On 1 July 2021 Rishi Sunak, Chancellor of the Exchequer, set out the steps that the UK government will take to deliver its vision for the future of financial services. The speech was a strong message to Europe and the rest of the world that the UK intends to strengthen its regulatory regime, competitiveness and thought leadership position.
To reach this future state there is still some housekeeping to be taken care of. As the Temporary Permissions Regime comes to an end, two major challenges have to be resolved: the impact of Brexit on clearing and the future plans for issuance and settlement of Irish securities.
Impact on clearing
Brexit triggered great consternation around the industry on the topic of equities clearing. From a custodian and clearer’s perspective, the issue was EU Share Trading Obligations (STO). Under Article 23 of MiFir, relevant trades must take place on a recognised regulated market, multi-lateral trading facility (MTF) or equivalent. How are custodian clearers, such as BNP Paribas Securities Services, impacted when they do not trade themselves?
In order to act as a General Clearing Member (GCM) on the LCH Ltd a non-trading membership of the London Stock Exchange (LSE) is required. This is an unusual requirement specific to LCH and not required by either SIX x-clear or EuroCCP. Since under the EU Share Trading Obligation, non-trading custodians would no longer be able to hold this membership, they would be unable to clear trades on behalf of clients through LCH Ltd.
This posed a significant problem for the industry, one which was solved when ESMA stated that the EU Share Trading Obligation does not capture GCMs. Furthermore, ESMA limited the STO to EEA shares traded in currencies other than sterling on UK trading venues. Essentially, this paved the way for dual-listed securities to be traded on the LSE in any currency other than Euro. As a result, a number of EU-based clients either set up UK entities to trade in euros on UK venues or solely to trade on EU venues post-Brexit.
The Irish CSD conundrum
It has been more than twenty years since Irish securities were first issued and settled by Euroclear UK and Ireland (EUI). Now that EUI is a third-country CSD, EU securities can no longer be issued through the platform. There have been many proposals with regard to how this may be addressed. EUI had considered an Irish version of their CREST system and there were also talks of Clearstream establishing itself as the Irish CSD. Ultimately, however, Euroclear Bank (the Belgian iCSD) has emerged as the issuer CSD of choice, with EUI becoming an investor CSD as it is for all other non-domestic securities. In this solution, EUI provides issuer CSD services through the use of CREST Depository Interests (CDIs), which are in effect securities incorporated under English law which represent an interest in an underlying non-domestic security held by EUI in other CSDs through its own custodial arrangements.
This is not a new situation for EUI. In 2015 most Irish ETFs such as Blackrock iShares and the Vanguard ETFs changed issuer CSD from EUI to Euroclear Bank and the holdings were converted to CREST Depository Interests (CDIs). Irish equities, however, come with additional considerations. For example, dual listed securities’ can be traded on different venues (LSE and Euronext Dublin), each with different clearing and settlement arrangements.
Migration of clearing and trading volumes to Europe
In the run-up to Brexit, the headlines predicted clearing and trading volumes leaving the UK and moving to Europe. In truth, while some flows have gone to Europe, indeed Amsterdam has now surpassed London for share trading volumes, the exodus was not as stark as predicted. Whether this is simply a reflection of exceptional post-Covid volumes, it is perhaps a little early to tell. Whatever the reason, we have continued to see very high UK volumes from a trading, clearing and settlement perspective, allaying earlier concerns.
Change brings opportunity
Whilst EUI have effectively lost the Irish market, some opportunities remain. A UK listing review was issued by the Chancellor in the spring of 2021, with a drive to increase the listing of foreign companies in the UK. Essentially, the proposal is to ease listing rules and improve financing opportunities. EUI (Euroclear UK and Ireland) has confirmed its ambition to expand the service to support foreign listings if possible. It is an interesting time for the UK issuer landscape including discussion of establishing SPACs (Special Acquisition Companies) in the UK.
As the post-trade world adjusts to the post-Brexit model, attention begins to shift towards what needs to be done to realise the UKs future vision. Regulatory alignment is an area to watch, with the UK no longer required to directly apply European regulations or transpose European directives. Indeed, the UK is keen to explore ways to reinvigorate its markets. In his recent speech, Rishi Sunak stated “now that we’ve left the EU, we have a unique opportunity to take an approach that better suits our markets, while still maintaining high regulatory standards.” An early example is the CSDRs Settlement Discipline Regime and the hotly debated mandatory buy-ins. The UK has already confirmed that it will not implement the Settlement Discipline Regime as it is set out in CSDR, despite being committed to strengthening its regulatory regime. It remains to be seen whether we will see increasing divergence in regulation between the UK and EU, and which levers government will pull in a bid to reinvigorate the UK market and drive greater competitiveness. As Sunak states the UK now has the freedom to do things differently and better.