Sell-side worries that CESR will muddy water for crossing systems

The Committee of European Securities Regulators' recommendations to the European Commission as part of its MiFID review have met with mixed responses from the industry.
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The Committee of European Securities Regulators' (CESR) recommendations to the European Commission (EC) as part of its MiFID review have met with mixed responses from the industry. Sell-side firms have come out against the recommendation to impose a size limit on broker crossing networks saying it could negatively impact buy-side execution strategy, but market participants have been more supportive of plans for regulatory involvement in creating a consolidated tape.

CESR, which aims to harmonise securities regulation across the continent, made the recommendations as part of the technical advice it provided to the EC on reform of MiFID. The recommendations were based on feedback to a consultation launched in April that sought comment from market participants.

Part of its recommendations included the requirement for a generic identifier for broker crossing systems (BCSs) to be included in post-trade reports and the publication of daily aggregate trade information for each BCS to regulators. Trades executed on broker crossing systems are currently not separated out from manual over-the-counter trade reports in post-trade reports, which prevents post-trade analysis analysing the liquidity available in networks.

While greater transparency of broker crossing networks has been strongly advocated in recent months, CESR also urged the imposition of a limit on the amount of business that can be executed by BCSs before they become classified as multilateral trading facilities (MTFs). If broker dark pools were required to turn into MTFs, orders would have to be transparent on a pre-trade basis and brokers would have to ensure fair and open access to all market participants. Sell-side firms have indicated that being held to such conditions would have a significant impact on the way buy-side traders execute business.

“Redefining a BCS as an MTF would be a very significant business change for the entity involved,” said Chris Jackson, head of execution sales, EMEA at Citi, which operates the Citi Match internalisation venue. “In the context of the current MIFID review, one of the buy-side's biggest concerns is they would have to transact the entirety of a block order on a lit trading venue. Exchanges and MTFs are not always the most appropriate venues for block orders and as such may not always derive the best execution price possible for the institution or its underlying client.”

A crucial factor in deciding when to reclassify a BCS will be the precise size and nature of the threshold put in place, according to Kee-Meng Tan, managing director and head of Knight's electronic trading group in Europe.

“The amount of trading in a BCS can fluctuate significantly on a day-to-day basis, which means regulators will have to carefully consider how to define such a threshold,” said Tan. “For example, will the limit be placed on all stocks or done on a stock specific basis? It could end up being a very difficult rule to police and continuously recalculate.”

One possible solution could be to follow the US, where currently a dark pool accounting for 5% or more of the volume in a stock must display its best priced orders to the public for a specified length of time. US regulator the Securities and Exchange Commission has proposed reducing the threshold to 0.25% from 5%.

Market participants are more supportive of CESR's recommendations to create a standardised consolidated source of post-trade data, the lack of which has hindered the buy-side's ability to gain a full picture of the market when making investment decisions or conducting transaction cost analysis.

In its advice to the EC, CESR proposed standards for post-trade data that would facilitate the creation of a consolidated tape.

This includes the creation of Approved Publication Arrangements (APAs), which would have responsibility for cleaning and standardising data to enable easier and uniform consolidation. Similar to the Trade Data Monitor (TDM) regime, under which firms such as Markit BOAT were established for the reporting of off-exchange trades, APAs – which are expected to be drawn from existing market data providers and trading venues – would process post-trade data to a common standard.

CESR recommended that the technical implementation of the APA regime should be left to the industry, along with the creation of the tape, but added that if a solution did not materialise, “MiFID should identify a clear course of action and require the establishment of a mandatory single European consolidated tape run as a not-for-profit entity on the basis of terms of reference and governance to be set out by ESMA”.

Denzil Jenkins, director of regulation at pan-European multilateral trading facility Chi-X Europe, believes this is an approach that will attract widespread support from the industry.

“Regulation is designed to address market failure. The market has thus far not been able to resolve this issue or reduce the cost of data, so it is only sensible that the mandatory consolidated tape has been suggested,” said Jenkins. “The direction of travel on this issue is pretty clear and is it time for people to step up to the challenge. If not, the regulators will be fully justified in taking a more heavy-handed approach.”

CESR also envisaged a “short timeline” for delivering an adequate consolidated tape solution, thought to be within two years, but with the pan-European regulator readying itself for restructuring as the European Securities and Markets Authority (ESMA) at the start of next year, some feel a solution may take longer than expected.

“It's hard to believe a consolidated tape that is backed by the whole industry will be created anytime soon,” commented Simmy Grewal, European analyst at consultancy Aite Group. “CESR's proposals are a step in the right direction but there still needs to be a consensus on cost of data and appropriate flagging of trades, which could take some time.”