Whether or not FX spot contracts relating to currencies are financial instruments for the purposes of the Markets in Financial Instruments Directive (“MiFID”) has been the subject of much discussion. The European Commission is now considering adopting a delegated regulation (“Draft MiFID II FX Regulation”), as a MiFID II1 Level 2 measure, which will clarify this issue under MiFID II. If adopted, the Draft MiFID II FX Regulation will also have implications for other legislation which relies on the MiFID definition of financial instrument. This includes the European Market Infrastructure Regulation (Regulation 648/2012) (“EMIR”), the fourth Capital Requirements Directive (Directive 2013/36) and the Market Abuse Directive (Directive 2014/57).
MiFID establishes the general framework for a regulatory regime for financial markets in the European Union. Financial instruments for the purposes of MiFID are defined
in Section C of Annex 1, which includes currency derivative contracts. MiFID will be replaced by MiFID II and the related MiFIR2 with effect from 3 January 2017.
Given the implications of a currency contract being a MiFID financial instrument, it is hardly surprising that there has been considerable debate surrounding the issue of when an FX contract is a currency payment or FX spot contract on the one hand, or an FX forward contract on the other: the former does not comprise a MiFID financial instrument, while the latter does. It is broadly agreed that a currency contract which settles within two trading days is a spot contract while one which settles after seven trading days is an FX forward contract. However, Member States have taken different approaches to the classification of FX contracts the settlement date of which is between 3 and 7 trading days. Moreover, some Member States have transposed MiFID so as to exclude certain categories of FX forward contracts from the definition of financial instrument and those excluded categories themselves vary across the Member States.
EMIR is the European implementation of the 2009 G20 Summit commitments to improve over-the-counter (“OTC”) derivatives markets through the clearing of standardised OTC derivative contracts through central counterparties, their reporting to trade repositories, the imposition of higher capital requirements on non-centrally cleared OTC derivative contracts and the implementation of certain other risk mitigants. EMIR defines the terms “derivative” and “derivatives contract” by reference to the MiFID definition of a financial instrument.
In February 2014 the European Securities and Markets Authority (“ESMA”) wrote to the Commission explaining that the lack of a single EU-wide definition of derivative or derivative contract for EMIR purposes, and the different transpositions of MiFID across Member States, was preventing the convergent application of EMIR. It also called on the Commission to adopt an implementing act clarifying the ambit of FX transactions encompassed by MiFID.
In March 2014 the Commission replied to ESMA indicating that it would urgently assess the options for action to ensure consistent application of the legislation. Subsequently, on 10 April 2014, the Commission published a consultation document on FX Financial Instruments. In July 2014 the Commission wrote to ESMA explaining that it no longer had the power to issue an implementing act to clarify the definition of a financial instrument relating to foreign currency contracts under MIFID and that any such act would need to be effected pursuant to MIFID 2 legislative measures. Notwithstanding this, the Commission noted that, during the public consultation and certain European Securities Committee meetings, a broad consensus appeared to have been reached regarding the concept of an FX spot contract. According to this consensus:
- a T+2 settlement period should be used to define FX spot contracts for European and other major currency pairs and the standard delivery period for all other currency pairs;
- where contracts for the exchange of currencies are used for the sale of a transferable security, the accepted market settlement period of that security should be used to define an FX spot contract, subject to a 5-day cap; and
- an FX contract that is used as a means of payment to facilitate payment for goods and services should also be considered to be an FX spot contract.
The Draft MiFID II FX Regulation
The Draft MiFID II FX Regulation largely reflects the terms of the consensus described by the Commission in its July 2014 letter, providing that a currency contract will not constitute a MiFID II financial instrument if it is either a spot contract or a means of payment that fulfils specified conditions.
The Draft MiFID II FX Regulation provides that:
- a spot contract is a contract for the exchange of one currency against another currency, where delivery is scheduled to be made:
- within two trading days in respect of any pair of major currencies3;
- for currencies that are not major currencies, the longer of two trading days and the period generally accepted in the market for that currency as the standard delivery period;
- where the contract is used for the sole or main purpose of the sale or purchase of a transferable security, within the shorter of: (a) the period generally accepted in the market for the settlement of that transferable security as the standard delivery period; and (b) 5 trading days,
provided that, irrespective of the time for which delivery is scheduled, a contract will not be a spot contract if there is an understanding between the parties to the contract that delivery of the currency will not be performed within the period specified in the contract and will be postponed; and
- a means of payment will not be a financial instrument under MiFID where it must be settled physically otherwise than by reason of a default or other termination event and is effected to facilitate payment for goods, services or direct investment.
Implications under Irish Law
For the purposes of the Irish transposition of MiFID (“Irish MiFID Regulations”) a forward FX contract is not considered to be a financial instrument unless:
- its terms are determined principally by reference to standard or regularly published economic terms (such as price, lot and delivery date);
- it is traded, or is expressly stated to be equivalent to a contract that is traded, on a regulated market, a multilateral trading facility or a third country trading facility that performs a similar function; and
- it is cleared or settled through a recognised clearing house or is subject to regular margin calls.
Not all of these will be excluded from scope under the Draft MiFID II FX Regulation and so, if that Regulation is adopted, the ambit of the FX contracts treated as in-scope in Ireland will expand once MiFID II takes effect on 3 January 2017.
The position regarding FX contracts that are treated as in-scope for EMIR purposes in Ireland has diverged from the approach taken by the Irish MiFID Regulations, notwithstanding that the EMIR definition of “derivative” tracks the MiFID concept of a financial instrument. In August 2014, the Central Bank of Ireland (“Central Bank”) published guidance regarding the extent to which FX forwards are to be considered to be derivatives for EMIR reporting purposes. According to that guidance, FX transactions with settlement before or on the relevant spot date need not be reported while those with settlement beyond seven days must be reported. FX transactions with settlement between the spot date and seven days need only be reported if one counterparty to the trade is located in a jurisdiction which would deem the transaction reportable. The Central Bank stated that its guidance in this regard was likely to remain unchanged at least until the Commission indicates whether and how it might use powers due to be conferred on it under MiFID II.
The FX contracts that will fall within the EMIR reporting obligations if the Draft MiFID II FX Regulation is adopted differ from those that must currently be reported under the Central Bank’s guidance.
Comments and Next Steps
The Draft MiFID II FX Regulation will next be discussed by the Expert Group of the European Securities Committee on 19 May 2015, which will be the final discussion before it is adopted by the Commission. It is at this stage unclear whether or not the Commission will then proceed to a public consultation on its proposal.
It is noteworthy that if the Commission does adopt the Draft MiFID II FX Regulation it will do so under powers conferred by MiFID II. The harmonised definition of an FX spot contract should, therefore, only apply once MiFID II and its associated implementing measures enter into effect from 3 January 2017, giving those affected some time to comply with any newly applicable legislative requirements.
However, as mentioned above, the Central Bank has stated that its guidance regarding the FX contracts that are in-scope for EMIR reporting purposes is likely to remain unchanged at least until the Commission indicates whether and how it might use powers due to be conferred on it under MiFID II. The possibility of that guidance being updated to reflect the Draft MiFID II FX Regulation prior to that adopted Regulation taking effect cannot, therefore, be excluded.