Future of Single-Dealer Platforms: SIs, MTFs or OTFs?

An excellent article in Risk.net covered also in FXWeek, looks at the future of Single-Dealer Platforms under MiFID II and discusses the options for bank platforms.

Should they register as:

  • Systematic Internalisers (SIs), which enables them to utlilise their own risk capital and trade on bilateral basis with customers
  • Organised Trading Facilities (OTFs), in which case they cannot use their own capital, and would in effect be running an agency business, but cannot run both an SI adn OTF under the same legal entity
  • Multilateral Trading Facility (MTF), which offers all to all trading

Initially, the SI regime seems obvious, as they can deploy their own capital, and trade with clients on a bilateral basis, which is what most SDPs currently do.

The test for an SI is that it executes client orders outside on an organised, frequent systematic and substantial basis. However, it get’s complicated, when an SDP offers agency trading, acting as a neutral ‘matched-principal’, where in effect the bank is ‘white labeling’ another bank’s rates and providing back-to-back execution against an upstream liquidity provider and earning a fee, either as brokerage, or in terms of an added margins around another bank’s pricing, instead of earning the bid-ask spread and taking principal risk. This could be deemed multilateral, and fall outside of the SI remit, and force the bank to register as an OTF.

In emails from The FCA, Stephen Hanks, a manager in the markets division at the FCA wrote:

“For us, the key issue is whether what the SI is doing amounts to operating a ‘multilateral system’, which requires authorisation as a trading venue. If matched-principal trading forms a significant part of an SI’s business model it seems to us unlikely that this could avoid being characterised as a multilateral system,”

Bank’s wanting to offer both SI (deploying it’s own capital), and agency execution in the form of matched-principal, could be forced to create a new legal entity to house the hybrid entity.

According to ESMA rules:

“A systematic internaliser should not be allowed to bring together third-party buying and selling interests in functionally the same way as a trading venue.

A systematic internaliser should not consist of an internal matching system that executes client orders on a multilateral basis – an activity which requires MTF authorisation.

An internal matching system in this context is a system for matching client orders, which results in the investment firm undertaking matched-principal transactions on a regular and not occasional basis.”

Handy Q&A from ICMA on Systematic Internalisers available here

Persoanlly, I found that one of the best sources of guidence for understanding the regulations are not to be found in the regulations themselves, but in the ‘survival guides’ issued by leading law firms, such as this one from Norton Rose here

Norton Rose survival guide

Investment firms as market operators:  MTF v OTF v SI v SEF
Source: Norton Rose

Available in FX Week here (behind paywall)

One Response

  1. Hi Paul…agreed this is indeed a very good article and one that is becoming a very much a key topic in particular the issues around matched principal as SDP’s in both jurisdictions (US & EU) are moving towards a more ‘agency’ style execution platform…Even with matched principal you are very much limited trading on OTF’s, as things stand now one of the specific rules around OTF’s says: ‘The investment firm or market operator running an OTF must not allow client orders to be executed against the proprietary capital of the firm or any entity that is part of the firm’s legal group. The only asset class for which the use of proprietary capital is permitted is illiquid sovereign debt instruments… An OTF may engage in matched principal trading where this has been agreed by the clients. This is not permitted for derivatives subject to the EMIR clearing obligation.’

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