First, here's the thought - when (if ever)
will the EU provide a definitive answer to the question of
whether a prop firm, which is outside scope of Mifid II under
Article 1, is brought into scope by the exemption from the
exemption in Article 2(1)(d)?
I doubt that such an answer is likely in
anything like the timeframe necessary for any firms to plan on
becoming authorised and regulated in the EU in time for January
2017. And there will always be those who can (pretty
reasonably) argue that on the text of Mifid II, a third country
principal trading firm is not in scope of Mifid II at
Let me explain: Mifid II Article 1 says
that the directive applies to "third-country firms providing
investment services or performing investment activities through
the establishment of a branch" in the EU.
If a third-country firm has no "branch" in
the EU, it cannot be covered by Mifid II.
So the argument goes that the 'exemption
from the exemption’ in Article 2(1)(d) - which
says that prop firms are not in scope of MiFID2 unless they are
market makers, are members of a trading venue, have DEA to a
trading venue, are HFT or deal on own account when executing
client orders - cannot apply to firms which are not caught by
Mifid II under Article 1.
And second, here's the issue - EU
politicians (the masters of Mifid II Level 1 text), want there
to be a 'level playing field’ for all participants
on EU markets.
This, to my mind, means not just 'no
unregulated market and no unregulated product’ but
also 'no unregulated participant’.
That regulation doesn’t
necessarily need to be EU regulation - firms authorised and
regulated in the US, Canada, Singapore etc are authorised and
regulated after all.
But let’s be fair,
supranational bodies don’t have a great history of
agreeing with one another about cross-border regulatory
Also, don’t forget that
Germany rejected 'equivalence’ of UK
locals’ regulatory regime under the German HFT law
because they were not subject to the same regulatory capital
requirements as full Mifid firms.
So 'level playing field’
therefore means 'regulated in the EU under Mifid
OK, I’ll go out on a limb and
Where was I?
Oh yes: a UK-based principal trading firm
has a server colocated in Frankfurt to trade Eurex; if it is
HFT under German law, then it requires a Mifid-passport to do
No such passport is required (or
available) if it is not HFT because its activities fall within
one of the exemptions under current the Mifid and do not fall
under the German HFT law.
So for what type of passport should the
firm apply if it needs one - a cross-border services passport
or a branch passport?
Most firms in this position do not have
personnel in Germany. It is physically difficult to squeeze a
human being into a server rack. Feeding him/her when
they’re there would be even more challenging.
But is a server a branch nonetheless?
The Germans never came up with a
satisfactory or unequivocal answer - their approach was that
they would process any passport notification a firm from
another EU state’s regulator sent them; be it for
a branch or for cross-border services.
As long as there was a passport, that firm
could conduct HFT prop trading in Germany.
The OECD tax plans seem to be going in the
direction of making a server a branch (as drawing a distinction
between e-commerce businesses like [insert reader's own choice
of household name here] and a colocated trading firm with an
in-country server is a difficult one for legislators).
Latest OECD and IOSCO papers state that
HFT firms, operating in a member country, would struggle to do
so but for the colocated servers and (so the argument goes)
those firms might have a taxable establishment in that
People will have waited for Godot more fruitfully.
The amount of tax attributable to that
establishment is immaterial to the argument - an establishment
for tax purposes is a permanent establishment and a branch.
Neither the OECD nor IOSCO seems to have
come to a conclusion as to how to deal with this; at the
moment, we’re at a place where they recognise the
issue and state that they have to do something about it.
But the hint is strongly that servers will
be permanent establishments.
It might matter whether the firm owns,
licenses or merely 'uses’ the server (ie where it
belongs to an intermediary or service provider), but given the
heat and light generated by news of 'tax
avoidance’ etc, my money’s on that
being disregarded in the long term.
Also to be disregarded will be that a
branch constituted by a server should have personnel.
That’s an inconvenient mismatch between tax laws
and regulatory requirements which I guess everyone will pretend
not to see.
So let's say for sake of argument that a
server will be a branch.
If so, then it requires a passport
permitting it to provide investment services in the country in
which the server is located. It's likely to be subject to local
tax on its profits.
And ... it's likely to provide politicians
with the 'solution' they need to ensure that there is a 'level
playing field' in EU markets for EU-regulated participants and
firms based outside the EU which are nonetheless colocated at
trading venues in the EU.
There’s then no disparity
between Article 1 and Article 2 of Mifid II; a third-country
firm has a branch in the EU and needs to be authorised and
So we shouldn’t wait for the
EU to pronounce on whether third-country prop trading firms
which cannot claim exemption under Article 2(1)(d).
People will have waited for Godot more
We should plan on being told (eventually)
that all third-country prop firms that would not be able to
claim an exemption under Article 2(1)(d) have to be authorised
and regulated in the EU.
Now we just need someone to let us know
what definition of HFT we'll have to use...!