4.III.1.2.2 Level 2 text: details of the definition

MiFID I obliged to specify the meaning of the SI definition through delegated acts. CESR drafted the advice in this context, that is – the meaning of the terms ‘organised’, ‘systematic’, and ‘frequent’. CESR noted that ‘organised’ and ‘systematic’ related to the organizational aspects of firms that internalised. CESR viewed them as being subject primarily to a qualitative assessment.1 CESR therefore proposed to define the concept of a SI in organisational terms. CESR suggested the following elements: (a) the use of a specific business model in which the activity had a commercial role; and/or (b) the existence of non-discretionary rules, protocols, procedures and/or practices governing the internalisation process; and (c) the assignment or use of personnel and/or an automated technical system for the purpose of carrying out the activity.2

For the meaning of ‘frequent’, the third term of the definition, CESR initially proposed a qualitative approach.3 CESR argued that any firm interested in the infrastructure needed for systematic internalisation would normally only do so if they intended to conduct the activity ‘on a frequent basis’.4 However, following comments to the CESR consultation, arguing that the purely qualitative position would result in a lack of definitional certainty, CESR suggested to include some quantitative criteria.5 CESR recommended that the activity of internalisation: (1) needed to be made available to clients on a regular and continuous basis; and (2) CESR provided negative criteria indicating when a firm was viewed as unlikely to be a SI.6 The following quantitative criteria were suggested as indicators that a firm was not undertaking the activity on a frequent basis:

A significant number of respondents to the CESR consultation criticized the proposed quantitative criteria. It was argued that criterion (1), that is – the ratio of internalisation compared to the total business of the investment firm, would discriminate against less diversified firms.8 In relation to criterion (2), being the ratio of internalisation compared to the total value of trading on the most liquid market, several respondents stated that the ratio was dependent on circumstances outside the control of the investment firm. Another counterargument were the costs for investment firms in calculating the thresholds.9

Respondents to the CESR consultation also argued that the proposed definition did not specifically exclude ‘OTC transactions’ referred to by the Level 1 text.10 The respondents were concerned that it was therefore not clear enough that the SI-definition excluded OTC transactions.11 CESR recognized the issue, but concluded it was not appropriate to introduce the point into Level 2 advice, since it was part of the Level 1 text.12

CESR also proposed recommendations for when a SI would cease its operations in one or several shares. CESR suggested that the SI needed to announce its intention to do so in advance. CESR stated that the announcement could take place through the same publication channel the SI used to publish its quotes.13 Some respondents to the CESR consultation stated that such an announcement was not necessary. Others noted that the communication through the same publication channel would not always be possible. CESR responded that it was important for investors to be aware when a SI was going to cease the activity in one or more shares.14 CESR therefore proposed to keep the requirement. CESR modified the proposal to accommodate other publication channels for the announcement as well.15

The Commission partially accepted CESR’s suggestions. On the one hand, the Commission adopted (a) the proposed qualitative elements of the definition and (b) the notification requirement for when a SI would cease its operations. On the other hand, the Commission removed (2) any quantitative criteria for the meaning of ‘frequent’, as evident in the final MiFID I text. The final MiFID I text only encompassed qualitative elements. The meaning of the term ‘frequent’ was merely referred to as being conducted on a ‘regular and continuous basis’. The qualitative approach present in the final MiFID I text reflected, among other things, the aim of preventing unnecessary costs for SIs (calculating the thresholds would not be necessary). The Commission also altered (2) the position of CESR by explicitly providing two conditions in the Level 2 text that excluded investment firms from being a SI. The two conditions were similar to the OTC characteristics referred to on Level 1. The two conditions in the MiFID I text made explicit that the SI definition excluded ‘OTC transactions’.