ESMA clarifies key issues regarding derivatives trading and use of benchmarks in the event of a no-deal Brexit
- Posted by Michael McKee
- On 18 March 19
- Benchmarks Regulation, Brexit, Derivatives, ESMA, MiFID II, MiFIR
On 7 March 2019, the European Securities and Markets Authority (ESMA) published a statement clarifying how certain aspects of regulation around derivatives trading and the use of benchmarks would continue to operate in the event of a ‘no-deal’ Brexit (Statement). In general, after exit day the UK will be considered as a ‘third country’ in relation to the EU and vice-versa. The Statement sets out how certain key provisions under the second Markets in Financial Instruments Directive (MiFID II), the Markets in Financial Instruments Regulation (MiFIR) and the Benchmarks Regulation (BMR) will apply after the UK leaves the EU.
MiFID II carve-out for wholesale energy products
MiFID II exempts from its scope certain physically-settled derivatives that qualify as ‘wholesale energy products’ and that are traded on an EU Organised Trading Facility (OTF). The Statement clarifies that post-Brexit, a derivative contract based on electricity or natural gas which is exclusively produced, traded and delivered in the UK will not benefit from this carve-out. This means that it would be classed as a MiFID II financial instrument. However, if such a derivative is traded on a spot trading platform in the EU, it may benefit from the carve-out.
Trading obligation for derivatives
Under article 28 of MiFIR, trading in certain derivatives must take place in specified trading venues, such as EU regulated markets, multilateral trading facilities and OTFs. These may also include third-country trading venues, provided that the EU Commission has adopted a relevant equivalence decision. Presently, the majority of derivatives trading takes place in UK-based trading venues. However, the Statement notes that by now most UK trading venues have established new trading venues in the EU27 offering the same product portfolio as they do in the UK. ESMA therefore does not have, at this point in time, any evidence that market participants will be unable to meet their trading obligations in the case of a no-deal Brexit and absence of an equivalence decision by the Commission covering UK trading venues.
Post-trade transparency and position limits
In general, transactions executed in third-country trading venues are considered as Over-The-Counter (OTC) transactions under EU law and are subject to certain post-trade transparency requirements under articles 20 and 21 of MiFIR. Moreover, commodity derivatives traded on third-country venues may be considered as Economically Equivalent Over-The-Counter (EEOTC) contracts under the EU position limit regime. ESMA has clarified in the past that the above do not apply in relation to third-country trading venues that meet certain conditions. After exit day, ESMA will again assess UK trading venues against the relevant criteria. In the meantime, the Statement specifies that EU investment firms will not need to disclose transactions executed on an UK trading venue through an EU Approved Publication Arrangement (APA). In addition, commodity derivatives contracts traded on UK trading venues will not be considered as EEOTC contracts under the EU position limit regime.
However, in order to ensure post-trade transparency, EU investment firms will need to disclose through an EU APA OTC transactions concluded with UK counterparties.
Third-country benchmarks administrators and third-country benchmarks
Post-Brexit, the relevant ESMA registers will not include UK benchmarks administrators or third-country benchmarks recognised or endorsed by the UK before exit day. However, the BMR provides for a transitional period during which EU supervised entities will still be able to use the benchmarks provided by third-country administrators, as well as third-country benchmarks. Therefore, EU-supervised entities will not be affected immediately by these changes.