Brexit is certainly rising in minds of asset managers, regulators, and investors as we reach the impending conclusion of the transition period on 11.00 p.m. (GMT) on December, 31. Despite having certain contingencies and accommodations already in place, several uncertainties remain as the UK and EU continue to wrangle over a deal to govern their future relationship. The political negotiations have pivoted primarily to issues such as rules to govern state aid, level playing field rules, and fishing rights. Asset management hasn’t been a significant area of negotiation focus; with time running out quickly, however, the Brexit impacts on asset management are still not fully formed.
With political maneuverings taking the lion’s share of the press coverage, there are a number of highly technical, but highly significant market issues that remain unresolved across the capital markets. Here, we explore just a few of those issues:
The European Commission (EC) is currently resisting pressure from both the UK and its own EU members who have made calls for certain accommodations to avoid the loss of access to London, which is host to a trading infrastructure that the EU greatly depends on. The EC and other EU policymaking bodies claim that they do not wish to make any decisions at this time which could potentially impact upon on the delicately poised Brexit negotiations. As such, anxiety is increasing across EU markets (including the UK) with suggestions that the ongoing “game of chicken” and brinksmanship between the EU and UK will ultimately damage both sides if not addressed imminently.
One problematic area identified recently relates to a MIFID requirement known as the “Share Trading Obligation,” or STO, that limits trading on non-EU exchanges once a share is regularly bought and sold on venues inside the EU. STO rules dictate that MIFID authorized entities such as EU asset managers and banks must ensure that their trading takes place on an EU regulated market, multilateral trade facility (MTF), Systematic Internaliser (SI), or an equivalent third-country trading venue. When Brexit happens, the UK becomes a non-EU third country. Without an equivalence determination in place, it doesn’t meet the criteria of any of the acceptable STO trading venues. This is problematic for both UK and EU and other global trading entities.
The STO rules create hurdles for companies whose shares are traded both in the UK and in the EU and creates potential to lock certain EU (and other) countries out of trading in London's deep capital markets. London is the largest share trading location in the EU, executing about 30% of EU trading volumes. There are also significant impacts to dual-listed companies. Take Ryanair as an example, who trade shares on more than one exchange. While Ryanair is one example among many, it demonstrates that global capital markets are highly interconnected and interdependent. An imminent loss of access to the “City of London” doesn’t exclusively impact UK regulated entities, the impact is much larger than that.
With the expiration of the transition period looming, the continued trading of shares and derivatives on UK trading venues without any disruption is dependent on those trading venues being recognized as equivalent by the EC. The Commission’s latest statement comes less than 80 days from Brexit day and the uncertainty has a lot of people in the market increasingly worried about the STO issue specifically due to the volume of trading that occurs today on London-based trading venues, which could be instantly disrupted if unavailable as at January 1.
The STO issue, however, is merely one of several “questions of equivalence” for financial services being deliberated on by the EU. Increasingly there are EU voices suggesting that it would be in the best interest of the EU accommodations to allow for the continued use of London as a trading center, particularly amid the ongoing pandemic, which has presented its own challenges.
The Clearing Issue
The European Securities and Markets Authority (ESMA) recently announced that the three prominent UK central counterparties (CCPs) are deemed equivalent for a limited time period. ESMA further agreed a new Memorandum of Understanding (MoU) governing the supervision of UK CCPs under EMIR with the Bank of England. As such, the UK becomes an eligible third country and the CCPs are eligible to provide services under EMIR and otherwise in the EU, after the end of the Brexit transition period. This decision takes effect on January 1, 2021 and will run for an initial period of 18 months until June 30, 2022.
UK Firms Regulatory Reporting
The problems do not reside solely on the EU’s side, as the Financial Conduct Authority (FCA) has recently taken action to address some issues arising from the end of the transition period. As we have written about previously, the FCA has been proactive in attempting to ensure elements of continuity for interactions between UK and EU regulated activity post-Brexit with useful measures such as its Temporary Permissions Regime (TPR) and Offshore Fund Regime (OFR). There are other areas, however, that are likely to impact UK regulated entities current activities where the FCA are powerless to help. Obligations such as certain reporting requirements under MIFID, EMIR, and the Securities Financing Transaction Regulation (SFTR) are beyond the remit of FCA.
The FCA recently warned UK entities that they must immediately prepare to comply with altered reporting obligations. ESMA published a statement reiterating that transactions carried out on UK venues by both EU firms and UK firms serving EU investors will undergo several changes to their reporting obligations. ESMA uses a reporting system known as Financial Instruments Reference Data System (FIRDS), which collects and links data feeds from various national regulators and trading venues. When Brexit happens, the FCA will no longer be part of that process and FIRDS won’t cover the UK.
With uncertainty remaining and time quickly running out, it’s clear that being Brexit-ready remains difficult for much of the market. My own personal Brexit strategy throughout has been: “Plan for the worst, hope for the best” and unfortunately even at this late stage, that remains my best advice.