The final draft of the European Commission’s proposed revisions to MiFID will impose new restrictions on high-frequency trading (HFT), confirm a ban organised trading facilities from crossing against prop trading flow, and define new rules for access criteria between central counterparties (CCPs) and trading venues.
A draft of MiFID II dated 7 October, seen by theTRADEnews.com, includes a number of dramatic changes from the interim document that was widely leaked last month.
Among the most substantial additions is a new liquidity requirement that seeks to stem HFT by forcing market making algorithms to operate continually during market hours. According to the draft, “an algorithmic trading strategy shall be in continuous operation during trading hours of the trading venue to which it sends orders or through the systems of which it executes transactions. The trading parameters or limits of an algorithmic trading strategy shall ensure that the strategy posts firm quotes at competitive prices with the result of providing liquidity on a regular and ongoing basis to these trading venues at all times, regardless of prevailing market conditions.”
News of the new requirement has been received with frustration by industry players who have seen the draft.
“This is an untenable situation and I cannot see how it could possibly work in practice,” said one insider who wished to remain nameless. While electronic market makers generally deploy algorithms that buy and sell at high frequency across market hours, these are typically triggered by specific market circumstances, rather than being automatically active during trading hours. The idea of imposing new requirements on market makers has been floated since the flash crash of 6 May 2010, which was blamed in part by a withdrawal of liquidity by many high-frequency trading firms. However, market participants have worried that regulatory action could cause such firms to withdraw from affected markets permanently. “This is alarming and unworkable,” the source added.
The final draft of MiFID II and the accompanying regulation – the Markets in Financial Instruments Regulation (MiFIR) – are scheduled to be presented by the EC on 19 October. According to one insider, while further negotiations are scheduled for this Thursday, further changes to the rules were “not expected to be significant”.
According to the draft, operators of OTFs – which include broker-crossing networks (BCNs) – cannot trade against their own proprietary capital – referred to as prop trading – while systematic internalisers (SIs) can. SIs are not, however, permitted to bring together third-party buying and selling interests “in functionally the same way” as a regulated market, multilateral trading facility (MTF) or OTF. SIs will also have a distinct pre-trade transparency regime from other regulated trading venues. OTF market surveillance requirements will be “materially the same” as for regulated markets and MTFs. A number of brokerage firms that currently operate BCNs have established MTFs in anticipation of MiFID II.
Other updates to previous drafts of MiFID include rules that define the criteria for trading venues accessing CCPs that include “fees relating to access and operational requirements regarding margining”, suggesting a tougher line on forcing exchanges that operate as vertical silos to open up to competition. However, MiFID’s access provisions are “without prejudice” to articles 8 and 8a of the European market infrastructure regulation (EMIR), which detail CCP and exchange access arrangements for OTC derivatives. Talks are being held this week to resolve differences between the drafts of EMIR prepared by the Council of the European Union and the European Parliament, after the UK government lost a battle to extend the regulation’s remit to exchange-traded derivatives. Although MiFID potentially covers all financial instruments, differences between MiFID II and EMIR on access could result in separate regimes governing OTC derivatives and all other financial instruments.
The final MiFID II draft also introduces new index licensing requirements, which assert that trading venues “should not be able to claim exclusive rights in relation to any derivatives subject to this obligation preventing other trading venues from offering trading in these [index and benchmark] instruments”.
Such an amendment could open the door for exchanges to trade indices licenced by rival bourses, for instance the London Stock Exchange could offer derivatives based on EuroSTOXX indices, which it has bee so far prevented from doing by Deutsche Borse.