On 29 September 2014, the European Securities and Markets Authority (ESMA) published a consultation paper regarding the definition of ‘commodity derivatives’ under paragraphs C6 and C7 of Annex 1 of MiFID I.
The consultation paper is the next stage in a process which began on 14 February 2014, when ESMA wrote to the EU Commission to highlight its concern that an inconsistent application of the definitions of “Financial Instrument” as defined under the MiFID directive, particularly as it applies to FX and physically settled commodity forwards, could have a significant detrimental effect on the consistent application of EMIR within the EU. In its response 12 days later, the EU Commission invited ESMA to consider issuing clarificatory guidelines in relation to physically settled commodity forwards. The consultation paper seeks comments on the draft advice.
Within the consultation paper, ESMA notes that the different approaches to the interpretation of MiFID I by Member States mean that there is no commonly-adopted application of the definitions of ‘derivative’ or ‘derivative contract’ in the EU for some asset classes. This issue has been brought to a head following the entry into force of EMIR which states that “derivative” or “derivative contract” means a “financial instrument” as set out in points (4) to (10) of Section C of Annex I to MIFID. These definitions are of fundamental importance as they determine the boundaries of various aspect of EMIR, such as:
- The reporting obligation;
- The clearing obligation;
- The clearing threshold for non-financial counterparties;
- The application of risk mitigation techniques; and
- CCP margin requirements.
Two specific questions arise in the context of commodity derivatives (a) whether paragraph (6) include forwards, and (b) the exact meaning of “physically settled” for the purposes of Paragraphs (6) and (7).
ESMA is of the view that forwards are included within the definition of paragraph (6) provided that:
- they can be physically settled; and
- they are traded on a regulated market and/or an MTF.
It also believes that the term “physically settled” incorporates a broad range of delivery methods and includes:
- physical delivery of the relevant goods themselves;
- delivery of a document giving rights of an ownership nature to the goods concerned; or,
- another method of bringing about the transfer of rights of an ownership nature in relation to the relevant quantity of goods without physically delivering them that entitles the recipient to the relevant quantity of the goods.
The deadline for comments is 5 January 2015.
 Under MiFID, a “financial instrument” includes: “(6) Options, futures, swaps and any other derivative contract relating to commodities that can be physically settled provided that they are traded on a regulated market and/or an MTF; and (7) Options, futures, swaps, forwards and any other derivative contract relating to commodities that can be physically settled not otherwise mentioned in C.6 and not being for commercial purposes, which have the characteristics of other derivative financial instruments, having regard to whether, inter alia, they are cleared and settled through recognised clearing houses or are subject to regular margin calls.”
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