5.III.1.4.3 Level 2 text: substantial basis

ESMA assisted in drafting regulatory technical standards specifying what constitutes a ‘substantial basis’. ESMA noted that with respect to the substantial basis, MiFID II required two thresholds to be used, namely: (a) the size of the OTC trading carried out by the investment firm in relation to the total trading of the investment firm in a specific financial instrument; or (b) by the size of OTC trading carried out by the investment firm in relation to the total trading in the EU in a specific financial instrument.1 ESMA indicated that the first threshold (a) referred to the extent to which internalisation is substantial compared to the firm’s total trading in a particular instrument. ESMA was of the opinion that the total trading of the investment firm needed to include all transactions executed in any capacity and executed on any trading venue or OTC.2 In addition, ESMA indicated that the second threshold (b) referred to the size of internalisation activity compared to the total trading in the EU for that instrument. ESMA noted that the level of the threshold needed to be set primarily by having regard to the efficiency of the price formation process in that instrument. In other words, the internalising firm undertakes sufficient activity in an equity instrument so that the price discovery process for that instrument is impacted.3

For the first threshold (a), that is - the size of the OTC trading carried out by the investment firm in relation to the total trading of the investment firm in a specific financial instrument - ESMA was of the view that the internalisation activity would substantial when it accounted for between 15 and 25 percent or more of the firm’s total activity in an equity instrument. For the second threshold (b), being the size of OTC trading carried out by the investment firm in relation to the total trading in the EU in a specific financial instrument, ESMA suggested that the threshold needed to be between 0.25 and 0.5 percent.4 Respondents generally agreed with the ranges proposed by ESMA, although some suggested the use of lower thresholds (intending that the SI-defintion would apply sooner).5 Based on the feedback received, ESMA advised internalisation to be substantial when it accounted either for: (1) 15 percent or more of the firm’s total trading activity for this instrument; or (2) 0.4 percent of the total trading activity for this financial instrument in the EU (a somewhat similar approach was recommended for the determination of on a ‘frequent and substantial basis’, see paragraph above).6

The Commission adopted ESMA’s proposal. This is apparent in the final MiFID II-text. In brief, under MiFID II an investment firm internalises on a substantial basis where the internalization activity is equal to or larger than (i) 15 percent of the total turnover in that equity instrument executed on a trading venue or OTC or (ii) 0.4 percent of the total turnover in that equity instrument executed in the EU.7