European Reform


ESMA Guidelines

On 22 December, 2011, the European Securities Market Authority (ESMA) published its recommendations Guidelines on Systems and Controls in Automated Trading Environment for Trading Platforms, Investment Firms and Competent Authorities, to help clarify existing obligations related to the legislative framework put into place by the Markets in Financial Instruments Directive (MiFID) and the Market Abuse Directive (MAD). The Guidelines have direct implications for the surveillance and risk management functions inside not only broker-dealers, but also proprietary trading firms.

Key new elements of ESMA’s Guidelines:

(1) Aggregate pre-trade risk checks: Under this requirement, an individual order must be prevented from entering the market if that order would breach a pre-set risk or exposure threshold on the system, client, instrument, group, desk, or overall firm level. Thus, if a client trades through multiple systems and asset classes, the order needs to be checked against the client’s overall exposure limit and the firm’s overall exposure limit. It is not specifically defined if the exposure limit includes open order exposure or just the exposure generated by executed positions.

(2) Real-time post-trade cross-market risk monitoring: Firms should monitor their orders as close to real-time as possible from a cross-market perspective to inspect for signs of disorderly trading. This means that cross-market aggregate open order exposure must be monitored on a real-time basis.

(3) Approval for pre-trade limit changes: The ESMA Guidelines specify that an adjustment or overriding in pre-trade risk thresholds or limits requires the approval from the compliance and the risk management staff. The requirement to conduct trade monitoring and risk management processes on a cross-market basis is also newly specified in the ESMA Guidelines. Although initial ESMA Consultation Paper of July 2011 made no reference to cross-market monitoring, the final version of the ESMA Guidelines, clearly states on a number of occasions that the monitoring of order flow by an automated trading system must include the facility to identify unusual trading patterns across multiple markets, meaning the ability to identify cross-market manipulation and market abuse.

To learn more about ESMA’s Guidelines, their impact on your business, and how this compares to MiFID II requirements and the SEC Market Access Rule in the U.S., download the overview located in the sidebar on the right »