MiFID3 View - November 2021

Welcome to our November edition of MiFID3 View highlighting recent developments in UK and EU MiFID2 reforms. After the lull of the summer, momentum is building and we expect to see further MiFID developments as 2021 draws to a close. In case you have missed our earlier MiFID3 View publications you can find them here. As ever, your feedback and thoughts are always welcome.

Firstly, some key dates to look out for in the coming months

• Q4 2021: EU's wider legislative package of MiFID2 reforms due to be published.
• November 2021: FCA expects to publish its final policy statement with rules in relation to best execution reporting and research unbundling based on feedback on its consultation paper "Changes to UK MiFID conduct and organisational requirements".
• 9 November 2021:Commission Delegated Regulation (EU) 2021/1833specifying the criteria for establishing when an activity is to be considered to be ancillary to the main business at group level comes into force. See below for further details.
• 22 November 2021: ESMA will hold an open hearing for its recent call to evidence published 1 October on a number of retail investor protection topics under MiFID2. You can register here.

Now let's look at some EU developments more closely

Update on the implementation of the EU "Quick Fix"

As you know the EU's 'Quick Fix' was published in the official journal on 26 February 2021 making a number of targeted changes to MiFID2 rules relating to product governance, payment for research, client information requirements, energy derivatives markets and best execution requirements. Under the 'Quick Fix' EU Member States have to publish and adopt implementing measures by 28 November 2021 and are expected to apply those measures from 28 February 2022. We have been tracking Member State implementation of the EU 'Quick Fix' in France, Germany, the Netherlands, Luxembourg, Spain, Ireland and Italy and you can access our implementation and gold-plating tracking table here. Of those jurisdictions only Luxembourg has thus far published its implementing legislation and intends to apply the obligations without any gold-plating. With regards to Spain, a proposed draft is still in the process of being approved and there may be some further amendments before being finalised. Under the proposed draft there is potential that there will be some gold-plating provisions relevant to research unbundling, information requirements to professional clients and eligible counterparties and exemptions to firms that trade commodity derivatives.  See our table for further information here. We will continue to track Member State implementation and will provide a further update in our December MiFID3 View.

EU changes to ancillary exemption

You will recall that back in July 2021, the European Commission adopted a Delegated Regulation  amending the criteria for ancillary activity test for the commodities regime in response to the EU's 'Quick Fix' package which noted that national regulators should be able to rely on a combination of quantitative and qualitative elements when establishing whether an activity is considered to be ancillary. The EU 'Quick Fix' empowered the Commission to provide guidance on this approach, and to develop a delegated act on the criteria to replace the Commission Delegated Regulation 2017/592 (RTS 20). See our MiFID3 View -  July edition.  This Delegated Regulation has now been published in the Official Journal and comes into force on 9 November 2021.The changes triggered by the amended ancillary activity exemption are the deletion of the overall market size test in Article 2 of RTS 20 and the introduction of the new de-minimis threshold test. This will no doubt be very welcome by those in the commodity industry who have  in the past found the market size test challenging to complete, not least because it required data that market participants were unable to obtain themselves and relying on estimates created legal uncertainty.

The Delegated Regulation continues to apply the established calculation methodologies and principles of RTS 20. It also retains a calculation period of three years set out in RTS 20 to address the legal uncertainty that would arise for non-financial groups that do not have a complete and representative set of data covering their main and ancillary activities. If calculated annually, the amount of capital employed and the size of the trading activity in financial instruments might fluctuate from year to year (for example, periodic events might require increased hedging in some years but not others). This could cause a non-financial group to fall within the scope of MiFID2 because it fulfils the relevant criteria in one year, but it may qualify for an exemption in another year. Therefore, the Delegated Regulation maintains that calculations to be undertaken to verify whether non-hedging trading is ancillary or not should cover a rolling average of three years.

It's worth noting that HM Treasury's Wholesale Market Review is also consulting on amending the ancillary activity test in the UK and like the EU proposes to move back to a more qualitative/principals-based test that applied pre-MiFID2. We are told that the exact proposals will be published when parliamentary time allows. So whilst the UK and EU's approach appears to be aligned the detail of the final proposals will need to be considered closely to determine any divergence. 

EU introduces harmonised third-country branch regime for non-EU banks

Whilst not a MiFID reform, we wanted to flag to you that on 27 October 2021, the European Commission published a new Banking Package, that finalises the implementation of the Basel II agreement and aims to strengthen the resilience of the banking system, enhance supervisory powers and support the transition to climate neutrality. The package includes a number of legislative reforms and in particular proposes amendments to the Capital Requirements Directive and Capital Requirements Regulation. Like the MiFID2 reforms the new package proposes a harmonised approach to third-country branches. Under the reforms non-EU firms will required to establish a branch in the EU before starting to provide 'banking services'. It also proposes to introduce minimum standards for the authorisation, capital, liquidity, governance, reporting and supervision of branches of third-country banks in the EU. There will also be introduced a subsidiarisation mechanism which would require third-country branches to become subsidiaries when reaching a certain size and determined to be a systematically important.  This will be particularly relevant to our global non-EU client base including UK clients post Brexit which currently operate from an EU branch or through relevant national exemptions in Member States. We are currently examining the draft proposal and will be producing a client alert which we will circulate and post on our MiFID3 View webpage in due course.

What's been happening in the UK?

Final rules on Best execution and research

This month we await the publication of the FCA's policy statement on its final organisational and conduct changes to best execution RTS 27 & 28 reporting and research unbundling following its consultation CP21/9. For a quick recap, see our note Top 10 things firms should know about the FCA CP21/9 which sets out the scope and summary of the proposed changes. Though we cannot say definitely, it is expected that most changes will be applied as consulted on. Firms impacted by these changes should be taking some preparation steps by conducting a gap analysis of current requirements versus future proposed changes; reviewing internal systems or changes they need to implement for future compliance; and reviewing changes required to both internal compliance and policy documentation and external communications with customers or service providers.

Update on wholesale market review and FCA's work on Derivatives Trading Obligation

Last week the FCA published its Regulatory Initiatives Grid providing an update on what's on the FCA's horizon. As an update on the FCA and HM Treasury's Wholesale Market Review, the FCA noted that the Government will be responding on proposed reforms in due course. Discussions within industry suggest  that the Government intends to stagger the developments over a period of time rather than introduce them altogether at one time. In addition, the FCA expects to publish its own consultations on necessary complimentary changes to the FCA handbook or Regulatory Technical Standards in Q1 and Q2 of 2022. So watch this space.

LIBOR Transition & Derivatives Trading Obligation

In another development, on 15 October the FCA published a policy statement on the LIBOR transition and the derivatives trading obligation setting out finalised amendments to the UK regulatory technical standards on the trading obligation for certain derivatives ('DTO RTS'). The changes to the DTO RTS follow the FCA's July 2021 consultation (CP21/22) and the final rules are set out in the Technical Standards (Markets in Financial Instruments Regulation) (Derivatives Trading Obligation) Instrument 2021. Key highlights include:

• The FCA is removing derivatives referencing GBP LIBOR under the current DTO and replacing them with OIS referencing SONIA.
• The DTO for SONIA OIS will apply to trade start types spot-starting and IMM (next 2 IMM dates) in the following tenors: 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 12, 15, 20, 25 and 30 years.
• EURIBOR-based swaps remain subject to the DTO.
• There is insufficient liquidity for a DTO for €STR OIS, but the FCA will monitor liquidity and impose a DTO should sufficient liquidity become manifest.
• Aligning with the Bank of England approach on the derivatives clearing obligation ('DCO'), no change is made to the DTO for USD LIBOR.
• SOFR OIS is not yet sufficiently liquid to justify a DTO.

The FCA states that the changes take account of the Bank of England's amendments to the scope of the DCO under UK EMIR, its updated liquidity analysis and the responses it received to CP21/22. The DTO implementation date is aligned with that for the modified DCO, chosen by the Bank of England: 20 December 2021.The FCA recognises that relevant deadlines and milestones are likely to increase liquidity in SOFR OIS products as the year progresses. Activity in €STR OIS products may also increase. The FCA will therefore continue to monitor market developments and liquidity in these products and consider making further changes to the scope of the DTO in due course, once it is satisfied that the class of derivatives is sufficiently liquid for inclusion in the DTO.

As always if you have any questions on the above developments then please do not hesitate to reach out to our dedicated MiFID3 Team.