Markets in Financial Instruments Directive Chris Bates September 2005 Interaction with the CRD

Markets in Financial Instruments Directive

Chris Bates

September 2005

Interaction with the CRD

Markets in Financial Instruments Directive: Interaction with the CRD · September 2005 2

Current position/today’s issues MiFID definition of investment firm/exemptions Scope of CRD/consolidated supervision Immediate impact of MiFID/CRD MiFID review and possible impact


Current position Commodities business outside the scope of:

Mandatory EU authorisation requirements EU passport regime EU consolidated supervision requirements

– Commodities firms not financial institutions under BCD/CAD/FGD

But: Member states (MS) can impose national authorisation

requirements on commodities firms (and many do) Some unilateral recognition of other MS’s authorisation Banks/investment firms carrying on commodities business

subject to BCD/CAD capital rules on that business– But MS can apply extended maturity ladder approach to firms with

significant, diversified commodities business (to end 2006)


Today’s issues for commodities business

Some entities pay price of capital regulation but face barriers to cross-border EU business

Authorised banks/investment firms and (if included in consolidated supervision) their unregulated affiliates

Commodities firms subject to national regulation

Barriers to cross-border EU business also affect: Unregulated entities within the EU Non-EU entities doing business with EU counterparties

(subject to overseas persons or other exemptions) But no regulatory capital rules


New MiFID definition of investment firm

Extension of “financial instruments” to include: Commodity/“other” derivatives traded on regulated

markets/MTFs/third country equivalents Cash settled OTC commodity/“other” derivatives Some physically settled OTC commodity/“other” derivatives

– If not “for commercial purposes” (and not spot) “Other” derivatives include derivatives on:

– weather, economic statistics, freight, emissions allowances, bandwidth and other fungible deliverables

Subject to finalisation of level 2 measures

Extension of ancillary services to cover: Some connected physical commodity business


But article 2(1) exemptions (b) Persons providing investment services exclusively for

group companies (d) Persons dealing for own account unless

They provide other investment services/activities They are market makers or They deal for own account outside a regulated market/MTF on an

organised, frequent, systematic basis by providing a “system accessible to third parties”

(i) Persons: Dealing for own account in financial instruments, ancillary to

group’s main business; or Providing investment services in commodity/“other” derivatives to

clients of group’s main business in a way which is ancillary to group’s main business

Provided group’s main business not investment services/banking


Article 2(1) exemptions (cont.) (k) Persons whose main business is dealing for own

account in commodities and/or commodity derivatives Provided group’s main business not investment services/banking

(l) Persons: Dealing for own account on derivatives markets (and on cash

markets for the purposes hedging positions on those markets) Dealing for the account of other market members or making prices

for them

Provided that: They do not provide other investment services/activities Business is guaranteed by clearing members of the market


CRD will apply to: Credit institutions carrying on commodities business Investment firms carrying on commodities business but

allows reduced requirements for firms: Firms that don’t deal for own account/underwrite Firms that deal for own account to execute client orders or under

clearing and settlement systems for client orders Firms dealing for own account but no external customers, don’t

hold client money, trades guaranteed by clearing institution Extended maturity ladder available to firms with significant,

diversified commodities business


Consolidated supervision will apply to:

Banking groups (and FGD financial conglomerates)

But commodities firms in group still not “financial institutions” even if investment firms

Investment firm groups Consolidated supervision will extend to EU and non-EU

“investment firms” But not other commodity firms in group


Immediate impact of MiFID and CRD Commodities business passport for:

Banks, mainstream investment firms Specialised commodity trading subsidiaries in banking/investment

firm groups– But may fall within A. 2(1)(d) or (l)

CRD rules apply with only limited exceptions Outside banking/investment firm groups, no passport/CRD for:

Nationally regulated commodity trading firms where e.g.:– Entity’s main business is own account dealing in commodities/derivatives– Entity’s business ancillary to group’s business within A 2(1)(i)– Possibly even if an investment firm today

Unregulated commodity producers, manufacturers, generators– Even if provide risk management services taking firm outside A 2(1)(d)– Likely to be exempt under one of A 2(1)(i), (k) or (l)– Extent of national regulation depends on national rules e.g. continuation of

“with or through” exemption in the UK


Commission to report by 30 Oct 2007:

Continuation of A. 2(1)(k) for entities whose main business is dealing in commodity derivatives

Not those whose main business is dealing in commodities Content/form of proportionate capital requirements for

those firms Continuation of A. 2(1)(i) as a whole

Not limited to aspects dealing specifically with commodities

…Working assumption that Commission would propose repeal of:

A 2(1)(i) provisions dealing with commodity/“other” derivatives A 2(1)(k) provisions dealing with dealers in commodity

derivatives only


Possible impact

Unlikely to affect entities in banking/investment services groups

Many nationally regulated (but exempt) entities likely to become investment firms, except where:

Entity’s main business is dealing in physical commodities (A. 2(1)(k) residual)

Locals and other own account dealers on exchanges (A. 2(1)(l))

Some entities whose business is ancillary to group’s main business (A. 2(1)(i) residual)


Likely principal impact Unregulated commodity producers, manufacturers,

generators and their trading affiliates may become investment firms, subject to CRD, if deal in derivatives

But may be able to: Restructure to rely on exemption for entities whose main

business dealing in commodities (A 2(1)(k) residual) Rely on exemption for business ancillary to group’s main

business (A. 2(1)(i) residual) Rely on exemption for non clearing market members (A.

2(1)(l)) Book business outside the EU, relying on exemptions for

cross-border business if booking business with EU counterparts


Non-banking/investment service groupFirm’s main business Post-MiFID Post-review

Commodity exchange clearing member and client order execution

Not exempt Not exempt

Own account dealing as commodity exchange clearing member (no client order execution)

Exempt (A. 2(1)(k)) Not exempt

OTC energy trading in physical product and derivatives

Exempt (A. 2(1)(k)) Possibly still exempt if physical business still main business (A. 2(1)(k)) or if “ancillary” to group’s main business (A. 2(1)(i)).

Clifford Chance, 10 Upper Bank Street, Canary Wharf, London, E14 5JJ, UK

© Clifford Chance LLP 2005

Clifford Chance Limited Liability Partnership

www.cliffordchance.com

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Markets in Financial Instruments Directive Chris Bates September 2005 Interaction with the CRD