After a brief summer hiatus, Markets View is back! And, true to form, we’ll be dishing out our monthly digest of financial markets ins ights. In this edition, we’ll be giving you a round-up of recent developments across all your favourite pieces of market regulation in the UK and Europe: from MiFID to EMIR, CSDR and more. There’s lots to look forward to, so let’s get stuck in. As ever, please do get in touch if you have any comments or suggestions that you would like to share.
UK MiFIR: DTO – What to Know
At the end of July, as part of the implementation of the UK Wholesale Markets Review (WMR), the FCA published a new consultation paper CP24/14 on certain aspects of the derivatives trading obligation (DTO). As a reminder, the DTO is set out in Article 28 of UK MiFIR and requires certain counterparties, when transacting in in-scope OTC derivatives, to do so only on regulated UK or equivalent third country trading venues.
The paper contains three core proposals:
To expand the classes of in-scope derivatives to include certain overnight index swaps (OISs) based on the US Secured Overnight Financing Rate (SOFR). The DTO only applies to particular classes of derivatives, as published by the FCA in a Register. The move to include certain SOFR-based OISs within that list can be seen as part of a broader (and widely-supported) effort to transition away from LIBOR to more robust and reliable reference rates like SONIA/SOFR. DTO coverage has already transitioned from GBP LIBOR to SONIA-based OISs, and this proposal will effect a similar transition away from USD LIBOR (which was removed in April last year). The FCA has proposed a 3-month delay between the publication of its Policy Statement and the changes coming into force, to allow firms to implement the system changes necessitated by the changes.
To expand the list of post-trade risk reduction services (PTTRs) that are exempted from the DTO and from other obligations. PTRR services are tools that firms use to manage and mitigate the risk exposures associated with their derivatives portfolios post-execution, without altering the economic terms of the original trades. The paper identifies three examples in particular: portfolio compression, portfolio rebalancing and basis risk optimisation. Where “non-price forming” transactions arise from these services, the FCA proposes to disapply the DTO, along with best execution obligations and the requirement to seek authorisation as a trading venue (where this isn’t already the case, and subject to certain other conditions and disclosure requirements). The general idea is to encourage sound risk management practices and thus enhance their efficiency and effectiveness in the market. Overall, this is positive news for the market – albeit rather complicated to navigate in places. This change would also be subject to a 3-month implementation period.
To explain when/how the FCA will suspend/modify the application of the DTO in the future. The FCA’s existing ability to suspend/modify the application of the DTO using its Brexit-derived temporary transitional powers will expire at the end of 2024, and will be replaced by a new power under Article 28a of UK MiFIR. The FCA previously modified the DTO (by way of a Direction) to enable firms trading with/on behalf of EU clients to transact or execute those trades on EU venues – this was to avoid creating potential conflicts where a firm could be subject to both the UK and EU DTO at the same time. The proposal advocates maintaining that modification. Going forwards, the FCA affirms that it would use its new Article 28a powers if it considered it to be necessary to prevent or mitigate disruption to financial markets and to advance its operational objectives; before doing so, it would have to consult with the Bank and the PRA, and to seek the Treasury’s consent. Overall, the fundamental objective remains the same.
Responses to the CP are due by the end of this month. We’d be very interested to hear any thoughts you have on how these proposed changes may impact the market.
EU MiFID3 Keeps on Giving
Moving across the Channel briefly, regular readers will recall that EU MiFID/MiFIR has been a frequent feature on Markets View this year. The big news was back in March, when the “MiFID3” changes became effective. However, as we flagged at the time, some of the changes would require secondary legislation to tell us how they’d work. ESMA published some of those proposals in May via its MiFIR Review Consultation Package (which closed for comments near the end of August). Suffice it to say, there’s no let-up – ESMA published a further consultation package CP3 in July, on topics including equity transparency (RTS 1/Org Reg), the volume cap (RTS 3) and circuit breakers (new RTS), and we’re expecting a further slew in October (each to be followed, inexorably, by Final Reports).
The best place to go to get a handle on all the developments is ESMA’s MiFID2 and MiFIR review page, where they set out an indicative timeline of everything that’s going on. It’s also a useful place to find the collected industry responses to some of ESMA’s proposals from earlier in the year. For example, responses relating to the consultations on non-equity trade transparency measures, consolidated tape providers and data reporting service providers (amongst other items) can now be downloaded. Typically we’re seeing concerns concentrating on technical issues, rather than fundamentals, at this stage.
UK EMIR Reporting – Start Your Engines
Moving seamlessly from MiFIR to EMIR, the most pressing news is on the UK side: counterparties who report derivatives under UK EMIR are set to be impacted by new reporting rules from 30 September 2024, as we mentioned back in May. This all stems from a February 2023 joint Policy Statement from the Bank of England and FCA, to be supported by follow-up guidance. Back in May, we got the first of two tranches of the guidance supporting that PS (taking the form of Q&As). Then, in July, the regulators published the second tranche of finalised Q&A guidance. Corresponding changes have also been made to the UK EMIR Validation Rules, which are now considered finalised.
To recap: the rationale for the changes to UK reporting requirements is to align the UK reporting framework with international guidance published in April 2018 by CPMI-IOSCO. UK reporting requirements and guidance will be different from the updated EU EMIR Refit rules and ESMA’s final report on guidelines for EMIR reporting, which came into force on 29 April 2024. Firms reporting under both the new UK as well as the new EU regimes will need to ensure they are familiar with the nitty-gritty of the differing approaches. Transitional arrangements under the updated UK rules will be applicable until 31 March 2025.
We are advising a number of clients on the new EMIR reporting requirements, including in the context of their delegated reporting arrangements and their misreporting notification obligations. If you would like to discuss any aspect of the new reporting requirements with us, please do get in touch with Craig Bisson and Paul Metcalfe.
EU CSDR – In the Mood to Accelerate
In April, we mentioned that the UK and EU were both looking at so-called “accelerated settlement” requirements for transactions executed on trading venues, and described how the UK aims to move from the current CSDR-based “T+2” standard (i.e. settlement by the second business day after trading) to “T+1” by the end of 2027. At the time, we also mentioned that we were expecting ESMA to report on the issue from an EU perspective this year.
We don’t have that ESMA report yet, and remarks given by ESMA’s Chair at a public hearing in July indicate that we shouldn’t expect it until mid-January 2025. However, her speech also suggested that ESMA’s recommendation will be to make the same shift from T+2 to T+1 that we’re seeing in the UK. Reportedly, 70% of the online attendees at the hearing voted for the change to be made in the final quarter of 2027. This would align with the UK Treasury’s aim to move to T+1 no later than the end of 2027. It would also come into alignment with the USA, Canada and Mexico, who moved to T+1 settlement in May this year – as well as India, which moved to T+1 last year. China already settles on T+0, but this is not on the cards elsewhere (yet) and nobody is seriously talking about instantaneous settlement.
The American move to T+1 seems to have been achieved smoothly, notwithstanding the significant operational challenges in halving the length of the settlement cycle, as well as the misalignment with jurisdictions that still settle on T+2. Fragmented capital markets across the 27 members of the EU pose additional back-office challenges for such a move in Europe. So, in a nutshell: T+1 in the EU by the end of 2027 looks increasingly likely, but we’ll have to wait until early next year for confirmation.
Commotion around Commodities
Metals traders will doubtless have heard that the LME published a White Paper setting out its plans for significant changes to enhance market liquidity. The biggest news item here is the proposal to introduce a formalised block trading facility (which, unlike other markets, the LME has never had to date) for certain liquid instruments in its electronic trading platform, “LMEselect”. The precise technical details in terms of trade sizes, reporting requirements, eligible contracts, etc., are set out in a Member Notice.
By enabling market participants to execute large trades privately (and to do so without impacting the market price), the LME hopes to encourage more liquidity on LMEselect overall. One key sensitivity is around the threshold for block trading: too low, and it will encourage a shift to bilateral trading (impacting market transparency and liquidity); too high, and it will force people to trade on the LMEselect order book who don’t want to. Therefore, a key element of the LME’s proposal is its plan to set the block trade threshold at 10 lots.
For a handy digest of this and other measures in the package, check out the LME’s Press Release and Overview.
Meanwhile, we’ve seen that Euronext and Nord Pool (which itself is majority-owned by Euronext) are launching a new market for the trading of cash-settled power futures in the Nordic and Baltic region. “Euronext Nord Pool Power Futures” will be cleared by Euronext Clearing, with testing set to start as soon as March 2025. We know that a number of firms are watching what’s happening in this space (particularly given the turbulent few years we’ve seen in European energy markets following the full-scale Russian invasion of Ukraine) and we have done lots of work advising members of energy derivatives exchanges – including Euronext Nord Pool’s soon-to-be-rivals EEX and Nasdaq Nordic, as well as Nord Pool’s existing spot venue. Do get in touch if this is also on your radar.
REMIT Roundup
Whilst we are on the subject of energy contracts, this is a timely reminder that the EU Regulation on wholesale energy market integrity and transparency (REMIT) was updated earlier this year, as we last touched on in April. The main upcoming deadline on people’s minds is 08 November 2024, which is the cut-off date by which third-country firms who are REMIT “market participants” will need to have designated a representative in the EU Member State where they are registered.
Over the summer, we’ve seen a couple of providers start to offer this service, and updates to the related registration processes. We’re expecting further guidance from ACER on firms’ obligation to notify the relevant authorities of their representative’s details. Otherwise, the last few months have been fairly quiet in terms of further guidance on the new rules, other than an ACER Open Letter on the other new notification obligations for firms using algorithmic trading or providing direct electronic access (that, among other things, helpfully confirms there is no DEA notification obligation for DEA clients).
If you are (or think that you may be) a third-country REMIT market participant, then we’d love to hear from you and to help ensure that you are correctly set up by the November deadline.
And that’s all for this month! Stay tuned for more developments in our next edition.
