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Global Trustee and Fiduciary Services News and Views | MiFID II Special Edition 2016
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Algorithmic trading and direct electronic access
MiFID II will require firms, including asset
managers, engaging in algorithmic trading
to put in place internal systems to ensure
the resilience of their trading systems and
prevent the sending of erroneous orders or the
malfunctioning of systems in ways that could
cause market disruption. The objective of these
rules is to contain the risk in EU markets of
events such as the infamous flash crash that
seized US stock markets in May 2010.
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Under
the new rules, firms will be required to notify
their regulators if they engage in algorithmic
trading and also to inform the operators of
the exchanges and trading venues where they
engage in algorithmic trading.
EU regulators will be able to require firms
under their supervision to provide information
on their algorithmic trading strategies on a
regular or ad hoc basis, including details of
trading limits or other parameters to which
the system is subject and information on key
compliance and risk controls instituted by the
firm. Firms engaged in high-frequency trading
will also have to keep complete time-sequenced
records of all orders (both executed and
cancelled) and quotes, and make those records
available to the regulator on request.
MiFID II will require firms that give their clients
direct electronic access (DEA) to a trading
venue to operate effective systems and controls
that ensure a proper assessment and review of
the suitability of clients using the service, that
prevent clients from exceeding appropriate
preset trading and credit limits, and that
properly monitor clients’ activities and control
risks that those activities might pose to the
firm itself or to wider market stability. Asset
managers afforded DEA should expect providers
to tighten their controls and do more besides
(for which, read on).
Firms that provide DEA will themselves
be responsible for ensuring their clients’
compliance with the MiFID II rules and the rules
of the relevant trading venue. Firms will have
to actively and closely monitor their clients’
trading activities and report any infringements
or cases of suspected market abuse to the
regulator. The rules require the firm and its
clients to enter into a binding written contract
to outline their essential rights and obligations
in connection with the provision of DEA.
To fully understand the impact of the new
MiFID II rules on firms that engage in HFT and
algorithmic trading, it is necessary to refer to
a set of regulatory technical standards (RTS)
that spell out the requirements in much greater
detail than MiFID II itself does. The EC adopted
these RTS in July 2016, following consultation
on earlier drafts prepared by the European
Securities and Markets Authority (ESMA). The
following discussion is based on the text of the
RTS as adopted by the EC in July 2016, but it is
important to note that the RTS themselves are
still subject to scrutiny by the European Council
and European Parliament, and we may not see
final rules until later in Q3 or Q4 of 2016.
STEP CHANGE: ASSET MANAGERS
FACE CHALLENGE FROM NEW
RULES ON ALGOs, HFT AND DEA
In June 2016, the EU amended MiFID II and MiFIR to delay their application
by one year to 3 January 2018.
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Part of the reason for the delay was to
give EU rule-makers more time to finalise the vast array of implementing
Level 2 rules required for the new regime to be able to operate in practice.
In this article, we provide a recap of the basic MiFID II/MiFIR requirements
on algorithmic trading and high-frequency trading (HFT), and examine the
regulatory technical standards adopted by the European Commission (EC)
in this area in July 2016.