The European Securities and Markets Authority (ESMA) and UK Financial Conduct Authority (FCA) have recently published statements on their approaches to their respective Share Trading Obligations (STOs) after the end of the Brexit transition period. Their approaches diverge significantly, reflecting the different political environments in which they operate.
ESMA has stated that EU investment firms will be able to trade sterling-quoted shares of European companies that are listed in London. ESMA has adopted the position that such trades will be subject to a pre-existing exception to the EU STO. It appears that this is as far as ESMA is willing or able to go, without seeking amendments to legislation. Whilst this amounts to a conciliatory measure, there will remain concerns about shares that are quoted in Euro and are currently traded in the UK in significant volume.
Conversely, the FCA will use its Temporary Transitional Power (TTP) to allow UK firms to continue trading all shares on EU trading venues.
The STO, under Article 23 of MiFIR, requires investment firms to ensure that the trades they undertake in shares that are admitted to trading on an EU regulated market or trading venue, take place on:
- an EU regulated market (or multilateral trading facility);
- an EU systematic internaliser (SI); or
- a third country trading venue assessed as equivalent under the MiFID II Directive.
One of the two limited exceptions to this are trades that are non-systematic, ad hoc, irregular and infrequent.
Impact of Brexit
After the end of the transition period, the London Stock Exchange and other UK markets and trading venues will no longer be EU regulated markets or MTFs. Unless there is an equivalence decision or other deal agreed between the EU and UK, MiFID investment firms will not be able to execute transactions subject to the STO on UK venues. Likewise, as part of the “onshoring” of EU regulation, the UK version of the STO will prevent UK firms from trading, on EU markets, in shares that are admitted to trading on UK markets. As explained below, this is subject to the FCA’s use of its TTP.
This division means that, in respect of shares listed on both a UK and EU exchange, a UK firm would be required to execute trades in dual UK/EU listed shares on a UK venue and a European firm would be required to execute the same trade on a European venue. This potentially results in a dilution of liquidity on any particular exchange. The issue is particularly acute for those dual-listed shares of EU companies which are traded in substantial volumes on UK markets.
The European authorities have not significantly changed their position despite lobbying to the contrary from several EU governments. Whether or not equivalence is granted seems likely to be a political decision that will depend on the outcome of the negotiations on the future relationship. ESMA published a statement on 26 October 2020 reiterating that once the transition period has ended, ESMA will assume that all EEA shares, which it defines as those with ISINs starting with EEA country codes (EEA ISINs) will be within the scope of the EU STO. UK shares (i.e. those with GB ISINs) will be outside the scope of the EU STO.
However, that statement also provided that EU investment firms will be able to trade sterling-quoted shares of European companies that are listed in London. Post-Brexit, trading of EU shares on a UK exchange in sterling will therefore be exempt from the EU STO. ESMA notes that shares with an EEA ISIN which trade on UK trading venues in sterling account for less than 1% of EU total trading activity. It can therefore be assumed, according to ESMA, that trading of these shares occurs on a “non-systematic, ad-hoc, irregular and infrequent basis” and therefore falls within the STO exemption.
This change allows European investors to continue trading in dual-listed companies that are quoted in sterling. However, there are several significant EU companies that are traded in large volumes in the UK and quoted in Euro. As things stand, European firms and investors will be unable to access the liquidity in these shares available on UK markets.
The FCA published its own statement on 4 November 2020, stating that it will use its TTP to take a more flexible approach to the UK STO. The FCA considers that neither the ISIN nor the currency in which a share trades should determine the scope of the STO. Its view is that “mutual equivalence between the UK and EU should be easy to agree and remains the best way of dealing with overlapping STOs.” In the absence of equivalence, the FCA will use its TTP to allow firms to continue trading all shares on EU trading venues and SIs, where those venues and SIs have the requisite UK regulatory status. This means they must either:
- be a UK Recognised Overseas Investment Exchange;
- use the UK Temporary Permissions Regime; or
- benefit from the UK Overseas Persons Exclusion.
The FCA also says that it will discuss with market participants and trading venues future steps to protect UK market integrity and to ensure that UK firms can continue to achieve high standards of execution, including when trading EU-27 shares. Rather ominously, these discussions “will include whether the MiFID II calibrations, which were designed for a pan-European market of 28 countries, remain appropriate for the UK in the absence of our current equivalence being recognised”. The FCA appears to be signalling a willingness to move away from European standards if the European authorities are unwilling to grant equivalence status.