Although the UK has voted to leave the EU, it remains part of the EU for the immediate future. Furthermore, under most models for the UK’s future relationship with the bloc, doing business with Europe will entail compliance with EU regulatory standards – at least where that business includes instruments the EU treats as energy or commodities (or related) derivatives.
Compliance with domestic regimes the EU assesses as “equivalent” is an alternative. For example, after protracted negotiations, equivalence or “substituted compliance” arrangements between European and US regulators are now being finalised and Switzerland is implementing its Financial Market Infrastructure Act and has already been assessed as equivalent in certain respects.
This article contains a round up of recent regulatory developments affecting commodity market participants.
Securities Financing Transactions Regulation (SFTR)
Record-keeping and certain other obligations have applied from January 2016 but the SFTR will really begin to bite on 13 July 2016, when requirements take effect for prior disclosures and express consent before financial instruments received as collateral can be reused, even in existing transactions. Reporting of securities and commodity repo and sell-buyback transactions (and certain other transactions) will be phased in from 2017.
New Market Abuse Regulation (MAR) finally comes into force
MAR will apply from 3 July, replacing the 2003 Market Abuse Directive (MAD) MAR is wider in scope than MAD in terms of products and trading venues covered, widens the insider dealing and manipulation offences, and widens the obligation to report suspicions of breach. It also imposes new obligations such as requirements in respect of market soundings, a capital markets practice which MAR defines in such wide terms it could impact solicitation and other pre-trade communications in relation to potential transactions involving commodity derivatives.
Commodity market participants should note that:
- “Inside information” is extended to cover information related to spot and forward physical commodity contracts.
- Manipulation provisions will apply to such contracts (except wholesale energy products within the scope of REMIT) where the manipulation affects financial instruments or, conversely, where the manipulation of financial instruments affects physical commodity contracts (including wholesale energy products).
- The new benchmark manipulation offence will cover a full range of energy, commodity, freight and related benchmarks as well as financial benchmarks. It is much broader than the criminal offence introduced in the UK following the LIBOR scandal. (Separately, an EU Benchmark Regulation adopted in May 2016 will regulate benchmark administrators, impose obligations on contributors and restrict use of unauthorised benchmarks.)
MiFID II – details for commodities firms emerge
From January 2018, MiFID II will replace, update and extend the 2004 Markets In Financial Instruments Directive (MiFID). MiFID II will:
- Broaden the range of commodity contracts treated as “financial instruments”.
- Extend “financial instruments” to include EU emission allowances.
- Impose requirements on “organised trading facilities” (OTFs), a newly defined category of trading venue.
In consequence, from January 2018, MAR will cover an even broader range of commodity instruments traded on a broader range of venues, and also emission allowance and related auctioned products.
Among the most controversial issues arising from MiFID II are:
- The narrowing of the exemptions for commodities business.
- The introduction of commodity position limits in respect of all commodity derivatives listed on an EU trading venue (regulated market, multi-lateral trading facility or OTF).
Key details were left to be determined by regulations to be adopted by the European Commission. After much delay, the Commission has recently finalised many of those regulations. Most will apply directly only to firms authorised under MiFID or trading venues, but they may affect market participants more or less indirectly – for example, commodity position reporting. Others will have a significant effect on commodity businesses – for example, the Commission’s definitions of commodity-related terms result in more commodity derivatives being captured by MiFID II than many had hoped.
The Commission sent several draft regulations back to the European Securities and Markets Authority (ESMA), requesting that ESMA tighten certain requirements. These included draft regulations on position limits and the ancillary activity exemption for commodity firms.
ESMA’s revised draft on position limits reduces to 2.5% the minimum position limit for derivatives with food-stuffs as the underlying commodity. Limits will apply to OTC contracts equivalent to venue-traded derivatives even if the terms differ slightly, and limits for non-spot months will be adjusted if the open-interest on which they would normally be based diverges significantly from deliverable supply.
The scope of the ancillary activity exemption is critical to commodity firms, even firms outside the EU who wish to deal with EU counterparties. It will replace the existing exemptions for ancillary activity and own-account commodity dealing. At present it remains in draft because ESMA and the Commission cannot agree on its terms. ESMA proposed a combination of market share and main business tests, comparing speculative commodity derivatives activity of a corporate group with the overall market and with the group’s total commodity derivatives activity. The Commission wants a capital employed test but ESMA has rejected that idea. What approach the Commission will now adopt, and how long it will take to finalise the regulation, are unclear.
To end on two positive developments:
- MiFID II will not come into effect until 3 January 2018 – formalities to confirm the delay are complete, but both regulators and firms have a huge amount to do before then.
- The current exemptions for commodity dealers under the Capital Requirements Regulation (CRR) have been extended to December 2020. (Under the CRR, commodity dealers are exempt from complying with the requirements for large exposures and the requirements for own funds. The extension is intended to allow time for the development of an appropriate prudential regime for commodity dealers.)