MiFID II may be grabbing all the limelight but Jannah Patchay, Markets Evolution argues now is the time to look at the Great Repeal Bill.
Following a cluster of European regulations going live at the outset of 2018, including MiFID II and PRIIPs, the industry has reluctantly turned its gaze towards Brexit. Depending on your point of view, it’s the stuff of either dreams or nightmares.
The initial 18 month period following the referendum decision consisted mainly of nerve-wracking suspense, interspersed with wistful fantasies about passporting rights being maintained. Now, however, the financial services industry has grudgingly accepted the need to expect the worst (whilst hoping for the best), and many firms’ Brexit plans are now chugging along, if not at full steam then at least with an air of inevitability about them.
With attention focussed on the more immediate practicalities of location strategy, the first three months of MiFID II have been something of a damp squib. There’s also a certain weariness amongst industry practitioners; having spent the past four or more years of our careers focussing on a single, all-encompassing motherlode of a regulation, go-live has been a somewhat deflating experience. However, for those who thrive on the fertile ground of uncertainty and change, there’s a lot more of that to come, with the impact of Brexit on MiFID II yet to be fully understood!
We know that the intention of the Great Repeal Bill is to transpose directly-applicable EU law into UK law, thus preserving legal certainty during the process of disentangling the UK’s affairs from the EU. This will include all current European financial markets’ Regulations. Directives, on the other hand, are already transposed into UK law. This is an important distinction. MiFID II, as a Directive, already exists in UK law. It’s mainly built into the FCA Handbook, with authorisation, governance and management, investor protection and other provisions embedded in the relevant sourcebooks.
Aside from the passporting arrangements, most of these, such as best execution, costs and charges, order record keeping, and senior management responsibilities and arrangements, are fairly standalone and likely to continue unaffected following a Brexit in any form. Furthermore, the FCA has historically played a very active role in developing these business conduct standards, and in some cases has even gold-plated the EU’s proposals. While there is scope for the FCA to diverge slightly from the EU in terms of detailed disclosure requirements, it’s relatively safe to assume that there will be little or no change to these principles.
MiFIR, on the other hand, represents the part of MiFID II that will have to become, in future, part of UK law. As a Regulation, it is currently directly applicable to all EU Member States. And this is where, for anyone with even a passing acquaintance with MiFID II’s impact on trade execution and transparency, things start to get really interesting.
Let’s start with the Systematic Internaliser (SI) regime, aimed at bringing bilateral OTC trade execution into a more lit environment, by imposing similar requirements around price transparency and execution as those to which multilateral trading venues are subject. An investment firm or credit institution is deemed to be an SI in an instrument or set of instruments if it exceeds certain thresholds in terms of its OTC trading with clients, as measured against total European activity. What happens, in practice, when the UK is no longer part of the EU?
The instrument scope of the SI regime is dependent on the “Traded On a Trading Venue” (TOTV) designation, which is determined by whether or not an instrument is available to trade on a MiFID trading venue (RM, MTF or OTF). Given the UK is currently (and will quite likely continue to be) home to a substantial proportion of total European trading activity, its departure will remove a significant chunk from the denominator of the SI calculation.
There is some uncertainty around how the TOTV scope will be impacted, as this is dependent on the Brexit plans of existing MiFID trading venues (many of which are currently UK-authorised and will likely need to migrate at least part of their activity to an EU27 location). Assuming the SI regime will remain largely intact in the UK, and all other things being equal, this means that many more firms could find themselves subject to either the EU or UK SI regimes (depending on where they are based).
If a firm is an SI, it has an obligation to make pre-trade quotes public via an Approved Publication Arrangement, or APA – like a market data vendor. APAs are currently authorised to operate across the EU. Post-Brexit, there will be a split between EU and UK APAs. What will this mean for the quality of pre-trade data (which is admittedly not great at the moment)?
Moving on to multilateral trading, what is the likely future for the Derivatives Trading Obligation (DTO)? The DTO scope is (typically, but not necessarily) a subset of the instruments subject to the EMIR Clearing Obligation. Trades in instruments subject to the DTO, and for which both parties are subject to the Clearing Obligation, may only be executed on a MiFID trading venue.
The determination of this subset of instruments is based on a number of factors, including liquidity, availability on more than one trading venue, accessibility to participants, etc. A split in liquidity across EU and UK instances of a trading venue will impact all of these factors. Furthermore, the ability of firms to continue trading with counterparts in other jurisdictions that are subject to their own trading obligations (such as the Trading Obligation for SEFs in the US, and a number of APAC variants) is predicated on an equivalence determination being made between both jurisdictions.
The UK must independently agree venue equivalence with not only those countries but the EU as well, in order to prevent both catastrophic liquidity fragmentation, and possibly irreparable damage to London as a trading hub in terms of the location strategies chosen by firms.
These are but a small taste of the wider challenges that the Great Repeal Bill will pose to both the UK and EU financial services industries, post-Brexit. It’s also worth bearing in mind that MiFID II is the primary source of EU rules around third country market access, both to and from the EU. Due to the highly politicised climate, many of these rules have yet to be fully defined by ESMA, pending the outcome of UK-EU negotiations – especially given the UK will be the third country most significantly impacted by them.