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Continuity of derivatives trading after Brexit: This week in regulation

01/03/19

The speed read

  • UK and US authorities issue joint statement on maintaining continuity of derivatives trading and clearing post-Brexit
  • FCA’s statement on ESMA’s temporary intervention measures on retail CFDs and binary options post-Brexit
  • FCA issues feedback on call for inputs on firms’ initial experiences with PRIIPs regulations
  • Publishing and disclosing workplace pension scheme costs and charges
  • The effect of MiFID II
  • Ending reliance on LIBOR

UK and US authorities issue joint statement on maintaining continuity of derivatives trading and clearing post-Brexit

The Bank of England (including the PRA), the FCA and the US Commodities Future Trading Commission (CFTC) have issued a joint statement designed to reassure market participants of the continuity of derivatives trading and clearing activities between the UK and US once the UK leaves the EU.

The statement confirms that all parties are taking steps to ensure that Brexit doesn’t create any regulatory uncertainty in the derivatives market and to support financial stability. To achieve this the:

  • Bank of England and the CFTC are updating their memorandum of understanding (MoU) around clearing activity
  • FCA and the CFTC are updating their MoUs around certain firms within the derivatives and alternative investment industries
  • CFTC will extend the existing regulatory relief granted to EU firms to UK firms at the point of withdrawal
  • UK authorities have confirmed that US trading venues, firms and CFTC-registered counterparties (CCPs) will continue to have access to UK markets based on the equivalence of the legal and supervisory frameworks.

 

FCA’s statement on ESMA’s temporary intervention measures on retail CFDs and binary options post-Brexit 

The European Securities and Markets Authority’s (ESMA) temporary intervention prohibiting the sale of binary options and restricting contracts for differences (CFDs) to retail investors will become part of UK law at the point the UK leaves the EU.

Firms are required to comply with ESMA’s decision notices until they expire on 1st April 2019 for binary options and 30th April 2019 for CFDs. The FCA is currently analysing the feedback on its consultation on making ESMA’s temporary product interventions permanent in the UK and intends to publish a Policy Statement and final Handbook rules in March 2019 for binary options and April 2019 for CFDs and CFD-like options. It is anticipated that any finalised rules will apply very shortly after publication.

If, for any reason, the FCA is unable to finalise its approach prior to the cessation of ESMA’s existing interventions, the regulator will consider adopting temporary product intervention measures to ensure UK consumers are protected from harm.

 

FCA issues feedback on call for input on firms’ initial experiences with PRIIPs regulations  

In July 2018, the FCA published a call for input (CfI) to determine firms’ initial experiences of PRIIPs regulations, focussing on the following areas:

  • Issues with clarifying the scope of PRIIPs
  • Their approach to calculating transaction costs
  • The presentation and calculation of the ‘performance scenarios’ which form part of the mandatory key information documents (KIDs)
  • The presentation and calculation of the summary risk indicator (SRI) and other key risks within the KID.

Now the FCA has published a summary of the feedback received and its response to the concerns raised.

Respondents raised significant concerns about the lack of clarity around the application of PRIPPs regulation for certain types of investment, with corporate bonds being of particular concern. The FCA has shared the responses received with European Supervisory Authorities (ESAs) and supports EU-level clarifications on the scope of PRIIPs.

Feedback highlighted that the SRI produced lower than expected risk ratings in cases where the underlying asset is illiquid. The FCA is currently in discussions with ESAs to ensure that SRIs are representative of the risks illiquid assets pose. There are also concerns that the scale rating presented by the SRI reflects the overall risk rating associated with the product.

Another area of concern was that the current method of presenting performance scenarios is misleading across all asset classes, with universal agreement that this is caused by the reliance on past performance in the PRIIPs regulatory technical standards (RTS) methodology.

 

Publishing and disclosing workplace pension scheme costs and charges

The FCA has issued a consultation paper outlining new rules and guidance on the disclosure of costs and charges information to workplace pension scheme members.

As per the Pensions Act 2014, the FCA and Department for Work and Pension (DWP) have a duty to make rules around the publishing and disclosure of costs and charges information for ‘relevant schemes’ including workplace pension schemes.

Since January 2018, FCA rules have required asset managers to report transaction costs and charges to the operator, trustee or manager of workplace pension schemes. Now the FCA is proposing to require scheme governance bodies to disclose this information to scheme members on an ongoing basis.

These changes are to ensure scheme members receive good value for money from their pension scheme and that it will meet their needs in retirement.

 

The effect of MiFID II

Andrew Bailey, Chief Executive of the FCA, recently gave an insightful speech into the positive impact MiFID II has had on the market and some of the challenges market participants have raised with the regulator. We bring you the highlights.

It’s been almost 14 months since the introduction of MiFID II and there have been a number of fundamental shifts in the market. We have seen the vast majority of traditional asset managers opt to fund research from their own revenues rather than using clients’ funds. The scale of this change has been beyond the FCA’s initial expectations and the market appears to be going through a period of price discovery. New technology is also changing the nature of research and how it is supplied, monitored and valued by the buyside.

The FCA has been engaged in a multi-firm review since last summer and has found that MiFID II is having a positive impact on the cost of execution and the accountability and discipline of the buyside when procuring research. Overall, the regulator estimates that investors have saved around £180m in charges during 2018. If this trend continues it equates to nearly £1bn over the next five years.

However, there are some areas where concerns have been raised, including the scope of the inducements regime, pricing and the potential unintended consequences of the new rules. To address the potential impact of these issues, the FCA took the following steps:

  • Allowed the free distribution of research that supports capital raising events
  • Allowed issuer-sponsored research to be freely circulated
  • Clarified that publicly available research will not be classed as an inducement.

The regulator is currently finalising its work to assess how the rules are bedding in and what impact they have had on asset owners, consumers and the market. Feedback on its findings will be published in the second quarter of the year.

 

Ending reliance on LIBOR  

In two years LIBOR production is likely to end, presenting asset managers with the challenge of managing their LIBOR exposures. In this recent speech, Megan Butler, Executive Director of Supervision – Investments, Wholesale and Specialists at the FCA, outlined the progress the regulator has seen so far, and what remains to be done.

Many firms are already moving their portfolios to SONIA-based swaps. The volume of overnight cash transactions that support the calculation of SONIA average £50bn a day, compared to the transactions underpinning three and six-month Sterling LIBOR, which average £187m and £87m a day respectively.

The FCA and PRA are also increasingly assessing firms’ readiness for the end of LIBOR as part of their supervisory approach. Recent submissions from firms show that there are different states of readiness across the industry, but it is imperative that that transition to a new benchmark is smooth rather than chaotic, as this could have serious repercussions in the market.

Inertia remains the biggest obstacle to a smooth transition away from LIBOR and the FCA is urging all firms to take action now. The regulator will not dictate how firms should approach this significant change. If firms are delaying their preparations in the fear that the FCA will change course between now and the end of LIBOR, Ms Butler ended her speech with the assurance that this will not be the case.

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