EU-Swiss share trading equivalence: a no-deal Brexit test case?
10 October 2019
Switzerland lost equivalence under the Markets in Financial Instruments Regulation (MiFIR) in July 2019. What could have seemed like a technicality, the expiry of a provision in EU law giving EU traders permission to trade in Switzerland, had become a political hot potato. In equity markets, which are all about increasing efficiencies, integrating markets and finding the best prices, such disruption was a big deal. It also made the headlines because of parallels drawn with Brexit. Three months on, what have we learnt from the Swiss experience?
Under MiFIR, shares which are liquid enough should be traded either in the EU, or in “equivalent” jurisdictions. The European Commission (EC) makes these determinations, based on a comparison of a third country’s regime against EU requirements. Switzerland had been deemed equivalent but only on a time-limited basis, subject to progress over an institutional framework agreement with the EU. As a result of the lack of progress in these negotiations, equivalence expired on 1 July 2019. For many commentators this episode showed the challenges with the EU’s current approach to equivalence determinations, not least that they can be revoked at short notice, which is far from ideal for cross border business.
For equity traders, this meant losing access to Swiss exchanges to execute some of their trades. To preserve trading in its home markets, Switzerland responded with a prohibition to trade in the EU shares of Swiss companies which are listed or traded on a Swiss stock exchange. UK commentators were quick to pick up on the matter because this is precisely the type of measure the financial services industry fears could arise between the UK and the EU in a no-deal Brexit.
The EC has explicitly stated it will not give the UK temporary equivalence under MiFIR in a no-deal Brexit scenario. According to guidance from the European Securities and Markets Authority (ESMA), EU firms would therefore no longer be able to trade in the UK any share with an International Securities Identification Number (ISIN) with an EU27 country code. Like Swiss authorities, UK regulators would be expected to take measures to preserve trading in the UK. This is why all eyes turned to Switzerland over the summer, as it could have provided an early test case for Brexit.
It’s early days but there is some evidence of market disruption as a result of the decision about Switzerland. In a piece of research quoted by the Financial Times, Virtu Financial, a market maker, found that the measures resulted in increased trading costs for buying and selling small and mid-cap stocks, which, according to their research became 20% more expensive. This figure was on the higher end of the spectrum however, and others like the think tank Bruegel found limited impact in the short-term.
What is however clear is that financial fragmentation reduces market liquidity and increases costs. Ultimately these costs will be borne by the real economy, through higher funding costs and more costly trading of financial assets. In our 2018 report on the Impact of loss of mutual market access in financial services across the EU27 and UK we found financial fragmentation between the UK and EU would be lose-lose, with a negative Gross Value Added impact for both the UK and EU27. Reduced market liquidity was a key driver of this, unsurprising as about half of the EU’s equity is raised through UK capital markets.
So the impact of EU firms losing access to the deep pools of liquidity found in London in a no-deal Brexit could be considerable, and dwarf the impacts we have seen in the Swiss case so far. Once again with Brexit, there is no direct parallel, but recent events between the EU and Switzerland reinforce the need to avoid unnecessary market fragmentation.