European Parliament Takes Further Step to Increase Requirements for Trading Venues and Algorithmic Trading, and to Introduce Commodity Position Limits in Europe

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Published Date : April 16, 2014

The European Parliament ("EP") approved new measures on April 15, 2014, that, once finally implemented, will increase regulation of European financial markets, including imposing new requirements on certain algorithmic trading.

The new measures, known as the Markets in Financial Instruments Directive (MiFID II) and Regulation (MIFIR), will impact investment firms; certain large traders on stock, financial and commodity derivative markets; and trading venues, among others. The measures potentially will have a cross-border impact for non-EU based persons doing business within the EU. 

MiFID II and MIFIR are still subject to additional legislative steps prior to formal adoption, and implementation is not expected until 2016 because of these steps and other requirements too.

The principle elements of these new obligations require:

  1. trading of certain financial and commodity instruments on regulated venues “wherever appropriate” including on stock exchanges; multilateral trading facilities (i.e., includes firms’ internal matching systems for client orders in shares, depository receipts, exchange-traded funds, certificates and similar financial instruments); or organized trading facilities (“OTFs”) for non-equity products such as interests in bonds, emission allowances and derivatives. There will be a mandatory trading obligation for shares and derivatives that are eligible for clearing under another applicable requirement (i.e., the European Markets Infrastructure Regulation or “EMIR”);
  2. firms supplying investment services to align investment products to different types of clients based on their needs and to ensure that marketing information is not misleading;
  3. algorithmic traders to have “effective systems and controls” to halt trading if price volatility becomes very high. Such traders must also test their algorithms to minimize systemic risk as well as to retain records of all placed orders and cancellations; and
  4. speculative traders to limit the size of their net position in commodity derivatives. The European Securities and Markets Authority is required to create a methodology to calculate these limits which would be applied country by country.  The imposition of these limits would be subject to unspecified “transitional arrangements to ease the impact.” Position limits would apply only to traders who are not acquiring positions “that are objectively measurable as reducing the risks directly related to [their] commercial activity” (i.e., effectively, hedgers).

The new measures also endeavor to:

  1. augment the pre and post trade transparency of financial instruments by including non-equity instruments such as bonds and derivatives;
  2. require “non-discriminatory access” to trading venues and clearinghouses (“CCPs”), although smaller venues will be subject to transitional rules;
  3. require algorithmic traders to be “properly regulated and to provide liquidity when pursuing a market-maker strategy”, as well as to maintain “systems and risk controls to prevent trading that may contribute to a disorderly market or involve market abuse;”
  4. ensure harmonized sanctions across the EU for rule violations; and
  5. introduce a “harmonized regime for granting access to EU markets from third countries …based on an equivalence assessment…”

Introduction of the requirement to provide non-discriminatory access to clearinghouses is meant to eradicate the model where trading and clearing are mandatorily linked. According to the EC,

“The issue at stake is about competition, stability and the integration of EU market infrastructures. Although the vertical integration model of trading and post-trading infrastructures may present advantages in terms of coordination, it may also introduce inefficiencies with respect to competition and price transparency. …Trading venues will be required to provide access, including data feeds on a non-discriminatory basis to [CCPs] that wish to clear transactions executed on the trading venue and CCPs will be required to clear transactions executed in different trading venues subject to certain well-defined conditions being fulfilled.”

The elimination of mandatorily linked execution and clearing relationships in connection with exchange-traded derivatives are subject to transition arrangements.

In addition to other requirements, certain algorithmic traders will be obligated to register as investment firms and be subject to an enhanced requirement to disclose to regulators information regarding their trading strategies. Trading venues will be required to maintain “robust controls” to help ensure against disorderly trading, erratic price movements, and capacity overload.

Originally, all commodity contracts traded on any type of trading venue that was physically settled were to be covered by MiFID II. However, the final version excludes wholesale energy contracts. Physically settled oil and coal contracts are included, however, except that the mandatory obligation to trade such products on an OTF is deferred for at least six years after the applicable provisions of MiFID II are effective.

According to the EC, the adoption of MiFID II is aimed to help implement the EU’s G-20 commitments in connection with derivatives. Says the EC,

“The US and EU approaches and legislation are very much aligned in terms of achieving the same objectives. For example, the revised MiFID complements the regulation on OTC derivatives, central counterparties and trade repositories (EMIR).”

MIFID II amends MIFID that initially was enacted in 2007. In January 2014, the EP and the European Council agreed “in principle” regarding provisions of MiFID II (see “European Parliament and European Council Agree ‘In Principle” on MIFID II” on this website; click Here to access).

The EP-approved drafts of MiFID II and MIFIR must now be formally approved by the Council of the EU. When (if) the Council finally approves these measures, they become effective 20 days after their publication in the various languages of the EU in the EU Official Journal. However, after that, individual EU countries must harmonize their local law to incorporate MIFID II and many of the technical details regarding these new measures must be determined by ESMA. As a result of all these processes MIFID II is not expected to take effect until late 2016.

(The Council of the EU is a legislative body composed of EU member states’ government representatives. It does not have fixed members. The composition of meetings depends on the topic. The Council is different than the European Council where EU leaders meet approximately four times yearly to discuss political priorities of the EU. For details regarding the EU legislative process, click Here to access relevant information.)

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The information contained in this article is not legal advice. For legal advice, please consult with your attorney. The information in this article is derived from sources believed to be reliable as of April 16, 2014, but no representation or warranty is made regarding the accuracy of any statement. To ensure compliance with requirements imposed by U.S. Treasury Regulations, Gary DeWaal and Associates LLC informs you that any U.S. tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Gary DeWaal and Associates may represent one or more entities mentioned in this article.




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