Implementation (un)certainty for corporates
In less that six months, the new EU Markets in Financial Instruments Directive (MiFID II) will come into force. In contrast to the previous MiFID, which was only indirectly relevant for corporate treasurers, from 3 January 2018 there will be a direct effect in certain instances due to the so-called ancillary activity exemption.
A fundamental difference for 'non-banks' stems from the fact that in future all trade activities with commodity derivatives as well as emission allowances (incl. derivatives thereof) will fall within the scope of application of MiFID II and consequently will require an authorisation. Of significance is that trading activity will be understood as any transaction involving one of the above products – exchange-traded as well as OTC transactions. Thus, unlike the case of financial derivatives, for which, according to the explanatory documents of MiFID II, a professional trading book remains necessary to be classified as an investment firm under the scope of the regulation, the impact is expanded to industrial firms.
To prevent any of these firms that use commodity derivatives in the ordinary course of business or deal on their own account on a very limited basis from having to undergo a licensing procedure including capital requirements, the MiFID II provides for the so-called ancillary activity exemption. Accordingly, firms which fall under the scope of application must inform the national supervisory authorities, e.g. BaFin for Germany, that they carry out an ancillary activity.
The notification itself is not further defined in MiFID II; therefore specific requirements are expected from the national supervisory authorities. However, it already seems clear at this point that notification will have to made merely in short form, not requiring accompanying documentation. Such documentation will then only have to be submitted to the national regulator upon request. In future, notification must be made in the first quarter of the calendar year. There is a derogation, which is not very clear for users, for the first year of application. According to the European Securities and Markets Authority (ESMA)'s Q&A, the first notification must already be made by 3 January 2018. This seems rather challenging in view of the implementation and the general period under review of three previous years in each case.
Pertinent for the determination as to whether an ancillary activity exists is a multi-stage test, which is defined in MiFID II as well as the related Regulatory Technical Standard 20. In this respect, firms must first carry out the so-called market size test to measure their own non-privileged trading activity against total market size. Transactions, which are effectively and demonstrably entered into to hedge risks, are deemed privileged and therefore not considered. Firms can rely on the existing processes of the European Market Infrastructure Regulation (EMIR), but should note that not only OTC contracts fall under the scope of application of MiFID II. Accordingly, all transactions carried out on trading venues are to be included.
For a wide range of commodities, determining the total market size to be used as a denominator in the market size test presents a particular challenge. The total market size has to be specified as an exogenous variable by the regulator or trading venues. As conceptually all derivatives, including bilateral contracts concluded outside a trading venue, are to be taken into account, many of the requirements are still pending. ESMA published an opinion most recently on 6 July on the determination of market size in individual commodity classes, which can be used as guidance.
As a second step, a test must be performed which relates to the main business of the group. There are two procedures to choose from:
All tests are to be calculated based on the previous three years.
In practice, for firms which do not engage in speculative trading in commodity derivatives or emission allowances, the question arises as to the extent to which a calculation could be dispensed with. Although to that effect no definitive clarity can be gleaned from the regulation itself, it seems permissible for companies to do without a complex calculation. This would then only be the case if the numerator consistently and demonstrably were 0. If companies decide to adopt such an approach, it is advisable that firms nonetheless prepare comprehensive qualitative documentation of the privileged status of all transactions in view of a possible request from the national supervisory authorities.
In conclusion, it can be observed that even in the case of limited trade in commodity derivatives and emission allowances (incl. derivatives thereof) action is required for 3 January 2018. The remaining time to implement the test calculation is growing short and many uncertainties remain which are often filled with the current emerging market and industry practice.
A further change introduced by MiFID II concerns the expansion of EU trading venues to so-called organised trading facilities (OTF). These constitute a further trading venue within the scope of the regulation, in addition to the regulated market and the multilateral trading facility.
An OTF is characterised as a multilateral system, in which a variety of buying and selling occurs, but is neither a regulated market nor an MTF. A significant distinguishing criterion is that, contrary to an MTF, buying and selling [the execution of orders] are carried out on a discretionary basis. Based on the information from BaFin, among others, we can currently assume that, contrary to the fears of many corporates, trading platforms like FXall or 360T will not fall under the definition of an OTF, as trades are not carried out on a multilateral basis in both directions, rather only the respective firm will act as a consumer.
This change introduced by MiFID II may result in subsequent changes to the scope of EMIR as well as the Market Abuse Regulation (MAR), both of which draw upon the trading venue definition of MiFID II. As there will be no generally available list of OTFs, unlike the regulated markets and MTFs, the final definition is likely to be clarified only over the course of time in the exchange between users and platform operators.
Source: KPMG Corporate Treasury News, Edition 69, July 2017
Author: Robert Abendroth, Senior Manager, Wirtschaftsprüfer [German Public Auditor], firstname.lastname@example.org
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