HM Treasury makes first set of sweeping changes to wholesale markets post-Brexit

Following HM Treasury’s first response to its Wholesale Markets Review consultation, Annabel Smith unpacks the government’s regulatory changes including plans for a consolidated tape and changes to the systematic internaliser regime.

HM Treasury has announced its first post-Brexit set of sweeping changes across the capital markets as part of its ongoing review of the UK wholesale markets.

Announced on 1 March, the paper is the result of the Wholesale Markets Review consultation launched in July last year by the HMT in an effort to enhance UK markets and attract more competition to them following Brexit. 

It focuses on HMT’s priority issues across equities, fixed income and derivatives, data, outages and trading venues, based on 78 responses received from across the industry. A secondary Regulatory Framework Review will be completed later to address other less urgent issues.

“We think that this step-by-step approach will ensure we can address the most burdensome requirements now while ensuring we maintain a coherent and agile regime for wholesale markets,” said Claudia Trauffler, head of capital markets at HM Treasury, speaking at the AFME Future of the Wholesale Markets event in early March.

Systematic internalisers 

As part of the changes to the UK systematic internaliser (SI) regime, HM Treasury has set out to allow them to execute at the midpoint between the best bid and offer below Large in Scale (LiS).

“Midpoint is vital and to have any restrictions on it is utterly ridiculous,” said Richard Worrell, head of EMEA equity trading at Janus Henderson, also speaking at the AFME event. “One key reason is choice. We have different execution levels, time scales, scenarios that we want to trade in. The key to it all is a fair outcome.”

With regards to increasing the minimum quote size for equity SIs as a proportion of standard market size (SMS) – which many consultation respondents suggested should be raised from the current minimum of 10% to near 100% – HM Treasury has concluded this is a matter for the FCA to handle in its upcoming Future Regulatory Framework review.

“The SI regime was created to put a regulatory wrapper around over the counter (OTC) trading. It should be regulated and should have a designated status but in some places this has morphed into limiting trading done under that badge. The reference price waivers should be about making sure that the marketplace is fair, they shouldn’t be about trying to decide which mechanism a participant should be forced to use,” said Steven McGoldrick, general manager of regulatory affairs at BNP Paribas, also at the conference.

“The UK understands that. We heard earlier dark is not dodgy. Dark is just a normal mechanism of any market. If you’re trading large amounts of fruit you’re not going to announce it to everyone.”

Other changes include that systematic internalisers should be clarified as qualitative as opposed to quantitative to simplify and reduce their “costs and burdens”. The reporting regime of SIs was also a topic touched upon in the WMR consultation, suggesting that they be determined at an entity level rather than instrument by instrument to clarify their post-trade reporting obligations.

According to the response paper, participants believed this could be taken further instead suggesting the reporting regime determine them at an asset class level and suggesting that the requirement for SIs to report transactions undertaken with investment firms who are not SIs, be separated from the other obligations of being an SI. HM Treasury said these changes fell under the remit of technical standards looked after by the FCA, adding that the regulator planned to consult on the matter in the first half of this year.

“Historically there has been an unspoken agreement that post-trade reporting was done by the sell-side. MiFID II sought to codify that. This linkage of who does the reporting to the SI status was I’m sure an innocent mistake, I don’t think there was anything untoward about it but it hadn’t appreciated that not all sell-siders are SIs, so it created a problem where there wasn’t one previously,” said McGoldrick.

Equity markets 

In the equity markets, HM Treasury has – as announced last year – moved to officially scrap double volume caps (DVCs) and the share trading obligation (STO) alongside the requirement for algorithmic trading firms to enter into market making agreements with venues.

“The scrapping of DVCs goes back to the midpoint before, it’s the fairer outcome. There’s a lot of talk about how dark venues are branded, if you could rebrand them as block crossing venues it would be a lot more palatable to regulators,” said Worrell. “I will agree that we should look at the market quality metrics and check that trading in the dark or off venue is not having a detrimental impact on the markets but I don’t think any of those things are true. We’re in good shape, spreads are tight and costs are low, so I think we should be supportive of scrapping DVCs.”

The WMR also consulted the industry on whether reference price systems should be allowed to match orders at the midpoint within the current bid and offer of any UK or non-UK trading venue that offers the best bid or offer. Following a supportive response, the paper concluded that these changes to pre-trade equity waivers should be delegated to the FCA to be implemented when parliamentary time allows.

“Reference prices waivers and the changes to that will be crucial to the work that the industry and the FCA is considering to mitigate the risks relating to market outages,” added Trauffler.

HMT added that the watchdog would consult in the first half of this year on the potential for an extension of the concept of the most relevant market in terms of liquidity for the purposes of the reference price waiver (RPW) to include overseas trading venues. “This will formalise and broaden the approach that is currently being taken in relation to EU and Swiss shares,” HM Treasury said.

With regard to tick sizes, HM Treasury concluded that trading venues should follow the tick size applicable to the primary market of a share even when that market is overseas and that they should to establish tick sizes for new shares “until sufficiently robust data is available”.

Market outages

The WMR response paper has acknowledged that further work is needed to be done to ensure resilience by developing a playbook to be used in the case of a market outage, however, rather than legislating the issue the government said it believed this would be best addressed by regulators using existing tools and communicating with firms. 

It added that in light of this, the FCA would confer with participants to clarify its policies including whether an amendment should be made to the two-hour window that venues currently are advised to resume within and would consult on this later this year. 

“There’s some obvious things we can do around best practices in terms of altering data immediately, creating a standardised reopening messaging system,” added Worrell. “We need that resilience. We need a back-up; we cannot have an outage where a market goes down for three hours and we lose the closing auction and then can’t trade. That is the legislative change that we need.” 

An overwhelming majority agreed with the consultation’s proposals to allow reference price systems to match at the midpoint and to recommend that UK authorities set out alternative mechanisms to a closing auction during an outage. Plans have subsequently been laid out to bring forward legislative changes to delegate the pre-trade equity waivers regime to the FCA, when parliamentary time allows, transferring responsibility to the watchdog to take the matter forward using the consultation responses.

“The market could not afford to pay for systems that never go down. To engineer them to that level we’d have to give up a lot of functionality or pay a lot more. Systems will always go down but when they do the impact should be minimised,” commented McGoldrick. “We’ve got a system that does not have a single point of failure but we behave as though it does. In some instances when there’s a primary market that goes down they’re not particularly incentivised to try and make the transition to alternatives as seamless as possible because they would profess to be the true former of price.”

The government’s proposed amendments to align the scope of counterparties under the derivatives trading obligation (DTO) and the EMIR clearing obligations (CO), as well as expanding the grounds for an exemption from the DTO beyond portfolio compression to all post-trade risk reduction (PTRR) services are also to be actioned when parliamentary time allows. 

HM Treasury set out several changes to pre-and post-trade transparency in the fixed income markets in its Wholesale Markets Review including the potential to limit the scope of the regime to systems such as electronic order books and periodic auctions and streamlining the deferral regime, however, delivery on this has been delegated to the FCA to take forward. 

Market data 

With regards to the implementation of a consolidated tape, the government has given the FCA the responsibility of drafting the requirements for consolidated tape providers with the aim of implementing one or more consolidated tapes “for any asset class and for either pre- and post-trade data, or both.” Despite consultations respondents’ concerns over having multiple consolidated tape providers, HM Treasury outlined that this would maintain competition in the space. 

“Pre-trade real-time multi-asset is the way we should be heading. I think one tape initially would be better and then we could move onto multiple. Multiple initially makes me a bit nervous. How do you choose which one? How does the revenue work? It feels more challenging,” said Worrell. “We wouldn’t buy a 15-minute delayed post-trade tape.”

HM Treasury added that the FCA would continue to examine high market data costs in its ongoing investigation following concerns raised by respondents in the WMR consultation. 

Within reporting, the Treasury has said that the case for amendments to investor protection reports and product identifiers was not conclusive and will continue to engage stakeholders throughout this year.

Trading venues 

With regards to trading venues, the government has concluded that it will not amend the legal definition of a multilateral system, however, added that it alongside regulators would consult on new guidance following their work in the ongoing Wholesale Markets Review. 

Elsewhere, the government said there is a clear case for removing matched principal trading restrictions for investment firms operating a venue while also retaining obligations to prevent conflicts of interest, adding that the FCA would be focusing on this topic as a regulatory matter. OTFs will also be allowed to execute transactions in equities when dealing in packages. 

“The government believes that the case for this change is not conclusive, and therefore further consideration of whether the potential conflicts could be adequately mitigated is needed,” said HM Treasury in its paper.

It also sets out plans to explore the proposal for a new type of venue for SMEs reflecting feedback from participants that greater market access was needed for all.

Divergence post-Brexit

The developments come as Europe is conducting its own MiFIR Review. In a Capital Markets Union (CMU) update in November, European regulators moved to introduce new regulations to drive volumes back onto lit markets including introducing a blanket double volume cap (DVCs) and a set of stringent new regulations for SIs. 

Included was the prevention of alternative trading venues (MTFs) from using the reference price waiver to execute small trades by introducing a minimum threshold and limiting systematic internalisers’ ability to match at mid-point to when they are trading above twice the standard market size but below the large in scale (LIS) threshold. Europe has also set out plans to implement a single real-time post-trade consolidated tape provider per asset class. These vastly different takes on capital markets regulation could mean participants are forced to create dual operations to adhere to them. 

“As this progresses, AFME urges EU authorities to ensure they put in place the right conditions for building-out the bloc’s wholesale markets capacity to ensure EU markets remain attractive and competitive globally,” said AFME in a statement following the announcement of the UK’s changes. 

 “AFME members are global wholesale banks that support European clients internationally, therefore, it is a priority to ensure the continuity of cross-border services and to avoid market fragmentation. In this respect, AFME advocates for the same policy approaches in both the UK and the EU.”