MiFID II May Roil Algo Trading

Terry Flanagan

Juan Pablo Urrutia, European General Counsel at broker ITG warned that new European trading rules may cause mayhem in algorithmic trading and caps dark pool trading could be difficult to implement.

This week European lawmakers agreed revisions to the Markets in Financial Instruments Directive governing trading in the region. The agreement on the primary legislative, or level 1, texts has taken more than two years and there are likely to be nearly 90 secondary, or level 2, measures.

Algorithmic Trading

Commissioner Michel Barnier said in a statement that MiFID II will ensure legislation keeps pace with technology as dramatic increases in speed and volume of orders can pose systemic risks.

Urrutia told Markets Media there is latitude in the Level 1 texts to treat the disclosure of algos as having information that is equivalent to a client brochure. However Level 2 could give regulators the option to require the release of source codes to the authorities. “We question how well prepared regulators are to safeguard this highly sensitive commercial information,” he added.

It is also possible that Level II could give regulators the option to require that firms obtain their consent for the operation of algos, rather than just a disclosure obligation.

“From an operational perspective, this would be impossible and cause mayhem,” said Urrutia.”There is also the question of what is a new algo as they exist to protect our clients from the market and so have to continually evolve.”

Baringa Partners, a consultancy, said that MiFID II will require firms to implement controls to halt trading in the case of high price fluctuations, to test all algorithms on venues and to put in controls around direct market access.

James Nicholls, director of risk and compliance at Baringa Partners, said: “The high cost of these controls may make provision of direct market access  not viable for some firms.

Dark Pool Caps

Last year the European Council agreed to impose a cap of 8% on the total consolidated amount traded in any stock during a trading day in dark pools and 4% of total trading per stock on a single dark venue and both of these caps are in MiFID II. However trading volumes across the region are difficult to measure as there is no consolidated tape.

“The exchanges have sole rights to market data and for a commercial solution to work they would have to be happy to give away data at a reduced price or for free,” added Urrutia. “MiFID II provides no agreement on who will provide the consolidated tape and it could take years to come up with a solution.”

In 2012 the COBA Project, an independent initiative was set up to establish a consolidated tape for European equities but was forced to close in March last year.

In addition the European Securities and Markets Authority may find it difficult to define a measure for trading volumes.

“Esma has to devise a measurement for the caps that does not discriminate against any member state,” said Urrutia. “A member state, such as the UK, could refuse to implement these rules if it considered that they were calibrated in a discriminatory manner and may then choose to take the case to the European Court of Justice.”

Anne Plested, head of Fidessa’s regulation change programme, said in an email: “It’s not yet clear what the new MiFID II market structure framework will introduce for investment firms operating internal matching systems or if the holy grail of a level playing field can be achieved. Without the detailed text it’s impossible to pre-judge the impact.”

Access to Clearing 

MiFID II had been expected to mandate open access to clearing.

Rebecca Healey, senior analyst at consultancy Tabb Group, said: “While open access won the day – it is a day some way off , provisions to allow access to trading and clearing exchange-traded derivatives can be deferred by exchanges operating vertical silos for up to five years if approved by their national authority.”

Tabb Group,as part of a collaborative group with the Centre for European Policy Studies and Insead OEE Data Services is starting a market impact assessment of MiFID II for ESMA, which is expected to last two years.

Urrutia said: “My biggest regret is that the European Parliament, Commission and Council missed the opportunity to push free markets more aggressively through open access to clearing and market data not just at reasonable rates but, demanding stronger safeguards, systems and controls to ensure the data is in fact provided at a reasonable cost.”

Magnus Billing, president of Nasdaq OMX Stockholm, said in an email: “With regards to market data we think the emphasis on quality, reliability and format is the right way to proceed.”

Urrutia expects MIFID III as there is unfinished work on the central trading and the central clearing of derivatives.

“In relation to some commercial interests, MiFID II may be described as the equivalent of an episode of The Sopranos where some people looked to settle scores left open in the current MiFID, while MiFID III may end up looking like an episode of The Borgias,” he added.

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