On July 19, 2016, the European Commission adopted a Commission Delegated Regulation in the form of RTS specifying the organizational requirements of investment firms engaged in algorithmic trading. The adopted RTS supplement MiFID II by specifying the systems, procedures, arrangements and controls to be put in place and maintained by investment firms to address the risks that may arise in financial markets due to the increased use and development of trading technology. The adopted RTS also outlines requirements of systems and controls for investment firms acting as general clearing members (those not involved with algorithmic trading).
The adopted RTS outline the general requirements for investment firms to monitor its trading systems and algorithms with formalized governance arrangements that set out clear lines of accountability and effective procedures for the communication of information within the investment firm. A firm’s compliance staff will be required to have at least a general understanding of how algorithmic trading systems work within the firm as well as continuous contact with those in the firm with technical knowledge of the firms algorithmic trading systems and algorithms, including individuals with access to the “kill functionality.”
The adopted RTS outline requirements for the resilience of investment firm algorithmic trading systems, including testing and compliance procedures for their pre-deployment, deployment and post deployment. The adopted RTS also specifies the systems and controls for firms acting as general clearing members, providing such clearing services to its clients. Clearing firms will need to undertake due diligence assessments of prospective clearing clients, set out and communicate to their clearing clients trading and position limits so that they can manage their own risks and publish the conditions of offering clearing services. The adopted RTS also sets minimum specifications for direct access trading systems and requires due diligence to be carried out on a prospective client to ensure that it meets the requirements of the adopted RTS (which include diligence on the prospective client’s governance) and the rules of the trading venue to which access is being offered.
The content and format of reporting by firms engaged in high-frequency algorithmic trading is set out in the annexes to the adopted RTS. Such firms will be required annually to self-assess the nature of their business and consider such factors as their regulatory status and role in the market. A validation report based on the self-assessment would then be subject to approval by the firm’s senior management. An investment firm is then required to remedy any deficiencies in the validation report. The adopted RTS must still be approved by the European Parliament and the Council of the European Union and be published in the Official Journal before entering into force. The adopted RTS will apply from January 3, 2018, which is when MiFID II comes into effect.
The adopted RTS on algorithmic trading requirements is available at: https://ec.europa.eu/transparency/regdoc/rep/3/2016/EN/3- 2016-4478-EN-F1-1.PDF and the Annex is available at: https://ec.europa.eu/transparency/regdoc/rep/3/2016/EN/3-2016-4478- EN-F1-1-ANNEX-1.PDF.