Questions and Answers on MiFID II and MiFIR transparency topics, ESMA70-872942901-35
Questions and Answers on MiFID II and MiFIR Systematic Internaliser Regime
Question 1 [Last update: 03/11/2016]
By when will ESMA publish information about the total number and the volume of transactions executed in the Union and when do investment firms have to perform the assessment whether they should be considered as systematic internalisers for the first time in 2018 as well as for subsequent periods?
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 does not provide for any transitional provision which would allow the systematic internaliser regime to be fully applicable as of 3 January 2018. In the absence of such provisions, the first calculations are expected to be performed only when, in accordance with Article 17 of the Commission Delegated Regulation of 25.4.2016, there will be 6 months of data available.
In accordance with the clarifications provided below:
(i) ESMA will publish the necessary data (EU wide data) for the first time by 1 August 2018 covering a period from 3 January 2018 to 30 June 2018.
(ii) Investment firms will have to perform their first assessment and, where appropriate, comply with the systematic internaliser obligations (including notifying their National Competent Authority (NCA)) by 1 September 2018.
This timeline applies also to investment firms trading in illiquid instruments. While it is possible for those firms to carry out part of the test based on data at their disposal, the complete determination of the SI activity necessitates an assessment of the investment firms OTC-trading activity in a particular instrument in relation to overall trading in the Union. In order to ensure a consistent assessment and to ensure that all investment firms are treated in the same manner, for all instruments, irrespective of their liquidity status, the assessment should therefore be performed by 1 September 2018.
Similarly, although Commission Delegated Regulation of 25.4.2016 allows shorter look-back periods for newly issued instruments compared to the six months described above, ESMA considers that it is important to ensure a level playing field between all instruments and, therefore, suggests to apply the schedule proposed above also to newly issued instruments - i.e. first publication by ESMA of the necessary EU-wide data by 1 August 2018 and earliest deadline to comply, where necessary, with the SI regime set on 1 September 2018.
It is nevertheless important to stress that investment firms should be able to opt-in to the systematic internaliser regime for all financial instruments from 3 January 2018, for example, as a means to comply with the trading obligation for shares.
In accordance with Article 94 of MiFID II, the systematic internaliser definition and the transparency regime applicable to internalisers in shares admitted to trading on a regulated market under MiFID I will be repealed by MiFID II by 3 January 2018. Those firms, following the publication of the data of the first six months from 3 January 2018, will also have to determine whether their activity is frequent, systematic and substantial on the basis of the available data published in accordance with this note.
For subsequent assessments, ESMA intends to publish the necessary information within a month after the end of each assessment period as defined under Article 17 of the Commission Delegated Regulation of 25.4.2016 – i.e. by the first calendar day of months of February, May, August and November every year. After the first assessment, investment firms are expected to perform the calculations and comply with the systematic internaliser regime (including notification to their NCA) no later than two weeks after the publication by ESMA – i.e. by the fifteenth calendar day of the months of February, May, August and November every year.
Question 2 [Last update: 31/01/2017]
Do the calculations to identify if an investment firm is systematic internaliser have to be carried out at legal entity level or a group level? How are branches of investment firms being treated?
The definition of systematic internaliser under Article 4(1)(20) of MiFID II refers to "investment firms" established in the EU and, therefore, the calculations should be carried out at legal entity level. For EU investment firms operating branches in the Union, the activity of those branches would need to be consolidated for the purpose of the systematic internaliser calculations.
Question 3 [Last update: 31/01/2017]
i. Should investment firms, when determining if they are a systematic internaliser, include (i) transactions that are not contributing to the price formation process and/or are not reportable and (ii) primary market transactions?
ii. Should investment firms, when determining if they are a systematic internaliser, include trades executed on own account on a trading venue but following an order from the client?
iii. Are off order book trades that are reported to a regulated market, MTF or OTF under its rules excluded from the quantitative thresholds for determining when an investment firm is a systematic internaliser?
i. Article 13 of RTS 1 and Article 12 of RTS 2 exempt investment firms from reporting certain types of transactions for the purposes of post-trade transparency. ESMA is of the view that those types of transactions should not be part of the calculations for the purposes of the definition of the systematic internaliser regime, both for the numerator and the denominator of the quantitative thresholds specified in the Commission delegated regulation [add reference number once published on the OJEU]. The types of transactions included in Articles 13 of RTS 1 and 12 of RTS 2 are technical and cannot be characterised as transactions where an investment firm is executing a client order by dealing on own account. More importantly, the lack of a reporting obligation for those types of transactions would be a considerable challenge for competent authorities to supervise and for investment firms to comply with the systematic internaliser regime.
Primary market transactions in securities as well as creation and redemption of ETFs' units should not be included in the calculations.
ii. Article 12(6) of RTS 1 and in Article 7(7) of RTS 2 clarify that two matching trades entered at the same time and for the same price with a single party interposed are considered as a single transaction. An investment firm may, on the back of a client order, execute a trade on own account on a trading venue and back it immediately to the original client. While the trade can be broken down into two transactions - the first transaction executed on own account by the investment firm on the trading venue and the second transaction executed between the investment firm and the client - such transactions should be considered economically as one trade. ESMA is of the view that where the market leg is executed on a trading venue and immediately backed to the client at the same price, the investment firm is not deemed to execute a client trade outside a regulated market, an MTF or an OTF. Therefore, only one trade should be counted for the denominator for determining the systematic internaliser activity (total trading in the EU), and no trade should be included in the numerator when determining whether an investment firms is a systematic internaliser.
However, in case the market leg transaction is not immediately backed to the client or in case the price is not the same, the trades should be counted as two for the denominator and the trade with the client should be counted for the numerator.
iii. An investment firm dealing on a trading venue is not deemed to act as a systematic internaliser. A trading venue is a multilateral system that operates in accordance with the provisions of Title II of MiFID II concerning MTFs and OTFs or the provisions of Title III concerning regulated markets. According to recital (7) of MiFIR a market which is composed by a set of rules that governs aspects related to membership, admission of instruments to trading, trading between members, reporting and, where applicable, transparency obligations is a regulated market or an MTF.
A transaction is deemed to be executed on a trading venue if it is carried out through the systems or under the rules of that trading venue. There is no requirement for the transactions to be executed on an electronic order book for the trade to be subject to the trading venue's rules. Therefore, only off order book transactions that benefit from a waiver from pre-trade transparency should be considered as executed on a trading venue, and should not count for the numerator when determining whether an investment firm is a systematic internaliser.
Question 4 [Last update: 03/10/2017]
a) On which level is the systematic internaliser threshold to be calculated for derivatives? On a sub-class level or on a more granular level?
b) On which level is the systematic internaliser threshold to be calculated for structured finance products (SFPs)?
c) What constitutes a 'class of bonds' under Article 13 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? Do senior, subordinated or convertible bonds from the same issuer constitute different classes?
d) On which level is the systematic internaliser threshold to be calculated for emission allowances?
a) The calculation should be performed at the most granular class level as identified in RTS 2. Where an investment firm meets the thresholds for such a class, it should be considered as a systematic internaliser for all derivatives within that most granular class.
With respect to equity derivatives, the sub-classes as defined in Table 6.2 of Annex III of RTS 2 for LIS and SSTI should be used.
b) For SFPs, calculations should be performed at ISIN level and where, for a specific ISIN, an investment firm is above the thresholds prescribed, it should be considered a systematic internaliser for all SFPs issued by the same entity or by any entity within the same group.
c) A class of bonds issued by the same entity, or by any entity within the same group is a subset of a class of bonds in table 2.2 of Annex III of RTS 2 (sovereign bond, other public bond, convertible bond, covered bond, corporate bond, other bond). Hence, where an investment firm passes the relevant thresholds in a bond it will be considered to be a systematic internaliser in all bonds belonging to the same class of bonds according to table 2.2. of Annex III of RTS 2 issued by the same entity, or by any entity within the same group.
It is therefore possible to distinguish between, for instance, corporate bonds and convertible bonds as different classes of bonds, but the debt seniority of a bond does not constitute a different class.
d) The calculation should be performed at the level of the emission allowance type. In other words, both the numerator and the denominator shall refer to the same sub-asset class level as identified in RTS 2.
Question 5 [Last update: 31/05/2017]
a) Can systematic internalisers meet their quoting obligations under Article 18(1) of MiFIR
for liquid instruments by providing executable quotes on a continuous basis?
b) Can client orders routed by an automated order router (AOR) system be considered as 'prompting for a quote' according to Article 18(1)(a) of MiFIR?
c) For how long should quotes provided by systematic internalisers be firm, or executable?
d) What are the obligations for systematic internalisers dealing in non-equity instruments for which there is no liquid market under Article 18(2) of MiFIR?
e) Which arrangements should systematic internalisers use when publishing firm quotes? Should these be the same arrangements as for equity instruments?
f) Should systematic internalisers disclose their identity when publishing firm quotes?
a) The systematic internaliser regime for non-equity instruments is predicated around a protocol whereby the systematic internaliser provides a quote or quotes to a client on request. However, nothing prevents the systematic internaliser, especially in the most liquid instruments, to stream prices to clients. Where those prices are firm, i.e. executable by clients up to the displayed size (provided the size is less than the size specific to the instrument), the systematic internaliser would be deemed to have complied with the quoting obligation under Article 18(1) of MiFIR. The systematic internaliser can, in justified cases, execute orders at a better price than the streaming quote.
b) Yes. The provisions in Article 18 of MiFIR are neutral concerning the technology used for prompting quotes. A systematic internaliser can be prompted for and provide quotes through any electronic system.
c) The quote should remain valid for a reasonable period of time allowing clients to execute against it. A systematic internaliser may update its quotes at any time, provided at all times that the updated quotes are the consequence of, and consistent with, genuine intentions of the systematic internaliser to trade with its clients in a non-discriminatory manner.
d) Where a systematic internaliser receives a request from a client for a quote for an instrument which is traded on a trading venue and for which there is not a liquid market, and the systematic internaliser agrees to provide that quote, the systematic internaliser does not have an obligation to make this quote available to other clients and to make it public. However, Article 18(2) of MiFIR requires the systematic internaliser to disclose to clients on request the quotes provided in illiquid financial instruments. That obligation can be met by allowing clients, on a systematic or on a request basis, to have access to those quotes.
This is without prejudice to the possibility for systematic internalisers to benefit from a waiver for this obligation where, as set out in the last sentence of Article 18(2) of MiFIR, the conditions in Article 9(1) of MiFIR are met.
e) Article 13 of the Commission Delegated Regulation (EU) No 2017/567 specifies how systematic internalisers should make their quotes public and easily accessible for equity instruments. There are no corresponding provisions on the publication arrangements for systematic internalisers for non-equity instruments, but Article 18(8) of MiFIR requires the quotes to be “made public in a manner which is easily accessible to other market participants”.
ESMA considers that systematic internalisers should use the same means and arrangements when publishing firm quotes in non-equity instruments as for equity instruments as specified in Article 13 of the Commission Delegated Regulation (EU) No 2017/567. Furthermore, the quotes should be made public in a machine-readable format as specified in the above mentioned Regulation and the quotes should be time-stamped as specified in Article 9(d) of RTS 1.
f) Yes, as for equity instruments, systematic internalisers should disclose their identity when making quotes public through the facilities of a regulated market or an APA.
Question 6 [Last update: 31/05/2017]
a) What information should the notification from systematic internalisers to their NCA contain?
b) For what period of time should an investment firm follow the obligations for systematic internalisers after crossing the relevant thresholds in a financial instrument?
c) When/How often do investment firms have to notify their NCAs of their systematic internaliser status?
a) The notification from systematic internalisers to their NCA should contain information that is at least provided at the level of the MiFIR identifier as specified in field 4 of table 2 of Annex III of RTS 1 (i.e. shares, depositary receipts, exchange traded funds, certificates and other equity-like financial instruments) and in field 3 of table 2 of Annex IV of RTS 2 (i.e. bonds, ETNs, ETCs, structured finance products, securitised derivatives, derivatives, and emission allowances) for the instruments and classes of instruments for which the investment firm is a systematic internaliser. This is without prejudice of the possibility for CAs to require the submission of more granular information if considered appropriate.
b) The obligation will last for three months after crossing the relevant thresholds in a financial instrument at the relevant quarterly assessment. The obligation period will be slightly shorter for the first assessment in 2018, which covers 1 September to 15 November 2018.
c) Investment firms are required to notify their NCA in case of a change in status, i.e. where an investment firm passed the thresholds for an instrument with a particular MiFIR identifier in the previous period, but did not meet the thresholds for any instrument with the same MiFIR identifier in the consecutive assessment period, it should notify its CA of its change of status. Where there is no change in the systematic internaliser status from one assessment period to the next (i.e. where the investment firms is still above the threshold or decides to voluntarily opt-in as systematic internaliser for any instrument with the same MiFIR identifier), the firm does not have to notify its NCA thereof.
Question 7 [Last update: 03/10/2017]
For the purpose of the SI determination, when should an investment firm be considered as “executing client orders” when dealing on own account outside of trading venues?
For the purposes of the SIs’ determination, ESMA considers that in all circumstances where an investment firm is dealing with a counterparty that is not a financial institution authorised or regulated under Union law or under the national law of a Member State (‘financial institution’), the investment firm is deemed to be executing a client order and the transaction should count towards the calculations (both the numerator and the denominator). Where the investment firm is dealing with a financial institution, ESMA considers that one party to the transaction will always act in a client capacity. Therefore, in order to determine when an investment firm is “executing client orders” when dealing on own account outside of trading venues, investment firms need to assess which of the two parties to the transactions acts in the capacity of executing client orders.
Investment firms may determine this either on a transaction by transaction basis or by type of transactions or type of counterparties. Different indicators could be used for determining which party executed a client order: e.g. whether an investment firm has classified the counterparty as a professional client, who initiated the trade or who received the instruction to deal and the extent to which the counterparty relied on the other party to conclude the transaction.
Question 8 [Last update: 03/10/2017]
What are the limitations to the commercial policy for restricting access to quotes in accordance with Article 18(5) of MiFIR?
The commercial policy needs to be set out and made available to clients in advance. The commercial policy should determine meaningful categories of clients to which quotes are made available. Systematic internalisers should only be able to group clients based on non-discriminatory criteria taking into consideration the counterparty risk, or the final settlement of the transaction.
Furthermore, a number of provisions safeguard the ability of the systematic internaliser to properly manage risk. For example, a systematic internaliser may update its quotes at any time (Article 18(3) of MiFIR) and can limit the number of transactions they undertake to enter into with clients pursuant any given quote (Article 18(7) of MiFIR).
Question 9 [Last update: 03/10/2017]
Are systematic internalisers allowed to limit the number of transactions they undertake to enter into with clients pursuant to any given quote under Article 18(7) of MiFIR to one transaction?
Yes, Systematic internalisers may limit the number of transactions they undertake to enter into with clients to one transaction. As a minimum the quote provided to a client following the request for such a quote should be potentially executable by any other clients where for example the requesting client has decided not to trade against it (or to execute only part of it). In any case, should SIs decide to establish non-discriminatory and transparent limits on the number of transactions they undertake to enter into with clients, they should make these limits public and provide a justification.
General Q&As on transparency topics
Question 8 [Last update: 03/10/2017]
Do real time post-trade transparency requirements apply equally to trading venues and systematic internalisers?
Yes, the requirements in Articles 6 and 10 of MiFIR as further specified in Article 14 of RTS 1 and Article 7 of RTS 2 apply to both trading venues and investment firms. ESMA expects that trading venues and investment firms, in particular systematic internalisers, that use expedient systems publish transactions as close to real time as technically possible. In particular, since systematic internalisers are competing with trading venues over customers’ order flow, it is important to provide for a level playing field. Therefore, trading venues and systematic internalisers using similar technology and systems should process transactions for post-trade publication at the same speed.