BCNs face a dark future under MiFID II

A compromise text drafted by the Cypriot presidency of the Council of the European Union suggests a bleak future for broker crossing networks as common ground emerges between European policy makers on MiFID II.

A compromise text drafted by the Cypriot presidency of the Council of the European Union suggests a bleak future for broker crossing networks (BCNs) as common ground emerges between European policy makers on MiFID II.

On Wednesday the European Parliament’s Economic and Monetary Affairs Committee (ECON) voted unanimously on its version of MiFID II, which includes many amends to the draft first tabled by the European Commission last October.

ECON’s version of the directive would effectively force BCNs to reclassify as multilateral trading facilities (MTFs) or systematic internalisers, instead of allowing them to fall under the organised trading facility (OTF) category that was initially proposed by the Commission.

MEPs have decided that OTFs should only be used for non-equities, i.e. the OTC derivatives that migrate onto trading platforms following the introduction of new swaps rules under the European market infrastructure regulation. OTFs will be given an element of discretion on how they match orders but would not be able to execute orders against proprietary capital. 

The position has been backed by exchanges, which have been seeking a limitation of BCN activity for some time.

Burçak Inel, FESE“We are supportive of MEPs' stance to prohibit equities from the OTF regime as it will ensure the stability of the market,” Burçak Inel, deputy secretary general at the Federation of European Securities Exchanges, told “All BCNs perform matching activities that can easily be incorporated under existing MTF or SI classifications."

Brokers say they will continue to lobby on the issue, as BCNs are a service that is favoured by institutional customers.

Mark Goodman“We operate a BCN because our clients have told us they want to use a venue with a level of discretion that protects their order flow,” said Mark Goodman, head of quantitative electronic services, Société Générale. “The most disappointing thing is that the buy-side firms that have asked for this are representing individual investors and their voice isn’t being heard.”

The Commission’s draft included many of same OTF provisions agreed upon by ECON, but allowed their use for equities.

Council support

ECON’s stance appears to be broadly supported by the Council of the European Union, which is also obliged to conduct its own reading of the Commission’s draft as part of the overall MiFID review process.

A paper from the Cyprus presidency that sets out an alternative proposal for OTFs states it is, “important to retain the OTF category for non-equities, in order to meet the Commission’s objective of bringing all trading venues inside the regulatory perimeter without harming liquidity provision”. It also states that prohibiting the use of OTFs for equities would prevent further fragmentation of equity markets. But unlike ECON, the Council will allow orders to execute against proprietary capital in order to facilitate client trades.

“Without some ability to trade against own capital, the non-equities market will continue to trade mostly bilaterally…the quality and likelihood of execution may suffer if an OTF operator is not allowed to facilitate liquidity by taking the other side of a transaction”.

Admitting the member state representatives have been “spilt into two camps regarding the OTF category”, the Cypriot paper aims to strike a balance between the divergent rules.

HFT curbs

In addition to the effective elimination of BCNs, ECON also voted on high-frequency trading (HFT) curbs, including an obligation for all orders to have a minimum resting period of 500 milliseconds, a measure that many market participants believe will leave them open to increased risk. Sources suggest the measure was included as a compromise that offers evidence of a tougher line on HFT activity in Europe. The final ECON paper also included a ban on sponsored, and naked sponsored access, which would forbid brokers from allowing other trading firms from accessing markets using their infrastructure.

However, the obligation for all algorithms to be in continuous operation during all trading hours has been scaled back to cover only those trading firms that have contractual market making agreements with trading venues.

Moreover, MEPs voted to ban maker-taker pricing structures based on an amendment to the text proposed by Pascal Canfin MEP, which stated that “an investment firm shall not receive any remuneration, discount or non-monetary benefit for routing orders to a particular trading venue or execution venue”.

The elimination of maker-taker pricing – favoured by almost all MTFs – would also likely curb HFT activity, as many strategies with razor thin margins are dependent on the rebates they are rewarded for providing passive liquidity.

In addition, a requirement for trading venues and central counterparties to offer open access to each other has been watered down by ECON to only include “transferable securities and money market instruments”. This would in effect protect the siloed derivatives trading venues operated by the likes of NYSE Liffe and Deutsche Börse’s Eurex.

After a plenary vote on ECON’s version of MiFD II next month, MEPs will be required to reconcile their amendments with those of the Council, with input for the European Commission. The implementation of MiFID II is expected in 2014-15.