29 January 2020
- are traded on an OTF, and
MiFID II refers to C6 energy derivatives contracts in transitional provision of Article 95.
Specification for C6 energy derivatives' underlying
What exactly is hidden under this new nomenclature is specified in the MiFID II delegated acts.
ESMA's Technical Advice to the Commission on MiFID II and MiFIR of 19 December 2014, ESMA /2014/1569 (p. 408) proposed to define the scope in the following manner:
- C 6 energy derivative contracts relating to oil are to be understood as contracts having mineral oil, of any description and petroleum gases, whether in liquid or vapour form, including products, components and derivatives of oil and oil transport fuels, including those with bio-fuel additives, as an underlying.
- C 6 energy derivative contracts relating to coal are to be understood as contracts with coal, defined as a black or dark-brown combustible mineral substance consisting of carbonised vegetable matter, used as a fuel, as an underlying.
Considering the issue whether only different grades of crude oil should qualify as C6 energy derivatives contracts or whether also other contracts where the underlying is derived from crude oil (i.e. contracts related to refined oil products) should be within the scope of the exemption, ESMA in the above-mentioned Technical Advice of 19 December 2014 (p. 400, 401) tends to a wide definition of oil (i.e. to the latter option).
Moreover, ESMA considers that pure biofuel could not be classified as oil, however adding biofuel as a mandated minority component to gasoline or diesel should not prevent such gasoline or diesel to be caught by the wider definition of oil.
The aforementioned ESMA's propositions have been broadly transferred into 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 - see Article 6 and Recital 4 (see box below).
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
Energy derivative contracts relating to oil and coal and wholesale energy products
(Article 4(1)(2) of Directive 2014/65/EU)
1. For the purposes of Section C(6) of Annex I to Directive 2014/65/EU, energy derivative contracts relating to oil shall be contracts with mineral oil, of any description and petroleum gases, whether in liquid or vapour form, including products, components and derivatives of oil and oil transport fuels, including those with biofuel additives, as an underlying.
2. For the purposes of Section C(6) of Annex I to Directive 2014/65/EU, energy derivative contracts relating to coal shall be contracts with coal, defined as a black or dark-brown combustible mineral substance consisting of carbonised vegetable matter, used as a fuel, as an underlying.
3. For the purposes of Section C(6) of Annex I to Directive 2014/65/EU derivative contracts that have the characteristics of wholesale energy products as defined in Article 2(4) of Regulation (EU) 1227/2011 of the European Parliament and Council shall be derivatives with electricity or natural gas as an underlying, in accordance with points (b) and (d) of Article 2(4) of that Regulation.
[...] It is important to also clarify how oil and coal energy derivatives should be understood for the purposes of Section C6 of Annex I to Directive 2014/65/EU. In this context, contracts related to oil shale should not be understood to be coal energy derivatives.
Contracts that must be physically settled
In order to be covered by the exemption at issue contracts must be physically settled.
Regulatory framework for C6 energy derivatives contracts
The increased significance of 'C6 energy derivatives contracts' under MiFID 2 is involved with the fact that MiFID II brings commodity derivatives that can be physically settled that are traded on an OTF within the scope of financial instruments.
Commodity derivatives that can be physically settled were already within the scope of MiFID if they had been traded on regulated markets or MTFs, hence an OTF has been only added to the above MiFID-relevant set of trading venues.
Article 95 MiFID II
1. Until 3 January 2021:
(a) the clearing obligation set out in Article 4 of Regulation (EU) No 648/2012 and the risk mitigation techniques set out in Article 11(3) thereof shall not apply to C6 energy derivative contracts entered into by non-financial counterparties that meet the conditions in Article 10(1) of Regulation (EU) No 648/2012 or by non-financial counterparties that shall be authorised for the first time as investment firms as from 3 January 2018; and
(b) such C6 energy derivative contracts shall not be considered to be OTC derivative contracts for the purposes of the clearing threshold set out in Article 10 of Regulation (EU) No 648/2012. C6 energy derivative contracts benefiting from the transitional regime set out in the first subparagraph shall be subject to all other requirements laid down in Regulation (EU) No 648/2012.
2. The exemption referred to in paragraph 1 shall be granted by the relevant competent authority. The competent authority shall notify ESMA of the C6 energy derivative contracts which have been granted an exemption in accordance with paragraph 1 and ESMA shall publish on its website a list of those C6 energy derivative contracts.
Given the potentially severe effects of above fundamental change in commodity derivatives treatment, transitional provision has been considered appropriate under which competent authorities will be able to exempt from the Regulation No 648/2012 (EMIR) to some extent non-financial counterparties' oil and coal derivatives which are traded on an OTF and must be physically settled (i.e C6 energy derivatives contracts).
For a transitional period of 3.5 years after the entry into application of the said Directive (till 3 July 2021):
(a) the clearing obligation set out in Article 4 of EMIR and the collateralisation requirement as an element of EMIR risk mitigation techniques will not apply to C6 energy derivative contracts entered into:
- by non-financial counterparties below the EMIR clearing threshold, or
- by non-financial counterparties that will be authorised for the first time as investment firms as from the date of entry into application of the Directive; and
(b) such C6 energy derivative contracts will not be considered OTC derivative contracts for the purposes of the EMIR clearing threshold.
As regards timelines the initially envisioned deadline for the said exemption was 3 July 2020, but it has been replaced with 3 January 2021 (Article 1(4) of the Proposal for a Directive of the European Parliament of the Council amending Directive 2014/65/EU on markets in financial instruments as regards certain dates, 10.2.2016, COM(2016) 56 final, 2016/0033 (COD) and Article 1(9) of the Directive (EU) 2016/1034 of the European Parliament and of the Council of 23 June 2016 amending Directive 2014/65/EU on markets in financial instruments).
MiFIR recitals require the technical standards specifying the clearing obligation developed in accordance with EMIR should take the said exemption into account and refrain from imposing a clearing obligation on derivative contracts, which would subsequently be subject to the transitional exemption for C6 energy derivative contracts.
In spite of the above easements, C6 energy derivatives contracts still remain categorised financial instruments with consequences, this fact entails (being subject to other MiFID II provisions, position limits including). This feature clearly distinguishes the said category from the REMIT carve-out, where contracts covered are excluded from the very financial instruments' definition in Annex I to the MiFID II Directive.
The above exemption is dependent on the relevant competent authority decision.
The competent authority has to notify ESMA of the C6 energy derivative contracts which have been granted an exemption in accordance with the above provisions and ESMA is required to publish on its website a list of those C6 energy derivative contracts.
However, as follows from the ESMA's Report: MIFID II: C6 energy derivative contracts and the EMIR requirements (ESMA70-151-290, 7 January 2020, p. 7) as of January 2020 ESMA has not received any notification under Article 95 of MiFID, and “is thus not aware of any entity benefiting from the exemption provided for these products”.
Pursuant to Article 90(4) MIFID II, at the latest by 1 January 2019 the European Commission is required to prepare a report assessing the potential impact on energy prices and on the functioning of the energy market as well as the feasibility and the benefits in terms of reducing counterparty and systemic risks and the direct costs of C6 energy derivative contracts being made subject to the following EMIR provisions:
- the clearing obligation (Article 4), and
- the risk mitigation techniques (Article 11(3)), and
- inclusion in calculating the clearing threshold (Article 10).
Requirements not covered by transitional regime
C6 energy derivative contracts benefiting from transitional regime will be subject to all other applicable EMIR requirements, i.e. EMIR reporting regime, as well as all, other than collateralisation, risk mitigation techniques, including, in particular:
If the Commission considers that it would not be feasible and beneficial to include these contracts, it will submit, if appropriate, a legislative proposal to the European Parliament and the Council.
The Commission will, moreover, be empowered to adopt delegated acts to extend the transitional period.
ESMA's input to the said report has been published on 7 January 2020: Report, MIFID II: C6 energy derivative contracts and the EMIR requirements, ESMA70-151-290.
Referring to the fact that currently, the clearing obligation is limited to two asset classes of OTC derivatives subject to the clearing obligation:
a. interest rates OTC derivatives, and
b. credit OTC derivatives,
ESMA observes in the said report that making C6 derivative contracts subject to EMIR requirements would not have an immediate impact on the clearing obligation as commodity derivatives are not currently subject to the clearing obligation.
Moreover, “in view of the relative size, structure and use of the C6 energy derivatives, C6 energy derivative classes would appear to be a of much lesser priority for the clearing obligation than other classes from other asset classes, for which ESMA did not at this stage mandate clearing”.
Questions and Answers on MiFID II and MiFIR commodity derivatives topics, 19 December 2016, ESMA/2016/1673
Ancillary activity [Last update: 19/12/2016]
Question 2 [Last update: 19/12/2016]
Does trading activity in C6 contracts which takes place on OTFs after 3 January 2018 need to be counted towards the ancillary thresholds prior to that date?
We differentiate between wholesale energy products categorised as C6 within the REMIT scope (derivatives with electricity and natural gas as underlying traded on an OTF that must be physically settled), C6 energy derivatives contracts (those with coal or oil as underlying traded on an OTF that must be physically settled) and the rest of C6 instruments.
Financial instruments under MiFID I which will also be financial instruments within C6 under MiFID II should count towards the trading activity and assessed against the ancillary thresholds.
C6 with coal or oil as underlying and the rest of C6 instruments count throughout the calculation period to determine market size, as OTC instruments until January 3, 2018 and as OTF on-venue instruments after that. For C6 instruments with coal or oil as underlying traded on OTFs this assessment is based on them only being exempted from certain EMIR obligations for a transitional period while they are being classified as financial instruments throughout the period. The same applies to the computation of positions by non-financial corporates.
C6 energy derivatives contracts - regulatory chronicle
29 January 2020
MiFID II, Article 95
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, Article 6, Recital 4