Confusing obligations in MiFID II are causing banks such as Swiss-based UBS to re-evaluate their dark trading offerings and could negatively impact execution choice for buy-siders.
Richard Semark, head of European client trading and execution relationships at UBS, said proposed changes to MiFID had forced the bank to conduct a strategic review of its Price Improvement Network (PIN), a crossing service exclusively for UBS institutional clients.
“Our strategy has always been very clear. We want to provide choice in a transparent way,” said Semark. “PIN has always been an offering which has had a clear purpose – to allow UBS customers to cross with other client flow which includes flow traded in a principal capacity, such as swap hedges and the unwinding of client risk and consequently we allow no third-party access.”
Issued last month, the European Commission’s MiFID II proposals are due to be debated by the European Parliament from 5 December. One of the most substantial changes to MiFID is a tightening of the rules governing broker crossing networks (BCNs), which will be formally recognised for the first time under a newly-created organised trading facility (OTF) regime. Separately, rival texts of the European market infrastructure regulation (EMIR) drafted by the European Parliament and the Council of the European Union are currently being harmonised.
“The approval process for MiFID and EMIR is at a very political stage at the moment, and simultaneously, Europe is discussing the possibility of a transaction tax,” said Semark. “As these regulatory discussions develop, we will review PIN to ensure it continues to service our clients in the best possible way within the regulatory constraints.”
Semark said MiFID II’s definition of OTFs and systematic internalisers could lead banks to adjust their strategies for providing dark trading venues.
Under its current wording, a BCN which crosses with its own proprietary flow will be considered a systematic internaliser, while those which allow third-party access would be reclassified a multilateral trading facility (MTF). Many commentators have claimed the new rule stemmed from European regulators’ uncertainty on how to adequately supervise BCNs and prop trading.
“There is still a lot of confusion over the obligations of systematic internalisers,” said Semark. “As the current draft stands, PIN would be categorised as an OTF but it is conceivable that means we would not be able to include client-related flow traded in a principal capacity in the way we presently do.”
Semark says it was unlikely UBS would move PIN to a multilateral trading facility model, as UBS has already set up UBS MTF with low fees, interoperable clearing and open access.
“PIN as an MTF is not the most attractive option but MiFID had thrown up a number of variables that venue providers will need to consider,” said Semark. “PIN could theoretically continue under the OTF regime and still only be available for UBS clients, it simply wouldn’t be open to external flow.”
HFT proposals and minimum order sizes unclear
It is also unclear what MiFID II means for automated trading and high-frequency trading.
“Presently, the proposed rules do not delineate between the two activities and this will require further comment and definition before brokers know what they can and cannot do in their crossing networks and external venues,” said Semark.
For UBS, MiFID’s handling – or lack of handling – of order minimum sizes in dark venues is another area which is problematic. MiFID II has delegated the minimum size issue to ESMA and Semark said it was unclear whether or not minimums will be imposed at all.
“Rather than an arbitrary minimum size for everyone, it makes sense that the choice should be left to the broker and the client. To not do so could lead to a dramatic change in the dynamics of the industry,” said Semark. “If large minimum sizes are imposed, then small orders cannot benefit from price improvement.”
Often small orders result from the slicing up of larger parent orders to minimise risk against benchmarks. “Imposing a minimum order size at the child order level could lead to much more risk for the buy-side against benchmarks,” said Semark. “Minimum order sizes are not a good idea in MiFID and delegating it to ESMA – an agency with a lot on its plate and less than 100 staff – prolongs uncertainty.”