ESMA confirms changing scope of multilateral trading definition including request-for-quote and execution management systems

The conclusion comes as part of a consultation on the scope of a multilateral trading venue launched by the EU watchdog in January last year to level the playing field.

EU markets watchdog ESMA has confirmed its new definition of a multilateral trading venue, bringing some RFQ and EMS systems into scope to the dismay of some industry participants. 

ESMA launched its consultation in January last year in a bid to level the playing field: focusing on grey areas in the market including RFQ systems, technology providers, execution management systems (EMS) and systems that allow for pre-arranged transactions.

“Mifid II requires all multilateral systems to be authorised as trading venues,” ESMA said in its opinion. “The objective of co-legislators was to bring more trading activity into the regulated sphere, in particular by increasing the number of transactions on regulated venues to ensure better protection for investors.”

According to its findings published on Thursday, RFQ systems – whereby a client requests and quote to a set number of dealers and responses are sent individually back to the client – are multilateral and should require authorisation as a venue.

ESMA clarified that RFQ-to-one – systems that allow clients to request a quote from one dealer – would still be considered multilateral also as they are allowing for the interaction of third-party interests, one of the regulators four key characteristics when defining an MTF, as clients are able to send requests to multiple dealers whether than be at the same time or separately.

An area for consideration noted by ESMA is when an RFQ-to-one functionality only provides for a single liquidity provider e.g., when a firm such as a bank operates a single dealer system and deals on its own account. This system would not be considered multilateral, ESMA has found, as it is not bringing together third-party interests.

Execution management systems

Execution management systems have proved one of the more contentious areas of the consultation, with many in the industry waiting with bated breath to hear ESMA’s findings.

In terms of technology providers, ESMA has concluded that systems that facilitate the interaction of third-party interests related to financial instruments should be considered multilateral.

As part of its clarification, the regulator concluded that an EMS that simply supports users order managing processes should not be considered multilateral. However, those systems that present what ESMA has defined as additional features and complexity such as the ability to gather quotes from multiple players that are able to interact with one another could be considered a multilateral system.

ESMA noted it is important to consider the role of the entity operating the system, whether that be software vendor of investment firm. If a software vendor has embedded a number of rules that govern interaction of trading interests and the investment firm is not able to set its own rules then that software vendor is operating a multilateral system.

Pre-arranged transactions

Another grey area to be addressed by ESMA are pre-arranged transactions – a process that does what it says on the tine i.e., trading that takes place at a specified price that has been agreed upon before execution.

Its overall findings for pre-arranging transactions stress the need for firms and systems who practice this to ensure these transactions take place on trading venues and have formal agreements to ensure they do so. The regulator as part of its findings has concluded that if a system arranges a transaction in a multilateral way it should require authorisation as a trading venue.

However, ESMA noted several situations under which pre-arranged transactions are not considered a multilateral trading system. The watchdog has outlined two characteristics that must be in place for it to qualify as such. The first being that all transactions arranged through the investment firm’s system have to be formalised on a trading venue and the second that any transaction benefits from a pre-trade transparency waiver in the venue where it will be formalised.

“ESMA considers that under these circumstances the main objective of MiFID II of ensuring on-venue trading, which provides for increased transparency and investor protection, has been achieved,” the watchdog said in its opinion.

Should the formalisation of the transaction happen over the counter, the pre-arranging activity requires authorisation as a trading venue, ESMA said, as would a pre-arranging system capable of formalising transactions.

“ESMA expects that NCAs [national competence authorities] require firms to assess their systems against this opinion and reflect whether they are operating under the appropriate authorisation capacity,” ESMA concluded in its report.