Lecture 6

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Questions and Answers

What is an advantage of dealer markets when it comes to product handling?

Greater order flow competition

Ability to handle illiquid products and block sizes (correct)

Lower operational risks

High transparency in transactions

Which of the following is a disadvantage of dealer markets related to pricing?

Opacity in price formation (correct)

Increased market impact

High informational efficiency

Costs associated with block transactions

Which component is NOT part of a trading system?

Order-driven matching system

Information systems

Bilateral trading agreements (correct)

Organisation of trading sessions

What best defines a multilateral matching service?

It systematically matches all buying and selling interests without broker intervention. Signup and view all the answers

Which of the following statements correctly characterizes bilateral matching systems?

They involve direct quotes between two parties. Signup and view all the answers

What is a common operational risk associated with auction markets?

Information asymmetries leading to market breakdown Signup and view all the answers

In contrast to dealer markets, what is a characteristic advantage of auction markets?

Increased resilience to information asymmetries Signup and view all the answers

Which of the following best explains the difference between multilateral matching systems and bulletin boards?

Multilateral matching systems provide actionable quotes or interests. Signup and view all the answers

What is a key advantage of systematic internalisers (SIs) in the dealer market?

They offer firm quotes during normal trading hours. Signup and view all the answers

Which factor must be satisfied for an investment firm to be classified as a systematic internaliser?

Frequent and systematic dealing on own account. Signup and view all the answers

What is a disadvantage of dealer markets, particularly for systematic internalisers?

They have greater regulatory scrutiny and reporting obligations. Signup and view all the answers

In the context of bilateral matching services, what is a major requirement for systematic internalisers?

Provide two-way firm quotes regularly. Signup and view all the answers

What is a critical component of the best execution rules that systematic internalisers must follow?

Prioritizing the interests of the clients over the firm’s interests. Signup and view all the answers

What distinguishes bilateral matching services from multilateral matching services in trading?

Bilateral matching services involve only the investment firm and the client. Signup and view all the answers

How does the size of OTC trading affect the classification of an investment firm as a systematic internaliser?

There must be a substantial size of OTC trading relative to the firm's other trading activities. Signup and view all the answers

What is essential for systematic internalisers when dealing with illiquid instruments?

Disclosing their quotes to clients on request. Signup and view all the answers

Which of the following best describes a key characteristic of a multilateral matching service?

It provides non-discretionary execution and access. Signup and view all the answers

What is a primary disadvantage of bilateral matching systems?

They rely on a non-fiduciary mandate towards clients. Signup and view all the answers

What distinguishes a dealer market's multilateral matching from bilateral matching?

Multilateral matching allows for multiple counterparty interests. Signup and view all the answers

Which of the following is true regarding the execution of trades in bilateral matching systems?

They may trade against proprietary capital. Signup and view all the answers

What is a defining feature of the regulated markets under MiFID for equities?

They involve admission to trading accompanied by specific EU regulatory requirements. Signup and view all the answers

In what way does a broker/dealer crossing network (BCN) integrate bilateral and multilateral systems?

It combines algorithmic trading from multiple dealers. Signup and view all the answers

What does a fiduciary duty imply in the context of bilateral matching?

The client can trust the intermediary's actions for optimal execution. Signup and view all the answers

Which is NOT a feature of non-neutral trading venues?

Riskless counterpart execution. Signup and view all the answers

What role does a prospectus play in admission to regulated markets?

It serves as a mandatory disclosure document for most companies. Signup and view all the answers

How does objective criteria influence access in non-discretionary trading systems?

It ensures equal access based on predefined rules. Signup and view all the answers

What can be a result of trading against proprietary capital in bilateral systems?

Tendency for conflicts of interest to arise. Signup and view all the answers

What limitation do multilateral trading facilities (MTFs) impose compared to regulated markets?

Less stringent transparency requirements. Signup and view all the answers

Why might clients prefer multilateral matching systems over bilateral ones?

For greater order execution efficiency and access. Signup and view all the answers

Study Notes

Request for Quote (RFQ) Markets

Auction Markets
- Pros: High transparency, price informational efficiency, order flow competition, low transaction costs for small trades
- Cons: Market impact, market breakdown due to information asymmetries, operational risks related to capacity
Dealer Markets
- Pros: Handling of illiquid products and large trades, resilience to information asymmetries, execution certainty
- Cons: Costs, opacity in price formation, accessibility if OTC, low competitive pressures

Trading Systems

Composed of three main components:
- Matching system:
  - Order-driven (multilateral): Orders are matched based on predefined rules
  - Quote-driven (multilateral): Orders are matched based on quotes submitted by market makers
  - Request for Quote (bilateral): Orders are matched through direct negotiations between parties
- Organization of trading sessions:
  - Continuous auctions: Orders can be placed and executed at any time
  - Batch auctions: Orders are collected and matched at specific times
- Information systems: Provide pre and post trade data disclosures
Differentiates between trading systems and bulletin boards:
- Bulletin boards only advertise interests
- Trading systems imply binding quotes or (actionable or non-actionable) indications of interests (IoIs)

Multilateral Matching Service

A multilateral market involves a market operator or investment firm acting as a riskless counterpart that brings together buyers and sellers systematically
Does not apply discretion in matching orders, product admission to trading, or platform access
Relies on ex-ante rules and objective criteria, and has no fiduciary mandate towards clients
Does not trade against proprietary capital or on its own account

Bilateral Matching Service

A bilateral matching system applies discretion to matching, product admission to trading, or platform access
Can trade against proprietary capital and establishes a mandate (potentially fiduciary duty) between client and intermediary
Acts as a non-neutral counterpart

Multilateral vs Bilateral Matching/Execution

Multilateral matching:
- Orders flow through a multilateral platform
- Matches orders based on objective criteria
- Riskless counterpart
- No discretion
Bilateral execution:
- Orders are handled by a dealer
- The dealer uses discretion to match orders
- Potentially involves a fiduciary duty
- Non-neutral counterpart

Interaction Between Bilateral/Multilateral Trading Systems

Broker/dealer crossing network (BCN):
- Clients send orders to broker/dealers
- Orders can be directed to external liquidity pools or internal crossing systems
- Orders are split and diced algorithmically before being sent to open markets, dark markets, or internal crossing systems
- Facilitates the matching of orders within a broker/dealer's own inventory

Mapping Trading Venue Types

Trading venues can be classified by type (e.g., RMs, MTFs, SIs, OTFs)

MiFID Trading Venues

Distinguish MiFID trading venues for equities:
- Neutral:
  - Multilateral matching
  - Non-discretionary access and execution
  - Riskless intermediary
  - Includes regulated markets (RMs) and multilateral trading facilities (MTFs)
- Non-Neutral:
  - Bilateral matching
  - Discretionary access and execution
  - Best execution
  - Systematic internalisers (SIs)

Neutral Trading Venues for Equities

Regulated Markets: Venues of admission to trading and official listing for the majority of companies
- Authorized at national level
- Partially regulated by MiFID
Admission to trading requires a prospectus and other specific requirements
Multilateral Trading Facilities (MTFs): May not require a prospectus unless communication qualifies as an "offer of securities to the public"
- The use of internal matching systems for bilateral trading is permitted under MiFID rules.

Non-Neutral Trading Venues for Equities - Systematic Internalisers (SIs)

Defined as investment firms which, on an organized, frequent, systematic, and substantial basis, deal on own account, executing client orders outside of RMs, MTFs or OTFs, without operating a multilateral system
Two cumulative conditions:
- "Frequent and systematic" - large number of OTC trades
- "Substantial" - a relevant size of OTC trading compared to the IF or trading EEA
Must execute client orders against own capital (unless an OTC exemption applies)
No third-party orders involved; each client order must be individually matched
Subject to registration for asset class (equities and non-equities)
Must provide quotes to clients based on liquidity rules for both liquid and illiquid instruments
Subject to best execution rules and other conduct of business rules due to fiduciary duty to clients

Systematic Internalisers (SIs)

Success of SIs under MiFID 2 and MiFIR remains to be determined

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Description

Explore the intricacies of Request for Quote (RFQ) markets and various trading systems in this quiz. Learn about the pros and cons of auction and dealer markets, and understand how matching systems operate. Test your knowledge on these key financial concepts.