Memorandum submitted by the Financial Services Authority (FSA)
REGULATORY IMPLICATIONS OF THE TAKEOVER OF LIFFE BY EUROTEXT
1. This memorandum is submitted to the Committee in response to its request for a note from the FSA outlining the regulatory implications of the takeover of the London International Financial Futures and Options Exchange (LIFFE) by Euronext.
REGULATORY STATUS OF LIFFE
2. LIFFE is supervised by the FSA as a UK Recognised Investment Exchange (RIE) under the Financial Services and Markets Act 2000 (FSMA). The FSA's supervision of investment exchanges relates in particular to two of the regulatory objectives set for the FSA under FSMA: market confidence; and the protection of consumers. In carrying out its functions in this field the FSA has regard to the principles of good regulation laid down in the FSMA, especially those relating to the desirability of facilitating innovation; and the international character of financial services and the international competitiveness of the UK financial sector.
3. Recognised Investment Exchanges do not fall under the general authorisation regime for financial services business but are subject to a particular regime under the FSMA. To qualify as an RIE, an exchange must meet a set of Recognition Requirements laid down in secondary legislation. These requirements cover matters such as maintaining sufficient financial resources for the performance of its functions; fitness and propriety; having adequate and appropriate systems and controls; ensuring orderly markets and affording proper protection to investors using the exchange; and maintaining effective arrangements for monitoring and enforcing compliance with the rules of the exchange. The Recognition Requirements must be satisfied by UK RIEs at all times while they are recognised.
4. LIFFE has been an RIE since 1987 (the recognition regime was originally introduced by the Financial Services Act 1986) but has been operating since 1982. As with other RIEs, the FSA supervises LIFFE via a mixture of analysis of written material provided by the exchange (Notification Rules specify the information to be provided); regular monitoring meetings with the senior management and staff; and ad hoc contacts as required on particular issues. As an RIE, contracts traded on LIFFE come under the scope of the new market abuse regime introduced under section 118 of FSMA. The regime applies to all trading carried out on LIFFEthat from overseas as well as trading done by UK firms and persons.
5. LIFFE also has a joint venture with the US Nasdaq exchange to provide a trading platform for futures contracts in US equities ( known as "single stock futures"). The joint venture company, NQLX, is based in the US and regulated there jointly by the Securities and Exchange Commission and the Commodity Futures Trading Commission. For the purposes of its operations in the UK, NQLX is regulated by the FSA as a Recognised Overseas Investment Exchange.
REGULATORY EFFECT OF THE EURONEXT TAKEOVER
6. Following the completion of the takeover, LIFFE will become a wholly owned subsidiary of the Euronext Group. LIFFE is not the first UK RIE to be owned by an overseas company. OM London Exchange (OMLX), established in 1989, is a wholly owned subsidiary of OM AB, which also owns and runs the Stockholm Exchange. OM AB also owns Jiway, a UK equities RIE, established in 2000 and currently being integrated into OMLX. The International Petroleum Exchange, a UK energy derivatives RIE, was taken over last year by Intercontinental Exchange, a US trading system for energy related products.
7. Euronext currently operates equities and derivatives exchanges in Amsterdam, Brussels and Paris. Euronext also has a subsidiary company, Clearnet, which provides clearing services (assuring performance of transactions entered into by market counterparties). Euronext is supervised by the relevant financial regulatory authorities in France, the Netherlands and Belgium, who have a co-operation agreement regarding its supervision.
8. To a great extent, the takeover of LIFFE by Euronext will not affect the existing regulatory position of the exchange. Euronext have established a wholly owned UK subsidiary, Euronext UK, as the immediate holding company for LIFFE. However, underneath this, the present LIFFE corporate structure will be unchanged. LIFFE will remain a UK company and a UK RIE supervised by the FSA, subject to the existing regulatory requirements. All LIFFE's existing contracts will continue to trade on the exchange and the existing trading system, known as LIFFE CONNECT, will continue to be used.
9. Moreover, Euronext have said that LIFFE will continue to be run from London by its current management team, complemented by certain Euronext managers, with Sir Brian Williamson continuing as Chairman and Mr Hugh Freedberg as Chief Executive. Euronext have also said that they will ensure the continued presence on LIFFE's Board of a minimum of two non-executive directors and a variety of user representatives. The FSA will continue to supervise LIFFE's business as before. Similarly, NQLX will continue to be supervised as a UK Recognised Overseas Investment Exchange
10. The principal difference compared with the current position will be that, as LIFFE will now be part of the Euronext Group, the FSA will clearly have an interest in the affairs of the Group as a whole. This applies particularly to the financial position of the Group. It has therefore been agreed that the FSA will receive not only the accounts for LIFFE but also those for Euronext. The FSA will also ensure direct contacts with the management of Euronext as appropriate. (It should also be noted that Mr Freedberg will be joining the Euronext Management Board and that two UK representatives will sit on the Euronext Supervisory Board.)
11. Looking further ahead, the nature of the regulatory relationship will obviously be heavily influenced by how the business of the exchange develops. It is expected that LIFFE's becoming part of Euronext will result in increased numbers of existing Euronext members using LIFFE for derivatives trading. However, as an electronic exchange, LIFFE already has many overseas members and so the difference will be one of degree rather than principle. Overseas members of LIFFE have to comply with the rules of the exchange in the same way as UK firms and would be subject to action by LIFFE to enforce these rules.
12. Euronext plan that, following a transitional period, all the derivatives products traded on their existing exchanges should migrate to be traded on LIFFE's CONNECT electronic trading platform. Euronext have also said that London will be headquarters for Euronext's derivatives operations. Euronext have yet to come forward with detailed plans for the future of LIFFE and how they propose to develop its derivatives business. As part of our ongoing supervision of the exchange we will discuss these plans with LIFFE and Euronext as they are developed to determine the appropriate regulatory treatment. It is important to underline, however, that LIFFE will continue to be obliged to satisfy its obligations under the Recognition Requirements.
CO -OPERATIOn WITh OTHEr EUROPEAn REGULATORy AUTHORITIEs
13. LIFFE's becoming part of Euronext will also entail enhanced co-operation between the FSA and the French, Dutch and Belgian regulatory authorities responsible for supervising Euronext. We already have good co-operation arrangements with our opposite numbers in these countries B both bilaterally and through the multilateral for a of the Committee of European Securities Regulators and the International Organisation of Securities Commissions. Sharing information of mutual interest between the various supervisors already works well. The precise arrangements for co-operation going forward will again depend to a great extent on Euronext's plans for the development of its business.
14. One of the Recognition Requirements for RIEs specifies that the RIE must ensure that there are satisfactory clearing and settlement arrangements for transactions carried out on the exchange. Trades done on LIFFE are currently cleared by the London Clearing House (LCH), a Recognised Clearing House, supervised by the FSA. As noted above, Euronext has its own clearing company, Clearnet. Euronext has said that LIFFE products will be cleared through the LCH and Euronext's equity-based products through Clearnet and that there are no plans to remove LIFFE's business from the LCH.
15. In the light of Euronext's intention to maintain LIFFE's status as a UK RIE carrying on all the business it currently transacts, the regulatory regime will remain substantially as it is at present. The takeover will, however, add an extra dimension to the FSA's regulatory role in relation to LIFFE, given that we will need to take an interest in the parent group and develop even closer links with our French, Dutch and Belgian counterparts. The plans for the development of LIFFE under Euronext's ownership are still being formulated and it is therefore not possible at this stage to predict all the detailed regulatory ramifications of the takeover. However, the change of ownership will not affect LIFFE's obligation to comply with the Recognition Requirements for Recognised Investment Exchanges.
10 The Financial Services and Markets Act 2000 (Recognition Requirements for Investment Exchanges and Clearing Houses) Regulations 2001 (SI 2001/995). Back