In a frustrating twist to the dangerously slow-moving narrative on cross-border financial market access post- Brexit, ESMA yesterday (25 November) issued a public statement confirming the EU’s hardline stance to the derivatives trading obligation (DTO) under MiFIR. The DTO requires EU investment firms to trade certain classes of derivatives only on EU-authorised trading venues – or third country trading venues certified by the European Commission as equivalent. No such equivalence decision has been made or signalled by the EU for purposes of the DTO – and ESMA’s latest statement declines to offer any forbearance or similar relief to EU firms currently using UK venues for this purpose.
This is particularly disappointing after recent commentary from the UK and EU that discussions in this area were ongoing – leading some to hope for a more flexible stance from both sides on the DTO. As things stand, ESMA’s approach will limit EU firms’ ability to access UK venues, with the result that UK and EU counterparties will no longer be able trade with each other on UK venues. This is expected significantly to affect liquidity in certain derivatives markets. Having a UK branch will not provide a solution for EU firms, as the UK branch will generally be subject to both the EU DTO and the parallel UK version of the DTO – the latter mandating trading on UK authorised venues. ESMA’s statement acknowledges this particular issue but holds the UK responsible in its approach to implementing the DTO into UK law. ESMA’s comment that this conflict may require changes to EU firms’ business practices may be an implied nod to one emerging industry solution, which would see EU firms (including their London branches – or possibly UK firms) surmounting the conflict by shifting derivatives trading onto (equivalent) US swaps platforms. It remains to be seen whether this is a feasible option for all derivatives trading and what its broader impact might be.
ESMA’s statement implies that its hardline stance on the DTO is incentivised by its potential to encourage a shift in liquidity to EU trading venues, although it confirms that it will continue monitoring the situation closely to assess whether EU markets would be sufficiently liquid to enable EU firms to comply with the DTO post-Brexit.
On the UK side, the FCA has also so far declined to grant relief or adjust its approach to the DTO and has instead continued to focus on the prospect of reciprocal equivalence as the optimal solution. Publicly, the FCA continues to maintain this stance, but firms will be wondering whether the FCA’s position might soften given its recent change in approach to the Share Trading Obligation (STO), where it has decided to use the Temporary Transitional Power to permit UK firms to continue trading shares on EU venues in the absence of mutual equivalence. Firms should not, however, assume that this will be the case given the different nature of the equities and derivatives markets (and, in particular, the higher concentration of derivatives trading and related activities such as clearing in the UK).
The prospects of such a solution materialising in the near future may be affected by the outcome of the wider Brexit negotiations, and whether a deal can ultimately – and imminently – be agreed. In the meantime, however, the UK has granted equivalence to the EEA in various areas, including for certain purposes relating to derivatives trading under EMIR. The FCA has also published a notice and updated its EMIR webpage to reflect this.
In more welcome news for industry (albeit also designed to shift trading to EU markets) ESMA also this week issued a joint statement with the other European Supervisory Authorities confirming amendments to EU delegated legislation to facilitate novation of EU firms’ legacy derivatives contracts with UK counterparties to EU counterparties, without triggering clearing or margin obligations under EMIR.