Despite the continuing absence of the Commission's Level 2 legislation implementing the revised Markets in Financial Instruments Directive and Regulation (MiFID 2) package, and the rumours of a delay to the implementation date of 3 January 2017, FCA has met its commitment to publish its consultation paper on markets aspects of MiFID 2 before the end of 2015.
What has happened so far?
In March 2015, Treasury consulted on changes it would need to make to UK legislation to implement MiFID 2, and FCA published a discussion paper seeking views on a range of issues. The stance it will ultimately take will depend, at least to some extent, on the (delayed) finalised delegated legislation and technical standards. ESMA has now provided the Commission with a set of Regulatory and Implementing Technical Standards (RTS and ITS) but these are subject to change if the EU legislative bodies do not agree with them. However, at this stage, and on the understanding that publications at EU level may affect some of the final rules, FCA is consulting specifically on the issues related to its regulation of the secondary trading of financial instruments. It believes it has enough certainty to consult meaningfully on this topic.
FCA's approach to implementation
FCA says that, in principle, it will not copy out swathes of text from MiFID 2. Instead, it will include references to the relevant parts. It will provide more detail only where it needs to – for example where there is a national discretion it needs to exercise.
What does the consultation cover?
The consultation will affect many market participants. FCA has divided it into several chapters:
Regulated Markets (RMs)
MiFID 2 sets new obligations that increase transparency, strengthen risk management around algorithmic and high frequency trading (HFT), direct electronic access, tick sizes, business continuity and systems and controls. ESMA has proposed detailed rules in half a dozen RTS. From a UK perspective, Treasury has consulted on necessary changes to the recognition requirements (RR) for recognised investment exchanges (RIEs) under FSMA. FCA proposes changes to reflect Treasury's changes and to take account of MiFID and the RTS. Its plan is to address these by making changes to the Recognised Investment Exchanges Sourcebook (REC). There will be new sections in REC dealing with management bodies of RMs, position management and reporting for commodity derivatives (which will be in a new chapter of the Market Conduct Sourcebook (MAR), on which FCA will consult in 2016), and the operation of a data reporting services provider (DRSP). It also needs to make significant changes to other parts of REC to cover changes to the trading processes for MTFs and the introduction of OTFs (see below), to suspension and removal of financial instruments and trade transparency, and requirements on algorithmic trading.
Multilateral Trading Facilities (MTFs)
FCA proposes making changes to the chapter in the Market Conduct sourcebook (MAR) that currently sets requirements on MTFs, which is MAR 5. MiFID 2 has, broadly, aligned the requirements on MTFs more closely with those on RMs, and FCA's changes take this into account. Its proposals include new sections on the functioning of an MTF and trading suspensions, as well as revisions to existing rules to deal with operational requirements and access to MTFs.
Organised Trading Facilities (OTFs)
FCA notes the key distinctions between MTFs and OTFs (although many of the same requirements will apply – such as transparency and financial resources requirements) and sets out its expectations that many "off-venue" instruments will be traded on OTFs. Some of these instruments will be subject to the trading obligation and others will not. FCA plans clarifications in REC on the position of RIEs when operating OTFs. It also plans to introduce a new Handbook chapter, in MAR 5A. Parts of MAR 5A will mirror MAR 5, but FCA thinks it is clearer to include some duplication in order to make the rules as usable and accessible as possible to all OTF operators.
Systematic Internalisers (SIs) Most of the changes to the SI regime are directly applicable because they stem from MiFIR. The key changes are to expand the instruments within the regime and to introduce specific pre-trade transparency requirements for trading of bonds and derivatives. The EU will address the changes in delegated acts, and two RTS apply to them. FCA will need to amend MAR 6. It plans to delete most of it, and keep only amended provisions that cover scope and purpose, and the notification requirements. It will also transpose the MiFID 2 requirement for an SI to publish data on execution quality.
MiFID 2 expands transparency requirements to cover equity-like and non-equity markets. RTS have already addressed some of the key concepts, and the MiFID 2 provisions that deal with transparency are directly applicable. As a result, FCA will delete many of its current rules. FCA rules do, though, need to set out its approach to pre-trade transparency waivers and post-trade transparency deferrals. This will mean changes to sections of the Handbook for trading venues including REC, MAR 5 and the new MAR 5A. FCA will delete MAR 7.
The consultation covers FCA's thoughts on when it should grant waivers from pre-trade transparency in:
- shares, exchange traded funds and depositary receipts. It proposes to do so in relation to systems matching orders on the basis of a reference price, systems that formalise negotiated transactions, orders that are large in scale and orders held in an order management facility pending disclosure;
- bonds, structured finance products, derivatives and emission allowances. It proposes to do so in relation to orders that are large in scale, orders held in an order management facility pending disclosure, actionable indications of interest in request-for-quote and voice trading systems, derivatives that are not subject to the trading obligation under article 28 of MiFIR, and other financial instruments for which there is not a liquid market.
FCA plans to provide clarity on the application process and asks whether it should include template waiver forms.
FCA sets out its thoughts on:
- equity deferrals: it plans to allow deferral of publication of post-trade information in relation to large in scale transactions in shares, ETFs, and depositary receipts executed by investment firms acting in a principal capacity; and
- non-equity deferrals: it plans to provide for deferred publication in relation to transactions that are large in scale, in financial instruments for which there is not a liquid market, above the size specific to the instrument, and packages.
It also seeks views on whether it should provide guidance on application of deferrals, and on whether to use its further powers to allow trading venues and investment firms to further calibrate the deferral, as set out in Article 11(3) of MiFIR and the RTS.
Changes will introduce the new DRSP category of firms and their responsibilities, and also covering transaction reporting. FCA currently caters for Approved Reporting Mechanisms (ARMs) and the UK has data trade monitors that carry out functions similar to those of Approved Publication Arrangements (APAs). However, the MiFID 2 provisions are more complex than the existing UK requirements and the current MiFID entities, so existing authorisations cannot be grandfathered. FCA proposes a new MAR 9 to cover DRSPs, which will operate alongside Treasury regulations and relevant RTS. FCA seeks views on this, and on whether it should apply MiFID 2 transaction reporting obligations to managers of collective investment undertakings and pension funds. For the moment, it plans to amend SUP to reflect its decision not to do so, but may review this decision in light of the MiFID 2 requirements. It also plans a step-by-step guide on permissions and notifications, and guidance on decision making, procedures and penalties relating to DRSPs. Finally, it seeks views on its proposals to require connectivity with FCA systems for certain entities that will be sending it transaction reports and reference data.
Algorithmic and HFT Requirements
ESMA has already set out detailed rules in several of its RTS that will mitigate the risks arising from algorithmic and high frequency trading. FCA proposes controls for MTFs and OTFs in MAR 5 and the new MAR 5A, and for trading firms in the new MAR 7A. The new MAR 7A is closely linked to senior management arrangements, systems and controls (SYSC) provisions, but FCA preferred to implement the requirements in MAR. These proposals cover, among other things, business continuity, systems and controls, financial crime and market abuse, direct electronic access and tick sizes.
Passporting and UK branches of non-European Economic Area (EEA) firms
FCA has considered the technical changes needed to make the correct references to MiFID 2 provisions and to highlight the harmonised forms required for passporting notifications. FCA notes both the ESMA RTS and ITS that address passporting, and notes that dual-regulated firms will need to comply with PRA requirements. These changes will predominantly apply to the Supervision manual (SUP). FCA also plans to clarify that UK branches of non-EEA firms are subject to the same rules as investment firms when undertaking investment services and activities. It plans to do this by inserting new rules in its General Provisions (GEN). FCA notes that MiFID 2 allows a greater range of services to be passported, although FCA notes that it does not believe MiFID 2 will allow the passporting of services in relation to structured deposits which are not MiFID 2 investments – it says banks should discuss with PRA whether this can be done under the fourth Capital Requirements Directive.
Principles for Businesses (PRIN)
FCA needs to amend PRIN because MiFID 2 extends some conduct of business obligations. It does not require Member States not to apply certain principles to certain business. FCA had originally amended its rules to disapply some principles to certain business so as to comply with EU law. Now FCA proposes extending the application of Principles 1, 2, 6, 7 and 8 to include firms that conduct business with clients categorised as Eligible Counterparties (ECPs) under MiFID 2.
The Perimeter Guidance manual (PERG): PERG 13 provides guidance on the scope of MiFID, which will need amendment where MiFID 2 has changed or extended the current MiFID. Changes will include guidance on what is a "multilateral system", the extension of the MiFID service of "executing orders", guidance on the fact the matched principal exclusion no longer applies to the MiFID definition of "dealing on own account", how structured deposits fit within the MiFID and Regulated Activities Order perimeter, and changes to the own account dealing exemption.
Other issues – MiFIR and Technical Standards
MiFIR and the RTS and ITS apply directly so will have effect in the UK without changes to UK law or rules. FCA notes that a number of important changes will take place because of MiFIR, RTS or ITS, but it will not consult on them. These include:
- the double volume cap mechanism to restrict the "dark" trading of equity and equity-like financial instruments (article 5 MiFIR);
- the trading obligation in shares (article 23 MiFIR);
- the obligation of investment firms to maintain records of transactions, and of trading venues to keep data relating to orders (article 25 MiFIR);
- transaction reporting (article 26 MiFIR);
- the obligation to supply instrument reference data (article 27 MiFIR);
- the obligation to trade on an RM, MTF or OTF (article 28 MiFIR);
- the clearing obligation for derivatives traded on an RM and timing of acceptance for clearing (article 29 MiFIR);
- portfolio compression (article 31 MiFIR); and
- non-discriminatory access to central counterparties and trading venues and non-discriminatory access to, and obligation to, licensed benchmarks (articles 35 to 38 MiFIR).
FCA has also produced a draft MiFID 2 Handbook Guide, intended to show its approach to implementation. It will produce further guides alongside later consultations if it thinks this would be helpful.
What happens next?
Consultation closes on 8 March 2016. FCA will then consult on further aspects of implementation "in the first half of 2016", and understands PRA plans a consultation then also. The second consultation will address changes to the following parts of FCA rules:
- the Conduct of Business sourcebook (COBS);
- Senior Management Arrangements, Systems and Controls (SYSC);
- the Client Assets sourcebook (CASS);
- the Decision Procedures and Penalties manual (DEPP); and
- the Enforcement Guide (EG).
There will also be further changes to PERG to reflect issues related to certain exemptions and definitions of financial instruments being dealt with in the implementing measures.
However, if the implementation timetable within MiFID 2 as adopted stands, all implementing measures must be published by 3 June 2016 to take effect on 3 January 2017. With the continued delays in certainty at EU level, it is going to be at best difficult and rushed to achieve this. FCA is, however, trying to give firms the most possible time to prepare.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.