Regulation

ESMA consultation to clarify automated trading responsibilities

The European Securities and Markets Authority (ESMA), the pan-European securities regulator, has released a new consultation on automated trading which seeks to clarify the obligations of market participants under the legislative framework provided by MiFID and the Market Abuse Directive (MAD).

The paper addresses the operational, credit and market risks that can arise from a highly automated trading environment and is designed to establish a set of common guidelines for the systems and controls used by trading venues and market participants.

The consultation is split into four sections comprising: the electronic trading systems used by investment firms; the obligation of investment firms and trading venues to maintain a fair and orderly trading environment; the prevention of market abuse and market manipulation; and direct market access and sponsored access arrangements.

According to ESMA, investment firms will have to ensure they have clear and formalised procedures for monitoring and testing electronic trading systems, periodic reviews of procedures and arrangements relating to their systems and appropriate records about the attributes of automated trading applications. While ESMA uses ”investment firms' as a catch-all term to describe market participants, the review is likely to focus on the low-latency automated systems largely employed by brokers, electronic market makers and other users of high-frequency trading strategies.

The paper focuses on the controls required by investment firms to prevent erroneous orders and perform effective risk management. Guidelines for trading firms will incorporate mechanisms to halt trading during specific circumstances and the undertaking of adequate due diligence of members before they are granted access.

In terms of direct market access and sponsored access, the paper proposes guidelines for dealing with breaches of trading venue rules, assessing and monitoring market participants that use sponsored access, and the prevention of market abuse arising from direct access arrangements. ESMA also sets out standard procedures for dealing with market abuse and manipulation through appropriate monitoring, staff education and recordkeeping.

“Clarification of the organisational arrangements which competent authorities can expect from regulated markets, multilateral trading facilities and investment firms to cope with the particular challenges of a highly automated trading environment is an essential step in providing a harmonised supervisory approach in this area, commented Steven Maijoor, chair, ESMA.

The deadline for submissions to the ESMA consultation is 3 October.

The guidelines, which are expected to be released before the end of this year, will clarify the obligations for automated trading set out by MiFID and MAD, both of which are currently under review by the European Commission (EC). When amendments to the two directives are finalised, ESMA's guidelines will be amended accordingly. The EC is expected to make its final proposals for MiFID II in October having been delayed from Q1 this year. New rules relating to the market abuse directive have also been delayed from May 2011, and are now expected around the same time as the MiFID II proposals.

“A common interpretation of the existing requirements in MiFID will ensure that safeguards in relation to electronic trading systems, fair and orderly trading, direct market access and sponsored access; as well as market abuse will be applied in a homogenous manner and that increased competition in a highly automated trading environment will not lead to an uneven playing field,” added Maijoor.

ESMA first began its work on examining the impact of automated trading in April 2010, when it issued a call for evidence on the micro-structural issues of European equity markets under the guise of its predecessor, the Committee of European Securities Regulators.

Under draft proposals for MiFID II made by the EC earlier this year, firms engaged in high-frequency trading would be formally recognised as a sub-category of a broad automated trading regime and brokers could be made to explain the design and function of their algorithms to regulators. Furthermore, ESMA could be given authority to set standards on tick sizes and circuit breakers.