Insights

Blogs

MIFID II RTS 6 Update

On the 19th July, a final update to draft Regulatory Technical Standard (RTS) 6, which focuses on algorithmic trading controls, was released by the European Commission. Along with another 27 Regulatory Technical Standards RTS 6 defines detailed guidance to investment firms and trading venues for MiFID II compliance by January 2018.

Stay current on your favourite topics

Subscribe

Citihub has previously performed a detailed analysis of the topics in RTS 6 (See: Algo Controls Whitepaper). The RTS 6 final update is the final evolution of the draft RTS 6 that was published in September 2015. As with other updated RTSs, it is never a simple task to compare versions paragraph-by-paragraph to understand the differences.

When reviewing the RTS 6 update the EU’s favourite redrafting approaches should be kept in mind:

  1. Re-ordering of the recitals. These are the summary paragraphs before the main articles in each RTS. The commission team often combines items and/or splitting them apart as the document evolves.
  2. Use of synonyms. Single words or phrases can change in a sentence or paragraph. It is easy to agonise over interpretations of these. However, if the overall sense of the text has not change it is probably not worth being overly concerned.
  3. New text. Small amounts of new text can creep in. Some can be very small indeed – see table below.
  4. Big impact from small changes. Herein lies the biggest challenge: small changes can result in significant changes to the meaning of the text. There is no substitute for reading both old and new texts together (line by line) and trying to spot these. The same change for one firm may not have the same impact for another firm. Hence each organisation will need to interpret them based on its business.

In practical terms, all changes are evolutionary and minor. However, any organisation that is diligent about traceability of legal interpretations and business requirements to a raw text has a great deal of work as a result of this update. Considerable effort may be required to ensure this latest text is reflected over-writing prior versions.

Citihub’s brief guide to the MIFID II RTS 6 update:

 Recitals:

The overall meaning of the recitals stays intact. However, the numbering has changed. It is difficult to compare paragraphs one for one. Our view of the most amended recitals is as follows:

Articles:

Chapter 1: General Organisational Requirements

Article 1: General organisational requirements

Citihub View: Wording has minor drafting updates but essential meaning unchanged.

Article 2: Role of the compliance function

Citihub View: Wording has minor drafting updates but essential meaning unchanged.

Article 3: Staffing

Citihub View: Wording has minor drafting updates but essential meaning unchanged. However, paragraph 4 now has an additional bullet point that explicitly calls out “sufficient knowledge of algorithmic trading and strategies”.

Article 4: IT outsourcing and procurement

Citihub View: Wording has minor drafting updates but essential meaning unchanged.

Chapter 2: Resilience of Trading Systems

Article 5: General methodology

Citihub View: Paragraph 3 explicitly calls out record keeping as one of the areas that general methodology should cover.

Other than this, intent and meaning largely unchanged albeit with drafting changes.

Article 6: Conformance testing

Citihub View: Largely unchanged except for paragraph 2 having text pulled out into two explicitly bullet points.

Article 7: Testing Environments

Citihub View: Wording has minor drafting updates but essential meaning unchanged.

Article 8: Controlled deployment of algorithms

Citihub View: Text factored out into bullet points – meaning remains unchanged

Article 9: Annual self-assessment and validation

Citihub View: Changes to text that seems to improve readability – paragraph 1 now has text pulled into bullet points.

New reference to a delegated regulation (with an incomplete referencing details) concerning the risk management function of the investment firm.

New paragraph – 5 – detailing what happens if there is no suitable risk function in the organisation

Article 10: Stress testing

Citihub View: “twice” replaced by “multiplied by two” …

Article 11: Management of material changes

Citihub View: Largely unchanged except for a more explicit focus of communication of changes directed at the traders in charge of the trading algorithm.  Previous text used “internally communicated”.

Article 12: Kill Functionality

Citihub View: Paragraphs see re-ordered but essentially little different in intent.

Article 13: Automated surveillance system to detect market manipulation

Citihub View: New title. Paragraph’s re-ordered, text changed and direct comparison difficult. However, article focus is on still on automated surveillance for intent based market manipulation.

Article 14: Business continuity arrangements

Citihub View: Largely intact. Having the arrangements documented in writing has been dropped – just “in a durable medium”.

Having arrangements bespoke to each venue dropped

Article 15: Pre-trade controls on order entry

Citihub View: Slight re-ordering of paragraphs but no change to the substance of what needs to be controlled.

Article 16: Real-time monitoring

Citihub View: One significant change in paragraph 2.

Previously: “Real-time monitoring of algorithms shall be undertaken by the trader in charge of the algorithm and also by an independent risk control function.”

Final Text: “The real-time monitoring of algorithmic trading activity shall be undertaken by the trader in charge of the trading algorithm or algorithmic trading strategy, by the risk management function or by an independent risk control function established for the purpose of this provision.”

 The change from “and” to “or” could be important for many organisations.

Article 17: Post-trade controls

Citihub View: Wording has minor drafting updates but essential meaning unchanged.

Article 18: Security and limits to access

Citihub View: Meaning largely unchanged across the entire article.

Paragraph 4 now mentions the simulation of cyber-attacks and appears to be more strongly worded.

Chapter 3: Direct Electronic Access

Article 19: General Provisions

Citihub View: Paragraphs combined but intent unchanged

Article 20: Controls of DEA providers

Citihub View: New title however article largely unchanged.

Article 21: Specification for the system of DEA providers

Citihub View: Updated title. However, despite drafting changes, largely unchanged

Article 22: Due diligence assessment of prospective DEA clients

Citihub View: Minor updates across the how article but intent and meaning unchanged

Article 23: Periodic review of DEA clients

Citihub View: Wording has minor drafting updates but essential meaning unchanged.

Chapter 4: Investment Firms Acting as General Clearing Members

Article 24: Systems and controls of investment firms acting as general clearing members

Citihub View: Wording has minor drafting updates but essential meaning unchanged.

Article 25: Due diligence assessment of prospective clearing clients

Citihub View: Wording has minor drafting updates but essential meaning unchanged.

Article 26: Position limits

Citihub View: Wording has minor drafting updates but essential meaning unchanged.

Article 27: Disclosure of Information about the services provided

Citihub View: Removal of some key phrases:

Paragraph 1 – “publically disclose” replaced by “shall publish”

Paragraph 2 – “publically disclose” replaced by “shall inform prospective and existing clients”

Small wording change but could increase the level of comfort for firms with MiFID II RTS 6 significantly.

Chapter 5: High-Frequency Algorithmic Trading Technique and Final Provisions

Article 28: Content and format of order records

Citihub View: Combines the draft articles 28 & 29. No change in intent.

However, still does not fundamentally older the contradiction between having to record data against HFT flows which is different from standard order record keeping. Nor does it reconcile the possible need to record two sets of data against the same flows.

Article 29: Entry into force and application

Citihub View: Signed for the commission by Jean-Claude Juncker.


Would you like to know more about our work?


The author

Bob Mudhar

Bob Mudhar

PARTNER, LONDON

Bob manages the firm’s regulatory/compliance & eTrading practices. With more than 25 years’ experience in blue chip investment banking institutions, his career has spanned a variety of business facing technology roles, helping to support, enhance and migrate systems.

bob.mudhar@citihub.com