Narrow definition of OTF favoured by MEPs

The version of MiFID II to be voted on by MEPs this week will not include equities or proprietary flow as part of the new organised trading facility regime.

The version of MiFID II to be voted on by MEPs this week will not include equities or proprietary flow as part of the new organised trading facility (OTF) regime.

The new OTF category will include no proprietary flow, meaning broker crossing networks (BCN) must become systemic internalisers (SI) or adapt their model to become multilateral trading facilities (MTFs).

The text of MiFID II and its attendant regulation MiFIR that rapporteur Markus Ferber MEP has put together based on recent discussions by the ECON committee of MEPs – seen by – shows OTFs will trade only non-equities, a move to push more trading back onto stock exchanges.

Instruments to be traded on OTFs, according to the proposed text, include bonds, structured finance products, emissions allowances and derivatives, and states OTFs should offer non-discriminatory access. In addition, the document makes clear that proprietary flow will not be part of the OTF classification, to avoid possible conflicts of interest.

“The operator of an OTF should be subject to requirements in relation to the sound management of potential conflicts of interest and non-discriminatory execution and should not be allowed to execute in the OTF any transaction between multiple third-party buying and selling interests including client orders brought together in the system against his own proprietary capital. This should also exclude them from acting as systematic internalisers in the OTF operated by them,” the document reads.

The decision on which instruments the OTF category would cover was a major point of difference between MEPs, and the decision to exclude equities changes the intent of the European Commission’s original document from October 2011, which foresaw that BCNs would become a subset of OTFs.

A significant addition to the wording of the OTF regulation in the Ferber document, compared with the Commission’s initial draft, explains the reasoning behind creating a clearer distinction between OTF and systematic internalisers.

“In order to guarantee the quality of the price formation process it is appropriate to limit the circumstances in which OTC trading can be carried out outside a systematic internaliser and  competent authorities should ensure that for shares, no participant in a system where an investment firm executes client orders against own proprietary capital is in a privileged position with regard to order execution,” it states.

Another major development added by MEPs in the document states that all OTC flow must go through systematic internalisers, with the exception of transactions deemed "large in scale" or involve the primary issuance of the instrument.

MEPs in the European Parliament’s Economic and Monetary Affairs Committee (ECON) finalised the wording of the document in meetings last week, and the formal vote on the document for ECON will take place this Wednesday 26 September.

Once voted on separately by all MEPs, the Parliament’s version of MiFID II will be reconciled with a version from the Council of the European Union with input from the European Commission. MiFID has a an expected implementation date of 2014.

The latest version of the Council’s version of MiFID – which is being drafted under the Cypriot presidency of the European Union – broadly supports the Commission’s original text on OTFs.