EC MiFID consultation targets broker dark pools and automated trading

The European Commission has proposed tightening up the regulations governing trading venues in its MiFID consultation, including the creation of a new regulatory category for broker dark pools.
By None

The European Commission (EC) has proposed tightening up the regulations governing trading venues in its MiFID consultation, including the creation of a new regulatory category for broker dark pools.

The consultation, which is expected to be released publicly next week, is the first stage of the EC's MiFID review process. It follows extensive work by the Committee of European Securities Regulators (CESR), which has consulted the industry on the effects of MiFID since an initial call for evidence.

CESR, which coordinates securities regulation across Europe, issued technical advice in July 2010 based on its various consultations that were designed to inform the EC's consultation. CESR's work was also supplemented by a number of additional working groups, such as those on post-trade transparency and the creation of a consolidated tape, as well as a recent paper by the European Parliament's Committee on Economic and Monetary Affairs, that was voted through on 9 November, and had a large focus on dark trading. The information gathered by the EC consultation, which is due to conclude before the end of this year, will act as guidance as it prepares a formal consultation proposal expected in spring 2011.

Out of the dark

According to a draft version of the consultation seen by, the EC has proposed a sub-regime of regulation for broker crossing networks (BCNs) that recognises their differences compared to other trading venues.

“Such systems [BCNs] can be viewed as a hybrid between a facility to assist execution of clients’ orders and a multilateral system that brings together orders,” read the document.

However, BCNs that allow third-party access to their system will be classified as multilateral trading facilities (MTFs), and brokers that use proprietary capital to execute orders in their dark pools will be registered as systematic internalisers (SI).

The consultation also proposes a category of trading venues called organised trading facilities (OTFs) that would capture any system operated by an investment firm or market operator that brings together buyers and sellers of financial instruments on an organised basis. The OTF category would include all venues other than MTFs and SIs with the suggested category for BCNs being a sub-category and could also include another subset for over-the-counter derivatives instruments that are not suitable for a regulated market, MTF or SI.

The EC has asked for feedback on the idea of placing thresholds on OTFs for becoming an MTF, the new OTF category and what should be included and its plans for a sub-regime for crossing systems.

Post-trade options

The EC has also suggested three options for the creation of a consolidated tape. This would address the inability for buy-side firms to obtain a standardised and consolidated source of post-trade data across multiple trading venues, which hinders their ability to benchmark their executions.

“The main problems [of the reporting and publication of trade data] relate to the quality and format of the information, as well as












the information,” says the draft. “If these issues are not fully addressed, they could undermine the overarching objectives of MiFID as regards transparency, competition and investor protection.”

All three options suggested by the EC would result in the creation of Approved Publication Arrangements (APAs), entities that are required to bring data up to the required standard to facilitate consolidation.

The first option would formally mandate the consolidated tape to be operated by a single, non-profit seeking entity, established and appointed by legal act, similar to the system used in the US.

The second option would also seek to mandate a consolidated tape, but the operator would be selected by a call for tender that would run for a limited period of time. Under the second option, APAs and trading venues would make their data available to the operator of the tape, who would then make it available to the market at a reasonable cost. Alternatively, all APAs and trading venues would have to make their data available for free and then be awarded revenues made by the consolidated tape operator according to a prescribed formula.

The last option would be to set the standards for creating a consolidated tape under MiFID and allow commercial solutions to emerge within a defined timeframe.

The EC has also recognised the need for domestic exchanges to unbundled their pre- and post-trade data to enable easier consolidation.

“A majority of market participants believe that requiring unbundling of the data…would contribute to bringing down costs,” read the paper. “The Commission services consider that the framework directive could be amended to require the selling of unbundled pre- and post-trade data.”

Trade body the Federation of European Securities Exchanges, which represents 52 exchanges, has already stated that its members plan to offer unbundled data by Q1 2011.

Tackling HFT

The consultation also suggests a definition of automated trading, which would include a category for high-frequency trading, to help deal with the potential threat it can pose to an orderly market structure.

“Perhaps the most significant new risk arising from automated

trading is the threat

it can pose to the orderly functioning of markets in certain circumstances. Such threats can arise from rogue algorithms, from algorithms overreacting

to market events or from the increased pressure on trading venue systems to cope with the large

numbers of

orders generated by automated trading,” read the paper. “There have also been concerns raised by some market participants that some specific algorithmic trading strategies may be contrary to [UK regulator the Financial Services Authority's] Market Abuse Directive.

The new MiFID could include tighter risk controls for firms that engage in automated trading, an obligation to notify authorities of algorithms, including an explanation of their design, purpose and functioning, require equal and fair access and tighter risk controls for firms that provide sponsored access to trading venues.

For dark pools operated by MTFs, the EC has identified areas of the pre-trade transparency waivers that may require revisiting, noting that “an increased use of dark pools…may ultimately affect the quality of the price discovery mechanism on the lit markets”. This includes adding a minimum size to the reference price waiver, which is used by most dark MTFs to forego the publication of pre-trade quotes.

Under the new proposed regime for pre-trade transparency waivers, the European Securities and Markets Authority (ESMA), which is set to replace CESR on 1 January 2011, would be given responsibility to propose





the specific methods


the application of

the waivers and monitor

the use of waivers on an ongoing basis.

In the area of post-trade reports, the EC noted that market participants have “expressed concerns related to the timing of publication”. As such, it has asked for feedback on a proposed change “specifying that post-trade information would









technically possible. This would result in a reduction in the timeframe allowed for real-time reporting, from three minutes to one minute and require systems to publish details or trades as soon as they are entered into the system, rather than in ”batch' form. There are also suggestions for shortening the delays used for large trades.

The consultation document seeks feedback on issues such as improving access to execution quality data in order to verify best execution policies of investment firms, clarification of sanctions for non-compliance with MiFID and a new regime for telephone and electronic monitoring to improve detection of abusive and manipulative behaviour. In Section 9 of the document, entitled ‘Reinforcement of supervisory powers in key areas’, the EC proposes new powers for both national regulators and ESMA, which would allow them to ban specific products and activities in exceptional circumstances.