MiFID : some success in tackling food speculation and high speed trading
Markus Henn1, World Economy, Ecology & Development (WEED)
While the EU/USA free trade agreement has been criticized by some for its opacity and its potentially harmful impact on agriculture, other recent developments – particularly in Brussels – demonstrate the progressive concern over the harmful effects of unregulated liberalization and excessive speculation in agricultural commodity markets.
After more than two years of negotiations on the amendment of the EU Directive on Markets in Financial Instruments Directive (MiFID), an agreement in principle was reached on 15 January between the European Parliament and the Member States in order to improve supervision and particularly to limit excessive speculation in commodity markets as well as high frequency trading. For the first time, the authorities may set limits on the positions a trader may hold on commodity derivative markets, including agricultural.
We recommend reading the excerpts from this SOMO article2. It sets a particularly instructive light on the future of European financial regulation. This amendment, named MiFID II, will not lead to ambitious new regulation or lessen the omnipotence of financial markets, but it still offers significant advances in transparency and the control of speculative excesses particularly in agricultural commodity markets.
Remember, failures in the architecture of the global financial system are real and have been particularly troublesome in recent decades. Reforms, such as that adopted in principle by Brussels on 15 January, to be applied at the national level in 2017, are essential but should be pursued in a context of constant change, structural instability and extreme volatility.
momagri Editorial Board
Commodity speculation: certain limits, but no prohibitions
There will be obligatory position limits on commodity derivatives’ trading which is more than the Commission initially proposed and which was contested by some member states until the last days of the trilogue while being called for by civil society. The details are:
The limits will be decided by the national authorities. The best solution would have been to have it set by European authorities, given the danger of national competition. This was also the EP’s position but the final compromise is that national authorities will have to use a ‘methodology for calculation’ by the European Securities Regulator ESMA. How this methodology and thus the limits will be defined and set remains to be seen.
The limits have to be applied at all commodity derivatives trading venues and also for ‘economically equivalent’ over-the-counter (OTC) contracts. The inclusion of OTC contracts was not in the Commission’s and EP’s draft but only came due to pressure by civil society. The wording on the equivalence is the same as in the U.S. where regulators already had bad experiences with not covering the OTC markets.
The limits apply to the ‘net position’. This means that a trader can internally calculate two opposite positions of the same commodity derivative contract as a zero position. This is clearly not the best solution, however, it is not clear how big the effect of this will be.
A position includes those derivatives ‘held by a person and those held on its behalf at an aggregate group level’. So a corporation cannot evade the limits just by setting up many separate legal entities.
The limits shall apply to all the different months at which a contract is delivered (spot month and other months) as well as to all types of contracts (physically and cash settled). Both were called for by civil society and came into MiFID only after the Commission’s proposal.
The limits shall ‘prevent market abuse’ and ‘support orderly pricing and settlement conditions, including prevention of market distorting positions and ensuring, in particular, convergence between prices of derivatives in the delivery month and spot prices for the underlying commodity’. This complex wording is the result of various amendments. It may be helpful to tackle some harmful speculation, but is not as effective as to state clearly that the limits shall prevent ‘excessive speculation’, which was proposed by civil society.
The limits will not apply to the trading of non-financial firms that are insuring against the risk of price changes ‘related to their commercial activity’. While such an exemption is generally acceptable, the text says that it also relates to positions held ‘on behalf’ of such a non-financial firm. This might create a loophole for the financial industry.
The result means that there will be certain limits but with loopholes. Furthermore, there will be no prohibitions of commodity financial products as it was proposed by some fractions in the European Parliament.
High frequency trading: can price intervals solve the problem?
To regulate high-speed (high frequency) trading, there will be a refined prescription that trading venues can only quote prices in certain intervals (tick sizes). This will hinder some high-speed trading techniques that require small price changes to be profitable. Positive, too, is that the trading venues will have to test all high frequency trading techniques in their systems and will need to have a “circuit breaker” which means that they can stop the trading, if there is a problem with the prices.
On the other hand, some rules aimed for by the Parliament or some of its fractions did not survive. This includes the prohibition of all high frequency trading or at least of certain forms, in which there is direct access to trading venue computer systems. This measure, which should have prevented a speed advantage for certain traders, was not agreed upon, but it was decided that all traders should have equal access to the systems. There will also be no strong provision to discourage the massive cancellation of orders. This is disappointing given that high frequency traders often quickly cancel the vast majority of their orders to move prices or distract other traders. Proposals for a specific limitation of cancelled orders in relation to executed ones finally were not agreed, but only that venues will be ‘able’ to intervene in this respect. There is also no minimum holding time for orders as proposed by the Parliament. This could have slowed down trading significantly but the Council could not be convinced of this measure.
Level 2 and beyond
While the MiFID law is not even fully finalized yet, the next discussions start on the implementation of the many technical details that still need to be worked out and decided. These so-called ‘level 2’ rules will be mainly decided by the ESMA and the European Commission. Furthermore, the member states will have to transform the Directive into national law to make it legally binding, and apply and enforce many rules. All these implementations mean that the effectiveness and final result of the MiFID review is not yet clear. What is clear is that MiFID II and MiFIR will not lead to a really ambitious re-regulation and shrinking of the financial markets. However, the new laws include some important improvements on market transparency and oversight as well as on tackling commodity speculation and harmful high-speed trading.
1 Expert for the NGO World Economy, Ecology & Development (WEED)
2 The full article is available from here http://somo.nl/dossiers-en/sectors/financial/eu-financial-reforms/newsletter-items/issue-22-february-2014/mifid-some-success-in-tackling-food-speculation-and-high-speed-trading