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Summary of Public Hearing on Draft Advice on the Review of Commodities Business

Core Content

The public hearing on the Draft Advice on the review of commodities business was held by the Commodity Trading Forum (ComTF) in London on 7 July 2008. The hearing aimed to assess the regulatory and prudential implications of applying the Markets in Financial Instruments Directive (MiFID) and the Capital Requirements Directive (CRD) to firms involved in commodity derivatives and related activities.

The process leading up to the hearing included multiple calls for evidence and advice from the European Commission, CESR, and CEBS, culminating in the publication of the CP 3L3 08 02 on 15 May 2008. The consultation period ended on 1 August 2008, with 16 responses received, of which 13 were published.

Main Views and Key Findings

Market Failure Analysis

• Information Asymmetries:

  • While information asymmetries could lead to market failures, they are considered to have limited impact overall.
  • Concerns arise mainly from the opacity of OTC commodity derivatives markets, but responses suggest this is not a major issue in practice.
  • There is a risk of abusive market conduct (e.g., insider dealing, market manipulation), which is covered by the Market Abuse Directive.

• Negative Externalities:

  • Systemic risk is a concern, especially if firm failures impact the availability and price of commodities.
  • The risk is considered relatively low for specialist commodity derivative firms compared to credit institutions and ISD investment firms.
  • Firms with a central role in the economy (e.g., credit institutions) and those active in multiple financial markets pose higher systemic risk.

Regulatory Failure Analysis

• Differences in regulatory treatment across the EEA may lead to competitive distortions and regulatory arbitrage.
• The majority of ComTF believes that the full application of CRD to specialist commodity derivatives firms would be disproportionate and could result in regulatory failure.
• There is a need for regulatory convergence to avoid these issues, but the market is unlikely to correct them on its own in the short to medium term.

Advice on MiFID and CRD

MiFID Organisational Requirements and COB

• No evidence suggests the need to adapt MiFID's organisational requirements or transparency provisions.
• A recommendation was made to allow firms to treat undertakings as professionals if the clients are deemed capable of making their own investment decisions.
• This would be accompanied by a transitional provision similar to Article 71(6) of MiFID.

MiFID Definition of Financial Instruments

• No evidence was found to require clarification of the current definition of financial instruments under MiFID.

MiFID Articles 2(1)(i) and (k)

• These articles should be replaced with exemptions for firms that:
  • Provide investment services in commodity derivatives or derivative contracts in Annex I, Section C 10 to their main business clients, provided this is an ancillary activity.
  • Deal on their own account in commodity derivatives exclusively under arrangements with authorised investment firms or equivalent third-country firms.

Treatment According to Type of Entity or Underlying

• No evidence supports different treatment based on the type of entity or the underlying of the financial instrument.
• Risks from energy-only investment firms are not materially different from those of other specialist commodity derivative firms.

CRD LE and Free Deliveries Regime

• LE Regime:

  • Full application of the LE regime is considered disproportionate for specialist commodity derivatives firms.
  • These firms do not generate significant systemic concerns, and applying the regime would require excessive capital.

• Free Deliveries:

  • No adjustment to capital requirements is needed.
  • A more realistic treatment of the exposure period is recommended, aligning with market practices where payments are often delayed beyond 5 days.

CRD Maturity Ladder Approach

• The maturity ladder approach may over- or underestimate capital requirements for certain commodities.
• Alternative approaches, such as using current forward prices instead of spot prices, or developing a more comprehensive method, are suggested.

Ancillary Agricultural Commodities Business

• The frequent calculation of capital requirements under CRD would be overly burdensome for firms engaged in ancillary agricultural commodities business.
• A simplified approach is recommended for such firms.

Regulatory Options

Option 1: Adequate Financial Resources and Qualitative Risk Management

• Based on the principle of 'adequate financial resources' rather than detailed rules.
• Requires firms to meet qualitative risk management standards under CRD.
• Financial resources breakdown would be part of the annual report, similar to the ICAAP for full CRD firms.
• Supervisors could challenge firms' assessment of adequate resources.
• Specialist commodity derivatives firms could opt to apply full CRD if they demonstrate appropriate risk management and financial resources.
• Competent authorities could revoke authorisation if firms fail to meet these standards.
• Firms under this approach would be considered 'institutions' under CRD.

Option 2: Full Application of CRD

• Full application of CRD, including Pillar 1 capital requirements and the LE regime.
• Exemptions are recommended for firms that are systemically not relevant.
• Exempted firms would not be treated as 'institutions' under Article 3(1)c of the CRD.

Conclusion

The ComTF and responses to the CP suggest that a balanced regulatory approach is necessary. Specialist commodity derivatives firms should not be subject to the same stringent requirements as credit institutions or ISD investment firms. A simplified and proportionate regime that leverages existing risk management practices and aligns with market realities is preferred. Regulatory convergence and clarity are essential to prevent distortions and ensure fair competition.