11.28.2011
By Terry Flanagan

Regulators Seek To Mollify MIFID II Critics

European Commission softens stance on HFTs and proprietary trading.

Regulators are seeking to clarify portions of the new MiFID II that deal with high-frequency and algorithmic trading, as well as proprietary trading.

The directive, which was released in draft form by the European Commission in October, contains language that restricts HFT and prop trading.

In particular, it imposes market-making obligations on firms that employ high-frequency or algorithmic trading strategies, and prohibits operators of broker crossing networks from trading for their own account against order flow on those networks.

Valérie Ledure, senior policy officer, Securities Markets, in the European Commission’s Directorate-General of Internal Market and Services, said at a conference in London last week that the MiFID draft doesn’t exclude proprietary trading per se, but only excludes them from trading against order flow in their crossing networks, to be designated as organized trading facilities, (OTFs) under the new regime.

“We are banning prop trading because we want venues to be neutral. This doesn’t mean banks cannot prop trade. Just not in their own entity where clients are trading,” said Ledure, according to published reports. “[Banks] can go to another venue to prop trade.”

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 systems and single-dealer platforms for trading OTC derivatives.

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.

“Banks are able to operate both an OTF and a systemic internalizer,” said Ledure. “They are also allowed to have an SI and an OTF in the same instruments, but they cannot trade that instrument on their own [crossing network].”

As for the restriction on HFT and algo trading, the European Commission appears to be back-pedaling on the controversial language. “We want to address market integrity issues and safeguard investors,” Ledure said. “We have tried to explain clearly what type of HFT is abuse and we want to know which algorithms are behind it.”

The directive requires that “an algorithmic trading strategy shall be in continuous operation during the trading hours of the trading venue to which it sends orders or through the systems of which it executes transactions. The trading parameters or limits of an algorithmic trading strategy shall ensure that the strategy posts firm quotes at competitive prices with the result of providing liquidity on a regular and ongoing basis to these trading venues at all times, regardless of prevailing market conditions.”

“The liquidity provision has been highly controversial,” said Ledure. “We phrased it very broadly. Personally, I am open to improving this provision.”

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 result, 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.

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.

MiFID, the directive, amends requirements for providers of investment services, and rules regarding investor protection. Also included in the directive are rules applicable to different types of trading venue, providers of market data, and powers to be granted by Member States to competent national authorities.

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