On December 22, 2011, the European Securities and Markets Association (ESMA) published its final Guidelines on systems and controls in an automated trading environment. These were based on a consultation that ended in October 2011.

The Guidelines affect firms:

• authorized under the EU Markets in Financial Instruments Directive (MiFID) and non-MiFID firms who access markets through direct market access (DMA) or sponsored access (SA) or as direct members (including those trading for their own account) and certain other market participants, including out-sourcing companies which provide services to the market participants affected, and
• operating “electronic systems,” including electronic systems used to send trading orders to platforms, trading algorithms and smart orders routers only from the perspective of the risks involved in order entry.

ESMA stated that it was happy with its definition of “trading algorithm” (which is broad) and that it considers that its approach is necessary to avoid regulatory arbitrage. ESMA has revised its descriptions of what constitutes market abuse. ESMA has noted that the review of MiFID (the MiFID II review) is on-going but considers that it is appropriate to introduce the Guidelines now, although it is made clear that the review of regulation surrounding algorithmic trading is ongoing and does not stop with the Guidelines – in particular, work will continue on conflicts of interest between market operators and market participants and micro-structural issues not covered by the Guidelines.

ESMA states that compliance/regulatory staff at firms should be responsible for providing clarity on the firm’s regulatory obligations and introduce policies and procedures that seek to ensure the use of trading systems comply with the firm’s regulatory obligations and any failures to comply are detected.

ESMA has amended the Guidelines from the draft published for consultation in relation to organizational requirements for trading platforms to, among other things, highlight that measures to consider include message traffic rather than order flow, set out in more detail the due diligence to be undertaken by trading platforms on market participants and more clarity on the circuit-breaker obligations and volatility interruptions protections and information to be provided to the UK Financial Services Authority (FSA) and other competent authorities regarding significant risks that may affect the operation of a fair and orderly market.

The Guidelines state that trading platforms should consider allotting individual trading codes to clients accessing markets through SA/DMA.

The Guidelines will become effective one month after publication by the relevant competent authority (in the UK, the FSA), with a long-stop date of May 1, 2012. The FSA has indicated that it will broadly implement the Guidelines in the form published by ESMA.

The full Guidelines may be found here.