EU Opinion on Trading Venue Perimeter

On February 2, 2023, the European Securities and Markets Authority published a final report and an Opinion on the trading venue perimeter. The Opinion clarifies the definition of multilateral systems under the EU’s revised Markets in Financial Instruments Directive and sets out guidance on when systems should be considered as multilateral such that authorization as a trading venue would be required. In issuing the Opinion, ESMA is seeking to address the regulatory inconsistencies that have arisen because there is no EU-wide homogenous view as to what constitutes a multilateral system and to provide more certainty about when a system will be considered multilateral, and therefore should apply for authorization as a trading venue. The U.K.'s Financial Conduct Authority recently consulted on proposed guidance on the regulatory perimeter for multilateral trading facilities and on possible future changes to smaller trading venues' regulatory obligations. The FCA is expected to publish its final guidance in Q2 2023. 

MiFID II requires any multilateral system in financial instruments to operate one of the three types of trading venues provided for, which are regulated exchanges, multilateral trading facilities (MTFs) and organised trading facilities (OTFs). The definition of a multilateral system under MiFID II is “any system or facility in which multiple third-party buying and selling trading interests in financial instruments are able to interact in the system.” According to ESMA, the combination of these provisions means that any multilateral system must seek authorization as a trading venue, and once authorized comply with the requirements for an exchange, MTF or OTF.

In its Opinion, ESMA discusses the elements that make up a multilateral system. These are:

• It is a system or facility, which is a set of rules (in the form of contractual arrangements or standard procedures) that govern how third-party trading interests interact, including rules about matching, arranging and/or negotiation of trading interests. The underlying technology that is used is irrelevant to the issue. In ESMA’s view, where an investment firm sets the rules of interaction but uses a software provider, the software provider itself would not be a multilateral system.
• There are multiple third-party buying and selling interests. In this context, ESMA explains, ‘third-party’ refers to persons other than the system operator and ‘multiple’ means that the system allows various trading interests to interact in the same system or facility. Referring to the Robeco Hollands Bezit NV and Others v Stichting Autoriteit Financiële Markten (AFM) case, ESMA states that this would include a situation where two trading interests interact, provided the trading interests are brought together under the rules of the system operator. In ESMA’s view, a system will not be a bilateral system where the same participant always executes the order from an investor because it ignores the role of the system operator. Furthermore, if a system only has one liquidity provider, that does not mean that the system is a bilateral system.
• The trading interests are able to interact in the system. This means that the system must not merely display the trading interests but allow people to react to them. This would include being able to exchange information about the interests and to match, arrange and/or negotiate the terms of a transaction, although the conclusion of a transaction is not required for the definition of a multilateral system.
• The interaction of third-party buying and selling trading interests must be in financial instruments, as set out in MiFID II.

ESMA’s Opinion also considers three cases where it considers it may be more difficult to determine where the regulatory perimeter lies. These are technology providers, request-for-quote systems (RFQs) and systems that pre-arrange transactions. Each of these are discussed below.

• Technology providers

Under this heading, ESMA considers bulletin boards and Execution Management Systems (EMS). ESMA’s Opinion states that it is the functioning of the arrangement and what it allows users to do that is crucial for determining whether a facility would require authorization as a trading venue. For a facility to be considered a communication tool or bulletin board the following criteria must be satisfied:

• The system comprises an interface that only aggregates and broadcasts buying and selling interests in financial instruments.
• The system does not provide for communication or negotiation between advertising parties and does not require the use of tools of affiliated companies.
• The execution or the bringing together of buying and selling interests in the system is not possible.

Regarding EMS, ESMA’s view is that an EMS that only supports routing orders without any third-party prescribing rules would not amount to a multilateral system. However, if an EMS was more complex and allowed for the interaction of multiple third party buying and selling interests in financial instruments, it would need authorization as a trading venue.

• RFQs

RFQs are recognized under MiFID II as a type of trading system that could be operated by a trading venue. These are systems where quotes are provided in response to a request submitted by one firm and the systems allow for the interaction between multiple clients and multiple dealers. These systems, according to ESMA, are multilateral systems and require authorization as a trading venue, including where the system allows a client to request a quote from only one dealer because the system still provides the possibility of multiple interactions and is operated by an independent system operator. ESMA draws a distinction between a system operated by an investment firm that is also the sole dealer to which participants may submit a request for quote and a system operated by a third-party that has one dealer. Only in the latter case does ESMA consider authorization to be required.

• Systems pre-arranging transactions

These are situations where transactions are pre-arranged and then formalized on a trading venue. ESMA notes that where an investment firm arranges a transaction between two parties and the transaction is then formalized on a trading venue, the transaction would be considered to take place under the rules of the trading venue because a transaction cannot be concluded under the rules of more than one venue.

In ESMA’s opinion, the activity of pre-arranging transactions in a multilateral manner may only be carried out without authorization as a trading venue when: (i) all transactions arranged through the investment firm’s system or facility are required to be formalized on a trading venue; and (ii) the transaction benefits from a pre-trade transparency waiver in the trading venue where it will be formalized. In this scenario, ESMA considers that appropriate written arrangements should be in place between the investment firm providing the pre-arranging system and the trading venue to ensure proper compliance with the trading venue rules. Any pre-arranging system that is not authorized as a trading venue should be authorized as a MiFID II investment firm.

Authorization as a trading venue would be required if the execution occurs over-the-counter, or if the pre-arranging system is capable of formalizing transactions (even if this only occurs occasionally).