The incoming Markets in Financial Instruments Directive II (MiFID II) will introduce a slew of new requirements relating to functionality of systems and the relationships between trading venues and users.
Under MiFID I, which came into force in November 2007 and modernised the European trading experience via multilateral trading facilities (MTFs), the UK’s Financial Services Authority (FSA) required firms to assess best execution by taking into account price, costs and speed.
FSA rules also addressed the likelihood of execution and settlement, plus the size, nature and any other consideration relevant to the execution of an order. However, one of the major changes with MiFID II is that firms will be obliged to take all reasonable steps to secure best execution.
We’ve discussed previously how MiFID II places an emphasis on best execution, but MiFID II could well call for a wholesale change of technology in the front office to achieve a consistent approach to execution and performance measurement across all affected asset classes – i.e. FX, equities, fixed income, derivatives and any contract-based instrument.
Access & execution
One likely focal point for meeting the increased requirements mandated under MiFID II are the gateways that provide access to electronic markets and enable the routing of trades directly to trading venues and exchanges for execution.
Gateways are complex software applications performing diverse functions to ensure data flows among front-end applications, exchanges and the reporting applications employed by clearing and back-office systems.
Connecting to exchanges through an application-programming interface (API), gateway design varies by asset classes or vendors, but their core processes are to route orders to the exchange, disseminate market data to the trading screen and/or trading engine, and manage order execution and administrative functions. They typically include the following components:
- Price server – provides real-time market data information to the front-end application, with a data feed comprising information traders use to make their decisions, such as opening price, last traded prices, closing prices and settlement prices
- Order server – manages the flow of orders sent from the front-end application and routes orders to an exchange’s electronic trading system, where they are processed and matched
- Fill server – as the exchange matches orders, it sends the executed orders back to the Gateway, where the fill server receives them and updates the trader’s order book with confirmation and quantity of the fill
- Administrative process – tracks the information passed between trading screens and the exchange, such as account information, clearing firm code, order IDs, and time stamps for orders and fills, as well as authenticating traders and storing audit trails of trading activity
More art than science
To ensure best execution, gateways require low latency connectivity because instruments are often listed on multiple venues simultaneously. Once a bid offer is hit, the list quote for that instrument is then removed from all other venues. Speed is therefore of the essence when it comes to latency and reaching the best price.
In addition, both pan-European prime brokers and more specialist firms are increasingly exploiting smart order routing (SOR) infrastructure to offer electronic connectivity to Europe’s fast markets – primary exchanges, MTFs and broker and independent dark pools.
They are offering various levels of participation, from simple direct market access (DMA), through to enhanced DMA and sponsored access. SOR is getting smarter – as required by the incoming regulations – as it shifts from merely connecting to primary exchanges to embrace brokers and the dark pools and other trading platforms and execution facilities they operate.
Gateway design is an art unto itself, with systems required to comply with and fully exploit the nuances of execution venues’ individual rules and policies. These may, for example, limit the volume of orders per second a broker may route through a single gateway. This may precipitate the deployment of multiple gateways, with implications for latency monitoring, market exposure and risk.
As the point through which all orders must ultimately pass to reach a trading venue’s matching engine, gateways now need to take into account pre-trade risk checks as well as liquidity searching algorithms and other data inputs to be processed while adding as little latency as possible.
Several gateway vendors have introduced new solutions offering capabilities such as order entry, pre-trade risk and market data, as well as connectivity to more exchanges and execution venues across North America, Europe and Asia Pacific regions. They are also offering connectivity to dark pools, and supporting trading for all major asset classes globally.
Trading up on gateway technology
With market access a key determinate of success for firms that rely on volatility and trade in a variety of market venues, a gateway solution providing access to a broad and expanding range of venues is considered key to diversified trading strategy. However, for the majority of market participants, the cost and effort of supporting new venues are considerable.
No single front-office trading system provides all the needed functionality or market access, so firms have to support multiple trading front ends and execution management systems (whether they’re vendor supplied or home grown). Each order generation source has its own tightly coupled market access infrastructure, so firms end up maintaining a patchwork of market connectivity, gateways, and infrastructure.
Collocated data centres can provide a commercially efficient alternative. Choosing a collated data centre in the right location, with the right technology capabilities and interconnectivity means that leading systems integrators and gateway vendors are only a cross connect away.
A cross connect can provide access to all of the main market data vendors, independent software vendors (ISVs) and brokers while reducing network costs and latency to improve overall trading performance.
Find out how Interxion can give you easy access to the vendors that can help you comply with current and future regulation such as MIFID II and ensure you stay competitive at all times.