MiFID II will introduce a comprehensive regulatory regime governing direct electronic access (DEA) to trading venues (regulated markets, multilateral trading facilities and organised trading facilities).
What is DEA?
There are two types of DEA: direct market access (DMA) and sponsored access (SA). DMA is an arrangement where a member of a trading venue allows a client to use its trading code so the client can electronically transmit orders in financial instruments directly to the trading venue; such arrangements involve the use by the client of the member's infrastructure to transmit the orders. SA does not involve the use by the client of the member's infrastructure. SA clients are seen by ESMA as having a higher risk trading flow as it does not go via a DMA provider’s trading system; instead, SA clients’ order flow goes through validation checks provided by the trading venue and is monitored by the member of the trading venue which sponsors the access. Accordingly, a trading venue has an obligation to authorise the provision of SA on a case by case basis.
What is not DEA?
DEA does not include arrangements such as online brokerage where client orders are intermediated through electronic means by trading venue members. DEA is distinguished from online brokerage as, in DEA, the person transmitting the order to the trading venue can exercise discretion regarding the exact fraction of a second at which an order is entered. The use of smart order routers (SOR) is also not considered to be DEA unless the SOR are embedded into clients’ systems rather than the systems of the trading venue member.
Providers of DEA
A trading venue member firm which provides a DEA service to its clients must:
- notify its own competent authority and also the competent authority of the trading venue where it provides DEA;
- assess and review the suitability of clients using its DEA service (checking their systems and controls, intentions, capabilities, financial resources and trustworthiness);
- enter into a binding written agreement with clients regarding the rights and objectives of the parties regarding the DEA service;
- ensure that risk controls are imposed on the use of the service;
- retain responsibility for all trading submitted by its clients through the use of the firm’s systems or by using its trading codes;
- prevent clients exceeding appropriate pre-set trading and credit thresholds;
- monitor trading by clients using the firm’s trading code (including an automated surveillance system and real time monitoring of all algorithmic trading activity);
- establish policies and procedures to prevent trading by clients that may create risks to the firm, create a disorderly market, constitute market abuse or breach the rules of the trading venue;
- report trading infringements by clients to the competent authority; and
- carry out, whenever necessary, a review of the internal risk controls systems of DEA clients.
A client that receives DEA services:
- cannot normally use the dealing on own account exemption under MiFID II; and
- must have a suitable due diligence framework at least equivalent to that of the DEA provider if it wishes to grant access to its own clients (sub-delegation).
Trading venues which permit DEA must:
- only permit DEA to be provided by EU authorised members which are investment firms/credit institutions;
- set out and publish rules and conditions pursuant to which their members may provide DEA to their own clients;
- require that members providing DEA retain responsibility for all orders and trades executed on the trading venue using the DEA service;
- require that members set appropriate standards regarding risk controls and thresholds;
- ensure that trading by different DEA clients can be distinguished and that orders/trading of individual clients can be stopped separately where necessary; and
- have arrangements to stop DEA service provision by a member in the event of non-compliance with the above requirements.