How are hedge positions counted towards the position limit?

Commodity derivatives can be used to reduce risks directly relating to commercial activities in an objectively measurable way. Such transactions are known as hedging transactions.

Non-financial position holders, i.e. those whose main business is not financial, may now be exempt from position limits for positions in commodity derivatives if these are objectively measurable as reducing risks directly relating to non-financial commercial activities.

Financial entities are required to count hedging contracts towards position limits for commodity derivatives.

Which transactions are for hedging purposes?

A position held by a non-financial entity in a commodity derivative qualifies as a hedge position if it meets one of the following criteria:

1. It qualifies as a hedging contract pursuant to International Financial Reporting Standards (IFRS) adopted in accordance with Article 3 of Regulation (EC) No 1606/2002 of the European Parliament and of the Council, or
2. it reduces the risks arising from the potential change in the value of assets, services, inputs, products, commodities or liabilities that the non-financial entity 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.

In this case, the non-financial entity has to be able to describe and keep records of the following (where applicable):

• the types of commodity derivative contracts included in the portfolios used to reduce risks directly relating to commercial activity;
• their eligibility criteria;
• the link between the portfolio and the risks that the portfolio is mitigating;
• the measures adopted to ensure that the positions concerning those contracts serve no other purpose than covering risks directly related to the commercial activities of the non-financial entity, and that any position serving a different purpose can be clearly identified, and
• the class of commodity derivative, underlying commodity, time horizon and any other relevant factors (in a sufficiently disaggregated form).

The requirements correspond to those under EMIR for hedging transactions that do not count towards the clearing threshold. See also ESMA Q&A Implementation of the Regulation (EU) No 648/2012 on OTC derivatives, central counterparties and trade repositories (EMIR), Question 10 in the "OTC Questions" section.

What are the requirements for applying for a hedge exemption?

In order for non-financial entities to be exempt from position limits for positions in commodity derivatives, they must first submit an application pursuant to Article 57 (1) of Directive 2014/65/EU (MiFID II) in conjunction with Article 8 of Commission Delegated Regulation (EU) 2017/591 to the competent authority which sets the position limit for this commodity derivative. In the application process, non-financial entities are required to demonstrate that they are entering into positions in commodity derivatives that are objectively measurable as reducing risks directly relating to commercial activity.

Article 8 of Commission Delegated Regulation (EU) 2017/591 lays down the necessary requirements for competent authorities approving such an exemption. In accordance with these provisions, the non-financial applicant must, among other things:

• describe the nature and value of the commercial activities in the commodity to which the commodity derivative for which an exemption is sought is relevant;
• describe the nature and value of the activities in trading of and positions held in the commodity derivatives traded on trading venues and in their economically equivalent OTC contracts;
• describe the nature and size of the exposures and risks in the commodity which the applicant has or expects to have as a result of its commercial activities and which are or would be mitigated by the use of commodity derivatives;
• explain how using the commodity derivative directly reduces the applicant's exposure and risks in its commercial activities,
• confirm that the positions in question reduce risks within the meaning of Article 7(1)(a) in conjunction with section 2 of Commission Delegated Regulation (EU) 2017/591 directly relating to the non-financial applicant’s commercial activity or that the positions in question qualify as a hedging contract pursuant to International Financial Reporting Standards (IFRS) adopted in accordance with Article 3 of Regulation (EC) No 1606/2002 of the European Parliament and of the Council.

Such positions are not counted towards the position limit in accordance with Article 3 (3) of Commission Delegated Regulation (EU) 2017/591 if the exemption that has been applied for is approved. In addition, the hedge position must be flagged in reports as directly reducing risks.

After BaFin has approved the exemption, the non-financial entity must notify any significant changes to the nature or value of its commercial activities or its trading activities in commodity derivatives and submit a new application if necessary.

How is a position flagged as a hedging transaction?

All positions that a person holds in commodity derivatives (or positions in emission allowances or derivatives thereof) must be reported by the market operator (in the case of derivatives traded on trading venues) or the investment firm involved (in the case of positions in economically equivalent OTC contracts) to the competent authority or the central competent authority.

The positions that are used for reducing risks directly relating to commercial activity in an objectively measurable way have to be flagged in the reporting forms by providing the relevant information in a reporting field provided for this purpose.

A reportable position in a commodity derivative can be flagged as reducing risks directly relating to commercial activity, regardless of whether the aforementioned exemption from the position limit for such positions has been applied for or approved. Flagging reportable positions in this way is permitted only if the position holder is exposed to such risks as part of its commercial activities.

In which cases should a non-financial entity apply for a position limit exemption for positions in commodity derivatives?

In principle, applications for an exemption from position limits pursuant to Article 57 (1) of Directive 2014/65/EU (MiFID II) in conjunction with Article 8 of Commission Delegated Regulation (EU) 2017/591 for positions in commodity derivatives can be submitted if the positions in these commodity derivatives directly counteract the risks relating to the commercial activities to be reduced using the commodity derivative. However, such applications seem to be useful in only a very limited number of cases.

In practice, approved exemptions only have a noticeable effect if the non-financial entity concerned is expected to have a trading volume in the commodity derivative that moves along the lines of the actual position limit. However, if the actual trading volume or the trading volume anticipated for the foreseeable future falls significantly below these thresholds, submitting an application is unnecessary. In addition, such applications cannot be submitted for exemptions that may be needed at a later date. It should be noted that any significant changes to the nature or value of the commercial activities or trading activities in commodity derivatives have to be notified to the competent authority and a new application may also be required as a result.

If the positions entered into by a non-financial entity are not for speculative purposes, but rather for reducing risks directly relating to the non-financial entity’s commercial activities, these have to be flagged accordingly in the relevant reports. An approved application pursuant to Article 57 (1) of Directive 2014/65/EU (MiFID II) in conjunction with Article 8 of Commission Delegated Regulation (EU) 2017/591 is not a prerequisite for flagging in the context of reporting.

It should also be borne in mind that positions for which the approved exemption pursuant to Article 57 (1) of Directive 2014/65/EU (MiFID II) in conjunction with Articles 7 and 8 of Commission Delegated Regulation (EU) 2017/591 is claimed are not included in the aggregation pursuant to Article 3 of Commission Delegated Regulation (EU) 2017/591. This means that hedge positions would not be taken into account when netting long and short positions pursuant to Article 3 (2) of Commission Delegated Regulation (EU) 2017/591, and netting opposite positions would no longer be possible in this case.

To which authority should applications be submitted for a position limit exemption for positions in commodity derivatives?

Applications within the meaning of Article 57 (1) of Directive 2014/65/EU (MiFID II) in conjunction with Article 8 of Commission Delegated Regulation (EU) 2017/591 are to be submitted to the competent authority for setting limits. Where the non-financial applicant is established is thus irrelevant. As a result, BaFin is not necessarily the competent authority, even if the applicant is established in Germany. In turn, BaFin may be the competent authority even if the applicant is established abroad provided the commodity derivatives are traded on a trading venue that is authorised in Germany.

What does the application process at BaFin involve?

BaFin is responsible for handling applications within the meaning of Article 57 (1) of Directive 2014/65/EU (MiFID II) in conjunction with Article 8 of Commission Delegated Regulation (EU) 2017/591 that relate to commodity derivatives for which it sets position limits. Therefore, non-financial counterparties both in Germany and abroad that are seeking approval for such an exemption must make use of the application process set up by BaFin. This is described in more detail in the information on the specialised procedure "Position limits in commodity derivatives and reporting”. A guidance notice has also been provided for this purpose and includes the technical requirements for submitting the information required.

To make use of this specialised procedure, it is necessary to register with BaFin's reporting and publishing platform (MVP Portal).

Alternatively, applicants can submit their applications via email to Positionslimits-MIFID@bafin.de. However, applicants act on their own risk as this is not a secure tool.