On Monday the European Securities and Markets Authority (ESMA) published opinions on the Regulatory Technical Standards for position limits (RTS 21) and non-equity transparency (RTS 20) under MiFID II, in response to the Commission’s request to ESMA in April to modify the draft RTS issued in September 2015.
This article will detail the updates on the position limits and the implications for the industry. Setting position limits is a delicate balancing act, as the Commission wanted to allow competent authorities significant leeway while maintaining a uniform regime across the EU based on objective criteria.
In response to concerns over the impact of speculation on food prices, ESMA analysed the price volatility of contracts underlying agricultural commodities. In finding a lack of firm evidence that agricultural contracts differ substantially in volatility from other contract types, ESMA has not adjusted the baseline limit but instead has devised a system that enables competent authorities to set a lower limit of 2.5% for ‘any derivative contract with an underlying that qualifies as food intended for human consumption’ when considering their higher liquidity and volatility. Ultimately the decision will be down to the authority in setting these lower limits, but the option is now theirs.
In response to the Commission’s request for greater flexibility in the setting of position limits for highly illiquid contracts, ESMA has created a new asset class of ‘relatively illiquid contracts’ which extend the maximum limit from 35% to 50% for both spot and other months.
There was considerable criticism in the RTS use of open interest to set the limits for other months, as this can often drastically diverge from the actual deliverable supply of contracts (currently only used to set the limits in the spot month). Meeting this criticism halfway, the commission requested adjusting the limit in other months when this situation occurs. ESMA has subsequently added two paragraphs to the RTS stating where deliverable supply and open interest diverge significantly, the other months limit should be adjusted.
The definition of Economically Equivalent OTC contracts will be slightly widened to prevent the use of OTC trading to circumvent position limits requirements on venue. The re-write includes the provision that an OTC-only contract should be deemed economically equivalent to one traded on a trading venue “regardless of small differences in the contractual specifications concerning the lot sizes and dates of delivery”. This is likely to encompass more OTC energy derivative contracts in the position limits regime.
This very much marks the final standards laid down with regards to the MiFID II position limits regime. Given its extensive scope and deep implications, it has inevitably been under considerable tension since it was first proposed back in 2014. Perhaps this will mark a resting point for the regulators, having fought through the battle to maintain the original objectives of the regime to prevent speculation and market manipulation.
As with many other MiFID II requirements, firms will be needing to build the systems now in preparation for the January 2018 implementation. With technical complexities such as group level aggregation, it is imperative that the controls are up to scratch to monitor real time trading across the corporate group. Only a few months ago the CFTC fined a large firm for breaching position limits, so it’s fair to bet the regulators are taking this seriously.
RegTech, with its ability to monitor in real time and streamline compliance processes, has huge potential to alleviate this problem. Similar to a number of MiFID II requirements obligating real time monitoring of trades, Big Data solutions are already out in the market which can analyse and organise wide pools of unstructured data in order to help a firm meet their obligations. We have discussed the RegTech marketplace extensively, and the conditions for the industry to mainstream these solutions. You can stay up to date with our commentary on RegTech here.