The Wholesale Markets Review – no “big bang”

United Kingdom

On 1 March 2022, HM Treasury published its response to its consultation on the Wholesale Markets Review (WMR), which closed on 24 September 2021. A relatively large number of organisations from across the industry participated in the consultation and the response engages in some detail with the feedback received.

The response also explains how the Government and the Financial Conduct Authority (FCA) plan to deliver the various proposals, through a combination of legislative change, subject to the caveat that this will only occur “as parliamentary time allows”, and through changes to FCA rules and guidance. As the Government indicated in the WMR consultation, it was felt that a number of the proposals would most appropriately be taken forward by the FCA following completion of the post-Brexit Future Regulatory Framework (FRF) Review, which will involve the transfer of more rule-making powers to the FCA. The net effect is that implementation of the WMR will proceed on a piecemeal basis, rather than in the form of a “big bang”, and a number of the reforms may not take effect for some time.

In this article we summarise the latest developments that are likely to be of greatest interest to market participants. For more information on the original consultation, please see our earlier commentary on this topic (The Wholesale Markets Review – fine-tuning the MiFID II regime?).

  • Regulatory perimeter for trading venues. Although the Government recognises the need for greater clarity in this area, it is intended that the FCA will consult on new guidance in the first instance, rather than the Treasury bringing forward amendments to the definition of a “multilateral system”, the concept of which underpins the trading venue regulatory perimeter.

  • Removal of some restrictions on MTF and OTF operators. The Government believes that it would be appropriate to remove the matched principal trading restrictions for investment firms operating a multilateral trading facility (MTF), and to allow the operators of organised trading facilities (OTFs) to execute transactions in equities when dealing in packages. However, these issues have been deferred for now, with the FCA to consider them further post-implementation of the FRF Review.

  • SME markets. The Government will continue to explore the creation a new type of trading venue for small and medium-sized enterprises (SMEs) in close collaboration with the FCA and market participants as part of the wider UK Listings Review.

  • Market outages. The FCA will discuss with market participants how it can use its current tools to clarify what should happen when there is a market outage (and whether and how to amend the requirement for trading venues to resume trading within two hours of an outage) as a prelude to further consultation later in 2022.

  • Adjustments to the systematic internaliser (SI) regime. 

    • A return to qualitative thresholds. 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 intends to revert to qualitative thresholds (as was the case under MiFID I), in order to reduce the compliance burden on firms by removing the need to undertake complex quarterly calculations.

    • Simplifying the SI reporting regime. In principle, the proposal to simplify the reporting regime for SIs was welcomed by most respondents, although a number of different approaches were put forward. On the face of it, it appears that the Government’s original proposal that if a counterparty is dealing with an SI, the SI will always be responsible for reporting (whether or not they are an SI in the particular asset class that is being traded) may not be taken forward. It is expected that the FCA will consult on this in the first half of 2022.

    • Minimum quote sizes. The FCA has also been given responsibility for taking forward the proposal for increasing the minimum quote size for equity SIs as a proportion of standard market size (SMS) following the implementation of the outcomes of the FRF Review.

    • Midpoint crossing. The Government accepted that its proposal to introduce specific restrictions to midpoint execution might not be required, so long as SIs consider the extent to which their use of midpoint execution is consistent with their best execution obligations.

  • Removal of the Double Volume Cap (DVC). On 23 November 2021, the Economic Secretary to the Treasury committed to bring forward legislation to remove the DVC on trading that happens without pre-trade transparency under the pre-trade transparency waivers.

  • Removal of the Share Trading Obligation (STO). The Government has also committed to bring forward legislation to remove the STO.

  • Market makers and algorithmic trading. In the Government’s view, the requirement for algorithmic trading firms to enter into market making agreements with trading venues when they pursue market making strategies “does not fulfil any meaningful regulatory purpose and should be removed”. However, this is another proposal that the Government considers will be best taken forward by the FCA following the implementation of the FRF Review.

  • Reforming the tick size regime. Responses to the Government’s proposed reforms to the tick size regime were mixed. For example, there was opposition to the proposal to delegate the tick size regime entirely to trading venues, with some respondents commenting that this may lead to a “race to the bottom”. In any event, the Government has deferred reform in this area until after the implementation of the FRF Review.

  • Amendments to the Derivatives Trading Obligation (DTO). The Government intends to bring forward legislation to align the scope of the DTO with the scope of 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 will also be given a permanent power to modify or suspend the DTO, beyond the initial post-Brexit period.

  • Reforming transparency requirements for non-equity instruments. The responses to the Government’s proposals for reform indicate that the sentiment that the regime is poorly calibrated for bonds and in particular derivatives is widely shared. However, there will not be any immediate changes as the Government plans to delegate the responsibility for recalibrating the scope of the regime to the FCA when parliamentary time allows.

  • Changes affecting commodity markets. The Government is committed to revoking the requirement for position limits to be applied to all exchange-traded contracts, and to transfer the setting of position controls from the FCA to trading venues. The Government agrees with respondents that revoking the current ancillary activities test (AAT), re-introducing the commodity dealer exemption, and removing annual notification requirements would represent significant improvements to the current regime. It therefore intends to bring forward secondary legislation under existing powers to enact this change. The Government is not intending to make any immediate amendments to the Oil Market Participant and Energy Market Participant regimes, recognising the complexities involved and the potential for unintended consequences.

  • Enabling a Consolidated Tape (CT). Respondents to the consultation appeared to be broadly supportive of the Government’s proposals to support the emergence of a CT. However, somewhat predictably, there were a number of concerns about the potential cost implications and the usefulness of certain types of market data (such as pre-trade data in the fixed income market). Interestingly, given the long-standing issues on market data pricing, some respondents to the consultation argued that the legal requirement to make data available on a “reasonable commercial basis” is simply not working. The FCA will be consulting on specific changes to support the development of a CT following the implementation of the FRF Review.

  • Reporting. The Government will continue to engage relevant stakeholders in 2022, including consumer groups and retail-facing bodies, before taking any decision regarding next steps with regards to investor protection reports, including 10% depreciation reporting and the delivery of all reports electronically. As has become apparent, further work is required to improve outcomes in relation to the use of International Securities Identification Numbers (ISINs) for reporting purposes, in particular in relation to derivatives.

Article co-authored by Daniel Lederman.