KPMG Commodities Trading Survey 2016

Interesting survey here from KPMG highlighting the impacts on Commodities Traders of the key trends impacting the industry:

  • Long term importance of regulation and compliance
  • Increased importance of treasury and financing models as margins are squeezed and the cost of credit becomes more transparent
  • Existential pressure on some fuels and assets due to governmental climate change policy


A Snitch in Time!


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With all our recent focus on whether REMIT transaction reports are getting to the regulator at all, even with a T+1 reporting mandate, it is easy to loose sight of the importance of the relevant timestamps of orders, executions, and lifecycle events.

MiFIDII is very explicit on the subject, RTS 25 states:

“Competent authorities need to be able to reconstruct all events …… over multiple trading venues on a consolidated level to be able to conduct effective cross-venue monitoring on market abuse.”

This requirement is no less true of REMIT, which hands ACER the challenge of consolidating EMIR, REMIT and MiFID transaction reports from various venues and intermediaries. According to Tabb Group a ‘major European trading venue’ had to jump 30 seconds a few years back. Imagine today how many revised transaction reports that might entail today?  This is one area where things could get worse if MiFIDII really is delayed!

It might be worth checking your own infrastructure and also RRM service level agreements include timestamp accuracy tolerances.

MiFIDII Ancillary Activities Exemption: Progress Made …. More Work Required



Anyone familiar with even a snippet of MiFIDII will have come across threshold tests. On 28th September ESMA published its ” Regulatory technical and implementing standards – Annex I” (RTS), a document that uses the word ”threshold” no less than 439 times. Few of us will have had occasion to look into detailed calculation requirements of even one of these calculations, so I hope it will be useful to share some first impressions.

I have had occasion to look at one instance in some level of detail, the ‘Main Business Activity’ exemption threshold which intends to specify the conditions under which non-financial firms who engage in commodity trading may be exempted from applying for a MiFIDII license, thus sidestepping all the obligations that would entail.

Even a relatively short dip into the subject showed very clearly there is still a lot of uncertainty in the methodology to resolve, potentially unintended consequences to avoid, and some potentially perverse incentives that are introduced. The uncertainty is amplified to a large extent by a combination of inconsistency between the RTS text and the accompanying consultation feedback commentary, and silence in the RTS on some key computational assumptions.

Main Business Threshold

The Main Business Threshold (MBT) compares a 10% threshold against a ratio calculated (roughly speaking) a group’s European speculative derivatives trading activity divided by a proxy measure of the size of its main business. If the result is <10% then the group does not need to register a MiFID entity. If the result is >10%<50% a further test is required to establish exemption. I won’t go into that second test today.

Progress has been Made

First let’s recognise some progress made in this iteration. ESMA has made several sensible (N.B. Not every industry commentator/body agrees with me!) decisions since its first attempt at how this ratio should be calculated.

  • ESMA has withdrawn the suggestion that accounting measures should be used, apparently acknowledging that the cost of overhauling the double entry book-keeping for MiFID derivatives of an entire firm globally might actually be quite expensive, would produce a subjective result due to wide variances in accounting policy and practice, and most likely deliver the number too late, due to year-end close and audit timetables not aligning with the timeframe in the Level 1 text for exemption applications.
  • Instead ESMA has proposed a new calculation based on filtering and aggregating and comparing values that can be derived from individual trades and positions. This should be welcomed by the market participants at least in terms of simplicity, not least because it is a similar approach to the one they will recently have implemented for the EMIR NFC/NFC+ Threshold calculation.

The Calculation

The MBT compares speculative commodity derivative transactions of the group with third parties (sum of gross notional, or “GNV”) with the aggregate gross notional of all Financial Instruments of the group, speculative or hedged.

I should declare some simple but important interpretations on which my analysis relies:

  1. “Financial Instrument” means all asset classes, unless otherwise qualified. This means that the denominator includes tradeable securities, i.e. Equities and Bonds as well as derivative instruments in interest rates, FX and commodities. This is basic explicit MiFID Level 1 and RTS text so shouldn’t be too controversial.
  2. The calculation is performed on a ‘trading turnover’ or trade date window basis, not on contracts liver in the window as is the case with the EMIR NFC Threshold. The RTS is silent on this subject, but the momentum of the consultation commentary is consistent with the trade date window assumption.
  3. ‘Group’ means the whole group of companies globally, unless qualified by the term ‘European’. Again, this should not be controversial, but is easily confused when reading the text and various commentaries on various threshold calculations at once.

With these straightforward interpretations declared thee are some very problematic outcomes of the calculation as it is currently specified, outlined below:

Funding and Hedging Frequency Bias

The same firm may produce a different MBT ratio depending on how and when it last raised funds from the market, and how it chose to hedge the financing transactions. This is because the trade date window is a maximum of three years, and initially will be only one year.

  • Unlike many commodities the tenor of financial hedging instruments has no influence on Notional Value expressed in currency, so a 1 year EUR1m Interest Rate Swap has the same gross notional as a 10 year EUR1m IRS, and conversely ten 1 year swaps has ten times the gross notional of 1 ten year swap with the same terms and cash flows.
  • Regularly extended Short term finance (<3 years), by way of equity or bonds will have more impact on the ratio than long term hedging of the full investment payback of the underlying assets (often >10 or even >20 years)
  • Foreign Currency Bond finance plus Interest Rate hedge plus Foreign Currency hedge might count three times in comparison to the equivalent local currency bond with no hedges.

Reporting/Operating Currency Bias

  • A European firm of a particular business size will produce a different MBT ratio if its geographic profile means it needs to hedge foreign currency flows using Financial Instruments (which count in the denominator), as opposed to a single country/single currency entity with the same assets, and turnover.

Funding Instrument Bias

  • Equity is a significant portion of the balance sheet of most real-economy firms that use the financial markets. It should definitely be recognised in measuring the size of the main business. However the notional value of equity issued bears no resemblance to the size of most large public firms. I checked a sample of balance sheets and found that shares issued at 10 Euro cents often raise EUR10 funding for the business.   Measuring Equity Financial Instruments at notional just doesn’t make sense.


Anomalies like this lead to uncertain or arbitrary regulatory status, wasted resources, potentially provide perverse economic incentives, and at worst incentive to game the system. More work is required. ESMA might start with the following:

  • Adopt the EMIR approach of measuring outstanding contracts in the measurement window rather than new trades done thus avoiding spurious bumpiness of the MBT denominator.
  • Choose to measure the GNV of the bonds not their related Interest Rate/Currency derivatives, thus avoiding the double counting and potential gaming of the calculation.
  • Measure Equity as Shareholders Funds rather than notional value thus representing the true size of the business that is funded.

River Row 2015 Sponsorship

On 19th and 20th September 2015 Leen will be rowing 80 miles down the Thames River in a racing ‘eight’.  Joining crew of novice parent-rowers he is helping raise enough money to fund a care nurse for a year at Shooting Star Chase Children’s hospice in Hampton, Middlesex.  Shooting Star Chase provides invaluable hospice care for babies and children with life-limiting conditions.

See here for more details and hopefully to donate! No amount is too small.

Clearing Fees & MiFID2: Is there any pleasure to be had?


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I have met with colleagues on the buy side and the sell side of the commodities futures clearing business recently. We know that the cost to the banks/clearing brokers of clearing commodities in particular has been driven up by the new capital adequacy rules. See this June article from Tabb Group on the resulting exit of FCMs from the market.

From my conversations with both sides it is clear and logical that for those FCMs not existing, an attempt to pass the cost on to the client (smaller ones so far) is being made. High clearing fees and innovative new charges seek to make smaller customers rentable for the broker, or to drive them away entirely.

I wondered, if as these end-users feel the pain of paying higher clearing fees as Non-Financial Counterparties, will they be less averse to becoming Financial Counterparties under MiFID2? I haven’t done the maths but I hear psychologists say pleasure can be experienced as the relief of pain…….

If these customers were FCs instead of NFCs, it would indeed be less capital intensive for the brokers to deal with them, thus cheaper.  Of course the cost of extra capital would offset the benefit for the customer, so limited if any benefit over all, and anyway the small guys probably won’t be caught by the MiFID2 thresholds, because they are hedging not speculating, … or would be if they could afford to!

I suspect there is only pain.

Les Bourgs Hospice Support

My friend Mark Coffel has nearly completed his 30/30 challenge in aid of Les Bourgs Hospice.  That is 30 open water bay swims, no wetsuit, in 30 days.  I will show solidarity by joining him at Cobo Bay in Guernsey tonight.  Here is a link to his Just Giving page, and and here is a link to the 30/30 Bay Swim Challenge page if you would like to support this worthy cause.

Steven Maijoor at ECON MiFID II/MiFIR Scrutiny Hearing

On 15th July Steven Maijoor, Chair of ESMA, spoke about the challenges and importantly, ESMA’s objectives in determining specifics of MiFID2/MiFIR including non-Equity instrument transparency, setting position limits and the ancillary activity threshold for NFCs.

The overall message is that it will not be easy or pleasant, but it will go ahead.

On the ancillary activity threshold for example he stated bluntly “the whole point of the test in the first place …. the exemptions from financial regulation should be narrowed ….. and large non-financial players conducting activities identical to financial players ….. should compete on an even playing field”.

During the run-up to the implementation of EMIR we observed significant denial and procrastination in the industry, particularly that the transparency requirements would be shelved or delayed.  There is less of that tendency these days, the momentum around regulatory reform is established. This candid direction from ESMA serves to remind us to focus our energies on effective and efficient implementation and resist any temptation to waste time on wishful thinking that it will all go away.

The full text of Mr Maijoor’s speech is found here.

Surveillance: Prioritise or Procrastinate?


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I attended Nasdaq Smarts Trade Surveillance symposium last week. IT was a useful and well-constructed seminar, with valuable insights from Kinetic Partners, KPMG, Tabb Group and of course the Smarts team.

Upon reflection the key takeaways were

  1. There is still no established “best practice” in in the world of surveillance
  2. Many financial institutions (buy and sell side) are only ahead of the game in the sense that they have some surveillance capabilities already in place, but this is often limited to trade execution feeds.   They are challenged (budget, methodology, technology) to access and consolidate the pre-trade audit trail of orders, phone calls and chat expected by ESMA, let alone KYC type information and social media.
  3. There is some excitement stirred by innovative FinTech vendors entering the space with new capabilities for dealing with data integration, volumes, and unstructured data processing, but … refer to 1 above.
  4. The astronomic levels of fines and settlements, and the publication of the FCA case studies strongly underpin the business case for action on this front, driven by the almost ‘prove yourself innocent’ regulatory stance.

With the REMIT requirement for surveillance in place, and MiFID2/MAR deadlines moving rapidly towards us, there is a lot to be lost by doing nothing, and notwithstanding lack of clarity on the end-game, much that can be done usefully without regret.

Holistic Surveillance at JPM


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Bloomberg published an interesting article on JP Morgan’s new holistic surveillance capabilities.  They would seem to be now capable of looking at their employee activities from 360 degrees and even predicting bad behaviour.  I am a little sceptical of the use of the term ‘forecasting’, but certainly this kind of holistic surveillance is exactly the kind of compliance risk management that is at the forefront of practice, and sadly lacking in today’s packaged solutions.  See the Bloomberg article here, and also my earlier post, Surveillance Whack-a-Mole, here.