The European Commission has launched a consultation process on the definition of foreign exchange (FX) instruments, focusing on the definition of spot forex contracts. This is a significant and welcome development which will hopefully shed light on an area of investment services law which sorely needs it. Through the exercise, the Commission also hopes to clarify the boundary between FX and non-FX instruments.
The consultation document notes that spots are contracts for the purchase of a currency for immediate delivery. This immediacy means an FX contract can only be used to buy/pay for a currency and not for investment or hedging purposes and for this reason are not usually classified as financial instruments. The document contrasts this with FX derviatives such as FX futures which are contracts for the purchase of a currency for delivery at a later specified date; because the price of the currencies can vary over time, a loss or a gain may arise, meaning that the forward can be used for investment or hedging purposes.
The document observes that in practice, the delivery and settlement of a spot transaction does not take place immediately, for technical reasons or as a result of market practice, and normally takes place a number of days thereafter, and notes that it is therefore necessary to determine how long “immediate” is and at what point a spot becomes a forward.
This consultation is of significance to all operators in the FX sphere, since the categorisation can have various implications, inter alia:
MiFID: Classification of an FX contract as a financial instrument may therefore bring an entity within the authorisation requirement and subject them and this activity to other obligations such as the investor protection and algorithmic trading regimes.
EMIR: Inclusion of FX contracts as a financial instrument would mean that (1) mandatory reporting of transactions into trade repositories would be required; (2) FX contracts may be taken into account for the calculation of the clearing threshold; (3) A clearing obligation and bilateral risk mitigation techniques for non-centrally cleared transactions may be required under level 2 measures.
Market Abuse: the scope of the Regulation on insider dealing, the improper disclosure of inside information and market manipulation’s is defined by reference to financial instruments as defined in MiFID
