Legal definition of the 'multilateral system' is laid down by Article 4(19) of the MiFID II Directive. Pursuant to this provision 'multilateral system' means any system or facility operated and/or managed by:
- an investment firm or
- a market operator;
MiFID I did not use this definition.
The characteristic feature of the MiFID II is the requirement that all multilateral systems for the trading of financial instruments are a regulated market, MTF or OTF operated by an authorised firm or a regulated market.
ESMA Consultation Paper of 25 September 2020 (on the functioning of Organised Trading Facilities (OTF), ESMA70-156-2013, p. 21, 22) reminded that:
- the combination of the changes introduced in MiFID II, notably the obligation under Article 1(7) of MiFID II and the definition of a multilateral system under Article 4(19), has the effect of recognising that any multilateral system must request authorisation as a trading venue;
- that means that any multilateral system should operate in accordance with the definition of regulated market, MTF or OTF, regardless of the changes the facility needs to incur to comply with the requirements associated with the operation of a trading venue;
- therefore, the mere fact that the facility does not fall within the definition of any type of trading venue does not mean that such facility is outside of the trading venue boundaries;
- operating in accordance with the multilateral system definition is sufficient to be required to seek authorisation as a trading venue;
- furthermore, the definition of multilateral systems does not require the conclusion of a contract as a condition but simply that trading interests can interact within the system;
- it results from such definition, read in conjunction with Article 1(7) of MiFID II, that the conclusion of a contract is not a prerequisite for an investment firm or a market operator to be required to request authorisation as a trading venue for the system it operates;
- in other words, systems where trading interests can interact but where the execution of transactions is formally undertaken outside the system would still qualify as multilateral systems and be required to seek authorisation as trading venues.
Multilateral versus bilateral systems
It is sometimes underlined, MiFID II has introduced this term in the opposition to 'bilateral systems'.
UK Financial Conduct Authority (FCA) in the Consultation Paper I on the MiFID II implementation (CP15/43) of December 2015 observes: "Multilateral systems may be contrasted with 'bilateral systems' where an investment firm enters into every trade on own account. [...] Any system or platform is a multilateral system where more than one market participant has the ability to interact with more than one other market participant on that system or platform" (p. 264).
Article 4(19) MiFID II
'multilateral system' means any system or facility in which multiple third-party buying and selling trading interests in financial instruments are able to interact in the system
Article 1(7) of MiFID II requires all multilateral systems in financial instruments to operate as:
- a regulated markets,
It means, the definition of the 'multilateral system' under MiFID II is common to any trading venue, a new type - an OTF - including.
MiFID I provided for two types of trading venues only, regulated markets and MTFs, definitions thereof being very similar as sharing a number of features (in essence, both regulated markets and MTFs are systems which operate in accordance with non‑discretionary rules that bring together multiple buying and selling interests in a way that results in contracts).
Article 1(7) MiFID II
All multilateral systems in financial instruments shall operate either in accordance with the provisions of Title II concerning MTFs or OTFs or the provisions of Title III concerning regulated markets.
The aforementioned ESMA Consultation Paper of 25 September 2020 (on the functioning of Organised Trading Facilities (OTF), ESMA70-156-2013, p. 22, 23) makes some legislative propositions in this regard, i.e. in order “to ensure more legal certainty, to foster EU-wide consistency and convergence in the application of the framework, and to avoid any issues of transposition”, ESMA proposes that:
1) the restriction set out in MiFID II in Article 1(7) is moved into MiFIR, and
2) this restriction is worded as a prohibition so as to make it suitable for direct applicability in Member States.
According to the ESMA, for instance, it could be stipulated in MiFIR that:
1) it is forbidden to operate any type of multilateral system that does not also fit the definition of a regulated market, MTF or OTF; and
2) all multilateral systems in financial instruments are required to seek authorisation as a regulated market, MTF or OTF and where necessary modifying their operating arrangements to comply with the applicable trading venue definition.
Referring to "systems operating in a similar way to a trading venue but without proper authorisation" ESMA considers that "any system that allows trading interests in financial instruments to interact, including information exchange between parties on essential terms of a transaction (being price, quantity) with a view to dealing in those financial instruments is sufficient to require authorisation as a trading venue. The information exchanged does not need to be a contractual agreement between parties for the interaction to occur".
Further details regarding this general guidance has been provided through Q&As (in particular Q&A 7 and 10 of the section of Q&As on MiFID II and MiFIR market structures topics, ref. ESMA70-872942901-38).
In the aforementioned ESMA Consultation Paper of 25 September 2020 ESMA also invited National Regulatory Authorities (NCAs) to take remedial actions should some firms within their jurisdiction not operate in compliance with the MiFID II authorisation framework.
ESMA also intends to further clarify the conditions under which a facility should request authorisation as a trading venue via an ESMA Opinion.
Constituent elements of the definition of 'multilateral systems' - the requirement for trading interests to interact in the system
FCA in the above Consultation Paper of December 2015 (p. 48, 49) also argues, the MiFID II definition of the 'multilateral system' does not require the conclusion of contracts under the system's rules but only that trading interest is able to interact in the system.
FCA interprets the effect of combined Articles 4(19) and 1(7) that the MiFID requirement that a contract is executed under the system's rules by means of the system's protocols is now a sufficient but not necessary condition to be a multilateral system and hence to be regulated as a trading venue.
Instead it is required that trading interest is able to interact in the system.
FCA is of the opinion that the condition for trading interests to interact in the system is less stringent than that a contract is executed under the system's rules, or by means of the system's protocols or internal operating procedures.
FCA is, furthermore, of the view that interaction in a system or facility occurs when the system or facility allows multiple trading interests to exchange information relevant to any of the essential terms of a transaction in financial instruments (being the price, quantity and subject‑matter) with a view to dealing in such instruments.
In conclusion, pursuant to FCA, at a minimum, a platform will be considered a multilateral system (and hence must operate as a regulated market, MTF, or OTF in accordance with article 1(7) of MiFID II) if the system provides the ability for trading interests to interact with a view to dealing and:
- allows multiple participants to see such information about trading interest in financial instruments, or submit such information about trading interest in financial instruments for matching, and
- enables them, through technical systems or other facilities, to take steps to initiate a transaction, or be informed of a match.
MiFID II wording as well as the above FCA's analysis of the core, decisive elements of the very definition of the multilateral system indicates it is somewhat subtle concept, for example:
- a system that provides participants confirmation or notification messages about a matching opportunity between those participants, with a view to a transaction in financial instruments, qualifies as such a system or facility,
- on the other hand, any system that only receives, pools, aggregates and broadcasts indications of interest, bids and offers or prices is not considered a multilateral system for the purpose of MiFID II (this is because there is no reaction of one trading interest to another other within these systems – they do not 'act reciprocally' (see also recital 8 of MiFIR)).
In the FCA's view, interaction in a system or facility occurs when the system or facility allows trading interests to exchange information relevant to any of the essential terms of a transaction in financial instruments (being price, quantity, subject-matter).
The information exchanged need not be complete contractual offers, but may be simply invitations to treat or 'indications of interest'.
The FCA concludes that the definition of a multilateral system "goes beyond" the definitions of an OTF and MTF and of the systems operated by regulated markets.
The concept of a multilateral system under MiFID II is not, however, uniformly understood even among the EU Member States’ regulatory authorities.
Christoph Kumpan and Hendrik Müller-Lankow in the article “The multilateral single-dealer system - an oxymoron under MiFID II?” of 13 September 2017 (p. 8, 9) refer to the view of the German supervisory authority BaFin, according to which it is a bilateral system if the system operator not only brings together (or facilitates the bringing together of) third-party trading interests, but is itself a party to transactions for the purpose of market making.
The said BaFin’s approach is supported by German regional supervisory authorities responsible for the supervision of the stock exchanges in Duesseldorf, Hamburg and Munich, which have authorised the single-dealer systems Quotrix (MIC: DUSC), Lang & Schwarz Exchange (MIC: HAMM) and Market Maker Munich (MIC: MUNC) as regulated markets.
The above authors also note the multilateral systems’ further differentiation criterion developed by Diego Valiante (‘“Setting an institutional and regulatory framework for trading platforms: Is there a case for a new trading venue under MiFID?”, Journal of Financial Regulation and Compliance, 2013, no. 1), where a trading venue is multilateral if the operator has two characteristics:
1. neutrality, and
2. riskless operations.
If an infrastructure does not meet at least one of these criteria, it should be considered, according to Valiante, as a bilateral trading venue.
Multilateral single-dealer systems
It is restricted for an operator of multilateral systems to deal on own account.
Some trading venues express concerns due to emerging trends which allow alternative type of electronic platforms to offer very similar functionality to a multilateral system for the matching of multiple buying and selling interests. These electronic platforms are not authorised as regulated trading venues, hence they do not have to comply with the associated regulatory requirements, notably in terms of reporting obligations or business rules to manage clients’ relationships. The main argument advanced against regulation of these electronic systems is that they match trading interests on a bilateral basis and not via a multilateral system. However, according to traditional trading venues, this alternative electronic protocol may cause competitive distortions, effectively creating a level playing field distortion against the regulated trading venues which are bound by MIFID II/MiFIR provisions. There is a debate whether MiFID II /MiFIR should therefore take a more functional approach and define the operation of a trading facility in broader terms than the current definition of trading venues or multilateral system as to encompass these systems and ensure fair treatment for market players.
As a consequence, operators of multilateral systems are not allowed to bring together its own trading interests with other, third-party trading interests.
On the basis of this principle, Christoph Kumpan and Hendrik Müller-Lankow (op. cit, p. 13, 14, 21) conclude that a single-dealer system must be considered multilateral if the market operator only brings together the trading interests of the market maker and other third parties.
The differentiation of trading venues on the one hand and systematic internalisers and other OTC market makers on the other hand based on the terms ‘bringing together of third-party trading interests’ and ‘dealing on own account’ indicates that a single-dealer system can be multilateral if the market operator and the single-dealer are not the same person.
On the other hand, the bilateral trades are triggered by the European Commission, which in the public consultation launched on 17 February 2020 on the review of the MiFID II and MiFIR framework argues that the multilateral single-dealer systems offer very similar functionality to a multilateral system, hence MiFID II/MiFIR should encompass also these systems to ensure fair treatment for market players.
Treatment for the portfolio compression and post-trade confirmation services
Pursuant to the aforementioned FCA's analysis, neither the service of portfolio compression, which reduces non-market risks in derivative portfolios without changing the market risk, nor post-trade confirmation services, constitutes a multilateral system by itself.
However, if a firm operates a system that comes within the definition of a multilateral system without taking into account these activities, any portfolio compression or post-trade confirmation services that it provides for that system can form part of the multilateral system that the firm is operating.
System providing quote streaming and order execution services for multiple systematic internalisers (SIs)
System that provides quote streaming and order execution services for multiple SIs is a multilateral system and is required to seek authorisation as a regulated market, MTF or OTF in accordance with Article 1(7) of MiFID II.
Such an opinion has been expressed by ESMA on 7 July 2017 in Questions and Answers on MiFID II and MiFIR market structures topics, ESMA70-872942901-38.
Questions and Answers on MiFID II and MiFIR market structures topics, ESMA70-872942901-38
Question 19 [Last update: 07/07/2017]
Should a system providing quote streaming and order execution services to multiple SIs be authorised as a multilateral system?
Articles 14(1) and 18(1) of MIFIR require SIs to make public firm quotes, which may be published through an APA. Some prospective APAs propose setting up arrangements which, on top of their APA services, provide a suite of quote streaming and order execution services to SIs and their clients. Clients cannot interact with more than one SI via a single message but can send multiple messages to multiple SIs participating in the service provided.
Article 4(19) of MiFID II defines a multilateral system as” [...] any system or facility in which multiple third-party buying and selling trading interests in financial instruments are able to interact in the system”. Article 1(7) of MiFID II requires all multilateral systems to operate as either a RM, an MTF or an OTF.
In line with the criteria set out in Q&A 3 on OTFs published on 3 April 2017 for identifying multilateral trading systems, ESMA notes that:
a) If a system allows multiple SIs to send quotes to multiple clients and allows clients to request execution against multiple SIs, then this meets the interaction test foreseen in Article 4(1)(19) even if there is no aggregation across individual SI quote streams;
b) The arrangements described above have the characteristics of a system as they are embedded in an automated facility; and,
c) Those arrangements are not limited to pooling potential buying and selling interests from SIs but also cater for the direct execution of the selected SI quotes. Genuine trade execution would be taking place on the system provided.
Accordingly, a system that provides quote streaming and order execution services for multiple SIs should be considered a multilateral system and would be required to seek authorisation as a regulated market, MTF or OTF in accordance with Article 1(7) of MiFID II.
ESMA reminds that if a firm were to arrange transactions on one system and provide for the execution of the transactions on another system, the disconnection between arranging and executing would not waive the obligation for the firm operating those systems to seek authorisation as a trading venue.
MiFID II Directive, Article 4(19)