MiFID Muddle

Terry Flanagan

Organized trading facility (OTF) category should be abolished, exchanges say.

Operators of exchanges and multilateral trading facilities are objecting to provisions in the review of Markets in Financial Instruments Directive that relates to trading that takes place on broker crossing networks and dark pools.

They’re insisting that operators of off-exchange trading venues provide non-discriminatory execution and access for all instruments, including OTC derivative transactions.

Under MIFID II, OTC derivatives can be traded on regulated markets, MTFs, or on a new category of trading venue: organized trading facilities (OTFs).

OTFs would include both bilateral and multilateral systems, capturing all types of organized execution and trading arrangements not captured by regulated markets or MTFs, including broker crossing networks (BCNs) and single-dealer platforms for trading OTC derivatives.

“We do not believe that the OTF category is appropriately defined; indeed, the purpose of the OTF category is unclear to us,” Jim Rucker, credit and risk officer at MarketAxess, told Markets Media. “We believe that the transparency, organisational and market surveillance arrangements applying to MTFs and OTFs should be identical wherever possible.”

In the Unites States, standardized derivatives will only be able to trade on an exchange or a swap execution facility (SEF).  Although in the U.S. it does not appear that the SEF definition will allow for single dealer venues, such venues could be permitted under MiFID II.

Exchanges say that OTFs should not be permitted to trade standardized or vanilla OTC derivatives such as interest rate and credit derivatives, and that trading in such products on regulated markets or MTFs should be made mandatory.

OTF operators under MiFID may not execute any transactions against their own capital [as systematic internalizers] but will have discretion over how a transaction will be executed and may restrict access to clients with whom they don’t want to trade.

That’s anathema for exchanges, who say that operators of dark pools and crossing networks should be subject to the same open execution and access standards as regulated markets (i.e., exchanges) and MTFs.

The Federation of European Securities Exchanges (FESE) said that the OTF category should be abolished.

“We believe that the existing MiFID equity venue classification is already sufficiently exhaustive to capture most types of BCN activity, which should fall under either the MTF or SI categories,” FESE said in a position paper. “Therefore, MiFID does not need to be revised in any fundamental way to ‘capture’ BCNs.”

In November 2011, the European Parliament launched a consultation on Markets in Financial Instruments Directive/Regulation (MiFID/MiFIR), or MiFID II, one month after the legislation was unveiled by the European Commission.

MiFIR sets out requirements on disclosure of data on trading activity to the public, mandatory trading of derivatives on organized venues, and removing barriers between trading venues and providers of clearing services to promote competition.

The decision to place some elements of MiFID in a directive and others in a regulation (MiFIR) reflects the need to achieve a uniform set of rules in some areas, while allowing for national specificities in others.

As a regulation, MiFIR will have the force of law, and will not require transposition into law by Member States. Such a harmonized approach will help avoid confusion in the daily functioning of markets, and minimize opportunities for regulatory arbitrage between Member States.

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