In the final weeks of 2020, it was apparent that no agreement on equivalence was likely to be reached between the United Kingdom and the European Union with regards to share trading.
The wholesale shift of liquidity that took place on 4 January, moving €6 billion in daily volumes away from the City to trading venues in European capitals such as Paris and Amsterdam, was shocking even to those who were most prepared.
UK based pan-European trading venues saw their market share in the trading of EU-listed names evaporate from 16% to just 2.5% in the first two weeks of 2021 following Brexit on 31 December.
“Britain has ‘taken back control’ which is what I keep hearing politicians talking about, while Europe is actually taking back their markets,” says Alasdair Haynes, chief executive at London-based European equities exchange, Aquis.
According to a report by Liquidnet on 14 January, EMEA based trading venues saw their market share increase from 37% to 48.5%, while market share on off-exchange and systematic internalisers (SIs) increased significantly from 3% to 49%.
“I think what was so extraordinary about Brexit was that we all felt that there would be a split in liquidity between European shares traded in the UK and traded in the EU. But on 4 January that didn’t come to pass,” adds Haynes.
“What happened is almost 100% of the business moved to Europe. It was an extraordinary moment for the UK to watch something that they had been strong in, which is the trading of European shares, literally move overnight.”
The EU and the UK have failed to reach an agreement on equivalence post-Brexit, and this has driven euro-denominated business such as EU share trading, back to the bloc. Various amendments were made to the share trading obligation (STO) by EU regulators pre-Brexit, finally stating in October that only stocks with a European Economic Area ISIN could trade on a UK trading venue if traded in pound sterling. This allowance accounted for only 1% of EU share trading activity.
What’s more, after years of negotiations, the trade deal between the UK and the EU agreed upon on 24 December all but ignored financial services. UK based pan-European trading venues Cboe Global Markets, Aquis Exchange and the London Stock Exchange Group’s (LSEG) Turquoise found themselves facing a “no deal” Brexit, each opting to open European counterparties and relocate euro-denominated share trading businesses.
Most recent was Turquoise, putting in place a Brexit contingency plan for the launch of Turquoise Europe in Amsterdam in November in the event that the UK and the EU could not reach a decision of equivalence.
This decision proved itself to be make or break as on the morning of 4 January, Aquis Exchange, Cboe Global Markets, and Turquoise opened trading to find that north of 90% of their EU share trading volumes had migrated over to their European entities. Cboe Global Markets reported that 97% of its EU share trading volumes had moved to its European entity and with no signs of coming back.
“What is left in the UK in EU names is really more exchange traded funds (ETFs) and a little bit of residual liquidity from international investors,” explains Dave Howson, president of Cboe Europe.
Turquoise reported similar statistics, revealing that on average during the period from 4 to 28 January, 96% of its daily activity for EEA securities was now taking place on Turquoise Europe. In the same period, an average of 69% of notional activity was taking place on Turquoise Europe.
“Lit trading activity of EEA stocks at Turquoise has, for the most part, seen a complete shift across to the EU venue,” says Scott Bradley, head of business development, Turquoise and LSE cash equity secondary markets.
It’s never coming back
If there is no decision on equivalence, these volumes are very unlikely to return to the UK. It is not impossible for the UK to be granted equivalence for share trading at some point in the future, however, that being said it is extremely unlikely and without it, there is no way for these volumes to find their way back.
Brussels has proved itself keen to assert authority over euro assets that were previously under the control of overseas regulators. Up until 4 January and the weeks that have followed, up to 30% of all EU shares traded across the continent passed through London, arguably a sore spot for EU trading venues unable to dominate a market based on domestic stocks.
With EU names now trading on EU venues or primary exchanges in Paris and Amsterdam, Europe has regained the market. It seems unlikely that Brussels will throw this away with a decision on equivalence. Why would they?
“You would struggle to see why Europeans would think equivalence was a good thing to do now, given that they have more than 90% of trading in EU names back onto EU-based venues. Any form of equivalence now might endanger that,” adds Howson.
Even UK-based trading venues may not want to rock the boat and risk further disruption by encouraging a major shift of liquidity back to the UK in the event of an equivalence agreement. With the centre of gravity for liquidity now almost wholly shifted to Europe, even more volumes could also be at risk of moving from London to where is the opportunity for better pricing and liquidity.
Swiss parallels
The UK has equivalent rules and regulations in place for share trading, having been a member of the European Union since 1973. The question of equivalence is instead centred around whether Brussels would like to grant it.
“Equivalence is a gift of the European Commission, and the European Commission has the right to veto,” Haynes explains.
Switzerland found itself in a not dissimilar position 18 months ago when it was denied renewed equivalence by the EU, despite its rules being unchanged. The move meant that EU-listed securities could not be traded in Switzerland, much like the current situation in the UK.
Switzerland responded to this decision by banning EU trading venues from trading Swiss shares, the current situation remains that Swiss shares can only be accessed by European traders on the SIX Swiss primary exchange via a recognised broker or through an SI operating in the UK.
The UK and Switzerland have found themselves in similar equivalence stand-offs with the EU. An equivalence decision between the two nations has the potential to offer a partial remedy to those bearing the brunt of Brexit.
On 28 January, the UK and Switzerland were bound together officially outside of the EU. The Federal Councillor of Switzerland Ueli Maurer and UK Chancellor of the Exchequer Rishi Sunak agreed upon exchange equivalence that readmitted around 200 Swiss names previously removed from UK trading venues’ stock universe in 2019 following the EU’s decision not to renew Switzerland’s equivalence.
UK based pan-European exchanges were executing on average 7-10% of their trading volumes in Swiss securities before they ceased to be available in July 2019.
“That’s [Swiss share trading] going to be a nice bump to the UK platforms, and it’s an eagerly awaited return for us and our customers,” says Howson.
Looking ahead
With the trading of EU shares seemingly gone for now, the UK has looked at other ways to foster interest in alternative pools of liquidity through regulatory divergence.
MiFID II is an EU regulation, however, Brexit has given the UK leeway to amend some of these rules. For example, the UK’s Financial Conduct Authority (FCA) has made several regulatory changes in a bid to increase dark pool trading in the UK.
Earlier this year, the watchdog lowered the large-in-scale (LIS) thresholds for dark pool trading to €15,000, meaning that in the UK if a transaction is above €15,000, it can trade in a dark pool. In the EU, the minimum threshold for using a dark pool is €650,000, now significantly higher compared to the UK.
“[The UK’s lower LIS threshold] potentially makes it easier for non-EU firms to trade EU stocks in UK dark pools like Turquoise Block Discovery UK or Cboe LIS UK,” says Anish Puaar, European market structure analyst at Rosenblatt Securities.
The move by the FCA comes at a time when the EU continues to discourage dark pool trading in the bloc. In the MiFID II review, EU regulators made it clear that they remain steadfast on restricting dark trading to push volumes onto more transparent, lit venues.
As the EU clamps down on dark pool trading and the UK works towards making UK-based dark pools more attractive for trading in EU stocks, the door is potentially open for the return of a small portion of volumes lost by UK trading venues post-Brexit.
“The implication is that the UK creates a more liberal market structure for trading EU stocks in the dark,” adds Puaar.
Dark pool trading volumes at Turquoise Plato shifted almost entirely to its Amsterdam entity in the first few days of trading after Brexit.
“The biggest change in routing behaviour has been the relative proportion of dark trading that we have seen migrate in the first month,” says Bradley. “On 4 January, about 90% of anonymous trading on Turquoise Plato was executed in Amsterdam. At the end of January, that proportion is now up towards the mid-nineties.”
The impact of amendments to the LIS thresholds by the FCA on the EU’s stance on dark pool trading is yet to become clear.
“By the UK taking this position the EU could decide to rethink the dark pool reforms it is currently considering as part of the MiFID II review,” explains Puaar.
There is also the potential for the UK to amend its listings requirements to make UK capital markets look more attractive to new businesses and start-ups.
“We’ve always believed companies start small, they grow, and they mature but when you look at the listing and capital requirements, they all need capital at some point in time,” adds Haynes. “We tend to have a regulation which is one size fits all, but you don’t send a toddler to university.”
While the UK and the EU are looking to agree upon a memorandum of understanding that will set out terms for future cooperation in financial services by the end of March, whether this will be an extensive agreement is yet to be seen.
For now, the UK is on its own in terms of fostering interest in its financial markets post-Brexit. With this newfound solitude, the UK will likely focus on exploring options that were perhaps otherwise out of reach during its membership in the EU in what could potentially be the UK’s second Big Bang.