The rules governing access of third country investment firms to European investors are highly fragmented because MiFID I provides for national discretion in this area. These divergences raise concerns for the single market, lead to increased costs for third country firms and create considerable legal uncertainty. At the same time, under the impetus of the G20, FSB and IOSCO, international convergence is moving forward. We therefore believe it is necessary to harmonise requirements in the EU, and to avoid both gaps and overlaps in the treatment of third country firms.
The CRA Regulation and the AIFM Directive, as well as the European Market Infrastructure Regulation (EMIR), have included provisions on third country entities. We broadly support the Commission’s proposal to introduce a third country regime under MiFID II. The regime would be based on an equivalence assessment by the Commission of each relevant third country regime and the development of appropriate co-operation arrangements between EU and third country regulators.
The third county regime proposed by the Commission would be calibrated in order to take into account the level of sophistication of EU clients and to avoid unnecessarily restricting investment opportunities for them. This regime should only target professional investors, not retail.
Overall, these proposals appear balanced and reasonable. We would, however, suggest that a formal role be attributed to ESMA in the equivalence assessment, and that some services such as the management of a trading platform or the holding of client assets should always be provided either through an EU subsidiary or an EU branch.
Financial Services Authority’s David Lawton talks about how to reduce systemic risk in the markets and how to introduce stability.
FIXGlobal: What unique role do UK markets play in the larger European trading arena and to what extent should that be protected?
David Lawton, Financial Services Authority:
The UK is the predominant location for wholesale financial market activity in the EU. Providers based in the UK play a significant role in assisting commercial firms across the EU to finance themselves and manage the risks to which they are exposed.
Against that background therefore, there needs to be a continuing focus on raising the competitiveness of the EU as a location for financial services through efforts to improve the functioning of the single market in financial services. A more effective and well-regulated single market will benefit the EU as a whole as well as offering opportunities for the UK to continue to grow as a major international financial centre doing business across the EU and further afield.
FG: How will the Legal Entity Identifiers (LEI) system reduce systemic risk in the market? How specifically does this mode of transparency improve stability?
DL: The LEI will help improve financial stability in two main ways. The first is by enhancing the ability of regulators to use data from financial institutions and from trade repositories, and to aggregate data across trade repositories. Regulators will be better able to detect build ups of counterparty exposures and other risks and take steps to control them. The second main benefit from a global LEI system will be an improvement in firms’ own risk management, as they will be better able to aggregate their own exposures across the institution and more accurately identify their largest or riskiest counterparty exposures.
FG: If organized trading facilities (OTFs) rely on conflict management processes instead of a ban on operators trading their own capital, how stringent do they need to be to meet the Commission’s goals for market stability?
DL: The Commission’s stated objective in preventing the operator of an OTF from crossing client orders against their own proprietary capital is operator neutrality. The potential for conflicts of interest arise in any trading system where the operator is allowed to participate, including in systems regulated as multilateral trading facilities (MTFs), and so this is not a new problem.
In the UK, conflicts of interest management procedures, in line with the Commission’s proposed MiFID Article 19(3), have been used effectively on MTFs operated by investment firms to mitigate the potential risks whilst allowing the benefits of the liquidity provided by the MTF operator. Such procedures include operational segregation between the MTF operation and the firm’s proprietary trading desk. We believe that an entirely similar regime for OTFs would achieve the goal of operator neutrality whilst providing liquidity for the facilitation of trades – which is all the more important in the less liquid, non-equity instruments that are likely to trade on OTFs.
