Commodity derivative trading is just one of the many topic areas under MiFID II that firms need to ensure they are prepared for before 3 January 2018. One set of measurements in this area is that firms will be required to report commodities positions to National Competent Authorities (NCAs) on a daily basis. Another is that ESMA’s methodology in calculating position limits needs to be followed. This article aims to discuss position reporting and position limits in more detail and briefly look at the updated Q&A published by ESMA on commodity derivatives topics.
MiFID II imposes many key changes that aim to reduce speculative activity and systemic risk in the commodity derivatives market through new position limits and reporting requirements as well as allowing ESMA more powers to intervene. The various instruments that needs to be reported include:
- Energy derivatives, metal derivatives, agricultural derivatives and other food derivatives
- Intangible derivatives e.g. climate derivatives
- Flow-based delivery derivatives e.g. electricity and gas
- Both cash-settled and physically-settled derivatives
- Derivatives for any of the other instruments covered e.g. baskets, indexes, swaps.
A weekly report should be made public detailing the aggregate positions held by the different categories of position holders (e.g. investment firms or credit institutions, investment funds) for the different contracts traded on that trading venue. The report should specify the number of long and short positions by such categories, any changes since the previous report, percentage of the total open interest represented by each category and the number of position holders in each category – this obligation only applies when both the number of position holders and their open positions exceed minimum thresholds. Another requirement is to provide a breakdown of positions held by all position holders including members or participants and the clients on that trading venue on at least a daily basis.
The MiFID II commodities reporting obligation primarily affects MiFID investment firms trading commodity derivatives off-exchange. This is reiterated in the latest Q&A published by ESMA. However, as it is a directive, the scope may increase to cover more firms under local transposition in Member States.
Investment firms trading in commodity derivatives on regulated markets, MTFs and OTFs must, on at least a daily basis, provide details of their positions held through contracts traded on the relevant trading venue as well as those of their clients and the clients of those clients until the end client is reached.
Investment firms trading in commodity derivatives and economically equivalent OTC contracts outside a venue must, again on at least a daily basis, provide a complete breakdown of their positions held through contracts traded on that trading venue as well as those of their clients until the end client is reached. Where a commodity derivative is traded on multiple venues, the report must be made to the NCA of the venue that has the largest volume in that contract.
ESMA’s latest Q&A on commodity derivatives topics provides clarification to several areas within position reporting. One of the clarifications provided is that the public weekly aggregate position reports does not apply to securitised derivatives mainly because it would “send out a confusing picture to investors”, which defeats the main aim of providing a more wider transparency. Another is that trading venues and investment firms need to report their positions to their respective NCA by 22:00 CET on T+1.
NCAs for each Member State are responsible for setting a limit on the size of the net position that a person can hold in each commodity derivative contract traded on a trading venue as well as economically equivalent OTC contracts. This applies to all positions held by or on behalf of a person on an aggregate group level. Position limits do not apply to positions held by or on behalf of a non-financial entity.
National regulators will need to follow ESMA’s methodology in setting these limits. Position limits will be set for the spot month and all other months and will apply to both cash settled and physically settled commodity derivatives. The methodology for calculation should take into account at least the following factors:
- Maturity of the commodity derivative contracts
- Deliverable supply in the underlying commodity
- Overall open interest
- Volatility of the relevant markets
- Number and size of the market participants
- Characteristics of the underlying commodity market including patterns of production, consumption and transportation to market
- Development of new contracts.
It is the NCA’s responsibility to review position limits if there is a significant change in deliverable supply or open interest or any other significant change on the market. Member States need to ensure that an investment firm or a market operator operating a trading venue that trades commodity derivatives applies position management controls. Details of position management controls should be informed to both the NCA and ESMA. In addition, details of position limits established should also be given to ESMA.
It is important that firms have clear and efficient processes in place to ensure they are MiFID II compliant and this article gives an overview of the obligations firms need to follow regarding position limits and position reporting by the beginning of next year.
MiFID II related documents have grown since 2014 – we have tracked and uploaded over 150 documents in one of our RegDelta libraries mostly from EU and UK issuing bodies. We regularly discuss these latest documents and the areas under MiFID II in more detail in our MIG meetings. Our next MIG meetings are on:
- 20 July 2017 – MIG 92: Research guidance meeting 2
- 25 July 2017 – MIG 93: Record keeping guidance note meeting 2
If you wish to find out more about MIG, please contact email@example.com. You can also keep up to date with MiFID II related news on our LinkedIn Group or follow us on Twitter and subscribe to our newsletter alerts.