2 April 2012 | Volume 3 | Issue 7
The Blotter presents ITG’s insights on complex global market structure, technology, and policy issues.
Contributors Juan Pablo Urrutia Director, General Counsel in EMEA Juan-Pablo.Urrutia@itg.com +44 (0) 207670423
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MiFID II: Official Publication of European Parliament Report The first installment of a long-awaited report reveals that Broker Crossing Systems could go the way of the dinosaurs, while dark MTFs could be preserved in a tight, but politically unbiased, market structure environment.
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Markus Ferber, chief draftsman (or Rapporteur in Brussels speak) of the European Parliament’s position on the Markets in Financial Instruments Directive (MiFID) review, published the first of the two reports on the European Parliament’s opening negotiation position on the European Commission’s MiFID proposals (the Ferber Proposals). (We await the second, a report on the amendments to MiFID that could force buy-side clients to make markets on a continuous basis if they want to use algorithmic trading strategies.)
on those proposals (which will crucially shape European market structure). The Ferber Proposals suggest that the European Parliament is now set to prohibit the operation of broker crossing systems by investment banks, but will leave decisions on whether to impose minimum order size thresholds for dark trading to secondary legislation – a more technical, less politically charged environment for policymaking.
We commented last week on a leaked version of the Ferber Proposals. As the published Ferber Proposals are substantively and materially the same as the leaked draft on which we commented last week, we have not amended any of the following views
The Ferber Proposals main focus on market structure issues is to close all loopholes that have allowed investment banks to trade on an OTC basis (i.e. outside the organizational requirements of a primary exchange or a Multilateral Trading Facility
Broker Crossing Systems
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(MTF)), despite the fact that these trades are always executed in a systematic and multi-lateral basis. Herr Ferber proposes to: a) delete the Organised Trading Facitility (OTF) category from the European Commission’s proposals for equities (but not for non-equities, echoing Deutsche Borse’s calls); b) reduce OTC trading to primary issuances (what happens with secondary issuances? with the (very important) CFD give-up process? or, other large non-price forming trades?); and, c) sweep any remaining OTC trading effected by large investment banks into the “Systematic Internaliser” (SI) category by forcing even infrequent trades to be executed in that category. Today, SI includes the bilateral, systematic trading of natural client order flow against the investment bank’s own proprietary capital. In our November 2011 article on MiFID, we discussed how the European Commission’s OTF proposals could have wide, fundamental impact across the whole of the European market structure. Based on the Ferber Proposals, we no longer need to speculate if that will happen, at least for the equities space. We now only need to consider whether the liquidity in broker crossing systems will shift to MTFs, SIs or—as incumbent exchanges would prefer–to the primary exchanges. Both the MTF and the SI route would allow investment banks to continue to cross internalized client order flow against proprietary capital. This means that despite the primary exchanges heavy lobbying campaign to revert to the pre-MiFID bias in favour of concentration of liquidity in the incumbent exchanges, we are likely to see liquidity shifts only towards the MTFs and/ or the SIs. The decision to operate an SI or an MTF is likely to be conditioned, at least in part, by the calibration of not just the MTF rules that allow for dark trading, but also changes to the
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‘standard market size’ threshold, above which SI operators will be exempted from an obligation to pubish quotes . An open question is how the European Commission will define ‘standard market size’ – tweaks to this definition could substantively impact an investment bank’s decision on whether to operate an SI or an MTF. Dark Trading in MTFs The Ferber Proposals suggest that the European Parliament will accede to the European Commission’s view that any decision to impose a minimum order size threshold on certain dark trading in MTFs should be considered at the ‘technical level’ by way of secondary legislation. (Known in Brussels as ‘delegated acts,’ because neither the European Parliament nor the European Council vote on such subsequent delegated acts). Markets would welcome this decision, because primary legislative policymaking is notoriously politically charged, and markets have learned from prior attempts to consider similar rules (e.g. in Canada) that any such rule needs to be carefully calibrated to be dynamically responsive to market trends and to avoid a one-size-fits-all solution. In addition, the Ferber Proposals mandate the European Commission to carry out public consultations, as well expert reviews of any ‘delegated act’ proposal. Again, markets will welcome this decision. In particular, the buy-side will be in position to continue to inform the process and make its views known on the importance of the existing dark trading rules to their order execution strategies. Finally, as we mentioned in our November 2011 article on MiFID, the European Commission considered various policy options and concluded that abolishing the existing dark trading rules would cause “substantial damage to market liquidity”. We may cautiously deduce from the Ferber Proposals, as well as
THE BLOTTER | 2 April 2012 | Volume 3 | Issue 7
the European Commission’s previous analysis, that the existing dark trading rules will remain firmly in place. Policymakers will be focused on calibrating the existing rules, with eyes fixed on the impact to liquidity that any such calibration could cause. Next Steps The Ferber Proposals will now be presented to the European
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Parliament for debate before a common view is formed. The debate in the European Parliament could take a number of months, making it unlikely that the European Parliament will be in a position to begin negotiating the agreed Ferber Proposals with the European Commission and European Council before the fourth quarter, at the earliest. Stay tuned.
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