ESMA firms up multilateral system definition under MiFID II in bid to level playing field

Regulator to consult on technology provider, request-for-quote system and pre-arranged transaction system use cases that challenge the trading venue regulatory perimeter.

ESMA has set out plans to create a more concrete definition of what constitutes a multilateral system to ensure a more level playing field under MiFID II regulation.

In its consultation paper, the regulator has defined a multilateral trading facility (MTF) as a system or facility where multiple buying or selling third party interests in financial instruments are able to interact.

ESMA has also sought to bring some clarification to grey areas of the market across technology providers, request-for-quote systems and systems that allow for pre-arranged transactions, which all have characteristics that could class them as trading venues and bring them under the scope of MiFID II regulation.

For technology providers, the regulator has set out that a system must only “aggregate and broadcast” buying and selling interests as opposed to allowing for “communication and negotiation” between parties, including if a potential match is found, in order to not be classed as an MTF.

The securities regulator also confirmed that execution management systems (EMS) and order management systems (OMS), both of which have seen their status as venues subjected to debate, should not be considered MTFs unless they offer the opportunity for trading interests to interact.

Request-for-quote (RFQ) systems were another area to come under the spotlight in ESMA’s paper, with the regulator defining them as a system where quotes are provided in response to a request submitted by one firm.

In light of this definition, the regulator has concluded that a system that allows a client to request a quote from only one dealer should be considered multilateral regardless of whether it was designed by the client, whereas one that allows different clients to interact with only one counterparty can be considered bilateral.

However, the regulator added that in order to be considered a single-dealer bilateral system the system must not bring together third party interests and must deal on its own account.

Bilateral trading relationships in the fixed income, currencies and commodities (FICC) markets have become increasingly popular with sell-side counterparties and liquidity providers as a means to gain more control of their data and minimise transaction costs.

However, buy-side firms have been less inclined to turn to relationships with fewer counterparties as transaction costs are often absorbed by liquidity providers and implementation and design of these bilateral systems can be both  lengthy and costly.

“I don’t want to spend a lot of time and money building my own technological solution for a problem that doesn’t really exist for me at the moment. I would need that to be on a plate right in front of me offered as an out-of-the-box solution by my OMS provider and I would need to see some significant benefit to me trading bilaterally rather than through the venue. At that point I want to make sure I’m not a venue,” said head of trading at Bluebay Asset Management, Stuart Campbell, in The TRADE’s recent deep dive into bilateral trading. 

In its latest paper, ESMA also laid out guidelines for pre-arranged transactions taking place in a multilateral way but without authorisation as a trading venue, stating that all transactions arranged through an institution’s system must be formalised on a trading venue and that they must benefit from a pre-trade transparency waiver in said venue.

Industry participants have until 29 April to give their input on the regulatory changes proposed by ESMA with a final report expected to be published in the third quarter.

“ESMA expects that CAs [Competent Authorities] require firms to assess their systems against this opinion and reflect whether they are operating under the appropriate authorisation capacity,” said the regulator in its paper.

“ESMA expects CAs to require firms to take appropriate action, including further discussions with the respective CAs, in order to swiftly apply for authorisation as a trading venue where appropriate.”