A number of provisions in MiFID II and MiFIR (which, from now refer to jointly as “MiFID II”), apply to non-EU firms (referred to in EU regulatory parlance as third country firms) in different ways, depending on a number of circumstances.

Today we will talk about how the trading obligation in Art. 28 of MiFIR applies to transactions between an EU entity and a third country firm.

Art. 28 requires that all transactions that the European Commission has declared subject to the trading obligation (as listed on ESMA’s register) be concluded on either of a:

  • regulated market;
  • multilateral trading facility (“MTF”);
  • organised trading facility (“OTF”); or
  • third-country trading venue (e.g., a SEF) that the European Commission has declared to be equivalent.

The trading obligation does not apply when the transactions are intra-group transactions, or when one of the parties is a pension fund temporarily exempted under Art. 89 of EMIR (there is a list of Art. 89 exempted parties published by ESMA, the European Securities and Markets Authority).

As for whom the trading obligation applies to, the transaction must be entered into:

(a) by parties each of which qualifies as:

  • FC; or
  • NFC+

under EMIR, or:

(b) between an FC or NFC+, and a third-country firm that would qualify as an FC or NFC+ if it were established in the EU; provided that:

(i) the contract has a direct, substantial and foreseeable effect in the EU; or

(ii) applying the trading obligation is necessary or appropriate to prevent regulatory arbitrage.

(b)(ii) is an anti-evasion provision, designed to avoid transactions structured for the specific purpose of evading the application of the trading obligation.

However, (b)(ii) is trickier to determine, as the definition of a contract having a direct, substantial and foreseeable effect in the EU can have a number of moving parts.

Let’s see:

For a contract to have a direct, substantial and foreseeable effect in the EU, either:

I. it must be entered into between EU branches of third-country firms that would be FCs or NFC+ if they were established in the EU; or

II. one party to the transaction must be an FC or an NFC+ and the other must be a third-country firm that would qualify as an FC or NFC+ if it were established in the EU; and

a. its entire liability under one or more derivatives, including the transaction being assessed, is guaranteed by an FC established in the EU for an aggregated notional amount of at least EUR 8bn;

b. the total aggregate liability of the third-country firm under one or more OTC contracts is at least EUR8bn or equivalent (including transactions entered into before, and covered by, the guarantee); and

c. the guarantor’s liability under the guarantee represents an exposure of at least 5% of its total current exposure to OTC derivatives.

What the guarantor must check (Art. 2, RTS 5)

  • Increases to guaranteed amount: If a guaranteed amount initially below the threshold in II.a. is later increased, the guarantor must again carry out the checks in II.a., b. and c.
  • Increase in liability: If the guaranteed third-country entity increases its liability (see II.b.), the guarantor must re-assess, on the same day of the increase, the checks in II.a., b. and c.
  • Decrease in guarantor’s current exposure: The guarantor must check on a monthly basis whether there is a decrease of its current exposure to OTC derivatives (I.c.).

The checks required to continually assess whether a third-country firm transaction is subject to the trading obligation are complex and can be challenging, as they need continuing monitoring and real-time coordination between the guarantor (obliged to exercise control under MiFID II) and the guaranteed third-country firm.

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