The MiFID and the Markets - Unleashing the Trading Forces September 2008 Mike Jones September 2008 Mike Jones.

The MiFID and the Markets -Unleashing the Trading Forces

The MiFID and the Markets -Unleashing the Trading Forces

September 2008

Mike Jones

September 2008

Mike Jones

2

What is The MiFID about?What is The MiFID about?

The core LisbonThe core Lisbon

objectives objectives

.

Unifying EU countries around regulation, providing a single passport.Driving down the cost of capital

Customer protection

Greater transparencyAcross all trading activity

Ending the concentration rule to provide competition to exchanges

3

Trading structure and trendsTrading structure and trends

Regulation Regulation

.

-Exchanges-Multi-Lateral Trading Facilities-Systematic Internalisers-Centralised Counterparty Clearing-Settlement through Centralised Security Depositary Systems (CSD’s)

Buy side – Institutions and retail asset managers

Sell side – Institutional sales & trading

The trend is towards an increase in principal trading from 50% to 70% by 2015.Algorithmic trading is growing quickly in the UK – it accounts for 1/3rd of US trades (source IBM)

4

Receiving & Transmitting v Executing Receiving & Transmitting v Executing

BrokerBrokerFundFundManagerManager

MarketMarket

ClientClient ClientClient

Receiving & Transmitting –L2 Art 45

Best interestOf clients

Executing-L1 Art 21

Best outcomeFor clients

5

Where does Best Execution apply? – Cobs 11Where does Best Execution apply? – Cobs 11

Best ExecutionBest Execution

.

It applies inside or outside the European Community

It applies to all instruments, on and off market

Best execution exists when a contractual or agency obligation exists with a client

It applies to retail and professional clients, but not eligible counterparties

“A firm must take all reasonable steps to obtain on a consistent basis the best possible result for a client.The best possible result for a retail client is to be determined in terms of the total consideration, representing the price of the financial instrument and the costs incurred by the client related to execution.”

6

Prioritisation of execution factorsPrioritisation of execution factors

Best ExecutionBest Execution

.

Size

Speed

Cost

likelihood ofsettlement

Price

Liquidity

7

Best Execution steps Best Execution steps

StepStep 11: Selection: Selection of factorsof factors

StepStep 22: Selection: Selection of execution venuesof execution venues

StepStep 33: Linkage: LinkageTo execution venuesTo execution venues

StepStep 44: Execution: ExecutionOf orderOf order

Sort clients and instruments. Sort clients and instruments. Prioritise factors – price, Prioritise factors – price,

cost, speed, etc.cost, speed, etc.

Select venues for Select venues for ‘Best Possible Result’ ‘Best Possible Result’ on a consistent basison a consistent basis

All venuesAll venues

‘‘Best Possible Best Possible Result’ venuesResult’ venues

Best conditionsBest conditions

StepStep 55: Periodic: Periodic reviewreview

8

Markets MarketsMarkets

Recognised Investment Exchange (RIE)

Electronic market place providers

Systematic Internalisers

Regulated markets

MTF

Quote driven

ABN AmroDeutsche BankLehman BrothersMerrill LynchCitigroupUBSCredit Suisse

Order driven

Multi-lateral trading facilities(facilitates trades – is neither a buyer or seller)

London Stock ExchangePlus MarketsSWX Europe (Virt-X)

Chi-XEurex derivativesICAPCantorNYSE Euronext – AlternativeNasdaq OMXNyfix Euro Millenium (dark pool – Euro equities)Turquoise (September 2008)

Quote driven

Order booksAnonymous crossing systems

Quote driven (internalises client orders and cross against trading book)

9

London Stock Exchange – A Recognised Investment Exchange

London Stock Exchange – A Recognised Investment Exchange

LSE Tradelect services

SETS (a Regulated Market)Previously SETS/SETSMM

SETSQX (RM – previously SEAQ, Seats Plus

AIM – Exchange Regulated Market/MTF

Equities

-Eurosets – RM – Equities, order book and integrated market making – Dutch liquids - EQS – MTF – Equities – Quote driven Market making – EURM liquid securities-IOB – RM – Dep. Receipts – International order book

Equities & Fixed interest

FT All Share plus some Fledgling and AIM UK50

Quote driven market making

Equities

Quote driven together with periodic order book auctions

Equities & Fixed interest

Other services

SEAQ (MTF – previously SEAQ)

Order book and integrated electronic market making

Market Maker can enter 2 sided quotes using electronically executable quotesMM can deal off exchange as SI.Allows Limits, Iceberg, Market, Executable quotes.Trades novate to central clearing

FT all remaining main market, FT Fledgling, some AIM

Securities outside SETS and SETSQX, AIM

Uses SETS, SEAQQX, SEAQ

LSE SETS – an Order Driven systemLSE SETS – an Order Driven system

Here is an example of the order book in continuous trading mode:

Buy (Bid) Sell (Offer/Ask)Time Volume Price Price Volume Time

Order A 10:15 4,800 870 871 5,900 10:25 Order B 10:22 1,500 870 871 7,500 10:48 Order C 10:18 8,700 869 872 13,800 09:25

At 11:00 XYZ submits a Limit order to sell 10,000 shares with a limit price of 870. Two buyers are prepared to pay 870, which is the highest bid price on the book. The one on earliest gets first go, and 4,800 of XYZ’s shares are sold at 870, leaving XYZ with 5,200.

XYZ then sells 1,500 to the remaining buyer, who is prepared to pay 870.The bottom buyer now moves to the top of the book, but is not prepared to pay XYZ 870 – he would only pay 869. XYZ has 3,700 shares left, so XYZ now joins the order book himself, and goes straight to the top of the Sell side, as his selling price of 870 is more attractive to a buyer than the other sellers, who want 871 and 872.

11

LSE SEAQ – A Quote Driven systemLSE SEAQ – A Quote Driven system

12

LSE SETSQX – A mixture of quote driven & order drivenLSE SETSQX – A mixture of quote driven & order driven

Quote bookQuote book

----------------------------------------------------------------------

Order display which Order display which periodically uncrossesperiodically uncrosses

.

Market Makers enter orders to order book uncrossings

Settles outside CCP on a bi-lateral basis in Euroclear/Crest

Yellow strip shows best available bid & offer

Brokers telephone orders

Market Makers provide non-electronic executable quotes and liquidity

RSP Electronic quotes

Brokers’ electronic RSP gateway

Same order book technology as SETS, but not continuous order book execution. 4 uncrosses daily.

Orders executed electronically on the order book will be reported to CCP if the security is supported. Non-supported securities settle direct in Euroclear/Crest

Brokers enter orders – only named or anonymous limit orders – no market orders or iceberg orders

13

Plus Markets – a Recognised Investment Exchange, operating a Regulated Market and a Multi-Lateral Trading Facility

Plus Markets – a Recognised Investment Exchange, operating a Regulated Market and a Multi-Lateral Trading Facility

FTSE100FTSE100

FTSE250FTSE250

Smaller companiesSmaller companies

AIMAIM

European European

.

-Quote driven execution – telephone trading- Quote driven execution – electronic trading through RSP automated ‘RFQ’ services

Off exchange quotation facilities for Systematic Internalisers in liquid shares

10% share of FTSE Smaller Cap40% share of FT Fledgling50% AIM of UK retail market1/3rd

7,500 securities

Offers Protected Trades, i.e. MM accepts an order that is to be executed within a specified period on an improved basis.The trade must be of sufficient size end (minimum E45,000) to qualify for deferred publication up until end of MQP for current business day

MM will trade report (deals between non-mm members seller reports) through normal venues for that stock

14

SWX Europe (Virt-X) – a Recognised Investment Exchange, based in London, and regulated by FSA

SWX Europe (Virt-X) – a Recognised Investment Exchange, based in London, and regulated by FSA

Swiss blue chipsSwiss blue chips

Leading European Leading European blue chips blue chips

.

Clearing through LCH, Clearnet, SIS X-ClearSettlement through Euroclear, SIS Sega, SIS X-Clear

Order driven central limit order book

Operates a Regulated Market for Swiss securities, and is an MTF for non-Swiss securities

A wholly owned subsidiary of the Swiss Stock Exchange

15

Markets MarketsMarkets

Recognised Investment Exchange (RIE)

Electronic market place providers

Systematic Internalisers

Regulated markets

MTF

Quote driven

ABN AmroDeutsche BankLehman BrothersMerrill LynchCitigroupUBSCredit Suisse

Order driven

Multi-lateral trading facilities(facilitates trades – is neither a buyer or seller)

London Stock ExchangePlus MarketsSWX Europe (Virt-X)

Chi-XEurex derivativesICAPCantorNYSE Euronext – AlternativeNasdaq OMXNyfix Euro Millenium (dark pool – Euro equities)Turquoise (September 2008)

Quote driven

Order booksAnonymous crossing systems

Quote driven (internalises client orders and cross against trading book)

16

Chi-X “The first order driven Pan-European MTF”Chi-X “The first order driven Pan-European MTF”

Chi-XChi-X

FTSE 100FTSE 100

Dutch, German, Dutch, German, French French

.

Clearing – Fortis EMCF (European Multilateral Clearing Facility)

Owned by Instinet, which is owned by Nomura

Order driven central limit order book

Anonymous pre & post trade.Can deal anonymously off market as a ‘dark pool’

Order types:-Limit-Market-Iceberg-Fill or Kill (in full or not at all)-Execute & eliminate (execute to fullest extent possible)-Hidden

Agent Banks CSD’s

17

Turquoise – a new MTFTurquoise – a new MTF

300 pan European 300 pan European equitiesequities

1200 dark market 1200 dark market

.

Clearing EuroCCP (DTC)

Owned by leading investment banks who account for 45% of European trading.Owner banks provide liquidity through connections.

On & off order book trading.Onward order routing a possibility

Anonymous pre & post tradeDark pools allow hidden orders and delayed market release

Agent banks CCP’s

18

Some new competitors.. Some new competitors.. MTF’s BATS Trading – US – FTSE – Fortis Clearing Equiduct – 53% owned by Borse Berlin – Choice of clearing

systems. In testing Nasdaq OMX – 600 Pan European equities – Order routing

services provided by Citi for trades that cannot be fulfilled on Nasdaq OMX platform. 26 Sept.

NYSE Euronext Octopus – 400/500 Pan European blue chips. Central limit order book. November

Dark Pools (i.e. Not a public limit order book) -NYSE Euronext’s Smartpool -SWX’s Virt-x subsidiary links with Nyfix for Swiss blue chips -LSE Lehman Baikel (Europe’s deepest lake)

19

Systematic Internalisers Systematic Internalisers

L1 Art 27, L2 1287/2006/EC Art 21, FSA L3 Mar 6L1 Art 27, L2 1287/2006/EC Art 21, FSA L3 Mar 6

““A Systematic Internaliser must A Systematic Internaliser must publish a firm quote in those publish a firm quote in those

shares admitted to trading on a shares admitted to trading on a regulated market for which they regulated market for which they are systematic Internalisers and are systematic Internalisers and

for which there is a liquid for which there is a liquid market.”market.”

20

Order Routing Systems Order Routing SystemsOrder Routing Systems

Neonet - Independent agency brokerTrades with Regulated Markets, MTF’s, and 3rd party venues

Merrill Lynch POSIT

Morgan Stanley Passport

Client

UBS Direct Strategy

Lehman ETS

Goldman Rediplus

To most liquid market

Directed orders

Order Types:BestDiscretionaryFill or KillGTCGT date/timeIceberg (publicly displays only a portion of total volume, although total can be executed)

LimitMarket (unpriced)

Non-directed orders/baskets/blocks

To client specified market

Exhaust - saturate

Algorithms split orders to liquidity pools

Sweep (focus)

Amsterdam, Chi-X, Eurex, LSE, Euronext, SWX Virt-X, NYSE, Australia, Japan, Hong Kong, etc

21

Existing operational structure Existing operational structure

BrokersBrokersSettlementSettlement

systemsystem

ClearingClearingsystemsystem

BrokerBrokerTradingTradingplatformplatform

CentralCentralSecuritySecurity

DepositoryDepository

Transactionreport

22

Shifting the settlement Shifting the settlement

TradingTradingSettlementSettlement

serviceservice

ClearingClearingsystemsystemBrokerBroker

CentralCentralSecuritySecurity

DepositoryDepositoryTradingTradingplatformplatform

TransactionTransactionreportsreports

The MiFID and the Markets -Unleashing the Trading Forces

The MiFID and the Markets -Unleashing the Trading Forces

September 2008

Mike Jones

September 2008

Mike Jones