Legal definition of the 'multilateral system' is laid down by Article 4(19) of the MiFID II Directive.

                       
                 
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Pursuant to this provision 'multilateral system' means any system or facility operated and/or managed by:

 

- an investment firm or

 

- a market operator;

 

in which multiple third-party buying and selling trading interests in financial instruments are able to interact in the system. 

 

 

Article 4(19) MiFID II

  

'multilateral system' means any system or facility in which multiple third-party buying and selling trading interests in financial instruments are able to interact in the system

 

 

MiFID I did not use this definition. 

In turn:

  • the European Commission Proposal of 25 November 2021 for a Directive of the European Parliament and of the Council amending Directive 2014/65/EU on markets in financial instruments (COM(2021) 726 final),
  • European Commission Proposal of 25 November 2021 for a Regulation of the European Parliament and of the Council amending Regulation (EU) No 600/2014 as regards enhancing market data transparency, removing obstacles to the emergence of a consolidated tape, optimising the trading obligations and prohibiting receiving payments for forwarding client orders (COM(2021) 727 final)

 

move the 'multilateral system' definition into Article 2 paragraph 1 point (11) of MiFIR.

 

Recital 6 of the said Proposal of 25 November 2021 for the MiFID II amendment reads:
“Due to the removal of multilateral systems from the scope of Article 1(7) of Directive 2014/65/EU and into Regulation (EU) 600/2014, it is equally logic to move the corresponding definition of ‘multilateral system’ into that Regulation”.

 

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The characteristic feature of the MiFID II is the requirement that all multilateral systems for the trading of financial instruments are a regulated market, MTF or OTF operated by an authorised firm or a regulated market.

ESMA Consultation Paper of 25 September 2020 (on the functioning of Organised Trading Facilities (OTF), ESMA70-156-2013, p. 21, 22) reminded that:

- the combination of the changes introduced in MiFID II, notably the obligation under Article 1(7) of MiFID II and the definition of a multilateral system under Article 4(19), has the effect of recognising that any multilateral system must request authorisation as a trading venue;

- that means that any multilateral system should operate in accordance with the definition of regulated market, MTF or OTF, regardless of the changes the facility needs to incur to comply with the requirements associated with the operation of a trading venue;

- therefore, the mere fact that the facility does not fall within the definition of any type of trading venue does not mean that such facility is outside of the trading venue boundaries;

- operating in accordance with the multilateral system definition is sufficient to be required to seek authorisation as a trading venue;

- furthermore, the definition of multilateral systems does not require the conclusion of a contract as a condition but simply that trading interests can interact within the system;

- it results from such definition, read in conjunction with Article 1(7) of MiFID II, that the conclusion of a contract is not a prerequisite for an investment firm or a market operator to be required to request authorisation as a trading venue for the system it operates;

- in other words, systems where trading interests can interact but where the execution of transactions is formally undertaken outside the system would still qualify as multilateral systems and be required to seek authorisation as trading venues.

 


Multilateral versus bilateral systems

 

 

It is sometimes underlined, MiFID II has introduced this term in the opposition to 'bilateral systems'.

 

UK Financial Conduct Authority (FCA) in the Consultation Paper I on the MiFID II implementation (CP15/43) of December 2015 observes: "Multilateral systems may be contrasted with 'bilateral systems' where an investment firm enters into every trade on own account. [...] Any system or platform is a multilateral system where more than one market participant has the ability to interact with more than one other market participant on that system or platform" (p. 264).


Article 1(7) of MiFID II requires all multilateral systems in financial instruments to operate as:

 

- regulated markets,

 

multilateral trading facilities (MTFs), or 

 

organised trading facilities (OTFs).

  

 

Article 1(7) MiFID II

 

All multilateral systems in financial instruments shall operate either in accordance with the provisions of Title II concerning MTFs or OTFs or the provisions of Title III concerning regulated markets.

 

 


It is noteworthy that:

- European Commission Proposal of 25 November 2021 for a Directive of the European Parliament and of the Council amending Directive 2014/65/EU on markets in financial instruments (COM(2021) 726 final) and

- European Commission Proposal of 25 November 2021 for a Regulation of the European Parliament and of the Council amending Regulation (EU) No 600/2014 as regards enhancing market data transparency, removing obstacles to the emergence of a consolidated tape, optimising the trading obligations and prohibiting receiving payments for forwarding client orders (COM(2021) 727 final)

move the above rule into Article 2 paragraph 7a of MiFIR.
 

 

The definition of the 'multilateral system' under the MiFID II/MiFIR rules is common to any trading venue, a new type - an OTF - including.

 

MiFID I provided for two types of trading venues only, regulated markets and MTFs, definitions thereof being very similar as sharing a number of features (in essence, both regulated markets and MTFs are systems which operate in accordance with non‑discretionary rules that bring together multiple buying and selling interests in a way that results in contracts).

 

The aforementioned ESMA Consultation Paper of 25 September 2020 (on the functioning of Organised Trading Facilities (OTF), ESMA70-156-2013, p. 22, 23) makes some legislative propositions in this regard, i.e. in order “to ensure more legal certainty, to foster EU-wide consistency and convergence in the application of the framework, and to avoid any issues of transposition”, ESMA proposes that:

1) the restriction set out in MiFID II in Article 1(7) is moved into MiFIR, and

2) this restriction is worded as a prohibition so as to make it suitable for direct applicability in Member States.

 

According to the ESMA, for instance, it could be stipulated in MiFIR that:

1) it is forbidden to operate any type of multilateral system that does not also fit the definition of a regulated market, MTF or OTF; and

2) all multilateral systems in financial instruments are required to seek authorisation as a regulated market, MTF or OTF and where necessary modifying their operating arrangements to comply with the applicable trading venue definition.

 

Referring to "systems operating in a similar way to a trading venue but without proper authorisation" ESMA considers that "any system that allows trading interests in financial instruments to interact, including information exchange between parties on essential terms of a transaction (being price, quantity) with a view to dealing in those financial instruments is sufficient to require authorisation as a trading venue. The information exchanged does not need to be a contractual agreement between parties for the interaction to occur".


Further details regarding this general guidance has been provided through Q&As (in particular Q&A 7 and 10 of the section of Q&As on MiFID II and MiFIR market structures topics, ref. ESMA70-872942901-38).


In the aforementioned ESMA Consultation Paper of 25 September 2020 ESMA also invited National Regulatory Authorities (NCAs) to take remedial actions should some firms within their jurisdiction not operate in compliance with the MiFID II authorisation framework.


ESMA also intends to further clarify the conditions under which a facility should request authorisation as a trading venue via an ESMA Opinion.

 

 

Constituent elements of the definition of 'multilateral systems' - the requirement for trading interests to interact in the system

 

 

FCA in the above Consultation Paper of December 2015 (p. 48, 49) also argues, the MiFID II definition of the 'multilateral system' does not require the conclusion of contracts under the system's rules but only that trading interest is able to interact in the system.

 

FCA interprets the effect of combined Articles 4(19) and 1(7) that the MiFID requirement that a contract is executed under the system's rules by means of the system's protocols is now a sufficient but not necessary condition to be a multilateral system and hence to be regulated as a trading venue. 


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See also:

 

Broker Crossing Networks (BCN)

 

Christoph Kumpan, Hendrik Müller-Lankow, The multilateral single-dealer system - an oxymoron under MiFID II?, 13 September 2017

 

Instead it is required that trading interest is able to interact in the system.

 

FCA is of the opinion that the condition for trading interests to interact in the system is less stringent than that a contract is executed under the system's rules, or by means of the system's protocols or internal operating procedures.

 

FCA is, furthermore, of the view that interaction in a system or facility occurs when the system or facility allows multiple trading interests to exchange information relevant to any of the essential terms of a transaction in financial instruments (being the price, quantity and subject‑matter) with a view to dealing in such instruments.

 

In conclusion, pursuant to FCA, at a minimum, a platform will be considered a multilateral system (and hence must operate as a regulated market, MTF, or OTF in accordance with article 1(7) of MiFID II) if the system provides the ability for trading interests to interact with a view to dealing and:

 

- allows multiple participants to see such information about trading interest in financial instruments, or submit such information about trading interest in financial instruments for matching, and

 

- enables them, through technical systems or other facilities, to take steps to initiate a transaction, or be informed of a match.

 

MiFID II wording as well as the above FCA's analysis of the core, decisive elements of the very definition of the multilateral system indicates it is somewhat subtle concept, for example:

 

- a system that provides participants confirmation or notification messages about a matching opportunity between those participants, with a view to a transaction in financial instruments, qualifies as such a system or facility, 

 

- on the other hand, any system that only receives, pools, aggregates and broadcasts indications of interest, bids and offers or prices is not considered a multilateral system for the purpose of MiFID II (this is because there is no reaction of one trading interest to another other within these systems – they do not 'act reciprocally' (see also recital 8 of MiFIR)).

 

In the FCA's view, interaction in a system or facility occurs when the system or facility allows trading interests to exchange information relevant to any of the essential terms of a transaction in financial instruments (being price, quantity, subject-matter).

 

The information exchanged need not be complete contractual offers, but may be simply invitations to treat or 'indications of interest'.

 

The FCA concludes that the definition of a multilateral system "goes beyond" the definitions of an OTF and MTF and of the systems operated by regulated markets.

 

The concept of a multilateral system under MiFID II is not, however, uniformly understood even among the EU Member States’ regulatory authorities.

 

Christoph Kumpan and Hendrik Müller-Lankow in the article “The multilateral single-dealer system - an oxymoron under MiFID II?” of  13 September 2017 (p. 8, 9) refer to the view of the German supervisory authority BaFin, according to which it is a bilateral system if the system operator not only brings together (or facilitates the bringing together of) third-party trading interests, but is itself a party to transactions for the purpose of market making.

 

The said BaFin’s approach is supported by German regional supervisory authorities responsible for the supervision of the stock exchanges in Duesseldorf, Hamburg and Munich, which have authorised the single-dealer systems Quotrix (MIC: DUSC), Lang & Schwarz Exchange (MIC: HAMM) and Market Maker Munich (MIC: MUNC) as regulated markets.

 

The above authors also note the multilateral systems’ further differentiation criterion developed by Diego Valiante (‘“Setting an institutional and regulatory framework for trading platforms: Is there a case for a new trading venue under MiFID?”, Journal of Financial Regulation and Compliance, 2013, no. 1), where a trading venue is multilateral if the operator has two characteristics:

 

1. neutrality, and

 

2. riskless operations.

 

If an infrastructure does not meet at least one of these criteria, it should be considered, according to Valiante, as a bilateral trading venue.

 

 

Multilateral systems interpretation according to the European securities markets regulator

 

 

ESMA presented its views on the legal nature of multilateral systems in the Consultation Paper of 18 January 2022 on the Opinion on Trading Venue perimeter (ESMA70-156-4978).
   

Firstly, ESMA underlined that clarity as to when a facility qualifies as a multilateral system is indispensable for an effective application of the MiFID II provisions.

 

Secondly, the analysis, according to the ESMA, must be based on four different aspects of the multilateral systems’ definition introduced by MiFID II:
• it is a system or facility;
• there are multiple third party buying and selling interests;
• those trading interests need to be able to interact; and;
• trading interests need to be in financial instruments.

 

The ESMA’s remarks below refer to each of the above elements separately.

 

System or facility

 

In the context of Article 4(19) of MiFID II, a system must be understood as a set of rules that governs how third-party trading interests interact. Such rules or features could be contractual agreements or standard procedures that shape and facilitate interaction between participants’ trading interests.

A system in ESMA’s understanding is to be technology-neutral, hence the type of technology used or the fact that it is an automated or non-automated system, does not determine whether it is a system. The main criterion is whether there are specific rules concerning the interaction of multiple market participants to which participants shall adhere to.

Whilst a system is easily identified when embedded in an automated system, it is more difficult to identify for non-automated systems. As clarified in an ESMA Q&A, “(...) non- automated systems or repeatable arrangements that achieve a similar outcome as a computerised system, including for instance where a firm would reach out to other clients to find a potential match when receiving an initial buying or selling interest, would also be characterised as a system” (Q&As on MiFID II and MiFIR market structures topics, ref. ESMA70-872942901-38).

Out of scope of the definition of multilateral systems are general-purpose communication systems. In fact, despite that such systems allow for the possibility of being used for communication of trading interests, they are not governed by rules which facilitate such interaction of trading interests.

 

Multiple third-party buying and selling trading interests

 

The second criterion for a multilateral system, is whether the system involves multiple third-party buying and selling trading interests. The term “third-party” in this context relates to persons other than the system operator, that are not directly connected and are brought together in a transaction. The word ‘multiple’ refers to the system allowing various trading interests, to interact in the same system or facility.

In scope are also systems where only two trading interests interact, provided such trading interests are brought together under the rules of a third-party operator. This interpretation is supported by the legal reasoning established in the Court of Justice of the European Union (CJEU) Case C-658/15 (Robeco and others vs. AFM).


The Court’s judgement refuted the argument that a system was bilateral in nature, even where there is always the same investment fund on the one side of a trade which executes the order from an investor within its own system. Considering this system as bilateral would ignore the involvement of the system operator which runs the system as an independent operator in respect of the transactions. The CJEU held that the latter cannot be considered a feature of bilateral trading.

This is also the case, for example, of a single dealer system operated by someone other than the market maker (a single dealer system is to be understood in the context as a system where a single market maker is the counterpart to every trade in the system).

According to the ESMA’s view expressed in the above Consultation Paper of 18 January 2022 such system should be considered as a multilateral system as it involves a third-party operating the system.

Similarly, systems that allow multiple third-party interests to interact but where, occasionally, bilateral interaction occurs too, should also be captured within the trading venue perimeter. This applies, for example, to the case of RFQ systems that can be used by members or participants at their discretion as an RFQ-to-one tool, i.e. a tool that allows (or requires) sending a request to only one counterparty.


Third-party

 

“Multiple third party buying and selling trading interests” only excludes those systems where the interaction occurs between two counterparties only, with no actual or potential third-party involvement in the system. In general, those bilateral systems operate according to the rules and/or commercial policy of the dealer (the SI) without the intervention of any third party. The SI trades on own account on every transaction in the bilateral system and is required to take on market risk.

 

Interaction between trading interests

 

On the third criterion of trading interests being “able to interact” in the system, ESMA believes that for such interaction to occur, the system must allow not only the communication of the different trading interests but also that members must be able to react to those trading interests, i.e. it should be possible to act upon those trading interests and match, arrange and/or negotiate on essential terms (being price, quantity) with a view to dealing in those financial instruments.

The definition of multilateral systems does not require the conclusion of a contract as a condition, but simply that trading interests can interact within the system. Hence, the conclusion of a contract is not a prerequisite for a firm to be required to request authorisation as a trading venue for the system or facility it operates.

Systems or facilities where trading interests can interact, where there is confirmation of a trade or where the essential terms have been (or can be) negotiated (for example buy/sell, price, quantity), would still require authorisation as a trading venue, even if some further contractual details are arranged outside of the system as is the case with many derivative contracts. In such instances it cannot be argued that there is no interaction in between trading interests only because the final terms of the contractual agreement are concluded outside of the system or facility.

The interaction can be the result of automated mechanisms, for example, where there is an automated match on an order book system; or it can be the result of a concrete action by the member or participant, as is the case on some RFQ or quote driven systems. In both circumstances there is interaction between trading interests within the system.

A multilateral system, as clarified by Recital 8 of Regulation 600/201416 (MiFIR) regarding OTFs, “should not include facilities where there is no genuine trade execution or arranging taking place in the system, such as bulletin boards used for advertising buying and selling interests, other entities aggregating or pooling potential buying or selling interests, (...)”.

Hence, interaction requires that the system contains rules that concern the matching, the arranging and/or the negotiations of trading interests. General advertising and/or aggregation of trading interests alone do not qualify.

 

Financial Instruments

 

The final criterion is that the facility needs to allow for the system to allow the interaction of third-party buying and selling trading interests in financial instruments within the meaning of Article 4(15)17 of MiFID II.

As such, only systems that allow third party interaction on those instruments specified in Section C of Annex I of MiFID II should be considered as a multilateral system within the scope of MiFID II.

 

 

Multilateral single-dealer systems

 

 

It is restricted for an operator of multilateral systems to deal on own account. 

As a consequence, operators of multilateral systems are not allowed to bring together its own trading interests with other, third-party trading interests.

 

On the basis of this principle, Christoph Kumpan and Hendrik Müller-Lankow (op. cit, p. 13, 14, 21) conclude that a single-dealer system must be considered multilateral if the market operator only brings together the trading interests of the market maker and other third parties.

 

The differentiation of trading venues on the one hand and systematic internalisers and other OTC market makers on the other hand based on the terms ‘bringing together of third-party trading interests’ and ‘dealing on own account’ indicates that a single-dealer system can be multilateral if the market operator and the single-dealer are not the same person.

 

On the other hand, the bilateral trades are triggered by the European Commission, which in the public consultation launched on 17 February 2020 on the review of the MiFID II and MiFIR framework argues that the multilateral single-dealer systems offer very similar functionality to a multilateral system, hence MiFID II/MiFIR should encompass also these systems to ensure fair treatment for market players.

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European Commission launches public consultation on the review of the MiFID II and MiFIR framework, 17 February 2020, p. 82

Some trading venues express concerns due to emerging trends which allow alternative type of electronic platforms to offer very similar functionality to a multilateral system for the matching of multiple buying and selling interests. These electronic platforms are not authorised as regulated trading venues, hence they do not have to comply with the associated regulatory requirements, notably in terms of reporting obligations or business rules to manage clients’ relationships. The main argument advanced against regulation of these electronic systems is that they match trading interests on a bilateral basis and not via a multilateral system. However, according to traditional trading venues, this alternative electronic protocol may cause competitive distortions, effectively creating a level playing field distortion against the regulated trading venues which are bound by MIFID II/MiFIR provisions. There is a debate whether MiFID II /MiFIR should therefore take a more functional approach and define the operation of a trading facility in broader terms than the current definition of trading venues or multilateral system as to encompass these systems and ensure fair treatment for market players.

 

 

Treatment for the portfolio compression and post-trade confirmation services

 

 

Pursuant to the aforementioned FCA's analysis, neither the service of portfolio compression, which reduces non-market risks in derivative portfolios without changing the market risk, nor post-trade confirmation services, constitutes a multilateral system by itself.

 

However, if a firm operates a system that comes within the definition of a multilateral system without taking into account these activities, any portfolio compression or post-trade confirmation services that it provides for that system can form part of the multilateral system that the firm is operating.

 

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