MFA Proposes Ways to Best Incorporate EC Position Limit Amendments into MiFID II RTS

Bob Zwirb Commentary by Bob Zwirb

The Managed Funds Association ("MFA") made recommendations on how amendments proposed by the European Commission ("EC") concerning commodity derivative position limits could most effectively be incorporated into the European Securities Market Authority ("ESMA") MiFID II Regulatory Technical Standards ("RTSs"). In its letter to ESMA, MFA stated that its recommendations were aimed at "seeking a pragmatic outcome that adheres to the spirit of proposals made both by the [EC] and by the European Parliament."

The MFA made the following recommendations relating to commodity derivative position limits:

  • Baseline for Non-Spot Month Limits: The MFA urged the EC to rely on national competent authorities ("NCAs") to interpret what constitutes a "significant discrepancy" between open interest and deliverable supply.

  • Definition of "Economically Equivalent" in Commodity Derivative Contracts: The MFA proposed that ESMA revise the wording of the draft RTS to refer to over the counter commodity derivatives resulting in the "same economic exposure" (rather than referring to identical contractual specifications, etc.) as exchange-traded contracts.

  • Volatility: Although the MFA acknowledged that NCAs must take volatility into account in setting position limits, MFA does not consider that the RTS should mandate that greater volatility must result in lower position limits. The MFA emphasized that imposing a lower limit on a volatile market could result in market participants "racing" to close out positions and "further exacerbate volatility."

As to non-equities transparency, the MFA encouraged ESMA to amend RTS II such that the maximum permitted post-trade transparency delay for cleared derivatives is 15 minutes, in line with the CFTC regime.

Commentary

Bob Zwirb
Bob Zwirb

The letter presents an interesting contrast between the U.S. and E.U. approaches for position limits.  While the scope of the EU framework is, as MFA notes, “unprecedented” in that it will apply across all commodities, in the U.S. it will be limited, initially, to certain physical commodities—energy and metals-to-go along with the current one for agricultural commodities. Given the controversy surrounding the need for position limits in the first place, the U.S. approach appears to be more reasonably calibrated. 

Under either approach two important issues should be considered. First, who should be responsible for setting limits and interpreting key terms such as “deliverable supply”? In the U.S., members of the EEMAC are urging the CFTC to rely as much as possible on the exchanges, which historically set limits and accountability levels for commodities other than agriculture. In the E.U., MFA is urging that such concerns be left to “national competent authorities.” While both critiques appear to be nudging regulators away from relying upon remote authorities, the advice rendered in the U.S. by EEMAC offers more promise. Exchanges, after all, would seem to have a comparative advantage over “national competent authorities” in setting limits in a flexible manner and responding more quickly to changes in the market environment. 

Second, what methodology should apply? Given the broad range of commodity derivative contracts encompassed by the EU framework, MFA is urging that the methodology be “sufficiently flexible to adapt to a wide range of different contracts and market conditions.” This is also good advice for the U.S., where the CFTC intends to rigidly apply the same formula it uses for wheat and corn to oil and gas.

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