How Brexit is set to muddy Mifid transparency data

Market participants say duplicate reports in UK and EU will result in misleading public data

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Transparency report confusion: off-venue trades across the new EU-UK border will be reported twice

Dealers and investors trying to gauge the depth of trading from already patchy European Union data are due to face another setback from Brexit, as off-venue trades across the new EU-UK border will be reported twice.

“It has been a challenge to get the transparency regime to be an effective tool for investors, and actually adding in duplication by design is something that I think would be really quite unhelpful,” says Jason Waight, head of regulatory affairs at trading platform MarketAxess and its reporting division, Trax.

The second Markets in Financial Instruments Directive (Mifid II) requires investment firms to disclose the price and size of certain off-venue trades to the public via approved publication arrangements (APAs).

Known as post-trade transparency, the public data is meant to offer investors a tool to compare prices and gauge the depth of liquidity in European financial markets. Despite the good intentions of EU lawmakers, market participants have complained that public data for over-the-counter derivatives is still unusable.

After members of parliament twice rejected a withdrawal agreement signed by prime minister Theresa May, it is still unclear how or when the UK will exit the EU. Three options now appear to remain for the UK: Leave without a deal; agree to a deal with a transition period, where the UK remains in the single market until December 2020; or renegotiate for a close relationship with the EU after the transition period.

In any case, market participants warn the UK’s expected departure from the single market – either under a no-deal or after the agreed transition period – will make post-trade transparency data worse.

There will be duplicative transparency reports on that off-venue trade. We need to filter that out. It will affect assessments of liquidity and our best execution analysis
A dealer source

This will particularly affect off-venue trades between investment firms where one is in the EU and the other in the UK. The fear is that investors and dealers will then have a misleading picture of the amount of off-venue trading occurring in Europe.

A dealer source put forward one scenario: “What happens if you have an EU investment firm trading with a UK firm and it is not traded on a venue? There will be duplicative transparency reports on that off-venue trade. We need to filter that out. It will affect assessments of liquidity and our best execution analysis.”

Currently, trades between EU and UK counterparties are only reported once. If the trade is executed on-venue then the platform operator must report. Off-venue trades are reported to APAs either by the counterparty with the systematic internaliser (SI) regulatory label or by the counterparty considered to be the seller if both counterparties are investment firms or SIs. EU investment firms trading with third-country firms must report the trade.

Once the UK leaves the EU, UK law will place the same obligations on UK firms as EU law did. Under the local regulations of EU and UK investment firms, the other side of the trade would be considered a third-country firm for both counterparties, and so both would have to report the trade to their domestic APA.

Unavoidable doubling

Transitional measures taken by the UK Financial Conduct Authority to mitigate against the issue mean duplicative reporting will start in only a few circumstances immediately after Brexit, even in the event of a no-deal scenario.

A statement published by the FCA on March 13 declares UK investment firms will not need to report trades with EU investment firms if they do not have the obligation to report the same trades with the same counterparty before exit day. The transitional period would last 15 months after the UK leaves without a deal.

“There might be some double reporting that is unavoidable and there will be more double reporting after the transitional phase has expired. But this is an area where we have used all the flexibility given to us by HM Treasury to mitigate some of the issues with trade reporting,” says a spokesperson at the FCA.

The European Securities and Markets Authority has already indicated, in a statement published on March 7, that it will not provide similar relief.

EU investment firms are required to make public [any] transactions concluded [off-venue] with UK counterparties via an APA established in the EU27,” stated Esma. “This approach ensures all transactions where at least one counterparty is an EU investment firm will be made post-trade transparent in the EU27.”

This means that under circumstances where EU and UK investment firms trade with each other, both will only have to report when the UK investment firm is a SI or the seller of the instrument. If the EU firm is the seller or a SI, only the EU firm will have to report.

Most trades involving UK branches of EU firms will also initially be free from double reporting while they are in a temporary permissions regime that lasts for three years. The March 13 FCA statement says they can fulfil the UK reporting obligation by reporting through an EU APA.

However, there will still be duplicative reporting under circumstances where the branch has a UK counterparty, both are systematic internalisers and the counterparty is the seller to the trade. In this instance, the branch would report to an EU APA, while its counterparty would report to a UK APA.

And once the temporary regime is over, the UK branches will have to report all trades they conduct with UK investment firms to an EU APA, and trades where they act as a SI or the seller through UK APAs as well. Even where the branch is not a SI or the seller of a trade, the EU parent will have to report to an EU APA, while its UK counterparty will have to report to a UK APA as well.

Playing tag

Neither the EU nor UK versions of Mifid II provide a long-term solution to the problem, as there is no equivalence regime that would waive transparency obligations for off-venue trades, unlike the provisions for EU firms trading on third-country venues.

In December 2017, Esma published an opinion document saying EU investment firms should not have to disclose trades they execute on third-country trading venues that already publish their own public information. However, in the absence of equivalence determinations, Esma stated it would create its own list of third-country venues on which EU investment firms would not need to disclose trades to EU APAs.

Until Esma has created that list, the watchdog said EU investment firms are allowed to make their own determinations as to whether third-country trading venues report trades to the public in a way that is equivalent to the EU’s standards. As the list has not been created yet, EU investment firms trading on UK venues will not need to report, given that UK venues will be following rules identical to Mifid II in the first instance.

As the FCA is copying Esma’s opinions, this will also be the case for UK investment firms trading on EU trading venues.

“There is an Esma paper in relation to third-country trading venues and post-trade reporting that allows firms to make a determination as to whether the third-country trading venue is equivalent [and so avoid double reporting],” says Tim Cant, a partner at law firm Ashurst. “I’m not aware of a similar regime for off-venue transactions.”

In the absence of a solution from regulators, the dealer source suggests industry bodies could solve the problem by creating a tag that would identify duplicative reports. Both EU and UK APAs would have to tick the tag if a report is sent for an off-venue trade between an EU investment firm and a UK investment firm.

Investors and dealers will then be able to filter out reports from one jurisdiction’s APAs with the tag and include those from the other side, giving a more accurate reflection of the depth of trading in an instrument in Europe. It would also bring the advantage (for market participants, and potentially regulators as well) of being able to glean how much cross-border trading occurs between the EU and UK after Brexit.

This article first appeared on sister site Risk.net

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