Exchange Trading, OTCs And Alternative Trading Venues

Question 1

Explain the concept of exchange trading

Answer 1

1. Trading on exchanges e.g. on LSE
2. An exchange centralises the communication of bid/offer prices to all market participants
3. Once buyer and seller reach an agreement, the price at which the transaction is executed is communicated to the market
4. Level playing field that allows market participants to buy as low and sell as high as anyone else as long as exchange rules are followed

Question 2

What are some common centralised communication methods for exchange trading?

Answer 2

Voice

Hand signal

Electronic message

Computer generated electronic commands

Question 3

What are some common decentralised communication methods in OTC markets?

Answer 3

Telephone

Fax

Electronic network

Question 4

Explain the concepts of trading in an OTC market

Answer 4

1. Decentralised trading
2. Securities may not be listed on an exchange
3. Trading takes place via dealers/ two parties instead of an exchange.
4. It’s a Bilateral contract where two parties agree on how a trade or agreement is to be settled in the future
5. Market makers carry inventories of securities to satisfy buy and sell orders.
6. These are “off-book trades” or “upstairs trade”

Question 5

What are MFTs (multilateral trading facilities)?

Answer 5

1. Trading platforms organised by investment firms
2. Brings together third party buyers/ sellers
3. Can be operated by both the operator of a regulated market or the firm itself.
4. Regulated markets and MTFs need to follow the same regulatory standards on transparency and rule books

Question 6

What are Systematic Internalisers?

Answer 6

1. An investment firm that deals on its own account by executing customer order flows in liquid shares.
2. Executed outside a regulated market, an MFT and OTF (not via an exchange)
3. MiFID requires these types of firm/ to publish and honour buy-sell prices up to standard market size
4. They still need to adhere to pre and post trade transparency rules

Question 7

What are OTFs (organised trading facilities)?

Answer 7

1. Multilateral system NOT on a regulated market or MTF
2. New category of trading facility introduced in MiFID II
3. Designed to capture trading in bonds and certain derivatives that would not be treaded on organised markets or MTFs
4. Trading in OTFs are discretionary

Question 8

What are OTFs (organised trading facilities)?

Answer 8

1. Multilateral system NOT on a regulated market or MTF
2. New category of trading facility introduced in MiFID II
3. Designed to capture trading in bonds and certain derivatives (non equities) that would not be traded on organised markets or MTFs
4. Trading in OTFs are discretionary

Question 9

Give me examples of two of the largest MTFs

Answer 9

BATS Chi-X Europe

Turquoise

Question 10

What are dark pools?

Answer 10

1. Electronic crossing networks that provide liquidity which is not displayed on a conventional order book of an exchange
2. Price nor the identity of trader is displayed

Question 11

Explain some concepts of dark pools

Answer 11

1. MFTs that have opted out of the requirements for pre-trade transparency
2. Useful for traders wishing to buy/ sell large no. of shares without revealing themselves
3. Large traders can be traded without price impact, they trade in a market so, access to better price

Question 12

Give me examples of bilateral and multilateral systems

Answer 12

Bilateral - OTCs, private contracts
(no central intermediary. Trade/ agreement between two parties)

Multilateral - exchange trading, MFTs, OTFs
(multiple parties coming together to reach an agreement e.g. on a platform where multiple buyers and sellers can reach an agreement)