FCA consultation on equity markets

The latest FCA consultation on proposals to improve the UK equity markets takes forward some of the reforms proposed in the HM Treasury Wholesale Markets Review (WMR). The WMR aims to tailor the on-shored MiFID II and MiFIR regimes for the UK market now that the UK has left the EU. In particular, the FCA is consulting on:

• Improving the content and consistency of post-trade transparency reports
• Establishing a new designated reporter status for OTC trades
• Allowing UK trading venues to use reference prices from overseas markets where those prices are robust, reliable, and transparent
• Permitting the use of the tick size regime from overseas primary markets

The FCA is also seeking views on the structure of UK markets for retail orders and on its approach to improving UK markets' resilience to outages.

This consultation focuses on reforms that the FCA can enact without changes to the primary legislation that will be implemented via the Financial Services and Markets Bill, introduced by the UK Government in July 2022.

Reforms to MiFIR are also being debated in the EU. The FCA has recognised that many firms will be operating in both the EU and the UK as it has considered firms' responses to ESMA's review on RTS 1 (Equity markets transparency) in which similar topics are addressed.

Respondents to the WMR noted that it is difficult to interpret trading data in the equities market and identify addressable liquidity, i.e. liquidity that firms can interact with and use for trading decisions. Therefore, the FCA has proposed to:

• Make post-trade transparency more useful by excluding non-price forming transactions that add noise to post-trade reporting and increase the cost of reporting for firms e.g. intra-group transactions or transactions by investment management companies transferring shares between their managed collective investments
• Achieve greater consistency and limit duplications in the use of flags for trades that are exempted from: post-trade transparency; the share trading obligation; and pre-trade transparency under the negotiated trade waiver
• Improve the information content of trade reports by simplifying trade flags and other reporting fields
• Reform the framework that establishes the conditions under which investment firms are required to report trades executed OTC, to lower the cost of reporting for firms

In response to the WMR, there were calls to separate the ability to do post-trade reporting of OTC trades on behalf of clients from the other obligations of being a Systematic Internaliser (SI). Market participants also raised concerns that there is a degree of uncertainty about who should report OTC trades and that the current reporting regime creates operational complexity for firms.

The FCA is proposing to create a regime where firms will be able to register as designated reporters regardless of whether they are an SI in any instrument. Registration will be at entity level. The regime will apply across all classes of financial instruments, equities and non-equities. Designated reporters will be responsible for reporting only trades to which they are a counterparty. Where both or neither of the counterparties are designated reporters, the seller will report.

Trading venues are permitted to use waivers that, in specified circumstances, allow orders to be broadcasted and to interact without pre-trade transparency. The reference price waiver allows trading venues to waive pre-trade transparency for systems where orders are matched based on a reference price, and is used by trading venues to operate dark pools. The FCA is proposing changes to allow trading venues to derive reference prices from non-UK trading venues, subject to the prices being reliable, transparent and consistent with best execution. This would allow prices to be derived not only from EEA venues, but also from other jurisdictions such as the US or Switzerland whose shares are regularly traded on venues in the UK.

However, UK MiFIR will need to be changed via the Financial Services and Market Bill to give the FCA rule making powers to make further change to the pre-trade equities waivers regime such as allowing the use reference prices that are composite prices from multiple venues.

Under the order management facility waiver, trading venues can operate reserve (also known as iceberg) and stop orders which waiver some aspects of pre-trade transparency. The FCA is proposing to repeal the current fixed threshold of €10,000 for reserve orders, allowing trading venues to determine minimum size thresholds (in line with best execution) for reserve orders bringing them into line with stop orders.

The MiFID II regime sets a minimum tick size (the increment between quoted prices) to prevent the risk of too small tick sizes that could harm the price formation process. The FCA is now acting on feedback from the WMR consultation by proposing to amend RTS 11 to allow trading venues to set the minimum tick size at the level of the primary market located overseas. This proposal is most likely to impact the 2,000 US shares traded on UK venues whose the tick size could drop quite considerably.

Feedback from the WMR consultation highlighted a need for clearer and more timely communications from trading venues during an outage. The FCA's PS21/3 'Building operational resilience' sets out requirements for trading venues with an overall framework for improving communications but does not address specific issues linked to trading venue outages and market-wide resilience.

The FCA wants to work with market participants on guidance on communications and protocols on market outages on trading venues and is asking for feedback on the key areas it thinks the guidance should cover:

For trading venues:

• Monitoring system disruption and issue escalation mechanisms
• Communication during an outage, including standardised system statues for different types of outage and estimated timeframes for re-opening
• Playbook: expectations around procedures setting out different types of outage and policies on the treatment of the orderbook for these types of outage
• Post-outages: the need for trading venues to provide the FCA with a root cause analysis and remedial plan after all incidents
• Closing prices: expectations on the determination of alternative closing and settlement prices in the event of an outage

For market participants:

• Pre-outages: expectations of market participants to be well-informed about trading venue communication channels and protocols in case of a trading venue outage and have clear policies in place around best execution for clients
• Routing: expectations that system should allow orders to be routed to an alternative venue during a market
• Closing price: expectations on market participants, including index providers, in respect of policies and procedures to specify the use of an alternative closing reference price during a primary market outage

In the UK, about 95% of retail orders for shares are executed through the Retail Service Provider (RSP) system rather than on the central limit order books operated by trading venues. RSP trades are usually off book, on exchange transactions on the London Stock Exchange. The WMR consultation feedback on the RSP system was mixed. Benefits include price competition, low cost and client access segregation. Weaknesses include lower quality of execution as the retail order flow is only interacting with one part of the market. At this stage, the FCA is not making any proposals for rule changes but is seeking views on changes that would improve the regulatory regime around execution of retail client orders.

The consultation closes on 16 September 2022.