MIFID II and the energy sector
The amended Markets in Financial Instruments Directive will have a significant impact on the energy sector. The new legislation, which includes a directive (MiFID) and a new regulation (MiFIR), is known as MiFID II.
MiFID II introduces a new category of platform for non-equities - an organised trading facility (OTF), extends the scope of what’s classed as a regulated financial instrument and narrows a number of important exemptions in the commodity derivatives market.
Emission allowances (EUAs) have been brought within the scope of MiFID II. This will mean greater security for traders of EUAs without interfering with the purpose of the market, according to the European Commission.
Trading in allowance derivatives already falls under the scope of MiFID and the Market Abuse Directive, and by bringing emission allowances under the same framework, the spot market will be aligned with what is applicable to the EUA derivatives market.
However, provisions on position limits and position management controls for derivatives in MiFID II only refer to 'commodity derivatives', which does not include derivatives on EUAs.
Physically settled contracts
The definition of a financial instrument has been broadened to include physically settled contracts traded on the new OTFs.
However there will be an exemption for wholesale energy contracts covered under the regulation on the integrity and transparency of the market wholesale energy (REMIT).
Oil and coal physically settled contracts, on the other hand, will be included as financial instruments and therefore will be subject to position limits and transparency requirements.
However, as many of these contracts are not currently cleared, the application of EMIR provisions to these physically settled oil and coal contracts traded on an OTF are deferred by six years after MiFID II takes effect. A further extension of up to three years could be applied.
The EC states any decision on extending the deadline will be based on the potential impact on energy prices, as well as on reducing counterparty and systemic risks.
Under the original MiFID, firms trading commodity derivatives could rely on broad exemptions. But these are to be significantly narrowed. Firms relying on an exemption at present cannot rely on being outwith the new directive’s scope. “In future such firms will only be exempt where their activity is ‘ancillary’ to their main business and their main business is not financial services,” the UK’s FCA explains. In addition, they may not use a high frequency trading technique.
MiFID II also amends the exemption on dealing on own account, meaning firms cannot rely on this exemption in relation to commodity derivatives, EUAs or derivatives on EUAs. The exemption in Article 2(1)(k) in MiFID, the commodity dealer exemption, is not included in MiFID II.
There is a new exemption for those operating under the Emissions Trading Directive providing they do not execute client orders when dealing in EUAs and engage in no investment services or activities other than dealing on their own account in EUAs. Again this is not applicable to firms or persons applying a high frequency algorithmic trading technique.
A new exemption for electricity and gas transmission system operators is also being introduced. Optional exemptions for hedging transactions are available for EU member states if they choose.
The ‘ancillary’ exemption will make it nearly impossible for a group to have an unregulated commodity derivative trading subsidiary. Meanwhile, removing the commodity dealer exemption could impact the agency trading structure used by many commodities groups.
MiFID II requires that commodity derivatives be subject to limits.
In short, this means a limit on the size of the net position which a person may hold in commodity derivatives traded on a trading venue and economically equivalent OTC contracts. Position holders will be obliged to report details of their positions every day to trading venues, which must in turn submit weekly reports to ESMA.