Description of the sector

“Wholesale capital markets” covers a wide range of capital market linked activity. The subsector includes, in particular, many of the services traditionally associated with investment banks, such as Goldman Sachs and JP Morgan. It also includes banking activity carried out by more diversified market actors such as Barclays and HSBC.

Beyond banking, other firms in the sector include stock and futures exchanges such as the London Stock Exchange Group and ICE and wholesale market brokers such as TP ICAP and BGC Partners, as well as thousands of assorted smaller or specialist firms which operate in the wholesale markets “ecosystem”.

The current EU regulatory regime

There is a wide range of EU legislation that affects firms in this sub-sector. Much of this has either been revised or put in place following the 2008 financial crisis. Typically, a large firm like an investment bank may need to comply with several of these laws to offer its services.More specialist firms may rely on a narrower range of legislation.

Legislation governing wholesale markets activity is established by the EU in part to implement international standards, e.g. from FSB, G20 and IOSCO. However, EU rules will often go beyond these global standards both in terms of scope and granularity. Others are designed specifically for the EU market, although standards originating at international level have become increasingly prevalent, especially since the financial crisis. This is particularly true for prudential banking standards.

In aggregate, the areas of regulation that relate to this sector include rules in relation to e.g. bank capital, remuneration of staff, transparency of trading financial instruments and market abuse. The core list of EU legislation relevant to this sub sector is:
– Prospectus Regulation (PR)
– Markets in Financial Instruments Directive (MiFID II)
– Markets in Financial Instruments Regulation (MIFIR)
– European Market Infrastructure Regulation (EMIR)
– Capital Requirements Directive (CRDIV)
– Capital Requirements Regulation (CRR)
– Market Abuse Regulation (MAR)
– Benchmarks Regulation (BMR)
– Central Securities Depositories Regulation (CSDR)
– Financial Collateral Directive (FCD)
– Credit Ratings Agency Regulation (CRA)
– Securities Financing Transactions Regulation (SFTR)
– Transparency Directive (TD)
– Short Selling Regulation (SSR)
– Settlement Finality Directive (SFD)
– Bank Recovery and Resolution Directive (BRRD)
– Central counterparty recovery and resolution (still under negotiation)

These regulations rarely correspond neatly to different categories of firm within the wholesale markets subsector. In some cases, a firm may need to comply with numerous pieces of legislation, even where the scope of their activities is reasonably narrow. For example, an investment bank may be authorised under the Capital Requirements Directive (CRD) which determines how much capital banks must hold, and need to comply with at least MiFID and the Market Abuse Regulation to offer just its core market making services.

One of the most important pieces of legislation for the sector is MiFID (which is in the process of being replaced by MiFID II and MiFIR). Compliance with MiFID enables firms to conduct many core capital market activities across the EU, for example: reception and transmission of orders, execution of orders on behalf of clients, dealing on own account,advice to professional investors. MiFID is also the key directive for operating exchanges and trading venues.

Broadly-speaking, if a firm is authorised in one member state to provide investment services under relevant EU legislation, then it is permitted to serve clients across the EU under that authorisation. This arrangement is known in the industry as “passporting”. In some areas, similar rights of market access are achieved through third country equivalence or national market access regimes within the EU.

EU Financial Services legislation is generally applicable to Gibraltar but not Crown Dependencies or other Overseas Territories. Crown Dependencies and Overseas Territories with substantial Financial Services sectors may choose to adopt EU legislation.

Third country equivalence

Within the legislation described above, there are a range of rules affecting how firms from non-EEA countries may interact with the EU, known as third country regimes. These tend to involve so-called “equivalence assessments” (and also exist across parts of insurance, asset management and other financial activity).

Equivalence involves a set of piecemeal regimes that sometimes support market access to the EU (notably for MiFID and EMIR services), or sometimes operate to support market efficiency and avoid duplicate regulatory burdens, e.g. for CRR. The MiFID II third country regime comes into force at the start of 2018. Once this is in place many, but not all, capital market activities will be subject to third country access gateways under EU law. However, equivalence does not always provide a mechanism by which market access is secured, and the European Commission has itself observed that it is specifically not a system aimed at delivering international trade in financial services. There are, for example, no powers for the EU to extend CRR market access to non-EEA lending banks.

Additionally, national regimes may also establish rules under which third country firms can provide services. The requirements for achieving market access in this way differ under each individual national regime (and may be subject to a complete prohibition) and national regimes only confirm rights to access customers in that country. Therefore, a firm accessing EU markets on this basis could theoretically be subject to 28 different sets of regulatory and supervisory requirements.

Existing frameworks for how trade is facilitated between countries in this sector

The arrangements described in this section are examples of existing arrangements between countries. They should not be taken to represent the options being considered by the Government for the future economic relationship between the UK and the EU. The Government has been clear that it is seeking pragmatic and innovative solutions to issues related to the future deep and special partnership that we want with the European Union.

For financial services, only limited liberalisation has been achieved in the WTO context. Conventional Free Trade Agreements (FTAs) have not provided for either comprehensive market access or deep regulatory cooperation, even though there is no structural impediment that would prevent two contracting parties to agree a more comprehensive set of provisions if they so wished.

The EU’s FTA with Canada (CETA) is a recent example of one such conventional FTA.CETA provides market access in “WTO terms” for financial services firms, meaning access cannot be subject to quantitative restrictions on size and form of investment or service provision. CETA provides investment protection for investors in financial services and includes some commitments relating to transfer of data, regulatory transparency, nationality requirements for senior managers, membership of self-regulatory organisations and operations of payment and clearing systems. However, CETA does not remove barriers related to regulatory requirements and provides only for limited dialogue mechanisms to discuss and manage these.

Across all of the financial services, CETA does provide some clear commitments for provision of services in specific sub-sectors19 but this is partial. In practical terms under CETA, a European bank still requires a significant local presence in Canada to carry out extensive capital market operations and vice versa.

The EU has agreed similar provisions with respect to financial services in its free-trade agreements with Korea and Singapore.

Whilst there are limited models to point to in terms of international trade, progress to promote open global markets whilst still ensuring high, comparable standards is already a well-developed principle20 in international financial services regulation. This is especially notable within the G20, so as to support major cross-border financial services and avoid duplicate regulation and fragmentation.

While none of these principles have, as yet, been used to support material cross-border access in financial services, they have been used to allow complex wholesale market activity to occur within consolidated business entities, including in areas that raise issues of systemic risk such as the clearing and trading of derivatives. The most relevant principles and types of arrangements developed by financial services policymakers and regulators in this area include:
• Deference. A central commitment of the G20 is to “defer” to comparable rules wherever possible to protect global cross-border business.21 It is a principle which underpins the EU’s own equivalence regimes, albeit that these have been developed in an ad hoc way in individual post-crisis legislation, rather than as a strategic basis on which to support market access. Sometimes deference also takes the form of ‘substituted compliance’,e.g. in the US, in which comparable rules can be substituted for those of the host.
– Regulatory coherence and regulatory convergence. These are norms in international trade to foster comparable regulatory outcomes for cross-border markets,

– Mutual regulatory recognition. Mutual recognition exists in the area of services (including financial services) – stemming from Article 7 GATS23 – as well as in goods. It relies on the recognition by one party that the authorisation of financial firms in another’s territory is sufficient to permit that firm to provide cross-border services, and establishes any supporting mechanisms needed for such an arrangement to work for the two parties concerned. Mutual recognition can take the form of both unilateral or bilateral agreements, and is a key principle that has emerged as a tool to increase openness in
cross-border financial services activity, for the benefit of competition and avoiding fragmentation. For example, Australia and New Zealand have several mutual recognition agreements covering e.g. goods, recognition of equivalent occupations, and in relation to securities issuance.24
– Supervisory cooperation. Post-crisis, there have been new systems for regulatory cooperation and cross-border oversights established both at EU-level (e.g. via the creation of the European Supervisory Authorities and EU colleges for resolution and day-to-day supervision) and via global ‘norms’ (e.g. global colleges, crisis management groups).

Selected third country regimes

Relevant EU law Third Country Regime

MiFID II MiFID II introduces in January 2018 a third country regime with respect to investment services and activities provided to professional clients.Professional clients include other authorised financial services firms, institutional investors, corporate firms and governments.The Commission must adopt an equivalence decision with respect to a third country determining that the prudential and business conductrequirements in the third country have equivalent effect to those in the EU. Firms from the equivalent third country may then register with theEuropean Securities and Markets Authority (ESMA) to provide investment services and activities across the EU without any authorisation requirements in member states.

EMIR Under EMIR, the Commission may recognise third country regulatory regimes for CCPs as equivalent. Individual third country CCPs are then recognized by ESMA. The Commission has recognized 19 third countries’ regulatory regimes. It took three years for the US regime to be recognized as equivalent. Due in part to the size of the US market, the Commission set strong and detailed conditions on equivalency, which were the subject of complex and strenuous negotiations.

CRAs Third country CRA ratings can be used if either the rating is endorsed (after ESMA assessment) by an EU CRA to which a third country CRA is affiliated and which is in the same group as the EU CRA, or by having ESMA certify equivalence. CSDR The CSDR is the process of being implemented, and includes a third
country regime process, which involves an equivalence decision by the Commission. This allows a third country CSD to provide core services within the EU on a cross-border basis or provide its services through a branch. A transitional regime applies to existing third country CSDs that provide services in the EU whereby they remain subject to existing national regimes until they have been recognised by ESMA.

Benchmarks Following the full application of the Benchmarks Regulation in January 2018, a benchmark produced by an administrator based in a third country must follow one of three pathways to access to the EU market – equivalence by ESMA, recognition by external auditor/third country authority or endorsement by an EU registered administrator. Individual benchmarks/administrators can be found equivalent, rather than whole regulatory frameworks.

Prospectus Under the Prospectus Directive (and Prospectus Regulation, which Directive replaces it from 20 July 2019), the Commission can adopt implementing acts to deem prospectus rules of third countries equivalent to the EU regime. In this case, prospectuses drawn up in accordance with those rules and approved by the competent authority of the third country can be passported into the EU/EEA. Third-country issuers choose a home member state in the Union to get their EU prospectus approved.

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