Fears that broker crossing networks (BCNs) may be forced out of the market could be alleviated following the most recent MiFID II amendments tabled by MEPs.
Brokers had feared that the European Parliament’s Economic and Monetary Affairs Committee (ECON) was on track to outlaw BCNs, backtracking on proposals made by the European Commission in its initial October 2011 draft of MiFID.
The Commission wanted to bring BCNs under a new category known as the organised trading facility (OTF), that would also include new trading venues that emerge as a result of OTC derivatives legislation.
While supportive of the OTF regime for swaps, Markus Ferber, who is guiding the European Parliament’s review of MiFID II, has argued the new category for BCNs would only exacerbate fragmentation and “create new loopholes”.
In his amends, Ferber proposed reclassifying all BCNs as either multilateral trading facilities (MTFs) or systematic internalisers, thereby eliminating the ability for brokers to decide how they match orders in their venues.
But MEPs – who were required to table their amendments by 10 May – have given their backing to the OTF category for equities and have also put the issue of whether brokers should be allowed to include non client flow in their networks back on the agenda.
The Commission had initially stated that an OTF should not contain any non client flow at all because of the potential conflicts that can arise if a venue operator is allowed discretion over how it matches orders in a liquidity pool that includes its own flow.
Facilitating client flow
A number of MEPs, including Olle Schmidt and Kay Swinburne, have been in close consultation throughout the amendment process with the aim of presenting ECON with different options relating to how client facilitation flow in OTFs should be handled.
Swinburne has suggested that the use of proprietary capital in BCNs should be limited to those trades that can facilitate client-to-client transactions.
“We need alternatives to how proprietary trading is handled so that we have a spectrum of proposals that we can discuss in the compromise meetings,” Swinburne told theTRADEnews.com. “If it turns out that we do not have the OTF for equities and BCNs need to become MTFs, clients still need the ability to choose what kind of flow they want to interact with. Investors use BCNs because they want choice on order flow.”
Schmidt has proposed an amendment that states proprietary trading in OTFs should be permitted where “this is undertaken on a matched principal basis or with the consent of a client”. He defined matched principal as: “A transaction where the firm/operator sits in the middle of the trade and becomes the buyer to the seller and the seller to the buyer.” This would include trading done by brokers to facilitate client trades or retain client anonymity.
“This is a recognition that a strong enough case has not been made for an outright ban on proprietary capital and that two important principles were not reflected in the initial proposal,” said Rickard Ydrenäs, policy advisor to Schmidt. “The fact is that matched principal trading does not involve proprietary activity but is entirely derived from equal and opposite client flow, and ultimately investors must have the right to choose who they trade with preserved.”
Brokers appear encouraged by the latest developments and have reiterated that having a new category for BCNs that is too restrictive on the use of proprietary capital would be ineffective.
“A blanket prop trading ban in BCNs would be hard to implement, simply because it is so hard to define,” said Andrew Bowley, head of electronic trading product management at Nomura. “We think a more useful solution would be ensuring that broker-operated venues have adequate policies to control the potential conflicts of interest that could arise.”
Other market participants insist that such conflicts are already recognised and well managed.
“Concerns that principal trading in BCNs may cause an unmanageable conflict of interest are unfounded, brokers already have an overarching responsibility to manage a client’s order in the best interests of the client and to manage any potential conflict with that responsibility,” Andrew Morgan, head of Autobahn Equity Europe, the electronic trading division of Deutsche Bank. “If rules governing OTFs were to be publicly available with clients given the option of matching against principle business, then brokers breaching their own rules would face substantial commercial and regulatory risk"
According to figures from Thomson Reuters, broker crossing networks represented around 50% of the €52.7 billion of dark trading in Europe last month, with dark MTFs accounting for the remaining 50%. Overall dark trading represented 6.98% of total trading activity last month, down from March’s total of 7.24% but higher than the 5.24% recorded in April 2011.
Ferber will now take in amendments from the various MEPs and produce a compromise document that will be voted on by ECON in July. The Council of the European Union will then propose its version of MiFID II, before a final text is negotiated through the trialogue process, which involves the Parliament, Council and European Commission.