On January 14, the European Union’s three-branch government reached an agreement in Strasbourg, France, to regulate derivatives trading and other complex instruments.
The regulation’s main component is the so-called Markets in Financial Instruments Directive (“MiFiD”). The Parliament, the European Commission, and the Council of the European Union, representing leaders of 28 member countries, were struggling with intense lobbying from the oil and commodities industries. They were also under time pressure due to the Union’s upcoming parliamentary elections, which would have further stalled the process.
Europe’s effort to tighten regulations over derivatives trading has its roots in the 2008 financial crisis. Europe’s new regulations come long after the United States set its own in 2010 under the Dodd-Frank Act. While waiting for Europe’s MiFiD, the Commodity Futures Trading Commission, the main United States regulator that oversees derivatives trading on Wall Street, planned to regulate European branches and affiliates of American banks if the European Union’s new regulations were not sufficient or “comparable.”
One of MiFiD’s main features is to limit attempts from speculators to corner the market in raw materials, which can drive up commodity and food prices. MiFiD also requires greater transparency on trading activity, and includes specific regulation of high frequency trading. Michel Barnier, the European Commission official overseeing the issue, told The New York Times, “These new rules will improve the way capital markets function to the benefit of the real economy.”
Not everyone involved in the negotiations was satisfied with the final deal. The main point of disagreement over the last months focused on the so-called “forward contract.” These contracts are used to promise the delivery of various commodities at a future date at an agreed-upon price, and are often used to hedge risks or to engage in market speculation. Its regulation under the MiFiD would increase transaction costs and may be subject to position limits.
Lobbyists, mainly from the oil industry, were concerned with MiFiD’s impact toward companies that use forward contracts and actually deliver the commodities physically (e.g. oil, coal, gas and electricity). The final deal exempted electricity, oil, and gas from MiFiD regulations. It also granted a three-and-a-half year grace period for oil and coal derivatives – a notorious win for the lobbyists. However, the British government and British bankers are concerned about the impact of the regulations on market liquidity and the competitiveness of European companies because of increased transactional costs.
MiFiD’s broad lines have been drawn. Now, a transitional period of at least two years is expected to allow European Union’s technocrats to fill gaps in details, allowing the regulation to finally enter into force.