Dealing on own account

MiFID 2 Anatomy™ →Go uptown 4(1)(6) “dealing on own account” means trading against proprietary capital resulting in the conclusion of transactions in one or more financial instruments; 2(1)(d) Persons dealing on own account in financial instruments other than commodity derivatives or emission allowances or derivatives thereof and not providing any other investment services or performing any other investment activities in financial instruments other than commodity derivatives or emission allowances or derivatives thereof unless such persons: (i) are market makers; (ii) are members of or participants in a regulated market or an MTF, on the one hand, or have direct electronic access to a trading venue, 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; (iii) apply a high-frequency algorithmic trading technique; or (iv) deal on own account when executing client orders; Persons exempt under points (a), (i) or (j) of MiFID II Article 2(1) are not required to meet the conditions laid down in this point in order to be exempt. 2(1)(j) persons: (i) dealing on own account, including market makers, in commodity derivatives or emission allowances or derivatives thereof, excluding persons who deal on own account when executing client orders; or (ii) providing investment services, other than dealing on own account, in commodity derivatives or emission allowances or derivatives thereof to the customers or suppliers of their main business; provided that: —for each of those cases individually and on an aggregate basis this is an ancillary activity to their main business, when considered on a group basis, and that main business is not the provision of investment services within the meaning of this Directive or banking activities under Directive 2013/36/EU, or acting as a market-maker in relation to commodity derivatives, —those persons do not apply a high-frequency algorithmic trading technique; and —those persons notify annually the relevant competent authority that they make use of this exemption and upon request report to the competent authority the basis on which they consider that their activity under points (i) and (ii) is ancillary to their main business; MiFID 2: Less fondly known as EU Directive 2014/65/EU (EUR Lex) | MiFID 1Articles: 16(7) (Recording of Communications) Tell me more Sign up for our newsletter — or just get in touch: for ½ a weekly 🍺 you get to consult JC. Ask about it here.

Dealing on own account generally

The activity “dealing on own account” is vaguely defined in MiFID — always has been — as “'trading against proprietary capital resulting in the conclusion of transactions in one or more financial instruments” — but given MiFID’s purpose, generally has been understood as being restricted to brokerage and market-making activity; being continual prepared to fulfil third-party customer demand or provide market liquidity, but doing this as a principal not an agent, and therefore being permitted to hold “prop” inventory.

In other words, this is not about participants using their own capital to buy, and go on risk to, financial instruments. See, for example, this in the FCA’s Q&A to its perimeter guidance rules which, indeed, no longer represent European law but are all the same heavily influenced by it, to the point of being presently identical:

“Dealing on own account involves position-taking which includes proprietary trading and positions arising from market-making. It can also include positions arising from client servicing, for example where a firm acts as a systematic internaliser or executes an order by taking a market or ‘unmatched principal’ position on its books.

Dealing on own account may be relevant to firms with a dealing in investments as principal permission in relation to MiFID financial instruments, but only where they trade financial instruments on a regular basis for their own account, as part of their MiFID business. We do not think that this activity is likely to be relevant in cases where a person acquires a long term stake in a company for strategic purposes or for most venture capital or private equity activity. Where a person invests in a venture capital fund with a view to selling its interests in the medium to long term only, in our view he is not dealing on own account for the purposes of MiFID.”

Indeed, MiFID is meant to protect people like that, not regulate them.

The curious case of commodity derivatives and emissions

We mention this only because there are some odd provisions of MiFID 2 which potentially put SPVs into scope should they look to securitise commodity derivatives or carbon emission allowances or EA derivatives (which for sanity’s sake we will call “commodity products” on this page, even though it isn’t a fantastically accurate description).

So, an odd thing. In MiFID 1, commodity derivatives and carbon emissions products were (largely) excluded from scope. To ensure participants on commodity derivatives markets appropriately regulated and supervised, MiFID 2 narrowed exemptions, especially as regards “dealing on own account”. The idea being, you would think, to make sure that commodity based financial products that in other ways resembled MiFID financial instruments — and commodity swaps to that, as do emissions allowances — should be regulated in the same way. You wouldn’t expect them to be regulated more heavily.

Anyway. When trying to bring commodity derivatives and EUAs into scope for MiFID, the regulations and technical standards do a curious job of them handling the usual exemptions, such as those under Art 2(1)(d) (see full text in panel on right), which, in a nutshell, exempts from MiFID:

2(1)(d) Persons dealing on own account other than in commodity products and who do not provide any other investment services or do any investment activities other than in commodity products unless they are market makers participate on or have direct electronic access to a regulated market or MTF (excluding corporates who trade to hedge their commercial or financing activity in an objectively measurable way), use high-frequency trading algorithms, or are executing client orders.

All very tedious, but what is going on here is exactly as presaged above: if you are just a regular joe, and you aren’t making markets, using algos, executing client orders, or directly accessing a regulated market beyond your normal funding and hedging activity, you don’t need to be authorised under MiFID 2 ... unless you’re transacting in commodity products.

Like, what? we have gone from commodities being out of scope from MiFID altogether, to being in scope for MiFID 2, even when normal MiFID instruments aren’t. That cannot have been what the regulators intended. Can it? To see, we have to continue down the laundry list of exemptions. The next one that might help is Article 1(j) — again, set out in full in the panel for completists, but what it means in layperson’s terms is the following persons are exempt:

2(1)(j) persons who “deal on own account” commodity products, as long as they are not executing client orders or providing other investment services in commodity products to their customers or suppliers, an further provided that:

• taken together this activity is an ancillary to their main business at a group level,
• that main business is not providing banking or investment services, or acting as a market-maker in commodity derivatives
• they are not using high-frequency trading algorithms; and
• they annually notify their competent authority that they are using this exemption and, when asked, explain how consider their activity to be “ancillary to their main business”;

Ok we are getting somewhere, but — ah: there is this gnomic question of what counts as “ancillary to one’s main business”. Fear not: Article 2 also addresses that, but punts it off to ESMA to come up with some regulatory technical standards governing it. This has been recently updated and you can find the latest — as of June 2022 — here.

There are three alternative ancillary activity tests. Under the “de minimis threshold test”, a person’s activity is ancillary to its main business if its net outstanding notional exposure in cash settled commodity products traded in the EU, excluding those traded on a venue, is less than EUR 3 billion annually. The other two tests are a bit more speculative and fiddly to calculate, but for a repackaging SPV, the first one gives plenty of room to work with.

The annual threshold should be calculated against an average over three-years on a rolling basis.