Seventh Annual MIG seminar:
The Impact of MiFID II and EMIR on
Commodities
Hannah Meakin (Partner) and Cat Blake (Associate)
5 March 2014
Overview
• MiFID II: What are “financial instruments”?
• Additions and amendments to the type of financial instrument
that is within scope of MiFID
• MiFID II: Who is within the scope of MiFID II?
• Additions and amendments to the MiFID exemptions
• Are the “exemptions” really exemptions?
– Position limits and position management powers
– Algorithmic trading and HFT
• The link with EMIR
– How does MiFID II impact on post-trade obligations
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MiFID II: What are “financial
instruments”?
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MiFID financial instruments: commodity derivatives
MiFID I
Any changes?
Commodity derivatives No
that must be cash
settled or may be cash
settled (other than by
reason of default or
termination)
Commodity derivatives
which can be physically
settled provided they
are traded on an RM,
MTF or OTF except for
REMIT
wholesale
energy products traded
on an OTF which must
be physically settled
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What’s the impact?
N/A
Yes
•
• Includes
such
derivatives
traded on an OTF
• The REMIT carve out – subject
to an RTS
• Subset of these instruments
which relate to coal or oil, are
traded on an OTF and must be
physically settled are subject to
transitional provision in respect
of EMIR obligations – subject •
to an RTS
Inclusion
of
OTF
potentially includes much
wider
category
of
instruments. Note that
they will (subject to
transitional provision) be
in scope of EMIR and
OTC for the purposes of
EMIR. Impact on EMIR
threshold calculations
REMIT carve out – these
products will not be in
scope of MiFID or EMIR
MiFID financial instruments: commodity derivatives
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What’s the impact?
MiFID I
Any changes?
Commodity derivatives
that can be physically
settled but are not
traded on an RM, MTF
or OTF, nor a REMIT
instrument, are not for
commercial purposes
and which have the
characteristics of other
derivative
financial
instruments
Yes – RTS on derivative contracts Not yet clear
that have “the characteristics of
other
derivative
financial
instruments”
MiFID financial instruments: commodity derivatives
MiFID I
Any changes?
Derivatives relating to Yes:
climatic
variables, • Now includes assessment of
freight rates or inflation
whether they are traded on an
rates or other official
OTF
economic statistics or • RTS to be published on “having
any
other
assets,
the characteristics of other
rights,
obligations
derivative financial instruments”
indices or measures
not
otherwise
mentioned that must be
or may be cash settled
(apart from default or
termination); and have
the characteristics of
other
derivative
financial
instruments
having
regard
to
whether
they
are
traded on an RM, MTF
or OTF
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What’s the impact?
Inclusion of OTF potentially
includes
much
wider
category of instruments
Potential impact of the RTS
– not yet clear
MiFID financial instruments
• Emission allowances consisting of any units recognised for
compliance with the requirement of the EU Emissions Trading
Scheme are now MiFID financial instruments
• But are not EMIR instruments
• Note that derivatives on emission allowances remain both MiFID
financial instruments and EMIR instruments
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MiFID II: Who is within scope?
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MiFID II: The common exemptions used by commodity market participants
• The changes to the MiFID exemptions will have a significant
effect on the commodities markets participants.
MiFID I exemption
2(1)(b) – “the
exemption”
Still available?
group Yes
2(1)(d) – “the dealing on Yes
own account exemption”
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Any amendments?
No
Now only applies to
financial
instruments
other than commodity
derivatives, EUAs and
derivatives on EUAs
and
has
additional
requirements
MiFID II: The common exemptions used by commodity market participants
MiFID I exemption
Still available?
Any amendments?
2(1)(i) – “the ancillary Yes
business exemption”
Significant amendments
have been made to this
exemption
–
see
following slides
2(1)(k)
–
commodities
exemption”
N/A
“the No
dealer
• Any firms which currently rely on any of these exemptions would be well
advised to revisit and update their MiFID analysis
• NB there are other exemptions in MiFID, this presentation focuses on those
which are commonly used by commodity market participants
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MiFID II: Exemptions – what’s the impact?
Article 2(1)(i): Entities who, in relation to commodity derivatives, EUAs or EUA
derivatives:
•
•
deal on own account
• excluding those who deal on own account by executing client orders (execution of
orders as an ancillary activity between two persons who main business on a
group basis is neither the provision of investment services under MiFID nor
banking services under the BCD should not be considered dealing on own
account by executing client orders); or
provide investment services other than dealing on own account to the customers or
suppliers of their main business
Provided:
•
•
•
•
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In both cases, individually and on aggregate basis, this is an ancillary business to
their main business when considered on a group basis;
Main business is not the provision of investment services under MiFID or banking
services under BCD, nor acting as a market maker in relation to commodity
derivatives;
They do not apply a high frequency algorithmic trading technique; and
They notify the relevant competent authority that they make use of this exemption on
an annual basis and, on request, provide to the relevant competent authority the
basis on which they consider the activity to be ancillary to their main business
MiFID II: The exemptions
There are also new exemptions in relation to:
• Operators with compliance obligations under the ETS trading
directive
• Transmission system operators under the electricity and natural
gas directives and regulations
And optional exemptions for:
• JVs set up for the hedging requirements of local electricity
undertakings or operators (as defined in the ETS trading
directive)
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MiFID II: The exemptions
Can we really describe them as exemptions any longer?
• Persons relying on new 2(1)(da) or (i) will be subject to the
MiFID provisions in relation to algorithmic trading to the extent
that they are members of or participants in a RM or MTF
• The position management and position limit powers of both the
NCAs and ESMA apply to anyone with a commodity derivative
position – regardless of whether they are exempt under any
part of Article 2
• Product intervention powers of NCAs apply to anyone
regardless of whether they are exempt under any part of Article
2
• The trading obligation in respect of OTC derivatives applies to
EMIR NFC+s regardless of the fact that they are exempt under
Article 2
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Active intervention in markets: position limits
• The four step process for setting of position limits for commodity
derivatives:
•
Competent authority shall impose position limits in line with technical
standards determined by ESMA to prevent market abuse or support
orderly pricing and settlement conditions
•
Does not apply to hedging activity of non-financial entities
Layer 2
•
ESMA opines on whether position limits are in line with objectives and
methodology
Layer 3
•
Competent authority can set more restrictive limits where objectively
justified and proportionate taking account of liquidity and orderly market
for 6 monthly renewable periods
Layer 4
•
ESMA must opine on whether this is necessary
Layer 1
Active intervention in markets: position management
• Trading venues must have position management powers for commodity derivatives:
• Monitoring open positions
• Access to information about positions
• Require a person to terminate or reduce a position
• Require a person to provide liquidity back into the market
• Competent authorities can:
• Require information about size and purpose of position or exposure in a commodity derivative or
underlying; and
• Request a person to reduce positions and exposures in any derivative
• ESMA can:
• Request information about size and position of any derivative and require a person to reduce it
• Limit ability of a person to enter into a commodity derivative
• To address a threat to viability of financial system or orderly functioning and integrity or competent
authorities’ actions are inadequate
• Daily position reporting to competent authority by trading venues for commodity derivatives, emission
allowances and derivatives on them
• Weekly report of aggregate positions by category of trader, commercial undertaking, investment firm etc.
to public
• Complete breakdown of positions of members and clients to competent authority on request
• Daily position reporting of own and client positions to trading venue by members of an RM or MTF and
clients of an OTF
The link between MiFID II/MiFIR and
EMIR
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MiFID II and EMIR: How they work together
EMIR instruments
•
EMIR definition of derivative points to MiFID – if a particular product is a now a MiFID
instrument (C4-C10) then it will be within scope of EMIR
•
•
In particular look out for what commodity derivatives are being traded on OTFs
Note the REMIT carve out – these will not be within scope of EMIR
Counterparty classification
•
A counterparty that is no longer able to rely on the MiFID exemptions and has to become
authorised under MiFID will, upon such authorisation, become an FC for the purposes of
EMIR
•
More onerous obligations under EMIR, and potential notifications to existing
counterparties
The concept of OTC trading
•
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Remember that EMIR classes any derivative trade not executed on a RM as OTC
MiFID II and EMIR: How they work together
The transitional provision (Article 99 MiFID)
• Clearing and collateralisation obligations will not apply in relation
to derivatives in relation to coal or oil that are traded on an OTF
and must be physically settled (further details to be provided in
an RTS) entered into by NFC+s or those firms that have to
become authorised under MiFID for the first time as a result of
MiFID II; and
• Such derivatives shall not be considered OTC derivatives for the
purposes of the clearing threshold calculations of NFCs
Will be available for 42 months after the entry into application of
MiFID II
Does not apply to the EMIR reporting and other risk management
obligations
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MiFID II and EMIR: How they work together
The Trading Obligation (Articles 24-27 MiFIR)
•
FCs and NFC+s must execute all transactions in derivatives which have been declared subject to the
Trading Obligation on a Regulated Market, MTF, OTF or third country trading venue
•
The process for determining which derivatives will be subject to the Trading Obligation is similar to that
for the Clearing Obligation. Although note that the derivatives must have been declared clearing
eligible to be considered for the Trading Obligation
•
Applies to trades with third country counterparties who would be FCs or NFC+s if they were in the EU
– the same as the Clearing Obligation under EMIR
•
Direct applicability to third country entities where contract has direct, substantial and foreseeable effect
within the EU or where the obligation is necessary or appropriate to prevent the evasion of the MiFIR
•
Similarly to third country CCPs and TRs, the use of third country trading venues to satisfy the
obligation will be subject to positive equivalence decisions by the Commission
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MiFID II and EMIR: How they work together
Portfolio compression
•
Investment firms providing portfolio compression required to make public
through an APA the volume of derivative transactions subject to portfolio
compression and the times they were concluded in accordance with Article 9 of
MiFIR
•
Investment firms providing portfolio compression have to keep complete and
accurate records of all portfolio compressions they organise or participate in
(RTS to be published on this)
Indirect Client Clearing for exchange traded derivatives
•
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Are permissible (but not required) provided that the arrangements do not
increase counterparty risk and ensure assets and positions of the counterparty
benefit from protection equivalent to that required by Articles 39 and 48 of EMIR
(RTS to be published on this)
A few conclusions
1. Entities which deal on own account in commodity derivatives
that are part of investment services or banking groups are
unlikely to be exempt under MiFID II
2. Entities who currently rely on any of the exemptions mentioned
in this discussion will need to revisit their current regulatory
analysis
3. The required regulatory analysis under MiFID II is going to
involve the analysis of the business (on a group level) against a
number of metrics and measurements – is your business
organised in a way that will allow you to do this?
4. Even if you are exempt, MiFID II and MiFIR will still impact your
business
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