09.13.2012
By Terry Flanagan

Ferber Promises to Slow HFT Down and Banish Broker Crossing Networks with MiFID II

All high-frequency traders and broker-dealers should look away now.

Markus Ferber, the German center-right MEP tasked with guiding the revised Markets in Financial Instruments Directive (MiFID II) through the European parliament, today told Markets Media that new rules will be put in place to slow down high-frequency trading and that there will be no place for broker crossing networks in this post-MiFID II landscape.

Ferber, who is also a member of the Economics and Monetary Affairs Committee (Econ), said that Econ will be ready in two weeks to finally vote on MiFID II. Over 2,000 amendments postponed the original vote on MiFID II in July, which promises a huge shift in the way financial markets operate in Europe and will, according to Ferber, “close the loopholes” of the 2007 original.

“We are working on the amendments at the moment, as obviously we cannot vote on 2,145 amendments,” Ferber told Markets Media. “So there will be a compromise.”

Market participants are concerned that some of the proposed rules in MiFID II will bring about severe unintended consequences to Europe’s financial markets. However, Ferber was adamant that MiFID II would actually clean up a lot of the current ambiguities in European markets.

“The truth is MiFID II without consequences would not fulfill the obligations of why we have done MiFID II,” he said. “MiFID II is there to close loopholes, react on new developments and to close loopholes due to new technologies.”

Of particular interest to Ferber has been the rise of high-frequency trading since the original MiFID was enacted in 2007. The German MEP wants to stamp out much of what he sees as the predatory practices of HFT.

Ferber has previously called for the introduction of a minimum resting time for orders to remain valid on an exchange for at least 500 milliseconds as well as penalties for excessive order cancellations. And HFT firms that deal on their own account may also, in effect, be forced to become market makers and provide continuous liquidity to the market. Many in the HFT community feel that if these proposals were adopted it would all but kill off the practice.

“There will be no ban on high-frequency trading, but there will be rules on high-frequency trading,” said Ferber.

When asked which proposals may become more concrete, Ferber said that minimum resting periods, order-to-trade ratios, fee structures, circuit breakers and the testing of algorithms were all “nice ideas”.

“There will be a package of measurements out of these possibilities,” said Ferber.

Ferber, too, was dismissive of broker crossing networks. They currently operate outside of regulation to monitor trading venues as set out under the original MiFID document.

The three current categories of trading venue are either a regulated market for the existing exchanges, a multilateral trading facility (MTF) for venues that bring together buyers and sellers in a non-discretionary way and have been described as a form of ‘exchange lite’, and the little-used systematic internalizer, which is used for firms that execute orders from clients against its own book or against orders from other clients.

A fourth venue, an organized trading facility (OTF), has been proposed under MiFID II to capture broker crossing networks but the regulated exchanges are strongly opposed to this new less-regulated OTF category as they believe that it will lead to a less level playing field.

“Broker crossing networks should be replaced by one of the four possibilities—regulated market, MTF, OTF or systematic internalizer,” said Ferber. “Systematic internalizer does not fit [for broker crossing networks] but the three others are a possibility as we don’t want to have broker crossing networks in the future.”

Crossing networks, which are run by broker-dealers and do not show an order book and simply aim to match orders, were not categorized under the original three exchange classifications under the original MiFID rules back in 2007 and have operated as over-the-counter ever since. Some broker crossing systems match only client orders, while others also provide matching between client orders and house orders.

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 broker-dealers are already looking at establishing new internal trading venues that will allow them to operate within the new rules as they have assumed for a while that MiFID II would force them to adapt their business models.

Ferber says that other contentious MiFID II issues on position limits on commodities trading, consumer protection and third country regime have still to be decided on but “we are moving quite well therefore and I think in two weeks’ time we can vote in the committee”.

MiFID II still needs to be agreed on by the European parliament and the Council of the European Union and, after that, level two technical standards will need to be written by the European Securities and Markets Authority, the pan-European regulator, before MiFID II will likely come into force some time in 2015.

Although in two weeks’ time, European financial markets may have a much clearer idea as to what the lay of the land will look like if the European parliament can finally agree on MiFID II.

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