A regulatory spat over Europe’s commodity derivatives market offers a vivid example of the dilemma the City of London faces in the trade talks between the UK and the EU.
Mifid II regulations, which came into force in early 2018, required the UK to implement new rules around the commodity trades that can be made off-exchange. The aim, as with most of the regime, was to increase transparency.
London is sensitive to the changes, as it dominates Europe’s trading in commodity derivatives, which had a notional value of €11tn in 2018, according to the European Securities and Markets Authority. There is nothing really comparable in the EU.
The Financial Conduct Authority, the UK regulator, is usually keen to lead the way in implementing the rules it helped to write. In a rare example here, it has allowed leeway to the two main commodity exchanges, Intercontinental Exchange and the London Metal Exchange, in part because the exchanges view the rules as too blunt.
On Thursday, Esma publicly took the FCA to task for the slow pace of progress, saying the UK watchdog had taken “no appropriate action” to supervise its companies. It urged its British counterparts to “employ timely and proportionate supervisory measures to ensure compliance”.
The FCA disputes this, saying it wanted to ensure “that implementation happens in such a way as not to disrupt trading, which would affect end users of these markets”. ICE and the LME confirmed they would comply by the middle of the year.
There is a lot at stake. Take ICE’s Brent futures contract. It is one of the world’s most important securities, trading the equivalent of 1bn barrels of oil a day.
Under Mifid II, any trade in these futures that is more than 10 lots — a measure of contract size — can be done as a block off-exchange and revealed to the market only 15 minutes later. ICE argues that this would push a lot of its trading off-market. Its rules stipulate that trades under 100 lots must be done on its order book.
For some LME copper and aluminium contracts, the EU cut-offs are similarly too low. For others, they are too high.
This area seems a prime example of UK chancellor Sajid Javid’s “Brexit red tape challenge”, looking for useful places where Britain might diverge from EU rules. By the same token, it risks being caught up the negotiation on whether to align future UK-EU regulatory standards in financial services.
Both sides have something to lose from the bickering. EU investors do not want to be cut off from easy access to the City. The UK does not want to be forced to adopt rules that do not fit its markets.
Letting the rules diverge in places may be preferable. Traders go where the liquidity is. If the matter is unresolved, that might be the US.