On the 24th June 2019, the Swiss Federal Department of Finance gave notice that Swiss stocks, listed on MiFID II compliant trading venues, would no longer be tradable at those venues. In effect, despite having achieved compliance with MiFID II, Switzerland lost equivalence recognition. Citihub Consulting has previously discussed equivalence, however, the loss of equivalence for Switzerland adds a new twist to the Brexit dilemma for UK firms. The latest Financial Stability Report, published on July 12th 2019, by the Bank of England’s Financial Policy Committee, gives an update on the Resilience of the UK financial system to Brexit: “The perceived likelihood of a no-deal Brexit has increased since the start of the year… Actions by businesses and authorities… have resulted in some improvement in the preparedness of the UK for a no-deal Brexit. However, material risks of economic disruption remain.” This blog looks at the key lessons from the Swiss experience and presents pragmatic steps to provide some future-proofing for UK domiciled firms.
Equivalence is a political privilege. It is not, as is understood by some politicians, an automatic right granted when compliance to a regulation is achieved. Switzerland gambled on a last-minute reprieve assuming that reciprocity would force the EU to reconsider. In the final act, this turned out to be no strategy at all.
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Furthermore, equivalence is a continuous process and not a single checkpoint. Firms that expect to benefit from equivalence after Brexit will need the country to continue to have national equivalence. However, by implication, in-scope firms must also continue to meet MiFID II obligations (and avoid regulatory drift). Moreover, firms must continually prove they are continually compliant.
All firms should take immediate action to future-proof trading systems for the possibility of a country facing the temporary or permanent loss of equivalence, and have that applied at very short notice. Firms should investigate hardcoding of allowable venues for instruments; trade and order routing based on a range of determinates (e.g. ISIN level routing); and how reference data modelling can make changes dynamic and seamless for trading systems. Obvious targets for potential changes will include systems that meet MiFID II RTS 6 algorithmic trading obligations such as Smart Order Routers. It will include systems involved in determining transaction reporting eligibility based on Trading On Trading Venue (TOTV) values to reflect what and where instruments can be executed.
Loss of Swiss equivalence means that Swiss equity instrument (predominated Swiss Blue-Chip names) can only be traded on the Swiss exchange and not on EU MTFs or dark pools. This will have had a significant impact on Smart Order Routing (SOR) algorithms. These SORs rely on building a consolidated picture of market prices across a range of venues, and then executing on best prices. This can mean routing orders to multiple venues. In order to do this, algorithms must have a systematic way of understanding the venues that are in and out of scope for any given instrument – their fungibility. The loss of equivalence removes fungibility and forces SORs to trade only on the Swiss exchange. This, in turn, means updates to instrument reference data in order to move venues “out-of-scope” for smart order routers. There may have possibly been updates to order routing rules, and maybe even composite market data mechanisms. Changes to order routing rules and market data aggregators are relatively rare and may not, therefore, be automated. Manually crafting and applying changes may even involve hard coded rules in computer code.
If the UK exits the EU without achieving equivalence for its financial services sector, similar changes may be necessary. However, it would be prudent to plan and automate these changes. Furthermore, it will be important to practice putting venues in and out of a fungible product mix. Test scenarios should include UK names that cannot be traded on EU venues and EU names no longer being tradable on UK venues. There is a case where internal order routing rules increase in complexity for an eventuality that never occurs.
There is a potential impact to TOTV data that firms use for determining transaction reporting eligibility under a loss of equivalence for a country. This could impact both where instruments are allowed to trade and also which National Competent Authorities’ transactions must be reported to. This is a full front-to-back impact that could result in transaction reporting exceptions and misreporting. Firms must prepare to monitor and reconcile changes to TOTV with outbound transaction reports on trade data or as soon as possible after reports are submitted.
Other further aspects to consider and prepare for are:
- Post-trade transparency implications – also known as trade reporting
- Impact to systematic internalisation regimes
- Client communication
Equivalence with MiFID II after Brexit for UK firms is not guaranteed. Continued compliance with MiFID II is probably a basic requirement for trading firms whatever the equivalence status of the UK after Brexit is. Citihub Consulting recommends that firms learn from their reaction to the Swiss equivalence loss and make their changes to cope with it into a target operating model that will make them indifferent to future changes in EU equivalence for any country.