Markets View – January 2023

Welcome to the first Markets View of 2023. We live in uncertain times and early indicators seem to be that regulation of markets will divert further in 2023 – do listen to our podcast where Darren Fox and Rosali Pretorius discuss regulatory divergence.

The Edinburgh Reforms: Big Bang 2.0 or political pageantry?

On the theme of regulatory divergence, the Edinburgh reforms were billed as the widest range of reforms to the UK financial services regime in a generation. That might yet prove to be correct, but the reforms announced in the Chancellor's speech in Edinburgh at the end of last year, rather than being a Big Bang 2.0, appear more evolutionary than revolutionary. The scale of the changes remain to be seen, with many matters of detail to be filled out under powers given under the new Financial Services and Markets Act. However, as the centrepiece of the announcements was the replacement of EU-derived legislation, this was an opportunity for the new Government to bolster its getting-Brexit-done credentials.

Several reforms announced relate to wholesale markets.

To give the Government its due, some of the reforms did include some forward-looking changes:

• The launch of a taskforce on reducing the settlement cycle to below T+2, in line with developments in the US, Canada, and India. This is a welcomed departure from the EU's difficult to navigate rules under CSDR.
• The announcement of a DLT sandbox for FMIs. The EU, though, is already well underway with plans for its launch of its DLT Pilot Regime (see below). As with CSDR, the EU regime is quite prescriptive, so we are waiting to see if the UK regulators can come up with something more flexible.

What is also refreshing to see is that the Government is taking feedback into account. One example is a suggestion made in the Wholesale Markets Review for a new type of trading venue which works with trading windows rather than continuous trading. The Government has announced that it will work with the regulators and market participants to trial such a new class of venue.

Many of the other changes announced, though, were evolutionary rather than revolutionary and focused on reporting.

• New rules coming into force in June 2023 will remove the 10% depreciation loss reporting requirements for portfolio managers, and allow by default electronic communications with retail clients.
• The Government plans to replace the current threshold tests for the ancillary activities exemption, with a “commodity dealer exemption” modelled on MiFID I.
• On the plans for a UK consolidated tape, the Chancellor (ambitiously) committed to putting one in place by 2024, although the announcement (strategically) didn’t specify for what asset classes.

Watch our Flash Call on the Edinburgh reforms and read our analysis of the full package in our Edinburgh Reforms View.

Revamped IOSCO Principles for Commodity Markets

2022 was an eventful year in the commodity markets which saw energy and other commodities weaponised. In the wake of the ensuing market volatility and disruption and trends to increased globalisation, financialization and digitalisation of commodity market trading in the last decade, IOSCO has just published its Final Report updating its 2011 Principles for Commodities Markets.

IOSCO adds a new Principle 16 on Unexpected Market Disruptions—which is clearly extremely relevant to market disruptions like the LME nickel crisis in March 2022—to the Principles. Principle 16 requires financial regulators and operators of trading venues to make adequate arrangements to deal with extraordinary disruptions such as war. Those arrangements should include clarity as to the reasons for market suspension or cancellation of trades due to disorderly markets and price fluctuations and position limits to help mitigate excessive price volatility and to give market participants time to arrange necessary financing for margin calls.

The Final Report does not address all responses to the consultation. It does not make the change requested by FIA in relation to carbon markets and therefore leaves open the possibility that the Principles should apply to carbon. Nor does new Principle 16 separate out the roles of different “Market Authorities” as suggested thereby allowing government intervention ahead of market operator action in response to market disruption.

EMIR 3.0 – The European Commission's proposals to make EU clearing services more attractive

As part of the EU's Capital Markets Union initiative, the Commission has put forward a package of clearing-related measures to:

• reduce reliance on UK CCPs;
• encourage clearing in the EU; andmake EU CCPs more resilient.

Amongst other changes, the proposals amend EMIR and these amendments represent the culmination of a long debate about the concentration of Euro clearing in London. Although the proposals will have significant implications for firms, market participants will be glad to see that more punitive proposals, such as weighty capital charges, have been dropped.

Key changes include:

• EU CCP active account and minimum clearing requirements. To reduce reliance on UK CCPs, firms subject to the EMIR clearing obligation will be required to clear a proportion of EUR and PLN IRS, CDS and EUR STIR derivatives through active accounts opened directly at EU CCPs or, in certain circumstances, indirectly through a clearing member.

• Improving transparency on margin calls. To improve visibility of margin calls, clearing firms will have to make certain disclosures to clients.

• Facilitating access to clearing. In light of the recent volatility in energy, bank guarantees and public guarantees are to be considered eligible highly liquid collateral provided that they are unconditionally available upon request within the liquidation period.

• Simplifying the framework for intragroup transactions. To make intragroup exemptions from EMIR clearing, reporting and risk mitigation requirements available for affiliates in all jurisdictions unless they appear on a negative list.

The proposals have been submitted to the European Parliament and the European Council for review (during which the co-legislators can submit amendments) and adoption. This process is expected to take 12-18 months.

At a glance…

Brokerage firms beware: FCA fines firms for MAR compliance lapses

The FCA has fined BGC Brokers LP, GFI Brokers Limited and GFI Securities Limited £4,775,200 for failing to ensure they had appropriate systems and controls in place to effectively detect market abuse. This fine highlights that MAR compliance continues to be high up the agenda of the FCA and that is ready to hand out significant fines to firms for failings. We suggest that compliance teams at brokers and trading venues look at the failings described in the FCA’s Final Notice.

The key breaches noted in the Final Notice, which related to MAR and Principle 3 of the FCA’s Principles for Businesses, include:

• The failure to establish and maintain effective arrangements, systems and procedures to detect and report suspicious transactions and orders. The systems for monitoring market abuse did not have proper coverage of all asset classes subject to MAR, including equity derivatives, futures, and commodities. Gaps in the systems were not adequately mitigated and continued without remediation throughout the relevant period.

• The firms’ manual surveillance, automatic surveillance and communications surveillance processes were deficient and collectively inadequate in identifying potential market abuse by market participants. This increased the risk that potentially suspicious trading would go undetected, resulting in STORs not being made to the FCA.

• The firms were aware of the deficiencies in their systems but did not put measures in place to compensate for these limitations.

• In determining the seriousness of the breaches, the FCA had regard to the fact that, although the breaches revealed serious and systemic weaknesses in the firms’ market abuse surveillance systems, the firms did not profit directly from it, and appeared to be negligent rather than deliberate or reckless.

EMIR Refit Update: ESMA releases final guidelines for reporting trades and obligations for in-scope firms

ESMA published its final report containing guidelines, which will be effective from April 2024, for reporting trades in derivatives and obligations for (i) counterparties to OTC derivatives contracts, (ii) CCPs, and (iii) and trade repositories (TRs) under EMIR. The guidelines cover a wide range of reporting and data management topics under the EMIR Refit rules and provide some welcome practical guidance on implementation. Firms should pay particular attention to the updated EMIR XML messages, which have been revised with a view to create a fully standardised format for reporting to eliminate the risk of discrepancies due to inconsistent data.

There is guidance for TRs on how to verify the completeness and accuracy of data reported and the conditions and thresholds to apply to establish whether values reported by each counterparty matches. Included is a template for notifications of reporting errors and omissions to NCAs.

DLT Pilot Regime Update: ESMA issues guidelines for operating under the DLT Pilot Regime

ESMA published its guidelines on standard forms, formats and templates to apply for permission to operate a DLT market infrastructure (DLT MI) under the DLT Pilot Regime. Market participants looking to take advantage of the regime should look out for the templates to be used to apply for specific permissions to operate a DLT MTF, a DLT settlement system, or a DLT trading and settlement system. There are templates for the applicant’s DLT MI to request limited exemptions (subject to certain conditions) from specific requirements under MiFIR, MiFID II or CSDR. Instructions on how to submit this information should be published by the NCAs on their respective websites.

The guidelines will be effective from 23 March 2023. However, given the novel aspects of the DLT Pilot Regime, we advise applicants to get ahead of the game by (i) having a look at the guidelines now and (ii) liaising with the relevant NCAs to prepare their application for permission to operate a DLT MI.

Ready, set, go! Preparing for DORA

The Digital Operational Resilience Act (DORA) entered into force on 16 January 2023, and will be directly effective from January 2025 without transposing measures. DORA is broad and will apply to regulated financial institutions in the EU, including banks, PSPs/EMIs, investment firms, and fund managers. It aims to consolidate and upgrade ICT risk requirements in the EU to guard against cyber-attacks and ensure that in-scope financial entities are subject to standardised rules that mitigate ICT-related operational risks. Most significantly, it requires financial entities to:

• have internal governance and control frameworks that ensure they manage all ICT risks effectively;

• have a robust ICT risk management framework that enables them to address ICT risk;

• report major ICT-related incidents to NCAs;

• carry out digital operational resilience testing; and

• manage ICT third-party risk as an integral component of ICT risk within their ICT risk management framework.

DORA will have a substantial impact on financial institutions and will require significant efforts to ensure timely compliance by in-scope financial institutions. We recommend firms start scoping the impact of DORA on their businesses and carry out a comprehensive gap analysis of existing ICT risk management processes against DORA’s requirements – for more details listen to our webinar.

Market Watch 71: FCA sheds light on best practice for insider lists

This edition of Market Watch, contains FCA’s views on changes to advisory firms’ insider lists since the publication of Market Watch 60 (which was published in August 2019). FCA also reminds firms of the requirement under UK MAR to include personal information in insider lists, and reiterates the importance of maintaining accurate insider lists and strictly limiting access to inside information to employees on a need to know basis.

Judgement flash alert

Nickel Nixed: Judge denies Claimant's order against LME in market mayhem case

In the Commercial Court on 23 December 2022, the judge refused the claimant’s application for a Norwich Pharmacal order against the London Metal Exchange (LME). As a reminder, LME suspended nickel trading on 8 March 2022 due to extreme disorder in the nickels future market. In addition, LME ensured that arrangements made on the LME’s nickel market the morning prior did not result in binding contracts. AQR claimed a loss totalling over USD 95 million in profits arose out of the LME’s decision, and in contemplation of bringing claims against the defendants, they sought disclosure of a wide range of documents and notes relating to the suspension and cancellation decisions.

The court held that the claimants did not have a good arguable case that a legally recognised wrong had been committed against them, and the broad and intrusive disclosure they sought was not necessary to enable them to pursue a claim against the LME.