Changes Proposed to the FCA's Commodity Derivatives Regime

[1] Framework for setting Position Limits: Shifting Responsibility to Trading Venues  

The proposal recommends transferring the principal responsibility for setting position limits from the FCA to trading venues. This shift is justified by the belief that trading venues, being closest to trading activities, can more effectively set and adjust position limits based on real-time market dynamics.

Key responsibilities for a trading venue will include:

• Developing methodologies and procedures that allow it to set and enforce position limits and accountability thresholds;
• Administering exemptions, including granting exemptions and applying, where applicable, exemption ceilings; and
• Developing and maintaining a risk assessment framework and market risk analysis that underpins its market oversight and surveillance arrangements.

While trading venues will determine specific limits, the FCA retains the authority to intervene under certain circumstances.

The proposal introduces a comprehensive set of notification requirements for trading venues. This includes prior notification of:

• Governance arrangements

1. Allocation of senior management responsibility;
2. Policies for managing conflicts;
3. Systems and controls; and
4. Board oversight.

• Position limit methodologies and Accountability Thresholds

1. Identification of contracts related to critical contracts (together with decisions not to identify specific contracts);
2. Which positions will not be eligible for netting;
3. Detailed calibration of position limits and accountability thresholds set according to agreed methodologies.

• Related Contracts Definition 

1. The proposed list of related contracts, related OTC contracts and related contracts traded on overseas trading venues.

• Granting of Exemptions Framework

1. Policies and procedures relating to the granting of exemptions, including the approach to the setting of position ceilings.

• Position Limit Breach framework

1. Policies and procedures related to position limit breaches including resolution and access to enforcement tools.

• Risk assessment frameworks

1. Policies and procedures related to positions in excess of accountability thresholds; and
2. Arrangements for additional reporting, that should detail the content, format and frequency of reporting of OTC positions related to critical contracts.

The goal is to ensure transparency, receive feedback, and maintain consistency across trading venues.

 RegTrail Insights

The introduction of position limits set at trading venue level rather than by the FCA makes sense on many levels and assimilates to a degree the current US model. Operationally however, it potentially introduces another level of granularity for energy and commodity firms to track and manage. 

Firms will now need to review each trading venue, their requirements for position limit management, and reconcile this with their current position limit monitoring and reporting capabilities. 

New data reporting requirements (see [2] below – Scope of Position Limits] will increase the amount of information required to be captured and reported. Given there is no prescribed data format across all trading venues, firms will most likely need to accommodate data transmission requirements differently for each venue thus increasing systems and reporting processes and controls. Firms wishing to respond to the consultation may wish to highlight this fact and request that a standardised format be laid out by the FCA.

[2] Scope of Position Limits - Streamlining Position Limit Regime with focus on Critical Derivative & Related Contracts 

The FCA is focusing on a narrower set of contracts to include in the position limit regime with a particular focus on physically settled contracts across the agriculture, energy, and metals asset classes.  

Critical Contracts Definition. The proposal suggests narrowing the position limit regime scope to “critical” derivative contracts susceptible to market abuse or disorderly trading. This approach aims to remove unnecessary burdens on firms while focusing on high-risk market activities.

Position limits should apply to the participant’s net positions in a critical contract and all related contracts - the latter concept resembling the approach adopted by Dodd-Frank position limits in the US.

The FCA notes that they decided not to apply any fixed qualitative (e.g., physically settled vs cash settled) or quantitative thresholds (e.g. size of the market by lots traded or open interest) when defining a ‘critical’ contract however the following criteria shall be referenced:

• The settlement method at expiry. Physically settled commodity derivatives are more susceptible to the risk of disorderly pricing or disorderly settlement of positions than cash settled contracts.
• The size of the commodity derivative market compared to the underlying physical commodity and the robustness of the reference price used to settle contracts. For cash settled contracts, the FCA will have regard to the size and liquidity of the underlying commodity market and the robustness of the data from which the price of the cash settled derivative contract is derived (for example, whether the settlement price accurately reflects prices in the underlying physical commodity market and the extent to which pricing information is publicly available and timely, commercially acceptable and the sample used to determine the settlement is sufficiently broad).
• The type of underlying and the impact on end-users. In line with the need to minimise the risk that disorderly trading conditions or abusive practices in derivatives markets affect the underlying commodity markets and their users, the FCA will have particular regard to agricultural derivatives and consider whether the derivative contract is a key benchmark for pricing the underlying commodity market.
• The size of the market. Given its intention to apply position limits to contracts where the risk from disorderly trading carries the greatest potential negative impact by threatening the objectives of the regime, the FCA will have regard to the size and liquidity of the market by considering factors such as open interest, traded volumes and the number and variety of market participants.

A list of proposed Critical Contracts can be found on p. 26, Section 3.5.2 of the document, summarised as follows:

Metal – Physically Settled

• LME Aluminium
• LME Copper
• LME Lead
• LME Nickel
• LME Tin
• LME Zinc

Agriculture – Physically Settled 

• London Cocoa Futures
• Robusta Coffee Futures
• White Sugar Futures
• UK Feed Wheat Futures

Energy – Physically Settled

• Low Sulphur Gasoil Futures
• UK Natural Gas Futures

Energy – Cash Settled

• Brent Crude Futures (EFP, with option to cash settle)
• T-West Texas Intermediate

Related Contracts Overview. The FCA will also enhance the position limit regime by extending its application to contracts that are “sufficiently related” to these critical contracts. The FCA explain in more detail:

“A robust position limits regime should consider the complex ecosystem of derivatives contracts that relate in price/exposure, which provide different ways for commercial users to hedge their risk and for financial firms to offset their risk when providing risk reduction services.

The availability of contracts that are closely related to critical contracts, but outside the scope of position limits, would challenge the effectiveness of a regime. Firms might try to influence the pricing and settlement of the critical contract through positions taken in other related contracts.

It is therefore necessary to expand the scope of position limits to certain related contracts. Their inclusion aims to ensure that the protections provided by the regulatory regime are meaningful and not exposed to arbitrage.”

This approach shares similarities with what applies in other jurisdictions. For example, as above, in the US the CFTC applies federal limits to 25 physically settled core referenced contracts and certain associated "linked" contracts.

Definition of Related Contract. The definition of a related contract is as follows:

Related contracts should include, as a minimum, options on critical and related contracts, mini, Balmo and mini-Balmo contracts, inter-contract spreads that include a critical contract and cash settled look-alike contracts that are linked to the critical contract in accordance with the following criteria:

• Any commodity derivative traded on a UK trading venue the settlement price of which is directly linked to the settlement price of a critical contract. This criterion is aimed at including cash settled look-alike contracts, amongst others, when aggregating positions. For example, under the proposal that the Brent Crude Future is a critical contract, this criterion would likely bring in the Brent 1st Line Future as a related contract. Commodity derivatives listed on an overseas trading venue would not be included.
• Any commodity derivative traded on a UK trading venue that can result in a position or delivery obligation in the critical contract or another of its related contracts, either via exercise, settlement or expiration. This criterion is aimed at including options and spread contracts that contain the critical contract or a related contract as the underlying of the option or as one of the legs of a spread contract, for example, if the Brent Crude future is a critical contract, the Brent position arising from a Brent-WTI spread contract should be aggregated with the position in the Brent Crude Future contract.
• Any commodity derivative traded on a UK trading venue the settlement price of which is indirectly linked to the settlement price of the critical contract. This criterion is aimed at including contracts that have distinct but related features, such as the same underlying commodity, delivery location(s) or settlement types, but not necessarily all three. For example, the Dated Brent Future when compared to the Brent Crude Future.

The FCA provides several examples to illustrate a related contract. One example is as follows:

• When applying the position limit on the Brent Crude Future, market participants would aggregate their position on the Brent Crude Future with identified related contracts.
• Positions in related contracts could include those in the Brent 1st Line Future and those in the Dated Brent Future, any Brent-related leg components of a spread contract (e.g. Brent vs WTI) as well as delta-adjusted option positions on the critical contract and any related contracts.
• The aggregated position would then be assessed against the Brent Crude Future position limit.

Unit Measure – Related Contracts. Related contracts should be measured in units of the critical contract and aggregated and netted accordingly.

However, the trading venue shall not permit the netting of positions in relation to certain contracts where such netting exacerbates the risk arising from large positions to the orderly pricing and settlement of transactions.

Example:

• When reviewing trading venues’ approach to netting we will have particular regard to positions resulting from trade-at-settlement (TAS) transactions.
• Those are transactions that give market participants the ability to enter an order to buy or sell an eligible futures contract during the course of the trading day at a price equal to the settlement price for that contract, or at a differential to the settlement price.

 RegTrail Insights

The introduction of the related contracts concept poses challenges that those with experience of managing CFTC position limits mandated under Dodd-Frank will be familiar with. 

Firms will need to assess, in the absence of a formally published list, which contracts qualify as "related" based on the above criteria. This is not a one-off exercise, but rather a continuous process as new contracts are added to exchanges over time. While less likely in the UK given the current exchange landscape, there is also the potential that such "related" contract relationships can extend across venues. 

The US CFTC have published their assessment of such linked contracts although this assessment is not official/legally binding hence, while a useful reference, it does require a level of due diligence to be performed by market participants to ensure accuracy and completeness. 

Again, for those firms planning on responding to the consultation, insisting that a published list of such related contracts is provided would not go amiss. 

[3] Position Management - Strengthening Market Oversight through Enhanced Surveillance Controls

The consultation emphasizes the importance of trading venues having access to comprehensive data, including OTC positions, to manage risk effectively. It proposes rules to ensure the consistent determination and operation of position limits by trading venues, with the FCA actively monitoring and supervising this process.

Trading Venue Position Limit Setting Approach. 

The FCA is pivoting away from the current % position limit threshold approach taken in MiFID RTS 21 (e.g. baseline figure of 25% of the deliverable supply is the level at which a position limit were set for a spot month).

Instead, it is proposing to supervise the way in which trading venues set their limits having particular regard to their methodology, the inputs used, whether they adequately considered times of market stress when taking into consideration the parameters set to establish the limits, and separately consider position limits set in other jurisdictions for similar or equivalent contracts.

Enhanced Position Management Surveillance. The consultation introduces enhanced expectations for oversight and surveillance arrangements related to position management controls.

It includes a new “accountability threshold” for early risk identification, expanded data collection authority, and additional reporting requirements if thresholds are exceeded. This information allows trading venues to identify risks and potential spillover effects from the underlying physical markets, related OTC markets and related derivatives traded on overseas trading venues.

*New* Accountability Thresholds. Trading venues will be required to establish “accountability thresholds” for the same contracts to which position limits apply.

• Accountability thresholds are a position management tool that provide trading venues with early warning of growing positions in relevant contracts so that the trading venue can understand whether risks are emerging and what actions should be taken to manage that risk.
• It is set at a position size appropriately below a position limit and is used by trading venues to monitor the build-up of large positions on their markets. When an accountability threshold is breached, it triggers supervisory actions by trading venues.
• Where an accountability threshold is exceeded, it will also result in additional reporting requirements for both the market participant and the trading venue.

*New* Reporting Requirements for Accountability Thresholds. Should a market participant exceed an Accountability Threshold, the Trading Venue will review the following information:

• Historic and anticipated position sizes and risk management capabilities at market participant level taking into account prior knowledge of the market participant and the information received through exemption applications, including anticipated activity and, where relevant, the participant’s ability to unwind its positions at their highest point over the year ahead in a way that does not impair orderly markets.
• The extent and quality of the participant’s engagement with the trading venue and response to inquiries.
• Where a contract is physically deliverable, the complexity of the delivery process relative to that participant’s expertise in deliveries for that deliverable commodity contract.
• An assessment relative to the rest of the market, including peers of comparable type.

 RegTrail Insights

Firms with trading experience on US exchanges including the CME and ICE Futures US will be familiar with the concept of both reporting and accountability limits. This will however be a relatively new concept for those with UK and European exposure.

Firms will need to enhance their position management documentation to ensure that should they breach an accountability threshold with a trading venue, they are able to provide the information requirements as outlined in the bullets above.  

[4] Position Reporting – Increased Reporting Requirements across a broader data set

*New* Expanded Data Collection Authority. The recent disruptions in certain commodity markets e.g. the suspension of LME Nickel Futures in March 2022 have highlighted the need to strengthen position management controls and to ensure that trading venues have access to additional information to be able to operate effective surveillance arrangements. This is particularly true in respect of information on OTC positions.

To properly administer position limits and position management controls, trading venues need more extensive data on OTC positions to assess risks.

Consequently, Trading venues will have broader scope in data collection to ensure position management controls are effective. The FCA notes that the data trading venues can collect includes, at minimum:

• Position data in related OTC contracts (both members and their clients);
• Contracts traded on overseas trading venues;
• Physical Inventory or Storage positions (where deliveries into the futures contract are made);
• Forward (or ‘cash’) trades in the relevant underlying commodity; and
• Other data (to be defined by the exchange).

Definitions of related OTC derivatives and derivatives traded on overseas trading venues. The FCA provide a definition for related OTC derivative contracts and overseas contracts they would expect to be included as follows:

• Any OTC contract or derivative traded on overseas trading venue for which the settlement price references the settlement price of the critical contract (i.e. cash lookalike contracts).
• Any OTC contract or derivative traded on an overseas trading venue that can result in a position or delivery obligation in the critical contract, its related contracts or in the same underlying as the critical contract, either via exercise, settlement or expiration.

The FCA acknowledges the potential challenges in reporting OTC positions to trading venues in a consistent way given the bespoke nature of certain contracts. As a result, it does not propose to specify the format in which trading venues receive additional reporting data.

Also, the FCA does not expect the Trading Venue to send OTC positions to it given the less standardized data formats that exist. Instead, the FCA propose that trading venues be required to perform regular market risk analysis and report the analysis results to them.

Does UK EMIR solve the problem of such OTC reporting? Unfortunately not. The FCA considered whether existing regulatory reporting requirements can achieve the outcomes intended. Under the UK European Markets Infrastructure Regulation (UK EMIR) requirements, all UK reporting counterparties must report derivatives transactions to trade repositories.

The FCA receives UK EMIR data. However, this data does not cater for the global nature of firms participating in these markets and there are carve outs and reporting exemptions that result in key physically settled OTC derivatives either falling out of a reporting requirement or being reportable to other authorities, for example certain physically settled energy derivatives traded on OTFs. Therefore, the information the FCA receives through the current EMIR reporting regime does not provide sufficient information to address the risks identified.

How are OTC contracts defined? To avoid a similar outcome as that observed for economically equivalent OTC contracts (EEOTC contracts), related OTC contracts will need to include contracts that are likely to correspond closely in price/exposure to critical contracts. For this purpose, the FCA considered the CFTC’s US definition of referenced contract and LME’s definition of relevant OTC contract in its Appendix I OTC Booking Fee Policy.

*New* Removal of EEOTC contracts from position reporting and position limits. Under MiFID II, position limits apply to all commodity derivatives traded on trading venues and OTC contracts that are lookalikes of those contracts i.e. EEOTCs.

The FCA notes that the criteria used to determine whether an OTC contract is economically equivalent to a contract traded on a trading venue have resulted in a very narrow definition of EEOTC. Therefore, in practice very few OTC contracts are included in the calculations of position limits and reported to the FCA.

Consequently, as part of the revised scope of contracts, the FCA has removed EEOTC contracts from the scope of position reporting and position limits. 

Instead, it gives the FCA the power to establish the scope of the position limits regime, i.e., to specify the commodity derivatives to which limits must apply, with the exception of OTC contracts, for which it will not be possible to apply position limits.

*New* Additional Reporting Requirements. The FCA expect a trading venue’s risk assessment framework to specify the level of reporting required to enable it to monitor its markets effectively (i.e., for which additional reporting requirements apply). 

This will be determined by the venue’s market risk analysis assessment for certain markets and determining whether regular, systematic reporting requirements are necessary to ensure the trading venue can effectively monitor the orderliness of those markets. 

Conditions that trigger additional reporting include:

• When a participant’s aggregated exempt position is equal to or larger than the relevant exemption ceiling for specified commodity derivatives contracts set by the trading venue;
• When a participant’s aggregated position, including exempt positions, in critical and related contracts is equal to or larger than the relevant accountability threshold; and
• As otherwise determined by the trading venue in its risk assessment framework to support its general monitoring of the orderliness of its markets for individual contracts, including by reference to specific features of that market.

Where additional reporting is triggered, the reporting should continue for a period specified by the trading venue which is appropriate to the risks posed by the position in the market or as long the person’s position is above the relevant exemption ceiling or accountability threshold.

The duration and frequency of the reporting shall be set by the trading venue.

 RegTrail Insights

Although welcoming that the EEOTC reporting (and position aggregation) requirement will be removed, the inclusion of reporting on OTC derivative contracts and derivatives in overseas contracts means increased reporting for energy and commodity firms. 

While the new rules are likely well over a year away, firms may wish to consider which contracts may fall in scope of these requirements in order to forward plan an appropriate response. 

[5] Exemptions from Position Limits

The FCA are proposing new exemptions for liquidity providers and for financial firms dealing with non-financial firms that are hedging risks arising from their commercial activities. The rules aim to ensure that exemptions are consistent with maintaining orderly markets, and that reporting requirements increase if exemption ceilings are breached.

*New* Pass-Through Hedging Exemption for Financial Firms.

The FCA supports the introduction of a new pass-through hedging exemption which complements access to the hedging exemption by allowing financial firms that facilitate hedging activity to do so without breaching a position limit. This will help remove barriers that may prevent a financial firm from being able to facilitate hedging activity by a non-financial firm, which in turn supports the provision of liquidity to the market.

In respect of the pass-through hedging exemption, feedback from trade associations supported an approach in line with the US to allow for off-sets to be included.

The exemption provides a similar relief to the one available under CFTC rules. The FCA will allow trading venues to grant financial firms a pass-through hedging exemption when:

• The financial firm enters into an OTC position with a non-financial firm which is conducting hedging activity and the financial firm offsets the OTC position by entering into an in-scope commodity derivative contract; or
• The financial firm enters into an in-scope commodity derivative contract with a non-financial firm where the non-financial firm is using the hedging exemption.

In both scenarios above, the position in the in-scope commodity derivative contract would not count towards the financial firm’s net position subject to position limits.

The FCA comment and note that for compliant US trades, the industry have developed solutions, such as standardised agreements, which do not require trade-by- trade representation and would permit a similar solution to be used. It will be keenly awaited as to how this unfolds in the UK context.

*New* Hedging Exception includes requirement to prove ability to unwind positions.

The FCA proposed to maintain the definition of positions qualifying as reducing risks related to commercial activities as per Article 7 and 8 of MiFID RTS 21.

A new requirement the FCA is proposing is for trading venues to only grant a hedging exception where they satisfy themselves that the exempt positions can reasonably be managed by the firm, including to be able to unwind them in an orderly way during times of market stress where market liquidity may be constrained.

A non-financial firm shall provide the trading venue with information about the relevant commodity derivative positions it holds, including in related OTC commodity derivatives, and those it intends to hold over the year ahead. Specifically, this condition should focus on the non-financial firm’s ability to unwind its positions at their highest point anticipated over the year ahead (to take account of peaks in anticipated activity because of, for example, seasonality), in a way that does not impair orderly markets.

Documentation by a non-financial firm to the venue as part of the hedging exception request should at minimum include current and anticipated activity over the year ahead, which may reference information about the previous year’s activity, and include:

• The nature and value of the non-financial firm’s commercial activities in the relevant physical commodity underlying the commodity derivative for which an exemption is required.
• The nature and value of the non-financial firm’s trading activities and positions in relevant commodity derivatives, including in related OTC commodity derivatives.
• The nature and size of exposures and risks in the commodity which the non-financial firm has or expects to have because of its commercial activities and which are or would be mitigated using the commodity derivative.
• How the non-financial firm’s use of commodity derivatives directly reduces its exposure and risks in its commercial activities.
• Any other information that a trading venue may require to assess the non-financial firm’s ability to unwind its positions at their highest point anticipated over the year ahead, including during times of market stress, in a way that does not impair orderly markets.

*New* Liquidity Provider Exception. Financial firms providing liquidity will also have an exemption provided:

• The position arises as part of the firm’s obligation as a liquidity provider;
• The obligations to provide liquidity should be clearly defined by the trading venue and relate to observable metrics of market quality (e.g. depth and tightness of the spread);
• The position should not be held for longer than necessary to discharge those obligations as a liquidity provider and should be reduced as soon as reasonably possible but, in any case, sufficiently before the expiry of the contract.

*New* Exemption Ceiling. As part of the process of granting exemptions from positions limits, trading venues will need to consider whether limits to the size of exemptions, known as an ‘exemption ceiling’, should apply.

• An exemption ceiling is intended to mitigate the risk that these positions become too large, which may otherwise undermine the protections provided by the regime.
• To determine the size of the exemption ceiling, trading venues should consider factors such as the participant’s current and anticipated activity over the year ahead, their credit worthiness, risk management approach and experience.
• Market participant breaching its exemption ceiling would be subject to additional reporting requirements to the trading venue. These will cover related activity, including exposures that are relevant to the critical contract. 

 RegTrail Insights

There are significant changes to how firms will request and be approved for position limit hedging exemptions. Firms will now need to submit separate exemption requests to each individual trading venue and will require additional information to be supplied.

As noted above, the FCA is introducing a new minimum requirement that requires firms to demonstrate their ability to unwind positions during market stress before a trading venue grants a firm a hedging exception. In theory firms should already have some type of documentation in their Risk policies however this requirement appears to be more prescript and will require additional documentation e.g. model anticipated highest point of positions over the year and document your ability to unwind these positions in a way that does not impair orderly markets. Although very early in the process, firms may wish to begin reviewing what documentation currently exists and explore what additional information may be required through discussions with Risk teams.

In addition, firms applying for the hedging exception will need to articulate their future anticipatory trading activity inclusive of OTC and overseas derivative contracts and the relevant physical commodity underlying the commodity derivatives which previously was not a requirement. 

As a final observation, financial counterparties will undoubtedly welcome the pass-through exemption concept, particularly those providing risk management solutions to non-financial physical firms. The restrictive and asymmetric rules preventing financial counterparties from qualifying for exemptions under MiFID 2 are not likely to be missed.

[6] Additional Trading Venue Notification Requirements

Trading Venues will be required to provide the FCA with additional information as part of the updated position limit regime.

Specifically, the FCA is proposing to introduce several notifications relating to the operation of a trading venue’s framework which include:

• Annual Notification on effectiveness of Accountability Thresholds

- An annual notification requirement evaluating the adequacy and effectiveness of accountability thresholds and informing the FCA of the number of instances where thresholds have been exceeded, identification of the market participant(s) who caused the excess(es) and what steps were taken following the excess(es) to address identified risks.

• Summary of Exemption Notifications. 

- Notifications of each exemption granted, including where exemption ceilings have been applied.

• Annual Report on all Exemptions Granted and any Breaches

- An annual report of all the exemptions granted and where exemption ceilings are imposed, a report of any breaches of those ceilings and the steps taken following the breach.

• Market Risk Assessment

- Market risk analysis to be reported at a frequency agreed as part of the FCA's supervisory approach, but at least annually and when there is a significant change in market risk.

[7] Updated Ancillary Activities Test (AAT) Perimeter Guidance 

The FCA provide guidance on several AAT aspects but note that HM Treasury are still reviewing a replacement of the current quantitative AAT approach (as set out under MiFID) for a qualitative test. This is still under review as part of the UK’s Wholesale Markets Review (WMR).

Therefore, as part of this consultation, the FCA provide guidance on the: 

• Confirmation of the FCA’s understanding of ‘ancillary’, that it is something ‘related’ and ‘subordinate’ to the main business of the group and
• Confirmation that firms can look to the trading and capital employed thresholds used in the EU delegated regulation (MiFID) to judge what is ancillary.

In addition, it provides updates on: 

• Definition of in-scope contracts for AAT calculations (includes Emission Allowances);
• Confirms extension of ancillary exemption extension through 2024; and
• Removes annual FCA notification for firms using AAT exemption.

[a] Confirmation of FCA’s definition of Ancillary. The FCA provides its view on the definition of ancillary through updates to Annex F: Amendments to the Perimeter Guidance manual (PERG). We provide an excerpt below from the Annex update: 

Q45. What is an ancillary activity for the purposes of the commodities exemption and who can rely on it?

…More generally, the meaning of ‘ancillary’ for the purposes of the commodities exemption envisages the business being related and subordinate to the main business of the group. Where a firm’s activity goes beyond the use of commodity derivatives and emission allowances business for purely risk management purposes, in our view other factors are relevant to determining whether a person’s business is ancillary to the main business of their group. 

Consistent with well- established principles as previously set out in MiFID RTS 20, we consider that firms may continue to choose to rely on either:

• their trading activity against the overall trading activity of the group (the trading test); or
• the estimated capital their group would be required to hold against the market risk inherent in their trading in commodity derivatives, emission allowances and emission allowance derivatives (the capital employed test), when satisfying themselves that they are carrying on ancillary activity for the purposes of the commodities exemption. 

For these purposes, firms may have regard to the trading tests and capital employed tests in Commission Delegated Regulation (EU) 2021/1833 (references to the ‘Union’ being treated as references to the ‘UK’, ‘trading venues’ as references to UK and EU trading venues and authorised investment firms and credit institutions as references to corresponding UK and EU authorised entities).

In addition, when considering whether your investment services or activities are ancillary to your main business, when considered on a group basis, you may also have regard to the profits, staff numbers and their time spent in relation to these investment services or activities.

The commodities exemption is relevant to you if you carry on MiFID business and rely on an RAO exclusion (UK Treasury Regulated Activities Order) such as article 16 (Dealing in contractually based investments) or article 19 (risk management) (see PERG 2.8.4G) when carrying on investment services and activities in the UK. These exclusions are unavailable to firms when they are carrying on MiFID business, hence the relevance of this exemption.

[b] Ancillary Exemption extended through 2024. The FCA issued an additional clarifying statement in January 2023 (click here) and notes that this statement will continue to apply for the year ahead (2024-2025).

This will enable firms to continue using the ancillary activities exemption for 2024-2025 where they were able to rely on the exemption for 2022-2023 based on trading relating to the last previous published information (2018 to 2020) and maintain the additional flexibility alternatively enabling firms to have regard to their daily trading activity of the previous 3 years (2021- 2023) for the purposes of continuing to rely on the ancillary activities exemption.

The FCA removed the annual requirement for firms to notify them when they rely on the ancillary activities exemption. It notes however that they may still ask firms to provide information that would help it to understand the basis on which they take the view that they can rely on the AAE. 

The FCA also notes that it does not intend to ask firms to provide such information on a regular basis, but it will request information where it has a specific reason to understand why a firm takes the view that it can rely on the AAE.

[c] Inclusion of Emission Allowances as part of AAE test. The FCA proposed updates to its Annex F: Amendments to the Perimeter Guidance manual (PERG) which now includes Emission Allowances in the AAE calculation as follows:

Q44A. How do I know whether my main business is investment, banking or commodities? The determination of your main business as described in this answer is not directly related to the test for deciding whether your commodities business is ancillary to your main business (the ancillary test is referred to in the answer to Q45). This is because the ancillary test compares the size of your commodities commodity derivatives and emission allowance business (see guidance in PERG 13Q32 to 33C and 34A above) with the rest of your business but does not specify how to identify what your main business is within your non-commodities business.

 RegTrail Insights

The most significant update is the inclusion of Emission Allowances into the Ancillary Activity Exemption calculation. The inclusion of Emission Allowances will now be required to be captured, reported, and incorporated into any future ancillary exemption calculation. 

It is also worth calling out that the FCA provide further definitions to what they deem as ‘ancillary’ activity noting that firms may also want to review the profits, staff members, and time spent in relation to investment services which are ancillary to your main business. These factors most likely are easy to obtain with the exception of time spent which presumably is a metric no firm is currently monitoring.