At a Glance…

The European Commission (Commission) clarifies the meaning of the term “deal on own account” for the purposes of the Systematic Internaliser (SI) definition under MiFID II. This may have implications for the regulatory status of EU investment firms when they hedge their client orders with group companies. 

A question of definition

SIs are investment firms that, on an “organised, frequent, systematic and substantial basis,” execute client orders on their own account outside a trading venue.1 The regulators are keen to ensure that SIs are not allowed to engage in matched principal trading on a regular basis outside a trading venue.

In its recently published Commission Delegated Regulation, the Commission clarifies that, for the purposes of the SI test only, the term “deal on own account” should be understood as a reference to the commitment of proprietary capital by the investment firm (i.e., a risk-taking market actor) and should not normally include riskless principal trading unless all of the following requirements apply:

  • the matching arrangements are entered into by the investment firm with group companies;
  • the group company counterparty is unable to provide quotes or other information on trading interests to third parties or to reject or amend such intra-group transactions; and
  • the transactions are carried out for the sole purpose of centralising the risk management of the group.

This will mean that EU investment firms that, for example, have hedging arrangements in place with group companies may still qualify as SIs even if they are acting solely in a riskless principal capacity. Such firms should therefore have arrangements in place to determine whether their riskless principal trading activity in relevant financial instruments exceeds the applicable thresholds under the “organised, frequent, systematic and substantial basis” SI test.

SI threshold calculations

Transactions that do not contribute to the price formation process and/or are not reportable should not be included in the calculations for the purposes of the SI definition. Only those financial instruments that are traded on a trading venue (TOTV) will be required to be reported under the post-trade transparency and transaction reporting regime.

The term TOTV is not specifically defined in MiFID II. The European Securities and Markets Authority (ESMA) has stated in its opinion dated May 2017 that transactions executed outside a trading venue (i.e., executed over-the-counter (OTC)) will be treated as TOTV if they involve a specific type of instrument that trades on a trading venue.

The concept of TOTV for shares, bonds and exchange-traded derivatives that are fully standardised is likely to be clear but the position for OTC derivatives will be less clear. However, the ESMA opinion clarifies that OTC derivatives that have similar characteristics to exchange-traded derivatives by virtue of sharing the same reference data except the issuer and trading venue fields will be treated as TOTV. In relation to transaction reporting, index or basket instruments will be treated as TOTV if a component of the index or basket is TOTV.

Investment firms are expected to notify their home state regulator of their SI status by September 2018, although it is possible to opt into the SI regime from 3 January 2018.