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UK regulation of derivatives to become less… derivative

  • United Kingdom
  • Brexit
  • Financial services and markets regulation - Derivatives
  • Financial services

25-06-2020

On 23 June 2020, the UK Chancellor of the Exchequer published a statement setting out a number of future points of divergence between the existing EU financial services regulatory framework and the future UK regime to be developed following the expiry of the transition and implementation period (“TIP”) on 31 December 2020.

As part of the wider proposals, the statement sets out how certain EU regulations affecting the derivatives and securities financing transaction (“SFT”) markets will be adapted when on-shored in the UK. This briefing summarises those points of divergence. 

Reporting under SFTR

UK non-financial counterparties (“NFCs”) will not be required to comply with the same reporting obligations that apply under the Securities Financing Transaction Regulation (“SFTR”). These obligations are due to take effect in the EU from 11 January 2021. The view expressed by the Chancellor is that reporting of transactions by financial counterparties is already sufficiently extensive to allow UK regulators to identify systemic risks in the SFT market and that the additional regulatory burden created by reporting by NFCs is unnecessary.  

LIBOR cessation and amendments to the Benchmarks Regulation

HM Treasury has also published a separate ministerial statement relating to cessation of the London inter-bank offered rate (“LIBOR”). The cessation of LIBOR will have significant implications for the derivatives market. For more information in relation to the impact of LIBOR cessation on derivatives, please see our previous briefing, 'Buy-side perspective: IBOR transition and derivatives'. 

The ministerial statement notes that the “government shares both the regulators’ pragmatism in recognising the interim timetable for transition has been slowed by COVID-19 and their urgency that the markets must continue actively transitioning away from LIBOR”. The statement emphasises that it is in the interests of firms and clients to continue efforts to transition away from LIBOR ahead of the existing deadline of the end of 2021.

The ministerial statement sets out new measures to deal with contracts that have no appropriate alternatives to LIBOR and cannot be renegotiated or amended (known as ‘tough legacy’ contracts). Although the derivatives market is developing various solutions for the bilateral and multilateral amendment of LIBOR referencing legacy derivatives contracts, some derivatives may still be tough legacy contracts. This might, for example, be the case if a derivative is used to hedge an exposure under a tough legacy contract or forms part of a more complex structure, where the derivative is subject to the same or similar constraints as the underlying tough legacy contract it hedges.

In order to introduce the new measures, the UK will modify the requirements of Regulation (EU) 2016/1011 (the “BMR”) when it is on-shored into UK law (“On-Shored BMR”) so as to provide the FCA with enhanced powers to manage an orderly transition from critical benchmarks such as LIBOR. The new powers will include an extension of the circumstances in which the FCA can require an administrator to change the methodology of a critical benchmark.

On-Shored BMR will also:

  • prohibit the use of an individual critical benchmark in circumstances where a regulator has found that the representativeness of the benchmark will not be restored; and  
  • refine ancillary areas of the UK’s regulatory framework for benchmarks to ensure its effectiveness in managing the orderly winddown of a critical benchmark. These amendments will include new requirements designed to ensure that administrators have adequate plans in place to deal with the wind-down of a critical benchmark.

The Chancellor also announced plans to amend the BMR to ensure UK firms have continued access to third-country benchmarks until the end of 2025. The UK government will publish a further policy statement in relation to this in July 2020.

The Financial Conduct Authority (“FCA”) has published a supporting statement together with Q&As on its proposed new powers.

Finalising the onshoring of EMIR REFIT 

The European Market Infrastructure Regulation[1] (“EMIR”) will be on-shored into UK law by the European Union (Withdrawal) Act 2018. Legislation on-shoring Regulation (EU) No 2019/834 (the “EMIR Refit Regulation”) amending EMIR has not yet been published. In its statement, the Chancellor confirmed that legislation to on-shore EMIR Refit Legislation will be published. On-shoring the EMIR Refit Regulation will ensure that measures in respect of trade repository data and those ensuring that buy-side firms are able to access clearing services provided by clearing members and clients, on fair and reasonable terms (the “FRANDT Principle”) will form part of the UK regime.

It remains unclear however whether the FRANDT Principle will be implemented in the same way in the UK as is likely to be the case in the EU. The EU regime has, in some respects, failed to address a number of key risks faced by buy-side firms when procuring clearing services, particularly in respect of onerous contract terms which might result in the build-up of systemic risk down the clearing chain. Divergence in the implementation of the FRANDT Principle might present UK regulators with opportunity to address some of the shortcomings of the proposed EU regime.       

How can Eversheds Sutherland assist?

We are assisting a number of clients with Brexit planning in relation to their derivatives portfolios. The support offered can range from a deep-dive, tailored horizon scanning or initial scoping projects to review current trading arrangements and documentation to identify any potential action points.

We would be happy to discuss how we can help you with your Brexit planning and execution of those plans.


[1] Regulation (EU) No 648/2012 of European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories.