Why the lack of rush to be internalisers ?

Systematic Internalisers ? Who are they and why very few large players have declared their intention to become systematic internalisers ?

The MiFID directive defines a systematic internaliser as “an investment firm which on an organised, frequent and systematic basis, deals on own account by executing client orders outside a regulated market or an MTF” [ Directive 2004/39/|EC of European Parliament of 21 April 2004 Article 4 (7) ]

A lot of people think of a SI (common acronym for systematic internaliser) as a Market Maker, but MiFID defines a market maker as “a person who holds himself out on the financial markets on a continuous basis as being willing to deal on own account by buying and selling financial instruments against his proprietary capital ay prices defined by him” [Directive 2004/39/|EC of European Parliament of 21 April 2004 Article 4 (8) ]

The differences between the two should explain why there has not been a rush to declare intentions to become systematic internaliser even in markets like London where market making is common.

What are exactly the obligation of a systematic internaliser ?

1) Publish Quotes

2) Pre-trade transparency reports for liquid shares (and although liquidity is centrally defined, single regulator can act on that definition in two ways, (a) when they transpose or (b) by specifically designating an otherwise illiquid share as a liquid share in accordance with Article 22(3)

3) Make trades public within three minutes of execution (this includes both liquid and illiquid shares) as part of the reporting obligations of a trading venue. They also need to make their market data available to the public at reasonable costs on a commercial and non discriminatory basis.

4) They also have to state their intention of being systematic internalisers and the specific security (or other financial instrument) they want to be systematic internaliser for. The relevant home regulator will keep a list of all systematic internalisers and that list will be made public by CESR (one of the first instances of an operational role as a coordinator of all the regulators). This list will have to be updated regularly and it will include the average daily turnover, average daily number of transactions and free float.

Limiting the disclosure to liquid shares is already a step forward towards transparency given that currently there is no such an obligation for large trades that happen outside markets (and they do happen). Information on illiquid shares can be inferred from post trade reporting.

So… a lot of reporting headaches, what are the strategic advantages in being SI ?

Let’s see what restriction do market makers have :

1) they still fall under MiFID (the exemption for persons who do not provide any investment services or activities other than dealing on own account specifically states “unless they are market maker or deal on own account outside a regulated market or an MTF [Directive 2004/39/|EC of European Parliament of 21 April 2004 Article 2 (1) (d)]

2) When the authorisation to operate a regulated market is mentioned in Art 1 (49) there is a specific reference to “the medium of designated market maker appointed by the regulated market” , therefore it could be inferred that a market maker is tied to a specific regulated market and therefore the interesting legal questions lies in “What happens if an institutions wants to market make securities listed in different regulated market ? Will they have to seek authorisation from all the regulated markets ? (If that is the case we have the first strategic advantage of being a SI, you only deal with your home regulator). There are several references in the text of MiFID to ‘registered market maker’

3) One of the other interesting issues is that the pre-transparency rules for a venue mean that they have to include the “best bid and offer by price of each market maker”, so indirectly a market maker is not exempt from transparency rules completely.

4) Even more interesting is Article 44 of Best Execution Rules (Best Execution Criteria) that states “for the purpose of this Article and Article 46, ‘execution venue’ means a regulated market, an MTF, a systematic internaliser, or a market maker, or other liquidity provider or an entity that performs a similar function in a third country to the functions performed by and any of the foregoing”. Yet again not much difference there.

The only conclusion to draw so far is that a market maker has to be designated by a regulated market and act in according to the practice of that market. A systematic internaliser does not have to be designated and can create its own trading rules – within the limits stated by MiFID - therefore an institution can be a systematic internaliser for shares listed on different stock exchanges and that may open opportunities for companies who have market making capabilities in several countries in Europe to be internalisers across jurisdictions.

So there does not seem to be much difference from an operational point of view, any legal mind that would like to join the debate will be mostly welcome.

After all, this is maybe one of the several instances of MiFID where an operation expert and a legal professional should work together to the best advantage of their client.