ESMA Issues Commodity Derivative Consultation Paper (with Topping Comment)

The European Securities and Markets Authority ("ESMA") issued a consultation paper regarding the application of the definition of "derivative" or "derivative contract" for some asset classes under MiFID.

According to ESMA, the different approaches to the interpretation of MiFID I across member states mean that there is no commonly adopted application of the definition of "derivative" or "derivative contract" in the EU for some asset classes, the practical consequences of which have come to the forefront with the implementation of EMIR.

The European Commission therefore invited ESMA to consider issuing guidelines on the application of the definitions of "C6" and "C7" of Annex 1 of MiFID. ESMA prepared the consultation paper in order to consult interested parties for the purpose of producing these guidelines.

Of note in the consultation paper:

• ESMA stated it is of the view that forwards are included within the definition of "C6" for the following reason: The language of C6 includes explicitly "any other derivative contract" and refers specifically to options, futures and swaps. A forward - that is, a type of derivative contract - could thus be captured; and
• contracts that can be physically settled in all cases fall initially under C6 or C7, depending on the place of execution, except when there is an option available to one of the parties to cash settle, in which case the contract will fall under C5. In this regard, however, ESMA notes that it has not been able to identify any instrument that can be described accurately as "must be physically settled," since all instruments appear to contain force majeure provisions that would prevent physical delivery.

Comments on the consultation paper are due by January 5, 2015.

Topping Comment: ESMA's guidelines are not legally binding. MiFID 1 has been in force since 2007, and each EU member state has already built the MiFID 1 rules into its domestic financial services regulatory regime and has had nearly seven years' practical experience interpreting and enforcing those rules. Therefore, the ESMA guidelines are unlikely to have a material impact in the near-term MiFID 1 regulatory regime.However, the guidelines do give us a clear insight into how ESMA views these contracts, which is relevant going forward given that ESMA is in the process of writing level 2 rules relating to the definition of "commodity derivatives" for MiFID 2. These rules come into force in January 2017 and will be legally binding throughout the EU, without the same scope for divergent interpretations by national regulators as exists under MiFID 1.