On 26 May 2021, the European Securities and Markets Authority (ESMA) launched a public consultation on its new technical standards on commodity derivatives. By way of background, ESMA was mandated by the recent amendments to MiFID II – the so called MiFID Quick Fix – to develop a set of new regulatory technical standards (RTS) on the application of position limits to commodity derivatives, the procedures for financial entities undertaking hedging activities and for liquidity providers to apply for an exemption from position limits, the position management controls and the format of position reports taking into the account the exclusion of securitised derivatives from the scope of position limits. We discussed the revised European commodity derivatives regime in our recent MiFID Review Series article.

Key points to note in the current consultation include:

  • Exemption from position limits for risk-reducing positions held by financial entities: in terms of an aggregation of positions, ESMA proposes that hedging positions held by a financial entity in commodity derivatives shall not be aggregated for the purposes of comparing the net position of that financial entity with the limits for that commodity derivative. Regarding financial entities’ positions qualifying as risk reducing, ESMA proposes to replicate the relevant conditions applicable to similar positions held by non-financial entities (NFEs). Finally, in respect of application procedure for the exemption from position limits for financial entities, ESMA proposes to mirror the application procedure for NFEs, albeit with some necessary adjustments.
  • Exemption from position limits for positions resulting from liquidity provision: in respect of an aggregation of positions, ESMA proposes that positions resulting from transactions entered into to fulfil obligations to provide liquidity on a trading venue shall not be aggregated for the purposes of comparing the net position of that person with the limits for that commodity derivative. Regarding the application for the exemption from position limits, ESMA proposes it draws on the current procedure for NFEs to apply for a hedging exemption, albeit with the necessary modifications. Finally, regarding positions qualifying as resulting from transactions entered into to fulfil mandatory liquidity provision, ESMA proposes that such positions should be identified by the trading venue and the liquidity provider will have to ensure that its own records of transactions undertaken to comply with the written agreement entered into with the trading venue are consistent with the trading venue’s records.
  • Method for calculating the size of the net position of a person: in terms of an aggregation and netting of positions in a commodity derivative, ESMA proposes that the aggregation includes positions held in “commodity derivatives that are based on the same underlying and that share the same characteristic in accordance with paragraph 6 of Article 57 of MiFID II”. Regarding spread contracts, ESMA proposes to clarify in the new RTS that position limits should apply to outright contracts and that the use of spread contracts should be included in the limits set for those outright contracts so that the Level 1 goal can be met.
  • Methodology for national competent authorities (NCAs) to calculate position limits: regarding a methodology for determining the baseline figure for spot month limits, ESMA proposes that, where the deliverable supply is significantly higher than the open interest, the NCA should set the baseline for the spot month limit as 25% of the open interest. The same approach would apply for setting the baseline for commodity derivatives with an underlying that qualifies as food for human consumption. In respect of a deliverable supply, ESMA proposes to clarify that the deliverable supply should be determined by reference to the average monthly amount of the underlying commodity available for delivery based on the most recent available data covering a one year period immediately preceding the determination. For open interest, ESMA proposes that the reference amount used for setting those limits also include open interest in economically equivalent OTC (EEOTC) contracts, clarifies that the open interest should be calculated on a net basis, and suggests that it would be more appropriate for the open interest to be calculated “over a representative period of time” which would depend on the characteristics of the commodity derivative. ESMA also considers a new approach for new and less liquid agricultural commodity derivatives, and sets out provisions on the adjustments to the overall open interest based on a comparison between the size of deliverable supply and open interest. Finally, regarding the number of market participants, ESMA is of the view that a small number of market participants justifies increasing the position limits up to 50% of the reference amount on their own, even without additional available upward adjustment factors. It also proposes that NCAs should be able to adjust the position limit upward to 50% of the reference amount when the commodity derivative is an agricultural commodity derivative with a net open interest below 300,000 lots and when there are less than three market makers in that agricultural commodity.
  • Position management controls: ESMA proposes to specify that the ongoing monitoring of positions held by persons with close links should be part of the position management controls implemented by trading venues. Regarding accountability levels, ESMA suggests that trading venues should be required to set out accountability levels in the spot month and in the other months at least for each physically settled commodity derivative made available for trading. Trading venues should also consider whether it is appropriate to set accountability levels for the other commodity derivatives available for trading.  Finally, the accountability levels should be calibrated taking into account the characteristics of the physically settled contract traded and of the underlying commodity, as well as the contract trading characteristics.

Stakeholders have until 23 July 2021 to submit comments.