Key legal and regulatory developments driving and shaping M&A
The European regulators are working to finalise the rules that will determine the scope of exemption for commodity market participants from the EU financial services legislation, and the measures on the application of position limits for commodity derivatives.
In September 2015 ESMA submitted a package of draft regulatory technical standards under MiFID II/MiFIR to the Commission for endorsement. Since then, the vast majority of draft technical standards has been endorsed by the Commission and passed to the European Parliament and the Council for obligatory scrutiny.. At the time of writing of this article (early September), the only two outstanding technical standards that remain to be finalised by the Commission are those of crucial importance to the commodity market participants, i.e. the regulatory technical standards on “ancillary activity” exemption and on the methodology for setting position limits under Articles 2(4) and 57 MiFID II respectively.
Delays and political pressure have marked the adoption of the rules that will determine the whole new framework for the functioning of commodity markets. Commodity firms that will be unable to avail themselves of ancillary activity exemption will need to get authorised as investment firms – and become subject to the whole set of existing financial services legislation, effectively meaning no hedging exemption from position limits, no thresholds for clearing obligation and compliance with stringent prudential rules. The commodity market participants have therefore long argued that the exemption has to be applied cautiously, given the existing problems around the quality and availability of data necessary to conduct relevant calculations.
Following a review period of over six months, which was in excess of the three month period foreseen in Article 10(1) of the Regulation establishing European Securities and Markets Authority (ESMA), the draft technical standards were formally sent back by the European Commission to ESMA on 20th April. The Commission demanded changes to the drafts prepared by ESMA to permit – among others – lower position limits for some agricultural commodity derivatives and a revised methodology for the “main business” assessment in the ancillary activity exemption.
On 2nd May ESMA responded to the Commission with its opinion on the proposed changes to the draft technical standard on position limits. Expressing support for most of the changes requested by the Commission, ESMA proposed to permit national competent authorities to apply position limits as low as 2.5% for derivatives with foodstuffs as an underlying. This move has been perceived by the industry as the regulators bowing to pressure from some European legislators who have been long advocating the introduction of a stringent limits regime. ESMA also proposed changes to the definition of economically equivalent OTC contracts (EEOTC) and adjustments to the other months’ limits where there is a significant discrepancy between open interest and deliverable supply.
Subsequently, on 30th May ESMA passed an amended version of the draft technical standard on ancillary activity exemption back to the Commission. This version included amendments to the main business threshold, which would restrict the so-called “proxy approach” to determining the relative size of non-privileged trading activity. ESMA also provided a number of options to the Commission on a main business assessment for the exemption based on capital, including options for calculation numerators and denominators. For the proposed numerators, ESMA suggests using the annual gross notional amount of transactions in commodity derivatives in the EU, a simplified approach derived from the Capital Requirements Regulation (CRR), using markedto- market derivatives positions or a measure of margin or collateral. For the denominator in the calculation ESMA is considering using the figure disclosing “property, plant and equipment” of the firm’s assets or using “total equity” or the alternative financing measure from the liability side of the balance sheet. The ultimate decision as to which option, or the combination thereof, to include in the amended technical standard has been left to the Commission. Contrary to the commodity industry’s suggestions, ESMA proposed no changes to the phase in of the authorisation requirement.
Over the last few months the Commission services have been working on the technical details of the revised technical standards, focusing in particular on addressing the prevailing data availability and quality issue for ancillary activity determination. The precise timing of the adoption of the final draft technical standards remains to be confirmed, but they are now expected to be published very shortly. The exact scope of the changes introduced to the technical standards following ESMA’s proposals is also unclear. Albeit politically-motivated, changes to the technical standard on position limits seem to be rather straightforward. However, the priority issue from the industry perspective remains the calibration of the ancillary activity test. No substantive changes are expected to the trading activity thresholds, but the Commission is expected to endorse amendments to include an alternative “main business” assessment based on capital employed. Uncertainty remains as to the calculation period.
Following the upcoming publication of the amended technical standards by the Commission, the legislators will have a three-month review period. The regulatory process for the adoption of EU position limit rules continues to generate tension among some of the legislators. The European Parliament’s left-wing political groups continue to exercise pressure on the Commission, demanding further amendments to the technical standards on position limits. Certain legislators go as far as demanding rejection of the technical standards if no additional demands are taken on-board. This autumn developments will certainly keep the industry and the regulators busy.
Finally, despite the results of the EU referendum vote, the UK’s implementation of MiFID II is in full swing. On 27th July the Financial Conduct Authority (FCA) published its second consultation paper on MiFID II implementation. The FCA cites in the first paragraph of the consultation document its statement published in the direct aftermath of the referendum in which it advised that “firms must continue to abide by their obligations under UK law, including those derived from EU law and continue with implementation plans for legislation that is still to come into effect”. In line with this business-as-usual approach, the FCA is currently consulting on a whole range of issues, including the framework for position limits and commodity derivatives reporting.
In this issue, we cover a broad spectrum of ‘hot button issues’ for boards and companies operating internationally.
© Norton Rose Fulbright LLP 2021