In recent months, the political landscapes of both Britain and mainland Europe have been dominated by talks of Brexit. Perhaps more than any other event in recent history, Brexit will seriously impact the state of markets across the whole of Europe. In particular, the uncertainty surrounding the timing and nature of the UK’s departure from the European Union, and in particular the possibility of a no-deal Brexit, has called into question the future of ESMA’s European financial regulations.
In an attempt to assuage doubts about how the regulations outlined by MiFID II and MiFIR would be impacted, ESMA has released a statement outlining their stance on 6 key areas of regulation in the event of a no-deal Brexit. In particular, ESMA discussed:
- The MiFID II C(6) carve-out
- Trading obligations for derivatives
- Third-country trading venues for the purpose of post-trade transparency and position limits
- Post-trade transparency for OTC transactions
- Third country benchmarks under BMR
- The ESMA register administrators
The C(6) carve-out is an exemption laid out in Annex 1 of MiFID II which outlines the criteria a derivative contract must meet so as not to be considered as a financial instrument. If a derivative contract meets these criteria, it will be eligible for the exemption outlined in section C(6) of MiFID II. These three criteria state that a derivative contract i) must qualify as a wholesale energy product, ii) must be traded on an OTF and iii) must be physically settled.
ESMA has stated that a no deal Brexit will impact the first two of these conditions. Firstly, they have clarified that ‘a derivative contract related to electricity or natural gas that would be exclusively produced, traded and delivered in the UK would no longer qualify as wholesale energy product post-Brexit’, and would therefore not be eligible for the C(6) carve-out.
Secondly, in instances where a derivative contract based on electricity or natural gas would no longer be eligible to the C(6) carve-out under MiFID II, it could still become a financial instrument under Section C(6) if it is traded on an EU regulated market, MTF or OTF.
With regards to trading obligations for derivatives, ESMA has stated that it does not believe that market participants will be unable to continue meeting their obligation for derivatives in the case of a no-deal Brexit. While most trading venues that allow for the execution of instruments subject to the trading obligation in the EU are based in the UK, most of these venues are in the process of establishing new trading venues in the EU27 and plan to offer the same product portfolio as they did in the UK. Despite this, ESMA has expressed that it will closely monitor ‘how liquidity develops post-Brexit and whether markets will be sufficiently liquid to allow EU27 market participants to execute transactions in derivatives subject to the trading obligation on eligible trading venues’.
ESMA continued that, in the event of a no-deal Brexit, UK trading venues will no longer be considered as EU trading venues. As a result of this, ‘transactions concluded on UK trading venues would be considered OTC-transactions and would be subject to the post-trade transparency requirements’ outlined by MiFIR. This has the further implication that, pending the publication of the outcome of relevant assessments, ESMA will not require EU27 investment firms to make transactions that are executed on UK trading venues public via an EU APA.
ESMA also wrote that, as with trading venues, a no-deal Brexit would mean that investment firms established in the UK would no longer be considered as EU investment firms, and would instead be considered as counterparties established in a third country. This means that EU investment firms are required to ‘make public transactions concluded OTC with UK counterparties via an APA established in the EU27’.
Finally, ESMA has claimed that a no-deal Brexit would result in UK administrators included in the ESMA register of administrators and third-country benchmarks being deleted from the ESMA register. Instead, they would qualify as third country administrators. Despite this, during the BMR transitional period, EU27 supervised entities would still be permitted to use the benchmarks provided by these UK administrators.
ESMA’s statement has certainly provided some much-needed clarity about the state of the financial regulatory landscape following the UK’s potentially hasty exit from the European Union. In the event of a no-deal Brexit, both the European Union and the UK will have to adopt new financial practices, and it seems that ESMA’s statement signifies the first step towards this reality.
Benjamin Parker, CEO of eflow, claimed that “Whilst a No-deal Brexit is not a situation that would be welcomed by most in the markets, the ESMA guidance is timely and provides something tangible for Market participants to work to”.