UK government reveals transition from EU to UK law for financial instruments

HM Treasury has published the latest in a series of draft statutory instruments which will amend retained EU law to ensure that it operates in the UK after Brexit. The Markets in Financial Instruments (Amendment) (EU Exit) Regulations 2018 (84 page / 1.14MB PDF) addresses the changes needed to regulate the trading of financial instruments by banks, investment managers and other financial services institutions.

It follows the implementation of MiFID II into EU law earlier this year. HM Treasury said the policy approach set out in the EU legislation would not change after the UK had left the EU and the statutory instrument “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”.

The instrument transfers the functions of the European Securities and Markets Authority (ESMA) to the FCA and the Prudential Regulation Authority (PRA). Their new responsibilities will include developing binding technical standards, and both bodies have said they are intending to consult on the changes needed to the MiFID II standards to ensure they continue to operate effectively on the day the UK leaves the EU.

The FCA will be given flexibility over the transparency regime for the regulations for a period of up to four years. The aim is to preserve existing outcomes of the transparency regime as far as possible, while providing the FCA with the time required to operate the regime and avoiding any potential for regulatory arbitrage with relevant transparency regimes in third countries.

The transparency regime includes thresholds and waivers for making price and volume data of orders and transactions public, which are currently calculated using EU-wide data.

The Treasury said 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.

As a result, the FCA will be able to exercise powers, under specific circumstances, to amend certain transparency calibrations, direct the application of the mechanism which limits the proportion of trading that can take place without being subject to pre-trade transparency, and freeze the obligation to publish trading information in respect of certain instruments.

Under the new regulations, UK branches of firms headquartered in the European Economic Area (EEA) will need to submit transaction reports to the FCA, rather than their home regulator, as is currently required for the UK arms of firms headquartered outside the EEA.

Financial services regulation expert Elizabeth Budd of Pinsent Masons, the law firm behind Out-Law.com, said: "This statutory instrument is one of many pieces of legislation that will be needed to ensure that the financial services industry in the UK can continue to operate on a sure legal footing and shows that HM Treasury and the UK regulators are working hard to smooth transition where it is in the ability to do so. However, much of smoothing the transition does depend on co-operation agreements and equivalence decisions being put in place and although many are positive about the likelihood of these being in place in time, the brinkmanship that is now coming into play is concerning and makes planning difficult."

"While some of the proposed changes might be considered to be mere housekeeping such as transferring the ESMA functions to the PRA and FCA, this transfer does have practical implications for firms," she said. "Firms have only recently introduced systems for transaction reporting and whilst it may seem a simple change to simply report to the FCA rather than a branch’s home state regulator, such a change is often not straightforward."

The Treasury is anticipating a post-Brexit situation where there is no negotiated agreement with the EU, by introducing a provision allowing EEA firms that want to continue operating in the UK to do so through a ‘substituted compliance’ regime. Firms operating under the temporary permissions regime will not be deemed in breach of the UK’s MiFID II rules if they can demonstrate that they comply with corresponding provisions in the EU’s MiFID II rules.

However substituted compliance will not be available for all aspects of MiFID II. The instrument specifically notes that EU trading venues will not have the right to request access to a UK clearing counterparty 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.

Although the instrument treats the EU as a ‘third country’, it makes certain exceptions for some products in order to maintain the status quo. In particular, 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.