The European Securities and Markets Authority (“ESMA”) has written to the European Commission requesting that the definition of “derivative” or “derivative contract” in Regulation (EU) No 648/2012 on OTC derivatives, central counterparties and trade repositories (“EMIR”) is clarified. This is to ensure that EMIR is applied in a consistent manner in all Member States of the EU, which is one of the stated aims of EMIR.

EMIR/MiFID

EMIR applies to financial instruments that it categorises as a “derivative” or “derivative contract” and defines these as financial instruments as set out in points (4) to (10) of Section C of Annex I to Directive 2004/39/EC on markets in financial instruments (“MiFID”).

MiFID took the form of a directive, which meant that Member States had a degree of discretion in how MiFID was incorporated into domestic law. This has resulted in differing views and approaches between Member States on what constitutes a derivative and may prevent the uniform application of EMIR across all Member States.

For example, the obligation to report details of derivatives transactions to trade repositories under EMIR applies to all derivatives. Different definitions of what constitutes a derivative across Member States may lead to a requirement to report certain transactions which are classed as derivatives in one Member States but not needing to report them in other Member States which do class them as derivatives. This would mean that EMIR is being applied inconsistently across Member States.

Different interpretations

Of particular concern is whether foreign exchange (“FX”) forwards and physically settled commodity forwards fall within the definition of “derivative” or “derivative contract”.

FX forwards

There are differences of opinion between Member States on when an FX transaction is an FX spot and when it is an FX forward.  Spot transactions are not considered to be derivatives whilst FX forwards are considered to be derivatives. ESMA’s view is that there is broad agreement that transactions that settle within two business days of being entered into are spot transactions and transactions that settle after seven business days or more of being entered into are considered to be FX forwards. Member States have different views of FX transactions that settle within three and six business days inclusive.

There is also a question over whether FX forwards entered into for commercial purposes are within the scope of MiFID. Member States do not agree on whether such transactions are within the scope of EMIR. For example, the Financial Conduct Authority in the UK does not believe that FX forwards entered into for commercial purposes are within the scope of MiFID. It is also unclear whether the concept of “commercial purposes” is broader than hedging.

Physically settled commodity forwards

Due to the wording of MiFID, it is not clear whether physically settled forwards traded on a regulated market or a multilateral trading facility fall within the scope of MiFID and Member States have different views on this.

The wording of MiFID has also created questions over what phrases such as “physically settled” and “can be physically settled” mean.

The result is that Member States have different views on whether certain physically commodity forwards are within the scope of MiFID and therefore whether they are a “derivative” or “derivative contract” for the purposes of EMIR.

Next steps

ESMA has asked that the European Commission uses its powers under MIFID to clarify what types of derivatives fall within the scope of points (4) to (10) of Section C of Annex I of MiFID. This would ensure a common approach to which types of derivatives are within the scope of EMIR across all Member States. We await the European Commission’s response to ESMA’s letter.