Systematic Internaliser: what does this really mean under MiFID II?

investment firm

What is a systematic internaliser?

A Systematic Internaliser (SI) is an investment firm which is a counterparty dealing with its proprietary capital and is not a trading venue.

The formal definition is provided in Article 4(1)(20) of MiFID II, which states that SIs are investment firms which on an organised, frequent, systematic and substantial basis, deal on own account when executing client orders outside a regulated market (RM), multilateral trading facility (MTF) or organised trading facility (OTF) (together, Trading Venues) without operating a multilateral system. We’ve broken down this definition into its constituent elements and their meanings in the following table.

Element of definitionApplication
Investment firmLegal person whose occupation or business is provision of investment services or performance of investment activities (Article 4(1)(1) of MiFID II)
Organised

Frequent

Systematic

Substantial basis
Assessed qualitatively
Measured by number of OTC trades on own account as a proportion of number of derivatives executed in the union (at least 2.5%); and transactions occur at least once per week (Article 15(a) of regulation EU/ 2017/565)
Size of OTC trading on own account as a proportion of total turnover of the investment firm (5%) or total turnover in the EU (1%) (Article 15(c) of regulation EU/ 2017/565)
Deal on own accountUse of proprietary capital
Execute client ordersThe investment firm is taken to execute the client order where the counterparty is not an authorised financial institution
Outside RM, MTF or OTFThe SI cannot bring together third-party interests in the same way as a trading venue
Without operating multilateral systemThe SI should be the sole dealer
When does the definition apply?

Where the pre-set limits for frequent and systematic and substantial basis are crossed; or
Where the investment firm opts-in to the SI regime

Difference between SIs and Trading Venues

While Trading Venues are facilities in which multiple third-party buying and selling interests interact in the system, a systematic internaliser is not permitted to bring together third-party buying and selling interests in functionally the same way as a Trading Venue.  Such activity requires authorisation as an MTF.  The main differences in characteristics are as follows.

SITrading Venue
Deal on own accountDo not deal on own account (deal with client’s capital)
Considered a counterpartyNot considered a counterparty but a facility
Single dealerMultilateral dealer platform
Cannot engage in matched principal trading (MPT) on a regular basisCan engage in MPT in some cases (OTFs)
Registered as SI and corresponding authorisations and obligationsRegistered as regulated market or investment firm

MiFID II Trading Venues
FeaturesRestrictions
Regulated Market (RM) Operated by market operator
Authorised by NCA under MiFID II (Title III) as regulated market
No discretion in execution rules
Examples: London Stock Exchange, Euronext London, Cyprus Stock Exchange
Cannot deal on own account
Cannot act as matched principal
Multilateral Trading Facility Operated by investment firm or market operator
Authorised by NCA under MiFID II (Title II) as investment firm
No discretion in execution rules
Examples: UBS MTF, Sigma X
Cannot deal on own account
Cannot act as matched principal
Organised Trading Facility (OTF) Not an RM or an MTF
Authorised by NCA under MiFID II (Title II) as investment firm
Interests in bonds, structured finance products, emission allowances or derivatives
Has discretion in execution rules
Examples: Cube Investing, Mariana Capital, Reyker
Cannot deal on own account
Can act as matched principal in limited circumstances
Needs to be licenced
Conduct of business requirements
Systematic InternalisersAre systematic internalisers a type of trading venue?
No, systematic internalisers are a counterparty, not a trading venue. Systematic internalisers are firms which, on an organised, frequent, systematic and substantial basis, deal on own account when executing client orders outside a regulated market, an MTF or an OTF.

MiFID II does not allow an SI to bring together third part buying and selling interests in functionally the same way as a trading venue.
OTC TransactionsWhat about OTC transactions?
Financial instruments whose immediate underlying is admitted to trading on a trading venue are also subject to MiFID II requirements, even when these instruments are traded off-venue e.g., OTC derivatives contracts that are deemed to be ‘economically equivalent’ to the venue-listed instruments.

Take a look at our table on Trading Venues and SIs comparing these characteristics between SIs and the types of Trading Venue.

When will counterparties become SIs?

The status of a firm as an SI needs to be measured against the relevant criteria on a quarterly basis, based on data from the past six months.  Based on the dates on which ESMA is scheduled to publish trade volume data which is necessary for this assessment (described in the section immediately below), an assessment of SI status must be made starting on 1 September 2018.

Publication of trade volume data (relevant for determining whether trades are carried out on a substantial basis

Regulation 2017/565/EU provides that whether an investment firm is dealing on own account on a substantial basis is to be determined with reference to the volume of OTC transactions as a proportion of the total turnover in that class of derivatives for the investment firm, or of the total turnover in that class in the European Union, both either on a Trading Venue or OTC.  Where the latter is used, ESMA’s published values will be used to determine total trading volumes in the Union, which is published with the following timeframes.

For equity, equity-like and bond instruments.;

  • 1 August 2018: ESMA has published information on the total number and the volume of transactions executed in the European Union for the first time on 1 August 2018, covering the period from 3 January 2018 to 30 June 2018 The results of the data is published and will be updated on the ESMA website in spreadsheet format which can be accessed here.
  • 1 September 2018: Was when investment firms had to undertake their first assessment by this date and comply with the SI obligations where appropriate (including notifying their National Competent Authority).

For ETCs, ETNs, SFPs, securitised derivatives, emission allowances and derivatives;

  • 1 February 2019: ESMA will publish information on the total number and the volume of transactions executed in the European Union for the first time by 1 February 2019, covering the period from 1 July 2018 to 31 December 2018
  • 1 March 2019: investment firms must undertake their first assessment by this date and comply with the SI obligations where appropriate (including notifying their National Competent Authority).

Quarterly updates: for subsequent assessments, ESMA will publish data by the first calendar day of February, May, August and November. Investment firms are expected to perform the calculations and comply with the SI regime by the fifteenth calendar day of February, May, August and November respectively.

The earliest mandatory deadline on which firms must comply with the SI regime, when necessary, is 1 September 2018 although MiFID II and MiFIR apply from 3 January 2018. However, ESMA stresses that investment firms can opt-in to the SI regime for all financial instruments from 3 January 2018 as a means of complying, for example, with the trading obligation for shares.

Asset classes within the scope of the SI regime

Whereas under MiFID I the systematic internaliser regime applied solely to shares/equities, it applies under MiFID II to a much broader range of asset classes:

  • equity-like instruments (ETFs, depositary receipts, certificates and other equity-like instruments), and
  • non-equity instruments (derivatives, bonds, structured finance products and emission allowances).

SIs and Matched Principal Trading

Pursuant to Delegated Regulation 2017/5812 as regards the specification of the definition of systematic internalisers, a systematic internaliser is not allowed to engage, on a regular basis, in the matching of buying and selling interests via MPT or other types of de facto riskless back-to-back transactions in a given financial instrument outside a Trading Venue.

Recital 19 of Delegated Regulation 2017/565 provides that an internal matching system for matching for client orders constitutes MPT on a regular and not occasional basis.  ESMA has clarified in its MiFID II and MiFIR market structures topics of 18 December 2017 that an SI would not be engaging in matched principal transactions on an occasional and non-regular basis if the investment firm:

  1. operates a system intended to match client orders;
  2. has a recurrent or significant source of revenue derived from non-risk facing activities; or
  3. markets or promotes its matched principal basis.

Obligations of SIs

As an SI deals on own account and so uses proprietary capital rather than that of clients or counterparties, it is risk-facing and therefore restrictions are imposed to safeguard other market actors from the risks created.  The purpose of the SI regime is to allow identification of firms that function as SIs so that appropriate regulatory obligations can be imposed.  It also precludes the need to obtain the relevant authorisations for Trading Venues.

An investment firm that meets the criteria for the SI regime needs to notify their national competent authority (NCA) by 1 September 2018. SIs are subject to pre- and post-trade transparency requirements.  They must make public pre-trade quotes (on request or by choice) through a Trading Venue, Approved Publication Arrangement (APA) or on the firm’s website. Accordingly, SIs will need to establish means for responding to requests for quotes.  They are also subject to post-trade transaction reporting requirements, whereby a wide range of information in relation to the trades executed needs to be reported to an Approved Reporting Mechanism (ARM).  SIs will need to have systems in place for gathering and report relevant data.

Forex (FX) brokers and contract for difference (CFD) brokers: am I an SI?

FX brokers and CFD brokers are unlikely to be classified as SIs due to the products they offer do not fall within the scope of SI regime.

If you would like to discuss any aspects of this article or understand how you can comply with your transaction reporting requirements as an SI, please call us on +44 20 8050 1317 in the UK or +357 25 123 309 in Cyprus.

Share this Post:

Stay in the Know

Recent Articles:

Do crypto-asset service providers have MiFIR reporting obligations?
MiFIR/MiFID II

Do crypto-asset service providers have MiFIR reporting obligations?

To address the Money Laundering/Terrorism Financing (ML/TF) risks emanating from crypto-assets, the Cyprus Securities and Exchange Commission (CySEC) published a policy statement (PS) on 13 September 2021 to outline its approach to the registration and operations of Crypto Asset Services Providers (CASPs).