2.1.2.8 Operating a Multilateral Trading Facility or an Organized Trading Facility

87. 1) Introduction - Under MiFID II operating a multilateral trading facility (MTF) or an organized trading facility (OTF)1 is considered to be an investment activity. MiFID II defines an MTF as “a multilateral system,2operated by an investment firm or a market operator, which brings together multiple third-party buying and selling interests in financial instruments – in the system and in accordance with non-discretionary rules – in a way that results in a contract in accordance with Title II of [MiFID II]”.3 An OTF is defined as “a multilateral system which is not a regulated market or an MTF and in which multiple third- party buying and selling interests in bonds, structured finance products, emission allowances or derivatives are able to interact in the system in a way that results in a contract in accordance with Title II of [MiFID II]”.4 Both an MTF and an OTF are trading venues5 on which an investor can trade certain financial instruments.6 The types of financial instrument for which an OTF can provide the trading venue is limited,7 whereas an MTF is less restricted in the types of financial instruments for which trading can be facilitated on its trading platform.

88. 2) Relevant risks - From a prudential supervision perspective, the risk of a trading platform is primarily a loss of service. If the trading platform operators of an MTF or OTF were to temporarily or permanently cease operations,8 this might impact financial stability. “The regulation of trading venues is primarily directed to ensuring market integrity, efficiency, and stability; in support of these aims, it has long been associated with protecting liquidity”.9

89. Under MiFID II an operator of an MTF is not allowed to engage in matched principal trading.10 The prudential risks directly influencing an investment firm operating an MTF can be limited. However, the risks these investment firms pose to the financial system and financial stability can be large and as such warrant strict prudential treatment.

90. For investment firms operating an OTF the same reasoning applies as for investment firms operating an MTF. However, an OTF is allowed to engage in matched principal trading11 and to deal on own account.12 Furthermore, an OTF is a discretionary trading venue,13 whereas an MTF is a non-discretionary trading venue.14 This means that an OTF may intervene in the transactions executed on its platform, whereas an MTF may not intervene. That possibility of intervention increases the operational risk of an OTF operator as that operator will thereby also become a participant in the trades on the platform it is operating itself.

91. As the definition of matched principal trading, discussed in the Section concerning ‘Matched principal trading’, states that “the facilitator […] is never exposed to market risk throughout the execution of the transaction”, this does not mean the investment firm is not exposed to prudential risks at all. The OTF is not exposed to market risk for its matched principal trading, as the activity of matched principal trading implies that the payment of the financial instrument and the delivery of that financial instrument take place simultaneously. As the payment and delivery of the financial instrument take place simultaneously, the investment firm will never hold that financial instrument and is thus not exposed to the risk of movements in the price of that financial instrument. There are financial risks, however, which occur when performing the investment activity of operating an OTF. The operator of an OTF is exposed to market risk for any positions resulting from own-account dealing activity. From a prudential perspective, the investment firm operating an OTF is, therefore, exposed to greater risks than the investment firm only operating an MTF. The actual risk of an OTF is fully dependent on the amount of transactions it takes on its own account and the duration of these positions on the balance sheet of the OTF similar to investment firms dealing on own account. The fact that an OTF is allowed to deal on own account increases its risk potential, but this should not alter its inherent perceived risk profile, as an OTF that does not deal on own account is, in essence, very similar to an MTF. However, an OTF that is actively dealing on own account may be considered to have an amplified risk profile.

92. The more active an MTF or OTF market platform becomes and the more transactions that take place on that platform, the higher the risk to the financial system. If the MTF or OTF market platform becomes the single location where certain financial instruments can be traded, the stability of the financial markets is closely linked with the ongoing performance of that MTF or OTF. The prudential requirement for an investment firm operating a market platform should therefore take into consideration the fact that many third parties rely on the smooth operations of these platforms. The operational risk of an MTF or OTF operator for the financial system can therefore be significant. The risk to the financial system should thus be included in the prudential supervision framework.

93. 3) Framework for assessing risks – The risk profile of an investment firm operating an MTF or OTF should therefore be assessed along the dimensions of operational and financial risk, but should also take into account a possible systemic risk for those investment firms whose platform becomes a predominant or only market in which certain financial instruments are traded and as such can become a risk to financial stability.