Pan-European securities watchdog the European Securities and Markets Authority (ESMA) has unveiled its final automated trading guidelines, which will become effective by 1 May 2012.
The guidelines are intended to create a comprehensive regime for the operation of electronic trading systems by trading venues and brokers, and will apply to automated trading of all financial instruments defined under MiFID.
Under the guidelines, trading venues will be required to have a number of measures in place to ensure they can operate fair and orderly markets.
These include: adequate pre-trade controls, such as the possibility to limit the number of orders which each participant can send to the trading platform; conformance tests to ensure that members’ IT systems are compatible with electronic trading systems; and automatic and discretionary mechanisms to constrain or halt trading during times of market turmoil.
Exchanges and alternative venues will also need to undertake due diligence before accepting new members and have clear rules and procedures in place to prevent, identify and report instances of possible market abuse and market manipulation.
Brokers using algorithms must also have arrangements in place to maintain fair and orderly trading. This comprises an appropriate governance process for developing or buying algorithms, rolling out the live use of the algorithm in a cautious fashion and ensuring staff have the necessary expertise to run and monitor the behaviour of algorithms.
Like trading venues, brokers should also have adequate pre-trade risk controls in place to protect against erroneous order entry and maintain pre-set risk management thresholds, and undertake due diligence on clients that access markets via DMA or sponsored access.
Brokers and trading venues will also both need to keep adequate records of the systems and controls they have in place that are covered by the guidelines, so that regulators can assess their compliance with MiFID.
“The publication of today’s guidelines is an important step towards improving the oversight of automated trading,” said Steven Maijoor, ESMA’s chairman, “ESMA is committed to ensure that technological innovation does not pose a risk to the orderly functioning of the markets and will continue to monitor closely the developments in financial markets, including those which could impact on the resilience of market infrastructures. These guidelines will contribute to the stability and robustness of European electronic trading systems, which is why ESMA implements these guidelines now without waiting for the completion of the MiFID review”.
The proposals follow a questionnaire sent by ESMA to market operators and trading firms in July titled ‘Guidelines on systems and controls in a highly automated trading environment for trading platforms, investment firms and competent authorities’.
ESMA added that work related to automated trading will not end with the finalisation of the guidelines, and will continue within the context of the MiFID review.
The current version MiFID II, which is currently being debated by the European Parliament, seeks to impose market making obligations on all firms that employ the use of algorithms. The European Commission has stood by its proposals despite widespread criticism from a number of market participants.