An inappropriate definition of commodity derivatives would shift the majority of trading activities in wholesale gas and electricity derivatives to a less regulated environment. Today, the Europex Board – fully supportive of the G-20 Pittsburgh commitments of promoting more transparent, non-discriminatory and systemically safer markets – is calling upon the European Securities and Markets Authority (ESMA) and the European Commission to find a proportionate and activity-based definition for gas and power derivative contracts ”that must be physically settled”.
The Board is deeply concerned about the potential impact of the current Level 2 discussions in the framework of the review of the Markets in Financial Instruments Directive (MiFID II/MiFIR). Europex’ concerns refer mainly to the ’wholesale energy products’ exemption in the financial instrument definition in MiFID II[1]. The exemption applies to power and gas derivatives “that must be physically settled” and that are traded on Organised Trading Facilities (OTFs). Such derivatives will not be considered as financial instruments under MiFID II – unlike equivalent energy derivative contracts traded on Regulated Markets (RMs) and Multilateral Trading Facilities (MTFs).
“This highly specific exemption in the definition of financial instruments has been created for the sole purpose to exclude a small share of European energy trading directly linked to physical real economy transactions from the scope of MiFID II. The intention has never been to exempt the major share of wholesale gas and power trading in Europe”, underlines the Chairman of Europex, Massimo Ricci.
All subsequent regulatory obligations of MiFID II such as position limits, position reporting, rules on algorithmic trading and pre- and post-trade transparency will thereby not apply to the carved out gas and power derivative contracts. Other EU regulations which directly refer to the MiFID II financial instruments definition do not apply either, such as the European Market Infrastructure Regulation (EMIR) or the upcoming Regulation on indices used as benchmarks in financial instruments and financial contracts for instance.
Depending on the final technical details of the definition, the wholesale energy products exemption is likely to cause a major shift of liquidity away from RMs and MTFs to the newly created and less transparent OTFs, moving trading outside the scope of financial regulatory oversight. As a result, the G-20 Pittsburgh commitments to increase transparency and to provide for greater systemic stability would not be achieved as a large share of the European energy trading would take place completely off the MiFID II radar screen.
The Europex representatives, however, stress that notably the MiFID II ancillary services activity exemption should be comprehensive enough in order to ensure that the great majority of energy companies in Europe will not be classified as investment firms. Without a need for a MiFID license, those firms do not have to fully comply with all MiFID II/MiFID rules, especially with regard to the Capital Requirements Directive (CRD IV/CRR).
The classification of derivative contracts as financial instruments will allow for more and better transparency, a well-functioning position limits regime and a comprehensive application of the OTC clearing framework of EMIR. It is crucial to enable regulators to keep a comprehensive overview of the energy markets beyond the Regulation on wholesale Energy Market Integrity and Transparency (REMIT), which has not been designed to handle the risks linked to financial markets such as market squeezing, risks arising from algorithmic trading or counterparty risk management.
Massimo Ricci concludes: “After the publication in the EU’s Official Journal, it is of utmost importance to implement MiFID II correctly and in accordance with the agreed Level 1 legislation. Recital 10 provides clear and unmistakable guidance for establishing a limited exemption, based on actual physical production and consumption.”
The Board explicitly highlights the Europex response to ESMA’s MiFID II / MiFIR consultation in which it has made an own proposal for the specification of the expression “must be physically settled”. The Europex approach is based on the guiding principle that for each individual market participant the volume of the exempted contracts should be limited to the quantities related to its actual production and/or consumption of power and gas.