Wholesale financial market participants have been subject to significant regulatory scrutiny and rule change since the financial crisis.
It seems unlikely that this will change, with the regulation of wholesale markets featuring highly in the Financial Conduct Authority's (FCA) recent business plan. With its strategic objective to ensure that financial markets in the UK work well, the FCA continues to deliver the message that it is focused on ensuring "markets are clean, orderly, transparent, and resilient as well as competitive".
We have identified below the key issues facing wholesale financial markets over the coming 12 months.
One of the FCA's key priorities for wholesale financial markets is, and will be, the impact of the UK's withdrawal from the European Union (EU).
Following the 2016 referendum result, the UK has been poised to leave the EU for some time. The Agreement on the withdrawal of the UK from the EU and the European Atomic Energy Community (the Withdrawal Agreement) and the Political Declaration setting out the framework for the future relationship between the EU and the UK (the Political Declaration) published in November 2018, looked as if it might offer the financial services sector (as well as the rest of the UK) some much needed certainty on how they would continue to function in a post Brexit world.
However, unless the Withdrawal Agreement is approved or the UK manages to secure another extension, the UK will leave the EU on 31 October 2019, without a deal. The FCA has planned for a number of Brexit scenarios and has plans in place to make sure UK financial services continue to work even if there is no deal.
Cross-sectoral priorities such as financial crime and the Senior Managers & Certification Regime (SM&CR) will also be relevant but aside from Brexit, what else will be on the FCA's radar for the wholesale sector?
In February 2019, the FCA expressed concerns with the implementation of the Market Abuse Regulation (MAR), and in particular that some firms did not think about the significant effect of inside information (e.g. dialogues with brokers, pitches) being used outside of the firm and becoming a "market defining event".
Accordingly, it seems likely the FCA will focus its activities specifically on a firm's ability to prevent leaked information being used for criminal activities by paying attention to "areas such as the control of inside information within M&A businesses and corporate broking functions".
Firms should therefore consider the FCA's Financial Crime Guide for Firms 2018 update, which has recently been updated to add a chapter on insider dealing and market manipulation, providing observations "of good and bad market practice around the requirement to detect, report and counter the risk of financial crime" in relation to insider dealing and market manipulation.
The Markets in Financial Instruments Directive (MiFID II)
MiFID II requires firms to provide FCA with information about transactions and the circumstances in which the transaction took place. These transaction reports will also be used by the FCA to detect and monitor market abuse (with the FCA reserving the right to monitor data quality and intervene where necessary).
The FCA also plans to carry out further work to ensure firms are complying with the requirement to have certain policies in place. For example, investment firms are expected to obtain the best possible results for clients when executing their orders (i.e. performing their "best execution" obligation). The execution arrangements should be outlined in a firm's order execution policy, which should be regularly monitored to identify any deficiencies.
Successor to LIBOR
Some market participants have already begun to transition to alternative benchmarks. The FCA seems pleased by this as it has been championing the Sterling Over Night Index Average (SONIA) as its preferred alternative for nearly two years.
In its "Dear CEO" Letter to banks and insurers (published in September 2018 jointly with the Prudential Regulation Authority (PRA)), the FCA asked those firms to explain the steps they were taking to manage transition from LIBOR to an alternative interest rate benchmark. We expect the FCA will continue to ask those questions of firms (with a focus on firms that it believes are not effectively managing their transition risks).
Access and use of data
Developments in technology, the use of data and innovation generally all have the ability to make the role of any regulator difficult. The FCA acknowledges this as it knows that changes from technology and innovation create new risks as new financial services products test the FCA's regulatory perimeter.
It is clear from the FCA's business plan that it does not want innovation to limit access to financial markets. To overcome this, the FCA intends to perform diagnostic work to understand the changes brought about by technology.
Additionally, there will be a call for input to:
- better understand market dynamics, competition and other regulatory issues to decide which of them, if any, the FCA can address through further work, such as a market study or supervisory work;
- potentially prompt customers to come forward with complaints that may be relevant from a competition law enforcement perspective;
- if the evidence warrants, conclude that action is not needed at this stage, as happened with the FCA's call for input on big data in insurance
The regulatory future for financial markets
It seems the wholesale markets will continue to be the subject of "regulatory scrutiny" in 2019/20. This is not surprising given the implementation of new regulation like MAR and MiFID II.
However, there is an underlying sense that most of the pressure may be felt by the regulator as it tries to monitor and supervise this diverse market against the backdrop of increasing technological innovation and Brexit. It will certainly be interesting to see how matters develop over the next 12 months.