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MiFID II - Algorithmic trading

MiFID II will bring about important changes in the market structure of European capital markets.

Algorithmic trading is trading in financial instruments where a computer algorithm automatically determines the individual parameters of orders. Examples of these parameters are the initiation, the timing, the price and the size of the order. The algorithm also determines how the executed order will be managed. This is done with little or no human intervention.

Investment firms that engage in algorithmic trading have to notify the AFM.

High frequency trading (HFT)

High frequency trading (HFT) is a form of algorithmic trading. With HFT, a trading system analyses market data at a very high speed and then sends large numbers of orders or revises these orders within a very short timespan in reaction to this analysis. HFT is not a strategy, it is a technology with which traditional trading strategies are executed.

Measures and risk controls

MiFID II introduces a combination of measures and specific risk controls for algorithmic trading. MiFID II aims to limit the operational risks by regulating internal control and the business operations of market participants. In addition, MiFID II introduces measures in the area of trading mechanisms that influence the nature of price formation and the behaviour of market players.

Investment firms that engage in algorithmic trading and HFT have to satisfy requirements regarding internal business operations and information and documentation obligations. Market disruptions can thus be avoided. In addition, investment firms that engage in algorithmic trading and HFT as market makers have to satisfy specific requirements under MiFID II. Proprietary traders who engage in HFT must have a licence and must comply with the applicable MiFID II rules. They cannot make use of an exemption from MiFID II.

Resilient trading systems

In addition, the MiFID II rules apply to trading venues that enable algorithmic trading and HFT. This includes regulated markets, MTF’s and OTF’s. There rules must prevent algorithmic trading and HFT from leading to a disorderly market and from engaging in market abuse. Trading venues must ensure that their trading systems are sufficiently resilient and have been tested to handle large numbers of orders and distressed conditions.

Trading venues must ensure that their systems are equipped with circuit breakers to temporarily suspend or restrict trading in the event of unexpected price fluctuations.

Investment firms that trade algorithmically are required to annually perform a self-assessment on their compliance with the RTS6 articles. In addition, an Investment Firms is required to draw up a validation report on their algorithmic trading activities. (Article 17 MiFIDII and Article 9 of RTS6).

Template self-assessment 

The AFM created a template to help structure the self-assessment. Investment Firms are free to make use of it, it is not required.

Analysis 2019

In 2019 the AFM analysed the self-assessments of twenty proprietary trading firms under its supervision. The main finding of this analysis can be found in the presentation on the right hand side of this this website.

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