Markets View – December 2024

Happy almost-Christmas! In our last and most festive edition of the year, we'll be bringing you a veritable sleigh-ful of markets-related developments from across the EU, UK and beyond.

Dashing Through the Decade: ESMA Looks Ahead to 2030

On 03 December, Verena Ross, chair of ESMA, gave a speech in Brussels on Securities markets in 2030, in which she set out ESMA's expectations - and aspirations - over the next 5 years. Some of the key themes are worth unwrapping:

• AI: Ross likened the growth of AI trading to that of electronic trading in the 1990s - not a "paradigm change", but top of the list of innovations to existing practices. The target is to deliver more efficient and orderly markets. However, this can't be taken for granted. ESMA identifies exchanges as a crucial link in the chain, as they will need to invest in AI for their own operations while also overseeing use of AI by their members, participants and beyond.
• Pre-trade transparency waivers: Ross spoke of how ESMA tracks changing trading patterns when issuing pre-trade transparency opinions and noted in particular a recent blurring of the lines between lit and dark trading (e.g. in connection with Frequent-Back Auctions and Dark-Lit Sweep orders). We can expect ESMA to be keeping an eye on the impact on price discovery and liquidity.
• Consolidated tapes will also be established by 2030, which she framed as a "major game changer" for de-fragmenting EU markets. ESMA will be launching the selection for the bonds CTP in January 2025 and the equities CTP in June 2025, and we are expecting decisions on each by July/December respectively, as we mentioned in our October edition.
• Pan-European Liquidity Pools: On the aspirational side, Ross highlighted ways ESMA wants to help entrepreneurs to grow. She spoke of the potential for trading venues to promote national hubs to support local entrepreneurs, and of pan-European SME segments to then help those companies embrace public markets. Work is already underway here, in particular through the Listing Act
• Central Supervision of FMIs: Finally, and tied to the point above, Ross expressed willingness to look at moving towards centralised EU-level supervision of trading venues, seeing them as a potential lynchpin for integrating European markets given their multifaceted role in trading, listing and corporate governance.

Brussels Sprouts EMIR 3.0

We've talked a lot about EMIR 3.0 this year, and the work that the European Supervisory Authorities are undertaking in the background to line up new rules - in particular around active accounts and initial margin model authorisation. For an overview of the key changes, refer to our "Top 10 things you need to know" summary from earlier this year.

All year we've been waiting for the regulation itself to be published in the Official Journal - and lo, it has come to pass. You'll find the final text here. The 20 day wait-period post-publication means it will enter into force on Christmas Eve (!)

This effective date in turn sets the timetable for calculating when ESMA has to submit technical standards on various aspects of the regulation. First up are the standards relating to the requirements and conditions for maintaining an active account (due 24 June 2025), which we mentioned last month are currently in draft form and subject to consultation, with responses due by 27 January.

May All Your Christmases be REMIT-Compliant

One of the big topics of 2024 was the overhaul of the Regulation on Wholesale Energy Market Integrity and Transparency (REMIT 2). We've done a lot of work, particularly for non-EU firms accessing the EU energy market, to help ensure compliance with the new rules.

There's quite a lot to unpack here, but a common fact pattern we see is UK/US firms who trade Dutch natural gas futures on ICE Endex in Amsterdam, who now find themselves potentially within the scope of REMIT and needing to register with the Autoriteit Consument & Markt (ACM) and designate a representative in the Netherlands.

Unsurprisingly, the ACM has been looking closely at this too. We are aware they have recently contacted various firms who they believe may need to register with them. If you have received such a letter, please let us know if we can help.

Unwrapping the UK MiFID Org Reg Consultation

You may recall that last month we mentioned various aspects of the UK's programme to repeal its EU-derived regulation. We mentioned HMT's Policy Paper on next steps for reforming the UK's MiFID regime specifically, including revocation of the assimilated MiFID Org Reg (i.e. the UK-onshored version of Commission Delegated Regulation (EU) 2017/565, covering the conduct and organisational rules for UK MiFID firms).

We now have the FCA's consultation paper on transferring the requirements of the MiFID Org Reg into the FCA Handbook (CP24/24). It's a big one, clocking in at 351 pages, which will take a while to pick through. However, we note that the expressed intention of the CP is not to make any policy or substantive changes to the current requirements.

That said, Chapter 4 offers a window on what comes next (Future amendments to EU Derived Organisational and Conduct Rules). It invites discussion on reforms including, amongst other things, rationalisation of the Handbook (with various specific examples cited), and potential changes to the client categorisation rules in COBS to make them work more effectively. With a view to the even longer term, the CP also includes an open-ended question (Q34) asking if firms think any sector-specific changes are needed.

There is a split deadline for responses: comments on Chapter 4 are due by 28 March 2025, with responses on other aspects being due by 28 February. By way of a reminder, responses to the FCA's separate DP24/2 on MiFID transaction reporting (which we covered in last month's edition) are due by 14 February.

Also, while we're on the subject of UK MiFID/MiFIR, the FCA announced on 03 December the start of its process to appoint a CTP for bonds, along with a concession notice setting out a description of the role and the next steps for the tender process. We can expect the FCA to publish draft tender documents by 31 January 2025.

Deck the Hall with Dear CEO Letters

Some of you may have seen the FCA's recently-published suite of Dear CEO portfolio strategy letters, covering aspects of the FCA's strategy and expected next steps across Benchmark administrators, Contracts for difference providers, Custody and fund services, Data reporting services providers, and Trading venues.

As this is Markets View, we wanted to focus in particular on the last of these, which the FCA sent out to RIEs, MTFs and OTFs.

Like ESMA, the FCA see a multifaceted role for venues, and so its strategy has to balance a range of issues from ensuring venues' resilience and orderly operation, to fostering innovation and growth and promoting effective competition. The letter neatly sums up and contextualises a lot of the ongoing developments in this space:

1. Operational Resilience: This is billed as the FCA's highest priority. It calls out the need to minimise disruptions from operational outages, while effectively managing and remedying any that occur. This includes addressing challenges from cyber threats and third-party supplier failures. Upcoming supervision will review the preparedness of trading venues, noting that venues should be acting "at pace" to tackle any identified issues.

2. Market Orderliness: In an upbeat note, the FCA highlights the resilience of UK trading venues during recent stress events and periods of heightened volatility. However, it emphasises the ongoing need for effective mechanisms to manage market volatility and monitor participant activity. This includes adapting controls for new technologies like AI and ensuring algorithmic trading does not contribute to disorderly conditions.

3. Competition, Innovation, and Growth: No surprises here: regular readers will be aware of the big push for innovation, including the two new FMI sandboxes (DSS and PISCES - for a refresh, see last month's edition).

4. Market Reform: There is a lot of regulatory reform happening in this space, not least off the back of the Treasury's Wholesale Markets Review (including the recent PS24/14, also covered in last month's edition, as well as the awaited PS on CP23/27 and ongoing work on the consolidated tape). As we've seen from the consultation processes for these changes, there will be plenty of legwork to be done by trading venues here.

5. Voluntary Carbon Markets (VCMs): While voluntary carbon credits are outside the FCA's regulatory perimeter, trading venues offering markets in VCM-related products must ensure these markets remain orderly, addressing concerns about the quality and integrity of underlying carbon credits.

All in all, plenty to think about. The FCA expects venue CEOs to be discussing these issues and identifying next steps.

Jingle All the Way to Liquidity Preparedness

The Financial Stability Board published its final report on Liquidity Preparedness for Margin and Collateral Calls on 10 December 2024, following a consultation in June (along with an overview of responses to the consultation). The report focuses on non-bank financial intermediaries (NBFIs) - such as insurance companies, pension funds, hedge funds, other investment funds, and family offices - in centrally and non-centrally cleared derivatives and securities markets.

The FSB analysed recent incidents of liquidity stress - the March 2020 market turmoil, the Archegos failure in March 2021, the commodities markets turmoil in 2022, and the September 2022 issues experienced by many pooled liability-driven investment funds in the UK. The findings suggest that margin and collateral calls can amplify demand for liquidity, and identify liquidity risk management and governance weaknesses as key causes for inadequate liquidity preparedness. Factors that could further amplify stress include: the amount and concentration of leverage, how easy/difficult that leverage is to identify and measure, volatile prices or valuations, inadequate risk management and liquidity imbalances.

The FSB makes eight policy recommendations, covering liquidity risk management and governance, stress testing and scenario design, and collateral management practices of non-bank market participants. It focuses on liquidity risks arising from spikes in margin and collateral calls, including under "extreme but plausible" stressed conditions. For example, there should be a well-documented contingency process for unwinding leveraged exposures if warranted, such as in scenarios where the market participant identifies a material risk of not meeting its margin calls. The FSB recommendations are high-level, and it is for the relevant international standard-setting bodies to specify requirements for their sectors.

Shining bright?  The LME White Paper on Enhancing Liquidity

Staying with the focus on liquidity, in response to the concerns raised by the UK regulators and the Oliver Wyman review following the March 2022 nickel market crisis, the London Metal Exchange (LME) set about the process of modernising the market.  An LME white paper, issued on 4 September 2024, outlines a package of measures aimed at modernising the LME's market structure to enhance liquidity, transparency, and price competition while preserving the unique features that serve the physical metal communities.  The period for commenting on this paper comes to an end at the end of 2024 and will be followed by a consultation paper in the new year.  Final rules are expected by July 2025.

Trade associations have been considering the white paper (unsurprisingly, members are sceptical of many of the ideas) and the LME formed a Blocks Working Group to engage on the proposals. However, as many of the proposals will impact clients of LME members, we thought you would like to see a list of key initiatives for a warm-up:

1. Market Structure Modernisation: The LME proposed to boost transparency and increase price competition by introducing industry-standard block rules and a liquidity provider program to support on-screen liquidity. Basically, all trades under a block size in the most liquid contracts will need to be shown on LMESelect rather than just executed in the inter-office market. What the thresholds will be (members do not like the 10 lot threshold for every contract), and which contracts will be covered (just the 3rd Wednesday monthly contracts, other monthly contracts, or the spreads too?) are still under discussion.

2. OTC Market Considerations: To ensure a level playing field between the OTC and on-exchange markets, the LME intends to apply similar block rule requirements to OTC contracts that reference LME prices. This is to prevent volume from being incentivised away from the transparent central liquidity pool.  This proposal feels rather like a derivative trading obligation (DTO) which is not something we think an exchange can impose. 

3. Enhanced Market Data Transparency: The LME plans to require all risk transfer trades to be booked into LME systems and made public, ensuring maximum practical transparency. This includes publishing all member-to-client trades in the exact instruments traded.  Another controversial idea.  Members are worried that publishing OTC open interest data could compromise client confidentiality and negatively impact members' ability to manage risk.

Member clients and physical market participants should look at these proposals with a view to considering impact on their metals trading and hedging.

Naughty or Nice: £13m FCA Fine for Control Failings

The FCA has issued a Final Notice fining the London branch of Macquarie Bank over £13m for serious control failings (breaching Principle 3 of the FCA's Principles for Business). These failings enabled a relatively junior trader, Travis Klein, to book over 400 fictitious trades to hide trading losses over a period of 20 months to February 2022. Some of the weaknesses in the bank's systems and controls had been brought to its attention in 2020, but it had failed to fix them.

In particular, the daily profit and loss reporting process failed to identify discrepancies between daily trading book positions and a trader's daily P&L estimate. The End of Day (EoD) futures reconciliation process failed to ensure that discrepancies in the reconciliation process were adequately managed. The cancelled, amended and backdated trades (CABs) post-trading reporting control relied on the flawed EoD reconciliation process, and so failed to adequately report on exchange cleared futures trades. Hence Klein was able to submit falsified broker quotes against which the profitability of his positions was assessed.

Besides the FCA's £13m fine, the fictitious trades cost the bank nearly USD60m to unwind, although they had no impact on clients or the market. Klein received a separate Final Notice stating that he breached individual conduct rule 1 (acting with integrity) in the Code of Conduct sourcebook and was prohibited from the financial services industry. He would have been fined £72,000 but for his financial hardship.