Market participants are worried the forced categorisation of broker crossing networks (BCNs) into existing trading venue categories could diminish execution quality, after an MEP revealed that a new venue regime in MiFID II may not cover equities.
Speaking to theTRADEnews.com last week, Markus Ferber MEP said the organised trading facility (OTF) category, introduced by the European Commission in its October draft of MiFID II, could now be limited to non equity instruments.
This would mean BCNs, currently classified as over-the-counter trading under MiFID, may be forced to become multilateral trading facilities (MTFs) or systematic internalisers (SI) under a revised directive.
Buy-side traders are unhappy at the impact this could have on execution performance, arguing broker control over BCN orders helps limit information leakage and improve execution quality.
“There is a risk the MiFID proposals will leave buy-side traders with no flexibility when it comes to choice of trading venue,” Sören Steinert, associate director, equities at Germany-based Quoniam Asset Management, told theTRADEnews.com. “If choice is restricted to MTFs or SIs, this will be a disadvantage for me.”
If brokers were forced to turn into MTFs, they would lose the ability to decide who can access their BCN, how trades are matched and would have to publish prices on a pre-trade basis unless obtaining a MiFID-defined waiver.
The waivers – currently used by all dark MTFs – require trading venues to match orders at the mid-point or trade above a certain size in order to forego pre-trade price obligations. Many BCNs match orders of all sizes at any point within the bid-offer spread.
A systematic internaliser can include trades which use proprietary capital but MiFID II will prohibit them from matching two client orders. SIs will also be required to publish quotes that are below ‘standard market size’.
Brokers had welcomed the Commission's apparent recognition of the nuances of BCNs and their categorisation as an OTF.
“The OTF regime as it stands allows us to preserve a degree of discretion on how we handle order flow, which is one of the most important jobs we have vis-à-vis our clients,” said Chris Marsh, head of Advanced Execution Services, Europe at Credit Suisse.
“While the OTF definition needs work, it brings a formally recognised vehicle that enables BCNs to be regulated more transparently,” added Tim Wildenberg, head of European electronic trading, Citi. “OTFs sit nicely between MTFs and SIs, and will help to provide more visibility into this part of the market.”
But both the buy- and sell-side have reservations over the proposed structure of the OTF regime – in particular its ban on proprietary trading, which some observers note is impractical for BCN activity.
“There appears to be an assumption that if you are trading on principal, you are trading on your own interests,” said Wildenberg. “However, many brokers book all client flow as principal because that’s what clients demand. The discretion afforded to BCNs means they are currently not required to show client flow to the wider market, thereby allowing brokers to work in their clients’ best interest.”
Steinert noted that BCN fills information he receives from brokers shows many trades are matched against flow from prop desks, or risk trades being unwound.
“The current structure governing broker dark pools does not need to be adjusted,” he said.
Marsh said Credit Suisse had been working with sell-side trade body, the Association for Financial Markets in Europe, to devise a more detailed definition of the type of proprietary trading that would not be allowed in an OTF.
Some exchanges have long opposed the ability of brokers to match flow internally, arguing BCNs effectively perform the same function as a regulated market or MTF, just under a lighter regulatory regime.
But exchanges also believe the OTF regime does not adequately solve this problem.
“The current proposal allows OTFs to discriminate in terms of access and also allows operators to give better deals to some of their clients – such as non-discretionary execution,” said Judith Hardt, secretary general of bourse trade body the Federation of European Securities Exchanges. “We are therefore worried that this will impact investors’ protection and market fairness.”
The next meeting of the European Parliament’s Economic and Monetary Affairs Committee on MiFID II is scheduled after the Easter break. During this meeting, Ferber is expected to table a series of amendments to the European Commission’s draft proposals. Implementation of MiFID II is expected to start by 2014 at the earliest.