MiFID3 View - December 2021

Welcome to our December edition of MiFID3 View highlighting recent developments in UK and EU MiFID2 reforms. In case you have missed our earlier MiFID3 View publications you can find them here. As ever, your feedback and thoughts are always welcome.

The big tickets this past month are the publications of the long-awaited EU's Capital Markets Union package of reforms and the FCA's Policy Statement on 'Changes to UK MiFID conduct and organisational requirements'. We set out below a summary highlighting key takeaways from both publications.

Firstly, some key dates for this month

• From 1 December 2021 ​- UK firms are no-longer required to prepare RTS 27 and RTS 28 reports (see FCA's final changes to best execution and inducement rules below).
• 23 December 2021 - Deadline for responses to ESMA's Consultation Paper on MiFID2 Best Execution Reports - see our MIFID3 View – October update.
• 31 December 2021 - EBA and ESMA revised Guidelines on the assessment of the suitability of members of the management body and key function holders taking into account the amendments introduced by CRD V and the IFD, in particular with regard to money laundering and financing terrorism risks, and gender diversity will apply.

Now let’s look at some EU developments more closely

Capital Markets Union- Package of reforms amending MiFID2/ MiFIR

On 25 November 2021, the Commission (EC) published a Communication on the delivery of its 2020 Capital Markets Union (CMU) Action Plan. It was accompanied by a set of legislative proposals reviewing MiFID2/MiFIR, AIFMD and the European Long-Term Investment Fund (ELTIF) Regulation and creating a European Single Access Point. Some of the key developments proposed in the package include:

• Single Consolidated Tape Provider for each asset class: The main highlight of the proposals is the introduction of an EU-wide consolidated tape for shares, bonds, exchange-traded funds (ETFs) and derivatives. Currently, financial instruments are traded across various execution platforms. All these platforms need to publish information, such as the volume, time and price of each individual transaction. The outcome is that information is fragmented and for smaller investors, including retail investors, it is impossible to obtain a complete picture of the market. Even for the more sophisticated investment firms, navigating the information is complex and expensive. The Commission is therefore proposing for ESMA to appoint a single consolidated tape provider ('CTP') (through a tender process) in each asset class, with a suggestion that there may be separate CTPs for derivatives sub-asset classes. Under the proposals, all market data sources would be mandated to make standardised core market data available in a harmonised format and as close to real time as possible to market data aggregators.
• Share trading obligation and Derivatives Trading Obligation: In line with ESMA recommendations, the Commission proposes to clarify the scope of the share trading obligation ('STO') and limit it to EEA ISINs, but with trading on third-country venues allowed where the trade is in the local currency. It also proposes to establish an EU “official list” of shares subject to the STO. The derivatives trading obligation ('DTO') is proposed to be amended to de-scope small financial counterparties ('FC's) (to align with EMIR Refit). Two powers to suspend the DTO are proposed – one to suspend the DTO where the clearing obligation has been temporarily suspended, and one to allow standalone suspension of the DTO with respect to specific investment firms that would be subject to overlapping obligations when interacting with non-EU counterparties on non-EU platforms.
• Open Access Regime: The Commission notes that innovation in exchange-traded derivatives is not served by the “open access” obligation, as this rule removes incentives to launch new exchange-traded derivatives contracts if competitors do not have to make the upfront investment. Accordingly, the Commission proposes to amend the "open access" obligation for exchange-traded derivatives so that central counterparties ('CCPs') in the EU will no longer be obliged to clear derivatives trades that are not executed on their vertically integrated trading platform. Similarly, EU trading venues will no longer need to accept that non-affiliated clearing infrastructures clear trades executed on their platform.
• Proposed changes to the transparency regime: In relation to the pre-trade transparency regime for equities, the Commission proposes to replace the “double volume cap” to a “single volume cap” of 7% of trades that are executed under the reference price waiver. In relation to non-equities, the Commission proposes amendments that would mean liquidity and investment grade (IG) or high yield (HY) classification would be taken into account when deferrals are determined.
• Prohibition on Systematic Internalisers offering payment for order flow: The Commission’s proposals include a prohibition on systematic internalisers ('SI's) from offering payment for retail order flow. This is intended to put an end to certain high-frequency traders, organised as SIs due to their large transaction volumes, paying retail brokers in exchange for the brokers channelling their retail orders to the high-frequency trader for execution. The Commission wants to encourage the placing of retail orders with a transparent market (a regulated market or MTF) for execution.
• Dealing on own account: ​Under the proposals the exception from the MiFID2 dealing on own account exemption for persons accessing a trading venue via DEA is to be removed.
• RTS 27 Best Execution Reports: The Commission proposes to remove RTS 27 best execution reporting requirements noting that firms rarely use these reports and sufficient post-trade information will be covered in CTP reports. As you know these these are currently suspended under the EU 'Quick Fix' until 28 February 2023. The Commission makes no mention of RTS 28 reporting requirements which ESMA is currently consulting on. See our MIFID3 View – October update.
• European Single Access Point: Under the proposals a European Single Access Point ('ESAP') will be launched in 2024, and operated by ESMA. The ESAP will offer a single access point for public financial and sustainability-related information information about EU companies and EU investment products. This will give companies more visibility towards investors, opening up more sources of financing. This is particularly important for small companies in small capital markets, as they will more easily be on the radar screen of EU, but also international investors. The ESAP will also contain sustainability-related information published by companies, which will support the objectives of the European Green Deal.

Initial responses to the package have been positive, with many seeing it as an important step to achieving the aims of the key objectives of the CMU Action Plan. However, some have highlighted some deficiencies or areas that require further thinking. ICMA noted in its preliminary thoughts, that it is concerned that the suggested maximum deferral for the reporting of a transaction price for large and illiquid trades is end of day arguing that it will likely disadvantage EU fund managers, asset managers, pension funds and banks by compromising their market positions. ICMA recommends for large and illiquid bond trades a two-week price and size deferral and noted that there should also be a published methodology for liquidity determination. Concerns have also been raised around the need to prioritise a consolidated tape for equities and the need to extend the scope of the consolidated tape for equities to include pre and post trade trading data from the outset.

Next Steps - The Commission proposals will be subject to the ordinary legislative procedure, so the next step is for the European Parliament and the Council to negotiate a final legislative text on the basis of the proposals - probably around 18 months at the earliest. The proposals, once finalised, will also require additional delegated acts and technical standards covering the detail, for example on the content of standardised market data templates. So, we are at least a few years away from final legislation.

Commodity Derivatives On 22 November 2021, ESMA published a final report on draft technical standards for commodity derivatives. ESMA was required to develop technical standards under its EU ‘Quick Fix’ recovery package which introduced a number of changes to the MiFID2 commodity framework, including to the position limit regime. ESMA proposes:

• Draft RTS 21a laying down rules for the calculation of the net position held by a person in a commodity derivative, the methodology for calculating the position limits on the size of that position and the procedures for applying for exemptions to position limits. The draft RTS repeal Commission Delegated Regulation (EU) 2017/591 (RTS 21).
• Draft RTS on specifying the content of position management controls by trading venues position management, designed to provide additional tools for market monitoring by trading venues.
• Draft implementing technical standards (ITS) amending Commission Implementing Regulation (EU) 2017/1093 laying down ITS with regard to the format of position reports by investment firms and market operators.

The draft technical standards are set out in Annexes to the final report.ESMA has submitted them to the Commission for endorsement. The revised MiFID2 regime for commodity derivatives is proposed to apply at the end of February 2022.

Clearing Obligation and Derivatives Trading Obligation: ESMA has published a final report on draft regulatory technical standards ('RTS') amending the RTS on the clearing obligation ('CO') and on the derivative trading obligation ('DTO') under Article 5(2) of EMIR (648/2012) and Article 32 of MiFIR (600/2014) respectively. ESMA's proposed amendments to the draft RTS aim to ensure a smooth benchmark transition while maintaining an effective scope for the CO and DTO, in line with the G20 objectives. The final report amends the scope of the CO and the DTO to accompany the benchmark transition for OTC derivatives away from EONIA and LIBOR and on to new Risk-Free Rates (RFR). In particular, for the clearing obligation, ESMA proposes to remove the EONIA, GBP LIBOR and JPY LIBOR classes, to introduce the Euro Short-Term Rate and Secured Overnight Financing Rate classes and to extend the Sterling Overnight Index Average class. For the derivatives trading obligation, it proposes to remove the GBP LIBOR and USD LIBOR classes. ESMA has submitted the draft RTS to the Commission for endorsement in the form of a Delegated Regulation. Following a non-objection review by the European Parliament and Council they would only enter into force after publication. ESMA’s proposal would be for the changes to apply from 3 January 2022 (or 20 days after publication, whichever is the latest). ESMA notes that it is mindful that the approval process can take some time although it would see benefits in a quick process to accompany the actual benchmark transition milestones taking place shortly and to facilitate coordination and convergence with regards to the changes introduced by authorities in other jurisdictions to the scopes of their mandatory and trading obligations.

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.

Developments in the UK

FCA's final changes to best execution and inducement rules

On the 30 November 2021, the Financial Conduct Authority (the “FCA”) published its’ final Policy Statement (PS 21/20) "Changes to UK MiFID's conduct and organisational requirements" removing RTS 27 and RTS 28 best execution reporting requirements and widening the scope of exempted research from inducement rules. This follows feedback from the FCAs Consultation Paper (CP 21/9) back in April 2021 and as expected most of the final rule changes have been applied as consulted on. These changes form part of the FCA’s work with HM Treasury on Capital Markets reform aimed at reviewing current regulation and ensuring that the UK regime is proportionate and not overly burdensome whilst still maintaining high standards of investor protection. The results of the final policy statement is that:

• From 1 December 2021, firms are no-longer required to prepare RTS 27 and RTS 28 reports.
• From 1 March 2022, asset managers and research firms can exercise the options on exempting the following from inducement rules on research: research on SMEs below a market capitalisation of £200m (including SME ‘Corporate Access’), FICC research, research provided by research providers who do not provide execution services and are not part of a group that offer execution services and openly available research.

What are the changes to the inducement rules?

The FCA final changes will amend the inducement rules in COBS relating to research by widening the exemption of what constitutes a minor non-monetary benefit.

SME research - In order to boost research coverage and liquidity in the SME market, the FCA’s final policy statement introduces an exemption for research on listed or unlisted SMEs with a market capitalisation below £200m provided the research is offered on a rebundled basis or for free. The market capitalisation is to be calculated with reference to the average closing price of the shares of the company at the end of each month to 31 October for the preceding 24 months. For companies newly admitted to trading, determination of the threshold should be based on the market capitalisation at the close of day one trading and apply until the date of the next re-assessment (i.e. 31 October). It is highlighted that a number of respondents to (CP 21/9) argued that the £200m threshold is too low, noting a €1bn threshold would be preferable to align with the EU’s ‘Quick Fix’ reforms. However, the FCA confirmed its view that it is the appropriate level based on analysis of where the issue of lack of research is most acute.

FICC research - an exemption for third party research that is received by a firm providing investment services or ancillary services to clients, where it relates to fixed income, currency or commodity instruments. Whereas the FCA’s original proposals in their consultation applied this exemption to research ‘in connection to an investment strategy’ that relates primarily to FICC instruments, to make it operationally straightforward the final rules apply the exemption to research on FICC instruments to save firms from having to make that analysis.

Independent research providers’ exemption - an exemption for research provided by a research provider where the research provider is not engaged in execution services or not part of a group that includes a firm that offers execution or brokerage services.

Openly available research - an exemption for written material that is made openly available from a third party to any firms wishing to receive it or to the general public. In this context, “openly available” means that there are no conditions or barriers to accessing it, for example requiring a log-in, sign up or submission of user information in order to access that material;

‘SME’ Corporate Access - an exemption for corporate access services (the practice of where a broker brings about contact between an asset manager and an issuer and the broker charges the asset manager for this introduction) which relate to listed or unlisted companies with a market capitalisation below £200m. This exemption was not proposed as part of (CP 21/9), however the FCA recognises that including SME corporate access will avoid unnecessary complexity for asset managers who would have to differentiate between SME research and corporate access.

The FCA makes clear that it is not mandating its changes to the inducements regime and it will be up to firms to determine whether they wish to make use of the available exemptions. Whilst these changes may be welcomed by many firms, in particular smaller investment banks with sub £200m listed clients, it may be that many of the larger firms who have already greatly invested in their research models find that the cost to change their current systems and processes outweigh the benefits.

What are the changes to best execution reporting requirements?

The FCA has amended the best execution rules in COBS to remove:

• the obligation on execution venues to publish a report on a variety of execution quality metrics to enable market participants to compare execution quality at different venues (RTS 27 reports); and

• the obligation on investment firms who execute orders to produce an annual report setting out the top 5 venues used for executing client orders and a summary of the execution outcomes achieved (RTS 28 reports).

These changes supplement and confirm the legislative changes made by the Treasury to the UK MiFID implementing regulation through the UK ‘Quick Fix’ which has removed the obligation on firms to produce RTS 28 reports and RTS 27 reports. See out MiFID3 View – July update for more details.

How do the FCA’s final rules diverge from the current EU’s package of reforms?

Given, the changes under the UK ‘Quick Fix’, and the responses to (CP 21/9), these final changes come as no surprise. However, they also highlight a further area of divergence between the UK and EU regulatory reforms. On inducement reforms, whist the UK has extended their exemptions to the 5 additional areas of research which will apply from 1 March 2022, the EU "Quick Fix" has only introduced a partial exemption from the inducements rules for research on issuers with a market capitalisation below Euro 1bn. In relation to best execution, the EU "Quick Fix" has also temporary suspended RTS 27 reports until 28 February 2023. However, in the recently published MiFID2/MiFIR Capital Markets Union package of reforms the Commission is proposing to permanently remove RTS 27 obligations as noted above.

What remains unclear is the EU’s position on RTS 28 reporting. The Commission made no mention of these in their reform package. Whilst, ESMA did recently proposed changes to RTS 28 reporting requirements in its Consultation Paper on MiFID2 Best Execution Reports it made no indication that it would suggest removing them altogether – see our MIFID3 View – October update. It may be that the EU maintains RTS 28 obligations on firms in which case firms with EU and UK presence will have to continue producing those reports for their EU operations only.

Update on HM Treasury's wholesale markets review

In a recent speech, John Glen, Economic Secretary to HM Treasury, provided an update on the government's Wholesale Markets Review. Mr Glen reports that there had been a broad consensus on the vast majority of the issues discussed in the government's July 2021 consultation on its review, and that he will publish a full summary of the responses to the consultation early in 2022, together with the government's plans for taking the work forward. He confirms that the government intends to legislate as early as parliamentary time allows to implement many of the changes proposed in the consultation, which include:

• Revoking the share trading obligation (STO) and the double volume cap (DVC).
• Recalibrating the transparency regime for fixed income and derivatives markets.
• Reducing the scope of the position limits regime for commodity derivatives and transferring the setting of position limit controls from the FCA to trading venues.

Mr Glen adds that the government is working closely with the FCA on this agenda since some reforms will require changes to regulatory rules or guidance, and that the FCA has committed to starting that process in 2022. We therefore await 2022, to see further developments and in particular, how far the Government will align their changes with the EU Capital Markets Union package.

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