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.
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.