Europe’s Broker Crossing Networks Consider Future After MiFID II Ruling
Investment banks that run broker crossing networks in Europe are weighing up their options after the European parliament said that it wants to better regulate these privately-run internal crossing networks.
Last week, the European parliament voted overwhelmingly in favor of updating the Markets in Financial Instruments Directive, otherwise known as MiFID II. One of its provisions was to tighten up rules governing exchanges.
The original MiFID document in 2007 classified three types of exchange venue. The first governed regulated markets for existing exchanges, while a multilateral trading facility (MTF) category was created for venues that brought together buyers and sellers in a non-discretionary way and has been described as an ‘exchange-lite’. The third category was that of the little-used systematic internalizer whereby investment firms could match ‘buy’ and ‘sell’ orders from clients or against its own book in-house provided they conformed to certain criteria, including pre-trade transparency.
Privately-run crossing networks, which are run by broker-dealers and can encompass both client and proprietary flow, stayed out of the original three exchange classifications under the first MiFID rules back in 2007—much to the chagrin of more regulated exchanges—and have operated as over-the-counter ever since.
There were proposals on the table for a fourth category to be introduced in MiFID II, that of an organized trading facility which would have encompassed crossing networks, but the parliament has said that this new category will now only be used in derivatives and bonds.
The new MiFID II rules are aimed at better defining the three original categories and will force all trading platforms on to one of the three categories. For example, under the current MiFID II proposals, systematic internalizers will not now be allowed to match two client orders but can include proprietary flow.
“Our clients will continue to want the services we give them and this similar functionality will be delivered by systematic internalizers or MTFs, or a combination of both,” an executive at a European investment bank that runs a broker crossing network told Markets Media.
“We won’t have to fundamentally change our business model because of the new regulations. Some of the functionality will still be delivered, but whether it will be delivered in a coherent and well regulated fashion in the future I don’t know.
“We don’t want to be operating outside of the rules and creating grey areas. But we will probably be able to give our clients what they want but we will have to be more creative in linking things together to remain in the rules structure. This could be counter-productive for the regulator.
“The things that are easily identified now could become a mixture of different things in the future. Whereas previously you had this activity that was well recognized and potentially well regulated, you will potentially have it spread around the place.”
Broker crossing networks account for roughly 4% of all European volumes.
“A lot of people use these systems heavily and a lot of people like them,” said a senior London-based buy-side trader. “But it is only 4% of the market. So whether the regulators rule it out or leave it in, it’s still just 4% so we should put it in context and remember that.”
One group that is happy with the MiFID II progress in this area is the Federation of European Securities Exchanges (Fese), which lobbies on behalf of 46 of the region’s exchanges, including NYSE Euronext and Deutsche Börse.
“One of our concerns with the MiFID text was that the introduction of organized trading facilities in equities was going to further fragment and complicate the trading landscape,” Judith Hardt, secretary-general of Fese, told Markets Media.
“The fact that the parliament has deleted OTFs for equities is relatively positive for the market structure and transparency overall. We understand that there are some concerns about what will happen to the business that is currently being conducted in ECNs [electronic communication networks] but we’re optimistic that the final result will be better for long term investors.”
A number of investment banks in the European Union 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.
There is still some way to go in the political process in Brussels before MiFID II becomes binding. The parliament’s Economic and Monetary Affairs Committee (Econ) draft of MiFID II, which was last week passed overwhelmingly by Econ, will soon be voted on by all MEPs, although this is thought to be a mere formality. Then the Council of Ministers will table its own version, likely around the end of November, with input from the European Commission before the three institutions of Europe sit round a table and thrash out the final law, in a process called trialogue. Formal implementation is not expected until 2015.
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The analysis is based on transactions publicly reported by 30 European APAs and venues.
A similar service is available on the BIDS platform in the US equity market.