European Commission Public Consultation: Review of the Markets in Financial Instruments Directive (MiFID)

Transcription

1 European Commission Public Consultation: Review of the Markets in Financial Instruments Directive (MiFID) A Response by the Futures and Options Association FEBRUARY 2011

2 European Commission Public Consultation: Review of the Markets in Financial Instruments Directive (MiFID) 1. Introduction The Futures and Options Association ( the FOA ) is the principal European industry association for over 170 firms and organisations engaged in the carrying on of business in futures, options and other derivatives. Its international membership includes banks, financial institutions, brokers, commodity trade houses, energy and power market participants, exchanges, clearing houses, IT providers, lawyers, accountants and consultants (see Appendix 1). The FOA welcomes this opportunity of being able to comment on the European Commission s consultation paper Review of the Markets in Financial Instruments Directive (MiFID) ( CP ). 1.1 Executive Summary of Key Points General Concerns (summary of section 1.2 below) While the FOA recognises the need for and is generally supportive of the overall direction of the proposed changes and its response is therefore intended to go with the grain of the core proposals there are a number of real concerns (a) The Commission s proposals should sustain the original objectives of the MiFID, i.e. choice, diversity and competitiveness, as well as harmonising business conduct rules, etc. (b) The Commission should weed through the additional obligations and requirements placed upon firms, particularly in the area of authorisation, scope, product definitions and information disclosure, to ensure that they are not duplicative and are necessary (not just nice-to-haves ), cost-effective and justified by cost-benefit analysis. (c) A number of the requirements do not seem to take into sufficient account the fact that authorised firms are necessarily deemed fit and proper to carry on their business, i.e. some requirements appear to be based on the opposite assumption and are unnecessarily detailed. (d) The workload on a thinly-staffed, under-resourced ESMA will be intense, notwithstanding reliance on their equally under-resourced member regulatory authorities and will impact on both the process and timetable for implementation (and could generate shortcuts in the consultation process and quick fix solutions). (e) The implementation lessons and problems surrounding the original MiFID need to be taken into full account in setting implementation timelines for MiFID 2. Market Infrastructures (Chapter 2) Qualified support (because there is no regulatory detail) for classifying infrastructures as regulated markets, MTFs, systematic internalisers, OTFs (broken down into a few subregimes) and ad hoc OTC trading, but regulation must be tailored according to the size, functionality and asset classes of each group and recognise the need to maintain venue diversity. 1

3 1.1.3 Bilateral execution should continue to be a matter of choice and be fairly priced, but recognising that issues of transparency, trade reporting, post-trade efficiency and prudential regulation will have to be addressed but proportionately Tests for eligibility for CCP clearing are not necessarily the same as those that would be required to assess suitability for multilateral execution; and multilateral execution should not be the subject of a regulatory mandate The power to ban CCP-eligible trades that are not cleared by a CCP is, in effect, a backdoor mandate and could distort the risk-based argument about eligibility Market infrastructure operators have to maintain market integrity and orderliness, and these should include the power (but not a mandate) to impose minimum tick sizes and circuitbreakers (but much will depend upon where the thresholds are set). Automated Trading (Chapter 2) If high-frequency trading is to be the subject of additional and special requirements, it needs to be more closely defined Involvement with HF trading should not lead automatically to an authorisation requirement Resting periods are not appropriate and will militate against the right of an HF trader to withdraw from a stressed market. Circuit breakers are a better way of addressing volatility Sponsored access and HF trading must be effectively risk-managed as suggested. Pre- and Post-Trade Transparency (Chapter 3) The approach to transparency must strike a proper balance between conflicting priorities (e.g. liquidity, visibility, trading confidentiality) and the promise of a tailored and flexible approach to transparency in differentiated markets should be delivered on the ground While this may vary from market to market, the majority of participants are satisfied that there is an adequate level of transparency in most (if not all) non-equity asset classes. Some improvement with regard to retail-size trades may be appropriate There seems little advantage in, for example, pre-trade transparency obligations in relation to illiquid or highly-tailored contracts It does not follow that greater transparency will automatically result in close approximation between quoted prices and listed prices on regulated markets or MTFs, insofar as the former will reflect the market and counterparty risk assumed by dealers and that will vary from dealer to dealer. Data Consolidation (Chapter 4) No particular problem with the concept of APAs In view of the fact that a consolidated tape is expected to cover all prices in all markets and, bearing in mind the potential proliferation of OTC venues, there are potentially significant feasibility and cost issues surrounding a consolidated tape. There is less need to cover non-equity markets, particularly commodities. 2

4 Industry support appears divided between Options B and C (and the FOA has indicated a preference for B), but there is united resistance to Option A Data disaggregation is supported, but it must be empathetic to trading motives and end-user requirements. Matters Specific to Commodity Derivatives Markets (Chapter 5) The current arrangements for contract design do not need to be changed The role of speculators in commodity markets is critically important, and speculative activities should be addressed through the more dynamic and market-sensitive approach of position management rather than position limits (but recognising that position limits are likely to be a specific power made available to regulatory authorities) The MiFID commodity exemptions should be broadly retained, but there are differing views over the wording Any revision to definitions must ensure that commercial purpose physical forward transactions, as well as spot transactions, remain outside MiFID scope Emission certificates should remain outside scope and closer regulation (which is needed) should be a matter for the physical regulators. Transaction Reporting (Chapter 6) The extension of transaction reporting to any commodity derivative transactions, whether it is exchange traded or OTC, will not assist competent authorities to detect market abuse. The best tool to monitor commodity markets for manipulation is through position reports The introduction of an obligation on firms that receive and transmit or otherwise handle orders (but which are not executing the orders themselves) to pass on required details of such orders to the executing firm cannot be supported. A firm should rather be allowed to report required order details, such as the identification of its client, directly to a competent authority It is not considered useful to introduce a separate trader ID as in many cases the trader is not the person who made the initial decision to trade We welcome the Commission s proposal to waive the MiFID transaction reporting obligation on a firm which has already reported an OTC contract to a trade repository. However, the Commission should work closely with the industry to ensure that the data content standards for transaction reports and reports to the trade repository are consistent as firms will otherwise not be able to take advantage of the proposed waiver. Investor Protection and Provision of Investment Services (Chapter 7) There is a clear information overload and more consideration should be given (i) to the capability of investors to seek further information; and (ii) to imposing disclosure requirements only where necessary, practical and where there is evidenced need There should be no substantive change to execution-only business and neither Option A or B are acceptable. 3

5 Customer classification works well and should be left alone (although there may be a case for municipal authorities being re-classified) and there should be no undermining of the caveat emptor approach in the case of non-retail dealings Title transfer (subject to certain defined exceptions) is generally not appropriate in the case of most retail-based dealings. Further, it should not be the subject of a prohibition at the option of member states, insofar as this would undermine the optionality in the Collateral Directive and goes against some of the amendments in the latest Presidency Text of EMIR, which are predicated on the assumption of the continuance of title transfer as an option. Further Convergence of the Regulatory Framework and of Supervisory Practices (Chapter 8) All member states should permit and have a common approach to the use of tied agents Provisions on telephone taping must be proportionate and cost-sensitive (e.g. 6 months rather than 3 years records) Article 4 should continue, notwithstanding the harmonising role of ESMA, insofar as it is a valuable discipline on regulatory authorities that wish to gold-plate EU provisions The use of sanctions for deterrence purposes should not outweigh the need for proportionality. Reinforcement of Supervisory Powers in Key Areas (Chapter 9) The use of product bans will have severe implications for the value of products and the function of markets and may even exacerbate risk to the financial system and most such bans will, in the case of a market emergency, be carried out as a knee-jerk reaction. No view can be given on this power until significantly more detail is made available as to the criteria governing its exercise and the process authorising such a ban See para 2(d) for views on the right to ban CCP-eligible OTC transactions which are not CCP-cleared and para 6(b) as regards position limits The transfer of the powers of individual member states to grant exemptive relief to foreign exchanges / broker-dealers to the European Commission / ESMA may have the advantage of bringing a more harmonised approach, but the emphasis on strict equivalence is inappropriate and will encourage a tit-for-tat approach towards EU-based organisations looking to secure access in other jurisdictions and, as experience has shown, could provide a vehicle for EU protectionist behaviours. 1.2 General Points for Consideration The FOA notes that CESR has consulted widely. That is equally true of the Commission and the FOA believes that this should be of significant assistance in terms of developing a proportionate approach to reviewing the MiFID The FOA recognises and supports: (a) the Commission s overall programme for regulatory repair; (b) the underlying objective to respond to lessons learned from the recent financial crisis; (c) the observation by the Commission that the MiFID needs updating and that this will involve targeted reforms ; and 4

6 (d) the Commission s statements on the objectives and impact of the MiFID in its Introduction to the CP, namely, that: MiFID s main objectives are to improve the competitiveness of EU financial markets by creating a genuine single market for investment services and activities, and to ensure a harmonised, high degree of protection for investors in financial instruments, such as shares, bonds, derivatives and various structured products ; Greater competition across Europe in the provision of services to investors and between trading venues is intended to contribute to deeper, more integrated and liquid financial markets, to drive down the cost of capital for issuers, to deliver better and cheaper services for investors, and thus to contribute to economic growth and job creation ; and that the original MiFID has achieved these objectives and, in particular, resulted in lower trading costs per transaction, reduced bid-ask spreads and faster trading times as well as more choice for investors and greater opportunities for pan- European trading At the other end of the scale, a number of the proposals in the CP go beyond the CESR recommendations, and, while a differentiated view is clearly within the discretion of the Commission, some of them would, in the view of the FOA, restrict market functionality and user choice to the point where EU markets could become positively unattractive from an international perspective The FOA would urge the Commission to ensure that its proposals for change to the MiFID are necessary, evidenced by demand, supported by market impact analysis and, where possible, consistent with the original objectives of the MiFID. This means that the Commission s underlying policy, in updating the original MiFID and addressing unforeseen developments, should be to endeavour to deliver what is a very difficult balance between: (a) establishing safer and more closely-regulated markets without impairing market functionality, product diversity and investor choice; (b) re-pricing previously under-priced products and services without distorting the economics of trading, investment, raising capital and managing risks; (c) establishing closer market oversight without impairing the continuing need for innovation and development; (d) ensuring that regulatory reform is effective without introducing the kind of costly nice-tohaves that second-guess the authorisation process, i.e. requirements that do not take adequate account of the fact that investment firms, once authorised, are deemed fit and proper to carry on their business with all the behavioural assumptions that go with that determination; and (e) setting regulatory requirements for large cross-border firms without over-burdening small- or medium-sized domestic financial service providers which do not carry on cross-border business and for whom regulatory change is therefore a cost burden with little or no attendant benefit The need for the adoption of a balanced approach was addressed in the Commission s Communication Ensuring efficient, safe and sound derivative markets: future policy actions (COM(2009) 563/4) in a number of statements, including the following: 5

7 Derivatives play a useful role in the economy: they can be used to transfer (all or part of) the risks inherent to economic activity from economic agents who are not willing to bear them to those who are. The Commission does not want to limit the economic terms of derivative contracts, neither to prohibit the use of customised contracts nor to make them excessively costly for non-financial institutions. While these quotations are directed towards developing a revised regulatory approach to derivatives, they reflect a regulatory/economic balance that should govern the review of the MiFID The FOA would emphasise that a number of the new provisions put forward in this CP have extensive, even severe, change, resource and/or cost implications, particularly in terms of potential IT spend. It is to be hoped that the Commission will take these consequences heavily into account in assessing the cost-benefit of the provisions. In this context, the FOA notes that, in March 2007, the EU s Heads of Government agreed to reduce the administrative burden resulting from EU law by 25% by 2012, on the basis that it would save European businesses a total of 150billion. In January 2009, the Commission, in its Annex to the 3 rd Strategic Review on Better Regulation (COM(2009) 16f final) stated: (a) in its Introduction, that Suppressing unnecessary administrative burdens is more important than ever in difficult economic times, when EU businesses have fewer resources and need to invest to remain competitive ; (a) in Footnote 25, that The burden placed on SMEs that are not involved in trans-border activities should in particular remain proportionate ; and (b) in Section 8 of the Annex, that it would systematically look for further reductions in administrative burdens whenever EC legislation undergoes (sunset) review or revision. The FOA would urge the Commission to take these policy objectives, which have been reaffirmed post-crisis, into full account in the process of reviewing the MiFID (and which are mirrored by comparable policy objectives recently announced by the US President) The FOA recognises and supports the general role of ESMA in developing technical thresholds and standards and ensuring that there is even-handed interpretation, implementation and enforcement of directives across the EU, but is concerned that: (a) while much of the work will be delegated to working groups made up of its already overburdened member authorities, ESMA does not appear sufficiently resourced to analyse and finalise all the standards and thresholds allocated to it, not just in the CP, but across a number of other regulations and directives (in addition to overseeing certain regulatory functions; directly supervising a number of organisations; analysing an extensive amount of data; and serving as a supervisor of supervisors ); (b) the underlying policies and requirements standing behind any new legislation could be impaired, changed or overridden by the setting of overly restrictive technical standards/thresholds; (c) where MiFID expressly provides that member states competent authorities should have a degree of implementation discretion or regulatory choices, ESMA, in harmonising the implementation of any legislation that flows from this Consultation, could impair the free exercise of those discretions. 6

8 1.2.8 The FOA noted and welcomes the assurances given by the European Commission in its previous consultation papers that it will look to ensure that there will be full market impact analysis before the implementation of its policy orientations. It would observe only that such analysis has a key role to play well before the process of implementation, i.e. as part of the consultation and decision-making process, otherwise the findings could run behind the finalisation of Commission policy It is a matter of particular concern that some of the Commission s proposals (e.g. in Questions 65 and 66, which are addressed in paragraphs 5.19 to 5.23 in this response) will have a major cost and business impact on market participants and the FOA would urge the Commission to review them carefully to reduce the risk of unintended consequences. More particularly, we would draw the Commission s attention to the FOA s intention to put forward specific proposals with regard to modifying the exemptions in Articles 2(1)(i) and (k) of the MiFID (see para 5.13 in this response) So far as convergence with the US is concerned, the FOA supports the intention to harmonise regulatory approaches between the EU and the US and reduce the potential for regulatory arbitrage, but is concerned that: (a) the US, having adopted its legislation and now actively developing its regulatory implementation standards, the European Commission s negotiating position is less about negotiating convergence between the EU and US approaches and more about responding to US pressure to copy out the US approach; (b) the FOA would urge the Commission to avoid an approach of convergence for convergence s sake, particularly where it would involve any undermining of market functionality, undue restriction in investor choice (e.g. in the case of execution venues), the imposition of excessive costs or the adoption of disproportionate laws and regulations. The US negotiating position is perhaps best demonstrated in the US Treasury paper A New Foundation: Rebuilding Financial Supervision and Regulation (June 2009), setting out the post-crisis US programme for structural and regulatory reform, in which it was stated that the US leadership position in the international community should be used to promote initiatives compatible with the domestic regulatory reforms described in this report and that higher regulatory standards here the US mean that we must ask the world to do the same With regard to the matter of implementation, the FOA recollects the problems with the MiFID and would urge the Commission: (a) to balance out the different tiers of implementation fairly as between member states (where applicable), competent authorities, markets, firms and customers by setting timetables which avoid the kind of operational implementation squeeze that is so often faced by many firms and their customers which are at the end of the line in terms of implementation timetable; (b) to establish appropriate grandfathering and transitional arrangements, as well as implementation lead times which are practical and deliverable; (c) to allow sufficient lead times for authorised firms, their customers and markets and newly-categorised infrastructures to document and liaise with customers and put new systems in place or adapt existing systems to fulfil any new obligations. 7

9 2. Developments in Market Structures 2.1 The FOA supports the overall objective to enhance the regulation of different types of trading entities, providing it is proportionate to functionality, scale and risk. The responses to the following questions are not intended to undermine that objective, but there is a risk that regulatory straightjackets or one-size-fits-all policies and needless harmonisation could restrict venue diversity/functionality and the entry capability of new infrastructures and it is these new infrastructures that have forced the pace on technological innovation, pan-european offerings, speed of execution and cost-reduction. 2.2 The FOA notes the opening sentence of para 2.2 of the Consultation that MiFID is not prescriptive about where trades must be executed and provides flexibility and a choice for investors about where and how they wish to execute trades. Unfortunately, some of the proposals set out in this CP do not appear to be in line with that objective and are actually quite prescriptive about where trades may or may not be executed and, as a result, deny execution choice to end-users. We are also concerned that the proposals may not sufficiently recognise the fundamental differences between transferable securities, listed derivatives and OTC derivatives with respect to fungibility and transferability. The FOA believes strongly that sustaining the original MiFID objectives and the continuance of venue diversity would not undermine the need for closer and higher standards in the regulation of all execution venues. Q1: What is your opinion on the suggested definition of admission to trading? Please explain the reasons for your views. 2.3 The basis for admission should be appropriate for each venue and should not undermine the need for diversity in different types of venues serving different needs and offering different products. The FOA would urge the Commission to consider amending its proposed definition of admission to trading to read to be traded on or under its rules, rather than just on its systems, to allow a higher degree of execution flexibility and breadth of service offering, bearing in mind that trading could take place through and not just on a system or not on a system at all. We also point out that because the term admission to trading is used in the Market Abuse Directive, the Transparency Directive and the Prospectus Directive, it should be ensured that it is used consistently and that its extension to MTFs and other organised trading facilities does not result in additional information and reporting requirements in relation to financial information by issuers or corresponding duties of platform operators. Q2: What is your opinion on the introduction of, and suggested requirements for, a broad category of organised trading facility to apply to all organised trading functionalities outside the current range of trading venues recognised by MiFID? Please explain the reasons for your views. Q3: What is your opinion on the proposed definition of an organised trading facility? What should be included and excluded? 2.4 The absence of regulatory detail makes this a difficult question to answer. Subject to this fundamental concern, however, the FOA generally supports the proposal to establish a broad new category of organised trading facility (OTF) to capture all forms of organised execution venues that bring together buying and selling interests. 8

10 However, if this new category is to capture fairly and on a non-discriminatory basis bilateral / multilateral, discretionary / non-discretionary and voice / hybrid voice / electronic execution, it is essential that: (a) since many OTFs operate internally within authorised firms, full consideration should be given to the fact that they are already subject to extensive regulatory requirements; (b) the regulatory standards applying to each sub-regime are proportionate to its functionality, scale and asset classes, particularly in the case of voice-broking; (c) needless regulatory complexity that could confuse rather than simplify choice of venues is, wherever possible, avoided; (d) each sub-regime is readily accessible to those participants for whom they are intended, consistent with the Commission s statement that flexibility and a choice for investors about where and how they wish to execute trades should not be the subject of unnecessary prescription (or complexity). In this context, the FOA notes the cautious approach adopted by CESR in its Advice to the EU Commission, where it states that The key objective of CESR s further work should be to determine whether other trading platforms, in addition to RMs and MTFs, meeting all or part of the criteria set out, may qualify as organised trading venues. 2.5 The current definition of OTF needs to be more closely defined. The FOA notes that the proposed definition will exclude bilateral OTC trading, which is carried out on an ad hoc basis between counterparties and not under any organised facility or system. The FOA is concerned that the description of ad hoc trading does not reflect the fact that, in the wholesale institutional markets, trading takes place at multiple times in a day. Further, it is not yet clear what degree of organisation would be necessary to meet the threshold of being classified as an OTF. In addition, the FOA would emphasise the importance of enabling counterparties to be able to execute transactions bilaterally as an EU passportable open and fairly-priced service, alongside all the other forms of venues. 2.6 The FOA supports the requirements set out in Section 2.2 of the CP, providing that they are appropriately calibrated to the scope, scale, functionality and products of any particular venue. For example: (a) the requirement in (f) to monitor trading with a view to identifying conduct involving market abuse recognises that market infrastructure providers will not always be able to identify market abusive conduct and should therefore be no more than an all reasonable steps test; (b) with regard to (g), the FOA would emphasise that competent authorities should exercise their powers to remove financial instruments from trading reasonably, on a properly evidenced basis and after the provision of a statement of reasons and if it does not do so, the market operator should have the right to challenge the basis upon which that decision is made; and (c) with regard to (h), see the FOA responses to Q Q4: What is your opinion about creating a separate investment service for operating an organised trading facility? Do you consider that such an operator could passport the facility? 9

11 2.7 The FOA recognises that market infrastructure operators that manage organised venues should be licensed, but, until the various proposed sub-regimes/categorisations are developed, it will not be clear as to whether, in each case, it will be an investment service or a market service. That said, it would be more efficient and less costly to rely on existing licences and provide for a simple framework of registration. We would welcome clarity as to how the authorisation process would work, including whether it would apply to individual asset classes. For confirmation, the FOA believes strongly that parity in (proportionate) regulatory treatment across the EU should mean that all venue operators should be entitled to passport their facilities and services across the EU. Q5: What is your opinion about converting all alternative organised trading facilities to MTFs after reaching a specific threshold? How should this threshold be calculated, e.g. assessing the volume of trading per facility/venue compared with the global volume of trading per asset class / financial instrument? Should the activity outside regulated markets and MTFs be capped globally? Please explain the reasons for your views. 2.8 In general terms, the FOA recognises the potential importance of some OTFs to the system and that where such a facility mirrors the scale, size and importance of an MTF, there may be a case that it should become an MTF. On the other hand, some forms of OTF will not replicate an MTF, regardless of the volume of trades executed on its platform. Trading volumes should not be the subject of any cap and, while significant increases in trading volumes may call for closer oversight, it does not justify a change in venue type or functionality. In view of the fact that this kind of conversion will restrict choice, add operational complexity and increase cost to achieve a purpose that is not clear, the FOA would urge the Commission to undertake a full analysis to identify the market or regulatory failure that is sought to be addressed by converting OTFs to MTFs. Q6: What is your opinion on the introduction of, and suggested requirements for, a new subregime for crossing networks? Please explain the reasons for your views. Q7: What is your opinion on the suggested clarification that if a crossing system is executing its own proprietary share orders against client orders in the system then it would prima facie be treated as being a systematic internaliser and that if more than one firm is able to enter orders into a system it would be prima facie be treated as a MTF? Please explain the reasons for your views. 2.9 The FOA recognises that, while some broker crossing networks may replicate the functionality of an MTF or a systematic internaliser, they, at present, account for a small percentage of the total market in equities (estimated by FSA to be in the order of 1.25%) should be a separate sub-regime. More information is needed on the kind of regulation to which they will be subject in order to ensure, for example: (a) that institutional client interests are not prejudiced; (b) any read-across in regulatory requirements should be proportionate to the nature of the business; and (c) their operators, as investment firms, are already subject to exacting regulatory obligations and burdens, particularly conduct of business rules. The FOA makes no observations on systematic internalisers. 10

12 Q8: What is your opinion of the introduction of a requirement that all clearing eligible and sufficiently liquid derivatives should trade exclusively on regulated markets, MTFs, or organised trading facilities satisfying the conditions above? Please explain the reasons for your views In its Technical Advice to the European Commission on Standardisation and Organised Platform Trading of OTC Derivatives, CESR emphasised that standardised derivative products on organised trading venues should be incentivised by regulators, even though not mandated at this stage. The FOA believes in open competition between execution venues, but is against the use of regulatory mandates at any stage. Such a mandate and the proposed power to ban trading in CCP-eligible OTC contracts which are cleared by a CCP would, in the view of the FOA, run directly counter to: (a) the main policy objectives set out in the Introduction to the CP; (b) the Commission s opening statement (which the FOA wholly supports), that MiFID is not prescriptive about where trades must be executed and provides flexibility and a choice for investors about where and how they wish to execute trades and that notwithstanding section above concerning derivatives, the MiFID could continue to be neutral as to where a trade is executed (para 3.5 of the CP); and (c) the exemption from clearing afforded to non-financial counterparties, who will be denied access to OTC contracts which otherwise would be available to them. However, it appears that, in many respects, the Commission s approach is not neutral as to the methodology of execution. In this context, while some market participants are concerned over the lack of granular information about the nature and extent of trading that has taken place in various instruments outside regulated markets, MTFs and systematic internalisers, this concern will be addressed, presumably, through increased transparency and the Commission s approach to data consolidation. On that basis, the FOA would urge the Commission to sustain its neutrality on this issue and would note that the IMF, in its Global Financial Stability Report Meeting New Challenges to Stability and Building a Safer System (April 2010) stated that Many end-users continue to prefer OTC bilateral arrangements in order to meet their specific hedging requirements and hence have a desire for customised contracts (Chapter 3, p10). The FOA has frequently made the point that, providing the bilateral execution of OTC trades meets the yet-to-be-determined requirements on transparency, trade reporting, post-trade execution efficiencies and revised prudential rules, it continues to be unclear as to what is the remaining level of execution risk that attaches to bilateral execution that would justify removing an execution business model from the dealers and execution choice for end-users. Any new requirements must accommodate the continuance and accessibility of voicebroking. Q9: Are the above conditions for an organised trading facility appropriate? Please explain the reasons for your views. Q10: Which criteria could determine whether a derivative is sufficiently liquid to be required to be traded on such systems? Please explain the reasons for your views The FOA notes the observation that where appropriate, trading in standardised OTC derivatives should move to exchanges or electronic platforms, but would emphasise the 11

13 importance of developing appropriate standards of eligibility for such execution (e.g. as suggested in para of the CP). More particularly, the criteria for determining whether or not a CCP-eligible OTC derivative is eligible for multilateral execution will not be the same as those which determine whether or not an OTC derivative is eligible for CCP clearing and even where they are, it will be to a different extent/degree, e.g. the derivative: - while it must be standardised, the degree of standardisation is likely to be significantly higher than would be necessary for simply clearing the derivative; - must be part of a suitably developed market (and have the support of a sufficient number of market participants willing and able to trade it); and - must be sufficiently liquid and, here again, the text of liquidity may need to be deeper and more exacting if a tradable market is to be established. The test of sufficient liquidity can vary even intra-day and is a composite of, for example, a large number of variables such as numbers of participants, depth of the market, volume, leverage, open interest, volatility, frequency of trading all of which make it difficult to determine whether liquidity is or is not sufficient It should be borne in mind that many exchanges have launched new derivative contracts which were eligible for CCP clearing, but were abandoned because they were found to be inappropriate for multilateral execution. Trading models will vary widely in the way they bring buying and selling interests together. The Commission s suggested criteria of multi-lateral access may be problematic in that many derivatives are traded bilaterally and by voice execution. We would welcome clarification on this point. As an aside, the FOA is particularly concerned at the proposal in para 9.1 of the CP that, if ESMA is satisfied that a derivative is eligible for clearing, but no CCP is in a position to clear it, the competent authorities would have the power to ban trading in that OTC derivative pending a CCP offer to clear that derivative a power which would be coordinated through ESMA. The FOA believes that such a power could, because of user and/or regulatory pressure, inhibit CCPs from refusing to clear a derivative on grounds of an unacceptable enhancement of risk to the CCP and in relation to the contingent risk of its clearing members (see para 9.2 in this response). Q11: Which market features could additionally be taken into account in order to achieve benefits in terms of better transparency, competition, market oversight, and price formation? Please be specific whether this could consider for instance, a high rate of concentration of dealers in a specific financial instruments, a clear need from buy-side institutions for further transparency, or on demonstrable obstacles to effective oversight in a derivative trading OTC, etc In general terms, the FOA supports the significant efforts that are underway to improve the stability, transparency and oversight of OTC derivatives markets, subject to the observations made in its response to the Commission s Public Consultation on Derivatives and Markets Infrastructure (see also para 3.6 in this response). Q12: Are there existing OTC derivatives that could be required to be traded on regulated markets, MTFs or organised trading facilities? If yes, please justify. Are there some OTC derivatives for which mandatory trading on a regulated market, MTF, or organised trading facility would be seriously damaging to investors or market participants? Please explain the reasons for your views. 12

14 2.14 The FOA notes that derivatives could, where appropriate, be required to move not just to regulated markets and MTFs, but also to what is described as a specific sub-regime of organised trading facilities which fulfils the conditions set out in para of the CP, provides non-discriminatory multilateral access, meets transparency and trade reporting obligations and offers appropriate systems and facilities for the execution of trades. In response to this proposal, the FOA would reiterate the observations made by it in response to Qs 8, 9 and 10, and particularly the point that many newly exchange-listed contracts are eligible for CCP clearing but not for multilateral execution. Q13: Is the definition of automated and high frequency trading provided above appropriate? 2.15 The FOA supports the view that high frequency trading adds volume and liquidity to the market by reducing spreads and helps to align prices across markets. Its emergence is a natural evolutionary consequence of market development from chalk and board through to open outcry and telephone trading, and ultimately to electronic trading The FOA believes the definition is too broad and may capture unintended activities. For example, it does not just involve execution of trades as principal but also the execution of client trades on a principal or agency basis. It should certainly be the subject of a much clearer definition than being described as a sub-category of automated trading. This is largely to ensure that the consequential cost and burden of any new regulatory obligations are proportionate and reasonable. We note CESR s July 2010 Technical Advice to the Commission in the Context of the MiFID Review Equity Markets, where CESR stated that further work is necessary to better understand high frequency trading As a general point of principle, the FOA would urge the Commission to be cautious about restricting market participation / trading methodologies and motivations, other than where the potential for abusive or manipulative activities is so significant or so deeply integrated in the particular process that it is beyond any form of correction or management. In the view of the FOA, that is not the case here, particularly since firms are already under an obligation to monitor transactions for market abuse. Q14: What is your opinion of the suggestion that all high frequency traders over a specified minimum quantitative threshold would be required to be authorised? 2.18 The FOA notes the proposal that traders which engage in high frequency trading over a certain threshold should be licensed, but believes that the MiFID licensing criteria should not be defined by volume or trading methodologies, but by functionality and the nature of the activity undertaken. The system by which individual trades are executed should not be a determinant as to whether or not its user should require to be authorised as an investment firm. MiFID provides that, subject to certain exemptions, dealing on own account, if it is carried on as a regular occupation or business on a professional basis is a licensable activity (Article 5), but the term involved with high-frequency trading is too wide and could catch customers of authorised firms. Finally, in its Technical Advice to the Commission in the Context of the MiFID Review Equity Markets (referred to above), CESR recommended that further work be done on direct members of RMs/MTFs that currently fall under the MiFID Article 2(1)(d) exemption for nonmarket making firms that trade only on a proprietary basis. The FOA agrees that further analysis is needed in this area and would reiterate our comments in para 2.17 of this response that restricting market participation should be approached with caution. Q15: What is your opinion of the suggestions to require specific risk controls to be put in place by 13

15 firms engaged in automated trading or by firms who allow their systems to be used by other traders? 2.19 In general terms, the FOA supports most of the proposed additional organisational requirements set out in para (c) of Section 2.3 of the CP, particularly the importance of having in place clear, robust risk controls and filters in the case of sponsored access (some of which may be more easily provided by market infrastructure providers). The FOA understands that this is already common practice. The FOA believes that requiring firms to provide their computer algorithms and all related details to regulated authorities is likely to be meaningless. Q16: What is your opinion of the suggestion for risk controls (such as circuit breakers) to be put in place by trading venues? 2.20 The operators of trading venues already have a wide range of powers to ensure the maintenance of market integrity and orderliness and circuit breakers (depending on thresholds / calibration) will have a part to play in that process. The exercise of risk controls should be within the discretion of trading venue operators, albeit subject to compliance with common EU standards and working in association with the relevant regulatory authority. They should not, however, be the subject of any form of mandate or overly prescriptive controls. Q17: What is your opinion about co-location facilities needing to be offered on a non-discriminatory basis? 2.21 The industry wholly supports non-discriminatory access to co-location facilities. However, it does not believe that it would be appropriate for the regulatory authorities to equalise artificially the role of market participants on the basis that some of them are not able to make a similar investment in trading technology. This level of resource differentiation exists across every form of economic/financial activity. Further, the regulators should not impair the ability of market infrastructure providers to set reasonable commercial charges for making those facilities available. Q18: Is it necessary that minimum tick sizes are prescribed? Please explain why While there is some support for minimum tick sizes, this should not result in a momentum towards them becoming smaller and smaller, because this would have the effect of fragmenting liquidity. The setting of them should be subject to on-going review and, once again, be a matter for exchanges and other alternative platform providers, working in association with market participants. Q19: What is your opinion of the suggestion that high frequency traders might be required to provide liquidity on an ongoing basis where they actively trade in a financial instrument under similar conditions as apply to market makers? Under what conditions should this be required? 2.23 The FOA believes that further analysis is needed before determining whether high frequency traders pose a risk to the orderly functioning of markets, so determining whether they should be required to become market makers is premature. As noted in para 2.16 above, CESR s Technical Advice in the context of the MiFID Review stated that further work is necessary to better understand high frequency trading. Q20: What is your opinion about requiring orders to rest on the order book for a minimum period of 14

16 time? How should the minimum period be prescribed? What is your opinion of the alternative, namely of introducing requirements to limit the ratio of order to transactions executed by any given participant? What would be the impact on market efficiency of such a requirement? 2.24 The FOA believes that it would not be appropriate to require that orders rest on the order book for a minimum period of time. The FOA believes that any such requirement is unnecessary in view of the provisions that will be introduced to ensure (rightly) that high frequency trades are properly risk managed and are not susceptible to abusive behaviours. Transaction ratios are already in place in a number of exchanges on an ID basis. The FOA does not share the view that there may be some benefit in introducing further requirements to limit the ratio of orders to transactions executed by any given participant. Here again, the test should be whether or not the volume of orders constitutes market manipulation or abuse, or some other improper form of market activity. Q21: What is your opinion about clarifying the criteria for determining when a firm is a SI? If you are in favour of quantitative thresholds, how could these be articulated? Please explain the reasons for your views. Q22: What is your opinion about requiring SIs to publish two sided quotes and about establishing a minimum quote size? Please explain the reasons for your views The FOA believes these are questions which are best addressed by those trade associations and organisations whose role covers dealings in shares. Q23: What is your opinion of the suggestions to further align organisational requirements for regulated markets and MTFs? Please explain the reasons for your views The FOA recognises that there is a case for parity in regulatory treatment to be made where, as it is put in the CP, competing business models are similar, but regulation must also be tailored to fit the scale and nature of a business and the services and asset classes covered by particular markets, irrespective of whether they are regulated markets or MTFs or OTFs. There is also the question of the risk profile posed by competing business models and the nature and extent of the users of each market, all of which may call for differentiated regulatory treatment. Put another way, MTFs should not be forced to adopt an RM business model, recognising that it is the differences between them that offer choice to clients, in terms of specificities and differences. MTFs, for example, should be allowed to continue to operate a broad range of trading models, as demanded by market participants. Q24: What is your opinion of the suggestion to require regulated markets, MTFs and organised trading facilities trading the same financial instruments to cooperate in an immediate manner on market surveillance, including informing one another on trade disruptions, suspensions and conduct involving market abuse? 2.27 The FOA fully supports this proposal even the mandating of prompt information-sharing and co-operation among market venues, particularly those that trade the same financial instruments, in order to better detect and prevent market misconduct or deal with systems disruptions. At the same time, there are categories of information that will be held in confidence by competing venues and which, while disclosable to a regulatory authority, could be commercially damaging if disclosed to a competing venue. 15

17 2.28 The FOA would urge the Commission to be particularly sensitive to avoid the risk of overburdening small-size MTFs and OTFs with a regulatory cost burden that is predicated on the basis of one size fits all or which would otherwise create an unreasonably high barrier to entry by new start-up trading facilities and therefore impair market competitiveness. Q25: What is your opinion of the suggestion to introduce a new definition of SME market and a tailored regime for SME markets under the framework of regulated markets and MTFs? What would be the potential benefits of creating such a regime? Q26: Do you consider that the criteria suggested for differentiating the SME markets (i.e. thresholds, market capitalisation) are adequate and sufficient? The FOA believes that questions regarding the Commission s proposal to define and establish a separate regime for SME markets are best addressed by trade associations and firms which cover SME markets. We do however appreciate the importance of these issues, and would encourage the Commission to establish an industry working group, comprised of exchanges which currently operate growth markets or which would be interested in doing so, along with representatives of investors, issuers and advisers. The group would be tasked with reviewing the way in which current growth markets operate within the EU, to identify common principles and guidelines, and to determine whether these could be used to develop a cohesive pan-european approach to supporting SMEs. The objective should be to enable Europe s SME markets to gain a critical mass of issuers, intermediaries and investors. 3. Pre- and Post-Trade Transparency 3.1 The FOA supports the Commission s view that transparency should be able to provide investors with access to information about current trading opportunities, facilitate price formation and assist firms to provide best execution to their clients. It should also be sufficient to enable those clients and other end-users to assess the quality of execution of trades executed with them or on their behalf and to evaluate their exposures with a reasonable degree of accuracy on an on-going basis. It should not, however, result in the imposition of retail obligations in wholesale markets. 3.2 The FOA also believes, however, that a balanced approach towards transparency is necessary to ensure that the objectives set out in para 3.1 above can be achieved without breaching necessary trading confidentiality, inhibiting dealer participation or generating migration of trading liquidity to less transparent venues in other jurisdictions. The FOA would point out that market liquidity is highly dependent on the ability of market makers to assume significant transactional risk and of end-users to have trading confidentiality. 3.3 The FOA notes the Commission s concerns that the absence of reliable price information would increase cost for investors, create valuation uncertainties and generate significantly less transactions, resulting in reduced liquidity and increased indirect transaction costs. The FOA understands these concerns, but questions whether greater transparency would, as stated, have the effect of actually increasing liquidity. More to the point, significant reductions in market liquidity and increases in transaction costs are more likely to be motivated by increases in clearing fees (as a result of significantly higher regulatory standards applicable to CCPs), the pass-on costs of dealers to end-users, higher prudential rules and, potentially, increased margin calls called more frequently and tighter rules on collateral. 16