European Union : OPINION on position limits on ICE Low Sulphur Gasoil contracts

Date: 18 January 2019

ESMA70-155-5088

OPINION on position limits on ICE Low Sulphur Gasoil contracts

I.Introduction and legal basis

• 1. On 9 February 2018, the European Securities and Markets Authority (ESMA) received a notification from the Financial Conduct Authority (FCA) under Article 57(5) ofDirective2014/65/EU on markets in financial instruments1 ("MiFID II") regarding the exact position limits FCA intends to set for ICE Low Sulphur Gasoil Futures and Options commodity contract in accordance with the methodology for calculation established in Commission Delegated Regulation (EU) 2017/591 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to regulatory technical standards for the application of position limits in commodity derivatives2 ("RTS 21") and taking into account the factors referred to in Article 57(3) of MiFID II.

• 2. ESMA's competence to deliver an opinion is based on Article 57(5) of MiFID II. In accordance with Article 44(1) of Regulation (EU) 1095/2010 of the European Parliament and of the Council of 24 November 2010 establishing a European Supervisory Authority (European Securities and Markets Authority)3 ("ESMA Regulation"), the Board of Supervisors has adopted this opinion.

II. Contract classification

Commodity base product: energy (NRGY)

Commodity sub product: oil (OILP)

Commodity further sub product: gasoil (GOIL)

Name of trading venue: INTERCONTINENTAL EXCHANGE - ICE FUTURES EUROPE

MIC: IFEU

Venue product code: G4

1 Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU (OJ L 173, 12.6.2014, p. 349).

2 Commission Delegated Regulation (EU) 2017/591 of 1 December 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to regulatory technical standards for the application of position limits commodity derivatives (OJ L 87, 31.3.2017, p. 479).

3 Regulation (EU) 1095/2010 of the European Parliament and of the Council of 24 November 2010 establishing a European Supervisory Authority (European Securities and Markets Authority), amending Decision No 716/2009/EC and repealing Commission Decision 2009/77/EC (OJ L 331, 15. 12.2010, p. 84).

4 This is the primary venue product code (VPC) for this contract. However, the position limits set will apply to other associated VPCs as well. For a complete and updated list of VPCs to which the same limit applies, please check the FCA website athttps://www.fca.org.uk/markets/mifid-ii/commodity-derivatives/position-limits.

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III.Market description

• 3. Gasoil is also known as diesel oil. Gasoil is primarily a medium distillate, distilling between 180°C and 380°C. Several grades are available depending on uses. The underlying physical market for Low Sulphur Gasoil is diesel barges delivered in the ARA (Amsterdam, Rotterdam, Antwerp including Flushing and Ghent) region.

• 4. Gasoil is a product of crude oil and is used for heating purposes and for generating power.

  It accounts for about 25% of the yield from a barrel of crude oil. This represents the second largest "cut" after petrol. Low sulphur gas oil has less than 0.1% of sulphur content. In the UK, it is also known as red diesel.

• 5. Gasoil includes transport diesel, heating oil and other gasoil. Transport diesel oil is used to power diesel engines in ships, buses, trucks, trains, cars and other industrial machinery.5

• 6. Gas oil is traded widely in Europe as a hedging tool for the physical industry. Gas oil trading futures are used by companies to hedge against diesel and jet fuel costs. They are used as the pricing reference for all distillate trading across Europe.

• 7. The ICE Low Sulphur Gasoil Future is a monthly physically settled future based on the ICE daily settlement price for Low Sulphur Gasoil Futures. The ICE Low Sulphur Gasoil Future is used as the pricing reference for all distillate trading in Europe and beyond. ICE Low Sulphur Gasoil plays the same role for middle distillate oil that ICE Brent Crude plays for the crude oil market.

• 8. Trading in the ICE Low Sulphur Gasoil Future contracts takes place in lots. One lot is equivalent to 100 metric tonnes (MT). 96 consecutive months are available for trading.

• 9. ICE also offers trading in Low Sulphur Gasoil Options. The ICE Low Sulphur Gasoil Options Contract is based on the underlying futures contract and if exercised will result in a corresponding futures position. Contracts are for American-style exercise, allowing the buyer to exercise an option anytime up to and including expiry day.

• 10. ICE further offers trading in Bullet Futures, which is a variation of the main contract. The

  Bullet contract shares specifications with the whole month contract (the principal) and is priced off the same underlying. However, settlement for bullet contracts is based on the price on the penultimate trading day of the main future contract and has a minimum price fluctuation and settlement price quotation of $0.001 per barrel, as opposed to of $0.025 per barrel for the principal contract, which may assist in refining.

• 11. During the final month of trading in the ICE Low Sulphur Gasoil Future contract, the

Exchange contacts holders of Low Sulphur Gasoil positions to confirm their intent and

5 Source: International Energy Agency, Oil Market Report Glossary & European Commission, Energy Statistics Manual

capability of making or taking delivery and may require that positions be reduced to limit position concentration, ensure price convergence with the physical market, and maintain market integrity.

• 12. Contracts are for the future delivery of low sulphur gasoil from the seller to the buyer onto a barge (or coaster up to 10,000 dwt) or by in-tank or inter-tank transfer from an Exchange Recognised Customs and Excise bonded storage installation or refinery in the Amsterdam, Rotterdam, Antwerp (ARA) area (including Flushing and Ghent) nominated by the seller and on a day nominated by the buyer within a mutually agreed 5 day delivery range between the 16th and the last calendar day of the delivery month. Quantity and quality is verified by one Exchange approved inspector selected from two nominated by the buyer. Buyers and sellers adhere to strict deadlines set out in the Exchange Contract Rules and Procedures.

• 13. Physical deliveries between the months of October and March must be of winter grade quality with deliveries outside of these months (i.e. from April to September) being of summer grade quality. Full quality specifications are published in the ICE Futures Europe Rulebook6. Product of any origin is deliverable under the contract.

• 14. The International Maritime Organisation announced in October 2017 that it will implement a global sulphur cap of 0.5% on marine fuels starting from January 1, 2020. This has led the oil majors to announce that they will offer a range of fuel solutions to comply with the cap.

• 15. In addition to ICE Futures Europe, trading for European Low Sulphur Gasoil Futures contracts is conducted on New York Mercantile Exchange (NYMEX). The price of this cash-settled NYMEX Low Sulphur Gasoil Futures contract is based on the first nearby contract month settlement price of this ICE contract.

• 16. Factors influencing the price of Gasoil Low Sulphur futures include the price of crude oil, amounts in storage, and currency fluctuations. In addition, the price may be affected by geopolitical concerns, consumer trends and alternative sources of fuel such as green energy.

• 17. There is a large number of market participants. The vast majority of market participants are entities with exposure to the underlying physical market for the commodity which use the futures market to hedge the risks associated with such exposure. Examples would include oil exploration and drilling firms, specialist commodity trading firms with physical exposures, producers, exporters/importers, coffee roasters, cocoa processors, sugar refiners, food and confectionary manufacturers, millers, crushers, utility companies who consume oil to generate power. There are less than three market makers as defined in Article 4(1)(7) of MiFID II.

6https://www.theice.com/publicdocs/contractregs/15_SECTION_J1.pdf

IV.Proposed limit and rationale

Spot month position limit

Deliverable supply

• 18. Deliverable supply amounts to 135,391 lots. A lot is equivalent to 100 MT.

• 19. On expiry, the physically deliverable futures contract can be delivered by barge in the

  Amsterdam-Rotterdam-Antwerp (ARA) corridor of the Netherlands and Belgium into recognised delivery installations. Deliverable supply takes into account low sulphur gasoil from Belgium and the Netherlands which is easily transported to the ARA delivery points.

• 20. The deliverable supply data has been calculated using production (refinery output),

  import and stock data from Eurostat for 2016. Total production and imports for 2016 was 61,351,000 metric tonnes for total gas/diesel oil (blended with bio components). This is then divided by 12 for an average monthly figure of 5,112,583. The average monthly stock figure for 2016 was 8,426,500 metric tonnes. When combined this provides a deliverable supply figure of 13,539,083 metric tonnes7.

• 21. The final monthly deliverable supply figure is then converted into lots by dividing the above figure by 100 resulting in 135,391 lots.

Spot month position limit

• 22. Spot month limit amounts to 58,850 lots, which represents 43,5% of deliverable supply.

  The spot month limit applies to the ICE Low Sulphur Gasoil Futures and Options contracts as well as to Bullet contracts which are based on identical core (underlying) contractual specifications, terms and conditions. The FCA's website provides an updated list showing the names and codes for these contracts.

• 23. The FCA is of the view that if separate limits are applied to Bullet futures and other types of closely related contracts, the overall position of a participant on the same underlying may not be clearly represented. The FCA also considers that setting a single position limit for Bullet and principal contracts traded on the same venue where there are identical contract specifications, terms and conditions, is compliant with the objectives of the MiFID II regime and of RTS 21. It avoids the creation of multiple limits for identical commodities and the potential undermining of the overall intentions of the regime. In particular, it enhances the approach already established with the aggregation of positions under Article 57 of MiFID II and Articles 5 and 6 of the RTS 21 for same commodity derivatives and EEOTCs, where positions are also aggregated with the primary on-venue contracts and become subject to

7 Source: Eurostat: All (closing) stocks on national territory, Imports, Transformation output from refineries,http://ec.europa.eu/eurostat/data/database

one position limit. It also appears consistent with Article 3 of RTS 21, which provides for position holders to calculate their option positions on a delta adjusted basis by commodity derivative and then aggregate these with the principal commodity derivative contract.

Spot month position limit rationale

• 24. The baseline for the spot month limit has been set at 25% of deliverable supply as required by RTS 21 Article 9(1).

• 25. Although gasoil is also traded on NYMEX, no adjustment has been made under Article 17 of RTS 21 to the deliverable supply as that NYMEX contract is financially settled and will not cause disorderly physical settlement of the ICE contract.

• 26. In accordance with Article 18(1) of RTS 21, a downward adjustment of 4 percentage points was made for the very large open interest in the contract (913,452 lots). A further downward adjustment of 2.5 percentage points was made for the significant number of participants holding positions (514), in accordance with Article 19 (1) of RTS 21.

• 27. The situation set out in Article 19(2)(b) of RTS 21 applies in respect of this contract as the number of investment firms acting as a market maker in accordance with Article 4(1)(7) of Directive 2014/65/EU in the commodity derivative at the time the position limit is set or reviewed is lower than three. This factor means that a higher maximum position limit is available. Analysis of market data on the composition and role of market participants under Article 20(2)(d)) also indicated that although there are a significant number of small positions held by market participants there are also commercial positions in excess of the 25% baseline. The FCA has therefore made an upward adjustment of 25 percentage points to reflect the criterion and factors described in Articles 19(2)(b) and 20(2)(d) of RTS 21 in order to avoid the risk of unduly constraining normal trading in this derivative market and preventing it from working adequately. The upward adjustment will in particular allow commercial market participants, who may be unwilling to apply for an exemption, to hedge their positions. Once the position reporting regime is in place and has enabled analysis of a longer run of data, including information on the speculative/commercial breakdown of positions, the FCA will be able to give further consideration to adjustments for this contract.

• 28. All other factors have been considered and are not regarded by the FCA as material or relevant to require additional adjustments, either up or down, from the baseline. In considering the volatility in the contract, as required by Article 21 of RTS 21, there has been some variation in the price of the commodity derivative but the FCA has not found evidence that this is excessive or that lower position limits would reduce volatility.

• 29. A total upwards adjustment was made of 18.5 percentage points resulting in a limit of

43.5%. This provides a figure in lots of 50,895 which has been rounded down to a figure of 50,850 lots. This equates to a final limit as a percentage of deliverable supply of 43.5%.