With the ever-progressing convergence between physical and financial markets, there has been a growing need to stretch the scope of financial regulations to its various extended markets. After the reforms in the MiFID, the new and improved MiFID II has extended its focus to commodity markets. Commodities exchange refers to the trade of commodities including metals, energy, livestock and agricultural products, from where it is produced to where it is needed. Aligning the G20 agreement to enhance regulation, operations and transparency of commodities markets, MiFID II has introduced several regulations to cover a wider scope of the commodities trading industry which will affect buyers, brokers and venues involved.
One of the biggest enhancements is the introduction of Organised Trading Facilities (OTFs). Within an OTF, multiple third-party buying and selling interests in bonds, structured finance products, emission allowances or derivatives can be traded. This has led to the inclusion of Emission Allowances (EUAs) as financial products. In addition, commodities having “characteristics of a financial instrument” have also been classified as financial products being traded in OTFs. The classification of these somewhat vague products will be determined by the level of standardisation and trade situation of the contracts binding these products.
MiFID II has also altered and removed a few of the exemptions which previously enabled some commodity derivative trading firms to rely on these exemptions to avoid the MiFID authorisation. The “dealing on own account” exemption which relieved firms dealing with commodity derivatives, EUAs or derivatives on EUAs from MiFID authorisation has been heavily reworded to remove a lot of products from it’s scope. MiFID II has significantly altered the ancillary activity exemption as well. The scope of ancillary activity exemption has been narrowed down to qualify only certain types of investment firms that fulfil specific criteria. The commodity dealer exemption, which was tailored for individuals dealing in commodity derivatives has been disbanded as well. In addition, new “specialist exemptions” have been introduced for operators under the Emissions Trading Directive.
Under MiFID II, position limits criteria have been introduced to minimise risks and disorderly trading. ESMA has drafted two Regulatory Technical Standards (RTS) to brief local authorities on setting the methodology to limit the net position an entity can hold in the market. Similarly, MiFID II has implemented the position reporting requirement which requires commodity traded venues to publicly issue a weekly report of the accumulated positions held by the various categories of position holders within the venue. Interestingly, position reports apply on EUAs while position limits don’t.
With many exemptions being removed, many firms and brokers in the commodity trading industry could now expect additional bureaucracy and costs that didn’t exist before. The reformed ancillary activity exemption has the potential to cause complications for MiFID regulated firms who additionally deal with out of scope products. Similarly, newly introduced position limits and reporting criteria could present buyers and venue operators with numerous constraints. The overall impact on the commodities trading industry perhaps won’t be uniform and will depend on how each entity is structured.