Brexit: FCA Moves Decisively on Trading Dilemma

With only 52 days left until the conclusion of the Brexit transition period at 11.00 p.m. (BST) on December 31, time is rapidly running out and several key regulatory areas remain uncertain. As political agreement is seemingly still far from assured, the Financial Conduct Authority (FCA) recently moved to make decisions which aim to fill in some of the remaining gaps on the Brexit regulatory puzzle. 

What is the latest Political Update?

Despite a significant uptick in the cadence and intensity of the political negotiation between the EU and UK, the mood music on a deal remains downbeat. Although there has been positive progress in some areas (policing and judicial cooperation for example) according to Michel Barnier, lead Brexit negotiator for the EU, there remains “very serious divergences” overall. Two contentious areas where the parties seem far away from consensus are Level Playing Field provisions and fishing rights. As of now, we still do not know for sure whether years of debate, dispute, and Brexit brinksmanship will ultimately result in a deal.   

Why is the “Level Playing Field” key to a Brexit Deal?

The Level Playing Field (LPF) is the central tenet of all EU trade-policy and competition rules. It applies equally to EU member states and any country wishing to do business within its single market. The Level Playing Field also played a large role in the initial high-level Political Declaration, which even though it is not legally binding, has guided the Brexit negotiations ever since. The declaration states that given the parties “geographic proximity and economic interdependence,” the future relationship must include “robust commitments to ensure a level playing field.”

Simply put, LPF are a set of rules and standards that work to prevent businesses in one country gaining a competitive advantage through arbitrage over other countries by reducing their own standards, laws, or regulations or providing governmental subsidies to businesses. Fundamentally, LPF defines how near or far the UK veers from the EU rules. One of the cornerstones of Brexit was to free the UK from the yoke of EU rules and bureaucracy. However, if the UK and EU do not agree to terms such as environmental standards, labor laws and taxation, then there will be no deal. The EU has long maintained that it will not allow UK access to the single market while at the same time the UK obtains an unfair commercial advantage through regulatory arbitrage. That’s why LPF is so crucial. 

“Without a level playing field on environment, labour, taxation and state aid, you cannot have the highest quality access to the world’s largest single market.” – Ursula Von Der Leyen

The overarching LPF issue also heavily influences whether sectoral deals such as on financial services will be agreed before year end. The concept of “mutual regulatory equivalence” has been a constant area of focus and concern for asset managers throughout the Brexit process, and it very much remains a live issue. 

What do the politics mean for asset managers? 

Many uncertainties remain for asset managers. Given the high degree of interconnectivity between EU and UK asset managers, banks and capital markets, the fact that many rules have not yet been fully determined is a cause of uncertainty and concern so close to the end of the transition period. Many rules remain uncertain because the EU has not yet granted the UK regulatory “equivalence.” For example, we identified a known issue with the MIFID “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. Without an equivalence determination in place, the UK and its market participants do not meet the criteria of any of the acceptable STO trading venues under EU rules. This is problematic for both UK and EU and other global trading entities. There are a host of similar activities between EU and UK regulated entities governed under regulations which require an equivalence determination which as it stands remains uncertain without the EU granting the UK equivalence. As time is quickly running out, the FCA has moved to take action.

What has the FCA done on MIFID STO?

Last week, the FCA used its Temporary Transitional Powers (TTP), to confirm that it will allow firms to continue trading all shares listed on EU trading venues and systematic internalisers (SIs) where they choose and are permitted to do so. The FCA action signals a more pragmatic approach to the STO issue that the approach of European Securities and Market Authority (ESMA) whose public statement had previously set out more restrictive requirements. 

The ESMA decree states that upon expiry of the transition period that EU traders can only trade EU company shares in London if those shares have a sterling listing, otherwise they must trade in a venue within the EU. That would have the effect of splitting market liquidity by forcing euro denominated trading to move out of London, Europe’s current hub for multi-currency cross-border stock trading.

The FCA approach self-described as “simple and comprehensive” on the other hand, allows UK regulated entities to continue trading all EU shares regardless of currency denomination on EU venues if they so wish and are authorized to do so. The FCA cite the requirement to ensure best execution for investors as the driver. This requirement is the first significant example of material divergence from an existing EU regulation by the UK. In refusing to mirror ESMA’s currency restrictions, the FCA recognize that they must act in order to ensure continuity of trading for entities in their jurisdiction in lieu of an equivalence determination. 

At the same time as announcing this divergence, the FCA also stated that it may need to diverge further from EU rules such as other MIFID requirements if the EU fails to grant the UK equivalence and unfettered access to the EU capital markets. It shows the tensions that will continue to arise on both sides of the divide created by several uncertainties lack of deemed equivalence for the United Kingdom creates. By far the most preferable outcome for the capital markets in both UK and EU would be the EU to grant full share trading access for the UK, but in the meantime this accommodation gives some much-needed breathing room as we collectively reach the Brexit precipice.

In lieu of an equivalence determination, the Brexit puzzle will continue to perplex and confuse asset managers, and it might be that the FCA need to deviate from the status quo and bend the rules of the game or fill in certain pieces of the riddle as they see fit. What does remain certain is that even with just 52 days left, we are likely to see more action as we reach end game.