Provisions within Mifid II to regulate direct electronic
access could result in thousands of non-EU firms ceasing
trading on European derivatives markets.
The European regulator Esma is currently consulting on the
technical standards that will form the basis of the
implementation of the Markets in Financial Instruments
Directive or Mifid II.
Central to the intentions of European regulators is the
tightening up of regulation around the provision of direct
electronic access (DEA).
Under the current Mifid II text all firms trading on
European exchanges through a DEA agreement could be required to
be regulated under Mifid II, which among other onerous
requirements would necessitate that firm having a physical
presence in Europe.
This would mean that thousands of foreign firms, including
hundreds of US CTAs and other hedge funds could cease trading
on European markets.
"If this is what is ultimately agreed, it could result in
thousands of foreign firms simply stopping trading on Eurex and
Liffe and other European markets overnight," said one broker
speaking under condition of anonymity.
Exemption from the exemption
At the centre of the current fears over the reach of Mifid
II is the so called "exemption from the exemption" in Article
2(d) of the Mifid II text.
This article states that all firms who have direct
electronic access to a trading venue are exempt from the
broader exemption that covers firms that trade on their own
The full implications of the exemption from the exemption
are only now becoming apparent following the release of the
Consultation Paper from Esma and subsequent discussions between
market participants and local regulators.
Should the proposals be implemented as written in the text,
non-EU entities trading electronically will need to become
regulated in the EU under Mifid to continue to trade on
European exchanges via a DEA arrangement with an FCM.
It also calls into question whether the current FCM omnibus
relationship model in which a US entity offers local clients
access to EU markets via an omnibus structure with the
FCM’s EU entity.
Potentially all US clients would have to sign up with the
FCM’s European entity for DMA access and be
regulated as an EU entity.
Non-EU firms are supposedly not in scope of Mifid II, however,
it is believed that the DEA provisions could over-ride this
exemption as has been the case with the German HFT law.
Get out clause?
In the Consultation Paper, Esma states that it
"considers…clients transmitting orders to an investment
firm in an electronic format to be outside of the scope of DEA,
as long as the electronic access to the market is shared with
other clients through a common connectivity channel, no
specific capacity and latency is provided to any particular
client (e.g. web based applications)".
This is understood that this exemption applies to retail
focused web-based firms rather than FCMs tailoring to the
professional market but will be used by market participants to
push for a wider provision of this de-scoping.
"What [European authorities] essentially want is for
everyone playing in the European markets to be regulated in the
EU," said one legal adviser close to the Mifid II
The market has long feared a fragmentation of liquidity in
the face of extraterritorial implementation of local laws.
Efforts between US and European regulators to establish
equivalence that would mitigate extraterritoriality have been
beset by problems.
News of the potential requirement for non-EU firms to become
authorised under Mifid II comes as DEA providers are coming to
terms with the implications of the additional controls and due
diligence they must have for their clients.
FCMs have warned that DEA providers could be unwilling to
underwrite the risks of reviewing and taking responsibility for
third party algorithms resulting in less choice and higher fees
for market users who will be forced to rely on manually
executed electronic care orders and voice orders.