MiFIR: ESMA publishes draft RTS on the derivatives trading obligation

What has happened?

On 28 September 2017, ESMA published its final report (Report) on the draft regulatory technical standards (RTS) relating to the MiFIR¹ derivatives trading obligation (DTO) which will apply from 3 January 2018. The Report, which follows a September 2016 discussion paper and a June 2017 consultation paper, sets out draft RTS specifying the classes of derivatives which will be subject to the DTO and the timelines for its application.

The Report has been submitted to the European Commission for review and, once adopted, will be subject to further review by the European Parliament and the Council.

What is the derivatives trading obligation?

MiFIR will apply across the EU from 3 January 2018 and will introduce the DTO. Broadly speaking, the DTO will require certain derivatives to be traded on one of the following:

• a regulated market (RM);
• a multilateral trading facility (MTF);
• an organised trading facility (OTF); or
• a trading venue in a third-country that has been deemed to be "equivalent" by the European Commission.

Systematic internalisers are not permitted execution venues under the DTO.

The DTO will only apply to classes of derivatives that are subject to the clearing obligation established by the European Market Infrastructure Regulation (EMIR²) (the EMIR Clearing Obligation). It will not apply to derivatives that not mandated for clearing (this includes transactions which would otherwise be subject to the EMIR Clearing Obligation but which benefit from an exemption, such as the intragroup exemption).

Not all "clearable" derivatives will automatically be subject to the DTO. Once a derivative has been mandated for clearing under EMIR, in order for it to also be subject to the DTO, it must:

1. be admitted to trading or traded on at least one admissible trading venue (i.e. an RM, MTF or OTF) – commonly referred to as the "Venue Test"; and
2. be sufficiently liquid - commonly referred to as the "Liquidity Test".

The above criteria have been taken into account by ESMA in determining which classes of derivative should be subject to the DTO and in preparing the draft RTS.

Once a class of derivative has been designated as being subject to the DTO, it will be added to a register on ESMA's website, which will be available before 3 January 2018. The register will list (i) the classes of derivative which are subject to the DTO and (ii) the date from which the DTO applies. ESMA intends to maintain a separate register which lists the venue(s) on which that class of derivative is traded or admitted to trading.

When will the DTO apply?

As the DTO is intrinsically linked to the EMIR Clearing Obligation, so must its application date be. Under the EMIR Clearing Obligation, four categories of counterparty have been identified and a phased in application has been adopted, to accommodate the requirements of each counterparty type (see the "What You Need to Know" section of the Ashurst EMIR Portal for more information). Consequently, the application date of the DTO to a particular counterparty will depend on the counterparty's EMIR category. The application date will be the later of (i) 3 January 2018 and (ii) the date from which the EMIR Clearing Obligation applies to the counterparty type in question. This is clear from the Recitals section of the delegated regulation setting out the draft RTS (EU Delegated Regulation 2016/2020) but is less clear in the main body of text, so it may be that this text changes following review by the European Commission.

Issues for further consideration

Market participants will welcome publication of the draft RTS, particularly given that the MiFIR application date is now less than three months away. However, there are still several issues which need to be addressed before 3 January 2018. Some of these issues are considered below.

Additional phase-in

The EMIR Clearing Obligation already applies to certain categories of counterparty (see "When will the DTO apply?" above), meaning that, for these counterparties, the DTO will apply from 3 January 2018. Industry feedback has suggested that operational issues, a lack of equivalence decisions, potential late (i.e. post 3 January 2018) authorisations of OTFs, and the time required to become a member of a trading venue mean that application of the DTO to these counterparties should be deferred. In the Report, ESMA says that it would "not be opposed" to a delay of application of the DTO of no longer than three months. However, unhelpfully, this is not addressed in the draft RTS.

Equivalence

The ability of EU entities to trade in-scope products with non-EU entities will, from 3 January 2018, be dependent on an "equivalence" decision being granted in respect of that third country by the European Commission. This is not just a practical decision but also a political one, and equivalence decisions have in the past taken a long time – sometimes years – to be granted. Moreover, there is no guarantee that any such decision will be forthcoming. If there are no equivalence decisions granted, or if they are granted at the last minute, this could cause huge operational upheaval for firms trading across jurisdictions.

Brexit

ESMA notes in the Report that the departure of the UK from the EU may have implications for the DTO in the future. This is particularly the case when assessing classes of derivatives which are traded on UK trading venues, since, post-Brexit, these will no longer be EU venues and will only be accessible as DTO trading venues if an "equivalence" decision is granted in respect of the UK (see "Equivalence" above). ESMA goes on to say that, at present, the UK is still in the EU and the Report must be drafted accordingly – i.e. trading on UK trading venues must be assessed in the same way as trading on any other venue in the EU.

Packaged transactions

Market participants have for some time been requesting clarification on the treatment of packaged transactions. A particular concern is that it is not clear whether, where one element of a packaged transaction is subject to the DTO, the entire transaction is also caught by the regime. ESMA notes the requests for clarification in its Report, and agrees that clarification is needed. It goes on to say that, while it is not empowered to develop a "tailored regime" for such products, it hopes to provide some clarification on this area through future Q&A. However, depending on when such Q&A are published, this may not allow sufficient time for firms to establish appropriate trading protocols for packaged transactions.

+/- 5 days rule

ESMA proposes in the Report including a rule that all trades with a tenor which is plus or minus five days of a benchmark trading obligated tenor should also be subject to the trading obligation, as an anti-avoidance mechanism (although this has clearly not been incorporated into the draft RTS). Clearly, this rule is not necessarily a credible deterrence mechanism to an entity attempting to avoid the trading obligation, as the trade could simply be structured to be six days off benchmark. Such a rule would also take the scope of the DTO beyond the scope of the similar Made Available to Trade rules in the United States, which would lead to an uneven playing field and which could result in regulatory arbitrage.