Trading venues decry disruptors as MTF battle heats up

Unregulated tech vendors accused of operating as de facto venues; a claim dismissed as “entirely outrageous”

  • Regulated trading venues have raised concerns about technology firms improperly offering trading services without being authorised as MTFs.
  • But experts say that a fuzzy dividing line separates regulated and unregulated activities, complicating assertions from stakeholders.
  • Firms named specifically include Symphony, Neptune and OTCX – all of which maintain they are correctly categorised.
  • The rules allow exclusions for certain unregulated firms and official guidance precludes MTF regulation for bulletin board-like services.
  • Still, tech providers active in the UK may need to obtain arranging permissions, even if they fall outside the MTF regulatory boundary.

Imagine, for a moment, a trading tool that allows buy-side users to send quote requests to multiple dealers in one click. The tool collects responses and then displays the quotes on the buy-sider’s screen. The dealer sees only a single request for a trade. Should this service be described as a trading venue, or is it a chat tool with extra frills?

The tool exists: it is called Sparc, and it was launched last year by tech vendor Symphony as a bolt-on to the firm’s messaging platform. Sparc is not designated as an official trading venue in Europe, termed a multilateral trading facility (MTF). As such, it does not have to meet the same costly regulatory requirements as MTFs.

Regulated venues are crying foul over tools like these. They argue they are at a competitive disadvantage to firms such as Symphony, which can offer similar services at a lower cost and in a more nimble fashion by avoiding the rules. They are pushing for the disruptors to be forced to register as MTFs, or at least for regulators to clarify the rules.

Tech vendors that offer these services, among them Symphony, argue they merely distribute data or enable single parties to communicate with each other, and should not be in scope of the regulation.

At the centre of the debate is the interpretation of a European Union directive on market trading and transparency. Lawyers admit the regulation is not clear-cut.

“The problem is the rules are crafted quite generally, and I think there can be some ambiguity,” says Steven Burrows, a senior associate at law firm Fieldfisher.

Risk.net spoke with five regulated venues that expressed varying degrees of concern about technology firms performing unregulated activities. Some of them have brought particular firms to regulators’ attention, Risk.net understands.

A senior member of a regulated venue called the situation “one of the biggest competitive threats” to their business. The member complains certain technology firms “compete with us on an unlevel playing field” because of their unregulated status, which enables them to swerve potentially onerous requirements to set up risk management controls and to report trades, among others.

One London-based lawyer who represents software vendors under scrutiny refutes this view. The lawyer calls the position of regulated platforms “entirely outrageous” and says some of those vendors are “deeply frustrated” by being caught in the discussion.

“I think it’s entirely within the letter of the law and the spirit of the regulation to have services that are not properly characterised as MTFs, even though they help facilitate communications and potential trading interest,” says the lawyer.

You may think what I’m doing is just adding functionality that makes my pricing service work more attractively to users. But what you’re actually doing, if you’re not careful, is turning yourself into a trading venue
Peter Bevan, Linklaters

The Financial Conduct Authority is understood to have had conversations with market participants regarding the scope of rules governing trading venues in derivatives markets.

The FCA declined to comment on the record.

The European Securities and Markets Authority, which has said it has been made aware of the issue and is looking into it, declined to comment further.

Peter Bevan, global head of the financial regulation group at Linklaters, says that as technology providers look to expand their services and offer more sophisticated capabilities, they have to be mindful of the boundary where regulatory requirements start to kick in.

“You may think what I’m doing is just adding functionality that makes my pricing service work more attractively to users. But what you’re actually doing, if you’re not careful, is turning yourself into a trading venue,” says Bevan.

Letter of the law

The second Markets in Financial Instruments Directive, or Mifid II, came into force across the European Union at the start of 2018. The regulation defines an MTF as a “multilateral system operated by an investment firm or market operator, which brings together multiple third-party buying and selling interests in financial instruments in the system, in accordance with non-discretionary rules, in a way that results in a contract”.

Despite being relatively recent, the definition “struggles to keep up with technical innovation,” says Bevan, whose firm represents both MTFs and tech providers affected by the scope of regulatory definitions.

The FCA states that all multilateral systems operated in the UK must be arranged as an MTF or an organised trading facility (OTF). But the regulator does not consider systems like bulletin boards that broadcast messages to fall under the multilateral system definition.

Its guidance states: “In our view, any system that merely receives, pools, aggregates and broadcasts indications of interest, bids and offers or prices should not be considered a multilateral system.”

Burrows at Fieldfisher says the essence of an MTF is the bringing of multiple parties together to transact. Some may argue a tool such as Sparc meets this criterion, but Scott Eisenberg, general counsel at Symphony, disagrees.

“Bilateral is the key to how this all works,” he says, referring to Sparc. “Rather than have, say, five different chat windows with your five dealers, you have a single view of the world where you’re engaged in several bilateral discussions.”

Eisenberg argues the tool, which is in a limited release phase with roughly a dozen clients, is “no different than having five telephone conversations going at once”.

Bilateral is the key to how this all works. Rather than have, say, five different chat windows with your five dealers, you have a single view of the world where you’re engaged in several bilateral discussions
Scott Eisenberg, Symphony

Eisenberg says Symphony, which is not overseen by financial regulators in any jurisdiction, has not discussed Sparc with either the FCA or Esma.

Symphony is one of three tech vendors – along with data aggregation firm Neptune Networks and request for quote (RFQ) platform OTCX – whose regulation status is the subject of concerns raised by market participants.

Neptune brings together information on dealer bond axes and inventory for the buy side. Neptune interim chief executive officer Byron Cooper-Fogarty says he is aware that market participants have questioned whether Neptune should be regulated, and he disagrees with the view.

“Our core business is about the distribution of data from the dealers to the buy side. That’s not a regulated activity,” he says.

The firm is not looking to become a regulated venue, Cooper-Fogarty adds.

FactSet subsidiary and multi-asset execution management system provider Portware, which one bank’s e-forex sales head has suggested may function similarly to an MTF, argues the firm does not operate on a multilateral basis.

“Portware and other technology products that help the buy side execute bilateral trades do not fall under MTF designations as they are not multilateral execution venues, nor do they aggregate buyers and sellers,” a FactSet spokesperson said in a statement.

Diego Ballon Ossio, senior associate at law firm Clifford Chance, says he has heard concerns about unregulated firms from MTF clients, adding that some firms have stretched the rules close to their extreme.

“There are some which have taken this to quite a detailed degree – they took the bulletin board idea and converted it into this very slick, very easy-to-use platform. The more technology you put into it, and the more you aggregate, the more it starts looking like an MTF or another regulated activity,” he says.

Close to the border

The question is at what point the add-on capabilities transform the tech platform into a regulated venue. Ballon Ossio says one of the markers of this boundary is the creation of rules of engagement for the platform.

When a service has reached a level of “understanding between everybody who joins that this is how the behaviour is going to be done on this particular bulletin board or aggregator, then you have de-facto created the non-discretionary rules”, says Ballon Ossio.

Symphony argues the absence of rules on its platform is a distinguishing factor from regulated venues.

“It is up to the customer to determine who they speak with, how they speak with them, what they discuss, and whether to decide I’m done or not,” says Eisenberg.

Another determinant of whether a platform should fall under the regulation centres on execution. The FCA guidance on bulletin boards says a platform should not be considered an MTF if “there is no reaction of one trading interest to another [user] within these types of facilities”. The description rules out trade execution occurring on the platform.

The more technology you put into it, and the more you aggregate, the more it starts looking like an MTF or another regulated activity
Diego Ballon Ossio, Clifford Chance

But identifying exactly where execution takes place can be tricky: “If you communicate that [trade] agreement to me outside the system – let’s say you pick up the phone and call me – or you communicate back to me through the same system, when did the execution happen, and in whose system did it happen? Did it happen over the phone? Did it happen on your trading desk? Did it happen through the act of passing back the message through the system? It gets very metaphysical,” says the London-based lawyer.

Symphony, Portware and Neptune all say they have no involvement with how or where execution occurs.

Even with execution taking place with a UK counterparty, the technology provider may not need to be regulated, says the London-based lawyer. Article 25D of the UK’s Regulated Activities Order (RAO) includes the operation of an MTF as a regulated activity, but article 72 includes an exemption allowing foreign firms to perform MTF-like activities unregulated in the UK as long as participants are FCA authorised or exempt firms.

Symphony’s Eisenberg also cites the exemption as one of the reasons he believes the company can operate in the UK without needing to be regulated.

The regulation also applies differently across asset classes. Spot foreign exchange trades, for instance, do not fall under the Mifid II definition of financial instrument, so a firm offering a trading platform in those products would not have to be regulated as an MTF.

Symphony says Sparc allows RFQs only for bespoke and illiquid instruments not required to be traded on a trading venue. The tool enables users to structure requests based on predefined options, and its customer contract permits only trading securities not required to be traded on venues.

Not all regulated trading venues are concerned with tech providers possibly encroaching on their space. Vikas Srivastava, chief revenue officer at Integral, which operates a regulated MTF as well as services outside the MTF regulations, is one of those unconcerned.

He sees the firm’s regulated status as an advantage that can bring benefits to users, including mandated data collection that helps users demonstrate best execution.

“If for whatever reason some platforms are avoiding registering as an MTF, they might be doing a disservice to their customers because they are not providing all the benefits that trading on a proper registered MTF brings,” says Srivastava.

Arranger danger

An unregulated firm operating as a bulletin board may still need to gain formal classification as an arranger, which is a regulated activity under the RAO. In the UK, the rules for arrangers predate Mifid II and cover entities that facilitate financial transactions.

The FCA guidance says bulletin boards may be performing arranging activities, requiring the firms to register with the regulator as an arranger.

There may be a danger in applying to register, though, says the London-based lawyer. Even though the lawyer would suggest clients close to the line consider obtaining arranging permissions, getting on to the regulator’s radar could pose future risks if in future the regulator determined the firm should, in fact, be permissioned as an MTF as well.

OTCX is an “authorised representative” of Helford Capital Partners, which holds arranging permissions with the FCA. OTCX operates a multi-dealer RFQ platform that offers straight-through processing with a user’s internal trade systems, according to its website.

OTCX provides sophisticated bilateral trading workflow solutions for buy-side firms that would like to have a structured audit trail of their manual over-the-counter negotiations with their sell-side counterparts,” the firm’s chief executive Nicolas Koechlin said in a statement.

We continuously review our service with legal experts and regulators to ensure we are operating with the appropriate permissions in place
Nicolas Koechlin, OTCX

“We continuously review our service with legal experts and regulators to ensure we are operating with the appropriate permissions in place in the regions our service is being used,” Koechlin continued.

At the extreme, carrying out regulated activities without the proper permissions is a criminal offence. But experts doubt authorities would resort to draconian punishments, especially without evidence of harm to consumers.

“In the absence of some specific egregious scenario it is probably more likely that [regulators] would issue new guidance and require people to either amend the way their system operates or get appropriately authorised,” says Bevan.

New guidance on the issue could come centrally from Esma – though an FCA guidance could still carry significant weight across the EU – and any changes would affect markets across the EU, making it less likely there will be any big moves, says Ballon Ossio.

“I think there would be reluctance to come out in a case where there are no clear customer detriments to try and clarify this because the knock-on consequences for the industry may be more wide ranging than previously thought,” he says.

Correction, January 14, 2020: An earlier version of this article stated that Helford Capital Partners is the parent company of OTCX. This is not the case, and the article has been amended accordingly.

Editing by Alex Krohn

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