Chapter 1 - Exchanges, MTFs, OTFs and Systematic Internalisers

Question 1

What is a RIE?

Answer 1

Recognised Investment Exchange

Question 2

What FCA criteria does a firm have to meet to become a RIE?

Answer 2

• Fit and Proper
• Sufficient financial resource
• Ability to share information with the FCA
• Maintain high standards of integrity, fair dealing
• Record, monitor and enforce compliance rules
• Enforce disciplinary actions

Question 3

What are 4 disciplinary actions that an exchange could take against its members?

Answer 3

1. Reprimand
2. Fine
3. Suspension
4. Expulsion of member or trading representative

Question 4

What is an MTF?

Answer 4

Multilateral Trading Facility - multiple investors are brought together to trade financial instruments ‘off exchange’. The MTF platform is operated by an investment firm or market operator.

Question 5

Which piece of regulation introduced MTFs?

Answer 5

MiFID - replaced rules that required trades to be executed at local exchanges.

Question 6

What are systematic internalisers?

Answer 6

Market makers - investment firms who match ‘buy’ and ‘sell’ orders from clients in-house rather than sending orders to a central exchange. e.g. Credit Suisse and UBS.

Question 7

Under MiFID how many asset classes can a firm act as an SI for?

Answer 7

1

Question 8

What are the transparency requirements of an SI?

Answer 8

They have to show the price of a trade beforehand and report trade information.

Question 9

What are the features of a Recognised Investment Exchange?

Answer 9

• Formal market
• High entry standards
• listed companies must meeting listing and disclosure requirements.

Question 10

What are the benefits of an RIE?

Answer 10

• Quality of business raising capital
• Investor confidence is maintained
• Maintains a pool of capital

Question 11

What are the features of a MTF?

Answer 11

• No listing process
• Cannot change regulatory status of a security
• Price of orders to be available pre trade
• Real time publishing of trades
• Prices and charges are to be applied consistently across all members

Question 12

What are the benefits of a MTF?

Answer 12

• Greater competition between trading venues
• Higher trading speeds - high frequency trading
• Lower cost based
• Trading incentives relating to trade volumes

Question 13

What are the features of a Systematic Internaliser?

Answer 13

• Executes orders against own book

- Mini exchange subject to pre and post trade transparency requirements.

Question 14

What are the benefits of a SI?

Answer 14

• Lower trading costs

- Faster trading speeds

Question 15

What is an OTF?

Answer 15

Organised Trading Facility

Question 16

Which regulation introduced OTFs?

Answer 16

MiFID 2

Question 17

What cannot be traded on an OTF?

Answer 17

Equities

Question 18

What is the difference between an OTF and MTF?

Answer 18

An OTF has discretion when matching buying and selling interests.

Question 19

How do transparency requirements apply to OTFs?

Answer 19

They apply in the same way as MTFs - pre and post trade transparency is a requirement with current bids and offers published with real time publication of trades.

Question 20

What must OTFs ensure in regards to client orders?

Answer 20

That they are not executed against the propriety capital of:
- the firm or any entity that is part of the firm’s legal group.

Question 21

What is the exception to the rule that client orders cannot be posted against their propriety capital?

Answer 21

When illiquid sovereign debt is traded.

Question 22

Under what circumstances can matched principal trading be conducted on an OTF?

Answer 22

When it has been agreed by both clients and any derivatives trades that are not subject to EMIR clearing obligations.

Question 23

Can the same legal entity operate both an OTF and SI?

Answer 23

No

Question 24

Can trades between two OTFs interact?

Answer 24

No

Question 25

What is counterparty risk?

Answer 25

Risk that a counterparty may not honour its obligations under a contract when the become due.

Question 26

How is counterparty risk managed over the time life of a contract?

Answer 26

Clearing

Question 27

What are two types of clearing that can be used with contracts?

Answer 27

1. Central clearing through a CCP

2. Bilaterally

Question 28

Which type of clearing method is most commonly used in the OTC derivatives market?

Answer 28

Bilateral clearing

Question 29

How is operational risk created with OTC derivatives markets?

Answer 29

When derivatives contracts are confirmed, there are several steps that have to take place before the contact is completely fulfilled. OTC derivatives contracts are often bespoke, complex and involve manual interventions which gives rise to operational risk.

Question 30

How did the EU seek to regulate the OTC derivatives market?

Answer 30

• Require all market participants to report all the necessary information on their OTC derivatives portfolios to a trade repository or directly to regulators.
• Publish aggregate positions
• Reduce counter party risk and operational risk by using CCP clearing.
• Create a post trading market infrastructure.

Question 31

What kind of instruments are traded on OTFs?

Answer 31

Bonds, structured debt, emission allowances and derivatives.