Physically-settled commodity derivatives - regulatory mess
Sunday, 13 April 2014 17:02

 

Is it really physically-settled gas and power forwards traded on multilateral trading facilities (MTFs) are 'financial instruments' for MiFID purposes?

 

 

UK FCA statement of 11 September 2013:

 

Physically settled gas and power forwards that are traded on multilateral trading facilities (MTFs) are 'financial instruments' for the purposes of MiFID, and 'OTC derivatives' or 'OTC derivative contracts' for the purposes of EMIR.

 

 

Clear and uniform regulatory set-up for physically-settled commodity forwards, as purported to be implemented through the MiFID II, can't be overestimated.

 

 

ESMA letter to the European Commission of 14 February 2014 on physically settled commodity forwards:

 

"With reference to physically settled commodity forwards, it should be noted that the interpretation and application of definitions in points 6 and 7 of Section C of Annex I to MIFID (C6 and C7) is not convergent across the EU. These definitions have given rise to the following queries:

 

a. C7 explicitly applies to "futures" and "forwards" whereas C6 omits any reference to forwards.

Consequently, there are divergent views with regard to whether physical forwards traded on a regulated market or a MTF fall within MiFID's scope.

 

b. C6 and C7 apply to instruments which can be "physically settled". However, "physically settled" is not a defined term under MiFID. Further, C5 refers to instruments that "must be settled in cash or may be settled in cash at the option of one of the parties" whereas C6 and C7 refer to instruments that "can be physically settled".

 

Consequently, determining what is meant by can, may and must be physically settled should be considered for the identification of the contracts that fall within the definition of derivatives.

 

Contracts under point a. above and for which the definitions under point b. are relevant, are not clearly identified as derivatives across the Union."

 

When someone refers for instance to the UK FCA statement of 11 September 2013 (classifying the above trades made on MTFs as 'financial instruments' for the purposes of current MiFID, and 'OTC derivatives' or 'OTC derivative contracts' for the purposes of EMIR) or to the ESMA letter to the European Commission of 14 February 2014 acknowledging that divergent transpositions of MiFID across EU Member States mean that 'there is no single, commonly adopted definition of derivative or derivative contract in the European Union' there should be no doubt that urgent regulatory intervention is needed.

 

The European Commission letter of 26 February 2014 to ESMA on this issue (Markt/G3/PO/or/(2014)

s. 510569) practically postpones the wind-up of the problem till the MiFID II implementing acts (i.e. by several years), which can not satisfy anyone.

 

 

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