Despite continued concern from some market participants, new proposals contained in the current draft of MiFID II would not severely hamper brokers from customising their execution algorithms, according to Bradley Duke, European head at Knight Direct, the electronic trading business of agency broker Knight Capital.
MiFID II contains a series of measures that would require firms to provide descriptions of their trading algorithms, ensure they have adequate pre-trade risk controls in place, and warrant that algorithms are properly tested before use. Many industry players had initially expressed fears such requirements would impede the ability of investment firms to innovate and customise their algos – and that it might lead to loss of critical intellectual capital.
Endorsed by the European Commission (EC), MiFID II compels an investment firm which engages in algorithmic trading to “at least annually provide to its home competent authority a description of the nature of its algorithmic trading strategies, details of the trading parameters or limits to which the system is subject, the key compliance and risk controls that it has in place and details of the testing of its systems”.
However, Duke believed the likely remit of the information expected by regulators was unlikely to drill down to a level as granular as an algorithm's source code. "We have no issue with disclosure of basic information and descriptions of our algorithms," Duke told theTRADEnews.com. "We provide this to clients already. We are already regulated by the UK Financial Services Authority to a high standard, so it is debatable whether more checks are needed, but I do not believe these MiFID II proposals will stop us from innovating."
MiFID II also allows that regulators may at any time request further information from an investment firm about its algorithmic trading and the systems used for that trading. The provision comes from EC concerns that the relatively rapid evolution of execution algorithms and their methodologies might be outpacing regulatory oversight.
When the new draft rules were revealed in October, some observers questioned whether it might be expected that an investment firm would have to effectively request permission from a regulator every time a change was made to its existing algorithms, thereby adding an extra layer of cost and complexity to the process. But Duke suggests regulators are likely to follow a more pragmatic approach.
"Algorithms do change over time, but since the MiFID II document posits an annual provision of information, there should be no difficulty in simply updating regulators on any changes that have been made," he said.
But not all market participants agree with MiFID II's approach. While firms such as Deutsche Bank have compared the directive's algorithm requirements to existing best market practice, the Futures and Options Association (FOA) objects to the proposals. In its response to a MiFID II questionnaire issued by the European Parliament's MiFID rapporteur, MEP Markus Ferber, FOA argues that requiring a firm to provide a description of the nature of its algorithmic trading strategies on an annual basis does not add enough value to regulators or firms to be justified.
“While it may be useful for competent authorities to have certain types of information during investigation or enforcement proceedings, a blanket requirement on a firm to provide what would amount to volumes of largely meaningless information does not seem appropriate, and it is not clear to us what purpose this would serve,” said the FOA in its response.
The European Banking Federation said it supported the introduction of new organisational safeguards and risk-controls on firms engaged in algo trading – though it added that such controls should reflect existing best market practice, where possible.
MiFID II is currently being reviewed by the European Parliament. Once parliament agrees its amendments, the Council of the European Union will conduct its own review of the legislation. The implementation of MiFID II is expected during 2014.