Concerns have been raised that EU-based asset managers will be cut off from trading on UK venues such as the London Stock Exchange (LSE), creating the potential for a "cliff edge of liquidity" in the UK market in the event of a no-deal Brexit.
According to Lorraine Johnston, regulatory counsel at law firm Ashurst, the share trading obligation of MiFID II, which came into force in January, prevents firms based in the bloc from trading on venues outside the EU.
Johnston explained: "If you are an EU MiFID firm, you are limited to where you can place trading orders to venues that are EU trading venues. In the event of no deal, EU asset managers would no longer have access to the LSE or the AIM, for example.
"The liquidity of those markets is likely to be affected."
The warning follows the 23 August publication of 25 technical notices, in which the government outlined contingency plans for the financial services sector in the event of a no-deal Brexit.
While the government said it was taking "unilateral action" to prevent such disruption, it acknowledged: "Without action from the EU, when the UK leaves the EU, UK trading venues would no longer qualify as EU trading venues.
"This means that, under their national law, EEA firms may not be able to be members of UK venues.
"UK venues will also not be eligible venues for EEA firms to execute certain equity and derivatives trades."
Johnston said while there is a clause within the share trading obligation that allows for equivalence to be assigned with non-EU venues, "there is a very long waiting list [of other non-EU countries] and it is not a very quick process".
She added: "Given the state of negotiations, the government knows this needs to be figured out to avoid complete disruption. This is an issue not only for EU firms, but also for the UK market, which may be facing a cliff edge of liquidity.
"The MiFID II trading provisions will likely cause market disruption that no amount of unilateral action by the UK government can solve, without the buy-in from their European counterparts. This is the issue to watch as we head towards March 2019."
Elsewhere in its no-deal technical notices, the government warned UK financial services firms are set to lose the right to market their products into the EEA post-Brexit, unless EU authorities take action.
Commenting on the government's publication of the notices, Richard Frase, financial regulation partner at Dechert, said there is "no reason" why the UK cannot enter into co-operation agreements with the remaining 27 EU member states, as has been done with "a wide range of non-EU countries".
But he added: "Technically, the UK cannot enter into a co-operation agreement until it actually becomes a non-EU country. But in order to avoid a regulatory lacuna, the substance of the arrangement needs to be agreed in advance. And at the moment, this does not seem to be happening.
"It would be extraordinary if the EU was actively discouraging its member states from putting these otherwise uncontroversial arrangements in place."
However, despite growing concerns over the potential for a so-called "cliff-edge" Brexit, hope was offered by the EU's chief negotiator Michel Barnier on 29 August when he indicated progress was being made on a final deal.
Sterling spiked against all major currencies after Barnier said the EU was ready to "offer the UK a partnership such as there never has been with any other third country".
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