LIBA
L O N D O N I N V E S TM E N T B AN K I N G A S S O C I A T I O N
6 Frederick's Place, London, EC2R 8BT
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e-mail: liba@liba.org.uk website: www.liba.org.uk
Proposed CESR standards for alternative trading systems: January 2002
consultation
A response by the London Investment Banking Association (LIBA)
_____________________________________________________________________
SUMMARY OF KEY POINTS
INTRODUCTION
Paragraphs 1-4
GENERAL ISSUES
Risks and regulatory objectives
Paragraphs 5-12
Discretionary differentiation or disapplication of standards Paragraphs 13-14
Interaction with the Commission’s review of the ISD
Paragraph 15
Country of origin application of the standards
Paragraph 16-17
Definition of ‘qualifying systems’
Paragraphs 18-20
DETAILED COMMENTS ON THE STANDARDS
Introductory paragraph
Paragraph 21
Standards 1-7
Paragraph 22
Standard 1: Registration and notifications
Paragraph 23
Standard 2: Fair and orderly trading
Paragraph 24
Standard 3: Publication of trading information
Paragraphs 25-29
Standard 4: Monitoring
Paragraph 30
Standard 5: Arrangements with Regulators Facilitating
Market Integrity and Investor Protection
Paragraphs 31-34
Standard 6: Systems
Paragraph 35
Standard 7: Clearing and Settlement
Paragraph 36
Reclassification of user-facing standards as guidance on
conduct of business rules
Paragraps 37-39
FEEDBACK STATEMENT: Comments on summary of key issues
_____________________________________________________________________
SUMMARY OF KEY POINTS

We welcome the fact that CESR has made some helpful amendments to its earlier
proposals.

However, CESR’s analysis of risks is still hypothetical and is not well-defined.
CESR’s regulatory objectives are correspondingly unclear.

CESR’s lack of definition of risks and objectives has particularly serious
consequences in the case of Standard 3 (Publication of trading information).
CESR should not proceed with Standard 3 before a thorough analysis of risks and
impacts, which both CESR and the Commission are about to launch.

CESR’s narrowing of the definition of ‘qualifying systems’ is welcome, but it
needs to be better defined. CESR should also consider excluding systems whose
share of the overall market falls below a de minimis level.

CESR’s lack of definition of risks and objectives makes quantitative discussion of
costs and benefits difficult. Nevertheless, CESR must not underestimate the
serious consequences in many markets of mandated transparency that has not been
well considered and explained.

CESR’s recognition of the need to differentiate or disapply the standards in
appropriate circumstances is welcome, but should be more definitely stated.

CESR’s recognition of the need for country of origin regulation is welcome, but
should be reinforced and properly enforced.

CESR’s redefinition of user-facing standards as guidance on conduct of business
rules is welcome, but the proposals should be scaled back for professional
systems, and not apply to inter-dealer systems.
INTRODUCTION
1. As CESR is aware, the London Investment Banking Association (LIBA)
represents the major European and international investment banks which base
their European activities in London. LIBA Members connect to clients and each
other in a range of markets through a range of systems, including both ‘qualifying
systems’ as redefined in the second consultation paper, and the ‘bilateral systems’
in respect of which CESR proposes further work, as well as through regulated
exchanges. LIBA Members also operate systems which would fall within either
‘qualifying’ or ‘bilateral’ categories. A list of our Members is attached as Annex
1.
2. Given the major concerns which we and other commentators expressed about
FESCO’s initial proposals for standards for ATS regulation, we welcome the fact
that CESR has decided to consult again on revised standards. This is consistent
with CESR’s Statement of Consultation Practices. We are keen to help CESR to
develop a regulatory regime for ATSs and for market transparency which
appropriately and proportionately addresses identified risks. In this context a
group of European associations, including LIBA, are proposing to brief CESR in
detail about the commercial and technical context of market transparency. We
have had the opportunity to consider the responses of several other associations to
CESR’s consultation, including those of the International Swaps and Derivatives
Association, the International Securities Market Association, and The Bond
Market Association, and we generally support their comments.
3. We welcome the fact that CESR has recognised the need for changes to its
original proposals. In particular, we welcome:

the willingness to narrow the definition of qualifying systems,

the recognition of the need to eliminate duplicative regulation by specifying
that it is the country of origin of the system which is responsible for applying
the standards,

the recognition that minimal or no standards need be applied to many systems
in professional markets, and

the recognition that conduct of business matters should be clearly
differentiated.
4. In spite of these helpful developments, we think that CESR’s revised proposals do
not go far enough to remove the serious concerns we expressed in our response to
FESCO’s 2001 consultation. We continue to have serious concerns about both the
absence of specific evidence of risks arising and the consequent vague regulatory
objectives, and the detail of the text of the standards. We think that the standards
can and should be considerably improved by making the changes we suggest in
this response. We believe that many of the changes we suggest are implicit in
CESR’s consultation paper and feedback statement, but need to be more positively
brought out. Unless the standards can be improved as we suggest, we fear that
hasty implementation would carry severe risks to the quality of European markets.
Particularly in the area of market transparency, we think that these risks deserve a
more measured approach: building CESR’s work on ATSs, and its proposed work
on ‘bilateral’ systems and market transparency, into a wider and more thoroughly
researched analysis of market quality and its regulatory implications, which would
provide a sound basis for European regulation of this area and eventually feed into
the Lamfalussy Level 2 and 3 work on the new ISD. We are eager to contribute
positively to this analysis. (It is worth noting that the US system of ATS
regulation was based on a thorough and publicly debated analysis of actual
problems and risks, and resulted in a regime which gives a much clearer picture
than does CESR’s latest draft document of circumstances in which regulatory
requirements do or do not apply, and the reasons why.)
GENERAL ISSUES
Risks and regulatory objectives
5. The standards still appear to be based on a general concern that ATSs may pose
risk (paragraphs 4, 9 and 10). CESR does not set out in detail the evidence of the
reality of the risks which the standards are intended to forestall, nor the extent to
which the market mechanism and existing requirements which are imposed on
market participants will reduce or eliminate many risks. Indeed, in paragraph 5 of
the Cost and Benefits Framework (paragraph II.5 of the Feedback Statement),
CESR acknowledges explicitly that no specific risks have materialised: ‘The
European marketplace has not developed in the way it was anticipated when
CESR began to consider the need for a regulatory treatment of ATSs. While
ATSs have made a considerable impact in wholesale bond markets, their role in
equity trading in Europe is not yet significant. However, CESR considers that the
risks posed by the potential penetration of the retail market by ATSs still remain’.
Similarly, in paragraph II.7 of the Feedback Statement CESR makes an
unsupported assertion that there would be ‘benefit’ in establishing a ‘proportionate
regulatory approach’ for new systems in bond and derivative markets: provided
such an approach is genuinely ‘proportionate’, it may not be particularly harmful,
but no regulation is proportionate unless there is an identified need for it.
6. As we explained in our response to FESCO’s 2001 consultation, ATSs enhance
the liquidity of the overall market by increasing competition. ATSs also bring
business to regulated markets by laying off risks in them. ATSs innovate to
provide services which are absent from existing market mechanisms, or to exploit
new technologies, although their growth in Europe has been less than in the US
because European exchanges have been more responsive to user needs. Thus
even when ATSs do assume a more important role in the overall market, their
impact is more likely to be beneficial than negative. It is important not to stifle
these beneficial effects, especially since technological solutions and market forces
are likely to limit any tendency to fragment markets or dilute transparency.
7. CESR’s concerns about ‘bilateral systems’ appear to be similarly general
(paragraphs 15, 23), and the lack of any identified need for additional regulation
of them would appear to belie CESR’s concern. For both ‘bilateral’ and
‘multilateral’ systems, effective and proportionate regulation will depend on clear
identification and analysis of the risk to be tackled, and taking account of the
effect of the discipline of the market mechanism in particular markets. It is not
apparent how such an approach can be compatible with a rush to impose
precautionary standards, with unpredictable and possibly harmful consequences,
in response to hypothetical and generalised ‘risk’.
8. Apart from generalised statements about the need for market integrity, market
efficiency, and investor protection, the objectives and purpose of the proposed
standards are also still not clearly articulated. CESR’s focus appears to remain on
transparency as an end in itself, rather than as one of a range of tools to achieve
efficient and liquid markets. We welcome the greater recognition that increasing
transparency may harm liquidity and the other elements which together contribute
to the quality of markets, but this recognition comes across as incidental to the
standards: for instance, the recognition of the need to allow deferred trade
reporting in certain circumstances in order to preserve liquidity is hidden away in
paragraph II.18 of the Feedback Statement, whereas it should be included in the
standards paper itself. The articulation of objectives of regulatory standards for
ATSs needs to be linked to the articulation of risks.
9. We do not object to the content of the proposed standards where they would
require operators of ATSs to do things which it is appropriate to require of them.
Many of the standards propose requirements which effectively already exist in
many Member States. Provided that ‘qualifying systems’ are appropriately and
narrowly defined, that their application is appropriately differentiated, and that
standards are applied on a country of origin basis without country of destination
overlap, most of the standards are unexceptionable (though we do have some
detailed concerns which are set out in paragraphs 21-36 of this response).
10. However, this is not the case for Standard 3 on transparency. Market transparency
is an important but complex issue which deserves thorough analysis in the context
of both the ISD review and CESR’s planned work. Transparency standards for
ATSs cannot sensibly or legitimately be introduced in isolation from a more
general review of the role of transparency in the broader market, including how
transparency interacts in different ways in different markets with other factors to
maintain the overall quality of those markets. There is a grave danger that
mandating transparency standards for ATSs now - before a comprehensive review
has revealed whatever evidence of market failure there may be - would severely
damage other important elements of market quality, in particular liquidity and
competition. Furthermore, the lack of consistent reporting systems raises
questions regarding the practicality of the means by which wide-ranging
transparency can be achieved.
11. It is also very important that CESR avoids distorting markets by inappropriately
reinforcing the competitive position of certain participants in them. For example,
Euronext’s recent position paper on the internalisation of order flow raises
important issues, but we believe that its conclusions, which are broadly consistent
with CESR’s proposed Standard 3, are flawed. In an area as important to the
quality and efficiency of Europe’s markets as transparency, CESR needs to
consider very carefully all the arguments and all the evidence. The benefits
foreseen from CESR’s proposed transparency standards for ATSs could prove
illusory, and the rushed implementation of inappropriate standards could even
harm the liquidity of both the overall market and regulated exchanges.
12. The absence of detailed evidential analysis of risks, the lack of clearly articulated
objectives, and the consequent difficulty of conducting a meaningful cost/benefit
analysis, underlines the importance of ensuring, if CESR does decide to rush
through standards on ATSs, that the standards:

Adopt a tightly circumscribed and narrowly defined definition of ‘qualifying
systems, including a thorough analysis of systems which are and are not
included (see paragraph 18 of this response);

Introduce rigorous provisions on differentiation and disapplication in
appropriate circumstances (see paragraph 13 of this response);

Strictly apply country of origin control (which should apply to the conduct of
business guidance as well), and do not allow Member States to derogate from
the country of origin approach at will (see paragraphs 16-17 of this response);

Defer the imposition of new transparency obligations until the broader review
of the role of transparency in the markets as a whole has been completed (see
paragraphs 10-11 and 25-29 of this response).
Discretionary differentiation or disapplication of ‘standards’
13. CESR’s proposals are formulated as ‘standards’ or ‘requirements’, whilst the
provisions which would limit their application in certain markets are described as
‘commentary’, ‘guidance’, or ‘matters to be taken into account’. CESR appears to
recognise that the market mechanism must be allowed to operate freely to serve
users’ needs. We welcome CESR’s recognition of the need for differentiation or
disapplication of the standards in relevant markets, and its recognition that, in
particular for systems which provide services to professional markets, there is
likely to be little or no need for them. However, leaving such differentiation to
the discretion of national regulators risks inconsistent or inappropriate application
of the ‘standards’ in different Member States. In order to avoid the risk of
inappropriate, disproportionate, or damaging regulation, the standards should
specify more definitely the circumstances in which regulators should not apply the
standards.
14. In some cases where the ‘standards’ and their relationship to the ‘guidance’ which
supports them is open to different interpretations, the Feedback Statement, in
particular sections I and II, contains a much clearer, and in many cases helpful,
statement of CESR’s intentions. CESR should make greater use of wording from
the feedback statement to reduce or remove ambiguities, inconsistencies, or
inappropriate application in the text of the ‘standards’ themselves.
Interaction with the Commission’s review of the ISD
15. CESR stresses that its proposals are intended to be consistent with the
Commission’s ISD revision proposals. But Paragraph 9 states that ‘the standards
take into account the Commission’s preliminary proposals for revision of the
ISD’. We and other commentators expressed serious concern about the
Commission’s proposals in the 2001 consultation on reclassifying regulated
markets and investment firms, with a new category of ‘non-regulated organised
markets’ to which the ISD would not apply. It is by no means clear at present
whether or not the Commission will persist with or amend (and if so how) its 2001
proposals. A further consultation by the Commission is expected shortly. We
question whether CESR’s proposed June 2002 finalisation timetable is consistent
with its stated intention to ensure consistency with the ISD, especially since the
agreed shape of the new ISD cannot be clear by then. We also question CESR’s
assertion in paragraph 22 that ‘systems will be subjected to similar market
integrity/efficiency disciplines under a revised ISD regardless of whether they are
ultimately classified as investment firms or organised or regulated markets’ – the
relative obligations of investment firms and regulated markets, in particular the
trade reporting obligations of the former, remain highly contentious unresolved
issues in the Commission’s 2001 proposals.
Country of origin application of the ‘standards’
16. We welcome CESR’s support for the avoidance of overlapping application of
ATS standards by different Member States. The statement in Paragraph I.8 of the
Feedback Statement that regulatory responsibility lies solely with the country of
origin of the investment firm which operates the system is welcome, and should
be included in the standards paper itself, where only Standards 1, 5, and 6 specify
which regulator’s rules apply. Furthermore, Standards 1, 5, and 6 allocate
responsibility to the home country regulatory authority. It would be inappropriate
and impractical for a system operated by a branch to be regulated anywhere else
but the country of origin, except to the extent that the home State authoriser has a
prudential responsibility under the directives. The standards should state
explicitly that for cross-border services the country where system users or their
clients are located has no role in the regulation of the system.
17. As things stand, however, we fear that the usefulness of the mere statement of
country of origin control will be limited because regulatory authorities in some
Member States do not have the authority to apply the standards on this basis
(Paragraph 25), or are unwilling to accept it (Footnote 9). It is particularly
disappointing that CESR has not rejected Footnote 9: the mutual recognition
which is essential if the country of origin approach is to yield benefits to European
markets and investors will be undermined if Member States are at liberty to ignore
it whenever they wish. Paragraph I.8 of the Feedback Statement also implies that
Member States may continue to interpret Article 11 of the ISD to impose country
of destination conduct of business rules: such an overlay on country of origin
control of ‘market integrity standards’ would give too much scope for interference
with the country of origin regulation of the system’s market-facing conduct, and is
inconsistent with both the Electronic Commerce Directive and what we know of
the proposed revision of the ISD. ATSs (as defined by CESR) could well decide
not to offer their services on a cross-border basis if required to face multiple
requirements across different jurisdictions.
Definition of ‘qualifying systems’ (CESR’s Question 1)
18. Despite the welcome restriction to ‘multilaterality’, the boundary of the definition
of ‘qualifying systems’ is still not well-defined. In the absence of specified
exclusions, this lack of definition gives too much scope for the imposition of the
standards in inappropriate circumstances. The specific exclusion in Paragraph 14
of firms which act as a single counterparty to all transactions is helpful. However,
CESR should limit the definition further to ensure that the ‘standards’ cannot be
applied to systems which do not have regulated-market-like characteristics. In
particular, a ‘qualifying system’ should be defined in terms of the system itself,
not the ‘entity’ which operates it, and should exclude order-routing systems,
systems where the ‘non-discretionary rules’ are a matter of internal procedure
rather than publicly-offered service, systems which are not automated, and
systems where the operating firm takes trading risk or commits its capital.
Furthermore, CESR should define terms. For example, ‘buying and selling
interests’ should be restricted to firm orders, not indications of interest; ‘or results
in a contract’ should exclude the circumstance where a transaction is subsequently
agreed outside the system: so that the definition is restricted to systems which are
capable of automatically forming binding contracts as a result of the input of
orders. CESR should also provide comprehensive analysis of what types of
systems would or would not be included in the definition. The lack of definition
in the boundary of ‘qualifying systems’ reflects the absence of thorough analysis
of risks and objectives. We believe that if CESR were to perform such an
analysis, it would point to an appropriate and unambiguous definition.
19. In order to avoid imposing burdensome requirements on systems which do not
have a large enough share of the overall market to give rise to regulatory concern,
CESR should consider applying a de minimis limit, below which the standards
would not apply. The limit should be defined as a percentage of the overall
volume (off- and on-exchange) for a product in the European time zone. The US
applies a limit of 5% of the overall market, below which regulatory requirements
do not apply. We therefore suggest that CESR could initially set a limit of 5% of
the overall market. CESR should ascertain how many systems in different
markets would be captured by a 5% de minimis limit, and publish the results: this
information would in itself, perhaps accompanied by a comparison with the
number of systems which would be captured by a 10% limit, provide very helpful
evidence of the impact and risks of ATSs in Europe, and therefore help to
determine whether incremental regulation of European ATSs is justified. There
should also be a de minimis limit to exclude systems where products are
infrequently traded in the overall market: in these circumstances, even a larger
market share than 5% should not give rise to the regulatory concerns that underlie
the standards.
20. We note CESR’s concern about the potential ‘risks’ of ‘bilateral systems’, and its
intention to undertake a broader review of them and of market transparency. As
noted in paragraph 2 of this response, we and colleagues in other associations are
very keen to assist CESR with expert advice on this important issue. It will be
important for CESR to ground this work in a thorough analysis of existing market
dynamics and transparency arrangements, identification of specific risks to market
quality, and clear specification of regulatory objectives. Indeed, as noted in
paragraphs 10-11 and 25-28 of this response, we think that CESR should carry
forward its current work on ATS transparency - even as applied to multilateral
‘qualifying systems’ - in the context of the wider review of market transparency,
including analysis of how transparency interacts with other features of market
quality, rather than to rush through ATS transparency standards at this stage.
DETAILED COMMENTS ON THE STANDARDS (CESR’s Question 2)
Introductory paragraph
21. The introductory paragraph (2 on page 7) states that the ‘standards set out the
requirements that authorities…should impose’, whilst the commentary ‘covers the
circumstances in which requirements may be differentially imposed’. Differential
application and disapplication of the standards in relevant circumstances should
not be discretionary, but obligatory in the same way as the ‘imposition’ of the
standards itself (see paragraph 13 of this response).
Standards 1-7
22. All standards should state explicitly that they are to be applied only by the country
of origin regulator, and may not be applied by the country of the user or the user’s
customer where this differs from the country of origin regulator. Generally,
application of the standards by the home country regulator to a system operated by
a branch in another Member State would be inappropriate (subject to legitimate
home country prudential supervision under the directives) - see paragraphs 16-17
of this response.
Standard 1: Registration and notifications
23. Standard 1 now requires firms to ‘register/authorise’ the establishment of a
‘qualifying system’. It is not evident precisely what such a requirement is
intended to mean, but it would not be appropriate for regulators to impose a
separate licensing requirement as a prerequisite for an already licensed firm to
offer an ATS service. A ‘standard’ about the provision of information to
regulators should be worded exclusively in terms of ‘notification’.
Standard 2: Fair and orderly trading
24. We welcome the recognition in the third paragraph of the commentary that
regulators ‘should not need to intervene in properly operating commercial
disciplines between purely professional players’. Given the degree of regulatory
control which the standard envisages over the detail of the mechanism of the
system/user relationship, and in order to limit the scope for disproportionate
regulatory intervention, this statement should be strengthened to specify that the
standard should not be applied to professional-only ATSs unless exceptional
circumstances, such as the ATS exerting a dominant role in price formation,
threaten the integrity of the wider market.
Standard 3: Publication of trading information
25. This standard mandates an absolute level of transparency which is wholly new by
comparison with FESCO’s previous proposals, especially where pre-trade
transparency is concerned, and which would elevate transparency above all the
other factors of market quality in a way which could reduce liquidity, discourage
innovation, distort competition, and diminish the competitiveness of European
markets and their ability to respond to users’ demand. CESR is about to launch a
wide-ranging review of transparency in the market as a whole. The Commission
is about to consult again on the ISD review, where its original market
transparency proposals were controversial and heavily criticised. A wide-ranging
imposition of mandatory transparency on one particular sector of the market,
before there has been a thorough analysis of where the problems are or what the
impact on the market as a whole would be, would pre-judge the outcome of both
CESR’s and the Commission’s further work.
26. Our stress on the need for a thorough and well-informed analysis and debate
before additional transparency requirements are imposed does not mean that we
are opposed to an appropriate level of price transparency in all markets. On the
contrary, transparency is such an important element of the quality of markets that
it is vital to get the regulatory approach to it right. But CESR’s analysis in the
proposed standards and guidance does not take account of the importance and
complexity of the issues. The proposed standard appears still to be designed
purely according to the traditional model of the listed equity markets, where
regulated markets occupy a dominant role: liquidity is provided primarily by
investors rather than intermediaries, and transparency has long been recognised as
a key factor in the quality of that market. Even in equity markets, however,
regulatory intervention would be justified only if it could be demonstrated that
fragmentation was significantly harming price formation, or that retail transactions
were being conducted on ATSs at worse prices than those obtainable on regulated
markets. The standard does not discuss, for example, the various ways of defining
and enforcing pre-trade transparency. It does not discuss the impact of changes to
commercial judgements intermediaries might make about charging commission as
opposed to retaining the spread.
27. Non-equity markets in turn have evolved different balances between transparency
and other factors of market quality, reflecting the relatively lesser importance of
price transparency to the price-formation process. In particular, in fixed interest
and OTC derivatives, regulated markets do not play a dominant role, most
instruments are infrequently traded or tailor-made, offered and traded prices
provide little information about supply and demand (except in benchmark
government bonds), and the development of systems for pre-trade transparency
and reporting of completed trades would be enormously costly without substantial
corresponding benefit. The current level of transparency in these markets has not
inhibited significant growth and diversification.
28. The absence in CESR’s proposed standard of any differentiation between types of
market, or any apparent discretion or obligation for regulators to vary the
transparency requirement to take account of specific market features, is very
disturbing in view of the way in which commercial incentives tend to maintain an
appropriate balance between transparency and other market-quality factors,
particularly in the debt and derivative markets: the final paragraph of the
commentary acknowledges the value of market-induced levels of transparency,
but effectively negates it by providing for it to be superseded at regulators’
discretion. If it is to be retained, this standard requires extensive revision to limit
mandatory transparency obligations to circumstances where their absence would
either imperil the integrity of the wider market, or disadvantage vulnerable market
users, and also to require regulators to consider the differing role of transparency
in different markets as one of a number of factors which together contribute to
market quality. As explained in paragraphs 10-11 and 26 of this response, we
believe that the necessary revision can best be achieved as part of the imminent
broader reviews of transparency issues in the market as a whole.
29. Paragraph II.18 of the Feedback Statement contains provisions about ensuring
‘pragmatic transparency obligations when providing delayed reporting for risk
positions’. Given the important role which delayed publication of risk positions
fulfils in maintaining market liquidity, such a provision should be included in the
‘standard’ itself.
Standard 4: Monitoring
30. As we said in our response to FESCO’s 2001 consultation, a regulatory
requirement to monitor compliance with system rules would be appropriate only
in order to protect the interests of vulnerable market users. Even for such users,
conduct of business obligations should be sufficient to protect their interests in
most circumstances. CESR acknowledges in the second paragraph of the
commentary that for professional users and where the system does not play an
important role monitoring will be less important: CESR should specify that the
standard should not be applied in these circumstances unless, exceptionally, for
instance because the ATS has a dominant role in price formation, the integrity of
the wider market or the interests of vulnerable users are threatened.
Standard 5: Arrangements with Regulators Facilitating Market Integrity and Investor
Protection
31. It is reasonable for regulators to expect operators of ATSs to be able to cooperate
with regulators to facilitate monitoring of trading to prevent market abuse.
However the active role for the system operator which the final paragraph of the
commentary envisages is likely to be both costly and, especially in fixed interest
and derivative markets given their particular characteristics, difficult or impossible
to perform. CESR should specify that the standard should not apply in
circumstances where monitoring by the system operator would be either
disproportionately costly or yield no benefit given the characteristics of the
market.
32. The use of the term ‘client abuse’ is not appropriate, especially since user-facing
issues are now to be dealt with via conduct of business rules, and it should be
deleted. Conduct of business obligations should be avoided in market integrity
standards.
33. CESR should ensure consistency in this area with the proposed Market Abuse
Directive. Standards in this area should not be finalised before the final shape of
the Market Abuse standards is apparent.
34. Before implementing Standard 4 and Standard 5, CESR should explain and justify
its position as to why the normal processes of regulation of investment firms are
inadequate.
Standard 6: Systems
35. Under existing regulation, investment firms will already be subject to prudential
requirements to exercise proper management and controls over their systems. The
standard should state that additional requirements should not be imposed where
these other requirements already provide sufficient regulatory control. The
comments in the final paragraph of the commentary about the need for less
regulatory obligations where sophisticated users are involved should be
strengthened to provide that the standard should not apply to such systems unless,
exceptionally, the integrity of the broader market was threatened. This should be
the case, contrary to the final sentence, even if the ATS is a monopoly provider:
sometimes systems will have a monopoly because the volumes in the market will
not support more than one platform; sophisticated users will always find new
ways of forming a market if one is needed. Similarly, in the second paragraph of
the commentary, CESR should state explicitly that standby trading facilities
should not be required except in circumstances of exceptional threat to overall
market integrity, for example where the ATS has a dominant role in price
formation.
Standard 7: Clearing and Settlement
36. We repeat our previous comment that in non-retail markets clarity of
responsibilities for clearing and settlement should not be a matter for regulation.
Reclassification of user-facing standards as guidance on conduct of business rules
(CESR’s Question 3)
37. This reclassification helpfully reduces overlap between ATS ‘standards’ and
conduct of business ‘standards’. In line with our comments on CESR’s conduct of
business standard proposals, and with CESR’s policy in the ATS ‘standards’ and
the Commission’s policy on the ISD review, CESR should reduce overlap further
by specifying the application of the country of origin principle here also.
38. CESR refers in the second paragraph of section 2.2 to the requirement in ISD
Article 11(1) to take account of the professional nature of customers. CESR
should build on the differentiation principles in the ATS standards to exclude
these conduct of business principles for relationships with professional users of
systems. Item c) in particular implies a level of obligation to ensure professional
users have access to information about types of instruments traded which is
unnecessary for users of that level of sophistication.
39. It will be important to ensure that CESR’s standards on classification of investors
and conduct of business rules draw the boundaries appropriately between
counterparties, professional investors, and retail investors, and apply appropriately
light requirements to business with professionals, and none at all for counterparty
business. Similarly, any additional guidance on conduct of business rules for
operators of qualifying systems should not apply at all to inter-dealer systems.
FEEDBACK STATEMENT
Comments on summary of key issues
1 – We do not think that CESR has resolved all of the issues surrounding the
relationship with the ISD revision - see paragraph 15 of this response.
2 – We have continuing concerns about the definition and the extent to which it needs
further modification to avoid impediments to competition - see paragraphs 18-19 of
this response. See paragraph 20 of this response on the proposed wider review of
‘bilateral’ systems.
3 – We welcome CESR’s moves towards differentiating the standards (though we
think that the status of ‘differentiation’ should be equivalent to the status of the
‘standards’ themselves - see paragraph 13 above). We also welcome the clearer
statement of where regulatory responsibility lies. However, concerns about differing
implementation by national authorities remain – see paragraph 17 of this response.
4 - We welcome CESR’s moves towards differentiating the standards (though we
think that the status of ‘differentiation’ should be equivalent to the status of the
‘standards’ themselves - see paragraph 13 of this response).
5 – We welcome the separation of conduct of business guidance, though we have
some continuing concerns - see paragraphs 37-39 of this response.
6 - We welcome CESR’s moves towards differentiating the standards (though we
think that the status of ‘differentiation’ should be equivalent to the status of the
‘standards’ themselves - see paragraph 13 of this response). Whilst it may not be
appropriate to exclude inter-professional trading networks altogether, the ‘standards’
should go further to specify that they should apply to such networks only in
exceptional circumstances. The relationship between users and underlying retail
clients should be governed by conduct of business rules.
7 – We welcome CESR’s statement that its aim is to balance risks against benefits of
ATSs. We think that this will be possible to do only with a clearer articulation of
risks and regulatory objectives, which is particularly critical for Standard 3 – see
paragraphs 5-12 and 25-28 of this response.
8 – We welcome CESR’s strong endorsement of the country of origin approach, but
we have identified in paragraphs 16-17 of this response a number of respects in which
CESR should consolidate it.
9 and II (Costs and Benefits Framework) – We welcome CESR’s commitment to
cost/benefit analysis. We also welcome the thoroughness with which CESR has
identified the breadth of possible impacts in the Costs and Benefits Framework in
section II: as we have noted above, this contains much material which should be
incorporated into the text of the ‘standards’ themselves: the extent to which possible
impacts are mitigable depends to a very large extent on whether CESR modifies the
standards as we have proposed in this response, and how well CESR thereby controls
its implementation by national authorities.
Our difficulty in providing specific information about the magnitude of costs and
benefits derives to a large extent from uncertainty about the practical effect of
CESR’s standards, which is itself a function of the poor definition of objectives, risks,
background analysis of existing market disciplines and requirements, and
differentiation and disapplication of standards in different markets. If CESR ensures
that implementation is well-controlled and proportionate, costs and ‘harm to the
markets’ (i.e. ‘negative benefit’) will decrease, and the possibility of benefit without
disproportionate cost will increase.
The lack of certainty about the effect of Standard 3, and the enormous harm which
could be caused by inappropriate or disproportionate imposition of transparency
obligations, make the stakes so high that CESR should not carry it forward without
significantly more thorough definition of objectives and analysis of risks, costs and
benefits.
The following cost/benefit factors can be identified

Withdrawal of ATSs from the European markets because of market-insensitive
regulatory requirements depriving them of market share and industry support,
with consequent harm to innovation and competition in European markets.

Withdrawal of ATSs from cross-border service provision because of overlapping
and/or inappropriate regulation, with consequent reduction of competition in
European markets

Withdrawal of liquidity from and reduction of competition in European markets
because of market-insensitive mandatory transparency (this represents a much
greater ‘European market fragmentation’ threat than any development of
competing platforms within Europe).

Cost of system development to meet any pre-trade transparency requirements.

Cost of system development to enable reporting of completed trades; this cost
would be compounded by the complexity of different reporting mechanisms to
different regulated markets.

Cost of system development to meet any requirement to monitor market abuse.
London Investment Banking Association
15th March 2002
TMMB/Mar14/COM77A
MEMBERS OF THE LONDON INVESTMENT BANKING ASSOCIATION
Ansbacher & Co Limited
ABN AMRO Bank N.V.
Arbuthnot Latham & Co., Limited
BNP Paribas
Bank Insinger de Beaufort plc
Barclays Capital
Bear, Stearns International Limited
Beeson Gregory Limited
CIBC World Markets Plc
Cazenove & Co. Ltd
Close Brothers Corporate Finance Ltd
Collins Stewart Limited
Commerzbank AG
Credit Suisse First Boston International
Daiwa Securities SMBC Europe Limited
Dawnay, Day & Co., Limited
Deutsche Bank AG London
Dresdner Kleinwort Wasserstein
Goldman Sachs International
Greenhill & Co. International LLP
Hawkpoint Partners Limited
HSBC Investment Bank plc
ING Barings
Instinet UK Ltd
Investec Bank (UK) Limited
JPMorgan Chase Bank
KBC Peel Hunt
Knight Securities International Ltd
Lazard
Lehman Brothers
Merrill Lynch Europe PLC
Mizuho International plc
Morgan Stanley International Ltd
Nomura International plc
N M Rothschild & Sons Limited
Robert W. Baird Group Limited
Schroder Salomon Smith Barney
Singer & Friedlander Holdings Limited
Société Générale
3i Group plc
The Toronto Dominion Bank
UBS Warburg
Westdeutsche Landesbank Girozentrale