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MiFID II/MiFIR series
Trading venues and market infrastructure
Briefing
Introduction
March 2014
The Markets in Financial Instruments Directive (MiFID) is one of the
cornerstones of EU financial services law setting out which investment
services and activities should be licensed across the EU and the
organisational and conduct standards that those providing such services
should comply with.
Following technical advice received from the European Securities and
Markets Authority (ESMA) and a public consultation, in 2011 the European
Commission published legislative proposals to amend MiFID by recasting it
as a new Directive (MiFID II1) and a new Regulation (MiFIR2). The European
Parliament and the Council of the EU (the Council) have been debating the
text since then, taking into account the efforts of the financial services and
wider industry to influence the direction of certain provisions. Following
informal agreement between the EU institutions, in February 2014 the
Council published the final compromise texts of MiFID II and MiFIR
and these were subsequently approved by the Permanent Committee of
Representatives. These texts, on which this briefing is based, must now be
approved by the European Parliament to enable the Council to adopt them.
The European Parliament is expected to consider MiFID II and MiFIR during
its March 10_13, 2014 plenary session.
The deadline for implementation of MiFID II by Member States and the
time at which the provisions in MiFIR will start to apply are not yet known
although they are not expected to be until the end of 2015 at the earliest.
ESMA and the other European authorities need to develop the numerous
technical standards intended to flesh out some of the requirements in more
detail before that time. ESMA has indicated that a discussion paper on the
1 Directive on Markets in Financial Instruments repealing Directive 2004/39/EC and amending Directive 2011/61/EU
and Directive 2002/92/EC.
2 Regulation on Markets in Financial Instruments and amending Regulation 648/2012.
MiFID II/MiFIR series
technical standards will be published shortly after the European Parliament approves the
final texts. Following the responses to the discussion paper, ESMA will publish a consultation
paper on draft technical standards later in 2014 or early in 2015.
Organised trading facilities
Definition
MiFID II and MiFIR introduce a new category of trading venue, the organised trading facility
(OTF). Alongside regulated markets (RMs) and multilateral trading facilities (MTFs), this
will be a third type of multilateral system in which multiple buying and selling interests can
interact in a way that results in contracts. However, unlike RMs and MTFs, an OTF will only
relate to bonds, structured finance products, emission allowances or derivatives. Operating
an OTF will be an investment service so a person wishing to do so will need to be licensed as
an investment firm (IF). The operator of a RM will also be able to operate an OTF.
The main distinguishing factor between RMs and MTFs on the one hand and OTFs on the
other is that the execution of orders on an OTF is carried out on a discretionary basis. There
are two different levels of discretion for the operator of an OTF: (i) when deciding to place or
retract an order on the OTF, and (ii) when deciding not to match a specific client order with
other order available in the system at a given time, provided it is in compliance with specific
instructions received from a client and best execution obligations. The operator of an OTF
that crosses clients’ orders may decide if, when and how much of two or more orders it wants
to match within its system. The operator of an OTF that arranges transactions in non-equities
may facilitate negotiation between clients so as to bring together two or more potentially
compatible trading interests. As a result of this discretion, the operator of an OTF will owe
certain conduct of business duties to its clients including acting in accordance with their
best interests, appropriateness, best execution and order handling. Please see our briefing on
conduct of business requirements for more information on these subjects.
The concept of OTF does not include facilities where there is no genuine trade execution or
arranging taking place in the system, such as bulletin boards, aggregation engines, electronic
post-trade confirmation or portfolio compression arrangements.
Restrictions on an OTF operator’s business
As with RMs and MTFs, the operator of an OTF will not be permitted to trade against its
proprietary capital. However, while this ban also applies to the capital of any entity that is
part of the OTF operator’s corporate group, the OTF operator benefits from an exception with
regard to sovereign debt instruments for which there is no liquid market. Unlike the operator
of a RM or MTF, the OTF operator is also permitted to engage in matched principal trading in
bonds, structured finance products, emission allowances and derivatives that are not subject
to the clearing obligation pursuant to EMIR3 provided the client consents to the process.
The operator of an OTF will not be permitted to be a systematic internaliser (SI), nor to
connect with an SI in a way which enables orders in the OTF and orders or quotes in the SI to
interact. An OTF will also not be permitted to connect with another OTF to enable interaction
of orders between the two systems. It will be permissible for an OTF to engage market makers
but any such IFs must not have close links with the OTF operator.
3 Regulation (EU) No 648/2012 on OTC Derivatives, Central Counterparties and Trade Repositories.
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Trading venues and market infrastructure
Level playing field and new requirements for RMs and MTFs
Level playing field
One of the aims of MiFID II and MiFIR is to ensure that functionally similar activities are
subject to a level playing field of regulation. The requirements that apply to the operators of
RMs, MTFs and OTFs (trading venues) are therefore quite similar. Most of the organisational
requirements that already apply to RMs and MTFs have been extended to OTFs. For example,
they must all have transparent rules and procedures for fair and orderly trading and objective
criteria for the efficient execution of orders, as well as transparent rules for determining
which instruments can be traded and transparent, non-discriminatory and objective
membership criteria. There are also new requirements relating to fee structures, which must
be transparent, fair and non-discriminatory, and not create incentives that contribute to
disorderly trading or market abuse.
Market surveillance
All types of trading venue will be subject to enhanced and identical surveillance
requirements with monitoring for compliance with their rules and monitoring of orders,
cancellations and transactions undertaken in order to identify breaches, disorderly trading
and market abuse. They will have to inform their competent authority of any such concerns.
If a trading venue suspends or removes an instrument and any related derivatives from
trading due to suspected market abuse or on request of a competent authority, other trading
venues will be required to do the same, except where this could cause significant damage to
investors’ interests or the orderly functioning of the market.
Functionality
MiFID II and MiFIR aim to catch up with certain technological developments that outpaced
MiFID. All trading venues will be required to have in place effective systems, procedures and
arrangements to ensure their systems are resilient and have sufficient capacity to ensure
orderly trading under severe stress, and have effective business continuity arrangements.
There are also numerous requirements as to functionality, many of which will be further
detailed in regulatory technical standards, including the ability to reject orders that
exceed thresholds or are erroneous, halt or constrain orders and cancel, vary and correct
transactions. There are also requirements as to tick sizes for certain instruments and
synchronisation of business clocks.
Algorithmic trading, market making and direct electronic access
Both trading platforms and IFs face greater regulation in relation to algorithmic trading,
market making and direct electronic access, with a number of new requirements relating to
both functionality of systems used and formalising the relationship between trading venues
and users. For more information, please see our briefing on these subjects.
Transparency and transaction reporting
The new transparency and transaction reporting obligations in MiFIR apply to all three types
of trading venue, albeit calibrated for different types of instrument and different types of
trading, and to IFs when trading financial instruments admitted to trading on a RM or traded
on a MTF or OTF. The transaction reporting requirements will also be extended to financial
instruments traded on an OTF or whose value depends on such an instrument. For more
information, please see our briefing on these subjects.
Norton Rose Fulbright – March 2014 03
MiFID II/MiFIR series
Trading obligations
Derivatives
MiFIR will implement the G20 commitment that was not included in EMIR, to mandate
the trading of standardised derivatives on exchanges and electronic platforms by requiring
certain derivatives to be traded on a RM, MTF or OTF or certain trading venues in third
countries that have been considered equivalent for that purpose and reciprocate by
recognising EU trading venues. The obligation departs from the normal scope of MiFID II
and MiFIR and applies to financial and non-financial counterparties that are subject to the
clearing obligation in EMIR, as well as third country entities that would be subject to it if they
were established in the EU and either trade with in-scope EU entities or other third country
entities where their transactions could have a direct, substantial and foreseeable effect
within the EU or it is appropriate to prevent evasion of MiFIR.
Regulatory technical standards will be developed to determine which derivatives will be
subject to this trading obligation. It appears that the starting point will be those derivatives
that are mandated for clearing under EMIR. However, to be mandated for trading, the
derivatives must also be traded on at least one trading venue and be considered to be
sufficiently liquid, taking into account the average frequency and size of trades over a range
of market conditions, the number and type of active market participants and the average size
of spreads. ESMA must also consider the likely impact of listing a derivative on its liquidity
and the commercial activity of end users, and may determine that a particular derivative
is only sufficiently liquid in transactions below a certain size. However, ESMA also has an
own initiative power to identify classes of derivatives that should be subject to the trading
obligation but which no central counterparty (CCP) has been authorised to clear or which are
not admitted to trading on a trading venue.
Shares and equity like instruments
IFs will be required to trade shares that are admitted to trading on a RM or traded on a
trading venue shall take place on a RM, MTF or SI or a third country trading venue that has
been assessed as equivalent for these purposes. The obligation does not apply to trades that
are non-systematic, ad hoc, irregular and infrequent, or are carried out between eligible and/
or professional counterparties and do not contribute to the price discovery process (a test
which will be fleshed out in regulatory technical standards).
An IF that operates an internal matching system which executes client orders in shares,
depositary receipts, exchange traded funds, certificates and other similar financial
instruments on a multilateral basis must be licensed to operate an MTF.
Extension of SI regime
The SI regime and obligation to publish firm quotes that was previously only applicable to
shares has been extended to depository receipts, exchange traded funds, certificates and
other similar financial instruments traded on a trading venue for which there is a liquid
market. If there is no liquid market, an SI need only provide a quote on the request of a
client. There are also some changes to the detailed requirements applicable to SIs in these
instruments which are further discussed in our briefing on transparency and transaction
reporting. MiFIR will also introduce a new regime, under which SIs will have to make public
quotes in respect of bonds, structured finance products, emission allowances and derivatives
04 Norton Rose Fulbright – March 2014
Trading venues and market infrastructure
for which there is a liquid market, but only if the SI is prompted for a quote by a client and
the SI agrees to provide a quote. Again, more information on the detailed requirements is in
our briefing on transparency and transaction reporting.
The definition of an SI has been updated to reflect the introduction of OTFs, as well as to
provide that a SI is an IF that deals on own account on a substantial, as well as an organised,
frequent and systematic basis. The terms frequency and substance have been clarified such
that frequency is to be measured by the number of OTC trades in the financial instrument
carried out by the SI on own account by executing client orders and substance is to be
measured either by the size of the trading outside trading venues carried out by the SI
in relation to the total trading of the SI in a specific financial instrument or by the size of
the OTC trading carried out by the SI in relation to the total trading in the EU in a specific
financial instrument. There is also a possibility for an IF to opt into the SI regime.
Access between trading venues and CCPs
Within the EU
CCPs are required to clear financial instruments on a non-discriminatory and transparent
basis regardless of the trading venue on which a transaction is executed, although the CCP
may require the trading venue to meet operational and technical requirements. The CCP may
only grant access if a relevant competent authority considers that this would not threaten
the smooth and orderly functioning of the markets or, in certain cases relating to derivatives,
where it would not require an interoperability arrangement. The CCP can only deny access
under certain conditions to be defined in regulatory technical standards, but which will
include the anticipated volume of transactions, the number and type of users, arrangements
for managing operational risk and complexity and other factors creating significant risk.
On a similar basis, a trading venue must, on request, provide trade feeds on a nondiscriminatory and transparent basis to a CCP that wishes to clear transactions that are
concluded on that trading venue.
There are also requirements on persons with proprietary rights in benchmarks to ensure
that CCPs and trading venues are permitted access to relevant price and data feeds and
information on composition, methodology and pricing for the purposes of clearing and
trading and licences on a fair, reasonable and non-discriminatory basis. Access must be
given on a reasonable commercial basis and taking into account the price at which access is
granted on equivalent terms to other CCPs and trading venues. Different prices can only be
charged where objectively justifiable.
These provisions reflect similar provisions relating to OTC derivatives in EMIR.
Third countries
Non-EU trading venues that are recognised for the purposes of the derivatives trading
obligation and non-EU CCPs that are recognised as such under EMIR are permitted to make
use of these access rights if the Commission has concluded that the relevant third country
provides reciprocal access to its trading and clearing infrastructure to foreign trading venues
and CCPs. There is a similar reciprocity requirement for third country trading venues and
CCPs wishing to request a licence and access rights to a benchmark on the same terms as
EU infrastructure.
Norton Rose Fulbright – March 2014 05
MiFID II/MiFIR series
MiFID II and MiFIR will introduce new requirements for firms wishing to carry on investment
activities with and provide investment services to clients in the EU. In most cases, these
will require third country entities to establish a branch and become licensed in the relevant
Member States for business with retail and elective professional clients or to register with
ESMA for business with per se professional clients and eligible counterparties. This regime is
discussed in more detail in our briefing on the subject.
06 Norton Rose Fulbright – March 2014
Trading venues and market infrastructure
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Norton Rose Fulbright – March 2014 07
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