European Union: More Than Market Access: The Regulatory Impact Of Brexit On EU And UK Firms

Last Updated: 25 January 2019
Article by Owen Williams

Most Read Contributor in UK, March 2019

A hard Brexit will not only affect UK firms and gives rise to more issues than just market access.

Much attention has been given to the problems which UK firms will face in accessing EU markets in the event of a hard Brexit. However there are a number of less headline- grabbing changes which firms will also need to consider. These changes will not just impact UK firms and EU firms should not think of Brexit as simply a British problem. Indeed, a number of the changes brought about by a hard Brexit may have a bigger impact on EU firms than on UK firms.

As with any article on Brexit, this one comes subject to the usual caveat that the actual position following the UK's withdrawal from the EU will depend on the terms of any agreement reached between the UK and EU. This article considers what the position would be in the event of a no deal Brexit, assuming no side arrangements are made between EU and UK regulatory bodies.

For commodity traders, some of the most important changes relate to the impact a hard Brexit will have on their status and obligations under the main pieces of legislation governing derivative trading, namely the European Market Infrastructure Regulation (EMIR) and the Markets in Financial Instruments Directive (MiFID II). This article will focus on the ways in which these two pieces of EU legislation are to be "on-shored" in the UK following Brexit, the approach to central counterparties (CCPs), the calculation of the clearing threshold, and the availability of the intragroup exemption, under EMIR, and the calculation of the ancillary exemption under MiFID II.

On-shoring

Readers are likely to be familiar with the general process by which the UK will on-shore EU law following Brexit. Under the European Union (Withdrawal) Act 2018 (the Withdrawal Act), the UK will retain all UK legislation that implements EU Directives and incorporate EU Regulations into UK law.

Unsurprisingly, this is not a straightforward task. It is not possible to simply cut and paste EU legislation into UK law. For example, references to EU agencies need to be replaced with their UK equivalents. For this reason, the Withdrawal Act allows the government to correct deficiencies in retained EU legislation that result from the UK's withdrawal from the EU. .

The UK has published three statutory instruments (some of which are still in draft form) to onshore EMIR under the Withdrawal Act (UK EMIR) and a draft statutory instrument to onshore MiFID II (UK MiFID II). The process of correcting deficiencies in UK EMIR and UK MiFID II may result in some differences in firms' status and obligations after Brexit.

EMIR - Clearing threshold

Both EU and UK firms will have to consider whether their clearing status under EMIR will change following a hard Brexit.

Currently firms whose speculative OTC derivative contracts (as opposed to speculative contracts traded on exchanges) are valued above a certain threshold, known as the "clearing threshold", must comply with stricter risk mitigation rules under EMIR.

In the event of a hard Brexit, UK exchanges will no longer be recognised by the EU and contracts traded on UK exchanges will be classed as OTC. As a result EU firms will need to treat contracts traded on UK exchanges as OTC and include such contracts when calculating whether their speculative OTC trading exceeds the clearing threshold.

Similarly, under UK EMIR, contracts traded on EU exchanges will be considered OTC and UK firms will need to include such contracts in calculating whether they exceed the clearing threshold under UK EMIR.

Thus, a number of firms, both in the EU and UK may find that, following a hard Brexit, they no longer fall below the clearing threshold and may need to reclassify as NFC+.

EMIR - Intragroup exemption

A hard Brexit could mean that companies are no longer able to rely on the intragroup exemption under EMIR.

The intragroup exemption exempts trades between two EU members of a group, or between an EU company and a company in a third-country which benefits from an equivalence decision, from EMIR's clearing obligation.

If Britain leaves the EU without a deal or any equivalence decision, intragroup trades between an EU company and its UK sister company will no longer benefit from the intragroup exemption. As a result, certain EU companies will be required to clear intragroup trades with UK companies.

For UK companies, the position is different. Under UK EMIR, the government has proposed a temporary exemption regime, which will allow UK companies that relied on an intragroup exemption prior to exit day, to continue to rely on this exemption after Brexit. This appears to be one area in which Brexit will have a more direct impact on EU firms than on UK firms.

EMIR - Central Counterparties

One of the main concerns of EU firms over the past few months has been the risk that EU will no longer recognise UK CCPs.

Under EMIR, certain firms are required to clear their OTC derivatives with a CCP which is authorised or recognised by the EU. The vast majority of derivatives are currently cleared through UK CCPs. In the event of a hard Brexit, these UK CCPs will no longer be recognised by the EU for the purposes of EMIR. Thus clearing an OTC trade with a UK CCP will no longer be sufficient to meet the clearing obligation under EMIR.

With an estimated £67 trillion worth of notional derivatives cleared by EU firms on UK CCPs, the EU has recognised that this is an issue which could potentially undermine market stability. On 19 December 2018 the European Commission adopted an Implementing Decision which will allow UK CCPs which were authorised prior to Brexit to continue providing clearing services after Brexit. The European Securities and Markets Authority has said that it is aiming to adopt recognition decisions in relation to UK CCPs well ahead of Brexit. It appears that this is one of the few issues where a hard Brexit should have a limited impact.

MiFID II – Ancillary activities exemption

Following a hard Brexit, firms will need to consider their status under MiFID II. In particular, those commodity traders which currently rely on the ancillary activities exemption will need to ensure that they can still do so after a hard Brexit.

The ancillary activities exemption allows firms that trade commodities derivatives on own account largely for the purposes of hedging to remain outside the regulatory scope of MiFID II. In order to rely on the exemption firms must pass two tests, one of which, the "market share test", compares the size of their speculative trading activity in the EU against the overall trading in the EU in each particular asset class.

In the event of a hard Brexit, trading data from the UK will no longer be taken into account in determining the overall volume of trading undertaken in the EU. In addition, EU firms will no longer have to consider trading done on UK venues when considering the size of their own speculative positions. Given that almost all trading in certain asset classes, such as coal, oil and metal, takes place in the UK, the fact that UK data will no longer be included in the market share test could lead to problems for EU firms. It remains to be seen whether the EU will make any amendments to the market share test following Brexit. However, without UK trading data, the calculations will look quite different after Brexit.

For UK firms, there is a little more certainty. Under UK MiFID II firms must continue to consider trading in the EU in determining their status under the "market share test". Thus most UK firms which currently pass the market share test are likely to continue to do so after a hard Brexit. Again this is another area where a hard Brexit may have a bigger impact on EU firms than UK firms.

More than market access

A hard Brexit will impact commodities firms beyond the obvious market access issues. This article does not provide a complete list of factors which firms will need to consider. However firm's should note that a hard Brexit will require all firms, and not just those in the UK, to look closely at all aspects of their business. Unfortunately this is a task for which there are no short-cuts.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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