Regulation Pushing Prop Trading Firms Out of Europe: Survey

Proprietary trading firms in Europe are considering giving up their Mifid II licenses and/or moving operations outside the continent in order to mitigate the impact of new capital and other Mifid II-related rules, according to the latest Acuiti Proprietary Trading Management Insight Report.

The report, which is based upon a quarterly survey of the Acuiti Proprietary Trading Expert Network, a group of 120 senior proprietary trading executives from across the globe and produced in partnership with Avelacom, found that just over a quarter of firms were considering giving up their Mifid II licence as a result of the Investment Firm Prudential Regime (IFR/D), effectively ceasing to trade the European markets.

In addition, around half of firms were considering moving their European trading activities outside the EU or UK to avoid the burden of regulation.

Acuity points out that prop trading firms that give up their Mifid II licenses would still be able to operate in the UK and EU but would effectively not be able to trade on European markets. “If significant numbers of firms returned their licenses, the impact on liquidity in Europe would be severe,” it states.

IFR/D, which came into force from 2021, was designed to introduce a lighter touch capital and governance regime for Mifid II investment firms who would otherwise have been subject to the regime designed for banks. For proprietary trading firms, however, the result has been sky-high capital requirements and significant governance burdens.

While almost three quarters said that their capital requirements had increased, just 12% of respondents said that they thought the new regime accurately captured the prudential risk that their firm posed to the market. 92% said that their reporting requirements had become more of a burden.

Depending on the size of the firm and the instruments traded, IFR/D poses different challenges. No proprietary trading firm qualifies for the Class 3 designation, which was designed to provide a low touch capital and governance regime.

The findings of this study should send shockwaves through Brussels and local regulators across Europe

Smaller proprietary trading firms, coming into scope as Class 2 firms, have reported facing capital requirements of many times the multiples they are required to hold in margin and also have to meet strict governance rules regarding clawbacks, non-cash bonuses, and the establishment of independent pay review bodies.

For larger firms, the risk is that they come into scope as Class 1 firms if their assets exceed a certain threshold. In some instances, this would mean that they are required to register as credit institutions and subject to requirements equivalent to and designed for banks, the report finds.

For the largest market-making firms this threshold could be reached during periods of volatility, especially if global operations are taken into account. As a result, almost two thirds of market makers reported having to reduce their exposure during periods of high volatility, just the period in which they are needed most in the market.

“The findings of this study should send shockwaves through Brussels and local regulators across Europe,” says Will Mitting, founder of Acuiti. “Proprietary trading firms provide a vital service to capital markets providing liquidity and lowering execution costs and spreads for end users.

“A Sword of Damocles is hanging over many firms in Europe as exemptions to new capital rules expire over the next four years,” he adds. “Unless the rules are reviewed and proprietary trading firms are subject to a lesser regulatory burden, there is a very real risk that significant numbers of proprietary trading firms will cease trading on markets in the EU and UK. This would have a devastating impact on market liquidity.”

“Most proprietary trading firms fully accept the need to be regulated under Mifid II,” Mitting continues. “However, the disproportionate impact of IFR/D and other rules that have been automatically applied to Mifid II investment firms is resulting in an unsustainable regulatory burden for firms.”