How Has the Interaction between the Lis Waiver and Systematic Internalisers Evolved since the Implementation of Mifid Ii? ▴ Question

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Concept

The implementation of MiFID II initiated a profound restructuring of European financial markets, altering the very architecture of liquidity interaction. At the heart of this transformation lies the relationship between two key components ▴ the Large-in-Scale (LIS) waiver and the Systematic Internaliser (SI) regime. Understanding their evolution requires moving beyond a simple checklist of regulatory changes. It demands a systemic view, recognizing how these two mechanisms co-evolved, creating a new, complex ecosystem for institutional trading.

The LIS waiver, a provision allowing for the execution of large orders without pre-trade transparency, was designed to protect institutional investors from the market impact of their trades. Concurrently, the SI regime formalized and regulated the practice of investment firms executing client orders against their own capital, bringing a significant volume of off-venue trading into a structured framework.

Initially, the interaction between these two was characterized by a degree of ambiguity and fragmentation. The MiFID II framework extended the SI regime beyond equities to encompass all financial instruments, compelling a larger number of firms to operate under this designation, either by meeting quantitative thresholds or by voluntarily opting in. This expansion created a dynamic where SIs became central players in the provision of liquidity, particularly for large orders.

The LIS waiver became a critical tool for SIs, enabling them to absorb substantial client flow without exposing their positions to the broader market. This symbiosis was not a static arrangement; it has been in a constant state of flux, shaped by regulatory adjustments, technological advancements, and the strategic responses of market participants.

The evolution of the LIS waiver and Systematic Internalisers under MiFID II reflects a continuous recalibration of the balance between pre-trade transparency and the need for efficient execution of large orders.

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The Initial Framework and Its Ambiguities

The initial implementation of MiFID II established a framework where SIs in non-equity instruments were subject to pre-trade transparency requirements, though with significant differences from the equity markets. A key provision was the ability for SIs to use waivers, such as the LIS waiver, to manage their risk when quoting for large trades. However, the early days of the regime were marked by a lack of clarity on certain operational aspects.

For instance, it was not initially clear whether SIs needed to formally apply for a waiver in the same way that trading venues did, creating a potential unlevel playing field. This ambiguity, coupled with the increased complexity and fragmentation of the market, was a point of concern for both regulators and market participants.

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The Role of the Opt-In Provision

A significant factor in the evolution of the SI landscape has been the voluntary opt-in provision. Many investment firms chose to become SIs even if they did not meet the mandatory quantitative thresholds. This strategic decision was often driven by a desire to provide a more comprehensive service to clients, offering them a reliable source of liquidity for a wide range of instruments.

The opt-in mechanism effectively accelerated the growth of the SI regime, making it a cornerstone of the post-MiFID II market structure. For these firms, the ability to utilize the LIS waiver was a critical operational consideration, allowing them to manage the risks associated with providing liquidity for large, and often illiquid, client orders.

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Strategy

The strategic interplay between the LIS waiver and Systematic Internalisers has been a defining feature of the post-MiFID II landscape. For institutional investors and the investment firms that serve them, navigating this environment requires a sophisticated understanding of the evolving rules of engagement. The strategies that have emerged are a direct response to the opportunities and constraints created by the regulatory framework. These strategies are not static; they are continuously refined as the market adapts to new interpretations of the rules, technological innovations, and the competitive dynamics of liquidity provision.

A core strategic consideration for SIs has been how to leverage the LIS waiver to build a competitive franchise. By offering firm quotes for large orders, SIs can attract significant client flow, particularly from institutional investors seeking to minimize market impact. The LIS waiver provides the necessary protection for SIs to take on this risk, allowing them to internalize trades without immediately revealing their positions to the wider market. This has led to the development of sophisticated pricing and risk management systems within SIs, designed to accurately assess the risks of large trades and provide competitive quotes to clients.

Strategic adaptation to the evolving MiFID II landscape has centered on optimizing the use of the LIS waiver within the Systematic Internaliser framework to enhance liquidity provision and manage execution risk.

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How Has the Regulatory Landscape Shaped SI Strategies?

The regulatory landscape has been a primary driver of SI strategy. The initial focus of MiFID II on increasing transparency led to the introduction of pre-trade quote obligations for SIs. However, the practical challenges of applying these obligations to non-equity markets, which are often less liquid than equity markets, soon became apparent. Subsequent reviews and amendments to the MiFID II framework have sought to address these challenges, leading to a more nuanced approach to SI regulation.

For example, recent changes have removed the pre-trade transparency requirements for SIs in non-equity instruments, a move that is likely to further enhance their role in the market. This evolving regulatory environment has required SIs to be agile and adaptable, continuously adjusting their business models and technological infrastructure to remain compliant and competitive.

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The Competitive Dynamics of Liquidity Provision

The rise of SIs has intensified competition among liquidity providers. SIs compete not only with each other but also with traditional trading venues such as regulated markets and multilateral trading facilities (MTFs). This competition plays out across multiple dimensions, including price, speed of execution, and the ability to handle large and complex orders.

The LIS waiver has been a key differentiator for SIs in this competitive landscape, allowing them to offer a unique value proposition to clients with large trading needs. As the SI regime has matured, we have seen the emergence of specialized SIs that focus on particular asset classes or client segments, further segmenting the market and increasing the complexity of the competitive environment.

The following table provides a comparative overview of the key features of different liquidity provision models under MiFID II:

Feature	Systematic Internalisers (SIs)	Regulated Markets (RMs)	Multilateral Trading Facilities (MTFs)
Primary Function	Executing client orders against the firm’s own capital.	Bringing together multiple third-party buying and selling interests in a non-discretionary way.	Bringing together multiple third-party buying and selling interests in a non-discretionary way.
Pre-Trade Transparency	Subject to quote obligations, but with waivers for large-in-scale trades.	Full pre-trade transparency, with limited waivers available.	Full pre-trade transparency, with limited waivers available.
Use of LIS Waiver	Extensive use to manage risk on large trades.	Available for large orders, but subject to strict conditions.	Available for large orders, but subject to strict conditions.
Key Strategic Advantage	Ability to provide deep liquidity for large orders with minimal market impact.	Centralized price discovery and a diverse range of participants.	Flexibility in trading rules and lower costs.

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Execution

The execution of trades within the SI and LIS waiver framework is a complex process, governed by a detailed set of rules and operational protocols. For institutional investors, understanding these mechanics is essential for achieving best execution and minimizing transaction costs. The interaction between the client, the SI, and the broader market is mediated by a series of technological and procedural steps, each of which can have a significant impact on the outcome of a trade. From the initial request for a quote to the final post-trade report, the entire lifecycle of a trade is shaped by the MiFID II framework.

A key aspect of the execution process is the management of information. The LIS waiver is designed to control the flow of information to the market, preventing the premature disclosure of large orders that could lead to adverse price movements. SIs have developed sophisticated systems to manage this information flow, ensuring that they can provide firm quotes to clients while minimizing their own risk. These systems often involve a combination of automated and manual processes, with traders and risk managers playing a key role in overseeing the execution of large trades.

Effective execution within the SI framework hinges on the precise application of the LIS waiver, a process that requires sophisticated technology and a deep understanding of market microstructure.

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The Lifecycle of a LIS Trade

The execution of a trade under the LIS waiver typically follows a structured process:

Request for Quote (RFQ) ▴ The client sends an RFQ to one or more SIs, specifying the instrument and size of the desired trade.
Quotation ▴ The SI provides a firm quote to the client. This quote is typically valid for a short period of time.
Execution ▴ If the client accepts the quote, the trade is executed between the client and the SI.
Post-Trade Reporting ▴ The SI is required to report the details of the trade to the public. However, under the LIS waiver, the publication of the trade can be deferred, allowing the SI time to hedge its position without revealing the full details of the trade to the market.

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What Are the Key Operational Challenges?

The execution of LIS trades presents a number of operational challenges for both clients and SIs. For clients, the key challenge is to ensure that they are receiving competitive quotes and achieving best execution. This requires a robust process for selecting SIs, evaluating their quotes, and monitoring the quality of their execution. For SIs, the main challenge is to manage the risks associated with providing liquidity for large trades.

This includes market risk, credit risk, and operational risk. SIs must have in place sophisticated risk management systems and procedures to mitigate these risks.

The following table details some of the key operational considerations for LIS trades:

Consideration	Client Perspective	SI Perspective
Best Execution	Ensuring that the SI is providing a competitive price and minimizing market impact.	Demonstrating to clients that they are providing best execution in line with regulatory requirements.
Counterparty Risk	Assessing the creditworthiness of the SI.	Managing the credit exposure to the client.
Information Leakage	Minimizing the risk that information about the trade will leak to the market before it is executed.	Controlling the flow of information to the market to protect the SI’s position.
Post-Trade Analysis	Analyzing the execution quality of LIS trades to identify areas for improvement.	Using post-trade data to refine pricing models and risk management strategies.

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The Future of LIS and SI Interaction

The interaction between the LIS waiver and SIs is likely to continue to evolve in the coming years. The ongoing review of the MiFID II framework, coupled with technological advancements and changes in market structure, will create new opportunities and challenges for market participants. The trend towards greater automation and data-driven decision-making is likely to accelerate, leading to the development of more sophisticated tools for executing and analyzing LIS trades. At the same time, the regulatory focus on transparency and investor protection will remain a key driver of change, ensuring that the evolution of the market is aligned with the broader public interest.

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References

European Securities and Markets Authority. (2020). MiFIR report on systematic internalisers in non-equity instruments. ESMA70-156-2756.
PwC Legal. (2024). MiFIR/MiFID II Review ▴ making sense of the key amendments.
FIA. (n.d.). Special Report Series ▴ Transparency.
European Securities and Markets Authority. (2022). Opinion on the assessment of pre-trade transparency waivers. ESMA70-155-6641.
Ashurst. (2024). EU changes to the MIFID regime are here.

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Reflection

The intricate dance between the LIS waiver and Systematic Internalisers under MiFID II is more than a regulatory footnote; it is a foundational element of modern European market structure. The evolution we have traced reveals a system in constant adaptation, a complex interplay of rules, technology, and strategic behavior. For the institutional professional, a deep understanding of this dynamic is not merely academic.

It is the bedrock of effective execution strategy. The ability to navigate this landscape, to understand the motivations of different liquidity providers, and to leverage the available tools to achieve specific trading objectives is a critical component of a superior operational framework.

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How Does Your Framework Measure Up?

As you reflect on the insights presented, consider your own operational framework. How does it account for the nuances of the SI regime? How do you assess the quality of execution you receive on LIS trades?

What data do you use to inform your decisions, and how do you use that data to refine your strategies over time? The answers to these questions will determine your ability to thrive in the complex and ever-changing world of institutional finance.