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Systematic Internalisers: Challenges and Opportunities in the MiFID II Era

Traders Magazine Online News, June 14, 2018

John D'Antona Jr.

MiFID II is intended to deliver better outcomes for end-investors across Europe, by increasing transparency, consumer protection and competition, while reducing cost, risk and conflicts of interest. To achieve these aims, the new directive introduces some major reforms to Europeís equity markets: common transparency and reporting rules; tougher best execution requirements; and a limit on trades that donít contribute to price discovery. At six months in, itís too early for investors to feel the benefits. But itís clear that many market participants are committed to MiFID IIís aims as they start to execute trades via new mechanisms such as systemic internalisers (SIs).

Trading venue operators, liquidity providers and seekers are anticipating the release of the first execution quality data under MiFID IIís RTS 27 at the end of June. This will reveal for the first time the pre- and post-trade data reported by trading venues, including SIs, as required by MiFID IIís new transparency rules with the intention of helping investment firms deliver best execution to end-investors.

The sense of expectation was palpable at the May 23 roundtable hosted by Vela at Londonís Saddlers Hall, as was the sense of frustration that the data is being published only after a three-month delay, rather than on a T+1 basis, and is likely to be inaccurate and incomplete, until data reporting and aggregation processes bed in. Indeed, if official data does not deliver the transparency needed to improve end-investorsí outcome, SI operators may take matters into their own hands.

Early indications of interest

Anecdotal evidence suggests that SIs operated by broker-dealers and electronic liquidity providers (ELPs) are both receiving orders via smart order routers from firms seeking liquidity through bilateral market-making channels. However, it is impossible for SI operators to be certain of their market share or the execution quality they are providing without further corroboration.

A number of roundtable participants saw similarities with the early days of the original Markets in Financial Instruments Directive (MiFID I), when brokers and their clients tentatively explored the trading experience available from new venues set up in competition to national exchanges, both dark and lit. Then as now, firms are submitting small orders (brokers initially sending only internal flow), then committing gradually more flow once rigorous scrutiny of TCA data proves satisfactory.

One participant pointed out that the buy-side had been presented with a range of execution options following the elimination of broker crossing networks in MiFID II and its imposition of limits on dark trading volumes below block thresholds. ďA number of solutions are emerging Ė not just SIs but periodic auctions Ė however none are a direct replacement. SIs are just one way to solve one problem for one set of clients, alongside many other options. But we need the data to determine whether SIs are providing a kind of interaction for a particular need. Further, we should remember that good execution is not about a single point of data, but requires instead a wider conversation,Ē he said.

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