EU Watchdog Warns Exploitation Of Loopholes In New Legislation

European Securities and Market Authority (ESMA), a key regulatory body has written a letter to the European Commission urging policymakers to take steps to close a major loophole in the new market regulations as it could result in reduced transparency in trading.

The MiFID II legislation is expected to come into force from the beginning of 2018 and contains a slew of provisions seeking to make things more transparent and competitive in equities trading in Europe. One of its most important objectives is to discourage trading in dark pools, which are private off-exchange trading forums where traders deal directly.

The regulator has pointed out that there is a possibility for misuse of the systematic internaliser (SI) program being proposed under MiFID II. Systematic internaliser (SI) refers to those institutions who handle their own accounts and can match customer orders on their own networks.

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According ESMA, some brokers might use this loophole to set up a new type of trading infrastructure that would circumvent requirements being laid down in the MiFID II regulations. It is expected that several brokers might get the designation of SI which would allow them to trade privately as a result of the exceptions made to pricing and being transparent. This according to ESMA, will defeat the legislative purpose of ensuring trading is fair and open.

Chair at ESMA, Steven Maijoor, has also raised the concern that this form of trading could become popular and go beyond share trading. In a statement Maijoor said

We are very concerned about this potential loophole. We encourage the European Commission, if it shares the concerns described above, to look into this matter to determine whether it should use any of its regulatory tools, like the power to adopt delegated acts further specifying the definitions.

Dark pool trading is said to account for nearly 9 percent of the total European market, a rapid increase from less than 2 percent trading recorded in 2010. Regulators are concerned that they might not have full visibility into equities trading and that public prices might no longer indicate the accurate value of the share.

The regulator has asked the commission to examine if there is a need to change or clarify definitions in the regulations to ensure such loopholes aren’t exploited. MiFID II has been drafted over a span of five years and contains detailed technical standards. ESMA is expected to closely monitor the issue and might take steps to clarify the scope of activities allowed under the SI program among other things through a Q&A.

Charlie Harrison

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