The Multilateral Single-Dealer System ‒ an Oxymoron Under MiFID II?

Among European regulators and in the academic literature diverging criteria have been developed to distinguish multilateral from bilateral trading systems. Depending on which criteria are applied, operators of multilateral systems may or may not organize multilateral trading in the form of a (quote-driven) single-dealer system. This article is meant to present our position on this issue. We argue that the wording of the second sentence of recital 7 of MiFIR (Regulation (EU) No 600/2014) disguises the true legal intention of MiFID II/MiFIR, which, at a minimum, allows market operators to structure a regulated market as a single-dealer system.

J.I.B.L.R. Article Kumpan/Müller-Lankow, 'The Multilateral Single-Dealer System ‒ an Oxymoron Under MiFID II?' (2019) 34 Journal of International Banking Law and Regulation 301

Content

A. Introduction

B. Certain Regulated Markets Organised as Single-Dealer Systems

I. Quotrix, Lang & Schwarz Exchange and Gettex

II. Market Operators’ Regulation and Supervision of Market Maker Prices

C. Regulatory Classification of Single-Dealer Systems

I. ’Bilateral’ Trading

1. Meaning of ‘Bilateral’

2. Legislative History

3. Systematic Interpretation on the Basis of Article 3(2) and Article 8(2) MiFIR (Types of Trading Systems)

4. Systematic Interpretation on the Basis of Recital 20 MiFIR (Single-Dealer Platforms)

II. Bringing Together of Trading Interests vs. Dealing on Own Account

1. Bringing Together of Third-Party Trading Interests

2. Dealing on Own Account

3. Interim Conclusion

III. Multiple Trading Interests

IV. Ability of Trading Interests to Interact in the System

V. Considering Central Counterparties

D. Investor Protection Within Multilateral Single-Dealer Systems

I. Regulation of the Market Maker‘s Quotes

II. Market Operators’ Supervision of Quotes

III. Legal Status of Multilateral and Organised Trading Facilities

IV. Interim Conclusion

E. Conclusion

Kumpan/Müller-Lankow, 'The Multilateral Single-Dealer System ‒ an Oxymoron Under MiFID II?' (2019) 34 Journal of International Banking Law and Regulation 301

A. Introduction

The increasingly diverse financial services available in marketplaces impacts market structures. The changes are especially visible with respect to trading systems for trading financial instruments. Developments in structuring trading systems are reflected in regulations governing them. Directive 2004/39/EG (hereinafter MiFID I) introduced the ‘multilateral trading facility’ and the ‘systematic internaliser’ as new categories of regulated execution venues, which are in addition to regulated markets offering trade-execution services which were previously recognized. Directive 2014/65/EU (hereinafter MiFID II) and Regulation (EU) No 600/2014 (hereinafter MiFIR) replace MiFID I with effect from 3 January 2018. MiFID II and MiFIR will define a new category of trading venues offering trade-execution services called ‘organised trading facilities’. Trading venues, i.e. regulated markets, multilateral trading facilities and organised trading facilities , are multilateral systems, while systematic internalisers and other over-the-counter (OTC) market makers are bilateral systems. Differentiating between multilateral and bilateral systems has become less clear due to increasing diversity among trading systems. A clear example of such ambiguity is the single-dealer system. Implemented by some market operators, the central feature of single-dealer systems is that members may only interact with a single dealer(market maker). Uncertainty about how to classify single-dealer systems has important implications for regulated markets. According to the definition of a regulated market in article 4(1)(21) MIFID II, the market operator is an operator of a multilateral system. The argumentum e contrario is that a market operator may not operate a bilateral system as regulated market. If a single-dealer system is a bilateral system, such a system may not be operated as regulated market.

For operators of multilateral or organised trading facilities, the right classification of single-dealer systems is ultimately not relevant. According to article 18(7) MiFID II, EU member states shall require that multilateral and organised trading facilities have at least three materially active members or users, each having the opportunity to interact with the others in respect to price formation. As the members to single-dealer systems can only interact with the single dealer (market maker) in respect of price formation, operators of multilateral or organised trading facilities may not implement such a system.

This article analyses the growing border area between multilateral and bilateral systems and defines the border between the systems. For this purpose, this article analyses already existing single-dealer systems which are operated as regulated markets, and the regulation and supervision by the market operators of prices quoted by dealers (market makers) in part B below. Part C below contains an analysis of MiFID II/MIFIR with regard to differentiating between multilateral and bilateral systems, and part D contains an analysis of the implications of investor protection on differentiating between bilateral and multilateral systems, and discusses legal requirements that must be fulfilled by a market operator in trading systems with a single market maker.

B. Certain Regulated Markets Organised as Single-Dealer Systems

In general, dealer systems can be characterized by whether transactions may only be concluded with one market maker (single-dealer system) or several market makers (multi-dealer system). For buyers and sellers, the market maker is an indispensable intermediary. These trading systems are also called ‘quote-driven systems’ or ‘market maker systems’. According to article 4(1)(7) MiFID II, a market maker means a person who holds himself out on the financial markets on a continuous basis as being willing to deal on own account by buying and selling financial instruments against that person’s proprietary capital at prices defined by that person. In this article, the term ‘market maker’ is used synonymously with the term ‘dealer’.

Conversely, an order-driven system is characterized by the trading process, in which participants have the opportunity to interact with all the other members, typically by way of order book trading. Those systems may also implement a single market maker, who provides liquidity to the market on a continuous basis. The difference between an order-driven system with a single market maker and a single-dealer system is the fact that in an order-driven system members may also interact with each other without intermediation of the single market maker.

I. Quotrix, Lang & Schwarz Exchange and Gettex

Certain German market operators have implemented single-dealer systems as regulated markets, where a single market maker (dealer) is counterparty of every trade. The Duesseldorf Stock Exchange and the Hamburg Stock Exchange each offer trading in an order-driven system with a single market maker (Skontrofuehrer) and trading in a (quote-driven) single-dealer system. The single-dealer systems are called Quotrix (MIC: DUSC) and Lang & Schwarz Exchange (MIC: HAMM). Both regulated markets have implemented request for quote systems where members may request a quote from a single dealer (market maker). Requests also include information on intended trading volume. The respective single dealer responds with a firm quote, consisting of a bid- and an ask-price for a certain trading volume. The market operator brings together the trading interests of the member and the dealer, if the member confirms either the sell-side or the buy-side of the quote and its declaration arrives at the exchanges’ matching system within ten seconds after the dealer has provided the quote. At the Duesseldorf Stock Exchange, the single dealer is ICF BANK AG, and at the Hamburg Stock Exchange the single dealer is Lang & Schwarz TradeCenter AG & Co. KG.

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Full article: Kumpan/Müller-Lankow, 'The Multilateral Single-Dealer System ‒ an Oxymoron Under MiFID II?' (2019) 34 Journal of International Banking Law and Regulation 301