On 14 January, and after more than two years of intense negotiations, the European Parliament and the Council reached an informal political agreement on updated rules for markets in financial instruments (MiFID II). The definition of financial instruments proved particularly contentious. The final agreement does not apply to physically settled electricity and gas contracts traded on organised trading facilities (OTF) – the so-called ‘REMIT carve-out’ – and includes a temporary 3.5 year exclusion for oil and coal contracts.
The final text extends the definition of commodity derivatives that are subject to MiFID to physically settled contracts traded on OTFs, except for wholesale energy products which are already covered by sector-specific European regulations on energy market integrity and transparency (REMIT), i.e. natural gas and electricity contracts. This means that all trades covered by REMIT are also exempted from related EU regulations on over-the-counter (OTC) commodity derivatives trading rules, known as EMIR. EMIR requires, among other things, that financial counterparties to report all commodity derivatives trades considered as financial instruments to a trade repository, as of 12 February this year. It also requires mandatory clearing of standardised OTC derivatives trades by central counterparties, as well as stricter risk mitigation for non-centrally cleared trades.
In order to ensure a smooth transition, last week’s political agreement also provides a transitional period for physically settled contracts on oil and coal that are traded on OTFs: these contracts are not subject to the clearing obligation and risk mitigation techniques under EMIR for three and a half years after the directive takes effect. This deferral could be extended by two years, and then again by a further year, depending on the outcome of a European Commission review, to be planned by 1 January 2018, of the impact an inclusion of oil and coal contracts would have on energy prices and the functioning of the electricity market.
As expected, the final text sets mandatory position limits on commodities derivatives markets, but also sets a hedging exemption for positions entered into by, or on behalf of, a non-financial entity for the purpose of managing commercial risks. EU negotiators have not yet shared any information as to the outcome regarding the exemption framework.
The informal agreement on MiFID II must now be formally approved by the European Parliament and the Council before it can become binding. The revised rules could apply from the end of 2016: after the Parliament’s vote in March and the Council’s approval they could be published in the EU Official Journal in June, and EU governments would then have to implement the rules within 30 months.
In the meantime, it is safe to predict that the struggle will continue, as many implementation measures still need to be developed by the European Securities and Markets Authority ESMA, including, for instance, criteria to define the ancillary activity exemption or criteria and methods for determining whether a position qualifies as reducing risks related to commercial activities. It is of crucial importance that the upcoming ESMA paper (expected for May/June) stick to the philosophy of the political agreement and take into account the specificities of physical power markets.