RegTech Intelligence 
A brief exchange of correspondence between regulators over the last fortnight has brought aspects of MiFID II’s regulatory technical standards back into question.
On 14 March, a letter from the European Commission to the European Securities and Markets Authority (ESMA), seen by Reuters, requested that the technical standards on position limits be rewritten, with the reason that those submitted last September were not tough enough.
ESMA wrote back swiftly, notifying the Commission that the formal deadline for requesting amendments to the RTS ended in December, but allowing this as an exceptional case. They subsequently stated they will immediately start work on an opinion on the proposed amendments.
This has not been the only source of commotion in the position limits area. It was less than one month ago when a report chaired by a CFTC commissioner called the very existence of position limits into question. While the report was withdrawn swiftly following backlash, it has certainly served as a reminder of how much of a heated debate remains around position limits.
So why are position limits so contentious? What is MiFID II attempting to do? And what can we imply from the Commission’s request for a rewrite? To answer these questions, it may be useful to travel back to the start.
What are position limits?
Following the financial crisis of 2008/9, which also saw commodity prices skyrocket, there was a keen drive from the regulators to restrict the number of contracts any one entity could hold in a given commodity. These position limits would seek to stifle excessive speculation in the commodities markets, while reducing liquidity issues and preventing market manipulation.
First up to tackle the issue was the US position limits regime. Revamped by the Commodities Futures and Trading Commission in 2013, the new rules set a baseline limit of 25% of deliverable supply for spot months (the month in which the commodity derivative is to be delivered) and, for non-spot months, it would be 10% of open interest for the first 25,000 contracts in that given commodity, followed by 2.5% of open interest thereafter.
The position limits regime introduced by MiFID II, however, is a different game completely. Its scope goes far beyond the CFTC position limits regime, which applied to 9 agricultural contracts (soon to be expanding to 28 physical commodity contracts), by encompassing contracts trading on all MiFID regulated exchanges as well as OTC contracts that are ‘economically equivalent’ to these.
For MiFID II, the rules aim to provide National Competent Authorities (NCAs) with a significant amount of flexibility in setting the limits, based on the underlying nature of the given commodity. While the base limit of 25% of deliverable supply for spot months has been set, ESMA’s RTS allowed NCAs to deviate 10-20% from these limits so the total range decided for each commodity can be from 5-35%. But the recent letter from the Commission has called these back into question.
The issue is that position limits have been one of the most heavily attacked areas of post-crisis regulation. The main line of criticism follows that position limits will restrain liquidity in the commodity markets but, when critics on the other side argue that large positions increase speculation, the regulators have a hot topic on their hands.
A limited position
It is well known now that setting position limits is one of the most complex tasks a regulator may be required to do. Speaking at IDX 2015 on MiFID’s ambitious attempt to go further and deeper than any regime has gone before, Verena Ross of ESMA referred to her task as the snake in the tunnel approach – allowing enough flexibility for the NCAs to set their own limits, but keeping these within constraints (the tunnel) so that limits are set consistently.
What the Commission are looking for in the revised technical standards is more flexibility within this – not just in setting lower limits for highly liquid, volatile instruments but also higher limits for less liquid instruments.
There will likely be much pain around the position limits area for considerable time to come, while ESMA will also need to come up with well-articulated definitions of terms such as ‘economically equivalent’ and ‘deliverable supply’. With any luck, ESMA’s recent establishment of a Commodity Derivatives Task Force should help to provide accurate and detailed support to the determination and monitoring of position limits in the future, given that their responsibilities lie in gathering accurate market data and analysing developments in the commodity markets to oversee financial stability.
However the limits are decided, it will no doubt be a battleground until the rules are certain. Even then, concern has been expressed about how the netting of long and short positions, and the aggregating of positions across group entities, will work in practice. ESMA have stated that they will act quickly on this, so we should have an answer soon, alongside some clearer guidelines when the implementing standards are released.