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MiFID II 

Automated trading and related issues 

01 December 2011

Impact Red traffic light

High impact on firms involved in automated/algorithmic/high frequency trading and those providing direct market access to such entities - extra compliance obligations and systems changes necessary.

Other areas to consider

MTFs, Organised trading facilities; Systematic Internalisers

Current MiFID rules

There are currently no MiFID rules covering automated trading

FSA rules

There are currently no FSA rules covering automated trading

Proposed changes
Draft Directive Recitals (46)-(48), Articles 4(30) and (31), 17 and 51

The Commission is proposing:

Algorithmic Trading

  • Including a definition of algorithmic trading as trading where a computer algorithm automatically determines individual parameters of orders such as whether to initiate the order, the timing, quantity and price of the order. The definition specifically excludes order routing systems.
  • Persons involved in high frequency trading who are direct members of a trading venue will have to be authorised as investment firms.
  • New organisation requirements for firms engaging in algorithmic trading such as: robust risk controls to mitigate potential trading to ensure resilience an capacity of the system and to ensure the system cannot be used in a way that is contrary to the Market Abuse Directive; a requirement to notify competent authorities of the nature of its algorithmic trading, strategies, parameters and compliance and risk controls and details of the testing of its systems.
  • Requiring an algorithmic trading strategy to be in continuous operation during the trading hours of the trading venue, and to be able to provide liquidity (i.e. firm quotes) on a regular and on-going basis, regardless of market conditions.

DMA

  • Firms that provide direct electronic access to have in place the effective systems and controls to: ensure proper assessment of suitability of persons using the service; ensure pre-set trading/credit thresholds not exceeded; proper monitoring; robust risk controls and filters to detect errors and attempts to misuse facilities.

Obligations on Trading Venues and Market Operators in relation to DMA/Algorithmic Trading

  • Trading venues (i.e. regulated markets, MTFs, OTFs) to ensure they have in place effective systems, procedures and arrangements to ensure trading systems are resilient, have capacity to deal with peak order flow and under market stress, reject orders above pre-set limits or which are clearly erroneous, able to halt trading or cancel, vary or correct transactions.
  • Trading venues to have in place effective systems, procedures and arrangements to ensure that algorithmic trading systems cannot create or contribute to disorderly trading conditions on the market, including systems to limit the ratio of unexecuted orders to transactions that may be entered into the system, to be able to slow down the flow of orders if there is a risk of system capacity being reached and to limit the minimum tick size. Where the trading venue permits direct electronic access, it should ensure that members are only permitted to provide such services if they are an authorised firm under MiFID. A trading venue should also be able to distinguish between, and if necessary stop trading by a person using direct electronic access, separate from trading carried out by a member or participant. The trading venue shall also ensure that its rules on co-location services and fee structures are transparent, fair and non-discriminating.     
  • Market operators would be required to ensure that high frequency traders who execute a significant number of trades in financial instruments continue providing liquidity to the market, subject to similar conditions that apply to market makers.
  • ESMA is tasked with preparing technical standards covering these matters, including measures to ensure trading systems of markets are resilient and have adequate capacity and control concerning direct electronic access.
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