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This publication is available at https://www.gov.uk/government/publications/draft-markets-in-financial-instruments-amendment-eu-exit-regulations-2018/markets-in-financial-instruments-amendment-eu-exit-regulations-2018-explanatory-note
The European Union (Withdrawal) Act 2018 (EUWA) repeals the European Communities Act 1972 on the day the UK leaves the EU and converts into UK domestic law the existing body of directly applicable EU law. The purpose of the EUWA is to provide a functioning statute book on the day we leave the EU. The EUWA also gives Ministers powers to make Statutory Instruments (SIs) to prevent, remedy or mitigate any failure of EU law to operate effectively, or any other deficiency in retained EU law. We refer to these contingency preparations for financial services legislation as ‘onshoring’.
HM Treasury is using these powers to ensure that the UK continues to have a functioning financial services regulatory regime in any scenario.
This SI is part of the wider work the government is undertaking to prepare for the UK’s withdrawal from the EU. It is not intended to make policy changes, other than to reflect the UK’s new position outside the EU, and to smooth the transition. The changes made in this SI would not take effect on 29 March 2019 if, as expected, we enter an implementation period.
The attached draft SI is to provide Parliament and stakeholders with further details on our approach to onshoring financial services legislation. The draft instrument is still in development. The drafting approach, and other technical aspects of the proposal, may change before the final instrument is laid before Parliament.
3. Policy background and purpose of the SI
What does the underlying EU regulation and UK law do?
The revised Markets in Financial Instruments Directive (MiFID) and the linked Markets in Financial Instruments Regulation (MiFIR) – collectively referred to as MiFID II in this policy note – are the key pieces of EU legislation that govern the buying, selling and organised trading of financial instruments, such as shares, bonds, units in collective investment schemes and derivatives. As such, MiFID II governs the practices of investment banks, stock and futures exchanges, broker-dealers, investment advisers and investment managers. It also contains a ‘passport’ that permits firms to provide investment services cross-border and to establish branches in another EEA state on the basis of their authorisation in their ‘home’ Member State.
MiFID II took effect in early 2018 and aims to create more robust and efficient market structures, requires more trades to be conducted through trading venues to promote transparency and financial stability, introduces new safeguards for algorithmic and high frequency trading, and provides a stricter framework for trading commodity derivatives by introducing a position limits and position reporting regime. It also strengthens investor protection including through enhanced controls on the distribution of financial products.
3.1 Deficiencies this SI remedies
Consistent with the government’s objective of providing continuity to businesses and consumers as far as possible, the policy approach set out in MiFID II legislation will not change after the UK has left the EU. This SI will support the fair, stable and transparent operation of UK financial markets after EU withdrawal, and provides for investors to have the same protections they currently enjoy. However, to ensure that the MiFID II regime continues to operate effectively once the UK is outside of the EU, certain deficiency fixes to the legislation will be necessary. These deficiency fixes are explained below.
MiFID investment firms and market operators should also have regard to amendments made in separate SIs, which will be published in due course. These will include, amongst others, amendments to the Financial Services and Markets Act 2000 (FSMA), the Regulated Activities Order 2001 (RAO), and the Recognition Requirements for Investment Exchanges and Clearing Houses Regulations 2001.
Transfer of functions
Functions under MiFID II that are carried out by EU authorities, principally the European Commission and the European Securities and Markets Authority (ESMA), would no longer apply in the UK after EU withdrawal. This SI removes this deficiency by generally transferring the functions of ESMA to the relevant UK regulator—the Financial Conduct Authority (FCA) or the Prudential Regulation Authority (PRA)—and the functions of the Commission to HM Treasury.
Binding Technical Standards (BTS)
Under the EU system of financial regulation, drafts of Binding Technical Standards (BTS) are developed by European Supervisory Authorities (ESAs). Across financial services regulation, HM Treasury is transferring responsibility for making BTS to UK regulators. The basis on which this function is to be exercised is set out in the Financial Regulators’ Powers (Technical Standards etc.) (Amendment etc.) (EU Exit) Regulations 2018. Consistent with this approach, this SI transfers responsibility for making BTS under MiFID II to UK regulators, including responsibility for correcting deficiencies in MiFID II BTS so that they operate effectively immediately on exit day and that they remain fit for purpose thereafter.
As such, the FCA and the PRA will be making changes to the relevant parts of the MiFID II BTS, and they have stated that they intend to consult on such amendments in the Autumn.
Information sharing and cooperation requirements between UK and EEA regulators
This SI deletes provisions in retained EU law that will become redundant when the UK leaves the EU, such as requirements regarding automatic recognition of an action by an EU body and other references to EU bodies and EU Member States. In MiFID II, there are also obligations on UK authorities to cooperate and share information with EEA authorities. This SI removes these obligations from UK legislation. Instead, UK authorities will be able to continue to cooperate and share information with EEA authorities, in the same way as they can with authorities outside the EEA, based on the existing domestic framework provisions for cooperation and information sharing, which allow for this on a discretionary basis.
Under MiFID II, a third-country’s regulatory or supervisory regime may be deemed by the European Commission to be equivalent to the approach set out in MiFID II. For example, a third-country regime may be equivalent in relation to trading venues for the purpose of the trading obligations for shares and derivatives, or for the purpose of the provision of investment services and activities to professional clients. Equivalence decisions reduce duplication in regulatory or supervisory requirements between the EU and third-countries and facilitate international trade in financial services.
To ensure that the MiFID II equivalence regimes can continue to operate effectively in the UK, HM Treasury will take on the Commission’s function of making equivalence decisions for third-country regimes. Where the Commission has taken equivalence decisions for third-countries before exit day, these will be incorporated into UK law and will continue to apply to the UK’s regulatory and supervisory relationship with those third-countries.
Firms operating under the Temporary Permissions Regime (TPR)
As the EEA financial services ‘passporting’ system will be unworkable without a negotiated agreement with the EU, the Government is introducing a Temporary Permissions Regime (TPR), which is set out in the EEA Passport Rights (Amendment, etc., and Transitional Provisions) (EU Exit) Regulations 2018. The TPR will enable relevant EEA firms and funds operating in the UK via a passport to continue their activities in the UK for a limited period after exit day and allow them to obtain UK authorisation or transfer business to a UK entity as necessary. This SI makes special provisions for EEA firms which intend to operate in the UK under the TPR by introducing the possibility of ‘substituted compliance’ in cases where not doing so could lead to conflicts of law. This means that a firm operating under the TPR will not be deemed in breach of the UK’s MiFID II rules if it can demonstrate that it complies with corresponding provisions in the EU’s MiFID II rules.
Substituted compliance will not be available for all aspects of MiFID II. For example, it will not apply to those aspects of MiFID II where supervisory responsibility is reserved to the host state regulator, such as conduct of business obligations for branches. Finally, this SI disapplies certain requirements or rights for firms operating under the TPR which would be otherwise unworkable without a negotiated agreement with the EU. For example, EU trading venues in the TPR will not have the right to request access to a UK CCP in the way that a UK trading venue can do under the open access regime, unless an equivalence decision is made by HM Treasury relating to EU trading venues.
Data Reporting Services Providers (DRSPs)
As DRSPs fall outside the TPR described above, this SI makes amendments to the UK’s Data Reporting Services Regulations 2017 to put in place a transitional arrangement in which EU-authorised DRSPs that meet the required conditions will be granted temporary authorisations to continue to provide data reporting services in the UK for a period of up to one year. The intention of this amendment is to allow DRSPs to consider their options and, if appropriate, establish a UK branch or subsidiary to obtain permanent UK authorisation during the transitional arrangement. DRSPs seeking the temporary authorisation described above will need to notify the FCA. This SI also ensures that Gibraltar-based DRSPs providing data reporting services in the UK, that are authorised in accordance with Gibraltarian law that enacts MiFID II, will continue to be able to provide data reporting services in the UK. This is in line with the UK Government’s Statement in March 2018.
Recognition of EU firms, instrument scopes and market data
In general, this SI provides that the EU is treated as a third-country. However, certain exceptions to this approach have been made to help provide for a smooth transition for market participants by maintaining existing outcomes as far as possible. These include the following exceptions:
- EEA emission allowances will continue to be a financial instrument so that there is no change to how they are currently traded on UK markets
- energy forwards that must be physically settled and are traded on Organised Trading Facilities (OTFs) in the EU will continue to be excluded from the definition of financial instruments, to ensure there is no change in the requirements applied to UK market participants trading these instruments
- the exemption from authorisation for commercial firms trading commodity derivatives, the ‘Ancillary Activities Exemption’ (AAE), which involves looking at a firm’s trading activity compared to overall trading activity in the market, will continue to be based on UK and EU market data. This is to ensure that in this regard, the scope of the regulatory perimeter is not changed by EU withdrawal. There will be a separate SI to fix deficiencies in the Regulated Activities Order (RAO), which will maintain the current provision granting firms an exemption from the general prohibition on carrying out a regulated activity, until they can perform the annual calculation determining whether they still meet the terms of the AAE. If the calculation indicates that they no longer qualify for the AAE, then the exemption under the RAO will continue, provided they seek authorisation as a MiFID investment firm within a specified period
- UK firms will be able to treat Undertakings for Collective Investment in Transferable Securities (UCITS) in the EU as automatically non-complex instruments, so that they can, in general, continue to be sold to retail clients in the UK without a client undertaking an appropriateness test
MiFID II transparency regime
This SI grants the FCA a set of temporary powers that will allow the FCA some flexibility over how the MiFID II transparency regime is operated during a transitional period of up to four years. The powers being granted to the FCA aim to preserve existing outcomes of the transparency regime as far as possible, while providing the FCA with the time required to operate the transparency regime when the UK is no longer a member of the EU (including making any necessary changes to aspects of the transparency regime that are in the Binding Technical Standards) and avoiding any potential for regulatory arbitrage with relevant transparency regimes in third countries.
The MiFID II transparency regime requires that buyers and sellers of financial instruments disclose price and volume information for their trades. For each class of financial instrument, there are various thresholds and waivers which apply in respect of making price and volume data of orders and transactions public. Some of these thresholds and waivers protect investors who place large orders while others take account of the illiquidity of some instruments. Waivers relating to the trading in equities are also subject to a mechanism which limits the proportion of trading that can take place without being subject to pre-trade transparency (the ‘Double Volume Cap Mechanism’).
The waivers and thresholds contained in the MiFID II transparency regime are generally calculated on the basis of EU-wide market data. An abrupt move to using UK-only data could pose operational challenges for the FCA and could result in adverse implications for the functioning of markets. For this reason, the FCA is being granted temporary powers in regard to the regime during a transitional period.
These temporary powers include the ability, in specified circumstances, to:
- amend certain transparency calibrations (which are otherwise frozen on exit day)
- direct the application of the Double Volume Cap Mechanism
- freeze the obligation to publish trading information in respect of certain instruments
In exercising these powers, the FCA will take into account in each instance specified factors (e.g., where the use of the relevant power would advance the FCA’s integrity objective or where a failure to use the power would unduly harm price formation). In addition, certain transparency conditions (such as the requirement to publish trading carried out under the waivers) will be suspended for the duration of the transitional period (on the basis that the FCA will not have sufficient data or resources during the transitional period to comply with such transparency conditions). The FCA will have a statement of policy on how these temporary powers will be used in place before exit day. This statement of policy, and any subsequent changes to it, will be published and made publicly available.
In addition to the temporary powers described above, certain other changes will be made to the long-term operation of the transparency regime. These changes will allow the FCA to take into account trading data from countries other than the UK in determining certain transparency thresholds. The FCA will be permitted to do this where it is able to obtain sufficient, reliable trading data from other countries in respect of trading in the relevant financial instruments. This is to enable the FCA to appropriately take into account instruments which are traded significantly both in the UK and in another country (or countries). In such cases, in order to set thresholds which achieve the intended outcomes of the transparency regime, the FCA will be able to use trading data from another country (or countries), assuming it is available to the FCA, as well as UK trading data.
MiFID II transaction reporting regime
Under the transaction reporting regime in MiFID II, investment firms are required to submit a report to their national regulatory authorities following the execution of a trade. These transaction reports are used by regulators to detect and prevent market abuse. The transaction reporting regime in MiFID II is explicitly linked to the Market Abuse Regulation (MAR), in that MiFID II provides for the collection of data used to identify possible instances of market abuse, and MAR provides for its investigation and enforcement.
UK branches of EEA firms currently send transaction reports to their home regulator rather than to the FCA. The effect of this SI is to require UK branches of EU firms to report to the FCA, in the same way as UK branches of non-EEA firms are required to do. UK branches of EEA firms will need to adapt their reporting systems accordingly.
Under this SI, firms will continue to be required to submit reports on trades in financial instruments admitted to trading, or traded, on trading venues in the UK and in the EU. This will maintain the existing scope of the FCA’s monitoring of markets.
A separate SI will address the deficiencies which arise from EU exit in the retained Market Abuse Regulation. A draft of this SI will be published in due course.
Firms and other regulated entities should note that they may have to implement operational changes as part of the transfer of functions to UK authorities that are currently carried out by EU authorities under MiFID II. For example, firms may need to make changes to be able to send and receive MiFID II transaction reporting and transparency data to and from the FCA. Firms and other regulated entities should continue to refer to consultations published by the regulators for further guidance and respond accordingly. HM Treasury has engaged with industry bodies where possible to ensure awareness of these provisions. As already noted, the intention in this SI is not to make policy changes, other than to reflect the UK’s new position outside the EU, and to smooth the transition to this position.
4. Next steps
HM Treasury plans to lay this instrument before Parliament in the autumn.
5. Further information
If you have queries regarding this instrument, email FSlegislationEUWA@hmtreasury.gov.uk