MiFID II: Systematic internalisers and liquidity unbundling

ITG's Harald Carlens and Duncan Higgins look at how MiFID II will evolve the European liquidity landscape.

By Harald Carlens and Duncan Higgins, ITG

The European equity liquidity landscape is in flux as brokers and venues adapt to new dark trading rules soon to be imposed by MiFID II. Given these changes, we examine the potential impact on the ability of buy-side traders to source liquidity effectively.

The rules curtail trading in dark venues, requiring many venues and brokers to change the way they operate. Double volume caps and the obligation to bring electronic trades on-venue, leading to the disappearance of broker crossing networks, are expected to have the widest-ranging impact.

Many venues have implemented mechanisms designed to comply with the new rules. The two main approaches are to focus on enabling Large in Scale (LIS) trading, which is exempt from the volume caps, or to set up periodic auction mechanisms, which are pre-trade transparent in a limited way.

Brokers generally have not announced their strategies for next year. The broker crossing network (BCN), a structure used by many brokers to cross client orders, is not compatible with the new rules and will not continue to exist come January 2018. While some of the activity taking place in BCNs will be able to continue in systematic internalisers (SIs), they are not a replacement.

Reviewing the regulatory dialogue around SIs, we offer our interpretation of which subsets of BCN trading will continue as SI trades. We expect brokers to continue to aggregate liquidity across SIs and other venues through smart order routing technology, resulting in limited disruption for their clients. There is a potential benefit to the buy-side trader from increased post-trade transparency and more granular control over trading counterparties.

The more things change, the more they stay the same. MiFID II rules designed to restrict trading away from central limit order books are causing venues and brokers to change their structures. But while the exact trading mechanisms may change, we expect the extent of alternative liquidity available to buy-side traders through brokers’ liquidity aggregation tools to remain largely unchanged.

For the buy-side trader, finding liquidity under MiFID II will be business as usual.

 Read our full whitepaper on the topic here.