The term ‘Investment Firm’ is in principle the same as in MiFID I with the exception of the operation of OTF platforms that will constitute a licensed operation. This means that companies that have operated such business without a license will have to become an investment firm. In addition a number of companies that have not had licenses will no longer be able to exercise waivers within MiFID I meaning that the following will have to apply for a license to become an investment firm: 1) companies that engage in their own account trading but are members of a regulated market or an MTF platform or have electronic access to a trading venue, make use of algorithmic high frequency trading, or trade in their own account at the execution of client orders and 2) such companies that trade in their own account with commodity derivatives, emission rights or derivatives of emission rights.
They have to apply to NFSAs. There is no transitional period and the license needs to be in place on 3 January 2018. This means that current trading is significant for determining whether they are below / above the thresholds for each asset class. We will most likely have in our rules an annual requirement for the members to confirm their regulatory status. They also need to confirm to the NFSA annually.
There is no general implied requirement that the member is an investment firm. A regulated market may accept investment firms, credit institutions authorized and other persons who have sufficient good reputation, a sufficient level of trading ability, adequate organizational arrangements and sufficient resources as members. Analyzing the language of the RTS it is evident that the status would need to be checked annually. A suitable option (awaiting further guidance from the relevant authorities) would be to require members to annually confirm their status and to provide excerpts from public registers showing relevant authorizations.
What requirements does MiFID II introduce for Investment Firms that engage in Algorithmic Trading? What if Investment Firms provide Direct Electronic Access (DEA) to clients using Algorithmic Trading?
MiFID II introduces several new requirements on Investment Firms that use Algorithmic Trading. First, Investment Firms that engage in algorithmic trading must have in place suitable systems and controls to ensure their trading systems are resilient and have sufficient capacity; are subject to appropriate trading thresholds and limits; prevent erroneous orders and prevent the system to create or contribute to a disorderly market. Firms must have business continuity arrangements in place and ensure that their systems are tested and monitored. They must also have systems and risk controls to ensure that their trading systems cannot be used in any way that is contrary to the Market Abuse Regulation or the rules of a trading venue to which they are connected.
Additionally algorithmic trading for market making purposes must be carried out continuously during a specified proportion of a trading venue’s trading hours, except under exceptional circumstances, in order to provide liquidity on a regular and predictable basis. Firms engaged in algorithmic trading to pursue a market making strategy must enter into a binding written agreement with the trading venue and have effective systems and controls in place to ensure they comply with their obligations.
Firms engaged in algorithmic trading must notify the competent authorities of their home country and of the relevant trading venue of their algorithmic trading strategies and other required information. The home country regulator may request additional details regarding their activities and may communicate this information to the trading venue’s regulator upon request. Such firms must keep related records. Firms engaged in high frequency trading must store time sequenced records of all placed orders, including cancellations of orders, executed orders, and quotations on trading venues and make them available to competent authorities upon request.
Direct electronic access
MiFID II also imposes requirements on Investment Firms which provide their clients direct electronic access (DEA) to a trading venue. Such a firm must have systems and controls in place to review the suitability of clients using the service, to prevent clients from exceeding pre-set trading and credit thresholds, to monitor trading, and to implement appropriate risk controls. DEA without these controls is prohibited. The investment firm will be responsible for ensuring that its clients comply with the requirements of MiFID II and the rules of the trading venue. Rights and obligations must be set out in a binding written agreement between the firm and the client, under which the firm retains responsibility under MiFID.
As with algorithmic trading, a firm providing DEA to a trading venue must notify its home regulator and that of the trading venue. The home regulator may require a description of the firm’s systems and controls and evidence that they have been applied, and may communicate this information to the trading venue’s regulator upon request. Such firms must also keep related records. For complete details on requirements for investment firms engaging in algorithmic trading and offering DEA to their clients, refer to the MiFID II text, among others recitals 59-68, Article 17.
While investment firms will still have to report details of their transactions in instruments admitted to trading or traded on an RM or MTF (and now also an OTF) to their national competent authorities, they will now also have to report transactions in financial instruments (a) where admission to trading has been requested, and (b) where the underlying is a financial instrument (or an index or basket of financial instruments) traded on a trading venue.
The reporting obligation applies regardless of whether the transaction is carried out on a trading venue. The reported information must include the identity of the client (using legal entity identifiers where appropriate) and the person or algorithm responsible for the investment decision and execution. Short sales and any applicable waivers must also be identified. In the case of commodity derivatives, the report must indicate whether the transaction reduces risk in an objectively measurable way in accordance with MiFID II.
Investment firms that transmit orders must include the relevant information in the transmission of that order. Alternatively, the firm may choose to report the executed order as a transaction, in which case the report must state that it pertains to a transmitted order. Trading venues will be required to report transactions by firms not subject to MiFIR.
Reports can be made by approved reporting mechanisms (“ARMs”) on behalf of investment firms. Trading venues must have adequate security mechanisms, resources and back-up facilities in place to carry out this function. The firm will remain responsible for the completeness, accuracy and timely submission of the reports, other than failures attributable to the ARM or trading venue (provided the firm takes reasonable steps to ensure the completeness, accuracy and timeliness of those reports). If there are errors or omissions, a corrected report must be submitted to the competent authority. Transactions reported in accordance with EMIR to a trade repository which is approved as an ARM will satisfy the MiFIR reporting requirement, provided the other requirements of MiFIR have also been met. Trading venues must provide competent authorities with identifying instrument reference data for the purposes of transaction reporting. SIs must also provide reference data for instruments subject to reporting. The reference data must be ready to submit in an electronic and standardized format before trading commences in a financial instrument and must be updated whenever there are changes to data in respect of that instrument.
Investment firms must keep data for five years relating to all orders (as well as transactions). Recordkeeping requirements for investment firms will be extended to trading venues, and ESMA will be able to access investment firm records. Records maintained by trading venues must include data that constitute the characteristics of an order, including data that link orders to executed transactions. For complete details on requirements for investment firms engaging in algorithmic trading and offering direct electronic access to their clients, refer to the MiFID II text, among others recitals 32-36, Articles 24-27; MiFID, Article 66.
MiFID II includes new requirements for management bodies of investment firms, RMs, and data reporting services providers.
Investment firms and their management bodies must comply with the corporate governance provisions of CRD IV (Directive 2013/36/EU), though members of the management body may hold one additional non-executive directorship than allowed under that Directive. Management bodies must be accountable for the implementation of governance arrangements that ensure effective and prudent management, including the segregation of duties and prevention of conflicts of interest in a manner that promotes market integrity and client interests. The management body must monitor and periodically assess the effectiveness of the governance arrangements and take steps to address deficiencies.
As set out in Article 88 of CRD IV, the management body must:
- have overall responsibility for the firm and approve and oversee the implementation of its strategic objectives, risk strategy and internal governance;
- ensure the integrity of the accounting and financial reporting systems;
- oversee the process of disclosure and communications; and
- oversee senior management.
The chairman of a firm may not simultaneously act as the chief executive officer of the same firm, unless justified by the firm and authorized by competent authorities.
The composition of the management body must reflect an adequate range of experiences and be sufficiently diverse. Members of the management body must:
- commit sufficient time to perform their functions;
- comply with numerical limits on the number of executive and non-executive directorships they can hold;
- have adequate collective knowledge, skills and experience to be able to understand the firm’s activities and main risks; and
- act with honesty, integrity and independence of mind to effectively assess and challenge the decisions of senior management where necessary and oversee and monitor management decision-making.
Firms must devote adequate resources for the induction and training of members of the management body.
Some large or complex firms may also be required to establish nomination committees composed of non-executive members of the management body. Among other things, the nomination committee must take diversity into account when proposing candidates. The committee must also decide on a target for the representation of the underrepresented gender in the management body and prepare a policy for meeting that target. The target, policy and implementation must be made public. The nomination committee should also try to ensure that the management body is not dominated by one individual or a small group of individuals.
These provisions are intended to accommodate the different governance structures used across Member States, including unitary and dual board structures.
Regulated Markets (RMs) and data reporting services providers
RMs are subject to governance requirements similar to those for investment firms, including with regard to numerical limits on directorships, diversity, and nomination committees. Data reporting services providers are subject to more limited governance requirements, with no numerical limits on directorships or requirements for diversity or nomination committees.
For more information on the topic of governance for investment firms, refer to the text of MiFID II, including recitals 53-55, Articles 9, 45, 63.
DISCLAIMER: All information contained herein is obtained by Nasdaq from sources believed to be accurate and reliable. However, the Markets in Financial Instruments Directive and Regulation and related level 2 and level 3 texts (“MiFID II/R”) have not yet been fully adopted and/or implemented. Neither Nasdaq Nordic Exchanges nor any of its affiliates or subsidiaries (collectively “Nasdaq”) assumes any responsibility for any errors or omission contained herein. The information herein is not intended to provide legal advice on any matter, nor is it intended to be comprehensive. All information is provided “as is” without warranty of any kind. While the information has been prepared on the basis of the best information available, Nasdaq accepts no liability for decisions taken by any party, based on this information.