A new dawn? UK financial market regulation after Brexit

This article was written by Christian Benson, Regulatory Affairs Specialist at Bloomberg.

Following its exit from the EU, the UK is rethinking and recalibrating its regulatory approach to financial services and capital markets. This piece provides a short round-up of the landmark regulatory workstreams that are guiding the UK’s new direction for capital market reform.

There are three significant initiatives in-flight to ensure that the UK regulatory framework better reflects the specific needs of the UK and its status as a global financial centre. Namely, the Wholesale Markets Review (WMR), the Financial Services and Markets Bill (FSMB) and the Edinburgh Reforms all speak to the level of change currently afoot for UK financial services regulatory reform.

Across these three initiatives there are significant areas of overlap as policymakers and regulators progress on different tracks towards an end-state regulatory framework.

Wholesale market review (HMT)

After the UK’s official departure from the EU, HM Treasury (HMT) published its Wholesale Markets Review (WMR) in July 2021. The WMR sketches out proposals for an overhaul of the UK’s financial services regulatory regime and signposts that the UK’s emphasis will be on openness, competitiveness and proportionality when it comes to regulating its capital markets.

It would however be wrong to describe the WMR as anything approaching a ‘regulatory bonfire’ of EU-inherited legislation. The UK’s leading role in the development of much of the EU financial framework always meant that a complete rewriting of the rules was unlikely. Instead, the WMR indicates the UK is taking a more targeted approach by using its new-found regulatory leeway to tweak and tailor, rather than slash and burn. This allows the UK to remove legislation that either did not work as intended or is no longer relevant for a single jurisdiction. Emphasis has been placed on removing burdens for firms. In one sense, the WMR can be seen as equivalent to the MiFIR review currently going on in the EU as it pertains to broadly the same issues – albeit with some important divergences.

Here are some of the main components of the WMR:

• Trading venue definition: Clarification of the current ‘trading venue’ definition governing the perimeter between trading venues and bilateral systems.
• Trading conflicts of interest: Examination of the existing restrictions that govern the conflicts of interest between multilateral trading facilities (MTFs) and organised trading facilities (OTFs).
• Outages: Trading venues and market participants will be required to implement a playbook for responding to and recovering from outages.
• Systematic internaliser (SI) regime: Return to a qualitative definition of the Systematic Internaliser (SI) concept with entity level determination.
• Equity market reform: Removal of the share trading obligation (STO) and double volume cap (DVC) which curtails ‘dark trading’.
• Non-equity transparency reform: Recalibration of the pre and post trade transparency regime for fixed income and derivatives markets.
• OTC derivative transparency criteria: Remove the concept of traded on a trading venue (ToTV) for OTC derivatives transactions and make central clearing the key determinant of transparency eligibility.
• Commodities regime: Revamp the commodities regime and revoke the requirement for position limits to be applied to all exchange-traded contracts.
• Consolidated tape: Amend the market data regime to facilitate the creation of a commercially viable consolidated tape.
• Identification: Examine whether there are better identifiers than ISINs for derivatives.

Following industry feedback, in March 2022 HMT published an official response to its consultation and committed to carrying forward a package of reforms. Specifically, HMT highlighted the simpler approach to determining SI status, a more sensitive transparency regime, and further clarification of the trading venue perimeter.

Wholesale market review (FCA)

While some of the WMR items will be implemented through primary legislation, most has been delegated to the FCA to turn many of the high-level policy intentions into technical requirements to be implemented by the industry.

This process began in the summer of 2022 when the FCA consulted on reforms to equity market structure, alongside broader changes including the creation of a new designated reporter regime for the post-trade transparency regime. The FCA also proposed guidance on trading venue outages covering communications protocols and monitoring. A policy statement is expected later this year.

The FCA also consulted last autumn on guidance concerning the trading venue perimeter and we expect further announcements on this later this year.

Regarding non-equity market structure reform, we expect the FCA to publish proposals for changes to the UK transparency regime for fixed income and derivative instruments toward the end of this year.

Finally, in line with HMT’s commitment to establish a consolidated tape regime by 2024 the FCA will consult this summer on proposals for a bond consolidated tape (CT) regime and the priority will be the bond and equity tape.

Financial Services and Markets Bill

The Financial Services and Markets Bill (FSMB) covers the institutional arrangements for how the UK’s departure from the EU will impact financial services rule-making.

First announced in the summer of 2022, the FSMB is designed to repeal various items of retained EU law with a view to establishing a more proportionate UK financial services regulatory framework. As part of this new institutional arrangement, the UK financial regulators will be given secondary objectives to facilitate the international competitiveness of the UK economy. Additionally, the UK Parliament is expected to have more scrutiny over – and engagement with – financial regulators than before under the new regulatory architecture.

The Bill also contains elements of the Wholesale Markets Review that require legislation to take effect, including:

• SI definition – Reversion to a qualitative definition of a Systematic Internaliser (SI) and provide the FCA the power to specify how the new definition should be interpreted.
• Midpoint crossing – To permit SIs to execute client orders more flexibly, i.e. at the mid-point within the best bid and offer for trades below the large in scale (LIS) threshold.
• Double volume cap (DVC) – Removal of the DVC that limits the level of dark trading from the MiFID II framework. The FCA will be required to monitor UK markets in order to continue its own research into assessing the impacts of trading with no pre-trade transparency.
• Share trading obligation (STO) – Removal of the STO so that firms can trade shares on any trading venue in the UK or overseas with any counterparty or on an OTC basis.
• Realignment of the DTO and CO scope – Formal realignment of the counterparties (including financial, non-financial and analogous third country entities) in scope of the derivatives trading obligation (DTO) with those in scope of the clearing obligation (CO) in EMIR.
• Exempt PTRR services from the DTO – Expansion of the exemptions that currently apply to portfolio compression to other risk reduction services. To ensure that the right services are covered by the exemption, the Bill gives the FCA a new rule-making power to specify which post-trade risk reduction (PTRR) services can benefit from the exemptions listed above as well as the conditions attached to their use.
• Exempt PTRR services from the CO – The Bill also gives the BoE a similar rule-making power, so that the same types of services can, if appropriate, be exempted from the CO as well. The Bank will be able to specify the post-trade risk reduction services that are to benefit from an exemption from the CO.
• Position limits – Revocation of the requirement for the FCA to apply position limits to all commodity derivative contracts that are traded on a trading venue and economically equivalent OTC contracts, and transfers responsibility for setting position limits from the FCA to trading venues.
• DTO scope – The Bill gives the FCA a new, permanent power to modify or suspend the DTO, subject to HM Treasury approval, to prevent or mitigate disruption to markets. This power will allow the FCA to make changes to the DTO in respect of which counterparties it is imposed upon; which derivatives come within its scope; and the venues on which transactions must be concluded by counterparties in scope of the DTO.
• Consolidated tape (CT) – Empowerment of the FCA to make requirements for consolidated tape providers with the aim of facilitating the emergence of one or more consolidated tapes.
• Pre-trade transparency waivers regime – The Bill revokes the existing system of waivers from pre-trade transparency requirements and instead gives the FCA new rule-making powers to determine under which circumstances waivers are available and any conditions that are to be attached to their use.
• Non-equity transparency regime– To reduce the complexity of the current regime and ensure that the right instruments fall within scope by delegating responsibility for calibrating the scope and firm facing transparency requirements to the FCA.

The FSMB is nearing the end of its legislative journey through the UK Parliament, having cleared the House of Commons last year and is now in the House of Lords. The Bill is expected to become law before Parliament closes for summer recess.

Edinburgh Reforms

Finally, to tie together the work being done across the WMR and the FSMB, UK Chancellor Jeremy Hunt announced last December a substantial package of regulatory reform regarding the UK financial services, dubbed ‘The Edinburgh Reforms’. This forms an important part of the broader legislative and policy work to rethink UK financial services post-Brexit, and contains a wide range of initiatives designed to make the UK a more attractive, proportionate and forward-facing financial services centre.

For example, items relating to the Wholesale Markets Review include the following:

• Consolidated tape: Committing to having a regime for a UK consolidated tape in place by 2024.
• New class of intermittent trading venue: The Government will work with the regulators and market participants to trial a new class of wholesale market venue which would operate on an intermittent trading basis to help bridge the gap between public and private markets. The government’s hope is that this new type of venue will allow companies to access global investors before they are ready to be fully public and in turn allow investors to gain access to some of the most exciting companies earlier than they otherwise would.
• Investor reporting regime: The government will implement the changes to the investor reporting regime that HMT consulted on as part of the WMR. The changes in the SI remove the need for firms to inform retail clients when the overall value of their portfolio depreciates by 10% and makes electronic communication the default method of communication for retail clients.

In addition to the WMR the Edinburgh reforms also include a range of items relating to the wider financial services landscape, including:

• Investment research reform: Establishment of an independent Investment Research Review to assess the contribution of investment research to UK capital markets competitiveness. This will include but will not be limited to the effects of the EU’s MiFID unbundling rules and is part of the government’s wider commitment to enhance the UK’s ability to attract companies to list and grow.
• Senior managers and certification regime: The Government began its review into reforming the Senior Managers & Certification Regime in Q1 2023. HMT is concerned that the SM&CR is a barrier to top talent and stops senior figures from moving to the UK.
• PRIIPs revocation: Repealing the Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulation, and consulting on a new direction for retail disclosure in the UK.
• Settlement: Establishing an Accelerated Settlement Taskforce to explore potential for faster settlement of financial trades in the UK, such as moving to a T+1 standard settlement period. Initial findings to be published by December 2023 with full report and recommendations by December 2024.
• Bank ring-fencing: Reforming the ring-fencing regime for banks by following the recommendations of the independent panel for modest and sensible reforms and consulting on the more significant recommendation of taking banks out of ring-fencing where they are fully resolvable.
• Green finance: The Government has published an updated Green Finance Strategy in early 2023 and is consulting on bringing ESG ratings providers into the regulatory perimeter.

Future Direction

While many of the initiatives and market implications associated with the WMR, FSMB and the ‘Edinburgh Reforms’ are yet to take effect, as policymaking process intensifies, market participants can expect to see tangible reform sooner rather than later. Furthermore, outside of the three of main regulatory reform workstreams, there are several other initiatives post-Brexit – from listing to insurance reforms – which will have important implications for UK market participants. As the political and industry momentum for regulatory reform gathers pace, both the material requirements for firms and the structural way in which policy is developed is set to undergo significant change over the coming years.