5.II.4.2 What does an ‘internal matching system’ mean?

There is no definition of the term ‘internal matching system’. MiFID II does note that ‘a system for matching client orders which results in the investment firm undertaking matched principal transactions on a regular and not occasional basis’ should be considered as an ‘internal matching system’.1 However, the MiFID II provision is written in the specific context of when an SI requires authorisation as an MTF.2 It is therefore not entirely clear what the term ‘internal matching system’ means. It is likely that, for the sake of consistency, NCAs will use the MiFID II provision to interpret the MiFID II obligation for certain internal matching systems to authorise as an MTF.3

The lack of legal certainty with respect to the term ‘internal matching system’ suggests that EU clarification would be beneficial here.4 Until such clarification is provided under MiFID II, an interpretation of the Commission under MiFID I can be used as a guide. The Commission guidance concerned broker crossing networks. The Commission gave the following explanation about the term broker crossing network:

‘A number of investment firms in the EU operate systems that match client order flow internally (…). Generally, these firms receive orders electronically, utilise algorithms to determine how they should best be executed (given a client’s objectives) and then pass the business through an internal system that will attempt to find matches. Normally, algorithms slice larger ‘parent’ orders into smaller ‘child’ orders before they are sent for matching. Some systems match only client orders, while others (depending on client instructions/permissions) also provide matching between client orders and house orders. Broker crossing networks do not show an order book (…)’ (italics writer).5

Three elements of the Commission’s interpretation are worth to emphasize. First, the Commission regarded a broker crossing network to be ‘an internal system that will attempt to find matches’ (emphasis added). The Commission’s wording is highly similar to the term ‘internal matching system’ under MiFID II. Second, the Commission argued that broker crossing networks (i.e. the internal system attempting to find matches): (1) match client orders and/or (2) provide matching between client orders and house orders.6 Translating the Commission’s words into legal-economical concepts, internal systems match orders based on: (a) agency crossing and/or (b) internalisation. Third, and finally, the Commission stated that broker crossing networks did not show an order book, that is – broker crossing networks did not publish pre-trade data with respect to the potential trades in the internal system.7

As noted above, MiFID II intends to ensure that any trading system in financial systems, ‘such as broker crossing networks, are properly regulated’, whereas the wording ‘properly regulated’ refers in this context to being authorised as an RM or MTF.8 Following the Commission’s interpretation, the broker crossing network, simply put – an internal matching system, can be functionally similar to a multilateral trading venue (i.e. agency crossing) or SI (i.e. internalisation).