Crafting the EU position limits legal framework seems to require an immense creativity along with an extreme caution on the part of European legislators.
Dealing with this unprecedented task reveals problems so far unknown, nevertheless of an utmost practical importance.
Who would care for the issue whether OTC derivative is considered economically equivalent to a commodity derivative traded on a trading venue where it has identical contractual specifications, terms and conditions with the exception of delivery date diverging by less than one calendar day, if the position limits were not in place?
But there are already some people who care for such abstract ideas and the Paris-based European Securities and Markets Authority (ESMA) belongs thereto in the first place.
The whole issue is involved with the determination of the scope of an allowable netting when establishing the persons' position under MiFID II.
ESMA's Opinion (Annex), Amended draft Regulatory Technical Standards on the methodology for the calculation and the application of position limits for commodity derivatives traded on trading venues and economically equivalent OTC contracts, 2 May 2016, ESMA/2016/668
(Article 57(1) of Directive 2014/65/EU)
OTC contracts economically equivalent to commodity derivatives traded on trading venues
An OTC derivative shall be considered economically equivalent to a commodity derivative traded on a trading venue where it has identical contractual specifications, terms and conditions, excluding different lot size specifications, delivery dates diverging by less than one calendar day and different post trade risk management arrangements.
The EU legislature seems to be hesitant, since if the definition of an economically-equivalent OTC contract (EEOTC), and consequently - the netting possibilities - are broad, it will potentially enable circumvention of position limits by offsetting positions taken in on-venue contracts against only roughly similar OTC positions (the overall person's position would be in effect smaller).
Crafting the EEOTC's definition restrictively is also sub-optimal since it may allow contracts that are similar to on-venue contracts not to be considered when establishing the net position of a specific market participant and thus allow circumvention of the position limit regime's purpose by spreading positions across exchange-traded and OTC contracts.
Considering the above circumstances, ESMA in the Opinion of 2 May 2016 (ESMA/2016/668) has modified its earlier stance and covered additional possibilities where the contractual specifications might not be identical but still qualify as EEOTC.
These allowable exclusions are:
- different lot size specifications,
- delivery dates diverging by less than one calendar day, and
- different post trade risk management arrangements.
Different delivery locations will prevent contracts to be considered equivalent since, according to ESMA, such contracts have different economic characteristics.
"If, however, minor differences in delivery arrangements or other contract parameters are in future used with the apparent intent of circumventing the regime, ESMA may propose further amendments to the definition," the EU financial regulator said.
Undoubtedly, the fundamentals for the position limits framework will be subject to the hottest debate soon.