Markets View – January 2022

2022 is here and, looking ahead, the regulatory change agenda promises to be a packed one for financial markets, from the post-Brexit development of the UK's regulatory framework to the EU's MiFID Quick Fix, staying on top of regulatory changes will remain as essential as ever. This month we focus on the extension of EU regulatory equivalence of UK CCPs, the EU's DLT Pilot Regime, operational resilience and more. For more detail on MiFID3 developments please see our upcoming MiFID3 View.

EU plans 3-year extension to UK clearing system access

The European Commission's recognition of the regulatory equivalence of UK CCPs is valid until 30 June 2022. As this deadline approaches, ESMA has published its assessment of the risks posed to EU financial stability by two UK systemically important third-country central counterparties (Tier 2 CCPs), LCH Ltd and ICE Clear Europe Ltd, and the implications of deciding not to extend recognition of UK CCPs beyond June. The report concluded that the costs and risks of derecognising these services would outweigh the benefits to the EU at this time but sets out policy measures to address identified risks relating to the two UK CPPs. ESMA's proposed measures include:

• Reducing EU exposure - Providing appropriate incentives to reduce EU exposure to Tier 2 CCPs.
• Comparable compliance - Revising the comparable compliance framework so ESMA has appropriate supervisory and enforcement tools to assess and take action to ensure ongoing compliance with EMIR.
• Recovery and resolution requirements, Tier 2 CCPs - Requiring Tier 2 CCPs to comply directly with all or part of the provisions in the CCP Recovery and Resolution Regulation (EU) 2021/21 (CCPRRR) and granting ESMA the power to approve recovery plans of Tier 2 CCPs.
• Participation of EU clearing members - Granting ESMA the power to request from Tier 2 CCPs, and their supervisory authorities, notification before imposing limitations on access on EU clearing members.

EU clearing members using the services provided by the two UK CCPs will be reassured that, following the publication of the assessment, European Commissioner Mairead McGuinness confirmed that the European Commission would begin consultations on extending the regulatory equivalence decision for UK CCPs to June 2025.

ESMA calls for evidence on the DLT Pilot Regime and MiFIR transparency and reporting requirements

ESMA has published a call for evidence intended to gather expertise and perspectives on the use of distributed ledger technology (DLT) for on-venue trading and settlement from stakeholders. It sets out ESMA's reflections on the amendments required to the technical standards on transparency and reportingrequirements developed under MiFIR to support the EU's Regulation on a pilot regime for market infrastructures based on DLT (the DLT Pilot).

Organisations considering operating under the DLT Pilot, as well as market participants that plan to use DLT market infrastructures, should consider ESMA's proposals and their implications carefully. Key issues that organisations should focus on include:

• Conditions for the transaction reporting exemption - Certain users of the DLT Pilot may benefit from a full exemption from transaction reporting requirements if they record relevant details on the DLT and give direct access to regulators. Input is requested on if there are technical impediments in recording on the DLT all the transaction reporting information. The size of this information may negatively impact the scalability of DLT systems and raise a congestion risk.
• Regulatory access to DLT - The DLT Pilot requires certain users to grant direct and immediate access to the DLT for several purposes. Input is requested on how to admit regulatory observer participants. Considerations will include clear governance models, relevant technical specifications and functions, and determining appropriate levels of access.
• Definition of key concepts - The definitions of key concepts may not be applicable in the context of DLT. For example, given the current definition of relevant terms, it is not clear if orders can be transmitted in a DLT network or when a transaction should be regarded as executed. Input is requested on the suitability of the existing definitions and ESMA's proposed amendments.

Responses should be submitted using the form on ESMA's website before the call for evidence closes on 4 March 2022. Should ESMA conclude that amendments are necessary, it will consult on its proposals.The DLT pilot is expected to begin in early 2023.

Changes to liquidity thresholds and trade percentiles determining SSTI for bonds under MiFIR

The European Commission has adopted a draft Delegated Regulation amending Delegated Regulation (EU) 2017/583 (RTS 2) that relates to the transparency requirements for trading venues and investment firms. The changes relate to the methodologies for assessing the liquidity of bonds and the size specific to the instrument (SSTI), which are relevant for the application of transparency waivers and deferrals. Under MiFIR, illiquid instruments are eligible for pre-trade transparency waivers and post-trade transparency deferral while, if the size of an order is above the SSTI, then a pre-trade waiver is available for orders placed through RFQ or vox systems and post-trade deferral available regardless of the trading systems being used.

The changes made by the Delegated Regulation are as follows:

• Liquidity thresholds for bonds - Currently bonds are deemed liquid if: average daily notional amount traded is at least EUR 100,000; average daily number of trades (ADNT) is at least 10; and, if on at least 80% of the days during the last quarter, trading took place. The ADNT criterion is subject to a phase-in (Phase 1 - 15, Phase 2 - 10, Phase 3 - 7, Phase 4 - 2). The amendments to RTS 2 implement Stage 3 so the ADNT will decrease from 10 to 7, which should increase in the amount of liquid bonds.
• Trade percentile for SSTI - The SSTI is the higher of a fixed threshold of the daily notional amount traded or the amount above the 40th percentile of actual daily notional amount traded. Based on 2020 data, the pre-trade SSTI waiver applies for tickets of EUR 400.000 or higher for corporate bonds and EUR 900,000 or higher for sovereign bonds. The SSTI is also subject to a phase-in. Moving to phase 3 means that the 40th percentile will be replaced by the 50th percentile, increasing the threshold above which a pre-trade transparency waiver is available respectively to EUR 600,000 and to EUR 1,500,000.

Market participants using pre-trade transparency waivers and post-trade transparency deferrals should watch the progress of the draft Delegated Regulation closely so they know when to update their calculations. The draft Delegated Regulation will be submitted to the Council of the EU and the European Parliament to consider for approval. If neither objects, it will enter into force 20 days after it is published in the Official Journal of the European Union.

FCA launches market studies on accessing and using financial markets wholesale data

The FCA published a feedback statement on accessing and using financial markets wholesale data and announced its intentions to launch two market studies in response to findings that limited competition in markets for benchmarks, indices, credit ratings, and trading data may increase costs for investors and affect investment choices. The feedback statement identifies:

• Trading venues (including regulated markets, MTFs, OTFs) - Concerns that ownership of data may confer market power resulting in: (i) increasing data charges that are increasing costs to end investors; (ii) data charges influencing asset managers' investment decisions in a way that is limiting competition between asset managers, e.g. where they result in asset managers deciding not to enter markets because of the costs involved; (iii) data charges limiting the efficiency of trading activity in a way affecting price formation; and, (iv) ineffective regulatory provisions for free delayed data so that such data is of little use.
• Access to benchmarks - Concerns relating to complex contracts and T&Cs leading to difficulty in comparing the quality, charges and innovation between different benchmark providers and that factors such as contractual terms, administrative costs and performance monitoring present barriers to switching benchmarks.
• Market data vendors - Concerns about (i) barriers to switching for the same reasons as for benchmarks, (ii) practices of credit rating agencies (CRAs), including bundling of services, and (iii) of the market position of the big three CRAs.

The feedback statement does not identify outcomes the FCA may take to address any of the above concerns. While no immediate action is therefore required from firms, you should, if appropriate, participate in and monitor the outcomes of the FCA's upcoming market studies. The first market study, to begin this summer will look into complex contracts for benchmarks and indices preventing switching to alternative providers. The second market study, to begin before the end of the year, will assess if high charges for access to credit ratings data is adding costs to investors and limiting new market entrants.

ESMA reports show derivatives and securities market shrunk two-thirds following Brexit

ESMA has published two Annual Statistical Reports (the Reports). The Reports analyse the EU's derivatives and securities markets and offer a post-Brexit view of the EU derivatives and securities markets. In both Reports, the impact of the withdrawal is significant. Excluding data from UK financial participants, both (i) the size of derivatives markets and (ii) the volume of securities trading have reduced by around two-thirds. For securities, markets turnover volumes decreased to EUR 8.8tn for equities and EUR 17.9tn for bonds.

• Derivatives Market Observations- Derivatives markets in the EEA30 saw a 4% decline in 2020 to EUR 254tn, even with market structures remaining largely unchanged, the fall being driven mainly by currency and equity derivatives. The makeup of the market is composed of interest rate derivatives (79%), currency derivatives (13%), and equity derivatives (4%). ESMA highlighted that exposures continue to be highly concentrated in a few counterparties (specifically credit institutions and investment firms) noting that CCPs are less visible with the removal of UK CCP reports.
• Securities Market Observations - The distribution of instruments by both (i) type and (ii) trading patterns have remained broadly unchanged. In equity markets, volumes peaked in March (EUR 1.1tn) as a result of COVID-19 with the majority of volumes being in shares (86%), even though ETF share of equity volumes (12%) continued to increase in 2020. ESMA also highlighted a strong home trading bias with 65% of volumes of EEA30 equities occurred on a trading venue or a systematic internaliser in the same jurisdiction as the issuer.

IOSCO publishes consultation report on operational resilience with key lessons

The International Organization of Securities Commissions (IOSCO) has published a Consultation Report (the Report) to gather stakeholder feedback on the operational resilience of trading venues and market intermediaries (Regulated Entities) during the COVID-19 pandemic. In particular, IOSCO was concerned with (i) the definition of operational resilience, (ii) impacts, risks and challenges faced by Regulated Entities (including in relation to remote working), and (iii) any other lessons learned from the experience of Regulated Entities.

Regulated Entities should especially note IOSCO preliminary insights for improving operational resilience, which include:

• considering dependencies and interconnectivity, critical to this being the role of service providers and offshore services;
• operational resilience ismore than just technological solution depending as much on the regulated entity's processes, premises and personnel;
• that the pandemic highlighted the importance of an effective governance framework to facilitate and support operational resilience, particularly when novel and fast-paced change arises; and
• greater automation and less of a dependence on physical documents meant that Regulated Entities may better accommodate a remote workforce but there is also a greater information security risk; decentralised and remote work increases the importance of monitoring processes to help ensure information security.

Comments may be submitted before 14 March 2022. Comments via email should be sent to consultation-01-2022@iosco.og with the subject line "Operational resilience of trading venues and market intermediaries during the COVID-19 pandemic".