As change is the law of life, laws are prone to change. MIFID II was a response to the financial crisis, and while at it, also meant to erase some of the unintended consequences caused by MIFID I. MIFID II has still to come into effect but the European Commission is already looking at changes.
What's going on? It's the SI-regime. SI stand for Systematic Internalizer and it was meant to replace the dark pools of this world, to create more visibility and transparency and to push trading volume on exchange. So, lit, not dark! Some investment firms like Virtu saw a real business opportunity.
ESMA and FESE have now seen seen the light. The SI-regime could have, according to ESMA, the exact opposite effect and it's pointing to HFT (again). They argue that HFT could set up an SI and provide execution to a wide set of counterparties and keep flow away from the exchange. On top of that, the evil HFT-firm will most likely hedge the transaction before the market knows that the trade took place. HFT can do this because they have a speed advantage in execution compared to the speed at which trade data is disseminated.
Now the European Commission came up with the idea to prevent investment firms to hedge their transaction immediately (read the text here). This kills the SI as we (were going to) know it.
Think about it. An investment firm wishing to register as an SI can only match trades with proprietary capital. So, what the European commission is saying is that an investment firm maintaining an SI can buy a position but then needs to wait before it can sell, hence it will run an uncontrolled risk. In other words, a prop trader should risk its own money in an uncontrollable way. I thought that was what a regulator would like to see avoided.
I’m curious what will happen in the next couple of weeks. A lot of firms spent a lot of money to comply with new regulation. If the change in the SI-regime is definite, then a lot of money has been wasted. There must be other ways to close the loophole in the regulation.