Template:M intro mifid2 Dealing on own account

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 See, for example, this in the FCA’s Q&A to its perimeter guidance rules which, indeed, no longer represent European law but are all the same heavily influenced by it, to the point of being presently identical: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.

So our starting point is this: whatever the regulations actually say — and God knows they are a mess, and we have met no-one with (or for that matter without) any expertise who is prepared to declare, hand on heart, what they actually say — it cannot be right that they are meant to to bring emissions investors — who are, by and large, acting through the agency of MiFID-regulated brokers and dealers — to themselves be regulated by MiFID. That would be a stupid outcome.

The curious case of commodity derivatives and emission allowances

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 are hedging 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 all commodity activities being out of scope from MiFID 1 altogether, to some being in scope for MiFID 2, even when the same activities in other, “normal” MiFID instruments are not.

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 2(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” in commodity products, as long as they are not executing client orders or providing investment services in commodity products to their customers, and:

• Taken together this dealing activity is “ancillary” to their group’s “main business”,
• That main business is not providing banking or investment services or making markets in commodity derivatives
• They are not using high-frequency trading algorithms; and
• When asked, explain to their competent authority 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.