Further EU Clarification For Financial Services Firms in a No Deal Brexit

1. The carve out for UK derivatives under MiFID II, Annex, Section C, paragraph 6  (usually known as the "REMIT carve out")

The Markets in Financial Instruments Directive provides that derivatives that: (i) qualify as wholesale energy products; (ii) are traded on an organized trading facility; and (iii) are physically settled, will not be classed as financial instruments. The classification means that activity involving such derivatives will be out of scope of the MiFID II requirements. ESMA has confirmed that derivatives contracts based on electricity or natural gas that are traded on a U.K. OTF would no longer fall within this exclusion on a no deal Brexit because they may not meet the relevant conditions.  

2. The trading obligation for derivatives and U.K. trading venues

The Markets in Financial Instruments Regulation requires investment firms to conclude transactions in certain derivatives on regulated markets, multilateral trading facilities, OTFs or third-country venues in jurisdictions benefiting from an EU equivalence decision. No U.K. venues have been so designated.  The trading obligation applies to certain fixed-to-float interest rate swaps denominated in EUR, USD and GBP and to index credit default swaps (iTraxx Europe Main and iTraxx Europe Crossover). The trading obligation for both IRS and CDS applied from January 3, 2018, except where the clearing obligation for a particular class of derivatives has not yet entered into force, in which case the trading obligation will apply from the date that the clearing obligation begins for that class of derivatives.
 

ESMA notes that most of the trading of derivatives subject to the trading obligation takes place on U.K. trading venues.  It has asserted in its paper that most of these venues are in the process of establishing new venues in the EU27 and intend to offer the same services in the EU27.  This assertion is somewhat strange, in the sense that relocation steps are not being taken universally in the industry and no material movement of liquidity from the U.K. to the EU has yet been observed. ESMA are however correct to note that there are certain EU27 trading venues that offer trading for the relevant derivatives. ESMA has determined that it does not consider that market participants are in jeopardy of being unable to comply with their trading obligation in a no deal situation and no equivalence decision. However, it intends to monitor the situation, and, in particular, the effect on any liquidity of markets.

3. The position limits regime and post-trade transparency for OTC transactions and the impact of these on U.K. ETDs

ESMA has confirmed that, in the absence of any assessment of U.K. trading venues as equivalent, EU27 investment firms will not be required to make transactions executed on a U.K. trading venue public in the EU27 via an EU Approved Publication Arrangement and that commodity derivatives traded on U.K. trading venues will not be considered as economically equivalent OTC (EEOTC) contracts for the EU position limits regime. ESMA has also confirmed that EU27 investment firms trading with U.K. counterparties will be required to make public OTC transactions via an EU APA. 
 

4. Use of third-country (U.K.) benchmarks under the BMR

ESMA confirms that it will remove all U.K. benchmark administrators from its register of EU administered benchmarks because the administrators will no longer be EU administrators but will be third-country administrators, for which different provisions apply. It is possible that some U.K. benchmarks will be endorsed or approved under one of the third country regimes at or around the time of Brexit.  However, in the absence of this taking place, ESMA considers however that the transitional provision in BMR, which expires on January 1, 2020, will apply to U.K. benchmarks, allowing EU supervised entities to use them, even if they are not included in ESMA's register or otherwise approved as third country benchmarks. Similarly, during the BMR transitional period, EU27 supervised entities will be able to use third-country benchmarks that have been endorsed or recognized in the U.K. prior to the U.K. leaving the EU and which will also be deleted from ESMA's register.