The European Securities and Markets Authority (ESMA) published the follow-up papers to its summer consultations on the revised Markets in Financial Instruments Directive (MiFID 2) and Regulation (MiFIR) on 19 December 2014. The papers, comprising technical advice to the Commission and a long further consultation paper, address numerous aspects of delegated legislation and technical standards to be made under MiFID 2 and MiFIR.
In this note, we summarise the key aspects of the advice, and the main proposals in the draft Regulatory Technical Standards (RTS) and Implementing Technical Standards (ITS). Where we refer to "firm", we mean an "investment firm" for the purposes of MiFID 2. All articles we refer to are articles in MiFID 2 unless we say otherwise. The Technical Advice In its Technical Advice paper, ESMA has summarised its proposals, responses from consultation and ESMA's reaction and then, in relation to each matter the advice had to cover, given the advice itself. The advice, and the consultation paper, are divided into sections. The advice covers: Investor protection Exemption for investment service provided in an incidental manner Respondents generally supported ESMA's recommendations, and ESMA's final advice now provides that an investment service is provided in an incidental manner if all three of these conditions apply: there is a close and factual connection between the professional activity and the provision of the investment service to one client, so the investment service is regarded as accessory to the main professional activity; the provision of investment services to the clients of the main professional activity does not aim to provide a systematic source of income for the firm; and the person providing the professional activity does not market or otherwise promote his/her availability to provide investment services, except where as disclosed to clients as being accessory to the main professional activity. Investment advice and the use of distribution channels Again, respondents were mainly supportive of ESMA's proposals, but some suggested that a recommendation issued exclusively through a distribution channel to a wide group would not be a personal recommendation. ESMA believes this is not necessarily so. Its final advice is that the definition of a personal recommendation set out in Article 52 of the current MiFID 1 Implementing Directive should stand, but the reference to distribution channels should be removed, so the relevant part of the article will merely state that a recommendation is not a personal recommendation if it is issued exclusively to the public. Compliance function ESMA had proposed, in principle, to adopt the current provisions in the MiFID 1 Implementing Directive and to upgrade its current guidelines into Level 2 measures. Respondents made 2 several significant comments, including that certain provisions of the current guidelines are not proportionate. ESMA has decided to go ahead with its proposal, but has made some amendments to the current guidelines. The key elements of its final advice are: to require firms to establish, implement and maintain adequate policies and procedures designed to detect any risk of failure by the firm to comply with its obligations under MiFID 2, including having a permanent and effective compliance function that operates independently and which has responsibility for: monitoring the adequacy and effectiveness of the firm's required compliance procedures; helping persons responsible for carrying out investment services and activities to comply with the firm's obligations under MiFID 2; reporting to the management body, at least annually, on the implementation and effectiveness of the overall control environment, risks and complaints-handling reporting as well as actual or planned remedial action; and monitoring the complaints-handling process and taking into account complaints received as part of its general monitoring responsibilities; and conducting a risk assessment and establishing a risk-based monitoring programme. to require firms to ensure that: the compliance function has the necessary authority, resources, expertise and access to all relevant information; the compliance officer is appointed and replaced by the management body and the compliance function must have a direct ad-hoc reporting line to it; and (unless disproportionate to the particular firm) compliance staff must not be involved in the performance of services or activities they monitor, nor must their remuneration compromise their objectivity or be likely to do so. Complaints-handling Many respondents disagreed with significant parts of ESMA's proposals - including that the complaints-handling rules should apply in respect of professional customers and that firms should tell complainants of their rights to seek civil remedies. Some also said it was not right that the compliance function should be responsible for complaintshandling. ESMA has not changed its view on any of these issues. The advice requires firms to: establish and maintain a complaints management policy for clients or potential clients, endorsed by the management body, with clear, accurate and up-todate information about the complaints-handling process. They should publish the details of the process to be followed when handling a complaint and provide it to clients on request, or when they complain. They must also explain the options for referring the complaint to an alternative dispute resolution entity or for taking civil action; accept complaints free of charge; set up a complaints management function which may be carried out by the compliance function; communicate to clients in plain language and respond to complaints "without unnecessary delay"; provide information on complaints and complaintshandling to their regulator or appropriate alternative dispute resolution body; and ensure the compliance functions analyses complaints and complaintshandling data to identify and address any risks or issues. Record-keeping (other than recording of telephone conversations or other electronic communications) ESMA had suggested a nonexhaustive table of recordkeeping requirements. Some respondents felt it should be exhaustive, and said that allowing national regulators to add to it risked regulatory arbitrage. ESMA, however, feels it must be flexible. It also notes there will be additional requirements for MiFIR and the Market Abuse Regulation and also that ESMA will elaborate further in technical standards. Its advice does not cover the proposed technical standards nor anything other than MiFID 2. As a result the Technical Advice includes a revised version of the MiFID Implementing Directive wording, together with a table of requirements categorised by the nature of the obligation and the type of record required. Recording of telephone conversations and electronic communications These proposals also led to significant comment from respondents, much of which ESMA has taken on board, including that often it will be appropriate for English to be the only language used. Its advice, which requires firms to put in 3 place effective arrangements and policies to comply with the recording requirements, overseen by the management body, and subject to risk-based monitoring also states, among other things, that: arrangements to comply with recording requirements must be technology neutral; firms must keep up-to-date details of individuals who have firm devices or privately owned devices approved for use by the firm; firms must tell all clients, in the language in which they usually communicate with the client, before performing reception, transmission and execution of orders or related services, that the conversations and communications are being recorded and a copy of the records will be kept for at least five years; all relevant information related to relevant face-toface conversations with clients must be recorded, with a list of the minimum information that will be "relevant"; and firms must keep records in a durable medium, ensure they are accessible and not capable of being amended or deleted, and be able to provide them to clients on request. Product governance Many respondents asked for clarification of key terms, such as "manufacturer" and "distributor" and on the extent to which the requirements applied to different products and whether they applied where sales were on an execution-only basis and on the secondary markets. On the whole, ESMA says the requirements apply, but should be proportionate. Its advice is detailed, including requirements that: firms maintain procedures and measures to ensure the product design complies with conflicts management rules and does not represent a threat to the orderly functioning or to the stability of financial markets; management bodies have effective controls over the governance process, the compliance function oversees the arrangements, and relevant staff have the right expertise to understand the products the firm manufactures there be a written agreement in place where investment firms collaborate on product development; firms must be able to identify the target market for whom a product is suitable, and those for whom it is not suitable and to whom it should not be offered. They must consider whether the product meets the identified needs of the target market, including in terms of the charging structure; firms assess scenario analyses to gauge when poor investor outcomes could result; firms ensure information for distributors enables distributors to understand and sell the product properly; firms review products regularly to assess any new potential risks to their target markets, including to identify potential events that might affect return to investors. They should take appropriate action if they identify such risks; product governance obligations for distributors apply to investment firms when deciding the range of products they intend to offer to clients, regardless of who manufactures them; separate to the suitability and appropriateness requirements, distributors ensure the products and services they intend to offer are compatible with the needs, characteristics and objectives of an identified target market and that the intended distribution strategy is consistent with that identified target market. They must also review their strategies regularly to identify any event that could materially affect investor risk. The management body must have control over the process and ensure relevant staff are properly trained to understand the products, the target markets and investor needs; distributors supply manufacturers with information to support manufacturers' product reviews; the compliance function oversees the development and periodic review of product governance; when investment products are manufactured by thirdcountry firms or non-MiFID firms, including UCITS management companies and AIFMs, distributors take all reasonable steps to ensure that the level of product information obtained from the manufacturer is of a reliable and adequate standard; and where different firms work together in the distribution of a product or service, the final distributor in the chain (i.e. the firm with the direct client relationship) has ultimate responsibility to meet the product governance obligations but the intermediate distributor firm(s) must ensure appropriate information is given to the final distributor, enable the manufacturer to get the information it needs 4 and apply the manufacturer obligations as appropriate. Safeguarding of client assets Many respondents objected to ESMA's suggestion that a single officer be appointed with responsibility for compliance with the requirements to safeguard client assets. ESMA, however, thinks this is not disproportionate and says the individual can hold other functions too. Many respondents also felt that ESMA was trying to ban the use of Title Transfer Collateral Arrangements (TTCAs) with non-retail clients, but ESMA says it is not, it is merely putting in place greater safeguards. ESMA also notes, in respect of retail clients, that prohibiting title transfer will not prohibit models such as pledging. Many respondents objected to the proposal to introduce a 20% limit on intragroup deposits of client funds, but ESMA says its proposals are achievable and has carried them through into the advice. Finally, on the use of third-country entities, ESMA has clarified that firms should only be permitted to rely on "other equivalent measures" where, in a third-country jurisdiction, they are unable to comply with the usual segregation requirements because of applicable law in that jurisdiction - and not just because of custom. The advice covers: governance: firms must appoint an individual of sufficient skill and authority with specific responsibility for matters relating to the firm’s compliance with its obligations regarding the safeguarding of client instruments and funds, but may decide whether the individual also has other responsibilities; inappropriate use of TTCAs for non-retail clients: firms must not conclude TTCAs without proper consideration. The advice gives examples of where TTCAs will not be appropriate and says firms must highlight the risks to the client and be able to show they have properly considered the use of a TTCA; securities financing transactions and TTCAs: the advice confirms that firms may not effect stock lending and repo arrangements in such a way that they would be prohibited under the TTCA provisions; securities financing transactions and collateralisation: firms must ensure a borrower of client assets provides the appropriate collateral. Any express prior consent of the client must be clear, recorded in writing, and affirmatively executed by signature or equivalent. ESMA also says MiFID 2 should clarify that prior client consent is required for use of client assets by any person; considering diversification of an investment firm’s holding of client funds as part of due diligence requirements: firms depositing client funds at a third party must consider the diversification of these funds as part of their due diligence. In principle, firms can deposit only up to 20% of client funds intra-group; inappropriate security interests, liens or rights of set-off over client financial instruments and funds, and recording liens and other encumbrances: these are not allowed except if a relevant third-country law requires it. In these cases, firms must tell clients of the risks, and ownership must be clearly recorded; segregation of client financial instruments in third-country jurisdictions: firms can rely on "other equivalent measures" only where they cannot comply with the segregation requirements in third-country jurisdictions because of applicable law, and must make appropriate disclosures to clients where this is the case; preventing unauthorised use of client financial instruments: the advice provides a list of measures firms should take to prevent this; and making information readily available to insolvency practitioners and relevant authorities and strengthening record-keeping requirements: firms must make accounting and client money information available to regulators, insolvency practitioners and resolution authorities. Conflicts of interest Many respondents objected to ESMA's proposal to require an annual review of conflicts policies, but ESMA believes this is appropriate. On disclosure, some felt ESMA's proposals went beyond the Directive, but ESMA disagrees. Its advice covers: the need to amend Article 22 of the MiFID Implementing Directive in respect of required disclosures. Firms must ensure that disclosure is used only as a last resort where effective organisational and administrative arrangements cannot be certain to prevent damage to the client. Any disclosure must explain this and include a specific description of the conflict of interest that arises in the provision of investment and/or ancillary services, in such a way and such detail as to enable the client to make an informed decision; firms must assess and periodically review - at least annually - the conflicts of interest policy. Overreliance on disclosure of conflicts of interest will be poorly regarded; and5 the provisions of the MiFID Implementing Directive on investment research should be extended and should require a physical separation between the financial analysts involved in the production of the investment research and other relevant persons whose responsibilities or business interests may conflict with the interests of the persons to whom the investment research is disseminated. Underwriting and placing – conflicts of interest and provision of information to clients ESMA received many comments on its proposals and has made several changes to its advice to reflect them. The advice covers: proposed new organisational requirements to be issued under Article 16(3) and/or provision of information requirements to be issued under Article 24: there is significant potential for conflicts of interest in the underwriting and placing process; advising to undertake an offering: where the firm is advising the corporate finance strategy and providing the service of underwriting and placing, the firm must explain to the issuer, before accepting the mandate, how it proposes to deal with the instruction and potential conflicts that may arise; pricing: firms must identify and manage conflicts that arise in relation to possible under-pricing and overpricing of issues and involvement of relevant parties in this process, including book-building, and must provide clients with information about how the firm determines its recommendation as to the price of the offering and the timings involved; placing: firms must prevent placing recommendations from being inappropriately influenced by any existing or future relationships. The advice contains a nonexhaustive list of practices that would be abusive. Firms must also have an allocation policy that sets out the process for developing allocation recommendations, which it must disclose to and discuss with the issuer; retail advice/distribution: firms must have in place systems, controls and procedures to identify and manage conflicts that arise where a firm provides investment services to an investment client to participate in a new issue, or where a firm gets commissions or fees in relation to arranging the issuance. They must also make certain disclosures to clients, especially where an instrument is offered instead of a deposit; lending/provision of credit: firms must have arrangements in place to identify and manage any conflicts of interest that may arise as a result of the proceeds of an issue repaying a loan; record-keeping: firms must keep records of the content and timing of instructions received from clients, and record of the allocation decisions taken for each operation; and oversight: a centralised process should identify all underwriting and placing operations of the firm and keep a record of this information. ESMA notes that sometimes the only way to deal with a conflict will be to refuse the instruction. Remuneration Most respondents supported the principles of the consultation, but following comments ESMA has made some changes to its advice, particularly in relation to variable remuneration. The advice confirms its application to all relevant persons who can have a material impact, directly or indirectly, on investment and ancillary services provided by the investment firm or on its corporate behaviour to the extent that their remuneration and similar incentives may create a conflict of interest that encourages them to act against the interests of any of the firm’s clients. The advice also says: firms' management bodies should approve the design of remuneration policies, and must make sure the design of their remuneration policies does not create incentives that would make individuals favour their or the firm's interests over those of clients. Senior management should take responsibility for the policy; and firms should not base remuneration and similar incentives solely or predominantly on quantitative commercial criteria and must keep an appropriate balance between fixed and variable components of remuneration. Fair, clear and not misleading information ESMA made some clarifications to its proposals in response to comments on its consultation and its advice now recommends the current requirements in the MiFID Implementing Directive be adjusted to cover: that information for retail clients should fairly and prominently address risks, in a font size at least equal to the predominant font and, where it contains projections, information should be based 6 on performance scenarios in different market conditions, and should reflect the nature and risks of the specific types of instruments included in the analysis; and that information for professional clients does not have to meet such strict criteria but must nevertheless clearly address potential risks, not disguise, diminish or obscure important items, statements or warnings and should be accurate and up to date. Information to clients about investment advice and financial instruments ESMA received many comments, but has made few adjustments from the consultation version. Particularly, it considers its advice should in principle apply to professional clients as well as retail. The advice now covers: a duty to inform clients about the nature and type of the advice provided to them, including clear information on where there may be a combination of independent and non-independent advice; a duty to explain to the client the range of financial instruments that may be recommended, including the firm's relationship with the issuers or providers of the instruments. Firms must give details on the types of financial instruments and providers considered, and, where relevant, how the advice is independent; information about any periodic suitability assessments; and amending the MiFID Implementing Directive to provide for an additional requirement for investment firms to inform clients about the functioning and performance of financial instruments in different market conditions (including both positive and negative conditions), and to specifically address the risk of financial instruments involving impediments or restrictions for the disinvestment. Where a financial instrument is composed of two or more different financial instruments or services, the firm must explain how the instrument works and the risks it presents. Information to clients on costs and charges Most respondents disagreed with ESMA's proposal to require that significant information be provided to non-retail customers. At the very least, they suggested these customers should be able to opt out. ESMA disagrees, though accepts firms may be able to agree disclosure of limited information. The final advice covers a number of aspects of disclosure, mainly: scope: in principle, detailed information on costs and associated charges should be made available to retail clients, professional clients and eligible counterparties, but firms can agree a limited application for professional clients except where the services include investment advice or portfolio management, or where the relevant instruments embed a derivative, and for eligible counterparties except where the financial instruments concerned embed a derivative and the eligible counterparty intends to offer them to its clients; point of sale disclosure: these requirements will apply where the firm recommends or markets financial instruments to clients or it has to provide clients with a key information document under other EU legislation. Otherwise it has to inform the client about all costs and charges relating to the investment and/or ancillary service provided. Clients must receive details of the costs and charges of each relevant firm involved; and post-sale periodic disclosure: these requirements will apply in similar circumstances to the point of sale requirements. There are detailed requirements on how to present aggregated costs and charges. The legitimacy of inducements to be paid to/by a third person This was one of the most controversial parts of the consultation and indeed of MiFID 2. Most respondents objected to the exhaustive list proposed by ESMA for many reasons. ESMA has stuck to the list but has enabled the Commission to let ESMA add to it. As expected, most respondents disagreed with the ban on research. ESMA explains the circumstances in which it thinks research may be permissible and has invited the Commission to clarify. The advice covers: accepting and not retaining third party payments: independent investment advisers and portfolio managers must return to clients any monetary third party payments received in relation to the services provided to that client as soon as possible after receipt, and clients informed of the payment. Firms providing these services cannot receive non-monetary benefits unless they are minor; minor non-monetary benefits: the Commission should introduce an exhaustive list of minor non-monetary benefits that should be acceptable, and if they are reasonable and proportionate unlikely to influence the recipient's behaviour in any way that is 7 detrimental to the interests of the relevant client. ESMA suggests the list should include certain information, participation in conferences, hospitality and other benefits that meet certain conditions. It says firms must clearly disclose these benefits before providing investment or ancillary services to clients; investment research: ESMA says provision of research by third parties to clients should not be regarded as an inducement if it is received in return for payment directly from the firm, or from a separate, properly controlled, research account. The firm must agree with each client the research charge and its frequency. Where a firm uses a research account, it must be subject to conditions and oversight, and the firm must provide prescribed information to clients about it. Firms providing execution services should identify a separate charge for services that only reflect the cost of executing the transaction - any other goods or services should not be influenced by levels of payment for execution services. ESMA thinks it should maybe produce more guidance on this, and suggests the Commission should also consider clarifying that a firm that provides execution and research services, and also carries out underwriting and placing activities, should have adequate controls in place to manage any potential conflicts between these activities and between their clients who receive them; ESMA wants the Commission to clarify that the provisions in MiFID 2 on conditions under which a fee, commission or non-monetary benefit may be provided or accepted, should apply cumulatively and firms should take appropriate measures to ensure that these provisions have been met on a case-by-case basis. It also wants the Commission to set out a non-exhaustive list of circumstances and situations that regulators should consider in determining when the quality enhancement test is not met. It gives some guidance but thinks further recommendations would be useful; and permitted inducements - disclosure requirements: firms must disclose the nature and amount of payments in advance wherever possible, and update clients at least annually. Investment advice on independent basis ESMA has made some changes to its advice following consultation, but has in the main proceeded with its proposals. The main change was to remove a requirement for firms to refer clients to another firm if they were unable to provide the advice required. ESMA is continuing to allow a firm to give both types of advice, but says clients would get too confused if one individual could do so. The advice covers: sufficient range of sufficiently diverse financial instruments available on the market: firms must define and implement a selection process to assess and compare a sufficient range of financial instruments available on the market to show advice is independent. ESMA gives a nonexhaustive list of what the process should include and says if the comparison is not possible the firm cannot say it is “independent”. However, it does set conditions under which a firm can give independent advice on a specific range of products or categories; and investment firms providing both independent and nonindependent advice: firms can provide both types of advice but must not say they are "independent" as a whole and must make clear disclosures to clients and have in place controls to ensure that each type of advice and adviser is kept separate, such that no individual can give both independent and nonindependent advice. Suitability ESMA has taken on board some comments from respondents that suggested it was further overloading investors with mandatory paperwork. However, it did not agree that its suggestions for enhancing the suitability process were unduly burdensome on the whole. Its advice covers: suitability assessment: ESMA wants the current MiFID Implementing Directive to clarify that: the firm is responsible for the suitability assessment and must clearly explain its purpose to the customer; the suitability assessment is not limited to recommendations to buy financial instruments - every personal recommendation must be suitable; firms must be able to show they understand the instruments they are assessing and whether there could be suitable alternatives; firms that offer a limited range of instruments must not recommend any if they are all unsuitable; if recommending switching, firms must be able to show that the 8 benefits outweigh the costs; firms must have procedures that enable them to keep up-to-date information on on-going clients; firms must assess what information they need from their clients and ensure it is reliable. This will include making sure the client has the right levels of understanding and experience generally and of particular products, and, where a client is not a natural person or is acting with another person, ensuring there is a proper agreement evidencing how the firm will take instructions; and use of an automated or semi-automated system does not absolve a firm of the need to carry out the suitability assessment. suitability reports: when giving advice to retail clients, firms must provide suitability reports,including information on the advice given and why the recommendation is suitable. The reports must highlight whether periodic reviews will be required. Appropriateness Many respondents objected to ESMA's proposal to treat certain instruments as "complex". ESMA says instruments should only be considered as automatically complex if they meet the criteria specified in the Directive. So, it says units in structured UCITS, shares that embed a derivative and certain debt and moneymarket instruments and structured deposits will be considered complex. It says investments in non-UCITS collective investment undertakings should be considered complex, regardless of whether they take the legal form of shares or of units. ESMA has confirmed in the advice that in order to regard as non-complex an instrument not included explicitly in Article 25(4)(a) of MiFID 2 the instrument: could not incorporate a clause, condition or trigger that could fundamentally alter the nature or risk of the investment or pay-out profile; and could not include any explicit or implicit exit charges that have the effect of making the investment illiquid even though technically frequent opportunities to dispose or redeem it would be possible. ESMA also recommends the Commission clarify that if an instrument is excluded from the list of non-complex financial instruments it should be considered complex and should not be assessed against the criteria for assessing other noncomplex instruments. The advice also requires firms to keep records of appropriateness assessments and warnings they give to clients. Client agreement Respondents were in the main happy with ESMA's proposals and the advice states that investment firms providing services to new professional clients should enter into a client agreement. It also sets further guidance and examples of "essential requirements" for all client agreements, making clear that these are minimum harmonisation requirements. Reporting to clients Most respondents objected to ESMA's proposal to extend reporting requirements to all clients (including eligible counterparties (ECPs)) but ESMA has confirmed this, although it will allow ECPs to request a different calibration of reports, and to the proposal that reporting take place quarterly. ESMA has confirmed this also, subject to a small amount of flexibility. The advice covers: a requirement for firms to send execution reports to professional clients no later than the first business day following execution and to align the contents of reports for professional clients and ECPs to those for retail clients. But firms may agree a different structure of report with ECPs; reports relating to portfolio management should include a fair and balanced review of the activities undertaken and of the performance of the portfolio during the relevant period, for both retail and professional clients; the basic frequency for reports for portfolio management services should be quarterly instead of every six months, but this requirement may be met in certain cases if information is freely available online; in respect of portfolio management, and retail accounts that include positions in leveraged instruments or contingent liability transactions, firms must report to the client where the overall value of the portfolio at the beginning of each reporting period depreciates by 10% and thereafter at multiples of 10%; and firms must report at least quarterly on instruments and funds held for clients. Best execution On the whole, ESMA's advice is unchanged from consultation, except for a few clarifications. The advice covers: amending the current MiFID Implementing Directive 9 requirements to take into account the increased levels of disclosure of matters relating to execution of client orders and consideration of MiFID 2's data publication requirements and the creation of the organised trading facility (OTF); detail of information on execution policies: policies must include certain information including a summary of: how venue selection occurs; specific execution strategies employed; the procedures and processes used to analyse the quality of execution obtained; and how the firm monitors and verifies that the best possible results were obtained for their clients. Firms must include a list of execution venues, and say which they use for each class of instrument; how firms check the fairness of the price when executing orders over-the-counter (OTC); disclosure and consent: requirements include information to be given to clients where orders may be executed outside trading venues and a change to the current requirements so that prior express consent is not required where firms transmit or place orders that may be executed outside a trading venue. But firms should give clients appropriate information if clients ask; content of disclosure: if fees differ depending on the execution venue or entity retained, firms must clearly explain this. Clients must receive a policy summary focused on the total costs; third party payments: where firms are allowed to receive third party payments clients must receive clear information about these, and firms be told of any benefits the firm receives if it charges more than one participant in a transaction; use of a single execution venue: firms may use a single venue provided this satisfies the overarching best execution requirement; and firms must provide details to customers even where they do not execute client orders but select other investment firms to provide the execution service. Client order-handling ESMA received few comments on this and the advice confirms the provisions of the MiFID Implementing Directive should apply. Transactions executed with eligible counterparties Responses were split on the changes to the ECP requirements. ESMA had confirmed that recognising undertakings that are not large undertakings as ECPs is not in line with the objectives of the MiFID review. So its advice is to confirm this, and to set out the procedure for ECPs to request treatment as professional clients. Product intervention Respondents mainly asked for some clarification of ESMA's proposals. The advice sets out factors and criteria that will be relevant when assessing whether there is a “significant investor protection concern or a threat to the orderly functioning and integrity of financial markets or commodity markets and to the stability of the whole or part of the financial system of the Union”. The advice: notes the existence of a “threat” is the intervention pre-requisite in terms of orderly functioning and integrity of markets or stability of the financial system, while for the investor protection pre-requisite, the test is whether there is a “significant concern”; and lists the factors ESMA considers relevant, with ESMA confirming it may sometimes be enough that only one factor exists. The factors relate to complexity of the instrument, the size of possible detriment, the type of clients affected, transparency of the product or practice, particular features of the instrument, ability to switch or sell, pricing and associated costs, degree of innovation of the instrument, activity or practice, selling practice, situation of an instrument's issuer, availability of reliable information, risks to performance of transactions, risk of compromising the integrity of the price formation process, susceptibility of instruments for us in financial crime, risk to market resilience, risk of disparity in prices between derivatives and underlyings, risk of significant disruption to financial institutions, relevance of instrument as a funding source for its issuer, risks to the market or payment systems infrastructure, and threat to investor confidence. Transparency Liquid market for equity and equity-like instruments ESMA has set out detailed thinking in its response, including analyses of tables relating to each type of instrument. Its final advice specifies that an instrument must meet, cumulatively, all of the four criteria listed under Article 2(1)(17)(b) of MiFIR (free float, average daily number of transactions, average daily turnover and daily traded) in order to be deemed to have a "liquid market". But, if a Member State would be the most relevant market for fewer than five liquid 10 instruments per asset class (i.e. for shares, exchange traded funds (ETFs), depositary receipts (DRs) and certificates), the Member State may designate, for each asset class, one or more additional liquid instruments so long as the total number of liquid instruments will not exceed five per asset class. ESMA has set four conditions under which each type of instrument will be considered liquid - these are based on daily trading, a set minimum free-float amount and set minimum levels of daily transactions and turnover. ESMA suggests a procedure for newly issued instruments. Delineation between bonds, structured finance products and money market instruments While several respondents called for consistency of definitions across pieces of EU legislation, and ESMA agreed this was desirable, it has finalised its suggested definition of money market instrument. The advice says this should be treasury bills, certificates of deposits, commercial papers and other instruments with substantially equivalent features that (i) have a value that can be determined at any time, (ii) are not derivatives and (iii) have a maturity at issuance of 397 days or less. The definition of systematic internaliser ESMA has carefully considered responses to its consultation and has provided detailed advice, focusing on when investment firms will be treated as systematic internalisers (SIs) in respect of (i) shares, depositary receipts, ETFs, certificates and similar instruments, (ii) bonds (iii) structured finance products, (iv) derivatives, and (v) emission allowances. The advice considers what "frequent and systematic" and "substantial basis" means in each case. The feedback explains ESMA's analysis. Transactions in several securities and orders subject to conditions other than the current market price ESMA's advice is that: execution in several securities will be part of one transaction if that transaction is a portfolio trade that involves an order for execution of 10 or more financial instruments from the same client and at the same time and the single components of the trade are meant to be executed only as a single lot; and an order for the execution of several securities in a portfolio trade will be subject to conditions other than the current market price where it meets any of three conditions related to price calculation and contingencies. Exceptional market circumstances and conditions for updating quotes ESMA's advice says an SI can withdraw its quotes under exceptional market conditions, which are circumstances where the obligation to provide firm prices to clients would be contrary to the prudent management of the risks the investment firm is exposed to in its capacity as an SI. It gives examples of what might constitute exceptional market conditions. It also provides that an SI can update its quotes at any time provided that the quoted behaviour is consistent with genuine trading intentions and with non-discriminatory treatment of its clients. Orders considerably exceeding the norm The advice says that the number or volume of orders shall be regarded as considerably exceeding the norm when an SI cannot execute those orders without exposing itself to undue risk and requires SIs to have a policy for assessing when this will be the case. Prices falling within a public range close to market conditions ESMA's advice merely states that this will be a price within the bid and offer quotes of the SI provided that those quotes reflect prevailing market conditions for that financial instrument. Pre-trade transparency for SIs in non-equity instruments ESMA recommends that the Commission and ESMA work closely together and the Commission relies on existing advice to establish appropriate sizes of instruments falling within the relevant sections of MiFIR. Data publication Access to systematic internalisers’ quotes ESMA saw no need to change its proposals and recommends considering the publication of a quote as "regular and continuous” if it is available at all times during normal trading hours unless “exceptional market conditions” arise. It specified what "normal trading hours" are and set out how SIs should distribute their quotes simultaneously through all the means they utilise and what "easily accessible" means. It also addresses the concepts of "human" and "machine" readability. Publication of unexecuted client limit orders on shares traded on a venue The advice says client limit orders in respect of shares admitted to trading on a regulated market or traded on a trading venue which have not been immediately executed under prevailing market conditions will be available to the public when the investment firm has submitted the order for execution to a regulated market or a multilateral trading facility (MTF) or the order has been published by a data reporting 11 services provider located in one Member State and can be easily executed as soon as market conditions allow. It says regulated markets and MTFs should be prioritised according to the firm’s best execution policy, to ensure execution as soon as market conditions allow. Reasonable commercial basis (RCB) ESMA has provided detailed feedback and advice on clarifying “reasonable commercial basis” (RCB). It concluded it is not appropriate to limit data charges by imposing a limit on the share that data revenues can have of total venue revenues, nor to limit data charges by reference to costs. It recommends the Commission use a principles and transparency based approach. The advice also sets criteria indicating whether data has been sold on an RCB, and recommends the Commission assess whether the information on costs should be published or provided to competent authorities only. The advice also addresses: transparency of costs (if the Commission takes this option); data from providers other than venues; that data should be available on its own, unbundled from other services; sellers should offer the same prices, and other terms and conditions, to all customers who are in the same position according to published, objective criteria, and trading venues should ensure members can always have equal access to data feeds; venues are responsible for third party suppliers they use; and ESMA recommends that trading venues should offer their clients a “per-user” based model. The advice includes detailed tables setting out its, and consultants', analyses of the various options. Micro-structural issues Algorithmic and high frequency trading (HFT) ESMA had proposed two approaches to defining HFT and algorithmic trading. It has considered responses, and tested options, and its final advice is: that where a computer algorithm automatically determines individual parameters of orders this will in principle be included in the definition of algorithmic trading; the Commission should follow one of the three options - absolute threshold per instrument, absolute threshold per trading venue and per instrument or relative threshold - as proxies for the identification of “high message intra-day rates”; and when defining HFT only proprietary order flow should be considered. If an investment firm is classified as HFT, the firm may challenge this classification if they believe this is a direct result of their non-proprietary messaging flow. Direct electronic access (DEA) ESMA's advice is that the MiFID 2 definition of DEA does not encompass any other activity beyond the provision of Direct Market Access and Sponsored Access, and the critical element is the ability to exercise discretion regarding the exact fraction of a second of order entry and the lifetime of the orders within that timeframe. The advice also considers the difference between smart order routing and automated order routing. SME Growth Markets This part of ESMA's advice covers how to register and deregister SMEs based on the 50% thresholds set out in the MiFID 2 package. It also sets the criteria for operating SME growth markets, including responsibilities on issuers and market operators. Suspension and removal of financial instruments from trading The advice covers the list of circumstances constituting significant damage to investors’ interests and the orderly functioning of the market, which could then be the basis of a decision not to follow a suspension or removal notification. Substantial importance of a trading venue in a host Member State ESMA believes the current criteria for determining when the operations of a regulated market become of substantial importance in a host Member State should stay and should also apply to MTFs and OTFs but with an additional test to ensure that the cooperation arrangements envisaged by MiFID 2 are not automatically triggered in the case of small MTFs and OTFs. Monitoring of compliance – information requirements for trading venues ESMA's advice requires notification to regulators of significant events which have the potential to jeopardise the role and function of trading venues as part of the financial market infrastructure. ESMA has not given an exhaustive list, but suggests cases where it would be safe to assume there have been: significant infringements of the rules of a trading venue; disorderly trading conditions; or system disruptions12 that should trigger the information requirement. Monitoring of compliance with the rules of the trading venue - determining circumstances that trigger the requirement to inform about conduct that may indicate abusive behaviour ESMA made significant proposals in this area, and many of the responses focused on the proportionality of the advice. The detailed advice includes an Annex containing a set of indicators/signals of insider dealing and market manipulation that are not of themselves market abuse or attempts of market abuse but that should be taken into account when market operators are assessing abusive behaviour. ESMA stresses the list is neither exhaustive nor determinative of market abuse or attempts of market abuse. The Annex includes signals: of possible insider dealing or market manipulation; of possible insider dealing; of possible market manipulation (of which it lists 20); and for cross-product market manipulation, including across different trading venues. Commodity derivatives Financial instruments definition - specifying Sections C6, 7 and 10 of Annex I of MiFID 2 This is one of the most significant changes the MiFID 2 package brings. ESMA has stated its wish to clarify that options, futures, swaps and other derivative contracts relating to commodities that can be physically settled and are traded on an Organised Trading Facility (OTF) as financial instruments, in addition to those instruments that trade on Multilateral Trading Facilities (MTFs) and Regulated Markets (RMs) will all be financial instruments under MiFID 2. But wholesale energy products within the scope of the Regulation on Energy Market Integrity and Transparency (REMIT) that are traded on an OTF and that must be physically settled are outside scope. This will exclude from MiFID 2 wholesale energy products within the scope of REMIT which are derivatives contracts with electricity (or power) or natural gas as the underlying. There is also a transitional period for “C 6 energy derivatives contracts”. ESMA has decided to apply definitions within this category relating to oil as widely as possible. It also consulted on what "must be physically settled" means in this context. Respondents differed significantly in their views. ESMA's conclusions reflected in the advice are: a contract must be physically settled (for the purposes of specifying wholesale energy and energy derivatives contracts under section C6) if: it contains provisions which ensure that parties to the contract have proportionate arrangements in place to be able to make or take delivery of the underlying commodity; it establishes unconditional, unrestricted and enforceable obligations of the parties to the contract to deliver and take delivery of the underlying commodity; it is not possible for either party to replace physical delivery with cash settlement; and the obligations under the contract cannot be offset against obligations from other contracts between the parties concerned, without prejudice to the rights of the parties to the contract, to net their cash payment obligations (operational netting in power or gas markets is not offsetting for these purposes); the existence of force majeure or bona fide inability (both as defined in the advice) to settle provisions do not prevent a contract from being characterised as “must be physically settled”; the existence of default clauses providing that a party is entitled to financial compensation in the case of non- or defective performance of the contract should not prevent the contract from being characterised as “must be physically settled”; contracts that are physically settled can have a broad range of delivery methods, including physical delivery and delivery of a document giving ownership rights; C6 energy derivative contracts relating to oil are contracts having mineral oil of any description and petroleum gases, whether in liquid or vapour form, including products, components and derivatives of oil and oil transport fuels, including those with bio-fuel additives, as an underlying; and C6 energy derivative contracts relating to coal are contracts with coal, defined as a black or dark-brown combustible mineral substance consisting of carbonised vegetable matter, used as a fuel, as an underlying. ESMA's advice on C7 contracts is that a contract should be considered as having the characteristics of other derivative financial instruments if it is 13 standardised and if it trades in line with set conditions. It cannot be a spot contract nor a contract for commercial purposes only. As clarification ESMA thinks: a contract is standardised if parameters such as the price, the lot, the delivery date or other terms are determined principally by reference to regularly published prices, standard lots or standard delivery dates; a contract is traded in such a way as having the characteristics of other derivative financial instruments if (i) it is traded on a third-country trading venue that performs a similar function to an RM, MTF or OTF; (ii) it is expressly stated to be traded on, or is subject to the rules of such an EU or third-country market; or (iii) it is equivalent to a contract traded on such a market, with regards to the price, the lot, the delivery date or other terms; a spot contract is a contract for the sale of a commodity, asset or right, under the terms of which delivery is scheduled to be made within the longer of two trading days or the period generally accepted in the market for that commodity, asset or right as the standard delivery period; a contract is not a spot contract if there is an understanding between the parties that delivery of the underlying will be postponed and not performed within these time limits, regardless of what the contract says; and a contract will be for commercial purposes if it is entered into with or by an operator or administrator of an energy transmission grid, energy balancing mechanism or pipeline network and it is necessary to keep in balance the supplies and uses of energy at a given time. In relation to contracts on underlyings that fall within category C10, these will have the characteristics of other derivative financial instruments if they are either (i) settled in cash or may be settled in cash at the option of one or more of the parties to the contract, other than by reason of default or other termination event; (ii) they are traded on an RM, MTF, OTF or equivalent thirdcountry market or (iii) they fulfil the conditions for contract under section C7. Derivative contracts on other specified underlyings, including bandwidth, storage capacity, renewable energy allowances and indices will also be derivatives contracts if they meet these criteria. Position reporting thresholds ESMA's advice is that:trading venues must make public a weekly position report for commodity derivatives or emission allowances or derivatives thereof when both thresholds of: 30 open position holders exist in a given contract on a given trading venue; and the absolute amount of the gross long or short volume of total open interest, expressed in the number of lots of the relevant commodity derivative, exceeds a level of four times the deliverable supply in the same commodity derivative, expressed in number of lots apply. Position management powers of ESMA ESMA consulted widely on these powers, and its final advice is consistent with that on product intervention. It also sets out factors consistent with the Short Selling Regulation which it considers are relevant as well as a further, non-exhaustive list of relevant factors. In relation to its power to require “the appropriate reduction of a position or exposure entered into via a derivative”, “appropriate” action may differ on a case-bycase basis. ESMA sets a further list of factors that may be relevant. ESMA also sets criteria and factors that are relevant when determining the situations where a risk of regulatory arbitrage could arise. Finally, ESMA explains how it will differentiate between situations caused by a national authority's failure to act as opposed to its inability to sufficiently address a threat. Portfolio Compression This final part of the advice addresses portfolio compression and covers: criteria of the definition of portfolio compression: these will cover process, the legal documentation and the economic outcome of portfolio compression. ESMA sets out guidance on each of these areas; measurement of the portfolio compression: ESMA says this should focus on the reduction of the aggregated notional value of the portfolio submitted for compression for all participants on an aggregated basis, and should be performed at the level of each individual participant in a portfolio compression activity; and information to be published: ESMA advises on detail and timing of this information. The Consultation Paper The Consultation Paper is divided into two parts. ESMA invites comments on all its proposals by 2 March 2015. 14 The paper covers each area included in ESMA's May discussion paper, and gives feedback following responses to it as well as proposing the content of the relevant RTS and ITS that are now also published for consultation. Investor protection The consultation addresses four specific aspects of investor protection: procedures for granting and refusing requests for authorisation of investment firms; freedom to provide investment services and activities/establishment of a branch; provision of services and performance of activities by third-country firms following an equivalence decision (general provisions); and information relating to execution of orders. On the whole, respondents supported the views in ESMA's discussion paper, so its proposals show little change from these views. ESMA proposes the following technical standards and asks 36 specific questions. Draft Technical Standards Authorisation RTS 1: Article 7(4) (information to be provided on application for authorisation). ITS 2: Article 7(5), annexing an application form for a firm, list of members of the management body and notification of information on changes in the management body. Passporting and tied agents RTS 3: Articles 34(8) and 35(11) (information to be provided on application to exercise single market passport). ITS 4: Articles 34(9) and 35(12), with annexes of notification formats for passporting of investment services and activities, access to trading venues, branch notifications, tied agent notifications, notifications between regulators and notification of termination of passport rights or branches. Third-country firms RTS 5: Article 46(7) of MiFIR, information to be provided by a third country firm applying for authorisation. Execution data RTS 6: Article 27(10)(a), information on execution data. RTS 7: Article 27(10)(b), format of information on top five execution venues. Transparency This part of the paper addresses issues relating to transparency, and confirms ESMA's approach that the starting point for setting requirements should depend on the trading venue. The paper explains the aspects of the consultation that caused the greatest amount of comments. On the whole, while appreciating the contrary views, ESMA has confirmed its approach. 55 specific questions cover this part of the paper. Equity and equity-like financial instruments Pre-trade transparency for trading venues in respect of equity and equity like financial instruments: the paper covers (i) pre-trade information to be made public by type of trading system; (ii) most relevant market in terms of liquidity; (iii) negotiated transactions; (iv) order management facility waiver; and (v) what is considered large in scale for the purposes of large in scale waivers. Pre-trade transparency for investment firms in respect of equity and equity-like financial instruments: considering (i) arrangements for the publication of a firm quote; (ii) quotes reflecting prevailing market conditions and standard market size (on this, ESMA has decided to use its second consultation option, which groups the two smallest classes into a single class for shares with an average volume of transactions between zero and €20,000 and set a standard market size of €10,000). Trading obligation for shares: ESMA proposes an exhaustive list of types of transactions in shares which do not contribute to the price formation process. Post-trade transparency for trading venues and investment firms in respect of equity and equity-like financial instruments: here the consultation covers (i) content of the information to be made public; (ii) identifiers (including a list of flags); (iii) timing (ESMA proposes to keep its definitions of "normal trading hours" and "maximum possible delay"; (iv) securities financing transactions and other transactions determined by factors other than the current market valuation of the financial instrument; and (v) deferred publication of transactions. ESMA has proposed to increase the number of liquidity bands to make the pre- and post-trade transparency obligations more consistent. Non-equity financial instruments Liquid market definition for nonequity financial instruments: here, ESMA considers: (i) general remarks on the definition of liquid market; (ii) fixed income financial instruments; (iii) securitised derivatives; (iv) interest rate derivatives; (v) equity derivatives; (vi) commodity derivatives - considering separately metals, energy and agricultural; and (vii) 15 emission allowances. ESMA's key decision here has been to use Classes of Financial Instruments Approach (COFIA) as the basis for determining the liquidity of all relevant instruments. On this basis, it provides detailed lists of investments that should be considered to be liquid. The paper also provides significant detailed analysis of how ESMA has reached its conclusions in relation to each relevant instrument. Pre-trade transparency for nonequity instruments: this looks at trading models and waivers for non-equity instruments. ESMA again proposes to define the key characteristics of orders held in an order management facility without narrowly prescribing specific characteristics of those orders. It proposes to clarify that instruments eligible for the waiver are derivatives subject to the clearing obligation but for which ESMA has determined that they shall not be subject to the trading obligation; and bonds, derivatives, structured finance products and emission allowances deemed illiquid in the draft RTS 9. Post-trade transparency requirements for non-equity instruments: this part covers (i) content and timing of post-trade transparency requirements; (ii) application of post-trade transparency to certain OTCtransactions; (iii) deferred publication regimes; and (iv) supplementary deferral regime at the discretion of the national competent authority. Following consultation, ESMA has amended some of the flags it plans to list. It seeks views specifically on various changes it has made and on its proposals relating to timing of requirements, and thresholds it has set for various instruments. Again, its paper gives granular evidence to support its proposals. Application of transparency requirements Temporary suspension of transparency requirements: ESMA has refined the thresholds it proposed in its Discussion Paper. The paper also discusses exemptions from transparency requirements in respect of transactions executed by a member of the European System of Central Banks. The double volume cap mechanism Here ESMA seeks views on its proposals for the double volume cap mechanism and on the provisions of Article 22 of MiFIR on providing information for the purposes of transparency and other calculations. ESMA is considering the best and most sensitive way of gathering and calculating the necessary information. Trading obligation ESMA discusses the criteria for determining whether derivatives should be subject to the trading obligation, looking at criteria for determining whether derivatives have a direct, substantial and foreseeable effect within the EU. ESMA describes in detail the factors it will need to take into account for different instruments when deciding whether they are subject to the trading obligation, and, specifically, the criteria relating to the effect of derivatives in the EU (where it notes the similarities with the analysis it carried out in relation to the European Market Infrastructure Regulation (EMIR)). Draft Technical Standards The paper annexes the following draft RTS: Transparency requirements RTS 8: transparency requirements in respect of shares, depositary receipts, ETFs, certificates and other similar financial instruments and on the trading obligation for investment firms. RTS 9: transparency requirements in respect of bonds, structured finance products, emission allowances and derivatives. Double volume cap mechanism RTS 10: the double volume cap mechanism and the provision of information for the purposes of transparency and other calculations. Trading obligation RTS 11: criteria for determining whether derivatives should be subject to the trading obligation (Article 32(6) of MiFIR). Direct, substantial and foreseeable effect of derivatives RTS 12: criteria for determining whether derivatives have a direct, substantial and foreseeable effect within the EU (Article 28(5) of MiFIR). Microstructural issues In this section, ESMA addresses: organisational requirements for investment firms (Article 17): ESMA explains in detail the issues it needed to consider, and has suggested a set of guidelines following feedback from its discussion paper; organisational requirements for trading venues (Article 48): again this detailed analysis covers matters such as governance, staffing, outsourcing and capacity. It also considers means to ensure stability and necessary controls; market making, market making agreements and market making schemes: ESMA has clarified when a market making agreement will be necessary and 16 elaborated on related requirements; ratio of unexecuted orders to transactions: ESMA has made some substantial amendments to its proposals following consultation and seeks views on its decision; co-location and fee structures: again, ESMA has made changes following consultation, and particularly seeks further views on where fee structures are not based on genuine trading activity; tick sizes (Article 48(6) and Article 49): ESMA has adopted various elements of its original proposals and has developed a tick size table on which it seeks views; and material markets in terms of liquidity. Draft Technical Standards This part of the paper has around 40 questions and annexes the following draft standards: RTS 13: organisational requirements of investment firms engaged in algorithmic trading, with an annex of parameters that, as a minimum, have to be considered in the firm’s selfassessment.
RTS 14: organisational requirements of RMs, MTFs and OTFs and parameters that, as a minimum, have to be considered in the trading venues’ self-assessment. RTS 15: market making, market making agreements and market making schemes. RTS 16: orders to transactions ratio. RTS 17: co-location and fee structures. RTS 18: tick size regime for shares, depositary receipts, exchange traded funds and certificates. RTS 19: material market in terms of liquidity. Data publication and access This part of the paper contains around 25 specific questions for respondents and covers: general authorisation and organisational requirements for data reporting services; publication chain of posttrade transparency information: this considers the scope of the consolidated tape for different instruments and technical arrangements for consolidation. It also covers the content of the information published by the equity consolidated tape provider (CTP) and the approved publication arrangements (APA); data disaggregation: ESMA proposes each venue must offer its pre- and post-trade data disaggregated by four asset classes; must disaggregate by further criteria, unless there is insufficient demand for such data streams; and, if a venue decides that there is not sufficient demand to disaggregate by a particular criterion, it should state this alongside its price lists, and in response to any request for pricing information; identification of the investment firm responsible for making public the volume and price of a transaction (Articles 20(3)(c) and 21(5)(c) of MiFIR); non-discriminatory access to CCPs and trading venues: this section looks at detailed criteria, but all on the assumption that the necessary market players are properly authorised or recognised in the EU. In principle, ESMA says access should be granted if after reasonable efforts to manage the risks arising from access no significant undue risks remain. The conditions for denying access and the conditions under which access is granted should be aimed at meeting these objectives. ESMA considers: denial of access by a CCP or trading venue; conditions under which an access request may be denied by a CCP to a trading venue – Article 35(6)(a); conditions under which an access request may be denied by a trading venue to a CCP – Article 36(6)(a) of MiFIR; conditions under which granting access will threaten the smooth and orderly functioning of the markets or would otherwise adversely affect systemic risk; conditions under which access must be permitted; general terms of access conditions; fees charged by CCPs and trading venues; conditions for nondiscriminatory treatment of contracts; notification procedure and calculation of notional amount with regard to transitional provisions; and non-discriminatory access to and licensing of benchmarks: this looks at benchmark information, other conditions under which access must be granted and new benchmarks. ESMA has concluded it is not possible to give exhaustive guidance and acknowledges there may be instances when venues need to seek further information. 17 Draft Technical Standards The relevant draft RTS cover: RTS 20: authorisation and organisational requirements for data reporting services providers. RTS 21: publication of transactions by APAs and CTPs. RTS 22: data disaggregation. RTS 23: identification of the investment firm responsible for making public the volume and price transparency of a transaction. RTS 24: access in respect of trading venues, central counterparties and benchmarks. Requirements applying on and to trading venues ESMA's proposals largely reflect its consultation and current MiFID requirements and the requirements of the level 1 legislation. In relation to information on MTFs and OTFs, ESMA has produced a detailed list on which it seeks comments. admission to trading; suspension and removal of financial instruments from trading - connection between a derivative and the underlying financial instrument; and information requirements of MTFs and OTFs. Draft Technical Standards ESMA has produced the following draft technical standards: RTS 25: admission of financial instruments to trading on regulated markets. RTS 26: suspension and removal of financial instruments from trading. ITS 27: description of MTFs and OTFs. Commodity derivatives This part of the consultation addresses in detail which firms might be able to use the remaining exemptions relating to commodity derivatives activity, and the consequences of needing authorisation under MiFID 2. This includes that authorised firms will be considered financial counterparties for the purposes of EMIR, which will have several knock-on effects: ancillary activity: ESMA sets out detail of the thresholds it believes should apply in assessing whether activities are ancillary activities for the purposes of the MiFID 2 exemption and addresses aspects of (i) minority of activities; (ii) size of trading activity; (iii) privileged transactions; and (iv) period for calculation in relation to exemption; methodology for calculating position limits: ESMA proposes to keep the key features of the methodology it set out in its discussion paper and to set position limits for both cash settled and physically settled contracts with reference to the deliverable supply. The baseline figure for the position limit for each commodity derivative, for both spot month limit and the other months limit, will be 25% of deliverable supply that would be available for the spot month contract, or for the appropriate prediction of deliverable supply that will be available to meet the obligations arising for the other months; application of position limits: the paper explains feedback from respondents on several aspects of applying limits, and sets out ESMA's response; and position reporting. Draft Technical Standards ESMA asks around 60 questions on this section and has produced the following draft technical standards: RTS 28: criteria for establishing when an activity is to be considered to be ancillary to the main business. RTS 29: methodology for calculating position limits for commodity derivatives traded on trading venues and economically equivalent OTC contracts. RTS 30: application of position limits for commodity derivatives traded on trading venues and economically equivalent OTC contracts. ITS 31: position reporting, with tables of fields annexed. Market data reporting This is a detailed and technical section of the consultation. Respondents raised several issues, both requesting clarification on key terms and disagreeing with ESMA's proposals. There were concerns about the breadth of definitions and the costs of implementing ESMA's proposals. ESMA addresses these, and in many instances has simplified its approach. The consultation addresses: data standards and formats; obligation to report transactions; obligation to maintain records of orders; requirement to maintain records of orders for firms engaging in high-frequency algorithmic trading techniques; clock synchronisation; and obligation to supply financial instrument reference data.18 Draft Technical Standards ESMA asks around 25 questions and annexes the following draft RTS: RTS 32: reporting obligations under Article 26 of MiFIR. RTS 33: obligation to supply financial instrument reference data. RTS 34: obligation to maintain records of orders. RTS 35: requirement to maintain records of orders for firms engaging in highfrequency algorithmic trading techniques. RTS 36: clock synchronisation. Post-trading issues Finally, the paper addresses two specific aspects of post-trading issues: obligation to clear derivatives traded on regulated markets and timing of acceptance for clearing: the main issues respondents raised focused on certainty of timing. ESMA looks at certainty of clearing, timeframe for submission to CCPs and acceptance by clearing members and CCPs. It also addresses how to deal with rejected transactions; and indirect clearing: many respondents expressed concerns on the lack of offering of indirect clearing services for OTC derivatives. The consultation now offers a choice between segregation models - a net omnibus account (the same as under the EMIR RTS on OTC derivatives) and a gross omnibus account. Draft Technical Standards ESMA annexes draft RTS on: RTS 37: obligation to clear derivatives traded on regulated markets and timing of acceptance for clearing (STP). RTS 38: indirect clearing. Conclusion This paper has highlighted several key aspects of the Technical Advice and Consultation Paper. It is clear, though, that firms must consider in detail those parts of both the completed and incomplete work that relate to their businesses. The consultation period lasts only until 2 March, with a public hearing set for 19 February. There is not much time for those who object to the proposal