Esma navigates a Brexit maze over equivalence

In March, Risk.net heard stories of decision-making on equivalence at the European Securities and Markets Authority being paralysed by concerns that a generous equivalence regime could weaken the negotiating hand of the EU 27 in Brexit talks.

It now seems Esma has managed to solve this conundrum, at least in regard to allowing European Union firms to continue trading shares on third-country venues.

Unfortunate wording in the Markets in Financial Instruments Regulation (Mifir) will bar EU investment firms from trading any shares on non-equivalent third-country venues once the rule takes effect on January 3.

The rule, known as the share-trading obligation, stipulates that if shares are traded in the European Economic Area, Mifid-regulated investment firms can only trade them on EEA-regulated markets or multilateral trading facilities, with an EEA systematic internaliser or on a third-country venue deemed equivalent by the European Commission (EC).

With time running out, there is uncertainty around which jurisdictions will be granted equivalence in time for the start of Mifir. So far, the only official, positive EU equivalence announcement has been a broad agreement with the US for the derivatives-trading obligation.

The risks of delayed equivalence decisions are particularly acute for non-EEA equities that have some limited trading in the EEA, but a much larger liquidity pool located elsewhere. This category would mainly consist of dual-listed stocks and EEA-listed depository receipts of third-country issuers, but could in practice affect many other shares, which are very marginally traded on a single EU venue.

Industry players have put forward various workarounds of the obligation, capitalising on different interpretations of Mifir. For example, EU authorities could clarify best execution overrides the share-trading obligation.

This kind of approach would have allowed trading on non-equivalent third-country venues to continue in some form. But it could potentially weaken the trading obligation overall, making it easier for EU investment firms to trade in the UK after Brexit, even if the British regulatory regime diverges from Mifir.

Esma has opted for its own legal solution that hinges on an undefined exemption to the share-trading obligation

Instead, Esma has opted for its own legal solution that hinges on an undefined exemption to the share-trading obligation. This allows trading on non-equivalent third-country venues if it is “non-systematic, ad hoc, irregular and infrequent”.

In a press release published on November 13, Esma stated if the EC has not made an equivalence determination for a jurisdiction, it indicates there is “no evidence that the EU trading in shares admitted to trading in that third country’s regulated markets can be considered as systematic, regular and frequent”.

Normal service?

So unless the EC explicitly states a jurisdiction is not equivalent, trading can continue as normal on those jurisdictions without an equivalence decision, on the basis that current EU trading flows on those venues are insignificant.

This cute interpretation of the law is welcome for market participants, as it means they can still trade shares on venues for which the EC has not yet been able to make an equivalence decision in time for the start of Mifir.

And yet it also leaves EU authorities with the option of using the share-trading obligation to prevent EU investment firms trading any shares on specific third-country venues, even in the absence of an equivalence decision. 

There is no definition or threshold for trading activity that meets the “non-systematic, irregular and infrequent” criteria. But London-based Cboe Europe, for instance, routinely reports market shares for trading in French and German stocks at more than 20%. It would be a brave investment firm that tried to tell Esma this was “irregular and infrequent” trading in an attempt to benefit from this newly minted exemption. This keeps share-trading venue equivalence as a Brexit bargaining chip in EU negotiators’ hands.