At the end of June, Britain and the European Union signed a long-delayed post-Brexit cooperation pact in financial services – the memorandum of understanding on regulatory cooperation. The aim is to increase cooperation on financial services, establishing
a forum where the EU and UK can meet twice a year to discuss financial regulation and standards.
What should brokers and other participants be thinking about now that the UK and the EU are willing to work together on regulatory changes?
The industry is gearing up once again around regulatory change awareness and preparation. Traders are seeking to understand the Financial Conduct Authority’s (FCA) post-Brexit rule changes to share-trading markets. The changes aim to enhance execution quality
for investors by lowering the cost of trading, reducing market impact, and increasing liquidity.
Companies involved in trading and investing need to update their systems to follow new rules for reporting post-trade information. This includes trading venues, investment firms, and Approved Publication Arrangements (APAs). UK firms have until 29 April
2024 to adapt and implement this first step.
What are the April 2024 regulatory changes?
For UK trading venues, there is a focus on global competition and best execution for investors.
Regarding pre-trade transparency, UK trading venues can now use reference prices from overseas trading venues – provided those prices are robust, reliable, and transparent.
UK Exchanges are now able to set the appropriate minimum tick size when the primary market is located overseas.
Investment firms will have some exemptions from trade publication and changes to post-trade flags to remove unnecessary information from the post-trade tape.
The big-ticket item, however, looks to remove pressure on firms registered with the FCA as systematic internalizers (SI) solely due to OTC trade reporting on behalf of clients. The FCA is set to introduce a new regime based on a register of Designated Reporters
(DRs). This decoupling of OTC trade reporting from SI provision will allow brokers to meet clients’ needs without the costly overheads and pre-transparency requirements of operating a SI. The new scheme is intended to help from an OTC reporting perspective,
whilst keeping complexity away from the buy side.
It is hoped that these measures, and others, will boost liquidity in the UK’s equity markets following Brexit.
Why these changes matter for the UK
The UK’s equity markets have suffered in recent years due to long-term trends, including the effects of Brexit. London has lost its status as Europe’s leading share-trading hub, and Amsterdam now holds this position.
These changes are part of the response to the Wholesale Markets Review led by HM Treasury over the past two years. Some of the changes from the WMR require legislative changes
and are being progressed in the recently passed Financial Services and Markets Bill (FSMA). More broadly, it underscores the regulator’s ambition to tidy up the UK rule book, by tweaking rules inherited from the EU (MiFID II) that don’t make sense in a post-Brexit
This is happening as the European regulator ESMA itself reviews MiFID II. The UK and the EU are starting from the same place, having implemented MiFID II in January 2018.
While the FCA wants to avoid, change for the sake of it, they are seeking the best outcome for the UK now that it is outside of the EU.
From a trading platform perspective, in the interests of minimizing costs and improving efficiency, no one wants divergence between the EU and UK rules. Coordination on implementation dates would also be highly desirable. However, with the first phase of
EU changes set for January 2024 and UK for April, a divergence of both rules and timings appears to be unavoidable.
What are the implications?
As a result of rule book changes and divergence, UK venues and firms are facing increasing costs to allow for EU and UK flavors of regulation. Even within each region there is already some potential mismatch between requirements for post-trade transparency
and transaction reporting.
With plans to remove the double volume cap, the FCA is changing its approach to flagging negotiated trades. This could see a return to pre-MiFID trading strategies and a move away from maintaining market-maker quotes since 2018 to avoid the cap.
The FCA is to introduce a designated reporter regime (DRR). While details are yet to be defined, this will free up firms forced to become SIs in 2018 due to Client trade reporting needs. They can from April instead, become DRs. This will likely impact existing
client agreements around OTC assisted reporting created as an unintended consequence of MiFID II.
What do brokers need to do now?
It’s good to talk. If there was one lesson I think we all learned from the implementation of MiFID II for 2018, it’s that reaching industry consensus on the interpretation of regulation takes time and effort. Collaboration is essential to regulatory change
management. Understanding what the changes mean for your firm and each venue is critical. Time is short, and April is not far away, significantly if changes will impact business models, trading strategies, and (potentially) client agreements. Talk to your
trading partners, industry associations and service providers.
When planning and implementing solutions, it’s good to focus on:
- Standardization – many exchanges have already adopted the FIX MMT standards for post-trade flags, which will make future data consolidation
- Integration – using an integrated trade reporting solution that covers the multiple stages of the order lifecycle makes straight-through processing (STP) easier.
The FCA PS23/4 policy statement is a positive step for the UK’s post-Brexit capital market development and has been well received by the industry. Crucially, this is heralded as the start of the journey towards reducing the burdensome requirements across
a raft of areas regulated under the UK’s Markets in the FSMA 2023 package.
More broadly, the evolution of Financial Services aims to protect consumers, ensure market integrity, and promote effective competition – all driving growth in the UK.
All these regulatory changes will require careful planning, and firms need to get their affairs in order now to be ready for April 2024.