The U.K. government is consulting, in the Wholesale Markets Review, on proposals to amend the U.K.’s Markets in Financial Instruments regime. This regime is based upon the Markets in Financial Instruments Directive and related Regulation, as well as several pieces of delegated legislation thereunder, collectively and colloquially known as MiFID II, which the U.K. on-shored with minor amendments following its exit from the European Union. HM Treasury is now seeking feedback on how the U.K.’s approach to regulating secondary markets should be adapted now that the U.K. has left the EU. The intention is to amend the regime to reflect that the U.K. market is one of the largest capital markets globally. Changes are also proposed where the rules have had unintended outcomes, are duplicative or excessive or have curbed innovation. Responses to the consultation may be submitted until September 24, 2021.
The proposals are wide-ranging and will impact many market participants. Some of the changes represent fundamental amendments to the regime, for example, those for the commodity derivatives markets, while others focus on reducing unnecessary burdens on market participants. All the changes demonstrate the U.K. government’s commitment to high standards and proportionate regulation.
The final changes to the U.K.’s MiFID II regime will be implemented either through legislation or changes to the regulator’s rulebooks. The Financial Conduct Authority is expected to consult on related rule changes before the end of the year. Feedback to this consultation will be considered alongside the Future Regulatory Framework Review, in which HM Treasury is seeking to establish a blueprint for U.K. financial services regulation, ensuring a clear division of responsibilities between government, Parliament and the regulators, providing for appropriate policy input by democratic institutions and allowing regulation to adapt to changing conditions.
This client note summarizes the key proposals discussed in the Wholesale Markets Review consultation.
MiFID II requires the FCA to establish and apply position limits on the size of a net position in commodity derivatives traded on trading venues and economically equivalent OTC contracts. The limits apply to the size of a position that a person can hold, including any other positions held on behalf of that person by group entities. Trading venues are required to apply position management controls, including monitoring of open interest and obtaining information about the size and purpose of a position entered into, beneficial or underlying owners, concert arrangements and any related assets or liabilities. Trading venues also have powers to require termination or reduction of positions and to require a person to provide liquidity back into the market at an agreed price and volume to mitigate the effect of a large or dominant position. The position reporting regime is intended to support the application and enforcement of position limits.
The government believes there is potential for the U.K. to go further than the recent EU MiFID II Quick Fix changes and to substantially reduce the scope of the U.K. MiFID II requirements. The proposals include:
The EU’s MiFID II Quick Fix will, once it applies, reduce the scope of the EU position limits regime to agricultural commodity derivatives and to critical or significant commodity derivatives traded on trading venues and their economically equivalent OTC contracts. Critical or significant derivatives are commodity derivatives with an open interest of at least 300,000 lots on average over a one-year period.
The EU MiFID II Quick Fix will introduce a narrowly defined hedging exemption for an authorized financial institution within a predominantly commercial group that trades on behalf of that commercial group. There is also an exemption for positions resulting from transactions undertaken to fulfil obligations to provide liquidity.
The EU MiFID II Quick Fix also amended the ancillary activities test; however, it is a more limited change than that posed by HM Treasury. EU national regulators will be able to combine a quantitative and qualitative assessment, based on guidance to be issued by the European Commission.
The government is proposing to introduce a new type of trading venue or additional segment on existing platform tailored to requirements of smaller SMEs, giving as an example, SMEs with a market capitalization under £50 million.
The SME MTFs are working well, but evidence shows that they are mostly being used by medium-sized issuers and smaller issuers use crowdfunding and private markets to access funding, mostly because of overly burdensome requirements. Establishing the new trading venue could, among other things, involve:
MiFID II introduced requirements for a consolidated tape for equity and non-equity instruments including requiring a CTP to collect post-trade information published by trading venues and approved publication arrangements and to consolidate this into a continuous live data stream made available to the public, both for equity instruments and non-equity products. No CT has yet been set up in either the U.K. or the EU.
HM Treasury is seeking feedback on the establishment of a fixed income consolidated tape. The government is making this proposal to increase data standardization and accessibility and indicates that its preferred model is a private sector CT to ensure competition. To promote a private sector CT being set up, the government is proposing to:
The consultation paper states that industry engagement shows support for an equity CT for both pre-trade and post-trade data, and a fixed income CT for post-trade data. HM Treasury’s view is that a fixed income CT is more urgent because the market is less concentrated and is mostly executed OTC. The U.S. has a version of a fixed income CT in the form of the Trade Reporting and Compliance Engine, which the Financial Industry Regulatory Authority developed to facilitate the mandatory reporting of OTC transactions in fixed income securities.
HM Treasury is proposing to remove some of the limitations that are imposed on multilateral trading facilities and organised trading facilities, including allowing:
It is proposed that the U.K. reverts to a qualitative threshold to determine whether an investment firm must be authorized as a Systematic Internaliser. The existing quantitative threshold requires firms to undertake calculations that are calibrated at different levels for each asset class. To avoid the cost and administrative burden of the calculations, a lot of firms have opted into the Systematic Internaliser regime for all assets that they trade in. The government suggests moving to a qualitative definition where the Systematic Internaliser determination goes according to a firm’s market activity for a particular asset class. The determination would be made at entity level, not by asset class. It is hoped that these proposals would alleviate some of the reporting responsibility uncertainties.
The MiFID II “tick size” regime establishes minimum increments by which prices for equity and equity-like instruments can change. The requirements are intended to mitigate against high frequency trading gaining execution priority by offering fractional price changes as this could lead to disorderly markets and negatively impact price formation.
The calculation of tick sizes is based on the liquidity of the most liquid market in the U.K./EU, without any consideration being given to the liquidity on non-U.K. and EU trading venues. This has resulted in unnecessarily larger tick sizes for overseas shares. HM Treasury is proposing to change the tick size regime so that trading venues can follow the tick sizes applicable in the relevant primary market of a share where that share does not have its primary market in the U.K.
The government is also seeking feedback on whether the setting of tick sizes for shares admitted to trading for the first time should be delegated to trading venues, with appropriate controls. The government’s view is that trading venues have more insight into market demand at this stage than the FCA and may be better placed to undertake this role.
MiFID II imposes a trading obligation on financial counterparties and non-financial counterparties for transactions in derivatives that: (i) have been declared subject to the clearing obligation under the U.K.’s European Market Infrastructure Regulation; (ii) are admitted to trading or traded on at least one U.K. trading venue (a regulated market, MTF or OTF) or a third-country equivalent trading venue; and (iii) are sufficiently liquid.
It is proposed that the scope of the derivatives trading obligation should be aligned with that of the clearing obligation under U.K. EMIR. This would remove ambiguity where small financial counterparties are out of scope of the clearing obligation, but still subject to the DTO.
The government is also considering extending, subject to certain conditions, the exemption from the DTO for the termination or replacement of component derivatives in portfolio compression to all non-price forming post-trade risk reduction services. Views are sought on whether the same exemptions should apply to the clearing obligation under U.K. EMIR.
HM Treasury is also contemplating granting the FCA a permanent power to modify or suspend the application of the DTO, after it has consulted with the government. This is based on how market disruption was avoided by the FCA using its temporary transitional power to amend the scope of the U.K. DTO for Brexit.
MiFID II imposes pre- and post-trade transparency requirements for equity and non-equity financial instruments that aim to improve the quality and availability of market data and reduce the costs of purchasing data. The pre-trade transparency obligations require market operators and investment firms operating a trading venue to make public current bid and offer prices and the depth of trading interests at those prices which are advertised through their systems for equity and non-equity financial instruments.
Some of the proposals for enhancing the transparency regime include:
U.K. MiFIR requires U.K. investment firms to ensure that the trades they undertake in shares admitted to trading on a regulated market or traded on a trading venue take place on a U.K. regulated market, MTF, Systematic Internaliser or equivalent third-country trading venue. It is proposed that the share trading obligation be removed. It was introduced to bring more trading onto lit markets and increase transparency; however, these objectives have not been achieved. The STO is solely an EU concept and is not based on international standards. Furthermore, other jurisdictions do not have a STO, including the U.S., Switzerland, Australia and Hong Kong, all of whom benefit from U.K. STO equivalence.
The government is proposing to remove the requirement for algorithmic trading firms with a market making strategy to enter into binding, written market making agreements with trading venues, including the need for both entities to have effective systems and controls in place to fulfil their obligations under the agreement.
HM Treasury also points to areas where clarification would be beneficial, indicating that its preferred option would be to bring that about through regulatory guidance. One example is the regulatory perimeter for trading venues. HM Treasury recognizes that under the current definitions there is uncertainty as to whether a technology firm that allows investment firms to exchange trading interest and execute transactions with their clients needs to be authorized as an MTF. In addition, there is uncertainty about the regulatory status of brokers arranging transactions over the phone without operating a central mechanism to match client orders.
Another example highlighted in the consultation paper focuses on the roles of market operators and participants during an outage. HM Treasury’s view is that more is needed to ensure that trading can continue during market outages and that this could be done through the FCA developing common procedures, communication standards and guidelines.
 See HM Treasury consultation, Wholesale Markets Review, July 2021.
 The EU MiFID II Quick Fix provisions must be transposed into national laws and applied from February 28, 2022. The U.K. version of MiFID Quick Fix, The Markets in Financial Instruments (Capital Markets) (Amendment) Regulations 2021, will apply from July 26, 2021.
 See the FCA’s Supervisory Statement on the Operation of the MiFID Markets Regime after the end of the EU withdrawal transition period, published December 2020.
 See the FCA’s Statement on supervision of commodity position limits, published July 2021.
 The EU has also been considering how best to encourage an EU equity CTP. For details, see our blog on the 2019 report by the European Securities and Markets Authority, “EU MiFID II Review: First Review Report on Prices for Market Data and on the Consolidated Tape.”
 ESMA recommended the first two of the proposals in its 2019 report.