
•
A number of hot topics on the ESMA registration process:
–
Will ESMA adopt the literal equivalence approach or the EMIR style policy equivalence plus top up
–
The comparison of capital requirements is particularly sensitive as some non-EU countries have a
different and lighter approach
•
There is a genuine debate about when a cross border service is being provided in the markets space but
in reality any dealing with an EU counterparty will bite
•
Note that the regime applies even to performing investment activities with EU professional clients and
ECPs: Result is that even being a member of an EU market probably brings a third country firm into
scope
•
Note three year transitional period from the time of an equivalence assessment during which domestic
regimes can continue to exist
•
One of the big questions here is whether current domestic regimes will continue to permit access
pre-equivalence or are we on a path to a tougher world? – HMT has taken a helpful view on the continuation
of the overseas persons exclusion
•
HMT has taken a non-maximum harmonisation view of the branch provisions
•
Ambiguity about position of third country equivalents of MTF and OTF, e.g. SEFs: arguably they are
covered by the third country regime for firms
•
Separately they need to be treated as equivalent for Article 28 purposes as a third country market if EU
counterparties are to trade on them: this dual regime approach seems odd and no guidance yet on this
point
The new markets equivalence debate
• Relevant to both equities and derivatives
• EU Investment firms must trade shares admitted to trading on an EU trading
platform on either an EU trading platform or an equivalent third country market
– Third country market defined by reference to the Prospectus Directive
• EU Financial counterparties and non-financial counterparties plus (as defined
under EMIR) may only trade derivatives on EU trading platform or equivalent
third country market
• Some possible application to third country firms where derivatives have a direct,
substantial and foreseeable effect on the EU market
– Third country market defined by the Commission by reference to various
factors, including effective supervision, investor protection and market abuse
monitoring
• Open textured test and remains open how the Commission will interpret this
• Usual ESMA advisory role
The long arm of the EU?
•
Firms have operated a variety of follow the sun structures for
global trading
•
Historically there was a general view that the key was where the
main business activity was carried on
•
Often this meant that a single terms of business was issued and
the view taken that even if trading desks executed trades
elsewhere given time zone differences and trades were booked in
other branches that did not impact the jurisdictional analysis
•
This looks unsustainable in the MiFID 2 world: HMT and FCA
appear to take a broad view of territorial scope and it seems likely
that ESMA will share this view
Options for structuring global businesses
Option 1: Carry on doing principal trading from outside EU
•Works for trades with professional clients and ECPs in the UK under the overseas persons exclusion
•This gives a three year transitional from an equivalence decision on that jurisdiction so depending on how quickly ESMA and the Commission work there may be some years of leeway here
•Means a jurisdiction specific analysis around EU •Not a permanent answer
Option 2: Is there a way of avoiding ESMA registration entirely
•Most of the action in the market is around the link between the ESMA registration regime and the availability of MiFID exemptions
•Probably only works if all EU external relationships are effected through an EU regulated firm
Conclusions: what will it mean?
Restructuring/ consolidation?
•
Fairly clear that consolidation likely
given cost of transparency and
requirements for trading on venue
•
Some parts of industry need to ask
hard questions about future shape of
the business
End of OTC?
•
A key driver but unclear what it will
really mean
•
One of the most interesting issues is
how much it will be possible to
“repackage” parts of the OTC market
as a trading venue
More or less global markets?
•
Key question on the new mandatory
trading world
•
For markets and brokers it makes the
issue of an EU / non-EU venue and
firm optionality model a key question
More data and definitions
than we can cope with?
•
Goes to the cost of operating under
the new regime
•
Working out which “box” a business
line or model fits in is going to be key
•
Opportunities for service providers to
offer data and white labelled services
Algorithmic trading and DEA provisions
Conor Foley | Advisor - Government and Regulatory Affairs
8 July 2015
Background to MiFID II, MiFIR provisions
HFT – A MiFID political priority
•
Ensure all market participants are regulated
•
Address fears of ‘flash crashes’, ‘ghost liquidity’ and sophisticated manipulation
•
Keep liquidity providers in the market during periods of price volatility
•
Regulate market making
Practical effects
•
Article 1(5) MiFID II extends main provisions to unregulated market participants
•
Article 2(1) MiFID II changes mean broader authorisation requirement
•
Article 17 MiFID II requirements for all members / participants of RMs, MTFs
•
Article 48 MiFID II sets out corresponding requirements for trading venues
Algorithmic trading
What’s in?
Automated trading decisions
Automated optimisation of order execution
Systems making independent decisions
What’s out?
Order routing
Order confirmations
Post-trade processing of transactions
“trading where a computer algorithm automatically determines …
parameters of orders such as whether to initiate the order, the timing,
price or quantity … or how to manage the order after submission, with
limited or no human intervention”
“
Limited human intervention”
DDA (latest): shall mean that, for any automatic order or quote generation process or any
process to optimise order execution by automated means once a buy or a sell decision
has been made by human intervention, the system makes decisions at any of the stages
of initiating, generating, routing or executing orders or quotes according to pre-determined
parameters
HFATT
High frequency algorithmic trading technique
Algorithmic trading characterised by:
Infrastructure that is intended to minimise latencies, including at least one of:
−
co-location;
−
proximity hosting; or
−
high-speed direct electronic access
System determination of order initiation, generating, routing or execution without human intervention
for individual trades or orders; and
High message intraday rates which constitute orders, quotes or cancellations
High message intraday rate
Commission has opted for ESMA proposed “Option 2”
•
Minimum four (4) messages per second for all instruments traded on a trading venue; or
•
Minimum two (2) messages per second for any single instrument traded on a trading venue
•
Only messages for liquid instruments included in the calculation
Algorithmic trading: obligations
HFATT Article 2(1)(d), (e) and (j) MiFID II exclusion
Article 26 MiFIR requirement extends to orders
S&C’s IT procurement and outsourcing rules
Testing: conformance, initial, and non-live testing required
Self-assessment requirements
General and specific “kill” functionality
Business continuity arrangements
Pre- and post-trade controls
Specific GCM requirements
Supervision Notification to home and trading venue NCAs
Option for home and trading venue NCAs to request details of algorithmic trading strategies
CQO CQO applies to all financial instruments
30% MM trading hours → 50% CQO trading hours
Competitive quoting requirements
“Exceptional circumstances” exemption and non-performance penalties
Market making agreements and market making schemes
Other highlights Enhanced trading venue system capacity requirements
Mandatory order-to-trade ratio
Fair and non-discriminatory access to co-location services
Prohibition on fee structures that may incentivise disorderly trading
Direct electronic access
“Electronically transmitting orders directly to a trading venue”
DDA (latest):
“person can exercise discretion regarding the exact fraction of a second of order entry and
regarding the lifetime of the order within that timeframe”
In-scope: DEA Provider offers access to trading venue using its trading code and orders routed by
“device performing algorithmic trading” embedded in DEA User’s systems
In-scope: DEA Provider offers access to trading venue using its trading code and orders routed by
device that does not perform algorithmic trading embedded in DEA User’s systems
X
Excluded: DEA Provider offers access to trading venue using its trading code and orders routed by
“device performing algorithmic trading” embedded in DEA Provider’s systems
“an arrangement where a member or participant or a client of a trading venue
permits a person to use its trading code so the person can electronically
transmit orders relating to a financial instrument directly to the trading venue
and includes arrangements which involve the use by a person of the
infrastructure of the member or participant or client, or any connecting system
provided by the member or participant or client, to transmit the orders (direct
market access) and arrangements where such infrastructure is not used by a
DEA: ruling the chain
Main responsibilities
Regulatory status
Client
DEA User
Client
Underlying DEA User
Art 2(1)(d) MiFID II excluded
May be otherwise exempt
Article 17 MiFID II provisions apply
Trading Venue
Member
DEA Provider
Market operator or investment firm
Credit institution or investment firm only
Rules and conditions for DEA access
Must cancel SA in cases of breaches
Responsible for DEA User trading
Specific DEA policy and procedure
Due diligence on prospective DEA Users
On-going review of DEA User clients
Authorisation to sub-delegate access
End-user due diligence where sub-delegation
Pre and post-trade controls
Monitoring of DEA User orders
Separation of client, proprietary order flow
Cancel client flow and individual orders
Suspend or cancel DEA User access
The trading environment: The US story
Terry Arbit | Partner (Washington, DC)
Tara Mokijewski | Of Counsel (London)
What is a SEF?
Definitional Issues
•
Commodity Exchange Act § 1(a)(50) defines a “swap execution facility” (“SEF”) as a trading
system or platform where multiple participants are able to execute or trade swaps by
accepting bids and offers made by multiple participants
The CFTC’s implementing regulation (the “SEF rule”) focuses on platforms
that are: (1) multiple-to-multiple and (2) facilitate the execution of swaps (or
provide the ability to do so)
•
Footnote 88 in SEF rule: Registration requirement applies to platforms if they facilitate the
execution of any kind of swap (even swaps not required to be traded on a SEF)
•
But: “Single-dealer platforms” are not required to register because they are not
multiple-to-multiple
Security-based SEFs
•
No SEC rules yet for SEFs for security-based swaps (i.e. equity swaps, single
name/narrow-based credit default swaps)
Mandatory SEF execution
Mandatory clearing
•
Certain standardized swaps must be cleared through a CFTC-registered derivatives
clearing organization (“DCO”) if the CFTC determines that they should be subject to
mandatory clearing
Mandatory trading
•
If a swap is subject to mandatory clearing, it must be executed on a SEF or a futures
exchange (called a designated contract market (“DCM”)) unless no SEF or DCM makes the
swap “available to trade”
•
“Made Available to Trade” (“MAT”) determinations initially made by SEF/DCM and
submitted (usually through self-certification) to CFTC
•
“Required Transactions” are those subject to mandatory SEF/DCM trading
•
“Permitted Transactions” are all others
Mandatory SEF execution
Who?
• Financial entities
• Commercial end-users
when ineligible for
“end-user exception”
because they are not
hedging or mitigating
commercial risk
What?
• Swaps subject to
clearing mandate that
are determined to be
“made available to
trade”
• Unless large enough to
qualify as a block trade
or exempt from
clearing/trading under
end-user exception
When?
• Started February 15,
2014 for certain interest
rate swaps
• Started March 3, 2014
for certain credit default
swaps
SEF execution methods
“
Minimum functionality”: Order book
•
SEFs must offer an order book for all swaps listed on the SEF
•
An order book is a trading system in which all market participants have the ability to enter
multiple bids and offers, observe or receive bids and offers, and transact on such bids and
offers
Request for quote (“RFQ”)
•
SEFs may also offer an RFQ trading system
•
Through an RFQ system, a market participant may transmit a request for quote for a swap,
to which other market participants may respond
SEF execution methods
Required transactions
•
Must be traded using an Order Book or RFQ
•
Order Book / RFQ Interaction: When an RFQ requester receives the first responsive bid or
offer, the SEF must communicate to the requester any firm bid or offer pertaining to the
same instrument resting on the SEF’s Order Book
•
Some SEFs use voice-based systems as a form of RFQ
Permitted transactions
•
May be traded by any method of execution, including voice-based systems (i.e., not limited
to Order Book or RFQ)
•
However, SEFs must offer an Order Book for all Permitted Transactions (even if no one
uses it)
MTF v OTF v SI v SEF
MTF
OTF
SI
SEF
Assets All financial instruments Non-equities only All financial instruments
(but OTC only)
Swaps only Matching System Non-discretionary CLOB, RFQ, RFS Discretionary CLOB, RFQ, RFS
Full discretion (bilateral) RFQ, RFS Discretionary / Non-discretionary CLOB, RFQ, RFS Restrictions on Multilateral trading
Cannot execute against own capital and no matched principal trading
Matched principal is allowed if client is informed
Market making must be independent
Cannot operate a multilateral trading system
Permits limited matched principal trading primarily in the form of block trades
Other
Restrictions
Can operate an SI and can connect to SI
Cannot operate an SI and cannot connect to another OTF
Cannot operate an OTF Limit on dealer ownership
Participants Regulated only (not for
commodity derivatives)
Can be unregulated Clients only Eligible Contract Participants
Investor Protection
Very few COB rules Full COB rules apply including best execution
Full COB rules apply including best execution
Core principles apply; SEF has discretion to examine best practices and regulations
Resilience Limited requirements
(mainly HFT focus) Limited requirements (mainly HFT focus) Limited requirements (mainly HFT focus) Detailed requirements (not mainly HFT focus)
Purpose of new rules
Requirements have been aligned with those of RMs in order to create a more level playing field
Replace broker crossing networks
Replace broker crossing networks
Replace broker crossing networks, as well as regulate secondary markets for swaps
CFTC cross-border position
•
“Path forward”: CFTC staff relief that trade execution mandate can be satisfied by
executing the swap on a “qualifying” MTF in EU or “qualifying” market in Australia
•
“Qualifying” MTF or market need not register as a SEF with CFTC so long as it meets the
access, price transparency, and other conditions equivalent to requirements imposed on
SEFs in the US, for example:
1)Multilateral trading (order book for all swaps offered for trading)
2)Same execution methods (i.e., swaps subject to MAT determination must be executed on
order book or RFQ-to-3)
3)Straight-through processing (including pre-trade credit checks)
4)Same block sizes as those on SEFs
5)Same swap reporting to registered swap data repositories as done by SEFs
6)Non-discriminatory access
7)Oversight equivalent to that of SEFs
•
No European MTF has submitted the certification to CFTC necessary to rely upon this relief
•
However, Yieldbroker Pty Limited has notified the CFTC that it intends to apply for relief as
Impact on liquidity?
•
Nearly two dozen SEFs, which accounted for about half of total volume in 2014
•
But: Lack of cross-border liquidity is a significant concern
•
“Market fragmentation caused by the CFTC’s ill-designed trading rules – and the
application of those rules abroad – is increasing the systemic risk that Dodd-Frank
regulatory reform was predicated on reducing.”
Commissioner Giancarlo, Financial Times,
November 10, 2014
MTFs & SEFs:
fragmentation of cross-border liquidity
The CFTC’s ‘QMTF’ regime effectively became full compliance with Dodd-Frank
CFTC’s no-action relief (intended to allow MTFs time to comply with QMTF conditions) has since expired
Fragmented US / EU liquidity across multiple asset classes
Solution 1: an EU-based SEF-MTF (subject to dual regulation)
Solution X: another means to combine liquidity without dual regulation or cross-border issues?
US
Advantages
1. Single liquidity pool
Disadvantages
1. SEF must reapply for SEF licence following business transfer to UKMTF
2. Consider other US legal and regulatory implications
UK and EU Advantages
1. Single liquidity pool
2. UKMTF-SEF accesses EU participants directly
3. UKMTF-SEF can market on its own behalf across the EU
4. EU passport regimes applies
Disadvantages
1. Dual regulation by both the FCA and CFTC
2. Consider other US legal and regulatory implications 3. Consider MTF/non-MTF functionality