FX spot contract
European Union Electricity Market Glossary

 


 

 

Under MiFID I there were wide differences in the national implementations in respect of FX forwards and spots.

 

However, Level 2 Regulation under MiFID II (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 in Article 10 and in Recitals 8 - 13 clarifies the scope and includes definitions in relation to the circumstances under which other derivative contracts relating to currencies should be considered financial instruments as well as the meaning of spot contracts for currencies (see boxes below).

 

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Physically-settled OTC foreign exchange contracts are preferentially treated in the risk management procedures under the EMIR and BCBS-IOSCO legal frameworks for collateral.

 

For the said types of contracts it is sufficient the exchange of variation margin without initial margin.

 

 

 

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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 DirectiveArticle 10, Recitals 8 - 13

 

ESMA letter to the European Commission of 14 February 2014

 

European Commission consultation on FX financial instruments, 10 April 2014, and contributions

 

Commission Staff Working Document Impact Assessment Accompanying the document Commission Delegated Regulation supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council with regard to definitions, transparency, portfolio compression and supervisory measures on product intervention and positions {C(2016) 2860 final} {SWD(2016) 156 final}, 18.5.2016, SWD(2016) 157 final, p. 45 - 47, 124, 125

 

 

 

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Foreign exchange (FX) forward

 

Non-deliverable forwards (NDFs)

  

 

 

 

Instruments for which the classification as derivatives is not uniform across the EU

 

FX derivatives

 

12. Differences arise, in particular for FX forwards, depending on the settlement or delivery date, i.e. the frontier between an FX spot and an FX derivative. From the analysis carried out by ESMA, it is not controversial that contracts that settle within two trading days are considered spot contracts and that contracts that settle after seven trading days are FX forwards. In certain countries the contracts that settle up to 7 days are not deemed to be derivatives. Therefore, for contracts with a settlement date between 3 and 7 trading days there are different national laws, in some Member States, determining whether they are or not a derivative. For these FX forwards there is not a common definition and, therefore, they are not clearly identified as derivatives across the Union.

 

13. Other differences arise because of the commercial nature of the transaction. Currency derivatives are mentioned in point (4) of Section C of Annex I to MIFID. Such a definition does not contain any reference on whether the currency derivatives are concluded for commercial purposes. The only reference to commercial purposes in the MiFID definitions is included in point (7) of Section C of Annex I to MIFID, which deals with commodities derivatives.

 

14. The European Commission issued a Q&A specifying the scope of MiFID provisions for the provision of investment services, stating that "Even if FX forwards are qualified as a financial instrument in section C of Annex I to MiFID, their intermediation will be subject to MiFID requirements only in the case there is an investment service or activity performed in the sense of MiFID. In this respect, Annex I section B(4) of MiFID lists "foreign exchange services where connected to the provision of investment services" as an ancillary service, not as an investment service. Thus, FX forward transactions not connected to the provision of an investment service, i.e. commercial FX forward transactions, are not covered by MiFID. The qualification of FX forwards as a financial instrument is not important if there is no investment service or activity performed in the sense of MiFID."

 

15. Some Member States have therefore transposed MiFID by not considering as financial instruments FX forward transactions concluded for commercial purposes. These contracts are, therefore, not clearly identified as derivatives across the Union.

 

16. It should be noted that when ESMA developed the technical standards for the definition of the clearing threshold for non-financial counterparties, it considered the basic definition of MiFID, i.e. a potentially wide scope for the definition of FX derivatives. At that time National Competent Authorities and stakeholders did not raise issues of different definitions of FX derivatives among Member States and possible carve outs by some Member States of FX derivatives concluded for commercial purposes.

 

17. In addition, it should be noted that derivatives concluded for hedging purposes are already excluded from the calculation of the clearing threshold and specific criteria need to be met by transactions concluded by non-financial counterparties to qualify as hedging transactions (as defined in technical standards developed by ESMA). The concept of commercial purposes might potentially be broader than the hedging one.

 

ESMA letter to the European Commission of 14 February 2014, Annex I

 

 

 

 

Foreign Exchange – Delineating between spot and derivative transactions

 

The consistent application of the clearing and reporting obligations under EMIR and of investor protection and other requirements under MIFID II across the Union depends on clear and consistent definitions, in this case specifically with regard to foreign exchange (FX) derivative vs. spot contracts.

 

Under the implementing measures for MiFID II there is the possibility to bring legal certainty on what an FX contract is, based on the outcome of the work previously conducted by the European Commission in order to delineate between spot and derivative FX transactions. For further background please consult Annex 9 on 'A harmonised definition for FX spot contracts'.

 

No action option

 

EMIR reporting obligations to trade repositories and investor protection and other requirements under MiFID II/MiFIR would be applied unevenly across Member States depending on how FX spot contracts were defined by national legislators or regulators.

 

Option 1 – Defining FX spot contracts as contract with a settlement of up to T+2

 

FX contracts with a settlement period of more than two days (T+2) would be automatically considered as FX derivative contracts and hence qualified as financial instruments in scope of the MiFID II requirements.

 

Option 2 – Defining FX spot contracts as contracts with a settlement of up to T+2 with qualifications

 

Option 1 amended with some qualifications to ensure that the definition does not include contracts which by their nature are payments rather than financial instruments. More specifically: the T+2 settlement period would apply to European and other major currency pairs, the "standard delivery period" to other currency pairs to define an FX spot contract; using the market settlement period of the transferrable security linked to an FX spot contract in an FX security conversion to define the FX spot contract with a cap of (for example) five days; add a qualification for FX contracts that are used as a means of payment to facilitate payment for goods and services.62

 

Analysis of the Options and impact on stakeholders

 

No action would preserve the status quo of having a widely different implementation of MiFID with regard to FX spot contracts and FX derivatives and may lead to regulatory arbitrage. Most Member States currently define FX spot contracts as settling up to T+2. However, the United Kingdom, representing almost 80% of the EU's FX market (Europe Economics, Data gathering and cost-benefit analysis of MiFID II, L2, p. 231), and Ireland define FX spot contracts as contracts for the purchase of a currency with a delivery of between two and seven business days. Under the no action option transactions would therefore be treated differently in different EU jurisdictions. This lack of harmonisation of legal terms is not a desirable outcome, in particular for a cross-border business which FX contracts are per definition. In particular for cross-border transactions stakeholders may therefore need to consider different sets of rules when trying to establish whether an FX transaction is being classified as a spot or derivative transaction.

 

Option 1 would set a clear delineation. However, there would be no room for acknowledging different market practices, in particular in non-EU countries with regard to the settlement cycles of securities purchased. Option 1 would therefore require some reshaping of market practices and in particular would impact the UK market where investment firms who trade FX contracts at present with a delivery of between two and seven business days would be required to get a MIFID authorisation that they were not previously required to get, as these contracts would become financial instruments. Option 2 caters for these special cases and thereby ensures that unintended consequences, e.g. for non-financial corporates, would be avoided. It would also minimise the impact on market practices is the United Kingdom and Ireland. In fact, this option would most likely have very little direct impact on market participants. Its main benefit would be to harmonise the rules around current practices in the Union. Annex 9 includes a table on outright forwards with a settlement of over 7 business days. The figures for the United Kingdom and Ireland combined give an indication of the upper bound of these contracts that may be concerned by a reclassification under this option.

 

Comparison of the options

 

While the 'no action' option would not lead to the necessary harmonisation in definitions and hence not remedy the uneven application of rules to FX financial derivatives in financial markets today, option 1 would require a substantial change in how business is done today and would particularly impact commercial transactions linked to an FX transaction (payments and purchases of foreign securities). Option 2 sets a clear settlement period for FX spot contracts, but takes into account specific cases for security purchases and payments which are well-established and where a non-EU jurisdiction is involved and for commercial purposes. It is therefore less intrusive than option 1 but achieves a sufficient degree of harmonisation within an appropriate framework. As it is also the most efficient option, option 2 is the preferred option.

 

Stakeholder responses to the public consultation carried out by the European Commission (the Commission issued a consultation document on 10 April 2014. It also consulted the European Securities Committee on the issue):

 

Public authorities and non-market related non-governmental organisations welcomed the clarification of the notion of an FX spot transaction. However, they also noted that inconsistencies between EU regulation and regulation in third countries should be avoided bearing in mind that the FX market is global and that any differences in global approaches would create difficulties for market participants and the economy. Market participants (such as FX traders) strongly advocated special rules for security conversions (considering that they are concluded for payment purposes) and that they should not be treated as financial instruments. Non-financial companies stressed uses of FX contracts for payment purposes and underlined that onerous requirements for these should be avoided. Some market participants (credit institutions, payment institutions) suggested to rely on market practice rather than to implement new legislation on a harmonised definition.

 

Commission Staff Working Document Impact Assessment Accompanying the document Commission Delegated Regulation supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council with regard to definitions, transparency, portfolio compression and supervisory measures on product intervention and positions {C(2016) 2860 final} {SWD(2016) 156 final}, 18.5.2016, SWD(2016) 157 final, p. 45 - 47

 

 

 

 

Financial instruments are defined in Section C4 of Annex I of the Directive on markets in financial instruments (MIFID II) and include derivatives related to currencies (FX). However while Article 39(2) of Regulation (EC) No 1287/2006 (MiFID L2) provides a specification of what constitutes a spot contract for the purposes of commodities, none is provided for a spot FX contract. It emerged during ESMA task force discussions related to the EMIR implementation, that there were wide differences in the national implementation of MIFID in respect of FX forwards and spots.

 

Commission Staff Working Document Impact Assessment Accompanying the document Commission Delegated Regulation supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council with regard to definitions, transparency, portfolio compression and supervisory measures on product intervention and positions {C(2016) 2860 final} {SWD(2016) 156 final}, 18.5.2016, SWD(2016) 157 final, p. 124

 

  

 

 

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

 

Recitals 8 - 13

 

(8) In order to ensure the uniform application of Directive 2014/65/EU, it is necessary to clarify the definitions laid down in Section C(4) of Annex I of Directive 2014/65/EU for other derivative contracts relating to currencies and to clarify that spot contracts relating to currencies are not other derivative instruments for the purposes of Section C(4) of Annex I to Directive 2014/65/EU.

 

(9) The settlement period for a spot contract is generally accepted in most main currencies as taking place within 2 days or less, but where this is not market practice it is necessary to make provision to allow settlement to take place in accordance with normal market practice. In such cases, physical settlement does not require the use of paper money and can include electronic settlement.

 

(10) Foreign exchange contracts may also be used for the purpose of effecting payment and those contracts should not be considered financial instruments provided they are not traded on a trading venue. Therefore it is appropriate to consider as spot contracts those foreign exchange contracts that are used to effect payment for financial instruments where the settlement period for those contracts is more than 2 trading days and less than 5 trading days. It is also appropriate to consider as means of payments those foreign exchange contracts that are entered into for the purpose of achieving certainty about the level of payments for goods, services and real investment. This will result in excluding from the definition of financial instruments foreign exchange contracts entered into by non-financial firms receiving payments in foreign currency for exports of identifiable goods and services and non-financial firms making payments in foreign currency to import specific goods and services.

 

(11) Payment netting is essential to the effective and efficient operation of currency settlement systems and therefore the classification of a foreign currency contract as a spot transaction should not require that each foreign currency spot contract is settled independently.

(12) Non deliverable forwards are contracts for the difference between an exchange rate agreed before and the actual spot rate at maturity and therefore should not be considered to be spot contracts, regardless of their settlement period.


(13) A contract for the exchange of one currency against another currency should be understood as relating to a direct and unconditional exchange of those currencies. In the case of a contract with multiple exchanges, each exchange should be considered separately. However an option or a swap on a currency should not be considered a contract for the sale or exchange of a currency and therefore could not constitute either a spot contract or means of payment regardless of the duration of the swap or option and regardless of whether it is traded on a trading venue or not.

 

Article 10

Characteristics of other derivative contracts relating to currencies

 

1. For the purposes of Section C (4) of Annex I to Directive 2014/65/EC, other derivative contracts relating to a currency shall not be a financial instrument where the contract is one of the following:

 

(a) a spot contract within the meaning of paragraph 2 of this Article,

 

(b) a means of payment that:

 

(i) must be settled physically otherwise than by reason of a default or other termination event;

 

(ii) is entered into by at least a person which is not a financial counterparty within the meaning of Article 2(8) of Regulation (EU) No. 648/2012 of the European Parliament and of the Council;

 

(iii) is entered into in order to facilitate payment for identifiable goods, services or direct investment; and

 

(iv) is not traded on a trading venue.

 

2. A spot contract for the purposes of paragraph 1 shall be a contract for the exchange of one currency against another currency, under the terms of which delivery is scheduled to be made within the longer of the following periods:

 

(a) 2 trading days in respect of any pair of the major currencies set out in paragraph 3;

 

(b) for any pair of currencies where at least one currency is not a major currency, the longer of 2 trading days or the period generally accepted in the market for that currency pair as the standard delivery period;

 

(c) where the contract for the exchange of those currencies is used for the main purpose of the sale or purchase of a transferable security or a unit in a collective investment undertaking, the period generally accepted in the market for the settlement of that transferable security or a unit in a collective investment undertaking as the standard delivery period or 5 trading days, whichever is shorter.

 

A contract shall not be considered a spot contract where, irrespective of its explicit terms, there is an understanding between the parties to the contract that delivery of the currency is to be postponed and not to be performed within the period set out in the first subparagraph.

 

3. The major currencies for the purposes of paragraph 2 shall only include the US dollar, Euro, Japanese yen, Pound sterling, Australian dollar, Swiss franc, Canadian dollar, Hong Kong dollar, Swedish krona, New Zealand dollar, Singapore dollar, Norwegian krone, Mexican peso, Croatian kuna, Bulgarian lev, Czech koruna, Danish krone, Hungarian forint, Polish złoty and Romanian leu.

 

4. For the purposes of paragraph 2, a trading day shall mean any day of normal trading in the jurisdiction of both the currencies that are exchanged pursuant to the contract for the exchange of those currencies and in the jurisdiction of a third currency where any of the following conditions are met:

 

(a) the exchange of those currencies involves converting them through that third currency for the purposes of liquidity;

 

(b) the standard delivery period for the exchange of those currencies references the jurisdiction of that third currency.

 

 

 

 

 

 

 

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Attachment

 

 

Extract: Commission Staff Working Document Impact Assessment Accompanying the document Commission Delegated Regulation supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council with regard to definitions, transparency, portfolio compression and supervisory measures on product intervention and positions {C(2016) 2860 final} {SWD(2016) 156 final}, 18.5.2016, SWD(2016) 157 final, Annex 9, p. 124-125

 

 

Attachments:
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Download this file (Harmonised definition of FX spot contracts.pdf)Harmonised definition of FX spot contracts.pdfExtract: Commission Staff Working Document Impact Assessment {C(2016) 2860 final} {SWD(2016) 156 final}, 18.5.2016, SWD(2016) 157 final, Annex 9, p. 124-125260 Kb03/09/16 14:54

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