The new Markets in Financial Instruments Regulation (MiFIR) will introduce a share trading obligation. This requires EU investment firms only trade shares on an EU trading venue, with an EU systemic internaliser or an equivalent third country exchange.
Should the Swiss legal framework not be considered equivalent to the EU regulation on the launch date of 3 January 2018, EU investment firms would be required to trade dual-listed shares outside of Switzerland. Even if the deepest pool of liquidity is in Switzerland.
To enhance transparency in the EU stock market, article 23 MiFIR will introduce a trading obligation for shares. Trading of shares by EU investment firms on an EU trading venue must be executed:
- On an EU regulated market or multilateral trading facility (MTF),
- With an EU systematic internaliser (SI), or
- On a third country trading venue assessed as equivalent in accordance with article 25(4) of the Markets in Financial Instruments Directive II (MiFID II).
Each EU trading venue will benefit from a passport for the purpose of the share trading obligation. Third country trading venues like SIX Swiss Exchange AG (SIX) may obtain an equivalence recognition by the EU, which would allow EU investment firms to execute share trades on the respective third country trading venue as well.
a) Requirements and procedure for equivalence
With regard to granting equivalence under the new share trading obligation, article 23
MiFIR refers to article 25(4) MiFID II. The latter states that the legal and supervisory framework of a third country must be equivalent to the requirements applicable to EU regulated markets resulting from the Market Abuse Regulation, MiFID II, MiFIR, and the Transparency Directive.
In particular, third country trading venues must be subject to ongoing authorisation and effective supervision and enforcement, have clear and transparent rules regarding admission to trading, security issuers must be subject to periodic and ongoing information requirements and market transparency and integrity must be ensured.
The most onerous aspect of this equivalence procedure is the initiation of the equivalence assessment: the competent authority of a member state may request the adoption of an equivalence decision regarding a third country by the European Commission.
Several questions regarding the equivalence assessment under article 23 MiFIR/article 25(4) MiFID II remain open:
- Will there will be two separate equivalence decisions for article 25 MiFID II and article 23 MiFIR or a combined one?
- The wording of article 25(4) MiFID II (“third country regulated markets”) seems to provide the European Commission with an equivalence decision mandate for regulated markets only. Will only regulated markets benefit from the equivalence decision and will MTFs and SIs located in third countries remain excluded?
- Will equivalence decisions by the European Commission be taken with regard to certain third countries in their entirety or specific local trading venues only?
The share trading obligation implemented by MiFID II/MiFIR will be applicable as of 3 January 2018.
Due to the cumbersome equivalence procedure requiring a specific request submitted by a national authority, it is unclear whether and when such equivalence decisions will be taken. A consultation regarding the countries which should be prioritised seems to indicate that a first set of equivalence decisions may be taken by January 2018. Countries so chosen shall have the possibility to submit their equivalence analysis by May 2017. Between June and October 2017, the European Commission would conduct its evaluations and issue a decision which would then be published in the official journal in December 2017.
Will Switzerland be deemed equivalent under the new EU share trading obligation?
According to a first consultation, Switzerland is among the third countries listed in the first group of equivalence assessments (besides the US, Japan, Canada, Australia, Korea, Hong Kong, Singapore and certain Latin American countries). In general, the European Commission does not only consider technical aspects when deciding upon equivalence. Also financial stability, investor protection, the integration of EU financial markets and regulatory convergence are taken into account. In the end, the European Commission has full discretion on whether or not to pass a positive equivalence decision – this is a purely unilateral and discretionary act by the European Commission.
It remains to be seen whether the issues which are generally considered as critical in an international comparison, such as the self-regulation system of the Swiss exchanges, will be a hurdle. The Swiss Financial Market Infrastructure Act (FMIA) filled some gaps between the Swiss legislation and the EU regulation and lead to a positive equivalence decision by the European Commission with regard to third country central counterparty. Nevertheless, it cannot be taken for granted that the Swiss regulation will be assessed as equivalent by the European Commission for the purpose of the share trading obligation.
Challenges for market participants in case of no equivalence decision
A delay by the European Commission in rendering equivalence decisions under the new EU share trading obligation will cause various issues for the market participants. In particular, EU investment firms might be required to execute share trades outside the jurisdiction with the deepest pool of liquidity. Generally, low liquidity leads to wider spreads, resulting in worse prices. Such discrepancies might cause market distortions, especially since those firms which are not bound by the trading obligation (e.g. alternative investment fund managers) may make use of deeper liquidity pools available at trading venues outside the EU.
In addition to the economic disadvantage, the different market conditions within and beyond the EU also create an issue with regard to the EU investment firms’ obligation of best execution. This principle (article 27 MiFID II) obliges EU investment firms to execute orders on terms most favourable to the client, taking into account aspects like price, costs and speed. Hence, an investment firm might have to decide whether it infringes the best execution principle or the share trading obligation.
Specific for Swiss trading venues
A large part of the share trading activities on SIX derives from EU investment firms. According to SIX, a substantial portion of shares traded on its trading venue would be affected by the lack of an equivalence decision. If the trading obligation cannot be fulfilled by trading on a Swiss trading venue (because Switzerland is not considered equivalent), EU investment firms would have to switch to other trading venues recognised for the purpose of the share trading obligation. Thus, the equivalence decision under article 23 MiFIR is crucial for Swiss trading venues.
Positive decision: highly important for Swiss trading venues
A positive equivalence decision under article 23 MiFIR and article 25(4) MiFID II is of utmost importance for the Swiss trading venues. In case of a lack of equivalence, EU investment firms will be forced to execute trades on another trading venue outside Switzerland. This would harm the Swiss financial market in its entirety, since a strong share trading venue with an international circle of participants is crucial for an international financial centre like Switzerland.
We believe the introduction of the FMIA will increase the probability of a positive equivalence assessment by the European Commission regarding Swiss trading venues. Even though various aspects of the equivalence procedure are still unclear and while technical equivalence does not ensure a positive decision on a political level, current signs are promising. Swiss exchanges could be among the first third country trading venues to be considered equivalent for the purpose of the share trading obligation.
The full article has been published in CapLaw.