A decision by the European Securities and Markets Authority (ESMA) on the ‘trading venue perimeter’ consultation which denotes when trading systems are regulated trading venues, and when they are unregulated systems, has pinned down decision making – who makes it and how automated it is – as a key element. However, it has also said that a case-by-case judgement may be needed.
The greatest element of concern around this discussion was in the potential regulation of trading desk technology such as execution management systems (EMSs) which are used by some buy-side firms to manage electronic trading.
In light of the feedback received, ESMA says it did not intend to capture systems “which provide pure connectivity services between investment firms and execution venues. In general, EMSs employ software or technical tools aimed at facilitating order execution by offering an overview of liquidity and prices on various venues, subsequently sending the orders to the preferred trading venue or trading venues for execution. Therefore, an EMS which purely supports routing orders without a third-party prescribing the rules for this interaction, should not be considered as a multilateral system and would hence not be required to seek authorisation as a trading venue.”
The caveat to this is that systems which “present additional features and level of complexity that allow for the interaction of multiple third party buying and selling interests in financial instruments, thus combining all four criteria identifying a multilateral system, should be required to seek an authorisation as a trading venue.”
That means an EMS which would allow for firms to gather multiple quotes from multiple sources, and where these trading interests can interact with other trading interests within the system could be, “depending on the specifics, considered a multilateral system. In this context, it is important to consider the role of the entity operating the system, i.e. whether it is the software vendor itself or rather the investment firms.”
The regulatory authority says that this is most relevant This is particularly relevant where rules have been put in place, whether by a software vendor – if it has embedded rules governing the interaction of trading interests in the system and does not allow investment firms to set its own rules then the software vendor would be operating a multilateral system.
As such, the determination of who sets rules for routing of orders will be a major determinant of categorisation.
In equity markets which are largely traded on-exchange, or within an electronic venue, such as a multilateral trading facility (MTF) there is greater clarity around EMS/venue differences. Order types can be set within an EMS because it is at the venue that they are put into play trading with counterparties.
In bond markets which trade largely bilaterally, often without a trading venue, there had been concern that that the application of the trading venue perimeter could necessitate the creation of a ‘venue’ at some point in the trading workflow, if any automation was applied by either counterparty.
The DESK
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