Final UK MiFID Response
Transcript of Final UK MiFID Response
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UK response to the Commission Services‟ consultation on the Review of the Markets in Financial Instruments Directive (MiFID)
1. INTRODUCTION
MIFID has been decisive in strengthening the Single Market in wholesale financial services and the Commission and EU should be proud of its success. The abolition of the concentration rule has allowed for alternatives to conventional stock exchanges to emerge, fostering greater competition among trading venues. This is generally recognised as having driven down trading charges and stimulated innovation. These changes have also brought challenges. One consequence of competition has been the fragmentation of equities trading, which in turn has given rise to difficulties in data consolidation. Such issues need to be addressed if MiFID‟s clear single market and competitive benefits are not to be compromised. New technological developments and market practices have also emerged, partly to deal with the challenges of this fragmentation but also in response to the legislative framework itself. Given these developments, the UK agrees it is appropriate to assess whether and how the MiFID regime needs to be adapted to ensure resilient and sound financial markets. We also need to consider how elements of the MIFID review fit in to the international regulatory reform agenda, led by the G20, in response to the financial crisis. In this context, one aspect of MiFID will be critical in enabling the EU to deliver the G20 commitment to increase electronic platform trading of standardised derivatives where appropriate.1 As we develop our own definition of suitable platforms in Europe, building on international agreements, we should remind ourselves of the objectives of the G20 – mitigation of systemic risk, enhanced transparency and added protection against market abuse. The UK considers that the MiFID review provides an opportunity to:
contribute to the EU's delivery of the G20 commitment to enhance transparency, mitigate systemic risk and protect against market abuse;
strengthen the quality and consolidation of post-trade information, as a key step in mitigating the risks from market fragmentation. The private sector should play the lead role in delivering this outcome, within clearly set parameters;
further strengthen and develop the EU regulatory framework, taking account of the global dimension. The current MiFID arrangements for the treatment of third country providers have worked well. We do not support the imposition of a new regime for granting access from third countries to EU markets only on the basis of a strict equivalence assessment;
ensure that MIFID continues to provide a robust basis for competition between different types of trading venue. We support delineating as a new type of trading venue those
1 Statement No. 13, Leaders’ Statement: The Pittsburgh Summit (September 24 – 25, 2009),
http://www.g20.org/ Documents/pittsburgh_summit_leaders_statement_250909.pdf
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types of OTC trading mechanism which have significant functional overlap with Multilateral Trading Facilities (MTFs). This includes those that would be suitable for on-venue trading of OTC derivatives. But it does not make sense to try to characterise broad swathes of OTC trading as taking place on an "organised trading facility" as some of the systems that would appear from the consultation document to fall into this category are not venue-like;
enhance market transparency in non-equity markets, through the introduction of post-trade transparency requirements. Such requirements will need to be carefully calibrated and based on detailed evidence and impact assessment so as not to damage liquidity in these markets, recognising that risk capital plays a significant role in supporting liquidity;
ensure that regulators have the information needed to be able to police markets effectively and ensure their integrity. A strong system of transaction reporting should be at the heart of such information, but the costs and benefits of collecting such reports need to be carefully assessed in each case. In some markets - such as commodity derivatives - position reporting is likely to be a more effective tool;
ensure that our markets are resilient and robust in the face of new technological developments. We need to take account of the benefits which these changes - such as automated trading - have brought, while ensuring that regulators have the appropriate tools to be able to address any risks;
ensure that commodity derivative markets provide robust and consistent price discovery mechanisms for the underlying commodities, and are sufficiently liquid to enable participants to hedge and manage their risks. However, there is no evidence that financial market regulatory tools can be used to systematically control commodity prices, and it would therefore be a mistake to develop policy proposals on this basis;
reform conduct rules to ensure that clients are better informed about the products and services they are offered and tackle the potential for remuneration set by product providers to bias investment advice.
SMEs In reviewing MiFID, we have a valuable opportunity to consider a targeted set of reforms that seek to improve SME access to European capital markets. This is about more than listing models (important as those are). We need to take a holistic approach to improving access to finance for SMEs and join up thinking across institutional boundaries and initiatives. Increasing the range of funding options that are available to SMEs is an important objective of the Commission and Council2. The Commission has made a good start with its proposals for a “SME market” regime that could be appropriately tailored to meet the needs of smaller companies. But there will be other funding options (such as early stage investment by business angels) that MiFID could facilitate more easily and we would therefore encourage the Commission to be ambitious and consider a package of reforms targeted towards SME financing. Investor protection Investor protection is a key theme of MiFID. We strongly support the Commission‟s work to increase the overall level of protection for investors. We have long been working to improve consumer outcomes, through initiatives such as the retail distribution review, and we are
2 Communication from the Commission, COM (2010) 608. Towards a Single Market Act
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committed to pursuing this principle at the EU level. We hope that the UK‟s experience in this area will be of use. We must also be conscious of the economic and social need to provide consumers with the best opportunities for return on their investments, particularly during a time of economic recovery, and we must ensure there is an appropriate balance between protection, consumer responsibility and cost. We welcome the Commission‟s attention to selling practices, and in our response to the proposals for investment advice we provide detail from our own experience on how the proposals can be made more robust. For example on the definition of “independence” and in ensuring that all firms are clear in disclosing the basis upon which investment advice is provided, including where that advice is not “independent”. We also suggest that the Commission should stop product providers from setting remuneration for all firms providing investment advice, not just those whose advice is "independent". It will also be important to take existing frameworks into account and ensure that current levels of investor protection are retained, as explained in our response to section 8.1 on Article 4. However, we highlight our significant concerns for the proposals for the so-called “execution-only” and client classification regimes. We also remain concerned about the proposal to deliver selling practices for PRIPs through two distinct legislative instruments and processes, the MiFID and Insurance Mediation Directive reviews, rather than through an ambitious cross-sectoral approach. We hope that the Commission will take a more consolidated and ambitious approach to avoid unjustified divergence, and ensure a good outcome for consumers and a competitive market for firms as well as strengthening the single market. Review proposals There is much to welcome in the Commission‟s consultation paper. To ensure the review builds on the successes of MiFID, however, the UK considers it essential that any proposed reforms to markets regulation must be assessed against the following tests. Firstly, the proposals must promote the growth of the European economy. Secondly, we must look for ways that reform can strengthen the single market and encourage the global competitiveness of European markets. Thirdly, we must also ensure that the proposals continue to underpin sound and efficient markets. Finally, there must be a clear evidence base for intervention, with any legislative proposals supported by a full quantitative assessment of the costs and benefits. We would note that the Commission rejects or departs from CESR‟s detailed technical advice in a number of areas without explanation, including in the areas of pre and post-trade transparency, target setting for platform trading, transaction reporting, and client categorisation. CESR‟s advice was developed after extensive consultation with stakeholders and detailed consideration of the issues. We therefore consider that some justification of the Commission‟s approach in these instances is necessary so that its reasons for not following the CESR advice can be understood. The Commission has also proposed some changes where we consider the objective is unclear. Our detailed commentary on the issues raised in the consultation document is set out in the following sections. We highlight some of the main themes below. 3rd country provisions MiFID has had a positive impact on EU GDP - according to one study,3 it may have raised the long-run level of EU GDP by as much as 0.8%. It is therefore important to preserve the benefits
3 “Understanding the Impact of MiFID in the context of Global and National Regulatory Innovations”, a Report
prepared by London Economics for the City of London Corporation, October 2010
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and advocate change only where this promotes further growth, taking care not to restrict the financing options available to European corporates or weaken competition. In this context, it is important to recognise that financial markets are global and that Europe is the world leader in global finance. If the European economy is to continue to grow, our companies and governments need more capital from beyond European borders – fortress Europe is not the answer. Global markets are highly sophisticated. Major changes are best contemplated on a step by step basis and in full understanding of different asset classes. Against that background we have strong reservations about the proposal to introduce a third country regime in MiFID based on the principle of exemptive relief for equivalent jurisdictions, which we consider has the potential to undermine both the principle of free movement of capital and the ability of EU firms to do international business To illustrate the significance of this issue, research by the IMF indicates that between 2008-09 and 2009-10 investment by third country firms in EU securities increased in value terms by 26%. A recent report by the World Economic Forum in collaboration with McKinsey noted that to support economic development, global credit levels must grow substantially over the next decade.4 It specifically warns that financial protectionism may constrain cross-border financing and that there is likely to be strong competition to attract finite global credit between the world‟s economies. Already we are seeing fierce competition not just from traditional financial centres in the US but increasingly from Asia. However, the growth of emerging market economies offer huge opportunities for Europe‟s financial services industry. Access of third country firms to invest in EU businesses should be seen as a key enabler for the EU‟s 2020 strategy for smart, sustainable and inclusive growth. Automated trading and related issues The Commission makes a number of proposals in relation to automated trading, with specific reference to the type of automated or algorithmic trading known as High Frequency Trading (HFT). The UK agrees with the Commission that „HFT is typically not a strategy in itself but the use of very sophisticated technology to implement traditional trading strategies‟ and that HFT is a „subcategory of automated trading‟. We also agree that existing evidence is inconclusive about its impact on markets. We need to understand better the impact of trends in computer automated trading. The UK Treasury is therefore sponsoring a new research project, led by the UK Government Office for Science, to explore how computer-generated trading may evolve in the future. We hope that the findings of this research will usefully inform debate on this area. In the meantime, we support the Commission‟s proposals for robust risk controls to be put in place by firms involved in automated trading or who provide sponsored access to automated traders. However in the absence of further research, we must be careful not to introduce measures based on the assumption that high frequency trading is, per se, harmful to markets. We do not think a case has been made to mandate the provision of liquidity by high frequency traders. Forcing high frequency traders to become market makers may deter them from entering the market altogether thereby removing the benefits of the liquidity they currently provide voluntarily. It may also create prudential risks to these firms, leaving them exposed to market movements when other participants are at liberty to withdraw. Similarly, the UK does not believe that the case has been made to require orders to rest on the book for a minimum period of time, or to limit the ratio of orders to transactions executed by
4 “More Credit with Fewer Crises: Responsibly Meeting the World‟s Growing Demand for Credit”, World Economic Forum Report, January 2011
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any given participant. Any participant may wish to delete an order quickly for prudential reasons. Forcing participants to remain in the market could damage overall market efficiency and compromise firms‟ risk management. New category of Organised Trading Facility (OTF) The UK agrees that it is important to assess whether MiFID‟s existing regulatory categories remain appropriate given the new forms of trading functionality that have emerged. The UK recognises that Broker Crossing Systems (BCSs), for example, are growing in significance, and that in some instances they appear similar to other trading models. Following the principle of functional regulation it therefore may be reasonable to introduce requirements for BCSs that are consistent with, although differentiated from, those for MTFs. We also see justification in the provision of a new category of trading facility for trading services in standardised and sufficiently liquid OTC derivatives, which fall outside the boundaries of existing regulated market/MTF definitions. The minimum characteristics of such an Organised Trading Venue (or “OTV”) should be broadly defined so as to capture a spectrum of single/multi dealer trading models, as it would then be practicable to trade a greater range of standardised OTC instruments on such platforms, furthering G20 objectives and ensuring competition. However, following the principle that any intervention must be clear in its objective and supported by a robust evidence base, we do not see justification for an additional, broader-ranging OTF category aimed at other, unspecified, activities. Clarity on the purpose of this proposal will be necessary to ensure that intervention is justified and that the objectives of the regime are well defined. Regulators need to be able to define clearly what they are regulating and why; and market participants need to be clear about the rules that apply to them. Powers to ban services and activities With regard to intervention powers, as the Commission recognises, its proposal for a European level power to ban the provision of investment services and the carrying out of investment activities in certain financial instruments has potentially significant consequences for market participants and businesses. Banning products of any kind should be undertaken with great caution as otherwise innovation, effective risk management and economic growth could be detrimentally impacted. A greater justification is needed for the introduction of these powers without safeguards. We note that powers already exist under MiFID that effectively empower national regulators to ban a product, and for European cooperation on such action. Similarly, the new European Supervisory Authorities (ESAs) have been given the power to ban products temporarily (together with appropriate attached powers to obtain information critical to such decisions). We would therefore query how some of the proposals under this section relating to EU banning mechanisms would relate to these existing powers; and the consequent necessity for such powers. Commodities The UK welcomes the consultation‟s focus on measures to support delivery of the G20 commitment to improve the regulation, functioning, and transparency of financial and commodity markets to address excessive commodity price volatility. In determining which individual proposals to adopt to deliver this, it is important these are proportionate and evidence based. Of the proposals in the MiFID review the UK welcomes those to provide more position data in a standardised form to enable regulators to have stronger oversight and understanding of what is
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happening across markets, enabling them to act if they have concerns of risks building up. The UK has particular concerns about the adoption of position limits, where there is a need for further evidence of their utility and where other proposals such as position management may meet the objectives of countering market manipulation without risking unintended consequences including harming market liquidity. Transparency The UK fully supports increased transparency where this will either help with regulatory oversight and / or improve the price formation process. An effective, well-calibrated regime is critical for ensuring fair, efficient and stable financial markets. There are clearly some areas of financial market regulation where we need to see change. However, poorly calibrated transparency regimes can have damaging and unintended consequences. Failure to understand these issues properly and at a granular level can lead to withdrawal of liquidity from markets and stifle the development of products which serve the needs of end-users. Before introducing new transparency regimes, we therefore need to be clear what the market failure is that we are trying to address. And it is essential that any transparency regime targeted at derivatives and corporate bonds takes account of the diverse range of asset classes, whose trading characteristics can differ significantly, and which will therefore require tailored requirements incorporating an appropriate system of waivers. Next steps The consultation paper implies changes that will have profound implications for many firms, ranging from retail financial advisers to the largest wholesale investment firms, across the EU and internationally. It is therefore vital that the Commission‟s ambition for reform is grounded in full appreciation of its possible impact. We are therefore surprised that the Commission considered such a short consultation period of eight weeks (over a holiday period) would be sufficient to canvass views from such a broad spectrum and collect enough evidence for a meaningful impact assessment. In the UK‟s view, the consultation period is inappropriately curtailed and not conducive to sound policy making or the production of carefully considered legislative proposals. We have addressed all the issues raised in the consultation as thoroughly as possible given the time constraints, but the extent of the proposals is such that we may wish to make further comments if, on further consideration, this becomes necessary. Looking ahead, it will be essential that the Commission continues to work closely with all interested parties to address the concerns of businesses across Member States, and ensure that any proposals are evidence-based and supported by a robust impact assessment. We hope this response will help in that process and look forward to close and constructive working with the Commission. 4/2/2011
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2. DEVELOPMENTS IN MARKET STRUCTURES .................................................................... 8
2.1. DEFINING ADMISSION TO TRADING ......................................................................................................... 8 2.2. ORGANISED TRADING FACILITIES ........................................................................................................... 9 2.3. AUTOMATED TRADING AND RELATED ISSUES ....................................................................................... 20 2.4. SYSTEMATIC INTERNALISERS ............................................................................................................... 25 2.5. FURTHER ALIGNMENT AND REINFORCEMENT OF ORGANISATIONAL AND MARKET SURVEILLANCE
REQUIREMENTS FOR MTFS AND REGULATED MARKETS AS WELL AS ORGANISED TRADING FACILITIES 26 2.6. SME MARKETS ..................................................................................................................................... 27
3. PRE- AND POST-TRADE TRANSPARENCY ...................................................................... 31
3.1. EQUITY MARKETS ................................................................................................................................. 31 3.2. EQUITY-LIKE INSTRUMENTS ................................................................................................................. 34 3.3. TRADE TRANSPARENCY REGIME FOR SHARES TRADED ONLY ON MTFS OR ORGANISED TRADING
FACILITIES ............................................................................................................................................ 35 3.4. NON EQUITY MARKETS ......................................................................................................................... 36 3.5. OVER THE COUNTER TRADING .............................................................................................................. 40
4. DATA CONSOLIDATION ............................................................................. 41
4.1. IMPROVING THE QUALITY OF RAW DATA AND ENSURING IT IS PROVIDED IN A CONSISTENT FORMAT .... 42 4.2. REDUCING THE COST OF POST TRADE DATA FOR INVESTORS ................................................................. 44 4.3. A EUROPEAN CONSOLIDATED TAPE ..................................................................................................... 45
5. COMMODITIES ............................................................................. 49
5.1. SPECIFIC REQUIREMENTS FOR COMMODITY DERIVATIVES EXCHANGES ................................................ 50 5.2. MIFID EXEMPTIONS FOR COMMODITY FIRMS ....................................................................................... 53 5.3. DEFINITION OF OTHER DERIVATIVE FINANCIAL INSTRUMENT ............................................................... 55 5.4. EMISSION ALLOWANCES ....................................................................................................................... 57
6. TRANSACTION REPORTING ............................................................................. 58
6.1. SCOPE ................................................................................................................................................... 58 6.2. CONTENT OF REPORTING ...................................................................................................................... 62 6.3. REPORTING CHANNELS ......................................................................................................................... 64
7. INVESTOR PROTECTION AND PROVISION OF INVESTMENT SERVICES .................... 65
7.1. SCOPE OF THE DIRECTIVE ..................................................................................................................... 67 7.2. CONDUCT OF BUSINESS OBLIGATIONS .................................................................................................. 68 7.3. AUTHORISATION AND ORGANISATIONAL REQUIREMENTS ................................................................... 81
8. FURTHER CONVERGENCE OF THE REGULATORY FRAMEWORK AND OF THE
SUPERVISORY PRACTICES ............................................................................. 90
8.1. OPTIONS AND DISCRETIONS ................................................................................................................. 91 8.2. SUPERVISORY POWERS AND SANCTIONS ............................................................................................... 95 8.3. ACCESS OF THIRD COUNTRY FIRMS TO EU MARKETS .......................................................................... 100
9. REINFORCEMENT OF SUPERVISORY POWERS IN KEY AREAS ................................ 103
9.1. BAN ON SPECIFIC ACTIVITIES, PRODUCTS OR PRACTICES .................................................................... 103 9.2 STRONGER OVERSIGHT OF POSITIONS IN DERIVATIVES, INCLUDING COMMODITY DERIVATIVES ......... 105
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2. DEVELOPMENTS IN MARKET STRUCTURES
As the consultation paper notes, there have been significant market developments (including the
types of trading facilities, the technological applications and the methods of execution that are
available) since the introduction of MiFID. The review presents an important opportunity to
assess whether legislative amendments are needed to take account of these developments.
The UK supports the Commission‟s stated objective at page 8 of the consultation paper that any
amendments to MiFID should aim to support market liquidity and efficiency, and improve
investor confidence. In preparing our response, the UK has considered the Commission‟s
proposals against these criteria.
The UK has also considered how the proposals might best deliver the reforms agreed by the G20
to enhance transparency, mitigate systemic risk and protect against market abuse in the
particular context of the trading of standardised OTC derivatives5. In this context, the UK is
mindful of the work already underway in other countries as well as international fora6 and would
encourage the Commission to ensure consistency as far as practicable in order to avoid
regulatory arbitrage and any competitive disadvantage to EU markets.
2.1. Defining admission to trading
(Q1)
(1) What is your opinion on the suggested definition of admission to trading? Please explain the
reasons for your views.
The UK is unclear as to the purposes the proposed definition is intended to serve. The UK
assumes that the proposal is not intended to modify, or affect the scope of, the requirements of
European directives (particularly the Market Abuse Directive and the Transparency Directive)
based upon an admission to trading, although if the Commission takes a different view this
5 Statement No. 13, Leaders‟ Statement: The Pittsburgh Summit (September 24 – 25, 2009), http://www.g20.org/ Documents/pittsburgh_summit_leaders_statement_250909.pdf
6 The FSB report of October 2010 mandated the IOSCO Task Force on OTC derivatives to prepare by 31 January 2011, a report analysing (i) the characteristics of the various exchanges and electronic platforms that could be used for derivatives trading; (ii) the characteristics of a market that make exchange or electronic platform trading practicable; (iii) the benefits and costs of increasing exchange or electronic platform trading, including identification of benefits that are incremental to those provided by increasing standardisation, moving to central clearing and reporting to trade repositories; and (iv) the regulatory actions that may be advisable to shift trading to exchanges or electronic trading platforms.
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should be clarified and the precise implications spelled out. In general terms, the UK is unaware
of any circumstances where the absence of a definition has caused difficulties. If a legislative
definition is considered to be appropriate, its purposes and effect need to be clearly articulated
and such definition should specify that admission to trading occurs once the decision of a
platform operator becomes effective and the security is available to be traded (conditionally or
unconditionally) on the facilities of the platform.
During the recent review of the Prospectus Directive, the UK is aware that an issue arose in
relation to admission to trading. This was because the Prospectus Directive captures shares on
primary multilateral trading facilities (MTFs), such as AIM and PLUS in the UK, when public offers
of shares are undertaken. This was an issue during the negotiations of the amending Directive as
the proposals only benefited companies admitted to trading on a regulated market. This would
have meant that smaller companies who are often quoted on primary MTFs would have been
unable to benefit from a proportionate disclosure regime. However, the UK considers that the
Commission will be able to address this issue successfully through its proposal for a SME Market
and consequently this avoids the need for a definition of admission to trading.
2.2. Organised trading facilities
(Q2-5)
(2) What is your opinion on the introduction of, and suggested requirements for, a broad category
of organised trading facility to apply to all organised trading functionalities outside the current
range of trading venues by MiFID? Please explain the reasons for your views.
The UK understands from the Commission proposals that:
(a) the Organised Trading Facility (OTF) category will capture all organised trading that
occurs outside the current range of MiFID venues;
(b) the Commission‟s aim is to level the playing field between those venues (RMs, MTFs and
SIs) that are already subject to specific MiFID obligations as trading venues and those
regulated intermediaries that provide a type of organised trading service that is currently
categorised as OTC;
(c) broker crossing networks and organised trading venues (for certain standardised
derivative contracts) would be particular sub-regimes within the overall OTF category;
(d) the Commission does not intend the OTF category to capture any OTC trading that is
engaged in on an ad hoc and purely bilateral basis;
(e) The OTF would not replace the basic intermediary regulation to which firms are subject
but, where necessary, supplement it. We also note that the Commission proposes to
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exclude systems or facilities used simply to execute an order on an external trading venue
or to route an order to an external trading venue.
The UK agrees that it is important to assess whether MiFID‟s existing regulatory categories remain
appropriate given the new forms of trading functionality that have emerged. We can see the case
for creating a new category of venue for broker crossing networks. We can also see the case for a
new category of trading facility which provides a mechanism to authorise and oversee facilities
offering trading services in standardised and sufficiently liquid OTC derivatives, which fall outside
the boundaries of existing regulated market/MTF definitions, as a basis for measures to help
deliver G20 commitments. (For convenience we refer to this proposed category as “OTV”, or
Organised Trading Venue, throughout this response).
However, we do not see that the Commission has provided any clear justification for going
further than this, and creating an overarching, very broad new category of “organised trading
facility”. The UK has significant concerns regarding the implications of such an approach, such
as the potential to require illiquid or bespoke OTC derivatives unsuited to organised trading to be
traded on an OTF, when this would not generate any benefits.
Instead, the minimum characteristics of an “OTV” should in our view be more broadly defined so
as to capture a spectrum of single/multi dealer trading models, as it would then be practicable to
trade a greater range of standardised OTC instruments on such platforms, furthering G20
objectives. We do not therefore support the proposal for an additional, broader-ranging “OTF”
category on top of that.
Any intervention must be clear in its objective and supported by a robust evidence base. The
consultation paper is not specific about exactly what activity the OTF category is intended to
capture, and why. Moreover, the requirements which the Commission indicates might attach to
the “OTF” category are already requirements which are reflected in the investment firm
regulatory regime. Applying an additional one-size-fits-all regulatory requirements on a category
of ill-defined facilities (which may serve different objectives and different needs of the market)
does not appear a sensible approach. Regulators need to be able to define clearly what they are
regulating and why; and market participants need to be clear about the rules that apply to them.
In this context, the UK notes the Commission‟s statement that MiFID is not intended to be
prescriptive about where trades much be executed and that the legislation is intended to provide
flexibility and choice for investors about where and how they wish to execute trades (page 9 of
consultation paper). The UK considers it essential that such flexibility is retained, both to facilitate
competition and investor choice.
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(3) What is your opinion on the proposed definition of an organised trading facility? What should be
included and excluded?
As indicated in our response to Question 2, the UK supports the creation of some additional
categories, but has significant reservations about the creation of a generalised “OTF” category.
(4) What is your opinion about creating a separate investment service for operating an organised
trading facility? Do you consider that such an operator could passport the facility?
As a matter of principle, any separate investment service created under MIFID should be capable
of being passported.
(5) What is your opinion about converting all alternative organised trading facilities to MTFs after
reaching a specific threshold? How should this threshold be calculated, e.g. assessing the volume
of trading per facility/venue compared with the global volume of trading per asset class/financial
instrument? Should the activity outside regulated markets and MTFs be capped globally? Please
explain the reasons for your views.
As noted above, the UK has significant reservations about the creation of an “OTF” category. In
relation to broker crossing systems and organised trading venues, the UK does not consider it
would be necessary or appropriate that these types of system should be required to convert to
MTFs after reaching a specific threshold. This is on the basis that the obligations of any new
category should provide the regulatory oversight and transparency the UK believes the proposed
conversion to MTF status is intended to deliver (meaning in other words that the regulatory
benefit of any conversion to an MTF would fall away). Presumably the intention of the
Commission is that any new regulatory category (whether OTF or otherwise) would introduce a
clear set of robust regulatory requirements, that would be proportionate and capable of being
calibrated to the level of activity undertaken by the facility or system. The UK believes that it
would be inappropriate to require an operator of an organised trading facility to convert to an
MTF as this could necessitate an unjustifiable change to its business model simply as a
consequence of reaching a specific threshold.
(6) What is your opinion on the introduction of, and suggested requirements for, a new sub-regime
for crossing networks? Please explain the reasons for your views.
The UK recognises that Broker Crossing Systems (BCSs) are growing in significance, and that in
some instances they can look similar to MTFs. Following the principle of functional regulation it
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therefore may be reasonable to introduce requirements for BCSs that are consistent with,
although differentiated from, those for MTFs.
The UK agrees with the definition of a BCS given in the CESR technical advice, namely „an internal
electronic matching system operated by an investment firm that executes client orders against
other client orders or, occasionally, house account orders on a discretionary basis‟. Furthermore,
the UK agrees that the additional requirements for the sub-regime as set out in points a) and b)
under section 2.2.2 of the consultation document are necessary to ensure that regulators are
able to undertake proper surveillance of the market and address concerns about the lack of
transparency in the market.
(7) What is your opinion on the suggested clarification that if a crossing system is executing its own
proprietary share orders against client orders in the system then it would prima facie be treated
as being a systematic internaliser and that if more than one firm is able to enter orders into a
system it would prima facie be treated as a MTF?
Under present legislation, it is not the case that a BCS executing its own proprietary share orders
against client orders is prima facie a systematic internaliser. MiFID (Article 4(1)(7) of Directive
2004/39/EC) states that for an investment firm to be classified as a systematic internaliser, it must
deal on its own account by executing client orders on an „organised, frequent and systematic
basis‟. Therefore an investment firm using its BCS for proprietary trading on an ad hoc basis
would not fall under this definition – and the suggestion in question 7 would represent a
substantive change, not simply a clarification.
Even if a firm were placing orders into a BCS, it is unclear why this should automatically result in
the firm being classified as systematic internalisation, because, for example, simply placing orders
into a BCS may not satisfy the SI frequency condition. What seems important to the UK in the
circumstances described above is that there is clarity that the SI obligations apply irrespective of
how the firm conducts its trading, if the SI conditions are met. Importantly, if venue identifiers
are to be applied across a wider range of venue-like systems (e.g. a specific MIC for a given
broker crossing system), a key issue will be to ensure there is an agreed protocol for the identifier
to be used for trade reporting in respect of, say, a situation where an SI trade is undertaken in a
broker crossing system.
Furthermore, the UK believes that the operator of a BCS must be able to apply discretion in order
to provide tailored outcomes for clients and ultimately achieve best execution. This is a valuable
service to brokers‟ clients and is distinct from other kinds of venue-like operations. By contrast, a
systematic internaliser must carry out its activities „in accordance with non-discretionary rules and
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procedures‟ (Article 21 of MiFID Level 2 Regulation). This implies that these two business lines are
clearly distinct, involving the firm in question undertaking fundamentally different roles. As such,
the UK believes that there is no particular reason why a single firm cannot simultaneously be
both a systematic internaliser and the operator of a BCS.
In the same way, the UK does not consider that if more than one firm is able to enter orders into
a BCS it is prima facie an MTF. MiFID (Article 4(1)(15) of Directive 2004/39/EC) dictates that, to
be classified as an MTF, a firm must both operate a multilateral system and do so „in accordance
with non-discretionary rules‟. The UK recognises that the yielding of some element of discretion
to clients potentially takes broker crossing systems into a grey area that would benefit from more
clarity, but it also considers that any clarifications in this area need to result in consistency with
the functionalities of other regulatory categories.
The UK notes that this response assumes no change to the definition of a systematic internaliser
or an MTF. We recognise that the BCS category should not be used by firms to circumvent the
transparency requirements associated with being a systematic internaliser or MTF operator.
(8) What is your opinion of the introduction of a requirement that all clearing eligible and
sufficiently liquid derivatives should trade exclusively on regulated markets, MTFs, or organised
trading facilities satisfying the conditions above? Please explain the reasons for your views.
The UK is fully supportive of the G20 commitment to strengthen the functioning of derivatives
markets, including through greater levels of trading of standardised OTC derivatives on organised
trading platforms, where appropriate. The UK considers that such trading can complement and
reinforce post-trade measures by ensuring that platforms offering markets in standardised
derivatives are subject to authorisation and oversight in accordance with a set of clear regulatory
standards.
The UK considers that detailed measures around platform trading of OTC derivatives should be
applied where they would provide the specific benefits envisaged by the G20 (namely, the
mitigation of systemic risk, enhanced transparency and added protection against market abuse)
and in a manner not otherwise achieved by greater standardisation, central clearing and use of
trade repositories. In this context, the UK notes that a number of initiatives are already underway,
both at the EU7 and international level and while it is important to ensure consistency with this
work it is also essential to avoid duplication.
7 Such as the Proposal for a Regulation of the European Parliament and of the Council on OTC derivatives, central
counterparties and trade repositories (“EMIR”) 2010/0250 (COD), 15 September 2010.
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In relation to the introduction of a requirement that all clearing eligible and sufficiently liquid
derivatives should trade exclusively on organised platforms, the UK considers this may be
unnecessarily restrictive. 100% mandation would prevent eligible derivatives from being
transacted to on an OTC basis even where there was a legitimate reason for doing so (for
example, where a transaction is composed of a number of inter-dependent legs). The UK notes
that in its technical advice8 to the Commission, CESR advocated the formulation of sufficiently
ambitious industry targets, to be developed in consultation with market participants. This
approach would increase the level of organised platform trading while recognising and
preserving the possibility of OTC execution for a specified proportion of business.
The UK notes that, with respect to other regulatory initiatives, regulatory action based on setting,
monitoring and revising performance targets has proved effective. For example, the OTC
Derivatives Supervisors Group (ODSG) has been working with market participants (referred to as
the G-14 dealers) for a number of years to increase central clearing of certain OTC derivative
products. The G-14 dealers committed in July 2008 to using a central counterparty for certain
credit derivatives transactions, and in September 2009, established targets for submitting and
clearing trades for certain interest rate and credit derivatives. In March 2010, the G-14 dealers
set dates to increase many of these targets. Regulatory action based on performance targets for
trading, with appropriate monitoring and enforcement capabilities, would build on this wider
approach and mitigate the risk of unintended market disruption arising from 100% mandation.
The UK notes that the G20 commitment refers to platform trading of derivatives “where
appropriate” and any proposal for 100% mandation would need to be supported by a robust
cost-benefit analysis. In the absence of any further data or evidence from the Commission to
support a move away from CESR‟s recommendation, the UK considers that an appropriate
target-setting process, combined with arrangements for such targets to be monitored, could
deliverthe G20 commitment while at the same time minimising any impact on the efficient
functioning of the derivatives markets.
In the context of a possible trading obligation, the UK would welcome clarification from the
Commission as to whether there will be an exemption for non-financial entities participating in
OTC derivatives markets for commercial purposes. The UK notes that other trading regimes in
the course of development, such as the US financial authorities‟ implementation of Dodd-Frank,
envisage an end-user exemption for non-financial entities that access derivatives markets to
mitigate a commercial risk. In addition, a similar exemption for entities which are not financial
institutions is expected to be made available within the Commission‟s proposed EMIR, in relation
to clearing obligations. The UK considers that, if a trading requirement is introduced,
8 CESR/10-1096
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exemptions should be made available for commercial entities, other than those which meet pre-
determined criteria to be deemed to be of systemic importance.
The UK agrees with the Commission that liquidity is an essential criterion for determining
whether an OTC derivative is suitable for trading on an organised venue. In this regard, the
appropriate liquidity threshold will be linked with the minimum characteristics that a venue
would need to possess in order to qualify as an organised trading venue (the greater the
flexibility in permissible trading functionalities, the wider the range of standardised OTC
derivatives for which on-venue trading will be practicable). The UK notes that, in addition to an
assessment of liquidity, the Commission proposes an OTC derivative should first be subject to the
clearing obligation in order to be deemed eligible for platform trading. The UK does not
consider that acceptance for central clearing is, of itself, a necessary or sufficient condition for
platform trading. As an alternative to the clearing criterion, the UK considers that the
assessment of trading eligibility should (in addition to liquidity) focus upon the level of
standardisation (from the legal, process and product point of view) of an OTC derivative, given
that acceptance for central clearing does not assure a sufficient degree of standardisation to
support platform trading. This approach would be consistent with the conclusions of the 2010
FSB report on OTC Derivatives which noted that the relevant individual criteria for defining
whether an OTC derivatives was 'standardised' (i.e. standardisation and liquidity) could be met to
different degrees for central clearing vs. exchange trading.
(9) Are the above conditions for an organised trading facility appropriate? Please explain the reasons
for your views.
As a starting point, the UK would observe that previous public consultations on these issues9
have demonstrated there is a broad spectrum of trading functionalities already available for the
execution of derivatives transactions, which have been developed to meet a wide range of needs.
In this context, the UK believes that regulatory intervention to limit the range of market models
that can be made available to trade OTC derivatives should be approached with care. Continued
access to a wide range of functionalities (both voice and electronic) will help ensure future
market resilience during periods of stress, and as noted previously the wider the range of venues
the greater the number of derivatives that can be traded on them (thereby facilitating delivery of
the G20 commitment).
The UK suggests that the key elements of a regulatory regime that will ensure an effective and
proportionate delivery of the G20 commitment are as follows:
9 For example, CESR‟s consultation exercise with regard to the standardisation and exchange-trading of OTC
derivatives.
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(a) regulatory action should be based on the use of targets developed in consultation with
industry, which ensure an increased level of trading of eligible derivatives on organised
trading platforms, appropriately defined, but do not exclude the possibility of transacting
by other means where justified;
(b) regulatory action should be targeted at a sub-set of standardised derivatives meeting
transparent and objective liquidity criteria which are consistent with international
principles;
(c) there should be a clear definition of an organised trading platform, which references a
minimum set of functional characteristics. Such characteristics should be those that, after
consideration of any costs and benefits, further the achievement of the G20 objectives
above and beyond greater standardisation, the use of trade repositories and central
clearing. On this basis, a definition should include those characteristics described at
paragraph 2.2.1 (currently proposed for organised trading facilities generally), combined
with appropriate transparency, but exclude the additional characteristic of multilateral
access proposed for the relevant sub-regime, if this would serve to exclude single dealer
platforms as an element of the market structure;
(d) it is not necessary to regulate systems or facilities offering execution services in bespoke or
illiquid derivatives as organised trading venues, as the characteristics associated with such
trading would not yield benefits for these instruments; and
(e) the transparency requirements attached to orders and transactions on organised trading
venues should be tailored to the particular product class and trading functionality in
question and incorporate an appropriate system of waivers.
The views of the UK in relation to specific elements of the proposed OTV regime are provided
below.
Multilateral Access:
The intended meaning of the term “multilateral access” used in the consultation document has
not been elaborated. The term could be interpreted to require the operator of a single dealer
platform to offer access to multiple liquidity takers according to transparent and non-
discriminatory rules. The UK considers this to be the preferable interpretation, given the
distinction between this term and the language currently used in MiFID to describe the
multilateral nature of other platform types, but notes that this could also be viewed as a
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provision requiring the interaction of multiple third party buying and selling interests, in a way
that would preclude the provision of single dealer platforms, and so inhibit competition.
In the event the proposed requirements are intended to refer to a trading methodology which
requires multiple buyers to have the opportunity to interact with multiple sellers within the
system, the UK does not consider such a characteristic to be necessary in order to improve
transparency, protect against market abuse or mitigate systemic risk. In our view, facilities based
on the provision of liquidity by a single provider to multiple third party users (such as a single
dealer platform) could provide a component of an appropriate organised trading regime, co-
existing alongside multilateral platforms. The imposition of tailored requirements upon single
dealer markets as authorised entities, encompassing access rules, transparency, market
surveillance, management of conflicts of interest and operational resilience, would be sufficient
to ensure that derivatives markets adapt in the way envisaged by the G20 while providing
competition and choice to market participants.
In the example of a standardised OTC derivative which, while passing a liquidity threshold for
organised platform trading, does not exhibit the highest levels of liquidity necessary for order
book trading, a requirement for multilateral access would involve the agreement of multiple
liquidity providers to provide prices/quotes on a continuing basis. This may not be feasible for
instruments at the lower end of the liquidity spectrum, resulting in no admission to trading of
the instrument concerned and loss of the associated benefits. The argument has been made that
a requirement for multilateral trading will lead to pricing competition between liquidity providers,
thereby narrowing spreads. In the view of the UK, it should be the case that where multilateral
trading of a derivative product is practicable, liquidity will naturally gravitate to such competitive
models in order to exploit these pricing efficiencies without a regulatory mandate. The
continuing role for single dealer markets tends to suggest that, in some instances, execution
needs may be different (e.g., prioritising certainty or speed of execution, which may be better
achieved where a liquidity taker is able to deal bilaterally with the liquidity provider).
Transparency:
Comments on pre- and post-trade transparency requirements for non-equity instruments are set
out elsewhere in this response. The UK would observe here that while the transparency
requirements for shares within MiFID could be taken as a starting point, it is essential that any
transparency regime targeted at derivatives takes account of the diverse range of asset classes,
whose trading characteristics can differ significantly, and which will therefore require tailored
requirements incorporating an appropriate system of waivers. Market participants have noted
that information regarding completed trades in certain OTC derivatives would not be a reliable
guide to prevailing market conditions, as trade prices are seen to be particularly susceptible to
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trade-sensitive factors such as trade size and the perceived position of the counterparty, in a way
that equities transactions are not.
In addition, the UK considers that any transparency regime should reflect the spectrum of trading
functionalities currently made available to trade OTC derivatives, and which in future could
operate within the parameters of an organised trading regime. Such functionalities include
voice, electronic and hybrid models, for which transparency may be most effectively delivered in
different ways including by means of request for quote facilities and the dissemination of
indicative prices. The UK notes that other trading regimes in the course of development, such as
those for swaps and securities-based swaps in the US, are likely to provide flexibility for organised
platforms to offer request for quote systems based on suitable transparency arrangements,
alongside other execution possibilities.
The UK considers that there should be an opportunity for extensive industry consultation in
relation to the calibration of pre- and post-trade transparency requirements, and that any
proposals in this area must be supported by a robust cost-benefit analysis.
Operators should be able to adopt trading processes which involve the use of discretion
(provided other regulatory requirements can be met). Such discretion is a critical component of
voice based models (often offered as an element of a hybrid model that includes electronic
execution), and ensures that the trading needs of clients can be met in the most efficient fashion.
In the view of the UK, the organisational and operational requirements for organised trading
facilities set out at paragraphs (a) to (h) of section 2.2.1 would be sufficient to ensure that the
G20 objectives were met in relation to the trading of OTC derivatives, when combined with a
carefully specified transparency regime. In addition, the UK would support clarification that
inter-dealer broker systems (bringing together third-party interests and orders by way of voice
and/or hybrid voice/electronic execution) could be examples of organised trading facilities in the
specific context of trading-eligible OTC derivatives. However, the UK does not believe that it is
necessary to regulate (as organised trading venues) systems or facilities offering execution
services in bespoke or illiquid derivatives, which do not meet the criteria to be deemed trading-
eligible. We note that non-standardised derivatives fall outside the scope of the G20
commitment with regard to the promotion of organised platform trading, and that the
characteristics of organised trading would not yield the benefits envisaged by the G20 for such
instruments.
(10) Which criteria could determine whether a derivative is sufficiently liquid to be required to be
traded on such systems? Please explain the reasons for your views.
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The UK notes that work is currently underway under the auspices of IOSCO to consider the
characteristics of an OTC derivative that make on-platform trading practicable, including the
required level of liquidity. As this response was being finalised, IOSCO was due to finalise its
Trading Report imminently. The UK considers that criteria developed for the purposes of EU
legislation should be consistent with international principles and recognise that any liquidity
thresholds will be intrinsically linked to the level of flexibility afforded to trading platforms in
developing execution functionalities. Such criteria should be transparent and objective.
(11) Which market features could additionally be taken into account in order to achieve benefits in
terms of better transparency, competition, market oversight, and price formation? Please be
specific whether this could consider for instance, a high rate of concentration of dealers in a
specific financial instruments, a clear need from buy-side institutions for further transparency, or
on demonstrable obstacles to effective oversight in a derivative trading OTC, etc.
The UK considers that the key factors in the determination of eligibility for platform trading
should be the levels of standardisation and liquidity. Additional factors based on a judgement of
the condition of a particular market could also be valid, but would be secondary to the question
of whether on-platform trading would be practicable.
(12) Are there existing OTC derivatives that could be required to be traded on regulated markets,
MTFs or organised trading facilities? If yes, please justify. Are there some OTC derivatives for
which mandatory trading on a regulated market, MTF, or organised trading facility would be
seriously damaging to investors or market participants? Please explain the reasons for your views.
We support the technical advice of CESR in this regard and consider that the use of industry
targets could have some advantages over a mandatory trading requirement. Adopting a target-
based approach will incentivise platform trading as well as provide flexibility to undertake a
specified proportion of business in standardised derivatives on an OTC basis, where there is a
legitimate reason. Although out of scope of the G20 commitment in relation to the increased
use of trading platforms, and any resultant regulatory action, it is important to note for the sake
of completeness that market participants need to have the ability to trade customised products
on an OTC basis in order to meet legitimate hedging or risk mitigation needs. It is noted that
Dodd-Frank and its associated draft rule-makings do not envisage that “bespoke or illiquid”
swaps will fall within the scope of US trading requirements for “required transactions”10.
The mandatory trading of an OTC derivative on an organised platform could have a significant
detrimental impact where the range of trading functionalities within which such trading could
10
See , for example, draft CFTC rule-making “Core Principles and other Requirements for Swap Execution Facilities” http://www.cftc.gov/LawRegulation/FederalRegister/ProposedRules/2010-32358.html
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take place could not support an instrument possessing the trading characteristics of that
derivative (e.g., the trading of a less liquid instrument on an order book), or where the associated
transparency requirements were too high (for example, in markets dependent on the support of
liquidity providers).
2.3. Automated trading and related issues
(Q13-20)
Summary comments on this subsection
Advances in technology continue to transform how our financial markets operate. The volume of
financial products traded through computer automated trading at high speed and with little
human involvement has increased dramatically in recent years. The UK fully recognises the need
to understand better the impact of these trends, in particular in light of the US “Flash Crash” on
May 6 2010, when US equity markets fell dramatically in the space of minutes, before sharply
rebounding. The UK Treasury is therefore sponsoring a new research project, led by the
Government Office for Science, to explore how computer-generated trading may evolve in the
future. This work will look at price formation, liquidity, financial stability and other issues, and
will complement work already undertaken by the FSA. The UK hopes that the findings of this
research will helpfully inform debate on these issues.
In the meantime there are steps that should be taken to ensure that high risk management
standards prevail across Europe, and the UK supports the Commission‟s proposals for robust risk
controls to be put in place by firms involved in automated trading or who provide sponsored
access to automated traders. Similarly the UK encourages the Commission to look at ways to
tailor the Market Abuse Directive to address any new market abuse risks that may be presented
by algorithmic trading.
However in the absence of further research the UK does not support measures based on the
assumption that high frequency trading is, per se, harmful to markets. The Commission‟s
proposals to subject high frequency traders to market-maker type obligations, and to introduce
restrictions on the submission of orders, appear to be made on the assumption that high
frequency trading is of itself a harmful activity. However, as high frequency traders are also
considered in some cases to be important providers of liquidity, the UK believes it is essential that
any such measures should only be considered after a thorough and scientific assessment of their
costs and benefits.
(13) Is the definition of automated and high frequency trading provided above appropriate?
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We believe that a distinction should be drawn between automated and algorithmic trading. The
Commission defines automated trading as ”the use of computer programs to enter trading
orders where the computer algorithm decides on aspects of execution of the order such as the
timing, quantity and price of the order”. However we think this definition applies to a subset of
automated trading – since automated trading could also include, for example, trades entered
manually but executed electronically. We therefore suggest automated trading be defined as
trading involving the use of a computer, with algorithmic trading given the definition currently
assigned to automated trading in point a) and quoted above.
The UK agrees with the Commission that „HFT is typically not a strategy in itself but the use of
very sophisticated technology to implement traditional trading strategies‟ and that HFT is a
„subcategory of automated trading‟. However, the UK believes that further clarification is needed
on what differentiates a high frequency trader from any other automated trader. As such, the UK
would suggest a more detailed description of HFT as a form of trading with the following
characteristics:
(a) Highly automated and electronic;
(b) Latency sensitive;
(c) A small dispersed inventory, holding positions often for very short periods of time (this can
vary from milliseconds to potentially days or weeks, dependent on strategy);
(d) Low exposure or even „flat‟ overnight which minimises residual risk at end of day; and
(e) Strategies that seek to enter and leave the market with little or no impact.
HFT is not a new phenomenon but rather a natural progression of trading. The basic premise of
trading has not changed, but automation and technology has enabled proprietary traders to do
what they have always done albeit at greater speed and volumes with reduced margins per
trade.
(14) What is your opinion of the suggestion that all high frequency traders over a specified minimum
quantitative threshold would be required to be authorised?
The UK believes that HFT firms that are currently outside the scope of regulation under MiFID
should be regulated where failure to do so might reduce the ability of the markets to remain
efficient, orderly and fair. We do not believe that this occurs at any definable quantitative
threshold. Instead we would suggest that HFT firms could be required to be authorised as
investment firms if they are direct members of trading venues. As direct members, the activities
of high frequency traders directly affect the market and the risks they pose mirror those of
regulated investment firms. However for HFT firms accessing the market through an
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intermediary, the risks associated with their trading (e.g. of erroneous activity) are taken on and
managed by the intermediary and the appropriate regulatory oversight can be delivered via the
regulation of the intermediary. To this end we are strongly supportive of ensuring that firms who
provide sponsored access have robust risk controls in place.
We note that this proposed approach would mesh well with the Commission‟s separate proposal
that trading venues be required to report the transactions of non-authorised members and
participants.
(15) What is your opinion of the suggestions to require specific risk controls to be put in place by
firms engaged in automated trading or by firms who allow their systems to be used by other
traders?
We agree with the Commission‟s view that robust risk controls need to be put in place by firms
involved in automated trading or who provide sponsored access to automated traders.
Automated trading firms need to ensure that they maintain their own strict risk controls both in
quantitative terms and in terms of monitoring trader/programmer competence and behaviour. In
that context, the majority of requirements the Commission propose for regulated firms are
sensible but need to be more specific.
However The UK does not agree with the proposal to require firms „to notify their competent
authority of the computer algorithm(s) they employ‟. The UK‟s reasons are threefold:
(a) Algorithms are continuously updated, which would make it difficult for regulators with
their current resources to keep on top of the latest changes.
(b) The parameters around an algorithm can be as important as the algorithm itself in an
assessment of the impact it might have on a market. For example, an algorithm may have
a parameter that limits its trading to a set percentage either side of the previous day‟s
closing price for a particular stock. A price deviation of a few percent may be reasonable,
but setting the parameter at, say, 20% gives sufficient latitude for the algorithm to cause a
significant shift in the market. Therefore analysis of the algorithm without knowledge of
the parameters is insufficient to form a reliable conclusion on its possible market impact.
Competent authorities being continuously updated with changes to the parameters,
however, would lead to an amplification of the challenge identified above as each
algorithm‟s parameters may be changed every day.
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(c) Algorithms are developed by highly-trained technical specialists. It is therefore unlikely that
competent authorities would have the necessary expertise to conduct any meaningful in-
depth analysis of their functionality.
The UK therefore recommends that this point is not taken forward into legislation. What might
be of greater value would be to develop guidance on the types of algorithmic activity that might
be viewed as abusive. This could be addressed in the Commission‟s review of the Market Abuse
Directive.
(16) What is your opinion of the suggestion for risk controls (such as circuit breakers) to be put in
place by trading venues?
The UK agrees with the principle that risk controls should be in place at trading venues, and
indeed this is already a longstanding focus of the FSA‟s supervisory approach. However we would
point out that there are established alternatives to circuit breakers such as limit-up/limit-down
systems (which allow continuous trading within prescribed bands).
We also consider that trading venues need to have real-time trading checks and controls in place,
with the ability to halt a trading firm‟s message and order flow if needs be. Venues should also
conduct ongoing checks of their participants to ensure that they maintain and update their
controls as necessary, including those who co-locate at the platform data centre.
(17) What is your opinion about co-location facilities needing to be offered on a non-discriminatory
basis?
The UK agrees that space in a data centre for co-location should be provided on a non-
discriminatory basis. However, the UK believes that „equal and fair access‟ should refer to equality
of opportunity rather than equality of outcome. Venues do not have unlimited space available to
offer co-location facilities, and not every market participant has the resources or desire to invest
in the necessary infrastructure for co-location. Therefore the UK considers that: i) pricing should
be transparent and non-discriminatory; ii) co-location should be offered on reasonable
commercial terms; and iii) venue operators should be free to determine the space available for
co-location.
(18) Is it necessary that minimum tick sizes are prescribed?
We do not believe that it is necessary to prescribe minimum tick sizes. We consider that the
market has found and will continue to find the right levels of tick sizes, and that the possibility of
regulatory intervention provides sufficient incentive to ensure continued harmonisation. We are
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unaware of any significant problems to date with the way venues set tick sizes; indeed the need
for a venue (and market participants) to update systems when tick sizes change or other venues
have different tick regimes tends to provide a natural check on frequent (and therefore
potentially disruptive) changes to tick sizes. Further we believe that, as venues are closer to
trading participants than regulators, they are better placed to understand their needs and set
appropriate ticks.
The potential difficulties and unintended consequences of mandating minimum tick sizes can be
seen in the US, where a minimum tick size of 1c is in place for all stocks over $1. There is a
strong belief amongst some market participants that trading of these stocks has been driven into
dark pools. Citigroup is commonly cited as a low-price equity (c.US$4-5) that is traded on dark
(ATS) venues that have a competitive advantage over registered exchanges due to the fact that
they are not bound by a minimum tick size regime. We are aware of a recent industry led
agreement on harmonised tick sizes and support this initiative.
(19) What is your opinion of the suggestion that high frequency traders might be required to provide
liquidity on an ongoing basis where they actively trade in a financial instrument under similar
conditions as apply to market makers? Under what conditions should this be required?
We do not think a case has been made to mandate the provision of liquidity by high frequency
traders. If trading platforms want to provide members the opportunity to become market makers
they can already do so. The UK considers that forcing high frequency traders to become market
makers may deter them from entering the market altogether, thereby removing the benefits of
the liquidity they currently provide voluntarily. It may also create prudential risks to these firms,
leaving them exposed to market movements when other participants are at liberty to withdraw.
Given these potentially harmful side effects, and an absence of evidence as to the potential
benefits, we cannot support this proposal.
(20) What is your opinion about requiring orders to rest on the order book for a minimum period of
time? How should the minimum period be prescribed? What is your opinion of the alternative,
namely of introducing requirements to limit the ratio of orders to transactions executed by any
given participant? What would be the impact on market efficiency of such a requirement?
We do not believe that the case has been made to require orders to rest on the book for a
minimum period of time. Any participant may wish to delete an order quickly for prudential
reasons, and preventing them from doing so would effectively ensure they realised a loss
(although we note one conceivable unintended consequence could be participants trading
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against their own positions to hedge their risk). Forcing participants to remain in the market
could therefore damage overall market efficiency and compromise firms‟ risk management.
The UK also disagrees with the proposal to limit the ratio of orders to transactions executed by
any given participant. Venues are generally able to throttle orders submitted to their book by a
given participant if they feel it necessary, thereby preventing too many orders flooding the order
book at any given moment. This allows each venue to manage its own risk in an appropriate
manner.
We suggest that problems occur when the ratio is high as a result of abusive strategies. In other
words, it is the motivation behind the trading that must be questioned. If abusive strategies are
used, imposing a limit will have no effect on changing the mindset of the trader. Instead any
such behaviour can be addressed through market abuse provisions. To better facilitate this, the
UK is supportive in principle of the Commission‟s proposal (6.1 (f) Transaction Reporting) to
require firms to store order data for 5 years.
2.4. Systematic internalisers
(Q21-22)
(21) What is your opinion about clarifying the criteria for determining when a firm is a SI? If you are
in favour of quantitative thresholds, how could these be articulated? Please explain the reasons
for your views.
The UK agrees that clarification of the criteria for determining whether or not an activity
constitutes systematic internalisation would be helpful. The UK would favour amplification of
the defining characteristics of an SI activity, such that the meaning of “material commercial role”
in Article 21 of MiFID‟s implementing Regulation were expanded by incorporation of the text
currently set out in Recital (15) of the Regulation, and the reference to non-discretionary rules
and procedures was clarified according to the recommendation set out in CESR‟s technical
advice11 on equity markets. The UK agrees that there should be a clear basis for determining the
material commercial relevance of a particular activity, but notes that quantitative thresholds
serving as a reliable indicator of relevance would require careful calibration, and may lead to the
undesirable consequence of excluding activities that would be deemed material based on a
subjective assessment. The UK agrees with the view expressed by CESR that such a proposal
11
CESR/10-802. The suggested clarification would specify that „non-discretionary rules and procedures‟ refers to a set of pre-defined, common standards developed by the investment firm for providing a service such that it does not differentiate between comparable clients. In other words, based on the categorisation of its clients the investment firm does not exercise discretion regarding access to this service and provides the same prices for the same volume of trading interest in the same market situation, irrespective of the individual client within its categorisation.
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should only be taken forward based on further work examining their appropriateness, and would
suggest that ESMA be mandated to undertake this.
(22) What is your opinion about requiring SIs to publish two sided quotes and about establishing a
minimum quote size? Please explain the reasons for your views.
The UK supports the Commission‟s proposals to amend the obligations of a systematic
internaliser and agrees with CESR12 that the rationale of the systematic internaliser regimes needs
to be reviewed, such that an assessment can be made of whether SI obligations deliver their
intended objectives. In the context of a regime to deliver investor protection and transparency,
particularly in markets with a high level of retail participation, the UK is not convinced that it is
necessary to continue to apply price improvement restrictions in relation to orders of retail size.
Banning price improvement is likely not only to result in a wider traded spread than would
otherwise be the case but also to reduce the incentive for firms to act as liquidity providers and
post firm minimum quotes on a continuous basis. The ban in respect of all trades of up to
€7,500 is also more widely restrictive given the sharp decline in trade sizes right across the
market. The UK therefore considers that the purpose of the price improvement restriction should
be considered as part of a broad review of the SI regime.
2.5. Further alignment and reinforcement of organisational and market surveillance requirements for
MTFs and regulated markets as well as organised trading facilities
(Q23-24)
(23) What is your opinion of the suggestion to further align organisational requirements for regulated
markets and MTFs? Please explain the reasons for your views.
The UK calibrates its regulatory standards according to the regulatory outcomes it is seeking to
achieve. We believe that Multilateral Trading Facilities (MTFs) with a similar market impact or
market share as Regulated Markets should receive the same level of supervision as those markets.
We are aware that there have been some concerns that the differing requirements for regulated
markets and MTFs could lead to an unlevel playing field. The UK takes the view that regulated
markets and MTFs should be regulated in a comparable manner, but taking in to account
differences relating to, for example, volumes and products traded. We therefore support the
Commission‟s proposal to further align the organisational requirements for these trading venues,
on the understanding that sufficient flexibility is retained to account for venue-specific factors.
12 As set out in CESR Technical Advice to the European Commission in the Context of the MiFID Review - Equity Markets, CESR/10-802
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(24) What is your opinion of the suggestion to require regulated markets, MTFs and organised
trading facilities trading the same financial instruments to cooperate in an immediate manner on
market surveillance, including informing one another on trade disruptions, suspensions and
conduct involving market abuse?
The UK supports ways of enhancing cooperation between venues. However, it is important it is
done so in a considered way. We are also of the view that there should be an obligation on
trading venues to inform the market on trading disruptions and suspensions. A requirement for
regulated markets and MTFs to cooperate in an immediate manner in respect of market
surveillance issues does not, to us, seem practicable. Market surveillance activities are often
focussed on developing trends or activities. For example those relating to potential market abuse
could involve surveillance over a number of months. In these circumstances, it would be
inappropriate to require regulated markets and MTFs to communicate their concerns, in an
immediate manner, to other venues trading the same financial instrument. Conversely, in real-
time scenarios, where events unfold and change rapidly, it could be operationally difficult for one
venue operator to contact, potentially numerous, other markets to alert them to developments.
2.6. SME markets
(Q25-26)
(25) What is your opinion of the suggestion to introduce a new definition of SME market and a
tailored regime for SME markets under the framework of regulated markets and MTFs? What
would be the potential benefits of creating such a regime?
Enabling small companies to access finance on the capital markets is a crucial element for
allowing innovation and creativity to create jobs and support economic growth, and therefore
the UK welcomes the creation of a tailored regime for SME markets within the current MTF
regime. The key objective of such a regime should be to help bring a wider set of investors to
Europe‟s SMEs. Given that larger EU SME markets such as Alternext, AIM, First North, Marché
Libre, Open Market and PLUS presently operate as MTFs the UK believes that the MTF regime
provides an appropriate starting point and would therefore advocate keeping SME markets
separate from regulated markets and developing the concept of a Primary MTF (or “SME market”
as mentioned in the Commission review) framework subject to an appropriate level of investor
protection. This would also reflect the Commission‟s recent Summary of Responses to the
Transparency Directive Review13, that EU legislation should recognise there are, and should be,
different capital market types with different regulatory intensities: exchange-regulated markets
13
Feedback Statement: Summary of Responses to the consultation by DG Internal Markets and Services on The Modernisation of the Transparency Directive (2004/109/EC) 17 December 2010.
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(SME markets); regulated markets; and premium segments within regulated markets based on
regulatory add-ons.
Should such a framework be developed the UK believes it would better reflect the existence of
tailored primary markets for SMEs and would offer the following benefits:
(a) recognition of the substantial differences between primary and secondary MTFs;
(b) raise the profile of SMEs through the implementation of a framework which formally
recognises the role of the SME markets and provides future certainty regarding their
regulatory status;
(c) improve the visibility of SMEs by requiring minimum levels of information to be placed on
officially appointed mechanisms; and
(d) offer the opportunity for improved access to finance for SME issuers and be a catalyst for a
range of initiatives designed to raise their profile and visibility and attract investors to the
SME asset class (e.g. please see our response to q.106 on business angels)
In contrast, creating a separate segment within regulated markets with lower regulatory
obligations for SMEs carries with it a number of significant risks: it would diminish the brand of
regulated markets and reduce transparency in particular the visibility of the SME issuers due to
the comparatively lower amount of information available. It would also negatively impact
investor protection and investor awareness of the regulatory obligations of the particular issuer,
all of which would impact liquidity for SME issuers. This could lead to a weakening of the EU
markets‟ competitive position within global markets and particularly within the perceptions of
investors, as well as negatively impacting SME issuers‟ ability to raise equity finance.
The UK considers the framework of a PMTF should take into consideration the following:
(a) Harmonisation should take into consideration that PMTFs would need to retain the
flexibility to evolve to serve the individual market needs within a framework of outcome
focused principles that would allow flexibility as to the specific market model adopted.
These models should allow full or partial delegation of responsibilities to advisers meeting
pre-determined criteria (as is currently the case with Alternext, AIM, Entry Standard and
First North), with the possibility of additional arrangements for exchange-led or competent
authority-led adviser supervision at the discretion of individual Member States;
(b) a set of initial and continuing disclosure obligations which balance the needs of smaller
companies with the information requirements of investors. Within this regime
consideration should be given to whether an EU framework should prescribe standards to
be met by operators in the formulation of rules, or whether it should prescribe the rules
themselves;
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(c) the need to define the key operating processes for the maintenance of an orderly market,
with particular emphasis on the relative roles and responsibilities of competent authorities
and PMTF operators with regard to matters such as the preparation and approval of
admission documents, the adoption of issuer rules outside directive requirements,
suspensions, taking of disciplinary action and market surveillance;
(d) the relative positioning of any PMTF framework against the admission and disclosure
standards for Regulated Markets and Listing Rules under CARD; and
(e) the need for clear branding/labelling in order to ensure differentiation from
regulated/listed markets, and the benefits of clear disclosure highlighting the risks and
rewards typically associated with investment in smaller companies; and
(f) any potential issues that the current MiFID legislation raises in relation to the trading on a
secondary MTF of securities admitted to trading on a PMTF would need to be considered.
Any strategy that seeks to assist SMEs in obtaining appropriate funding must also deal with
more than the regulatory environment for admitting to trading and secondary market
regulation; the SME sector (however defined) is a complex mix of types of issuers, investors and
advisers and all aspects must be addressed to have any prospect of delivering a successful
outcome. Growth markets across the Member States already vary widely as to the size and
nature of the companies supported, the profile of the investor base, the type of regulatory
environment and other cultural and economic factors; the key element in any initiative to
support SMEs is to recognise the need for all these elements to be managed in some way.
(26) Do you consider that the criteria suggested for differentiating the SME markets (i.e. thresholds,
market capitalisation) are adequate and sufficient?
The UK agrees with many of the suggested requirements set out within the consultation paper,
such as those relating to an adapted admission document; audited annual report with relaxed
timeframes; fair and orderly trading; transaction settlement; pre/post-trade transparency; and
competent authority oversight. These are broadly similar to the approach currently taken for
those existing SME markets that are MTFs.
However, designating thresholds based on market capitalisation is not a viable option as it is
too volatile a parameter, no matter whether it is a fixed threshold or based on a percentage of
the overall average market capitalisation of the regulated market of a particular Member state,
because this would raise issues such as:
(a) a significant proportion of listed companies on smaller regulated markets would be
captured by a fixed threshold (for instance a market capitalisation threshold of €50m
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would result in all of the stocks on the Prague exchange being designated SME
issuers);
(b) it would be difficult to reconcile with the low level of minimum market capitalisation
set by CARD; and
(c) use of such an objective level would also cause concerns for issuers passing through
the threshold upwards who would presumably be forced to apply for admission to the
regulated market when this was not suitable for them. Such a decision should be
taken by the issuer, their adviser and their shareholders.
The UK believes the criteria should instead be based on a subjective evaluation undertaken in
accordance with conditions set by the market operator or authorised advisers (dependent on
the model employed). These should be consistent with the objective of allowing suitable
smaller companies access to the market, while screening out those which are not investment-
ready and encouraging those that are more suited to the regulated market to apply for
admission on those markets.
Examples of the type of quantitative criteria which the UK would advocate are:
(a) a sufficient free float to ensure an orderly interaction between supply and demand (but
with no prescribed minimum %);
(b) in combination with (a) the requirement to have at least one liquidity provider (as
necessary to ensure liquidity);
(c) no minimum trading record but additional controls (e.g. lock-ins), for companies with
little or no record;
(d) no minimum market capitalisation;
(e) a requirement for the shares to be freely transferable and eligible for electronic
settlement;
In addition to the above requirements, other judgement-based criteria could be set to certify a
company‟s suitability on a wider qualitative basis such as:
(a) the need to have sufficient working capital for at least 12 months;
(b) appropriate corporate governance frameworks;
(c) clear disclosure of any close links with controlling shareholders or other related parties;
(d) technical reports for specialist issuers (e.g. mineral exploration)
(e) considerations for non-trading companies (e.g. cash shells)
The UK notes the suggestion within the consultation on eligibility conditions that key persons in
SMEs should be fit and proper. The UK does not believe that it is within the scope of the directive
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to directly regulate such persons within issuers who admit securities to trading on such a market.
However, if this was not the intention of the drafting the UK would be keen to understand the
underlying basis for this point.
3. PRE- AND POST-TRADE TRANSPARENCY
Summary Comments
The UK is supportive of increased transparency where this will either help with regulatory
oversight and / or improve the price formation process. However, the UK has a number of
important comments with regard to the appropriately tailored pan-European pre-trade
transparency waivers, which are set out in the responses to the relevant questions and to which it
would draw the Commission‟s particular attention.
The UK supports greater post-trade transparency in non-equity markets, delivered on a balanced,
tailored basis that does not damage liquidity provision. Such a regime should be deliverable for
certain derivatives and bond markets; however, a broader application to other non-equities will
be challenging given the illiquidity of many of the instruments. Any new requirements must be
based on a detailed impact assessment to inform the calibration.
The UK also supports the idea of mandating appropriately tailored pre-trade transparency
requirements for the trading of non-equity instruments on Regulated Markets and MTFs.
However, the UK is concerned about the ability of investment firms to provide OTC quotes in a
range of non-equity products given the market risk and capital commitment that this would
involve. In addition, the value of transparency information as a tool for price formation in relation
to a customised non-equity product or an illiquid product is questionable.
3.1. Equity markets
(Q27-31)
(27) What is your opinion of the suggested changes to the framework directive to ensure that waivers
are applied more consistently?
The UK welcomes the Commission‟s proposed amendments. In line with the CESR technical
advice, the UK believes that a move from a principles-based approach to a rule-based approach
to pre-trade transparency waivers is necessary to provide greater clarity for both market
participants and competent authorities. The UK agrees that ESMA should be required to monitor
the waivers and report annually to the Commission on their use. These reviews should inform
application of the waivers to reflect market developments where appropriate.
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(28) What is your opinion about providing that actionable indications of interest would be treated as
orders and required to be pre-trade transparent? Please explain the reasons for your views.
The UK agrees with the Commission that actionable indications of interest (IOIs) should be
treated as orders and be subject to pre-trade transparency requirements. An IOI may be used to
provide information to a select group of participants without being made public. If such an IOI is
actionable (i.e. it contains sufficient detail and is firm such that an execution can take place
against it), and therefore contains information which may be deemed relevant to price formation
in the instrument concerned, the IOI should be transparent on the same basis as an order. As in
the CESR technical advice, the UK believes that actionable IOIs should be visible to all or dark to
all, and as such agrees that they „could not be made transparent to direct participants in a
trading system without also being made public‟. Clearly if an actionable IOI is to be treated as an
order, the IOI‟s originator should have the same right to make use of any applicable pre-trade
transparency waiver.
(29) What is your opinion about the treatment of order stubs? Should they not benefit from the large
in scale waiver? Please explain the reasons for your views.
Our view is that the unexecuted parts of initially large in scale (LIS) orders (“stubs”) which no
longer meet the thresholds should benefit from the waiver. The purpose of the LIS waiver is to
protect large orders from adverse market impact. Forcing the stubs of a partially executed large
order to become lit could reveal the size of the original order (because this will happen at the
same instant that the associated trade is printed), contravening the purpose of the waiver. This
may mean that LIS orders are entered as “Immediate or Cancel” (IOC) or “Fill or Kill” (FOK)
thereby damaging liquidity and making it unnecessarily difficult to execute block trades. We
believe that the LIS criteria should be relevant to the size of the initial order, and on that basis the
order should continue to benefit from the waiver until the point it is fully executed, whether that
is achieved in a single fill or in multiple fills. The case for keeping stubs dark would be all the
stronger if keeping the existing LIS thresholds were not reduced to reflect the lower average
trade size.
However we do note that, in the case where a stub is modified such that the resultant order is
below the LIS threshold, the LIS waiver should no longer apply. Modifying a stub has the same
effect as deleting it and re-entering a new order. As this new order would be below the LIS
threshold, it should be subject to pre-trade transparency requirements.
(30) What is your opinion about prohibiting embedding of fees in prices in the price reference
waiver? What is your opinion about subjecting the use of the waiver to a minimum order size? If
so, please explain why and how the size should be calculated.
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The UK agrees that „trades executed under the reference price waiver would be executed at the
gross price and would not incorporate any embedded fee in the price‟. This is necessary to ensure
that prices published in trade reports clearly correlate with the venue‟s stated pricing
methodology.
However, we are not persuaded that the waiver should be subject to a minimum order size. The
purpose of the reference price waiver is not only to protect orders from market impact but also
to allow for “passive pricing”: namely, where the execution price is taken from a price generated
by another system and hence has no additional value to the price formation process. These are
two distinct motivations. Introducing a minimum threshold would prevent small orders being
executed on reference price systems, meaning retail-size orders would be excluded from the
benefits that price referencing venues can bring (particularly, the ability to execute an order at
the mid-point of a reference market, as opposed to trading at the bid/offer price of a market and
incurring the cost of the spread). Finally, given that reference price systems typically offer the
possibility for participants to set a minimum execution size for their own orders, we question
what benefit introducing a blanket minimum threshold would bring, in particular given it would
appear retail investors may be disproportionately impacted.
(31) What is your opinion about keeping the large in scale waiver thresholds in their current format?
Please explain the reasons for your views.
The UK believes that the LIS waiver, as an element of the wider pre-trade transparency waiver
regime, serves an important purpose in balancing the benefits of pre-trade transparency with the
costs of market impact. The waiver recognises that, once an order reaches a certain size, the
price formation benefits of public transparency are surpassed by the costs to the participant of
exposing that trading interest to the market. In light of its purpose to limit the market impact of
large trades, the UK considers that there is merit in reviewing what constitutes “large” (as a
relative concept), in order to take account of market developments and trading practice, and
how these might have affected the market impacts of orders of different sizes. In recent years,
average trade sizes have fallen significantly – this suggests markets are changing and the UK
considers that a re-assessment of the large in scale waiver would therefore be justified. For
example, the average trade size on the London Stock Exchange was €22,266 in 2006 compared
with €11,608 in 2008 and €9,923 in 2009. This issue should be viewed in the context of the
current scale of use of the LIS waiver. Statistics compiled by CESR, and set out in its technical
advice on equity markets14, indicate that in Q1 2010, trades utilising the LIS waiver accounted for
3.8% of all trades in EEA shares that took place on a regulated market or MTF. This indicates
14 CESR/10-802
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that there is scope for review and, if appropriate, re-calibration. The UK also notes that in
response to the CESR consultation of spring 2010, a large number of market participants
indicated that a review of the thresholds would be timely.
3.2. Equity-like instruments
(32) What is your opinion about the suggestions for reducing delays in the publication of trade data?
Please explain the reasons for your views.
The UK supports the technical advice put forward by CESR on this issue, including the proposed
recalibration of post trade delays,15 and agrees with the view that the overall benefit of improved
transparency will outweigh any potential adverse effects.
(33) What is your opinion about extending transparency requirements to depositary receipts,
exchange traded funds and certificates issued by companies? Are there any further products (e.g.
UCITS) which could be considered? Please explain the reasons for your views.
The UK is of the view that instruments that are similar to cash equities in structure (i.e.
representing a part-ownership in a corporate vehicle) and/or the manner in which they trade (i.e.
on multilateral venues, with or without the support of market makers), such as exchange-traded
depositary receipts and exchange-traded funds, should be subject to broadly the same
requirements regarding pre- and post-trade transparency as shares admitted to trading on a
regulated market. However, the UK would not support the automatic application of the equity
transparency regime to instruments that are structured differently and trade only on an OTC
basis. Transparency requirements may need to be carefully tailored to ensure they are suitable for
the instruments in question and how they trade. Instruments that are less „equity-like‟ may need
a separate regime designed for them and so the UK would strongly recommend that the
Commission undertake further research to ensure any regime that is introduced is appropriate.
(34) Can the transparency requirements be articulated along the same system of thresholds used for
equities? If not, how could specific thresholds be defined? Can you provide criteria for the
definition of these thresholds for each of the categories of instruments mentioned above?
Given the importance of these markets to a range of participants (including retail investors), the
UK recommends strongly that further research be undertaken into the liquidity, trade sizes and
trading frequency of these instruments to determine the detail of an appropriate transparency
15 CESR Technical Advice to the European Commission in the Context of the MiFID Review - Equity Markets 29 July 2010, CESR/10-802, page 24 para 117
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regime. This would include, for instance, determining appropriate thresholds for orders to be
considered large in scale and trades to be permitted deferred publication. In part, this is to
ensure that the introduction of prescriptive transparency requirements does not damage liquidity
provision as, for instance, the trading of ETFs is often heavily reliant on liquidity supplied by
registered market makers. The UK remains open-minded as to what the details of such a regime
would look like and whether, in practice, they would or would not differ significantly to those
already in place for the trading of shares.
3.3. Trade transparency regime for shares traded only on MTFs or organised trading facilities
(Q35-36)
(35) What is your opinion about reinforcing and harmonising the trade transparency requirements for
shares traded only on MTFs or organised trading facilities? Please explain the reasons for your
views.
The UK supports the principle of extending MiFID's transparency requirements for shares
admitted to trading on a regulated market to shares that are traded only on an MTF. MTF shares
have largely the same characteristics, with the same legal form, trading arrangements and pricing
conventions (i.e. pricing in monetary rather than percentage/basis terms, with the price factoring
in anticipated future dividends). However, consistent with our comments above regarding the
creation of an „organised trading facility‟ category, the UK would not support the extension of
MiFID‟s transparency requirements to shares that trade only on an organised trading facility.
(36) What is your opinion about introducing a calibrated approach for SME markets? What should be
the specific conditions attached to SME markets?
In line with the response to question 34, above, the UK would recommend strongly that research
be undertaken into the liquidity, trade sizes and trading frequency of these instruments to ensure
that introducing harmonised transparency requirements does not harm liquidity provision. These
are important considerations for any transparency regime, and are not specific to shares in SMEs.
In the UK's experience, trading in the vast majority of MTF shares is reliant on firms registering
with the MTF operator in question as official market makers and providing continuous, two-way
prices during the trading day. Thus the introduction of a separate mandatory transparency
regime should take into account the potential impact on liquidity provision by market makers.
For instance, it is possible that the Commission‟s proposed shortening of the delays available
under the deferred publication regime could have a material adverse impact on less liquid
stocks/SME shares. A more calibrated approach to SMEs may be required to ensure that the
liquidity of these stocks is not adversely affected.
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3.4. Non equity markets
(Q37-41)
Summary comments on this subsection
The UK thinks that in most circumstances transparency facilitates market efficiency, fosters
investor confidence and strengthens investor protection. This notwithstanding, we believe that
not all securities and markets would benefit equally from the same mandatory degree of
transparency. Moreover, in the UK and Europe, various market-driven initiatives provide different
degrees of pre-trade transparency for bonds (corporates and governments) and derivatives, in
both wholesale and retail segments. For example, pre-trade information is available through
brokers‟ proprietary systems to their clients. Third-party managed electronic systems (e.g. those
operated by data vendors) host and disseminate real-time data on quotes and volumes for a
range of instruments, often made available from a large pool of dealers. The development of a
variety of trading systems in recent years has been driven in part by an aim of providing greater
transparency and efficiency. Competing multi-dealer electronic trading platforms allow
transparent trading in non-equity instruments according to predefined rules. And, finally, a
number of regulated markets already offer pre-trade transparency in an electronic order book or
market-maker environment for government, supranational and corporate bonds for retail
investors. This existing transparency can usefully be borne in mind when considering the form
that any mandatory transparency requirements should take. The Commission rightly recognises
that the MiFID transparency regime for non-equities should be tailored by asset class, not just
copied out from the equities regime.
(37) What is your opinion on the suggested modification to the MiFID framework directive in terms of
scope of instruments and content of overarching transparency requirements? Please explain the
reasons for your views.
We continue to believe that the transparency proposals put forward in CESR‟s Technical Advice
on non-equity transparency are appropriate and would recommend them to the Commission as
its starting point. We agree that bonds and a sub-set of standardised derivatives which are
sufficiently liquid should be subject to appropriate transparency requirements, in circumstances
where this would provide benefits in relation to price formation and the reduction of information
asymmetries. In this regard, the UK would invite the Commission in due course to clearly
articulate the rationale for each element of any new transparency regime and the outcomes
which it is seeking to achieve.
The appropriate degree of transparency would clearly deliver greater benefits. Importantly,
though, feedback we have received from a broad cross section of market participants transacting
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non-equity products, including institutional investors, suggests that if transparency requirements
are too onerous or their scope is too broad, liquidity may be negatively affected with the
consequence of raising the cost of trading in these securities. There is a trade-off between
achieving greater transparency and reducing liquidity for both standardised and, especially, non-
standardised non-equity products. For instance, the UK notes the proposal to extend
transparency requirements to derivatives reportable to trade repositories, and notes that this will
capture an extremely broad array of products, including those which are non-standardised and
have not necessarily been deemed eligible for central clearing or organised platform trading. The
value of pre and post trade transparency information as a tool for price formation in relation to a
customised product, tailored to the needs of a particular participant, or in an illiquid product
trading very infrequently, is unlikely to assist with price formation in a way that is fair to the end
investor.
To achieve the best outcome for the end investor – namely the narrowest spreads and best
returns on investments across a wide spectrum of asset classes – the UK recommends that
transparency requirements be differentiated between non-equity products at a sufficient level of
granularity to reflect the wide diversity of trading characteristics both between and within asset
classes.
The UK encourages thresholds for non-equities to:
(a) be set according to product type, with suitable differentiation between products of
different trading characteristics;
(b) be calibrated at a high enough level;
(c) incorporate an appropriate system of waivers, including (but not limited to) block trades;
and
(d) be subject to rapid change and recalibration in the event market conditions require this.
(38) What is your opinion about the precise pre-trade information that regulated markets, MTFs and
organised trading facilities as per section 2.2.3 above would have to publish on non-equity
instruments traded on their system? Please be specific in terms of asset-class and nature of the
trading system (e.g. order or quote driven).
The UK agrees that it may be appropriate to apply pre-trade transparency requirements to a wide
range of trading platforms, including OTVs, on which non-equity instruments are traded, but not
to OTFs. In this fashion, requirements should apply to those products which are sufficiently
standardised and liquid to ensure transparency information is of benefit to market participants
and price formation.
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It will be important to calibrate the transparency regime to take account of the specificities of
OTC derivatives and bonds given the significant differences between these markets and equity
market structures. For example, liquidity providers in derivatives markets do not operate in the
same way as market makers in equity markets: in derivatives markets, liquidity makers often
provide liquidity on demand via request-for-quote (RFQ) systems as opposed to continuous firm
quotes. This would need to be taken into account in designing any pre-trade transparency
regime. In addition, the transparency regime would need to accommodate discretionary voice
trading as a potential system that could be provided within the Commission‟s proposed OTV
category. The UK would also highlight that, for products deemed to be sufficiently standardised
and liquid to support platform trading, there will be an obvious need for a comparable system of
waivers to equity markets, albeit calibrated for the instruments in question, including an effective
block trading regime which ensures that market participants retain the ability to trade significant
risk positions. Products which are determined to be unsuitable for organised platform trading
are by definition less liquid or non-standardised and hence the application of pre-trade
transparency obligations is unlikely to produce market benefits.
The UK believes that requiring brokers which trade OTC products to publish pre-trading
information in a continuous manner and commit to trade below a certain size could have
adverse and unintended consequences for the market and end investors, and the additional
capital required may prompt the withdrawal of liquidity. An appropriately-tailored mandatory
pre-trade transparency requirement could be introduced on RMs and MTFs for sufficiently liquid,
fungible and standardised products, such as derivatives that are eligible to be traded on
organised venues. Products which are determined to be unsuitable for organised platform
trading are, by definition, less liquid or non-standardised and hence the application of pre-trade
transparency obligations seems unlikely to produce market benefits.
In terms of bonds, the UK supports CESR‟s technical advice16. The trading of benchmark
government bonds and corporate bonds on RMs and MTFs can be subject to the pre-trade
transparency requirements as such instruments will tend to be sufficiently liquid. However, it
should be noted there is no clear evidence of a wide-reaching bond market failure under the
current transparency obligations and, for that reason, the UK believes the Commission should be
very cautious before imposing a general pre-trade transparency requirement across all bond
markets. Given the potential implications for market liquidity in corporate bonds and thereby
corporate funding, any proposals in this area would need to be evidence-based and supported
by a robust cost-benefit analysis.
16 CESR/10-799
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In terms of other non-equity products such as structured financial products, credit default swaps
(CDS) and other derivatives, the success of any pre-trade transparency regime is dependent upon
the liquidity, frequency of trading, degree of standardisation and fungibility of a given product.
The UK believes imposing transparency obligations (especially if accompanied by firm quote
obligations for trades below a certain size) on market participants offering execution services in
non-standardised or illiquid products outside an organised trading venue may well lead such
market participants to either widen spreads to account for the greater risk of having to provide
quotes or potentially withdraw from the market altogether.
The unintended result might be that end investors receive significantly worse prices and returns
on investment, with buy-side participants (such as fund managers and pension funds) being
among the investors most likely to suffer.
(39) What is your opinion about applying requirements to investment firms executing trades OTC to
ensure that their quotes are accessible to a large number of investors, reflect a price which is not
too far from the market value for comparable or identical instrument traded on organised
venues, and are binding below a certain transaction size? Please explain the reasons for your
views.
The UK considers it would be challenging for investment firms to offer firm quotes in an array of
instruments to large numbers of investors at a price near or identical to the comparable
instrument traded on an organised venue. We note that execution prices in bilateral OTC
derivatives reflect various factors including counterparty risk, and the proposed obligation could
affect dealers‟ ability to manage these risks. Moreover forcing a participant to disclose trading
interest to the market could have the effect of moving the market against the relevant
participant. In response, dealers may be less likely to quote ormay increase prices (via commission
or spread) to accommodate the extra expense and risks. In other words, for many of the
instruments under discussion, there may be a negative correlation between transparency, on the
one hand, and liquidity on the other.
(40) In view of calibrating the exact post-trade transparency obligations for each asset class and type,
what is your opinion of the suggested parameters namely that the regime be transaction-based
and predicated on a set of thresholds by transaction size? Please explain the reasons for your
views.
The UK agrees that post-trade transparency is achievable for standardised products such as
bonds with a prospectus and standardised derivatives traded on an organised venue as explained
in our responses to questions 37 and 38 above. However, a post trade transparency regime will
only be successful if the right balance is struck between transparency and liquidity.
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The UK suggests that post-trade transparency measures should be delineated by asset class. The
level of liquidity and fungibility of individual instruments will almost certainly not be uniform, and
may vary widely within a given asset class. This means that the transparency regime should be
tailored to the class of financial instrument and to the type of financial instrument as well as the
underlying variable (for derivatives). Taking a one size fits all approach within one asset class is
likely to damage liquidity for individual instruments and this would run counter to the
Commission‟s stated aim of the review, namely to improve market efficiency and liquidity. Critical
in this context will be the delay in publication permitted for large trades in less liquid
instruments. The less liquid an instrument, the more its liquidity providers will be dependent on a
significant delay in publication. Calibration of the transaction size is not the only indicator of
liquidity, as discussed below in 41.
(41) What is your opinion about factoring in another measure besides transaction size to account for
liquidity? What is your opinion about whether a specific additional factor (e.g. issuance, size,
frequency of trading) could be considered for determining when the regime or threshold
applies? Please justify.
The UK endorses the approach taken in the CESR Technical Advice on non-equity markets
transparency regarding calibration of post-trade transparency17. This sets out a sensible solution
to initiate a post-trade transparency regime for various asset classes involving, to begin with, a
simply calibrated system of publication requirements, differentiated by asset class, with delays
and disclosure requirements dictated by transaction size. Once the regime has had a suitable
period of operation (e.g. one year), the UK would strongly support factoring in other measures
besides transaction size to measure liquidity. Liquidity is also a function of all of the following:
(a) trade size;
(b) frequency of trading; and
(c) frequency of bids and offers displayed (or, more simply, how many people are prepared to
make a market in the instrument in question).
Taking the above indicators of liquidity into account in designing the transparency regime will be
important. The UK agrees with the CESR Technical Advice regarding the importance of a post-
implementation review of the impact any post-trade transparency measures have.
3.5. Over the counter trading
(Q42)
17
CESR/10-799
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(42) Could further identification and flagging of OTC trades be useful? Please explain the reasons.
The UK supports CESR‟s technical advice and agrees that there needs to be more granularity on
OTC trade reporting so that there is transparency over which trades are for administrative
purposes and which are commercial.
With respect to transaction type standards and other trade flags, the UK supports incorporating
the following OTC trade flags which will improve the quality of post-trade data:
(a) „B‟ Benchmark trade flag OTC
(b) „X‟ Agency cross trade flag OTC
(c) „G‟ Give-up/give-in trade flag OTC
(d) „E‟ Ex/cum dividend trade flag OTC
(e) „T‟ Technical trade flag OTC
The UK recommends the use of a unique transaction identifier along with a unique code
identifying the publication arrangement to help reconcile cancellations and amendments with
the original trade reports and to facilitate the consolidation of the data. Cancellations and
amendments should be published with a „C‟ or „A‟ flag together with the unique transaction
identifier of the original transaction as soon as possible and no later than 1 minute after the
decision to cancel or amend is made.
4. DATA CONSOLIDATION
(Q43-59)
Summary comments
The UK is supportive of many of the Commission‟s proposals with respect to data consolidation.
The Approved Publication Arrangement framework would be a positive step forward in
improving data accuracy. Similarly, steps to improve the quality of post-trade data through the
standardisation of how individual data fields should be populated would also clearly be beneficial
to the markets.
The UK also supports the ambition to establish a consolidated tape of equity trade data. Of the
options proposed, the UK believes that Option C is most likely to deliver the optimal solution.
Allowing a number of commercial providers to operate tapes should promote competition and
ultimately lead to benefits for end-users.
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It will of course be important to clarify what constitutes “reasonable commercial terms” for the
provision of transparency data. Doing so should help to ensure that a fairly-priced consolidated
data solution is delivered. The UK believes this is particularly important as there may be genuine
challenges in ensuring a tape is affordable. For instance, the demand for a consolidated tape,
and the price its users are prepared to pay, may be insufficient to cover its costs. If the fees raised
by a tape would not cover its operation, the charges for the feeds into the tape (i.e. from trading
venues and APAs) would have to be lowered or the tape will have to be subsidised from the
public purse. Otherwise the aim of establishing an affordable tape will not be achieved. Clearly,
the optimal outcome would be to strike a balance such that: i) a tape is affordable; ii) its
operation respects the right of those providing inputs to it to receive a reasonable commercial
price for their data; and iii) there is no burden on European taxpayers.
4.1. Improving the quality of raw data and ensuring it is provided in a consistent format
(43) What is your opinion of the suggestions regarding reporting to be through approved publication
arrangements (APAs)? Please explain the reasons for your views.
The UK is supportive of the introduction of an APA regime and believes that it will improve the
quality and consistency of post-trade transparency information, and assist in the consolidation of
trade data. The UK considers it fundamental to ensuring high quality post trade data, and
market confidence in that quality, that all post trade data is reported through mechanisms that
are subject to basic standards and which have obligations, and capabilities (including powers), to
monitor data with a view to preventing the publication of incorrect and incomplete data.
Having formal requirements in place ensuring that trades are published through APAs will ensure
that appropriate bodies are present to then monitor and be responsible for the publication
process. The data published through APAs should be more reliable for market participants and
can then be used for data consolidation purposes, easing the creation of a consolidated tape.
Prescribed standards will set the framework needed to ensure that the APA regime is robust and
allow trade information submitted by investment firms to be subject to monitoring and checking
for accuracy.
The UK believes that the introduction of APAs will begin to address the issues arising from the
fragmentation of transparency information and assist in price discovery, in addition to helping to
facilitate best execution. This will partly be due to market participants having more confidence in
the data that will be disseminated by these bodies.
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(44) What is your opinion of the criteria identified for an APA to be approved by competent
authorities? Please explain the reasons for your views.
Requiring APAs to operate data publication arrangements to prescribed standards will be
essential for having data quality of a high standard. The UK supports the criteria that the
Commission has identified for an APA to be approved by competent authorities, and note that
this reflects Annex 1 of CESR‟s Technical Advice to the European Commission in July 2010.
These criteria are sufficient to allow a regime to exist which will monitor and hold responsibility
for data publication to certain standards and expectations. Requiring APAs to identify
information that may be incomplete or possibly erroneous will lead to trade data which,
ultimately, will be more trusted by users of that data and is a vital part of the requirements
placed on such bodies.
Whilst stringent criteria for approval are essential, ongoing monitoring will also be important to
ensure the success of the regime. This will be possible as, amongst other things, trade data
submitted to APAs by investment firms can be scrutinised by competent authorities through
regulatory reporting responsibilities being placed on those APAs.
The UK suggests that the Commission consider whether competent authorities should have
enforcement tools at their disposal if an APA breaches its condition for approval /obligations.
Such tools could include the ability to fine an APA or require it to remedy the breach (rather than
just withdraw its approval).
(45) What is your opinion of the suggestions for improving the quality and format of post trade
reports? Please explain the reasons for your views.
The UK welcomes the suggestions put forward to improve both the quality and format of post-
trade reports. Poor quality trade reporting can be detrimental to the efficient functioning of
markets and hinder the ability of market participants to make informed trading decisions.
Standardised formats for trade reports will be an important step to achieving data consolidation
and improving the quality of those reports.
Whilst the UK generally supports the use of ISO standards for trade reports, their universal
adoption may have a potentially significant impact on participants that trade
Sterling-denominated shares (including costs associated with systems changes) as the ISO
currency unit standard is to use the major currency unit (i.e. pounds) whereas the current market
practice for UK securities is usually to use the minor currency unit (i.e. pence). The UK would
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therefore encourage the Commission to produce a robust cost-benefit analysis that takes into
account the benefits of standardisation against the cost of system changes for market
participants trading in Sterling-denominated securities.
(46) What is your opinion about applying these suggestions to non-equity markets? Please explain the
reasons for your views.
The UK recognises the need for consistent, high quality and reliable post-trade information. If a
post-trade transparency regime is introduced for non-equity markets it will be necessary to have
some form of APA regime in order to ensure the accuracy and quality of trade reports. As a
result, the UK fully supports the Commission‟s broad proposal in this regard.
The UK would note, however, that it may not be a straightforward process simply to apply the
proposed APA regime for equity markets to non-equity markets. Many non-equity instruments
(and, particularly, many OTC derivatives) can be considerably more complex and bespoke than
fungible equity instruments, which could result in challenges for APAs when monitoring. For
example, a key role of any APA would be to identify potentially erroneous information in trade
reports, which may be done by methods ranging from volume alerts and price benchmarks to
checks against static reference data. These aspects of non-equity instruments may vary
significantly due to the bespoke nature of some products. Taking this into consideration, any
APA regime introduced for non-equities would need to be suitably tailored to the asset classes to
which the transparency regime applied.
4.2. Reducing the cost of post trade data for investors
(47) What is your opinion of the suggestions for reducing the cost of trade data? Please explain the
reasons for your views.
The UK agrees there would be benefit in reducing the cost of trade data and welcomes the
Commission‟s proposal to require the unbundling of pre and post trade data. This should reduce
the costs for some users by enabling them to choose whether to purchase pre-trade data or
post-trade data. Further, most venues (RMs, MTFs and APAs for OTC data) already provide post-
trade transparency information to market participants for free 15 minutes after the initial
reporting of the trade.
(48) In your view, how far data would need to be disaggregated? Please explain the reasons for your
views.
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The UK supports the principle that pre- and post-trade data should be sold separately. The UK
would welcome a discussion of further disaggregation possibilities which could include
disaggregation by sector, country of listing, key index constituent etc.
(49) In your view, what would constitute a “reasonable” cost for the selling or dissemination of data?
Please provide the rationale/criteria for such a cost.
It is important that the calculation and delivery mechanism for the selling or dissemination of
data at a reasonable cost is qualitative not quantitative. Competition should be the main
mechanism between vendors for driving innovation to optimise data services supplied to financial
markets. The UK believes that the definition of reasonable cost will require further analysis and
consultation with competition authorities. Currently, the absence of a consistent EU-wide
framework is creating supervisory challenges. The UK would suggest that the Commission
advocate the development (through ESMA) of a qualitative framework ahead of any legislative
changes. Alternatively details could be left to ESMA to develop binding technical standards.
(50) What is your opinion about applying any of these suggestions to non-equity markets? Please
explain the reasons for your views.
In principle the UK can see merit in applying these principles to non-equity markets, where
appropriate. However, many non-equity markets have different trading structures and data
charging may therefore work very differently. In some instances charges may not be made for
data at all, or data may be bundled/disseminated in different ways to in the equity markets. It
may therefore take time to see how these markets evolve and what role data charging comes to
play. What will be important is to ensure that data charges do not become unreasonably high.
4.3. A European Consolidated Tape
(51) What is your opinion of the suggestion for the introduction of a European Consolidated Tape for
post-trade transparency? Please explain the reasons for your views, including the advantages and
disadvantages you see in introducing a consolidated tape.
The UK supports the introduction of a European consolidated tape. By consolidating post-trade
transparency information, which has become increasingly fragmented, market participants will
have the ability to access information from a single point, thereby increasing confidence and
certainty. Furthermore, a consolidated tape will assist with price discovery and allow market
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participants to efficiently monitor and compare information on prices emanating from a number
of different trading venues and OTC. It is also valuable as a tape of record.
(52) If a post-trade consolidated tape was to be introduced which option (A, B or C) do you consider
most appropriate regarding how a consolidated tape should be operated and who should
operate it? Please explain the reasons for your view
Option C is on balance our preferred solution, of those proposed. Option C would allow a
number of commercial providers to operate by adhering to stringent conditions, such as those
similar for the approval of APAs. This would promote competition, which would ultimately lead
to benefits for end-users.
Moreover, an industry-led solution would allow the development of a tape which would most
likely to meet fully the needs of its users. The UK notes that industry possesses the relevant
expertise and technology to implement a consolidated tape in a relatively short timeframe, with
some solutions already commercially available.
(53) If you prefer option A please outline which entity you believe would be best placed to operate
the consolidated tape (e.g. public authority, new entity or an industry body).
The UK does not support option A. The UK believes an industry body would be best placed to
operate the consolidated tape. US experience has shown that a utility model is unable to deliver
what many market users need in terms of functionality or speed.18
(54) On options A and B, what would be the conditions to make sure that such an entity would be
commercially viable? In order to make operating a European consolidated tape commercially
viable and thus attaining the regulatory goal of improving quality and supply of post-trade data,
should market participants be obliged to acquire data from the European single entity as it is the
case with the US regime?
Given the potential drawbacks of Options A and B it would be essential to conduct a thorough
cost-benefit analysis before proceeding with one of these options. However if one of these
options were to be selected, following the model used in the United States may be a possible
way in which the operation of a European consolidated tape could be commercially viable. This
would, however, need to be adapted to take into account the European model and market
structure to ensure fair distribution of revenues. A requirement placed on market participants to
acquire data would most likely be necessary. However, the UK sees it as sub-optimal approach to
18 See the “Seligman report”: http://www.sec.gov/divisions/marketreg/marketinfo/finalreport.htm#merits
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require participants to buy data, especially when the data may not necessarily be useful to those
who are required to buy it. Participants would likely continue to maintain their existing, direct
data connections to trading venues, as is often the case in the US, thus adding to costs.
(55) On option B, which of the two sub-options discussed for revenue distribution for the data
appears more appropriate and would ensure that the single entity described would be
commercially viable?
The first sub-option would be more likely to ensure that the single entity would be commercially
viable. It appears akin with current market practice in Europe which would create less disruption
for market participants and avoid some of the issues experienced around revenue-sharing that
the UK understands has arisen in the US.
If the second sub-option is implemented, it is important to ensure the fair and equitable division
of revenues between trading venues, market participants and APAs on the one hand, and the
entity responsible for operating the consolidated tape on the other.
(56) Are there any additional factors that need to be taken into account in deciding who should
operate the consolidated tape (e.g. latency, expertise, independence, experience, competition)?
The most significant market data issue that market participants have been raised with the UK is
ensuring that any operator of a consolidated tape provides data to the market as a whole on a
reasonable commercial basis. Concern has been expressed that, at present, what constitutes
“reasonable commercial terms” is unclear, and some participants consider current market data
charges are too high. The UK believes that care needs to be taken to ensure that those whose
existing business models rely on data sales do not find those models fundamentally undermined,
but it is clearly the case that further analysis needs to be done to determine what constitutes
reasonable charges for market data. Any consolidated tape provider will therefore need to be
able to balance these factors as part of its own business model and operation.
Furthermore, it is critical that data providers can respond rapidly and effectively to developing
market needs. Centrally operated systems tend to be relatively inflexible and unable to respond
rapidly or at all to market needs. For example, anecdote suggests that the centrally managed
feeds in the US are unable to deliver what some market users need in terms of functionality and
speed, and that market participants have to make additional alternative arrangements. This
suggests a solution delivered by a commercial provider is more likely to meet the industry‟s
needs.
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(57) What timeframe do you envisage as appropriate for establishing a consolidated tape under each
of the three options described?
Option A: 3-5 years
Any model that involves the development of new technology would be lengthy, complicated and
very expensive. The US proposal to build a consolidated audit trail system provides some
illustration of the time and costs involved (while the UK acknowledges that this system is
different to a consolidated tape, it would probably require building some similar infrastructure).
The SEC has estimated this system to involve upfront costs of $60 million + 262,500 hours and
then $100 million per year just for the central repository itself (costs to the industry for
appropriate systems are estimated to be substantially more – $1.9 billion + 7.75 million hours
upfront and $1.0 billion and 3.7 million hours per year)19.
Option B: 2-3 years
While this would still involve a public tender and selection of a consolidator by the Commission,
the UK believes there are some vital steps the Commission could take in the tender process to
reduce the time and costs to the industry and the Commission. These could include:
(a) Making use of existing mechanisms that receive and combine data, such as data
vendors;
(b) Requiring the consolidator to use technology and standards that are widely in use across
the EEA; and
(c) Allow the consolidator to provide value-added services based on the consolidated tape,
so long as they provide a basic version of the tape with the characteristics outlined by
the Commission.
Option C: 1 year or less
There are a number of vendors who already supply pre and post consolidated trade data
solutions. The industry possesses the relevant expertise and technology to implement a
consolidated tape in a relatively short timeframe. Providers would need to obtain data from the
numerous trade sources such that consistent and complete tapes are produced.
19
http://www.sec.gov/rules/proposed/2010/34-62174.pdf; http://www.sec.gov/news/press/2010/2010-86.htm
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(58) Do you have any views on a consolidated tape for pre-trade transparency data?
The UK does not consider a consolidated tape for pre-trade transparency data is needed at this
time. The creation of a consolidated tape for pre-trade transparency data may not meet the
varying needs of market participants or assist best execution requirements, for example where a
broker and client have agreed upon a particular best execution policy.
Moreover, factors such as the number20 and physical distance between execution venues
dispersed across the EU would have an impact on the effectiveness of such a model due to the
importance of low latency for many participants in the European trading environment. This
would mean that a consolidated tape of pre-trade data could never be any more than a guide,
even with the most technically advanced consolidation system and the fastest connection speeds
to each of the individual venues.
(59) What is your opinion about the introduction of a consolidated tape for non-equity trades?
Please explain the reasons for your views.
A consolidated tape could work for liquid standardised investments like corporate debt for
example the TRACE system in the US. However, there would be high up front costs for
introducing a consolidated tape for other non-equity trades given the institutional nature of the
non-equity market and the bespoke nature of the products. It would require quite different
structures for each type of derivative and class of derivative and the cost of maintaining static
data for bespoke non-equity trades, which may only trade once, would be significant.
Developing a consolidated tape would be extremely difficult and costly as it would require quite
different structures for each type of derivative and class of derivative.
The UK notes that the Commission‟s EMIR legislative proposal states that trade repositories will
be required to publish aggregate positions by class of derivatives. This will provide overall
transparency around the market and as such the UK does not consider the introduction of a
consolidated tape for non-equity trades is warranted at this time. If this measure were to be
explored further it would be important to conduct a full cost-benefit analysis.
5. COMMODITIES
Summary Comments
20
See http://fragmentation.fidessa.com/europe/
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The UK supports greater transparency in commodities derivatives markets, including the
proposed introduction of formalised position reporting for regulated markets and MTFs. This
should provide regulators a standardised and readily analysable data set and the key benefit of
being comparable across markets. Publishing position data, classified by trader type would
provide valuable additional transparency to the market and facilitate analysis of market trends
and historical development. In establishing such a system we encourage the Commission to
explore how classifications could be most closely aligned with the CFTC trader classification
system so that as wide a market picture as possible may be built from directly comparable data
sets. However, we urge caution on the adoption of price movement restrictions aimed at
reducing volatility since there is no conclusive evidence to support this and indeed significant
opinion suggests that restrictions may be counter-productive.
We do not believe there is a case for a significant change in the boundaries of MiFID as they
affect firms trading commodity derivatives. Changes to the exemption in Article 2 of MiFID need
to be carefully thought through to avoid bringing into the scope of MiFID firms who are not
systemically important and who mainly use financial markets to hedge risks arising from their
commercial activities. Wealso believe that changes to exemptions in MiFID should be assessed
alongside those in the Capital Requirements Directive, as the costs and benefits of decisions
about the boundaries of MiFID cannot be divorced from the regulatory regime that firms inside
the directive would face.
5.1. Specific requirements for commodity derivatives exchanges
(60) What is your opinion about requiring organised trading venues which admit commodity
derivatives to trading to make available to regulators (in detail) and the public (in aggregate)
harmonised position information by type of regulated entity? Please explain the reasons for your
views.
The UK supports the CESR advice to the Commission in relation to position reporting21. For
regulators, position reports are the most useful information for understanding market
behaviours, including for investigations, managing deliveries and judging orderliness of markets.
Introducing an EU wide reporting requirement should lead to standardisation of current ad hoc
position reporting arrangements, making data more easily comparable across different trading
venues. Such information would be easier for regulators to analyse, interpret and act where
necessary.
Public disclosure of aggregated position reports would provide:
21
See http://www.cesr-eu.org/index.php?page=document_details&from_title=Documents&id=7279
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(a) useful data to stakeholders seeking to interpret market behaviours,
(b) complement the data already provided by CFTC22
Public disclosure of aggregated position reports should also, for many commodities, enable a
wider and in some instances “whole market” view across regulated markets23. Greater public
disclosure of data should improve market confidence, provided the granularity of the data does
not lead to confidential information on individual positions becoming discernible as this would
damage market functioning.
(61) What is your opinion about the categorisation of traders by type of regulated entity? Could the
different categories of traders be defined in another way (e.g. by trading activity based on the
definition of hedge accounting under international accounting standards, other)? Please explain
the reasons for your views.
Classification of traders by type of regulated entity would provide a degree of certainty around
classification with infrequent changes. This would appear a relatively straightforward option
since the classifications are already defined and their allocation is subject to an existing regulatory
process.
The UK cautions however that since classification is ultimately determined by regulated firms, the
degree of certainty will inevitably be impacted by the degree of consistency of application of the
classifications by those firms.
Before addressing the point of hedge accounting, under some national GAAPs derivatives may
not be included on the balance sheet in any case which would affect any data collection exercise.
In addition, it is not possible to state that all derivatives not designated as hedging instruments
under the IAS 39 hedge accounting rules are taken out for speculative purposes. Hedge
accounting is an accounting choice where due to the mixed measurement model in accounting
standards, firms wish to eliminate asymmetry between derivatives which were measured at fair
value through profit and loss (FVTPL) that are used as part of risk management purposes to
hedge an item that is not measured at FVTPL to show the true economic effect in their income
statement. However, due to the strict requirements of applying hedge accounting, many firms
do not in fact apply hedge accounting. For example, a common reason is that non-financial
components of items cannot be hedged and therefore airline companies cannot apply hedge
accounting for the hedge of the commodity component of their future fuel costs.
22 CFTC‟s Commitment of Trader (“CoT”) Reports. See http://www.cftc.gov/MarketReports/CommitmentsofTraders/index.htm 23 By allowing comparison with positions on US Designated Contract Markets for which CoT reports are produced.
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The UK points though to the existing CFTC trader classification system and would emphasises
that European classification should be as closely as possible aligned with these. One of the
principal benefits of making further position data available would be to provide a wider view of
the market. The CFTC and European classifications need therefore at the least to be broadly
comparable to enable comparison between data sets.24
(62) What is your opinion about extending the disclosure of harmonised position information by type
of regulated entity to all OTC commodity derivatives? Please explain the reasons for your views.
The UK supports the CESR advice given to the Commission on this point.25 The UK has already
referred to the benefits potentially afforded by providing data sets which give wide coverage or
“whole market” views. Extending aggregated position disclosure to OTC markets would increase
this benefit further. The data collected on OTC positions collected by the trade repositories
mandated by EMIR should provide an appropriate database for achieving this objective. The UK
cautions again that the level of disclosure should not damage market functioning by allowing
confidential information on individual positions to be discerned. Therefore disclosure may not be
appropriate for all market types, particularly where there is low liquidity or relatively few
participants. Properly understanding at a granular level the characteristics of different
commodities markets will be essential.
(63) What is your opinion about requiring organised commodity derivative trading venues to design
contracts in a way that ensures convergence between futures and spot prices? What is your
opinion about other possible requirements for such venues, including introducing limits to how
much prices can vary in given timeframe? Please explain the reasons for your views.
The UK agrees that derivatives contracts traded on organised venues must be designed to ensure
convergence with the underlying physical. Indeed, the UK would expect that contracts traded on
European exchanges should already have been designed with convergence to the physical in
mind, as part of satisfying existing orderly markets objectives26. Convergence is important as
contracts go to delivery because it is of particular importance for market confidence that prices
should converge at this point.
The UK is aware of the operation of intra-day price limits in certain existing exchange traded
contracts. Clearly such provisions can act to restrict excessive price movements by “slowing a
24 The UK notes the initiatives of IOSCO‟s Commodity Markets Task Force which has already advance co-operation between regulators in relation to this type of reporting and suggest that it may be well placed to assist with alignment of classification systems. 25 See FN19 above. 26 Additionally the UK notes the guidance on convergence as a part of contract design contained in the 1997 Tokyo Communiqué on supervision of commodity futures markets, available at http://www.meti.go.jp/policy/commerce/intl/tkyc.pdf
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market down” and or giving it time to recover. This may be valuable if the price movement is
irrational and has caused “herding” to occur.
The UK cautions though that the operation of such limits may restrict a market from making
rational price movements which are needed because of changing fundamentals and that to
restrict these seems to us a danger which is not justified by the possible benefits. Further, the UK
notes that in many instances, when markets re-open following a pause brought about by virtue
of a price movement restriction, they may actually be more volatile than before the pause was
effected because of the “held back” trading which certain participants may need to have carried
out during the pause but were unable to. Also, participants may decide to route business to OTC
venues and away from exchanges during market pauses, particularly given that the cash markets
(and potentially linked or similar financial contracts available in other jurisdictions) to which many
financial commodity markets are linked will continue in operation during the financial market
pause.
The UK is not aware of conclusive evidence which suggests that markets where price movement
restrictions have operated have been less volatile than those without such restrictions.
The UK notes that commodities markets are diverse and therefore envisage that the ability to use
price limits amongst a regulator‟s toolset may be of value in certain limited circumstances, for
example in times of extreme market volatility. On balance though, the UK does not see a case
for their widespread introduction.
5.2. MiFID exemptions for commodity firms
(64) What is your opinion on the three suggested modifications to the exemptions? Please explain the
reasons for your views.
Article 2(1)(i) currently exempts persons who deal on own account, or provide investment
services in commodity and exotic derivatives to their parent company‟s‟ clients, on an ancillary
basis to the main business of the group. The Commission has proposed to narrow this exemption
by:
(i) clarifying that firms providing investment services to their parent company‟s clients cannot
deal on own account with those clients;
(ii) clarifying the meaning of ancillary which applies to both parts of the exemption.
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The proposed change in section 7.2.8 to reclassify matched principal trades as dealing on own
account also have an impact on the first of the Commission‟s proposals. This would prevent a
firm providing services in commodity and exotic derivatives to its parent company‟s clients from
entering into back-to-back transactions with those clients. It will be important for the
Commission to find out if potential users of the exemption enter into back-to-back transactions
as part of hedging physical and price risks. For example, it is sometimes necessary when
executing client orders on regulated markets trading commodity derivatives for the intermediary
to enter into the contract on exchange on a principal basis and therefore have a back-to-back
contract with their client.
The word „ancillary‟ appears in financial services directives other than MiFID, such as in Directive
2006/49/EC. Whilst an attempt to define it for the purposes of Article 2(1)(i) would not fix the
meaning of the word in its other uses it might have an influence on how they are interpreted. In
defining ancillary it would therefore be necessary to have regard to the other uses that are made
of the word in financial services legislation.
In defining ancillary it is important to ensure that it is not defined in such a narrow way that it
prevents commercial firms from using the exemption in Article 2(1)(i) when hedging physical and
price risks. Having both quantitative and qualitative criteria seem appropriate in an area where
drawing a line is not straightforward. However, suggesting a firm cannot have specific resources
or personnel for carrying out an ancillary activity is not consistent with allowing commercial firms
to use appropriate expertise when using financial markets or with the ordinary and natural
meaning of ancillary.
The Commission is also suggesting that Article 2(1)(k) that exempts firms whose main business is
dealing on own account in commodities and/or commodity derivatives (as long as they are also
not part of an investment services or banking group) is deleted. There is overlap between Article
2(1)(k) and other exemptions such that deletion of article will not necessarily bring a significant
number of firms into the scope of the directive.
Firms within Article 2(1)(k) might also be exempt by virtue of Articles 2(1)(d) and/or Article 2(1)(i).
This is because their main investment service/activity is likely to be dealing on own account in
commodity derivatives.
Article 2(1)(d) is an exemption that was clearly written with equities business in mind. The
Commission would need therefore need to consider clarifying how it is supposed to apply to
dealing on own account in commodity derivatives, particularly in relation to OTC trading.
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As indicated above, with Article 2(1)(i) it will be important that the definition of ancillary activity
is not drawn too narrowly so that commercial firms who are users of commodity derivatives
markets are brought into MiFID.
The Commission received advice on the exemptions from both CESR/CEBS and the European
Securities Markets Experts group. Both advised that there remains a justification for clearly
distinguishing between those using commodity derivatives markets to manage risks arising from
a commercial business and intermediaries. This is something we believe is reinforced by other
proposals in the consultation paper and in the draft European Markets Infrastructure Regulation
(EMIR) and Regulation of Energy Market Infrastructure legislation. Taken together what is
proposed would mean significantly more information would be made available to competent
authorities and to the market about the trading in commodity derivatives of commercial firms.
As the Commission is aware, a significant change in the boundaries of MiFID would have an
impact through EMIR. If a firm is inside MiFID then it will be subject to the obligation to clear
derivatives in EMIR. Commercial firms, except in certain circumstances, will not be subject to this
clearing obligation. A widening of the scope of MiFID would therefore narrow the scope of the
exclusion from the clearing obligation in EMIR with consequences for the costs of firms within
MiFID.
When the Commission began its review of the commodity exemptions in MiFID, with a Call for
Evidence at the end of 2006, it was considering the regulatory environment for commodities as a
whole. This included looking at the exemptions in MiFID alongside those in the Capital
Requirements Directive (CRD). This reflected the fact that the costs and benefits of decisions
about the boundaries of MiFID cannot be divorced from the regulatory regime that firms inside
the directive would face.
The consultation paper appears to indicate that consideration of the exemptions in MiFID is now
to happen separately from a consideration of those in the CRD. The UK believes that the
Commission should consider both sets of exemptions together even if this means delaying
consideration of the exemptions in MiFID. On the right prudential regime for specialist
commodity derivatives firms our starting point is that it is not appropriate to apply the CRD to
such firms.
5.3. Definition of other derivative financial instrument
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(65) What is your opinion about removing the criterion of whether the contract is cleared by a CCP or
subject to margining from the definition of other derivative financial instrument in the
framework directive and implementing regulation? Please explain the reasons for your views.
EMIR causes a problem for the definition of financial instruments in MiFID. The clearing
obligation in EMIR applies to financial instruments as defined in MiFID. Under MiFID a physically
settled commodities contract which is not traded on a regulated market or an MTF is a financial
instrument if it is not a spot contract and meets each of three criteria set out in Article 38 (1) of
the implementing regulation. The second criterion is:
“(b) it is cleared by a clearing house or other entity carrying out the same function as a central
counterparty, or there are arrangements for the payment or provision of margin in relation to the
contract”.
Whether certain commodities contracts are financial instruments under MiFID could therefore
hinge on whether or not the contract is cleared. This creates a potential circularity: whether the
clearing obligation in EMIR applies to some physically-settled commodities contracts could
depend on whether the contracts are cleared (because if it is not cleared then it would not be a
financial instrument under MiFID).
It is, however, important to be very careful about changes to Article 38 of the implementing
regulation. The Commission, Member States, CESR and industry spent a lot of time and effort
considering this when the implementing regulation was being negotiated. This was to ensure
that the definition of financial instrument drew an acceptable boundary between financial
instruments on the one hand and commercial forward contracts on the other. The UK believes
that hitherto the definition in the implementing regulation has been successful in drawing such a
boundary and does not believe that it is appropriate to significantly widen the existing definition
of financial instruments in relation to physically-settled commodity derivatives.
On balance the UK believes that deleting the criterion of cleared by a clearing house (although
not necessarily the wording on margin as commercial forward contracts often do not involve
margin payments) would not significantly change the boundary between financial instruments
and physical forwards.
The criterion in Article 38(1)(a) of the implementing regulation about contracts being
„…expressly stated to be equivalent to a contract traded on a regulated market, MTF or such
third country trading facility;” also remain important to distinguishing between contracts that are
financial instruments and those that are commercial forward contracts. They help give effect to
determining whether or not contracts are for commercial purposes by allowing the parties to
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indicate whether they are seeking to agree a contract which is equivalent to contracts which are
financial instruments by virtue of section C(6) of Annex I of MiFID (under which physically settled
commodity contracts are financial instruments if they are admitted to trading on regulated
markets and MTFs).
Changes to Article 38 of the implementing regulation would also probably require changes to
Article 2(1)(2) of MiFID and sections C(7) and C(10) of Annex I of MiFID. All these include
references to the clearing of contracts that are given effect by Article 38(1)(b) of the
implementing regulation.
5.4. Emission allowances
(66) What is your opinion on whether to classify emission allowances as financial instruments? Please
explain the reasons for your views.
A benefit of classifying emissions allowances as financial instruments would be the resulting
unified treatment of the entire emissions market (i.e. spot and derivative), although there would
be a corresponding divergence in treatment to the closely linked markets just mentioned. This
could pose difficulties for participants active in all of these markets because of the differing
approaches.
The UK acknowledges the incidences of phishing and the VAT fraud and that these have
damaged confidence in the overall emissions market, i.e. both spot and derivatives. Classifying
allowances as financial instruments would lead to the spot market being regulated and this could
contribute to mitigating that loss of confidence and to preventing further instances. The UK
suggests however that the problems referred to would not necessarily have been mitigated by
imposing financial regulation and that it is more appropriate to consider this in the context of
the overall emissions market review, rather than in the review of MiFID.
However, the UK is very mindful of the nature of participants in the emissions spot market and
that many participants, especially amongst SMEs, are “compliance only” participants, i.e. they
have no financial services motive associated with their participation. These types of participant
are likely to find the burdens of financial regulation onerous, yet the UK considers them unlikely
to pose significant systemic risk as a group. In view of the wider agenda to minimise
administrative burdens on SMEs and facilitate their growth, the UK emphasises therefore that if it
is decided to classify emissions allowances as financial instruments it would be essential to craft
an appropriate regulatory treatment for this type of participant. This could be achieved either by
exemptions or by integrating within financial services legislation an appropriate bespoke
approach.
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6. TRANSACTION REPORTING
(Q67-83)
Summary comments
The UK strongly supports the need of a robust transaction reporting regime in the EU. As the
Commission‟s consultation paper notes, transaction reporting is one of the main tools for market
abuse, therefore the requirements under MiFID need to mirror the scope of the Market Abuse
Directive (MAD). However, the UK believes that reporting should only be extended to new
instruments where it is clear that such information is useful for combating market abuse.
Extending the scope of transaction reporting to financial instruments that are admitted to
trading on MTFs and organised trading facilities would provide important information for
supervisors. However, the UK is mindful that this proposal might include a large numbers of
instruments that are primarily traded outside the EEA (e.g. listed securities from Asia) and for
which the need will be limited. The UK would recommend that the extension of the transaction
reporting obligation be limited to instruments solely admitted to an EEA MTF or organised
trading facility, except those instruments that are dual listed but whose main listing is on an EEA
MTF.
Similarly, the UK notes the proposal to require transaction reporting for all financial instruments
that „correlate‟ to instruments admitted to trading. The UK believes this would encompass a
huge number of additional reports given that the trading of nearly every financial instrument will
be correlated in some way to an instrument admitted to trading. The UK would suggest
replacing the work „correlate‟ with „depend on‟ in order to avoid the extension of reporting to
unnecessary instruments.
The UK would also like to call on the Commission to give careful consideration to the significant
amount of time and costs of creating a transaction reporting mechanism at EU level. The UK
experience in this field demonstrates that this type of project would imply substantial technical
and resource investment. In addition, the UK is concerned about the efficiency and
responsiveness of such a system (supporting thousands of direct bilateral connections and
managing c. 30+ million reports daily). It is therefore essential that the Commission‟s impact
assessment takes these aspects into account.
6.1. Scope
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(67) What is your opinion on the extension of the transaction reporting regime to transactions in all
financial instruments that are admitted to trading or traded on the above platforms and
systems? Please explain the reasons for your views.
The Commission is proposing to extend transaction reporting regime to transactions in all
financial instruments that are admitted to trading or traded on MTFs and organised trading
facilities (OTFs). Since the MiFID transaction reporting regime is one of the principal tools for
market abuse, the UK agrees that it is important for the MiFID regime to be aligned with the
Market Abuse Directive (MAD). Moreover, from a market monitoring perspective, competent
authorities must have regular information about the trades on financial instruments negotiated
only in the so called alternative markets (MTFs and other trading facilities).
However, we are concerned about the Commission‟s proposal to extend transaction reporting to
all financial instruments that are admitted to trading on MTFs and other organised trading
facilities (OTFs) as a large number of dual listed securities will become reportable with no
additional benefit to its monitoring. For example, if a London firm trades an Asian stock on a
German MTF (and this stock is admitted to trading on the German MTF and on the Hong-Kong
Stock Exchange), the UK would not gain any additional benefit from collecting transaction
reports on this Asian stock. For this reason, the UK believes the Commission should follow CESR
advice and limit the transaction reporting extension to instruments that are „solely‟ or „only‟
admitted to trading to those trading platforms, except those instruments that are dual listed but
whose main listing is on an EEA MTF27.
(68) What is your opinion on the extension of the transaction reporting regime to transactions in all
financial instruments the value of which correlates with the value of financial instruments that
are admitted to trading or traded on the above platforms and systems? Please explain the
reasons for your views.
The Commission is proposing to extend transaction reporting to financial instruments the value
of which correlates with the value of financial instruments that are admitted to trading or traded
on RM, MTFs and OTFs.
The UK is concerned about the use of the word „correlate‟. Arguably, all financial instruments are
correlated in one way or the other. For instance, an EU stock can be correlated to a US stock (i.e.
a European Airline‟s shares‟ performance might be impacted by the economic activity of an US
27 For example, China Shoto Plc is a stock whose main listing is on AIM, but it is also traded in the Bloomberg Bulletin Board and therefore we would want to collect transaction reports on this stock although it is a dual listed stock.
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oil producer). Under the proposal, the US stock would potentially become reportable however,
collecting this information would provide no additional benefit to EU market surveillance.
The UK believes the proposal should be changed to include OTC derivatives whose value is
„dependent‟ on a financial instrument admitted to trading in a regulated market or an MTF as
advised by CESR. Collecting this information enhances the Competent Authorities‟ ability to
detect suspicious activities since OTC derivatives are intensively used as an alternative to the
“traditional” financial instrument.
In addition, the UK believes reporting should not apply to a transaction in any OTC derivative, the
value of which is derived from or is otherwise dependent on indices or baskets of securities (i.e.
OTC option on FTSE 100) except where those securities are issued by the same issuer28.
(69) What is your opinion on the extension of the transaction reporting regime to transactions on
depository receipts that are related to financial instruments that are admitted to trading or
traded on the above platforms and systems? Please explain the reasons for your views.
This extension would include depository receipts not admitted to trading on a regulated market,
MTF or an organised trading facility but that relate to financial instruments that are admitted to
trading on the above platforms. Therefore the transaction reporting regime would be extended
to overseas depositary receipts. Competent Authorities would have difficulties in getting the
relevant reference data29 from overseas trading platforms as these have no regulatory obligation
to provide this information to EEA regulators.
(70) What is your opinion on the extension of the transaction reporting regime to transaction in all
commodity derivatives? Please explain the reasons for your views.
We agree in principle that the requirements under MiFID need to mirror the scope of the MAD.
For this reason we agree transaction reporting should cover commodity derivatives if they are
admitted to trading on a regulated market or MTF. (In developing this proposal we urge the
Commission to take into account the 2007 CESR agreement30 which provides for exchanges,
rather than firms, to submit transaction reports for commodity, interest rate and foreign
exchange derivatives.)
28 For instance, a swap on a basket constituted by Vodafone shares and Vodafone bonds. should be transaction reported because the underlying securities have all been issued by the same issuer (Vodafone). 29
Reference data is required in transaction reporting to validate the content of the reports. 30 CESR members agreed that the home Competent Authority of commodities derivatives markets would receive transaction reports directly from their regulated markets. Instead of automatically exchanging those reports (through TREM), the authority for the market would store the data and respond on an ad-hoc basis to requests for transaction reports from other CESR members.
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However there has been no consultation so far on the possibility, floated in the consultation, of
extending the scope of MAD to capture “market manipulation of commodities markets through
commodity derivatives markets”. We are reluctant to take a view on the associated transaction
reporting measure before more detail is available on the possible MAD provision. Nonetheless we
would at this stage make the following comments about the proposal to extend the new MiFID
transaction reporting framework to all commodity derivatives, including OTC commodity
derivatives:
(a) There would be significant technical difficulties and financial efforts involved in extending
transaction reports to all commodity derivatives. Commodity business is a specific activity
and different from cash market activity. Given in particular the need for specially-tailored
transaction reports on OTC derivatives, it would take a significant period of time for both
firms and Competent Authorities to make the necessary adjustments.
(b) Unlike other instruments on which transaction reports are collected, OTC commodity
derivatives (and their corresponding underlyings) do not have universally recognised
identifiers such as ISIN codes, which regulators rely on for monitoring transactions.
(c) The risk of abuse in this area relates more to market manipulation (such as market
“squeezes”) than insider dealing meaning that position reports collected by exchanges are
a more valuable tool in this respect. Indeed we note that without knowledge of a firm‟s
position in the underlying commodity a transaction could appear suspicious when it is fact
a hedge for an underlying position.
(d) Finally, Trade Repositories under EMIR will also collect information on OTC derivatives on
commodities. Therefore, the UK would urge the Commission to consider whether the
information collected by Trade Repositories would suffice for the purpose of market
monitoring, avoiding therefore the creation of a duplicate set of data.
(71) Do you consider that the extension of transaction reporting to all correlated instruments and to
all commodity derivatives captures all relevant OTC trading? Please explain the reasons for your
views.
The UK believes that the above proposals would include more information than needed for EEA
market surveillance.
(72) What is your opinion of an obligation for regulated markets, MTFs and other alternative trading
venues to report the transactions of non-authorised members or participants under MiFID?
Please explain the reasons for your views.
The UK supports the obligation for regulated markets, MTFs and other alternative trading venues
to report transactions of non-authorised members or participants under MiFID since trades
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executed by such firms contribute to the price formation process for the trading venue involved
and should therefore be subject to the MiFID transaction reporting requirements. Not collecting
this information is a serious gap in the current transaction reporting regime.
(73) What is your opinion on the introduction of an obligation to store order data? Please explain the
reasons for your views.
The UK supports in principle the idea of amending the framework directive to oblige regulated
markets, MTFs and organised trading facilities to store order data in a manner accessible to
supervisors. This will give regulators the reassurance that the data will be easily accessible for
their market abuse investigations. However, this proposal will need to be supported by a cost-
benefit analysis.
(74) What is your opinion on requiring greater harmonisation of the storage of order data? Please
explain the reasons for your views.
The UK is supportive of greater harmonisation as it would facilitate cross-market investigations of
cases and allow data to be available both with an appropriate level of exactness and with a
sufficient audit trail.
6.2. Content of reporting
(75) What is your opinion on the suggested specification of what constitutes a transaction for
reporting purposes? Please explain the reasons for your views.
This definition is suitable for transactions on cash equities and bonds. However, it might not be
suitable for OTC derivatives. Certain essential characteristics of OTC derivatives trades might
change without an economic reason (i.e. lifecycle events) for it and this change should be
captured by the transaction reporting regime. For example, in a Credit Default Swap (CDS), one
of the parties of the CDS contract might be replaced by another party during the life of the
contract, changing the exposure of the participants. Although there is not an effective buy or
sell, this change should be reported for the purpose of market surveillance.
(76) How do you consider that the use of client identifiers may best be further harmonised? Please
explain the reasons for your views.
The UK is very supportive of the requirement for Competent Authorities to collect the client side
information. This is a valuable input for market surveillance purposes. It is essential to identify the
initiator or beneficiary of a trade to enable the detection of market abuse and to protect the
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markets integrity. As far as further harmonisation on the use of client identifiers is concerned, the
UK is of the opinion that this should be part of the binding technical standards to be developed
by ESMA.
(77) What is your opinion on the introduction of an obligation to transmit required details of orders
when not subject to a reporting obligation? Please explain the reasons for your views.
The UK is unclear whether the Commission‟s proposal of obliging firms to transmit required
details of orders includes the transmission of client details along the chain to the executing
broker.
In the UK‟s view, the obligation to transmit client details cannot be dependent on a reporting
obligation. It should be the reverse. The firms need to decide, firstly, whether they want to pass
the client details along the chain and then, dependent on this decision, a transaction reporting
obligation may arise. If the obligation existed, many intermediary businesses would be negatively
impacted as they would potentially lose their clients (to the executing brokers).
The UK suggests that the Commission follows CESR‟s advice and leave the choice to the firm to
either pass on the client information or assume the obligation to report the trade to the
Competent Authority themselves. This approach would achieve the same goal from a supervisory
point of view.
(78) What is your opinion on the introduction of a separate trader ID? Please explain the reasons for
your views.
The UK does not see the benefit of including this additional field in the transaction reporting as
the vast majority of the trading activity is undertaken by computerised systems. Moreover, where
the trade was initiated by a client, there is no obvious advantage in adding the trader ID to the
set of information. The UK believes that the costs of making the necessary adjustments to the
current transaction reporting to include the trader ID out weighs the value of adding this
information. We would be interested to see the Commission‟s cost-benefit analysis on this point.
(79) What is your opinion on introducing implementing acts on a common European transaction
reporting format and content? Please explain the reasons for your views.
The UK fully supports harmonisation of transaction reporting as it would allow Competent
Authorities to understand the exchanged information on transactions. We also support the
introduction of implementing acts to progress the harmonisation. We would recommend that
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each step towards harmonisation must be strongly supported by rigorous cost and benefit
analysis and for Member States to be given sufficient time for implementation.
6.3. Reporting channels
(80) What is your opinion on the possibility of transaction reporting directly to a reporting mechanism
at EU level? Please explain the reasons for your views.
The Commission is proposing to amend the framework directive to enable investment firms to
report directly to a reporting mechanism at EU level.
The UK agrees that it is essential for competent authorities to have access to transaction data.
However, we would encourage the Commission to consider further the cost implications and
operational challenges of their proposals.
The FSA currently collects around 70% of the European transaction reporting flow. The FSA‟s
experience suggests that setting up a new centralised transaction reporting system (database)
would involve considerable time and cost (for example, the definition of requirements and
technical specifications, system development, system testing and the actual implementation).
There would be significant technical and resource constraints to support potentially thousands of
direct bilateral connections from EEA investment firms and to manage c. 30+ million reports on
a daily basis with an indeterminate on-line period for the facilitation of trade amendments and
cancellations.
The Commission suggests that a centralised database would remove the costs of running
separate databases. However we would emphasise that Competent Authorities would still require
systems to assimilate and assess the information collected by that centralised body, and will
already have invested in such systems. Moreover, from the perspective of a major recipient of
European transaction reports like the UK, this proposal could imply a significant number of
transaction reports being transferred from domestic firms to the centralised database and then
back to the Member State where the relevant firm is regulated. In considering potential
efficiencies the Commission needs to be mindful of this consequential inefficiency.
(81) What is your opinion on clarifying that third parties reporting on behalf of investment firms need
to be approved by the supervisor as an Approved Reporting Mechanism? Please explain the
reasons for your views.
In the UK transaction reports are reported to the regulator through Approved Reporting
Mechanisms (ARMs) that comply with specific requirements detailed in Article 12 of the MiFID
Level 2 Regulation. Firms seeking to become an ARM have to apply for ARM status and have to
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comply with strict technical specifications. Currently, the UK has seven ARMs that are directly
connected to the FSA UK system. The Commission‟s proposal would potentially oblige several
investment firms31 to become ARMs and this would significantly increase the number of direct
connections to the FSA‟s system which it would not be set up to technically support.
In addition, the only official sanction currently available for late, lost or invalid reports caused as a
result of ARMs processing, would be suspension or removal of their ARM status. This would be
invoked if the UK determined that the ARM no longer met the Article 12 MiFID regulation
conditions. This creates a rather extreme range of options when dealing with lower-level
breaches. Therefore the UK suggests that if the Commission takes forward this proposal then the
ARMs regime should be broadened to allow Competent Authorities to introduce a wider range
of proportionate sanctions.
(82) What is your opinion on waiving the MiFID reporting obligation on an investment firm which has
already reported an OTC contract to a trade repository or competent authority under EMIR?
Please explain the reasons for your views.
The UK would support in principle the Commission‟s proposal on waiving the MiFID reporting
obligation on an investment firm which has already reported an OTC contract to a trade
repository or competent authority under EMIR, so long as the standards defined under EMIR also
comply with the MiFID standards.
However, the UK would urge the Commission to consider that the purpose of trade repositories
is to capture systematic risk and not to monitor for market abuse and recommend to keep these
two distinct regulatory objectives separated.
(83) What is your opinion on requiring trade repositories under EMIR to be approved as an ARM
under MiFID? Please explain the reasons for your views.
The UK agrees that once Trade Repositories (TRs) are fully established, transaction reports could
be reported through these TRs so long as the TRs comply with MiFID obligations. From a
supervisory perspective, it is essential for TRs to comply with MiFID and, as a consequence, to be
recognised and approved as an ARM complying with the technical specifications.
7. INVESTOR PROTECTION AND PROVISION OF INVESTMENT SERVICES
(Q84-124)
31
In the UK, some investment firms have arrangements with other investment firms whereby one firm reports on behalf of the other firm.
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Summary Comments
We have pursued a strong agenda on investor protection in the UK. As well as through our
implementation of MiFID‟s conduct of business rules (largely consistent with our pre-existing
standards of investor protection), through initiatives such as the proposals under the Retail
Distribution Review (RDR)32 and a new consumer strategy for regulating firms‟ conduct with their
retail consumers, we continue to work to ensure that investors are suitably protected and receive
clear and unbiased advice.
We therefore strongly support the Commission‟s work to increase the overall level of protection
for investors across the EU and enhancing the single market through greater harmonisation. At
the same time we must be conscious of the economic and social need to provide investors with a
choice of services at reasonable prices, particularly during a time of economic recovery.
We believe that the review of the MIFID Directive will play an important role in creating this
framework for investors.
When receiving investment advice investors are placing reliance on others to guide them to make
effective investment decisions. We therefore welcome the proposals to strengthen the selling
practices regime in this area. It is crucial that investors receive the information they need to
make decisions about investment services and advice and we agree that firms providing
investment advice should be required to make it clear on what basis this is provided. It is
important that in setting the standard for independent advice, it must be comprehensive and
unrestricted in its considerations of different products, providers and type of products. Where
this is not the case, consumers should fully understand they are being advised on a restricted
section of the market and that there may be more suitable products available elsewhere.
Our own experience is that there is significant potential for commission bias to drive consumer
detriment and undermine consumer confidence and we welcome the Commission‟s attention to
inducements. However, in order to reduce consumer detriment and help consumers fully
understand their relationship with their adviser, no firms providing investment advice should
have their remuneration set by product providers. Supervisors also need to be more proactive in
preventing consumer detriment, and they will be assisted in doing this if there are clearer
obligations on firms to have proper governance and controls on new products and services.
Furthermore, there are two areas where we have significant concerns.
32
http://www.fsa.gov.uk/pages/About/What/rdr/index.shtml
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The first is in relation to the so-called „execution-only‟ regime. We believe that it is wrong to
suggest that all financial services are inherently complex. More investor education is needed but
we must leave a space for people to make their own investment decisions within parameters that
provide protection in appropriate circumstances. MiFID allows execution-only services only in
limited prescribed circumstances, where the risks posed for the clients in question should be
smaller. To remove this option will increase the cost and complexity of the sales process by
requiring firms ask all clients about their knowledge and experience without, in our view,
providing necessary additional protections for non-complex products sold at the initiative of the
client that justify this increased cost and complexity. The current regime works well and there is
no justification for a significant intervention.
Second, while we believe that the client classification regime could be re-examined to ensure it
does not deter high net worth individuals like business angels from investing in high growth
SMEs, we do not support the proposed changes to the classification regime. The problems
discussed around client categorisation in the consultation paper relate not to misclassification
but to the failure to apply the substantive selling provisions of the Directive. A significant space
must be left for wholesale financial services to be conducted on a counterparty basis. This will be
important to retaining Europe‟s attractiveness as a global location for wholesale financial services
business.
7.1. Scope of the Directive
(Q85-86)
(84) What is your opinion about limiting the optional exemptions under Article 3 of MiFID? What is
your opinion about obliging Member States to apply to the exempted entities requirements
analogous to the MiFID conduct of business rules for the provision of investment advice and fit
and proper criteria? Please explain the reasons for your views.
We support the proposal to limit the optional exemptions under Article 3 of MiFID. We do not
expect that analogous national legislation to introduce the proposed high level principles in
Article 3 of MIFID (proper authorisation process, including the assessment of the fit and proper
criteria; information to clients; suitability; payments received from third parties (inducements);
reporting to clients; and duty to act in the best interest of the client when transmitting orders
received from clients), would have a significant impact on Article 3 firms in the UK. Article 3 firms
in the UK are already subject to rules adapted from MiFID covering the areas suggested.
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(85) What is your opinion on extending MiFID to cover the sale of structured deposits by credit
institutions? Do you consider that other categories of products could be covered? Please explain
the reasons for your views.
We agree with the proposals to extend MiFID to cover the sale of structured deposits by credit
institutions. In the UK, the issues we have tended to see on structured deposits relate to
consumers not understanding how structured deposits work or consumers not understanding
that penalties can apply, for example for early withdrawals. Additionally, we have a number of
concerns that focus particularly on how such products are described and offered to consumers.
For example, some structured deposits have been described as „guaranteed‟, „protected‟, or
„secure‟ without justification. As a result we consider that extending the MiFID provisions,
including the requirement that all information addressed to clients or potential clients shall be
fair, clear and not misleading, to cover the sale of structured deposits would be appropriate.
It will also be important for the MiFID proposals to clarify that even if some of its provisions apply
to structured deposits, the products remain deposits and are still covered by the Deposit
Guarantee Schemes Directive (DGSD) for compensation purposes (rather than the Investor
Compensation Schemes Directive which covers MiFID products).
(86) What is your opinion about applying MiFID rules to credit institutions and investment firms
when, in the issuance phase, they sell financial instruments they issue, even when advice is not
provided? What is your opinion on whether, to this end, the definition of the service of execution
of orders would include direct sales of financial instruments by banks and investment firms?
Please explain the reasons for your views.
We agree that it should be clear in MiFID that when a credit institution or investment firm
directly sells financial instruments that they issue through their distribution channels that the
MiFID conduct of business rules apply. However, we do not think that issuing of shares by a
credit institution or investment firm in itself means that the relevant credit institution or
investment firm is performing an investment service.
7.2. Conduct of business obligations
(Q87-110)
(87) What is your opinion of the suggested modifications of certain categories of instruments
(notably shares, money market instruments, bonds and securitised debt), in the context of so-
called "execution only" services? Please explain the reasons for your views.
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We agree that shares in companies trading on regulated market or an MTF or an equivalent third
country market, and bonds and securitised debt trading on regulated market or an equivalent
third country market, will generally face strict listing and / or admission requirements and should
therefore be treated as automatically non-complex.
We also agree that certain bonds and money market instruments that embed a derivative or
incorporate structures which make it difficult for the client to understand the risk could be
treated as complex. The Commission could consider incorporating into legislation a criterion of
having a structure which makes it difficult to understand the risk involved. The FSA has seen
several debt instruments with complicated underlyings which have been missold to investors.
(88) What is your opinion about the exclusion of the provision of "execution-only" services when the
ancillary service of granting credits or loans to the client (Annex I, section B (2) of MiFID) is also
provided? Please explain the reasons for your views.
We tentatively support this proposal to require firms to perform an appropriateness test in these
circumstances to establish whether the client has the necessary knowledge and experience to
understand the risks, regardless of whether the financial instrument is complex or non-complex.
However careful consultation will be necessary in order to identify any possible unintended
consequences and practical difficulties with the proposal.
(89) Do you consider that all or some UCITS could be excluded from the list of non-complex financial
instruments? In the case of a partial exclusion of certain UCITS, what criteria could be adopted to
identify more complex UCITS within the overall population of UCITS? Please explain the reasons
for your views.
UCITS are regulated products and that regulation is designed to ensure that they are products
which are appropriate for retail investors. If some UCITS were deemed to be complex products, it
would dilute the strong worldwide brand that the UCITS framework has developed and be
inconsistent and confusing for investors. There would also be practical problems with trying to
determine what constitutes 'complex portfolio management techniques', how this approach
would apply to collective investment schemes which are not UCITS funds and how information
on the designation of UCITS would be communicated to intermediaries selling UCITS.
(90) Do you consider that, in the light of the intrinsic complexity of investment services, the
"execution-only" regime should be abolished? Please explain the reasons for your views.
No, the “execution only” regime has worked well and should be retained. Any such change
would restrict the ability of investors who are sufficiently competent to invest in non-complex
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investment instruments. At a time when it is important to persuade people to engage with
financial services it would be very unhelpful, and we believe wrong, to suggest that all financial
instruments are so inherently complex it is necessary for investment firms to judge whether or
not they are appropriate for all potential investors.
The main impact of the requirement that clients buying any financial instrument should provide
information about their knowledge and experience would be to add a layer of complexity and
cost to the sales process. For example, some firms in the UK currently send out general mailings
to clients and potential clients concerning sales of shares admitted to trading on regulated
markets and UCITS. These mailings enable clients to make purchases by filling out a form with
know your customer and payment details and posting it back to the firm. The size of the form to
be filled out would need to increase to include questions about knowledge and experience and
the firm would need to do more processing work than currently on receipt of the completed
form. Clients who refuse to answer such questions would not be able to buy or sell financial
instruments on a non-advised basis.
We see the proposals in section 7.3.3 of the consultation paper (see question 115 below) as a
better way of dealing with the concerns that has given rise to this proposal.
(91) What is your opinion of the suggestion that intermediaries providing investment advice should:
1) inform the client, prior to the provision of the service, about the basis on which advice is
provided; 2) in the case of advice based on a fair analysis of the market, consider a sufficiently
large number of financial instruments from different providers? Please explain the reasons for
your views.
We believe that it is crucial that investors have all the necessary information to help them make
informed decisions about which adviser they want to use and what services they want to receive.
This must include information about the basis on which an investment firm will be providing
advice.
Under the Retail Distribution Review in the UK, firms providing investment advice will describe
their services as either „independent‟ or „restricted‟. These labels, which were devised with the
assistance of consumer testing33
, are to be used to distinguish when a firm provides either i)
comprehensive, broad-based advice looking at a sufficiently large number of financial
instruments or ii) more limited advice (e.g. advice on the products of only a few firms). To make
sure that investors receive clear, comprehensible information about the type of advice they are
33
Consumer Research 78 „Describing advice services and adviser charging‟ prepared for the FSA by IFF Research (June 2009) http://www.fsa.gov.uk/pubs/consumer-research/crpr78.pdf
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being offered, broad labels of this sort might usefully be applied to investment advice services -
either through EU legislation, or as appropriate, within Member States.
In setting the standard for those firms providing advice on the basis of an „independent and fair
analysis‟ it will be important to get right the breadth of the range of financial instruments that
such firms consider in providing advice. They should, in the light of the circumstances of the
client, be offering a comprehensive consideration of the relevant products available, without bias
or restriction. If the consideration is not comprehensive then this risk undermining the
achievement of „fair analysis‟ and clients being advised to buy sub-optimal products because the
firm providing investment advice has not considered the full range of relevant products.
We do not believe it is appropriate that firms providing investment advice, however it is
described, should have the level of their remuneration for the advice determined by product
providers. It is vital that investors can trust firms that provide them with advice to make
recommendations that cannot be biased by commission payment. Even where investment advice
does not cover a wide range of products, it is still important that advice on individual products is
not influenced by the remuneration received if the client buys one product rather than another.
Also, we believe that firms may simply stop describing their advice as „independent‟ if this would
allow them to continue to receive significant payments in return for recommending particular
products, making it difficult for consumers to choose between the different types of advice on
offer.
In respect of investment advice we support the suggestion made by CESR, that is mentioned in
the consultation paper, about amending the directive in order to clarify that information
provided through distribution channels can, when it meets all the other relevant tests in the
directive, constitute investment advice.
(92) What is your opinion about obliging intermediaries to provide advice to specify in writing to the
client the underlying reasons for the advice provided, including the explanation on how the
advice meets the client's profile? Please explain the reasons for your views.
We believe that there should, in certain circumstances, be an obligation on investment firms to
report to clients on the underlying reasons for the advice provided. The obligation should apply
where a firm is providing advice in relation to products which it is proposed should fall within the
PRIPs definition. We believe that suitability reports are important in these situations because of
the range of substitutable products that could be recommended and the link to long-term
savings decisions. Just as in the case of advice on individual shares and bonds, though, it may be
disproportionate to require suitability reports for recommending at least some types of
derivatives (e.g. single-share futures), where the same issues of substitutability do not arise.
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We also suggest that the Commission revisits the requirements on suitability in Article 35 of the
implementing directive to ensure that investment firms that give advice understand the duties
placed upon them. In particular, it could be highlighted that the suitability obligation necessarily
requires the firm making a recommendation to consider the costs and features of any product or
service to be recommended and, as appropriate, to make a comparison between the new
product or service and any existing investments that it will replace. These are areas where we
have found there can be particular failings in investment firms‟ suitability assessments.
(93) What is your opinion about obliging intermediaries to inform the clients about any relevant
modifications in the situation of the financial instruments pertaining to them? Please explain the
reasons for your views.
In a situation in which a client enters into a long-term relationship with an investment firm we
believe that it is appropriate for investment firms to keep clients updated, unless the client opts
out of receiving such updates. This obligation should not apply where the relationship between
the client and the investment firm is focused just on transactions and does not involve the
provision of custody services to the client. The trigger for the obligation to inform should not be
set at a level that requires investment firms to report frequently, except in exceptional
circumstances. Clients are unlikely to appreciate receiving a constant flow of reports from their
intermediary and as a result may fail to pay attention to the importance of any individual report.
(94) What is your opinion about introducing an obligation for intermediaries providing advice to keep
the situation of clients and financial instruments under review in order to confirm the continued
suitability of the investments? Do you consider this obligation be limited to longer term
investments? Do you consider this could be applied to all situations where advice has been
provided or could the intermediary maintain the possibility not to offer this additional service?
Please explain the reasons for your views.
We believe that firms offering investment advice should have a choice as to the sort of services
they offer and that clients should, in turn, have the right to decide what types of service they
want to buy. This should include giving firms the right to offer investment advice on a
transactional basis, i.e. without involving a commitment to an ongoing relationship with the
client. Requiring that a firm offering investment advice always has to enter into a long-term
relationship with the client will commit the client to making ongoing payments to the firm. This
is not something that the client will always want to do; may not be suitable for the
circumstances in which the client has sought the advice; and could even reduce access to advice
amongst individuals with simple requirements or little to invest. However, it should be made very
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clear to clients in advance of the type of service that they are signing up for so that if they
purchase transactional advice they will not get any further advice unless they approach the firm
again.
Where the client enters into a long-term relationship with an investment firm for the provision of
investment advice, evidence of which would be that they make ongoing payments to the
investment firm, for the provision of investment advice we agree that it is appropriate for the
investment firm to seek to update information about the client and to reaffirm that the client‟s
investments remain suitable on at least an annual basis. We believe that clients should be able to
opt out of receiving six-monthly information on the market value and performance of the
financial instruments recommended to them. Not all clients will want or need this information
when they are in a long-term advisory relationship.
(95) What is your opinion about obliging intermediaries to provide clients, prior to the transaction,
with a risk/gain and valuation profile of the instrument in different market conditions? Please
explain the reasons for your views.
(96) What is your opinion about obliging intermediaries also to provide clients with independent
quarterly valuations of such complex products? In that case, what criteria should be adopted to
ensure the independence and the integrity of the valuations?
(97) What is your opinion about obliging intermediaries also to provide clients with quarterly
reporting on the evolution of the underlying assets of structured finance products? Please explain
the reasons for your views.
We agree that in the light of the financial crisis that there is a need to improve the information
available to investors in asset backed securities and other complex products. Ensuring investors
have access to information is a key part of a series of important reforms to the financial system to
ensure investors understand their investments and are not overly reliant on third parties such as
rating agencies. This direction of reform is already evident elsewhere, such as the reforms to
securitisation in CRD article 122a which require much greater due diligence by investors, and in
the Credit Rating Agencies directive.
However, it is important to ensure that the information provided to investors is relevant to the
products concerned and emphasises the importance of investors developing their own
understanding. The proposal to provide risk/gain profiles and valuations of complex products is
not consistent with either of these principles. The valuation of complex products such as
securitisations is highly sensitive to a range of modelling assumptions. Any one particular
valuation is not in itself particularly informative or an objective fact. Rather than relying on a
particular valuation, it is very important for investors to understand the assumptions driving
different valuations and take a view on whether they share those assumptions. The transparency
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and reporting requirements recently put in place for securitisations by the European Central Bank
and the Bank of England recognise this by requiring disclosure not of static valuations but of a
cashflow model and asset data that investors can use to reach their own conclusions. The ECB
and BoE proposals have been well received by the industry and significant progress has been
made towards adopting them.
For securitisations we recommend that the Commission should pick up these already very
effective ECB/BoE proposals as part of the MiFID review and also consider what lessons they
provide for improving investor information about other complex products.
(98) What is your opinion about introducing an obligation to inform clients about any material
modification in the situation of the financial instruments held by firms on their behalf? Please
explain the reasons for your views.
It appears from the question that this obligation is intended to apply all financial instruments.
We believe that there might be a case for introducing such an obligation but that there are three
conditions that would need to be satisfied:
First, that the obligation does not cut across firms‟ existing obligations in Article 29 (6)
of the MiFID implementing directive, to update clients when there is a material change
in information they have previously supplied and an obligation, and Article 43 (1) of the
MiFID implementing directive, to provide annual reports to clients for whom they hold
financial instruments.
Second, that the threshold for reporting is set sufficiently high that clients are not
subjected to (and investment firms are not required to produce) a constant stream of
updates such that they do not pay attention when information of real significance is
provided.
Third, the obligation is to take „reasonable steps‟. A completely open ended obligation
might cause difficulties in particular if an investment firm holding the instrument on
behalf of a client no longer has a business relationship with the product provider. Clients
should have to right to waive any reporting requirement, albeit it would need to be clear
that firms should not encourage their clients to waive their rights in this respect.
(99) What is your opinion about applying the information and reporting requirements concerning
complex products and material modifications in the situation of financial instruments also to the
relationship with eligible counterparties? Please explain the reasons for your views.
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As set out above we believe the Commission should build on existing initiatives to improve on
information available to investors about complex products. This should result in more
information being available to all investors regardless of their classification. We do not, however,
believe that it is necessary to introduce specific rules governing investment firms‟ information and
reporting obligations when dealing with eligible counterparties (beyond requiring that all
information disclosed is far, clear and not misleading). The initiative discussed in our response to
questions 95 to 97 makes information available to all investors whatever their classification. It
would not appear to be necessary to go beyond this to impose specific obligations on those
distributing products with respect to their dealings with eligible counterparties.
(100) What is your opinion of, in the case of products adopting ethical or socially oriented investment
criteria, obliging investment firms to inform clients thereof?
Information to clients has to be fair, clear and not misleading. Therefore where products or
services are labelled as ethically or socially responsible, investment firms are already under an
obligation to make clear to clients what this means. Also investment firms have to respond to
reasonable requests from clients for information about products and services which are not
specifically labelled as ethically or socially responsible to enable the clients to form a view about
the ethical or social responsibility of those products or services. In both cases, ESMA may want
to consider whether specific guidance is required on investment firms‟ obligations but we do not
believe that it is necessary to impose a more general obligation on investment firms to make
disclosures about the ethical or social dimensions of each and every product or service.
(101) What is your opinion of the removal of the possibility to provide a summary disclosure
concerning inducements? Please explain the reasons for your views.
The MiFID implementing directive does not describe what a summary disclosure should contain,
except to say that it should disclose the essential terms of the arrangements relating to the fee,
commission or non-monetary benefit. Therefore in practice we have observed a wide range of
summary disclosures from firms, some of which have provided sufficient information to enable
an investor to make an informed investment decision prior to the provision of the service, while
others have not. CESR observed in its report „Inducements:good and poor practices‟ 34, that
clients at a large majority of the firms sampled did not request further information after receiving
a summary disclosure. Therefore we consider that an ex-ante summary disclosure is at least of
some use in enabling clients to make an informed investment decision and aides in the decision
to ask the firm for the full information. We would not support the idea of abolishing it. However
we would suggest that ESMA undertake work in describing what information should be
34
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contained in the summary disclosure and to differentiate it from a detailed disclosure. This work
should have regard to proportionality and ensuring that the disclosure is fair, clear and not
misleading (for example, it should be clear from a summary disclosure if the payments received
by an investment firm vary widely depending on which of a range of substitutable products an
investor buys).
(102) Do you consider that additional ex-post disclosure of inducements could be required when ex-
ante disclosure has been limited to information methods of calculating inducements? Please
explain the reasons for your views.
Additional ex-post disclosure of inducements should be made available at the request of the
client when an ex-ante disclosure has been limited because of the nature of the product. As
recognised in CESR‟s report on good and poor practice, there may be circumstances where the
exact amount of the commission, payment or non-monetary benefit cannot be ascertained
before the provision of the service. In these cases a reasonable band range of the commission,
payment or non-monetary benefit should be provided in the summary disclosure and it should
also contain the method of calculating the amount. In relation to ex-post disclosures, these
should be made available to the client on request and in conjunction with the method of
calculating should contain the exact amount of commission, payment or non-monetary benefit.
(103) What is your opinion about banning inducements in the case of portfolio management and in
the case of advice provided on an independent basis due to the specific nature of these services?
Alternatively, what is your opinion about banning them in the case of all investment services?
Please explain the reasons for your views.
We strongly welcome the suggestion that firms providing investment advice or portfolio
management should not have their remuneration set in whole or in part by product providers.
As discussed in section 7.2.2 (investment advice), we would like the Directive to go further and
stop product providers from setting the remuneration of all investment advisers and not just
those who provide advice on the basis of an independent and fair analysis; investment advice
should be provided without any potential for bias. However, we believe that product providers
should still be allowed to make some payments, such as training on the features of products, for
investment advisers and portfolio managers.
We do not believe that it would be appropriate to ban inducements in the case of all investment
services. This would involve a significant degree of uncertainty given that the directive does not
include a definition of inducements. We believe that it is better to focus on prohibiting specific
types of payment, such as those set out in the previous paragraph.
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(104) What is your opinion about retaining the current client classification regime in its general
approach involving three categories of clients (eligible counterparties, professional and retail
clients)? Please explain the reasons for your views.
The UK believes that the current tiered approach to client categorisation provides adequate levels
of investor protection to the three categories. There has been no significant increase since MiFID
implementation in customer complaints about mis-classification.
As MiFID already allows clients automatically classified as professionals or eligible counterparties
to opt down at any time, those clients that do not feel comfortable with their classification can
request additional regulatory protection. This is an important safety feature already built into the
regime.
(105) What are your suggestions for modification in the following areas:
a) Introduce, for eligible counterparties, the high level principle to act honestly, fairly and
professionally and the obligation to be fair, clear and not misleading when informing the client;
We support the proposal to clarify the obligations of eligible counterparties under the directive.
As the responses to CESR‟s Consultation Paper on this issue showed, the standards set out by the
Commission are those which the industry recognises are central to investment firms retaining
credibility as counterparties in financial markets.
b) Introduce some limitations in the eligible counterparties regime. Limitations may refer to entities
covered (such as non-financial undertakings and/or certain financial institutions) or financial
instruments traded (such as asset backed securities and non-standard OTC derivatives); and/or
In line with CESR‟s advice to the Commission, we do not support introducing limitations in the
eligible counterparties regime35. The current regime already includes the flexibility for clients to
request higher levels of protection. With respect to non-financial undertakings the existing
regime already includes differentiation between those who are automatically classified as eligible
counterparties and those who are not. And we believe that the current boundary in this area is
appropriate. Financial institutions ought to have the knowledge to determine when they need
additional protection in financial dealings and therefore we do not see a need to distinguish
between different types of financial institution who can be regarded automatically as eligible
counterparties. We also do not believe that categorisation should be based on the type of
instrument traded. Our experience is that the existing flexibility to opt for greater protection on a
trade-by-trade basis is rarely used because firms find it administratively easier to have a client opt
for a higher level of protection across all their dealings. We assume that it is likely therefore that
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firms would opt down clients for all of their dealings and not just in relation to specified
products.
We believe it makes more sense to retain the current flexibility to opt for higher protection,
provide information to those who are automatically eligible counterparties about the protections
they can gain and improve disclosures to investors in securitisations and other complex products.
Where an investment firm is willing to accept as a client an entity that is classified automatically
as an eligible counterparty then there might be a case for requiring investment firms to accept
requests from such clients to be treated as professional clients.
c) Clarify the list of eligible counterparties and professional clients per se in order to exclude local
public authorities/municipalities? Please explain the reasons for your views.
Substantial differences exist between Member States in the ability of local authorities to engage
in financial markets activities and the conditions that apply when they do. For example, in some
Member States, local authorities are, prohibited from entering into derivatives transactions and
subject to codes and regulations governing their interaction with financial markets.
We agree that it was not the intention in the drafting of MiFID to include local public
authorities/municipalities within „public bodies that manage public debt‟ and agree that this
should be clarified. However, we do not believe that this should mean that local public
authorities/municipalities should be automatically treated as retail clients unless they are treated
as professionals on request.
In the UK we have allowed local authorities to be treated as professional clients where they met
the criteria for large undertakings which reflects the large size of such bodies in the UK , the
limited range of financial instruments they can buy and the fact that they have professional
advice in undertaking transactions on financial markets. There would seem little to be gained
from having investment firms assess UK local authorities against the criteria for clients who may
be treated as professionals on request. It would add cost and complication for no obvious gain.
A better approach might be to allow individual Member States to be able to require that their
local public authorities/municipalities should be classified as retail clients unless they are treated
as professional clients on request.
(106) Do you consider that the current presumption covering the professional clients' knowledge and
experience, for the purpose of the appropriateness and suitability test, could be retained? Please
explain the reasons for your views.
The UK believes that the current presumption is reasonable and should remain. We do not
consider that it is appropriate that investment firms be required to assess the knowledge and
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experience of professional clients, not least because this would not be a proportionate response
to the Commission‟s concerns. This proposal is likely to affect only a small number of clients, so
any costs are very likely to outweigh any benefits.
However, in the context of seeking to increase investment in SMEs, it may be worth considering
the unintended consequences of the current professional client requirements on Business
Angels36.
A business angel investor, despite the fact he or she may be a high net worth individual with
considerable understanding of the risks involved in investing seed capital, is unlikely to fulfil the
requirements in Annex II.I of MiFID to be treated as professionals on request. The criterion
requiring investments of 10 per quarter over the previous 4 quarters is particularly problematic.
Business angels invest more irregularly than this, and it can also be a barrier for new/ prospective
business angels. We would therefore encourage the Commission to consider an exemption from
the three criteria in the final paragraph of Section II.I of Annex B of MiFID for members of a
Business Angel network. Alternatively, the Commission might consider changing the regularity of
investments in unlisted firms required in the quantitative test to the following:
“The client has carried out one or more investments in an SME (of an average of 100,000€ or
more) within the last two years, or has an existing portfolio of two or more SME investments (of
an average of 100,000€ or more).”
(107) What is your opinion on introducing a principle of civil liability applicable to investment firms?
Please explain the reasons for your views.
The UK already has a principle of civil liability for investment firms dealings with natural persons.
Such a principle can assist in ensuring that firms comply with their obligations and provides an
additional means to seek redress by those affected by firms failing to meet their obligations.
In introducing a principle of civil liability we think that it is necessary to be careful about
disturbing existing legal systems. We think that it would be better to require Member States to
impose liability on investment firms for which they are the Home Member State than to attempt
to impose a harmonised standard of liability. It would be difficult to achieve agreement on the
latter and the end result could work awkwardly in some jurisdictions.
36 Business Angels are high net worth individuals who invest on their own, or as part of a syndicate, in high growth small businesses. In addition to money, Business Angels often make their own skills, experience and contacts available to the company and may invest, between £10,000 and £750,000. Business Angels invest across most industry sectors and stages of business development, but especially in early- and expansion-stage businesses.
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We also believe that careful consideration needs to be given to scope of a principle of civil
liability. In the UK the principle has more or less been restricted to investment firms‟ dealings
with natural persons. This has reflected an effort to strike a balance between investor protection
and the legal risk of providing investment services. Another aspect of this is whether liability
should be restricted to cases only where the investment firm has failed to take reasonable steps
to comply with its obligations.
(108) What is your opinion of the following list of areas to be covered: information and reporting to
clients, suitability and appropriateness test, best execution, client order handling? Please explain
the reasons for your views.
In the UK our principle of civil liability applies to all conduct of business rules in respect of
investment firms dealings with natural persons. Given this, we are happy to explore the possibility
of requiring Member States to apply civil liability to the list of areas mentioned in the question as
long as the application is restricted to investment firms‟ dealing with natural persons.
(109) What is your opinion about requesting execution venues to publish data on execution quality
concerning financial instruments they trade? What kind of information would be useful for firms
executing client orders in order to facilitate compliance with best execution obligations? Please
explain the reasons for your views.
The production of execution quality data in a standardised form made available on websites
should facilitate comparisons of execution quality between execution venues. This would help
investment firms to select the venues they include in their execution policies and the destination
of their orders. Information that investment firms are likely to be interested in include price,
speed of execution and likelihood of execution; the sort of information that venues are required
to produce in the US as required by the SEC‟s Rule 60537.This rule applies only to trading in
shares. We think it would also be sensible in the EU to concentrate on producing data on
execution quality in the trading of liquid shares where there is greatest competition between
organised trading venues. If it is the Commission‟s intention to extend the requirement to non-
equity execution venues it will be important to recognise the differences between different asset
classes, and to conduct a cost-benefit analysis with respect to each asset class.
CESR noted in its advice to the Commission on execution data quality38 that it is also important
to be clear about the obligations on investment firms to collect and use data. There is no use
requiring additional information to be used unless investment firms‟ obligations to collect and
37 http://www.sec.gov/rules/final/34-51808.pdf 38 CESR/10-859
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use data are clear and we would welcome ESMA guidance in this area. We do not believe that
such guidance need await the completion of the MiFID review.
(110) What is your opinion of the requirements concerning the content of execution policies and
usability of information given to clients should be strengthened? Please explain the reasons for
your views.
We agree that efforts should be made to improve the content of execution policies and the
usability (and consistency) of information given to clients. When the FSA looked at execution
policies and the information provided to clients it found that the quality varied significantly. The
suggestions made by the Commission about greater clarity on internal matching and the use of a
single execution venue are welcome. We also believe that it could be helpful for firms to provide
figures to explain where their order flow is executed. Such disclosures might be facilitated by a
template but it will be important to ensure that disclosure comes in a form and in a language
which is appropriate to the clients to whom it is directed.
(111) What is your opinion on modifying the exemption regime in order to clarify that firms dealing on
own account with clients are fully subject to MiFID requirements? Please explain the reasons for
your views.
This modification should be implemented as it is needed for clarity.
(112) What is your opinion on treating matched principal trades both as execution of client orders and
as dealing on own account? Do you agree that this should not affect the treatment of such
trading under the Capital Adequacy Directive? How should such trading be treated for the
purposes of the systematic internaliser regime? Please explain the reasons for your views.
Matched principal trading is both trading on own account and executing client orders – so there
is a plurality. Such treatment should not affect CAD considerations. As for systematic
internalisers, the plurality still applies – such transactions are both dealing for own account and
the execution of client orders.
7.3. Authorisation and Organisational Requirements
(Q111-124)
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(113) What is your opinion on possible MiFID modifications leading to the further strengthening of the
fit and proper criteria, the role of directors and the role of supervisors? Please explain the reasons
for your view.
We welcome developments that provide clarification and promote the importance of ensuring
the suitability of individuals in the governing bodies of all regulated firms. We would strongly
encourage continuity and consistency of approach across all sectors, particularly with respect to
other recent EU initiatives such as the financial services-focused Corporate Governance Green
Paper.
The UK FSA has recently further developed its approach to assessing the fitness and propriety of
directors and non-executive directors and others likely to exert a significant influence on a firm‟s
affairs. Details of this approach can be found in the consultation paper and policy statement on
Effective Corporate Governance (CP10/03[1]] and (PS10/15[2]), and the possible MIFID
modifications are broadly consistent with our approach to assessing the capability of individuals
in key roles, both at the point of approval and afterwards. However, we acknowledge that one
size does not fit all, and there is a need for proportionality as well as cost benefit analysis of
specific proposals.
As such, any modifications, particularly specific interventions, should be designed to correct
identified failures by imposing a suitable framework on boards to achieve the desired outcomes.
These should be justified by rigorous analysis, including assessment of the costs and benefits of
the proposed intervention. There should also be sufficient flexibility for supervisors to exercise
judgment, taking into account of firms‟ activities and business models and the circumstances to
allow for this. Finally, these rules should be applied proportionately to firms that operate in a
wide variety of roles across the financial services sector; giving them the flexibility to adopt
policies and procedures that are appropriate to the size and organisation of the firm, and taking
into account the nature, scale, and complexity of their businesses.
For example, our view is that the level of competence required for an individual will be
dependent not only on the role to be performed but also on the balance of the team in which
the individual is going to operate. There may be cases where an individual lacking certain
knowledge would otherwise be an excellent candidate for a firm; in those circumstances, we
would expect the firm to assess the impact of this in the context of how the board will continue
to meet its collective responsibilities and to have prepared a structured development plan to
bring the candidate concerned up to speed in a timely way, and have the flexibility to do this.
Similarly, the time commitment required by a non-executive will differ depending on their role; as
[1] http://www.fsa.gov.uk/pages/Library/Policy/CP/2010/10_03.shtml [2] http://www.fsa.gov.uk/pages/Library/Policy/Policy/2010/10_15.shtml
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such it is the process adopted by the firm for establishing and agreeing the level of time
commitment which is relevant.
The Commission may wish to consider a further modification that would reduce the scope for
conflicts of interest, in the form of a requirement that there be an appropriate period (e.g. one
year) before a former public official is permitted to take a board-level position with a major
financial institution, and that the appointment, or any waiving of the requirement, be approved
by an independent body, such as the regulator.
Finally, EU-level principles to ensure adequate skill and independence in board level
appointments should also apply to publicly-owned or controlled financial institutions in order to
ensure good governance. Public appointment procedures for such directors should be open and
transparent to provide public assurance that the qualified candidates are appointed (for example,
in the UK, the Nolan principles provide a framework for fair and open appointments). Similarly, if
we are to require exemplary governance standards in private financial institutions, we must apply
comparable rigour to the arrangements in their regulatory agencies. The new European
Supervisory Authorities must have high-quality governance arrangements and operate with a
high level of transparency, if they are to be held accountable.
(114) What is your opinion on possible MiFID modifications leading to the reinforcing of the
requirements attached to the compliance, the risk management and the internal audit function? Please explain the reasons for your view.
Provided that existing requirements in respect of the three functions concerned remain subject to
the principle of proportionality, we support the proposal that a firm's compliance, internal audit
and risk management functions should be able to report directly to a firm's board of directors
and that the removal of an officer responsible for any of these functions should be subject to the
board's prior approval and should be notified to their supervisor. We believe this proposal would
strengthen the involvement of board members with these control functions and increase the
independence of the officers responsible for running them. We would also suggest that the
proposal make it clear that the functions should also have direct access to the relevant board
level committees, such as the risk or the audit committee, where they exist, and that supervisors
should be notified of any decision to remove any of the officers concerned and the reasons for
that dismissal.
(115) Do you consider that organisational requirements in the implementing directive could be further detailed in order to specifically cover and address the launch of new products, operations and services? Please explain the reasons for your views
Under the FSA‟s consumer protection strategy, launched in 2010, the FSA seeks to be more
proactive in anticipating consumer detriment where possible and preventing it before it occurs,
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including by intervening earlier in the product lifecycle. The aim is to reduce the frequency with
which large-scale market problems occur and, if possible, to stop them from happening at all.
The FSA recently published a discussion paper, DP 11/01, on this subject39.
As the Commission's consultation notes, MiFID sets a high-level framework for firms'
organisational requirements. We would support further debate in this area.
In the discussion paper the FSA asks for responses on a number of areas, in addition to some of
those set out in the Commission's consultation, where more prescriptive requirements might be
helpful to improve outcomes for retail clients (professional clients and eligible counterparties not
requiring the same degree of protection). For example:
Consumers might benefit from a requirement that providers consider how their
distribution strategy fulfils the need to act in their customers' best interests. For
example, if the firm allows a product designed for a specific target market to reach a
wider range of customers it may be this, rather than the product features, that causes
problems. A complex investment product intended only for sophisticated investors as
part of a balanced portfolio may be useful for some consumers but problems can arise if
it is sold without discrimination to less sophisticated customers who are led to take on
more risk than they expected. In particular, this might be an issue in the development of
the PRIPs regime where a product designed for the wholesale market has a Key Investor
Information Document which allows distribution to retail customers;
there may be a benefit to consumers if providers face further prescriptive requirements
on the need to consider the information needs of their distributors and to supply
sufficient detail in order to help ensure the end sale is suitable;
investment charges and charging structures are also important in delivering good
outcomes to customers. It may be that there should be a requirement for providers to
consider how the product charges meet the needs of their target market; and
as products change over time or there are changes to external conditions (like the
market environment or legislation) this may in turn alter the risk profile of the product
and it may therefore be worth considering an obligation on firms to keep their products
under review, to check that they are continuing to function as intended and are reaching
the target market for which they were designed.
39
http://www.fsa.gov.uk/pubs/discussion/dp11_01.pdf
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(116) Do you consider that this would imply modifying the general organisational requirements, the
duties of the compliance function, the management of risks, the role of board members, the reporting to senior management and possibly to supervisors?
The suggestions in the consultation are consistent with the high-level provisions already
contained in MiFID, but are more detailed and set more precise obligations to achieve the aims
of those high-level provisions. Greater detail may make expectations clearer and be helpful for
the supervision of product governance.
Pending responses to the discussion paper and the conclusions we draw from them, we are
neutral about changes to the requirements at directive level and will update our position in due
course.
(117) Do you consider that specific organisational requirements could address the provision of the
service of portfolio management? Please explain the reasons for your views.
We do not see the case for action here. We do not believe that any failing in this area relates to
organisational requirements. Documentation regarding investment strategies should be part of
the suitability assessment, as it would be challenging to assess suitability without a full
understanding of the way that the investment strategy is being implemented. Firms should also
be aware that both the investment strategy and the clients‟ requirements will change over time,
and that these may become mismatched. However, this issue should already be captured by the
suitability requirement and by the firms‟ own systems and controls. If any specific requirements
are introduced, they should take into account the range of business models in this sector, with
portfolios managed on a range of different bases, which may make it difficult to write rules that
are relevant to all potential situations.
(118) Do you consider that implementing measures are required for a more uniform application of the principles on conflicts of interest?
In our view, the current principles-based regime in MiFID constitutes a powerful, effective and
proportionate framework for the management of conflicts of interest that can arise in the sales
process. As such, we do not believe that the introduction of detailed and prescriptive binding
technical standards on conflicts of interest is necessary or desirable.
We would however welcome the idea of ESMA developing guidelines and recommendations
with a view to improving consistency in the application of the regime across the EU. ESMA could
look at practices across Member States and range more widely than is possible in a legislative
measure. These guidelines and recommendations could potentially involve examples of both
situations where conflicts cannot be managed (meaning that particular practices or relationships
should be avoided altogether) and situations where it would be appropriate for firms to have
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recourse to disclosure. Regarding the latter, we agree with the Commission‟s interpretation that
disclosure is not a self-standing measure for managing a conflict of interest and should only be
used as a measure of last resort.
We also understand that, having provided comments on the Guidelines on Remuneration Policies
and Practices produced by the Committee of European Banking Supervisors last year, ESMA has
plans to look at the remuneration of sales forces and the conflicts that might be associated with
such remuneration in 2011.
Finally, we wish to emphasise that any prospective additional measures on conflicts of interest
should be guided by the principle of proportionality, and we would urge the Commission take
this into consideration in developing any proposals.
Introduction to client assets
The UK strongly supports the Commission Services‟ stated objective of ensuring that MiFID
provides strong requirements in relation to the protection of client assets. In response to the
crisis and notable insolvencies, the UK FSA has set up a specialist integrated Client Asset Unit,
which undertakes data collection and analysis, firm supervision and policy development. The UK
FSA has increased its focus and resource and is pursuing a more intensive and intrusive
supervision approach of firms who hold client assets. As part of the UK FSA‟s increased focus in
this area the FSA has pursued a large number of enforcement cases (including the largest fine
levied by the FSA), as well as a number of policy initiatives.
While we provide specific responses to the questions posed by the Commission services we
provide two additional suggestions of areas for further review, in relation to question 123.
(119) What is your opinion of the prohibition of title transfer collateral arrangements involving retail
clients' assets? Please explain the reasons for your views.
In July 2010, the UK FSA consulted on prohibiting investment firms from making arrangements
with retail clients which resulted in the transfer of full ownership of client money and client
assets for the purpose of securing or otherwise covering present, future, actual, contingent or
prospective obligations (title transfer collateral arrangements, or TTCA).
On 1 December 2010, the UK FSA applied this prohibition for the benefit of retail clients in
relation to the activities of spread betting and most contracts for differences. The UK FSA is
currently in the process of considering extending this prohibition for the benefit of retail clients
to the full range of TTCA activities.
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We have taken this view because our supervisory and policy work produced evidence of firms
entering into TTCA with retail clients where the clients have not understood the effect of the
TTCA and have not given due regard to the client‟s best interests rule. We are also of the view
that retail clients are less able to assess the credit risk of their investment firms than professional
clients or eligible counterparties and should therefore benefit from the full protection of MiFID
and our rules in this respect.
We therefore support the Commission‟s view that TTCA should be banned for retail clients for
the activities for which the cost benefit analysis supports that conclusion.
However, we also observe that there is an interaction between the use of TTCA and the proposals
in the European Markets Infrastructure Regulation (EMIR). It will be important to ensure that any
revisions to MiFID are compatible with the provisions in EMIR.
(120) What is your opinion about Member States be granted the option to extend the prohibition
above to the relationship between investment firms and their non retail clients? Please explain
the reasons for your views.
We need to ensure compatibility with EMIR here.
Under the MiFID client categorisation regime, we consider that non-retail clients should have the
expertise and resources to determine whether or not to enter into TTCA, so the benefits of a
prohibition are, in our view, less than in relation to retail clients.
The Commission Services propose that where TTCA is allowed, clients would receive written risk
disclosures giving appropriate evidence of the risk of these arrangements. The UK FSA has
introduced a requirement, which enters into force on 1 March 2011, for prime brokers to
disclose the risks of re-hypothecation to clients40. This is to ensure that where clients enter into
agreements that provide for the use of their assets, they have been appropriately informed of the
risks. The UK FSA‟s consultation on this rule noted that we had considered restricting the use of
re-hypothecation but had concluded that it would be more proportionate to impose an
information requirement at that time. Accordingly, we would support the European
Commission‟s proposal to introduce a disclosure requirement in relation to TTCA.
(121) Do you consider that specific requirements could be introduced to protect retail clients in the
case of securities financing transaction involving their financial instruments? Please explain the
reasons for your views.
40 Please see Chapter 3 in PS10/16: http://www.fsa.gov.uk/pubs/policy/ps10_16.pdf
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A securities financing transaction is defined in article 2(10) of the MiFID Regulation (1287/2006)
as the following: “an instance of stock lending or stock borrowing or the lending or borrowing
of other financial instruments, a repurchase or reverse repurchase transaction, or a buy-sell back
or sell-buy back transaction”.
We consider that these activities will be significantly restricted if the suggested proposals above
prohibiting the use of TTCA are implemented.
If securities financing transactions are permitted whereby clients transfer ownership of their
financial instruments to their investment firm, or to a third party, those clients face greater risks
of loss. The UK FSA considers that these risks could be mitigated by appropriately targeted
provisions; for example, a requirement for investment firms to obtain and monitor the level of
collateral provided by the borrower of securities. The UK FSA also considers that the quality of
that collateral could benefit from regulatory protection.
Additionally, the UK FSA considers that article 19 of the MiFID Level 1 Directive (the client‟s best
interests rule) should be considered in relation to these transactions. So, for example, the UK
FSA‟s Client Assets sourcebook states (at CASS 6.4.2G) that the following conduct would result in
a firm generally being considered to be compliant in relation to stock lending for retail clients, if:
1) the firm ensures that relevant collateral is provided by the borrower in favour of the
client;
2) the current realisable value of the safe custody asset and of the relevant collateral is
monitored daily; and
3) the firm provides relevant collateral to make up the difference where the current
realisable value of the collateral falls below that of the safe custody asset, unless
otherwise agreed in writing by the client.
Accordingly, we welcome specific provisions which provide these protections.
(122) Do you consider that information requirements concerning the use of client financial instruments
could be extended to any category of clients?
The requirements in Article 32 of the MiFID Implementing Directive are currently only specifically
expressed to apply to retail clients or potential retail clients. The UK FSA supports the extension of
these requirements to professional clients and eligible counterparties in relation to the use of
client financial instruments. As noted above, we introduced a requirement, which enters into
force on 1 March 2011, for prime brokers to disclose the risks of re-hypothecation to all of their
clients. This was to ensure that, where any category of client enters into an agreement that
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provides for the use of its assets, that client has been appropriately informed of the risks. The
difficulties arising from the failure of Lehman Brothers International (Europe) have demonstrated
the need for improvements in risk disclosures to all categories of client.
(123) What is your opinion about the need to specify due diligence obligations in the choice of entities
for the deposit of client funds?
UK regulated firms hold billions of pounds of client money and MiFID requires firms to undertake
all due skill, care and diligence in the selection, appointment and periodic review of entities at
which client money will be deposited. Following the financial crisis, the UK FSA has introduced a
requirement, which enters into force on 1 June 2011, restricting the placement of client money
deposits within a group to 20% of the total client money held41. Accordingly, we would support
the European Commission‟s proposal to include diversification as one of the due diligence
obligations. We would suggest that the appropriate limit of intra-group client money deposits is
20%, being the level on which we consulted for the purposes of our rules and on which we
received broad support from consultation respondents.
We would also suggest that the Commission considers proposals for ensuring that intra-group
client money deposits are recognised as such, rather than as an intercompany loan. If client
money is deposited intra-group within the EU, the EU affiliate which receives the money must
treat it as client money and return it to the correct affiliate following the insolvency of the group.
If client money is treated as an intercompany loan, this will potentially leave the clients of the
affiliate which deposited the client money, with a subordinated claim upon the insolvent estate.
(124) Do you consider that some aspects of the provision of underwriting and placing could be
specified in the implementing legislation? Do you consider that the areas mentioned above
(conflicts of interest, general organisational requirements, requirements concerning the allotment
process) are the appropriate ones? Please explain the reasons for your views.
Introducing specific additional legislative requirements on underwriting and placing in the
implementing legislation is in our view not necessary. The current MiFID framework for the
management of conflicts of interest is in our view sufficiently flexible and robust to ensure firms
have in place systems and controls to identify and manage the conflicts of interest that arise in
the capital raising process effectively (see our answer to question 7.3.5 above).
As the principles-based rules in MiFID deal with these issues in a general rather than a specific
manner, we do however see merit in introducing targeted Level 3 measures (preferably by
41 Please see Chapter 4 in PS10/16: http://www.fsa.gov.uk/pubs/policy/ps10_16.pdf
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developing targeted guidelines and recommendations) to ensure that firms and their senior
management remain clear on how the current regime applies, and the standards that are
expected of them, in the management of an issue of securities.
Such measures would ideally focus on the systems and controls in place to ensure that the firm
treats each of its clients fairly (i.e. the „issuer‟ client and its investment clients). In this respect, any
prospective measures should aim to deliver in three specific areas, namely, oversight and
management (to include control over information flows), allocation practices (including improper
inducements) and pricing. With regard to record keeping, we believe that the existing MiFID
requirements are sufficient to ensure that firms maintain proper records of the entire
underwriting and placing process, including the allocation process.
Finally, the processes involved in delivering underwriting and placing services depend on the
issuer, the stage in the lifecycle of the capital raising process (initial public offering vs. secondary
market offering), the type instrument involved (equity vs. debt instrument), the issuing
mechanism (e.g. rights issue, placing etc.), and the mores and rules of the local market. It would
in our view be challenging to successfully apply prescriptive measures across a broad spectrum of
economic models and national approaches with the risk that they either become highly complex
or will run the risk that they will impose an inflexible „one size fits all‟ solution. Given these
fundamental differences, any measures introduced need to be capable of being applied in a
differentiated and proportionate manner and be flexible enough to allow for the various existing
legal and economic models. Otherwise, there is a significant risk that capital raising by corporates
will be negatively disrupted.
Prior to the implementation of MiFID, we had Handbook guidance in place that clarified our
expectations of firms‟ and their senior management when dealing with conflicts of interest in this
area (COB 5.10)42. At the time, we believed that because of the variance in firms‟ practices,
supplementary guidance would assist them in understanding how they should be able to identify
and manage conflicts when arranging an issue of securities. We believe that the outcomes
focussed guidance in COB 5.10 would serve as a useful point of reference for the Commission
legal services in considering these issues.
8. FURTHER CONVERGENCE OF THE REGULATORY FRAMEWORK AND OF THE SUPERVISORY
PRACTICES
(Q125-140)
Summary Comments
42 The pre-MiFID guidance in COB 5.10 („Corporate Finance Business Issues‟) was reduced when MiFID was implemented in the UK and the revised guidance is now included in SYSC 10.1.13 to SYSC 10.1.15 („Corporate Finance‟).
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We see a number of advantages in the retention of Article 4 of the MiFID implementing directive,
which formalises the right of member states to go beyond the directive where necessary to
ensure robust investor protection. No country should be required to lower investor protection
standards currently in force.
We agree with the Commission that there is scope for further progress towards harmonisation
on tied agents, recording requirements and supervisory powers and sanctions. In particular, we
believe that recording requirements are a vital tool in tackling market abuse. They help to deter
inappropriate behaviour and facilitate the investigation of possible instances of market abuse.
It is important for EU countries to have in place appropriate arrangements for access to the EU
by third-country investment firms and markets. These arrangements must seek to secure investor
protection and facilitate competition and choice. However, we have very significant reservations
about the suggestion of a mechanism for exemptive relief based around „strict equivalence‟. We
fear that such an approach would cause significant practical problems as well as potentially
damaging relationships with other jurisdictions at a time when increased global cooperation is
vital. At all times in developing this legislation we should bear in mind that protectionist attempts
to close down our borders or balkanize markets by currency or geography will do huge damage
to European growth.
8.1. Options and Discretions
(Q125-133)
(125) What is your opinion of Member States retaining the option not to allow the use of tied agents?
We agree that investment firms in all Member States should be allowed to use tied agents. The
current situation does not have much logic to it. A Member State can currently prohibit the use
of tied agents by investment firms for which it is the home Member State. However, consumers
based in that jurisdiction can still have services provided to them by tied agents through
investment firms (based in other Member States that allow their investment firms to use tied
agents) exercising their passporting rights.
(126) What is your opinion in relation to the prohibition for tied agents to handle clients' assets?
We agree that for reasons of consistency it would be better to have a situation where the tied
agents of all investment firms were prohibited from handling clients‟ money and/or financial
instruments.
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(127) What is your opinion of the suggested clarifications and improvements of the requirements
concerning the provision of services in other Member States through tied agents?
We support CESR‟s advice that the directive should be changed so that it is clarified:
“..that all tied agents established in a Member State other than the investment firm‟s home
Member State are treated as if they were part of a branch regardless of whether the firm
operates another place of business alongside the tied agents.”
It is important to be clear that this does not mean that a firm has to make a separate passporting
notification in respect of each tied agent it appoints to operate in a host Member State.
Operationally, the home Member State should make an initial branch notification specifying the
identity of the tied agent(s) to be used, together with a corresponding „programme of
operations‟, as per the CESR protocol on passporting. Any change in the identity of the tied
agent(s) being used, should be communicated to the host Member State as per article 32(9).
We also support the suggestion that CESR made for host state regulators to publish the identity
of tied agents that are being used in their jurisdiction, and to require credit institutions to make
notifications about their use of tied agents to provide investment services in the same way that
investment firms do (this will require CEBS/EBA to amend its „Guidelines for passport
notifications‟ accordingly).
(128) Do you consider that the tied agents regime require any major regulatory modifications? Please
explain the reasons for your views.
No. The UK has had a regulatory regime similar to the MiFID tied agent regime for a long time. It
has worked well in providing extra flexibility in the way that services are provided to clients whilst
at the same time continuing to offer consumer protection through the fundamental principle
that investment firms are responsible for the actions of the tied agents that they employ.
(129) Do you consider that a common regulatory framework for telephone and electronic recording,
which should comply with EU data protection legal provisions, could be introduced at EU level?
Please explain the reasons for your views.
We believe that a recording requirement is crucial for combating market abuse and can also play
an important, but lesser, role in dealing with conduct of business breaches. We are therefore
strongly supportive of introducing minimum harmonising recording requirements across the EU.
Flexibility is needed for Member States to ensure that existing rules that have been imposed in
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pursuit of objectives of reducing financial crime and investor protection do not have to be cut
back as part of efforts to achieve a greater degree of harmonisation in Europe.
The FSA introduced a recording rule which took effect in March 2009. This followed on from
looking at investigatory and enforcement work on market abuse. In a significant proportion of
market abuse cases where recordings were requested they were not available. In cases where
they were available they often helped to move cases along by providing specific evidence (which
might either lead to a case being shut down or assist a prosecution) or by suggesting additional
lines of enquiry. Recordings have also been of assistance in conduct work, for example where
cases of high-pressure selling techniques have been investigated.
(130) If it is introduced do you consider that it could cover at least the services of reception and
transmission of orders, execution of orders and dealing on own account? Please explain the
reasons for your views.
If the intention of the rules is to mitigate market abuse activity, as well as monitoring of conduct
of business standards then we think that these activities are essential to the scope of any
common European taping regime.
The UK has a conditional exemption for investment firms conducting discretionary investment
management that seeks to limit duplication of costs/effort between buy and sell side. We have
also exempted retail financial advisory firms who receive and transmit orders. These firms often
provide advice on a face to face basis, include many small firms and are mainly focused on
advising on collective investment schemes and other long-term savings products rather than
individual shares or derivatives priced off such shares.
The UK‟s rules also do not cover all conversations by individuals in firms performing the services
listed above. Our rules only capture conversations and communications that involve client orders
and/or conclude agreements to buy or sell financial instruments in relation to financial
instruments covered by the market abuse directive.This again reflects our focus on using a
recording requirement to tackle market abuse.
(131) Do you consider that the obligation could apply to all forms of telephone conversation and
electronic communications? Please explain the reasons for your views.
It is important that whatever rules are introduced, are essentially technology „neutral‟. This will
ensure that rules do not become outdated as technology develops. Whatever equipment or
means of communication (fixed, mobile and other handheld devices, voice, email, SMS, instant
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messaging, video conferencing etc) is used frequently for communications to, arrange, negotiate
and handle/execute client orders, should be subject to a recording rule in order to curtail market
abuse activity and to prevent loopholes opening up. Investment firms should be prohibited from
using equipment or means of communication that cannot be recorded for any conversations or
communications that would fall to be recorded under the recording rule.
(132) Do you consider that the relevant records could be kept at least for 3 years? Please explain the
reasons for your views.
The UK regime mandates that telephone records be kept for a period of six months as we believe
that suspicions of market abuse are likely to arise relatively quickly after a relevant conversation
has taken place. The UK previously consulted on introducing a 3 year retention period. Following
representations about the costs involved, it was decided to settle on a six month retention period
which was consistent with obligations that firms faced under the rules of regulated markets.
However, we believe that competent authorities should, in the course of investigations, be able
to require investment firms to hold onto recordings for longer than six months. Such a targeted
approach we believe is more proportionate than requiring all firms to hold all recordings for a
much longer period. In general, we believe that robust cost-benefit analyis is necessary before
taking regulatory action in this area.
(133) What is your opinion on the abolition of Article 4 of the MiFID implementing directive and the
introduction of an on-going obligation for Member States to communicate to the Commission
any addition or modification in national provisions in the field covered by MiFID? Please explain
the reasons for your views.
We do not believe that Article 4 should be abolished. It was always envisaged that Member
States would make relatively little use of Article 4 because otherwise this would not have been
consistent with additional requirements only being imposed in “exceptional cases”. The limited
number of notifications made under the provision therefore is a sign that it is working as
intended and not that it has proven difficult to apply. Article 4 also provides for Member States
to respond to new problems that emerge or become evident after the Directive is applied, so it is
unlikely to have been tested fully in the few years since implementation.
There are three main advantages that we see in Article 4:
First, it provides recognition that Member States can take action that they regard as
critical to investor protection in their jurisdiction which goes above and beyond the
provisions in the directive. It would seem very odd if a directive one of whose central
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aims is to deliver a high level of investor protection completely closed the door to
individual competent authorities introducing additional protections for consumers, or
made it difficult to respond to new risks as they emerge;
Second, it places tight constraints around additional action on the national level. This
ensures that Member States‟ freedom to introduce additional measures is limited and, in
particular, helps to ensure that the actions of individual Member States do not
undermine the single market objectives of the directive;
Third, it provides for transparency about the additional actions of Member States. They
are not buried in national transpositions but have to be made public on a European level
which increases the potential for scrutiny of what individual Member States are doing.
The UK has used Article 4 to make notifications covering, for example, the rules we are
introducing to improve retail distribution in the UK, the strengthening of our framework of client
asset protections and our (pre-MiFID) rules governing the use of dealing commission by
investment managers. In making these notifications we believe that we have benefited
significantly from the discussions we have had with the Commission which have been triggered
by the existence of Article 4.
We would also support a requirement on Member States to notify to the Commission changes to
their transposition of directives made after initial transposition. However, we would not see this
as an alternative to the existing Article 4 process and it is an issue that is relevant to other
financial services directives and not just to MiFID.
Should the Commission decide to delete Article 4 then we believe it is essential to ensure we
retain our existing level of investor protection by it being made clear in the directive that Member
States can retain rules covered by existing notifications. Nothing in this proposal should
compromise individual Member States‟ ability to take steps in future to ensure investor
protection where circumstances require it and such steps are in keeping with the spirit and letter
of MiFID and EU law. Therefore without Article 4, it would be important for the revised directive
to explicitly recognise the right of Member States to adopt additional measures where these did
not contravene the letter or spirit of MiFID or of EU law in general, to avoid confusion or
inconsistency of interpretation.
8.2. Supervisory powers and sanctions
(Q134-137)
General comments
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We agree with the Commission that, in principle, it is highly desirable that all Competent
Authorities (CAs) in all Member States are able to operate on a level playing field. For example,
lack of severity in the sanctioning powers of some CAs encourages regulatory arbitrage and risks
undermining the EU regulatory regime.
We also agree with the Commission that some minimum common standards should be set at an
EU level. The appropriate sanction in a particular case depends on the unique facts of that case.
Given this we consider that minimum harmonisation would be more appropriate than a
maximum harmonisation approach.
We agree that the Commission should explore and develop a framework of basic principles to
promote coherence of EU action and welcome the Commission‟s recent Communication on
Sanctions. We believe such an approach is preferable to seeking to harmonise sanctions by way
of a piecemeal approach as part of the MiFID and MAD reviews.
Powers of Competent Authorities
We agree that CAs should have the power to enter private premises and to seize documents.
These powers are an important enforcement tool. They are already provided for under UK law.
The FSA can apply to a justice of the peace for a search warrant. If granted, a search warrant
authorises a police officer to: enter and search specified premises; seize and take copies of
specified types of documents; require any person present to provide an explanation of any
relevant document or state where it may be found; and use such force as may be reasonably
necessary. The search warrant can only be executed by a police officer but may authorise FSA
staff to accompany the police officer and exercise the same powers of search and seizure.
Sanctions (definition, amounts, publication)
Scope of sanctions
We agree that CAs should have powers to require a breach is ended (either by way of injunctions
or the ability to prohibit an activity). We also agree that the CAs should, at least, have the power
to suspend members of the management or supervisory bodies. However, this power should be
limited to suspending approved persons but there should be the power to prohibit any person.
This is because, in the UK the FSA approves certain functions within an authorised firm (e.g. CEO,
compliance officer etc.). The FSA‟s powers of fining are restricted to these „approved persons‟. If
the FSA had the power to fine any employee that worked for an authorised firm, then arguably
issues may arise under the European Convention on Human Rights (ECHR) given that the ability
to fine such a wide group of individuals could be considered criminal in nature. This would
mean, amongst other things, that the FSA would not be able to require individuals to answer its
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questions during an investigation because of the right against self-incrimination contained with
the ECHR.
Minimum levels of fines
We think it would be extremely difficult to set minimum levels of fines for every single type of
breach. Every case is specific to its facts. We also note that the Commission‟s own fining policy in
relation to anti-competitive misconduct does not set out minimum fines for specific breaches.
In any case, any minimum level of fines must be subject to a reduction on the grounds of co-
operation and other mitigating factors (such as whether a person brings the misconduct to the
CA‟s attention). In addition, CAs should be allowed to reduce a fine where firms or individuals
agree to settle a case. The ability to settle a case is an important tool which allows CAs to dispose
of cases quickly thereby releasing extra resources to allow more investigations. The Commission
may also wish to consider the extent to which any fine, including prescribed minimum fines,
should be reduced because of the financial circumstances or impecuniousness of the subject of
enforcement action.
There is also the risk that setting a minimum fine would have a „freezing‟ effect on enforcement
action by regulatory authorities. Depending on the size of the minimum fine, a CA may decide
only to investigate those breaches which it considers are serious enough to justify the minimum
fine required.
Deterrence
We agree that sanctions should act as a deterrent. One important factor in ensuring that fines do
act as a deterrent is that they should, at the very least, include any profit (where it is practicable
to quantify) that a firm or individual may have made from a breach. Having a statutory maximum
for the amount of a fine could prevent CAs from being able to „claw back‟ any profit and we
would. Consequently we agree with the setting of „minimum maximum‟ levels of fines. In other
words, where a Member State sets a maximum cap on the amount a CA can fine, we agree that
the an EU Directive could specify the minimum level of such a cap i.e. CAs must be able to
impose a fine above € „x‟.
Whistleblowing and leniency programmes
We agree that whistleblowing and leniency regimes can be an effective tool to help enforcement.
In the UK the Public Interest Disclosure Act 1998 (PIDA) provides guidance on whistleblowing.
The FSA has a whistleblowing scheme which, consistent with PIDA, encourages employees to
raise concerns internally in the first instance, and explains the situations in which an employee
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will be protected by PIDA if they contact the FSA. Broadly, an employee will be protected if: they
reasonably believe the firm has breached FSA rules; they reasonably believe the information and
any allegations in it are substantially true; and they reasonably believe the FSA is responsible for
the issue in question. The FSA‟s whistleblowing scheme is explained on its website,43 including
details of how the FSA‟s whistleblowing team can be contacted.
The FSA also has a leniency regime in place: where market misconduct was carried out by two or
more individuals acting together and one of the individuals provides information and gives full
assistance in the FSA‟s criminal prosecution of the other(s), the FSA will take this cooperation into
account when deciding whether to commence a criminal prosecution, against the individual who
has assisted the FSA, or bring market abuse proceedings against him.
We also consider that as well as these two tools CAs should also have a power to require firms to
report to the CA any breaches of its rules it uncovers. The FSA finds this requirement very useful
in requiring, and encouraging, firms to inform it of their misconduct. It is also an aggravating or
mitigating factor which the FSA considers in setting the level of a fine.
Criminal sanctions
We see no case for harmonisation of criminal sanctions in this field. We consider that Member
States are best place to consider which breaches should attract criminal prosecution. It should
not be assumed that requiring certain breaches to be prosecuted on a criminal basis only has
advantages and not disadvantages, for example:
if the sanction is to be criminal CAs would not be able to carry out compelled interviews
in relation to the accused (because of the right against self-incrimination in criminal
cases);
similarly, such a requirement could have a freezing effect on CAs as they decide only to
take enforcement action in those cases where criminal sanctions are justified;
criminal trials can take longer and use more resources;
the burden of proof is higher;
cases are less likely to settle; and
43
http://www.fsa.gov.uk/Pages/Doing/Contact/Whistle/index.shtml
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in jurisdictions where criminal trials are decided by a jury, some breaches may not be
best suited to such a process, particularly where they involve misconduct of a complex
nature.
We therefore consider that any Commission proposal should give the Member State the choice
of deciding whether or not a particular breach should be treated as a criminal sanction.
Publishing sanctions
We agree that the final decision of the CA should be published, whether or not that decision is
appealed to a higher judicial body. We consider that CAs should be able to refrain from
publication only where to publish would be prejudicial to the interests of consumers or unfair to
the person who is the subject of the enforcement action. These are the two exceptions allowed
for in UK legislation.
We also believe that, should they so wish, CAs should retain a discretion to publicise
investigations at an earlier stage than the final decision.
(134) Do you consider that appropriate administrative measures should have at least the effect of
putting an end to a breach of the provisions of the national measures implementing MiFID and/or eliminating its effect? How the deterrent effect of administrative fines and periodic penalty payments can be enhanced? Please explain the reasons for your views.
As set out above, we agree that CAs should have the ability to ensure a breach has ended. In
practice the FSA finds that in most cases the breach has stopped before a case is referred to its
enforcement division.
To ensure that a penalty deters the following points should be noted:
the level of fine must be such that it deters the firm who committed the breach, or
others, from committing further or similar breaches;
the absolute value of the penalty must not be too small in relation to the breach;
it may be appropriate to impose larger fines than previously where previous regulatory
action in respect of similar breaches has failed to improve industry standards;
It may also be appropriate to impose larger fines than previously where the CA considers
that it is likely that similar breaches will be committed by the firm or by other firms in the
future in the absence of such an increase to the penalty; and
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where the FSA considers that the likelihood of the detection of such a breach is low a
larger fine may be appropriate.
(135) What is your opinion on the deterrent effects of effective, proportionate and dissuasive criminal
sanctions for the most serious infringements? Please explain the reasons for your views.
Whilst we agree that in some cases criminal sanctions can have a greater deterrent effect, for the
reasons set out above, it should not be assumed that creating a criminal offence will always have
the effect of increasing the overall deterrent effect. For example, 20 administrative cases which
impose large penalties may have more of a general deterrent effect than 5 criminal cases.
(136) What are the benefits of the possible introduction of whistleblowing programs? Please explain
the reasons for your views.
We consider that whistleblowing is an important tool for an enforcement authority. It often leads
to the authority getting valuable information to help it protect consumers, reduce financial crime
or maintain market confidence. It may also help the authority target its resources more
effectively.
(137) Do you think that the competent authorities should be obliged to disclose to the public every
measure or sanction that would be imposed for infringement of the provisions adopted in the implementation of MiFID? Please explain the reason for your views.
As set out above, we agree that the final decision of the CA should be published, whether or not
that decision is appealed to a higher judicial body. We also believe that, should they so wish, CAs
should retain a discretion to publicise investigations at an earlier stage than the final decision.
8.3. Access of third country firms to EU markets
We have strong reservations about this proposal.
Access to the EU by investment firms and markets authorised and established in other
jurisdictions is important for several reasons:
to enhance competition in the provision of investment services;
to enable EU investment firms to provide a high level of service to their clients (for
example by executing client orders on the market with the greatest liquidity for a
financial instrument or transmitting orders to firms best placed to offer the best possible
result for the execution of those orders); and
to enable clients to choose the investment service provider that most suits their needs.
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Using data from the International Monetary Fund‟s (IMF‟s) Coordinated Portfolio Investment
Survey, we were able to examine the importance of non-EU investors to EU Member States in
2009-10. Using Table 8, we looked at inter EU cross-border investment between Member States
and extra EU cross-border investment both from and in major international trading partners.44
Source: http://www.imf.org/external/np/sta/pi/09/Table08.xls, IMF Coordinated Portfolio Investment Survey
The chart above shows that non-EU investors provided 27% of the total investment in EU cross-
border securities. This means that US$5.2 trillion of cross-border investment in EU businesses
came from outside the EU. The IMF‟s data shows that investment by third country firms in EU
securities increased in value terms between 2008-9 and 2009-10 by 26%.
Meanwhile, a recent report by the World Economic Forum in collaboration with McKinsey noted
that to support economic development, global credit levels must grow substantially over the next
decade.45
It specifically warns that financial protectionism may constrain cross-border financing:
“Asian savers will continue to fund Western consumers and governments: China and Japan
will have large net funding surpluses in 2020 ( of US$8.5 trillion and US$ 5.7 trillion
respectively), while the US and other Western countries will have significant funding gaps.
44 These states are Argentina, Australia, Brazil, Canada, China, India, Indonesia, Japan, Malaysia, Mexico, Norway,
Russia, Saudi Arabia, Singapore, South Africa, South Korea, Switzerland, Thailand, Turkey, and the United States. 45 “More Credit with Fewer Crises: Responsibly Meeting the World‟s Growing Demand for Credit”, World Economic
Forum Report, January 2011
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The implication is that financial systems must remain global for economies to obtain the
required refinancing; “financial protectionism” would lock up liquidity and stifle growth.”46
The report forecasts that global credit would need to double to US$213 trillion by 2020 just to
keep global GDP flat. There is likely to be strong competition to attract finite global credit
between the world‟s economies. Access of third country firms to invest in EU businesses should
be seen as a key enabler for the EU‟s 2020 strategy for smart, sustainable and inclusive growth.
In this context it is essential that any proposal in this area does not harm the openness of the EU
economy or harm the ability of EU businesses to trade with non-EEA partners.
(138) In your opinion, is it necessary to introduce a third country regime in MiFID based on the
principle of exemptive relief for equivalent jurisdictions? What is your opinion on the suggested
equivalence mechanism?
We have strong reservations about this proposal which has the potential to undermine both the
principle of open markets and the ability of EU firms to do international business.
We would welcome the opportunity to discuss these issues with the Commission. As a starting
point we make some initial comments below:
first, any proposal in this area should not undermine individual Member States‟ existing
regimes for allowing third country investment firms and market operators to access their
markets and make the EU markets less open than they currently are.
second, making equivalence determinations is likely to involve very significant time and
effort as regulatory systems are compared. This task will be made much harder if the
standard being assessed is „strict equivalence‟.
third, we do not believe that the introduction of a mechanism for exemptive relief
should be used as a tool to demand reciprocity from other jurisdictions. It would be a
poor outcome if EU firms were to lose existing access to any third country jurisdictions.
As an alternative to a system of exemptive relief we would support exploring other options for
achieving the Commission‟s objectives. For example, it might be worth considering making more
explicit in MiFID that existing national regulatory regimes need to ensure that third country
investment firms and market operators are treated no more favourably by Member States than
EEA investment firms and market operators. The existing recital 28 is less clear on this point than
was the Investment Services Directive.
46
Pg 16, ibid
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(139) In your opinion, which conditions and parameters in terms of applicable regulation and
enforcement in a third country should inform the assessment of equivalence? Please be specific.
We are by no means convinced that an equivalence regime is appropriate, especially a regime
based on an assessment of “strict” equivalence. We would welcome a further discussion with the
Commission on these issues.
(140) What is your opinion concerning the access to investment firms and market operators only for
non-retail business?
As above, we would welcome a further discussion with the Commission on these issues.
9. REINFORCEMENT OF SUPERVISORY POWERS IN KEY AREAS
(Q142-148)
Effective market regulation requires competent authorities have appropriate supervisory and
enforcement tools. In some cases, intervention may also require coordination between
regulators, either through memoranda of understanding or the powers that have been given to
ESMA under the ESA Regulations. We would note in this context that the ESA Regulations
already provide ESMA with a power to coordinate product intervention. We therefore believe
that the existing provisions of the ESA Regulations, together with the existing powers of
competent authorities and the obligation to cooperate under MiFID, are sufficient to achieve the
Commission‟s objectives in this regard.
In relation to commodity derivatives, the UK agrees that it is essential that regulators have
sufficient oversight to detect market abuse and the necessary enforcement powers to deter it.
We note in this regard the advice provided by CESR, which makes clear that position
management tools are most effective in ensuring that large positions do not damage the
functioning of the market.
9.1. Ban on specific activities, products or practices
(142) What is your opinion on the possibility to ban products, practices or operations that raise
significant investor protection concerns, generate market disorder or create serious systemic risk?
Please explain the reasons for your views.
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In the FSA‟s recent discussion paper on product intervention the FSA notes that banning
products in order to protect retail customers should be an option available to supervisors in
certain prescribed circumstances. However, banning products of any kind should be undertaken
with great caution, and only in response to specific market failures, as otherwise innovation,
effective risk management and economic growth could be detrimentally impacted. While some
market failures may be common across the EU, in many cases they will be specific to the
particular characteristics of national markets. The potential procedure to ban any products
should be consistent for all products (i.e. they must present unacceptable levels of risk to investor
protection, market order or unacceptable systemic risk).
We already have the powers at a national level to make rules in relation to products, where this
does not conflict with our obligations under European law. These powers will be enhanced as
part of the UK‟s regulatory reform agenda to enable the forthcoming integrated conduct
regulator to promote better outcomes for retail investors.
We also note that powers already exist under MiFID that effectively empower the national
regulator to ban a product, and for European cooperation on such action. Likewise the new
European Supervisory Authorities (ESAs) have been given the power to ban products temporarily
(together with appropriate attached powers to obtain information critical to such decisions). We
would therefore query how some of the proposals under this section relating to EU banning
mechanisms would in fact relate to these existing powers.
On European powers specifically, we suggest that the Commission give some thought to:
whether the proposed European power to ban product temporarily as described does
not already exist in the ESAs;
how a permanent or temporary ban might work for a product such as a non-EU
unregulated collective investment scheme or other product. Clearly, we would not have
the remit to ban such a product directly. ; and
whether permanent (as opposed to temporary) European level bans should arise from
coordinated national action (as currently envisaged by the present powers in MiFID) with
improved coordination with the ESAs and the Commission.
(143) For example, could trading in OTC derivatives which competent authorities determine should be
cleared on systemic risk grounds, but which no CCP offers to clear, be banned pending a CCP
offering clearing in the instrument? Please explain the reasons for your views.
The consideration of the circumstances in which it might be appropriate to ban a product is
distinct from the consideration of whether a product could or should be cleared (and whether
this would be beneficial but not necessarily essential from a systemic risk perspective). Therefore
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whilst, as stated above, we agree that product operation banning might be necessary we do not
believe the example cited is specifically relevant.
Linking clearing eligibility and product banning could also increase systemic risk in the system. If
CCPs were unable to clear certain products, banning these products would directly affect the
market participants‟ ability to use them for legitimate commercial hedging. Taking away their
ability to hedge their risk could result in an increase of systemic risk. It seems counterintuitive to
punish the trading counterparties for the CCP‟s inability to risk manage certain products.
(144) Are there other specific products which could face greater regulatory scrutiny? Please explain the
reasons for your views.
From a consumer protection point-of-view, the Commission's Consumer Market Scoreboard
showed that, of all the sectors reviewed consumers tend to have the greatest difficulty with
investments, pensions and securities. Consumers struggle to protect their own interests in these
markets and products can - deliberately or inadvertently - be designed to take advantage of those
demand-side weaknesses.
The FSA‟s discussion paper on product intervention lists a number of product features that we
regard as potentially problematic and that might show products likely to play on these demand-
side weaknesses. These include, for example, complex products with opaque structures,
products with inherent conflicts of interest likely to lead to consumer detriment, products with
secondary charges or layers of charges and the use of non-standard assets for investment
purposes. We see these as warnings that the product might be detrimental if the firm has not
taken sufficient steps to mitigate the problems. We will give increased regulatory scrutiny to
products with these features and others that become apparent in the future. This would need to
be assessed on a case-by-case basis.
In some instances there may be products where it will prove almost impossible to mitigate the
risks satisfactorily and where regulatory action might be needed at a more general level, without
firm-specific analysis. Products that might be listed here may include: leveraged ETFs, some of
the more complicated structured products and investments based on traded life assurance
policies from the USA.
9.2 Stronger oversight of positions in derivatives, including commodity Derivatives
(Q145-148)
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We recognise that stronger oversight of positions in derivatives, including commodities, can play
a role in supporting fair and orderly markets. However, we remain to be convinced on the
benefits of adopting position limits, where we would like to see much clearer evidence on their
role, including demonstrating that they are more effective than other measures - such as a strong
position management and monitoring regime. As stressed elsewhere, the UK also recommends a
granular approach to these questions, recognising that individual commodities markets have
quite different characteristics, and a uniform approach to all markets will not be appropriate.
Additionally, before embarking on further action at the European level, given the global nature
of commodity markets we think it particularly important to await the outcome of the IOSCO
taskforce on commodities futures which is due in April 2011.
(145) If regulators are given harmonised and effective powers to intervene during the life of any
derivative contract in the MiFID framework directive do you consider that they could be given the
powers to adopt hard position limits for some or all types of derivative contracts whether they
are traded on exchange or OTC? Please explain the reasons for your views.
The UK supports the advice given by CESR to the Commission in relation to position management
and limits.47
Regulators should primarily use the enhanced powers of position management proposed by the
Commission to ensure that large positions do not damage market functioning. Markets are fast
changing, dynamic environments and position control needs to take account of this. By working
in conjunction with market operators and using their own experience and judgement, regulators
will be best placed to deal with undesirable positions if they have flexible powers.
These powers would properly include having authority to set position limits, as part of the tool
set, for both exchange and OTC markets, but not as the leading element. It is conceivable that
the application of some form of position limits is appropriate in some circumstances,e.g. where
liquidity is low either in the derivative or the underlying or where there are few participants in a
market or where the market is immature. However, discretion on when and at what level to
apply limits would most appropriately rest with the authority conducting the front-line
supervision of those markets (i.e. the national regulator and/or exchange level as appropriate for
the specific case).
In general, limits by their very nature are inflexible tools and, given the nature of markets, it is
likely that limits set for one month are unlikely to be appropriate in the next. Also, it is in
47 Whilst we note that this advice referred to commodity markets considerations, we note that we see no additional arguments suggesting benefit in applying position limits to other derivative markets.
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practice very difficult to categorise participants and set limits which are appropriate for all
members of particular category.
One of the benefits often attributed to position limits is that they provide certainty to market
participants. The UK notes however that to properly accommodate certain participants, in
particular “physical” participants and for hedging positions, it is almost always necessary to grant
exemptions and that this reduces that certainty. Position management on the face of it offers
less certainty, but the UK agrees with CESR that this can and should be redressed by setting
parameters and publishing guidance on how it will be applied.
The appropriate treatment for a position can in reality only be determined taking account of its
beneficial owner and of how it sits in the context of the prevailing real time market conditions
and how the market has developed to reach that point. Regulators can best meet this challenge
with flexible powers.
(146) What is your opinion of using position limits as an efficient tool for some or all types of derivative
contracts in view of any or all of the following objectives:
(i) to combat market manipulation;
(ii) to reduce systemic risk;
(iii) to prevent disorderly markets and developments detrimental to investors;
(iv) to safeguard the stability and delivery and settlement arrangements of physical commodity
markets. Please explain the reasons for your views.
For (i), (iii) and (iv) the UK refers to its answer to question 145. The UK believes position limits
may be an appropriate tool for these objectives in limited circumstances. However, the UK
considers that regulators should use their powers of position management as their primary tool
for these objectives given the greater flexibility and capacity for tailoring to precise circumstances
that they afford. The UK is not aware of evidence which indicates that any of these three
objectives have been achieved better in markets where position limits have operated than in
those where limits have not operated.
For objective (ii), systemic risk, it is theoretically possible that there is utility in applying limits to
restrain the overall build up of positions amongst particular participant types. Overall limits on
participant types could work in these circumstances to limit overall risk build-up48
. The UK
cautions however that position limits applied in this way may potentially damage liquidity in the
market if limits are set tightly and that this can have serious potential risk by leading to increased
volatility and by limiting the ability of market participants to lay off risk arising from their
legitimate business activities using market solutions. Accordingly the UK urges caution in
48 It is also a matter of debate whether there are any commodities businesses which, in the context of global financial markets can potentially pose systemic risk and suggest this warrants investigation.
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applying position limits to address this objective especially where an active position management
regime could more comprehensively handle the wider range of objectives. .
(147) Are there some types of derivatives or market conditions which are more prone to market
manipulation and/or disorderly markets? If yes, please justify and provide evidence to support
your argument.
Certain physically delivered contracts are more likely to be prone to manipulation, because of the
potential to manipulate the financial markets through the physical underlying. In general
however, the UK would expect these behaviours to be more likely to be exhibited in markets with
low liquidity or low numbers of participants. Where there are a small number of participants it
may be easier for one to acquire a dominant position which can either be used to leverage
manipulative strategies or which of itself may cause a market to function in a less orderly fashion.
(148) How could the above position limits be applied by regulators:
The UK supports the introduction of formalised position management powers which includes
empowering national regulators to set position limits where they see a legitimate purpose.
However, we do not support an imposed system of ex ante position limits. Nonetheless, if such
system were introduced then we envisage very limited benefit from them and difficulties and
costs as noted in our responses below:
a) To certain categories of market participants (e.g. some or all types of financial participants or
investment vehicles)?
For individual positions the UK envisages that limits would be set and published for fixed periods
with scheduled review dates. The UK does not think it would be appropriate to set aggregate
limits for categories of market participant since this may artificially constrain the markets
concerned and lead to increased volatility.
(b) To some types of activities (e.g. hedging versus non-hedging)?
Again, the UK would envisage published limits set for fixed periods with scheduled review dates.
The UK notes however that hedging is in many instances a difficult activity to identify and
classify. The nature of many markets and of participants‟ businesses means that hedging activity
is not always easy to isolate from other activity. Further, the nature of underlying activities in
many participants businesses mean that associated positions may change between these two
categories. Accordingly, there is likely to be a role here for granting block exemptions for certain
activity type, most likely based on analysis of typical business profile of the particular participant.
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(c) To the aggregate open interest/notional amount of a market?
The UK envisages only limited circumstances in which there would be a legitimate purpose to
limiting these overall metrics. As noted in the reponse to Q146, potentially such limits could be
applied to limit systemic risk. These could be set using assessment of overall prudential
exposures of the participants in the market. The UK notes however that the total open interest
and notional value of a market are usually very unreliable indicators of the actual exposure in a
particular market once netting of positions is taken in to account. Accordingly the UK sees very
little potential utility for such limits.
END