Matched principal trading (MiFID definitions)

Matched principal trading means a transaction where three elements are simultaneously fulfilled:

1) the facilitator interposes between the buyer and seller to the transaction in such a way that it is never exposed to market risk throughout the execution of the transaction (no-risk exposition component), 

2) both sides are executed simultaneously (timing component), and

3) the transaction is concluded at a price where the facilitator makes no profit or loss, other than a previously disclosed commission, fee or charge for the transaction (remuneration structure component).

MiFID II contains a Recital 24 mentioning that dealing on own account when executing client orders includes firms executing orders from different clients by matching them on a matched principal basis (back to back trading), which should be regarded as acting as principals and should be subject to the provisions of MiFID II Directive covering both the execution of orders on behalf of clients and dealing on own account.

The above provisions allow for the conclusion, a matched principal trading is in the first place a form of dealing on own account (all other forms of dealing on own account are sometimes flagged as "principal capacity" - see for example the regulatory technical standards on reporting obligations under Article 26 of MiFIR).

Article 4(1)(38) of MiFID II: 'matched principal trading' means a transaction where the facilitator interposes itself between the buyer and the seller to the transaction in such a way that it is never exposed to market risk throughout the execution of the transaction, with both sides executed simultaneously, and where the transaction is concluded at a price where the facilitator makes no profit or loss, other than a previously disclosed commission, fee or charge for the transaction.

It is also the view of FCA that "If a firm executes client orders by standing between clients on a matched principal basis (back-to-back trading), it is both dealing on own account and executing orders on behalf of clients" (Financial Conduct Authority, Markets in Financial Instruments Directive II Implementation – Consultation Paper I (CP15/43), December 2015, CP15/43, p. 262). Consequently, the matched principal trading is available only for investment firms possessing both permissions.

The reference to the matched principal trading is also significant, among others, for the following exclusions from the MiFID II application:

- ancillary activity (or "commodity derivatives trader") exemption - Article 2(1)(j), and

- dealing on own account exemption under MiFID II - Article 2(1)(d).

The key feature of the MiFID II framework is persons dealing on own account when executing client orders mustn't benefit from any MiFID II exemption, and in effect are mandatorily covered by the MiFID II (see Recital 23 MiFID II). Hence, MiFID II applies even if the trader executes client order in financial instrument against the proprietary capital of the trader (see the definition for the 'dealing on own account' - Article 4(1)(6) MiFID II). But what about the intragroup exemption, which already was and still will be the separate MiFID exemption (see MiFID II Article 2(1)(b)). Is it possible to carry out the intragroup matched principal trading under the MiFID II or not? The wording of MiFID II recitals 23 and 24 suggests it is not, since persons dealing on own account when executing client orders mustn't benefit from "any" MiFID II exemption. However, such an interpretation does not seem to be valid, if it were true, the consequences would be so serious...

Prohibition on matched principal trading for operators of regulated markets and MTFs

Engagement in the matched principal trading under MiFID II is prohibited for some types of regulated trading venues:

1. Regulated markets' operators are not allowed to execute client orders against proprietary capital, or to engage in matched principal trading on any of the regulated markets they operate (MiFID II Article 47(2));

2. Investment firms or market operators operating a multilateral trading facility (MTF) are not allowed to execute client orders against proprietary capital, or to engage in matched principal trading (MiFID II Article 19(5)).

Regulation of matched principal trading under the OTF legal framework

As regards organised trading facilities (OTFs), MiFID II Article 20(2), (3) and (7) creates the following interconnections with matched principal trading:

- investment firms or market operators operating an OTF are permitted to engage in matched principal trading in bonds, structured finance products, emission allowances and certain derivatives only where the client has consented to the process,

- an investment firm or market operator operating an OTF must not use matched principal trading to execute client orders in an OTF in derivatives pertaining to a class of derivatives that has been declared subject to the clearing obligation,

- an investment firm or market operator operating an OTF must establish arrangements ensuring compliance with the definition of matched principal trading,

- investment firms or market operators operating an OTF are allowed to engage in dealing on own account other than matched principal trading only with regard to sovereign debt instruments for which there is not a liquid market,

- the competent authority may require, either when an investment firm or market operator requests to be authorised for the operation of an OTF or on ad-hoc basis, a detailed information explaining, among others, the use of matched principal trading.

The competent authority is under the obligation to monitor an investment firm's or market operator's engagement in matched principal trading to ensure that it continues to fall within the definition of such trading and that its engagement in matched principal trading does not give rise to conflicts of interest between the investment firm or market operator and its clients.

"Matched principal trading does not exclude the possibility of settlement risk, although firms should take appropriate steps to minimise this risk", said the U.K. Financial Conduct Authority (Markets in Financial Instruments Directive II Implementation – Consultation Paper I (CP15/43), December 2015, p. 115).

Simultaneous execution as an element of matched principal trading

The timing component of the matched principal trading (where both sides are executed simultaneously) is important, but to a certain extent an ambiguous parameter. When transactions are executed simultaneously and when they are not may raise doubts. What time interval makes the transaction to qualify as not executed simultaneously? Regulators' interpretation on this issue would be welcome.

Another issue is how to interpret situations where the trading fulfils all elements making up the definition of the matched principal trading, with the single exception - for the simultaneous execution. The problem has already been perceived by the British Bankers' Association (BBA), which, on account of MiFID II transaction reporting schemas proposed the provision of an alternative trading capacity (in addition to the ones proposed by ESMA - "facilitation").

The BBA proposition (fully supported by ISDA) state the following:

"To provide a more complete view of where firms are acting as facilitator between buyer and seller having already identified the other side to a position, firms would suggest that ESMA considers broadening (i.e. create an additional trading capacity category in addition to the three above) the scope of the permissible scenarios for Trading Capacity to include "Facilitation". Firms would for example use this trading capacity where they are facilitating a client order across multiple venues or executions but where the facilitator makes no profit or loss other than a previously disclosed fee or commission. This is a recognised behaviour within firms where their internal systems and controls mean that they have credit risk against market side and client side counterparties but no position risk and would enable NCAs to clearly identify this activity as part of their surveillance. The reason why trades that firms facilitate in this way cannot fall under the existing definition of Matched Principal is because the trading is not always done simultaneously" (ISDA Response to ESMA'S MiFID II/MiFIR Consultation Paper of December 19, 2014, p. 193, 194) .

Transaction reporting for matched principal trading under MiFID II

ESMA’s Consultation Paper of 23 December 2015 “Guidelines on transaction reporting, reference data, order record keeping & clock synchronisation” (ESMA/2015/1909, p. 16, 18) building upon the aforementioned three elements of legal definition for matched principal trading, considers MiFID II reporting in that regard should be made as follows: 

"... the transaction report shall show that the executing investment firm does not have a change of position as a result of the transaction. A single transaction report shall be submitted including both the market side and client side information. The client shall be populated in the buyer/seller field while the venue or counterparty shall be populated in the seller/buyer field."

In the said document ESMA ads, moreover, investment firms dealing on a matched principal trading basis (as well as investment firms dealing on own account) are acting directly themselves and cannot transmit orders as any orders they submit to another firm are their own orders rather than being transmission of an order received from a client or resulting from a decision to acquire or dispose of a financial instrument for a client under a discretionary mandate.

 Investment firms dealing on a matched principal trading basis (as well as investment firms dealing on own account) "are not regarded as transmitting firms" (ESMA's aforementioned Consultation Paper of 23 December 2015, p. 19).

The ESMA's Guidelines of 10 October 2016 “Transaction reporting, order record keeping and clock synchronisation under MiFID II” (ESMA/2016/1452)maintain the approach of the Consultation Paper of 23 December 2015 as regards matched principal trading reporting and once more stress (p. 18, 21, 23) that investment firms dealing on a matched principal trading basis are acting directly themselves and cannot 'transmit orders' in the meaning of Article 4 of the Commission Delegated Regulation (EU) 2017/590 of 28 July 2016 supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council with regard to regulatory technical standards for the reporting of transactions to competent authorities, as any orders they submit to another firm or investment firm are their own orders rather than being transmission of an order received from a client or resulting from a decision to acquire or dispose of a financial instrument for a client under a discretionary mandate.

Matched principal capacity is flagged by the designation "MTCH" within the MiFID II reporting framework - Field 29 (Trading capacity) of the Table 2 in the Annex to the said Commission Delegated Regulation of 28 July 2016. Given the above circumstances, where an investment firm is acting in a matched principal trading capacity (Field 29 = 'MTCH'), Field 25 (Transmission of order indicator) should be populated with 'false'. Where an investment firm is acting on a matched principal basis for a single client then it should submit a single transaction report encompassing both the market side and the client side and should include all the fields applicable to the client.

Finally, ESMA does not expect investment firms to report in a matched principal trading capacity for aggregated orders since matched principal transactions are one for one with the client. When more than one client is involved, the aggregate client account should be used to link the market side with the allocations to each client and the client side reports should include all applicable fields. 

The said designation "MTCH" for matched principal trading capacity is also used within the trading venue's data under the Commission Delegated Regulation (EU) 2017/580 of 24 June 2016 supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council with regard to regulatory technical standards for the maintenance of relevant data relating to orders in financial instruments - Field 7 Trading capacity in the Table 2 in the Annex to Regulation.

If the order submission results from the member or, participant of the trading venue is carrying out matched principal trading under Article 4(38) of MiFID II the said Field 7 should be populated with "MTCH". According to the description, the said Field indicates:

"whether the order submission results from the member or, participant of the trading venue is carrying out matched principal trading under Article 4(38) of Directive 2014/65/EU, or dealing on its own account under Article 4(6) of Directive 2014/65/EU.

Where the order submission does not result from the member or participant of the trading venue carrying out matched principal trading or dealing on its own account, the field shall indicate that the transaction was carried out under any other capacity".

Transparency requirements

Recital 17 of the Commission Delegated Regulation (EU) 2017/583 of 14 July 2016 supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council on markets in financial instruments with regard to regulatory technical standards on transparency requirements for trading venues and investment firms in respect of bonds, structured finance products, emission allowances and derivatives stipulates: 

"It is important to maintain current standards for the publication of transactions carried out as back-to-back trades to avoid the publication of a single transaction as various trades and to provide legal certainty on which investment firm is responsible for publishing a transaction. Therefore, two matching trades entered at the same time and for the same price with a single party interposed should be published as a single transaction."

Positions reporting for matched principal trading

In the answer to the Question 12 in the Questions and Answers, on MiFID II and MiFIR commodity derivatives topics (ESMA70-872942901-28) updated on 13 November 2017 ESMA confirmed that an investment firm acting as broker and using a matched principal model is subject to the MiFID II position reporting framework.

According to the ESMA, any investment firm trading in commodity derivatives contracts traded on a trading venue or in economically equivalent OTC (EEOTC) contracts is subject to position reporting and should provide a complete breakdown of positions held on own account and on behalf of clients as the investment firm can end up holding a position even if trading on a matched principal basis. ESMA underlined that it is the investment firm’s responsibility to assess whether the transaction executed results in a change in the positions held on own account and/or on behalf of clients.

ESMA Questions and Answers on MiFID II and MiFIR market structures topics, ESMA70-872942901-38 Question 32 [Last update: 03/02/2021] To which extent can an investment firm engage in Matched Principal Trading? Answer 32 As set out in Recital 19 of CDR (EU) 2017/565 and further clarified in previous ESMA guidance, Matched Principal Trading transactions are incompatible with the operation of a systematic internaliser, unless these transactions are occasional and not on a regular basis, or these transactions are executed on a trading venue. Firms undertaking Matched Principal Trading are not ‘on risk’ for these transactions. The receipt of a performance fee or commission associated with the transaction is generally an indication that the firm is ‘off-risk’. Firms that operate as systematic internalisers should be able to demonstrate that they are effectively taking on the inherent financial risk of the associated transactions (notwithstanding any related risk mitigation arrangements that may be in place). In addition, a systematic internaliser is a bilateral execution mechanism and is not a trading venue for this purpose. Recital 19 of CDR (EU) 2017/565 makes clear that a system which increases the likelihood or efficiency of executing Matched Principal Trading transactions requires authorisation as a multilateral system. This clarification is not limited to investment firms operating as systematic internalisers.

   Regulatory chronicle

3 February 2021

ESMA updates the Questions and Answers on MiFID II and MiFIR market structures topics (ESMA70-872942901-38) - matched principal trading transactions are incompatible with the operation of a systematic internaliser, unless these transactions are occasional and not on a regular basis, or these transactions are executed on a trading venue.

   Documentation

MiFID II, Article 4(1)(38), Recital 24

Commission Delegated Regulation (EU) 2017/583 of 14 July 2016 supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council on markets in financial instruments with regard to regulatory technical standards on transparency requirements for trading venues and investment firms in respect of bonds, structured finance products, emission allowances and derivatives

Commission Delegated Regulation (EU) 2017/590 of 28 July 2016 supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council with regard to regulatory technical standards for the reporting of transactions to competent authorities

ESMA's Guidelines, Transaction reporting, order record keeping and clock synchronisation under MiFID II, 10 October 2016, ESMA/2016/1452

Consultation Paper Guidelines on transaction reporting, reference data, order record keeping & clock synchronisation 23 December 2015 (ESMA/2015/1909), p. 16, 18

Commission Delegated Regulation (EU) 2017/580 of 24 June 2016 supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council with regard to regulatory technical standards for the maintenance of relevant data relating to orders in financial instruments

Questions and Answers, on MiFID II and MiFIR commodity derivatives topics, ESMA70-872942901-28