The recent announcement by ESMA (European Securities and Markets Authority) with the final draft text for MiFID II (Markets in Financial Instruments Directive) gives some serious food for thought to the commodity traders. The commodity dealers have been currently trading under an exemption in the EU under MiFID and these exemptions will be notably reduced under MiFID II / MiFIR (Markets in Financial Instruments Regulation) come January 2017.
Following January 2017, MiFID II will significantly change the commodities market in the EU with the following key changes:
- Dealer exemptions reduced - Key change is the reduction of the exemptions available to commodity trading firms. The current MiFID Article (2 (1)(k)) has been deleted ensuring additional firms are now within scope along with other Article amendments.
- Product scope - Increasing the scope of instruments for both physically and cash settled commodity derivatives to be classed as Financial Instruments. This reclassification to Financial Instruments could lead to further repercussions too, as this could then potentially trigger the EMIRobligations on clearing etc and capital implications under CRD IV as per the required process for banks.
- Position limits / controls introduction - The further key change of an introduction of position limits and controls for commodity derivatives, covering items such as net positions, entity holdings and the burden of relating reporting obligations surrounding this, gives all involved firms a tough operational and implementation challenge ahead.
Certainly the proposals are to ensure the EU market is a safe and transparent place, but there is a huge amount still to be thought and discussed before implementation will be practical and possible. Here are some of the major market and participant challenges ahead:
- Data Issues - With the finer detail being released from ESMA, this gives the market participants a bulk of the details they require to analyse the impact to the current business model on becoming MiFID II compliant. However, to make this critical decision even more challenging, there are significant data issues in order to be able to quantify your position due to the lack of conclusive data within the market and trade repositories (TR's).
- Market Liquidity - Following a potential reduction of market participants with a combination of the proposed position limits, this could lead to certain dealers withdrawing their liquidity as and when a limit breach is near, causing a real liquidity issue within the market. This would create a tough market place when trying to hedge risk which is surely the opposite desired affect from the regulation.
- Market Volatility - A natural follow on from the mentioned random liquidity withdrawals would lead to enhanced volatility in the market place which will lead to obvious price concerns.
- Market cost - The participation cost regarding the potential changes under MiFID II will typically result in Bid / Offer widening without factoring in the issues of liquidity / volatility meaning the true cost of trading is increased in the EU. In some instances this could push certain participants to transact outside of the EU.
- Regulatory Capital - A final point that needs to be considered which we briefly mentioned earlier, is the potential capital impact, where firms regulated by MiFID are subject to CRD IV (Capital Requirements Directive (CRD) and Capital Requirements Regulation (CRR)). This could be a significant cost to the business to calculate and set aside enough high quality capital to cover the business risk. Again this potential impact point leads to firms having to revert back to their critical business decision in remaining within the commodities market.
To assist and ensure our clients are on track, MThree Consulting offer full programme management and SME assistance covering Business, Technology and Operations. MThree Consulting has significant direct implementation experience of regulatory compliance programmes across the globe. This gives us deep understanding of financial services across the spectrum across all asset classes, from Front Office trading and Post Trade Operations, through to Risk and Finance.
MThree Consulting can ensure you are on track and provide a clear path to compliance. Please contact Anthony for further discussion and assistance. Anthony.Ginn@mthreeconsulting.com