FIA EPTA welcomes the opportunity to provide input to ESMA on their draft Regulatory Technical Standards (RTS) on Level 2 of MiFID II / MiFIR.
Due to the vast scope of this project, FIA EPTA has focused its response on questions relating to Microstructural Issues and algorithmic / high-frequency trading. FIA EPTA drafted this response together with FIA affiliates FIA Europe and FIA Americas (hereafter the “FIA Associations”) following a period of extensive dialogue with members from each of these associations. As such, the FIA Associations collaborative response represents a consensus view across a variety of stakeholders, including principal trading firms, banks, general clearing members, ISVs, and trading venues on topics impacting market microstructure and automated trading.
Please note: FIA EPTA did not submit a response on other MiFID II / MiFIR topics such as transparency, indirect clearing, commodities, non-discriminatory access to trading venues, CCPs and benchmarks. Responses by other FIA affiliate associations may not reflect FIA EPTA’s views on such subjects.
In particular, we would like to highlight the following points with regard to ESMA’s proposals:
Key points from our response to the recent RTS from ESMA on MiFID II:
Organisational Requirements for Investment Firms
The FIA Associations are concerned that the costs of very prescriptive, cumulative, and incremental compliance and governance obligations set out in the draft RTS will hit small/medium firms hard, leading to a contraction in the number of market participants. A contraction in the number of market participants would disturb the ecosystem in the markets and ultimately reduce an important source of ancillary liquidity. For example, to require all investment firms to conduct annual stress testing is disproportionate. Further, ESMA’s approach to business continuity arrangements seems to be based on the leading principle that firms must resume trading as quickly as possible after a disruption (as opposed to only mitigating the impact of any potential disruption, and managing positions or winding down in a controlled manner). We believe this is neither appropriate nor proportionate and advocate preserving certain firms’ “right to fail.” With respect to algorithm testing, we believe non-live testing requirements should apply to investment firms, not trading venues, as this would be more effective, cost-efficient and avoid a tick-the-box approach to compliance. Finally, we strongly disagree with any requirements dictating the content of commercial agreements between investment firms and their vendors – the key is to ensure that investment firms are ultimately liable for compliance with their obligations and they must ensure that if they outsource, they remain in compliance with their regulatory obligations.
The FIA Associations believe the following points in the market making provisions require calibration:
- The minimum presence threshold at which an investment firm should be deemed to be pursuing a market making strategy should be in line with the minimum presence threshold at which it would be obliged to quote under a market making strategy, i.e. 50% (not a 30% threshold followed by 50% quoting requirement, as proposed by ESMA). This is because market making is a business model that requires significant product knowledge, risk management expertise, and sophisticated technology to conduct in a prudent manner; therefore the regulation should avoid capturing investment firms that do not intend to operate as a market maker. There are two potential risks in capturing these firms under the category of professional market makers:
(i) such investment firms could introduce additional risk to the market and/or contribute to disorderly trading, as they lack the experience or capacity to handle a continuous quoting obligation; and
(ii) many firms will attempt to avoid this consequence by abandoning current passive strategies, which would result in the loss of an important source of ancillary liquidity in European markets. If an investment firm is providing liquidity for a minimum of 50% of the time, it is clear it is a substantial rather than ad hoc activity: an appropriate threshold for the market maker classification.
- ESMA’s proposed definition for ‘competitive prices’, meaning “quotes posted within the average bid-ask spread”, is unworkable: – “average” is vague. Further, not only must it be calculated intra-day but it will also move more quickly than market makers will be able to adjust. Because market makers cannot quote continuously within any such spread, we are concerned that “average” will be construed as best bid offer (BBO). Current market practice is to quote within a fixed range of BBO, adjusted for the liquidity of the instrument. Therefore we propose to redefine RTS 15(7) in accordance with ESMA’s short selling regulation guidelines on the market making exemption – “competitive prices should be within the maximum bid/offer spreads that are required from the market makers/liquidity providers recognised under the rules of the trading venue where they are posted for the concerned instruments”.
- We agree with the introduction of extreme volatility as an exceptional circumstance but consider the proposed wording to be too restrictive, in that it requires an interruption of trading with respect to all instruments traded on a venue. Instead, circumstances of extreme volatility should be assessed at a per instrument level, with firms retaining their market making obligations for non-affected instruments.
- Finally, we strongly believe quoting in stressed market conditions should remain at the discretion of the investment firm.
The FIA Associations expect the impact of the proposed tick size changes will be large, and as a result will create a period of market disruption when implemented. With such a significant impact anticipated, we consider it a grave concern that the only mechanism for addressing potential deleterious effects is to propose revised RTS, which legislative process will span years. While we understand there is no mechanism in the European legislative process for a pilot program, we believe the RTS should contain a provision allowing national competent authorities to intervene and derogate in the event market quality is damaged, with notification to ESMA.
The requirement to synchronise the business clocks of trading venues and their customers is new to MiFID II. It will enable standardised recorded time on post-trade data, transaction reporting and, most importantly, order event auditing. Whilst the FIA Associations support this general principle, we strongly believe the requirement to calibrate to a maximum divergence of 1 nanosecond is vastly excessive, does not reflect currently available technology (or technology expected to be available in the short term), and would result in a massive cost to the industry. Nor do we support ESMA’s suggestion to link clock synchronisation requirements for investment firms directly to the trading venues on which they trade.
Trading venues do not cater to one specific type of market participant: the depth of liquidity available in the largest venues is due to the heterogeneous collection of investment firms participating.
Following ESMA's proposal, a broad swath of non-latency-sensitive investment firms will face excessive IT costs if they use even one trading venue that caters to latency sensitive clients. Instead, we propose establishing two categories of requirements calibrated for HFT firms and non-HFT firms.
Execution venues and market makers
The FIA Associations do not agree with the proposal to extend the definition of execution venues to include market makers or liquidity providers, which will trigger information requirements relating to ‘quality of execution’ that are intended to help investment firms’ selection of execution venues. However, the inclusion of market makers and liquidity providers should be considered out of scope for this purpose because reporting data stemming from such trades is duplicative of otherwise publically available market data. Both terms relate to the provision of liquidity to trading venues, and therefore all relevant data will constitute part of the data that the trading venue publishes. In their capacity as market makers, firms interact with clients directly only when they trade away from a trading venue, either as a systematic internaliser or OTC in a market using a central continuous order book. Where market makers or liquidity providers execute orders on behalf clients in these ways, they would already be required to operate as an authorised investment firm; ensuring investor protection would not be undermined. Similarly, if a market maker acts as a systematic internaliser, then the agreements in place with its clients already support publication of certain data. Therefore, their inclusion in the definition of execution venue, triggering requirements to double-disclose detailed information, would be overly complex and pose a serious risk that the intended consumers will simply not invest in the effort to understand it. Moreover the sheer number of metrics and complex structure will make it costly for regulators to ensure that the data is being produced in a consistent way that allows for valid comparisons. This will further undermine confidence in the data supporting the utility of best execution.
Additional topics to which FIA EPTA did not respond:
Non-discriminatory access to trading venues – RTS
FIA EPTA did not submit a response to this topic under the current consultation, but as a general principle believe that to achieve transparent and non-discriminatory access rules for OTC derivative trading venues, legal safeguards are necessary. Only then will it be possible to ensure that OTFs specify access parameters in an open and transparent manner rather than using their defined ability to determine and restrict access based on obligations to customers. Under MiFID II, trading venues for OTC derivatives (such as OTFs) must operate a system that allows multiple third-party buying and selling interests to interact (i.e., a “many-to-many” or “all-to-all” market). This includes all types of market participants (e.g. customer and dealer) and therefore means that any type of participant should be able to interact with any other. This would replace the existing “two-tier” market structure prevalent in many OTC derivatives trading venues. OTFs are able to determine and restrict access based on the role and obligations which they have in relation to their customers. However, any such eligibility criteria must be directly relevant to the system’s operation and not an attempt to prevent access by a class or category of participants. Any criteria that explicitly or implicitly exclude an entire class or category of otherwise eligible market participants by definition do involve discrimination.
FIA EPTA did not submit a response to this topic under the current consultation, but as a general principle support ESMA’s proposals to extend existing transparency requirements to a broader set of instruments. We believe waivers relating to pre-trade transparency and deferred publication of post-trade information should be carefully calibrated to promote transparency in trading and maximise the timeliness and completeness of information to all market participants. We recognize this is an enormous task for ESMA, complicated by the fact that in some cases, incomplete data sets (e.g. not covering global markets) or wrong data sets (e.g. post-trade data rather than order-book data) may have been used to assess whether certain subclasses of instruments have liquid markets. FIA EPTA looks forward to working with regulators and industry participants to navigate the substantial changes to transparency obligations.