The UK Financial Conduct Authority (FCA) announced on July 9 that, while changes to the scope of the UK commodity position limits regime are being consulted on, it will not take enforcement action against firms that breach position limits on cash-settled commodity derivative contracts unless the underlying is an agricultural commodity. However, the FCA will keep its stance under review, and reconsider if there are indications of market abuse.
The FCA’s announcement follows HM Treasury’s consultation on its wholesale markets review published on July 1 (the Consultation), which proposes, among other changes, to limit the scope of position limits to agricultural contracts and physically settled contracts.[1]
The FCA has also confirmed its December 2020 statement that it would not take enforcement action for position limits breaches by liquidity providers fulfilling their obligations to provide liquidity on a trading venue.[2]
While amendments were made to the EU commodity derivatives regime earlier in 2021 under the so-called MiFID “quick fix,” these were made after the EU withdrawal transition period and so were not required to be implemented in the United Kingdom. HM Treasury has proposed in the Consultation changes to the UK’s position limits regime in reaction to the EU-level amendments, but HM Treasury’s proposals go beyond the EU-level amendments. One of the most significant proposals in the Consultation would revert the UK position limits approach to that under the pre-MiFID II regime, revoking the requirement for position limits to apply to all exchange-traded contracts and transferring the authority to establish position limits from the FCA back to exchanges. To support these changes, HM Treasury explains that the MiFID II approach has resulted in the duplication of position controls across trading venues and the FCA, preventing liquidity from developing.
HM Treasury also identifies the difficulty in identifying over-the-counter (OTC) contracts that are economically equivalent to exchange-traded commodity derivatives and proposes to remove the automatic inclusion of economically equivalent OTC commodity derivative contracts from the scope of the UK MiFID regime. However, HM Treasury proposes to require the FCA and trading venues to continue accounting for relevant OTC contracts when they monitor markets. In connection with exemptions from position limits, HM Treasury proposes to include a “pass-through” hedging exemption for investment firms that deliver a wide range of risk-mitigation services. This way, firms could facilitate hedging activity for commercial entities, including when risk arises on different trading venues or off exchange.
As to the MiFID II “ancillary activities test” that is used to determine whether authorization is needed based on quantitative criteria, HM Treasury proposes to abolish the quantitative test and return to the principles-based, holistic approach that the FCA used prior to MiFID II. Under the proposal, the United Kingdom also would eliminate the annual notification requirement that is used to confirm that an unauthorized firm has performed the ancillary activities test and can remain unregulated.
Further, HM Treasury explains that the UK regimes for oil market participants and energy market participants are burdensome and unnecessary and, therefore, has proposed to remove these regimes and instead use the ancillary activities test to determine whether such market participants should be authorized. Although HM Treasury did not propose fundamental changes to the position reporting regime, it has welcomed specific proposals on strengthening the effectiveness of the reporting regime.
The Consultation closes on September 24, 2021. Market participants who wish to respond to the questions posed by HM Treasury should submit responses prior to this date.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:
Chicago
Michael M. Philipp
London
Simon Currie
William Yonge
Steven Lightstone
New York
Thomas V. D’Ambrosio
Boston
Katherine Dobson Buckley
[1] HM Treasury, Wholesale Markets Review (Jul. 1, 2021).
[2] FCA, Supervisory Statement on the Operation of the MiFID Markets Regime after the end of the EU withdrawal transition period.