Testing and testing environments. ESMA proposes to clarify the meaning of testing for “disorderly trading conditions”, which should refer to a market where the maintenance of a fair, orderly and transparent execution of trades is compromised. Also, the regulator considers that it would be useful to produce additional guidance covering the expectations for behavioural testing. Such clarifications could indicate that this type of behavioural testing should focus on the interaction between the tested algorithm and the market, and that it should in particular detect whether the tested algorithm contributes to amplification of market movements that are unrelated to real economic value.
RTS 6 self-assessment and validation. ESMA notes that currently there are very different outcomes in the level of detail of the submitted self-assessments and considers this exercise to be a proper due diligence assessment, noting that it should be more ambitious than a statement of compliance. To increase the quality of these assessments, ESMA proposes to:
- consider a specific format for self-assessment, harmonised at EU level
- ask investment firms to submit their self-assessment to their local regulators for review
- amend frequency of self-assessment to every two years (except stress testing requirements)
- require investment firms to report more information on testing environments
ESMA is also of the view that similar changes should be made to the RTS 7 self-assessments produced by trading venues.
Orders to transactions ratio (OTR) for venues. ESMA’s analysis suggests that at the moment there is a very significant divergence in terms of maximum OTR limits allowed across different trading venues. Therefore, it proposes to develop technical standards to set out the maximum OTR ratio, calibrated per asset class.
Monitoring of compliance with exchange rules. Given a number of operational incidents which took place in 2020 that led to significant halts of trading across a number of exchanges, ESMA would like to improve the process surrounding the monitoring of compliance with exchange rules. It proposes to develop a procedure to enable efficient and timely notification from trading venues to their local regulators and ESMA in case of IT incidents and systems outages.
Data for traders. Another proposal from the regulator is to require algorithmic traders to always use at least two different reference points to ensure there is always a possibility for trading activity to migrate from the main market to another trading venue in the case of an outage.
This section of the paper may potentially result in quite a significant uplift required by firms and deserves greater attention. While the industry would welcome lowering the frequency of self-assessments to 2 years, ESMA is considering a new obligation to report the self-assessment results to regulators. Also, more prescriptive and detailed testing requirements and using additional sources of data for traders would need to be looked at more closely as the draft rules are presented by ESMA.