Parts of the Mifid II regime do not work as intended, says HM Treasury director

Speaking at FIA’s IDX conference, Gwenyth Nurse provided an overview of the UK’s regulatory approach to wholesale financial markets, suggesting more work needs to be done to improve Mifid II. Could further divergence be on the cards for the UK?

‘Standing still is not an option in today’s evolving cleared derivatives environment’ was the tagline for this year’s FIA derivatives expo and Gwenyth Nurse, director general, financial services at HM Treasury, stressed that the same is true for regulation.

“Like the sector itself, regulation is not static and needs to adapt to ensure that the markets can flourish and develop,” said Nurse. “We’ve got a unique opportunity to look at our regulatory framework to assess whether it is fit for purpose with today’s challenges and indeed, those of the future.”

As a result of Brexit, the UK now finds itself in a position where it can take advantage of its new freedoms and to tailor rules that apply specifically to the UK markets.

Last year, in the Chancellor’s Mansion House speech, Rishi Sunak set out his vision for a financial services industry that is open, free, competitive and technologically advanced.

Nurse noted that the government wants to build on this, with the Treasury working to ensure that existing regulatory frameworks reflect the needs and ambitions of UK markets.

“Now that we have left the EU, the FRF review has considered how to ensure our regulatory framework works effectively for UK firms and markets,” said Nurse. “And in designing the FRF review, the government is focused on repealing retained EU law to enable a UK regime which is properly tailored for UK markets and which can be updated in an agile manner to reflect changing trends and practices.”

Last year, the Treasury published the Wholesale Markets Review consultation, which proposed a number of changes to the Mifid framework. The government claims to have consulted widely, built an evidence based and carefully considered the proposed changes – ensuring that they are not making changes simply for the sake of it.

“The UK remains committed to the objectives of the Mifid framework – it played a key role in developing it in the EU,” added Nurse. “The government continues to believe that the framework has been critical in ensuring the resilience and effectiveness of markets since the financial crisis.

“However, now that Mifid II has been enforced for four years, it is clear that parts of the regime simply do not work as intended. There are issues around duplication and excessive administrative burdens for firms, all of which we believe have stifled innovation.”

When the Mifid framework was initially put in place, a key aim was to ensure harmonisation across 28 nations with very different financial markets, however, following Brexit, Nurse noted that there is clear scope to tailor these rules to the UK.

Looking at the changes that the Treasury plans to make immediately, transparency is a major focus.

“Transparency is key for price formation and therefore a core part of the Mifid framework, but clearly the rules need to be designed for the products they cover. Mifid brought large scale, new transparency requirements for fixed income derivatives. However, four years on, it is clear that it has not worked,” said Nurse.

“There is limited impact on price formation as a high cost for industry. We think this needs proper reform and the government will give the FCA full control of both the pre- and post-trade transparency regimes for fixed income and derivatives markets. The FCA will be able to properly re-calibrate these roles and create a regime tailored to the instruments in it, ensuring better disclosure, lower costs and better support for best execution.”

Secondly, the Treasury is looking to focus on systemic internalisers. Nurse noted that again, it is clear that this regime is not fit for purpose.

The regular calculations which firms need to undertake to assess whether they are an SI or not have been said to be too burdensome and complex.

“These calculations might have been necessary to ensure 28 regulators achieve the same outcomes, but the UK does not need to hard code regulatory decisions in law in this way. I’m pleased, therefore, that as for many other areas, this judgement will be returned to the FCA, as was the case before Mifid II,” said Nurse.

In addition, the Treasury will amend the scope of the derivatives trading obligation to align with the counterparties and scope of the clearing obligation and to exempt more post-trade risk reduction services. Nurse highlighted that this would ensure greater clarity and help firms better manage risk. Finally, Nurse says the FCA will be given a permanent power to modify the derivatives trading obligation to support market resilience or prevent fragmentation.