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. Whilst this issue has in the past been noted as a concern since the implementation of MiFID, the practical consequences have come to the forefront with the implementation of the European Markets Infrastructure Regulation (EMIR).
What exactly is a derivative? That’s precisely what the European Securities and Markets Authority (ESMA) wants to pin down with it’s latest consultation draft. Why do they care? Because ESMA is worried that inconsistent application of the definitions of derivative instruments could have a significant detrimental effect on the consistent application of European Market Infrastructure Regulation (EMIR). According to ESMA, it is imperative that references to the these derivatives definitions be clarified to ensure that regulatory authorities are all taking a common approach to setting reporting and clearing obligations in Europe.
The issue arose primarily from difficulties encountered by the UK’s FCA in the regulation of FX forwards, non-deliverable currency forwards, and spot transactions for FX and commodities. The FCA found that these particular instruments sometimes did not fall within the definition of derivatives, and fell into safe harbors provided they satisfied a somewhat vague “commercial purpose” test. This inconsistent application of regulation to particular derivative contracts, sometimes as financial products, and sometimes not, has prompted much discussion amongst regulatory authorities in Europe. According to a spokesperson for ESMA:
“There’s been a lot of back and forth between ESMA and European Commission. The reason we’re issuing this now is that MiFID I has been implemented in different ways in the EU, so there are all kinds of different interpretations of the definitions of a financial product, which is referenced in EMIR, and there’s no harmonised say on that. We’ve spoken to the commission, they’ve agreed on the problem, but as it is legally difficult to change, we’re looking to solve the issue with guidelines in the interim between now and MiFID II.”
In response, ESMA’s September 9, 2014 consultation paper sets forth some proposed guidelines, specifically regarding forwards, spot transactions, FX, and commodities, and seeks comment on the definitions of each. The comment period for the consultation paper closes on January 5, 2015.