Proprietary Trading and Own Account Transactions - A Legal Perspective under MiFID II

Josef Bergt
2023

Introduction

The landscape of financial services, particularly proprietary trading and the differentiation of own account transactions is an intricate and complex matter. This article aims to provide a legal overview of the provisions governing proprietary trading and own account transactions, exploring their implications under MiFID II.

Statutory Provisions of Proprietary Trading

Proprietary trading or dealings on own account encompasses several variants:

• Continuous Offering of Financial Instruments: Involves the continuous offering of buying and selling financial instruments at self-set prices for one's own account using one's own capital.
• Systematic Internalization: Refers to frequent, organized, and systematic trading for one's own account on a significant scale outside of an organized market or a multilateral or organized trading system.
• Acquisition or Disposal of Financial Instruments as a Service for Others (dealing on own account when executing client orders): This variant includes the buying or selling of financial instruments for one's own account as a service to others.
• High-Frequency Algorithmic Trading: Involves trading on one's own account as a direct or indirect participant of an regulated market or multilateral or organized trading facility using high-frequency algorithmic trading technology.

The Concept of Own Account Transactions

Own account transactions cover the acquisition and disposal of financial instruments for one's own account that do not fall under proprietary trading or dealings on own account. They are considered an investment activity in the form of own account transactions when not executing client orders.

Detailed Analysis of Dealings on Own Account

Each variant of proprietary has specific characteristics:

• Market Makers: Typically engage in the continuous offering of buying and selling financial instruments for their own account at self-set prices.
• Systematic Internalizers: Engage in frequent, organized, and systematic trading for their own account outside of an organized market or trading system. Criteria for Systematic Internalization: The frequency and scale of trading outside a trading venue are crucial in determining whether an entity qualifies as a systematic internalizer.
• The third variant serves as a catch-all provision, encompassing the acquisition or disposal of financial instruments for one's own account as a service to others.
• High-frequency trading, the fourth variant of proprietary trading, involves buying or selling financial instruments for one's own account using high-frequency algorithmic trading techniques. This includes infrastructure to minimize network latencies, the ability to initiate, generate, forward, or execute orders without human intervention, and a high intraday message volume.

Regulatory Implications and Compliance

Entities engaged in proprietary trading or dealings on own account must navigate a complex regulatory landscape:

• Licensing Requirements: The expanded scope of licensing requirements necessitates compliance with MiFID II regulations.
• Operational Compliance: Firms must ensure that their trading activities align with the specific provisions and criteria set forth under MiFID II and applicable national laws.

The legal framework governing proprietary trading or dealings on own account under MiFID II presents a challenging yet vital aspect of financial market regulation. Financial institutions must meticulously adhere to these regulations to ensure compliance and operational efficiency.

Dealing on Own Account

The criterion "dealing on own account" differentiates proprietary trading from commission business. In proprietary trading, the service provider bears the full risk of price and fulfillment respectively settlement, as opposed to acting on behalf of a client.

As a Service for Others

The criterion of “as a service for others” or dealing on own account when executing client orders distinguishes proprietary trading from own account transactions. Proprietary traders engage with clients as service providers, ready to enter into contracts involving the acquisition or disposal of financial instruments. This relationship often involves an imbalance, where the trader has better market access or provides market entry to clients who would otherwise be unable to participate. Own account transactions involve the acquisition or disposal of financial instruments for one's own account that do not qualify as proprietary trading. These transactions are not considered a service and typically occur without a corresponding client order or apparent trade connection with potential clients.

Licensing Requirements for Dealing on Own Account

The operation of proprietary trading or dealing on own account requires licensing with the competent national supervisory authority. This applies to entities operating on a commercial basis or to an extent that necessitates a commercially organized business operation, regardless of the company's legal form.

Source: BaFin Factsheet Information on the elements of proprietary trading and own accountr transactions

Executive Summary:

• Definition of Proprietary Trading or Dealing on Own Account and Own Account Transactions: Under MiFID II, proprietary trading includes four specific variants, each with distinct operational characteristics.
• Systematic Internalization: Entities engaged in systematic internalization must meet specific criteria regarding the frequency and scale of trading outside organized markets or trading systems.
• Regulatory Compliance: Firms engaged in proprietary trading or own account transactions must comply with the licensing requirements based on MiFID II.
• High-Frequency Trading: This form of trading involves sophisticated technological infrastructure and is subject to specific regulatory provisions.