MiFID II / MiFIR series

Navigating the ESMA May 2014 Discussion Paper

Publication June 2014


The final legislative texts of the Markets in Financial Instruments Directive (recast) (MiFID II) and the Markets in Financial Instruments Regulation (MiFIR) were approved by the European Parliament on 15 April 2014 and by the European Council on 13 May 2014. Both will enter into force on the twentieth day following their publication in the Official Journal of the European Union (estimated in June 2014).

The European Securities and Markets Authority (ESMA) has listed 106 separate implementing measures for MiFID II and MiFIR. The implementing measures will take the form of delegated acts and technical standards. Delegated acts are drafted by the European Commission on the basis of advice by a European Supervisory Authority (ESA) and technical standards are drafted by an ESA and adopted by the Commission. With MiFID II and MiFIR the ESA will generally be ESMA.

On 23 April 2014, the Commission issued a request for ESMA to provide it with technical advice on possible delegated acts and technical standards. On 22 May, ESMA begun the formal process of producing its technical advice by publishing a discussion paper and a consultation paper. The purpose of the discussion paper is to seek views on key elements of future ESMA technical standards. The purpose of the consultation paper is to consult interested parties in order to produce technical advice to the Commission which will allow it to formulate delegated acts.

The discussion paper may be the longest that ESMA has so far produced being some 521 pages long. The time frame in which firms can digest the discussion paper is very limited with comments due in just over two months on 1 August 2014. Before the deadline ESMA will be holding a public hearing in Paris on 7 and 8 July.


The discussion paper is structured around 7 key topics, these being investor protection, transparency, data publication, micro-structural issues, requirements applying on and to trading venues, commodity derivatives and market data reporting.

ESMA will consider the responses it receives to the discussion paper and will publish a subsequent consultation paper that will include the draft technical standards. ESMA states that the consultation paper will be published in the “coming months”.

Investor protection: overview

The investor protection section (section 2) is one of the shorter sections of the discussion paper covering 30 pages (pages 15 to 45). It has four sub-sections covering:

  • authorisation of investment firms;
  • freedom to provide investment services and activities / establishment of a branch;
  • best execution – publication of data related to the quality of execution by trading venues for each financial instrument traded; and
  • best execution – publication of data regarding order flow to be provided by investment firms.

Investor protection: examples of ESMA’s approach

Authorisation of investment firms

Articles 7(4) and 7(5) of MiFID II require ESMA to develop technical standards in relation to the procedures for granting and refusing requests for the authorisation of investment firms, the information to be provided to the home state national competent authority (NCA) and the consultation prior to authorisation.

ESMA considers that CESR’s previous work on the MiFID passport is useful reference material in this area together with other work including the European Banking Authority’s guidelines on the assessment of the suitability of members of the management body and key function holders. ESMA then sets out the information that it considers should be provided by an investment firm to a home state NCA. The information proposed appears to be fairly standard including information on the organisation of the investment firm.

Best execution – publication of data by investment firms

ESMA begins by discussing certain general principles and then covers execution quality followed by data granularity.

As a general principle the investment firm reporting requirement on order flow and on execution quality applies to all MiFID investment firms. ESMA considers that investment firms should report the identity of the top five venues (including execution venues such as systematic internalisers, market makers, or other over-the-counter counterparties that qualify as execution venues) to which they direct their order flow. ESMA also considers that it may be beneficial to ensure that orders that arise as a result of clients’ specific instructions are reported in the same way as all other orders.

In relation to investment firm execution quality ESMA notes that this is an area of considerable complexity and that there may be limits to the ability to specify standard measures of execution quality. In light of the difficulty of specifying harmonised criteria to be used by investment firms when reporting on the quality of the execution they obtain, ESMA considers that it is proportionate to require them to publish a summary based on their own internal monitoring of execution quality achieved at the top five execution venues in terms of trading volumes, subject to certain minimum standards for the content of that monitoring.

Transparency: overview

The transparency section (section 3) is the largest section of the discussion paper covering 153 pages (pages 47 to 200). It has thirteen sub-sections which cover a variety of related issues including:

  • pre-trade and post-trade transparency for equities;
  • systematic internaliser regime for equities;
  • liquid market definition for non-equity financial instruments;
  • pre-trade and post-trade transparency requirements for non-equity instruments;
  • the transparency regime of non-equity large in scale orders and transactions; and
  • the trading obligation for derivatives.

Transparency: examples of ESMA’s approach

Pre-trade transparency – equities

MiFIR extends the pre-trade transparency obligations for equity markets in two ways. First, it extends the requirements to a wider range of instruments and order types so that pre-trade transparency applies to “equity-like instruments” and to actionable indications of interest. Second, it extends pre-trade transparency to a wider range of trading venues so that for equities and equity-like instruments the requirements apply not only to instruments which are admitted to trading on a regulated market (RM) but also those traded on a multilateral trading facility (MTF).

In its discussion paper ESMA covers a lot of ground on pre-trade transparency for equities including large in scale waivers, reference price waivers, negotiated trade waivers and double volume cap mechanism.

Post-trade transparency – equities

In relation to the content of post-trade information, article 27(1) of the MiFID Implementing Regulation provides that investment firms, RMs and investment firms and market operators operating an MTF make public the following details for transactions in shares admitted to trading on a RM: the trading day and time, the instrument identifier, the unit price and price notation, the quantity and the venue identifier.

ESMA considers the content of the information in trade reports currently required for shares admitted to trading on an RM to still be valid and applicable to other equity-like instruments. In relation to identifiers ESMA believes that the 2010 CESR technical advice on post-trade transparency standards remains valid.

Pre-trade and post-trade transparency requirements for non-equity instruments

Articles 8 to 11 of MiFIR describe a new transparency regime for a wide range of non-equity instruments. ESMA has to develop the majority of the implementing measures for this new regime via regulatory technical standards (RTS) and the discussion paper sets out its initial thinking on how to put the non-equity transparency regime into practice.

ESMA sets out its understanding as to how the new regime should work, what it has done for the purposes of the discussion paper and what still needs to be done leading up to the delivery of the RTS and what exactly is within the regime’s scope. For the discussion paper ESMA has also produced a detailed analysis of the European bond markets and six threshold scenarios for determining whether a bond shall be deemed liquid.

At this stage it may be fair to say that ESMA’s work in this area is still at an early stage with the material in the discussion paper describing the overall scope of the transparency regime and setting out a potential taxonomy of how to categorise and divide non-equity instruments into classes. Stakeholders are being asked to provide input on whether those classes are correct and whether they consider there is anything to be missing.

Micro-structural issues: overview

Unlike the consultation paper the microstructural section (section 4) is significant covering 123 pages (pages 201 to 324). It has eight sub-sections covering:

  • microstructural issues: common elements for articles 17, 48 and 49 of MiFID II;
  • organisational requirements for investment firms;
  • organisational requirements for trading venues;
  • market making strategies, market making agreements and market making schemes;
  • order-to-transaction ratio;
  • co-location;
  • fee structures; and
  • tick sizes.

Micro-structural issues: examples of ESMA’s approach

Overarching point

At the beginning of the section on micro-structural issues ESMA makes an overarching point that it is intending to base its advice on its 2012 guidelines on systems and controls in an automated trading environment.

Organisational requirements for trading venues and the proportionality principle

Article 48(12) of MiFID II provides that ESMA shall develop draft RTS specifying, among other things, the requirements to ensure that trading systems of RMs are resilient and have adequate capacity. ESMA proposes setting the minimum requirements that all trading venues should meet in relation to their trading systems linked to algorithmic trading. However, ESMA also considers that trading venues should in all cases assess their degree of compliance taking into account the nature, scale and complexity of their business. Accordingly, ESMA believes that they should establish more stringent organisational requirements where appropriate.

ESMA comes to a similar conclusion when discussing organisational requirements for investment firms and the proportionality principle.

Organisational requirements for trading venues (article 48 of MiFID II)

ESMA sets out a preliminary view that not only should all prospective members of participants of a trading venue, which permits algorithmic trading through its systems, be subject to adequate due diligence to ensure that they meet certain pre-defined parameters, but also current members/participants should meet those parameters. To that end, ESMA states that periodic reviews should be designed and implemented by trading venues. ESMA provides a draft list of elements that at least should be analysed by the trading venue when performing due diligence.

Monitoring and review of trading systems and algorithms

ESMA’s preliminary view is that investment firms should flag their algorithms also as an internal risk management tool to be able to identify rogue behaviour of an algorithm and the responsible trader/client and/or trading desk in an emergency situation. The flagging of algorithms should be taken into consideration when establishing the firm’s business continuity plan.

Pre-trade controls when providing DEA

In the discussion paper ESMA states that its intention is to specify more clearly that the provider of direct electronic access (DEA) is expected to monitor intraday, and on a real-time basis, the credit and market risk to which it is exposed as a result of the clients’ trading activity so that the DEA provider can adjust the pre-trade controls on orders (as well as the credit and risk limits) as necessary.

ESMA reminds DEA providers that wherever they source their pre-trade controls it is important that they have the ability to cancel a trade which is in-built and automatic if the trade poses a risk.

Tick sizes

The tick size regimes developed throughout the different European trading venues are not harmonised as there is currently no common legal framework prescribing any harmonisation. Article 49 of MiFID II requires Member States to require RMs to adopt tick size regimes in shares, depositary receipts, exchange traded funds, certificates and other similar financial instruments. ESMA is tasked with developing draft RTS to specify minimum tick sizes or size regimes.

The discussion paper contains ESMA’s initial thinking on this issue setting out a number of options which includes the creation of a tick size table that ESMA has developed and refined after conducting impact and sensitivity assessment exercises. The proposed table has two dimensions – a liquidity profile based on four pre-defined liquidity bands and price.

Data publication: overview

The data protection section (section 5) is another large section covering 45 pages (pages 326 to 372). It has eight sub-sections covering:

  • general authorisation and organisational requirements for data reporting services;
  • additional requirements for particular types of data reporting services providers;
  • technical arrangements promoting an efficient and consistent dissemination of information;
  • consolidated tape providers;
  • data disaggregation;
  • identification of the investment firm responsible for making public the volume and price transparency of a transaction;
  • access to central counterparties (CCPs) and trading venues; and
  • non-discriminatory access to and obligation to license benchmarks.

Data protection: examples of ESMA’s approach

General authorisation and organisational requirements

The material requirements that approved publication arrangements (APAs) should meet in order to be authorised by NCAs were previously analysed in CESR technical advice published in July 2010. In the discussion paper ESMA states that the technical advice is still valid and could be used as the basis for determining the organisational requirements and information to be provided by all types of data reporting services providers to NCAs under MiFID II.

Consolidated tape providers

In its discussion on consolidated tape providers (CTPs) ESMA discusses the additional services that CTPs could perform which increase the efficiency of the market (article 65(6) of MiFID II). ESMA concludes that a CTP could provide any other services as they complement its main activity, to the extent that they do not conflict with the quality and independence of the provision of its main activity, such as the:

  • provision of pre-trade transparency data;
  • provision of historical data;
  • provision of reference data;
  • provision of research; 
  • processing, distribution and marketing of data and statistics on financial instruments and market-related data; and
  • elaboration, management, maintenance and marketing of software, hardware and networks in relation to the transmission of data and information.

Access to CCPs and trading venues

Articles 35 and 36 of MiFIR provide for trading venues to have access to CCPs, and vice versa, subject to certain conditions. Article 35(6) provides that ESMA shall develop draft RTS specifying conditions under which an access request may be denied by a CCP. Article 36(6)(a) provides for the same in relation to a trading venue.

ESMA acknowledges that whilst the texts in articles 35 and 36 of MiFID II might be very similar  in practice they may impact CCPs and trading venues differently. In light of this ESMA has separated the analysis of the conditions under which an access request may be denied by a CCP or a trading venue.

Requirements applying on and to trading venues

The section on requirements applying on and to trading venues (section 6) is fairly short comprising of 13 pages (pages 373 to 385). It has two sub-sections covering: admission to trading and suspension and removal of financial instruments from trading.

In relation to admission to trading ESMA states that it will be taking the existing rules in articles 35 to 37 of the MiFID Implementing Regulation as the basis for developing technical standards that are envisaged in article 51(6)(a) of MiFIR. However, it also warns that some of the technical standards will need to be developed from scratch.

Commodity derivatives

The section on commodities derivatives (section 7) comprises of 51 pages (pages 386 to 437). It has three sub-sections covering:

  • ancillary activity;
  • position limits; and
  • position reporting.

Commodities derivatives: examples of ESMA’s approach

Ancillary activity

When developing draft RTS in respect of the exemption in article 2(1)(j) of MiFID II ESMA is to specify the criteria for establishing when an activity is to be considered as ancillary to the main business on a group level. When specifying the criteria ESMA has to consider the elements mentioned in article 2(4) of MiFID II. In the discussion paper ESMA explores how certain elements may best be taken into account when determining criteria for establishing when an activity is considered to be ancillary.

In summary, ESMA envisages that the procedure for determining whether firms fall within the scope of article 2(1)(j) of MiFID II is as follows: if a firm exceeds the thresholds set out in the ‘ancillary activity test’ (set out in the discussion paper) it will fall within the scope of MiFID II. If the firm does not meet the ancillary activity threshold but meets the threshold set in the ‘trading activity test’ (also set out in the discussion paper) then it will fall within the scope of MiFID II.

Another point that ESMA makes is that it is of the view that the execution of orders in financial instruments between two non-financials directly and without any further intermediation by third parties as ancillary activity is not covered by the term ‘dealing on own account when executing client orders’ and would therefore not prevent the persons concerned from using the exemptions under paragraphs (d) and (j) of article 2(1) of MiFID II.

Position limits

Article 57(12) of MiFID II requires ESMA to develop draft RTS to determine certain factors that NCAs will use in establishing position limits. Article 57(3) of MiFID II requires ESMA to develop draft RTS to determine the methodology for the calculation that NCAs must apply in establishing the spot month position limits and other months position limits for physically settled and cash settled commodity derivatives based on the characteristics of the relevant derivative.

ESMA recognises that its work in this area represents a new policy development and that there is no text with equivalent purpose to article 57 of MiFID II. When approaching the task of developing draft RTS under article 57 of MiFID II ESMA’s discussion is based on the following:

  • addressing some of the key overarching considerations on scope and application in terms of the requirements in article 57(12);
  • setting out a broad approach to a methodology for how limits may be calculated under article 57(3); and
  • posing a number of questions which would apply to the implementation of a position limits methodology.

Position management controls operated by trading venues is not covered by the discussion paper as ESMA is not mandated under MiFID II to develop RTS in this area. However, ESMA states that this regime will operate in tandem with position limits set by NCAs.

Market data reporting: overview

The section on market data reporting (section 8) is substantial comprising of 85 pages (pages 438 to 523). It has five sub-sections covering:

  • obligation to report transactions;
  • obligation to supply financial instrument reference data;
  • obligation to maintain records of orders;
  • requirement to maintain records of orders for firms engaging in high frequency algorithmic trading techniques; and
  • synchronisation of business clocks.

Market data reporting: examples of ESMA’s approach

Obligation to report transactions

Article 26(1) of MiFIR requires investment firms executing transactions in financial instruments to submit reports to the NCA with details of those transactions. As provided for in article 24 and recital 32 of MiFIR those details should enable the NCA to detect and investigate potential instances of market abuse, and to monitor the fair and orderly functioning of markets and investment firms’ activities.

In the discussion paper ESMA sets out a number of principles for determining whether an investment firm has executed a transaction for the purposes of article 26 of MiFIR. To help investment firms in understanding the scope of their reporting obligations, ESMA outlines a list of actions which are not considered execution of a transaction for the purposes of article 26 of MiFIR.

On the concept of ‘execution’ of a transaction ESMA states that this should not be limited to transactions concluded between the final intermediary and the trading venue or investment firm where the order was ultimately filled. ESMA believes that it is a broader concept than just market-side trades and (in a chain of intermediaries) covers the actions necessary for bringing about the transaction concluded between the final intermediary and the trading venue or investment firm where the order was ultimately filled.

Post trading issues

The final section of the discussion paper (section 9) covers post trading issues and covers two issues:

  • obligation to clear derivatives traded on RMs and timing of acceptance for clearing; and
  • indirect clearing access.

In relation to the first issue MiFIR extends the scope of the clearing obligation to all derivative transactions concluded on an RM and requires clearing members to ensure that derivatives are submitted for clearing acceptance as quickly as technologically practicable. ESMA is required to draft technical standards to specify the minimum requirements for systems, procedures and arrangements taking into account the need to ensure proper management of operational or other risks. The technical standards would apply to CCPs, trading venues and investment firms that act as clearing members and apply to all derivatives to be cleared and whether or not subject to the clearing obligation. ESMA’s discussion analyses the role of these parties and the flow of information they transfer in order to determine the appropriate systems, procedures and arrangements necessary to address risks for derivatives.

In relation to the second issue ESMA notes that the mandate given to develop RTS which specify the types of indirect clearing arrangements in the scope of MiFIR is very similar to the mandate granted under EMIR. However, it acknowledges that the mandate is not identical and asks stakeholders if it should adopt a different approach.


MiFID II and MiFIR are expected to enter into force in June 2014, in which case ESMA’s technical advice would be due in December 2014. On that basis, Member States would need to adopt and publish the domestic legislation necessary to transpose MiFID II by June 2016, such legislation and MiFIR would then apply from December 2016.

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