Markets View – November 2021

With more and more firms interested in our Trading Venue Reviewer, and given the popularity of EU View, SMCR+ View and Crypto View, we thought you might welcome a Markets View from the Simmons team.  Markets View will provide timely updates, analysis and commentary on developments and regulatory announcements affecting exchanges and other trading venues and market participants. We would love to hear your thoughts on it. 

This month we focus on the EC's announcement of an extension of equivalence for UK CCPs, ESMA's report on algo trading, as well as various proposals designed to improve the resilience of FMI.

1. EC Commissioner to propose extension of equivalence decision for UK CCPs

In a long-awaited announcement on Wednesday, the European Commission (EC) stated that it will soon propose an extension of the time-limited equivalence decision for UK-based central clearing counterparties (CCPs), currently due to expire on 30 June 2022. The extension will ensure that EU counterparties can continue to satisfy their clearing obligations under EMIR through UK CCPs without disruption and that EU clearing members can continue to offer clearing services on UK CCPs to their clients, addressing the possible short-term financial stability risk linked to an abrupt interruption in access to these clearing services.

The EC emphasised in its announcement, however, that this short-term solution would not address its medium-term financial stability concerns arising from the over-reliance on CCPs operating outside of the EU's single market. Next year, the EC will therefore announce measures to make EU-based CCPs more attractive to market participants by incentivising the expansion of domestic capacity and strengthening the EU's supervisory framework for CCPs.

The industry will await the outcome of the EC's proposal with interest as the granting of a short extension would still require market participants to prepare for a completely new situation.

2. ESMA's final report on the MiFID2 algo trading regime

The European Securities and Markets Authority (ESMA) recently published a report on the MiFID2 algo trading regime. The report concluded that there are no fundamental issues with the regime and that it had overall delivered on its objectives. Nevertheless, ESMA made a number of recommendations to simplify the regime and making it more efficient, some of which will no doubt be welcomed by the industry and others not. The report and its recommendations are relevant to EU market participants but will also be of interest if you're a non-EU participant engaging in algo or high frequency trading (HFT) on EU trading venues.

The report was based on a comprehensive review of all MiFID2 provisions directly and indirectly related to algo trading as well as recent market developments. The recommendations proposed by ESMA include amendments to MiFID2 and existing technical standards. The key recommendations firms should know about include:

• removing the authorisation requirement for EU DEA users dealing only on own account by removing the exception to the exemption to be authorised as an investment firm set out in Article 2(1)(d)(ii) of MiFID2;

• requiring non-EU HFT firms to be authorised as investment firms if they access EU trading venues through DEA or as a member or participant albeit with a specific third-country equivalence regime limited to such firms - this basically enacts at EU level a long standing German requirement;

• simplifying and reducing the market making requirements on EU trading venues generally and also in specific circumstances, such as government bonds which are handled by primary dealers, in order to benefit the resilience of liquidity;

• extending certain algo trading obligations to trading on systematic internalisers (SIs) including relevant governance, systems and controls, and notification requirements;

• changing to a principles-based algo-testing regime, where testing would ensure certain outcomes, e.g. no contribution to excess volatility, and improving the testing process as part of a further review of RTS 6; and

• developing guidance on communications during outages from trading venues setting out ESMA's expectations to ensure the effects of an outage are as limited as possible and there is continuity on other venues if a main market is affected by an outage.

The report has been submitted to the European Commission and its proposals will be taken into consideration as part of its broad upcoming review of the MiFID2 regime. The amendments of existing technical standards discussed in the report will be subject to specific consultations that ESMA will publish shortly.

3. BoE expectations of FMIs on material outsourcing to the public cloud

The Bank of England (BoE) recently published 'Dear CEO' letters it sent to Financial Market Infrastructures (FMIs) emphasising its expectations in relation to material outsourcing to the public cloud. The letters were addressed to:

• central counterparties;

• central securities depositories; and

• recognised payment system operators and specified service providers.

The BoE's outreach was prompted by the pace of digitalisation at FMIs, in particular the acceleration of plans to scale up reliance on cloud service providers (CSPs). (We note the news of CME's tie-up with Google on 4 November 20211 in this context).  The use of the public cloud clearly offers many benefits and opportunities to FMIs, including potentially enhanced resilience compared to current IT infrastructure models and lower operating costs, and forms a crucial foundation for adapting to the digital economy. However, the BoE highlighted that these opportunities come with risks that FMIs must manage, e.g. around the sharing of confidential data and the standards of outsourced services identified.  An increasing reliance on a small number of CSPs could increase financial stability risk in the absence of greater direct regulatory oversight of the resilience of their services.

Reliance on outsourcing arrangements is well established and many of these risks are not wholly new. Such arrangements and their risks are covered by regulatory requirements and the CPMI-IOSCO's Principles for Financial Markets Infrastructure with which FMIs must currently comply. In addition, FMIs must have regard to the BoE's recently published policy on operational resilience and any relevant international standards.

Expect more on this topic early next year as the BoE intends to consult on its guidance and policies for FMIs on outsourcing with specific reference to the use of CSPs. You can find more details of the BoE's upcoming initiatives on operational resilience and outsourcing in the November 2021 Regulatory Initiatives Grid.

4. FSB framework for information from FMI intermediaries to support resolution planning

You may have seen this summer that the Financial Stability Board (FSB) published a framework for gathering information from FMI intermediaries to support the resolution planning of FMI service users and their regulatory authorities (RAs). This framework builds on the guidance published by the FSB in 2017 setting out arrangements and safeguards to facilitate continuity of access to FMI services for a firm in resolution, with a view to maintaining the firm's critical functions that rely on the continued access to FMI services (2017 Guidance). As part of implementing the 2017 Guidance, these firms, as FMI service users, and their RAs must develop plans to facilitate continuity of access in resolution.

How do these resolution plans relate to FMI intermediaries? Well, in this context, the plans require relatively detailed information about the nature of the FMI service user's relationship with their critical FMI intermediaries. The framework provides a checklist for a baseline of such information that FMI service users should at a minimum cover in their contingency planning that they may need to obtain or discuss with their FMI intermediaries. The framework covers: (i) background information on the FMI services provided by the FMI intermediary and key parties; (ii) suspension or termination rights; (iii) the pre-resolution phase, during signs of distress at the client or an affiliate; (iv) the resolution phase; and (v) the scenario in which the FMI intermediary itself is in resolution.

The common framework this provides should reduce the information gathering burden and avoid duplication but requires quite a lot of upfront work by FMI intermediaries that they should be carrying out now and that will need to be refreshed. The most important steps FMI intermediaries should be taking now are: (i) reviewing their arrangements with FMI service users; (ii) developing standardised responses and streamlined response processes; and, (iii) considering their likely actions in resolution and pre-resolution scenarios. Although the onus is on the FMI service user and/or its RA to request any information and clarifications it may need from FMI intermediaries, FMI intermediaries should be prepared to provide their responses within a reasonable timeline.

In terms of next steps that you should watch out for, the first experience with the framework will be evaluated in the course of 2022 and FMI intermediaries and service users, as well as other key stakeholders, will then have the opportunity to provide feedback and suggestions on the framework and the process. So, watch this space as we expect that there to be industry engagement, particularly on the use of summaries of likely actions by FMI intermediaries. 

5. FCA proposal to extend the SMCR to RIEs

In its 2020/2021 annual perimeter report, the UK Financial Conduct Authority (FCA) announced its intention to broaden the scope of the Senior Managers & Certification Regime (SMCR) so that it applies to Recognised Investment Exchanges (RIEs). The FCA believes that extending the regime to RIEs would deliver greater accountability and robust oversight of functions that promote market integrity and ensure consistency in relation to its expectations of individuals discharging key responsibilities. In addition, a number of key trading venues are part of the same group as CCPs and the Treasury is currently consulting on creating a version of the SMCR for FMIs supervised by the BoE that would include these CCPs. If these proposals are taken forward, then the FCA sees this as another reason for extending the SMCR to RIEs as it would mean more consistency within key firms in the same group.