At over 330 pages, the new Financial Services and Markets Bill submitted to Parliament on 20 July, 2022 is the biggest piece of financial markets legislation since the original Financial Services and Markets Act (FSMA) was first published, way back in 2000. But is it the ‘Big Bang 2.0’ that government sources suggested we could expect – and could it herald a long-awaited (and widely hoped for) period of regulatory relaxation similar to the sudden deregulation of the financial markets under Thatcher in 1986?

The bill is wide-ranging, covering vast swathes of the financial markets across everything from insurance to payments, but for wholesale players it contains some particularly relevant provisions, under the aegis of the Future Regulatory Framework (FRF) Review, first established in November 2021 to explore how the UK’s regulatory framework should evolve to fit the country’s new ex-EU position.  

Sections three, four and five of the bill specifically outline broad powers for HM Treasury to modify or review retained EU onshored legislation and replace existing references to EU directives. The Treasury now has the authority to amend onshored legislation and EU directives “for the purpose of making the law clearer or more accessible,” which is in theory promising.  

Beyond that, however, there are few surprises, with much of the relevant content following a similar path to that already proposed across parallel platforms such as the UK Wholesale Markets Review, the UK Listings Review, and the FCA’s recently launched equity secondary markets review.  

A notable change is that the bill delegates power from primary legislation down to both the Financial Conduct Authority (FCA) and the Treasury, in keeping with the government ambition of “agile regulation,” which could see faster and more responsive updates to reflect industry needs.  

“This can be seen in giving the FCA power to frame waivers from post-trade transparency requirements, via a replacement Article 4 of the UK onshored Markets in Financial Instruments Regulation (MiFIR), as well as giving the FCA rulemaking power over both pre- and post-trade transparency requirements for both fixed income instruments and derivatives,” pointed out law firm DLA Piper. 

Another significant element of the new bill is that it deletes the Share Trading Obligation (STO), along with a large part of Article 23 of the UK’s onshored Mifir (the regulation governing Mifid II), meaning that UK firms’ only requirement to be authorised as an MTF would be to operate an internal matching system to executive client orders for equities and equity-like instruments.  

The bill also introduces the concept of new ‘financial markets infrastructure sandboxes’, particularly in the fields of digital and other alternative trading, clearing or settlement solutions where operations do not easily fit into existing regulatory criteria – a move that should come as welcome news to digital pioneers.  

In addition, a ‘critical third parties’ provision brings service providers to the financial markets closer to regulatory supervision – in particular, data and cloud services providers, along with some intermediaries.  

And the bill plans to extend current banking and payment system rules to include crypto assets including stablecoins – something that may not directly impact the trading community immediately, but is reflective of the wider move towards a more robust regulatory attitude in the crypto space. 

This liberalisation of the secondary markets, coming as it does on the heels of a new capital markets reform taskforce headed by the London Stock Exchange, a new secondary markets committee formed by the FCA and including numerous heads of trading, and of course the recent consultation launched by the regulator on how to improve the UK’s equity markets, suggests that momentum for streamlining the UK’s regulatory environment could finally be gaining pace.  

“After a long period of increasing regulation, this bill might well be the catalyst for a long period of decreasing regulation. Either way, the ability to adapt to change will continue to be a sort after attribute for financial market reporting processes and frameworks,” agreed Phil Flood, regulatory expert at Gresham Technologies, speaking to The TRADE.    

“It is fair to say that we’ve been talking about divergence post-Brexit for a while, but nothing materially has changed so far. Many have anticipated a period of deregulation as the promise of Brexit was a more competitive landscape for the industry in the UK, but the regulator hasn’t really moved things forward.” 

Given that the latest bill was introduced to Parliament just a day before the summer recess, we are unlikely now to see any movement until at least September. Once Parliament returns however, the new leader of the Conservative party – and by default, new prime minister (whoever that may be) is likely to be keen to drive forward these reforms as part of the party’s signature financial liberalisation package post-Brexit, suggesting that we could see swift movement once the ducks are finally in a row.  

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Following the UK’s departure from the European Union, Europe has favoured stringent rules around the SI regime including limiting their ability to match at mid-point on small trades and from using the reference price waiver to execute small trades by introducing a minimum threshold.

The UK in its Wholesale Markets Review (WMR) has taken a divergent approach, scrapping limits on SIs all together. These differing approaches have created what one panellist referred to as a “philosophically different approach to price formation” on either side of the channel.

Panellists speaking on the market structure and regulatory divergence panel hosted by The TRADE at the London Stock Exchange (LSE) on Tuesday were divided on whether the UK’s liberal approach would favour end investors or hinder them by damaging price formation and allowing institutions with the best technology to take advantage of access to private information that the rest of the market could not see.

“The more bilateral trading you have in the marketplace and the more private interactions that are happening out there, will mean there are advantages for certain people,” said one panellist.

“Some say that’s fair and reasonable but there are others who are worried that the smartest people in the room are touching flow that’s not been seen by others and as a result are making decisions based on private information. If I can’t access all those puddles of liquidity I’m going to be at a disadvantage. Yes, brokers can weave it all together for me, but that’s very convenient for brokers.”

Europe’s approach to limiting the quasi-dark trading mechanisms has been focused on smaller trades with the aim of pushing them back onto lit markets, leaving larger trades within the remit to be executed on SIs to limit market leakage.

“SIs have a place but we are concerned about the proliferation of bilateral mechanisms that are not offering an outcome that is any different from a normal trading facility. Same price, same size. Why is that liquidity not coming together to help deepen price liquidity?” the panellist continued.

However, this view was not upheld by all those on stage, with other panellists questioning where regulators should draw the line to define what constitutes a private network.

“Where is a private network? If someone has a dealer board and have buy-side phoning up wanting to trade a piece of risk is that a private network? Or is it the fact that you’re processing it electronically and you’re connecting a network together to process an electronic message.”

Transparency  

Regulators on both sides of the channel have favoured the scrapping of best execution RTS 27 and 28 reports and all panellists agreed this was a step in the right direction. However, with the reports gone and without a tape implemented, some participants raised the question of how best execution could be fairly measured.

“How do we ensure best execution? We need a tape to ensure best execution if RTS 28 reports are being scrapped and with no common benchmark,” said one participant.

“The US has a tape for every asset class. Our deferrals need to change too. Who cares about a trade that happened 4 weeks ago? Even the 605 and 606 reports in the US, those reports are helpful. Let’s replace RTS 27 and 28 reports with something helpful that allows us to do the maths and assess what is really happening. Until we have that we can’t prove best execution.”

Another speaker stressed the importance of post-trade transparency as a price indicator, highlighting that with it there was little need for pre-trade transparency within a consolidated tape in Europe and the UK. Whether or not the tape should include pre- and post-trade data has been a widely debated subject.

Both the UK and Europe have put forward proposals for a consolidated tape in their various regulatory reforms with Europe opting for a single post-trade tape provider per asset class and the UK yet to confirm whether it will opt for multiple tape providers and whether will be either post- or pre-trade or both.

“The next pre-trade transparency is the last post-trade transparency. The most important thing is post-trade transparency because it’s what the market paid for a particular security. It’s a true telling price,” the panellist said.

Liquidity

All panellists agreed that the vastly divergent approaches to regulation taken by the UK and post-Brexit had had and would continue to have a “detrimental” effect on liquidity. Upon the completion of Brexit, a lack of an equivalence decision between the two entities saw upwards of 95% of EEA securities trading migrate to Europe from the City. As rules diverge further, there is potential for this liquidity to become even further fragmented depending on the range of rules in each region.

“Pools of liquidity being segregated for investors is not what we want to see. We leaned on brokers heavily when there was that migration of liquidity to European venues. With divergence it’ll be the same again,” said panellist.

The market structure and regulatory divergence panel was part of a series of three panels hosted by The TRADE at LSE on Tuesday as part of its inaugural Mifid II Review Roadshow, attended by over one hundred industry participants. Click here for more information about additional Mifid Roadshow events taking place across Europe this summer.

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Chancellor of the exchequer, Rishi Sunak

The UK Treasury has published its capital markets review consultation that outlines its most detailed plans for sweeping changes to key MiFID II requirements in a post-Brexit world.

Under the government’s plans, MiFID II regulatory requirements for systematic internalisers (SIs), the share trading obligation (STO), dark trading restrictions and the tick size and transparency regimes will be overhauled.

Alongside changes to MiFID II, HM Treasury published several documents that outlined the UK’s approach to boost the finance industry post-Brexit. In a speech at Mansion House in London, chancellor of the exchequer, Rishi Sunak, said that as agreements with the EU on equivalence had not happened, the UK will now move forward with its own priorities.

“More open, more competitive, more technologically advanced, and more sustainable – that is our vision for financial services. The roadmap we are publishing today sets out a detailed plan for the next few years – and I look forward to delivering it, together,” Sunak added.

Under the proposed changes to Europe’s MiFID II, the UK government would allow multilateral trading facilities (MTFs) to execute transactions on a matched principal basis and dark pools to match orders at the mid-point within the best bid and offer of any UK or non-UK trading venue, rather than at the best bid and offer of the venue with ‘the most relevant market in terms of liquidity’ as defined under the requirements.

SIs would also be able to execute orders at the mid-point for all trades, including trades that are below large in scale (LIS), providing the executed price is within an SI’s quoted price. SIs became subject to the tick size regime last year, which proved controversial and restricted the venues’ ability to offer price improvements on orders below LIS.

Exchange groups have previously argued that SIs had an unfair advantage over lit venues in offering price improvement that would divert routing of client orders towards SIs instead of on-exchange venues. Major asset managers, including BlackRock, urged regulators to protect mid-point trading amid debate that the tick size regime would potentially be extended to SIs, periodic auctions and block trading venues.

The UK’s consultation added that amendments to the pre-trade transparency regime to encourage SIs to quote in more meaningful sizes would also contribute to price formation. SIs are currently required to publish quotes when they are quoting up to 10% SMS (standard market size) in liquid instruments.

As confirmed previously, the UK government will officially scrap the STO which requires investment firms to trade on a regulated market (RM), MTF, SI or equivalent overseas venues. The STO’s objective to increase lit trading activity has not been achieved, the consultation said, while the ability to execute at venues that offered the best price for investors had been limited.

The double volume caps (DVCs), which restrict the amount of dark trading that can take place on an instrument and market-wide level, will also be scrapped. The UK’s Financial Conduct Authority (FCA) will, however, monitor the level of dark trading and gain powers to suspend activity based on various metrics under the HM Treasury’s proposal.

Dark trading has been at the centre of the UK’s strategy to win back roughly €8 billion in trading volumes that left London-based venues in January 2021 for EU-based venues as the Brexit transition period came to an end. The UK has already slashed the threshold for LIS transactions for dark trading, in stark contrast to the EU which has limited dark trading, in an attempt to win back some of those volumes.

Citing a report from 2017, which suggested the DVCs were not suitable, the consultation said the DVCs are not an appropriate tool to protect price formation in UK markets. The FCA also highlighted in a separate report earlier this year that trading in dark pools can save execution costs for investors. Buy-side traders will welcome the decision to eradicate the DVCs. Following the EU’s review of MiFID II last year, a survey carried out by Rosenblatt Securities found that 75% of buy-side respondents supported the removal of the DVCs in their entirety.  

For fixed income and derivatives, the UK government is looking to overhaul the pre- and post-trade transparency regime. Complex liquidity calculations, which determine whether trades should be made public in real-time, would be replaced with a qualitative and quantitive assessment.

Highlighting that the liquidity calculations are not effective, the consultation said that between 52% and 69% of the corporate bonds that were included in an analysis by the FCA that were determined as liquid under the MiFID II calculations, were in fact illiquid.

The UK government also hopes to limit the scope of the pre-trade transparency regime to systems that operate under full transparency such as electronic order books and periodic auctions. The move would mean bilateral trades are exempt from the regime, and investors would gain more choice over opting into pre-trade transparency.

Elsewhere, the consultation explores options for a private sector established consolidated tape in fixed income. There is more urgency to develop a tape for fixed income data, the government said, as fixed income trading is less concentrated than equities and a larger share is executed OTC rather than on venues.

Plans for a consolidated tape in fixed income will also be welcomed by market participants, who have agreed that as there is still no tape in equities, it is a distant dream for fixed income. Some have argued that regulatory intervention is required if a tape is to be established as the task is deemed too costly to develop. The European Commission outlined plans to push for a tape in bond markets in January this year amid increasing pressure from the industry.

Market participants have been asked for feedback on all of the UK government’s proposed plans when the consultation opens on 2 July. Respondents have until 24 September to submit responses.

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Early signs of the UK’s split from EU regulations came last year when the UK Treasury confirmed it would not implement the Settlement Discipline Regime (SDR), set out under the Central Securities Depository Regulation (CSDR). 

UK Ministers are now reportedly planning to overhaul MiFID II, the EU’s main financial services legislation, as it looks to hold onto its place as a global financial centre. Changes could include scrapping the share trading obligation, which forced more than €6 billion a day of EU-denominated stocks out of London to European-based venues mainly in Amsterdam. 

With the UK and EU to set out separate paths on financial regulation, there are various implications this could have on the post-trade landscape alongside potential unintended consequences that may arise for firms. 

A battle for clearing

The battle to win euro-denominated derivatives clearing activity, a business worth some $660 trillion, is one of the fiercest between UK and EU regulators. Currently, London is the home to derivatives clearing, with most of the activity going through LCH. Despite moves from Eurex, the Frankfurt-based exchange group, to lure activity from London, LCH has maintained its hold of the market. 

A temporary 18-month equivalence for UK clearing houses was enacted in September 2020, enabling LCH to continue providing euro-denominated clearing services from January 2021 until June 2022. 

However, tensions are heating up between regulators, and it appears equivalence will not be extended beyond 2022. In February, the Bank of England’s Andrew Bailey warned over a “serious escalation” in relations with the UK if Brussels attempts to force banks to move all clearing of euro-denominated derivatives from London to the Eurozone. 

In his speech to the UK Treasury Committee, Bailey highlighted how the consequence of no further equivalence decisions at the end of the 18-month period would mean that a quarter of euro-derivatives clearing would move from the UK to the EU. This 25% chunk of euro-derivatives clearing is not a “viable” amount for the EU to process, Bailey explained to MPs.

“The reason is, particularly in an activity like clearing where the efficiency really comes from having a very big pool of derivatives that can be netted and cleared down, by splitting that pool up the whole process becomes less efficient and having the smaller part of the pool would be even less efficient,” he said. “The clearinghouses also involve a certain level of cross-currency netting to go on and that would break down as well.”

To obtain the remaining three-quarters of total euro-denominated derivatives activity, Bailey said the EU could potentially “force or cajole banks and dealers to say there will be some other penalty unless you move this clearing activity into the EU”. 

This, he warned, would create “a very serious escalation of the issue” and was something that the UK should “resist very firmly”. Activity has not yet shifted from the UK, as banks await clarity on what is to come. 

“The situation is unclear on what will develop after June 2022, and we have clear messages from the Commission to move euro-denominated contracts/products to EU-located CCPs,” says Haroun Boucheta, head of regulatory affairs at BNP Paribas Securities Services. “The industry has pressure from the Commission to work closely on operational solutions to migrate euro business, using EU27 CCPs.”

Post-trade fragmentation

The lack of cross-border equivalence for not only clearing, but also settlement of securities, means clear lines have been drawn between UK and European post-trade venues. Banks are concerned about the impact of fragmentation on costs for clearing and settlement. 

The costs will come from investment firms and banks having to adapt their technology infrastructure to manage a dual post-trade framework. Larger-sized firms may be able to absorb these costs, but it will make barriers to entry for smaller-sized firms even harder to overcome. As a result, some asset managers could be forced to operate in just one jurisdiction.

“Firms have broadly adopted a model where you have one system, but you guide the trade processing to different venues, with localised processing funnels,” says Samir Pandiri, president at Broadridge International. “A very small second group are firms who basically decided they didn’t have the scale in either the UK or the Continent to make it worthwhile preparing to continue service in that jurisdiction.

“Post-trade solutions need to take into account three variables: trading in multiple geographies, clients in different jurisdictions and where the post-trade processing is actually done. We did a lot of one-off configuration with new client entities since 2016, and that’s all been working well. But the Brexit work is also enabling a broader re-set on post-trade, with providers needing much more flexible/customisable systems to keep competitive. 

“With trading volumes moving around between venues, post-trade services must now offer much more price flexibility and more variable cost, which will act as a further stimulus to mutualisation. The increased complexity also highlights the necessity of better data models, to spot inefficiencies, such the costs of a fail for example.”

Regulatory fragmentation

As outlined, the UK is seeking to overhaul certain European regulations to make itself a more attractive financial services centre. It could appear that the UK is taking a different approach to post-trade regulation, following its decision to not implement the SDR rules. It did, however, state it will consider the future approach of the rules to the UK’s own post-trade framework.

The danger here for firms is that regulatory fragmentation could require double the amount of work and resources to stay compliant in both jurisdictions. 

“With the UK opting out of CSDR, there will be separate regimes around settlement discipline,” highlights Reto Faber, head of direct custody and clearing for EMEA at Citi. “It may look to align with some aspects of CSDR, but right now it looks like there will be a dual system affecting cross-listed shares. This is going to bring additional and duplicated costs, as well as increased complexity to deal with multiple regimes.” 

That being said, the decision by the UK to implement CSDR differently could provide a glimmer of hope for banks and investment managers that the EU will review its contentious mandatory buy-in regime. 

“Fragmentation is going to come on a wider scale throughout the year. With the UK implementing SDR separately, the regulation may come back to the table very differently where they could make the buy-in optional rather than mandatory,” says Linda Gibson, head of regulatory change at BNY Mellon’s Pershing.

“But the market is waiting on how the UK will implement SDR, causing some operational challenges to firms that are international. Those that have project plans in place are working on the EU regime, so the challenge is to anticipate how different the UK will be.” 

The European Commission recently closed its consultation of CSDR and is set to publish the findings of its review in the second quarter. Many are hoping European regulators will do away with the buy-in regime (which seems highly unlikely) or implement it on a discretionary basis. 

As a result, European regulators could opt for more favourable changes so that it is more aligned with the UK.

“We have pushed for a voluntary buy-in regime rather than a mandatory one, and specific exemptions in terms of products and operations which should be out of the scope of the SDR,” says Boucheta. “The UK move not to implement the full CSDR rules will bring the attention from EU regulators, and it is a good thing to help us push our various points.” 

In addition, Broadridge’s Pandiri believes that regulators will eventually look to align their respective frameworks that can preserve the flow of securities processing and post-trade activities. 

“While it looks like regulatory fragmentation at present, I do see this as a ‘creation moment’ for things coming back together, as practical market innovation starts to produce more fungible solutions that actually make securities processing easier across markets,” Pandiri says.

Going forward, the UK and EU will most likely stay in close contact when formulating and implementing financial services regulation. The UK has been a leading voice for many of the post-financial crisis regulations, and it is hoped their expertise will continue to be leveraged. 

“The UK played a very important role in Brussels, and though it is no longer directly involved, it should carry on discussions for securities services regulations to avoid unintended consequences,” Boucheta concludes.

This article was featured in the Spring 2021 edition of The TRADE magazine.

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Ahead of your participation on a panel discussion at TradeTech’s virtual conference on liquidity in a post-Brexit environment, tell us about the impact of market structure changes since Brexit.

We were quite fortunate and not massively impacted by the equivalence issue relating to trading venues because we don’t have any EU share trading obligation (STO) clients, so that part has been relatively straightforward for us.

But I think the situation with the Swiss Stock Exchange when they had 100% market share for a period after losing equivalence was a good experiment for the industry in many ways. It took away competition and it went back to a single venue. I’m keen to discuss that on the panel and whether we have gone too far in the debate about the benefits of competition between multiple trading venues, with all the issues that go with that around the availability and cost of market data, smart order routing, plus the impact on volumes, spreads, costs etc. 

With the Brexit scenario, we had a lot of time to prepare, and it was well thought out internally. The execution mechanics might be slightly different, but we still get the same outcome. London has lost its market share as the number one place to trade shares in Europe and most of that share has gone to Amsterdam, but it is just that venue location which has changed. 

When you look at market share and where volumes have migrated to it appears to have had quite high impact, but from the day-to-day point of view it has been very low impact. Whether the smart order router goes to Amsterdam or London, you know you’re getting the same price, at the same time from the same place.

What are the main challenges for traders sourcing liquidity in a post-Brexit landscape?

Operationally the main challenges were around client reporting. There were lots of new MIC codes that suddenly sprung up that nobody had seen before and they weren’t set up in the systems, so there were some issues on the transaction and trade reporting side. It took a few weeks to resolve those challenges. 

Structurally the liquidity hasn’t necessarily changed and it hasn’t suddenly created new participants. However, in terms of coverage, we’ve seen banks moving people to EU destinations and I think that has had quite a big impact. There have been some positive comments from the government about regulation and how they can make the UK more attractive while ensuring there is still a stringent code of ethics and protection. But for London as a trading hub, the impact is potentially much greater than on individual asset managers. 

What are your thoughts on the UK’s decision to loosen rules on dark trading? Is this a positive development for market participants?   

I think the development could take away a complication that emerged from MiFID II. The double volume caps and dark trading rules, even the large in scale calculations, were not quite right. But the market is very good at providing a solution to work around such issues. The outcome will be the same for us, but the venue that we are trading with will potentially be different. It won’t create new liquidity and it won’t take liquidity away, it will just change the mechanics of how it works.

There are other areas too like IPO listings. The UK is trying to make that more attractive, which is quite interesting. It has been a hot topic for years, but it seems things have really started in earnest with that. We, at Schroders, are very supportive of the proposed changes but I am conscious that there are differences of opinion. I’m also interested in other people’s opinions around SPACs as they come into Europe and as the SEC in the US has started to ask more questions regarding these vehicles. Listing can be costly and time-consuming, but safeguards are, of course, needed. If you take away the time-consuming part and some of the costs, do you remove those safeguards? Could it be a regulatory loophole in terms of listing quickly with less insight into the actual company? That’s an interesting area in terms of market structure. 

What other topics are you expecting will be discussed at this year’s TradeTech event?

It’s a very quiet period for regulation that we are going through. There was a lot of movement with Brexit, but that has come and gone quite successfully. The MiFID II review is interesting, particularly from a fixed income perspective, looking at the role of MTFs and OTFs. For equities, it is quite a stable platform and everybody is relatively content. I expect the consolidated tape will be a theme and we have been discussing that since the start of MiFID I. It is frustrating that we have been discussing it for so long and nothing has been done about it. The tape should be much more insightful than just looking at the volume, I think it should go a step further and look at participants’ market share. 

In my view, it should be broken down more so we can see HFT flow as direct members, and then for sponsored access we should be able to see broker access flow, broker client flow, broker proprietary flow – and this is easy to distinguish in terms of market share. That would be very useful, particularly on volatile days as we saw back at the height of the volatility in 2020. Some of the numbers from HFT firms show they were 70% of the volume, which I can believe because everyone went to the order book. But if you want to go back and analyse that period you need to know how much of a part the HFT firms played in that volatility, but you wouldn’t be able to.  

Which panel discussions are you most looking forward to attending at TradeTech this year?

I am looking forward to a number of the panels but the one regarding accelerating trading and automation will be interesting as we have been doing a lot of work in this area across multi asset over the last two to three years. It will also be interesting to hear views on crypto for institutions and the role that will play in the future.

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TP ICAP said in a statement that since losing its European passporting rights due to Brexit, its UK-based subsidiaries no longer have the full scope of regulatory permissions to continue servicing all clients in the EU.  

The broker added that due to the ensuing global pandemic, in particular stay-at-home restrictions and travel bans, it has been unable to relocate or hire new staff to operate its Paris-based Brexit office as planned.

TP ICAP’s UK business will continue to service certain EU clients under temporary permission regimes, and the firm does not expect any material impact to profits as a result of the issue.

“Following discussions with its lead regulators, the Group believes that, as a temporary measure, those lead regulators will allow the Group to continue to provide services to clients based in the 27 countries of the EU using London-based brokers acting on behalf of its UK-regulated entities, in order to support the stability and connectivity of the markets,” said TP ICAP.

The news marks one of the first major disruptions to financial services following the UK’s departure from the EU and the end of the Brexit transition period at the start of this year. As of 4 January, many trading venues and brokers continued to operate in EU hubs that were established prior to the transition deadline.

TP ICAP reaffirmed its commitment to complete the relocation of staff to Paris and launch the new entity as outlined but gave no indication as to when this will be completed.

The broker is currently undergoing a restructure of its broking business following a decline in revenues in 2020 due to extreme market conditions. TP ICAP said in November that it may reduce staff as it looks to achieve £35 million in savings by the end of 2021.

Elsewhere, TP ICAP is in the process of acquiring institutional trading network and platform Liquidnet after agreeing to a $700 million takeover in October. In a statement on 7 January, TP ICAP said that Liquidnet had proved “resilient” in the midst of the COVID-19 pandemic.

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The retractions from ESMA come just days after Britain’s departure from the European Union and its transition period.

“The move by ESMA was not unexpected. However, this shouldn’t have a major impact on the industry.  The trade repositories have set up EU domiciled entities and the switch over to those entities has gone smoothly.” Said Sean Tuffy, head of market and regulatory intelligence securities services at Citi.

TRs are used to comply with regulations such as EMIR and SFTR. . Policies require ESMA to retract the registration from any firm who no longer meets requirements they had when first registering.

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Under the rules, known as the derivatives trading obligation, derivatives that are in-scope of the requirements must be traded on venues within the EU or in third-country venues that have been granted equivalence.  

The European Securities and Markets Authority (ESMA) outlined its approach to the rules in March 2019, and in the most recent update confirmed it does not consider a change in its approach is warranted. It added that without a UK equivalence decision from the European Commission, it will provide no further guidance.

Most trading in derivatives subject to the trading obligation is currently executed on UK trading venues, but without equivalence, this activity will have to shift to Europe from 31 December as the UK’s Brexit transition period comes to an end.   

European banks with entities in the UK that trade derivatives subject to the rules will be particularly impacted, ESMA acknowledged, as they will be subject to conflicting trading obligations in both the EU and the UK. ESMA stated that “this situation is primarily a consequence of the way the UK has chosen to implement the derivatives trading obligation”.   

The development also means that EU and UK counterparties wanting to trade derivatives with each other on a cross-border basis would only be able to do so on swap execution facilities that are based in the US. 

ESMA added that most UK venues that offer trading in derivatives subject to the rules have established venues in the EU, allowing firms in Europe to comply with the trading obligation. However, as market participants are still being onboarded, such as major liquidity providers, ESMA admitted that trading on those venues is currently limited.  

An in-depth report from the International Swaps and Derivatives Association (ISDA) published in September said it is critical that the EU and the UK recognise equivalence of each other’s derivatives trading venues post-Brexit.

Without equivalence, ISDA warned, counterparties subject to the derivatives trading obligation will face significant issues as fragmentation of liquidity in OTC derivatives markets is exacerbated. 

“Given that UK and EU trading venues will operate under substantively the same regulatory  frameworks at the end of the transition period, there are no technical reasons why these  equivalence decisions should not be made,” ISDA said.  

The statement from ESMA on the derivatives trading obligation is the latest in a series of regulatory developments from both the UK and the EU as the deadline on 31 December marking the end of the Brexit transitions draws closer.  

Earlier this month, the UK agreed to allow banks and investors to trade on EU venues under the share trading obligation, despite the EU taking a more complex approach to the rules which is based on certain conditions.  

Shortly after, chancellor Rishi Sunak outlined a set of equivalence decisions for the EU covering certain areas in clearing, central securities depositories, benchmark administrators, as well as derivatives and OTC trading.  

“By taking as many equivalence decisions as we can in the absence of clarity from the EU, we’re doing what’s right for the UK and providing firms with certainty and stability,” Sunak commented at the time.  

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In a statement, Goldman Sachs said it will launch SIGMA X Europe MTF before 4 January next year and it will be available alongside its UK-based SIGMA X MTF. The Paris venue will include its dark pool and periodic auction order book.

The move will allow the investment bank’s clients within the European Union to continue accessing liquidity post-Brexit.

“We want to ensure that our clients continue to have access to all of our key liquidity sources post-Brexit,” said Liz Martin, global head of futures and equities electronic trading at Goldman Sachs. “SIGMA X MTF is central to ensuring we achieve the best execution for clients today. The launch of the European MTF will continue to deliver these execution benefits to all clients.”

Goldman Sachs added the SIGMA X Europe MTF will launch with European symbols across 15 markets as the UK-based venue continues to list UK and European symbols.

As the Brexit transition period prepares to come to an end, the UK recently confirmed it would grant the EU equivalence in key areas such as clearing, central securities depositories, benchmark administrators, as well as derivatives, and OTC trading.

Goldman Sachs is the latest institution to opt for a Paris-based European venue in preparation for the UK’s departure from the European Union, following other venues such as Aquis Exchange and XTX Markets. 

The bank has also recently expanded its SIGMA X MTF product universe to include emerging markets, beginning with the Czech Republic and Hungary. The SIGMA X periodic auction recently saw a record trade of $24.1 million on 27 May, followed by a record 12% European market share in the third quarter, making it the second largest periodic auction venue after Cboe Europe.

Goldman Sachs is an increasingly important part of the European equities trading landscape. According to a recent in-depth report from the EU markets watchdog, the bank’s systematic internaliser was the second largest venue in the region in 2019, trading more than the London Stock Exchange’s regulated market and MTF combined.

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The UK

Sunak and the HM Treasury outlined a set of equivalence decisions for EU and European Economic Area (EEA) member states from 31 December, stating that the UK’s approach to the issue post-Brexit would be technical and outcomes based.   

“By taking as many equivalence decisions as we can in the absence of clarity from the EU, we’re doing what’s right for the UK and providing firms with certainty and stability,” Sunak commented.  

The equivalence decision covers several key areas including clearing, central securities depositories, benchmark administrators, as well as derivatives and OTC trading. The UK government has not ruled out further equivalence decisions and encouraged open dialogue with the EU.   

The development has been welcomed across the industry through various trade groups and associations, as well as the Bank of England and the Financial Conduct Authority (FCA).  

 “We welcome the certainty provided through the equivalence decisions made today,” said Adam Farkas, CEO of the Association for Financial Markets in Europe. “We hope that further progress is made in the political negotiations and equivalence decisions by the EU and UK in further areas such as trading venues for the purposes of trading in shares and derivatives.” 

While the equivalence decision from the UK will provide some clarity for firms, the industry must now wait and see how the European Commission will respond. 

Just recently, the UK said it would allow firms to trade on venues based in the EU in what was considered a more holistic approach to the share trading obligation compared to Europe’s complex and stance.  

The FCA said upon confirming its approach to the share trading obligation that mutual equivalence between the UK and the EU should be easy to agree and remains the best way of dealing with overlapping rules post-Brexit.  

“We support the Chancellor’s approach to equivalence – taking a technical approach instead of a political one,” Chris Cummings, CEO of the Investment Association, commented.  

“Today’s announcements will provide UK-based firms a degree of clarity regarding access to critical infrastructure post-Brexit, and all eyes will now be on the Commission to reciprocate in the interest of savers and investors across Europe.” 

While Sunak and the HM Treasury laid out ambitions for the UK’s financial services post-Brexit to renew London’s position as a global financial powerhouse, research from EY just last month highlighted the impact of Brexit on the city. 

More than 7,500 jobs in financial services have relocated out of the UK due to Brexit with £1.2 trillion in assets from 24 financial firms expected to follow, EY’s financial services Brexit tracker stated. Of those jobs, 400 moved from London in the last quarter alone.  

“It is still in all parties’ within Europe or outside’s interests for London to retain its prominent position in the primary and secondary markets,” Chris Hollands, head of European sales and account management at TradingScreen, commented on the UK’s equivalence decision.  

“Between now and the end of the transition period, market participants will be looking for an open and detailed framework for EU based firms to continue to operate easily in the City. Only when these intricate nuances are agreed can the City gain a true picture of how global capital markets will function post-Brexit.”   

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