Each investment firm (IF) is required to make a quarterly assessment on its previous 6 months’ data to determine if it qualifies as a Systematic Internaliser (SI). Where an IF is classified as a SI, it will be obliged to meet the pre- and post-trade transparency requirements. TRAction guides you through the assessment process.
What is a Systematic Internaliser (SI)?
As defined in Article 4(1)(20) of Directive 2014/65/EU (“MiFID II”), a SI is an investment firm which executes client orders OTC (off exchange or outside a regulated market (RM), multilateral trading facility (MTF) or organised trading facility (OTF)) on its own account on a frequent, systematic and substantial basis.
What does a “frequent, systematic and substantial basis” mean?
The definition of frequent, systematic and substantial basis, as per EU Regulation 2017/565, depends on the instruments that have been traded, measured over a 6-month period.
- Systematic basis – the number of OTC client executions taking place on own account as a proportion of the number of transactions in the relevant instrument or class executed in the European Union (EU) on any trading venue or OTC. (ESMA publishes data on its website by the first calendar day of February, May, August and November every year)
- Frequent basis – on average how often OTC client executions take place own account
- Substantial basis – the size of OTC client executions on own account as a proportion of total turnover of the IF or total turnover across the EU.
What are the differences 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:
| SI | Trading Venue |
| Deal on own account | Execution only |
| Considered a counterparty | Not considered a counterparty but a facility |
| Single dealer | Multilateral dealer platform |
| Does not engage in matched principal trading (MPT) on a regular basis | All trades are principal to principal |
| Registered as SI and corresponding authorisations and obligations | Registered as regulated market or investment firm |
When is an IF considered a SI?
The table below shows the criteria that qualifies an IF to be a SI. A few examples are in the tables that follow:
| Instrument | Where there is a liquid market | Where there is not a liquid market | |||
|---|---|---|---|---|---|
| Systematic basis (minimum) | Frequent basis | Substantial basis | Frequent and Systematic Basis | Substantial basis (minimum) |
|
| • shares • depositary receipts • ETFs • certificates • other similar financial instruments | 0.4% | Daily | 15% of IF’s total turnover OR 0.4% of EU’s total turnover | Daily | 15% of IF’s total turnover OR 0.4% of EU’s total turnover |
| bonds | 2.5% | Weekly | 25% of IF’s total turnover OR 1% of EU’s total turnover | Weekly | 25% of IF’s total turnover OR 1% of EU’s total turnover |
| structured Finance Products | 4% | Weekly | 30% of IF’s total turnover OR 2.25% of EU’s total turnover | Weekly | 30% of IF’s total turnover OR 2.25% of EU’s total turnover |
| derivatives | 2.5% | Weekly | 25% of IF’s total turnover OR 1% of EU’s total turnover | Weekly | 25% of IF’s total turnover OR 1% of EU’s total turnover |
| emission Allowances | 4% | Weekly | 30% of IF’s total turnover OR 2.25% of EU’s total turnover | Weekly | 30% of IF’s total turnover OR 2.25% of EU’s total turnover |
| *liquid market is defined in Article 2(1)(17)(b) of Regulation (EU) No 600/2014 |
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Example 1
ABC Broking has the ‘dealing on own account’ authorisation on their licence and deals on their own account.
| Conditions | Meet Criteria? | |
|---|---|---|
| Step 1 – determine if there is a liquid market |
||
| Offers DAX ETFs | There is a liquid market | |
| Step 2 – determine if there is a frequent, systematic and substantial basis |
||
| Systematic basis | Internalises 10% of all orders received | Yes – 10% > 0.4% |
| Frequent basis | Deal with OTC transactions on own account everyday | Yes – daily |
| Substantial basis | The total turnover they internalise over 6 months is EUR 3 million and the total turnover they have during the same period is EUR 11.5 million | Yes – 3 million / 11.5 million = 26% > 15% |
| Step 3 - conclusion |
||
| Yes – ABC Broking is considered a SI in this instrument as all criteria have been met. |
||
Example 2
DEF Broking has the ‘dealing on own account’ authorisation on their licence and deals on their own account.
| Conditions | Meet Criteria? |
|
|---|---|---|
| Step 1 – determine if there is a liquid market |
||
| Offers illiquid bonds | There is not a liquid market |
|
| Step 2 – determine if there is a frequent, systematic and substantial basis |
||
| Frequent and Systematic basis | Deal with OTC transactions on own account every week | Yes – weekly |
| Substantial basis | The total turnover they internalise over 6 months is EUR 200 billion and the total turnover in EU during the same period is EUR 18 trillion | Yes – EUR 200 billion/EUR 18 trillion = 1.11 % > 1 % (substantial basis) |
| Step 3 - conclusion |
||
| Yes – DEF Broking is considered a SI in this instrument as all criteria have been met. |
||
Example 3
XYZ Broking has the ‘dealing on own account’ authorisation on their licence and deals on their own account
| Conditions | Meet Criteria? |
|
|---|---|---|
| Step 1 – determine if there is a liquid market |
||
| Offers Airbus shares | There is a liquid market | |
| Step 2 – determine if there is a frequent, systematic and substantial basis |
||
| Systematic basis | Internalises 20% of all orders received | Yes – 20% > 0.4% |
| Frequent basis | Deal with OTC transactions on own account once a week | No - weekly, it needs to be daily in order to meet the criteria |
| Substantial basis | The total turnover they internalise over 6 months is EUR 10 billion and the total turnover they have during the same period is EUR 83 billion | No – 10 billion/10 trillion = 12 % < 15% |
| Step 3 - conclusion |
||
| No – XYZ Broking is not considered a SI in this instrument as not all criteria have been met. |
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How does an IF become an SI?
As illustrated above in the examples, if the threshold is met in any of the relevant instruments, an IF will become as SI in that specific instrument and has an obligation to notify their local NCA of the status.
As IFs are able to opt-in to, or opt-out of, the SI regime for different asset classes at any time, they are required to notify their NCA in any one of the following circumstances:
- opt-in to act as SI;
- ceased to be a SI where they previously opted-in;
- ceased acting as SIs in all the classes of financial instruments previously notified;
- started acting as SIs in a class of financial instruments; or
- ceased acting as SIs in a class of financial instruments.
What does an SI have to do differently to an IF?
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”) or NCA. SIs will need to have systems in place for gathering and reporting relevant data.
Additionally, IFs should also create and maintain a list of all financial instruments for which they are a SI and the list should be made available if at any time their NCA request to access such information.
Is there a difference between FCA and ESMA in determining SI?
While there is currently no glaring difference, there has been a proposal by HM Treasury’s Wholesale Markets Review to replace the current definition of Systematic Internaliser (SI), which requires firms to carry out quantitative calculations on a regular basis, with a qualitative one.
The consultation also proposed determining SIs at an entity level rather than on an “instrument by instrument” basis for the purpose of reporting.
As of March 2022, the FCA is working closely with the government on the Wholesale Markets Review.
