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

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

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

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

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

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

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

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

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

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

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

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

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

Markets in Financial Instruments Directive: Interaction with the CRD · September Non-banking/investment service group Firm’s main businessPost-MiFIDPost-review Commodity exchange clearing member and client order execution 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)).

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