CESR’s level playing field poses questions for maker-taker

Today, CESR’s compact headquarters on the avenue de Friedland in Paris hosted an open meeting on the regulator’s consultation paper on the functioning of Europe’s equities markets, which will fo
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Today, CESR’s compact headquarters on the avenue de Friedland in Paris hosted an open meeting on the regulator’s consultation paper on the functioning of Europe’s equities markets, which will form a core part of the European Commission’s MiFID review. The Committee of European Securities Regulators (CESR) set aside three and a half hours for the meeting, but it’s a near certainty that items lower down the eight-point agenda were not allotted the same time or debated with the same vigour as those higher up.

Item seven, for example, brought attendees’ attention to ‘regulatory boundaries and requirements’, including the alignment of MiFID requirements between regulated markets and multilateral trading facilities (MTFs). In layman’s terms, this means reviewing the options for tweaking MiFID to ensure a level playing field for all Europe’s trading venues, old and new.

In one of three CESR consultation documents issued last month (‘CESR Technical Advice to the European Commission in the Context of the MiFID Review – Equity Markets’), the regulator acknowledged that regulated markets (typically Europe’s formerly monopolistic national exchanges) feel that MiFID has stacked the cards too much in favour of MTFs. Exchanges and MTFs have different capital requirements under MiFID, while rules relating to the admission to trading of financial instruments and the verification of issuer disclosure obligations apply only to exchanges. In addition, regulated markets face delays and procedures before they can trade shares already listed on another exchange; MTFs do not.

The CESR paper also points out that a further source of discontent among exchanges stems from the fact that MiFID only requires MTFs to “employ appropriate and proportionate systems, resources and procedures” to ensure “continuity and regularity” in the performance of their activities. Such ambiguous wording allows for significant levels of interpretation, both on the part of the MTF and the competent authorities. As a remedy, CESR proposes that MiFID’s requirements for exchanges outlined in Article 39(a) to (c) be extended to MTF operators, thus making it clear that MTFs and exchanges have the same obligations “as regards the operation of their trading platform”.

Fair enough, but if accepted in their current form, CESR’s proposals also mean that MTFs must have arrangements to manage any “potential adverse consequences” for its clients that arise out of any conflict between the interests of its owners and the “sound functioning of the MTF”. CESR’s proposals add that particular attention must be paid to where a conflict of interest “might prove prejudicial to the accomplishment of any functions delegated to the MTF by the competent authority”. MTFs will also have to bolster their risk management and business continuity arrangements.

What constitutes a conflict of interest between an MTF and its users? It may be argued that the stakes in MTFs owned by high-frequency firms may lead those venues to permit strategies or develop functionality, such as flash orders, that are of particular benefit to their owner-users. But is there also a potential conflict between a trading venue and its users in the former’s desire to maximise revenues will compromise the latter’s ability (on behalf of their clients) to execute at the best price? The practice of most pan-European MTFs of effectively paying for order flow via maker-taker pricing schedules tempts brokers to execute their buy-side clients’ business not where the best prices are but the lowest costs. One could argue that offering liquidity providers rebates in return for limit orders is perfectly acceptable as long as the practice is entirely transparent to the participants and their clients. But if maker-taker pricing could be seen as an inducement under European competition law, then the practice may attract further scrutiny. With responses to the CESR paper due to close at the end of May, it would be a surprise if submissions from market operators and participants did not result in a clarification of the regulator’s current proposal.

To vote in this month’s poll on trading venues, click here.