From 3 January 2017, the MiFID II regulatory package will impose major new obligations on businesses dealing in energy, commodities, freight and emissions. Many will need to become authorised for the first time, and therefore comply with EU’s investment services regime (which MiFID II reforms), and even non-authorised firms may be affected by new restrictions on the size of commodity positions. As the detailed rules become clearer, understanding how the changes will affect your firm becomes increasingly important. A lot of planning and execution is required before the rules take effect.
This article looks at the recent European Securities and Markets Authority (ESMA) consultation on MiFID II and focuses on some of actions to be taken now.
On 19 December 2014, ESMA published recommendations to assist the European Commission in developing regulations under MiFID II. ESMA’s recommendations are non-binding and take the form of a final technical advice sent to the Commission and a consultation paper (with annexed draft regulations) to which responses may be submitted until 2 March 2015. ESMA will review these before finalising the draft regulations and submitting them to the Commission later in the year.
ESMA’s technical advice covers a range of important definitions, including “financial instruments”, “systematic internaliser” and the meaning of “must be physically settled” in respect of commodity derivatives. It also addresses numerous investor protection issues and the reporting and management of commodity positions.
The consultation paper also covers investor protection, including access by third country firms, but is more focussed on transparency, liquidity and other issues of market structure and operation – including the mandatory trading of derivatives on organised venues, algorithmic and high frequency trading and direct electronic access. On commodities, it addresses two key issues: the criteria for the ancillary activity exemption for commodities and emissions business, and commodity position limits.
Key changes for commodities
Some of the most significant changes in MiFID II are those which will require many more commodity market participants to become authorised, especially as a result of the curtailment of existing exemptions widely used by them. For example, the exemption for own-account commodity dealers is being removed entirely and the ancillary exemption severely restricted.
The amended ancillary exemption will apply to activities in commodity derivatives, emissions allowances and derivatives on emissions allowances. It will be available only to firms which:
- Deal on own account in those instruments (except when executing client orders).
- Provide investment services (but not dealing on their own account) in respect of those instruments to the customers or suppliers of their main business.
These elements are subject to further conditions including that the activity is an “ancillary” activity to the main business at a group level in the EU.
MiFID II will introduce strict quantitative parameters, based on accounting capital employed and trading activity, to determine what is “ancillary”. These will be critical to firms and groups determining whether they qualify for an exemption. ESMA is currently consulting on what these parameters should be.
Firm relying on this exemption will need to notify the relevant regulator annually and may be required to provide supporting evidence.
MiFID II also introduces, for the first time in the EU, mandatory legal restrictions on the scale of commercial trading in commodity derivatives traded on an EU venue and ‘equivalent’ OTC contracts. Daily position reporting and weekly publication of venues’ aggregate positions will also be required.
In calculating position limits, certain hedges may be excluded where positions are held by, or on behalf of, non-financial entities. Loss of this facility is therefore a significant factor to take into account when considering authorisation under MiFID II.
While the precise formulation of many MiFID II rules will not be finalised until 2016, steps should be taken now to assess how MiFID II might apply to your firm, what the impact could be, and what steps you should take.
Firms currently exempt from MiFID, including those outside the EU that have EU business, should consider the need to restrict or restructure trading to maintain their exempt or other status and to manage the need for authorisation individually or across a group. This entails a detailed legal, financial and market analysis.
Whether or not authorisation will be required may depend upon future trading figures which will determine whether the firm needs to be authorised come 3 January 2017. How this will operate in practice is not yet clear - at present, no transitional arrangements are proposed to phase in authorisation requirements.
Notwithstanding these uncertainties, firms need to engage actively now to avoid business disruption in 2017.