On October 3rd, ESMA published a public consultation on MAR, intended to get market participants’ views on a number of possible changes to the provisions of MAR. The scope of the changes is very wide ranging, and includes a possible extension of MAR to cover spot FX contracts, establishing EU commons rules to provide administrative sanctions against market abuse, and implementing an EU framework for cross-market order-book surveillance. In the first of a series of Blogs, we look at ESMA’s assessment of extending MAR to spot FX contracts.
European financial and energy regulations have a clause in which the European Commission has to report back to the European Parliament on any issues with operating a particular piece of legislation, enabling the latter to make any necessary amendments. The EC is assisted in compiling its report by ESMA and/or ACER as appropriate. For MAR, Article 38 governs the report-submission process.
Specifically, Article 38 requires the EC’s MAR Report to assess a number of areas concerning the definition of inside information, the introduction of common rules governing sanctions on market abuse, the possibility of establishing a Union-wide framework for cross-market order book surveillance in relation to market abuse, and the scope of the application of the benchmark provisions. In order to compile this Report, the EC requires technical input and opinions from ESMA, who is itself free to comment on any relevant operational issues it has come across.
ESMA has used their mandate from the EC to hold a public consultation (1) on some issues raised while preparing their contribution to the Report. This Blog is the first of a series which comments on some of these issues raised by ESMA’s work, namely :
- Whether the scope of MAR should be extended to cover spot FX contracts;
- The content and maintenance of insider lists;
- The definition of inside information;
- The effectiveness of the mechanism to delay the disclosure of inside information;
- The possibility for establishing an EU framework for cross-market order book surveillance in relation to market abuse;
- The scope of the benchmark provisions.
This Blog focuses on the possible extension of MAR to cover spot FX contracts.
Spot FX contracts are currently classed as non-financial instruments and thus fall outside MAR, MiFID II and MiFIR (2). However, as an asset class FX accounts for around 12% of gross notional amount outstanding (3), so their exclusion needs to be carefully considered in the context of the aims of anti-market abuse legislation across asset classes. At the same time, the detailed mechanics of ensuring the compliance of spot FX contract trading with MiFIR Article 25 (obligation to maintain records) and Article 26 (obligation to report transactions) also needs careful consideration, because the idiosyncrasies of FX spot contracts could lead to complications of the compliance process.
ESMA list a number of arguments in favour of including FX spot contracts in MAR :
- Legally, NCAs’ oversight over regulated entities trading in spot FX contracts within their jurisdiction is little different from their oversight over the other regulated asset classes.
- A number of financial regulators (not just ones in the EU) have already levied fines on some market participants for misconduct in the G10 spot FX market.
- ESMA noted that back in 2015, the Bank of England concluded that the a new market abuse regime should be created for spot FX that included some of the key features of MAR-MiFID, including record-keeping, transaction reporting, and sanctions.
- The spot FX market has linkages to FX derivatives, so trading in unregulated FX spot can impact on trading FX derivatives and related instruments.
ESMA also lists some arguments against inclusion :
- ESMA notes that the publication of the FX Global Code of Conduct developed by central banks and market participants from sixteen jurisdictions around the globe has already achieved progress in promoting higher standards in the wholesale FX market. Its provisions cover some of MAR’s and MiFID’s.
- Many market participants have already signed the Code, and the fact that the Code itself is up for review next year suggests it may be worth waiting before extending MAR.
are practical difficulties involved in extending MAR :
- The spot FX market does not currently have the characteristics which would enable it to fit within and meet MAR’s framework and requirements;
- The spot FX market is predominantly an OTC market, whose trading platforms do not share all the features with MiFID II trading venues, especially the process of price determination. The OTC platforms also lack the transparency, systems, controls, and reporting aspects of MiFID II trading venues.
- There couldn’t be a ‘mechanical’ extension of MAR to cover spot FX contracts – some of MAR’s key concepts would need to be revised and adapted to make them workable, given spot FX’s unique characteristics. For example, who is the ‘issuer’ of a spot FX contract, what exactly is ‘inside information’ in FX, and who should be exempt from MAR while conducting FX spot trading operations?
- There would be a risk of false-positives in detecting market abuse involving spot FX contracts.Assuming that in principle, the MAR extension of market abuse treated spot FX contracts in the same was as spot commodity contracts, it may be much harder to establish which spot contracts do as opposed to do not impact upon financial transactions. Furthermore, the effects of a particular spot transaction could be detected in a wide range of financial transactions, only for it to be subsequently determined that there was no manipulative purpose or intent. This would waste time for NCAs and market participants alike.
- The FX spot market is huge in terms of the data quantitiesassociated with the orders and transaction data that would be required for market surveillance under MiFIR. ESMA believes that extension could cause NCAs and market participants considerable extra costs in upgrading their systems.
- The MiFIR regulatory and implementing technical standards covering data reporting and record keeping would need review and amendment in order to cover the unique features of spot FX contracts, especially around common identifiers and the attributes describing them.
ESMA does not come down unequivocally on inclusion or not, but throws the question out to market participants for comment.
At deltaconX, we are inclined to wait until 2020 when the FX Global Code of Conduct come up for review, and its efficacy in preventing the worst excesses of market abuse can be determined. Without wanting to pre-empt the findings of the review, we would hope that the authors of the Code may take the opportunity to align the Code more closely with MAR, thus saving market participants the problems of complying with both the Code and MAR. For the practical issues raised above by ESMA, a compromise solution in which an asset class-specific Code essentially delivers MAR-type compliance may be the best way forward.
Whatever the outcome, market participants trading spot FX contracts look set to fall under tighter regulation, be it the revised Code, MAR, or both. All comments need to arrive at ESMA by 29th November 2019. We recommend that if you trade spot FX contracts as part of your currency hedging or trading strategy, you carefully consider ESMA’s proposals and respond to the consultation.
(1) ESMA Consultation Paper – MAR Review Report 3 October 2019 ESMA70-156-1459.
(2) Under Article 10(1)(a) of Commission Delegated Regulation (EU) 2017/565
(2) ESMA Annual Statistical Report EU Derivatives Markets 2018
For more information on how deltaconX can advise you on the revisions to MAR and on implications for your business, please contact our Compliance Help Desk.