Mifid II was for many a case of scrambling to meet deadlines to ensure compliance on January 3 2018, Itiviti identified the expansion of the Systematic Internaliser (SI) regime as a key change that would bring business opportunities to its clients.

SIs were introduced under the original Mifid but were under-used as banks operated the more liquid Broker Crossing Networks (BCNs) to trade with clients.

Mifid II banned BCNs and introduced caps on dark pools while expanding the remit of SIs to include fixed income, ETFs and derivatives.

This created the opportunity for a host of new companies to launch SIs, most notably low latency Electronic Liquidity Providers (ELPs).

Jonas Lindqvist, head of the Principal Trading and Trade team at Itiviti, said there has been a bifurcation of the SI market.

“We see two types of SI among our client base: the ELP model that is actively quoting in the market and the broker SI, which operates more on an RFQ model or between an agency order and the principal desk,” he said.

“Both models enable the SI operator to offer better pricing than traditional venues. An ELP running an SI has the advantage of being able to control who can access the liquidity. This means that they can offer pricing with a lower risk of being gamed by another firm.

“On a broker SI, some of the problems that an agency desk might have in finding liquidity in illiquid instruments are negated by the link to a principal trading desk. So they can also benefit from better pricing.”

Technology requirements

The team at Itiviti recognised there were technical challenges in setting up the SI and then in integrating that with the wider market and both internal and external liquidity pools.

Itiviti leveraged its historic Tbricks and Orc market making software to develop RFQ management, integrations with OMS and EMS screens, the SI engine and the compliance functionality to ensure that the SI met pre- and post-trade transparency as well as record keeping and reporting requirements.

“We built support and tools for both kinds of SIs and all asset classes that are relevant to our clients,” said Lindqvist.

“The Tbricks platform has a modular construction, which allowed us to move fast in implementing new units for the regulatory rules that we have to align with.”

Itiviti also deployed SI support in its smart order router, which routes execution between the SI engine and 60+ liquidity pools and a multi-asset hedger to automatically control risk for SI operators.

“The problem with smart order routers is that many of them are not that smart,” said Lindqvist. “We make sure that ours can be tuned to act efficiently with the different venues that are out there.

“When you interact with an external SI you need to understand how they do business and what is driving that business and that should impact how you tune your smart order router.”

The future development of the SI regime

The expansion of the SI regime has not been without its controversies. Exchanges have claimed SIs are diverting trades from lit markets, while concerns over the increased complexity of European market structure have also been voiced.

But Lindqvist said there is likely to be continued growth in the use of SIs and that keener pricing on offer is of benefit to the market.

“There are currently 161 registered SIs in the European Union and I expect that to grow further in the coming six months,” he said.

“More than 60% of them are SIs in more than one asset class. Of course different asset classes have different requirements but from a technology point of view there are similar benefits. We are seeing more clients interested in using SIs to trade both equities and derivatives.”

In February ESMA will introduce the next wave of SI obligations, which will expand the coverage into derivatives, taking the SI regime into full effect.

“We also expect a number of clients will be required to be SIs next year and they are starting to prepare now for that, and with our platform they can extend into SI status if and when it makes sense to do so,” said Lindqvist.