Mifid amendments lift barrier to brokers owning OTFs

Tweaks to Mifid text would allow owners of OTFs to engage in matched principal trading

Brokers should be allowed to conduct so-called matched principal trades on new derivatives trading platforms created by the Markets in Financial Instruments Directive (Mifid), according to amendments filed by both the Council of the European Union and members of the European Parliament (MEPs) last month.

The European Commission's original version of the new legislation stated that owners of the platforms – dubbed organised trading facilities (OTFs) and introduced to meet a Group-of-20 (G-20) commitment to shift derivatives trading to recognised venues – would not be allowed to trade on the platform using their own capital. That could have been a problem for interdealer brokers, which operate by simultaneously conducting identical trades with two counterparties – known as matched principal trading. Many brokers are planning to set up OTFs.

Proposals from the council and MEPs are seeking to remove the threat. "To safeguard the provision of liquidity, matched principal trading, precisely and narrowly defined, and independent market-making should be allowed," says the compromise text published by the Danish presidency of the council, which suggests the job of coming up with a definition be left to the European Securities and Markets Authority.

Eight of the 10 MEPs that proposed amendments to the proprietary capital ban for OTF owners make some attempt to narrow its scope – although only one specifically mentions matched principal trading.

Outgoing French MEP Pascal Canfin – whose term ended on May 15, five days after amendments were submitted – and Danish MEP Anne Jensen are the only two that submitted amendments without weakening the ban.

To safeguard the provision of liquidity, matched principal trading, precisely and narrowly defined, and independent market making should be allowed

French MEP Sylvie Goulard and Finnish MEP Sirpa Pietikäinen both propose deleting the OTF category from article 20, which contains the proprietary capital ban. Italian MEP Alfredo Pallone, Dutch MEP Corien Wortmann-Kool, Portuguese MEP Diogo Feio and German MEP Wolf Klinz all suggest some form of opt-in amendment, allowing clients to choose whether to trade against the OTF operator's own capital or not. Swedish MEP Olle Schmidt also suggests an opt-in amendment, and refers to the importance of matched principal trading.

"We want an intelligent ban on proprietary trading, but we would also like clients to be able to operate as they choose. That's the main reason we want to have this changed," says Schmidt, one of five shadow rapporteurs for Mifid, responsible for assisting the main rapporteur, German MEP Markus Ferber, in shepherding the legislation through parliament. The other shadow rapporteurs are Canfin, German MEP Sven Giegold, Luxembourg MEP Robert Goebbels and UK MEP Kay Swinburne.

Narrowing the ban on deploying own capital will also be welcomed by banks that hope to operate their single-dealer platforms as OTFs. As things stand, dealer platforms only direct clients to the owner's execution desks – with the exception of a venue launched by UBS in February – meaning they fall foul of the own-capital ban, as well as a separate rule stating OTFs must be multilateral trading venues. None of the amendments tackles this latter obstacle, but Swinburne aims to broaden another category of trading venue to accommodate dealer platforms.

"We think we can make the systematic internaliser (SI) category work for single-dealer platforms," she says. "We thought this was the better way – rather than amend the multilateral element of OTFs, we will try to adapt the SIs."

SIs allow trades to be executed against the owner's proprietary capital, and are not required to involve multiple market-makers – but they are not recognised by Mifid as a platform on which standardised over-the-counter derivatives can be executed. Swinburne hopes to change that.

"They are a formal organised trading venue. They should be recognised as such and therefore be allowed to fulfil the G-20 obligation. It's a nice, simple argument. We don't know how much traction it will have, but we have tested it with a few people," she says.

Some dealers have declared they will instead develop OTF aggregators if they are prevented from market-making on their own OTC trading platforms. Aggregators offer clients access to multiple trading venues, but the ability to offer such a service was thrown into doubt when Mifid rapporteur Ferber banned what he called direct electronic access in the first parliamentary version of the legislation. To many in the industry, his rewritten version of the European Commission text appeared to bar dealers from providing a platform that allows users to access other venues, but it was generally thought to be unintentional.

In the new round of amendments, Ferber makes it clear he is seeking to ban "sponsored access", whereby a client is allowed to trade in a market using the bank's own account, thereby avoiding credit checks – a service that has also been subject to regulation in the US. The new language seems to have broad support from other MEPs that submitted amendments, with only one keeping Ferber's first version of the ban.

The parliament's secretariat will now work with Ferber to identify compromises between the many different amendments, before a series of meetings between the rapporteur and his five shadows. There will then be a public exchange of views later in June before a vote at the parliament's Economic and Monetary Affairs Committee, scheduled for July 10. The resulting compromise text will then progress to a three-way debate with the European Commission and council, where a final compromise text will be hammered out.