On 19 December 2016, ESMA published its Q&A paper on the topic of commodity derivatives within MiFID II and MiFIR. The document focuses on the promotion of supervisory approaches and practices for the application of position limits, position reporting and ancillary activity provisions. It also provides clarity on the technicalities of the policy and the practical application of the MiFID II requirements. Here, we will cover the main points under each section – please refer to the publication for a full breakdown of all that was discussed.
(i) Position limits
This framework should, in theory, make it possible to specify quantitative thresholds for the maximum size of a position in a commodity derivative that an entity can hold. For the purpose of the regime, ‘position’ is defined as the net accumulation of buy and sell transactions in a particular commodity derivative, at a specific point in time that has yet to be closed out, expired or exercised, as appropriate to the instrument concerned.
ESMA has previously noted there to be “no universally adopted and harmonised set of product codes for identifying commodity derivatives”. Broad categorisation for assets classes that fall within the scope include metals, oil and oil products, coal, gas, power, agricultural products, freight, climatic variables, inflation rates and economic statistics. As a result, definition of these financial instrument contracts is, by nature, complex.
In derivatives markets, there is no concept of a standardised lot for underlying assets in electricity, natural gas (gas) or liquefied natural gas (LNG). ESMA has tried to resolve this by outlining a suitable approach for defining the lot of power, gas and LNG energies by their delivery period, unit of registration, product type (base and peak loads) and nominal multiplier parameters. Reference is also made to RTS 21 of the EC’s supplementing Directive for the application of position limits to commodity derivatives. According to Article 9, where a lot is not defined for energy contracts, it should be taken as the minimum quantity tradable, calculated as the nominal parameters multiplied by the minimum number of contracts to be included in a trade.
The other main topic under position limits is the discussion of securitised derivatives; whether they fall within the definition of commodity derivatives under MiFID II, and how ESMA differentiates between these products and exchange traded commodities (ETCs).
Securitised derivatives are generally understood to be transferable securities whose value is based upon the underlying assets. However, neither MiFID I nor MiFID II/MiFIR contain a specific definition of these instruments. ESMA goes on to explain that, where a securitised derivative has underlying assets of one or more commodities, these instruments are classified under ‘transferable securities’ in Article 4(1)(44)(c) of MiFID II and, thus, within Article 2(1)(30) of MiFIR are categorised as commodity derivatives.
In contrast to this, the document stresses ETCs as debt instruments within the scope of Article 4(1)(44)(b) of MiFID II and, therefore, as lying outside the definition of commodity derivatives in Article 2(1)(30) of MiFIR, and accordingly negates the position limits regime from applying to them. ESMA defines exchange traded commodities as typically holding a specific set of features and, in comparison, uses the term ‘securitised derivatives’ to describe a set of financial instruments with a much wider scope of defining variables that do not necessarily distinguish ETCs.
(ii) Ancillary activity
ESMA defines that the exemption for trading in commodity derivatives, under Article 2(1)(j), is only applicable when the main business of the group is considered, on an overall basis, not to be the provision of investment services. Accordingly, all entities not considered as non-financial within the group are required to obtain authorisation, under MiFID II, as an investment firm, to trade commodity derivatives.
Differentiation is also made between wholesale energy products, energy derivatives contracts and other instruments that must be physically settled within C6 classification. The document confirms that financial instruments under MiFID I, and C6 of MiFID II, shall count towards the trading activity of a firm and be assessed against the relevant ancillary activity thresholds.
This publication outlines, amongst the technicalities, the complexity involved in the classification of financial instruments, and the confusion that can arise from this. ESMA have pledged a continuation of this Q&A, and will develop the paper by both adding questions and answers to the topics already covered and by introducing new sections that have not yet been addressed, including the position reporting regime. Additions can be expected in the coming months as EU Member States move closer to the 3 January 2018 implementation deadline.