Markets in Financial Instruments Directive II: Update for commodities businesses

If you are in the commodities or energy business and benefit from an exemption from the Markets in Financial Instruments Directive (MiFID) you should be aware of the changes to be brought in by MiFID II which are aimed at widening the net and bringing more firms within the scope of regulation.

When will an activity be considered to be ancillary to the main business?

Current exemption

If you are a commodities firm which deals on own account or provides investment services in commodity derivatives to clients of the main business, you are probably currently exempt from the scope of MiFID I, provided this is an ancillary activity to your main business (when considered at group level). (Exemption A) (Art 2(1)(i) MiFID I).

You will also currently be exempt if your business consists of dealing on own account in commodities or commodity derivatives as long as your firm does not belong to a group whose main business is investment or banking business (Exemption B) (Art 2(1)(k) MiFID I).

MiFID II exemptions for commodity derivatives transactions

On 19 December 2014, the European Securities and Markets Authority published final technical advice to the European Commission and a consultation paper on the MiFID II Directive and MIFIR (the Consultation Paper).

The Consultation Paper includes draft technical standards on criteria for establishing when an activity is to be considered ancillary to the main business at a group level. MiFID II provides a narrower interpretation of exempt activities bringing a range of previously excluded firms within the Directive's scope and addresses any perceived competitive distortions that arise under the existing exemptions for commodity firms under MiFID I.

Headlines

• Exemption B will disappear.
• The spirit of Exemption A will be carried over.
• Additional focus will be placed on the newly drafted exemption. (The New Exemption) (Art 2(1)(j) MiFID II)
• The New Exemption states that MiFID II will not apply to firms carrying on the following "eligible activity":
  • Dealing on own account, including market makers, in commodity derivatives or emission allowances (or derivatives of them) but excluding firms who deal on own account when executing client orders; OR
  • Providing investment services, other than on own account, in commodity derivatives or emission allowances (or derivatives of them) to the customers or suppliers of their main business.
• In both cases, the exemption is subject to the following conditions:
  • the activity is an ancillary activity to the firm's main business, when considered on a group basis
  • that main business is not the provision of investment services or banking activities or market making in commodity derivatives
  • firms do not apply a high frequency algorithmic trading technique
  • firms in the UK notify the Financial Conduct Authority (FCA) annually that they make use of the exemption and, if requested to do so, report to the FCA the basis on which they consider that their activity is ancillary to their main business.

A bit more detail

1. Two thresholds will apply to establish whether an activity is ancillary and a firm will not benefit from the exemption if it exceeds one of these two thresholds.
2. Draft methods of calculation of the thresholds are set out in Chapter 7 of the Consultation Paper.
3. The definition of group will include the parent undertaking and all its subsidiaries, including entities domiciled in the EU and in third countries, regardless of whether the group is headquartered inside or outside of the EU.
4. For the purposes of establishing whether an activity is to be considered ancillary to the main business of the group, certain activities, referred to as "privileged transactions", will be excluded. Privileged transactions will include the following:
   • Intra-group transactions for servicing group-wide liquidity or risk management purposes. The definition of these transactions is the same as Article 3 of EMIR.(Regulation 648/2012/EU). For non-financial counterparties, an intragroup transaction is an over-the-counter (OTC) derivative contract entered into with another counterparty in the same group provided both parties are included in the same consolidation on a full basis and subject to appropriate centralised risk evaluation, measurement and control procedures and that the counterparty is in the EU. If it is not in the EU there must be a Commission implementing act establishing equivalence, amongst other matters, in place.
   • Transactions in OTC and non-OTC derivatives which are objectively measurable as reducing risks directly relating to commercial activity or treasury financing activity.
   • Transactions in commodity derivatives and emission allowances entered into to fulfil obligations to provide liquidity on a trading venue, where those obligations are required by regulatory authorities in accordance with EU or national laws or regulations or by trading venues. An example of such obligations is the mandatory market making requirements established by Ofgem obliging the large electricity suppliers to post the prices at which they buy and sell wholesale electricity on power trading platforms up to two years in advance and to trade at these prices.

Next steps

• Conduct a review of your current and projected business model in the context of the draft criteria.
• Consider whether you might wish to respond to the Consultation.
• The Consultation is open for comments received by 2 March 2015.
• If you would like further information or advice please contact head of financial services regulation, penny.sanders@gowlingwlg.com.