UK Regulator Consults on Proposed Reforms to the Commodity Derivatives Regulatory Framework12/08/2023The U.K. Financial Conduct Authority has launched a consultation on proposals for reforming the commodity derivatives regulatory framework, which covers position limits, the exemptions from those limits, position management controls, the reporting regime and the ancillary activities test. Responses to the consultation may be submitted until February 16, 2024.
The Financial Services and Markets Act 2023 has already made several reforms to the U.K.'s commodity derivatives regulatory regime. The MiFID II requirement for commodities position limits to be applied to all exchange-traded contracts and over-the-counter, or non-venue traded ("OTC"), contracts that are economically equivalent to exchange-traded commodity derivatives was revoked. Instead, the FCA will decide the scope of the commodity derivates to which position limits will apply. In addition, the powers for setting position controls were transferred from the FCA to the operators of trading venues. This contrasts with the EU approach, where position limits are not just set by the regulators, but actually in formulae in legislation, which have proven ill-thought-through and problematic for numerous markets. The FCA has retained the power to set position limits if certain conditions are satisfied, and has new rulemaking powers to establish how trading venues should set and apply position limits and what position management controls they should operate. Generally, the reversion of position limit controls to exchanges as self-regulatory organisations reflects the U.K.'s status quo ante, i.e., prior to MiFID II.
The FCA's consultation paper sets out its proposed approach and rules to further develop a U.K. regime that will enhance the ability to identify risks, ensure changes can be made swiftly in response to changes in the markets, and remove unnecessary requirements to relieve the burden on firms. In summary, the FCA is proposing:
- To narrow the application of the position limits regime to a set of identified "critical" contracts and certain sufficiently related contracts. The FCA discusses how it intends to identify these contracts, which is not based on any fixed qualitative or quantitative measures. The final criteria will be set out in the FCA's Handbook to provide transparency. The FCA also provides a list of proposed critical contracts.
- To amend the existing criteria in RTS21 to provide the criteria that trading venues should consider when setting position limits. In addition, the FCA proposes: (i) that trading venues should apply different position limits to both spot months and other months; (ii) not to amend the scope of the regime as applicable to trading venues and participants; (iii) rules relating to trading venues' obligations to review position limits, governance and the criteria for setting the methodology for determining position limits.
- To require trading venues to establish accountability thresholds as a position management control. The FCA rules will set the scope and method for applying the thresholds, the methodology for setting accountability thresholds and require trading venues to notify the FCA of their methodology and accountability thresholds (which will need to be agreed with the FCA before implementation).
- Enhanced position reporting requirements. Trading venues will need to have access to additional information, including information on OTC positions held by their members and their clients.
- A new exemption for liquidity providers and the introduction of a pass-through hedging exemption for financial firms (similar to the Commodity Futures Trading Commission's exemption) and adjustments to the existing hedging exemption. Trading venues will be subject to enhanced requirements designed to ensure that exemption use does not disrupt the orderly operation of markets.
In addition, new guidance is being issued on the so-called "ancillary activities" test. This provides an exemption from the regulated activity of dealing as principal, when a company deals in financial instruments only in a way ancillary to its main business. The intention of this exemption is primarily such that general corporates who hedge their business risks do not require regulation. The FCA is proposing to provide guidance to the effect that "ancillary" is something "related" or "subordinate" to the main business of the group, and that firms may consider the trading and capital employed thresholds used in the EU delegated regulation in order to take a view on whether an activity is ancillary. The legislative changes made in the Financial Services and Markets Act 2000 (Commodity Derivatives and Emission Allowances) Order 2023 enter into force on January 1, 2025.
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