What Are the Key Differences between the UK and EU Approaches to SI Reform?

Concept

When approaching the divergence between the UK and EU frameworks for Systematic Internalisers (SIs), one must look beyond the surface-level political schism of Brexit. The core of the matter resides in a fundamental disagreement on the architecture of market structure itself. It is a debate about the very nature of liquidity, transparency, and the optimal system for price formation. Your experience has likely shown you that regulatory frameworks are not abstract legalisms; they are the operating system of the market, defining the protocols through which capital flows and risk is transferred.

The critical shift is this ▴ the UK is recalibrating its market architecture toward a principles-based, qualitative model, while the EU is doubling down on a prescriptive, quantitative-driven system. This is not a simple tweak but a forking of the evolutionary path of European market structure.

The SI regime, as originally conceived under MiFID II, was an attempt to bring transparency to the significant volume of bilateral, over-the-counter (OTC) trading conducted by investment firms. An SI is an investment firm dealing on its own account by executing client orders outside a regulated market or multilateral trading facility (MTF). Essentially, it is a formal recognition of a firm that has become a de facto market maker in certain instruments. The original sin of the MiFID II design, however, was its complexity.

It relied on intricate, instrument-by-instrument quantitative calculations to determine SI status, creating immense operational overhead. Furthermore, it tied this status directly to the obligation for post-trade reporting, a linkage that many market participants found to be an architectural flaw.

The UK’s post-Brexit reforms are a direct response to this perceived inefficiency. The decision to move from a rigid quantitative test to a qualitative one is a declaration of intent. It signals a philosophical shift from ‘rule-following’ to ‘outcome-oriented’ regulation. The system is being re-architected to trust firms to assess their own market footprint based on principles, guided by the regulator, rather than being bound by mechanistic thresholds.

This approach views liquidity provision as a dynamic function that cannot be perfectly captured by static calculations. It aims to reduce the regulatory drag on firms that, while providing valuable liquidity, may not fit neatly into the EU’s quantitative boxes. This is a system designed for flexibility and competitiveness, predicated on the belief that a less prescriptive framework will foster more efficient and bespoke liquidity formation.

Strategy

The strategic divergence in SI reform between the UK and the EU is a direct consequence of their differing post-Brexit objectives. The UK’s strategy is centered on creating a more competitive and agile financial center, tailoring its rulebook to the specific contours of its market. The EU, conversely, prioritizes regulatory harmonization and the integrity of the single market, seeking to ensure a consistent and level playing field across its 27 member states. These opposing strategic goals are the primary drivers behind the specific architectural changes to the SI regime.

The United Kingdom’s Strategy of Regulatory Competitiveness

The UK’s approach, outlined in the Wholesale Markets Review, is fundamentally about recalibrating the balance between regulation and market efficiency. The strategy is built on three core pillars designed to enhance London’s appeal as a global financial hub.

The UK’s strategic pivot on the SI regime is designed to reduce operational friction and enhance its global competitiveness.

• Simplification and Proportionality ▴ The primary strategic objective is to dismantle what is perceived as the disproportionate operational burden of the MiFID II framework. The move to a qualitative definition of an SI is the centerpiece of this strategy. Instead of forcing firms through constant, data-intensive calculations for thousands of instruments, the UK is creating a system where a firm’s status is determined by the nature of its activity. This reduces compliance costs and allows firms to focus resources on their core function of providing liquidity.
• Decoupling Obligations ▴ A key tactical decision was to sever the direct link between SI status and the responsibility for post-trade reporting. Under the old regime, many firms became “SIs by default” simply to control their reporting obligations, not because they were genuinely systematic market makers. By creating a separate “designated reporter” status, the UK allows for a more logical allocation of responsibilities, freeing firms from needing to take on the full SI mantle for purely operational reasons.
• Enhancing Liquidity Formation ▴ The removal of the Share Trading Obligation (STO) is another critical component. The STO mandated that trades in certain shares occur on a regulated venue or with an SI. Its removal provides firms with greater flexibility in sourcing liquidity and executing trades, aligning the UK with other major international markets and removing a significant constraint on off-venue trading.

The European Union’s Strategy of Harmonization and Transparency

The EU’s strategy remains anchored in the original goals of MiFID II ▴ increasing market transparency and ensuring uniform rules across the single market. The reforms proposed by the European Commission seek to reinforce these principles, viewing the UK’s divergence as a potential threat to the level playing field.

• Strengthening Quantitative Thresholds ▴ The EU continues to believe that objective, data-driven thresholds are the most effective way to ensure that firms engaged in significant bilateral trading are subject to the appropriate transparency requirements. The focus is on refining the existing quantitative tests, not abandoning them. This approach prioritizes consistency and predictability over the flexibility sought by the UK.
• Consolidating Market Data ▴ A central plank of the EU’s strategy is the development of a comprehensive consolidated tape (CT) for both equities and non-equities. For the CT to be effective, it needs a reliable and complete feed of post-trade data. Maintaining the SI regime’s link to reporting obligations is therefore seen as essential for ensuring the integrity of this data stream and providing a clear view of market-wide activity.
• Controlling Off-Venue Trading ▴ While the UK has removed the STO, the EU is focused on strengthening it. The EU maintains a stricter stance on limiting the amount of trading that can occur in “dark” or non-transparent venues, using mechanisms like the Double Volume Cap (DVC), which the UK has also abolished. The SI regime is a key part of this architecture, acting as a regulated channel for off-venue trading that still contributes to post-trade transparency.

Comparative Strategic Frameworks

The table below provides a clear comparison of the strategic objectives and resulting architectural choices of the two jurisdictions.

Execution

The strategic divergence in SI policy translates into significant operational and architectural differences for investment firms. Executing a trading strategy requires a deep understanding of these new market operating systems. The shift in the UK from a prescriptive, quantitative regime to a principles-based qualitative one demands a fundamental change in a firm’s internal processes, risk assessment, and technological architecture.

Executing under the UK’s Qualitative Framework

The most profound change in the UK is the move to a qualitative test for determining SI status. This is not merely a change in calculation methodology; it is a shift in regulatory philosophy that places greater responsibility on the firm itself.

How Will the Qualitative Test Be Implemented?

Firms will no longer be required to perform frequent, systematic, and substantial basis calculations against specific thresholds for every instrument. Instead, the Financial Conduct Authority (FCA) will expect firms to assess whether the nature of their dealing on own account when executing client orders is such that they should be classified as an SI. This assessment will be based on principles and guidance from the FCA, likely focusing on factors such as:

• Business Model ▴ Does the firm actively market itself as a liquidity provider or run a dedicated principal trading desk that routinely executes client flow?
• Risk Management ▴ Does the firm take on significant principal risk to facilitate client trades, as distinct from simply passing risk on?
• Market Impact ▴ Does the firm’s activity represent a meaningful source of liquidity in the UK market for certain asset classes?

The move to a qualitative SI test in the UK shifts the burden of proof from mechanistic calculation to reasoned internal assessment.

This change means compliance departments must develop robust internal frameworks for making and documenting these assessments. The operational burden shifts from data processing to qualitative analysis and justification.

Operational Impact of Decoupling Reporting

The ability to become a “designated reporter” without being an SI is a significant architectural change. Operationally, this allows a firm to streamline its structure. A firm might choose to centralize its trade reporting function in one entity that registers as a designated reporter, while other entities within the group that provide liquidity are no longer forced to register as SIs simply to manage their reporting. This unbundling reduces the compliance footprint and associated costs for those other entities.

The following table illustrates the operational shift for a UK firm that decides to cease being an SI under the new regime.

Executing within the EU’s Refined Quantitative System

In contrast, firms operating within the EU must continue to master the quantitative system. The execution focus here is on data accuracy, efficient calculation, and seamless integration with the broader transparency architecture, including the future consolidated tape.

What Are the Continuing Quantitative Obligations?

The EU framework will continue to rely on instrument-by-instrument quantitative tests. This means firms must maintain systems capable of:

1. Data Ingestion ▴ Consuming market-wide trading data from sources like the European Securities and Markets Authority (ESMA) to determine total market activity in each instrument.
2. Internal Calculation ▴ Accurately calculating the firm’s own trading activity against the total market volume and number of transactions for each of the thousands of financial instruments it trades.
3. Threshold Monitoring ▴ Continuously monitoring these calculations against the prescribed thresholds set out in Regulatory Technical Standards (RTS) to identify when the firm crosses the line to become an SI in a specific instrument.

This process is technologically intensive and requires significant investment in data management and processing infrastructure. The execution challenge is one of scale and precision. An error in calculation can lead to a failure to register as an SI, resulting in a breach of MiFIR.

The EU’s commitment to this model means that the operational coupling of liquidity provision and reporting remains. A firm that systematically provides liquidity in a given bond or equity will be an SI for that instrument and will carry the associated pre-trade and post-trade transparency obligations. There is no “designated reporter” escape route. This architectural choice is deliberate, designed to ensure that those who are significant sources of liquidity are also direct contributors to market transparency, feeding the consolidated tape and providing a clearer picture of price formation for all participants.

Reflection

The divergence of the UK and EU regulatory architectures for Systematic Internalisers presents more than just a compliance challenge; it is a prompt for introspection. The existence of two distinct market operating systems on Europe’s doorstep compels every institutional participant to re-evaluate the very design of their liquidity sourcing and execution frameworks. How does your internal system architecture interact with these external protocols? Does your firm’s structure allow you to adapt fluidly to a principles-based environment, or is it hard-wired for the certainties of a rules-based world?

The knowledge of these differences is not an end in itself. It is a critical data input. The ultimate strategic advantage will belong not to those who simply follow the new rules, but to those who re-architect their own internal systems to harness the unique opportunities presented by each.