Europe Seeks Clarity On Broker Crossing Networks

Terry Flanagan

Europe’s investment banks and exchanges continue to fight their corner over the future of broker crossing networks.

The latest proposals from the European parliament’s Economic and Monetary Affairs Committee suggest that broker crossing networks, which are undefined under the original 2007 Markets in Financial Instruments Directive (MiFID) and currently operate over-the-counter, may be forced to operate under the banner of multilateral trading facilities (MTFs) or, more likely, systematic internalizers.

“The possible reclassifying of broker crossing networks as systematic internalizers is a very important change,” Per Loven, head of international corporate strategy at Liquidnet Europe, a buy-side focused block trading broker that operates one of the world’s largest dark pools as a multilateral trading facility, told Markets Media.

“Market participants would like to know what the proposed changes to systematic internalizers are likely to be as the [European parliament] wording is quite unclear.”

A review of MiFID, which is being split into a directive and a regulation (MiFIR), is currently snaking its way through the European Union’s legislature and is looking to remedy issues not included in the first document, as well as re-assert laws in the original directive.

Reclassifying a broker crossing network as an MTF, which was introduced under MiFID and has similar rules to that of a regulated exchange, would mean broker crossing networks losing their ability to decide who can access their venue and how trades are matched, as well as being forced to operate under greater pre-trade transparency rules, such as publishing prices unless obtaining a large in size waiver or price referencing waiver to operate as a dark pool.

The third type of trading venue originally introduced by MiFID, a systematic internalizer, never really took off but it seems that regulators now want to re-establish it. It was defined as an investment bank making markets outside a regulated exchange or MTF. Most broker-dealers, however, continue to trade OTC through less regulated internal crossing networks, which encompassed both client and proprietary flow. Under MiFID II proposals, systematic internalizers will not be able to match two client orders but can include proprietary flow. Published quotes may also be required.

“Broker crossing systems are currently very well regulated with best execution, client order handling and conduct of business obligations,” Andrew Morgan, head of Autobahn Equity Europe, the electronic trading arm of Deutsche Bank, told Markets Media. “Regulators are looking at broker crossing systems under MiFID II, however, and have identified what they call OTFs [organized trading facilities] as being a new trading venue definition to capture the activity in broker crossing networks.

When the European Commission published its MiFID II legislative proposals in October last year a new trading venue definition, known as an OTF, was added to the mix aimed at better regulating broker crossing networks but intense lobbying by exchanges in Brussels and Strasbourg may be causing a U-turn on the matter.

“Exchanges are critical of the OTF proposals because brokers running these multilateral venues would be able to avoid some of these rules, in particular the non-discretionary execution,” said Judith Hardt, secretary-general of the Federation of European Securities Exchanges (Fese), which lobbies on behalf of 46 of the region’s exchanges. “This would allow bank crossing networks to offer better outcomes to some of their clients. This will be one of the major fights in the European parliament in the coming months.”

Fese says plans to introduce a new regulatory definition for an exchange to sit alongside regulated markets and multilateral trading facilities would distort the playing field in favor of the investment banks.

Markus Ferber, a German member of the European parliament who is responsible for guiding the revised version of MiFID through to the next stage of approval in Europe, has said repeatedly that broker crossing networks should fit into existing classifications.

“Your rapporteur questions whether the creation of a new category is the right way to capture organized venues which are not caught by the already existing categories,” wrote Ferber in a statement accompanying the recent Economic and Monetary Affairs Committee amendments to MiFID II.

A number of investment banks in the EU operate broker crossing systems that match client order flow internally such as Citigroup, Credit Suisse, Deutsche Bank, JP Morgan, Morgan Stanley and UBS.

Generally, these firms receive orders electronically, utilize algorithms to determine how they should best be executed, given a client‘s objectives, and then pass the business through an internal system that attempts to find matches. Some systems match only client orders, while others also provide matching between client orders and house orders. Broker crossing networks do not show an order book and simply aim to match orders; due this nature they are sometimes compared to dark pools.

The new MiFID proposals are likely to force the banks to change their business models and some are already looking at establishing new internal trading venues that allow them to operate within the rules.

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