MiFID2/MIFIR for
Commodities Markets
Key considerations for commodity trading firms
1
The revised Markets in Financial
Instruments Directive (MiFID2) was
passed into European law in April
2014. It represents a fundamental
change for the European financial
markets, especially for energy
and commodity firms that deal in
financial instruments.
Since the introduction of MiFID1 in November 2007, there
has been a substantial increase in the level of competition
and complexity within financial markets, including an influx
of players using commodity derivatives. As the market in
related financial products has grown, the orderly functioning
and integrity of commodities markets has come under both
political and regulatory scrutiny.
The 2008 financial crisis served to highlight flaws and
weaknesses within the existing regulation which resulted
in a wide-ranging review of the original MiFID legislation.
The resulting revisions under MiFID22 not only look to
address these weaknesses, but also broaden the scope of
the regulation with a renewed focus on commodity markets
and trading.
With commodity market risk management tools and
techniques advancing, the evolving convergence, and
dependency between physical and financial markets has
become ever more apparent. To reflect this development,
MiFID2 has been extended to cover instruments and
activities that bridge both markets — increasing the scope to
capture more commodity players requiring authorization as
investment firms. This carries broader implications for the
industry, including corporate and non-financial firms.
This change is likely to require
not only a major implementation
effort on the part of previously
unregulated entities but also a
reassessment of business models
and the legal entity structures for a
host of market participants. Given
the breadth and depth of MiFID2, it
is likely to entail far more than just a
compliance exercise.
Understanding the prospective impacts of MiFID2 becomes
even more important when considering the wider range of
regulatory reforms. The introduction of European Markets
Infrastructure Regulation (EMIR)3 and changes to the market
abuse regime for commodity markets i.e., the revisions
brought by MAD2/MAR4 and the introduction of Regulation for
Energy Market Integrity and Transparency5 (REMIT), etc. will,
in combination with MiFID2, potentially subject commodity
market participants to compliance obligations more akin to
those experienced by financial service and investment firms.
To this end, the response to regulatory compliance for
commodity firms will more than likely extend beyond simply
minor operational changes, to a broader rationalisation of
the organisation and, in many cases, require a review of the
firm’s overall strategy. Given many technical aspects of MiFID2
are still being considered, commodity firms should not delay
determining a response which looks not only at minimising
impact but also at identifying potential business opportunities.
While MiFID2 comes into force in January 2017, preparations
must start now.
Are you covered by MiFID2?
MiFID2, like its predecessor, applies across the EU and EEA member states and, with limited exceptions, applies to firms
providing "investment services or activities", as defined by the regulation. In addition to considering what sort of investment
services or activities a firm undertakes, the regulation also considers the type and quantity of "Financial Instruments" a firm
trades. MiFID2 is intended to capture more commodity instruments than the existing regulation, including physically settling
contracts in some cases.
The rules around precisely which firms fall into scope of MiFID2 can be complex and require close consideration by firms that
trade commodities.
Even if a commodity firm escapes full regulation under MiFID2, a number of requirements will apply regardless to firms who
trade in-scope commodity instruments, including adherence to regulatory position limits across commodity classes as we as the
compulsory reporting of positions in such commodities.
1. DIRECTIVE 2004/39/EC of the European Parliament and of the Council on markets in financial instruments 21 April 2004
2. DIRECTIVE 2014/65/EU of [..] on markets in financial instruments 15 May 2014, REGULATION (EU) No 600/2014 of [..] on markets in
financial instruments and amending Regulation (EU) No 648/2012 15 May 2014
3. REGULATION (EU) No 648/2012 of [..] on OTC derivatives, central counterparties and trade 4 July 2012
4. DIRECTIVE 2014/57/EU of [..] on criminal sanctions for market abuse 16 April 2014, REGULATION (EU) 596/2014 of [..] on market
abuse 16 April 2014
5. REGULATION (EU) No 1227/2011 of [..] on wholesale energy market integrity and transparency 25 October 2011
2
MiFID2/MIFIR for Commodities Markets
Why is this important for
commodity firms?
Until now, commodity firms have largely escaped full regulation under MiFID as a result of broad exemptions
made available for commodity trading firms, and other ‘non-financial’ organisations that use regulated
‘Financial Instruments’ predominantly for commercial purposes.
The changes under MiFID2 are significant in that they remove or limiting the exemptions available to
commodity trading and other non-financial firms, as well as broaden the scope of instruments for both
physically and financially settled commodity derivatives, classifying more of them as ‘Financial Instruments.’
Changes to ‘Financial Instruments’
applicable to commodity firms
Changes to exemptions applicable to
commodity firms
(Annex 1 – Section C of MiFID)
(Article 2 of MiFID)
►► The term ‘Forwards’ has been added to certain
definitions by which commodity derivatives (and
potentially physically settled FX*) will be treated as
‘Financial Instruments’ where:
►► The ‘commodity dealer’ exemption [Art.2(1)(k)] ‘persons
whose main business consists of dealing on own account
in commodities and/or commodity derivatives‘. This
exemption has been completely removed under MiFID2.
►► i) they ‘must’ or ‘may’ be settled in cash (C5), or
►► ii) t hey are physically settled and for noncommercial purposes (C7)
►► A new platform, an ‘Organised Trading Facility’ (OTF),
has been added to the list of regulated platforms which
includes ‘Regulated Market’ (RM), ‘Multilateral Trading
Facility’ (MTF) and ‘Systematic Internaliser’ (SI), by which
instruments traded on the venue will be considered
Financial Instruments (C6). However:
►► A carve out exclusion is granted explicitly for
wholesale energy products covered by REMIT
(i.e., gas and power) traded on OTFs that can be
physically settled;
►► ‘National Competent Authorities’ (NCAs) can offer
a temporary six year exemption for ‘Non-financial’
firms from including such instruments in the clearing
threshold calculation and from the risk mitigation
requirements under EMIR for physically settled oil
and coal derivatives traded on an OTF.
►► The ‘ancillary activity’ exemption [Art 2(1)(j)] is
available for firms dealing in commodity derivatives
provided it is ‘ancillary’ to their main business and does
not comprise ‘investment services’ (as defined by the
regulation). Under MiFID2 this exemption requires that
quantitative measures be applied to justify whether such
activities are ancillary to the main business (applied at
group level).
►► The ‘dealing on own account’ exemption [Art 2(1)(d)]
has been explicitly reworded to exclude commodity
derivatives under MiFID2 although this can still be used
cumulatively by commodity firms in conjunction with
the ‘ancillary activity’ exemption i.e., ‘execution of
orders in Financial Instruments between non-financials
directly without further intermediation by third parties’
treated as ‘ancillary’ and not ‘dealing on own account
while executing client orders’. This combined exemption
may provide relief for treasury financing activities for
some corporates.
►► Emission Trading Scheme (‘ETS’) allowances have been
incorporated (C10).
*Note: The directive definitions (as part of MiFID) require transposition into National Law by domestic NCAs – which could lead to differences in
interpretation and differences in treatment between member states.
”In commodity derivatives, MiFID2 brings a whole new
regulatory regime …
firms cannot hold back on developing their implementation
…
plans until all the details are available.”
David Lawton, Director of Markets, at the FCA (UK) MiFID2 Conference 2014
3
New requirements impacting
commodity firms?
MiFID2 introduces a number of measures specifically aimed at regulating commodity market participants.
The overall compliance burden applicable to commodity trading organisations will depend on their scope
of regulated activities under MiFID2 as a regulated investment firm, along with the nature and size of their
trading activity with respect to Financial Instruments.
Market
infrastructure
►► MiFID2 has extended the categories of regulated platforms to incorporate OTFs.
This is likely to capture a number of platforms used for commodity trading
beyond traditional exchanges, including broker crossing platforms, subjecting
them to rules governing platform operations (including trade execution and
transparency).
►► MiFIR, the Regulation, requires that derivatives which are deemed by ESMA as
eligible for clearing under EMIR, must be traded on a regulated venue i.e., either
an RM, MTF, SI or OTF (this only applies to Financial Counterparties ‘FC’ and Nonfinancial Counterparties, above the clearing threshold i.e. NFC+).
►► Commodity derivatives traded on regulated categories of platform will be
considered ‘Financial Instruments’ and therefore subject to both MiFID platform
requirements and potentially EMIR obligations (requiring compulsory clearing and
inclusion in ‘NFC’ threshold calculation.)
Position limits/
controls
►► Commodity derivatives traded on regulated venues will be subject to position
limits and position management controls applied by the relevant platform
operators.
►► Position limits will be applied on the aggregate net position a ‘person’ (and
‘group’) can hold at any time in a certain commodity derivative, but will not apply
to positions held by NFC entities where trades are deemed to be for ‘commercial
purposes’.
►► Venue operators are also required to implement position management controls
for commodity derivatives, which may force participants to reduce or terminate
positions where limits are exceeded, or in some cases introduce liquidity to illiquid
markets where requested to do so.
►► Reports on positions must be made available by venue operators, however these
reports will rely on data submitted by market participants on their positions
(potentially on a daily basis).
Trade
transparency/
reporting
►► Regulated Trading venues will be required to meet pre- and post-trade disclosure
requirements, which will require additional data to be supplied by market
participants
►► Pre- and post-trade transparency requirements will not apply to transactions
undertaken by NFCs deemed “for commercial purposes”
►► Regulated firms under MiFID2 are required to report ‘execution of transactions’ in
Financial Instruments to an approved reporting mechanism (‘ARM’) on a T+1 basis
4
MiFID2/MIFIR for Commodities Markets
Regulated firms are likely to be subject to authorization under domestic regulatory frameworks in addition
to MiFID2. In addition, commodity firms may become subject to regulatory capital requirements in future
following a review of the exemption currently extended to the sector.
Domestic
regulatory
frameworks
Regulatory Capital
Requirements
►► Governance and controls to ensure business activity and accompanying risks are
appropriately measured and managed.
►► Appropriate business conduct rules to ensure integrity is upheld for the respective
regulated activities.
►► An independent compliance function responsible for monitoring and policing
regulated activities as well as being actively involved in setting and enforcing the
rules for assessing client acceptance.
►► Non-commodity investment firms regulated by MiFID are subject to regulatory
capital requirements under the Capital Requirements Directive (CRD) and Capital
Requirements Regulation (CRR), collectively referred to as CRD IV.
►► A temporary exemption applies to CRD IV, which precludes commodity trading
firms from these requirements until the end of 2017.
►► This exemption is due for review prior to the 31 December 2017, and will require a
public consultation to begin no later than 31 December 2015.
What does MiFID2 mean for a diverse commodities market?
Commodity market participants comprise a diverse range of firms that include commodity trading houses, asset-backed traders
(such as utilities and oil producers), commodity end-users and financial institutions such as banks. The size and complexity of
these organisations can range from small regional players to large, global organisations with trading activities spanning across
multiple legal and regulatory jurisdictions.
The overall impact of MiFID2 across these firms is unlikely to be uniform. For those falling into scope of the regulation, much will
depend on how the organisation is structured from a legal entity perspective, precisely what regulated activities they perform,
and what regulated instruments are traded by each entity.
The extent to which such firms are experienced in dealing with large, complex framework regulation such as MiFID2 will
undoubtedly also have a bearing on its impact. For instance, banks that trade commodities, some asset-backed traders and
commodity trading houses already have regulated entities under the existing MiFID (typically structured to reduce their overall
“regulatory footprint”). This might however be an entirely new experience for smaller, regional European players, or foreign
firms looking to enter the European market.
Regardless, once regulated under MiFID2, firms will become subject to a rigorous set of governance and conduct of business
standards (in addition to the other impacts specific to commodities outlined in this paper).
There are two main indirect impacts all commodity firms should also consider. The first relates to other market regulation, the
applicability of which depends on the scope set by MiFID2, including EMIR, MAD2/MAR and capital requirements regulation
(discussed further on the next page). The second, which applies regardless of whether a firm is MiFID2 regulated or not, is the
potential impact on market structure and liquidity for some commodity classes, brought by changes to the market mix and cost
of trading as a result of new regulation.
5
The MiFID2 nexus: the link with
EMIR, REMIT, MAD2 and Capital
Requirements regulation
While MiFID2 will form a broad bedrock of European financial market regulation, its reach extends to many
other areas of market regulation. Regulatory boundaries comprising the scope of regulated activities and
instruments for financial and energy market regulations, including EMIR, MAD2/MAR and REMIT directly
reference MiFID2.
For commodity trading firms, it is therefore important to understand the linkages between these
regulations, their corresponding interaction and the potential knock-on effects should particular instruments
or activities be incorrectly or inconsistently interpreted.
The graphic below highlights some of these linkages and their potential impacts.
EMIR
►► The classification of an entity as either a financial counterparty (FC) or nonfinancial counterpart (NFC) is directly dependant on whether the entity is
MiFID regulated. The narrowing of scope exemptions under MiFID2 means that
more commodity trading entities may become classified as FCs, carrying with
it the more stringent compliance requirement, including compulsory clearing
for certain instruments.
►► The scope of traded commodity instruments covered by EMIR is set by MiFID.
This is potentially significant when considering the changes to the definition of
“Financial Instrument” under MiFID2.
►► MiFID2 does, however, explicitly exclude certain physical gas and power trades
from scope, as well as excludes certain oil and coal contracts from certain
EMIR requirements* for a “transitional” period of 42months.
Regulatory capital regulation
►► Investment firms regulated by MiFID are subject to capital requirements
under the Capital Requirements Directive (CRD) and Capital Requirements
Regulation (CRR). Commodity firms have thus far benefited from a general
exemption from such requirements.
►► While a review of whether or not to extend the exemption for commodity firms
is due to take place before 31 December 2017, the applicability of capital
requirements rules will remain linked to MiFID2 definitions.
►► While the outcome of this review and the ultimate applicability of capital
requirements regulation to commodity firms are not certain, this is a critical
strategic consideration for commodity firms.
►► The narrowing of available exemptions under MiFID2 in this context should be
carefully considered.
MiF
FID2
MiFID2/MIFIR for Commodities Markets
Market abuse regulation
►► The scope of traded commodity instruments covered by the revised Market
Abuse Directive and Regulation (MAD2) is set by MiFID2. This includes those
instruments traded on regulated venues as defined by MiFID2, including RMs,
MTFs * as well as OTFs, the new category of trading venue.
►► Further to the above, implicitly included in scope are Emissions Allowances
consisting of any units recognized for compliance with the requirements of EU
Emissions Trading Scheme.
►► The MiFID2 definitions explicitly excludes physical gas and power “wholesale
energy products” from scope and therefore from scope of MAD2. These will
instead be subject to specific market abuse and manipulation provisions under
REMIT**.
*Not covered by the original MAD **Power and gas derivatives traded on an MTF will be covered by
REMIT until MAD2 enters into force
Domestic regulation
►► As required for all EU Directives, the relevant elements of MiFID2 (i.e., the
elements laid out in the Directive itself, which is distinct from the Regulation)
must be transposed into domestic law.
►► Although the primary reason for MiFID2 being drafted as both a Regulation
as well as a Directive was to ensure that such inconsistencies in interpretation
between member states be removed as far as possible to ensure a level
playing field, there remains the possibility for jurisdictional differences in
interpretation.
►► Commodity firms should pay particular attention to this potential in the
context of existing differences in interpretation between member states with
regard to the original MiFID.
The boundaries between the regulations with respect to oversight and enforcement by domestic authorities
also need to be clearly defined. This will be important for commodity firms that may have limited existing
dialog with their domestic financial regulators and energy market regulators.
6
7
Is your organization ready
for MiFID2?
MiFID2 will present significant challenges for a number of commodity trading firms, with the introduction
of new obligations for authorized entities. However, the impact is likely to extend beyond pure compliance.
Knock-on impacts on market structure and liquidity are likely to affect non-regulated market participants.
Whilst largely dictated by the scale and complexity of your trading operations, the extent to which
MiFID2 impacts your firm should also be considered in combination with the broader regulatory change
environment. A comprehensive compliance response should be more than just a tactical response, and
should not only consider requirements for ongoing compliance but further feed into business strategy and
business continuity plans.
Firms are recommended to consider both operational and strategic perspective, when considering the
impacts of MiFID2 while weighing up a compliance response. A number of considerations are outlined below:
Strategic
►► Have you considered whether structural realignment
from a legal entity perspective may be required to
drive organizational and compliance efficiencies with
respect to the MiFID2 requirements, and to benefit from
exemptions where possible?
►► Have you taken a strategic view of the optimal type/
mix of trading venue(s) on which to execute post
MiFID2 implementation?
►► Do you fully understand the extent and purpose of the
group’s trading activities from a MiFID2 perspective (for
both external and intragroup trading activities), and how
these activities influence the firm’s scope and impact
under MiFID2?
►► Have you considered the potential change to the market
environment and structure in respect to liquidity and
costs of venue-based trading post MiFID2?
►► Have you constructed position-limit scenarios in
order to evaluate their potential impact on both your
trading strategy and operations per trading venue and
jurisdictional location?
►► Have you considered how the regulatory capital
implications of CRD IV (the scope of which is set by
MiFID2) might impact your operating costs and revenues
in the context of your broader strategic objectives?
Operational
►► Do you have the necessary systems, controls and
documentation in place to appropriately calculate and
evidence exemption criteria in a timely manner?
►► Have your trading desks and associated operations
teams developed methodologies to segregate hedging
and proprietary activity from a system, process and risk
management perspective?
►► Have you considered the potential impacts on credit risk
procedures and policies in line with the position-limit
changes that MiFID2 will prescribe?
►► Have you considered the potential impacts of MiFID2
on trading venues across your group structure, and
between your trading and treasury functions?
►► Do you have the necessary system and procedures
in place, to accommodate position management and
position reporting requirements on your own positions
and/or those on behalf of your clients?
►► Have you considered the potential challenges that
MiFID2 will pose to your group structure from a funding
and capability perspective, once available exemptions
are exhausted ?
►► Do you have the necessary control framework in
place, to ensure that ongoing MiFID2 compliance is
evidenced accurately and processes are performed
as documented?
8
MiFID2/MIFIR for Commodities Markets
Preparations should begin now …
Commodity trading firms are advised to undertake an immediate high-level impact assessment to determine,
at a minimum, the applicable scope boundaries, legal entity structure and business model impacts as well as
to establish an implementation roadmap to effect the necessary organizational response.
Phase 1
Initial
MiFID study
•
Phase 2
Impact
assessment
•
Phase 3
Strategic
analysis
•
Phase 4
Implementation
roadmap
►► An analysis of relevant
group activities to
identify relevant
activities that could be in
the scope of MiFID2
►► Develop scenarios to
test the firm’s business
model and the extent to
which its activities will be
impacted
►► Determination of
potential senior
management responses
to minimize the impact of
MiFID2
►► Develop a detailed,
prioritized
implementation road
map to implement the
appropriate response
►► Develop a view on
relevant exemption
criteria applicable to the
firm’s activities
►► Perform impact
assessment that covers
the relevant MiFID2
areas and highlights
the key impacts on the
firm’s business
►► Consider possible
legal entity
restructuring options
►► The road map should
cover legal entity
restructuring, activity
migration, market
infrastructure selection/
connectivity etc.
►► The group “quick scan”
will also define the
plan for the impact
assessment and the
strategic analysis
►► Consider potential knockon impacts of other nonMiFID regulations
►► Outline restructuring
options based on
geography, capital and
commercial viability with
compliance as a core
pillar
►► Compliance review and
development of evidence
“defence file”
9
How EY can help …
Experience gained from the implementation of the original MiFID regulation demonstrated the inherent
complexity, cost and risks for firms navigating such regulation. Given the limited guidance and precedent
often accompanying such regulation, it is strongly advised that firms implement a rigorous program of
assurance to ensure such costs and risk are reasonably reduced. Such a program may be managed and
resourced internally, or with the support of an external advisor with the right level of knowledge and
experience. EY has the skills and experience to help you.
Implementation
assurance
►► Rapid gap assessment with existing regulatory obligations
►► Support in defining appropriate risk measurements/metrics for support of i) market
monitoring framework, ii) hedge effectiveness and iii) intragroup exemptions
►► Review of extended group obligations and applicability for cross border trading
►► Development of “defence file” to demonstrate compliance in the case of investigation
►► Assessment of valuation methodologies and credit processes
►► Review of compliance with permissions in relation to domestic financial regimes
►► Review of “onboarding” of regulation-related service vendors, including review of
contractual arrangements
►► Internal training on regulatory awareness and compliance
Ongoing
compliance
►► Ongoing validity assessment of “hedge” determination with regard to trading activities in
relation to EMIR/MIFID2
►► Carry out regular “dawn raid” test exercises to live-test compliance
►► Regular assessment of governance framework and the effectiveness of your
compliance function
►► “Hedge accounting” support to satisfy regulatory “safe harbour” exemptions
►► Internal audit review of regulatory compliance programs and ongoing
compliance integrity
►► Regular review of internal compliance monitoring framework, including positionlimit monitoring
►► Regulatory-focused review in respect of due diligence for new transactions
►► Regulatory capital and trade funding review for group
10
MiFID2/MIFIR for Commodities Markets
Who we are
EY has a team of experienced professionals who understand commodity markets and who will work with you
to understand the requirements under the regulation, formulate a response appropriate to your market and
activities, and assist you in implementing it in an effective, cost-efficient manner. We have the regional and
global reach to help support you with your global response to the regulation.
The Commodities Markets teams are based in London, Houston and other major centers across Europe and
they bring together a range of skill sets and experience needed to deliver insights and services specific to
the commodity trading market. Our team includes industry-experienced professionals many of whom have
worked in the front, middle and back offices of leading energy and commodity trading organizations.
The Team’s experience in commodity trading is diverse and provides a broad range of advisory and
assurance services to a large number of leading European energy and commodity trading organizations
across multiple asset classes, including energy, metals, softs and renewables.
Contacts
UK
Andrew
Woosey
Partner
Tel: + 44 20 7951 8117
Mob: + 44 7766 498 328
Email: [email protected]
Shane
Henley
Director
Tel:+ 44 20 7951 9501
Mob: + 44 7739 127457
Email: [email protected]
Germany
Dr. Thomas
Edelmann
Partner
Tel: + 49 89 14331 21992
Mob: + 49 1755 244 137
Email: [email protected]
Carsten
Buhl
Tel:+ 49 35 14840 21596
Mob: + 49 1609 392 1596
Executive Director Email: [email protected]
Nordics
Christian C.
Eckhoff
Partner
Lars
SchwartzPetersen
Tel: + 47 24 00 21 71
Mob: + 47 240 02 171
Email: [email protected] Partner
Tel:+ 45 25 29 32 46
Mob: + 45 25 29 32 46
Email: [email protected]
France
Kirill
Verevitchev
Partner
Tel: + 33 1 46 93 45 05
Mob: + 33 6 89 53 23 90
Email: [email protected]
Olivier
Drion
Partner
Tel:+ 33 1 46 93 79 14
Mob: + 33 16 09 24 24 09
Email: [email protected]
Switzerland
Scott
Duncan
Partner
Tel: + 41 582 86 56 46
Mob: + 41 582 89 56 46
Email: [email protected]
Jean-Noël
Ardouin
Senior Manager
Tel:+ 41 582 86 55 63
Mob: + 41 582 89 55 63
Email: [email protected]
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