* The cost of EU regulations for commodity firms
* Consider use of deliverable supply to calculate position limits
* Consider a wider range of factors for ancillary services test
LONDON, March 18 (Reuters) - Tougher market share limits on food commodities traded in the European Union from January 2018 are needed, the bloc’s executive body said in a letter this week.
Position limits come under the umbrella of a new EU law called Markets in Financial Instruments Directive (MiFID II), with rules being fleshed out by the European Securities and Markets Authority (ESMA).
MiFID II is the biggest overhaul of EU securities rules in a decade, designed to apply lessons from the 2007-09 financial crisis when food prices hit record highs, with some policymakers blaming speculators and hedge funds.
The new law introduces curbs for the first time across Europe on how much market share a trader can build up in any commodity such as grains or copper.
This week, the bloc’s executive European Commission rejected the level of curbs proposed by ESMA, saying they were not tough enough to prevent speculation in grains and other foodstuffs.
The Commission said in a letter to ESMA, seen by Reuters, that some agricultural commodities should have lower position limits than ESMA has proposed because of their “high volatility”, but it also said ESMA should consider whether contracts with low liquidity should have higher limits.
The sole use of open interest to determine position limits needs to be rethought. Linking position limits on contracts with different maturities to open interest would yield higher limits.
“When the open interest is significantly higher than deliverable supply, the limits should be set lower,” the EU said. “When open interest is much smaller than deliverable supply, a higher limit should apply.”
It wants the definition of economically equivalent over-the-counter (OTC) contracts to be widened to include contracts that may not be identical but give similar exposure.
The Commission said ESMA should also consider a wider range of factors for determining which firms trade commodities as an ancillary service - meaning it is not a major part of their business - and should be exempt from the more burdensome capital requirements.
The EU executive said it wanted a more accommodative approach in applying the rules in the first few years.
“We would like a more cautious approach to be taken to the calibration of the regime in the initial years, during which ESMA should assess the functioning of the ancillary services test on the basis of data collected once data officially reported under MiFID II becomes available”
The issue is the “main business” test which measures speculative trading in commodity derivatives as a percentage of total derivatives trading, which may not in all cases accurately reflect a company’s main activities.
That could be because firms can hedge using “physical or financial means other than commodity derivatives” or because “significant parts of commercial activity are not hedged”.
The test does not take into account commercial activities that do not need to be hedged or for which there are no derivative-based hedging tools.
One thing to take into account could be the capital employed for carrying out the ancillary activity in relation to the capital employed for carrying out the main business.
“The proposed test neglects often considerable investments ... that are not reflected in corresponding hedging positions,” the EU said.
“The capital test should be available to those entities that have undertaken significant capital investments in the creation of infrastructure, transportation and production facilities.”
These investments cannot be hedged in financial markets.
Reporting by Pratima Desai, editing by David Evans
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