Michael Thomas, partner at law firm Hogan Lovells, said there are legal regimes available for UK market infrastructures to preserve the way they operate in the European Union but warned this may not be politically possible.
The UK voted to exit the European Union on June 23 and will have to negotiate its relationship with the trading bloc, including access for financial and professional services.
In a webinar, Market Infrastructure: Implications of Brexit, Thomas said that UK market infrastructures, such as central clearers, trading venues and central securities depositories, operate under a patchwork of UK and EU regulations. When the UK leaves the EU, there will be gaps that need to be plugged by domestic legislation, which will be a complex operation.
“The UK laws can align with the EU or diverge,” he added. “The more the divergence, the less equivalence and equivalence is a key consideration.”
Equivalence is when European regulators recognise that the legal, supervisory and enforcement arrangements of a non-EU country are equivalent to EU requirements. This is necessary for a market infrastructure, such as a central counterparty, trade repository or credit rating agency established in a non-EU country to provide their services in the trading bloc.
Thomas continued that MiFID II, the EU regulations for financial markets that come into force in 2018, allows third-party access but there is currently a debate over whether this is really useful. For example, operators of regulated markets may not be able to use this provision.
MiFID II also requires exchange-traded derivatives to be transacted on an authorised EU venue and for EU authorised CCPs to provide clearing services, unless there is an equivalence decision.
“This is crucial for CCPs,” added Thomas. “Counterparties who clear trades through a non-qualifying CCP have to set aside more regulatory capital which will make trades more expensive.”
Thomas continued that the UK already meets EU regulations so there is no reason that UK-based CCPs should not be given equivalence. “However politics is crucial and there are moves afoot to ensure euro-denominated clearing takes place in the EU,” he added.
In the worst case scenario, where the UK cannot clear euro-denominated transactions, then UK CCPs would need to set up an EU-incorporated CCP which is both timely and expensive, as the new operation will need, for example, its own capital, default fund and collateral.
This year the European Commission agreed an equivalence decision on derivatives clearing organisations in the United States after many years of negotiations. Thomas pointed out that after leaving the EU, the UK will have to negotiate its own agreement with US regulators. “‘We would expect the US CFTC to agree but nothing is certain in international negotiations,” he said.
Thomas argued that the most sensible approach would be for UK legislators to incorporate EU law into domestic legislation and for a transitional regime to be applied while the EU regulators make assessments, “This would be the sensible approach but politics may intrude,” he added.
TheCityUK, a lobbying group for the City of London, said in a report today that the UK exports more financial services than any other country and hosts the highest number of financial and related professional services headquarters. The report said the industry is responsible for 12% of economic output and employs nearly 2.2 million people.
Chris Cummings, chief executive of TheCityUK, said in a statement: “The industry is being transformed by automation and technology and this is likely to lead to reduced employment levels in some areas; the US is capitalizing on a leading position in growth areas; emerging markets are strengthening; and, regional centres in Asia are benefiting from rapid local GDP growth. These challenges are not a direct result of the vote to leave the EU, but Brexit does amplify the uncertainty and the urgency of addressing them.”
The report said the vote to leave the EU creates challenges such as the potential loss of the current level of access to the EU single market but also creates opportunities. The study set five priorities in order for the UK to sustain a competitive – connecting globally; driving national growth; expanding services; innovation and disruption; and building skills and attracting talent.
CityUK wants the UK government to negotiate an effective relationship with the EU that maintains mutual market access but also enhance trade and investment with developed markets, including the US and Japan, and emerging markets.
“To strengthen the relationship with the US, there should be efforts to grow FRPS exports and inward investment, and coordinate bilateral policy and regulatory coherence across FRPS and business more broadly,” added the report. “Similarly, Japan is a leading trade and investment destination which we should regard as a partner for more cooperation and investment.”
CityUK warned that employment and profitability is shifting away from fixed income, currencies and commodities business and into digital activity and emerging markets.
“In the secondary market, market infrastructure must be modernised (e.g. clearing and settlement facilities for emerging market currencies) and should support electronification of front and back office processes,” said the report.
In addition the UK should seek to build on strength in fintech.
“The potential Brexit impact on FinTech funding availability in the UK could be addressed by encouraging venture capital activity, increasing investment thresholds in existing tax initiatives, and promoting (and potentially simplifying) AIM listings,” added CityUK. “Scaling must be supported by a clearer industry playbook to help young FRPS technology firms engage with established institutions.”
The report also warned that Brexit could make it harder to attract international talent due to research funding for universities coming from the UK, an area where the UK had outperformed its peer group
“Free movement of high quality FRPS talent across the EU is essential to the UK remaining a leading financial centre,” said the report.
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