* EU foresees electronic trading of derivatives as "the norm"
* Broker crossing networks inside banks to be regulated
* New category of rules for high-frequency trading
* New starts face same regulatory requirements as exchanges
* "Third country equivalence" test for non-EU firms
(Recasts with more detail, banking reaction, Factbox link)
By Huw Jones
LONDON, Dec 2 (Reuters) - The European Union plans to strengthen its share trading rules to crack down on ultra fast and off exchange trading with other asset classes also brought under the net, a draft EU document showed on Thursday. The EU's executive European Commission is due next week to publish its plans for sweeping reforms of the bloc's markets in financial instruments directive (MiFID) which forms a cornerstone of Europe's single capital market.
The 80-page document has taken some bankers by surprise as it seeks to bring bonds, deposit receipts, commodities and other traded instruments tighter under the MiFID net. [ID:nLDE6B114X]
The aim is to apply lessons from the financial crisis and keep pace with advances in technology.
Exchanges, who have lost market share to new trading venues backed by banks, privately welcomed the plans while banks are already expressing disappointment.
The plans include regulating share trading inside banks and giving supervisors powers to set position limits in commodities markets and ban products they think are too risky.
Imposing civil liability on investment firms for breaking MiFID rules is also proposed.
Trading of standardised derivatives on an electronic platform rather than bilaterally between banks as is currently done, would become the "norm".
The ability of countries like Britain to slap on extra liquidity requirements on banks from other EU states operating on its turf could also be severely curtailed.
More explosively, investment firms from outside the EU who want to do business in the 27-nation bloc would have to show their home rules are just as stringent as those in the EU.
"This country equivalence is potentially very serious. We could have the hedge funds passporting issue mark II," said one banking official.
The United States accused the EU of protectionism when the bloc pushed for a similar set up for allowing hedge funds to operate in Europe and the bloc watered down its approach.
The EU's financial services commissioner Michel Barnier will make formal proposals to amend MiFID next summer. EU states and the European Parliament have the final say and the assembly has already signalled it wants a tough reworking of the rules.
Bankers say the plans mark a change in approach from automatic waivers from some MiFID rules unless there has been a market failure to having to work hard to justify any waiver.
"A switch in the burden of proof, if you like," a banker said.
SIGNIFICANT EXTENSIONS
MiFID has driven competition, innovation and better protection of investors and cut trading costs per transaction and speeded up trading, the draft consultation paper says.
But as part of global efforts to tackle less regulated and more opaque parts of the financial system, "significant extensions" are required, it added.
The consultation paper obtained by Reuters showed the EU's executive wants to crack down on trading inside banks and brokers which exchanges say reduces market transparency.
"The Commission services consider it appropriate to define and create a new sub-regime for crossing systems within the family of organised trading facilities," the document said. "Such a regime would cover not only equities but also other types of financial instruments."
Derivatives in the vast off-exchange market should be transacted on an electronic platform of some sort if they can be centrally cleared and are liquid enough, the document proposes.
"At a minimum this would imply that trading on exchanges and electronic platforms becomes the norm when the market in a given derivative is suitably developed and when the shift to such platforms further the G20 commitment," the document said.
This echoes a new law in the United States which also pushes derivatives trading onto electronic platforms and creates a new category of swap execution facility.
The consultation also proposes a new regime within MiFID to regulate the use of computer of high-frequency trading (HFT).
This refers to ultra fast trading which has raised concerns among regulators, particularly after the "flash crash" on Wall Street in May when blue chips went briefly into freefall.
Proponents say it provides up to a third of liquidity on
markets like the London Stock Exchange
"Perhaps the most significant new risk arising from automated trading is the threat it can pose to the orderly functioning of markets in certain circumstances," the EU document said.
It outlines a specific regime for automated trading of which high-frequency trading would be a subcategory and proposes several requirements such as risk controls and ensuring that orders can only be cancelled after a certain period.