Regulation of Investment Exchange

Question 1

FCA and Recognised Investment Exchange

Answer 1

FCA recognises certain RIEs under the FSMA 2000, meaning there is no need for authorisation

RIEs may operate regulated markets and MTFs

FCA recognises:
LSE, NEX, London Metal Exchange, ICE Futures Europe

Question 2

BoE and Financial Market Infrastructure

Answer 2

FSA 2012 makes BoE responsible for regulating Settlement Systems and RCHs

Banking Act 2009 makes BoE responsible for regulating payment systems

(collectively the ‘financial market infrastructure’)

BoE recognises:
LCH.Clearnet, LME Clear, ICE Clear Europe, CME Clearing Europe

Question 3

FCA vs BoE and Meaning of Recognition

Answer 3

Institutions which provide both exchange services and clearing services are regulated by BoE in respect of RCHs services and FCA separately

FCA or BoE recognition allows the institution to develop its own regulatory under their supervision

Question 4

London Stock Exchange

Answer 4

Authority responsible for admitting public companies for listing and raising capital

Companies added to Official List if they meet UKLA requirements

Companies which do not meet criteria can apply to AIM with lighter requirements

Question 5

ICE Futures Europe

Answer 5

An RIE where Futures and Options are traded, using an electronic Order Matching System

Only members are able to use, anyone else wanting a position in a contract must go through a member

1. Trader - either ‘locals’ acting on their own or on their company’s behalf. makes profits from positions on F / O contracts
2. Broker - acting on somebody else’s behalf. Makes profit on commission of trading for others

Question 6

Derivative Markets - Exchange vs OTC

Answer 6

Can be traded on Organised Exchange or OTC markets

On Exchanges

• derivatives contracts are standardised with specific delivery or settlement terms
• publicly reported and cleared in clearing house (which will honour trade is if seller defaults) NO default risk

On OTC

• bilateral in nature (contract between two parties and must take risk of other party) default risk
• All contract terms (quantity, date, price etc) are negotiable between the two parties

Question 7

Derivative Markets - Regulation and Transparency of Exchanges

Answer 7

In UK, all derivative exchanges are RIEs, so regulation of market is carried out by the exchange (whilst the FCA oversees)

Exchange, MTF and OTF derivative exchanges are subject to MiFID II pre and post-trade transparency requirements.

There are no MiFID II requirements for OTC derivatives, however EMIR regulation exists

Question 8

Derivatives OTC Regulation and Transparency

Answer 8

There are no requirements for transparency for OTC derivative transactions

However, EMIR requires entities entering into any derivative contract to:

1. Report derivative contract they enter into a trade repository
2. Implement new risk management standards for all bilateral contracts (i.e. trades not cleared by central counterparty)
3. Clear, via a CCP

Question 9

Derivatives reporting to Trade Repositories

Answer 9

The details of a derivative contract must be reported to Trade Repository no later than the Following Working Day

This obligation applies as to ALL derivatives, regardless of OTC/exchange

ESMA is the body which recognises trade repositories in Europe

IFRS 9 requires the reporting of derivative to be at ‘fair value’

Question 10

Clearing of Derivatives on ICE Futures Europe and London Metal Exchange

Answer 10

Once a trade has been matched, it is registered with a clearing house which becomes the CCP to the contract.

London Metal Exchange - LME Clear
ICE Futures Europe - ICE Clear Europe

If ICE Futures Europe member is trading on behalf of a client, then a separate ‘back to back’ contract is established with no link to ICE CE

Question 11

Initial Margin for clearing house on ICE and LME

Answer 11

To hold a position in ICE Futures Europe / London Metal Exchange future or option, there is an obligation to lodge an ‘initial margin’

IM is an amount of cash or liquid assets set down by the clearing house that ensures the customer can satisfy conditions of the contract

Futures - fixed IM
Options - IM varies to market conditions

Question 12

Margin Accounts and Revaluation on ICE and LME

Answer 12

Positions of the contracts are revalued daily, and profit and losses from price changes are paid into the trader’s Margin Account

If the trader’s margin level drops below the IM requirements, the clearing house requires an additional ‘variation margin’

Question 13

Delivery and Offset on ICE and LME

Answer 13

A position on these exchanges will be evaluated daily until Delivery or Offset

(an equal and opposition position must be entered into and the clearing house notified)

Question 14

Tile Transfer Collateral Arrangements (TTCAs)

Answer 14

Utilised by derivatives firms that enter into margined transactions with clients (primarily CFDs and Spread Betting)

TTCAs allow firms to treat margin as their own working capital, rather than segregated client money

MiFID II and FCA rules prohibt firms from using TTCAs with Retail Clients

Question 15

Systematic Internalisers: Non-equity Financial Instruments (including Derivatives)

Answer 15

SIs must provide firm quotes when prompted by a client and make such quotes available to other clients

Requires SIs to enter into transaction at or below a specific size

SIs however do retain some discretion, as they are able to choose their clients on a commercial basis

Question 16

Post-trade Disclosure of Investment Firms (including SIs)

Answer 16

Investment firms must make public info available about volume, price and time of execution through an Approved Publication Arrangement (APA)