Article 2(1)(d) of MiFID II exempts persons dealing on own account in financial instruments from the requirement to be authorised as a MiFID investment firm.

         
          
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25 November 2021


Proposal for a Directive of the European Parliament and of the Council amending Directive 2014/65/EU on markets in financial instruments (COM(2021) 726 final) - Article 1(2) removes the licensing requirement for persons dealing on own account on a trading venue by means of direct electronic access (DEA) to the extent that they do not provide or perform any other investment services

 

 

However, it also lists a set of circumstances where such an exemption does not apply.

 

In particular, dealing on own account exemption under the MiFID II Directive, Article 2(1)(d) mustn't be used with respect to commodity derivatives, emission allowances or derivatives thereof, thus in the case of the said products there is a need to refer to other possibilities,  for example:

 

MiFID II ancillary activity exemption or 

 

MiFID II exemption for EU ETS operators.

 

Dealing on own account exemption under MiFID II Article 2(1)(d)

 

MiFID II Directive does not apply to:

 

persons dealing on own account in financial instruments other than commodity derivatives or emission allowances or derivatives thereof and not providing any other investment services or performing any other investment activities in financial instruments other than commodity derivatives or emission allowances or derivatives thereof unless such persons:

 

(i) are market makers;

 

(ii) are members of or participants in a regulated market or an MTF, on the one hand, or have direct electronic access to a trading venue, on the other hand, except for non-financial entities who execute transactions on a trading venue which are objectively measurable as reducing risks directly relating to the commercial activity or treasury financing activity of those non-financial entities or their groups;

 

(iii) apply a high-frequency algorithmic trading technique; or

 

(iv) deal on own account when executing client orders;

 

Persons exempt under points (a), (i) or (j) of MiFID II Article 2(1) are not required to meet the conditions laid down in this point in order to be exempt.

 

Another restriction is that persons using dealing on own account exemption are not allowed to provide any other investment services and/or perform any other investment activities in financial instruments.

 

Moreover, MiFID II stipulates this exemption does not apply to persons who:

 

(i) are market makers

 

(ii) are a member of or a participant in a regulated market or multilateral trading facility (MTF), on the one hand, or have direct electronic access to a trading venue (DEA)on the other hand, except for non-financial entities who execute transactions on a trading venue which are objectively measurable as reducing risks directly relating to the commercial activity or treasury financing activity of those non-financial entities or their groups, or

 

(iii) apply a high frequency algorithmic trading technique; or

 

(iv) deal on own account when executing client orders.

 

As regards the DEA “Article 2(1)(d)(ii) of MiFID II does not include an explicit obligation for DEA users but rather introduces for this type of market participants an exception to the exemption from authorisation. In practice, this means that the exemption set out under Article 2(1)(d) is not available for them and that they are therefore required to be authorised” (MiFID II/MiFIR review report on Algorithmic Trading, ESMA, ESMA70-156-4572, 28 September 2021, footnote 11).

 

The said ESMA MiFID II/MiFIR review report of 28 September 2021 on Algorithmic Trading further explains:
“as provided for in Article 2(1)(d)(ii) of MiFID II, a person that only deals on own account and would otherwise be eligible to a MiFID II exemption, has to be authorised as an investment firm when having DEA to a regulated market, an MTF or an OTF.
Such authorisation aims, in particular to ensure that these firms are subject to appropriate organisational requirements under MiFID II and are properly supervised.
Under the current framework, co-legislators have therefore included the need for authorisation of DEA users as an additional risk mitigation measure on top of the obligations to be met by the DEA provider which ultimately retains responsibility for all trades entered into the venue’s trading system under its trading code.
As explained, ESMA has clarified in a Q&A that this authorisation to apply or authorisation only apply to Tier 1 DEA users”.

 

Referring to the last sentence of the above passage it is useful to note that the above exclusion relating to DEA does not apply to clients accessing an EU trading venue through sub-delegated DEA (Tier 2 DEA) - ESMA’s answer to the Question 24 (Questions and Answers on MiFID II and MiFIR market structures topics, ESMA70-872942901-3, Direct Electronic Access (DEA) and algorithmic trading, updated on 15 November 2017).

 
This authorisation requirement however does not apply to third-country firms having DEA to EU venues, as the ESMA notes: "thereby creating an unlevel playing field between EU and non-EU DEA users trading on own account on EU venues". Potential requirements are left to national discretion.

 

All above complexities may soon be be eased as Article 1(2) of the European Commission Proposal of 25 November 2021 for a Directive of the European Parliament and of the Council amending Directive 2014/65/EU on markets in financial instruments (COM(2021) 726 final) modifies Article 2(1), point (d), point (ii) of MiFID II by deleting any references to the DEA.

 

Explanatory Memorandum to the said European Commission Proposal clarifies that:
“Article 1(2) removes the licensing requirement for persons dealing on own account on a trading venue by means of direct electronic access (DEA) to the extent that they do not provide or perform any other investment services. This change is in line with a recommendation by ESMA in the Report on algorithmic trading”.

                                                                                                                         info                                

European Commission Proposal of 25 November 2021 for a Directive of the European Parliament and of the Council amending Directive 2014/65/EU on markets in financial instruments (COM(2021) 726 final)

Article 1
Amendments to Directive 2014/65/EU

Directive 2014/65/EU is amended as follows:

2. in Article 2(1), point (d), point (ii) is replaced by the following:
‘(ii) are members of or participants in a regulated market or an MTF;’

Recital 5

Article 2(1), point (d), point (ii), of Directive 2014/65/EU, exempts persons dealing on own account from the requirement to be licensed as an investment firm or credit institution, unless those persons have direct electronic access to a trading venue. Articles 17(5) and 48(7) of Directive 2014/65/EU require that providers of direct electronic access are licensed investment firms or credit institutions. Investment firms or credit institutions that do provide direct electronic access are responsible for ensuring that their clients comply with the requirements laid down in Articles 17(5) and 48(7) of Directive 2014/65/EU. That gatekeeper function is effective and makes it unnecessary for clients of the direct electronic access provider, including persons dealing on own account, to become subject to Directive 2014/65/EU. In addition, removing that requirement would contribute to a level playing field between third country persons accessing EU venues via direct electronic access, for which Directive 2014/65/EU does not require a license, and persons established in the Union.

 

 

Article 2(1)(d)(ii) of MiFID II had initially the wording:

 

"(ii) are a member of or a participant in a regulated market or multilateral trading facility (MTF) or have direct electronic access to a trading venue",

 

but 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 amended this provision as above.

 

The motives for this amendment have been explained, rather laconically, in Recital 12 of the said Directive 2016/1034, which reads:

 

"The exemption set out in point (d) of Article 2(1) of Directive 2014/65/EU should be extended to include non-financial entities who are members of or participants in a regulated market or a multilateral trading facility (MTF), or have direct electronic access to a trading venue when executing transactions on a trading venue which are objectively measurable as reducing risks directly relating to the commercial activity or treasury financing activity of those non-financial entities or their groups".

 
MiFID II makes also the reservation that persons who are exempt under the following points of paragraph 1 of Article 2 of MiFID II:
 
- a - covering insurance, reinsurance and retrocession activities,
 
- i - collective investment undertakings and pension funds or 
 
 
"are not required to meet the conditions laid down in this point in order to be exempt".
 
This provision requires more precise regulatory clearance. It remains ambiguous which concretely "conditions laid down in this point" need not to be observed by the above categories of participants, what it means, and what are the consequences. My hypothesis in that regard is shown in the diagram below.

MiFIDII-own-account-exemption 

 

Considering the above and the fact MiFID II recitals explicitly mention that dealing on own account and ancillary activity exemptions can be used in conjunction (this stance also accepted by ESMA - see: Discussion Paper on MiFID II/MiFIR of 22 May 2014, ESMA/2014/548), it requires to be determined whether, for eample, the firm exempt under Article 2(1)(j) (ancillary activity exemption) and willing to make simultaneous use of own account exemption is not prohibited from being market maker, a member of or a participant in a regulated market or multilateral trading facility (MTF) or from having direct electronic access to a trading venue, applying a high frequency algorithmic trading technique as well as from dealing on own account when executing client orders.

 

The proper answer to this question appears to require, however, the exact specification of the asset class at issue.

 

The EU financial sector's regulator has already adopted its stance in this regard (see ESMA's Consultation Paper, MiFID II/MiFIR of 19 December 2014 (ESMA/2014/1570) p. 505), quite restrictive, by the way.

 

As regards the last sentence of Article 2(1)(d) "ESMA is of the view that this sentence cannot be understood in a way that persons fulfilling the criteria of Article 2(1)(j) are not required to meet the conditions of Article 2(1)(d) in order to be exempt in relation to dealing on own account in financial instruments other than commodity derivatives, emission allowances and derivatives thereof. The differentiation between Article 2(1)(d) and (j) reflects different criteria being applicable to different asset classes. Consequently, ESMA understands the second sentence of Article 2(1)(d) to determine that persons seeking exemption under Article 2(1)(j) are not in addition required to meet the conditions laid down in Article 2(1)(d) in order to be exempt for the exemption under Article 2(1)(j)."

 


MiFID II, Recitals 22, 23

(22) Persons that deal in commodity derivatives, emission allowance and derivatives thereof may also deal in other financial instruments as part of their commercial treasury risk management activities to protect themselves against risks, such as exchange rate risks. Therefore, it is important to clarify that exemptions apply cumulatively. For example, the exemption in point (j) of Article 2(1) can be used in conjunction with the exemption in point (d) of Article 2(1).

(23) However, in order to avoid any potential misuse of exemptions, market makers in financial instruments, other than market makers in commodity derivatives, emission allowances or derivatives thereof provided that their market making activity is ancillary to their main business considered on a group basis and provided that they do not apply a high-frequency algorithmic trading technique, should be covered by the scope of this Directive and should not benefit from any exemption. Persons dealing on own account when executing client orders or applying a high-frequency algorithmic trading technique should also be covered by the scope of this Directive and should not benefit from any exemption.

 

What are the effects of this interpretation? I understand this in the following way: it is not possible for the person exempted under the MiFID II ancillary activity exemption to trade, for example, in IRS through the medium of direct, electronic access to a trading venue. Am I wrong?

 

Guidance of the ICE Futures Europe and ICE Endex Guidance on Member Requirements under MiFID II of June 2017 (p. 7) reads: 

 

"DEA Providers should also consider the authorisation status of their clients. Prior to the implementation of MiFID II, an exemption is available from the scope of MiFID for firms that deal on own account and do not provide any other investment services and activities. This means that they may not have been investment firms for the purposes of MiFID.

 

However, under MiFID II, these exemptions will not be available where a:

 

- firm dealing on own account in instruments other than commodity derivatives, emission allowances, or derivatives on emission allowances, accesses a trading venue through DEA or is a market maker, unless the firm is a non-financial entity executing transactions for hedging purposes;

 

- firm deals on own account, including market makers, in commodity derivatives or emission allowances or derivative products, unless the activity is ancillary to their main business;

 

- firm applies a high frequency algorithmic trading technique ("HFT")."

 

The importance of the clear-cut regulatory guidance on this exemption is underlined by Recital 36 of MiFID II, which requires of persons covered with an exemption to comply on a continuous basis with the conditions thereof. So, firms need to be cautious on an ongoing basis.

 

One more thing when it comes to own account exemption is also noteworthy, in the said Discussion Paper ESMA has also expressed the view that "the execution of orders in financial instruments between two non-financials directly and without any further intermediation by third parties as ancillary activity is not covered by the term 'dealing on own account when executing client orders' and would therefore not prevent the persons concerned from using the exemptions under paragraphs (d) and (j) of Article 2(1) MiFID II."

 

This appears somewhat enigmatic, hence it will require more comments from the regulator's perspective.

 

 

Questions and Answers on MiFID II and MiFIR market structures topics, ESMA70-872942901-38

 

Question [Last update: 07/07/2017]


Can a person that is not authorised as an investment firm but meets the requirements of Article 53(3) of MiFID II be a member or participant of a regulated market or an MTF?

 

Answer

 

Yes. Article 53(3) of MiFID II provides that an entity that is not an investment firm or a credit institution can be a member of a regulated market under certain conditions, this rule being extended to MTFs by Article 19(2) of MiFID II.

 

ESMA considers that this provision should be read in conjunction with the requirements of Article 2(1). Under this provision, a person falling under any of the categories listed in Article 2(1) would not have to be authorised as an investment firm.

 

However, pursuant to Article 2(1)(d) (ii) of MiFID II, when a person dealing on own account in financial instruments other than commodity derivatives or emission allowances or derivatives thereof and not providing any other investment services or performing any other investment activities in such instruments is also a member of or a participant in a regulated market or an MTF, it falls under the scope of MiFID II, and should accordingly be authorised as an investment firm unless:

 

- it is exempted under points (a), (i) and (j); or


- it is a non-financial entity which executes transactions on a trading venue which are objectively measurable as reducing risks directly relating to the commercial activity or treasury financing activity of that non-financial entity or its group.


As a consequence, the reference in Article 53(3) to persons other than investment firms and credit institutions only relates to entities that are exempted from authorisation under Article 2(1), such as insurance companies or collective investment undertakings, as long as their own regulatory framework permits them to do so.


This Q&A does not address the issue of non-EEA firms being a member or participant of an EEA trading venue.

 

Question [Last update: 31/01/2017]

 

Do the references to 'market makers' in MiFID II Article 2(1)(d)(i) and Article 2(1)(j) cover those market makers as defined under MiFID II Article 4(1)(7) or those firms engaged in a market making agreement according to Article 17(4) of MiFID II?

 

Answer

 

The reference to market makers' in MiFID II Article 2(1)(d)(i) and Article 2(1)(j) covers both firms engaged in a market making agreement according to Article 17(4) of MiFID II and other market makers covered by Article 4(1)(7) of MiFID II.

 

 

 

Requirements not covered by the exemption 

 

 

Even if traders are exempt under Articles 2(1)(d) of MiFID II, they will have to comply with the following MiFID II requirements:

 

1) position limits (only positions held by or on behalf of non-financials which are objectively measurable as reducing risks directly relating to commercial activity will not count towards the limits),

 

2) reporting obligations,

 

3) in accordance with Article 1(3) MiFIR, Title V of the MiFIR, (encompassing requirements for derivatives, in particular, the trading obligationclearing obligationindirect clearing arrangements as well as portfolio compression) apply to all financial counterparties and to all non-financial counterparties above the clearing threshold (EMIR Article 10(1)(b)).