ESMA clarifies SI networking position

ESMA outlines details of MiFID II’s systematic internaliser rules in latest Q&A.

Market participants will not be able to network multiple third parties under the systematic internaliser (SI) regime, although could be authorised to hedge positions from executing client orders.

The European Securities and Markets Authority (ESMA) clarified rules around the use of SIs under MiFID II within its latest Q&A and formally stated SIs operating similar to a trading venue must seek authorisation.

It will need authorisation if an SI has an arrangement with clients which go beyond a bilateral interaction or on a regular basis, if it doesn’t undertake risk-facing activity, or if third-party buying and selling interests are executed OTC.

ESMA said the above “does not prevent SIs from hedging the positions arising from the execution of client orders”, as long as it does not lead to the SI executing non risk-facing transactions and bringing together multiple third party buying and selling interests.

Banks were warned against using the SI regime to create networks enabling them to act in a similar manner to existing broker-crossing networks (BCNs).

Kay Swinburne MEP explained at The TRADE’s MiFID II pop-up event in February, she has been made aware of banks plotting to network SIs together, which could enable them to effectively act much like BCNs, which are banned under the new regulations.

“It’s disappointing with less than a year to go, to be told how some market players are seeking ways around the rules, seemingly using grey areas to avoid giving investors the best price,” she said.

The European Commission recently said it will enter into a dialogue with ESMA to figure out where potential loopholes through the systematic internaliser (SI) regime could be found and closed.

European Commissioner, Valdis Dombrovskis, acknowledged concerns via a letter to ESMA over the potential for banks to use the SI regime under MiFID as a loophole.

ESMA concluded in its Q&A that “an SI would not be bringing together multiple third party buying and selling interests as foreseen in Recital 19 where hedging transactions would be executed on a trading venue.”

MiFID II’s systematic internaliser regime has been forced into the spotlight as market participants stand in fear of its impact. We unravel the story of the regime and ask market experts about the possible unintended consequences.