The European Securities and Markets Authority (ESMA), the EU’s securities markets regulator, has updated its Q&As on Mifid II and Mifir market structure to provide more detail on various elements of algorithmic trading, particularly around the issues of automated order management and third party systems.
Clarified in mid-July, the first update confirms that orders executed through trading functionalities which offer automated managing of the order do indeed qualify as algorithmic trading.
As specified in Article 4 of Mifid II, ‘algorithmic trading’ means “trading in financial instruments where a computer algorithm automatically determines individual parameters of orders such as whether to initiate the order, the timing, price or quantity of the order or how to manage the order after its submission, with limited or no human intervention.”
That means that orders which are executed through functionalities which (additionally to routing orders to trading venues) offer automated managing of the order (e.g. automatically redirecting unexecuted portions of such orders to other venues or slicing orders prior to execution) do fall under the scope of the Mifid II definition.
“Such functionalities differ from automated order routing systems, as the latter merely determine the trading venue (or trading venues) to which the order has to be sent without changing any parameter of the order,” explains ESMA. “On the contrary, algorithmic trading encompasses both the automatic generation of orders and the optimisation of order-execution processes (e.g. slicing of orders) by automated means.”
“Firms trading through these functionalities should be considered as engaged in algorithmic trading and must therefore comply with the relevant regulatory requirements.”
The guidance confirms that firms trading through these functionalities should be considered as engaged in algorithmic trading and must therefore comply with the relevant regulatory requirements (found in Article 17 of Mifid II and RTS 6).
In addition, the Q&As also clarify how firms should ensure compliance when using third party systems which offer algorithmic trading functionalities.
“When firms use third party systems offering algorithmic trading functionalities, they are ultimately responsible for compliance with the relevant requirements,” confirms ESMA.
“However, lacking direct control over the system, its operation and the algorithms deployed, these firms might not be materially able to ensure that all requirements are met.”
In these instances, firms are allowed to ensure compliance with any technical requirements that can’t otherwise be met, through contractual arrangements with the system provider.