Industry bodies have warned of the potential negative impact of failure by European authorities to recognize UK trading venues in the case of a no-deal Brexit.
“If the UK authorities don’t recognize European venues, and the EU authorities don’t recognize UK venues this would definitely be detrimental. There might be readiness for firms and markets to limp on, but things will be worse than they were,” says Roger Cogan, head of European policy at the International Swaps and Derivatives Association (Isda).
“The fact that this is a bad outcome is a good enough reason for the EU authorities and the UK authorities to work together to address this problem. But we would also make the obvious point that the UK’s regulatory framework is the same regulatory framework as in the EU 27, and under the onshored rules which will be in place, the UK has mirrored EU regulation,” says Cogan.
In the case of a no-deal Brexit, trading venues established in the UK will from March 30 no longer be considered European trading venues.
On March 1, several industry bodies co-signed a letter to European authorities requesting urgent action on equivalence decisions regarding UK trading venues under the European Market Infrastructure Regulation (Emir) and the second Markets in Financial Instruments Directive (Mifid II).
For George Gilbert, assistant general counsel for capital markets at ICI Global, potential liquidity fragmentation across venues could result in adverse pricing.
“The derivatives market today is a global market, much of that trading occurs in the UK – some of the contracts and venues are only in the UK. It is certainly possible they would open new venues in Europe but then you have the potential for liquidity to fragment across two venues rather than being consolidated onto one, that could result in adverse pricing, it could result in other market impacts,” says Gilbert.
“Part of our objective in writing the letter is to urge regulators to reduce uncertainty. We recognize that there will still be details that will need to be ironed out, but it would be best for investors if regulators do what they can to ensure the orderly functioning of markets,” he says.
In a statement last week on the impact of Brexit on Mifid II and the Markets in Financial Instruments Regulation (Mifir), the European Securities and Markets Authority (Esma) said it “does not have, at this point in time, any evidence that market participants will not be able to continue meeting their obligations under the trading obligation for derivatives in case of a no-deal Brexit and in the absence of an equivalence decision by the Commission covering UK trading venues.”
As to why equivalence has not been granted, the Futures Industry Association’s (FIA) Mitja Siraj, vice president for legal in Europe, says that while there may be adverse consequence of no equivalence for trading venues, the EU has not acknowledged the UK’s trading venues as systemically important.
“Emir Article 2a equivalence has not been deemed systemically important for financial stability, unlike equivalence of UK CCPs for example. Whilst the lack of trading venue equivalence under Emir may be material for the impacted NFCs and Small FCs if they breach the clearing threshold, and may have adverse effects on them and their customers, the regulators and policymakers do not seem to be believe that this might have an impact on overall stability of financial markets,” says Siraj.
For Isda’s Cogan, another negative aspect of non-equivalence is the cost that would be incurred by non-financial corporates, and the small financial counterparty category that has been created in a recent revision in the Emir rules.
“If an exchange traded derivative contract in the UK is transacted on an exchange that is not recognized under EU rules, that derivative contract will become classified as an OTC derivative contract,” says Cogan.
“What that would mean for them is that they would be quite likely to exceed the clearing thresholds under Emir above which they would be required to clear contracts,” he says.
“They would be required to clear when this whole regime was created so that they can avoid the cost of clearing. So, it undermines a lot of the benefits that EU rules were designed to create for those small financials.”