Lower costs of collateral, direct access to the settlement system - all this due to the so-called "REMIT carve-out" - make the OTF (Organised Trading Facility) particularly interesting trading opportunity in the EU energy wholesale market under MiFID II (starting as from 3 January 2018).
The underlying fact is that physically-settled instruments covered by REMIT (wholesale energy products within the REMIT terminology - mainly electricity and gas) traded on an OTF do not qualify as MiFID II financial instruments and are consequently outside the scope of MiFID, EMIR and the CRD IV package.
However, while regulated markets and MTFs have non-discretionary rules for the execution of transactions, the operator of an OTF carries out order execution on a discretionary basis subject, where applicable, to the pre-transparency requirements and best execution obligations.
The way the discretion will be exercised by the OTFs operators is the most troublesome element, the regulators, market participants and the OTFs themselves currently intensively consider.
Why is this so important?
Market participants accustomed to the traditional trading platforms will have to assess risks, to which they are exposed in this novel trading formula.
Among the questions that may be asked is whether the discretionary order execution mean that from the two equivalent orders submitted by the two competitors one will be filled and the second not.
Is the trading in the OTF not subject to the principles of transparency and neutrality?
The answer to the latter question is positive - because an OTF constitutes a "genuine trading platform", the platform operator must be neutral - Recital 9 MiFIR.
Nevertheless, the said issue of the potential discrepancy in the execution of the two equivalent orders must be further examined.
As regards transparency, pursuant to MiFIR the market operator or investment firm operating an OTF are required to "make clear to users of the venue how they will exercise discretion."
However, as always, the devil is in the details.
I'm afraid that market participants potentially interested in trading in an OTF, acting in their own best interest, won't be free from carefully examining algorithms and programs used by the OTF to determine the matching and execution of trading interests.
The law gives in that regard market participants some tools to exercise their prerogatives.
Pursuant to Commission Implementing Regulation (EU) 2016/824 of 25 May 2016, a relevant operator has an obligation to provide its national competent authority with a detailed description of the functioning of its trading system specifying, among others, "a description explaining how the trading system satisfies each element of the definition of an OTF".
Further, the OTF's market operator in the case of an electronic or hybrid trading system, is required to provide information on the nature of any algorithm or program used to determine the matching and execution of trading interests.
ESMA recently underlined, the sophisticated algorithms supporting automated matching need to anticipate the circumstances under which the orders would not be matched; they also must have the capacity to ensure that the decision to match (or not to match) two opposite trading interests is in compliance with the best execution policy or a client specific instruction.
As one of the differentiating factors from execution algorithms operated by MTFs, the algorithms operated by the OTF will be expected to take into account external market factors or other external source of information to demonstrate the exercise of discretion.
Hence, the OTF's best execution policy will be of particular interest to the OTF's members and will have to be carefully examined.
As follows, another source of concern and scrutiny will be the specification of:
- "external market factors" and
- "other external sources of information"
used in the OTF's algorithms, politics and procedures.
However, this effort seems to be worth considering given substantial benefits, the OTF's trading formula gives to its members.