New EU financial market rules on the financial industry are likely to impact commodity trading companies. One of the most relevant in this regards is MiFID II.
Why is MiFID applicable to commodity trading?
The starting point of the Commission’s proposal to reconsider the current regulation of commodity trading under MiFID is the communiqué of G20 finance ministers and central bank governors of 15 April 2011. The communiqué stipulates the need to ensure that participants on commodity derivatives markets should be subject to appropriate regulation and supervision.
Who will be affected?
The current draft of the MiFID II regulation, as amended by Parliament (ECON) and the Council, keeps the essence of the exceptions for the commodities trading houses. As such, the Commission’s approach to modify the current exemptions from MiFID for various participants active in commodity derivative markets was to require that activities by firms, which are not part of a financial group, involving the hedging of production-related and other risks, as well as the provision of investment services in commodity or exotic derivatives on an ancillary basis to the main business, remain exempted, but that firms specializing in trading commodities for third parties and commodity derivatives trading are brought within the scope of the Directive.
What are the exceptions?
The draft of MiFID II seems, therefore, to keep the basic exemptions but also tries to respect the G20 recommendations at the same time. This led to a proposal which is currently not clear in all its details and not finalized. For the time being we can observe the different positions of ECON and of the Council on these issues. Generally, we expect that the distinction will be between physical commodity trading and financial commodity trading. Commodity firms with activities in the whole value chain of the commodities business with physical operations (mining/production, shipping, distribution etc.) and trading that will result in physical delivery can use derivatives to hedge without being subject to MiFID regulation. For these companies, trading with commodity derivatives is ancillary to their core business. Pure financial commodity trading, which is more speculative by nature, will not be exempted. The final wording (recently delayed to fall) and the second level regulation will give further guidance.
It should, however, be noted that there are other provisions in the draft rules that would require market participants that are connected to a trading platform to be included in prudential supervision. This could be applicable to the trading houses and increase regulatory oversight on their activities in Europe and with European counterparties.