The European Securities and Markets Authority (Esma)’s position limits for commodity derivatives could be set to focus purely on benchmark products, according to Laurence Walton, head of regulation and compliance at ICE Futures Europe.
“The paper from Esma actually hints at something that goes beyond just tweaks. It hints at that more radical approach when asked the question: ‘Should we dispense with the scope being all encompassing in terms of position limits, and should we only focus on a set of benchmark products, benchmark contracts rather than all the new and more esoteric contracts that kind of revolve around the benchmark ones?’” said Walton.
“That I think would be a very fruitful avenue to pursue, follow, and support with Esma through the process because really it is the benchmark products where price formation mainly occurs. And if you get it right for the benchmark products then the other products that revolve around the benchmarks largely follow in terms of the price formation process,” he said.
On May 24, Esma launched a call for evidence on position limits and position management in commodity derivatives.
“Esma notes in particular that according to Article 2(1)(30) of Mifid II, the definition of commodity derivatives includes securitised derivatives. However, the notions of spot month and other months, for which position limits are to be set under Article 57(3) of Mifid II are not relevant for securitised derivatives,” the paper stated.
“The concept of open interest does not apply either to those instruments in a straightforward manner and Esma had to find a meaningful approach to position limits in securitised derivatives in Article 15 pf RTS 21,” it continued.
Potential tweaks could be made on the illiquid side of the market suggested Jamie Turner, head of sales at the London Metal Exchange.
“On the illiquid side there are a couple of things that cause some difficulties with the market and it is certainly something we really recognized as a market operator,” said Turner. “Where we launch a new contract naturally what normally happens when a contract is growing, is they slowly grow, and slowly grow and they reach an inflection point where it is interesting for new participants to come in, for new participants to book businesses around those things.
“That causes a problem with the de minimis limits, because suddenly you see this growth where the position limits are still based on the de minimis limit but there isn’t an outside path to date for what’s actually coming through the market,” he said.
Additional considerations could also be made around the transition from de minimis limits to the usual position limit process.
“And there is a second avenue problem, when these new contracts start to build it is very natural that a few participants start to build business models with these contracts and therefore hold what would be for a very liquid contract a disproportionate margin with interest for positions,” said Turner. “But the de minimis limits mean that particularly where you have a market that is growing with a few participants and they have big proportions of positions, they suddenly get limited.
“One of the important tweaks could be looking at the way you transition from those de minimis illiquid limits through to the normal program of limits based on interest and things like that, to allow that transition to happen, because it is to the benefit of the whole market,” he said.
More room for maneuver is needed, according to Steffen Koehler, chief operating officer at the European Energy Exchange.
“I am not at all surprised that we and regulators themselves identified room for improvement. What I would hope for is that particularly when it comes to illiquid products, we would bridge the time until the second proposal was made with a bit more flexibility. I have to say I don’t know if it is a particular German issue but if we wanted to change position limits in Germany it is an administrative act that needs consultation, that can easily take months, and months,” said Koehler.