In the wake of the UK's surprise vote on June 23 to exit the European Union, it is fair to ask: could Brexit help the sizeable community of London-based energy and commodity traders escape some of the more onerous aspects of EU financial regulation?
It's not hard to find examples of EU regulation that have UK commodity firms up in arms. Perhaps the best example is the so-called ‘ancillary exemption' in the EU's new Markets in Financial Instruments Directive (Mifid II). Nonfinancial firms can use the exemption to escape Mifid II regulations – which include, potentially, bank-like capital requirements – but the latest version of the exemption, authored by the Paris-based European Securities and Markets Authority (Esma), threatens to suck a huge swathe of energy and commodities firms into a universe of rules written by financial regulators for financial companies.
Mifid II position limits, aimed at reining in speculation in commodity derivatives, are another bit of EU regulation that UK-based traders would love to dump. Unlike the Dodd-Frank position limits regime proposed in the US, the Mifid II version would impose limits on every commodity derivatives contract traded in the EU, even minor ones. This is plainly ridiculous, and critics of the idea include, among others, the UK Financial Conduct Authority – which, incidentally, has much more experience in regulating commodity markets than most of its peers in Europe.
So maybe Brexit can lead to a situation where the UK can abandon Mifid II position limits and implement a saner version of the ancillary exemption. UK-based traders and market operators would thrive as their counterparts across the English Channel choke under regulation that dries up liquidity in EU commodity derivatives.
Is that likely to happen? Unfortunately, no. The reason has to do with a phrase that has been heard a lot lately in London: passporting rights.
Passporting rights allow UK banks to do business anywhere in the bloc. The UK's powerful financial services sector is eager to preserve them in a post-Brexit world. If the UK is to retain them, it will likely need to adopt the entire body of EU financial regulations, from A to Z. It is very difficult to imagine a scenario where the EU allows the UK a few à la carte exemptions from Mifid II. Otherwise, countries remaining in the bloc might wonder why they shouldn't get those exemptions too.
If the UK still had a seat at the table, it could help Brussels come to a more reasonable place with respect to commodities regulation
As the Brexit negotiations proceed, UK-based commodity traders might make some noises about the need to soften Mifid II, but their voices will likely be drowned out by the lobbying efforts of the City of London. I know it's a risky proposition to predict the future, especially with something as uncertain as the regulatory landscape after Brexit, but if it ends up being a stand-off between the interests of banks and those of commodity traders, I expect the banks to win, hands down.
All this is ironic, because Brexit comes at a time when prominent voices on the continent seem to be having second thoughts about the commodities provisions of Mifid II. For instance, Valdis Dombrovskis, the acting European Commissioner for Financial Stability, Financial Services and Capital Markets Union, recently called for a redo of Mifid II position limits. The European Commission is also reworking the ancillary exemption after rejecting Esma's more hardline approach.
And that's the real tragedy of Brexit. If the UK still had a seat at the table, it could help Brussels come to a more reasonable place with respect to commodities regulation. After all, in past years the UK played a central role in getting the EU to adopt market-oriented policies in areas such as carbon trading and power market integration.
But now the UK has lost its ability to influence EU policy. Yet it will probably have to swallow all of Mifid II, including the least desirable parts. That would be an odd outcome for supporters of the Leave campaign, who thought they were casting off the chains of EU regulation. Instead, those chains suddenly feel even tighter.