A forward look at regulation of the UK’s wholesale financial markets

Speaker: Edwin Schooling Latter, Director of Markets and Wholesale Policy
Location: ISLA's 11th Virtual Post Trade Conference
Delivered on: 16 March 2021

Highlights

• Decisions to tailor securities financing transaction reporting and settlement buy-in rules to achieve the desired outcomes in the way that best fits UK-based markets.
• The FCA welcomes recommendations to look at aligning prospectus documentation requirements with the type of capital raise being undertaken.
• There is scope to simplify and remove costs from some parts of the MiFIDII regime without material loss of benefits.

It’s a pleasure to be with you all – virtually at least – this afternoon for ISLA’s 11th post trade conference.

It’s been quite a year – actually a year and a half – since the 10th annual conference in October 2019. Financial markets have endured the pandemic – and have been helping economies begin to recover from that pandemic. The UK left first the EU, and then at end-December last year, the EU single market.

11 weeks into the UK’s post-EU future, I know there is a lot of interest in the opportunities for London’s much-envied financial markets, and the FCA’s approach to regulating these going forwards given that rule-setting powers have been returned from Brussels and Paris to London.

We will be building on strong foundations.

For the past 10 years I have enjoyed the personal privilege of being part of regulating and supervising London’s wholesale financial markets – first at the Bank of England, and more recently at the FCA, and seeing just how strong those foundations are. I have been able to enjoy working with genuinely world-leading infrastructures for clearing, and for trading, and hugely talented individuals from the sell-side, the buy-side, from our law and professional services firms. I have seen what this community can deliver, whether that’s building new infrastructure such as trade repositories, or improving the way markets function, as in the – initially seemingly impossible – task of transition from LIBOR.

Looking ahead, we have a new opportunity and ability to shape our regulatory framework in a way that maximises the scope for the practitioners and customers of the UK’s financial markets to prosper.

You will have seen the Chancellor’s announcement in his budget that the government is examining the case for capital markets reforms, and that it will set out further plans on this soon. The FCA shares the government’s determination to ensure our regulatory framework is tailored to allow UK financial markets and their users, from around the globe, to thrive.

That doesn’t mean change for the sake of change. We know change can carry unwanted costs. Nor does it mean seeking low standards in pursuit of competitive advantage. We don’t think low standards are a competitive advantage. But where regulation has imposed costs without beneficial outcomes to justify that cost, then we will want to use our new ability to change direction.

Let me turn to a couple of specific examples, close to the interests of this audience.

SFTR reporting

I will start with the Securities Financing Transaction Regulation (SFTR). This reporting regime is one of the last pieces of regulation implemented in response to the 2008/09 financial crisis. This has helped create a data set that supports a Financial Stability Board (FSB) recommendation, endorsed by the G20, to enhance transparency of the securities lending and repo markets. As this audience knows well, the securities financing market supports liquidity management and trading liquidity in large parts of the financial system. The effort to improve data on this key market reflects the importance that authorities attach to the market’s smooth functioning.

Following a 6-month delay beyond its previously planned implementation date, SFTR reporting finally came into application in the EU and in the UK in July 2020 for credit institutions, investment firms, CCPs and CSDs. The delay of the first phase-in was a response to the immediate impact of Covid-19, allowing those firms to focus resource on managing their own liquidity risks and other priorities during that challenging period.

SFTR has been a complex regulatory reporting regime to implement. We recognise the considerable time and money this will have consumed. The number of fields to report is large. There is considerable complexity in how some are populated. Despite this, and the added complications of managing Covid-19 impacts, we saw largely smooth implementation, and relatively few issues compared with what might have been expected for a reporting regime of this scale. The engagement with firms and trade associations, including a very useful roundtable with ISLA and some of its members, has been good. We hope and expect this open dialogue with you will continue.

In onshoring SFTR, the FCA also assumed the new role of Trade Repository (TR) supervision. That role now dovetails neatly with supervision of the firms who report to TRs. This will make it easier to encourage efficient and timely remediation of reporting issues, feeding better data quality.

As SFTR was already in application for investment firms, credit institutions, CCPs, CSDs, UCITS, AIFs, insurance companies and pensions funds by the end of the Brexit transition period, we onshored the SFTR regime for these firms as it was. However, for non-financial companies (NFCs), for whom the regime only came into force in the EU in January 2021 – after the end of the transition period – we were not under the same obligation to onshore this extension of the reporting regime. Reporting by NFCs was not required under the FSB recommendation. Given that NFC-to-NFC securities lending or repo is rare, we don’t think such reporting is necessary for data adequacy or financial stability purposes.

The FCA therefore encouraged and supported HM Treasury’s decision not to bring non-financial companies into scope of UK SFTR reporting. Where NFCs do have significant trading activity, we will still be able to see almost all these transactions as they will be reported by their financial counterparties.

We are often asked whether we intend to diverge any further from the current regime. It seems prudent to allow the regime to mature before we consider if there is a case for refinement or trimming. We seek a balance in which the regime meets its overall objectives while remaining proportionate in terms of cost and operational burdens for UK-based firms.

One change we are open to considering is whether to remove commodities lending transactions from scope. These transactions were not included within the original FSB recommendations which focused on repo, securities lending and margin lending.

We will also assess carefully the evidence on the relative benefits of single versus double-sided reporting. This is something market participants and trade bodies have often raised with us in the context of EMIR reporting. But many of the costs of implementation, including of this 2-sided model, have already been borne. We do not wish to add to these costs with further expense from unnecessary change.

Likewise, we are conscious that many UK-based firms are part of groups with EU entities subject to the EU SFTR regime. Divergence between the 2 regimes could add additional complication or cost to groups who would then have to adhere to 2 different sets of reporting requirements. This is just 1 small example of a wider reality that we and the EU will continue to have very strong common interests in the functioning of our regulatory frameworks.

Any future policy considerations will also be made in close cooperation with our colleagues at the Bank of England, who will have responsibility for submitting the aggregated UK data to the FSB, and of course with HMT, who would be responsible for any amendments to the primary SFTR legislation.

CSDR

Another Regulation of importance to this community is the Central Securities Depositories Regulation. As with SFTR, the CSDR regime was onshored into UK legislation as it stood at the end of the transition period.

However, the EU CSDR settlement discipline regime had not begun to apply before the end of the transition period. Consequently, it could not be included in the UK CSDR as part of the onshoring process. And HMT could decide whether and how we implemented the settlement discipline regime in the UK CSDR.

Consistent with FCA advice, HMT decided not to implement the EU CSDR settlement discipline regime in the UK. For many years, we had argued in relevant EU fora that the case for introducing the regime, in particular the buy-in provisions and arrangements for resolving failed transactions, was not strong. Both buy-side and sell-side representatives have consistently expressed their concerns to us about these provisions. They have pointed to a seemingly credible risk of negative impact on market liquidity, perhaps particularly on the securities of smaller issuers.

That is a risk we have no desire to take. Some may have been attracted to these CSDR buy-in provisions and penalties as a constraint on short-selling activities. But we think the Short Selling Regulation is the better, more direct and more effective vehicle for setting regulatory parameters around that market. Investors in securities value liquidity. We should be wary of introducing measures which stand to reduce that liquidity in the name of investor protection.

Of course, together with colleagues at the Bank of England and HMT, we will remain open to ideas on whether, and, if so, how, the UK’s settlement arrangements could be refreshed to support both market liquidity and settlement efficiency. We would be happy to work with the grain of market consensus if and where there is a case for change.

The wider capital markets framework

In addition to post trade regulations, we also inherit from the EU the extensive framework of legislation and rules around secondary market trading – notably, but not only, in the form of MiFID II – and around primary market issuance of securities – in the form of the Prospectus Regulation.

On the primary markets side, Lord Hill’s recent review has usefully flagged scope for reform to the prospectus regime. We see real efficiency and effectiveness gains in better aligning prospectus documentation requirements with the type of transaction being undertaken. Follow-on capital raising by companies whose shares are already listed and traded on public markets is a very different type of transaction from an off-market public offer by a private company.

Yet the Prospectus Regulation seeks to cover both with the same rules. That was the result of a regulatory compromise in the EU. It is timely to revisit this framework, making the route to capital raising through public markets one which is efficient for issuers because the regulatory requirements are focused tightly on what their investors actually need, while maintaining alignment with existing standards where this is more efficient for market participants operating in UK, EU and other international markets.

The FCA is carefully considering Lord Hill’s recommendations for changes to our own listing rules, in line with our objectives, including on free float, dual class share structures, and special purpose acquisition companies (SPACs). We are treating a response to these as a priority.

On secondary markets for securities, derivatives, and other investments, it is timely to assess where MiFID II rules, and the costs some of them impose, have – or have not – achieved the intended benefits. The EU has been reflecting on this too, as we have seen in the already agreed changes in the so-called MiFID ‘quick fix’. We will shortly put out to consultation in the UK a similar set of changes – not absolutely identical, but we hope at least equally effective in achieving the same desired outcomes.

We have also had to consider or decide how to implement on a UK-only (as opposed to EU-wide) basis various elements of the MiFID transparency regime. For example, whether and when so-called ‘dark’ trading should be capped, and how thresholds for post-trade, and, in particular, pre-trade transparency should be calculated.

On dark trading, our initial approach is not to have automated caps in the absence of evidence that the levels of dark trading we have seen harm price formation or execution outcomes for investors, and given no need to preserve alignment of cap application in the absence of the EU accepting the equivalence of the UK share trading regime.  It’s no secret that the FCA has long been sceptical about the merits of this regime. The adjective ‘dark’ sounds unhelpfully pejorative. This is investors trying to protect their own interests by not telegraphing before they need to, their desire to buy or sell a share.

On threshold calculation and application, there are important questions about how best to achieve desired outcomes, and whether the complex, sometimes costly and cumbersome calculation procedures, do achieve those outcomes. We may be able to find ways of simplifying this currently elaborate machinery. Flexibility in our approach may indeed create options for alignment across jurisdictions where that is important for industry efficiency or other reasons. That might be better for all than rigidly insisting on different transparency thresholds for the same instruments in different jurisdictions because those thresholds are derived, under the letter of current MiFID rules, from different data sets.

The detailed machinery of the MiFID II transparency regime can be difficult to follow for those not immersed in its detail, but the key point is that we have important opportunities to refine our framework for securities and derivatives trading in a way that helps those doing business here, without sacrificing equivalent outcomes in terms of investor protection and market integrity.

Another part of MiFID II about which we have expressed doubts from the outset is the commodity derivatives regime. The EU has also identified the need for revisiting this regime as part of its ‘quick fix’. We think there is scope substantially to simplify this regime.

As we look to key themes of the years ahead, what is most striking is the common challenges facing market regulators in all jurisdictions – in the UK, the EU, the United States and beyond.

For example, we have been working together – through FSB and IOSCO – to look at what lessons can be learnt from the impact of Covid-19 on our markets, notably in terms of the liquidity stresses experienced in asset markets, and in various fund structures.

We are also working together on how financial markets can support that all-important transition to net zero. As with the global work completed over past years and now embedded in regulatory frameworks across jurisdictions – such as the agreement of common and equivalent standards for clearing and settlement, or the improved international data collection on securities financing markets which I talked about earlier – we will be striving for common outcomes.

We face the same global issues. The most effective and efficient way of addressing them will be through globally connected markets. We look forward to ensuring our approach in the UK is an integrated part of that coordinated international effort.