MiFID II will introduce a new regulatory regime for broker crossing networks (BCNs). Are they not subject to adequate oversight as it stands?
Brokers and exchange operators have divergent views on this matter but what counts is the opinion of regulators, who have at least two reasons for tightening up BCN regulation. First, MiFID outlines three categories of trading venue: regulated market; multilateral trading facility (MTF) and systematic internaliser. Many but not all BCNs have registered in this last category, which is widely regarded as ill-defined. Brokers say BCNs are an extension of their existing execution services – and as such do not require additional regulatory oversight – which help buy-side clients find liquidity without risking market impact or attracting exchange fees. Trading venues argue BCNs only differ from MTFs and regulated markets in terms of access and therefore create pockets of liquidity that are inaccessible to a large share of investors who subsequently suffer increased trading costs.
Second, BCNs are not required to provide the same level of detail on trading activity as other trading venues; reporting is voluntary and therefore inconsistent. Transparency is a key objective for all financial regulators in the post-Lehman world so – in line the MiFID II objective of creating a consolidated post-trade tape across Europe's financial markets – it is inevitable that BCNs and other trading venues currently outside existing MiFID categories must provide more transaction data.
Many regulators and politicians don't accept the need for internalisation by brokers and would rather push more trading back onto venues with full pre-trade transparency. For brokers, a new, clearer category for BCNs is by far the lesser of two evils.
Will MiFID II's new categories constrain the use of BCNs?
The MiFID consultation issued by the European Commission (EC) last December contained a number of proposals which could restrict the type and amount of flow that a BCN can trade and enforce real-time post-trade transparency.
In the first instance, given that BCNs weren't even strictly recognised under the first version of MiFID, the EC wants to make them a subset of a new, pervasive category of trading venue called organised trading facilities (OTFs).
As well as imposing a basic set of requirements in terms of technical operation and regulatory oversight, BCNs could be required to convert into MTFs if they trade over an as-yet-unspecified volume under this new regime.
Furthermore, if a BCN allows third-party access to its platform, it will be considered a MTF, while if it matches trades using proprietary capital, it will be classed as a systematic internaliser.
All BCNs may also be required to identify trades they execute in real time and make public information relating to the number, value and volume of all transactions executed using the system at the end of each trading day.
All of these proposals would go some way in helping the EC achieve its transparency goal.
How will these proposals impact the buy-side?
In short, the EC's proposals could give traders less control over the flow they interact with in the dark.
Most BCNs are only accessible via the operating broker's algorithms. The broker also has discretion over access to the BCN and can exclude certain types of flow at their behest.
If a BCN was forced to turn into a MTF, some functionality – such as a minimum order size – would help the buy-side maintain an element of control over the type of flow they interact, but it would not be as tight as the discretion that brokers hold currently.
With the scrap between exchanges and brokers continuing to dominate the BCN debate, buy-side traders – who have repeatedly said they would prefer to have a variety of options when choosing where to execute – are beginning to feel isolated.
Worried that their views aren't being fully represented in the MiFID review process, a number of buy-side heads of trading have tried to take matters into their own hands by meeting EC officials face-to face to ensure their views – including on BCNs – were fully understood. Time will tell whether the Commission got the message.