Organised trading facilities: how they differ from MTFs
July 2015 | PROFESSIONAL INSIGHT | BANKING & FINANCE
Financier Worldwide Magazine
The first MiFID Directive introduced definitions of ‘regulated market’ (RM) and ‘multilateral trading facility’ (MTF). The recast MiFID (MiFID 2), which will apply from the 3 January 2017, has introduced the concept of a multilateral system – which is neither a RM nor MTF – in which multiple third-parties buying and selling interests in bonds, structured finance products, emission allowances or derivatives are able to interact in the system in a way that results in a contract.
These new platforms are known as ‘organised trading facilities’ (OTF). Investment firms that wish to operate an OTF will need permission from the appropriate national regulator. In practice this will result in a new permission being granted, most likely that of ‘operating an OTF’.
The discretionary nature of OTFs means that many trading venues which have not been authorised as MTFs (primarily on the grounds that they fall outside of the MTF definition because they involve operator discretion) will need to be authorised as OTFs under MiFID 2. Venues which operate OTFs are permitted to exercise discretion in either or both of the following circumstances: (i) when deciding to place or retract an order on the OTF they operate; (ii) when deciding not to match a specific client order with other orders available in the systems at a given time.
National regulators are expected to pay close attention to the role of operator discretion when considering applications for permission to operate an OTF. The focus will seek to ensure that discretion is only being applied in the circumstances above but also to ensure that the applicant should not, in fact, be applying for permission to operate an MTF or systematic internaliser.
Despite the exercise of discretion, MIFID 2 puts in place a variety of measures designed to ensure OTFs are “genuine trading platform[s]” in which the operator is “neutral”. These measures include trade transparency obligations and access requirements which are equivalent, or in the latter case, broadly equivalent to that of an MTF. Likewise, OTFs and MTFs are also both restricted from executing client orders against proprietary capital.
Despite these overlaps, OTFs differ from MTFs in two distinct ways. First, OTF operators are permitted to engage in matched principal trading in bonds, structured finance products, emission allowances and derivatives (unless they have been declared subject to mandatory clearing under the European Market Infrastructure Regulation) whereas an MTF operator cannot. OTFs wishing to carry out matched principal trading will need to ensure their client has given consent. The likelihood is that most OTFs will obtain this consent through their terms of business, unless regulators seek a more express confirmation.
Second, OTF operators will be required to comply with the investor protection obligations in articles 24 (information to clients), 25 (suitability), 27 (best execution) and 28 (client order handling) of MiFID 2 whereas MTFs are not required to do so. The need for these additional protections stems from the discretion granted to OTF operators in the legislation. Article 24 for example requires, inter alia, an investment firm to act honestly, fairly and professionally in accordance with the best interests of its client, for all information addressed to clients to be fair, clear and not misleading, and all costs and charges to be aggregated to allow the client to understand the overall cost as well as the cumulative effect on return of the investment.
The extent to which investment firms will seek permission to operate OTFs as opposed to MTFs remains to be seen. The opportunity to apply discretion is likely to lend itself to certain (perhaps more illiquid) markets but the burden of having to comply with many additional investor protection rules may lead firms to conclude that their platforms could more easily be reconfigured to make them non-discretionary. Other firms may need to seek permission to operate an MTF because the discretion they have relied on to date to remain outside of the MTF regime will not fit squarely into the narrow circumstances in which discretion is allowed under the OTF regime.
Tim Aron is a partner at Arnold & Porter LLP. He can be contacted on +44 (0)20 7786 6144 or by email: firstname.lastname@example.org.
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