1. The MiFID and the Markets - Unleashing the Trading Forces September 2008 Mike Jones September 2008 Mike Jones

2. 2 What is The MiFID about? The core Lisbon objectives .. Unifying EU countries around regulation, providing a single passport. Driving down the cost of capital Customer protection Greater transparency Across all trading activity Ending the concentration rule to provide competition to exchanges

3. 3 Trading structure and trends Regulation .. -Exchanges -Multi-Lateral Trading Facilities -Systematic Internalisers -Centralised Counterparty Clearing -Settlement through Centralised Security Depositary Systems (CSD’s) Buy side – Institutions and retail asset managers Sell side – Institutional sales & trading The trend is towards an increase in principal trading from 50% to 70% by 2015. Algorithmic trading is growing quickly in the UK – it accounts for 1/3 rd of US trades (source IBM)

4. 4 Receiving & Transmitting v Executing Broker FundManager Market Client Client Receiving & Transmitting –L2 Art 45 Best interest Of clients Executing- L1 Art 21 Best outcome For clients

5. 5 Where does Best Execution apply? – Cobs 11 Best Execution .. It applies inside or outside the European Community It applies to all instruments, on and off market Best execution exists when a contractual or agency obligation exists with a client It applies to retail and professional clients, but not eligible counterparties “A firm must take all reasonable steps to obtain on a consistent basis the best possible result for a client. The best possible result for a retail client is to be determined in terms of the total consideration, representing the price of the financial instrument and the costs incurred by the client related to execution.”

6. 6 Prioritisation of execution factors Best Execution .. Size Speed Cost likelihood of settlement Price Liquidity

7. 7 Best Execution steps Step 1: Selection of factors of factors Step 2: Selection of execution venues of execution venues Step 3: Linkage To execution venues Step 4: Execution Of order Sort clients and instruments. Prioritise factors – price, cost, speed, etc. Select venues for ‘Best Possible Result’ on a consistent basis All venues ‘Best Possible Result’ venues Best conditions Step 5: Periodic review review

8. 8 Markets Recognised Investment Exchange (RIE) Electronic market place providers Systematic Internalisers Regulated markets MTF Quote driven ABN Amro Deutsche Bank Lehman Brothers Merrill Lynch Citigroup UBS Credit Suisse Order driven Multi-lateral trading facilities (facilitates trades – is neither a buyer or seller) London Stock Exchange Plus Markets SWX Europe (Virt-X) Chi-X Eurex derivatives ICAP Cantor NYSE Euronext – Alternative Nasdaq OMX Nyfix Euro Millenium (dark pool – Euro equities) Turquoise (September 2008) Quote driven Order books Anonymous crossing systems Quote driven (internalises client orders and cross against trading book)

9. 9 London Stock Exchange – A Recognised Investment Exchange LSE Tradelect services SETS (a Regulated Market) Previously SETS/SETSMM SETSQX (RM – previously SEAQ, Seats Plus AIM – Exchange Regulated Market/MTF Equities -Eurosets – RM – Equities, order book and integrated market making – Dutch liquids - EQS – MTF – Equities – Quote driven Market making – EURM liquid securities -IOB – RM – Dep. Receipts – International order book Equities & Fixed interest FT All Share plus some Fledgling and AIM UK50 Quote driven market making Equities Quote driven together with periodic order book auctions Equities & Fixed interest Other services SEAQ (MTF – previously SEAQ) Order book and integrated electronic market making Market Maker can enter 2 sided quotes using electronically executable quotes MM can deal off exchange as SI. Allows Limits, Iceberg, Market, Executable quotes. Trades novate to central clearing FT all remaining main market, FT Fledgling, some AIM Securities outside SETS and SETSQX, AIM Uses SETS, SEAQQX, SEAQ

10. LSE SETS – an Order Driven system Here is an example of the order book in continuous trading mode: Buy (Bid) Sell (Offer/Ask) Time Volume Price Price Volume Time Order A10:15 4,800870 871 5,900 10:25 Order B10:22 1,500 870 871 7,500 10:48 Order C10:18 8,700 869 872 13,800 09:25 At 11:00 XYZ submits a Limit order to sell 10,000 shares with a limit price of 870. Two buyers are prepared to pay 870, which is the highest bid price on the book. The one on earliest gets first go, and 4,800 of XYZ’s shares are sold at 870, leaving XYZ with 5,200. XYZ then sells 1,500 to the remaining buyer, who is prepared to pay 870. The bottom buyer now moves to the top of the book, but is not prepared to pay XYZ 870 – he would only pay 869. XYZ has 3,700 shares left, so XYZ now joins the order book himself, and goes straight to the top of the Sell side, as his selling price of 870 is more attractive to a buyer than the other sellers, who want 871 and 872.

11. 11 LSE SEAQ – A Quote Driven system

12. 12 LSE SETSQX – A mixture of quote driven & order driven Quote book ----------------------------------- Order display which periodically uncrosses .. Market Makers enter orders to order book uncrossings Settles outside CCP on a bi-lateral basis in Euroclear/Crest Yellow strip shows best available bid & offer Brokers telephone orders Market Makers provide non-electronic executable quotes and liquidity RSP Electronic quotes Brokers’ electronic RSP gateway Same order book technology as SETS, but not continuous order book execution. 4 uncrosses daily. Orders executed electronically on the order book will be reported to CCP if the security is supported. Non-supported securities settle direct in Euroclear/Crest Brokers enter orders – only named or anonymous limit orders – no market orders or iceberg orders

13. 13 Plus Markets – a Recognised Investment Exchange, operating a Regulated Market and a Multi-Lateral Trading Facility FTSE100FTSE250 Smaller companies AIMEuropean .. -Quote driven execution – telephone trading - Quote driven execution – electronic trading through RSP automated ‘RFQ’ services Off exchange quotation facilities for Systematic Internalisers in liquid shares 10% share of FTSE Smaller Cap 40% share of FT Fledgling 50% AIM of UK retail market 1/3 rd 7,500 securities Offers Protected Trades, i.e. MM accepts an order that is to be executed within a specified period on an improved basis. The trade must be of sufficient size end (minimum E45,000) to qualify for deferred publication up until end of MQP for current business day MM will trade report (deals between non-mm members seller reports) through normal venues for that stock

14. 14 SWX Europe (Virt-X) – a Recognised Investment Exchange, based in London, and regulated by FSA Swiss blue chips Leading European blue chips .. Clearing through LCH, Clearnet, SIS X-Clear Settlement through Euroclear, SIS Sega, SIS X-Clear Order driven central limit order book Operates a Regulated Market for Swiss securities, and is an MTF for non-Swiss securities A wholly owned subsidiary of the Swiss Stock Exchange

15. 15 Markets Recognised Investment Exchange (RIE) Electronic market place providers Systematic Internalisers Regulated markets MTF Quote driven ABN Amro Deutsche Bank Lehman Brothers Merrill Lynch Citigroup UBS Credit Suisse Order driven Multi-lateral trading facilities (facilitates trades – is neither a buyer or seller) London Stock Exchange Plus Markets SWX Europe (Virt-X) Chi-X Eurex derivatives ICAP Cantor NYSE Euronext – Alternative Nasdaq OMX Nyfix Euro Millenium (dark pool – Euro equities) Turquoise (September 2008) Quote driven Order books Anonymous crossing systems Quote driven (internalises client orders and cross against trading book)

16. 16 Chi-X “The first order driven Pan-European MTF” Chi-X FTSE 100 Dutch, German, French .. Clearing – Fortis EMCF (European Multilateral Clearing Facility) Owned by Instinet, which is owned by Nomura Order driven central limit order book Anonymous pre & post trade. Can deal anonymously off market as a ‘dark pool’ Order types: -Limit -Market -Iceberg -Fill or Kill (in full or not at all) -Execute & eliminate (execute to fullest extent possible) -Hidden Agent Banks CSD’s

17. 17 Turquoise – a new MTF 300 pan European equities 1200 dark market .. Clearing EuroCCP (DTC) Owned by leading investment banks who account for 45% of European trading. Owner banks provide liquidity through connections. On & off order book trading. Onward order routing a possibility Anonymous pre & post trade Dark pools allow hidden orders and delayed market release Agent banks CCP’s

18. 18 Some new competitors.. MTF’s  BATS Trading – US – FTSE – Fortis Clearing  Equiduct – 53% owned by Borse Berlin – Choice of clearing systems. In testing  Nasdaq OMX – 600 Pan European equities – Order routing services provided by Citi for trades that cannot be fulfilled on Nasdaq OMX platform. 26 Sept.  NYSE Euronext Octopus – 400/500 Pan European blue chips. Central limit order book. November Dark Pools (i.e. Not a public limit order book)  -NYSE Euronext’s Smartpool  -SWX’s Virt-x subsidiary links with Nyfix for Swiss blue chips  -LSE Lehman Baikel (Europe’s deepest lake)

19. 19 Systematic Internalisers L1 Art 27, L2 1287/2006/EC Art 21, FSA L3 Mar 6 “A Systematic Internaliser must publish a firm quote in those shares admitted to trading on a regulated market for which they are systematic Internalisers and for which there is a liquid market.”

20. 20 Order Routing Systems Neonet - Independent agency broker Trades with Regulated Markets, MTF’s, and 3 rd party venues Merrill Lynch POSIT Morgan Stanley Passport Client UBS Direct Strategy Lehman ETS Goldman Rediplus To most liquid market Directed orders Order Types: Best Discretionary Fill or Kill GTC GT date/time Iceberg (publicly displays only a portion of total volume, although total can be executed) Limit Market (unpriced) Non-directed orders/baskets/blocks To client specified market Exhaust - saturate Algorithms split orders to liquidity pools Sweep (focus) Amsterdam, Chi-X, Eurex, LSE, Euronext, SWX Virt-X, NYSE, Australia, Japan, Hong Kong, etc

21. 21 Existing operational structure BrokersSettlementsystem Clearingsystem Broker Tradingplatform CentralSecurityDepository Transaction report

22. 22 Shifting the settlement TradingSettlementservice Clearingsystem Broker CentralSecurityDepository Tradingplatform Transactionreports

23. The MiFID and the Markets - Unleashing the Trading Forces September 2008 Mike Jones September 2008 Mike Jones