European regulators are sounding the alarm about a loophole that could allow brokerage firms to circumvent oversight of their trading activity.

In a letter to the European Commission (EC) published earlier this month, the European Securities and Markets Authority (ESMA) warns that investment firms are setting up networks of systematic internalizers (SIs) in order to avoid certain obligations under the new European regulatory regime known as MiFID II. In particular, the regulators are concerned that firms are creating networks to avoid the obligation that internal matching systems be authorized as trading venues.

The MiFID II regime aims to close a loophole in the previous version of the European rules, which allows significant trading activity to take place outside of authorized trading venues. Yet, it also allows internalizers to undertake matched principal trading “on an occasional basis”, the ESMA says its letter.

“Several market participants have made ESMA aware of their observations that certain investment firms, that currently operate broker-crossing networks, might be seeking to circumvent the MiFID II requirements by setting up networks of interconnected SIs and other liquidity providers,” the letter adds; noting that these kinds of arrangements could allow firms to avoid the new oversight regime.

“We are very concerned about this potential loophole,” the ESMA. The group calls on the European Commission, “to determine whether it should use any of its regulatory tools” to address the issue.”