On 5 July 2023, the Financial Conduct Authority (“FCA”) published a Policy Statement (PS23/11) on the final version of its new guidance on the UK regulatory perimeter with respect to trading venues. The guidance is in the form of questions and answers (Q&As), which will form part of the Perimeter Guidance manual in the FCA Handbook and will come into force on 9 October 2023.
The aim of the guidance is to clarify the FCA’s interpretation of the definition of a “multilateral system”, which is the “trigger” for the need to be authorised as a trading venue under the Markets in Financial Instruments Directive (“MiFID”) regime, as implemented in the UK. The Policy Statement follows the FCA’s Consultation Paper (CP 22/18) in September 2022, which was issued in parallel to the European Securities and Markets Authority’s (“ESMA”) separate guidance consultation in relation to the equivalent definition in the EU MiFID regime.
The FCA has not significantly departed from the positions taken in its Consultation Paper, however it has provided some further useful colour on its approach to interpreting the UK trading venue perimeter. The FCA is clearly trying to strike a balance between ensuring a level playing field in the interests of existing exchanges and not unnecessarily stifling innovation. However, the FCA has made useful statements in support of the view that providers of technology solutions, order and execution management systems and single dealer platforms “need not” constitute multilateral systems.
Background
In the Consultation Paper, the FCA identified the four elements of the multilateral system definition, which firms should have regard to when determining whether they require authorisation as a trading venue. The four elements are whether: (i) the arrangements have the characteristics of a system or facility; (ii) there are multiple third-party buying and selling trading interests; (iii) such trading interests are able to interact in the system; and (iv) the system relates to interests in MiFID financial instruments. The FCA had proposed detailed guidance on its interpretation of each of these elements. If a person operates a multilateral system it will require authorisation to operate a trading venue and will in turn be required to structure that system as a regulated market, multilateral trading facility or organised trading facility in accordance with the relevant detailed requirements that are derived from MiFID. Where a firm does not meet the definition of a multilateral system, it will not require authorisation as a trading venue, but will need to consider whether it requires authorisation for other regulated activities, including arranging deals in investments and/or making arrangements with a view to transactions in investments.
In the Policy Statement, the FCA has now confirmed its final guidance and provided its responses to points raised during the consultation. Market sentiment has largely been split between those who emphasise the need to ensure a level playing field between heavily regulated trading venues and relatively lightly regulated (or unregulated) technology providers, and those who emphasise the need to prioritise innovation and the ever increasing digitalisation of order management and execution. ESMA’s delayed Final Report published on 2 February 2023 had somewhat softened ESMA’s initial position in its Consultation Paper. The FCA’s starting position was relatively favourable and it has not significantly moved between the Consultation Paper and Policy Statement. However, as discussed below, the FCA has provided some useful further clarifications in its responses to points raised during the consultation.
Key issues for market participants in the FCA’s final guidance
1. Technology providers
The FCA has helpfully stated that it agrees that there is in fact a distinction between vendors of technology solutions, providers of technology and the operators of trading venues. It has sought to draw a distinction between the more passive role of a technology “provider” and the more active role of an “operator” of a venue. The guidance sets out a range of factors that the FCA will consider when determining whether a service has the characteristics of a trading system or facility. The FCA has also provided useful clarifications in relation to the nature of the “rules” under which a multilateral system operates and the remuneration paid to a venue operator versus a technology provider. The distinction between providers and operators is helpful colour in applying each of the elements of a multilateral system discussed above.
The FCA has also provided a reminder of the fact that technology providers may nonetheless be carrying out other regulated activities, including making arrangements with a view to transactions in investments. In this respect, the FCA has provided some further colour on the purpose and intentions behind its service company regime, which is intended to be a lighter touch regulatory regime for providers of order routing, post-trade processing and similar services to market participants. The FCA has also confirmed technical amendments to the FCA Handbook definition of a “service company”.
2. Order management systems, execution management systems and single dealer platforms
One of the key concerns with the initial ESMA consultation was the degree to which ESMA suggested that order management systems (“OMS”) and execution management systems (“EMS”), which are tools used by the buy- and sell-side to aggregate prices, apply risk limits and route or execute orders, could potentially constitute multilateral systems. Concerns were also raised with regard to ESMA’s initial position with regards to single dealer platforms, where a third party is involved in providing the underlying technology platform.
The FCA has helpfully recognised specifically that an OMS or EMS need not constitute a multilateral system. However, it has not definitively closed the door on the possibility of an OMS or EMS needing to be regulated as a trading venue. Market participants will take some comfort from the FCA’s statement, but will still need to assess their technology solutions carefully. The FCA has been more definitive in agreeing that single dealer platforms, where a single counterparty holds itself out to execute client orders on an own account basis, are not multilateral systems.
3. Voice brokers
The final guidance clarifies that arranging or executing client orders over the telephone does not in itself constitute a multilateral system unless the voice trading system has the characteristics of a multilateral system. This might also be the case where voice broking is combined with other modes of execution, for example electronic execution via a screen, where the electronic order book is also operated by the same broker. This means that there is still latitude for arrangements whereby voice brokers internalise orders and/or submit them to external execution venues, without themselves needing to be licensed as a trading venue.
4. Portfolio managers operating internal matching systems
The final guidance confirms that internal matching systems operated by firms engaged in portfolio management do not constitute a multilateral system, provided there is a direct connection between such internal crossing and the portfolio management activity.
5. Systems operated for the sole purpose of executing trades on regulated trading venues
The FCA has clarified its draft guidance by removing the reference to “block trades” and broadening it to make it clear that arranging large in scale or negotiated trades are examples of trades that can be arranged off venue but executed on venue in accordance with the venue’s rules, without involving the operation of a multilateral system.
6. Primary market activity
The final guidance confirms that a crowdfunding platform which allows clients to participate in company fundraisings by buying shares or bonds from the issuer will not amount to a multilateral system. While the FCA did not take the opportunity to broaden this guidance out to primary market activities more generally, the FCA has acknowledged that there is a distinction between primary and secondary market activity in the context of the trading venue perimeter and has said that it is not obvious that a trading interest exists before a financial instrument is actually issued. This should be helpful to the operators of primary market platforms more generally (for example, in the context of the issue of structured products).
7. Bulletin boards
The final guidance provides further clarity in relation to bulletin boards, helpfully confirming that notifying users of general expressions of interest in financial instruments and introducing potential counterparties to each other does not amount to operating a multilateral system.
8. Status of pre-Brexit ESMA Q&As
The FCA has maintained its position that its final guidance will not incorporate pre-Brexit ESMA Q&As 7,10,11 and 12 from section 5 of ESMA’s Q&A on Market Structures and that such Q&As will be set aside and will no longer form part of the FCA’s supervisory expectations. The FCA states it wants to avoid duplication and confusion. The FCA did not take the point raised by the Financial Markets Law Committee (“FMLC”) in its response to the consultation, which had recommended that the FCA should formally set aside Q&A 25 in section 3 of ESMA’s Q&A on Market Structures. The FMLC explained that it is widely understood that this Q&A is incompatible with the UK’s overseas person exclusion.
9. Potential areas for future change
The FCA reiterated that although it is not currently making any changes to the regulatory regime applicable to trading venues, any potential future changes will be guided by reducing costs and burdens for firms, without lowering regulatory standards and market integrity. The Policy Statement includes a useful overview of responses to the consultation, which discusses many of the issues regularly debated in the market, including the high barriers to entry under the current regime.
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