CESR Secretariat Stockholm, 21 January 2005 11-13, avenue Friedland F-75008 Paris France CESR s Draft Technical Advice on Possible Implementing Measures of the Directive 2004/39/EC on Markets in Financial Instruments 2 nd Set of Mandates - Submission from OMX Exchanges OMX Exchanges STOCKHOLM HELSINKI RIGA TALLINN VILNIUS STOCKHOLMSBÖRSEN AB STOCKHOLM STOCK EXCHANGE. SE-105 78 Stockholm. SWEDEN. Tel. +46 8 405 60 00. Fax +46 8 405 60 01 Visiting Address: Tullvaktsvägen 15. Reg. No. 556383-9058. www.omxgroup.com EFFICIENT SECURITIES TRANSACTIONS
1. Introduction OMX Exchanges Limited is a Finnish company owned by OMX AB, as well as the brand name for the transaction division within the OMX Group. OMX Exchanges comprises Stockholm Stock Exchange, Helsinki Stock Exchange, Tallinn Stock Exchange, Riga Stock Exchange and Vilnius Stock Exchange, which are all fully or partly owned subsidiaries of OMX AB. OMX Exchanges co-operate with the other Nordic exchanges, notably Oslo Börs ASA, Copenhagen Stock Exchange A/S and Iceland Stock Exchange, within the framework of the Nordic exchange alliance NOREX. All exchanges within NOREX offer trading on the same trading platform and have harmonized access rules for members and rules for trading in equities. In addition, Stockholm Stock Exchange has developed an exchange- and clearing link co-operation with regard to derivatives with the Danish-, Norwegian- and UK-markets. 1 Stockholm Stock Exchange and Helsinki Stock Exchange are both members of FESE and as such fully subscribe to the views put forward by FESE to the current CESR consultation. In addition to the FESE response, we would like to submit some own remarks to the consultation. Those views are painted out in detail in the following. However, before going into details, we would like to reiterate the concerns which at a number of occasions have been raised by practitioners so far during the course of the level 2 discussions and which we brought forward in our response to the first round of consultation made by CESR namely the problem with the number of details in the level 1 directive as well as the draft CESR advice on level 2. One observation that is evident is that the number of detailed rules in MiFID on level 1 is difficult to combine with the bedrock in the Lamfalussy criteria that the level 1 regulation should be based on framework principles. Now, we have to face the fact that MiFID to a large extent is a product of compromises and far to detailed as would have been wanted or expected. We recognize that this puts a huge challenge for CESR in presenting its advice to the Commission. The indications so far is that CESR elaborates with even more details on level 2, and in doing so runs the risk of putting the over all objectives of MiFID in danger. In plain language, MiFID is to a large extent aiming at creating a level playing field amongst a variety of trading venues with the objective of promoting efficiency and to foster innovation in order to make the European markets truly competitive in a global environment. To take an example, to envisage only a limited number of market models and to propose detailed rules attached to such models is clearly a way which may effectively stifle innovation with regard to development of new market models. In fact, CESR does not even acknowledge the existence of hybrid markets, with the particular needs and concerns attached to such markets which, we would argue, are applied by most of the European markets today. 1 Notably, Oslo Börs ASA and NOS Clearing ASA in Norway, Copenhagen Stock Exchange A/S and Futop Clearing Centre A/S in Denmark and EDX.London Ltd. and LCH.Clearnet Ltd. in London. OMX Exchanges has also developed a co-operation with regard to trading in derivatives with Eurex. 2(8)
As we see it, the only feasible way for CESR to promote the objectives for MiFID would be to swift from proposing a number of detailed rules in favor of a more principle based approach. The rationale for such an approach would be to recognize that MiFID include a sufficient number of details, and that a principle based approach on level 2 would be the most efficient way to convert the level 1 rules into an practical environment, without setting the objectives of MiFID aside. 2. Section II Intermediaries 2.1 Execution Only [Article 19(6)] To start with, we question CESR s interpretation of the Level 1 text to exclude derivative instruments from the notion of non-complex financial instruments. The catalogue in Art 19.6 explicitly excludes only such derivatives as are embedded in a bond or other securitised debt. A restriction as narrow as the one proposed by CESR would be to rigid and exclude retail investors from the possibility to get cost efficient solutions for administration of their respective portfolios. It should be born in mind that strategies for trading in derivatives can be used for multiple purposes, ranging from pure speculation (sometimes with high risk) to hedging (normally with low risk). In respect of derivatives there is also, in our view, a difference depending on the type of transaction. For example, the holder of a standardized call option or covered warrant only risks to loose the premium once paid, whereas the issuer of such instrument is exposed to, in theory, unlimited losses. In respect of exchange traded derivatives, such issuer, or seller, typically has to collateralize his or hers positions in the derivative contract based on daily margin requirements calculated by the relevant CCP. Such risks are not involved in the warrant market, since warrants are transferable and normally issued by a credit institution. In our markets, exchange traded standardized warrants normally are considered retail products, and thereby non-complex by their very nature. Due to the above, we would instead advocate a solution, in respect of derivatives, based on the risks involved as well as the complexity of the instrument. We therefore propose that the reference to non-derivative in the first line under Definition of non-complex instrument in Box 10 be deleted. The remaining parts of the proposal would sufficiently address the concerns in respect of complex derivative instruments since Sub-paragraph a) safeguards that the derivative instrument need to be properly liquid, and thereby promotes an exit for the retail investor in respect of such derivative, Sub-paragraph b) safeguards that the retail investor will not risk to loose more than the contribution once paid for the derivative instrument, and neither will run the risk of having to provide collateral in respect of exchange traded derivatives, and Sub-paragraph c) safeguards that the terms in respect of the derivative instrument are transparent and easily understandable for the average retail investor. 3(8)
3. Section II Markets 3.1 Display of Client Limit Orders (Article 22.2) We fully endorse the proposals and considerations made by CESR. In particular, we support the proposal that any arrangement used for the purposes of Article 22.2 will have to meet both the visibility test and the accessibility test. We share CESR s view that public order books, let be in the form of an order driven market or a hybrid market, are straightforward and meet both criteria. In our view, such markets are well placed to serve as benchmarks when determining whether a given alternative arrangement should be acceptable or not, should a member state choose not to make publication on a RM or MTF mandatory as envisaged as an option in Article 22(2). 3.2 Pre-trade transparency-systematic Internalisers (Article 4 and 27) 3.2.1 General comments The above Section of the consultation goes to the heart of the discussion as to whether a trade has taken place On-Exchange or Off-Exchange, a discussion that sometimes seems to be somewhat confused. We would welcome if CESR made it clear that the distinction only is relevant to some parts of MiFID, notably the quote obligation for Systematic Internalisers in Article 27, and, bearing in mind the principle of subsidiarity, that individual member states would be free to define a particular trade as an On-Exchange Transaction for purposes outside the scope of MiFID. To our understanding, MiFID should be interpreted as follows. MiFID focuses to a large extent on the notions of pre-trade transparency and post-trade transparency. From a regulated markets (RM) point of view, pre-trade transparency normally relates to bid- and offer prices in the order book. Post-trade transparency, on the other hand, relates to either of the following two situations; (i) (ii) recently concluded trades that have been matched in the order book. reported trades/negotiated trades, i.e. trades that have been negotiated outside the systems of a RM, but reported to the RM by the member or members involved. It should be acknowledged that the notion of On Exchange Trading may have considerable legal consequences in the different members states. For example, different tax regimes may apply depending on whether a transaction has taken place on a RM or outside a RM. Other examples are that certain types of transactions may only be allowed if they take place on a RM or that a certain percentage of the over all transactions made by a certain institutional investor need to take place on a RM. It should also be born in mind that the internal transaction policies of some institutional investors require at least that certain part of the investments be made on a RM. 4(8)
With regard to MiFID, one of the core objectives is to create a Level Playing Field between different forms of trading venues. MiFID therefore emphazises that pre-trade transparency and posttrade transparency shall apply where trading takes place on a regular and organized manner, no matter the legal basis for the trading venue. In order to create a level playing field with regard to transparency, it is necessary to make a distinction between transactions that takes place on a RM, and transactions that takes place outside a RM. However, this should not result in that transactions that are not executed in the systems of a RM but under its rules could not be regarded as On- Exchange Transactions for purposes outside the scope of MiFID. Investment firms MiFID differentiates between Systematic Internalisers (SI) and other investment services provided by investment firms. For a SI, the quote obligation rule in Art. 27 apply, meaning that quotes published by SI s under such rule should be regarded as quotes outside a RM, but only for the purposes of Art. 27 2. It is important to stress that investment firms that are not SI s are not subject to any pre-trade transparency obligation except for what follows from the Client Order Handling Rule (Art. 22.2). This means that such firms, if they are not in a position to execute a client order instantly, are required to forward the order to the market or, as expressed in MiFID, making public immediately the client order. One option for publication from such an investment firm would be to forward the order to a RM 3, and then the pre-trade transparency regime for RM s would apply (Art. 44). With regard to post-trade transparency obligations, investment firms are required to publish information in respect of recently concluded trades to the market (Art. 28). The investment firm could do that by using the facilities of a RM, own approved facilities or the facilities of a third party service provider (notably a vendor). Except where the trade is published through the facilities of a RM, the transaction would be regarded as having taken place outside a RM. If the transaction on the other hand is published through the facilities of a RM, the transaction should be regarded as having taken place on such RM (or MTF), provided that the RM has adopted rules in respect of such trades executed outside its technical system and reporting is made in compliance with such rules. Regulated Markets Regulated markets are subject to pre-trade transparency requirements (Art. 44) as well as post-trade transparency requirements (Art. 45). However, MiFID does not in itself require transactions on a RM to take place in a technical system. It would be feasible, and accepted, under MiFID to organize a market in the form of a floor or as pure telephone trading, as long as the trading is subject to the 2 cf. recital 49 but also the definition of Systematic Internaliser, Art. 4.1. 7). The wording outside a regulated market should not necessarily be considered a synonym to Off Exchange Transaction. 3 or an MTF; but for the sake of simplicity that situation will be left out of this paper. Having said that, when reference is made in the text to a RM, the reference will apply equally to an MTF. 5(8)
rules of a RM 4. In fact, this is highlighted in recital (6) where it is stated The term system encompasses all those markets that are composed of a set of rules and a trading platform as well as those that only function on the basis of a set of rules. Consequently, the relevant decisive factor for whether a transaction has taken place on a RM or not should be the rules of the RM, not the form of execution. In light of the above, the distinction between On Exchange Trading and Off Exchange Trading according to MiFID should be made along the following lines; On Exchange Transactions Orders displayed in an order book maintained by a RM, normally in the form of a technical system (Pre-Trade) Orders forwarded to a RM by an investment firm under the rules of such RM due to the Client Order Handling Rule (Art. 22.2) (Pre-Trade) Orders or quotes made by a SI to comply with its obligations under Article 27, where such orders or quotes are made in the order book maintained by a RM in its systems and where the orders or quotes are executable in the technical system and subject to the rules of the RM (Art. 27). 5 Transactions concluded in an order book maintained by a RM, normally in the form of a technical system (Post-Trade). Transactions reported to a RM by an investment firm, including a SI, and which have been made in accordance with the rules of the RM (Art. 28) (Post-Trade). Off Exchange Transactions Orders that are routed to the market from an investment firm due to Art. 22.2, except where the publication is made through the facilities and rules of a RM Quotes published by SI s according to Art 27 which either o is published through proprietary facilities or the facilities of a third party service provider, or o is published through the facilities of a RM but outside the rules of the RM; e.g. a Bulletin Board Market. Negotiated trades, which an investment firm makes public to the market in accordance with Art. 28, but which are not published through the facilities of a RM. This would also apply in relation to trades as a result of quotes subject to Art. 27. Transactions reported to a RM by investment firms, which are not subject to the rules of the RM. 4 cf. recital (6) and the definition of Regulated Market, Art. 4.1.14). 5 Of course, in this situation, the investment firm will have to meet the criteria laid down in MiFID and related Level 2 implementation measures. The relevant RM could only add requirements in its rules, but not dispense with any requirements laid down in the legal instruments decided at EU-level. 6(8)
3.2.2 Definition of Systematic Internaliser We do not have any particular concerns in respect of this part of the consultation. 3.2.3 Scope of the Rule (Article 27.1) We firmly believe that liquidity should be measured on a national basis. Bearing in mind the context to which the measurement of liquidity is to apply, we also strongly advocate a solution as simple as possible in order to keep the regulatory costs down. Even though it might be feasible to put in place models for adequate calculation, such models would most probably require investments in sophisticated technical systems, involve an excessive number of staff and require time consuming exercises for compilation of adequate data in order to carry out the computation. It should be acknowledged that the need for fine-tuning the calculation in order to obtain the absolute truth in respect of liquidity is not a prerequisite to achieve the objectives behind Article 27. Instead, the use of proxies, perhaps in combination with user-friendly predetermined criteria, would get an acceptable result and thereby be sufficient for the purposes of Article 27. Consequently, OMX Exchanges strongly supports such a position. As to the different methods set out in the consultation paper, we would argue that the following proxies/pre-determined criteria should be used in concert, where appropriate: Trading Methodology: i.e. continuous trading (a), Trading activity of a certain stock: at least one trade a day (b) Turnover velocity: the problem with different approaches in respect of calculation of the free float can be circumvented by calculating the velocity based on the total number of outstanding shares, and not only limited to the free float (part of h), Tradable indices: Since exchanges have an interest in providing liquidity, one could assume that derivatives based on tradable indices normally are liquid. In addition, if a certain share is part of a tradable index that would per se promote the liquidity in that particular share. Nonetheless, it could be worthwhile to further analyze whether these assumptions are adequate in a European context. Top 5 percent, however not less than 5 shares on each regulated market: We support the view that liquidity should be taken into account not only on a European level but also on a domestic level. Otherwise, the drivers behind Article 27 would not be relevant at all to the smaller European markets, since it could be assumed that some markets would not have a single liquid share, if calculated in accordance with the standard methods. Consequently, at least the top 5 percent of the shares traded on each regulated market should be deemed liquid. Since some markets may have less than 100 shares in companies admitted to trading, there should be a supplementary rule stating that at least 5 shares should be deemed liquid. 7(8)
It should be noted that the first two bullet points are inadequate in order to measure liquidity, and therefore inappropriate for such purposes. However, they clearly envisage which shares should not be deemed liquid, and may therefore support other hard factors such as velocity, tradable indices and most traded. 3.2.4 The determination of the Standard Market Size/Classes of shares (27.1 and 27.2) Acknowledging the complexity of the rules pertaining to calculation of SMS, we have no objections against the proposals set out in Box 16. For practical reasons, we support to fix the SMS as a nominal value instead of converting it into number of shares. We also support annual revisions as an appropriate time frame for adjustments, which seems to strike a proper balance between the interest of having the SMS reflecting the realities of the markets and the interest of keeping the regulatory costs at an acceptable level. 3.2.5 Obligations of the Systematic Internaliser We support the proposals that quotes be made on a real time basis, that such quotes shall meet the accessibility test and that Systematic Internalisers (SI) shall remain responsible for their quotes, even where such quotes are made through the facilities of a third party. We also support the approach that publication on a website per se should not be regarded as having met the accessibility test. 3.2.6 Handling of client orders and executing the orders Our only comment under this section is that the retail size orders should be based on national approaches (cf. question 11.5). Again, any method chosen for the compilation of data and calculation should be as simple as possible in order to keep the regulatory costs down. Yours Sincerely, Mats Beckman General Counsel OMX Exchanges 8(8)