Mifid II must recognise that commodities are different

The commodity risk management industry has seen some major changes over the years following the 2008 financial crisis. Among other things, these include the introduction of requirements to centrally clear and report over-the-counter derivatives under the European Market Infrastructure Regulation (Emir) and US Dodd-Frank Act; a more onerous system of regulation for US swap dealers and European financial counterparties; and heightened regulatory capital requirements for banks dealing in commodities.

This list could go on. Yet one of the most significant pieces of post-crisis reform is still to come. Europe’s Mifid II legislation, which includes an updated directive and a regulation, came into force in June and is expected to be implemented from January 2017.

Mifid II has important differences compared with the previous version of Mifid, first introduced in 2007. Most notably, the law narrows exemptions from financial regulation that commodity trading firms previously benefited from and subjects a wider range of commodity transactions to financial rules. It also introduces a system of position limits for commodity derivatives similar to those proposed in the US by the Commodity Futures Trading Commission.

The extension of financial regulation to a more diverse group of companies and the instruments they trade is no trifling matter. Commodity transactions regulated by Mifid II will also be covered by Emir and subject to its rules on clearing and reporting for OTC derivatives, for example. Equally, companies regulated by Mifid II will have to comply with a host of requirements aimed squarely at the financial industry, including rules on ‘best execution’ and the segregation of client funds.

Furthermore, being regulated under Mifid II will require companies to comply with the fourth European Capital Requirements Directive (CRD IV) – a law that stipulates minimum capital standards for banks and other financial services firms. Because the rules are targeted at banks, commodity trading firms are particularly concerned about the possibility of punitive capital charges being levelled on their physical assets. Oil major Shell is among the companies fretting about CRD IV and estimates an impact “in the hundreds of millions of dollars, if not the billions of dollars”, according to a compliance officer who spoke at Energy Risk Summit Europe in October.

In fact, commodity trading firms regulated by Mifid II have a transitional exemption from certain parts of CRD IV until January 2018. Meanwhile, the European Commission (EC) is expected to propose an alternative capital regime to cover such companies. But it is unclear to what extent the EC will recognise the difference between firms trading financial instruments – or those that Mifid is primarily intended to regulate – and firms that play a critical role in the supply chain for commodities.