MiFID II ancillary activity exemption - trading test (derivatives ratio or proxy test)

 


 

 

 

The trading test (alternative descriptions: "derivatives ratio" or "proxy test" - all these terms are used interchangeably) serves for the determination whether the entity qualifies for the MiFID II ancillary activity exemption and represents, one of the two - alternative - methods of the main business test (MBT).

 

The details of this test are stipulated in Article 3(1)(a), (3), (4) and (10) 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).

 

Commission Delegated Regulation (EU) 2017/592 of 1 December 2016 has included the trading test in the regulatory set-up as the alternative to the capital employed test.

 

The trading test compares the ratio of non-privileged derivatives trading in the group (numerator) to the total derivatives trading of the group (denominator).

 

 

Article 3(1)(a), (3) and (4) and (10) 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

 

Article 3 


Main business threshold

 

1. The activities referred to in Article 1 shall be considered to constitute a minority of activities at group level where they comply with any of the following conditions:

(a) the size of those activities calculated in accordance with the first subparagraph of paragraph 3 does not account for more than 10% of the total size of the trading activity of the group calculated in accordance with the second subparagraph of paragraph 3;

 

....

 

3. The size of the activities referred to in Article 1 undertaken by a person within a group shall be calculated by aggregating the size of the activities undertaken by that person with respect to all of the asset classes referred to in Article 2(1) in accordance with the same calculation criteria as that referred to in Article 2(2). 
The total size of the trading activity of the group shall be calculated by aggregating the gross notional value of all contracts in commodity derivatives, emission allowances and derivatives thereof to which persons within that group are a party to.

 

4. The aggregation referred to in the first subparagraph of paragraph 3 shall not include contracts where the person within the group that is a party to any of those contracts is authorised in accordance with Directive 2014/65/EU or Directive 2013/36/EU.

 

 ...

 


10. The values resulting from the calculations referred to in this Article shall be denominated in EUR.

 

 

Numerator

 

 

To determine the size of the trading activity in order to compare it to the size of the main activity undertaken by the group the trading test takes into account volume of all trading activity in commodity derivatives, emission allowances or derivatives thereof measured in the gross notional value of the underlying.

 

It is taken "as a proxy for the commercial activity that the person or group engages in as its main business. This proxy should be easy and cost efficient for persons to apply as it builds on data already required to be collected for the first test while at the same time establishing a meaningful test" (Recital 7 of the Commission Delegated Regulation (EU) 2017/592 of 1 December 2016).

 

Recital 8 of the said Regulation further clarifies that this proxy is appropriate because "a rational risk-averse entity, such as a producer, processor or consumer of commodities or emission allowances, is deemed to hedge the volume of the commercial activity of its main business with an equivalent volume of commodity derivatives, emission allowances or derivatives thereof. Therefore the volume of all its trading activity in commodity derivatives, emission allowances or derivatives thereof measured in the gross notional value of the underlying is an appropriate proxy for the size of the main business of the group. As groups whose main business activities are not related to commodities or emission allowances would not use commodity or emission allowances derivatives as a risk-reducing tool, their trading in commodity derivatives, emission allowances or derivatives thereof would not qualify as hedging."

 

In the numerator, the following items are deducted from the volume of the overall trading activity undertaken by the person:

 

1. intra-group transactions as referred to in Article 3 of EMIR Regulation, serving group-wide liquidity and/or risk management purposes;


2. transactions in derivatives which are objectively measurable as reducing risks directly related to the commercial activity or treasury financing activity (i.e. hedging);


3. transactions in commodity derivatives and emission allowances entered into to fulfil obligations to provide liquidity on a trading venue ("where such obligations are required by regulatory authorities in accordance with Union or national laws, regulations and administrative provisions or by trading venues");


jointly: "privileged transactions" (Article 2(4) of MiFID II).

 

Trading activities conducted by a MiFID authorised firm within the group are also excluded from the said aggregation.

 

For the calculation of the numerator the notional amount of ETD option contracts should be determined with the use of the following formula (ESMA Opinion of 7 July 2017 on ancillary activity – market size calculation, ESMA70-156-165):

 

lot size/multiplier (number of underlying instruments to be delivered for one contract) * quantity (number of contracts traded) * strike price.

 

According to the document "Joint associations' Questions & Answers (Q&A) on Regulatory Technical Standard (RTS) 20 of the Markets in Financial Instruments Directive (MiFID II)" of 16 February 2017 the numerator of the proxy test is to be applied on the person (entity) level, by each entity within the same group dealing in derivatives and not on an aggregated group level.

 

The above organisations argue that "the clear wording under the first sub-paragraph of article 3(3) RTS 20 provides that the numerator is composed of the activities undertaken by “a person” within a group, i.e. the numerator is calculated on an individual person (entity) level".

 

 

Denominator

 

 

The total size of the trading activity of the group is to be calculated by aggregating the gross notional value of all contracts in commodity derivatives, emission allowances and derivatives thereof to which persons within that group are a party to.

 

However, there are doubts as to the denominator's scope, since the respective provision (Article 3 of the Regulation) is not explicit in that regard.

 

In the absence of clear restriction, it appears that the denominator is not limited to the EU activity and has the global reach.

 

 

Threshold's values

 

 

In principle, to pass the trading test the size of activities listed in the numerator must not account for more than 10% of the total size of the trading activity of the group (denominator) 

 

However, given the application of the so-called "backstop mechanism", the final figures are as in the table:

 

 

 

Proportion of non-priviledged

commodity derivatives trading

versus total EU commodity

derivatives trading at group

level (gross notional value)

 

Oil   Gas Power   Coal    Metals  Emissions

Derivatives on other commodities, 

including freight and "exotic" 

(Section C 10 of Annex I to MiFID II)

 

Under 10%

 

 3%  3%  6%  10%  4% 20%  15%

 

 10% - 49,9%

 

1.50%   1.50%  3%  5% 2% 10%  7.50%

 

 50% or greater

 

 0.60%     0.65%     1.20%    2% 0.80% 4%  3%

 

 

Overall, the practical functioning of the test is based on dependency: the higher the percentage of the speculative activity within all trading activity, the lower this threshold, for example:

 

 

Recitals 7 - 9 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

 

(7) The size of the trading activity as used under the first method of the second test is taken as a proxy for the commercial activity that the person or group engages in as its main business. This proxy should be easy and cost efficient for persons to apply as it builds on data already required to be collected for the first test while at the same time establishing a meaningful test.


(8) This proxy is appropriate because a rational risk-averse entity, such as a producer, processor or consumer of commodities or emission allowances, is deemed to hedge the volume of the commercial activity of its main business with an equivalent volume of commodity derivatives, emission allowances or derivatives thereof. Therefore the volume of all its trading activity in commodity derivatives, emission allowances or derivatives thereof measured in the gross notional value of the underlying is an appropriate proxy for the size of the main business of the group. As groups whose main business activities are not related to commodities or emission allowances would not use commodity or emission allowances derivatives as a risk-reducing tool, their trading in commodity derivatives, emission allowances or derivatives thereof would not qualify as hedging.


(9) The use of commodity derivatives as a risk-reducing tool however cannot be considered a perfect proxy for all the commercial activity that the person or group conducts as its main business since it may not take into account other investments in fixed assets unrelated to derivative markets. In order to correct the potential mismatch between a group's trading in commodity derivatives and the actual size of its main business with regard, in particular, to small groups the first method of the second test should contain a backstop which recognises that the trading activity undertaken by the persons within the group should also not exceed a certain percentage of any of the thresholds set under the first test for each relevant asset class to be deemed ancillary. The higher the percentage of speculative activity within all trading activity of a group, the lower the threshold set under the first test.

 

- 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.

 

Pursuant to legislators, calibrating the main business test in this way ensures 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.

 

 

 globe  

    Territorial scope   

 

 

With respect to the numerator of the proxy test, the wording under the first sub-paragraph of Article 3(3) of the Commission Delegated Regulation (EU) 2017/592 makes a reference to the calculation criteria of Article 2(2) and, therefore, the numerator of this test - analogously to the market share test - is limited to activities in the European Union.

 

In turn, the denominator of the proxy test is to be calculated on a world-wide group basis as the second sub-paragraph of Article 3(3) of the Commission Delegated Regulation (EU) 2017/592 refers to “all contracts...to which persons within the group are party to”.

 

In Recital (1) Commission Delegated Regulation (EU) 2017/592 it is stated that “In line with Article 2(11) of Directive 2013/34/EU of the European Parliament and of the Council', a group is considered to comprise the parent undertaking and all its subsidiary undertakings and includes entities domiciled in the Union and in third countries regardless of whether the group is headquartered inside or outside the Union.”

 

Such stance is shared by Bundesverband der Energie- und Wasserwirtschaft (BDEW), European Federation of Energy Traders (EFET), EURELECTRIC, Energy UK, EUROGAS, Futures Industry Association (FIA) and International Oil and Gas Producers association (IOGP) in the document of 16 February 2017 "Joint associations' Questions & Answers (Q&A) on Regulatory Technical Standard (RTS) 20 of the Markets in Financial Instruments Directive (MiFID II)".

  

 

 

 

IMG 0744

    Documentation    

 

 

 

 

ESMA Opinion of 6 July 2017 on ancillary activity – market size calculation, ESMA70-156-165

 

Questions and Answers, on MiFID II and MiFIR commodity derivatives topics, 7 July 2017, ESMA70-872942901-28

 

Joint associations' Questions & Answers (Q&A) on Regulatory Technical Standard (RTS) 20 of the Markets in Financial Instruments Directive (MiFID II), 16 February 2017

 

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 businessArticle 3(1)(a), (3) and (4) and (10), Recitals 7 - 9

 

Commission Delegated Regulation (EU) of 1.12.2016 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 C(2016) 7643 final

 

 

ESMA Consultation Paper – Annex B Regulatory technical standards on MiFID II/MiFIR of 19 December 2014 ESMA/2014/1570, p. 373-380

 

 

 

 

 

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Last Updated on Monday, 24 July 2017 21:59
 

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