The first article in this series provided an overview of the regulatory policy objectives of the G20 group of Finance Ministers and their aim to restore global growth, strengthen the international financial system and reform international financial institutions following the 2007/2009 banking crisis and subsequent recession. The second article considered the Dodd Frank Act, which is the US approach to meeting its G20 obligations. The third article looked at the equivalent European response to the G20’s demand for tighter financial regulation, the European Market Infrastructure Regulation (‘EMIR’).
This fourth article examines two other pieces of European legislation of relevance to commodity markets: the Market in Financial instruments Directive (‘MiFID’); and, the Regulation on Energy Market Integrity and Transparency (‘REMIT’).
MiFID I/ MiFID II
The Market in Financial instruments Regulation (‘MiFIR’) and MiFID both address market efficiency, safety and transparency and the prevention of market abuse. MiFIR additionally addresses the definition, prevention and criminalization of market abuse with the Market Abuse Regulation (‘MAR’) and the Market Abuse Directive (‘MAD II’).
MiFID I, which was adopted in 2004 and which took effect in 2007, aims to create a common internal European market and to promote competition amongst trading platforms. Unlike Dodd Frank MiFID I did not oblige OTC trades to migrate to regulated markets (‘RMs’).
Instead it recognized the concept of multilateral trading facilities (‘MTFs’) that are not exchanges, but were allowed to operate alongside RMs in the OTC market. Operators of MTFs were permitted to offer a wider range of more customized instruments than those that are offered on RMs. MTF transactions were subject to less onerous reporting provisions and consequently positions and exposures were more difficult to track.MiFID II / MiFIR, which repealed MiFID I and were adopted in 2014, recognizes an additional trading venue: the Organized Trading Facility (‘OTF’) in attempt to catch any other trading venues that are not unequivocally OTC. For example, broker crossing systems or inter-dealer broker systems may be regarded as OTFs. Running an OTF is an investment service and the operator must be licensed as an Investment Firm in the same way as an RM or MTF.
Unlike operators of RMs and MTFs, OTF operators have discretion in placing bids and offers and in matching orders, in accordance with clients’ instructions. For example, a client of an OTF may specify that it does not want its orders matched with a particular counterparty with whom, for example, it may already have reached an internal dealing limit.
RM, MTF and OTF operators cannot trade using their own proprietary capital, except in the case of OTFs dealing in illiquid sovereign debt instruments. The exclusion of the use of proprietary capital distinguishes these venues from the activities of Systematic Internalizes (‘SIs’). Such SIs include, for example, the centralized trading function of major oil company or utility or commodity trading house acting as a central dealer for its asset teams or its overseas affiliates. The SI may deal in the market with third parties or match orders from different affiliates within its own greater corporate book. SIs can use proprietary capital and do not have to be licensed to carry out this activity.
Algorithmic trading is regarded as a particular threat to market stability by prolonging and accentuating price movements. Algorithmic traders are required to install control systems to ensure their procedures are robust and have sufficient capacity, are subject to appropriate trading thresholds and ceilings and can prevent mistaken orders from triggering inappropriate market movements.