An Overview and Update on the EU’s Position Limits on Commodity Derivatives Under
MiFID II MIFID II AND POSITION LIMITS
The Markets in Financial Instruments Directive (Directive 2014/65/EU of the European Parliament and the Council, or “MiFID II”), which was originally published in the Official Journal of the European Union on June 12, 2014, once fully implemented, will impose mandatory reporting, clearing and exchange trading requirements, and a range of other requirements, on commodity derivatives markets and market participants in the European Union (“EU”). A key component of MiFID II is the requirement in Article 57(3) and (12) that directs the European Securities and Markets Authority (“ESMA”) to develop draft regulatory technical standards to determine the methodology for the calculations that competent national regulatory authorities in the EU must apply in establishing position limits for on-venue and economically equivalent over-the-counter (“OTC”) commodity derivative contracts. In addition, ESMA must develop the criteria and methods to be used to determine (i) whether a position is risk reducing, (ii) when positions should be aggregated, and (iii) the scope of an “economically equivalent OTC contract” under MiFID II.
ESMA’s standards for applying position limits to commodity derivatives are required to address a range of practical implementation issues including, for example, the methodology for netting (or aggregating) onvenue positions with OTC positions, the application process for obtaining an exemption from the limits for a risk-reducing positon, and the method for calculating where the largest volume of trading for a given commodity derivative takes place (which is relevant in part for determining which competent national regulatory authority will take the primary responsibility for setting the position limits for a given product).
ESMA REVISES DRAFT REGULATORY TECHNICAL STANDARD 21
On May 2, 2016, ESMA published a revised version of its draft regulatory technical standards that will guide the competent national regulatory authorities in EU member states that are required to implement the commodity derivatives positon limits requirements of MiFID II. Specifically, draft Regulatory Technical Standard 21 (“RTS 21”), which ESMA originally submitted to the European Commission (the “Commission”) for review and comment on September 28, 2015, responds to the MiFID II provisions that direct ESMA to develop draft regulatory technical standards to provide a methodology for calculating the position limit levels that will apply to (i) commodity derivatives traded on trading venues and (ii) economically equivalent OTC contracts in the EU.
The revised approach set forth in the May 2, 2016 draft of RTS 21 would generally require national authorities to set limits within a percentage range of deliverable supply (for the spot month) or open interest (for other, or non-spot months), subject to multiple considerations, including certain considerations with respect to new contracts and illiquid contracts (i.e., contracts with relatively low levels of liquidity and contracts with few market participants). The draft of RTS 21 would also require the aggregation of positions among trading persons that are under common control, with limited exceptions, and would provide national authorities with the authority to recognize exemptions from position limits for risk reducing or hedging positons held by non-financial entities. In contrast to the U.S. approach, which, as currently proposed by the U.S. Commodity Futures Trading Commission (“CFTC”), would apply position limits only to derivatives on 28 enumerated physical commodities, the EU limits would apply to all “commodity derivative” contracts traded in the EU, as defined under relevant EU law. “Commodity derivatives” is broadly defined in the EU and includes, in addition to commodity derivatives, securitized derivatives and cash-settled derivatives that do not have a tangible underlier. ESMA specifically indicated that this would include derivatives on climatic variables.
ESMA’s May 2, 2016 revisions to draft RTS 21, responding to comments received from the Commission on the version of draft RTS 21 that ESMA had originally submitted to the Commission on September 28, 2015, incorporated five key revisions from the original version. The revised draft:
- lowers the minimum level of limits that may be set for certain derivatives with foodstuffs as the underlying commodity;
- increases the maximum level of limits that may be set for contracts with few market participants or low levels of liquidity;
- provides that, in circumstances where deliverable supply and open interest diverge significantly, the other months’ position limits should be adjusted accordingly (i.e., other months limits should be adjusted lower if open interest is higher than deliverable supply, and vice versa), and that the definition of deliverable supply also include any substitute grades or types of a commodity that can be delivered in settlement of a commodity derivative contract;
- revises the definition of economically equivalent OTC contract to clarify that variations in lot sizes and delivery dates will not prevent a contract that yields a similar economic exposure from being characterized as economically equivalent; and
- further specifies the relationship between the levels at which limits should be set and the number of market participants, and also clarifies how or whether each factor that affects the setting of position limit levels should lead to a downward or upward adjustment of the limit.
EU REGULATORY PROCESS AND NEXT STEPS; TIMING
EU Process. Several procedural steps remain before the EU’s MiFID II position limits for commodity derivatives are finalized. First, the draft RTS 21 must be formally endorsed by the Commission and not objected to by either the European Council or the European Parliament, after which the RTS would be published in the Official Journal of the European Union and would enter into force on the day specified therein. After the final RTS on positon limits is published in the Official Journal, ESMA will be required to publish further implementation guidance for national authorities in the form of written guidelines and questions and answers, at which point the competent national authorities will be required to determine and set the actual position limit levels for commodity derivatives subject to their jurisdiction.
Timing. For both the EU and the U.S., some uncertainty remains with respect to the timing of final position limits. For the EU, most observers expect that the process is likely to continue into 2017. In the U.S., CFTC Chairman Timothy Massad has expressed a desire to finalize the CFTC’s position limits this year.