It is interesting that the architecture envisioned has, in its primary form, a decentralised character i.e. the respective decisions on the introduction of positions limits are to be taken at the level of the trading venue. It is to be borne in mind that pursuant to MiFID II legislative design the above developments will also be relevant for commodity derivatives as well as emission allowances and derivatives thereof. Market strategies mustn’t neglect that fact.
As a follow-up to the post 'Emission allowances position limits – transatlantic approach common in principle but methods of realisation different' it is useful to note recent MiFID II European Parliament amendments contained in the Markus Ferber (Committee on Economic and Monetary Affairs) Report 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) of 5 October 2012 (COM(2011)0656 – C7-0382/2011 – 2011/0298(COD)).
Position limits imposed at the level of the trading venues
Article 59 thereof (titled: “Position limits and checks”) provides for the rule that Member States must ensure that regulated markets, and operators of MTFs and OTFs which admit to trading or trade commodity derivatives apply limits on the amount of contracts or positions which any given market members or participants can enter into or hold over a specified period of time. This is done in order to:
- prevent market abuse;
- support orderly pricing and settlement conditions;
- promote convergence between prices in of derivatives in the delivery month and spot prices for the underlying commodity, without prejudice to price discovery in the market for the underlying commodity;
- prevent the build-up of market distorting positions.
The limits referred to above are intended to apply to both physically and cash settled contracts.
Limits must obviously be transparent and non-discriminatory, specifying the persons to whom they apply and any exemptions and taking account of the nature and composition of market participants and of the use they make of the contracts admitted to trading.
Limits will specify (if MiFID II in the proposed shape becomes binding law) clear quantitative thresholds such as the maximum net position persons can enter into or hold over a specific period of time, taking account the characteristics of the derivatives market, including liquidity, and the underlying commodity market, including patterns of production, consumption and transportation to market.
The feature of the new architecture for position limits which gains crucial importance is that the limits will not apply to positions which “in an objectively measurable way reduce risks directly related to commercial activities” (the category partially common with EMIR).
For such positions checks be carried out by the regulated markets and the operators of MTFs and OTFs in accordance with the following:
(a) members and participants of regulated markets, MTFs and OTFs must report to the respective trading venue the details of their positions in real-time, including any positions held on behalf of their clients.;
(b) regulated markets and operators of MTFs and OTFs may require information from members and participants on all relevant documentation regarding the size or purpose of a position or exposure entered into via a commodity derivative;
(c) after analysing the information received in accordance with points (a) and (b), regulated markets and operators of MTFs and OTFs may require that steps be taken by market members or participants affected, or may take steps themselves, to reduce the size of or to eliminate the position or exposure to commodity derivatives if this is necessary to ensure the integrity and orderly functioning of the markets affected;
(d) after analysing the information received in accordance with points (a) and (b), regulated markets and operators of MTFs and OTFs may, if the measures under point (c) are inadequate, limit the ability of market members or participants to enter into a commodity derivative, including by introducing additional non-discriminatory limits on positions which market members or participants can enter into over a specified period of time.
The regulated markets, MTFs and OTFs will be obliged to inform competent authorities of the information received.
Pursuant to the proposed provisions regulated markets, and operators of MTFs and OTFs which admit to trading or trade commodity derivatives may impose additional arrangements in relation to the contracts and positions for which limits are set in accordance with the above where this is necessary to ensure the integrity and orderly functioning of the markets affected.
Regulated markets, MTF and OTFs will be required to notify their competent authority of the details of the position limits or checks. It is envisioned that the competent authorities will communicate the same information to ESMA which will publish and maintain on its website a database with summaries of the position limits in force.
It is interesting that the architecture envisioned has a decentralised character i.e. the respective decisions on the introduction of positions limits are taken at the level of the trading venue.
RTS on position limits
The MiFID II proposal mentioned at the beginning provides for a role for ESMA to periodically examine the data received from trading venues and to assess whether any measures are necessary in relation to positions which in an objectively measurable way reduce risks directly related to commercial activities.
ESMA is assigned a task to draft regulatory technical standards (RTS) to determine the limits and to further specify the position check referred to above, in particular the limits on the amount of contracts or the net position which any person can enter into or hold over a specified period of time, the methods for calculating positions held by persons directly or indirectly, the modalities for applying such limits including the aggregate position across trading venues and the criteria for determining whether a position qualifies as directly reducing risks related to commercial activities.
The power to adopt RTS will be granted to the European Commission. It is noteworthy that the limits and position checks determined in RTS will take precedence over any measures imposed in that regard by national competent authorities.
Member States measures on position limits
In MiFID II competent authorities of Member States are given the powers, within the limits provided for in their national legal frameworks, “to limit the ability of any person or class of persons from entering into a commodity derivative, including by introducing non-discriminatory limits on positions or the number of such derivative contracts per underlying which any given class of persons can enter into over a specified period of time, when necessary to ensure the integrity and orderly functioning of the affected markets.”
Competent authorities mustn’t, however, impose limits which are more restrictive than those adopted in RTS except “in exceptional cases where they are objectively justified and proportionate taking into account the liquidity of the specific market and the orderly functioning of the market.” The restrictions adopted at the level of competent authorities mustn’t exceed six months from the date of its publication on the website of the relevant competent authority. Such a restriction may be renewed for further periods not exceeding six months at a time if the grounds for the restriction continue to be applicable. If the restriction is not renewed after that six-month period, it will automatically expire. When adopting more restrictive limits than those adopted in RTS competent authorities must notify ESMA.
A few reflections
The European MiFID II design for emission allowances position limits has been crafted in my opinion in far more flexible form than, for instance, the recent California legislative developments as regards carbon market infrastructure. Instead of imposing in the legislative text rigid and prescriptive ex ante position limits thresholds, the system has been built in the comprehensive (encompassing not only emission allowances, but also other commodity derivatives as well as the financial instruments), multi-level (trading venues, RTS, Member Sates authorities) form, allowing for greater elasticity in reacting to unexpected market events and developments. In balance, for market participants it means also greater uncertainty in building up their market strategies.