Explanatory Memorandum to COM(2020)280 - Amendment of Directive 2014/65/EU as regards information requirements, product governance and position limits to help the recovery from the COVID-19 pandemic - Main contents
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This page contains a limited version of this dossier in the EU Monitor.
| dossier | COM(2020)280 - Amendment of Directive 2014/65/EU as regards information requirements, product governance and position limits to help the ... |
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| source | COM(2020)280  |
| date | 24-07-2020 |
1.1. Reasons for and objectives of the proposal
EU Member States have been severely affected by the economic crisis resulting from the COVID-19 pandemic. T his calls for a quick reaction to support capital markets participants.
In the Communication of the Commission of 13 March 2020, entitled ‘Coordinated economic
response to the COVID-19 outbreak’, the Commission highlighted the importance of ensuring the liquidity of the EU financial sector and countering a threatening recession through actions
at all levels. Furthermore, on 27 May 2020, in its Communication entitled ‘Europe’s moment: Repair and Prepare for the Next Generation’ , the Commission presented key instruments
supporting the recovery plan for Europe, including measures that aim at kick-starti n g the economy and helping private investment. This Communication also stressed that liquidity and access to finance will be a continued challenge for companies.
The objective of this targeted amendment is to provide for the best possible conditions for European economies to emerge from the current COVID-19 pandemic. The rules on investments services can play a key role in promoting the recapitalisation of European companies as they emerge from the crisis. The modified commodities regime will allow companies in the real economy to react to market volatility while also enabling nascent comm odity contracts, which is also im portant to promote the international role of the Euro.
The present review is driven by two key objectives:
• Facilitating investments in the real economy and
• Allowing for a rapid recapitalisation of European companies.
To ensure that financial institutions and intermediaries can fulfil their essential function in financing the real economy, targeted adjustments of certain requirements of Directive 2014/65/EU (‘MiFID II’) are appropriate. Already in 2019, stakeholders had warned the Commission that several aspects of the MiFID II distribution rules were either unnecessary or perceived as overly burdensome. The current COVID-19 pandemic makes it even more important to remove formal burdens where they are not strictly necessary. A more finely calibrated view of investor requirements would also leave more resources for dealing with the consequences of the COVID-19 pandemic. The Commission therefore strives to recalibrate those areas to strike the right balance between a sufficient level of transparency towards the client, the highest standards of protection and acceptable compliance costs for firms.
In that context, this amendment to MiFID II applying to investments in financial instrument has the aim of removing administrati ve burdens that result from documentation and disclosure rules that are not counterbalanced by corresponding increases in investor protection. It also recalibrates the position limit and corresponding hedging exemption regime to foster nascent euro denominated markets.
1.2. Consistency with existing policy provisions in the policy area
While laying down extraordinary measures to soften the impact of the COVID-19 pandemic and help the economic recovery, this proposal remains in line with the overarching objectives of MiFID II to foster market transparency and integrity and to promote investor protection.
1.3. Consistency with other Union policies
This legislative proposal amending MiFID II is part of a set of measures to facilitate the economic recovery postCOVID-19 pandemic, which includes also legislative proposals amending the Prospectus Regulation1 the Securitisation Regulation2 and the Capital
Requirements Regulation3.
This legislative proposal also aims to complement the objectives of the Capital Markets Union to diversify market-based sources of financing for European companies and facilitate crossborder investments.
Furthermore, this initiative must be consistent with any additional proposals that the Commission aims to develop in different policy areas to soften the impact of the COVID-19 pandemic on capital markets, including the key instruments supporting the recovery presented in the Commission Communication entitled ‘Europe’s moment: Repair and Prepare for the Next Generation’ of 27 May 2020.
2. LEGALBASIS, SUBSIDIARITYAND PROPORTIONALITY
2.1. Legal basis
The proposed amendment is built on the same legal basis as the legislative act that is being amended, i.e. Article 53(1) TFEU which allows the adoption of measures for the approximation of national provisions concerning the access to the activity of investment firms, regulated markets and data service providers.
2.2. Subsidiarity (for non-exclusive competence)
Under Article 4 TFEU, EU action for completing the internal market must be appraised in the light of the subsidiarity principle set out in Article 5(3) of the Treaty on European Union (TEU). The objectives pursued by the proposed measures aim at supplementing already existing EU legislation and can therefore best be achieved at EU level rather than by different national initiatives. Financial markets are inherently cross-border in nature and are becoming more so. The conditions according to which firms and operators can compete in this context, including on investor protection, need to be common across borders and are all at the core of MiFID II today. Because of this integration, isolated national intervention would be far less efficient and would lead to the fragmentation of markets, resulting in regulatory arbitrage and distortion of competition. For instance, different levels of investor protection across Member States would fragment markets, compromise efficiency, and lead to harmful regulatory arbitrage.
Regulation (EU) 2017/1129 of the European Parliament and of the Council of 14 June 2017 on the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market, and repealing Directive 2003/71/EC (OJ L 168, 30.6.2017, p. 12).
Regulation (EU) 2017/2402 of the European Parliament and of the Council of 12 December 2017 laying down a general framework for securitisation and creating a specific framework for simple, transparent and standardised securitisation, and amending Directives 2009/65/EC, 2009/138/EC and 2011/61/EU and Regulations (EC) No 1060/2009 and (EU) No 648/2012 (OJ L 347, 28.12.2017, p. 35).
Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012 (OJ L 176, 27.6.2013, p.1).
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2.3. Proportionality
The proposal takes full account of the principle of proportionality, namely that EU action should be adequate to reach the objectives and does not go beyond what is necessary. The proposed measures to lighten the burden on investment firms respect the principle of proportionality. In particular, the need to balance investor protection, efficiency of the markets and costs for the industry has been central in laying out these requirements. Not only have all the proposed options been individually assessed against the proportionality objective, but also the lack of proportionality of the existing rules has been presented as a separate problem. The amendments are therefore compatible with the principle of proportionality, taking into account the right balance of the public interest at stake and the cost-efficiency of the measure.
2.4. Choice
of the instrument
The measures are proposed to be implemented by amending MiFID II through a Directive. The proposed measures indeed refer to or develop further already existing provisions inbuilt in those legal instruments. Article 53(1) of TFEU allows for the adoption of acts in the form of a Directive. Amendments to Directive 2014/65/EU can therefore only be achieved, by virtue of a Directive of the European Parliament and of the Council amending Directive 2014/65/EU.
3. RESULTS OF EX-POST EVALUATIONS, STAKEHOLDER CONSULTATIONSANDIMPACTASSESSMENTS
3.1. Impact assessment
This proposal is not accompanied by a separate impact assessment. Given the urgency of measures to be taken to help the recovery, the impact assessment was replaced by a cost-benefit analysis included in the Staff Working Document supporting the Capital Markets Recovery Package. The proposal primarily aims at providing, for exceptional reasons in the context of the current COVID-19 pandemic, for a streamlined application of the regulatory requirements, keeping high safeguards for retail clients while allowing for more flexibility for wholesale clients and ensure that fully functioning commodity markets can play their important role in the recovery of EU economies. An analysis of the proposed measures is included in the Staff Working Document supporting the Capital Markets Recovery Package.
3.2. Fundamental rights
The proposal respects the fundamental rights and observes the principles recognised by the Charter of Fundamental Rights of the European Union, in particular the freedom to conduct a business (Article 16) and consumer protection (Article 38). As this initiative aims at alleviating the administrative burden placed on investment firms while maintaining existing high standards for retail clients, this initiative would contribute to improving the right to conduct a business.
4. BUDGETARYIMPLICATIONS
The initiative is not expected to have any impact on the EU budget.
5. OTHERELEMENTS
5.1. Implementation plans and monitoring, evaluation and reporting arrangements
As the amendment aims at mitigating the effects of the COVID-19 pandemic an early application of the amendment would be most beneficial. It is therefore expected that the proposed amendment should start applying at the earliest opportunity.
In parallel, the European Markets and Securities Authority (ESMA) will continue to collect the necessary data for monitoring the effects of the COVID-19 pandemic on investment firms and investment activities in Europe and how the pandemic affects markets and supervisory practices. This will allow for the future evaluation of the new policy tools. Additionally, the Commission services will continue to carefully monitor the latest developments and to engage in the relevant fora, such as the European Securities Committee (ESC).
Compliance and enforcement will be ensured on an ongoing basis where needed through the Commission launching infringement proceedings for lack of transposition or for incorrect transposition or application of the legislative measures. Reporting of breaches of EU law can be channelled through the European System of Financial Supervision (ESFS), including the national competent authorities and ESMA.
5.2. Detailed explanation of the specific provisions of the proposal
5.2.1. Amendments to information requirements
The proposed amendments carefully recalibrate specific requirements in order to strike a more appropriate balance between protecting investors on the one hand and facilitating the provision of high-quality investment services on the other hand. To ensure that retail clients receive a high level of investor protection, the amendments will carefully calibrate between retail clients, professional clients and eligible counterparties. While limited alleviations would cut across investor categories (e.g. the phase-out of paper based information), the majority of the amendments to the current rule-book will focus on providing alleviations for professional clients and eligible counterparties.
The following table provides an overview of the proposed changes and identifies the investor categories affected by these changes:
Costs and charges disclosure: Introduction of an exemption for eligible counterparties and for professional clients for other services than investment advice and portfolio management.
Pursuant to Articles 29a and 30, eligible counterparties and professional clients are exempted from the costs and charges requirements where other services than investment advice and portfolio management are concerned. In addition, in case of distance communication all clients using all services should be able, under certain conditions, to receive costs and charges information just after the transaction (Article 24(4)).
Alleviate ex-post reporting requirements:
in particular, the end-of day loss reporting requirement promotes a short-term view among inexperienced investors and fosters “herd behaviour” which is not conducive to taking informed views of the market. Professional clients are allowed to opt-in.
Article 25(6) is added to the measures that eligible counterparties and professional clients are exempted from, and to which professional clients can opt in.
Suspend best execution reports: In their current form best execution reports are not read by investors, while buy-side investment firms receive all the relevant information via other means (e.g. via brokerage meetings). To reduce the burden of producing those reports, this obligation will be suspended, pending a thorough analysis with regard to a possible streamlining of the reports.
A new subparagraph is added to Article 27(3) that temporarily dis-applies the reporting obligation.
Alleviate cost benefit analysis: As part of the suitability assessment, firms are required to obtain information about the client in order to perform a cost-benefit analysis in case they ‘switch’ between products in the course of an ongoing relationship. For professional clients this is overly burdensome.
A new paragraph to Article 25(2) is inserted, setting the requirements for the cost-benefit analysis as they are currently laid down in Article 54(11) of Delegated Regulation (EU) 2017/565, adding an exemption combined with a possibility to opt-in for professional clients
Product governance: to facilitate the financing of the economy bonds with make-whole clauses will be exempted from the product governance regime.
Article 16(3), subparagraphs 2 until 6 and Article 24(2) will not apply to corporate bonds with make-whole clauses.
Detailed description of the measures:
(a) Phase-out of the paper-based default method for communication
Currently, MiFID II requires that all investor reports and information is provided in a “durable medium”, which includes electronic formats (e.g. E-mail), but paper remains the default method for communication (where durable medium is required). Given that clients are widely able to view their investment portfolios online (or contact their investment firm where necessary), providing them with a plethora of paper-based statements has become superfluous. Compliance with this requirement introduced under MiFID II imposes a considerable cost burden on banks and slows down the investment process.
Not only have some firms experienced difficulties in relation to the provision of paper-based disclosures to clients during the COVID-19 pandemic, but this default option for communication is also not aligned with the objectives of the Commission’s Green Deal and its Digital Finance Agenda. As the economic downturn caused by the COVID-19 pandemic has made it even more urgent to facilitate the investment process to increase the funding alternatives for European companies and to enable investment firms to use resources more efficiently, the default option of all client communication should consist in an electronic format (either E-Mail, a dedicated webpage or an electronic mailbox). The chosen default option should then be used for the provision of all information documents to ensure that the
client has all his or her information easily available in one place. Paper-based communication should therefore be phased out as soon as possible. Retail investors will still have the possibility to opt-in and receive their information by paper if they so wish.
(b) Introducing an exemption for eligible counterparties and professional clients from the cost and charges information
Costs and charges information is supposed to provide investors with basic levels of transparency regarding pricing and to enable them to compare different offers. Currently, the information requirements on cost and charges apply for all client categories alike. However, professional clients, eligible counterparts and ESMA4 have unanimously and repeatedly told the Commission that these requirements have no benefit where other services than portfolio management and investment advice are concerned. These clients have a different relationship with their investment firms than retail clients do; in many cases these market participants are familiar with the market conditions and prices of the various providers but also define the conditions of the transaction in question themselves. Professional clients and eligible counterparties furthermore generally place a large number of high-value orders compared to those placed by retail investors and attach great importance to swift order execution. Wholesale clients thus put, on their own volition, investment advisers and brokerage firms in competition when requesting pricing for their trades. This provides these investor groups with more influence and control of the prices than the average retail client. By alleviating the requirement for information that is claimed not to be used neither by eligible counterparties nor by professional counterparties, the information will be individualised and provide wholesale clients with the data they need.
Cutting red tape has become even more urgent during the COVID-19 pandemic, which placed the EU’s economy and financial system under strain. Streamlining the investment process for wholesale clients is likely to channel alternative financing option to those enterprises that are in need of new equity. With the addition of a new Article 29a and the amendment to Article 30(1) of MiFID II, eligible counterparties and professional clients will be fully exempted from receiving the costs and charges disclosures on other services than investment advice and portfolio management. For retail clients the requirement remains unchanged.
(c) Allow for a delayed transmission of cost information when using distant communication channels
Article 24 of MiFID II provides for detailed information requirements. Many transactions with all categories of clients tend to be concluded over the phone or by online means. All client categories have come to expect immediate execution of such “distance orders” as a standard feature of investment services. The supply of ex-ante cost information translates into time lags and the risk of adverse price movements between receipt and execution of an order. Often, the requirement of systematic ex-ante cost disclosures would be disadvantageous to clients. These circumstances would neither allow nor warrant ex-ante cost information, especially as the client would bear the market risk of adverse price movements in the time between preparation and provision of the ex-ante cost information.
The COVID-19 pandemic has accelerated the usage of electronic investment services and therefore the need for an efficient and fast trade execution online and on the phone. As the current application of the ex-ante costs disclosure requirements leads to delays in the
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execution of transactions for participants for whom time is of essence and these effects may therefore have a negative impact on best execution clients should be enabled to provide their consent to a delayed transmission of the cost information documents.
(d) Alleviations for service reports
MiFID II requires investment firms to send ex-post statements to clients concerning the services they have received. Eligible counterparties and professional clients should be exempted from receiving the ex-post statements all together. Professional clients, however, should be enabled to opt into receiving these statements. Giving these clients the ability to opt in will ensure that those who want to receive these statements may continue to do so and, conversely, those who do not derive any benefit from receipt of such standardised disclosures do not receive them.
For example, Article 25(6) of MiFID II obliges firms to provide post-transaction service reports to clients. These reports include the loss-reporting reports that are triggered by 10% portfolio losses. These reports have deemed not useful or even confusing for certain clients, especially when markets are extremely volatile, as was the case during the COVID-19 pandemic. Instead of forwarding reports that are triggered by volatility or by a mere administrative deadline, the COVID-19 pandemic has shown that individualised and timely information is of much higher relevance to wholesale clients. To allow both firms and clients to focus on providing and receiving (i.e. actively progressing) the information that is relevant to them, in particular during challenging market environments, these reports will therefore no longer apply with regard to eligible counterparties, while professional clients have the choice to receive them or not.
(e) Opt in for professional investors to cost benefit analysis in case of switching
Article 25(2) of MiFID II requires firms to perform a suitability assessment when they provide investment advice or portfolio management. This provision applies to retail clients and to professional clients. Eligible counterparties are excluded in Article 30(1). With regard to clients that are professional clients on request5, firms need to obtain such information as it is necessary to have a reasonable basis for determining that the specific transaction to be recommended, or entered into, meets the investment objectives of the client, including the client’s risk tolerance, and that the client is financially able to bear any related investment risks consistent with his investment objectives. With regard to professional clients as listed in Annex II, paragraph I of MiFID II, firms may assume that the client is able to financially bear the investment risks.
In case of ongoing relationships, firms are currently required to undertake a costs-benefit analysis of certain portfolio activities, which involve a “switching” between products. In this context, before executing a product switch, investment firms are required to obtain the necessary information from the client and be able to demonstrate that the costs outweigh the benefits. Suitability testing in case of a product switch is viewed as applying to all portfolio activity rather than those switches for which is was designed, such as the sale and purchase of an “equivalent” product (for example the sale of a European Equity investment fund and the purchase of a European Equity ETF with broadly the same features).
To facilitate the rapid capitalisation of the real economy, the process for wholesale clients to change their investment strategies should be as swift as possible. If switching becomes easier,
Based on Annex II, chapter II, paragraph II MiFID.
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this will also incentivise wholesale clients to invest in other and new business models and therefore help a broader range of firms at an early stage in the recovery process. Professional clients should therefore be allowed to choose whether this measure applies to them. To this end, the substantive requirements as they are currently laid down in Article 54(11) of Delegated Regulation (EU) 2017/565 will be added to Article 25(2) of MiFID II, and a reference to this provision will be included in the list of provisions professional clients are exempted from but can opt-in to.
(f) Product governance
The product governance requirements currently apply to all financial instruments and regardless of the client, even though there seems little benefit in assessing the particularities of a plain vanilla bond when transactions take place between eligible counterparties. In its guidelines on product governance6, ESMA has already partially addressed this lack of proportionality by explicitly recommending further flexibility for “non-complex products”.
Stakeholders to the MiFID II consultation have submitted evidence that product governance rules for certain instruments, which are often referred to as “plain vanilla” issuances, have prevented an optimal allocation of capital by means of vibrant secondary markets. In the light of the current crisis caused by the COVID-19 pandemic, it is indispensable to facilitate the issuing of capital. Issuers and investors must be equipped with the right tools to easily issue new capital and to easily get access to an increased investor base. The earlier these tools are operational, the better for companies and investors alike.
This proposal is therefore lifting the product governance requirements for simple corporate bonds with make-whole clauses (which are investor-protective features). The aim of this exemption, which would need to be complemented by a clear rule that a make-whole clause does not of itself make these instruments a packaged retail and insurance-based investment product (PRIIP), is to make more plain vanilla corporate bonds available to retail investors. This targeted exemption will allow issuers to tap a broader base of investors, allow sophisticated retail investors’ to access a larger choice of instruments and it will retain protection for all categories of investors, however categorised, when accessing complex products. It is an essential part of a recovery package that retail clients can obtain exposure to fixed income products, as such products are essential for diversification and risk-reduction reasons.
(g) Best-execution reports
Article 27(3) of MiFID II requires that each trading venue and systematic internaliser for financial instruments subject to the trading obligation in Articles 23 and 28 of Regulation (EU) No 600/2014 (‘MiFIR’) and each execution venue for other financial instruments, makes available to the public data relating to the quality of execution of transactions on that venue periodically. These periodic reports need to include details about price, costs, speed and likelihood of execution for individual instruments, which are further described in Delegated Regulation (EU) 2017/575 (‘RTS 27’). Stakeholders indicate that the reports are rarely read by investors, evidenced by very low numbers of downloads from their website. It is therefore assumed that investors cannot or do not make any meaningful comparisons between firms on the basis of this data. Buy-side firms informed us furthermore that they receive all the relevant information on best execution through other means (e.g., via brokerage meetings). The current
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Contents
- 620 guidelines on mifid ii product governance requirements 0.pdf
- ESMA will be mandated to develop draft regulatory standards to define those
- Amend Article 57(6)
- competing venues trading commodity
- Amend Article 57(8) to extend access to information in letter (b) to positions held in related contracts on other trading venues and OTC through members and
- In Article 57(1) introduced for
- In certain circumstances, as the COVID-19 pandemic has shown, the provision of liquidity is challenging even for the most liquid derivatives. Therefore, the Commission also introduces a
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crisis has increased the urgency to address problems with regard to the costly production of the best execution reports. This is evidenced by ESMA’s statement that firms may need to deprioritise efforts for the publication of these reports due to the exceptional circumstances created by the COVID-19 pandemic.7
Therefore, the requirement to publish the best execution report should be suspended. This would free up resources currently used for production of the report, without requiring firms and venues to invest in costly implementation. This option does not lead to a decrease of investor protection since investors currently do not read the reports at all and buy-side firms receive the relevant information through other means. In the context of the full review of MiFID II in 2021, the Commission will assess whether the requirement to publish the report should be deleted permanently, or if the reports need to be reintroduced in a revised manner.
5.2.2. Measures affecting energy derivatives markets
The proposed amendments carefully recalibrate the position limit regime and the scope of the hedging exemption in order to ensure that nascent euro denominated markets are able to foster and allow producers and manufacturers are able to hedge their risks whilst safeguarding the integrity of commodity markets, except for agricultural commodities, in particular those with food for human consumption as an underlying.
The following table provides an overview of the proposed changes:
Amendments in the field of commodities markets (except agriculture)
| affected | the |
| markets. | To |
| markets | can |
| limited | to |
| derivatives |
Amend position limits: in its current form, the position limit regime has negatively liquidity in new commodity ensure that new commodity develop, position limits are
agricultural commodity
or commodity derivatives designated as significant or critical.
agricultural derivatives subject to position limits and to define critical or significant derivatives subject to position limits. For the critical or significant derivatives, ESMA will take into account a gross size of open interest of 300 000 lots on average over one year, the number of market participants and the underlying commodity. For agricultural derivatives, particular focus will be on those derivatives that have food for human consumption as underlying.
Delete concept of “Same contract”: for
Change Article 57 whereby the scope of position limits would be amended to only apply to agricultural contracts and significant or critical contracts.
on position limits for
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reports-under-mifid-ii.
derivatives based on the same underlying and sharing the same characteristics, the current definition of “same contract” is detrimental to the less liquid market. To ensure a level playing field, the concept of “same contract” is deleted and replaced with a more cooperative approach between competent authorities (CAs).
Reinforce position management controls: significant dissimilarities exist in the way positions are managed by trading venues. Therefore, position management controls will be reinforced where necessary.
ESMA will be mandated to further clarify the content of position management controls taking into account the characteristics of the relevant trading venues.
Introduce exemption:
narrowly
defined
hedging
– This hedging exemption would be available where, within a predominantly commercial group, a person has been registered as an investment firm and trades on behalf of the group.
– A position limit exemption is also introduced for financial and non-financial counterparties for positions resulting from transactions undertaken to fulfil
mandatory liquidity provisions.
ESMA will be mandated for the narrowly defined hedging exemption and the liquidity provision exemption to determine a procedure setting how persons may apply the respective exemption.
Exclude securitised derivatives from the position limit regime as the current position limit regime fails to recognise the unique characteristics of those instruments.
Simplify the ancillary activity test as the quantitative tests of the ancillary activity test are particularly complex and have not altered the status quo in terms of persons that are
the “same contracts” and Article 58(2) on position reporting to the central competent authority for same contracts.
Amend Article 57(8) to extend access to information in letter (b) to positions held in related contracts on other trading venues and OTC through members and
participants, where appropriate.
hedging exemption is
- financial counterparties acting as the market facing entity of a commercial group for the positions held to reduce the risks of the commercial entities of the group;
- financial and non-financial counterparties for positions which are objectively measurable as resulting from transactions entered into to fulfil obligations to provide liquidity on a trading venue, in accordance with letter (c) of the fourth subparagraph of Article 2 i.
In Article 57(1) an exemption is introduced for financial instruments defined in point (44)(c) of Article 4(1) which relates to a commodity or an underlying referred to in section C(10) of Annex I.
Article 2(1)(j) will be changed in order to delete all quantitative elements.
a
a
eligible for the exemption.
The measures set out for positon limits and the hedging exemption for energy derivatives are interlinked. To the extent that position limits play a useful role, they should not prevent the commercial companies from entering into risk reducing transactions. Therefore, reducing the scope of the position limit regime to only the most developed commodity derivatives leaves less need for hedging exemptions. That is why the Commission considers targeted measures regarding the hedging exemption in combination with the position limits for critical benchmark derivatives.
(a) Position limit regime for critical benchmark contracts
The COVID-19 pandemic and its economic consequences have exacerbated the issues in the MiFID II position limit regime and its inflexibility. Various position limits in commodity derivatives markets are proven to be out of date, whilst adjusting them to accommodate for rapidly changing market conditions requires the completion of lengthy change processes. Position limits would be limited to derivatives with agricultural derivatives, in particular food for human consumption, as underlying and commodity derivatives traded on trading venues and in economically equivalent OTC (EEOTC) derivatives designated as significant or critical.
The Commission will mandate ESMA to draft regulatory technical standards (RTS) to determine the derivative characteristics in order to qualify as a significant or critical derivative and to define those agricultural derivatives subject to position limits, in particular those with food for human consumption as underlying. For the significant and critical derivatives, the criteria include an open interest of 300 000 lots over one year, the number of active market participants, and the underlying commodity. An open interest threshold for derivatives of a sufficiently high number of lots over a one-year period will ensure that only derivatives the price of which serves as a benchmark for the underlying commodity are captured. The relevant threshold for critical derivatives will be set at 300 000 lots, this ensures that only the appropriate significant or critical commodity derivatives traded in the EU remain subject to position limits. The other criteria will be determined in Level 2.
(b) Targeted hedging exemption
Under the current market circumstances, market participants can develop an urgent need to obtain hedging exemptions. However, in crisis conditions they may struggle to prepare and submit an application for a hedging exemption before a position limit unduly restricts their trading activity. MiFID II does not allow hedging exemptions for any financial entities. Prior to MiFID II, some commercial groups decided to register as an investment firm the entity that trades on their behalf for the risk reducing transactions of the commercial entities of the group. Because they are now financial entities, these entities within a predominantly commercial group are not eligible for the hedging exemption. The hedging exemption should be available where, within a predominantly commercial group, a person has been registered as an investment firm and trades on behalf of that commercial group. The exemption applies to the positions held by that financial counterparty that are objectively measurable as reducing risks directly related to the commercial activities of the non-financial entities of the group. This hedging exemption should not be considered as an additional exemption to the position limit regime but rather as a “transfer” to the financial counterparty of the group of the hedging exemption otherwise available to the commercial entities of the group.
In certain circumstances, as the COVID-19 pandemic has shown, the provision of liquidity is challenging even for the most liquid derivatives. Therefore, the Commission also introduces a
position limit exemption for financial and non-financial counterparties that are under mandatory liquidity provision obligations. This exemption mirrors the exclusion of transactions entered to fulfil obligations to provide liquidity on a trading venue from the ancillary activity test.
(c) Qualitative Ancillary Activity Test
Market participants that trade in commodity derivatives on a professional basis can make use of an exemption from authorisation as an investment firm when their trading activity is ancillary to their main business. Market participants have to notify annually the relevant competent authority that they make use of this exemption and provide the necessary elements to satisfy the quantitative tests. These quantitative tests are particularly complex and during the crisis present a significant burden for market participants working in business continuity mode. The ancillary activity test will be considerably simplified. The proposed simplification of the current and highly technical quantitative ancillary test is to return to a solely qualitative test. In addition, the ancillary activity exemption with regard to trading of emission allowances on EU and third-country trading venues will be reviewed to ensure that it supports the well-functioning and objectives of the EU emission trading system (EU ETS).