Josef Bergt
2023
Introduction
The landscape of financial services, particularly proprietary trading and the differentiation of own account transactions is an intricate and complex matter. This article aims to provide a legal overview of the provisions governing proprietary trading and own account transactions, exploring their implications under MiFID II.
Statutory Provisions of Proprietary Trading
Proprietary trading or dealings on own account encompasses several variants:
- Continuous Offering of Financial Instruments: Involves the continuous offering of buying and selling financial instruments at self-set prices for one's own account using one's own capital.
- Systematic Internalization: Refers to frequent, organized, and systematic trading for one's own account on a significant scale outside of an organized market or a multilateral or organized trading system.
- Acquisition or Disposal of Financial Instruments as a Service for Others (dealing on own account when executing client orders): This variant includes the buying or selling of financial instruments for one's own account as a service to others.
- High-Frequency Algorithmic Trading: Involves trading on one's own account as a direct or indirect participant of an regulated market or multilateral or organized trading facility using high-frequency algorithmic trading technology.
The Concept of Own Account Transactions
Own account transactions cover the acquisition and disposal of financial instruments for one's own account that do not fall under proprietary trading or dealings on own account. They are considered an investment activity in the form of own account transactions when not executing client orders.
Detailed Analysis of Dealings on Own Account
Each variant of proprietary has specific characteristics:
- Market Makers: Typically engage in the continuous offering of buying and selling financial instruments for their own account at self-set prices.
- Systematic Internalizers: Engage in frequent, organized, and systematic trading for their own account outside of an organized market or trading system. Criteria for Systematic Internalization: The frequency and scale of trading outside a trading venue are crucial in determining whether an entity qualifies as a systematic internalizer.
- The third variant serves as a catch-all provision, encompassing the acquisition or disposal of financial instruments for one's own account as a service to others.
- High-frequency trading, the fourth variant of proprietary trading, involves buying or selling financial instruments for one's own account using high-frequency algorithmic trading techniques. This includes infrastructure to minimize network latencies, the ability to initiate, generate, forward, or execute orders without human intervention, and a high intraday message volume.
Regulatory Implications and Compliance
Entities engaged in proprietary trading or dealings on own account must navigate a complex regulatory landscape:
- Licensing Requirements: The expanded scope of licensing requirements necessitates compliance with MiFID II regulations.
- Operational Compliance: Firms must ensure that their trading activities align with the specific provisions and criteria set forth under MiFID II and applicable national laws.
The legal framework governing proprietary trading or dealings on own account under MiFID II presents a challenging yet vital aspect of financial market regulation. Financial institutions must meticulously adhere to these regulations to ensure compliance and operational efficiency.
Dealing on Own Account
The criterion "dealing on own account" differentiates proprietary trading from commission business. In proprietary trading, the service provider bears the full risk of price and fulfillment respectively settlement, as opposed to acting on behalf of a client.
As a Service for Others
The criterion of “as a service for others” or dealing on own account when executing client orders distinguishes proprietary trading from own account transactions. Proprietary traders engage with clients as service providers, ready to enter into contracts involving the acquisition or disposal of financial instruments. This relationship often involves an imbalance, where the trader has better market access or provides market entry to clients who would otherwise be unable to participate. Own account transactions involve the acquisition or disposal of financial instruments for one's own account that do not qualify as proprietary trading. These transactions are not considered a service and typically occur without a corresponding client order or apparent trade connection with potential clients.
Licensing Requirements for Dealing on Own Account
The operation of proprietary trading or dealing on own account requires licensing with the competent national supervisory authority. This applies to entities operating on a commercial basis or to an extent that necessitates a commercially organized business operation, regardless of the company's legal form.
Source: BaFin Factsheet Information on the elements of proprietary trading and own accountr transactions
Executive Summary:
- Definition of Proprietary Trading or Dealing on Own Account and Own Account Transactions: Under MiFID II, proprietary trading includes four specific variants, each with distinct operational characteristics.
- Systematic Internalization: Entities engaged in systematic internalization must meet specific criteria regarding the frequency and scale of trading outside organized markets or trading systems.
- Regulatory Compliance: Firms engaged in proprietary trading or own account transactions must comply with the licensing requirements based on MiFID II.
- High-Frequency Trading: This form of trading involves sophisticated technological infrastructure and is subject to specific regulatory provisions.
FAQs
Under MiFID and MiFID II, dealing on own account means “trading against proprietary capital resulting in the conclusion of transactions in one or more financial instruments”. Dealing on own account can refer to investment firms taking positions, including proprietary trading and those created by market-making.
What is proprietary trading dealing on own account? ›
Proprietary trading or dealings on own account encompasses several variants: Continuous Offering of Financial Instruments: Involves the continuous offering of buying and selling financial instruments at self-set prices for one's own account using one's own capital.
When a bank trades on its own account it is known as proprietary trading? ›
Proprietary trading occurs when a financial institution trades financial instruments using its own money rather than client funds. This allows the firm to maintain the full amount of any gains earned on the investment, potentially providing a significant boost to the firm's profits.
What is MiFID 2 in simple terms? ›
MiFID II sets out to: Ensure trading takes place on regulated platforms. Draw up rules on algorithmic and high-frequency trading. Increase transparency and oversight of financial markets and address shortcomings in commodity derivatives markets.
Who is exempt from MiFID? ›
Generally speaking, collective investment undertakings are specifically exempt, as are their depositaries and managers. For collective investment undertakings within the scope of the UCITS Directive or AIFMD the "manager" corresponds to the management company or AIFM of the undertaking.
What is dealing on own account deal? ›
Dealing on own account is trading against proprietary capital resulting in the conclusion of transactions in one or more MiFID financial instruments.
What is an example of proprietary trading? ›
Let's consider an example of a proprietary trading desk at a major investment bank. The desk is staffed by a team of skilled traders and supported by advanced technology and research resources. They employ a range of strategies, including market making and statistical arbitrage, to generate profits.
What is the difference between proprietary trading and trading? ›
Both proprietary trading firms and traditional trading offer opportunities for individuals to make profits from markets. Proprietary trading firms provide traders with access to capital, training, and support, while traditional traders have independence and control over their trading decisions.
Why is proprietary trading bad? ›
Personal Risk: One of the significant drawbacks of prop trading is the potential personal financial risk. If a trader doesn't perform well, they may lose their deposit, and in some cases, their job. Loss Limitations: Prop firms often implement daily loss limits to protect their capital.
Is proprietary trading legal in the USA? ›
Prop trading operates within a complex legal and regulatory framework. Key to understanding this is the Volcker Rule, part of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. This rule significantly restricts banks from engaging in proprietary trading.
Prohibition on Proprietary Trading
The prohibition against proprietary trading applies not only to banks themselves but also to bank holding companies. Proprietary trading here is very broad, including almost all securities, derivatives, and futures.
What is proprietary trading under the Volcker rule? ›
The Volcker rule prohibits banks from engaging in proprietary trading activities. Proprietary trading is defined by the rule as a bank serving as a principal of a trading account in buying or selling a financial instrument.
What investments are covered by MiFID II? ›
What is covered by MiFID II?
- Shares, bonds and other forms of securities which are traded through a trading venue (trading venue includes all regulated markets, such as the London Stock Exchange in the UK).
- Units in collective investment schemes.
- Money market instruments.
MiFID requires investment firms to provide various information to clients and potential clients. This includes information relating to the status of the firm, the key terms that will apply to the business that is undertaken, and the costs and charges that the client may incur.
What does MiFID II apply to? ›
MiFID II governs the provision of investment services in financial instruments. It applies to investment firms, wealth managers, broker dealers, product manufacturers and credit institutions authorised to carry out MiFID activities.
What does acting for its own account mean? ›
Customer is acting for its own account, has made its own independent decision to enter into this Agreement and as to whether this Agreement is appropriate or proper for it based upon its own judgment, is not relying upon the advice or recommendations of TEP or any of its Affiliates in so doing, and is capable of ...
What is an example of personal account dealing? ›
Personal Account Dealing (PAD) is when employees of an organisation engage in specific investment transactions such as buying or selling shares for their own benefit.
What is a systematic internaliser dealing on own account? ›
What is a Systematic Internaliser? As defined in Article 4(1)(20) of Directive 2014/65/EU (MiFID II), a SI is an investment firm which executes client orders OTC (or off exchange) on its own account on a frequent, systematic and substantial basis. What does a 'frequent, systematic and substantial basis' mean?
Who is a dealer in stocks and shares on own account? ›
A dealer in the securities market is an individual or firm who stands ready and willing to buy a security for its own account (at its bid price) or sell from its own account (at its ask price). A dealer seeks to profit from the spread between the bid and ask prices, while also adding liquidity to the market.
