Regulators in France, Italy and Spain have indicated they will not allow brokers based outside the European Economic Area to offer third-country end-users electronic access to exchanges that reside in their jurisdiction, Risk.net has learned. Some sources claim the move is motivated by the UK’s decision to leave the European Union.
“There is definitely a political element here, obviously being complicated by the political situation in the UK and Article 50 being triggered,” says one industry source.
The EU’s revised Markets in Financial Instruments Directive (Mifid II) comes into force on January 3, 2018. The directive includes the term 'direct electronic access' (DEA), which describes trading activity where an end-user accesses a venue’s order book electronically using a broker’s trading code for that venue.
The level one legislative text of Mifid II places an obligation on multilateral trading facilities (MTFs), organised trading facilities (OTFs) and regulated markets to ensure that only firms authorised under Mifid II or the EU’s Capital Requirements Directive (CRD) can offer their clients DEA to those venues. Entities must be based in the European Economic Area to qualify as a Mifid II investment firm or a CRD credit institution.
As the rule is part of a directive, national authorities have the discretion to tweak provisions in the regulation as long as their transposition achieves the directive’s original goal. The UK is understood to have softened the requirement, but several EU regulators are considering a tougher approach to the restriction – meaning that brokers based outside the EU would be unable to offer DEA on exchanges domiciled in the more restrictive jurisdictions.
"Where we see most divergence between jurisdictions is in how regulators view the requirements for firms from outside the EU interacting with their marketplace. We see signs that countries such as France, Italy and Spain could be stricter in terms of their local rules for non-EU firms wanting to access their markets," says the industry source, who had heard the information in a joint meeting with regulators from several EU member states earlier this year.
In an email to Risk.net, a spokesperson for the Italian markets regulator, Commissione Nazionale per le Società e la Borsa (Consob), declined to comment, but stated that the “topic is under negotiation”.
Risk.net also contacted French regulator the Autorité des Marches Financiers and its Spanish equivalent, the Comisión Nacional del Mercado de Valores, for comment. Neither authority provided a response.
The industry source believes Brexit is the reason legislators in those countries might seek to impose a strict version of the requirement.
Should the UK and EU fail to arrive at some kind of special trading relationship – whether transitional or permanent – when the UK leaves the bloc, brokers in the UK will be in the same position as those based in other jurisdictions outside the European Economic Area. They would therefore be unable to offer end-users DEA on regulated markets, MTFs or OTFs in France, Italy or Spain, which would potentially reduce competition faced by local brokers in those markets.
Other sources question whether the move is so deliberately political. They suggest the motivation is to ensure that local supervisors have the powers necessary to regulate the end-users accessing exchanges operating in their jurisdiction.
Mifid II sets out requirements that exchange members must have in place if they are providing clients with DEA. These include real-time monitoring of their DEA clients, systems to detect market manipulation, pre-trade controls that could automatically block orders, and post-trade controls.
“There is a logic behind it, which is that European authorities clearly saw that what they were trying to construct was a regime to control a particular type of market access that they regarded as needing to meet certain standards. If they allowed access from a non-EU firm that isn’t subject to a requirement to implement the standards then they [would] create a two-tier system that undermines their own regime,” says Michael Thomas, a partner at law firm Hogan Lovells in London.
Not only would the restrictions affect UK firms post-Brexit, they would also hit any non-European broker, including those from the US.
“If their sponsorship is found to be DEA, it is a real problem for a third-country firm to be a member of an EEA venue and provide DEA to their underlying clients. They would most likely have to shift key aspects of the relationship to a firm that is authorised in the EU,” says Nathaniel Lalone, a London-based partner at law firm Katten Muchin Rosenmann.
Exchanges in France, Italy and Spain handle less cross-border trading activity from outside the EEA compared with exchanges in the UK and Germany, but all major EU exchanges receive a substantial amount of flow from firms based in the UK.
EU regulators could also restrict non-European DEA through Mifid II's treatment of so-called dealing on own account. Article 2 of the level one text exempts firms that deal on their own account from many parts of the directive, but in an exception to this exemption, firms that do so are subject to Mifid II if they access European exchanges using DEA.
Legislators and regulators wishing to be more restrictive could apply this provision when transposing the directive.
Christian Voigt, a senior regulatory advisor at trading technology vendor Fidessa, says there are two ways to interpret this exclusion. The more accommodating approach would be to say the whole of Article 2 applies only to entities referred to in Article 1 of Mifid II – that is, firms authorised in the EEA.
“Since Article 2 only applies to firms that are within the scope of Article 1, firms without a European establishment can’t be part captured by Mifid,” says Voigt.
The tougher interpretation, he says, would be that the DEA exclusion from the own-account exemption has a global reach, because it is the intention of the legislators to ensure anyone who has access to the European market via DEA is in scope.
“In the latter case, many more third-country firms could be in scope of Mifid. It seems it is still open for debate which interpretation applies,” says Voigt.
Softer UK stance
Authorities in the UK and Germany have so far taken the opposite approach to their counterparts in France, Italy and Spain.
The German finance ministry published its draft implementing act for Mifid II, known as Fimanog, on January 23.
The draft allows third-country firms to receive a dispensation from the German securities regulator, Bafin, to continue as exchange members if they are regulated in their home country. But it is unclear whether the dispensation would allow them to offer DEA, because Fimanog contains an obligation on regulated markets to ensure any DEA providers are authorised by Mifid or CRD. If this obligation is not removed in the final version of Fimanog, firms from outside the EEA will be unable to offer DEA in Germany.
UK Treasury published its draft version of Mifid II's transposition into UK law in February. The draft alters the original Mifid II obligation placed on exchanges, allowing them to permit a broker based outside the EEA to continue to provide DEA if the firm is deemed equivalent by the European Commission, or if it is permitted to provide services under the UK’s Financial Services and Markets Act. If the firm is not deemed equivalent, a three-year transitional period will apply from when Mifid II enters into force.
The reference to the Financial Services and Markets Act relates to the 'overseas person' exemption in the UK’s Regulated Activities Order law. As long as firms meet the conditions within that article, they can continue to offer DEA.
A London-based partner at a law firm says this has “significantly softened” the UK's implementation of the Mifid II text, because the EU legislative text provides no exemption where a firm is deemed equivalent.
Laurence Walton, director of regulatory policy at UK futures exchange Ice Futures Europe, says UK Treasury has extended permission to provide DEA beyond investment firms and credit institutions authorised in the EU.
“An exchange could also allow member firms in third countries to provide DEA if those members of the exchange applied a set of controls that were the same as the ones laid out in Mifid II. So there is a common control mechanism being applied by the exchange, and indeed by the member firms applying DEA wherever they are located,” says Walton.
The Financial Conduct Authority published a Mifid II policy statement on March 31 that extends the softer treatment to participants on MTFs and OTFs.