Questions and Answers on MiFID II and MiFIR market structures topics, ESMA70-872942901-38
Question [Last update: 31/01/2017]
Can an MTF operator be a member/participant of its own MTF?
Whether an MTF operator may become a member of its own MTF requires the application of two different MiFID II articles.
Article 19 of MiFID II does not prevent an investment firm operating an MTF to be a member of its own MTF. However, Article 19(5) prohibits investments firms and market operators operating an MTF to execute client orders against proprietary capital, or to engage in matched principal trading. As a consequence, the investment firm could only operate on its own MTF through pure agency trading.
Article 18(4) also requires the operator of an MTF to have arrangements to identify clearly and manage the potential adverse consequences for the operation of the MTF or for its members or participants, of any conflict of interests between the MTF, their owners or the investment firm and market operator operating an MTF and its sound functioning.
Appropriate management of conflict of interest is all the more important to ensure the effective implementation of Article 31 of MiFID II, which requires investment firms and market operators operating an MTF to monitor the compliance of its members and participants with the rules of the MTF and with other legal obligations.
Therefore, unless otherwise demonstrated by adequate and effective internal arrangements and procedures, ESMA is of the view that the potential conflicts of interest that may arise as a result of this would only be managed effectively by means of operating the MTF and the membership through different legal entities.
To ensure that having two separate legal entities serves a meaningful purpose, ESMA is of the view that the two investment firms should have arrangements in place that prevent information sharing on each other's activities. This would include for instance having distinct management and operational teams and physical separation of activities. Similarly, whereas some elements of the IT infrastructure could be shared, execution systems would be expected to be segregated and safeguards to be put in place to prevent information leakage across the two entities. Outsourcing from one legal entity to the other should only take place where the arrangements meet a similar test.
The arrangements described above shall be without prejudice to the ability of the MTF to monitor its participants for compliance with market rules and other legal obligations and also without prejudice to the MiFID II provisions on identification and management of conflicts of interest to be met by each of the two investment firms.
Question [Last update: 31/01/2017]
Would a trading venue locating its electronic systems on a third party data centre be required to comply with the co-location provisions under RTS 10 even where the venue is not providing the co-location service?
The principle underpinning Article 1 of RTS 10 is to ensure that electronic access to trading venues is fair and based on objective and non-discriminatory criteria. A trading venue should seek to ensure that this principle is not violated even when the connectivity service is provided by a third-party to members, participants or a client of the trading venue.
Therefore, the trading venue should take all the necessary steps to ensure that the third party proximity hosting service provider offers a fair and non-discriminatory access to all members/participants/clients of the trading venue subscribing to such services. Such a requirement may include the conclusion or amendment of an agreement between the trading venue and the service provider so as to remain fully compliant with the provisions in RTS 10.
Question [Last update: 07/07/2017]
Article 18(3) of MiFID II requires that investment firms and market operators operating an MTF or OTF establish, publish and maintain and implement transparent and non-discriminatory rules, based on objective criteria, governing access to its facility. A similar requirement is applied to regulated markets through Article 53(1) of MiFID II. What sort of behaviour or restrictions should be considered as non-objective, or discriminatory?
One of the benefits of more on-venue, pre-trade transparent trading is to broaden access to liquidity for market participants. In order for these benefits to be fully realised, it is important that trading venues do not have restrictive criteria governing their access, which place unreasonable restraints on certain market participants’ access to particular liquidity pools.
In particular, ESMA does not consider the following arrangements to be in compliance with Articles 18(3) and 53(1) of MiFID II. This is not, however, an exhaustive list of arrangements which are non-objective and discriminatory.
a) Trading venues should not require members or participants to be direct clearing members of a CCP.
Given the protections afforded to non-clearing members under MiFIR and EMIR, as well as the rules on straight through processing (STP), a trading venue should not require all its members or participants to be direct clearing members of a CCP. Trading venues may however require members or participants to enter into, and maintain, an agreement with a clearing member as a condition for access when trading is centrally cleared.
b) For financial instruments that are centrally cleared, trading venues should not allow members or participants to require other members or participants to be enabled before they are allowed to trade with each other.
There are legitimate checks that a trading venue might carry out before allowing a member or participant on to their venue. For example, in markets for non-centrally cleared financial instruments trading venues may wish to carry out credit checks, or ensure that a member or participant has appropriate capital to support the positions it intends to take on the trading venue. In a non-centrally cleared derivatives market, there may be a need for bilateral master netting agreements to be in place between participants before the trading venue can allow their trading interests to interact. Trading venues will also need to be comfortable that potential participants are meeting the regulatory requirements to be a member of a trading venue such as having appropriate systems and controls to ensure fair and orderly trading.
However, in centrally cleared markets, enablement mechanisms whereby existing members or participants of a trading venue can decide whether their trading interests may interact with a new participant’s trading interest are considered discriminatory and an attempt to limit competition. Enablement mechanisms also reduce the transparency around the liquidity available on different trading venues.
c) Trading venues should not require minimum trading activity.
Trading venues should not require minimum trading activity to become a member or participant of a trading venue, as this could restrict the access to the trading venue to large members or participants.
d) Trading venues should not impose restrictions on the number of participants that a participant can interact with.
In a request for quote (RFQ) protocol, a trading venue should not impose limits on the number of participants that a firm can request a quote from. Whilst a firm requesting a quote may, in compliance with Article 28 of MiFID II, want to limit the number of participants it requests quotes from in order to minimise the risk of unduly exposing its trading interest, which could result in it obtaining a worse price, this should not be mandated by the trading venue. For instance, where a smaller firm is requesting a quote to execute a low volume trade, it might be less concerned about the risks of exposing its trading interest, and so happier to request quotes from a larger number of market makers or liquidity providers.
Limiting the number of participants a firm can request quotes from risks restricting the ability of market participants to access liquidity pools, and only sending requests to traditionally larger dealers who they assume might have larger inventories. This simultaneously restricts the ability of the requestor to access the best pool of liquidity and reduces the likelihood of a smaller dealer receiving requests, despite it having a strong trading interest.
Question [Last update: 07/07/2017]
Can a person that is not authorised as an investment firm but meets the requirements of Article 53(3) of MiFID II be a member or participant of a regulated market or an MTF?
Yes. Article 53(3) of MiFID II provides that an entity that is not an investment firm or a credit institution can be a member of a regulated market under certain conditions, this rule being extended to MTFs by Article 19(2) of MiFID II.
ESMA considers that this provision should be read in conjunction with the requirements of Article 2(1). Under this provision, a person falling under any of the categories listed in Article 2(1) would not have to be authorised as an investment firm.
However, pursuant to Article 2(1)(d) (ii) of MiFID II, when a person dealing on own account in financial instruments other than commodity derivatives or emission allowances or derivatives thereof and not providing any other investment services or performing any other investment activities in such instruments is also a member of or a participant in a regulated market or an MTF, it falls under the scope of MiFID II, and should accordingly be authorised as an investment firm unless:
- it is exempted under points (a), (i) and (j); or
- it is a non-financial entity which executes transactions on a trading venue which are objectively measurable as reducing risks directly relating to the commercial activity or treasury financing activity of that non-financial entity or its group.
As a consequence, the reference in Article 53(3) to persons other than investment firms and credit institutions only relates to entities that are exempted from authorisation under Article 2(1), such as insurance companies or collective investment undertakings, as long as their own regulatory framework permits them to do so.
This Q&A does not address the issue of non-EEA firms being a member or participant of an EEA trading venue.
Application of MiFID II after 3 January 2018, including issues of ‘late transposition’
Question 1 [Last update: 18/12/2017]
Should authorisations as a regulated market granted under MiFID I still be valid after 3 January 2018?
Yes, the authorisations granted under MiFID I should continue to be valid after 3 January 2018. This applies also to the authorisations for market operators to operate an MTF. However, ESMA notes that competent authorities, as set out in Article 44 of MiFID II (and, already, Article 36 of MiFID I), should monitor that market operators comply at all times with the conditions for initial authorisation and therefore regularly review conditions for initial authorisation.