Citi Business Name | Subgroup Name

Sales & Trading Commentary Not a Product of Investment Research; Institutional Client Distribution Only

Citi Global Market Structure Update

Q2 2017 (June)
Americas EMEA (Europe)
MiFID II
Equities Market Structure
- Market Maker Intervention
Washington, D.C. Update: SEC Posts, Congressional
Hearing on U.S. Equity Market Structure - Potential Impact on High-Touch
Business
SECs Equity Market Structure Advisory Committee
Recommendations - Third Country Equivalence and
Unbundling
SIFMA Meets with SEC Staff re: SIP Market Data
New Market Initiatives Focused on the
Disappointment over Tick Size Pilot Leads to Claims of Pilot
Changing Regulatory Environment
Fatigue
- Block Initiatives
Consolidated Audit Trail (CAT) Fee Filing Raises Issues with
Regulatory Funding Model - Periodic Auction Mechanisms
FINRA & Exchange Rule Filings
- FINRA Desk Commentary Safe Harbor APAC (Asia-Pacific)
Australia
- BATS Market Close Proposal
China
Key Upcoming Dates
Hong Kong
India
Options Market Structure Indonesia
Proposed Changes to ORF Fees Highlight Issues with Japan
Regulatory Funding Model
Singapore
Taiwan

Citi Velocity video: Citi Global Market Structure Update (Q217)

Americas: Equities Market Structure

Washington, D.C. Update: SEC Posts, Congressional Hearing on U.S. Equity Market
Structure
The chips are starting to fall in place in Washington (albeit at a slower than normal pace), with new SEC Chair
Jay Clayton assuming his post in early May. His mandate is clear: enhance capital formation and increase the
number of public companies. Three of the five Commissioner slots are now occupied, with Republican Mike
Piwowar and Democrat Kara Stein remaining in place. Consultants are predicting that Hester Pierce, a former
SEC counsel and Senate aide who was previously nominated as a potential SEC Commissioner by then-
President Obama, is the Trump Administrations likely choice to fill the remaining Republican seat. Any such
nomination would likely be paired with the final Democratic nominee; while not finalized, two names that have
been floated are Robert Jackson, a Columbia University law professor, and Bharat Ramamurti, an aide to
Senator Elizabeth Warren (D-MA). A new Director of the Division of Trading & Markets has yet to be named,
among the most important posts for Equity Market Structure issues.

In Congress, the Capital Markets Subcommittee of the House Financial Services Committee (HFSC) conducted
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the first in a series of hearings on U.S. Equity Market Structure on June 27 . At the hearing, the Subcommittee
solicited views from the major exchanges and various market participants to examine the evolution of the equity
markets since Reg NMS was adopted. Topics covered included NMS Plan Governance, the Maker-Taker Model
and Market Data. While all hearing witnesses acknowledged the many improvements to Equity Market Structure
from both regulation and technology, common criticisms included excessive complexity, market fragmentation,
conflicts of interest and lack of transparency. Trading large blocks of stock and illiquid securities remains a
central focus of concern. Several Members asked questions related to NMS Plan Governance. The
Subcommittee plans to do a holistic review of the statutory framework for Reg NMS and determine if changes
are warranted to improve the liquidity and depth of the markets. Part 2 of the HFSC hearings on Equity Market
Structure is tentatively slated for the Fall, with a focus on Potential Solutions.

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In anticipation of the June 27 hearing, Citi Equities and Federal Government Affairs had a productive round of
meetings on June 19-20 in both New York and Washington, D.C. with key Members and Staff on the
Subcommittee (including six of the Members who were present at the hearing). We shared Citis views on equity
market structure reform, in particular those areas with opportunities for legislative involvement (namely NMS
Plan Governance and reform of the self-regulatory organizational (SRO) structure). Citi is also meeting with U.S.
Treasury to discuss capital markets issues in advance of Treasurys second report in response to President
Trumps Executive Order on Core Principals for Regulating the U.S. Financial System. The second report is
focused on Capital Markets issues and is expected sometime this Fall (likely in September).
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Citi View: Based on the June 27 Congressional hearing and the meetings weve had with
Members and Staff, it seems clear to us that momentum is building for some refinement to
the NMS Plan Governance process. Citi and SIFMA are actively seeking voting
representation on the NMS Plan Operating Committees for both sell-side and buy-side
representatives. The goal in not majority voting power on those Plan Committees, but
simply transparency and a voice on the Committees that govern the SIPs (market data),
Consolidated Audit Trail, Tick Size Pilot and Limit Up/Limit Down Plans. Receptivity
among HFSC Members and Staff was very positive, with a few Members expressing a
willingness to potentially engage more vocally in the debate. Some Members and Staff
even requested a broader swath of potential reforms to Market Structure beyond just NMS
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Plan Governance. Citis senior leaders within the Equities Division met on June 1 to
discuss our internal views on Equity Market Structure reform, and we are preparing to
share more of those views over time. Market data will be a key area of focus for us going
forward.

1 Sales & Trading Commentary Not a Product of Investment Research; Institutional Client Distribution Only
SECs Equity Market Structure Advisory Committee Recommendations

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The SECs Equity Market Structure Advisory Committee (EMSAC) met on April 5 to discuss two sets of
preliminary recommendations on the topics of: (1) Regulation NMS Rule 611 (Order Protection Rule) and Rule
610 (Access Fees); and (2) Exchange Immunity, Limitations of Liability and SRO Regulatory Centralization.

Reg. NMS Rule 611 (Order Protection Rule) and Rule 610 (Access Fees) The EMSACs Reg. NMS
Subcommittee presented a strawman for a potential pilot recommendation to repeal Rule 611 for all NMS stocks
market-wide. A pilot could also remove the Rule 610 prohibition on locked/crossed markets. This same
Subcommittee had previously recommended an Access Fee Pilot to the SEC Staff, which the SEC Staff is
currently working to draft and propose. Options for a new 611 pilot include: (a) a 611 pilot without removal of
the locked/crossed prohibition; (b) a 611 pilot with removal of the locked/crossed prohibition, after the Access
Fee Pilot is run and instituting a $0.0002 (or less) access fee cap; or (c) a 611 pilot with removal of the
locked/crossed prohibition, concurrent with the Access Fee Pilot but with a $0.0002 (or less) access fee cap.
Stated goals are to reduce excessive complexity, fragmentation and order types, and to foster competition and
innovation. Not surprisingly, the recommendations met with significant pushback at the meeting on behalf of
individual retail investors who are concerned about removing the best execution backstop of the Order Protection
Rule. The full Subcommittee memo is available here: https://www.sec.gov/spotlight/emsac/emaac-regulation-
nms-subcommittee-discussion-framework-040317.pdf.

Exchange Immunity, Limitations of Liability and SRO Regulatory Centralization The EMSACs Trading
Venues Regulation Subcommittee presented two preliminary recommendations to: (1) improve the structure for
SROs to compensate the industry for technology and other errors; and (2) centralize certain cross-market
regulation (e.g., compliance with CAT, surveillance-based inquiries, investigations, enforcement and
examinations). All exchanges should apply consistent liability limits, and exchanges should create and support a
reserve fund that allows for unpaid amounts to build up to a set limit (reserve fund limits should be higher for
listing exchanges given their role in IPOs and opening/closing markets). Further, the SEC should articulate and
support minimum standards for cross-market regulation to avoid regulatory duplication and limit the ability of
individual exchanges to regulate beyond their own markets. This Subcommittee had previously made two
recommendations, adopted by the full EMSAC, related to enhanced industry participation in certain SRO
regulatory matters. The full Subcommittee memo is available here: https://www.sec.gov/spotlight/emsac/emsac-
trading-venues-regulation-subcommittee-preliminary-recommendations-040317.pdf.

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Next Steps: The two Subcommittees that presented their preliminary recommendations at the April 5 meeting
will continue to refine and bring them for a full Committee vote at the next EMSAC meeting (likely this Summer),
while the other two Subcommittees will make their preliminary recommendations at that same meeting. The
EMSACs Charter is set to expire in August, unless renewed by the Commission before then. Additional industry
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comments on the EMSAC (including SIFMAs March 29 comment letter on Reg. NMS) are available here:
https://www.sec.gov/comments/265-29/265-29.shtml.

Citi View: We agree with the direction in which the EMSAC is moving: reducing the cap on
access fees, enhancing transparency for investors, and examining market data and SRO
structure (exchanges as self-regulatory organizations). We would like to see the SEC Staff
propose an Access Fee Pilot as soon as possible without a Trade-At component, and as
Commission rulemaking rather than an NMS Plan delegated to the SROs. It is often
debated whether the SEC should conduct a holistic review of Market Structure or take a
piecemeal approach, addressing one issue at a time. Ultimately there is no right answer to
that question; as an industry, we just need to decide on an approach and move forward,
taking a calculated regulatory risk to improve Market Structure. We support incremental
steps forward rather than inertia, targeting specific areas where improvement seems
necessary and logical: (1) reducing the cap on access fees; (2) changing the NMS Plan
Governance structure; and (3) reforming our outdated market data model.

Both Citi and SIFMA are planning to file comment letters recommending an extension of
the EMSACs Charter, and proposing some changes to its composition as well as future
agenda items (starting with market data).

2 Sales & Trading Commentary Not a Product of Investment Research; Institutional Client Distribution Only
SIFMA Meets with SEC Staff re: SIP Market Data

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SIFMA (including Mike Masone of Citi) met with the SEC Staff on May 8 to discuss issues related to one of the
SIP (Securities Information Processor) top-of-book market data fees and a NYSE filing that changed the way
display vs. non-display use is defined. It was the first meeting of SIFMAs Market Data Subcommittee with the
SEC Staff in several years related to SIP market data issues. NYSE claimed to be simply clarifying display vs.
non-display uses, to which different fee schedules apply; in reality, this clarification increased fees
exponentially, particularly for small and mid-size firms. Further, by classifying the fee increase as a
clarification, NYSE was able to file for immediate effectiveness without review and approval by the Commission
nor a notice and comment period for the broader industry.

Prior to 2014, professionals paid a single fee for data and used it for both display purposes (meaning viewed by
the human eye and able to be manipulated via Excel, etc.) and non-display purposes (fed into an algorithm and
not viewed by the human eye). In 2014, CTA (Consolidated Tape Association) imposed a new fee called a non-
display fee over SIFMA objections. CTA argued that black box trading was replacing large numbers of paying
eyeballs so this non-display fee was intended to generate additional revenues from High Frequency Traders by
levying a fee where data was not visibly displayed. SIFMA opposed the fee as it was not reasonably related to
cost. This NYSE interpretation obliterates the difference between display and non-display; display uses
would be defined as non-display, regardless of whether the data is visibly available. While many vendors have
carefully structured a system to ensure use of display data by only entitled users, NYSE has declared that the
efficacy of vendors encryption is irrelevant.

Citi View: The SIFMA group expressed a number of asks to the SEC Staff. First and
foremost, NMS Plan Committees like the SIP Operating Committees should include direct
representation by the industry (broker-dealers and asset managers), and those
representatives should have voting power on the Operating Committees, not just seats on
the advisory committees. All NMS Plan meetings should be transparent and open to the
public not conducted in Executive Session by the Plan Operating Committee without the
Advisory Committee present with agendas published well in advance and minutes
circulated soon after. Market data fee proposals should include cost information and
explain both direct and indirect effects on the total price paid by users, and thus not
immediately effective upon filing. Top-of-book market data fees must have a reasonable
relationship to cost as they are essential for trading, but without further transparency, the
industry has no way of knowing what those actual costs are (see below discussions of
CAT and ORF fees).

Further, the time has come to introduce competition in the SIP consolidation space, so
that this public utility remains competitive with the exchanges direct/proprietary market
data feeds. That means reducing latency and eventually adding depth-of-book data to the
SIP feeds. SIFMA continues to work on honing its Competing Market Data Aggregator
(CMDA) proposal, initially presented to the SEC Staff in October 2015 and met with very
positive receptivity. The goal is to introduce competition, reduce latency, provide
redundancy, promote fairness and address conflicts of interest. This will be an area of
acute focus for SIFMA and Citi later this year.

Disappointment over Tick Size Pilot Leads to Claims of Pilot Fatigue

The SECs long-awaited Tick Size Pilot finally went live last October, widening the quoting increment from a
penny to a nickel for certain small cap (under $3 billion market cap), illiquid (under 1 million share ADV) stocks.
Each of three different test groups of approximately 400 stocks has a slight variation on trading, with a Trade-At
component as part of Test Group 3. Preliminary reports indicate that most of what we expected to happen is
happening: very limited improvement in trade size and overall volume, with increased execution costs and
volatility. As expected, spreads have widened, though typically only where spreads were previously inside of 5
cents naturally. Depth of book has also increased, for all stocks. Trading on inverted exchanges and off-
exchange venues has increased as the investor experience is typically better there for illiquid names; the notable
exception, as expected, is for Test Group 3, where the Trade-At requirement has forced more trading to the for-

3 Sales & Trading Commentary Not a Product of Investment Research; Institutional Client Distribution Only
 profit exchanges. And lastly, if the costs of trading pilot securities increases as expected, it could eventually
impact volumes negatively.

Because of this, many are criticizing the Tick Size Pilot as a failure and calling for its early termination (currently
scheduled to last until October 2018). But this is highly unlikely to occur; the SEC Staff has repeatedly said that
it is still too early to determine the Pilots efficacy in meeting its stated aims. Many are also claiming that the
implementation costs of the Tick Size Pilot have so outweighed the empirical benefits, and thus extrapolating that
no further pilots should be conducted. This is despite the Trump Administrations clear mandate that any future
regulation be grounded in empirical data rather than just policy, and the fact that the SEC Staff has several times
confirmed that it is actively working on an Access Fee Pilot in response to the SECs EMSAC recommendation.

Citi View: The for-profit exchanges will no doubt point to increased exchange trading of
Test Group 3 names as evidence that Trade-At is good for markets. To us, its no surprise
that a regulatory requirement to trade at exchanges would increase volumes there. The
larger question is whether that type of regulatory intervention is needed. As weve seen in
the SECs EMSAC recommendation for an Access Fee Pilot, Trade-At has been expressly
rejected. We agree that it should be it is a regulatory solution in search of a problem.
Given some recent attempts by the for-profit exchanges to revive the Trade-At debate, we
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again debated it internally at our June 1 roundtable among Citis senior leaders within the
Equities Division. While we still do not support Trade-At, we may be willing to consider it
with inclusion of certain major exceptions (market makers who commit capital, block-size
orders in aggregate), but only in return for significant concessions by the exchanges
around pricing and market data.

On the broader issue of Pilot Fatigue, its become quite common to hear market
participants say that we have too many pilots and should not adopt any more. But that
was not the consensus view in the room at a recent Market Structure Roundtable hosted
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by ICI on June 14 in which Citi participated. Several members of the SECs EMSAC were
present, and echoed the view that the only responsible way to inform potential regulatory
action is by running pilots to solicit empirical data. In particular, an Access Fee Pilot
would target more liquid securities that are by definition not part of the Tick Size Pilot, so
there would be no overlap. We are of the view that carefully constructed pilots with well-
articulated goals and measurable outcomes are the most responsible way to inform the
rulemaking process.

Consolidated Audit Trail (CAT) Fee Filing Raises Issues with Regulatory Funding
Model
After Thesys Technologies, LLC was selected as the (somewhat surprise) CAT Plan Processor in January, the
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SROs filed their original fee schedule on May 8 . The SROs followed a 75/25 cost allocation, with brokers
paying 75%, and exchanges & ATSs paying the other 25%. Of the exchanges 25%, thats further broken down
with 75% to equities exchanges and 25% to options exchanges. Estimated cost for the year beginning
November 2016 is $50 million, with ongoing annual costs around $37 million. A particular firms share depends
on which tiers it hits. Rough estimates for the largest brokers are $800K-$900K, with exchanges at roughly
$1.3M-$1.9M each. SROs are be required to begin reporting to the CAT within one year (November 15, 2017),
large broker-dealers the following year (November 2018), and small broker-dealers the year after that (November
2019). SIFMAs Comment Letter is available here: https://www.sec.gov/comments/sr-batsbzx-2017-
38/batsbzx201738-1788188-153228.pdf.

Citi View: Overall costs are not as bad as many feared when CAT was first introduced
the industry (with some help from Congress) significantly reduced the overall costs by
successfully advocating the SEC to eliminate the real-time reporting requirement in the
original proposal. But issues around the Regulatory Funding Model are as acute here as
they are in the market data arena and the ORF (see below under Americas: Options
Market Structure). Regulatory fees must have a reasonable relationship to the cost of
regulation, but without further transparency, the industry has no way of knowing what

4 Sales & Trading Commentary Not a Product of Investment Research; Institutional Client Distribution Only
 those actual costs are. The CAT funding model should have been a product of
collaboration between the SROs and the broker-dealer community, especially since
brokers were allocated approximately 88% of the total costs. Instead, the SROs developed
the proposed fee schedules without incorporating any substantive input from industry
members. This underscores the need for broker-dealers and asset managers to be given
voting representation on NMS Plan Operating Committees.

FINRA and Exchange Rule Filings

FINRA Desk Commentary Safe Harbor: FINRA filed its Regulatory Notice 17-16 on April 12th, proposing a
limited safe harbor from FINRAs Equity and Debt Research Rules (Rules 2241 and 2242, respectively), for
specified brief, written analysis distributed to eligible institutional investors that comes from sales & trading or
principal trading personnel but that may rise to the level of a research report (desk commentary). The proposed
safe harbor would be subject to conditions, including compliance with a number of the Rule 2241 or Rule 2242
provisions to mitigate research-related conflicts. In addition, the proposed safe harbor would require firms to
include a health warning on desk commentary and to obtain negative consent from eligible institutional
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investors to receive such commentary. The comment period has been extended to July 14 .

Citi View: After a series of Citi and SIFMA meetings with FINRA and the SEC from
December 2015 through May 2016, we were pleased to see FINRAs willingness to work
with the industry to arrive at a compromise that would continue to allow desk commentary
to be produced off Sales & Trading desks. However, some Research personnel feel that
FINRA actually lowered the bar on what constitutes a Research Report, taking a step
backwards. SIFMAs comment letter (available here:
http://www.finra.org/sites/default/files/notice_comment_file_ref/17-
16_SIFMA_comment.pdf) suggests ways for FINRA to modify the description of eligible
content to include commentary that may meet the definition of a Research Report. It also
requests that FINRA modify and eliminate certain conflict management provisions to
permit ordinary course activities of Sales & Trading personnel. Without these changes,
SIFMA would not support the use of the proposed safe harbor in its current form. We still
believe the safe harbor has some utility as proposed, and are committed to continue
engaging with FINRA to arrive at a workable solution for the industry.

BATS Market Close Proposal: BATS filed its BATS Market Close (BMC) proposal on May 8 th, to create a
competitive alternative to the primary market closing auctions from both a pricing and resiliency perspective. The
end-of-day match process for non-BATS listed securities is meant to address the rapid increase in closing
auction fees at NYSE and NASDAQ. Under BATSs proposal, participants can elect to route Market-On-Close
(MOC) orders to BMC on BATSs BZX Exchange starting at 6am ET, where they are pre-matched with other
MOC orders at 3:35pm ET (with no cancels/modifications after this cut-off time). Pre-matched trades are then
executed when the primary exchange closing price is published. Any MOC orders that go unmatched are
rejected back to the participant, who can then send to the primary exchange closing auctions. Limit-On-Close
(LOC) orders are not part of BATSs offering, their attempt to avoid distorting auction price formation. IEX is
apparently considering a similar proposal for non-IEX listed securities, in addition to their plans to begin their
listings business later in the year.

Citi View: We are generally supportive of competition in most forms as a means to control
excessive costs, though we do recognize the value of having one (or two) primary closing
auctions where significant liquidity events can occur. That said, BATS has modest
expectations of its market share gains, which we share; most of our institutional
customers use LOC (not MOC) orders. Not being able to cancel/modify after the 3:35pm
cut-off time will be another deterrent to use. This ultimately may be a good tool for retail
customers but not necessarily for institutional customers, many of whom want to execute
on the primary exchanges at the close. At a minimum, it ought to put some pressure on
NYSEs and NASDAQs fees. SIFMA filed a comment letter in support of the proposal
(available here: https://www.sec.gov/comments/sr-batsbzx-2017-34/batsbzx201734-
1800004-153681.pdf). We understand the SEC Staff concerns are focused around (i)

5 Sales & Trading Commentary Not a Product of Investment Research; Institutional Client Distribution Only
 impact to price discovery process at primary exchanges (especially publication of
matched volume) and (ii) whether this is actually a remedy for single points of failure.
BATS is expecting any SEC action on the proposal wont occur until late 2017/early 2018,
given the turnover and still vacant seats at the Commission, so rollout wouldnt be until
mid-2018 if at all.

Key Upcoming Dates

July 14, 2017 Deadline for comments on two FINRA Regulatory Notices: (i) 17-16s Proposed Limited Safe Harbor
from FINRA Equity and Debt Research Rules (2241 & 2242) for Desk Commentary distributed to eligible institutional
investors (SIFMAs comment letter is here: http://www.finra.org/sites/default/files/notice_comment_file_ref/17-
16_SIFMA_comment.pdf); and (ii) 17-14s Capital Formation rules (SIFMAs comment letter is here:
http://www.finra.org/sites/default/files/notice_comment_file_ref/17-14_SIFMA_comment.pdf).

July 24, 2017 NYSE to begin proposed phased rollout of Pillar platform; transition of MKT to NYSE American (first
gateways open).

August 20, 2017 deadline for SEC to either approve or disapprove extend CHXs Liquidity Enhancing Access Delay
(LEAD). One more potential final extension is possible until October 19, 2017.

August 31, 2017 Tick Size Pilot data (Appendix B data) to be published on FINRAs website (delayed due to
confidentiality concerns and concerns over potential reverse engineering of trading strategies); awaiting new FINRA
masking policy.

September 5, 2017 Target date for the U.S. move from a T+3 to a T+2 settlement cycle.

September 13-15, 2017 STA Annual Market Structure Conference in Washington, DC (program available at
https://securitytraders.org/wp-content/uploads/2017-Program-Glance.pdf).

October 16-17, 2017 NOIP Conference in New York.

October 23-24, 2017 SIFMA Annual Meeting: The Capital Markets Conference in Washington, DC (program
available at http://sifmaannualmeeting.org/).

November 15, 2017 SROs to begin reporting to the CAT (large broker-dealers begin reporting in November 2018,
and small broker-dealers in November 2019).

Expected Fall 2017 Part 2 of House Financial Services Committee hearings on Regulation NMS, focused on
Potential Solutions; also U.S. Treasurys second report in response to President Trumps Executive Order, this one
focused on Capital Markets issues.

January 3, 2018 MiFID II implementation date.

6 Sales & Trading Commentary Not a Product of Investment Research; Institutional Client Distribution Only
Americas: Options Market Structure

Proposed Changes to ORF Fees Highlight Issues with Regulatory Funding Model
Circa 2000, the CBOE filed to have the ORF (Options Regulatory Fee) changed from charging firms per
Registered Rep (~$75.00 per Rep) to what was perceived as a more fair process, of charging per contracts
traded. Other exchanges picked up on the fact that they could charge this fee and initiated it, charging ORF as
well. At some point in time, an exchange decided that they could charge ORF on all contracts traded at every
exchange; this practice was approved by the SEC and shortly thereafter copied by other exchanges as well.

ORF was originally designed as a pass-through fee to end customers. But currently, each option exchange
charges a different ORF and has a different methodology in how they collect the ORF. The variances create
complexity and uncertainty, making it difficult for some broker-dealers to pass along the fee to their customers on
the execution report. ORF was originally intended to cover a portion of an exchanges regulatory costs but
there is no transparency in how ORF is used.

Citi View: Weve previously written about the deficiencies with the current Regulatory
Funding Model. Late last year, SIFMA submitted a comment letter on a NYSE filing to
make the point that for-profit exchanges need to provide greater transparency about their
regulatory fees (http://www.sifma.org/issues/item.aspx?id=8589963365). Without such
transparency, the SROs have virtually unfettered ability to charge whatever regulatory fees
they see fit, without any reasonable relation to the cost of regulations they are meant to
enforce. These costs inevitably get passed on to customers, so it becomes an issue of
fairness for everyone. This continues to be a top priority in 2017 the Regulatory Funding
Model needs a fresh look by the SEC.

ORF is just another example of this problem. Exchanges should not necessarily have the
right to charge an additional regulatory fee, unless and until member firms have greater
transparency into the costs of the regulations such fees are meant to recoup. After this
broader review, then a full review of the ORF process should be conducted in an effort to
try and simplify the collection of the ORF (e.g., transparency on how ORF Fees are
allocated and used by each exchange).

SIFMA is working on a strawman for a New Options Regulatory Fee (NORF) to replace the
exchanges current ORF rules, with goals of simplification, harmonization and
transparency. Re: simplification, ORF should be charged only for executions that occur
on the exchange, and clear in the customer range at OCC. SROs have no statutory basis
upon which to charge transaction or regulatory fees for activity that occurs away from
their exchange. NORF should be collected by the OCC, from the OCC member that
ultimately clears the trade, and OCC should distribute the funds to the respective
exchange that executed the trade. Re: harmonization, each exchange should adopt the
same rule set for ORF since it is a regulatory fee, as opposed to a fee designed to support
commercial activities. The exchanges have already established a precedent for this with
the nearly universal adoption of rules that require the exchanges to provide 30 days
written notices prior to a fee change, and alter their fees only two times a year (in February
and August). Re: transparency, each Exchange should disclose the total amount of
revenue collected from ORF and the corresponding amount regulatory activities that it
funds. This should be based on previously disclosed guidelines, and exchanges should
ensure that funds are used for regulatory costs, not their commercial interests. Finally,
NORF revenues and expenditures should be entered in a ledger that is reviewed annually
by an independent third-party auditor or the SEC.

7 Sales & Trading Commentary Not a Product of Investment Research; Institutional Client Distribution Only
EMEA (Europe)

MiFID II

MiFID II remains the key focus in Europe as we head towards 3 January 2018 go-live. As a point of reference, Steven
Maijoor, the chair of the European Securities Markets Authority quashed rumours of any delay to implementation at the
recent FIA International Derivatives Expo in London, stating one delay has been enough for all concerned. However, with
only a limited amount of time before implementation, a number of key areas, which could be significantly impacted by
regulatory change, remain fluid.

Market Maker Intervention

Most notably, the biggest topic of discussion has been around whether systematic internalisers (SIs) will be able to
connect to other SIs and in what capacity. Only very recently, on 20 June, the European Commission published a draft
amendment to the Delegated Regulation (EU) 2017/565 defining Systematic Internalisers. And even then, this remains
subject to a four-week consultation period, the outcome of which will determine whether there will be more fragmentation
of liquidity amongst SIs or more concentration of liquidity on public markets. Either outcome will potentially impact the
liquidity landscape in a significant way. To recap the concerns raised by MEP Marcus Ferber and his colleagues, the
focus is on Investment Firm SIs and Market Maker SIs connecting to each other to replicate broker crossing networks by
bringing buyers and sellers together on a multilateral basis without being authorised as a trading venue.

How this will be addressed is yet to be seen, but SI-to-SI connectivity purely on a bilateral basis doesnt immediately seem
to fall afoul of those concerns unless either the Market Maker SI is not meeting the true definition of an SI and taking on
risk, or ultimately the regulators see this as business that should be transacted on a trading venue and are looking to
close down SI-to-SI connectivity altogether.

Citi View: Even if we end up with some liquidity fragmentation among electronic market
makers, we dont anticipate that liquidity on public markets will dry up as some have
suggested. Keep in mind the addressable flow, looking for a new home under MiFID II, will
only be the 10% of total equity business internalised today.

Potential Impact on High-Touch Business

Aprils ESMA Q&A on Market Structure also raised industry concerns on the potential MiFID II impacts on high-touch
trading. The primary concern is that high-touch trading could fall under the MiFID II matched principal definition, which is
essentially outlawed unless considered ad-hoc or infrequent and exempt from the Share Trading Obligation (MiFIR Article
23). This remains open to interpretation in respect to what is considered ad-hoc or infrequent when comparing to the
overall business by trade count or by revenue, but this concern could be compounded by the use of client natural
Indications of Interest, which brokers use to target potential contra liquidity.

The solution could be to be use the Negotiated Trade Waiver for high-touch business and report as On Exchange and
not under the Systematic Internaliser Umbrella, noting this would need to be Large In-Scale so as not to impact the
Double Volume Caps. However, it does mean paying the exchanges to print this business. Regardless we may still see
some further guidance or clarity on this from ESMA or the Commission.

Citi View: The lack of realisation from the regulators as to the potential impact this could
have on high-touch trading may indicate it was not the intention of the regulator when
penning MiFID II to impact high-touch trading in this way.

Third Country Equivalence and Unbundling

Under the new MiFID II Share Trading Obligation, if venues outside of Europe are not considered equivalent by MiFID II
go-live, European investment firms will not be able to trade on those venues in shares available for trading in Europe,

8 Sales & Trading Commentary Not a Product of Investment Research; Institutional Client Distribution Only
regardless of available liquidity, which could be in direct conflict with best execution obligations. So far no third country
venues have been deemed equivalent. However, it is understood the European Commission has started, alongside the
National Competent Authorities, the process to look at equivalence and we now anticipate some clarity on this in early Q4.

Citi View: Industry discussions advocating for STO exemption where centre of liquidity is
on third country venue and consideration around receipt & transmission of business may
also guide the regulators to a more pragmatic outcome on this topic.

In parallel, the buy-side have also been grappling with new trade and transaction reporting requirements, best execution
obligations and research unbundling. Both best execution and unbundling have wider extraterritorial impacts where global
firms look deploy global solutions, especially for those firms outside of Europe managing European client money or
looking to win European mandates. The conflict between European regulations which require hard dollar payment for
Research and U.S. regulations which expressly prohibit hard dollar payment to steer clear of investment adviser
status is an area of intense focus in the U.S. It could potentially threaten the competitiveness of U.S. broker-dealers in
European and global markets. The topic was raised at a 27 June hearing before the Senate Appropriations Committees
Financial Services and General Government Subcommittee, where U.S. SEC Chair Jay Clayton and CFTC Chair Chris
Giancarlo both testified. The industry is hoping for some type of relief that would continue to allow provision of Research
in the U.S., but the 3 January 2018 implementation date is rapidly approaching.

New Market Initiatives Focused on the Changing Regulatory Environment

Block Initiatives

The first half of the year saw the introduction of the BATS LIS designated broker model, allowing for direct buy-side
access to the platform. Initially launched to the sell-side in December 2016, BATS LIS, powered by BIDS, is an indication
of interest negotiation and execution platform for trading Large-In-Scale blocks. Since launch the service has seen
month-on-month growth in value traded, which is currently at around 40+ million. Similarly Turquoise Plato Block
Discovery, the first conditional block matching platform in Europe to address the challenge of decreasing trade sizes in
Europe, continues to see good growth. May saw a record month by value traded of 3.34 billion, 12x more than recorded
in May 2016. This growth has been fuelled in part by the signing of the Plato Partnership Agreement in September 2016,
a non-for-profit industry led initiative to develop block trading services.

Later this year will also see the launch of Euronext Block, a Multilateral Trading Facility powered by AX Trading
technology, which will allow participants to invite trusted counterparties to submit block liquidity using an Invitation to
Trade mechanism. Participants will signal trading interest to selected counterparty groups by choosing who they notify of
their intention to trade as well as how much detail they want to disclose, depending on their trading strategy and how
quickly they need an order to be filled. At launch, Euronext state trading will be available on over 2,000 instruments on 15
markets.

Periodic Auction Mechanisms

th
On June 7 , NASDAQ launched Auction on Demand with initial support from its Nordic members. Auctions on Demand
takes place throughout the day in lit continuous trading and is triggered when there is an opportunity to match orders.
When there are matching bids offers, an auction uncross is triggered, and price and volume are then made public.
Random timing of the uncross, a speed bump and minimum execution size are all features of the service. This, alongside
the BATS Periodic Auction and the LSE intraday auction, should provide alternative liquidity sources for smaller sized
business limited by the MIFID II Double Volume Caps in dark trading. Note auction business is price forming and therefore
exempt from the caps.

Citi View: The use of random, periodic auction on demand solutions have garnered little
support in Europe, but we fully anticipate an increase in use under MIFID II as an
alternative source of liquidity.

9 Sales & Trading Commentary Not a Product of Investment Research; Institutional Client Distribution Only
Other recent MiFID initiatives, like SwissAtMid launched in October last year, are also seeing continued growth, with
CHF380 million traded in June. As the Swiss market is not regulated by MiFID and therefore not impacted by the Double
Volume Caps, SIX Swiss Exchange is marketing the service as an opportunity to match in dark at mid-price in business
below LIS.

Citi View: SIX Swiss may need to relent their position on this if they felt that by not
deploying the MiFID II DVCs, it would prevent them from receiving equivalence.

Separate from MiFID II, A2X, the first South African Multilateral Trading Facility, has been granted a license and should be
operational in Q4 of this year. Partnering with Aquis Exchange, A2X will be styled on the European Multilateral Trading
Facility model listing qualifying equity securities, and will clear all trades executed on it, overseeing and providing
assurance of settlement using Strate as its CSD. With volumes significantly down in that region, it will be interesting to see
the impact competition has on the liquidity landscape.

10 Sales & Trading Commentary Not a Product of Investment Research; Institutional Client Distribution Only
APAC (Asia-Pacific)

Australia
The Australian Securities Exchange (ASX) has released a consultation paper seeking feedback into the outcome
of an internal review into ASXs cash equity market closing price methodologies, particularly in a market outage
scenario.

China
Upon approval by the China Securities Regulatory Commission (CSRC), the Shanghai International Energy
th
Exchange (INE), on 15 May, officially published numerous business rules, including but not limited to the
Articles of Association and the General Exchange Rules of the Shanghai International Energy Exchange, among
other things.

SAT releases the final Common Reporting Standard Guideline. According to the guidelines, financial institutions
including depository institutions, custodians, investment institutions and designated insurance institutions in
China shall carry out due diligence on financial accounts opened in the institutions, identify the tax residency of
account owners and collect relevant account information.

Hong Kong

th
MSCI announced on 20 June that it will include 222 China A Large Cap shares in the MSCI Emerging Markets
Index using a two-step inclusion process beginning in June 2018. MSCI performed an extensive and in-depth
cross-regional consultation on the potential partial inclusion of China A shares in the MSCI Emerging Markets
Index. This global consultation included a large number of asset owners, asset managers, broker-dealers and
other market participants.

The Peoples Bank of China (PBoC) and the Hong Kong Monetary Authority (HKMA) have approved China
Foreign Exchange Trade System & National Interbank Funding Centre, China Central Depository & Clearing Co.,
Ltd, Shanghai Clearing House (together the Mainland Financial Infrastructure Institutions), together with Hong
Kong Exchanges and Clearing Limited and Central Moneymarkets Unit (together the Hong Kong Financial
Infrastructure Institutions), to collaborate in establishing mutual bond market access between Hong Kong and
Mainland China (Bond Connect). The date of formal launch of Bond Connect will be announced later.

HKEX announced that CAS Phase 2 will be launched tentatively in early Q3 2017, subject to relevant regulatory
approvals by the Securities and Futures Commission and market readiness. The exact launch date will be
announced in due course. The main changes in Phase 2 are: (i) input of regulated short selling orders; and (ii)
list of CAS securities will expand to also include constituents stocks of Hang Seng Composite SmallCap Index
(HSSI).

th
The Stock Exchange of Hong Kong Limited (SEHK) announced that with effect from 12 May, 44 additional
securities will be eligible for short selling and 40 existing securities will be removed. The total number of
designated securities for short selling will be 942 after the revision.

Hong Kong Securities Clearing Company Limited (HKSCC) plans to provide Real-time Delivery versus Payment
(RDP) money settlement for Settlement Instructions (SIs) in China Connect markets, tentatively to launch in Q4
2017 (subject to the Securities and Futures Commissions approval). Investors may elect to settle China Connect
SIs on a RDP basis, as well as the existing Free of Payment (FOP) and Delivery versus Payment (DVP) money
settlement methods.

11 Sales & Trading Commentary Not a Product of Investment Research; Institutional Client Distribution Only
India
The Securities and Exchange Board of India (SEBI) has amended SEBI (Foreign Portfolio Investors) (FPI)
Regulations, 2014, prohibiting issuance or transfer of Offshore Derivative Instruments (ODIs) to Resident Indians
(RIs) /Non-Resident Indians (NRIs) or to entities that are beneficially owned by RIs/NRIs.

SEBI has granted recognition to the NSE IFSC Limited under the Securities Contracts (Regulation) Act, 1956.
The NSE IFSC Limited, which is a wholly owned subsidiary company of National Stock Exchange of India
Limited, has accordingly set up a dedicated stock exchange as per the SEBI (International Financial Services
th
Centres) Guidelines, 2015, and has commenced operations with effect from 5 June.

Indonesia
Government of Indonesia has issued Government Regulation in Lieu of Law No. 1 Year 2017 on Access of
Financial Information for Taxation Purposes. This regulation gives access to the Indonesia Directorate General
of Taxation (DGT) to have access to the financial information from financial institutions such as banks, capital
markets, insurance, other financial institutions and/or other entities categorized as financial institutions, in
accordance with the financial information exchange standard based on the taxation international agreement.

The Indonesia Self-Regulatory Organization (SRO) has obtained approval from the Indonesia Financial Services
Authority (Otoritas Jasa Keuangan /OJK) to implement the T+2 settlement in Indonesia in Q1 2018.

Japan
Oversight of high frequency trading (HFT) will be tightened by introducing registration requirement on the trading
th
firms in 2018. An amended Financial Instrument and Exchange Act (FIEA) was made to the public on 24 May,
after passing the current Diet session. The effective date will be set later, but it should be within one year.

Singapore
FTSE Russell announced that constituents of the Straits Times Index (STI) will remain unchanged following the
conclusion of the latest quarterly review.

Taiwan
Taiwan Futures Exchange (TAIFEX) had announced to offer after-hours trading for equity index futures/options,
th th
as well as foreign currency futures/options (FX Futures/Options) on 18 April, with effective date 15 May.

th th
TAIFEX had announced the introduction of S&P 500 and DJIA index futures on 19 April, with effective date 15
May.

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12 Sales & Trading Commentary Not a Product of Investment Research; Institutional Client Distribution Only