EUA’s and CER’s Daily Futures Contracts traded on ECX are physically deliverable within two trading days - are they spot contracts or financial instruments triggering regulatory framework of MIFID?
Background in short
Section C10 of the Annex I to the MIFID Directive enumerates different classes of financial instruments. The said specification is crucial to triggering regulatory framework of MIFID Directive – obviously, when we deal also with an “investment services and activities” and conditions to qualify under exemptions provided for in Article 2(1) of the Directive are not met.
Regulatory framework of MIFID means for the CO2 broker the necessity to register as an investment firm – which, in exchange for the fulfillment of multiple, legal and organisational requirements, gives the entity the “European passport” i.e. the freedom to act in all Member States.
But there is an important question for many CO2 brokers, to what extent they can trade without triggering MIFID requirements. This question is, in principle, reduced (with the above-mentioned reservations) to determination whether a given contract relates to financial instrument or not.
Physical OTC forward
It follows from the Section C10 of the Annex I to the MIFID Directive as well as the Article 38(3)(a) of the Commission Regulation No 1287/2006 of 10 August 2006 implementing Directive 2004/39/EC of the European Parliament and of the Council as regards recordkeeping obligations for investment firms, transaction reporting, market transparency, admission of financial instruments to trading, and defined terms for the purposes of that Directive (OJ L 241, 2.9.2006, p. 1) that OTC options, futures, swaps and other derivative contracts relating to emissions allowances are regulated under MiFID if they can be settled in cash.
Depending on the detailed terms of the contract, the obligations of the parties have to be satisfied by the delivery of emission allowances or through a cash settlement process.
When carbon contract is traded via bilateral bespoke contracts (over-the-counter) and there is no possibility for cash settlement (the physical delivery only) such a OTC forward is non-financial instrument and not covered by MiFID. This conclusion leads us to the assessment that CO2 brokers not having investment firm’s legal status may engage in such contracts without violating the MIFID regulatory framework.