FX spot contract

Instruments for which the classification as derivatives is not uniform across the EU 


FX derivatives

Differences arise, in particular for FX forwards, depending on the settlement or delivery date, i.e. the frontier between an FX spot and an FX derivative. From the analysis carried out by ESMA, it is not controversial that contracts that settle within two trading days are considered spot contracts and that contracts that settle after seven trading days are FX forwards. In certain countries the contracts that settle up to 7 days are not deemed to be derivatives. Therefore, for contracts with a settlement date between 3 and 7 trading days there are different national laws, in some Member States, determining whether they are or not a derivative. For these FX forwards there is not a common definition and, therefore, they are not clearly identified as derivatives across the Union.

Other differences arise because of the commercial nature of the transaction. Currency derivatives are mentioned in point (4) of Section C of Annex I to MIFID. Such a definition does not contain any reference on whether the currency derivatives are concluded for commercial purposes. The only reference to commercial purposes in the MiFID definitions is included in point (7) of Section C of Annex I to MIFID, which deals with commodities derivatives.

The European Commission issued a Q&A specifying the scope of MiFID provisions for the provision of investment services, stating that "Even if FX forwards are qualified as a financial instrument in section C of Annex I to MiFID, their intermediation will be subject to MiFID requirements only in the case there is an investment service or activity performed in the sense of MiFID. In this respect, Annex I section B(4) of MiFID lists "foreign exchange services where connected to the provision of investment services" as an ancillary service, not as an investment service. Thus, FX forward transactions not connected to the provision of an investment service, i.e. commercial FX forward transactions, are not covered by MiFID. The qualification of FX forwards as a financial instrument is not important if there is no investment service or activity performed in the sense of MiFID."

Some Member States have therefore transposed MiFID by not considering as financial instruments FX forward transactions concluded for commercial purposes. These contracts are, therefore, not clearly identified as derivatives across the Union.

It should be noted that when ESMA developed the technical standards for the definition of the clearing threshold for non-financial counterparties, it considered the basic definition of MiFID, i.e. a potentially wide scope for the definition of FX derivatives. At that time National Competent Authorities and stakeholders did not raise issues of different definitions of FX derivatives among Member States and possible carve outs by some Member States of FX derivatives concluded for commercial purposes.

In addition, it should be noted that derivatives concluded for hedging purposes are already excluded from the calculation of the clearing threshold and specific criteria need to be met by transactions concluded by non-financial counterparties to qualify as hedging transactions (as defined in technical standards developed by ESMA). The concept of commercial purposes might potentially be broader than the hedging one.

ESMA letter to the European Commission of 14 February 2014, Annex I

Commission Delegated Regulation (EU) 2017/565 of 25 April 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council as regards organisational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive

Recitals 8 - 13

(8) In order to ensure the uniform application of Directive 2014/65/EU, it is necessary to clarify the definitions laid down in Section C(4) of Annex I of Directive 2014/65/EU for other derivative contracts relating to currencies and to clarify that spot contracts relating to currencies are not other derivative instruments for the purposes of Section C(4) of Annex I to Directive 2014/65/EU.

(9) The settlement period for a spot contract is generally accepted in most main currencies as taking place within 2 days or less, but where this is not market practice it is necessary to make provision to allow settlement to take place in accordance with normal market practice. In such cases, physical settlement does not require the use of paper money and can include electronic settlement.

(10) Foreign exchange contracts may also be used for the purpose of effecting payment and those contracts should not be considered financial instruments provided they are not traded on a trading venue. Therefore it is appropriate to consider as spot contracts those foreign exchange contracts that are used to effect payment for financial instruments where the settlement period for those contracts is more than 2 trading days and less than 5 trading days. It is also appropriate to consider as means of payments those foreign exchange contracts that are entered into for the purpose of achieving certainty about the level of payments for goods, services and real investment. This will result in excluding from the definition of financial instruments foreign exchange contracts entered into by non-financial firms receiving payments in foreign currency for exports of identifiable goods and services and non-financial firms making payments in foreign currency to import specific goods and services.

(11) Payment netting is essential to the effective and efficient operation of currency settlement systems and therefore the classification of a foreign currency contract as a spot transaction should not require that each foreign currency spot contract is settled independently.

(12) Non deliverable forwards are contracts for the difference between an exchange rate agreed before and the actual spot rate at maturity and therefore should not be considered to be spot contracts, regardless of their settlement period.

(13) A contract for the exchange of one currency against another currency should be understood as relating to a direct and unconditional exchange of those currencies. In the case of a contract with multiple exchanges, each exchange should be considered separately. However an option or a swap on a currency should not be considered a contract for the sale or exchange of a currency and therefore could not constitute either a spot contract or means of payment regardless of the duration of the swap or option and regardless of whether it is traded on a trading venue or not.

Article 10

Characteristics of other derivative contracts relating to currencies

1. For the purposes of Section C (4) of Annex I to Directive 2014/65/EC, other derivative contracts relating to a currency shall not be a financial instrument where the contract is one of the following:

(a) a spot contract within the meaning of paragraph 2 of this Article,

(b) a means of payment that:

(i) must be settled physically otherwise than by reason of a default or other termination event;

(ii) is entered into by at least a person which is not a financial counterparty within the meaning of Article 2(8) of Regulation (EU) No. 648/2012 of the European Parliament and of the Council;

(iii) is entered into in order to facilitate payment for identifiable goods, services or direct investment; and

(iv) is not traded on a trading venue.

2. A spot contract for the purposes of paragraph 1 shall be a contract for the exchange of one currency against another currency, under the terms of which delivery is scheduled to be made within the longer of the following periods:

(a) 2 trading days in respect of any pair of the major currencies set out in paragraph 3;

(b) for any pair of currencies where at least one currency is not a major currency, the longer of 2 trading days or the period generally accepted in the market for that currency pair as the standard delivery period;

(c) where the contract for the exchange of those currencies is used for the main purpose of the sale or purchase of a transferable security or a unit in a collective investment undertaking, the period generally accepted in the market for the settlement of that transferable security or a unit in a collective investment undertaking as the standard delivery period or 5 trading days, whichever is shorter.

A contract shall not be considered a spot contract where, irrespective of its explicit terms, there is an understanding between the parties to the contract that delivery of the currency is to be postponed and not to be performed within the period set out in the first subparagraph.

3. The major currencies for the purposes of paragraph 2 shall only include the US dollar, Euro, Japanese yen, Pound sterling, Australian dollar, Swiss franc, Canadian dollar, Hong Kong dollar, Swedish krona, New Zealand dollar, Singapore dollar, Norwegian krone, Mexican peso, Croatian kuna, Bulgarian lev, Czech koruna, Danish krone, Hungarian forint, Polish złoty and Romanian leu.

4. For the purposes of paragraph 2, a trading day shall mean any day of normal trading in the jurisdiction of both the currencies that are exchanged pursuant to the contract for the exchange of those currencies and in the jurisdiction of a third currency where any of the following conditions are met:

(a) the exchange of those currencies involves converting them through that third currency for the purposes of liquidity;

(b) the standard delivery period for the exchange of those currencies references the jurisdiction of that third currency.