ESMA has published a consultation paper on draft guidelines on the application of the definitions of derivative contracts referred to in Annex 1, Section C, points (6) and (7) (‘C6’ and ‘C7’) of MiFID I.

In its consultation paper ESMA explains that the different approaches to the interpretation of MiFID I across Member States mean that there is no commonly-adopted application of the definition of derivative or derivative contract in the EU for some asset classes. Whilst this issue has in the past been noted as a concern since the implementation of MiFID, there are significant problems in the implementation of EMIR caused by the non-harmonised classification of financial instruments as derivatives. This is the case in particular for physically settled commodity forwards. These different interpretations may lead to an inconsistent application of MiFID, EMIR and potentially other directives and regulations that rely on MiFID definitions of financial instruments.

ESMA considers it essential to ensure, amongst other things, a consistent application of EMIR in the EU and is therefore considering the adoption of guidelines to ensure the consistent classification of certain financial instruments as derivatives.

The Guidelines proposed by ESMA are as follows:

Application of C6 of Annex 1 of MiFID

ESMA considers that definition C6 of Annex 1 of MiFID applies in the following way:

  • C6 has a broad application, applying to all commodity derivative contracts, including forwards, providing that:
    • They can be physically settled
    • They are traded on a regulated market and/or an MTF
  • Physically settled” incorporates a broad range of delivery methods and includes:
    • Physical delivery of the relevant goods themselves
    • Delivery of a document giving rights of an ownership nature to the goods concerned; or
    • Another method of bringing about the transfer of rights of an ownership nature in relation to the relevant quantity of goods without physically delivering them that entitles the recipient to the relevant quantity of the goods

Application of C7 of Annex 1 of MiFID I

ESMA considers that definition C7 of Annex 1 applies in the following way:

  • C7 forms a category that is distinct from C6 and applies to commodity derivative contracts that can be physically settled which are not traded on a regulated market or an MTF providing that the commodity derivative contract:
    • Is not a spot contract as defined under Article 38(2) of The MiFID I Implementing Regulation
    • Is not for commercial purposes as described under Article 38(4) of The MiFID I Implementing Regulation
    • Meets one of the three criteria under Article 38(1)(a) and also the separate criteria under Article 38(1)(b) and 38(1)(c) of The MiFID I Implementing Regulation
  • Physically settled” incorporates a broad range of delivery methods and includes:
    • Physical delivery of the relevant goods themselves;
    • Delivery of a document giving rights of an ownership nature to the goods concerned; or
    • Another method of bringing about the transfer of rights of an ownership nature in relation to the relevant quantity of goods without physically delivering them that entitles the recipient to the relevant quantity of the goods

Physically settled commodity derivatives which do not fall within the definition of C6, i.e. are not traded on a Regulated Market or an MTF, may fall within the definition of C7and the definitions of C6 and C7 form two distinct categories as C7 applies to commodity derivatives “that can be physically settled not otherwise mentioned in C.6”.

The other characteristics of commodity derivatives under C7 - “not being for commercial purposes, which have the characteristics of other derivative financial instruments, having regard to whether, inter alia, they are cleared and settled through recognised clearing houses or are subject to regular margin calls” - are further defined under Article 38 of the MiFID I Implementing Regulation.

ESMA notes that the conditions defined in the MiFID I Implementing Regulation, whilst set out separately, are to be applied cumulatively.”

Next Steps

ESMA has invited comments on the draft guidelines until 5 January 2015.