Backstop mechanism - Emissions-EUETS.com

The details of the backstop mechanism are stipulated in Article 3(2) of the Commission Delegated Regulation (EU) 2017/592 of 1 December 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to regulatory technical standards for the criteria to establish when an activity is considered to be ancillary to the main business (ESMA's RTS 20).

Important update

Directive (EU) 2021/338 of the European Parliament and of the Council of 16 February 2021 amending Directive 2014/65/EU as regards information requirements, product governance and position limits, and Directives 2013/36/EU and (EU) 2019/878 as regards their application to investment firms, to help the recovery from the COVID-19 pandemic substantially modifies legal framework regarding MiFID ancillary exemption.

The said Directive set out new provisions regarding the ancillary activity tests and empowers the European Commission to adopt a delegated act specifying the relevant criteria.

The delegation was exercised by adoption on 14 July 2021 of the Commission Delegated Regulation supplementing MiFID II by specifying the criteria for establishing when an activity is to be considered to be ancillary to the main business at group level.

According to the Regulation of 14 July 2021 the "Overall Market Test has been removed as the commodity derivatives landscape in the Union has changed to such an extent that the Overall Market Test would render entities no longer eligible to the ancillary activity exemption even with no change to their business conduct" (Recital 18).

This modification is not reflected in the remainder of this article, which is based on previous provisions.

Pursuant to Adjustment of ESMA's approach towards the ancillary activity exemption (13 July 2015) ESMA proposed a test combining the market share test with a trading activity test.

This methodology represented a significant modification if compared with the earlier approach of December 2014 since:

- the trading activity test exclusively took into account the commodity derivatives transactions concluded in the EU;

- the test compared the sum of the non-privileged/speculative commodity derivatives transactions in the EU (numerator) with the overall sum of all commodity derivatives transactions (denominator) in the group at a European level;

- there were three threshold categories of the trading activity test (< 10%; 10% - 49.9%; ≥ 50%).

Depending on the outcome of this trading activity test, firms were allocated to three different categories of market size thresholds.

For example, a firm which stays below 10% of the trading activity test would be allowed to have a market share of 20% in emission allowances (the higher the percentage of the speculative activity within all trading activity, the lower thethreshold).

The purpose of this backstop mechanism was to ensure that only relevant and sizable participants in European commodity derivative markets should be determined as not conducting their activities as ancillary to their main business.

It was additionally explained by ESMA in the MiFID II Briefing on Non-Financials Topics of 28 September 2015 (ESMA/2015/1470):

- if a firm's speculative trading activity is 10-50% of its total trading, it may be MiFID II exempt providing its market share is less than 50% of each threshold in the market share test e.g. 2% for metals, 1.5% for oil etc.

- if a firm's speculative trading activity is above 50% of its total trading, it may be MiFID II exempt providing its market share is less than 20% of each threshold in the market share test e.g. 0.8% for metals, 0.3% for oil etc.

Table: Market share thresholds by commodity group under ancillary exemption test pursuant to ESMA's Final Report of 28 September 2015

Proportion of non-priviledged commodity derivatives trading versus total EU commodity derivatives trading at group level (gross notional value)	Decreasing factor	Oil	Gas	Power	Coal	Freight	Emissions	Metals
Under 10%	1	3%	3%	6%	10%	15%	20%	4%
10% - 49,9%	0.5	1.50%	1.50%	3%	5%	7.50%	10%	2%
50% or greater	0.2	0.60%	0.65%	1.20%	2%	3%	4%	0.80%

ESMA's Final Report of 28 September 2015 includeed also a graphical depiction of the backstop mechanism, as follows:

MiFID-ancillary-exemption-main-activity-test

Diagram source: ESMA's Final Report of 28 September 2015 (ESMA/2015/1464), p. 330

The underlying measurement for all of the transactions was gross notional value (GNV).

The backstop mechanism as set out in the table above has been finally implemented in Article 3(2) of the Commission Delegated Regulation (EU) 2017/592 of 1 December 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to regulatory technical standards for the criteria to establish when an activity is considered to be ancillary to the main business - see box.

Article 3(2) of the Commission Delegated Regulation (EU) 2017/592 of 1 December 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to regulatory technical standards for the criteria to establish when an activity is considered to be ancillary to the main business

The following derogations from paragraph 1(a) shall apply:

(a) where the size of the activities referred to in Article 1 calculated in accordance with the first subparagraph of paragraph 3 accounts for more than 10% but less than 50% of the total size of the trading activity of the group calculated in accordance with the second subparagraph of paragraph 3, ancillary activities shall be considered to constitute a minority of activities at group level only where the size of the trading activity for each of the asset classes referred to in Article 2(1) accounts for less than 50% of the threshold established by Article 2(1) for each relevant asset class;

(b) where the size of the trading activities calculated in accordance with the first subparagraph of paragraph 3 accounts for equal to or more than 50% of the total size of the trading activity of the group calculated in accordance with the second subparagraph of paragraph 3, ancillary activities shall be considered to constitute a minority of activities at group level only where the size of the trading activity for each of the asset classes referred to in Article 2(1) accounts for less than 20% of the threshold established by Article 2(1) for each relevant asset class.

Recital 10 of the said Regulation explains that the backstop based on a group not exceeding a certain percentage of any of the thresholds set under the market share test for each relevant asset class is particularly relevant for very small groups with negligible overall footprint in the relevant commodity derivative trading.

On the one hand, those groups may be required to undertake a costly analysis of their trading activities to determine whether that trading reduces risk or not without the result being conclusive on the ancillary nature of the trading activity.

On the other hand, those groups are usually not equipped to engage in the capital test as an alternative to the test based on trading.

The said Recital 10 further argues that in order to avoid disproportionate burdens on those groups, it is appropriate that groups whose trading activity for each relevant asset class accounts for less than one-fifth of the threshold set under the market share test be considered as carrying out that trading as an ancillary activity to their main business.

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