MiFID II is European Union legislation that regulates firms that provide services to clients linked to financial instruments and the venues where those instruments are traded. The legislation introduces new rules and transaction reporting obligations that went into effect on January 3, 2018. The rules are intended to:
- Improve investor protection
- Reduce the risks of a disorderly market
- Reduce systemic risks
- Increase the efficiency of financial markets and reduce unnecessary costs for participants
The rules affect Direct Electronic Access (DEA), algorithmic trading, high frequency trading (HFT) and market making and introduce very specific transaction reporting requirements.
MiFID II defines algorithmic trading as trading in financial instruments where a computer algorithm automatically determines individual parameters of orders, such as whether to initiate the order, the timing, price or quantity of the order, or how to manage the order after its submission, with limited or no human intervention.
MiFID II defines DEA as an arrangement where a trading venue member, participant or client permits a person to use their trading code to electronically transmit orders relating to a financial instrument directly to the trading venue.
Transaction Reporting Requirements
As a means to provide the level of transparency required under MiFID II, ESMA has mandated transactional reporting requirements whereby investment firms must report their transactions, with very specific information, to the appropriate regulatory bodies on a T+1 basis.
To facilitate these requirements, exchanges and other trading venues are supplying fields in their API specifications for electronic trading that adhere to the new regulations. Fields that must be populated on each order (on a pre- and post-trade basis) by all firms providing DEA include but are not limited to:
- Direct Electronic Access: Indication of whether or not the order is DEA.
- Trading Capacity: Indication of a dealing on own account, matched principal and any other capacity.
- Liquidity Provision: Indication of market making.
- Commodity Derivative Indicator: Indication of whether the order is for hedging purposes.
- Investment Decision: Indication of who made the trading decision.
- Execution Decision: Indication of who (or what algo if applicable) submitted the order.
- Client: Indication of the customer (LEI/Short Code).
Additionally, investment firms must include timestamps that are synchronized to global GPS. The timestamps on all HFT orders must have microsecond level precision, and timestamps for non-HFT orders must have millisecond level precision.
Algorithmic Trading Requirements
Investment firms have several obligations related to the use of algorithmic trading, HFT and market making including but not limited to:
- All algos, whether developed by the firm, a client, a vendor or anyone else, must be tested and registered with the appropriate trading venue.
- Firms must stress test algos by running high message and trade volume tests and ensure that algos will not result in disorderly markets.
- All orders sent by an algo must be sent with an ID that represents the algo registration ID.
If there is a material change to an algo, the details must be recorded and the algo must be re-versioned and re-registered with a new identifier.
- Firm administrators must be able to control access to algos that have been properly tested.
- Firms must have pre-trade risk controls, including price collars, position limits and message limits, among others, in place for each instance of every algo.
- Firms must continuously monitor credit and market risk exposure and be able to fully stop running algos.
MiFID II regulations have introduced rules and transaction reporting requirements for investment firms and trading venues across Europe. While Trading Technologies is not subject to MiFID II regulations, we are making changes to our trading platforms to facilitate our customers’ efforts to comply with the regulations themselves. The changes are being made throughout both the X_TRADER® and TT® platforms and specifically impact order execution on the following exchanges:
We are adding the necessary fields across all relevant components of both the X_TRADER and TT platforms and making changes to support the tagging of several message types to comply with MiFID II including the addition of the following fields:
- Direct Electronic Access (DEA)
- Trading Capacity
- Liquidity Provision
- Commodity Derivatives Indicator
- Investment Decision ID
- Execution Decision ID
- Client ID
- FFT 4-6 (free form text fields to handle non-standard fields)
Users of front-end interfaces and FIX applications as well as algo and API developers will all be able to populate the required fields that map to the proper tags in each of the exchange connections.
The values for these fields flow to and from the exchanges with each order message and are displayed in various windows and widgets. Additionally, administrators may control and lock down certain fields to minimize mistakes and ease the burden on end users.
For all TTNET™ and X_TRADER ASP customers, we have implemented a solution in our London and Frankfurt data centers to provide microsecond-level timestamps synchronized to global GPS on the X_TRADER platform. We are documenting the solution such that customers who host their own X_TRADER platform may implement the same solution. The TT platform already has microsecond-level precision for its timestamps.
Our customers use various methods to store records for compliance purposes. Since all of the timestamps and relevant tags flow throughout both X_TRADER and TT platforms, customers can continue to use their existing compliance solutions.
Many customers use FIX for their compliance solutions, and we have added new message types and all of the necessary tags to FIX Drop Copy on both platforms. We are also adding ISIN codes via the FIX security downloads for any exchange that provides them on their feed.
Both platforms generate files that contain records of order activity specific to each exchange. We are enhancing the existing files to include the new data. Customers that host their own X_TRADER platform can collect their own Gateway Audit Files. For TTNET and X_TRADER ASP customers, we will make the Audit Files available on an EFT site. For TT platform customers, we will make Exchange Compliance Records available on an EFT site.
Algos on the X_TRADER and TT platforms
We provide several algos on the X_TRADER and TT platforms. The algos deliver a broad range of order-execution capabilities and include:
- Position Transfer
- Synthetic Order Types
Algo Oversight Council
We have created an Algo Oversight Council (AOC) to refine, monitor and communicate our efforts to support MiFID II compliance within our platforms. Comprised of leadership in the areas of Product Development, Engineering, Quality Assurance and Product Documentation, the AOC advises the operation and refinement of the following:
- Our product development processes and toolsets to assure MiFID II compliance in new algorithmic trading tools as well as the continued compliance of existing tools.
- Tools to monitor algorithmic trading within the TT platform to identify and resolve any problematic algo behavior.
- Business continuity measures intended to prevent disruptions to market stability.
Since MiFID II requires investment firms to thoroughly test algos before deploying to production and we provide algos of our own, we are taking steps to document our internal testing processes and plans related to algos. Our AOC oversees the development and documentation of test plans. We will provide the documentation of our testing methodologies for algos to our customers such that they may provide that to any regulatory bodies.
Order tagging for algos
Some of MiFID II’s order tagging requirements are specific to the use of algos. All necessary fields are being added to both the X_TRADER and TT platforms. Users will have the ability to populate fields that are specific to the use of algos from a user interface, through FIX and from all APIs. When an algo submits child orders to an exchange, the child orders are auto-tagged based on your configuration. The fields that are specific to algos are:
- Direct Electronic Access (DEA)
- Investment Decision
- Execution Decision
Access to algos
Our customers have complete control over who may access specific algos on both the X_TRADER and TT platforms, including TT-supplied algos, bank algos and third-party algos as well as algos developed using ADL® and TT Algo SDK. On the X_TRADER platform, administrators use TT User Setup to control access to algos, and on the TT platform, administrators use the Setup application to control access.
Risk management and monitoring
We provide a series of long-standing pre-trade risk controls. All of the controls apply to all orders, including orders generated from algos, that flow through both the X_TRADER and TT platforms. Administrators use TT User Setup on the X_TRADER platform and the Setup application on the TT platform to set and apply the risk controls. The risk controls include price controls, max order size, message limits, position limits and credit limits. We are enhancing both platforms to include a duplicate order check.
In addition to the pre-trade risk controls, we provide the ability for risk administrators to monitor positions and P/L per account with X_RISK on the X_TRADER platform and the Monitor application on the TT platform. Risk administrators may use these applications to delete orders, and the applications will support the MiFID tags for the order actions.
Both platforms include a “kill” switch, which allows an administrator to disable trading at the user, account and group/firm levels as well as globally.