Position limits for commodity derivatives
As part of the implementation of the Markets in Financial Instruments Directive II (MiFID II), position limits for commodity derivatives are being introduced from 3 January 2018. This means that upper limits for holding derivatives whose underlying is a commodity are applicable from this date. Neither individual undertakings nor groups of undertakings are allowed to hold positions that, in aggregate, exceed these thresholds.
What are commodity derivatives?
The term "commodity derivative" is defined in the Markets in Financial Instruments Directive II (MiFID II) with reference to Article 2 (1) (30) of the Markets in Financial Instruments Regulation (MiFIR) and to Annex I, Section C, points (5), (6), (7) and (10) of MiFID II.
According to the above, commodity derivatives are, in particular, options, futures, swaps or forwards relating to commodities or underlyings which may be settled physically or in cash. Commodities can be food, agricultural products, energy carriers or electricity, for instance. Underlyings include climatic variables or freight rates, for example.
Under MiFID II, securities, such as certificates, also qualify as commodity derivatives if they relate to a commodity. However, emission allowances and derivatives on emission allowances are not commodity derivatives within the meaning of MiFID II, but they are subject to position reporting nevertheless.
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What are position limits for commodity derivatives?
Under Article 57 (2) of MiFID II, position limits specify clear quantitative thresholds for the maximum size of a position in a commodity derivative that persons or groups of undertakings can hold. This position is generally the netted position in this commodity derivative.
What is the aim of the regulation?
The regulation is aimed at improving the transparency of financial and commodity markets and making it possible to set limits for the positions of individual market participants in certain commodity derivatives. This is aimed at preventing market abuse, supporting orderly pricing and settlement conditions, preventing market distorting positions and ensuring, in particular, convergence between prices of derivatives in the delivery month and spot prices for the underlying commodity, without prejudice to price discovery on the market for the underlying commodity.
What are the main legal bases?
The main legal bases that will apply to position limits for commodity derivatives were established equally at EU level for all Member States. Articles 57 and 58 of MiFID II are key sources. The Directive's content has been transposed into German law via the Second Act Amending Financial Market Regulations (Zweites Finanzmarktnovellierungsgesetz – 2. FiMaNoG) of 23 June 2017 (Federal Law Gazette I, p. 1693). Sections 54 to 57 of the new version of the German Securities Trading Act (Wertpapierhandelsgesetz – WpHG), which will be applicable from 3 January 2018, transpose these EU provisions into German law. In addition, section 6 (6) of the new version of the WpHG regulates BaFin's powers of intervention as the competent authority. Section 120 of the new version of the WpHG contains provisions on administrative offences and administrative fines that may be imposed.
In addition to MiFID II and its transposition into the WpHG, MiFIR contains further provisions that have a direct binding effect at national level. In particular, the term "commodity derivative" is defined in more detail in Article 2 (1) (30).
Commission Delegated Regulation (EU) 2017/591 specifies the rules set out in the MiFID II Directive for setting position limits for commodity derivatives and the procedure for potential exemptions.
Commission Implementing Regulation (EU) 2017/1093 lays down technical standards with regard to the format of position reports of investment firms and market operators.
Who is subject to the regulation?
The impact of the requirements relating to position limits for commodity derivatives for individual market participants depends on whether this relates to the obligation to comply with the position limits that have been set or to the obligation to report to the competent authorities.
In principle, the position limits set by the competent authorities will apply to every single person. These can be natural or legal persons. In the case of legal persons, position limits are to be taken into account not only at the level of the actual position holder but also at group level.
However, non-financial entities may be exempt from considering the applicable position limit for positions in commodity derivatives if these positions are objectively measurable as reducing risks directly relating to their primary commercial activity (cf. Hedge exemption – application process for position limit exemptions).
Non-financial entities are persons that are not one of the following:
- investment firms authorised in accordance with Directive 2014/65/EU,
- credit institutions authorised in accordance with Directive 2013/36/EU,
- insurance undertakings authorised in accordance with Directive 73/239/EEC,
- insurance undertakings authorised in accordance with Directive 2002/83/EC,
- reinsurance undertakings authorised in accordance with Directive 2005/68/EC,
- undertakings for collective investment in transferable securities in accordance with Directive 2009/65/EC,
- institutions for occupational retirement provision within the meaning of Article 6(a) of Directive 2003/41/EC,
- alternative investment funds managed by alternative investment fund managers (AIFMs) authorised or registered in accordance with Directive 2011/61/EU,
- central counterparties authorised in accordance with Regulation (EU) No 648/2012, or
- central securities depositories authorised in accordance with Regulation (EU) No 909/2014.
Entities established in a third country qualify as non-financial entities if no authorisation would have been required under one of the aforementioned acts had they been established in the EU and been subject to EU law.
The obligation to report to the competent authorities concerns the operators of trading venues on which commodity derivatives are traded and investment firms that are involved in transactions with economically equivalent commodity derivatives outside a trading venue (over-the-counter – OTC).
Members or participants in trading venues as well as clients of investment firms are themselves required to report their own positions in commodity derivatives and those of their clients and the clients of those clients until the end client is reached, at least on a daily basis, to the person subject to the reporting obligations. The end client is the first non-financial client in the reporting chain. If there are other persons that follow, it may be advantageous for the end client to disclose the other persons’ positions as well to avoid giving the impression that the end client itself has a high position.
In addition to positions in commodity derivatives, holdings in emission allowances and derivatives thereof are also subject to the reporting obligations. Position limits do not apply to emission allowances or derivatives thereof.
What is BaFin's role?
BaFin is the competent authority for setting and monitoring position limits in commodity derivatives that are traded exclusively or predominantly on a German trading venue. If economically equivalent contracts are traded within the EU with the participation of an institution (i.e. a bank or a financial services institution) outside a trading venue, BaFin's competences will also extend to include the receipt of position reports from this institution. This is regardless of the Member State in which the institution is established. Positions in such economically equivalent contracts are also taken into account when calculating the total position of a person in a commodity derivative.
When setting position limits, the competent authorities have to comply with the methods specified in Commission Delegated Regulation (EU) 2017/591 for calculating position limits.
The competent authorities are to notify the European Securities and Markets Authority (ESMA) of the position limits they intend to set. ESMA will draft an opinion for the competent authority concerned in which it will determine whether the respective limit is suitable for preventing market abuse and ensuring orderly pricing and settlement conditions. In its opinion, ESMA will also assess whether the methods for calculating limits have been complied with. ESMA will publish the opinions on its website.