The Wholesale Markets Review – fine-tuning the MiFID II regime?

United Kingdom

On 1 July 2021, HM Treasury published a consultation paper launching its Wholesale Markets Review, which is pitched as an opportunity to make the UK’s financial services rulebook “nimble and fit for purpose” following the UK’s departure from the EU. The consultation paper addresses a number of areas under the inherited MiFID II framework which market participants and the Government have identified as not achieving outcomes that are desirable for the UK market. The Government has also in many cases invited respondents to the consultation to give their views as to other changes that could improve or increase the effectiveness of the current regime, and firms may want to take this opportunity to engage before the consultation closes on 24 September 2021.

Although a number of the proposed changes will be of interest and significance on a day to day basis to the firms affected by them, as the Government admits, the Wholesale Markets Review “is not about revolutionising the rulebook” and it does not represent a fundamental departure from the current second Markets in Financial Instruments Directive (MiFID II) based regulatory regime. In this article we highlight some of the points that are likely to be of interest to market participants.

  • Trading venues perimeter. The Government is seeking views as to how to better clarify the regulatory perimeter for trading venues, given the breadth of the current definition which brings any “multilateral system” where trading interests can interact within scope. For example, the Government considers that the current definition has created ambiguity about the perimeter for technology firms who are bringing buyers and sellers together on an informal basis, and around whether brokers arranging transactions by telephone without operating a central mechanism to match client orders need to be registered as a trading venue. However, there does not appear to be an intention to fundamentally reassess the organised trading facility category introduced by MiFID II.

  • Potential removal of some restrictions on MTF and OTF operators. The Government is seeking views as to whether some of the current restrictions on the operators of multilateral trading facilities (MTFs), who are not permitted to deal as matched principal, and on the operators of organised trading facilities (OTFs), who are not permitted to operate a systematic internaliser within the same entity, should be retained. 

  • Adjustments to the systematic internaliser (SI) regime. Whether or not a firm is an SI in a particular instrument is currently determined by reference to quantitative thresholds, which are calibrated at different levels for each asset class. The Government is proposing to revert to qualitative thresholds (as was the case under MiFID I), in order reduce the compliance burden on firms by removing the need to undertake complex quarterly calculations. There is also a proposal to simplify the rules for identifying which counterparty is responsible for post-trade regulatory reporting, by stipulating that whenever a counterparty is dealing with an SI, the SI will be responsible for reporting, regardless of whether the firm is an SI in the particular instrument that is being traded. Finally, the Government is also proposing to offer increased flexibility on pricing by allowing SIs to execute at the mid-point whether or not a trade is large in scale, provided certain conditions are met.

  • Removal of the Double Volume Cap (DVC). Although the Government expresses its view that generally the current equity pre-trade transparency regime works well, it is proposing to remove the DVC on trading that happens without pre-trade transparency under the pre-trade transparency waivers. Instead, the Financial Conduct Authority (FCA) would have the power to limit dark trading where there is evidence that it is undermining the efficiency of the price formation process.

  • Potential removal of the Share Trading Obligation (STO). Prior to the FCA’s use of its Temporary Transitional Power to alleviate the impact in November 2020, the potential conflict of the UK STO and the EU STO was one of the key issues of uncertainty for the sector in the lead up to Brexit. The Government “does not believe that the way the STO restricts trading is appropriate, effective or conducive to price formation or stability” and is therefore proposing to remove it. Although the Government argues that “[t]his change will ensure that investors can get the best price for their trade”, clearly the EU STO will continue to apply and so at least some trades with or for EU-based clients and counterparties (or execution chains containing clients/counterparties subject to the EU STO) are still likely to be required to be carried out on certain trading venues.

  • Market makers and algorithmic trading. The Government is proposing to remove the requirement for algorithmic trading liquidity firms that pursue a market making strategy to enter into a binding market making agreement with their trading venue(s), which will reduce the compliance burden for such firms.

  • Amendments to the Derivatives Trading Obligation (DTO). The Government is proposing to realign the scope of the DTO with the Clearing Obligation (CO) so that counterparties that are in scope of the CO will also be in scope of the DTO, as well as extending the exemption from the DTO to all post-trade risk reduction services, provided certain conditions are met. The FCA may also be given a permanent power to modify or suspend the DTO, beyond the initial post-Brexit period.

  • Clarifying the scope of transparency requirements for non-equity instruments. Although the term “traded on a trading venue” (ToTV) is not defined in the MiFID II legislative package, the concept is used to set the scope of the transparency requirements, including for non-equity instruments such as over the counter (OTC) derivatives. This has resulted in confusion as to whether certain OTC derivatives are considered ToTV or not, and therefore whether or not they are subject to the transparency requirements. Although the European Securities and Markets Authority has previously issued an opinion explaining how it expects transparency to work in this context, this has been difficult for firms to implement in practice. The Government is proposing to remove the concept of ToTV for OTC derivatives entirely, instead subjecting such transactions to the transparency regime where they are centrally cleared. Among other things, in the context of non-equity instruments, the government is also reviewing liquid market determinations, the applicability of pre-trade transparency to bespoke trades and reducing the number of post-trade transparency deferrals that are available.

  • Changes affecting commodity markets. The Government is considering narrowing the scope of the commodity derivatives regime, including by removing the automatic inclusion of economically equivalent OTC commodity derivatives from the scope of the regime. Among other changes, with regard to position limits, the government is proposing to revoke the requirement for these to be applied to all exchange traded contracts, and to transfer the setting of position controls from the FCA to trading venues, although it is only proposing small adjustments to position reporting. The Government is also considering whether to remove the Oil Market Participant and Energy Market Participant regimes.

  • Enabling a Consolidated Tape (CT). One of the perceived key failures of MiFID II has been the fact that, despite providing for a framework to enable the collection of post-trade reports in a US-style consolidated tape, a CT has failed to materialise in the EU. The UK Government is proposing certain changes to the regime, such as making it mandatory for trading venues to submit their data to a CT, to overcome these issues. There are likely to be sensitive and difficult issues around pricing and access to be addressed in greater detail (as has been the case with other market data topics). Another possibility that is being explored in the consultation is a public sector CT.

  • Reporting. No changes are currently proposed to the trade and transaction reporting regimes, although the Government is keen to understand the extent of any overlap between MiFID II and EMIR regulatory reporting requirements. Following the recent introduction of legislation which will remove or reduce the burden of reporting information to professional clients, the Government is also asking for views in relation to the provision of information to retail clients (including 10% depreciation notifications).