Brexit's share-trading standoff shifts market liquidity to EU

This analysis is by Bloomberg Intelligence analysts Sarah Jane Mahmud and Jakub Busz. It appeared first on the Bloomberg Terminal.

The shift in equity trading to the EU from London, as a result of regulatory disaccord over the post-Brexit application of MiFID II's share-trading obligation, is unlikely to reverse or even slow, we believe.

Yet, U.K.-based trading venues appear relatively well protected, having established EU hubs before Britain's Dec. 31 departure from the bloc.

London's liquidity stripped by trading shifts

In the first week of trading after Brexit, London-based venues saw their share of the consolidated market in equity-trading fall to 25% (12% excluding the London Stock Exchange) from almost 50% weeks prior to the split, fragmenting pools of liquidity, hampering price formation and restricting EU investment firms' best-execution obligations. Europe's largest exchange Cboe saw over 40% of its stock trading move to its Amsterdam hub, representing 75% of the overall value. Aquis has seen over 60% of share-trading volume, about 70% of value, move to its newly established Paris hub. Yet, as these U.K.-incorporated venues, along with Turquoise and Liquidnet, set up EU-27 hubs in advance of Brexit to mitigate disruption, we believe they're relatively well positioned to protect trading revenue.

Source: Cboe Global Markets

Disagreement may not end soon, if ever

Liquidity in equity markets is unlikely to return to London any time soon, we believe, as the odds of political compromise are slim. Regardless of trading volumes and ease of execution, it may become normal for EU investment firms to trade shares with an EU ISIN only on trading venues approved by the European Securities and Markets Authority as having a broadly equivalent regulatory regime in place. We're skeptical ESMA will grant equivalence based on its revocation of Swiss share-trading equivalence in July 2019 and its plans

to build up the bloc's single capital market, which includes reduced reliance on London.

Source: Cboe Global Market

Small concessions help mitigate disruption

Small regulatory concessions have helped mitigate a wider shift in liquidity and minimize disruption. U.K. investment firms may continue to trade shares on EU venues until 2Q22, preserving their ability to seek best execution, as a result of the FCA's temporary transitional decision. Meanwhile, EU investment firms may

trade sterling-quoted shares of EU companies listed in London such as AIB and Ryanair, due to the ESMA's 4Q change-in-position, yet there are only about 50 such companies, which represent 1% of trading activity.

Investment firms are required under article 23 MiFID II Regulation (MiFIR) to trade EU-listed shares on EU-regulated or EU-approved venues. From the Jan. 1 end of Brexit's transitional period, the LSE and other U.K. venues aren't EU-regulated and, absent an equivalence decision, remain EU-unapproved.

Key quotes

"In the absence of an equivalence decision, the potential adverse effects of the STO after the end of the transition period are expected to be the same as in the no-deal Brexit scenario."

European Securities and Markets Authority

"Absent a determination of equivalence, the FCA will engage with market participants and trading venues about the steps that may be needed to protect the integrity of markets in the U.K."

Financial Conduct Authority

What is regulatory equivalence?

Third-country equivalence helps companies based outside of the EU access its market. It allows those beyond the bloc's borders to do business within them on similar terms to a financial passport's. The European Commission, the EU's executive arm, must determine the country's regulatory regime to be at least as rigorous, and the relevant regulator (EBA, ESMA or EIOPA) registers each firm from that nation. But equivalence is more political than technical. Talks with the U.S. on clearinghouses, for example, were prolonged, affecting CME and others.

RBS, BNP Paribas, Commerzbank, BlackRock and and 3I are among companies that avail of the EU passport regime. Risk is declining, though, due to relocation activities (e.g., Barclays shifting operations to Dublin) and gaining extra regulatory approvals (e.g., Schroders in Luxembourg).

Key points

The Commission's equivalence assessment would verify that the U.K. has legally binding requirements, ensures effective supervision, and achieves the same results as corresponding EU laws.
The relevant supervisory authority (European Securities and Markets Authority, European Banking Authority, European Insurance and Occupational Pensions Authority) would advise the Commission.
Equivalence may be granted in full or partially, indefinitely or with a time limit.