After years of bickering, exchanges and brokers finally have a chance to compromise over the way broker crossing networks are regulated in MiFID II.
Until now, commercial factors have clouded the BCN debate. Exchanges lose money when their biggest members internalise trades, while investment banks boost margins by avoiding exchange fees and giving the buy-side a range of execution options.
Above the noise, regulators have been trying to figure out what’s best for the market. Does a BCN create a two-tier market that offers selective access to liquidity, or does it allow brokers to achieve best execution for institutional investors, ultimately improving the performance of pension funds?
The latest MiFID II draft from the Council of the European Union, dated October 2011, appears to go some way in finally finding a happy medium.
It basically proposes that BCNs fall under a new organised trading facility category that prohibits the inclusion of prop trading, but allows client facilitation activity to be included.
After MEPs sought an outright ban of BCNs, brokers are seemingly content with the Council’s position. Exchanges, however, have voiced their opposition, most recently with the Federation of European Securities Exchanges sharing its concerns with German and Nordic banking associations.
However, according to some exchange executives, bourses’ ongoing disapproval of the OTF could be soothed if MiFID II offers a clean definition of over-the-counter equity trading. The Council’s draft suggests trading of “liquid shares” should only take place on exchanges, multilateral trading facilities or OTFs, unless “it is non-systematic and infrequent or it is carried out between eligible or professional counterparties and does not contribute to the price discovery process”.
How one defines liquid, infrequent or contributing to price discovery remains to be seen.
This approach could hand exchanges the opportunity to claw back some of the market share they have lost to brokers’ private venues. Investment banks, meanwhile, retain the opportunity to run BCNs within an appropriate regulatory framework, while still having some discretion on how trades are matched.
Perhaps hopes of a happy medium are optimistic, but sooner or later, something’s got to give.