As European financial markets come to terms with the outcome of the UK referendum, Brexit has severe implications for the Markets in Financial Instruments Directive (MiFID). MiFID II/R is the cornerstone of EU’s regulation of financial markets. It aims to improve competitiveness in the EU by creating a unified market for investment activities and services, and to ensure a high degree of harmonised protection for investors. But if the UK — a leading financial institution of the world — exits the EU, will it still be required to implement these extensive and strict new regulations?
The impact of Brexit on the field of financial instruments
UK firms that held passporting rights to do business with any other state in the EEA (European Economic Area) can no longer rely on their passport. EEA firms looking to undertake MiFID business in the UK will not be able to do so either. Both UK and EEA firms will need a certain amount of restructuring to continue doing business with each other.
The impact on providing cross-border MiFID investment services could be diluted by the MiFID II regime allowing non-EEA firms to offer investment services to professional clients across EEA upon registering with the ESMA. It still wouldn’t be an immediate solution, because it would depend on ESMA making an equivalence determination under MiFID II/R concerning the UK, and the timing would be highly uncertain. The UK could implement an equivalent regime to ensure its position as an “equivalent” third country that EEA firms can do business with.
Financial institutions in the UK would have to consider the regulatory perimeter in each EEA country where another institution wishes to undertake business. Conversely, EEA institutions need to evaluate the UK perimeter to identify what activities by them in the UK would engage a registration requirement locally in the UK.
Under MiFID II/R, EEA members have to allow investment firms from other EEA states access to clearing and settlement systems, and regulated markets established in their country. Post-Brexit, UK investment firms would no longer be able to depend on those provisions, but EEA firms looking to access the UK wouldn’t either. It’s this definite possibility of mutually assured destruction —combined with the UK’s status as Europe’s leading financial centre— that could drive some hard bargaining after Brexit, by both sides, towards a constructive outcome in favour of continuing integrated financial markets and services.
Impact of Brexit on trade reporting
British firms that deal in Over the Counter (OTC) derivatives are expected to report trades as prescribed by ESMA through the:
One of the biggest focuses for OTC derivatives firms will be whether they’re expected to continue reporting under EMIR and MiFID II/R regulations, or if Britain will implement its own trade reporting legislation. In 2009, Britain pledged its allegiance to trade reporting and oversight of the OTC derivatives industry at the G20 summit held in Pittsburgh and has continually been an active contributor to the development of both the regulations. Britain has to continue maintaining its commitment to trade reporting regulation, either via existing requirements or by the development and implementation of its own trade reporting requirements.
One of the most significant changes under MiFID II/R is the stricter rules on ‘third country firms’. These are firms that buy and sell their financial products from outside of the EU. Britain’s exit from the EU means that its constituents classified as reporting entities under the OTC derivatives requirements would become third country firms. Meaning that entities wanting to provide services to EU resident clients will have to look at becoming regulated inside the EU. EMIR also requires non-member countries to apply for recognition as a third-party CCP (central counterparties). Just these changes will create extensive restrictions for firms dealing in OTC derivatives in addition to potential changes in trade reporting requirements.
Introducing new requirements would mean the establishment of new trade reporting legislation and also trade repositories, requiring licensing to accommodate British regulation. Entities that have only just wrapped their head around ESMA and MiFID regulations and developed adequate systems to report trades compliantly will have to, once again, prepare for the development of updated requirements to accommodate new British regulation.