Shearman & Sterling LLP | FinReg | European Securities and Markets Authority Recommends Changes to EU Algorithmic Trading Rules
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  • European Securities and Markets Authority Recommends Changes to EU Algorithmic Trading Rules

    The European Securities and Markets Authority has published a review report on algorithmic trading under the EU's Markets in Financial Instruments package. The Markets in Financial Instruments Directive requires the European Commission to review and report on the impact of the MiFID II requirements on algorithmic trading, including high frequency trading and direct electronic access. ESMA's report will assist the Commission with that remit, including determining whether any legislative changes are appropriate.

    The MiFID II requirements aim to mitigate and ensure the management of the risks that a trading algorithm might function in a way that could disrupt the market, or be deployed in a way that gains an unfair advantage over other market participants. Additional requirements are imposed where a high frequency strategy is used and specific requirements apply to market makers using algorithmic techniques.

    ESMA makes numerous recommendations for changes that it believes will ensure financial stability, investor protection and also bring further harmonization of the rules across the EU. The recommendations include:
    • Removing the requirement for authorization as an investment firm for DEA users that are only dealing on own account. ESMA surveyed the national regimes in EU member states and notes the disparity of requirements, with some states allowing third-country firms to deal on own account without a branch authorization. Removing the authorization requirement would level the playing field between EU and third-country DEA users that only trade on own account and create a consistent EU regime.

    ESMA continues to support the view that non-EU members of EU exchanges must be authorized as an investment firm under MiFID II to provide client access to EU exchanges through DEA. We argued how that position is of questionable legal accuracy in our client note, "ESMA Sounds a Death Knell for Cross-Border Exchange Access, in Conflict With UK Legislation and MiFIR", and also highlighted how it would reduce the attractiveness of and liquidity of the EU exchanges. It is notable that ESMA's survey reveals that some EU member states (e.g. Germany) do not require such authorization. The U.K. position remains the same post-Brexit; third-country firms may provide DEA on U.K. exchanges if they are within scope of the overseas persons exclusion or under the U.K. MiFIR equivalence regime.
    • Requiring a third-country HFT firm to be authorized as an investment firm where the firm accesses EU trading venues through DEA or as a participant. In addition, ESMA recommends introducing an equivalence framework for third-country HFT firms (which would remove the EU authorization requirement). ESMA suggests these new regimes would be without prejudice to those firms providing services through MiFIR's equivalence framework.
    • Moving the requirements for tick sizes from the MiFID II Directive to MiFIR to make the provisions directly applicable and therefore ensure legal certainty and consistency of application.
    • Introducing a requirement for trading venues to have non-discriminatory trading mechanisms, and a requirement for trading venues to implement speedbumps, including the duty to monitor the impact of speedbumps on the quality of liquidity available.

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