We respond to ESMA s specific questions below.

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BT Pension Scheme Management Limited Lloyds Chambers 1 Portsoken Street London E1 8HZ Tel (020) 7680 8080 ESMA consultation on guidelines on systems and controls in a highly automated trading

1 BT Pension Scheme Management Limited Lloyds Chambers 1 Portsoken Street London E1 8HZ Tel (020) ESMA consultation on guidelines on systems and controls in a highly automated trading environment for trading platforms, investment firms and competent authorities BTPS Management welcomes this paper from ESMA and the issues which it raises. We welcome the opportunity to comment. By way of background, the BT Pension Scheme is the UK s largest corporate pension scheme, managing assets worth around 35 billion and responsible for some 340,000 beneficiaries under a defined benefit (DB) structure. As ultimate asset owners, pension schemes have a strong interest in transparent and efficient markets. These will most efficiently deliver the capital allocation and capital growth benefits which financial markets offer. We note that most participants in the financial markets are not ultimate asset owners, or principals; rather they are agents. Many agents will benefit either directly or indirectly from market inefficiencies and a lack of transparency, using this to gain trading advantages which they try to hold exclusively for themselves. Our firm view is that market regulation needs to favour transparency and efficiency and work to ensure that market structures and practices are not skewed to the benefit of a limited group of market participants. We welcome the current attention being paid to high frequency trading by ESMA, and also by other organisations such as IOSCO. We agree with ESMA s working definition of high frequency trading, and would note that this definition needs to be interpreted with care so that less systemically risky investment strategies such as commodity trading advisers do not become inappropriately caught in any emerging regulations. One comment which we made in response to the recent IOSCO consultation bears repeating at this stage. A key element which should underpin regulators consideration of these issues is what characteristics of liquidity are of most value economically and so which forms of liquidity should be most fully facilitated by regulation. In particular, we believe that any definition of liquidity needs to encompass not just an ability to trade large size quickly, at a low cost, when you want but also the ability to trade at scale without having a significant impact on pricing. We note that the nature and intent of many high-frequency trading algorithms is expressly contrary to this ability. We would welcome regulators considering what form of liquidity they are most seeking to encourage and facilitate. We would also note that beyond a certain level, we do not believe that additional liquidity adds anything to the process of price discovery. Rather, we believe that additional liquidity after a point simply favours additional trading activity, which may in fact drive trend-following behaviours in investment markets, leading to a greater propensity to bubbles and busts. We respond to ESMA s specific questions below. Registered office: Lloyds Chambers, 1 Portsoken St, London E1 8HZ. Registered in England and Wales. Registration No

2 Background Q1: Do you agree with ESMA that it is appropriate to introduce guidelines already before the review of MiFID covering organisational arrangements for trading platforms and investment firms in relation to highly automated trading, including the provision of DMA/SA? We believe that the proposed guidelines are timely and valuable and agree that it is appropriate not to wait for MiFID to be finalised before promoting these guidelines. We would note that we do believe that ESMA should turn its attention to other aspects of high frequency trading, such as those focused on in the recent IOSCO consultation on the topic, and in particular both co-location and stub quotes. We also take this opportunity to draw ESMA s attention to our response to the Commission s review of MiFID, and in particular to two key paragraphs in our comments: We note that the Directive s focus was principally on removing barriers to the free movement of capital across Europe s borders. It also sought to drive more efficiency in Europe s capital markets through removing unnecessary frictional costs. We are agreed that these were positive steps, and as underlying owners we welcome the removal of unwarranted frictional costs on our investments. But the focus on reducing transactional costs has some significant impacts on the markets, increasing the potential returns from trading strategies while decreasing the benefits of longterm investment. One impact of the removal of this friction has been a remarkable increase in the level and velocity of trading in financial instruments in Europe. As long-term investors we are not sure that this is wholly a good thing: while illiquid markets can be problematic, there is a law of diminishing returns and it appears to us that the level of liquidity and the speed of trading is now beyond the level at which it assists investors, and it may instead be a negative. The investment and trading activities which led to the financial crisis were benefited at least in part by the velocity of trade in the European and world markets. Costs are added to other parts of the economy because companies and long-term investors perceive greater need to hedge against this additional market volatility. In addition, longer-term investment activities can become swamped by this noise, and the impact on public companies can at times be actively detrimental: they feel the need to respond to short-term investors and temporary share price volatility rather than focusing on generating long-term returns for their investors and building their businesses to the benefit of all stakeholders. Electronic trading systems trading platforms Q2: Do you think that the draft guidelines adequately capture all the relevant points relating to the operation of trading platforms electronic trading systems? Q3: Are there areas where it would be helpful to have more detail on the organisational requirements applying to trading platforms electronic trading systems? Q4: Do you have additional comments on the draft guidelines on organisational requirements for trading platforms electronic trading systems?

3 We agree with and support the proposed guidelines. We believe that the standards regarding the testing of trading systems are necessary and of particular importance. Electronic trading systems investment firms Q5: Do you think that the draft guidelines adequately capture all the relevant points related to the operation of trading algorithms? Q6: Are there areas where it would be helpful to have more detail in the guidelines applying to the organisational requirements for investment firms electronic trading systems? Q7: Do you have additional comments on the draft guidelines relating to organisational requirements for investment firms electronic trading systems? We agree with and support the proposed guidelines. Again, we believe that the standards regarding the testing of trading systems are necessary and of particular importance. We also believe that standards for record-keeping and reporting of major incidents need to be maintained at a high level. Promoting fair and orderly markets trading platforms Q8: Do the draft guidelines on organisational requirements for trading platforms to promote fair and orderly trading offer a sufficiently comprehensive list of the necessary controls on order entry? Q9: Are there any areas of the draft guidelines on organisational requirements for trading platforms to promote fair and orderly trading where you believe it would be helpful to have more detail? Q10: Do you have additional comments on the draft guidelines on organisational requirements for trading platforms to promote fair and orderly trading? We agree with and support the proposed guidelines. While we agree that it would not be appropriate for ESMA to prescribe the form and nature of circuit breakers (as different forms will be appropriate in different markets to respond to the specific regulatory structures they have in place), the requirement for some form of circuit breakers is of central importance. We believe that the pause in trading which they apply can be highly valuable in extreme circumstances. Promoting fair and orderly markets investment firms Q11: Do the draft guidelines on organisational requirements for investment firms to promote fair and orderly trading offer a sufficiently comprehensive list of the necessary controls on order entry? Q12: Are there any areas of the draft guidelines on organisational requirements for investment firms to promote fair and orderly trading where you believe it would be helpful to have more detail? Q13: Do you have additional comments on the draft guidelines on organisational requirements for investment firms to promote fair and orderly trading?

4 We agree with and support the proposed guidelines. We believe in particular that the requirements on risk management and on over-riding pre-trade controls must be applied by firms with significant rigour. Preventing market manipulation trading platforms Q14. Are there any areas of the draft guidelines for trading platforms on organisational requirements for regulated markets and MTFs to prevent market manipulation where it would be useful to have extra detail? Q15. Do you have additional comments on the draft guidelines on organisational requirements for RMs and MTFs to prevent market manipulation? We agree with and support the proposed guidelines. However, we do believe that there is significant scope to go further: we believe that the current rules on market abuse on their face do encompass orders generated by modern technology, but we fear that the current narrow definition of those activities which fall foul of the market abuse regime is too narrow. We believe that on any natural understanding of language and appropriate market behaviour, trading activities which involve posting large numbers of bids and offers, the bulk of which are withdrawn and were never intended to be fulfilled but were only placed to gain market knowledge must be market abuse. These are phantom bids and offers and as their intent is never to be fulfilled, such phantoms seem deliberate attempts to take advantage of other market participants simply to the benefit of the party posting these phantom quotes. To be clear, we believe that this analysis extends beyond just flash orders, which we would strongly favour seeing banned; we believe active consideration needs to be given to regulatory intervention which goes well beyond just flash orders. We would encourage ESMA to give active consideration to extending the understanding of market abusive behaviours beyond simply the current list (ping orders, quote stuffing, momentum ignition, and layering and spoofing). Preventing market manipulation investment firms Q16: Are there any areas of the draft guidelines on organisational requirements to deal with market manipulation for investment firms where you believe it would be helpful to have more detail? Q17: Do you have additional comments on the draft guidelines relating to organisational requirements to deal with market manipulation for investment firms? We agree with and support the proposed guidelines. However, we would note the implications of our earlier answer: that the definition of market abuse should be reconsidered and that therefore there may be some need for additional staff training beyond that envisioned in the draft guidelines. Direct market access/sponsored access trading platforms Q18: Do the draft guidelines on organisational requirements for trading platforms whose members/participants or users offer DMA/SA deal adequately with the differences between DMA and SA?

5 Q19: Are there any areas of the draft guidelines on organisational requirements for trading platforms whose members/participants or users offer DMA/SA where you believe it would be helpful to have more detail? Q20: Do you have additional comments on the draft guidelines relating to organisational requirements for trading platforms whose members/participants or users provide DMA/SA? We believe that very active consideration needs to be given to whether direct market access or sponsored access are appropriate at all. We fear that this structure inevitably reduces the trading platform s control over the quality and appropriateness of those who trade on the market, and also therefore reduces the scope for oversight by regulators. While the guidelines do provide a basis for improving controls around these mechanisms for market access we are not sure that they are sufficient to mitigate the negative impacts on market quality which may arise from these practices. Direct market access/sponsored access investment firms Q21: Do the draft guidelines on organisational requirements for investment firms providing DMA/SA deal adequately with the differences between DMA and SA? Q22: Are there any areas of the draft guidelines on organisational requirements for investment firms providing DMA/SA where you believe it would be helpful to have more detail? Q23: Do you believe that there is sufficient consistency between the draft guidelines on organisational requirements for investment firms providing DMA/SA and the SEC s Rule 15c3-5 to provide an effective framework for tackling relevant risks in crossborder activity and without imposing excessive costs on groups active in both the EEA and the US? Q24: Do you have additional comments on the draft guidelines on organisational requirements for investment firms providing DMA/SA? As we indicate above, while we believe that the proposed guidelines improve the situation somewhat we remain to be convinced that the use of direct market access or sponsored access is appropriate at all. We fear that its impact on market quality and the ability of trading platforms and regulators to oversee market behaviours can only be assisted in a limited way by establishing higher standards for the investment firms allowing the use of their systems in this way. Draft guidelines in Annex VII Q25: Does the explanatory text provided in addition to the guidelines (see Annex VII to this CP) help market participants to better understand the purpose and meaning of the guidelines? Should it therefore be retained in the final set of guidelines? We believe that the explanatory text is helpful and should be retained.

ESMA S CONSULTATION SYSTEMS AND CONTROLS IN A HIGHLY AUTOMATED ENVIRONMENT FOR TRADING PLATFORMS, INVESTMENT FIRMS AND COMPETENT AUTHORITIES

ESMA S CONSULTATION SYSTEMS AND CONTROLS IN A HIGHLY AUTOMATED ENVIRONMENT FOR TRADING PLATFORMS, INVESTMENT FIRMS AND COMPETENT AUTHORITIES RESPONSE TO THE PUBLIC CONSULTATION OCTOBER 3, 2011 page1 Table