by Folker Trepte, Partner, PwC’s Corporate Treasury Solutions Group, Germany
The updated rules for markets in financial instruments (MiFID II), agreed by the European Parliament and Council in January, will improve the capital markets function by increasing pre- and post-trade transparency, bringing real economic benefits.
Changes in MiFID II relating to the definition of derivatives and exemptions are most relevant to non-financial counterparties. In particular, participants in commodity derivative markets will suffer from narrowed exemptions. In addition, MiFID II introduces a position–limit regime for non-financial counterparties.
Exemptions from MiFID II
MiFID II does not apply to persons who provide investment services exclusively for their parent undertakings or for subsidiaries. Persons who provide such investment services also to external parties are prohibited from applying this exemption.
Persons who do not provide any other investment services and/or perform any other investment activities – other than dealing on own account in financial instruments that are not commodity derivatives, emission allowances or derivatives – are exempt unless they are market–makers, members or participants of a regulated market or MTF, or have direct electronic access to a trading venue, apply a high–frequency algorithmic trading technique or deal on own account when executing client orders.
When dealing on own account by executing client orders in financial instruments other than commodity derivatives, emission allowances or derivatives thereof, persons cannot benefit from other exemptions.
The directive also does not apply to persons who deal on own account in commodity derivatives, emission allowances or derivatives thereof, or persons providing investment services, other than dealing on own account, in the financial instruments mentioned above to the customers or suppliers of their main business, provided that this is an activity that is ancillary to their main business and the persons do not deal on own account when executing client orders. Executing orders from different clients by matching them on a matched principal basis (Back-to-Back) is an example of dealing on own account when executing client orders. Qualitative and quantitative criteria (e.g,. size of trading activity) for establishing when an activity is ancillary to the main business on a group level will be specified by ESMA.
Commodity derivatives in scope of MiFID II
Financial instruments encompass options, futures, swaps, forwards and any other derivative contract relating to commodities that must be settled in cash, may be settled in cash at the option of one of the parties or must be settled physically provided that they are traded on a regulated market, a multilateral trading facility (MTF) or an organised trading facility (OTF).
The definition of physically settled commodity derivatives in MiFID II carves out electricity and gas products when traded on an OTF (REMIT carve-out). ‘Energy derivative contracts’ relating to coal or oil are included, but under the conditions ‘traded on an OTF’ and ‘must be settled physically’ exempted from clearing obligations and risk mitigation requirements set out in EMIR for a period of 42 months after the entry into application of MiFID II (this might be extended by a delegated act once, by one year or two years). After this transition period (at the latest, by 1 January 2018), the Commission should assess whether the full inclusion of energy derivative contracts is beneficial and whether an amendment to existing regulations such as REMIT is appropriate.