Algorithmic And High- Frequency Trading For Investment Firms

MiFID II 7 January 2016 made amendments to the stress testingobligations that firms have, including limiting thenumber of mandatory test scenarios to two; made changes to the pre-trade controlframework, including reducing the number ofmandatory pre-trade controls prescribed; and made changes to the business continuityrequirements to add flexibility. For example, theprescribed list of disruptive scenarios initiallyprovided has been replaced by a generalrequirement to have appropriate businesscontinuity arrangements in place. ESMA hasalso clarified that it no longer requires all firmsto resume trading after an event —there maybe scope for firms to wind down theiroperations instead.Market making strategyMiFID II imposes obligations on algorithmic traderswhen they pursue a market making strategy. A personengaged in algorithmic trading will be considered topursue a market making strategy when its strategy(when dealing on its own account) involves the firm,simultaneous posting of two-way quotes of comparablesize and at competitive prices relating to one or more11financial instruments on a regular and frequent basis.A person pursuing such a strategy must:(a) except under exceptional circumstances, carry outthis market making continuously during a specifiedproportion of the trading venue’s trading hours;(b) enter into a binding written agreement with thetrading venue specifying its market makingobligations; and(c) have in place systems and controls to ensure its12compliance with the agreement in (b).Further requirements have been set out in RTS 8 of13ESMA's September 2015 RTS release in relation towhen an investment firm will be deemed to pursue amarket making strategy, minimum obligations to be11Article 17(4), MiFID II Directive.12Article 17(3), MiFID II Directive.13ESMA, Regulatory technical and implementing standards: Annex I,MiFID II/MiFIR, 28 September 2015. See also ESMA, Final Report,28 September 2015.3specified in the agreement, and detail on the"exceptional circumstances" in (a). ESMA made anumber of changes to its approach compared with itsDecember 2014 Consultation Paper. In particular,ESMA changed its view on when an investment firm willbe considered to be pursuing a market making strategy,which triggers the requirement to sign a market makingagreement.Direct electronic accessMiFID II seeks to ban the provision of direct electronicaccess to markets by investment firms for their clientswhere such access is not subject to proper systems and14controls.Under MiFID II, direct electronic access means:"an arrangement where a member or participant orclient of a trading venue permits a person to use itstrading code so the person can electronically transmitorders relating to a financial instrument directly to thetrading venue and includes arrangements which involvethe use by a person of the infrastructure of the memberor participant or client, or any connecting systemprovided by the member or participant or client, totransmit the orders (direct market access) andarrangements where such an infrastructure is not used15by a person (sponsored access)."Under such arrangements, clients are permitted to enterorders on an intermediary's internal electronic system,which then automatically places an order on a tradingplatform using the intermediary's ID or the intermediaryallows clients to transmit orders electronically anddirectly to the trading platform using the intermediary'sID without being routed through the intermediary'sinternal electronic systems.The own account dealing exemption is removed for16persons who have direct electronic access.ESMA was invited to provide technical advice to clarifythe definition so as to capture all types of arrangementsthat might be covered by this definition. The ESMATechnical Advice makes the following clarifications forthe purposes of direct electronic access:14Article 17(5), MiFID II Directive.15Article 4(1)(41), MiFID II Directive.16Article 2(1)(d)(iii), MiFID II Directive.

MiFID II 7 January 2016 4is a risk that a trade could contribute to adisorderly market; andthe key characteristic of direct electronic accessis the ability to exercise discretion regarding theexact fraction of a second of order entry andthe lifetime of the orders within that timeframe;where a client order is effectively intermediatedby the member or participant of the tradingvenue or a system that simply allows clients totransmit orders to an investment firm in anelectronic form, this would be outside the scopeof direct electronic access (provided the clientdoes not have discretion as to the exact timingof the book entry or an ability to react to marketdata);Smart Order Routing ("SOR") is a type ofalgorithm concerned with the execution of anorder, and not where the order should beexecuted. The algorithm will split a large orderinto smaller orders. SORs come within thedefinition of "algorithm trading". If client ordersare routed via a SOR that is embedded in themarket member/participant's routing systemand not in the client's order generating systemthen this will be outside the scope of directelectronic access as the client does not havethe requisite control over the time of submissionof the order and its lifetime;Automated Order Routing or ("AOR") is asystem used by an intermediary to allow aclient to place an order on the market under theclient's ID. The use of the ID allows theintermediary to monitor and stop any trades ifnecessary. AOR does not necessarily fall in orout of the definition of direct electronic accesshowever, if the client does not have discretionas to how the order is executed, it will not comewithin the definition of direct electronic17access. monitoring of client's trading activity on a realtime basis to allow the trading venue to adapt18such pre-trade controls where necessary.The September 2015 RTS release includesrequirements in respect of systems and controls andparticularly, due diligence of direct electronic accessclients, on-going review of direct electronic access19clients, and pre- and post-trade controls. A personproviding sponsored access must have equivalentcontrols in relation to sponsored access users.ESMA recommends that unique identification numbers20are assigned to all users of direct electronic access, toallow a firm to identify a user, and subsequentlysuspend or terminate the user's direct electronic accesswhere there is a risk of disorderly trading. This shouldthen be reported to the relevant national competentauthority ("NCA").Member state notificationA firm engaging in algorithmic trading must notify itsNCA. It must keep records of all key compliance andrisk controls it has in place, along with its algorithmictrading strategies and any relevant limits. It mustprovide such information and records to its NCA on21request.A person providing direct electronic access must notifyits NCA, and where applicable notify its trading venue. Itmust keep records all key compliance and risk controlsit has in place and provide such information and records22to its NCA on request.General clearing membersA firm that acts as a general clearing member must:The new MiFID II system and controls requirements forproviders of direct electronic access are as follows: 17a proper assessment of the suitability of allusers; pre-set trading and credit thresholds; pre-trade controls in place to allow theautomatic cancellation of a trade, where there18Article 17(5), MiFID II Directive; and RTS 13 in ESMA, ConsultationPaper, 19 December 2014.19RTS 6 in ESMA, Regulatory technical and implementing standards:Annex I, MiFID II/MiFIR, 28 September 2015.20ESMA, Technical Advice, chapter 5.2, pp. 343-4.RTS 6 in ESMA, Regulatory technical and implementing standards:Annex I, MiFID II/MiFIR, 28 September 2015.21Article 17(2), MiFID II Directive.22Article 17(5), MiFID II Directive.

MiFID II 7 January 2016 enter into a written agreement with the tradingvenue which specifies its market makingobligations; and have in place systems and controls to ensureits services are only applied to suitable23persons.The September 2015 RTS release includesrequirements for firms acting as general clearingmembers in respect of systems and controls,determination of suitable persons, position limits, and24client disclosures.Timescales for implementationThe MiFID II Directive and MiFIR came into force on 3July 2014. Most of their provisions are currently statedto come into effect in member states from 3 January2017, with Member states having until July 2016 totranspose the MiFID II Directive into national law.However, following discussions between ESMA and theEuropean institutions, it is now expected that theimplementation of MiFID II will be delayed until January2018.ESMA submitted draft technical standards to theCommission on 28 September 2015. In principle, theCommission has had three months to consider whetherto endorse the technical standards (i.e. by 28December 2015). However, in the context of ongoinguncertainty regarding the legislative timetable, theCommission has not met this deadline.The European Commission is also drafting delegatedacts on the basis of the Technical Advice received fromESMA in December 2014.2324Article 17(6), MiFID II Directive.RTS 6 in ESMA, Regulatory technical and implementing standards:Annex I, MiFID II/MiFIR, 28 September 2015.5

www.hoganlovells.comHogan Lovells has offices st*CaracasColorado o Chi Minh CityHong KongHoustonJakarta*Jeddah*JohannesburgLondonLos AngelesLuxembourgMadridMexico CityMiamiMilanMonterreyMoscowMunichNew YorkNorthern VirginiaParisPhiladelphiaRio de JaneiroRiyadh*RomeSan FranciscoSão PauloShanghaiSilicon ValleySingaporeTokyoUlaanbaatarWarsawWashington DCZagreb*"Hogan Lovells" or the "firm" is an international legal practice that includes Hogan Lovells International LLP, Hogan Lovells US LLP and their affiliated businesses.The word "partner" is used to describe a partner or member of Hogan Lovells International LLP, Hogan Lovells US LLP or any of their affiliated entities or anyemployee or consultant with equivalent standing. Certain individuals, who are designated as partners, but who are not members of Hogan Lovells InternationalLLP, do not hold qualifications equivalent to members.For more information about Hogan Lovells, see www.hoganlovells.com.Where case studies are included, results achieved do not guarantee similar outcomes for other clients. Attorney Advertising. Hogan Lovells 2015. All rights reserved.*Associated offices

Jan 07, 2016 · to resume trading after an event —there may be scope for firms to wind down their operations instead. Market making strategy MiFID II imposes obligations on algorithmic traders when they pursue a market making strategy. A person engaged in algorithmic trading will be consid