Buy-side uneasy on EC dark trading proposals

Fears that the reclassification of broker crossing networks will restrict choice of execution channels have topped buy-side concerns at the close of the consultation on reforms to MiFID by the European Commission.
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Fears that the reclassification of broker crossing networks (BCNs) will restrict choice of execution channels have topped buy-side concerns at the close of the consultation on reforms to MiFID by the European Commission (EC).

The Investment Management Association (IMA), a UK-based trade body whose members are responsible for £3 trillion in assets under management, has raised the issue in its response to the consultation which ended today. The EC plans to issue draft legislation before the end of Q2 this year, with a view to legislation being adopted by 2013.

In a consultation document released in early December, the EC proposed that BCNs should be classified as a subset of ”organised trading facilities', a new catch-all category of trading venue. It also asked for feedback on the possible imposition of a size threshold above which a BCN must convert to a multilateral trading facility (MTF), and proposed that any BCNs that cross proprietary flow should be re-registered as a systematic internaliser, while those that allow third-party access would be reclassified as an MTF.

According to its director of wholesale, Guy Sears, the IMA's response highlights the risk that reclassification of BCNs could restrict investor choice.

“It is not feasible for buy-side traders to have pre-trade transparency on every trade,” Sears told “It's not about dark versus lit, it's about going to venues where you think there will be other likeminded entities trading in the opposite direction. Having a variety of business models is useful for the buy-side, and we would like to keep the choice of venues available to us at the moment.”

Chi-X Europe, which operates both a lit and dark pan-European trading venue, also raised concerns about the EC's plans for BCNs. In a draft response of its submission seen by, the MTF argued that the business transacted in BCNs is not similar to MTFs, making a threshold for reclassification unworkable. Unlike MTFs, BCNs can discriminate on market access, with trades subject to best execution obligations between the broker and the sell-side client. Chi-X added that any restrictions on BCNs should only be considered if there is evidence to prove they are detrimental to market quality.

Andrew Bowley, head of electronic trading product management, Nomura, which has also submitted a response to the EC, said that reclassification of BCNs may not be the optimal way of controlling them.

“Instead of automatically reclassifying BCNs into MTFs, it would be more appropriate to cap BCN business,” he said. “This would ensure that BCNs do not have a different business model imposed on them, although the exact nature of a cap would need to be carefully considered.”

He added that while there was a need to clearly delineate between broker crossing engines that cross orders at the mid-point and those which internalise, i.e. conduct market making, the EC proposals did not make a provision for those platforms that engage in both.

But in its response, the Federation of European Securities Exchanges (FESE) contends that almost all BCNs could easily fall into the SI or MTF category.

“The EC needs to seriously consider the fact that MiFID may not have to be revised to capture equity BCNs, because the fundamental characteristics of these platforms are already captured in the MTF or SI definitions,” said Burçak Inel, deputy secretary general at FESE. “On the contrary, not treating them as such, when they do the same business as regulated markets, MTFs or SIs, would mean allowing unfair competition and undermining investor protection and market integrity.”

Controlling HFT

The EC's plans for regulating automated and high-frequency trading in MiFID II have received a mixed response, with Chi-X's director of regulation, Denzil Jenkins, saying he was “surprised” at some of the proposals.

The EC consultation paper considers several ways to monitor high-frequency traders, including defining them as a sub-category of a new regime to regulate all automated trading, introducing liquidity provision requirements and either imposing minimum quote resting periods or limiting the ratio of order to transactions.

“The EC's motivations for restricting high-frequency trading (HFT) are slightly unclear, particularly as the previous call for evidence by the Committee of European Securities Regulators (CESR) said that more work was required in this field,” said Jenkins. “Introducing rules on minimum quoting times for example would have a significant effect on liquidity and spreads. We would caution that these should be put to one side until more empirical evidence is available.”

CESR, the pan-European securities regulatory body that was replaced by the European Securities and Markets Authority (ESMA) at the start of 2011, conducted a call for evidence in April 2010 looking at market microstructure in Europe, which covered a number of issues related to HFT.

Furthermore, while noting that regulatory action on tick sizes would primarily be welcomed to ensure harmonisation across trading venues, Jenkins added that HFT could also be one factor determining the optimal tick size.

The EC paper suggests giving ESMA the power to vary tick sizes, the increments by which a stock price can move on a trading venue. Recent research from agency broker CA Cheuvreux supports the theory that tick sizes can be an effective tool in controlling HFT volumes.

Official record

The EC paper laid out three options for the creation of a consolidated pan-European tape of post-trade data – the lack of which has hampered investors' ability to make accurate trading decisions and gauge execution performance. The paper asked for feedback on whether the market would be best served by either establishing a non-profit organization, selecting a commercial operator based on a call for tender or allowing vendors to create their own competitive solutions within defined guidelines. All three would entail the creation of approved publication arrangements, entities that will clean and standardise data to facilitate consolidation.

While most market participants have previously said they would prefer a commercially-driven solution for data consolidation, there now seems to be consensus that regulatory intervention is required, with the tender option preferred by most.

“It would be nice to leverage the technical capabilities of the likes of Bloomberg and Thomson Reuters, but so far we do not have a consistent solution that the market is willing to adopt,” said Bowley. “We need an official tape of record that set standards on issues like which venues to include and how data should be flagged.”

Sears said the IMA backed the tender option but said that its success would depend on establishing a workable model for allocating fees and revenues.

FOA objections

Futures and Options Association CEO Anthony Belchambers expressed concerns about plans to give ESMA more powers, as part of the MiFID review.

The EC is currently working to introduce central clearing and reporting for the vast majority of OTC derivatives through its European Market Infrastructure Regulation, unveiled on 15 September 2010.

However Belchambers objected to a proposal in the MiFID consultation document that would effectively outlaw use of a specific derivative if no central counterparty (CCP) could be found to clear it. He warned that, in the drive to push as many OTC contracts through clearing as possible, the danger could arise that traders would find themselves banned from trading certain products.

“While we support its overall direction, a number of the requirements in the review are needlessly oppressive, particularly the proposed limits on execution-only business and bilateral execution. Additionally, the swathe of costly disclosure obligations is more likely to confuse than inform customers,” said Belchambers.

In September 2010, the Group of 20 countries agreed that all standard OTC derivative contracts should be traded on exchanges or electronic trading platforms where appropriate, and cleared through CCPs by the end of 2012 at the latest.