17Regulators and Licences

A firm that trades only its own money need not be a client of anyone, and it has no clients of its own. Whether it needs a licence is another matter. The second Markets in Financial Instruments Directive keeps an exemption for firms dealing on their own account in the European Union, and then takes it away from almost every firm this series describes: from market makers, from members of a trading venue and firms with direct electronic access to one, and from any firm that applies a high-frequency algorithmic trading technique, however small it is and although it has no clients. Where a firm may trade, and what it must be to do so, is set by rules that differ by country and by activity, and the map of them is part of the firm’s design.

17.1 Why a trading firm needs permission

Regulation follows activities, not firms. The same firm can be unregulated for one thing it does, registered for another and licensed for a third, and a new desk, product or office can move it across a line it did not know was there.

The chapter’s working tool is a map of these rules as data, each row naming a jurisdiction, an activity, the regime it touches, the legal reference, the statutory decision period where there is one, the month it was checked and the ledger rows that source it (Listing 17.1). The map is information about where the rules are; whether a particular firm is inside a perimeter is a question for its lawyers and its regulator.

def check(rows):
    problems = []
    for i, r in enumerate(rows):
        missing = [k for k in FIELDS if k not in r]
        if missing:
            problems.append((i, "missing " + ", ".join(missing)))
            continue
        for k in ("reference", "as_of", "source"):
            if not r[k]:
                problems.append((i, f"empty {k}"))
        if r["status"] not in STATUSES:
            problems.append((i, f"bad status {r['status']}"))
        if len(r["as_of"]) != 7 or r["as_of"][4] != "-":
            problems.append((i, "as_of not YYYY-MM"))
    return problems


def query(rows, profile):
    """profile: iterable of (jurisdiction, activity)."""
    p = set(profile)
    return [r for r in rows if (r["jurisdiction"], r["activity"]) in p]


def regimes(rows):
    return sorted({(r["jurisdiction"], r["regime"]) for r in rows})

17.2 The United States: the SEC, the CFTC and the self-regulatory organisations

The United States divides the field by instrument. Securities fall to the Securities and Exchange Commission, futures, options on futures and swaps to the Commodity Futures Trading Commission; each delegates much of the registration and day-to-day supervision to a membership body.

For a proprietary trading firm the 2023 amendment is the hook in American form: a firm that trades off-exchange, even for itself, now needs the securities association’s membership and its rulebook. Market access (Rule 15c3-5, Book 11) adds pre-trade controls whoever sponsors the firm’s orders.

17.3 Europe and the United Kingdom

The European exemption is worded so that almost no electronic trading firm meets it. A proprietary firm that is a member of an exchange, or that reaches one through direct electronic access, is out; one that co-locates, generates its orders without human intervention and sends many messages is applying a high-frequency technique (Book 10’s definition in the directive’s words, article 4(1)(40)) and is out again. What it gains in return is the passport.

17.4 Asia-Pacific

Asia’s markets are regulated country by country. In Hong Kong a corporation carrying on a business in a regulated activity needs a licence from the Securities and Futures Commission; the Securities and Futures Ordinance lists thirteen types, among them dealing in securities (type 1), dealing in futures contracts (type 2), providing automated trading services (type 7) and asset management (type 9). Whether a firm trading only its own money is carrying on such a business turns on the ordinance’s definitions and exemptions, so the map marks it as a check, not a requirement. Singapore, Japan and Australia each have their own licences; this chapter’s map carries only the rows it has sourced, and says so.

17.5 Rules for algorithmic trading

Once inside the perimeter, an electronic firm carries obligations specific to algorithms. They are the controls of Book 11’s chapter on risk controls, written into law: in the European Union, article 17 of MiFID II and its technical standards; in the United States, the market access rule for the broker whose connection the firm uses (Table 17.1).

17.6 Tutorial: three offices

The London firm touches one regime, a set of checks on the UK’s general prohibition; Chicago adds three (broker-dealer registration, association membership unless it trades only on its own exchanges, and the market access rule); Hong Kong adds a licence check. The longest statutory decision on the path is the UK’s six months for a complete application, twelve for an incomplete one; the US broker-dealer decision is 45 days, or up to 210 if the SEC opens proceedings and extends them. The statutory periods start when the application is complete: the months spent writing the programme of operations, hiring the approved persons and capitalising the entity come first, and the periods are the part of the path a firm does not control.

17.7 Build: the regulatory map

17.8 Exercises

17.9 Problem: Three Offices

17.10 Interview questions