Eighth Annual Markets Infrastructure Group Seminar: How will MiFID change the way we trade? Imogen Garner Partner 8 July 2015

Transcription

1 Eighth Annual Markets Infrastructure Group Seminar: How will MiFID change the way we trade? Imogen Garner Partner 8 July 2015

2 Timing: MiFID II / MiFIR 2 July MiFID II and MiFIR entered into force 19 December Level 2 Consultation on technical standards commenced. ESMA provided final report on technical advice to the Commission on delegated acts 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 1 August Level 2 Consultation on advice on delegated acts and Discussion Paper on technical standards closed 2 March Level 2 Consultation on technical standards closed 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 2

3 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 3

4 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 - 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 Government expects that the draft legislation will be made in

5 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 12:00 Refreshments and networking 5

6 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 K Reception 6

7 CPD accreditation This MIG seminar attracts 2.25 accredited CPD points Course reference is: L 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 7

8 Safety notice Should you hear the fire alarm please listen for instructions and exit the building via the front entrance 8

9 The trading environment of the future Jonathan Herbst Partner Hannah Meakin Partner Tara Mokijewski Of Counsel 8 July 2015

10 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? 10

11 Where will you be able to trade equities and derivatives?

12 What should I be thinking about? Best execution Trading obligations Transparency? Z Asset manager Introducing broker Agency broker Executing broker 12

13 Trading obligations: shares and derivatives 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 13

14 How will they decide which derivatives to mandate? TOP DOWN 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 BOTTOM UP 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 14

15 What trading models will be available?

16 Trading venues new concepts and boundaries Regulated Markets (RMs) Non-discretionary execution Managed by market operator Operating is not an investment activity or service Multilateral Trading Facilities (MTFs) Non-discretionary execution Market operator or IF managed Operating is an investment service Few conduct of business rules apply Multilateral systems Multiple third party trading interests interact in the system in a way that results in the formation of contracts 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 16

17 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 system "results in a contract". 17

18 MTFs and trading protocols (RFQ and RFS) 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 #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" 18

19 MTFs and trading protocols (RFQ and RFS) Regulators across Europe differ in their acceptance of the counter-arguments Reasons for rejecting the counterarguments also vary 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 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 19

20 OTFs and trading protocols (discretion) 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" 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". 20

21 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 Will this view hold going forward? 21

22 MTFs: advantages and disadvantages Advantages of MTFs Disadvantages 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 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 crossborder 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 22

23 OTFs: advantages and disadvantages Advantages of OTFs Disadvantages 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 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? 23

24 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 nonliquid 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) 24

25 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 Substantial basis threshold criteria 1 OR Substantial basis threshold criteria 2 Minimum trading frequency (average during last 6 months) 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 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 Daily At least once a week At least once a week At least once a week At least once a week 15% 25% 30% 25% 30% 0.4% 0.5 to 1.5% 1.5 to 3% 0.5 to 1.5% 1.5 to 3% 25

26 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 multidealer platform, with multiple 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 26

27 What would this bond arrangement be? Indicative prices 1 Firm streams indicative prices to market 3 If firm can t satisfy from its own stock it looks for other side of trade Client A Client X 2 Client asks for price 5 6 Firm gives price to client, which places order FIRM Firm accepts order and enters trades with clients X and B 4 Client B agrees to trade Client B Client C 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? 27

28 UK REGIME MIFID II ACTIVITIES/SERVICES TRADING PLATFORMS Mapping out the brokerage world Systematic internaliser MTF OTF for non-liquid sovereign debt possible OTF with consent (save for mandatory traded derivatives) possible OTF 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 28 Map is an attempt to show correlations between different concepts in MiFID II. It should not be understood to mean that an MTF or OTF requires separate permissions for providing investment activities and services this remains to be seen.

29 Pre-trade transparency, dark pools and best execution

30 Pre-trade transparency on trading venues Equity instruments: shares depositary receipts ETFs certificates Equity Instruments similar financial instruments that are traded on a trading venue Non-equity instruments: bonds Non-Equity Instruments structured finance products emission allowances derivatives that are traded on a trading venue Make public bid and offer prices and depth of trading interest Make public bid and offer prices and depth of trading interest Extended to actionable indications of 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 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 30

31 Pre-trade transparency for trading in equities Exception Type Instruments Covered Pre-trade Waiver Post-trade Deferral Large-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) Illiquid instruments Non-equities Yes Yes 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) 31

32 Pre-trade transparency for trading in non-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 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 32 Exception Type Instruments Covered Pre-trade Waiver Post-trade Deferral Large-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) Illiquid instruments Non-equities Yes Yes

33 Issues from the Level 2 consultations Liquid market definition Data COFIA approach Cross border convergence 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 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 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 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 33

34 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 Whenever instruments are executed on trading venues 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 34

35 Pre-trade transparency for systematic internalisers Equity like instruments Non-equity like instruments Make public quotes for liquid instruments Quotes requirements Update / withdraw Access to quotes Obligation Acceptable limits On a regular and continuous basis during normal trading hours - When prompted by client - When agree to provide a quote Must achieve best execution and reflect prevailing market conditions Can update any time but can only withdraw in exceptional conditions Must make available to other clients but can have commercial policy on access provided objective and non-discriminatory Execute at quoted price in sizes up to standard market size minimum quote size Number of trades with same client and total trades at same time provided non-discriminatory and transparent Enter transactions under published conditions if at or below size specific to instrument 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 35

36 Enhanced best execution 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 36

37 How do you achieve best execution? Trading venues and SIs to publish information about execution quality BEST EXECUTION (take all sufficient steps to achieve best possible result) 37

38 The international dimension

39 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 Interregulator MOU No passport National regime Maintains current position Rules likely to differ across EU No passport ESMA Register No branch Equivalence Reciprocity Submit to jurisdiction Passport Authorised branch Harmonises rules across the EU Interregulator MOU Passport National regime Maintains current position Rules likely to differ across EU No 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 39

40 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 preequivalence 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 40

41 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 41

42 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 42

43 Options for structuring global businesses A complex area but firms are looking at a number of strategies 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 43

44 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 44

45 Algorithmic trading and DEA provisions Conor Foley Advisor - Government and Regulatory Affairs 8 July 2015

46 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 Article 26 MiFIR additional orders requirement for persons engaging in HFATT 46

47 Algorithmic trading 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 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 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 47

48 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 Includes messages under the Continuous Quoting Obligation 48

49 Algorithmic trading: obligations HFATT S&C s Supervision CQO Other highlights Article 2(1)(d), (e) and (j) MiFID II exclusion Article 26 MiFIR requirement extends to orders 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 Notification to home and trading venue NCAs Option for home and trading venue NCAs to request details of algorithmic trading strategies 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 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 Fee structures for testing 49

50 Direct electronic access 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 person (sponsored 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 X 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 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 50

51 DEA: ruling the chain Regulatory status Main responsibilities Market operator or investment firm Trading Venue Rules and conditions for DEA access Must cancel SA in cases of breaches Credit institution or investment firm only Art 2(1)(d) MiFID II excluded May be otherwise exempt Article 17 MiFID II provisions apply Member DEA Provider Client DEA User Client Underlying DEA User 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 Record DEA User orders submitted 51

52 The trading environment: The US story Terry Arbit Partner (Washington, DC) Tara Mokijewski Of Counsel (London) 8 July 2015

53 Trading platforms SEF basics

54 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-tomultiple Security-based SEFs No SEC rules yet for SEFs for security-based swaps (i.e. equity swaps, single name/narrow-based credit default swaps) 54

55 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 55

56 Mandatory SEF execution Who? What? When? Financial entities Commercial end-users when ineligible for enduser exception because they are not hedging or mitigating commercial risk 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 Started February 15, 2014 for certain interest rate swaps Started March 3, 2014 for certain credit default swaps 56

57 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 RFQ must be received by at least 3 unaffiliated participants 57

58 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) 58

59 MTF v OTF v SI v SEF Assets Matching System Restrictions on Multilateral trading Other Restrictions Participants Investor Protection Resilience Purpose of new rules MTF OTF SI SEF All financial instruments Non-equities only All financial instruments (but OTC only) Non-discretionary CLOB, RFQ, RFS Cannot execute against own capital and no matched principal trading Can operate an SI and can connect to SI Regulated only (not for commodity derivatives) Very few COB rules Limited requirements (mainly HFT focus) Requirements have been aligned with those of RMs in order to create a more level playing field Discretionary CLOB, RFQ, RFS Matched principal is allowed if client is informed Market making must be independent Cannot operate an SI and cannot connect to another OTF Full discretion (bilateral) RFQ, RFS Cannot operate a multilateral trading system Cannot operate an OTF Swaps only Discretionary / Nondiscretionary CLOB, RFQ, RFS Permits limited matched principal trading primarily in the form of block trades Limit on dealer ownership Can be unregulated Clients only Eligible Contract Participants Full COB rules apply including best execution Limited requirements (mainly HFT focus) Replace broker crossing networks Full COB rules apply including best execution Limited requirements (mainly HFT focus) Replace broker crossing networks Core principles apply; SEF has discretion to examine best practices and regulations Detailed requirements (not mainly HFT focus) Replace broker crossing networks, as well as regulate secondary markets for swaps 59