MiFID II Update | KPMG | UK
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MiFID II Update

MiFID II Update

Details of key exemption tests for corporates released.



KPMG in the UK


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On 1 December 2016, the European Commission adopted the long-awaited final draft of RTS 20.

The RTS 20 governs the provisions under which persons dealing in commodity derivatives, emissions allowances and derivatives thereof (collectively “commodity derivatives” for the purposes of this summary), may be exempt from the provisions of MiFID II and MiFIR.

The so-called “Ancillary Activities Exemption” envisaged by MiFID II, is critical to many corporates and commodity traders who use commodity derivatives in their commercial activities, but who do not provide other investment services to clients and want to avoid becoming an authorised investment firm.

The mechanics of the exemption have been the subject of a long and public tussle between the European Securities and Markets Authority (ESMA) and the Commission, resulting in a complex compromise that offers plenty of scope for interpretation.

Two key threshold tests

  • The Overall Market Test, which compares a firm's speculative commodity derivative activity with the size of the EU market (exchange traded derivative – ETD, and over the counter - OTC) on an asset class basis; and
  • The Main Business Test, which compares the size of a firm's speculative commodity derivatives activity, across all asset classes to the main activities of the group, which can be calculated in two ways.

Certain transactions can be excluded from the size of a firm's speculative trading activity, including intra-group transactions serving group-wide liquidity or risk management purposes, hedging transactions and transactions undertaken in an authorised group entity.

In both cases the result is an average of three annual results, unless the trading activity or estimated capital allocated has declined in the current year, and in total over the three year period by more than 10%, in which case only the last year can be used. The calculations are also required to be undertaken in Euros.

Focus on the Overall Market Test

  • The Overall Market Test is calculated annually, for each firm holding commodity derivatives in the EU, by asset class and averaged over three annual periods.
  • The ratio is based on the Gross Notional Value (‘GNV’) of a firm’s ETD and OTC commodity derivatives compared to that of the EU as a whole (only speculative commodity derivatives activity counts to the numerator).
  • The level of Overall Market Test threshold for each asset class, is dependent on the Main Business Ratio (see below) if firms have chosen the GNV approach for the Main Business Ratio. In such cases, the threshold for the Overall Market Test is reduced if the Main Business Ratio is higher. No such allowance is available however for the capital based approach to the Main Business Ratio (i.e. it is a binary pass/fail on the Main Business Test if using the capital approach).

Focus on the Main Business Test

  • Firms are free to choose from two ways to perform the calculation.
  • Option 1 - Gross Notional Value of derivatives trading
    • The 'GNV approach' compares the volume of speculative commodity derivatives traded in the EU each year in all asset classes with the total GNV of all commodity derivatives including hedges, in all asset classes, by all firms in the group to which the firm belongs.
    • Where firms choose this approach, the resulting ratio determines the size of the hurdle for the Overall Market Threshold.
  • Option 2 - Simplified approach derived from the Capital Requirements Regulation
    • This option, the 'capital approach', compares an estimated capital requirement for speculative commodity derivatives to the sum of total assets, less short term debt in the consolidated financial statements of the group at the end of the calculation period (31 December each year).

Questions and issues

There are a number of potential issues with these tests. Among the obvious is the difficulty of applying the tests retrospectively for the first calculation period starting 1 January 2015 and, even at this stage, 2016 on a consolidated group level, especially if the group financial year-end is not 31 December. There will also be challenges associated with obtaining group-wide data where the ultimate parent is not an EU member firm. Our experience of the similar GNV approach to the European Market Infrastructure Regulation (EMIR) Clearing Threshold has revealed key sensitivities around hedging policy assumptions on the result. We anticipate similar challenges to be experienced with these tests. 

Additionally, we note there are a number of important accounting standard changes to come in the next few years and their impact on the capital test will need to be considered carefully.

Next steps

Firms should undertake structured and documented work to ensure they are, and remain eligible for, this exemption (which must be applied for annually), or apply for authorisation as a MiFID investment firm if they do not meet the exemption criteria. Some areas to focus on are:

  • Formally engage with other group companies and the ultimate parent.
  • Review the use of commodity derivatives in the group.
    • Seek external help if you are unsure about the impact of provision of investment services (including to other group members), use of high frequency algorithmic trading, or use of a regulated entity within the group to arrange transactions for the group, even on a hedging basis.
  • Review the policies, procedures and mandates (approved trading and hedging strategies) under which commodity derivatives are transacted and the supporting risk management systems.
    • If hedging takes place, but you do not currently qualify for hedge accounting, you are likely to need to tighten your policies and procedures in this area. You may even need to refine your business model or booking strategy to retain exemption under this provision.
  • Perform trial calculations of both tests, and under both options for the Main Business Test.
    • Use assumptions where required e.g. on EU market sizes.
    • Explore the data on commodity derivatives in your systems through the calculations. 
    • Test and further refine the definition of qualifying 'risk reducing transactions'.

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