In our previous blog we saw how MiFID II intends to ensure transparency across all asset classes, including those that are not in scope today, and the impact it will have on market participants. In this second installment we look at the regulation of commodities through position limits.
To recap, most commodities trading firms are exempted from MIFID when trading on their own accounts. The result, as postulated by the regulators, was increasing food prices due to unencumbered speculation[1]. The main concern is insufficiency of the intervention power of regulators with regard to commodity markets. More stringent rules in MiFID II attempt to remedy this area of concern.
The key reforms
Position limits on commodities trading have been added to MiFID II to limit speculation on energy and food prices. The key considerations in this area are as follows:
- Position limits must be objectively justified and proportionate, taking into account the liquidity of the specific market and its orderly functioning;
- Some position limits will automatically expire within six months unless they are renewed by financial authorities;
- Where national authorities set restrictions that are different from those suggested by ESMA, the governing body will have to notify the supervisor and explain their reasons for doing so.
Organisations will be required to provide real time position reports detailing their own and client holdings to the venue they are a member of. These reports will then be scrutinised by a regulator. Reports of aggregate positions by trade and financial instrument category will be published weekly, and execution venues will also be required to supply content of such reports to national regulators when requested.
In the interests of providing uniform protection to investors across the EU, the proposition is to amend existing exemptions as follows:
- There will be exemptions for firms that do not hold client money and whose services are limited to investment advice and/or arranging transactions;
- Under the new proposals, the exemption may only be granted where requirements equivalent to the MiFID II authorisation conditions, supervisory procedures and investor protection requirements are imposed on exempt firms by national regulators.
The impact
MiFID II will have a significant impact across the whole securities value chain, from front-office sales and trading to back-office reporting. Specifically for commodities, the impact is likely to be shaped as follows:
- Type and number of trading venues are expected to increase;
- Greater numbers of firms expected to trade commodities;
- Introduction of position limits;
- Revision of current exemptions;
- New or revised IT infrastructure that will include all MiFID rules;
- Market liquidity will be impacted significantly. The finer details are yet to be finalised by the FSA, but it is an area that all parties are closely watching to see what the outcomes may be;
- Position limits will redistribute market share.
It’s fair to say there will be a high impact on commodity derivatives. All constituents need to begin their impact analysis immediately to ensure they are ready to implement the necessary changes and not have to face the possibility of sanctions by regulators. Greater powers will be given to financial authorities to monitor firms and intervene in any trading activity, which should stop any potential mis-selling of derivative contracts; but what ESMA will do exactly is yet to be seen. As organisations begin the analysis on the effects of MiFID II, the predicted impacts will become reality and the financial industry will see what the future of commodity derivatives will hold.
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