Subscribe to Itiviti Talks

The role of the Systematic Internaliser under MiFID II

By LARS WIBERG, VP STRATEGIC RESEARCH, TRADING & TRADE EXECUTION, ITIVITI
December 5, 2017
Share:

The EU’s Markets in Financial Instruments Directive II (MiFID II) is characterized by a stress on transparency designed to realise the investor protections the regulation aims to enforce so as to avoid a repetition of the credit crisis of 2007/2008. One new aspect of this push for transparency is an enhanced systematic internalisation regime, that takes the concept of the Systematic Internaliser (SI) from MiFID I and extends its scope and requirement.

While the final rules around systematic internalisation remain subject to an ongoing market consultation process kicked off in June, it’s generally assumed the rules won’t diverge fundamentally from the definitions promulgated by the European Commission for the past several years. In short, investment firms need to decide whether they will qualify as a systematic internaliser based on the frequency and volume of the client orders they cross internally, and then choose whether to adhere to the obligations as outlined in the directive.

External factors may contribute to the decision as well. For example, in the post-MiFID II trading environment buy-side firms – particularly smaller ones – may decide to engage only with sell-side firms with SI status in order to benefit from ‘free’ reporting compliance.

Based on current understanding as of the time of writing, firms may find they qualify as SIs come January 3, where previously they did not. Furthermore, the combination of MiFID II’s updated Trading Obligation and Double Volume Caps will increase the attractiveness of operating a Systematic Internaliser. The current definition of SI – outlined in Article 4 of the MiFID II directive and Article 14 of its associated MiFIR regulation – will extend pre-trade transparency requirements to equity-like instruments where there is a liquid market, and other non-equity securities.

Under the new rules, SIs necessarily handle bilateral transactions, with orders executed on a discretionary basis based on distinct categories of client. Many non-SIs and broker crossing networks (BCNs) will be forced to decide whether to become an SI or desist from matching client orders against proprietary capital. Their decision may take into account a number of factors, among them the business model they are pursuing. However, the new regulation will force those opting to take the SI route to undertake a series of significant process and technology upgrades.

The situation is compounded by the fact that there were very few official systematic internalisers under MiFID I. Even where infrastructure from independent software vendors (ISVs) exists, the new legislation will force a reassessment of functionality, flexibility and performance requirements.

Meanwhile, many firms operate as informal internalisers, matching client orders with proprietary orders, a process that is often handled manually. Under MiFID II, qualifying activities will need to be automated, and the appropriate transparency requirements applied.

Under MiFID II’s trade and transaction reporting rules, SIs must publish pre-trade prices (quotes) that form part of the SI offering to the marketplace, via a trading venue, web-site, Approved Publication Arrangement (APA) or some other publishing channel. Additionally, selling SIs must provide report post-trade details to an APA; so firms need to understand whether or not their counterparty is an SI in order to understand their potential reporting obligations.

Several factors are driving firms’ motivations for taking the SI route. For one thing, many firms plan to establish SIs merely because they feel they ‘have to’ under MiFID II in order to continue to cross trades internally because their activities exceed the regulation’s threshold of 0.4% market share.

Whatever the case, those registering as SIs will need a number of additional capabilities in order to meet the associated regulatory requirements. At its core, an SI needs an order-matching engine capable of reporting the trades and publishing the quotes to the appropriate APA, or to a trading venue, and it needs to be able to react to requests for quote (RFQs).

From a regulatory standpoint, the firm needs to fully understand and execute on the quoting and reporting requirements under the new SI rules. It needs to incorporate a client order management function to ensure that all necessary information is captured for reconciliation purposes. From a technology standpoint, the SI solution needs the kind of speed and accuracy required for publishing and adjusting quotes in fast market conditions.

In short, firms will need to decide if and when they will be acting as an SI, and ensure they have the technological facilities and flexibility to react to each instance of their SI status. As such, the SI requirement is perhaps one of the most challenging for firms covered by MiFID II, even if much of it has been in place since MiFID I.

Itiviti Systematic Internaliser

Related Content

Exploring the business side of Systematic Internalisation

Exploring the business side of Systematic Internalisation

Risk & Compliance Nine months into the MiFID II era, it’s time to look beyond the compliance issues and start considering the business opportunities presented to firms operating under the Systematic Internaliser regime. With the support from a value-adding regulatory solution, SI status can be used for competitive advantage, suggests Jonas Lindqvist, Principal, Trading and Trade Execution, Itiviti. […] October 9, 2018

Industrializing the trading technology stack: the benefits of UL Bridge

Industrializing the trading technology stack: the benefits of UL Bridge

Risk & Compliance Trading firms across the board are discovering that operational and regulatory requirements increasingly demand a consistent approach to connectivity, messaging and data management. To industrialize their response to these emerging requirements – to address the challenges in a streamlined, consistent and scalable way – firms need to put in place a centralized connectivity and messaging […] September 25, 2018

MiFID II: The implications for trading systems and infrastructure

MiFID II: The implications for trading systems and infrastructure

Risk & Compliance MiFID II marked a sea change in the approach to the handling of order, trade and transaction data. Rigorous new requirements around data capture, analysis, reporting and record-keeping made the communication of data a central theme in ensuring trading systems were MiFID II compliant, and connectivity – between external and internal systems, databases and processors […] August 14, 2018

MiFID II in action: half-year review

MiFID II in action: half-year review

Risk & Compliance Roughly six months after the introduction of MiFID II, Johannes Frey-Skött – VP Apps Engineering, Itiviti – talks to The TRADE about the short-term impact of the regulation on European market players, looking at both the positive and negative effects witnessed so far. He also outlines current pain points in MiFID II compliance and the […] July 17, 2018

Itiviti Talks

Itiviti Talks is your source for the technology perspective on the global capital markets. We have created this to be an engaging forum for sharing ideas with our clients, partners and other industry professionals. You will find videos, blog posts, white papers and more that deal with the needs and challenges of brokers, market makers and trading executives.
 
Watch, read and enjoy for new inspiration and insights.

By submitting this form, you acknowledge that data collected by us will be handled in accordance with our Privacy Notice.

Itiviti Talks

Get our view on global capital markets

Subscribe

Subscription successful

Thank you for subscribing!

Close window

Itiviti Talks

Get our view on global capital markets

Weekly email

    Trends in global capital markets from a technology perspective.

By submitting this form, you acknowledge that data collected by us will be handled in accordance with our Privacy Notice.