ESMA Sounds A Death Knell For Cross-Border Exchange Access, In Conflict With UK Legislation And MiFIR

Guidance of questionable legal accuracy from the European Securities and Markets Authority (ESMA) casts doubt on the ability of non-EU members of EU exchanges to provide client access to such exchanges through a technique referred to as "direct electronic access" (DEA). If ESMA's guidance were correct, clients wishing to access EU exchanges would only be able to do so through EU-regulated entities who are members of the relevant exchange. This is likely significantly to reduce the attractiveness of and liquidity on those EU exchanges. ESMA's interpretation is based on a linguistic legal interpretation of a particular provision without reference to other conflicting EU legislation. By contrast, the UK has already taken the clear and rational view in its legislation that non-EU members of UK exchanges can provide DEA to those exchanges for their customers since this is expressly permitted in other provisions of the same legislative package. There is now a conflict between the UK's statutes—which prevail within the UK—and ESMA's guidance.

On 15 November 2017, ESMA published new questions and answers (Q&A)1 on the EU's Markets in Financial Instruments Directive (MiFID II) and related Regulation (MiFIR), which come into effect this January. The Q&A include new guidance prohibiting non-EU entities from offering client trading services as EU exchange members, based on Article 48(7) of MiFID II. ESMA overlooked that such access is inextricably linked to the MiFID II activities of "execution of orders on behalf of clients" and "reception and transmission of orders."2 These activities may be carried out by third-country firms under Article 54(1) of MiFIR. For that reason the UK took the view in its legislation implementing MiFID II[3] that third-country firms may provide DEA to UK exchanges.

ESMA's new stance puts it on a collision course with UK legislators. It is also unattractive commercially for non-UK EU exchanges. This note explains the ESMA guidance, highlights why it is of questionable legal accuracy and discusses the enforceability of this guidance and interpretation in the UK, France and Germany. The note also considers the implications of the guidance in the context of Brexit.

Whether a Firm Needs to be Locally Regulated Under Mifid II to Provide DEA to an EU Trading Venue?

In its Q&A, ESMA has answered this question in the affirmative, stating that "Article 48(7) of MiFID II provides that trading venues should only permit a member or participant to provide DEA 'if they are investment firms authorised under [MiFID II] or credit institutions authorised under Directive 2013/36/EU.' Therefore, non-EU firms (including non-EU firms licensed in an equivalent jurisdiction) or EU firms without a MiFID II licence are not allowed to provide DEA to their clients. This applies regardless of where the clients using the DEA service are located."

Is ESMA's Q&A Binding?

ESMA's Q&A is informal interpretative guidance that is not held out to be legally binding, as confirmed by ESMA on its website.4] The intention of the Q&A is to enhance the consistent application of EU law, which is one of ESMA's general objectives. Both MiFIR and MiFID II contain provisions requiring ESMA formally to prepare guidelines on aspects of MiFID II. ESMA also has certain powers under Article 16 of the ESMA Regulation.[5] However, this Q&A is not issued under such powers and, moreover, MiFIR does not empower ESMA to develop formal guidelines in relation to Article 54(1). As a result, the status of ESMA's Q&A is not definitive as to the effect of that provision.6 Given the informal nature of the ESMA Q&A on this topic, it does not by its nature prevail over a UK statute or other contradictory member state laws. UK laws therefore will prevail over the Q&A.

A separate and more difficult question may arise as to, if the ESMA guidance is a correct interpretation of MiFID II, whether MiFID II would then over-ride a contradictory member state law, such as the UK statutory instruments implementing MiFID II. In our view, under the EU treaties and EU case law, even if ESMA were correct, their interpretation of Article 48(7) of MiFID II would not override the UK's statutory instrument.

MiFID II, which is a directive and contains the troublesome provisions on DEA, can have direct effect in some circumstances, even if the UK were to be found to have failed to implement MiFID II into national laws or to have implemented it incorrectly.[7] The first principle in interpreting apparently contradictory EU directives and member state laws is to attempt to reconcile them so as to achieve the purpose of the directive.8 However, national courts cannot apply such an interpretative approach where a member state law and EU directive are in direct, irreconcilable conflict, as is the case here.9 Where there is a direct conflict, the EU directive then cannot prevail over national laws so as to impose an obligation on individuals.10 This principle has been somewhat eroded in recent case law as regards civil obligations. However, it remains a cornerstone of EU law that an untransposed directive cannot have the effect of imposing or exacerbating criminal liability.11 The EU courts have also been reluctant to interpret EU laws so as to impose tax code breaches and the same principle should likely apply to regulatory breaches. The UK's regulatory perimeter12 is in any event a criminal law regime. ESMA's interpretation of MiFID II is one that eliminates rights of certain persons to carry on certain activities so as to render such activities potentially criminal. The UK implementation preserves such rights and does not criminalise third-country entities providing access to UK exchanges for their clients. As a result...