Concern over share trading loophole
The FT's Phil Stafford and Rob Crane, head of electronic trading at KCG Holdings in London, discuss how the new Mifid II rules due for January 2018 are likely to push more equities trading off-exchange.
Produced by Alessia Giustiniano. Filmed by Petros Gioumpasis.
They've been seven years in the making, but new European rules, known as Method II, are finally coming into effect from January. And all of a sudden, people are now worrying about what this might mean. European regulators have already warned that some of the spirit of the rules could be broken. With me to talk about it is Rob Crane, Head of Execution Services at KCG Europe. Rob, welcome.
Now, European regulators are focused on this rather esoteric concept called a systematic internalising regime. Very briefly, what's it about, and are they right to be worried here?
So, the systematic internalizer is really a way for banks and market makers to provide liquidity to customers. So, the regime is very much focused on principal trading, whereby a broker commits their own capital and makes it available to clients through the regime.
And if we look at the current setup of the markets, we have a chart here from [INAUDIBLE] gives you an idea of how much is an electronic, how much is off the exchange. Which part of the market are we talking about this affecting?
Well, it affects all of it, to some varying degrees. But if the electronic order book is the [? lit order ?] books, in this context--
This is the exchanges.
That's right. And the [? lit MTFs. ?]
Dark pools would be the dark MTFs. An off-order book could be a proxy for what happens in the Broker [? Crossing ?] Networks, the BCN. I think in particular the bit that's under focus is the 10%, which is dark pools and off-order book.
Mhm. And now the [? regulators, ?] [INAUDIBLE] could affect the spirit of the rules, the spirit being that the intention is to make more of it electronic. How could this be perverted here?
Yeah, I think the spirit of certainly the SI regime was for it to be bilateral in all instances. And really, it's market makers committing capital. So, I think things that might challenge the spirit of the [INAUDIBLE] are any outcome that looks multilateral, so bringing multiple parties together, or anything that's committing capital in a riskless fashion. And they've been speaking about a notion called matched principal, which is something the regulators are most focused on.
And we have another chart, just looking at [INAUDIBLE]. Essentially, the idea is to bring this right down, isn't it?
Yeah, so I think this graph is slightly misleading, in as much as it contains CFD trades or Contracts For Difference, which is a synthetic derivative product. I think if you looked at the actual volume we're talking about here, traded through the BCNs, it's much more 10% to 15%.
And what exactly is the concern here? Are they right to be worried that these rules could be subverted or broken, the spirits of them broken in some way?
Yeah, so I think in Europe the regulations are principles-based. They're non-prescriptive. And therefore, they are based on interpretation. So, there is room for people to interpret them in different ways. I think the regulator has recently been very clear about the spirit of the law. The spirit of the law is bilateral trading. That's between a broker and its client on capital. And it's also to avoid any network effects, where a broker may try and capture the flow from multiple liquidity providers and pass it off as their own.
And if there is this wiggle room, and then potentially transfer for differing interpretations here, given the timeframe, what can be done?
So, I think the likely outcome we're expecting is a set of Q&A's from [? ESMA ?] that will clarify exactly what they mean by the regime.
And that's the technical guidelines here, as opposed to ripping up all of the text and rewriting--
And again, I think they've been keen to point out that a rewrite could be done. But I think, given the complexity and the lack of time we have until this comes into force, that would be an extremely challenging outcome.
Is this a bit of a unique approach that Europe is taking here?
Yeah. It's very interesting, actually. We've a regime in the US that's very similar called ELP, which is electronic liquidity provision. And in the US, that captures around 15% of the market, and is really how lots of the retail flow in the US is done. It's something that we at KCG spend a lot of time doing. But it's also how liquidity is provided to institutional customers via broker dealers. So, it's actually not a new regime, it's something we're very familiar with.
Rob, thank you very much.