The opinion of the ITRE Committee highlights the fact that physically settled forward products in MiFID II EC proposal are classified as financial instruments. The essence of the recent ITRE proposal is, however, to explicitly exclude products that can be physically settled and that are entered into for commercial purposes and do not display the characteristics of other derivative financial instruments.
If somebody hadn’t a sufficiently clear picture of legal situation of the commodity trading firms after proposal for MiFID II , the draft opinion of the rapporteur Holger Krahmer for the Committee on Industry, Research and Energy for the Committee on Economic and Monetary Affairs on the proposal for a directive of the European Parliament and of the Council on markets in financial instruments repealing Directive 2004/39/EC of the European Parliament and of the Council (recast) (COM(2011)0656 – C7-0382/2011 – 2011/0298(COD)) would shed some light on the issue.
Generally, the opinion of the ITRE Committee represents a substantial support for all, who believed that non-financial firms like commodities industries should, due to their nature, not be fully covered by the MiFID.
Furthermore, those, who, after having read the MiFID II proposals, regarded the manner, in which the exemptions are formulated, misleading or not clear enough, shouldn’t be confused, since the rapporteur for the ITRE Committee acknowledged exactly the same.
As ITRE underlined, if, under MiFID, non-financial firms are considered financial firms, they have to fulfil costly obligations of several financial regulations. For example they become subject to the clearing obligation of all their standardised 'over-the-counter' derivate transactions as defined under the European Market Infrastructure Regulation (EMIR) or might be required to hold a capital buffer under the Capital Requirements Directive (CRD) after 2014.
If non-financial firms are considered financial firms under MiFID, they become subject to the clearing obligation of all their standardised 'over-the-counter' derivate transactions as defined under EMIR.
Physically settled forward products in MiFID II proposal are classified as financial instruments. However, these forwards are crucial for risk management of commercial firms and are fundamentally different from speculative financial instruments - they do not involve any financial (cash) settlement and the underlying physical commodity will actually be delivered on schedule. Consequently physically settled forwards do not pose any risk to financial markets. The consequences of physical forward products being considered financial instruments include several implications under MiFID, EMIR and the Market Abuse Regulation (MAR).
According to the draft opinion the consequences for considering these products as financial instruments are not proportionate for non-financial firms and include negative implications regarding:
- reduced possibility to use the ancillary activity exemption mentioned in Article 2(1)(i) of MiFID;
- Market Abuse Regulation compliance;
- increased probability for non-financial firms to hold positions beyond the clearing threshold under EMIR and become subject to the clearing obligation;
- physical forward contracts would become subject to position limits.
As the opinion observes, the current MiFID II proposal reduces the ability of firms to take advantage of the ancillary activity exemption (Article 2(1)(i)) as the majority of their trading is in physical forward contracts. Also physically settled forwards could then be subject to position limits outlined in Article 59. Under EMIR, the classification of physically settled forwards as financial instrument would increase the probability for non-financial firms to hold positions beyond the so-called clearing threshold which would make them subject to the clearing obligation. Moreover, limiting firms’ positions in the derivative market will constrain their ability to efficiently manage risks or access emission allowance markets which will ultimately increase costs and the overall risk level in their sector. It may also force them to seek hedging opportunities in other less liquid and riskier markets, pushing up risk management costs and ultimately prices to consumers.
The support for ITRE Committee proposals is found in the respective draft law in the United States (i.e. Dodd-Frank-Act), which uses another definition of financial instruments and also excludes physically-settled derivatives expressively.
ITRE underlines, moreover, the fact that physically settled forwards in the energy sector are already covered by the Regulation on wholesale energy market integrity and transparency (REMIT).
In effect, the firms active in the said markets and trades are still facing significant uncertainty when it comes to the regulatory framework. More clarity on the issue will be available, when the institutions come to an agreement in this respect.