1. The one certainty at the moment is uncertainty. What does Brexit mean for capital markets firms?

In this new paradigm post-EU referendum world, firms are taking stock of what Brexit actually means for them – the challenges and the opportunities in the near term as well as looking to the longer term and how plans can be kept flexible to deal with such uncharted waters.

For firms operating in the capital markets, a lot of focus is still on dealing with the initial aftermath in markets, reassuring clients and staff and the regulator and continuing work on upcoming regulatory developments while making more concrete future plans.

The FCA’s statement on the EU referendum result made its expectations clear – all existing regulations still apply (for now), regardless of whether they originate from the EU, and firms should continue with their implementation plans for upcoming EU legislation – so there should be no letting up on the updated rules for the Markets in Financial Instruments Directive (MiFID II) plans.

Of major concern is whether passports giving firms access to all levels of client in the EU will continue. If they do, then how will the absence of the UK’s voice at the debating table – particularly around areas such as bond market transparency/liquidity and ratio of fixed to variable remuneration debate (see earlier Review article from SIRG for more on this) impact the final regulations we will need to follow to maintain EU equivalence?

Impetus for many current rule changes emanates from the G20 and the Financial Stability Board, very much reflecting Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) priorities, so it is unlikely that the much vaunted wish of less EU meaning less EU regulation will materialise. Instead if the UK needs to retain equivalence, it will need to maintain the bulk of current and proposed regulation.

UK firms will now also need to give consideration to their clearing settlement arrangements – access to EU central counterparty clearing houses (CCPs); wording of contracts and whether these will be impacted – in particular any impact on client asset arrangements. The Client Assets Sourcebook (CASS) risk assessments will need to ensure Brexit risks are covered, particularly in terms of consideration of insolvency laws of banks and custodians in EU jurisdictions post-Brexit.

2. How will the use of English law in contracts and agreements be affected overall – Rome II jurisdiction clauses; choice of English law overall?

We won’t to need to start updating documentation as yet, but there are a few areas of consideration for any new agreements (should we be looking at successor wording for references to EU related matters?):

• Legal consequences
  The Government will need to set out how it is going to deal with existing laws and regulations emanating from EU directives and regulations. Directives that are already enacted in UK law will probably remain as they are for a time, but how existing EU regulations (that have direct impact without being enacted into UK law) will be treated remains to be seen, eg, Capital Requirements Regulation, the new Market Abuse Regulations (MAR – more on that later) and of course European Market Infrastructure Regulation (EMIR) and Markets in Financial Instruments Regulation (MiFIR), the latter of which is particularly important for any firms hoping to rely on third country equivalence clauses (if the European Commission deems the UK equivalent) to do business with eligible counterparties (ECPs) and per se professional clients in the EU.

• Securities and derivatives underlying product documentation
  Issuing documents, prospectuses, medium-term notes (MTN) programmes and other industry-standardised documents will need analysis and updating – trade bodies are likely to be helpful here.

  Treatment of UK issued securities is a concern in terms of whether they can continue to be held in Undertakings for the Collective Investment in Transferable Securities (UCITS) funds, whether they are recognised as eligible collateral with the European Central Bank (ECB) and whether they qualify as eligible liquid assets for the purpose of the liquidity coverage ratio (LCR) and capital requirements regulation (CRR).

  There were already moves afoot for euro-denominated clearing to move into the eurozone. Brexit is likely to speed this up, and as for the Capital Markets Union – it’s likely to go on, but without UK participants. Views on the UK triggering other country exits don’t seem quite as popular now that other countries are seeing the reality of the UK situation and perhaps watching and waiting …

  Again, updates will be needed for client documentation to alter references to EU legislation and regulation, even down to removing references to the EU and the EEA. Should we start to look for Brexit-proof wording in new agreements now? Other contracts and agreements with third parties as well as internal policies and procedures, internal capital adequacy assessment processes (ICAAPs), individual liquidity adequacy assessments (ILAAs), and the recently written Recovery and resolution plans will all need review and updating.

• People
  The position of non-UK EU staff is hopefully an area Government will resolve quickly, but firms need to consider implications both in terms of existing staff and future recruitment plans. Another matter to bear in mind is recognition of existing qualifications and the position of UK staff working in EU branches and subsidiaries post-Brexit.

  All the above changes are also going to need a lot of people to implement – do firms have sufficient legal and regulatory expertise? Will there be enough lawyers and compliance officers to go around in the UK?

  And finally, have you made sure that the relevant people, boards, non-executive directors and others have been formally notified of the situation and implications?

3. Getting to grips with Market Abuse Regulation
So, now we know EU regulations aren’t going away any time soon, firms will be well on their way to getting to grips with the practical aspects of MAR implementation (started 3 July) and, much as this is EU regulation, the FCA will want firms to be up to speed (see helpful FCA pages on MAR and the new suspicious transactions and orders reporting regime). The FCA is contacting many firms to check their progress in market soundings, insider lists, buy-backs and stabilisation, market manipulation, reporting, accepted market practices and other areas where there is no current solution, such as recording orders (see below).

What’s new? Instruments covered have increased to now include securities transacted on a wider range of markets (regulated markets, multilateral trading facilities and organised trading facilities), bringing many non-EU securities into scope if they are traded on one of these EU markets and raising questions of extra-territoriality. A wider range of derivatives will thus also come within scope, as does trading in emissions allowances, and behaviour in respect of benchmarks.

For some time, the FCA has expected firms to report market abuse suspicions that have not resulted in a transaction. The new MAR rules now require firms to detect and report attempts to commit market abuse (suspicious orders, quotes, amendments and cancellations). This includes a requirement to monitor for this – a systems and technology challenge for firms.

If you hold inside information as an issuer or someone acting on behalf of an issuer, keeping insider lists becomes more onerous – MAR gives a precise template for deal specific and permanent lists, including an insider’s personal details (address and national ID number). The challenge is ensuring this personal data is kept up to date. For example, how will you ensure any house moves or passport changes are captured on time? Company secretariat teams may well know who should be on this list – but will they have access to such granular levels of up-to-date personal information? MAR introduces a new concept of “investment recommendations” covering just about every communication with clients that isn’t a one-to-one conversation or a “personal recommendation” specific to that client. Again the challenge is whether technology is available to keep adequate records of all “investment recommendations”, and to recognise quite which communications are caught.

4. Recovery planning remains high on the agenda

Just as the credit crisis began to seem a long time ago, market turmoil post-Brexit is a reminder of the need for robust and resilient wind up and recovery plans. So the FCA’s publication of initial observations on recovery plans is timely.

Overall the FCA liked plans that had a gradated approach from amber early warning through to red emergency situations. Generally, plans were submitted on time and to prescribed formats, with appropriate board ownership.

But gaps and deficiencies exist and firms need to address these promptly: issues of interconnectedness, both internal and external, need to be better addressed, and more consideration of the potential impact on clients is needed. Maybe this is an area that could be linked into firms’ approaches to culture and conduct?

Identifying appropriate recovery plan indicators (RPIs) and providing supporting evidence for them has proven challenging for firms. The FCA does not like firms using a breach of individual capital guidance as a trigger – this would leave no time for effective intervention.

The credibility of some recovery plans was questioned – assuming you won’t fail is not an option, and assuming a parent firm will provide a bail-out might not stand up to scrutiny. Importantly, firms are reminded to consult the FCA at an early stage.

Finally the FCA emphasises the importance of having appropriate communication strategies to deal with a crisis.

Recovery plans should operate on a stand-alone basis – in the event of a crisis, staff need a one-stop shop to know what to do. Make sure recovery plans are being reviewed in light of the FCA’s observations as well as any specific feedback from them, and to take into account any unforeseen impact arising from Brexit.

5. Common reporting: are you up to scratch?

Meanwhile, at the PRA a cross-firm thematic review of common reporting (COREP) is likely, given the number of corrections that some have had to make. Although addressed to specific firms currently, the PRA is proposing to select a number of banks for S166 reviews of COREP, with firms obtaining third party assurance of the returns now being more likely to avoid one. It shows the regulatory trajectory on the reporting requirements which should now be well embedded in firms. Have you made sure your regulatory reporting systems are in order, well documented and with the ability to demonstrate that data feeding into automated returns is accurate and mapping correctly?

6. Transaction reporting: no stone left unturned

A number of new transaction reporting requirements will hit securities and derivatives trades in 2018 – with the interplay between MiFIR, EMIR and Securities Financing Transaction Regulation (SFTR) increasing complexity (and that’s without questions around whether UK firms will even be reporting to the European Securities and Markets Authority (ESMA) by then). It sounds a way off, but the level of system development needed to comply with detailed and interconnected reporting requires planning now despite uncertainties. Taking a holistic view of the different regulations now, may save work later.

Some products are captured by multiple reporting regimes. Derivatives that are currently reportable to the trade repository under EMIR may be reportable to regulators under MiFIR. MiFIR exempts securities financing transactions from reporting, but firms that deal with counterparties that are EU public bodies managing public debt, or the Bank for International Settlements (BIS) that is exempt from SFTR reporting, will need to check whether these transactions are then reportable under MiFIR (see examples)

Finalised guidance on MiFIR transaction reporting is expected this year, but for now it is clear firms will need to accurately report trades resulting in changes in positions – both for the firm and its clients – while ensuring reports are not duplicated.

If two investment firms trade outside a trading venue, they must both report the transactions from their perspective – with all other details including time, quantity, price and instrument details being the same (how will this work in reality?).

There are three types of trading capacity: dealing on own account, matched principal trading and any other capacity. Firms just transmitting an order are not required to report.

MiFIR extends the definition of trading venues. Firms will need to determine whether they are trading in or outside a trading venue – many counterparty firms that deal with over-the-counter (OTC) will become trading venues – as this determines who needs to report the transaction.

Meanwhile, SFTR requires reporting of securities financing transactions to a trade repository or ESMA. This includes composition of collateral, collateral availability for re-use or actual re-use; any substitution of collateral; and any haircuts applied. In theory this should be aligned with the same reporting framework adopted for EMIR – in reality this could prove challenging given the significant differences between derivatives transactions and those for repo, securities lending, and margin transactions.

SFTR reporting requires significant system development – information for both new transactions and changes to existing transactions are required (the list of transactional events is yet to be agreed). Assets used as collateral, their type, quality and value will all be reportable. Draft technical standards are due by early 2017, which doesn’t give firms very long – make sure plans and budgets are in place, IT development teams are put on notice and have started discussions with vendors, ready to step up a gear once guidelines are finalised.

7. A few more areas to keep an eye on

Whistleblowing – new processes to be in place to reflect FCA guidelines published in PS15/24: Whistleblowing in deposit-takers, PRA-designated investment firms and insurers by 7 September.

Central Securities Depository Regulation (CSDR) – we await full UK implementation of level 2 measures, but questions remain around the mandatory buy-in for settlement fails issue. How concerned should we be, especially for illiquid products?

SFTR – firms have busily exchanged notices on collateral risks, and (see above) are starting preparations for the new reporting regime.

General Data Protection Regulations (GDPR) – the Information Commissioner sets out that their policy base has not changed post-Brexit, with work progressing on GDPR guidance, especially implementation of requirements for breach notification and data portability. We still need to keep tabs on this (implementation May 2018). Also relevant to post-Brexit planning.

FCA REP-CRIM – the FCA will require firms subject to Money Laundering Regulations 2007 to submit annual money laundering reports via GABRIEL – reportable information includes location of clients, which countries are flagged as high risk, and firm’s views of the most prevalent fraud types. Money laundering reporting officers should check that databases hold the required information in a format that can produce the required data and be prepared for reporting next year (30 days from firm’s accounting reference date).

Cloud computing – for firms planning to hold/holding data in the cloud, the FCA has confirmed FG16/5 – Guidance for firms outsourcing to the ‘cloud’ and other third-party IT services. If providers of such services may be loath to amend contracts to reflect individual firm requirements, having a clear mandate from the regulator will help firms push back and ensure the risks can be managed while benefiting from evolving technology. Firms with existing agreements will need to review these to make sure they comply and can give FCA direct access to data held in the cloud.

These interesting points are personal to the writer so should not be interpreted as being those of the CISI or anyone else.