The Evolving Role of Systematic Internalisation Under MiFID II

The MiFID II Challenge and Systematic Internalisation

It’s easy, and perhaps convenient, to forget the mad scramble to be ready for MiFID II. Many firms struggled to interpret the operational implications of the 1.7 million paragraphs of text, turn them into policy, and assess their potential business impact.

The ‘day 1’ priority was just getting compliant with the new regime. Few firms had the luxury to plan how best to optimise their businesses. They also lacked time to exploit the changes. One key question was whether to commit to systematic internalisation under the new regime. Firms also considered changing their business models to avoid inclusion.

Larger firms and regional specialists dominated certain asset classes or instruments. They had little choice but to embrace the new regulation. Others initially shied away from the stringent regulatory oversight and reporting obligations. These obligations came with adopting Systematic Internaliser (SI) status.

Systematic Internalisation as a Liquidity Source

Two years on, the post-MiFID II landscape has become much clearer, as have some of its consequences. As discussed in our previous article on the evolving shape of European market liquidity, systematic internalisation has become an increasingly valuable source of liquidity provision. According to data solutions provider big-xyt, October saw a record €1.5 billion in daily notional turnover by ELP SIs across Europe. But what is driving this growth?

Best Execution and Systematic Internalisers

MiFID II extended the best execution regime to cover the buy-side as well as the sell-side. This means that asset managers must prove they have their own best execution mechanics, rather than just rely on brokers. It also requires them to justify why they select one broker over another.

The definition of best execution extends beyond price to include cost, speed, likelihood of execution and settlement, and client characteristics. Broker-dealers can enhance execution quality by improving price, reducing cost, or minimising market impact through systematic internalisation. This approach is clearly beneficial to their clients.

Trade Reporting and the Benefits of Systematic Internalisation

On the face of it, asset managers can avoid burdensome trade reporting obligations when routing their flow to an SI. Naturally, this must be done within the context of best execution. However, there is added complexity—sell-side firms may be SIs for some sub-asset classes but not others, and counterparties must determine who has the reporting responsibility at an instrument level.

When the SI assumes the trade reporting obligation, it removes operational and administrative overheads for the buy-side entity, making systematic internalisation an attractive option.

The Business Case for Systematic Internalisation

The number of registered SIs has grown from just 14 in 2017 to over 200 today. This suggests that firms see clear benefits that outweigh increased regulatory scrutiny, transparency obligations, and organisational requirements.

In an environment of thinner margins, rising participation costs, and economic challenges, many broker-dealers have concluded that investment in the right systematic internalisation technology and operations is essential. For example, a mid-tier regional bank managing order flow from retail, wealth management, and corporate customers—as well as running its own institutional cash equity desk—may first look to match these orders internally rather than automatically routing them to lit venues.

The Regulatory Impact on Systematic Internalisation

The SI opportunity has also been fuelled by unintended consequences of ESMA’s transparency initiatives and restrictions on dark pool trading volumes. The introduction of Double Volume Caps was meant to constrain trading in non-displayed liquidity by limiting the use of transparency waivers. The goal was to push orders onto lit venues, but research has shown that, in fact, liquidity often shifts to systematic internalisation rather than reverting to lit markets.

Systematic Internalisers and Market Transparency Concerns

While systematic internalisation continues to grow, regulators remain concerned about its impact on wider market transparency. Their initial response has been to propose that SIs must adhere to the public tick regime, aiming to remove one of their advantages over lit venues.

This move could challenge an SI’s ability to price improve on non-LIS trades. However, there is an open question: will ESMA’s push for transparency actually reduce execution quality in certain cases?

The Future of Systematic Internalisation

The Systematic Internaliser regime under MiFID II is now an established part of the European liquidity landscape, with average daily value traded exceeding 2% of total turnover. The buy-side benefits from improved execution quality by accessing broker-dealer internal inventory, while the sell-side gains advantages such as increased revenue, new order flow, and reduced counterparty risk.

For sell-side firms that have not yet embraced systematic internalisation, the time to act may be now—before regulators introduce new rules that make the barriers to entry even higher.