London Stock Exchange Group

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The principles seem sensible and recognise that the current regime focuses too much on banks and involves a great deal of unnecessary calculation. We believe that simplicity is key, particularly in terms of monitoring and reporting. It is difficult for us to comment on the approach without performance of the calibration exercise (i.e. not knowing what the K-factor scalars will be).

However, having reviewed the approach, whilst the proposed solution seems much more appropriate for the majority of investment firms than the current regime, it still does not seem highly applicable to investment firms that operate only MTFs and for which do not hold client positions. In particular, only one or two of the K-factors seem applicable the nature of MTF operators.

In general though, the new regime would seem an improvement on the present regime.
As an alternative, we recommend that it may be more simple to merge Class 3 with Class 2, and have a regime with built-in proportionality (i.e. “higher of…” type dynamics). This could avoid “cliff-edge” classifications of firms, where regulatory classifications drive business decisions (which is a problem with the current CRR, i.e. for firms holding client money).
Given the nature of the customers of MTFs, and the risks to which their operators are subject, we see no reason why operators of MTFs should be precluded from classification as ‘Class 3’ investment firms, if such a classification regime is implemented. However, given the other criteria discussed (i.e. quantitative thresholds), it seems unlikely that many MTF operators would fall into this category.

We question if “being a member of a wider group” (letter H of Q4) is a criterial for automatically classifying an IF as Class 2. In particular, paragraph 18 discusses whether IFs that are part of a wider group (especially where it is a non banking group) should be considered interconnected. This approach would be a barrier to a more simple capital treatment for IFs belonging to a corporate group. If would penalise them from IFs that operate the same business on a stand alone basis but perform the same business and present the same risks.
We believe that the approach is fundamentally sensible – however we have some doubts around the RtF. Given the principles of the proposed approach are designed to protect “customers” and “markets”, the risk to the firm shouldn’t matter for its own sake. We understand the rules are driving at the potential increased risk of conduct issues but we question the presence of a “solution” to this via prudential regulation. For MTFs, conduct controls exist through our systems and controls framework and governance structures and are actively supervised by member state supervisors.

We believe that the leverage ratio may also be too complex in its calculation for these purposes, without some kind of simplification.
The K-factors do not seem appropriate to operators of MTFs, who are unlikely to also have assets under management / advice / safekeeping, or liabilities to customers / client money held. The only RtC that seems potentially applicable is the “customer orders handled”, but even that seems to have been written with brokers in mind. The paper mentions this under paragraph 40 (talking also about the “Proprietary Trading Activity” RtM).

We particularly question the fact that both K-factors are based around number of orders/trades, as opposed to value. This metric does not acknowledge that fact that, for example, the average size on an equity MTF may be less than €10,000, whilst for a fixed income MTF could be hundreds of thousands or millions of Euro. Also, counting “orders” is very subjective, given that MTFs do not have visibility of underlying client orders, only those sent by members (who are likely to be operating multi-venue strategies and hence splitting client orders from “parents” into multiple “child” orders). Additionally, many MTF members do not use the “amend” functionality on orders, instead they are more likely to cancel and replace with new orders to change size or price. Such trading practices may “distort” order volumes and therefore it would not a reliable factor upon which to base capital requirements.

We believe that a useful approach may be to have a K-factor (or sub K-factor) specific to MTF (and potentially OTF) operators. Perhaps, since an issue that the EBA identify is around “market access”, a proxy for substitutability of the MTF services may be used. However any such factor should be structured in a way that does not penalise an MTF for success.

On the other hand, since the focus is on having enough capital to wind down (non-systemic firm would still be subject to CRR), we shouldn’t worry that these factors will be n/a (i.e. 0) and be left with the FOR (as a proxy for a wind down). On that note (and relating to “Question 9”), we believe that FOR should remain part of the capital regime.
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For the purposes of simplification, we don’t see the need to have a separate concept of eligible capital for initial capital / own funds etc. These should be consolidated.
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We note that for the first time for most investment firms, liquidity requirements may be introduced. We would be keen to understand the potential liquidity measures and do not believe that these should be unduly burdensome (i.e. LCR/NSFR). If LCR is to be used, then it should not be implemented in the same manner as for credit institutions, where interbank receivables, i.e. cash at bank, is excluded, given that investment firms are not likely to have access to central bank liquidity. This is touched upon in the discussion paper.

This, the third of the three posited scenarios on liquidity risk, seems to be most sensible, as it ties back liquidity requirements to capital requirements (i.e. K-factors and FOR), which a firm will already be calculating (and so adds the least burden). This seems the most aligned with the fundamental objective – i.e. ensuring an orderly wind down. Would like further clarity around what would count as a “liquid asset” however (i.e. is this as per HQLA rules, per BIPRU etc.).

Finally, this review of “pillar 1” minimum capital requirements will need to go hand-in-hand with a review of “pillar 2” (i.e. additional requirements on an individual firm basis), otherwise it will not have much if any impact. No point changing pillar 1, if this will just be again uplifted by a pillar 2 adjustment to prior levels.
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The UK Financial Conduct Authority (and national competent authorities in other member states) have implemented remuneration tiering system that take into account the risk profile of MTFs (which are designed to be risk neutral) by putting them at the lowest level of application of the remuneration rules. We believe that the same principle should be applied to other entities which do not seek to take market or credit risks, and that CRD IV should be amended to explicitly reflect this.

We believe that more useful proposal would be to omit investment firms that do not take credit risk from the scope of the remuneration “bonus cap” rules. Such rules do not serve the aim of acting a break on risk taking, in this context they only encourage increased fixed pay and cause the costs of such firms to become more inflexible (as well as increasing fixed overheads and hence capital requirements). An exemption would allow MTF operators to better manage their businesses to meet market conditions.
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Corentine Poilvet-Clediere
L