|Dealing on own account exemption under MiFID II - Article 2(1)(d)|
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:
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
Note, however, that the above exclusion relating to DEA does not apply to clients accessing an EU trading venue through sub-delegated DEA (Tier 2 DEA) - see 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).
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
- j - ancillary activity;
"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.
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)."
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.
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),
3) in accordance with Article 1(3) MiFIR, Title V of the MiFIR, (encompassing requirements for derivatives, in particular, the trading obligation, clearing obligation, indirect 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)).
MiFID II Directive, Article 2(1)(d)
|Last Updated on Wednesday, 07 March 2018 13:59|