Głowacki Law Firm

Direct Electronic Access (DEA)
European Union Electricity Market Glossary

 

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Questions and Answers on MiFID II and MiFIR market structures topics, ESMA70-872942901-38 updated on 28 March 2018

 

Direct Electronic Access (DEA) and algorithmic trading, Question 23

 

Pursuant to Article 4(1)(41) of MiFID II, Direct Electronic Access (DEA) means:

 

- an arrangement where a member or participant or client of a trading venue permits a person to use its trading code so the person can electronically transmit orders relating to a financial instrument directly to the trading venue and includes arrangements which involve the use by a person of the infrastructure of the member or participant or client, or any connecting system provided by the member or participant or client, to transmit the orders (direct market access), and

 

- arrangements where such an infrastructure is not used by a person (sponsored access).

 

 

MiFID II Article 48(7)

 

Member States shall require a regulated market that permits direct electronic access to have in place effective systems procedures and arrangements to ensure that members or participants are only permitted to provide such services if they are investment firms authorised under this Directive or credit institutions authorised under Directive 2013/36/EU, that appropriate criteria are set and applied regarding the suitability of persons to whom such access may be provided and that the member or participant retains responsibility for orders and trades executed using that service in relation to the requirements of this Directive.

 

Member States shall also require that the regulated market set appropriate standards regarding risk controls and thresholds on trading through such access and is able to distinguish and if necessary to stop orders or trading by a person using direct electronic access separately from other orders or trading by the member or participant.

 

The regulated market shall have arrangements in place to suspend or terminate the provision of direct electronic access by a member or participant to a client in the case of non-compliance with this paragraph.

 

International Organization of Securities Commissions (IOSCO) observes there are divergent understandings of the term “Direct Electronic Access” (Policies on Direct Electronic Access, February 2009, p. 7).

 

Nonetheless, there is general agreement that DEA falls into two key categories: intermediated and non-intermediated.

 

Intermediated DEA generally refers to:

 

(a)  customers being given direct access to the market through a registered intermediary’s system/infrastructure, i.e. "automated order routing” (AOR) or


(b)  customers of an intermediary being given direct access to the market without going through the intermediary’s system/infrastructure, i.e., “sponsored access" (SA).


In either case, however, the order is sent to the market as the intermediary’s order, i.e., using the intermediary’s trading ID.

 

In the intermediated DEA the intermediary therefore retains full responsibility for the order.

 

According to the said IOSCO document of February 2009, the non-intermediated direct access generally refers to markets providing direct access to non-intermediaries (i.e., parties other than registered brokerage firms), as market-members and in that capacity connecting directly to the market, without going through an intermediary.

 

Credit risk is a key concern raised by DEA arrangements.

 

 

Automated Order Routing (AOR)

 

This describes a situation where an intermediary, who is a market-member, permits its customers to transmit orders electronically to the intermediary’s infrastructure (i.e., system architecture, which may include technical systems and/or connecting systems), where the order is in turn automatically transmitted for execution to a market under the intermediary’s market-member ID (mnemonic). In this case, the intermediary retains the ability to monitor internally and, if necessary, stop an order before it is executed. Such access is often referred to as “automated order routing.”

 

Sponsored Access (SA)

 

This describes a situation where an intermediary, who is a market-member, may permit its customers to use its member ID (mnemonic) to transmit orders for execution directly to the market without using the intermediary’s infrastructure. In this case, the intermediary is not able to use the internal controls applied with respect to AOR (e.g., does not have a real time view and cannot stop an order).

 

International Organization of Securities Commissions (IOSCO), Policies on Direct Electronic Access of February 2009 (p. 10)

 

This is maybe the main cause that, as the IOSCO Report underlines, although the use of DEA continues to increase, the number of DEA customers appears to be relatively small as a percentage of all customers.

 

 

Sponsored access

 

 

Compliance or regulatory risks are more pronounced when a customer that is not a market-member places orders directly on a market in the name of the intermediary, and that credit risks are more pronounced where the customer, who has DEA, is a non-clearing member of the market.

 

The reasons for not permitting “sponsored access” for some DEA providers are, among others, due to the inability of the DEA intermediary under such circumstances to impose sufficient pre-execution risk controls (against orders placed in error, “abnormal activity” alerts, etc.).

 

On a sponsored access basis, the customer’s orders are not visible to the DEA intermediary before execution, other than through supervisory terminals made available by connectivity providers under AOR.

 

Even in North America, where the extent of sponsored access is greater than in many other jurisdictions, a number of intermediaries indicated to IOSCO that they do not permit such access at all.

 

The aforementioned IOSCO report makes comment that the lack of jurisdiction by markets over persons accessing the markets, especially under sponsored access arrangements, may be problematic when such a sponsored access client engages in manipulative trading practices but the responsible intermediary is found to have in place fully adequate policies and supervisory procedures.

 

The concern expressed was that even though market rules may provide that market-members are responsible for their customers’ trading through DEA, it may be difficult to prosecute an intermediary for the underlying violation of the market rules caused by the customer and instead, actions may be taken to sanction the market-member for a lack of supervision of trading.

 

It was the IOSCO's opinion (dated 2009), that "it may be difficult for a market authority to prove that the intermediary had inadequate policies and procedures in place", but it occurs in practice that such enforcement procedures become more and more often.

 

 

Service bureaus

 

 

IOSCO further sheds some light on the activity of “service bureaus” that play a significant role in DEA in some jurisdictions.

 

Service bureaus are technology companies that provide order-routing and connectivity services for both intermediaries and institutional customers.

 

The service bureaus enter into agreements with markets that authorize their electronic connections and are at the electronic front end that directs orders to a particular market.

 

The use of service bureaus by intermediaries can be seen as an outsourcing of functions that are normally performed internally (possibly including pre-trade controls).

 

Service bureaus may be used in both AOR and sponsored access.

 

 

Questions and Answers on MiFID II and MiFIR market structures topics, ESMA70-872942901-3

 

Direct Electronic Access (DEA) and algorithmic trading

Question 25 [Last update: 15/11/2017]

 

Does a firm need to be authorised as an investment firm under MiFID II to provide DEA to an EU trading venue?

 

Answer 25

 

Yes, Article 48(7) of MiFID II provides that trading venues should only permit a member or participant to provide DEA “if they are investment firms authorised under [MiFID II] or credit institution authorised under Directive 2013/36/EU”. Therefore, non-EU firms (including non-EU firms licensed in an equivalent jurisdiction) or EU firms without a MiFID II licence are not allowed to provide DEA to their clients. This applies regardless of where the clients using the DEA service are located.

 

 

Eligibility to provide DEA to an EU trading venue

 

 

Firm must be authorised as an investment firm under MiFID II to provide DEA to an EU trading venue.

 

Article 48(7) of MiFID II provides that trading venues should only permit a member or participant to provide DEA if they are investment firms authorised under MiFID II or credit institution authorised under Directive 2013/36/EU.

 

ESMA’s answer to the Question 25 (Questions and Answers on MiFID II and MiFIR market structures topics, ESMA70-872942901-3, Direct Electronic Access (DEA) and algorithmic trading, updated on 15 November 2017) clarified that non-EU firms (including non-EU firms licensed in an equivalent jurisdiction) or EU firms without a MiFID II licence are not allowed to provide DEA to their clients.

 

This applies regardless of where the clients using the DEA service are located.

 

 

Exclusion of DEA users from the dealing on own account exemption under Article 2(1)(d) of MiFID II

 

 

 

Questions and Answers on MiFID II and MiFIR market structures topics, ESMA70-872942901-38

 

Direct Electronic Access (DEA) and algorithmic trading, Question 24 [Last update: 15/11/2017]

 

Can DEA clients accessing an EU trading venue through sub-delegated DEA benefit from the exemption offered under Article 2(1)(d) of MiFID II?

 

Answer 24

 

Article 2(1)(d) of MiFID II exempts persons dealing on own account in financial instruments from the requirement to be authorised as a MiFID investment firm. However, it also lists a set of circumstances where such an exemption does not apply, including where such persons have DEA to a trading venue.

 

Article 4(1)(41) of MiFID II defines DEA as “an arrangement where a member or participant or client of a trading venue permits a person to use its trading code so the person can electronically transmit orders relating to a financial instrument directly to the trading venue”. A person who directly interacts with the member to obtain the use of the trading code will be the person granted permission under an arrangement. The DEA provider has direct knowledge of that person’s use and must be taken to allow it; such a person (Tier 1 DEA client) therefore should be understood to have DEA to a trading venue.

 

However, in some cases a DEA provider may allow a DEA user to sub-delegate the access rights onto a third entity (Tier 2 DEA client). Unlike a Tier 1 DEA client who directly interacts with the member to obtain the use of the trading code, a Tier 2 DEA client would, in most cases, not technically be in possession of the trading code of a DEA provider. The trading code is not passed down to the ultimate users of DEA, but only appended to the order message by the DEA provider before being submitted to the trading venue. Therefore, ESMA does not consider such Tier 2 DEA clients as having DEA for the purposes of Article 2(1)(d) of MiFID II.

 

ESMA notes that any risks posed by Tier 2 DEA clients are indirectly regulated through the provisions of Article 17(5) of MiFID II as well as Articles 22 and 23 of RTS 6.

 

In addition, Article 21(4) of RTS 6 requires the DEA providers to be able to identify the different order flows from the beneficiaries of such sub-delegation without being required to know the identity of the beneficiaries of such arrangement.

 

Dealing on own account exemption under Article 2(1)(d) of MiFID II does not apply to persons who have direct electronic access to a trading venue except for non-financial entities who execute transactions on a trading venue which are objectively measurable as reducing risks directly relating to the commercial activity or treasury financing activity of those non-financial entities or their groups.

 

However, in the answer to Question 24 (Questions and Answers on MiFID II and MiFIR market structures topics, ESMA70-872942901-3, Direct Electronic Access (DEA) and algorithmic trading, updated on 15 November 2017) ESMA referred specifically to the application of this exemption to DEA clients accessing an EU trading venue through sub-delegated DEA.

 

ESMA does not consider such Tier 2 DEA clients as having DEA for the purposes of Article 2(1)(d) of MiFID II.

 

In the ESMA’s opinion such Tier 2 DEA clients would, in most cases, not technically be in possession of the trading code of a DEA provider.

 

In such a case the trading code is not passed down to the ultimate users of DEA, but only appended to the order message by the DEA provider before being submitted to the trading venue.

 

As a consequence DEA clients accessing an EU trading venue through sub-delegated DEA are in the above circumstances able to benefit from the dealing on account exemption offered under Article 2(1)(d) of MiFID II.

 

 

Direct electronic access to an OTF under MiFID

 

 

In the Answer to Question 19 in the Questions and Answers on MiFID II and MiFIR market structures topics, ESMA70-872942901-38 ESMA clarified on 3 October 2017 the issue how the OTF best execution obligations apply when third-party brokers are clients of the OTF or when these brokers provide Direct Electronic Access (DEA) (Article 4(1)(41) of MiFID II).

 

According to ESMA, when an investment firm or a market operator operating an OTF receives orders or indications of interest from a broker acting on behalf of its own clients, the operator of the OTF should be implementing its own best execution policy when executing the order from the broker orders as it owes its user clients (the broker) the duty of best execution.

 

The broker should determine that the OTF it selects allows it to comply with its best execution obligations towards its own clients.

To that end, the broker should conduct a performance assessment of the OTF including how discretion is exercised.

 

In the specific case of DEA to an OTF, the DEA order is entered in the OTF client’s name (the broker) and the OTF operator should execute the DEA order as it would for any OTF client order.

 

Alternatively, the operator of the OTF may decide not to permit DEA to its system.

 

ESMA also notes that a DEA order could be considered as a client specific instruction to the broker providing the DEA arrangement to its clients.

 

Internal regulations of ICE Futures Europe envision that DEA providers should consider the authorisation status of their clients (Guidance ICE Futures Europe and ICE Endex Guidance on Member Requirements under MiFID II of June 2017).

 

Pursuant to the Consultation Paper of the Financial Conduct Authority on Markets in Financial Instruments Directive II Implementation (CP15/43) of December 2015 (p. 120, 121), a firm which permits direct electronic access to an OTF it operates must:

 

(1) not permit members or participants of the OTF to provide such services unless they are:

(a) investment firms authorised under MiFID; or

(b) CRD credit institutions; or

(c) third country investment firms; or

(d) overseas firms registered in accordance with article 46 of MiFIR;

 

(2) set, and apply, criteria for the suitability of persons to whom direct electronic access services may be provided;

 

(3) ensure that the member or participant of the OTF retains responsibility for adherence to the requirements of MiFID in respect of orders and trades executed using the direct electronic access service;

 

(4) set standards for risk controls and thresholds on trading through direct electronic access;

 

(5) be able to distinguish and if necessary stop orders or trading on that trading venue by a person using direct electronic access separately from:

(a) other orders;

(b) trading by the member or participant providing the direct electronic access; and

 

(6) have arrangements to suspend or terminate the provision of direct electronic access on that market by a member or participant in the case of any non-compliance with this rule.

 

 

DEA agreements

 

 

The aforementioned IOSCO Report of 2009 indicates that most intermediaries enter into written contractual agreements with their DEA customers, the purpose of which is to restrict, condition or otherwise control how their customer utilizing their infrastructure may transmit orders, as well as to seek to ensure compliance by their DEA customers with market rules.

 

Some of the key terms and conditions contained in such contracts include the following:

 

- provisions that address the respective rights and liabilities of the parties such as statements that the customer accepts all liabilities resulting from DEA use (including use of identification codes, settlement and delivery);


- provisions relating to the security (physical and IT security) of the infrastructure (user identity, passwords, authentication codes, etc.), to avoid unauthorized system access;


- limits that are expressed as a notional amount for each customer above which the orders are rejected by the system, as well as by reference to the maximum amount per order/per user;


- warranties, indemnities, charges and customer/product specific conventions;


- conditions (such as for entering orders, error trade policies, etc.) and restrictions such as the right to suspend the service, to reject or cancel orders, etc.;


- use of specific standard format for order routing such as SWIFT or FIX;


- a requirement to have knowledge of trading rules and applicable laws and regulations or a requirement to comply with these;


- a requirement that the customer's users are authorized, qualified and competent.


These terms and conditions are usually standard in terms of restrictions, conditions and controls although most intermediaries clarify that they are adapted to the business relationship with the customer and the type of service provided (dealing services, clearing services, prime brokerage).

 

 

 

Article 17(5) MiFID II

  

An investment firm that provides direct electronic access to a trading venue shall have in place effective systems and controls which ensure a proper assessment and review of the suitability of clients using the service, that clients using the service are prevented from exceeding appropriate pre-set trading and credit thresholds, that trading by clients using the service is properly monitored and that appropriate risk controls prevent trading that may create risks to the investment firm itself or that could create or contribute to a disorderly market or could be contrary to Regulation (EU) No 596/2014 or the rules of the trading venue. Direct electronic access without such controls is prohibited.

 

An investment firm that provides direct electronic access shall be responsible for ensuring that clients using that service comply withthe requirements of this Directive and the rules of the trading venue. The investment firm shall monitor the transactions in order to identify infringements of those rules, disorderly trading conditions or conduct that may involve market abuse and that is to be reported to the competent authority. The investment firm shall ensure that there is a binding written agreement between the investment firm and the client regarding the essential rights and obligations arising from the provision of the service and that under the agreement the investment firm retains responsibility under this Directive.

 

An investment firm that provides direct electronic access to a trading venue shall notify the competent authorities of its home Member State and of the trading venue at which the investment firm provides direct electronic access accordingly.

 

The competent authority of the home Member State of the investment firm may require the investment firm to provide, on a regular or ad-hoc basis, a description of the systems and controls referred to in first subparagraph and evidence that those have been applied.

 

The competent authority of the home Member State of the investment firm shall, on the request of a competent authority of a trading venue in relation to which the investment firm provides direct electronic access, communicate without undue delay the information referred to in the fourth subparagraph that it receives from the investment firm.

 

The investment firm shall arrange for records to be kept in relation to the matters referred to in this paragraph and shall ensure that those records be sufficient to enable its competent authority to monitor compliance with the requirements of this Directive.

 

 

 

 

Commission Delegated Regulation (EU) 2017/565 of 25.4.2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council as regards organisational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive

 

Article 20
Direct electronic access
(Article 4(1)(41) of Directive 2014/65/EU)


1. A person shall be considered not capable of electronically transmitting orders relating to a financial instrument directly to a trading venue in accordance with Article 4(1)(41) of Directive 2014/65/EU where that person cannot exercise discretion regarding the exact fraction of a second of order entry and the lifetime of the order within that timeframe.

 

2. A person shall be considered not capable of such direct electronic order transmission where it takes place through arrangements for optimisation of order execution processes that determine the parameters of the order other than the venue or venues where the order should be submitted, unless these arrangements are embedded into the clients' systems and not into those of the member or participant of a regulated market or of an MTF or a client of an OTF.

 

Recitals 20, 25 - 27

 

(20) For reasons of clarity and legal certainty and to ensure a uniform application, it is appropriate to provide supplementary provisions in relation to the definitions in relation to algorithmic trading, high frequency algorithmic trading techniques and direct electronic access. In automated trading, various technical arrangements are deployed. It is essential to clarify how those arrangements are to be categorised in relation to the definitions of algorithmic trading and direct electronic access. The trading processes based on direct electronic access are not mutually exclusive to those involving algorithmic trading or its sub-segment high frequency algorithmic trading technique. The trading of a person having direct electronic access may therefore also fall under the algorithmic trading including the high frequency algorithmic trading technique definition.

...

(25) The definition of direct electronic access should be further specified. The definition of direct electronic access should not encompass any other activity beyond the provision of direct market access and sponsored access. Therefore, arrangements where client orders are intermediated through electronic means by members or participants of a trading venue such as online brokerage and arrangements where clients have direct electronic access to a trading venue should be distinguished.

 

(26) In case of order intermediation, submitters of orders do not have sufficient control over the parameters of the arrangement for market access and should therefore not fall within scope of direct electronic access. Therefore, arrangements that allow clients to transmit orders to an investment firm in an electronic format, such as online brokerage, should be not be considered direct electronic access provided that clients do not have the ability to determine the fraction of a second of order entry and the life time of orders within that time frame.

 

(27) Arrangements where the client of a member or participant of a trading venue, including the client of a direct clients of organised trading facilities (OTFs), submit their orders through arrangements for optimisation of order execution processes that determine parameters of the order other than the venue or venues where the order should be submitted through SORs embedded into the provider's infrastructure and not on the client's infrastructure should be excluded from the scope of direct electronic access since the client of the provider does not have control over the time of submission of the order and its lifetime. The characterisation of direct electronic access when deploying smart order routers should therefore be dependent on whether the smart order router is embedded in the clients' systems and not in that of the provider.

 

 

 

 

Direct Electronic Access

 

"'Direct Electronic Access' means an arrangement where a member or participant or client of a trading venue permits a person to use its trading code so that the person can electronically transmit orders relating to a financial instrument directly to the trading venue and includes arrangements which involve the use by a person of the infrastructure of the member or participant or client, or any connecting system provided by the member or participant or client, to transmit the orders (direct market access) and arrangements where such an infrastructure is not used by a person (sponsored access)."

 

Unless clearly delineated, Direct Electronic Access (DEA) may qualify as infrastructure intended to minimise network and other types of latencies in the sense of the definitions of 'algorithmic trading' and 'high-frequency algorithmic trading' under Articles 4(1)(39) and 4(1)(40). It is therefore necessary to further clarify the distinction of DEA and in particular where a particular use of DEA may trigger the obligation to comply with provisions of MiFID II/MiFIR.

 

ESMA's technical advice:

 

ESMA in its technical advice identified the ability to exercise discretion regarding the exact fraction of a second of order entry and the lifetime of the orders within that timeframe as the critical element to qualify an activity as DEA. Where the submitter of the order does not have control over those parameters, the arrangement would be out of scope of DEA, this also holds for systems that allow clients to transmit orders to an investment firm in an electronic format (online brokerage). Nevertheless the investment firm would conduct algorithmic trading when submitting those client orders if it uses smart order routers and in that case, it should be compliant with Article 17 of MIFID II.

 

With regard to the distinction between DEA, SORs (smart order routers) and AORs (automated order routers) ESMA considers that:

 

- SORs are algorithms used for the optimisation of order execution processes and may determine parameters of the order other than the venue(s) where the order should be submitted. SORs fall within the definition of 'algorithmic trading' and the relevant MiFID II articles should apply to them and not those on DEA.

 

- AOR encompass those functionalities that determine the trading venue(s) where the order should be submitted without changing any trading parameter of the order (an SOR would be able to do the same, but also modify parameters of the order, in particular the time of submission of orders). Use of an AOR as described does not qualify or disqualify the provision of DEA in case it is embedded in DEA systems. Use of an AOR in isolation should not be considered as DEA.

 

Assessment of IA need:

 

The definition of DEA is needed to clarify when an investment firm carries out algorithmic trading according to Article 17 and has to fulfil the relevant requirements of the Directive. ESMA reached a compromise on a solution to a technical issue. It is therefore the Commission's view that it is not proportionate to subject this solution to a technical problem to further impact assessment.

 

Commission Staff Working Document Impact Assessment Accompanying the document Commission Delegated Regulation supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council with regard to definitions, transparency, portfolio compression and supervisory measures on product intervention and positions {C(2016) 2860 final} {SWD(2016) 156 final}, 18.5.2016, SWD(2016) 157 final, p. 72, 73

 

 

 

 

MiFID II reporting for DEA

 

 

When it comes to MiFID reporting, DEA provider should report as acting in a matched principal (MTCH) or "any other capacity" (AOTC) (Guidelines Transaction reporting, order record keeping and clock synchronisation under MiFID II, 10 October 2016, ESMA/2016/1452, p. 21).

 

Annex to 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 envisions that information on DEA must be an element of the content of the order details to be maintained at the disposal of the competent authority (this is effected in the Field 2 of the respective format where if the order was submitted to the trading venue using DEA as defined in Article 4(1)(41) of MiFID II, the parameter value should be "true" and - in the opposite case - "false").

 

Moreover, in case of DEA, the identity of the DEA provider should be put in the Field 1 (Identification of the entity which submitted the order), which, in principle, should indicate the identity of the member or participant of the trading venue.

 

The similar case is for the Field 3 (Client identification code), which is designed to indicate the code used to identify the client of the member or participant of the trading venue. Also in the Field 3 in case there is DEA, the code of the DEA user is required to be used.

 

The practical ambiguity appeared whether an investment firm using DEA services provided by an intermediary firm (such as a broker) should list:

 

- the execution venue selected via the DEA arrangement (under the reporting obligation envisioned in the Commission Delegated Regulation (EU) 2017/576 of 8 June 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to regulatory technical standards for the annual publication by investment firms of information on the identity of execution venues and on the quality of execution (RTS 28) or


- the broker providing the DEA service (in the report to be published pursuant to Article 65(6) of the Commission Delegated Regulation (EU) 2017/565 of 25 April 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council as regards organisational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive.

 

ESMA referred to this issue in the Questions and Answers on MiFID II and MiFIR investor protection and intermediaries topics (ESMA35-43-349, Answer 17 updated on 3 October 2017).

 

ESMA refers firstly  to Article 4(1)(41) of MiFID II, which defines DEA as arrangements where a member or participant or client of a trading venue permits a person to use its trading code.

 

On this basis ESMA considers that the provider of DEA is the firm executing orders.

 

As such, an investment firm using DEA services to specifically direct an order to a particular venue are expected to list the intermediary firm providing that service for the purposes of the report to be published under the said Article 65(6) of the Commission Delegated Regulation (EU) 2017/565 of 25 April 2016.

 

The above report is consistent with the report required under the aforementioned RTS 28.

 

In these instances, the investment firm would be considered as giving a specific instruction to the intermediary providing DEA regarding the choice of the execution venue.

 

Correspondingly, the intermediary providing DEA service would still have an obligation to include trades executed via such access arrangements in its RTS 28 reports, although these trades could be classified as “directed orders” given the venue on which orders are executed is specified by the client (as set out in Article 2(c) of RTS 28).

 

This differs from a situation where the intermediating broker retains discretion over some parameters of the execution of the order, particularly, the venue destination, including where a broker’s smart order router determines where an order is executed.

 

While transactions are intermediated by the broker providing the DEA service, ESMA also recognises that the objective of the report to be published under Article 65(6) of the Delegated Regulation (EU) 2017/565 is to help clients understand the execution practices of investment firms transmitting or placing orders via DEA services and directing the choice of execution venues (as outlined above), and this objective is best served by the provision of information about the execution venues orders are routed to (where the investment firm is exercising discretion over the choice of execution venue).

 

In order to ensure that the report provides a complete picture of the investment firm’s order routing arrangements, ESMA considers that the investment firms should also disclose the identity of the main venues it commonly selects via DEA arrangements and the existence of any close links and specific arrangements with such execution venues, in its summary of execution quality (which, as required by Article 65(6) of the Delegated Regulation (EU) 2017/565, must be consistent with the information to be provided in accordance with Article 3(3) of RTS 28).

 

 

Requirements for DEA providers offering indirect clearing services

 

 

DEA providers which also offer indirect clearing services for the purposes of MiFID and the EMIR Regulation must ensure that they comply with rules applying to indirect clearing under:

- MiFIR Article 30,

- EMIR Article 4, and

- the relevant level 2 measures.

 

 

Algorithmic trading requirements for DEA

 

 

Algorithmic trading requirements for DEA are stipulated in Articles 19 - 23 (Chapter III) of the Commission Delegated Regulation (EU) 2017/589 of 19 July 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to regulatory technical standards specifying the organisational requirements of investment firms engaged in algorithmic trading (RTS 6 - see below).

 

On 3 October 2017 ESMA underlined (Answer 23, Questions and Answers on MiFID II and MiFIR market structures topics, ESMA70-872942901-3) that the suitability checks and controls a DEA provider should perform on clients using the service are also applicable in case of clients that are not investment firms authorised in the EU.

 

ESMA stressed the obligations that fall on a DEA provider as per Article 17(5) of MiFID II and as specified in RTS 6 apply regardless whether the client is an authorised EU investment firms or not.

 

In particular, all clients accessing an EU trading venue through the sub-delegated DEA should be subject to the controls and suitability checks of Article 17(5) of MiFID II as well as provisions of Articles 19 to 23 of RTS 6.

 

 

 

Commission Delegated Regulation (EU) 2017/589 of 19 July 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to regulatory technical standards specifying the organisational requirements of investment firms engaged in algorithmic trading

 

Recitals 13 - 15

 

(13) An investment firm providing direct electronic access (‘DEA provider’) should remain responsible for the trading carried out through the use of its trading code by its DEA clients. A DEA provider should therefore establish policies and procedures to ensure that trading of its DEA clients complies with the requirements applicable to that provider. That responsibility should constitute the principal factor for establishing pre-trade and post-trade controls and for assessing the suitability of prospective DEA clients. A DEA provider should therefore have sufficient knowledge about the intentions, capabilities, financial resources and trustworthiness of its DEA clients, including, where publicly available, information about the prospective DEA clients' disciplinary history with competent authorities and trading venues.

 

(14) A DEA provider should comply with the provisions of this Regulation even where it is not engaged in algorithmic trading, since its clients may use the DEA to engage in algorithmic trading.

 

(15) Due diligence assessment of prospective DEA clients should be adapted to the risks posed by the nature, scale and complexity of their expected trading activities and to the DEA being provided. In particular, the expected level of trading and order volume and the type of connection offered to the relevant trading venues should be assessed.

 

CHAPTER III
DIRECT ELECTRONIC ACCESS

 

Article 19

General provisions for DEA

(Article 17(5) of Directive 2014/65/EU)

 

A DEA provider shall establish policies and procedures to ensure that trading of its DEA clients complies with the trading venue's rules so as to ensure that the DEA provider meets the requirements in accordance with Article 17(5) of Directive 2014/65/EU.


Article 20

Controls of DEA providers

(Article 17(5) of Directive 2014/65/EU)

 

1. A DEA provider shall apply the controls laid down in Articles 13, 15 and 17 and the real-time monitoring laid down in Article 16 to the order flow of each of its DEA clients. Those controls and that monitoring shall be separate and distinct from the controls and monitoring applied by DEA clients. In particular, the orders of a DEA client shall always pass through the pre-trade controls that are set and controlled by the DEA provider.


2. A DEA provider may use its own pre-trade and post-trade controls, controls provided by a third party or controls offered by the trading venue and real time monitoring. In all circumstances, the DEA provider shall remain responsible for the effectiveness of those controls. The DEA provider shall also ensure that it is solely entitled to set or modify the parameters or limits of those pre-trade and post-trade controls and real time monitoring. The DEA provider shall monitor the performance of the pre-trade and post-trade controls on an on-going basis.


3. The limits of the pre-trade controls on order submission shall be based on the credit and risk limits which the DEA provider applies to the trading activity of its DEA clients. Those limits shall be based on the initial due diligence and periodic review of the DEA client by the DEA provider.


4. The parameters and limits of the controls applied to DEA clients using sponsored access shall be as stringent as those imposed on DEA clients using DMA.


Article 21

Specifications for the systems of DEA providers

(Article 17(5) of Directive 2014/65/EU)

 

1. A DEA provider shall ensure that its trading systems enable it to:


(a) monitor orders submitted by a DEA client using the trading code of the DEA provider;


(b) automatically block or cancel orders from individuals which operate trading systems that submit orders related to algorithmic trading and which lack authorisation to send orders through DEA,;


(c) automatically block or cancel orders from a DEA client for financial instruments which that client is not authorised to trade, using an internal flagging system to identify and block single DEA clients or a group of DEA clients;


(d) automatically block or cancel orders from a DEA client that breach the risk management thresholds of the DEA provider, applying controls to exposures of individual DEA clients, financial instruments or groups of DEA clients;


(e) stop order flows transmitted by its DEA clients;


(f) suspend or withdraw DEA services to any DEA client where the DEA provider is not satisfied that continued access would be consistent with its rules and procedures for fair and orderly trading and market integrity;


(g) carry out, whenever necessary, a review of the internal risk control systems of DEA clients.


2. A DEA provider shall have procedures to evaluate, manage and mitigate market disruption and firm-specific risks. The DEA provider shall be able to identify the persons to be notified in the event of an error resulting in violations of the risk profile or in potential violations of the trading venue's rules.


3. A DEA provider shall at all times be able to identify its different DEA clients and the trading desks and traders of those DEA clients, who submit orders through the DEA provider's systems, by assigning a unique identification code to them.


4. A DEA provider allowing a DEA client to provide its DEA access to its own clients (‘sub-delegation’) shall be able to identify the different order flows from the beneficiaries of such sub-delegation without being required to know the identity of the beneficiaries of such arrangement.


5. A DEA provider shall record data relating to the orders submitted by its DEA clients, including modifications and cancellations, the alerts generated by its monitoring systems and the modifications made to its filtering process.


Article 22

Due diligence assessment of prospective DEA clients

(Article 17(5) of Directive 2014/65/EU)

 

1. A DEA provider shall conduct a due diligence assessment of its prospective DEA clients to ensure that they meet the requirements set out in this Regulation and the rules of the trading venue to which it offers access.


2. The due diligence assessment referred to in paragraph 1 shall cover:


(a) the governance and ownership structure of the prospective DEA client;


(b) the types of strategies to be undertaken by the prospective DEA client;


(c) the operational set-up, the systems, the pre-trade and post-trade controls and the real time monitoring of the prospective DEA client. The investment firm offering DEA allowing DEA clients to use third-party trading software for accessing trading venues shall ensure that the software includes pre-trade controls that are equivalent to the pre-trade controls set out in this Regulation.


(d) the responsibilities within the prospective DEA client for dealing with actions and errors;


(e) the historical trading pattern and behaviour of the prospective DEA client;


(f) the level of expected trading and order volume of the prospective DEA client;


(g) the ability of the prospective DEA client to meet its financial obligations to the DEA provider;


(h) the disciplinary history of the prospective DEA client, where available.


3. A DEA provider allowing sub-delegation shall ensure that a prospective DEA client, before granting that client access, has a due diligence framework in place that is at least equivalent to the one described in paragraphs 1 and 2.


Article 23

Periodic review of DEA clients

(Article 17(5) of Directive 2014/65/EU)

 

1. A DEA provider shall review its due diligence assessment processes annually.


2. A DEA provider shall carry out an annual risk-based reassessment of the adequacy of its clients' systems and controls, in particular taking into account changes to the scale, nature or complexity of their trading activities or strategies, changes to their staffing, ownership structure, trading or bank account, regulatory status, financial position and whether a DEA client has expressed an intention to sub-delegate the access it receives from the DEA provider.

 

 

 

 
Commission Delegated Regulation (EU) 2017/584 of 14 July 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to regulatory technical standards specifying organisational requirements of trading venues (RTS 7), Recitals 15 - 17

 

15) The provision of direct electronic access (DEA) service to an indeterminate number of persons may pose a risk to the provider of that service and also to the resilience and capacity of the trading venue where the orders are sent. To address such risks, where trading venues allow sub-delegation, the DEA provider should be able to identify the different order flows from the beneficiaries of sub-delegation.


(16) Where sponsored access is permitted by a trading venue, prospective sponsored access clients should be subjected to a process of authorisation by the trading venue. Trading venues should also be allowed to decide that the provision of direct market access services by their members is subject to authorisation.


(17) Trading venues should specify the requirements to be met by their members in order for them to be allowed to provide DEA and determine the minimum standards to be met by prospective DEA clients in the due diligence process. Those requirements and standards should be adapted to the risks posed by the nature, scale and complexity of their expected trading, and the service being provided. In particular, they should include an assessment of the level of expected trading, the order volume and the type of connection offered

 


 

 

Questions and Answers on MiFID II and MiFIR market structures topics, ESMA70-872942901-38

 

Direct Electronic Access (DEA) and algorithmic trading 

 

Question 1 [Last update: 19/12/2016]


 

Does a simple algorithm qualify as algorithmic trading?

 

Answer 1

 

Yes. The fact that a person or firm undertakes trading activity by means of an algorithm which includes a small number of processes (e.g. makes quotes that replicate the prices made by a trading venue) does not disqualify the firm running such algorithm from being engaged in algorithmic trading.

 

Question 2 [Last update: 19/12/2016]

 

If an investment firm (firm A) merely transmits a client's order for execution to another investment firm (firm B) who uses algorithmic trading, is investment firm A engaged in algorithmic trading?

 

Answer 2

 

No. The transmission of an order for execution to another investment firm without performing any algorithmic trading activity is not algorithmic trading.

 

Question 3 [Last update: 19/12/2016]

Can a functionality be considered as an Automated Order Router (AOR) if it submits the same order to several trading venues? Would that qualify as algorithmic trading?

 

Answer 3

 

According to Recital 22 of Commission Delegated Regulation of 25.4.2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council as regards organisational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive, an AOR is characterized by only determining the trading venue or trading venues to which the order has to be sent without changing any other parameter of the order (including modifying the size of the order by "slicing" it into "child" orders). In case the same unmodified order is sent to several trading venues to ensure execution and it is executed in one of these venues, the functionality can also cancel the unexecuted orders in the other venues without qualifying as algorithmic trading.

 

Question 4 [Last update: 31/01/2017]


Do the references to ‘market makers’ in MiFID II Article 2(1)(d)(i) and Article 2(1)(j) cover those market makers as defined under MiFID II Article 4(1)(7) or those firms engaged in a market making agreement according to Article 17(4) of MiFID II?


Answer 4


The reference to market makers’ in MiFID II Article 2(1)(d)(i) and Article 2(1)(j) covers both firms engaged in a market making agreement according to Article 17(4) of MiFID II and other market makers covered by Article 4(1)(7) of MiFID II.


Question 5 [Last update: 03/04/2017]


 

How should the identification and authorisation take place for those firms applying a High-Frequency Trading (HFT) technique?


Answer 5


The mechanics of identifying whether a firm is deemed to be applying a HFT technique are detailed in Article 19 of Commission Delegated Regulation (EU) 2017/565. Firms should review their trading activities at least on a monthly basis to self-assess whether an authorisation requirement has been triggered over the course of the period in question. Upon request, trading venues must provide their members, participants or clients with an estimate of the average number of messages per second two weeks after the end of each calendar month. For this purpose, trading venues should only include messages generated by algorithmic trading activity as identified by the member, participant or client.


However, the onus remains on firms to ensure that the estimates provided by the trading venues accurately reflect their actual trading activity (and in particular that it only takes into account proprietary algorithmic trading activity on liquid instruments excluding, in the case of DEA providers, messages sent by DEA clients using the firm’s code).


Where a firm engages in HFT (as described above) and is not authorised as an investment firm under MiFID II, the firm is required to immediately seek authorisation as required under Article 2(1)(d)(iii) of MiFID II.


ESMA reminds that any firm engaged in algorithmic trading (including HFT) has to notify this circumstance to the national competent authority of its home Member State and to the national competent authorities of the trading venues at which it engages in algorithmic trading as member or participant.

 

Question 6 [Last update: 03/04/2017]


Given that the identification of HFT technique takes into account the previous twelve months of trading and that trading venues are only obliged to provide the data under Article 19 of Commission Delegated Regulation (EU) 2017/565 as of 3 January 2018, when the actual identification as high-frequency traders is expected to take place?


Answer 6


Trading venues are only required by Article 19(5) of Commission Delegated Regulation (EU) 2017/565 to provide estimates of the average of messages per second as of 3 January 2018. As a consequence, over 2018 trading venues have to provide the estimates corresponding to the trading activity of their members/participants from 3 January 2018 onwards. Trading venues may only be able to provide those estimates taking into account the previous twelve months of trading activity in the second week of February 2019. Provided that their 2017 records allow them so, trading venues may provide estimates taking into account the previous twelve months before that date.


As of 3 January 2018, persons engaged in algorithmic trading are responsible for their own self-assessment to determine whether their trading activity meets the characteristics of HFT as set out under Article 4(1)(40) of MiFID II and Article 19 of Commission Delegated Regulation (EU) 2017/565. If it is the case, they should proceed immediately as described in Answer 5. ESMA notes in this respect that the information provided by trading venues are only estimates that need to be refined according to each person’s own records of the messages sent.

 

Question 7 [Last update: 03/04/2017]


 

Can DEA users be identified as applying a HFT technique?

 

Answer 7


Yes. As clarified under Recital 20 of Commission Delegated Regulation (EU) 2017/565, DEA users may be classified as HFTs if they meet the conditions set out under Article 4(1)(40) of MiFID II and Article 19 Commission Delegated Regulation (EU) 2017/565.
In order to assess whether a DEA user meets the applicable message thresholds, firms accessing trading venues through DEA may contact their DEA provider which is obliged to record the data relating to the orders submitted, including modifications and cancellations under Article 21(5) of RTS 6 (Commission Delegated Regulation (EU) 2017/589 of 19 July 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to regulatory technical standards specifying the organisational requirements of investment firms engaged in algorithmic trading (OJ L 87, 31.3.2017, p. 417–448)).

 

However, the onus remains on investment firms to ensure that the estimates provided by the DEA providers accurately reflect their actual trading activity (and in particular that it only takes into account proprietary trading activity on liquid instruments excluding, in the case of DEA users sub-delegating the DEA provider’s code, messages sent by their own DEA clients).


Question 8 [Last update: 03/04/2017]


 

When would an investment firm using only algorithms which draw human traders’ attention to trading opportunities qualify as engaged in algorithmic trading?


Answer 8


The use of algorithms which only serve to inform a trader of a particular investment opportunity is not considered as algorithmic trading, provided that the execution is not algorithmic.


Question 9 [Last update: 03/04/2017]


Does the MiFID II obligation relating to algorithmic trading apply to electronic OTC trading? Are algorithms that provide quotes/orders to customers subject to the requirements set out in MiFID II?


Answer 9


Article 17 of MiFID II covers the trading activity that takes place on a trading venue. Therefore, OTC trading activity, such as the generation of quotes sent bilaterally to clients is not covered by the provisions in Article 17 of MiFID II (and any further requirements thereof).


Question 10 [Last update: 03/04/2017]


Please explain what is meant by Article 17(3) of RTS 6 which requires investment firms to “reconcile” their own electronic logs with information about their outstanding orders and risk exposures as provided by the trading venues to which they send orders, their brokers or DEA providers, their clearing members or CCP, their data providers or other relevant business partners?


Answer 10


The goal of post-trade controls is mainly to enable firms engaged in algorithmic trading to undertake appropriate management of their market and credit risk. To that end, and in order to make sure that post-trade controls are based on reliable information, Article 17(3) of RTS 6 requires investment firms to reconcile their own electronic logs with information about their outstanding orders and risk exposures as provided by external parties. This should be understood as an obligation to compare the trading activity’s reports generated by the investment firm itself with reports from other external sources. This should contribute in particular to:


a)  Early detection of any discrepancy between the different data sources and mitigation of errors and malfunctions;


b)  Accurate calculation of the firm’s actual exposure (in particular, where it accesses different multiple trading systems and/or brokers) and the timely generation of adequate alerts before the position and loss limits set out by the firm have been breached.

 

Question 11 [Last update: 03/04/2017]


 

Are firms required to store market data in order to fulfil the requirements contained in Article 13(7) of RTS 6 regarding the replay functionality of surveillance systems?


Answer 11


Under Article 13(1) of RTS 6, investment firms engaged in algorithmic trading are obliged to have in place monitoring systems capable of generating operable alerts to indicate potential market abuse. To that end, firms have to take into account not only their own message, order flow and transaction records but also information from other sources (trading venues, brokers, clearing members, CCPs, data providers, relevant business partners and so forth) which constitute not only the input used to generate messages but also the context of the trading activity.


Under Article 13 of RTS 6 there is no obligation to store internally all the information from other sources as long as it is possible to retrieve that information to operate the replay function.


Those operable alerts may lead to the submission to the national competent authority of a Suspicious Transaction or Order Report (STOR) under the Market Abuse Regulation (MAR). In particular, Article 5(3) of Commission Delegated Regulation (EU) 2016/957 of 9 March 2016 supplementing Regulation (EU) No 596/2014 of the European Parliament and of the Council with regard to regulatory technical standards for the appropriate arrangements, systems and procedures as well as notification templates to be used for preventing, detecting and reporting abusive practices or suspicious orders or transactions (OJ L 160, 17.6.2016, p. 1–14) prescribes that the information submitted as part of a STOR has to be based on facts and analysis, taking into account all information available to them.

 

Additionally, there is an obligation to maintain for a period of five years the information documenting the analysis carried out with regard to orders and transactions that could constitute market abuse which have been examined and the reasons for submitting or not submitting a STOR. That information shall be provided to the competent authority upon request (Article 3(8) of Commission Delegated Regulation (EU) 2016/957).

 

Question 12 [Last update: 03/04/2017]


Article 20 of Commission Delegated Regulation (EU) 2017/565 further clarifies the definition of direct electronic access as per Article 4(1)(41) of MiFID II by stating that persons shall be considered not capable of electronically transmitting orders relating to a financial instrument directly to a trading venue in accordance with Article 4(1)(41) of MiFID II where that person cannot exercise discretion regarding the exact fraction of a second of order entry and the lifetime of the order within that timeframe. What does “exercise discretion regarding the exact fraction of a second” mean?


Answer 12


One of the benefits of accessing a trading venue by DEA is in the ability of the firm submitting the order to exercise greater control over the timing of order submission. The use of DEA without passing through appropriate control filters of the provider of DEA and those of the trading venue, is not permitted under MiFID II. Such filters add minimal, but a finite amount of delay to the order reaching the matching engine of the trading venue and as such some may preclude the possibility of a firm submitting such an order to exercise discretion regarding the exact fraction of a second.


However, the phrase in question should be construed as whether the DEA user in question is able to exercise discretion regarding the exact fraction of a second in sending an order, not the exact timing of an order reaching the matching engine. This is a natural interpretation given that current network routing technology cannot provide certainty for a message to reach its destination with the precision of “exact fraction of a second”.


Question 13 [Last update: 31/05/2017]

 


What is meant by “continuous” assessment and monitoring of market and credit risk in Article 17(2) of RTS 6 which relates to investment firms’ post trade controls?


Answer 13


Under Article 13(1) of RTS 6, investment firms engaged in algorithmic trading are obliged to have in place monitoring systems capable of generating operable alerts to indicate potential market abuse. To that end, firms have to take into account not only their own message, order flow and transaction records but also information from other sources (trading venues, brokers, clearing members, CCPs, data providers, relevant business partners and so forth) which constitute not only the input used to generate messages but also the context of the trading activity.

 

Question 14 [Last update: 07/07/2017]

 


Does the format established for the record-keeping obligations of HFT firms established in RTS 6 apply to their non-algorithmic trading desks?


Answer 14


In addition to the general obligation of investment firms to maintain records of all orders and transactions in financial instruments under Article 25 of MiFIR, Article 17(2) of MiFID II establishes the obligation of investment firms engaged in HFT “to store in an approved form accurate and time sequenced records of all its placed orders, including cancellations of orders, executed orders and quotations on trading venues”.


For investment firms simultaneously engaging in HFT and non-HFT activities there are two formats that have to be considered:

 

- The format established in Annex 2 of RTS 6 has to be used to record the messaging activity related to activity using HFT technique. ESMA considers that ‘activity using HFT technique’ only includes the algorithmic proprietary trading activity of the firm on a trading venue with respect to any liquid instruments (see Article 19 of Commission Delegated Regulation (EU) 2017/565). 


With respect of the timestamping of those records (see fields 23 and 24 of table 3 of Annex II of RTS 6), the activity using HFT technique has to be timestamped within 1 microsecond or better (Table 2 of Annex to RTS 25, to which RTS 6 cross-refers).


- Non-HFT activity has to be recorded under the format established by Commission Delegated Regulation (EU) 2017/565. However, nothing prevents these investment firms from using Annex 2 of RTS 6 to record their non-HFT trading activity if their NCA so agrees. 


 

ESMA reminds that all other non-HFT algorithmic trading activity should be timestamped in one millisecond or better as provided for under ‘any other trading activity’ as specified in Table 2 of the Annex of RTS 25, to which Commission Delegated Regulation (EU) 2017/565 cross-refers. 


 

Question 15 [Last update: 07/07/2017]


Article 2(2) of Commission Delegated Regulation (EU) 2017/582 (RTS 26) requires trading venues to provide tools to ensure pre-execution screening on an order-by-order basis by each clearing member of the limits set and maintained by that clearing member for its client pursuant to RTS 6. Which specific provision of RTS 6 is the reference to limits in Article 2(2) of RTS 26 referring to?


Answer 15


The reference made to RTS 6 in Article 2(2) of RTS 26 is referring to Article 26 of RTS 6.


Question 16 [Last update: 07/07/2017]


Article 2(1) of RTS 26 provides an exemption from pre-trade, order-by-order checking for on- venue traded cleared derivatives if certain conditions are met. When this exemption applies to clearing members, does it also exempt clearing members from the requirement under Article 26(2) of RTS 6 to have “appropriate pre-trade and post-trade procedures for managing the risk of breaches of position limits”?


Answer 16


General clearing members and trading venues are not required to subject client orders for cleared derivative transactions on a trading venue to the relevant pre-trade checks required under RTS 26 where the conditions set out in Article 2(1) of RTS 26 are met. However, pursuant to Article 26(2) of RTS 6, they should have other pre-trade procedures to manage the risk of breaches of position limits by their clients, by way of appropriate margining practice and other means.


Question 17 [Last update: 07/07/2017]


Does the ‘kill functionality’ require having to integrate different systems in-house using a software approach so that a single button can cancel all orders in all asset classes for all house trading and client trading?


Answer 17


The requirement for an investment firm to have a kill functionality pursuant to Article 12 of RTS 6 obliges the firm to have the ability as an emergency measure to immediately pull any or all outstanding orders from any or all trading venues. ESMA considers that effective kill functionality is essential for ensuring adequate risk management and safeguarding of the orderly functioning of the market, given the risks to which algorithmic trading firms are exposed, in particular in situations where an algorithm is not behaving as expected.


In practical terms, this does not create an obligation for all systems connecting the firm to different trading venues to be implemented through a single unified piece of software, in particular when the investment firm comprises different trading systems. The functionality can comprise both procedures and switches that should be adjusted to the characteristics of the systems operated by the investment firm. For instance, when there is a unified system, a button could be set at the highest level of the system, with adequate and gradual procedures so as to limit risks of disorderly markets conditions. In any case, a single decision of the investment firm should be able to result in an immediate withdrawal of all orders or any subset of them.


Question 18 [Last update: 07/07/2017]


Under Article 3(2)(a) of Commission Delegated Regulation (EU) 2017/580 (RTS 24), there is a requirement to flag orders submitted to a trading venue “as part of a market making strategy pursuant to Articles 17 and 48 of [MiFID II]”. Should a firm start flagging orders when it decides to submit orders with a view to make markets in a particular instrument, or only when it concludes a formal agreement with the trading venue subsequent to triggering such an obligation under Article 1 of Commission Delegated Regulation (EU) 2017/578 (RTS 8)?


Answer 18


The primary purpose of flagging as required under Article 3(2)(a) of RTS 24 is to enable efficient detection of market manipulation by distinguishing the order flow from an investment firm based on pre-determined terms established by the issuer or the trading venue from the order flow of the investment firm acting at its own discretion (see Recital 6 of RTS 24).


ESMA therefore expects that only those orders submitted to a trading venue as part of a market making strategy subsequent to the conclusion of a market making agreement with the relevant trading venue should be flagged as such in field 8 as designated in Table 2 of the Annex of RTS 24. The same applies to field 3 of Table 3 of Annex II of RTS 6.


Question 19 [Last update: 07/07/2017]


 

Could trading venues set out different OTRs for different types of market participants (e.g. firms engaged in a market making scheme)?


Answer 19


As clarified by Recital 3 of Commission Delegated Regulation (EU) 2017/566 (RTS 9) trading venues may set the maximum ratio of unexecuted orders to transactions at the level they consider appropriate to prevent excessive volatility in the financial instrument concerned.


Nothing prevents trading venues from setting the limits on the basis of the different categories of market participants that operate in their systems. In particular, trading venues may determine a specific limit ratio for members or participants subject to market making obligations under a written agreement (Article 17(2) of MiFID II) or a market making scheme (Article 48(2)(b) of MiFID II).
The ratio limiting the number of unexecuted orders to transactions should be set in compliance with the objective of Article 48 of MiFID II and supported by statistical analysis of the activity of the different categories of members or participants and the liquidity of the instruments in which they operate.


Question 20 [Last update: 07/07/2017]


 

In terms of the Order to Trade Ratio (OTR), how should a trading venue tackle cases where a market participant has executed no trades after the submission of a high number of orders?


Answer 20


RTS 9 describes the methodology to calculate the actual OTR incurred by each member or participant of a trading venue using a fraction. In case there have been no trades, a strict application of the proposed methodology is not possible since one cannot divide by zero.


ESMA is of the view that trading venues should consider that the maximum OTR has been breached if the orders submitted without executing one single transaction surpassed the maximum authorised number of orders that can be sent for one transaction being executed. For instance if the maximum OTR set by the trading is 10, members or participants should not sent more than 10 orders without executing one transaction.


Question 21 [Last update: 07/07/2017]


Article 1(2)(d) of RTS 8 establishes that quotes shall be deemed to have competitive prices where they are posted at or within the maximum bid-ask range set by the trading venue. Does this mean that trading venues have to have published maximum bid-ask ranges for all instruments traded on their venues or only for the instruments on which they have a market making scheme in place?


Answer 21


There are two different obligations when an investment firm is pursuing a market making strategy in trading venues allowing or enabling algorithmic trading through their systems:


a) There is a generic obligation, not restricted to specific financial instruments, for trading venues to sign written market making agreements with all investment firms pursuing a market making strategy on their systems (Article 48(2) and Article 17(3) and (4) of MiFID II) when the circumstances described in Article 1(2) of RTS 8 are met; and

 

b) Trading venues must have market making schemes in place only with respect to the instruments listed in Article 5 of RTS 8.
In order for investment firms to assess whether they are posting competitive prices on a trading venue and may therefore potentially qualify as engaging into a market making strategy, and have to enter into a market making agreement, trading venues enabling or allowing algorithmic trading through their systems must make public a maximum bid-ask range for each financial instrument they made available for trading.


ESMA notes that trading venues may group financial instruments when setting the maximum bid-ask spread for these purposes.


Question 22 [Last update: 07/07/2017]


 

Under which circumstances a trading venue may cancel, vary or correct a transaction?

 

Answer 22


Trading venues enabling or allowing algorithmic trading through their systems shall be able to cancel or revoke transactions in case of malfunctioning of the trading venue’s mechanisms to manage volatility or of the trading system in the context of disorderly trading conditions, according to Article 18 of RTS 7.


However, Article 47(1)(d) of MiFID II also establishes the general organisational requirement for all trading venues “to have transparent and non-discriminatory rules and procedures that provide for fair and orderly trading and establish objective criteria for the efficient execution of orders”. Therefore, the rulebook of a trading venue may foresee other exceptional situations in which transactions might be cancelled provided that those situations are transparent and non-discriminatory.

 

Question 23 [Last update: 03/10/2017] - outdated

 

Are the suitability checks and controls a DEA provider should perform on clients using the service also applicable in case of clients that are not investment firms authorised in the EU?

 

Answer 23

 

Yes, the obligations that fall on a DEA provider as per Article 17(5) of MiFID II and as specified in RTS 6 apply regardless whether the client is an authorised EU investment firms or not. In particular, all clients accessing an EU trading venue through the sub-delegated DEA should be subject to the controls and suitability checks of Article 17(5) of MiFID II as well as provisions of Articles 19 to 23 of RTS 6.

 

Question 23 [Last update: 28/03/2018]

 

Are the suitability checks and controls a DEA provider should perform on clients using the service also applicable in case of clients that are not investment firms authorised in the EU? Where a DEA client extends its access to its own clients, is the DEA provider responsible for the conduct of these sub-delegated clients?

 

Answer 23

 

Yes, the obligations that fall on a DEA provider as per Article 17(5) of MiFID II and as specified in RTS 6 apply regardless whether the client is an authorised EU investment firms or not.

 

In particular, the DEA provider retains responsibility for all clients accessing an EU trading venue through its DEA, including the sub-delegated DEA clients, in relation to the requirements of Article 17(5) of MiFID II as well as provisions of Articles 19 to 23 of RTS 6.

 

In order to fulfil its responsibility, the DEA provider must have access to information on its DEA clients, irrespective of DEA clients’ jurisdiction or their authorisation status. A DEA provider may not provide services to its clients, including sub-delegated clients, unless all information can be made available to the Competent Authority of the trading venue for its supervisory and enforcement purposes.

 

The DEA provider should also clarify in the binding written agreement that the DEA service will be suspended or withdrawn from the client if the provider is not satisfied that continued access would be consistent with its rules and procedures for fair and orderly trading and market integrity - this includes a situation where the client fails to supply a reasonable explanation for a suspicious trading pattern or inappropriate trading behaviour that may involve market abuse.

 

Where a DEA sub-delegation is allowed, the DEA provider should require its DEA clients to have a provision to enable the DEA provider to have access to information on their sub- delegated clients’ trading activities for the express purpose of enabling the DEA provider to provide information to the Competent Authority of the trading venue.

 

Furthermore, trading venues must observe Article 22(3) of RTS 7 when permitting sponsored access, and where appropriate DMA, to their members and participants. TVs should clearly state in their rules the circumstance in which the TV suspends or terminates the provision of DEA, for example, where the conduct of a DEA client is reasonably suspected to be abusive.

 

Question 24 [Last update: 15/11/2017]

 

Can DEA clients accessing an EU trading venue through sub-delegated DEA benefit from the exemption offered under Article 2(1)(d) of MiFID II?

 

Answer 24

 

Article 2(1)(d) of MiFID II exempts persons dealing on own account in financial instruments from the requirement to be authorised as a MiFID investment firm. However, it also lists a set of circumstances where such an exemption does not apply, including where such persons have DEA to a trading venue.

 

Article 4(1)(41) of MiFID II defines DEA as “an arrangement where a member or participant or client of a trading venue permits a person to use its trading code so the person can electronically transmit orders relating to a financial instrument directly to the trading venue”. A person who directly interacts with the member to obtain the use of the trading code will be the person granted permission under an arrangement. The DEA provider has direct knowledge of that person’s use and must be taken to allow it; such a person (Tier 1 DEA client) therefore should be understood to have DEA to a trading venue.

 

However, in some cases a DEA provider may allow a DEA user to sub-delegate the access rights onto a third entity (Tier 2 DEA client). Unlike a Tier 1 DEA client who directly interacts with the member to obtain the use of the trading code, a Tier 2 DEA client would, in most cases, not technically be in possession of the trading code of a DEA provider. The trading code is not passed down to the ultimate users of DEA, but only appended to the order message by the DEA provider before being submitted to the trading venue. Therefore, ESMA does not consider such Tier 2 DEA clients as having DEA for the purposes of Article 2(1)(d) of MiFID II.

 

ESMA notes that any risks posed by Tier 2 DEA clients are indirectly regulated through the provisions of Article 17(5) of MiFID II as well as Articles 22 and 23 of RTS 6.

 

In addition, Article 21(4) of RTS 6 requires the DEA providers to be able to identify the different order flows from the beneficiaries of such sub-delegation without being required to know the identity of the beneficiaries of such arrangement.

 

Question 25 [Last update: 15/11/2017]

 

Does a firm need to be authorised as an investment firm under MiFID II to provide DEA to an EU trading venue?

 

Answer 25

 

Yes, Article 48(7) of MiFID II provides that trading venues should only permit a member or participant to provide DEA “if they are investment firms authorised under [MiFID II] or credit institution authorised under Directive 2013/36/EU”. Therefore, non-EU firms (including non-EU firms licensed in an equivalent jurisdiction) or EU firms without a MiFID II licence are not allowed to provide DEA to their clients. This applies regardless of where the clients using the DEA service are located.

 

 

 

 

Questions and Answers on MiFID II and MiFIR market structures topics, ESMA70-872942901-38

 

5.2 Organised Trading Facilities (OTFs)

 

Question 19 [Last update: 03/10/2017]

 

How do the OTF best execution obligations apply when third-party brokers are clients of the OTF or when these brokers provide Direct Electronic Access (DEA) (see Article 4(1)(41) of MiFID II)?

 

Answer 19

 

When an investment firm or a market operator operating an OTF receives orders or indications of interest from a broker acting on behalf of its own clients, the operator of the OTF should be implementing its own best execution policy when executing the order from the broker orders as it owes its user clients (the broker) the duty of best execution. The broker should determine that the OTF it selects allows it to comply with its best execution obligations towards its own clients. To that end, the broker should conduct a performance assessment of the OTF including how discretion is exercised. In the specific case of DEA to an OTF, the DEA order is entered in the OTF client’s name (the broker) and the OTF operator should execute the DEA order as it would for any OTF client order. Alternatively, the operator of the OTF may decide not to permit DEA to its system. ESMA notes that a DEA order could be considered as a client specific instruction to the broker providing the DEA arrangement to its clients.

 

 

 

 

Questions and Answers on MiFID II and MiFIR investor protection and intermediaries topics, ESMA35-43-349

 

1 Best execution

 

Question 16 [Last update: 3 October 2017]

 

How do the OTF best execution obligations apply when third-party brokers are clients of the OTF or when these brokers provide Direct Electronic Access (DEA) to the OTF (see Article 4(1)(41) of MiFID II)?

 

Answer 16

 

When an investment firm or a market operator operating an OTF receives orders or indications of interest from a broker acting on behalf of its own clients, the operator of the OTF should be implementing its own best execution policy when executing the order from the broker as it owes its user clients (the broker) the duty of best execution. The broker should determine that the OTF it selects allows it to comply with its best execution obligations towards its own clients. To that end, the broker should conduct a performance assessment of the OTF including how discretion is exercised.

 

In the specific case of DEA to an OTF, the DEA order is entered in the OTF client’s name (the broker) and the OTF operator should execute the DEA order as it would for any OTF client order. Alternatively, the operator of the OTF may decide not to permit DEA to its system.

 

ESMA notes that a DEA order could be considered as a client specific instruction to the broker providing the DEA arrangements to its clients (see Q.16).

 

Question 17 [Last update: 3 October 2017]

 

Should an investment firm using direct electronic access (DEA) services provided by an intermediary firm (such as a broker) list the execution venue selected via the DEA arrangement (under the RTS 28 reporting obligation), or the broker providing the DEA service (under the report to be published under Article 65(6) of the Delegated Regulation)?

 

Answer 17

 

Article 4(1)(41) of MiFID II defines DEA as arrangements where a member or participant or client of a trading venue permits a person to use its trading code. ESMA considers that the provider of DEA is the firm executing orders. As such, an investment firm using DEA services to specifically direct an order to a particular venue would be expected to list the intermediary firm providing that service for the purposes of the report to be published under Article 65(6) of the Delegated Regulation (which is consistent with the RTS 28 report). In these instances, the investment firm would be considered as giving a specific instruction to the intermediary providing DEA regarding the choice of the execution venue. Correspondingly, the intermediary providing DEA service would still have an obligation to include trades executed via such access arrangements in its RTS 28 reports, although these trades could be classified as “directed orders” given the venue on which orders are executed is specified by the client (as set out in Article 2(c) of RTS 28). This differs from a situation where the intermediating broker retains discretion over some parameters of the execution of the order, particularly, the venue destination, including where a broker’s smart order router determines where an order is executed.

 

While transactions are intermediated by the broker providing the DEA service, ESMA also recognises that the objective of the report to be published under Article 65(6) of the Delegated Regulation is to help clients understand the execution practices of investment firms transmitting or placing orders via DEA services and directing the choice of execution venues (as outlined above), and this objective is best served by the provision of information about the execution venues orders are routed to (where the investment firm is exercising discretion over the choice of execution venue). In order to ensure that the report provides a complete picture of the investment firm’s order routing arrangements, ESMA considers that the investment firms should also disclose the identity of the main venues it commonly selects via DEA arrangements and the existence of any close links and specific arrangements with such execution venues, in its summary of execution quality (which, as required by Article 65(6), must be consistent with the information to be provided in accordance with Article 3(3) of RTS 28).

 

 

 

 

Guidance ICE Futures Europe and ICE Endex Guidance on Member Requirements under MiFID II, June 2017

 

Firms that may provide Direct Electronic Access

 

Under MiFID II and with reference to the UK Government’s draft amendments to the Recognition Requirements Regulations to transpose MiFID II into UK Law5 and the Dutch Authority for the Financial Markets (AFM)’s Guidance on the MiFID II requirements6, ICE Futures Europe and ICE Endex may permit Members to provide DEA (“DEA Providers”) only if the Member is:

 

(i) an investment firm authorised in accordance with MiFID II ("MiFID Investment Firm");


(ii) a credit institution authorised under Directive 2013/36/EU ("Credit Institution");


(iii) exempt from MiFID under Articles 2.1(a), (e), (i), or (j) of MiFID II and for IFEU is authorised in the UK to provide investment services and activities. Authorisation is not required in the Netherlands in this instance;


(iv) a third country firm providing DEA subject to an equivalent regime under Articles 46(1) and 47(3) of MiFIR;


(v) a third country firm providing DEA in accordance with the relevant UK or Dutch national regime for the purposes of Article 54.1 (transitional provisions) of MiFIR - i.e. in the UK, providing services subject to the Overseas Persons Exclusion or in the Netherlands, in accordance with the Dutch Financial Supervision Act, is a firm from Switzerland, Australia or the USA; or


(vi) a third country firm which does not come within paragraph (iv) or (v) and is otherwise permitted to provide DEA under UK or Dutch Law.

 

If any Member is currently providing DEA to clients and does not meet any of the above criteria, they should seek their own legal advice on the matter. For further information, please contact the relevant Exchange.

 

DEA Providers should also consider the authorisation status of their clients. Prior to the implementation of MiFID II, an exemption is available from the scope of MiFID for firms that deal on own account and do not provide any other investment services and activities. This means that they may not have been investment firms for the purposes of MiFID.

 

However, under MiFID II, these exemptions will not be available where a:


-  firm dealing on own account in instruments other than commodity derivatives, emission allowances, or derivatives on emission allowances, accesses a trading venue through DEA or is a market maker, unless the firm is a non-financial entity executing transactions for hedging purposes;


-  firm deals on own account, including market makers, in commodity derivatives or emission allowances or derivative products, unless the activity is ancillary to their main business;


- firm applies a high frequency algorithmic trading technique ("HFT").

 

Such firms may be able to rely on the third-country provisions in MiFIR (Articles 46 and 47) or the UK Overseas Person Exclusion regime or any similar national exemptions or regulatory perimeter exclusions under the laws of other EEA countries. Guidance on MiFID II requirements has been issued by the AFM in the Netherlands and in the UK, MiFID II Transposition Draft legislation has been published by the UK Government, which covers DEA. Legal advice should then be sought by Members and their clients. For further information, please contact the relevant Exchange.

 

Additional Membership Criteria for DEA Providers

 

DEA Providers must meet certain criteria and have in place effective systems and controls before they can provide their clients with access to the trading venue, which ensure:


-  that the suitability of the client(s) using this service have been reviewed and assessed;


-  clients using the service are prevented from exceeding appropriate credit and risk limits;


-  trading by DEA clients is properly monitored; and


-  risk controls prevent trading by DEA clients which:


o may create risks to the Member itself;


o may create, or contribute to, a disorderly market;


o may breach the Market Abuse Regulation (MAR) or the Exchange Regulations.

 

These criteria include:


-  DEA Providers must always retain responsibility for the trading their DEA clients carry out in their name and for the effectiveness of the controls;


-  DEA Providers must establish policies and procedures to ensure that the trading of DEA clients complies with the relevant Exchange's Rules and Regulations and allows the DEA Providers to meet the requirements applicable to DEA.


-  DEA Providers must apply pre- and post-trade controls on the order flow of each of their DEA clients, as well as have in place real-time monitoring and market surveillance controls.


-  DEA Providers may use their own pre- and post-trade controls, controls offered by a third party, or the controls offered by the Exchanges, and they must have sole entitlement to set or modify the parameters of such limits that apply to the controls. The controls to be applied by DEA Providers must be separate and distinct from those of DEA clients. In particular, and regardless of the application by the DEA client of its own pre- and post-trade controls, real-time monitoring and market surveillance controls, the orders of DEA clients must always pass through the pre-trade controls that are set and controlled by the DEA Provider.


-  Pre-trade controls on order submission must be based on the credit and risk limits which the DEA Provider applies to the trading activity of its clients, based on the initial due diligence and periodic review of the client.


-  The DEA Provider must monitor the effectiveness of its pre- and post-trade controls on an on-going basis.


- The controls applied to DEA clients using sponsored access must be as stringent as those imposed on DEA clients using DMA.
The Exchanges recommend that such systems used by the DEA Provider have the ability to:


-  monitor any orders submitted by DEA clients using the trading code of the DEA Provider;


-  automatically block or cancel orders from:


o individuals which operate trading systems that submit orders related to algorithmic trading and which lack authorisation to send orders through DEA;

 

o a DEA client in financial instruments that a DEA client does not have permission to trade;

 

o a DEA client when they breach the DEA Provider's risk management thresholds.;


-  stop order flow transmitted by their DEA clients;


-  suspend or withdraw DEA services to any clients where the DEA Provider is not satisfied that continued 
access would be consistent with their rules and procedures for fair and orderly trading and market 
integrity; and


-  carry out, whenever necessary, a review of the internal risk control systems of a DEA client.


DEA Providers must have in place procedures to evaluate, manage and mitigate market disruption and firm- wide risk, and must be able to identify the persons to be notified in the event of an error resulting in violations of the risk profile, or potential breaches of the Exchange Regulations.


DEA Providers must at all times have the ability to identify its different DEA clients and the trading desks and traders of those DEA clients, who submit orders through the DEA Provider's systems by assigning unique identification codes to them.


Where a DEA Provider allows a client to sub-delegate the DEA access it receives to its own clients, the DEA Provider must be able to identify the different order flows from the sub-delegated entities. For these purposes, it will not be necessary for the DEA Provider to know the identity of these sub-delegated entities.


DEA Providers must record the relevant data relating to the orders submitted by their DEA clients, including modifications and cancellations, the alerts generated by their monitoring systems and the modifications made to their filtering process.


DEA Providers on ICE Futures Europe may be required on a regular or ad hoc basis to provide to the FCA:


-  a description of the systems used;


-  evidence that those systems have been applied; and


-  the information stored relating to:


o the due diligence performed on DEA clients; and

 


o the arrangements, systems and controls the DEA Provider has in place with respect to its DEA clients.


Sponsored Access

 

The provision of sponsored access will be subject to the authorisation of the relevant Exchange. Members must apply the same pre-trade and post-trade risk limits and controls that they are required to have in place as Members to clients accessing the trading platform through sponsored access. Please note that the Exchanges view firms accessing through WebICE as sponsored access clients.

 

...

 

Client due diligence

 

Additional and specific due diligence requirements apply to DEA Providers under MiFID II. DEA Providers, whether they provide Direct Market Access ("DMA") or Sponsored Access, are responsible for ensuring that their DEA clients comply with Exchange Regulations. To fulfil this obligation, DEA Providers must perform due diligence on prospective clients to ensure they meet the requirements set by the Exchange(s) or under any other applicable law, including MiFID II.


The due diligence must ensure that the DEA Provider discharges its obligations under the Exchange Rules, and must cover relevant matters including:


-  the governance and ownership structure;


-  the types of strategies to be undertaken by the prospective DEA client;


-  the operational set-up, the systems and the pre- and post-trade controls and the real-time monitoring 
of the prospective DEA client. Where the DEA Provider allows clients to use third-party trading software for accessing trading venues, it must ensure that the software includes pre-trade controls that are equivalent to the pre-trade controls set out in this Guidance;


-  the responsibilities within the prospective DEA client for dealing with actions and errors;


-  the historical trading pattern and behaviour of the prospective DEA client;


-  the level of expected trading and order volume of the prospective DEA client;


-  the ability of the prospective DEA client to meet its financial obligations to the DEA Provider;


-  the disciplinary history of the prospective DEA client, where available; and


-  verifying that the client is/was not the target of any Sanction.

 


Where a DEA Provider allows a client to sub-delegate the access it receives to its own clients, the DEA Provider must ensure that, before granting that client access, it has a due diligence framework in place that is at least equivalent to the one described above. 
DEA Providers are required to perform due diligence before giving clients access to the Exchanges and must perform a risk-based reassessment of the adequacy of their clients' systems and controls on an annual basis.


DEA Providers must have in place a binding written agreement between themselves and their clients which:

 

- details the rights and obligations of both parties arising from the provision of their services; and


- states that the DEA Provider is responsible for ensuring the client complies with the requirements of MiFID II and Exchange Rules.

 

...

 

Authorisation requirements for Members


Authorisation


Under the Exchange Regulations, Members are required to have in place all necessary authorisations to conduct their business and hold all licences, permits, consents, contracts and other approvals (if any) that are required to carry out business on the relevant Exchange, or be able to rely on an available exemption. This also includes ensuring the Members’ clients have the relevant authorisation and permission to conduct business on the Exchange or are able to rely on an available exemption.

 

Firms that may provide Direct Electronic Access

 

Under MiFID II and with reference to the UK Government’s draft amendments to the Recognition Requirements Regulations to transpose MiFID II into UK Law and the Dutch Authority for the Financial Markets (AFM)’s Guidance on the MiFID II requirements, ICE Futures Europe and ICE Endex may permit Members to provide DEA (“DEA Providers”) only if the Member is:


(i) an investment firm authorised in accordance with MiFID II ("MiFID Investment Firm");


(ii) a credit institution authorised under Directive 2013/36/EU ("Credit Institution");


(iii) exempt from MiFID under Articles 2.1(a), (e), (i), or (j) of MiFID II and for IFEU is authorised in the UK to provide investment services and activities. Authorisation is not required in the Netherlands in this instance;


(iv) a third country firm providing DEA subject to an equivalent regime under Articles 46(1) and 47(3) of MiFIR;


(v) a third country firm providing DEA in accordance with the relevant UK or Dutch national regime for the purposes of Article 54.1 (transitional provisions) of MiFIR - i.e. in the UK, providing services subject to the Overseas Persons Exclusion or in the Netherlands, in accordance with the Dutch Financial Supervision Act, is a firm from Switzerland, Australia or the USA; or


(vi) a third country firm which does not come within paragraph (iv) or (v) and is otherwise permitted to provide DEA under UK or Dutch Law.

 

If any Member is currently providing DEA to clients and does not meet any of the above criteria, they should seek their own legal advice on the matter. For further information, please contact the relevant Exchange.

 

DEA Providers should also consider the authorisation status of their clients. Prior to the implementation of MiFID II, an exemption is available from the scope of MiFID for firms that deal on own account and do not provide any other investment services and activities. This means that they may not have been investment firms for the purposes of MiFID. However, under MiFID II, these exemptions will not be available where a:


-  firm dealing on own account in instruments other than commodity derivatives, emission allowances, or derivatives on emission allowances, accesses a trading venue through DEA or is a market maker, unless the firm is a non-financial entity executing transactions for hedging purposes;


-  firm deals on own account, including market makers, in commodity derivatives or emission allowances or derivative products, unless the activity is ancillary to their main business; 
- firm applies a high frequency algorithmic trading technique ("HFT"). Such firms may be able to rely on the third-country provisions in MiFIR10 or the UK Overseas Person Exclusion regime or any similar national exemptions or regulatory perimeter exclusions under the laws of other EEA countries. Guidance on MiFID II requirements has been issued by the AFM in the Netherlands and in the UK, MiFID II Transposition Draft legislation has been published by the UK Government, which covers DEA. Legal advice should then be sought by Members and their clients. For further information, please contact the relevant Exchange.

 

Additional Membership Criteria for DEA Providers

 

DEA Providers must meet certain criteria and have in place effective systems and controls before they can provide their clients with access to the trading venue, which ensure:


-  that the suitability of the client(s) using this service have been reviewed and assessed;


-  clients using the service are prevented from exceeding appropriate credit and risk limits;


-  trading by DEA clients is properly monitored; and


-  risk controls prevent trading by DEA clients which:


o may create risks to the Member itself;


o may create, or contribute to, a disorderly market;


o may breach the Market Abuse Regulation (MAR) or the Exchange Regulations.


These criteria include:


-  DEA Providers must always retain responsibility for the trading their DEA clients carry out in their name and for the effectiveness of the controls;


-  DEA Providers must establish policies and procedures to ensure that the trading of DEA clients complies with the relevant Exchange's Rules and Regulations and allows the DEA Providers to meet the requirements applicable to DEA.


-  DEA Providers must apply pre- and post-trade controls on the order flow of each of their DEA clients, as well as have in place real-time monitoring and market surveillance controls.


-  DEA Providers may use their own pre- and post-trade controls, controls offered by a third party, or the controls offered by the Exchanges, and they must have sole entitlement to set or modify the parameters of such limits that apply to the controls. The controls to be applied by DEA Providers must be separate and distinct from those of DEA clients. In particular, and regardless of the application by the DEA client of its own pre- and post-trade controls, real-time monitoring and market surveillance controls, the orders of DEA clients must always pass through the pre-trade controls that are set and controlled by the DEA Provider.


-  Pre-trade controls on order submission must be based on the credit and risk limits which the DEA Provider applies to the trading activity of its clients, based on the initial due diligence and periodic review of the client.


-  The DEA Provider must monitor the effectiveness of its pre- and post-trade controls on an on-going basis.


- The controls applied to DEA clients using sponsored access must be as stringent as those imposed on DEA clients using DMA.


The Exchanges recommend that such systems used by the DEA Provider have the ability to:


-  monitor any orders submitted by DEA clients using the trading code of the DEA Provider;


-  automatically block or cancel orders from:


o individuals which operate trading systems that submit orders related to algorithmic trading and which lack authorisation to send orders through DEA;

o a DEA client in financial instruments that a DEA client does not have permission to trade;

o a DEA client when they breach the DEA Provider's risk management thresholds.;


-  stop order flow transmitted by their DEA clients;


-  suspend or withdraw DEA services to any clients where the DEA Provider is not satisfied that continued access would be consistent with their rules and procedures for fair and orderly trading and market integrity; and


-  carry out, whenever necessary, a review of the internal risk control systems of a DEA client.


DEA Providers must have in place procedures to evaluate, manage and mitigate market disruption and firm-wide risk, and must be able to identify the persons to be notified in the event of an error resulting in violations of the risk profile, or potential breaches of the Exchange Regulations.

 

DEA Providers must at all times have the ability to identify its different DEA clients and the trading desks and traders of those DEA clients, who submit orders through the DEA Provider's systems by assigning unique identification codes to them.

 

Where a DEA Provider allows a client to sub-delegate the DEA access it receives to its own clients, the DEA Provider must be able to identify the different order flows from the sub-delegated entities. For these purposes, it will not be necessary for the DEA Provider to know the identity of these sub-delegated entities.

 

DEA Providers must record the relevant data relating to the orders submitted by their DEA clients, including modifications and cancellations, the alerts generated by their monitoring systems and the modifications made to their filtering process.
DEA Providers on ICE Futures Europe may be required on a regular or ad hoc basis to provide to the FCA:


- a description of the systems used;


- evidence that those systems have been applied; and


-  the information stored relating to:


o the due diligence performed on DEA clients; and


o the arrangements, systems and controls the DEA Provider has in place with respect to its DEA clients.

 

 

 

 

 

 

IMG 0744

    Documentation    

 

 

 

 

Questions and Answers on MiFID II and MiFIR market structures topics, ESMA70-872942901-38

 

MiFID II, Article 4(1)(41), Article 17(5) and Article 48(7)

 

Commission Delegated Regulation (EU) 2017/565 of 25 April 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council as regards organisational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive, Article 20, Recitals 20, 25 - 27

 
Commission Delegated Regulation (EU) 2017/584 of 14 July 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to regulatory technical standards specifying organisational requirements of trading venues (RTS 7), Recitals 15 - 17

 

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

 

Commission Delegated Regulation (EU) 2017/589 of 19 July 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to regulatory technical standards specifying the organisational requirements of investment firms engaged in algorithmic trading (RTS 6), Recitals 13 - 15, Articles 19 - 23 (Chapter III)

 

Questions and Answers on MiFID II and MiFIR investor protection and intermediaries topics, ESMA35-43-349

 

Guidelines Transaction reporting, order record keeping and clock synchronisation under MiFID II, 10 October 2016, ESMA/2016/1452, p. 21

 

Financial Conduct Authority, Markets in Financial Instruments Directive II Implementation – Consultation Paper I (CP15/43), December 2015, p. 120, 121

 

Guidance ICE Futures Europe and ICE Endex Guidance on Member Requirements under MiFID II, June 2017

 

Commission Staff Working Document Impact Assessment Accompanying the document Commission Delegated Regulation supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council with regard to definitions, transparency, portfolio compression and supervisory measures on product intervention and positions {C(2016) 2860 final} {SWD(2016) 156 final}, 18.5.2016, SWD(2016) 157 final, p. 72, 73

 

International Organization of Securities Commissions (IOSCO), Policies on Direct Electronic Access, February 2009

 

 

 

 

clip2

    Links    

 

 

 

 

Direct Market Access (DMA)

 

Algorithmic trading

 

 

 

 

 

 

  

 

Last Updated on Tuesday, 31 December 2019 20:19
 

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