This is a summary piece written by Francis Kiwanuka (Head of Risk Management, CubeMatch UK) outlining proposals by HM Treasury and UK regulators regarding MiFID II rules in post-Brexit divergence from the EU.
On March 1st, 2022, the UK government announced reforms to capital markets regulation and listings rules. It follows the Wholesale Markets Review, established to improve the regulation of secondary markets following the UK’s withdrawal from the EU. The consultation closed on 24 September 2021 with responses from across the financial sector including trading venues, trade bodies, asset managers, market data vendors, investment firms and insurance.
The government aims to tweak the MiFID regime in post-Brexit divergence from EU, by cutting red tape to make the City of London a more attractive place to do business and invest. It has also committed to continue upholding the highest regulatory standards.
The UK's wholesale capital markets regulation comes from retained EU MiFID rules introduced in 2018 to harmonize statutes across EU member states. In addition, since 2017 the EU prospectus regulation oversees the ability to raise capital and float companies in the UK.
As part of its review of the UK financial sector after Brexit, HM Treasury together with UK regulators are proposing the following package of reforms:
- Cutting burdens on Systematic Internalisers (SI*), by replacing the complex instrument-specific quantitative calculations, viewed as unwieldy, with qualitative ones. Market participants welcomed the proposal because the current quantitative-based definition is complex, costly, thresholds are inflexible and do not increase transparency or aid price formation. A few firms would like to retain the ability to opt into the regime, even if the calculations are removed, to ensure that they can continue to choose to be an SI.To deliver this the government plans to bring forward legislation when parliamentary time allows.
- The consultation highlighted the existing ambiguity surrounding the regulatory perimeter for trading venues (TV**) and what type of firms need to be authorised as a multilateral trading facility (MTF***). Respondents argued that all companies should be treated in the same way to ensure some firms are not at a competitive advantage. Some respondents favoured regulatory guidance instead of changes to legislation.The government acknowledged there is a need for greater clarity regarding what types of firms need to be authorised as MTF. Therefore, the government does not intend to amend the legal definition of a multilateral system as there is support for this to be addressed through regulatory guidance. The FCA is currently working closely with HMT on the Wholesale Markets Review and has indicated that it will consult on new guidance and take the outcome of this consultation into account when drafting its consultation.
- The Markets in Financial Instrument Directive II (MiFID II) introduced a few operating conditions on MTF and organised trading facilities (OTFs****). The consultation sought to understand whether these conditions were beneficial or would prevent new firms from entering markets, competing and innovating. The government wanted to understand the implications on market integrity if restrictions were lifted to allow matched principal trading. Respondents overwhelmingly argued the current restrictions introduced to avoid potential conflicts of interest is costly and unnecessary. They believe that current rules effectively prevent conflicts of interest. Some respondents suggested removing the prohibition only if matched principal trades are mandatorily reported using recognised flags as part of post-trade transparency to ensure data consistency and to enable firms to identify their trading counterparties.
The consultation also explored the restriction that prevents housing a SI and OTF in the same entity. Some respondents supported lifting this restriction, arguing that having separate entities creates avoidable cost and bureaucracy. Others felt this proposal would lead to conflicts of interests even when there is a clear delineation between distinctive parts of the firm.
Lastly, the consultation examined suggestions to permit OTFs to execute transactions in equities when dealing in packages, as it would saves participants costs. However, some respondents argued that allowing equities to be traded on OTFs would probably reduce liquidity as equities are already traded on multiple types of venues.
The government concluded there is clear argument for removing matched principal restrictions for investment firms operating a trading venue, while retaining obligations to prevent conflicts of interest. According to the government it would be appropriate to allow OTFs to execute transactions in equities when dealing in packages. Similarly, the government believe the best way to take these changes forward is through the upcoming Future Regulatory Framework implementation.
As set out in the Future Regulatory Framework (FRF) consultation, the government intends, as a general approach, to take a power to repeal retained EU law, and specifically the direct regulatory requirements which apply to firms. This repeal will enable the appropriate regulator to replace those provisions with their own rules. For any areas where the regulators’ existing rule-making powers are not broad enough to be able to replace the relevant requirement in retained EU law, the government has set out its intentions to provide regulators with the necessary additional powers.
In many instances, the government would expect the regulators to initially replace the repealed provision with rules that are like those which are currently in place. However, for the changes identified through the Wholesale Markets Review, this approach will allow the regulators to ensure that the rules are properly tailored for UK markets, and appropriately reflect their objectives. Therefore, as part of the process of establishing the comprehensive Financial Services and Markets Act (FSM) model in this way, the Financial Conduct Authority (FCA*****) will have the opportunity to make the appropriate rule changes to implement some of the proposals set out. This approach will ensure the UK maintains a coherent, agile and internationally respected approach to financial services regulation that delivers appropriate protections and promotes financial stability.
*MiFID II defines an SI as a firm that deals on its own account by executing client orders on instruments outside the scope of regulated markets or multilateral trading facilities (MTFs) and does so on ‘an organized, frequent, and systematic basis’.
**Trading venues under MiFID II/ MiFIR mean facilities, in which multiple third party buying and selling interests interact in the system.
***A multilateral trading facility (MTF) is a European term for a trading system that facilitates the exchange of financial instruments between multiple parties.
**** Organised trading facilities are multilateral trading venues in the European Union enabling third parties to trade bonds, derivatives, structured finance products and emission allowances but not equities.
*****The Financial Conduct Authority (FCA) is a financial regulatory body in the United Kingdom, but operates independently of the UK Government, and is financed by charging fees to members of the financial services industry.
Wholesale Markets Review: Consultation Response
Ambitious reforms to capital markets regulation and listings rules announced