Is Matched Principal Trading Under MiFID II, One Leg or Dual Leg Reporting?
(Article updated on Dec 27 – see new comments at end of post)
When MiFID II arrives on January 3rd, 2018, it brings with it a greatly updated version of Transaction Reporting (MiFIR legislation, Article 26). Expanded are both the data fields that need to be reported from 24 to 65 and products under scope.
One of the big questions of the reports affecting both institutional and retail brokers is the status of Matched Principal trading. Popular among many different types of brokers and regional banks, Matched Principal transactions (also known as STP/Straight Through Processing) occur when every client trade is hedged with an equal transaction with a liquidity provider. The result is that the broker or bank isn’t carrying risk on the trade.
However, Matched Principal is different than a standard Agency brokering. In that model, the broker matches clients with sellers and each party has a message of who the other party it. This contracts to Matched Principal where the broker is the counterparty with both its client and liquidity party/venue. Where they are similar is that both models don’t take on risk on the trade.
Single or double leg?
As Matched Principal brokers and banks are completing two separate transactions, for MiFID II the question is whether each trade is reported separately. In relation to EMIR’s Transaction Reporting regulation, various European regulators have given different viewpoints on the matter. Therefore you will see Matched Principal transactions reported both as single and double reported under EMIR depending on the viewpoint of the reporting party and the regulator.
ESMA answers Matched Principal is a Single Leg Transaction
Luckily, one of the goals of MiFID II is unifying interpretation of the legislation among EU regulators. In this regard, ESMA provides two concrete interpretations.
In their definitions section of the MiFID II legislature (Article 4.1(38)) they defined Matched Principal trading (link). As stated above, this includes any transaction that is risk-less and is based on two legs between a client and separate investment firm. This definition is important as not every regulator calls STP brokers Matched Principal with some of them defined as Agency. Regardless, of the country definition, for MiFID II reporting purposes under the ‘Trading Capacity’ field, they are defined as Matched Principal.
Second, ESMA answered the single or double leg reporting question in their October 2016 MiFID II Guidelines report for Transaction Report (link) . Under the guidelines in 5.2.2, ESMA states that, only a single report is needed for the double legged trade.
For a buy transaction from the client, the fields are filled as follows:
Executing entity identification code: The Matched Principal bank or broker facilitated the trade
Buyer identification code: Client
Seller identification code: Liquidity provider or CCP for Venue Traded product
Trading Capacity: Matched Principal
(Added Dec 27, 2017). Since first publishing the analysis of single vs double leg, some readers and clients have bought up the potential issue of non-matching product types.
Intro: ESMA loosely defines Matched Principal as cases where the investment firm doesn’t take risk on the transaction. However, what they delve into is when there is a difference between the products traded in the two legs.
Leg 1: Retail Client and CFD Broker: 10 Lots of DAX 30 CFD
Leg 2: CFD Broker and LP: 10 Contracts DAC 30 Futures
The CFDs and Futures carry the same exposure, but have different ‘Venue Code’ definitions (XXXX vs XOFF). Therefore, the question is whether you use the Trading Venue from the first or second leg. Also, there is the potential that they Underlying ISIN may be different between the two legs. However, this is less common due to Futures and CFDs often sharing similar Underyling ISINs.