On 22 December 2011, and following a public consultation, ESMA published its final report, ‘Guidelines on systems and controls in an automated trading environment for trading platforms, investment firms and competent authorities’ in which it sets out a regime governing (a) the operation of an electronic trading system by a regulated market or Multilateral Trading Facility (MTF) and (b) the use of an electronic trading system, including a trading algorithm, by an investment firm. The Guidelines apply to trading in an automated environment of any financial instruments, as defined in MiFID and are effective as of 1 May 2012.
ESMA’s Guidelines include provision that regulated markets and MTFs should have arrangements in place to maintain the orderly functioning of the market, including:
- adequate pre-trade controls, such as the possibility to limit the number of orders which each user can send to the trading platform;
- conformance tests to ensure that users’ IT systems are compatible with those of the trading platform’s electronic trading systems;
- automatic and discretionary mechanisms to limit or halt trading in response to significant variations in price to prevent trading becoming disorderly;
- due diligence of users before accepting their market access;
- clear organisational requirements for members which are not regulated entities; and
- rules and procedures designed to prevent, identify and report instances of possible market abuse and market manipulation that are proportionate to the nature, size and scale of the business done through the trading platform.
Organisational requirement for investment firms
Under the Guidelines, investment firms which use algorithms must also have organisational arrangements to maintain fair and orderly trading, including:
- an appropriate governance process for developing or buying algorithms, rolling out the live use of the algorithm in a cautious fashion and staff with necessary up-to-date skills and expertise to run and monitor the behaviour of their live algorithms;
- pre-trade controls which address erroneous order entry and maintain pre-set risk management thresholds, including thresholds on maximum exposure to individual clients; and
- investment firms’ responsibility for all order flow to venues from clients using direct market access or sponsored access, conduct adequate due diligence on clients using direct market access and sponsored access services and ability to immediately halt trading by these clients.
ESMA Consultation on Guidelines on systems and controls in a highly automated trading environment for trading platforms, investment firms and competent authorities (July 2011)
Response to guidelines on systems and controls in a highly automated trading environment for trading platforms, investment firms and competent authorities (October 2011)
ESMA Guidelines - systems and controls in an automated trading environment for trading platforms, investment firms and competent authorities (February 2012)
ESMA Final Report on Guidelines on systems and controls in an automated trading environment for trading platforms, investment firms and competent authorities (December 2011)