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ESMA makes interesting point on physical forwards

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A contact has pointed out an interesting line in the guidelines published on physical power and gas forwards for dealing with current EU financial regulation.

The European Markets and Securities Authority (ESMA) has tried to clear up what is a derivative and what is a physical forward under the first version of the Markets in Financial Instruments Directive (MiFID). Different countries had applied different interpretations of what is a commodity derivative. This caused problems for trade reporting energy derivatives under the European Markets Infrastructure Regulation or EMIR, because what was considered a derivative and must be reported in one country might not be the same in another.

The guidelines pretty much keep the status quo that emerged for physical forwards, with energy brokers creating special platforms where they exercise caution when brokering deals. This means deals executed through these special platforms will not count towards the threshold under EMIR that can lead to a company having to clear everything.

The guidelines come into force in August, but will be replaced in January 2017 when MiFID II comes into force. The proposed definition in the updated directive is different, introducing a capability test when deciding what is a physical forward.

Energy companies are generally unhappy with the proposed definition in ESMA’s advice to the European Commission, because it could lead to quite  a few energy traders having to get a MiFID licence and all that entails. But in the guidelines for MiFID I, the agency said: “ESMA’s purpose is to ensure, wherever possible, there is continuity between the application of the MiFID I regime and the MiFID II regime in order to prevent disruption to the existing practices of the industry at the time of transition.”

As my contact suggested, this could be interpreted as ESMA moving towards an interpretation of physical forwards closer to that in the guidelines for MiFID I. Perhaps, or perhaps too much was read into it. In the end, it will be the European Commission through its delegated acts that will decide on the final definition.