The European Securities and Markets Authority (ESMA) and the National Competent Authorities (NCAs) have announced the launch of a common supervisory action (CSA) to assess the implementation of Mifid II pre-trade controls.
Specifically, the action will address the controls employed by EU investment firms using algo trading techniques, with the CSA carried out during in the course of 2024, the bodies confirmed.
Speaking to The TRADE, Chris McConville, global head of execution services and trading at Kepler’s KCx, stressed the importance of these controls across the market: “At KCx, we are passionate about pre-trade controls. This isn’t just because they are a requirement of RTS 6, but because they play a key part in our strategy to protect our customers.
“Some of the pre-trade controls we implement may never be noticed by our clients, and that’s exactly how it should be. We are in the business of abstracting away complexity and providing our clients with solutions they love.”
Through accurate pre-trade controls, investment firms can limit and prevent sending erroneous orders to trading venues.
The CSA is set to assess a range of factors when it comes to pre-trade controls, including: the use of hard and soft blocks in their design, the calibration methodology, the establishment of limits for credit and risk as well as assessing their interaction with the controls, the monitoring and implementation of pre-trade controls in cases of outsourced trading to third countries, and examining governance frameworks.
The move follows the flash crash of 2 May 2022, with the regulators paying special attention to the implementation of pre-trade controls in the EU, having gathered evidence through questionnaires submitted to a sample of EU investment firms. This launch of the CSA follows this step, as ESMA and NCAs look to find more detailed insights on how firms are using pre-trade controls across the EU.
The 2022 European stock market crash was the latest example of what Michael Lewis expounded in ‘The Flash Boys’, wherein he claimed that “people no longer are responsible for what happens in the market because computers make all the decisions”. Regulators are clearly making strides to combat this in the algorithmic trading sphere where some of the fastest large volume orders threaten instability.
Sylvain Thieullent, chief executive at Horizon Software, told The TRADE: “With the constant evolution of algorithmic trading, it’s essential that effective oversight is maintained. Pre-trade controls (PTCs) are a key ingredient for an execution desk to perform with business excellence and, ultimately, achieve best execution. Their capabilities to cancel or block orders that have the potential of overstepping an investment firm’s risk threshold are significant, alongside their role in preventing excessively large orders that could have substantial impact on the wider market.
“As such, PTCs demand necessary attention from regulatory bodies. ESMA, through its collaboration with NCAs, is correct to look more closely at their application.”
Read more: Lessons learned from Flash Boys
According to the regulators, the CSA initiative, as well as the related sharing of practices across NCAs “aim [to ensure] consistent application of EU rules, helping to promote stable and orderly markets in line with ESMA’s objectives”. ESMA and NCAs also reminded the market in its most recent announcement of the established rules which govern the use of pre-trade controls as set out in Mifid II – CDR 2017/589 (RTS 6).