MiFID II makes various adjustments to the exemptions under MiFID I, largely with the aim of tightening the regime and increasing investor protection.
Although two new exemptions have been added – for operators complying with the EU Emissions Trading Scheme Directive in certain circumstances, and for certain gas and electricity operators – these are consequent upon expansions to the scope of MiFID II rather than indicative of new concessions.
Most of the changes result in the narrowing of exemptions, particularly affecting firms that rely on the current exemptions for commodities firms and the dealing on own account exemption. Further, the exemption for “locals” (those who exclusively deal on own account on derivatives and cash markets for hedging purposes, or who deal for accounts of other market members or make prices for them, where performance is guaranteed by clearing members) has been deleted – although locals should still be able to benefit from an exemption in the Capital Requirements Regulation to avoid facing a dramatic shift in capital requirements.
Dealing on own account exemption
The main dealing on own account exemption (which does not apply to firms dealing on own account in commodity derivatives, emissions allowances or emissions allowance derivatives) has been significantly narrowed. Whilst MiFID I exempts persons who do not provide any investment services or activities other than dealing on own account (unless they are market makers or deal on own account outside a regulated market or a multilateral trading facility on an organised, frequent and systematic basis by providing a system accessible to third parties in order to engage in dealings with them), the equivalent exemption under MiFID II will not apply to:
- persons who are members or participants of a regulated market or a multilateral trading facility, or who have direct electronic access to a trading venue, except for non-financial entities carrying out hedging activities for themselves or their group;
- persons who apply a high frequency algorithmic trading technique; or
- persons who deal on own account when executing client orders.
The final point ties in with the move under MiFID II to bring matched principal dealing within scope of the dealing on own account activity; the recitals to the MiFID II Directive make clear that persons trading on a matched principal basis should not be able to benefit from any exemption. See our earlier alert on changes to scope for more detail on this change.
Exemptions for commodities firms
The current exemption for firms whose main business consists of dealing on own account in commodities or commodity derivatives has been deleted in its entirety.
The other key exemption for commodities firms – the exemption for persons providing investment services in commodity derivatives to the clients of their main business, where this is an ancillary activity to their main business (which must not be the provision of investment or banking services) – has been narrowed.
Subject to the conditions below, the equivalent MiFID II exemption applies to persons:
- dealing on own account in commodity derivatives, emission allowances or emission allowance derivatives; or
- providing other investment services in commodity derivatives, emission allowances or emission allowance derivatives to the customers or suppliers of their main business.
Although this maintains some form of dealing on own account exemption, as with the main dealing on own account exemption this does not apply to persons trading on a matched principal basis. The exemption also does not apply to persons using high-frequency algorithmic trading techniques.
Further, the new exemption is conditional upon:
- the activity being ancillary to their main business (which must not be the provision of investment or banking services, or acting as a market maker in commodity derivatives), when considered on a group basis; and
- the firm making an annual notification to the regulator, who may require evidence of eligibility.
The scope of this exemption, and thus its potential usefulness to commodities firms that currently rely on the dealing on own account exemption, largely hinges on the meaning of “ancillary” for these purposes. ESMA was asked to draft regulatory technical standards to clarify how this should be assessed.
ESMA’s original draft contained two tests: a trading activity threshold which looks at the size of the trading activity compared to the overall market trading activity in that asset class, and a main business threshold which looks at whether the activities constitute a minority of activities at group level.
Unfortunately, the Commission was unhappy with the draft and suggested the inclusion of a capital-based test. However, ESMA was unwilling to shift its position and sent the draft back to the Commission largely unchanged (although accompanied by some potential options for the Commission to consider as alternatives to the main business test). We wait to see how this will be resolved. In the meantime, uncertainty remains for firms hoping to be able to rely on the exemption.
New optional exemptions
There are some new optional exemptions under Article 3 of the MiFID II Directive, for joint venture vehicles owned by local energy utilities or operators of industrial installations under the EU Emissions Trading Scheme Directive, which carry out hedging activities on their behalf. However, it has been decided that these exemptions will not be implemented in the UK.
Although the FCA has already consulted on some of its perimeter guidance in relation to exemptions, it has stated that it plans to address various outstanding questions about exemptions, including those in respect of commodity businesses, in its third and final MiFID II consultation (currently expected to be published later this year).