Role of OTFs Questioned in MiFID Deliberations

Terry Flanagan

The establishment of organized trading facilities is among the more contentious issues being debated as lawmakers go about updating the Markets in Financial Instruments Directive (MiFID II).

At a meeting last week of the European Parliament’s Economic and Monetary Affairs Committee, Markus Ferber, a legislator who is steering MiFID II through parliament, noted that the situation in financial markets has changed due to technical progress, complex new trading strategies and the arrival of new market participants.

“There are gaps that have to be closed, because unregulated activities must not take place,” said Ferber.

MiFID II and European Market Infrastructure Regulation (Emir) are being developed at the same time as the U.S. and other G20 members implement similar legislation, creating potential regulatory loopholes or gaps.

“With greater integration of markets is also coming greater integration and homogeneity of regulatory standards,” Brian Sentance, chief executive of analytic and data provider Xenomorph, told Markets Media. “So while new geographies are opening up, the regulators want to establish level playing fields for all involved.”

Under MIFID II, over-the-counter derivatives could now 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 and single-dealer platforms for trading OTC derivatives.

“Reforms such as Dodd-Frank, Emir and MiFID II demand a greater level of transparency in the trade lifecycle, as well as impose more stringent regulator reporting requirements,” David Kubersky, managing director at investment management software provider SimCorp North America, told Markets Media.

OTF operators under MiFID II may not be able to 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 an 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, such as exchanges, and MTFs.

“It will be critical to ensure a true level playing field between the OTF and other multilateral trading venues, notably in maintaining the prohibition of trading on own account by the OTF operator, while removing its ability to perform discretionary execution,” according to a paper released by NYSE Euronext on the MiFID II proposals.

The OTF venue that was proposed by the European Commission received a mixed welcome by the ECON committee.

Jürgen Klute, a German member of the European parliament, argued that no such platform was needed, whereas the United Kingdom’s Kay Swinbourne said that the facilities should provide a regulated space for OTC transactions as well as for bespoke derivative contracts. Ferber said that the OTF should be reserved for non-equities such as corporate bonds or derivatives, to bring them within the scope of MiFID.

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.

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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