The Markets in Financial Instruments Directive (MiFID II) is one of the most significant pieces of legislation governing the financial markets across Europe. Originally designed to harmonize regulation across EU member states, MiFID II sought to increase transparency, enhance investor protection, and reduce systemic risks within financial markets. Following the UK’s departure from the European Union (Brexit), the impact of MiFID II on UK financial markets has been significant, with the UK retaining many aspects of the regulation but also diverging in certain areas.

This article explores the impact of MiFID II on UK financial markets after Brexit, detailing the regulatory changes that have shaped the financial landscape, the new trading practices firms need to adopt, and what the future may hold for the UK’s financial services sector.

Understanding MiFID II and Its Objectives

MiFID II is the revised version of the original MiFID regulation, which was implemented in 2007. The MiFID II package was introduced on January 3, 2018, with the aim of improving the functioning of European financial markets in response to the 2008 global financial crisis. It sought to improve transparency, investor protection, and market efficiency through several key reforms.

Key goals of MiFID II include:

1. Enhanced Transparency: Increasing the level of transparency in trading activities, particularly with respect to over-the-counter (OTC) and derivative instruments.

2. Investor Protection: Strengthening rules to protect investors, particularly retail clients, by ensuring that firms provide appropriate advice and act in the best interests of their clients.

3. Market Structure Reform: Introducing new trading venues, such as Organised Trading Facilities (OTFs), and regulating high-frequency trading.

4. Stronger Oversight of Trading Practices: Enhancing market supervision by providing regulators with more detailed data about market activity, including transaction reporting requirements.

The directive was designed to improve market integrity and to ensure that investors are protected from market abuse and financial instability. However, with Brexit, the UK's relationship with MiFID II has changed in key areas.

MiFID II and Brexit: The Shift in Regulatory Landscape

Since the UK left the European Union on January 31, 2020, the UK has operated under a separate legal framework from the EU. While much of MiFID II was retained in UK law through the European Union (Withdrawal) Act 2018, there have been significant regulatory adjustments post-Brexit.

The Retained EU Law and MiFID II in the UK

Upon Brexit, the UK took a pragmatic approach by incorporating EU laws, including MiFID II, into UK law through retained EU law. This means that, for the time being, MiFID II continues to apply to UK-based firms that provide services in the UK. The Financial Conduct Authority (FCA) remains responsible for overseeing financial markets in the UK, enforcing MiFID II compliance.

However, the UK has been able to diverge from EU regulations in certain areas, using the flexibility provided by Brexit to adapt its own regulatory framework. This has led to a number of important changes and future possibilities:

1. Changes to Reporting Requirements: The UK has established UK-specific reporting systems for transactions. While UK firms are still required to report transactions under the same core principles as MiFID II, the reporting is now done to the FCA, rather than the European Securities and Markets Authority (ESMA), which governs EU markets.
   
   

2. MiFID II Equivalence: The UK has established its own rules for investment firms and trading venues but continues to seek "equivalence" arrangements with the EU. These arrangements allow UK firms to access the EU market while complying with EU regulations. However, the EU is under no obligation to grant equivalence, which introduces uncertainty for UK-based financial institutions operating in the EU.
   
   

3. Reduced Passporting Rights: Under EU membership, UK firms could passport their services across the EU and vice versa. Brexit has ended this automatic right, meaning UK firms can no longer trade freely across EU borders unless they comply with MiFID II equivalence or establish operations within the EU. This has led some firms to set up subsidiaries in EU member states to continue serving EU clients.
   
   

Post-Brexit Divergence: The Potential for Future Changes

The UK has signaled that it may diverge from MiFID II over time as it seeks to tailor its regulatory framework to the needs of its financial markets. Some areas where divergence could occur include:

• Investor Protection: The UK may choose to ease certain investor protection rules to make it more attractive for investment firms, which could result in a regulatory environment that is less stringent than that of the EU.

• Reporting and Transparency: While the UK will retain strong transparency requirements, there could be a shift in how trading data is collected and reported, potentially making the regime more streamlined and less burdensome for firms.

• Market Structure: The UK could potentially develop its own trading infrastructure and venues, which may differ from the EU's regulatory approach to high-frequency trading and other market activities.

Key Areas of MiFID II Impacting UK Firms Post-Brexit

Despite the potential for regulatory divergence, several key areas of MiFID II continue to have a major impact on UK financial markets after Brexit. Firms based in the UK must continue to comply with these requirements for operations in the UK, and the future of UK-EU relationships in financial services remains uncertain.

1. Transaction Reporting and Transparency

MiFID II introduced stringent requirements for transaction reporting, aimed at enhancing market transparency and enabling regulators to better monitor market activities. The UK has retained these reporting requirements under retained EU law, meaning that UK firms still need to submit comprehensive reports on their trading activities.

Impact on UK Firms:

• Firms must report transactions in equity and non-equity instruments, including OTC derivatives, to the FCA under UK-specific rules.

• Reporting to UK trade repositories and maintaining compliance with FCA's reporting standards remain critical to the effective monitoring of financial market activity.

Brexit has not resulted in a drastic shift in transaction reporting rules, but UK firms must be mindful of potential changes if the UK diverges from the EU’s approach in the future.

2. Research Unbundling

MiFID II introduced the requirement for research unbundling, meaning that the cost of research must be separated from other services, such as execution services, when provided to clients. This regulation was designed to reduce conflicts of interest and ensure transparency in how investment services are priced.

Impact on UK Firms:

• UK firms must continue to comply with research unbundling requirements in the UK, as these rules have been retained post-Brexit. However, firms may face more flexibility if the UK decides to ease these rules or diverge from EU standards.

3. Algorithmic and High-Frequency Trading (HFT)

MiFID II introduced stricter rules around algorithmic and high-frequency trading (HFT), including requirements for firms to register algorithmic trading strategies and maintain records of their trading activities. These rules aimed to reduce the potential for market manipulation and enhance the stability of financial markets.

Impact on UK Firms:

• UK firms engaged in HFT or algorithmic trading must still comply with MiFID II’s algorithmic trading rules under the FCA’s supervision.

• Any divergence in how these rules are implemented in the future could have an impact on UK firms' trading practices.

4. Trading Venues and Multilateral Trading Facilities (MTFs)

MiFID II brought changes to the operation of multilateral trading facilities (MTFs) and Organised Trading Facilities (OTFs), imposing new rules for trading venues to increase market transparency and ensure fair access to all market participants.

Impact on UK Firms:

• UK-based trading venues must comply with MiFID II requirements for MTFs and OTFs as they apply to trading in the UK.

• However, the lack of automatic access to the EU market for UK venues could impact cross-border trading activity, as firms may need to establish separate operations within the EU to continue serving EU clients.

5. Best Execution and Client Protection

MiFID II's best execution rules ensure that investment firms execute client orders on the most favorable terms, considering factors such as price, speed, and cost. The regulation also introduced greater requirements around client suitability and appropriateness.

Impact on UK Firms:

• UK firms will continue to be bound by MiFID II’s client protection rules, including best execution, under UK law.

• Divergence in client protection and best execution standards could occur if the UK takes a different approach from the EU in the future.

Bringing It All Together: 

The Future of MiFID II in the UK

MiFID II continues to have a significant impact on UK financial markets post-Brexit. While the UK has retained many of the key provisions from MiFID II, there are signs that the UK may choose to diverge from the EU’s regulatory framework over time. As the UK seeks to adapt its regulations to its new position outside the EU, there could be changes in areas such as investor protection, reporting requirements, and market structure.

For UK financial firms, compliance with MiFID II remains essential for operating in the UK, and the potential for divergence requires careful monitoring. Understanding the evolving regulatory landscape will be crucial for firms aiming to navigate the post-Brexit financial services environment effectively.