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MiFID 2 Anatomy™
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2(4). ESMA shall develop draft regulatory technical standards to specify, for the purposes of point (j) of paragraph 1, the criteria for establishing when an activity is to be considered to be ancillary to the main business at a group level.
Those criteria shall take into account at least the following elements:
(a) the need for ancillary activities to constitute a minority of activities at a group level;
(b) the size of their trading activity compared to the overall market trading activity in that asset class.
In determining the extent to which ancillary activities constitute a minority of activities at a group level ESMA may determine that the capital employed for carrying out the ancillary activity relative to the capital employed for carrying out the main business is to be considered. However, that factor shall in no case be sufficient to demonstrate that the activity is ancillary to the main business of the group.
The activities referred to in this paragraph shall be considered at a group level.
The elements referred to in the second and third subparagraphs shall exclude:
(a) intra-group transactions as referred to in Article 3 of Regulation (EU) No 648/2012 [EMIR — Ed] that serve group-wide liquidity or risk management purposes;
(b) transactions in derivatives which are objectively measurable as reducing risks directly relating to the commercial activity or treasury financing activity;
(c) transactions in commodity derivatives and emission allowances entered into to fulfil obligations to provide liquidity on a trading venue, where such obligations are required by regulatory authorities in accordance with Union law or with national laws, regulations and administrative provisions, or by trading venues.
ESMA shall submit those draft regulatory technical standards to the Commission by 3 July 2015.
Power is delegated to the Commission to adopt the regulatory technical standards referred to in the first subparagraph in accordance with Articles 10 to 14 of Regulation (EU) No 1095/2010.
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RTS 5(1) For the purposes of point (b) of the fifth subparagraph of Article 2(4) of Directive 2014/65/EU, a transaction in derivatives shall be considered objectively measurable as reducing risks directly relating to the commercial activity or treasury financing activity when one or more of the following criteria is met:
(a) the transaction reduces the risks arising from the potential change in the value of assets, services, inputs, products, commodities or liabilities that the person or its group owns, produces, manufactures, processes, provides, purchases, merchandises, leases, sells, or incurs or reasonably anticipates owning, producing, manufacturing, processing, providing, purchasing, merchandising, leasing, selling or incurring in the normal course of its business;
(b) the transaction covers the risks arising from the potential indirect impact on the value of assets, services, inputs, products, commodities or liabilities referred to in point (a), resulting from fluctuation of interest rates, inflation rates, foreign exchange rates or credit risk;
(c) the transaction qualifies as a hedging contract pursuant to International Financial Reporting Standards adopted in accordance with Article 3 of Regulation (EC) No 1606/2002 of the European Parliament and of the Council.
(2) For the purposes of paragraph 1, a qualifying risk-reducing transaction taken on its own or in combination with other derivatives is one for which a non-financial entity:
(a) describes the following in its internal policies:
- (i) the types of commodity derivative, emission allowance or derivative thereof contracts included in the portfolios used to reduce risks directly relating to commercial activity or treasury financing activity and their eligibility criteria;
- (ii) the link between the portfolio and the risks that the portfolio is mitigating;
- (iii) the measures adopted to ensure that the transactions concerning those contracts serve no other purpose than covering risks directly related to the commercial activity or the treasury financing activity of the non-financial entity, and that any transaction serving a different purpose can be clearly identified;
(b) is able to provide a sufficiently disaggregate view of the portfolios in terms of class of commodity derivative, emission allowance or derivative thereof, underlying commodity, time horizon and any other relevant factors.
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This whole business of what is or is not in scope for MiFID — especially where it comes to the fractal coastline of commodities and commodity-like things, is an utter disaster with a face only a Eurocrat could love. This article stands as a sort of help to the articles on the MiFID-regulated investment service of dealing on own account, the related de minimis threshold test, and also EMIR’s hedging exemption.
This regulatory technical standard describes in better detail what is meant by “objectively measurable as reducing risks” directly relating to a person’s commercial activity or treasury financing activity.
So.
For a start, “dealing on own account” when it comes to emissions allowances and commodity derivatives is a regulated investment service, with, in Article 2(1)(j), some exceptions, buried amongst which is that the activity is “ancillary to their main business, when considered on a group basis”. Something will be considered ancillary (assuming all no other other criteria are triggered: see dealing on own account about this as it will do your head in), if it passes the de minimis threshold test, which looks at the “net outstanding notional exposure” in commodity derivatives for cash settlement or emission allowances or derivatives thereof for cash settlement.
What counts as “net outstanding notional exposure” is no cake walk, since the regulations teeter uneasily between scoping out physical commodities, and scoping in cash-settled ones, exchange-traded ones, and so on. It is a thorough mess. Cue this regulatory technical standard. It may not do what it sets out to do - by putting some contracts out of scope, one wonders whether one should be allowed to count them for risk-reducing purposes. For example: If I have a physical emissions contract (that is, I hold an emissions allowance) which I am hedging with a cash-settled emissions derivative, and when calculating my net outstanding notional exposure I must exclude the hedging transaction, because it is a hedging transaction, but cannot exclude the emission allowance it actually hedges, then this exemption puts me in a worse position than I would have been in had I not counted to the hedge.
This is madness of course, and is plainly not what is intended, but good luck getting a legal opinion confirming that without significant runniness around the edges.
Anyway, we are proceeding on the basis that what was intended was for hedging derivatives to reduce net outstanding notional exposure, that they therefore knock out any positions, however constituted that they hedge, and that therefore the hedging exemption is a good thing. In this case, any derivative that matches the exposure you face on an emissions allowance, to the return you must pay on a secured note repackaging the allowance and the derivative, on any account “reduces the risks arising from the potential change in the value of assets ... or liabilities that the person ... owns ... or incurs ... in the normal course of its business”.
This may not help: it may make things worse, but it feels like it ought to be a positive step.
See also