Council’s latest MiFID II text offers broker dark pool compromise

The Council of the European Union is likely to recommend that organised trading facilities encompass all asset classes as part of MiFID II, offering a reprieve to brokers that operate internal dark pools.

The Council of the European Union is likely to recommend that organised trading facilities (OTFs) encompass all asset classes as part of MiFID II, offering a reprieve to brokers that operate internal dark pools.

According to a draft version of MiFID II dated 12 February, seen by, which lays out the Council's position on some aspects of the legislation that were discussed at a meeting last week, finance ministers backed the use of OTFs for all asset classes.

The interim text - circulated by the Irish presidency prior to another Council meeting tomorrow afternoon - also bans the use of proprietary capital in OTFs and clarifies that matched principal trading, i.e. client facilitation trades, should only be used for OTFs that trade non-equities.

"Member States have made the point that matched principal trading is a form of riskless principal trading which means the broker does not take on additional market risk; therefore it should not be considered using proprietary capital," read an explanatory note from the Irish presidency that accompanied the draft. "We have included a requirement for the operator of an OTF [for non-equities] to provide information detailing the functioning of its matched principal trading to ensure it is in compliance with the specific definition."

OTFs were initially conceived by the European Commission as a way of regulating broker crossing networks (BCNs) that were classified as a form of over-the-counter trading under MiFID I. According to Thomson Reuters market share data, BCNs traded €33.7 billion worth of equities in January, making up half of the 9.12% of overall European trading activity executed in all dark pools. Thomson Reuters BCN data comprises daily trading activity reported to Markit from six of the largest broker dark pools.

However, the European Parliament's MiFID II text proposes that OTFs are permitted to trade non-equity asset classes only - primarily bonds and OTC derivatives that will migrate to trading venues under separate rules. This would require BCNs to fall under existing multilateral trading facility (MTF) or systematic internaliser (SI) designations.

MEPs were concerned that using the OTF for equities would lead to unnecessary liquidity fragmentation, thereby damaging the price formation process.

Improving transparency

The Council's MiFID II draft also includes a new requirement for brokers to trade on regulated markets, MTFs, OTFs or SIs, unless the trading of an instrument is "non-systematic and infrequent" or does not contribute to the price discovery process. 

"The rationale for this new provision is to try to incentivise as much trading as possible to be done on regulated trading venues, which is an important consideration to many Member States," read the explantory note. "We believe this obligation should contribute to achieving one of MiFID's overall objectives to increase transparency."

This proposal tones down an amendment added by MEPs that requires all OTC flow to be traded through SIs, with the exception of transactions deemed "large in scale" or involve the primary issuance of the instrument.

In terms of establishing a consolidated tape for equities, the Council has said it wants more time to assess an amendment made at last week's meeting that favours the appointment of a single tape operator selected through a competitive tender process.

The European Commission offered three approaches to establishing a consolidated tape, which included allowing multiple providers to offer competing products based on pre-defined data standards and the appointment of a single operator that would run the tape as a utility, as well as the competitive tender process.

Up until now, industry-led consolidated tape solutions have run into commercial barriers related to the costs charged by exchanges for market data. However, another industry-led initiative, the COBA Project, appears to be gaining traction from all sides of the industry and hopes to deliver a solution that resolves technical and commercial barrier ahead of a final MiFID II text.

The Council is aiming to conclude its MiFID II discussions by May, after which the regulation will enter the 'trialogue' phase, requiring the Parliament and Council to agree on a final text, with input from the European Commission. The trialogue could take up to six months, which would mean a final MiFID II text is signed off early next year.