ESMA and its impact on investor protection

What do the recent European Securities and Markets Authority (ESMA) updates on its Markets in Financial Instruments Directive (MIFID II) Q&A mean for investor protection? Emma Cleveland of Cleveland & Co, explains what ESMA says about algorithmic trading, commodity derivatives, and other topics in its Q&As.

What is the background to the questions answered by ESMA?

The purpose of the Q&A is to provide clarity on various investor protection-related topics with the aim of promoting a common supervisory approach and practices in the application of MiFID II (Directive 2014/65/EU)/ MiFIR (Market in Financial Instruments Regulation (EU) 600/2014).

What does ESMA say about algorithmic trading?

Where an algorithm is not behaving as expected, investment firms will be expected to have a ‘kill functionality’ which allows the firm the ability to immediately pull any or all outstanding orders from any or all trading venues. ESMA considers this an essential measure to manage risk and safeguard the orderly functioning of the market given the risks to which algorithmic trading firms are exposed.

What does ESMA say about the extension of a pre-existing MiFID I waiver to equity-like instruments?

After the date of application of MiFID II/MiFIR, equity-like instruments will be covered by MiFIR transparency provisions and can have formally approved waivers. Where a wavier is granted relating to the transparency and waiver regimes under the Markets in Financial Instruments Directive 2004/39/EC (MiFID I) to other equity-like instruments, for example Exchange Traded Fund (ETFs), depositary receipts, certificates, etc, this will be considered as granting a new waiver, and consequently that new waiver needs to go through the ESMA opinion process.

What does ESMA say about the systematic internaliser (SI) regime?

Quotes provided by an SI for the purposes of meeting their quoting obligations under Article 18 MiFIR must remain valid for a reasonable period to allow clients to execute against it. ESMA advised that quotes can be updated at any time as long as they are updated as a consequence of an in line, with genuine intentions of the SI to trade with its clients in a non-discriminatory way.

ESMA’s view is that SIs should use the same means and arrangements when publishing firm quotes in non-equity instruments for equity instruments, therefore, quotes in both circumstances should be made public and such quotes should be time-stamped.

Once investment firms have carried out the assessment as to whether they are an SI and where applicable, complied with their SI obligations, they will need to notify the Financial Conduct Authority (FCA) in relation to the instruments and classes of instruments for which the firm is an SI. This notification should contain the information as set out in Annex III of RTS 1, field 4 of table 2 and Annex IV of RTS 2, field 3 of table 2.

Notification of an investment firm’s status as an SI from then on only needs to be carried out if there is a change in status from one assessment period to the next.

What does ESMA say about non-equity instruments and data reporting services providers?

The FCA may authorise market operators and investment firms operating a trading venue to provide for deferred publication of certain transactions relating to non-equity instruments. It is the investment firm’s responsibility to ensure that the Approved Publication Arrangement (APA) is informed and publishes the information no later than after the lapse of the deferral. Investment firms should still report the transaction to the APA as soon as technically possible after the execution, regardless of the application of any deferrals.

What does ESMA say about commodity derivatives?

With regards to position limit exemptions, it is only necessary for a non-financial entity (NFE) to apply for a position limit exemption when it expects that one is necessary to permit it to hold a position that is risk-reducing for its commercial activities which would be in excess of the position limit for that commodity derivative which has been set by the FCA. There is no requirement under MiFID II to apply for a position limit exemption if an NFE does not expect to need one for its normal level of activities.

With regards to position reporting, where an investment firm is holding positions on behalf of their clients and also their own positions, such positions are only to be reported as the positions of the person on whose behalf they are held, to avoid double counting.

Where an investment firm is reporting the positions of an end client that is not an investment firm and does not therefore have reporting obligations of its own under MIFID II, its report should cover both the end-client’s own account positions and any positions that the end-client holds on behalf of third parties.

In relation to data protection and bank secrecy issues which may arise as a result of the reporting of client and end client positions, ESMA’s view is that the requirement to identify clients cannot be waived. Therefore, where an investment firm does not identify clients and end clients because of legal, regulatory or contractual impediments, that investment firm will not be deemed compliant with its reporting obligations.

ESMA is of the view that the requirement for trading venues to make public weekly aggregate position reports and to communicate those report to the FCA and ESMA, does not apply to securitised derivatives.

Emma Cleveland would like to thank Leela Fair, trainee associate at Cleveland & Co, for her valuable contribution to this article.

Interviewed by Nicola Laver.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

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