FX forwards: in or out of scope under MiFID II?

For years, the UK charted a lonely but pragmatic course with its interpretation that deliverable FX forwards are not investment instruments. UK payment and e-money institutions can offer such products without requiring authorisation under the Financial Services and Markets Act 2000 (FSMA) while counterparts elsewhere in the EEA had to be regulated. The implementation of MiFID II in January 2018 will, among other things, confirm the UK’s position but the new definition is a little tighter than what we are used to in the UK and payment and e-money institutions must consider whether they want to remain unregulated.

In the UK, under Article 84(2) of the Regulated Activities Order, FX forward contracts that are taken out for commercial purposes are exempt from regulation. Industry practice has been to regard virtually any FX forward taken out by a trading enterprise as being, de facto, for a commercial purpose.

Following pressure from the European authority with responsibility to protect investors’ interests,  European Supervisory and Markets Authority (ESMA) in 2014, the European Commission has effectively redefined commercial purpose through delegated regulation. For UK firms the definition has narrowed to only exempt from regulation trades where:

  • the currency is deliverable; and
  • the purpose of the trade is to facilitate a means of payment for identifiable goods and services.

What does the new definition mean in practice?

As we’d expect, FX spot contracts remain outside of scope provided that the funds are delivered within a specified number of trading days. The number of trading days depends on the type of contract. For major currencies, the specified period is two trading days and for non-major currencies, it is the period generally accepted in the market for that currency pair. The complication arises when we consider deliverable FX forward contracts which will be considered in scope of MiFID II unless the currency is deliverable and the purpose of the trade is to pay for goods and services.

The FCA’s third consultation paper gives helpful guidance on what constitutes identifiable goods and services and sets out scenarios which would not qualify for the ‘means of payment’ exclusion. We’ll look at two of these scenarios and consider how payments can be identified.

Scenario 1 – A customer wants to hedge its balance sheet because it has a euro exposure but reports financially in sterling.

In this scenario, the FCA says the exclusion does not apply because the FX contract is not entered into for the purpose of facilitating a payment for identifiable goods or services. Clearly, there is no third party payment.

Scenario 2 – A farmer’s farm payment under the EU basic payment scheme will be €10,000 and will be paid in sterling. The payment will be made in three months’ time. In order to fix the sterling amount he will receive, the farmer wishes to book a forward with a currency provider to sell €10,000 and buy sterling in three months’ time.

Here, the issue is whether the forward exchange contract relates to identifiable goods and services. The FCA consider that the exclusion does not apply because the payment is not linked to any specific goods or services being sold or bought by the farmer.

When assessing whether an FX forward is in scope, firms will need to determine whether the client plans to use the foreign currency to pay for goods or services and therefore meets the exclusion conditions. Where invoices can be produced or an instruction is given for payment to be made to a third party, there is no need to question further. Of course, some clients will be reluctant or unable to produce invoices and provide payment instruction so the question is, can you rely on the information provided by the client or does this information need to be verified? The FCA advises that firms may rely on the assurances provided by the client as long as there is no reason to doubt what the client has said.

MiFID II impact assessment

Firms that offer FX forwards but do not have a FSMA authorisation as an investment firm must consider their current practice and decide whether they can continue and remain outside the scope of regulation.

If the answer is ‘no’ or ‘probably not’ then firms must balance the cost of authorisation against the benefits of offering what will be classed as Non-Deliverable Forwards (NDFs).

For smaller firms, the biggest issues are likely to be:

  • the cost involved in not being allowed to use margin received from retail clients to fund their own position with their bank on a match principal basis, which could present a liquidity challenge; and
  • the set up cost to provide daily transactional reporting under the European Market Infrastructure Regulation (EMIR) and Markets in Financial Investment Regulation (MiFIR). As well as the set up and ongoing fees to trade repositories, the reporting itself is time consuming with more than 70 fields to complete each day.


Other obligations include:

  • maintaining a minimum capital requirement of €125,000;
  • undertaking quarterly COREP reporting;
  • implementing policies and procedures on suitability, best execution and product disclosure;
  • complying with the prescriptive CASS requirements for protecting client’s money; and
  • employing qualified staff who are competent in assessing suitability (if providing advised sales) and appropriateness (if the sale is execution only) and the compliance personnel to oversee the arrangements.


Another liquidity issue to consider is that some financial auditors assert that investment firms protect the ‘in the money’ (ITM) position of all derivatives under CASS 7.16.32. We disagree with this position on the basis that FX forwards are taken for hedging, not income generating, purposes but it if the auditor insists, it can create a very difficult situation.  

Investment firm authorisation

Firms that want to offer NDFs after 3 January 2018 and are not already FSMA-authorised will have to submit an authorisation application, along with the £5,000 fee. The application pack will include:

  • a business plan including financial forecasts;
  • information around governance, compliance, and systems and controls;
  • information about your IT systems; and
  • information about the owners of the business and the individuals responsible for managing the business.


Firms that are already authorised under FSMA should check that they have permission to deal in contracts for difference. If they don’t, they must submit a variation of permission application.

The FCA is concerned that to date there have been very few MiFID II applications, both new applications and variations of permission. The very latest that an application can be submitted and determined before 3 January 2018 is 3 July 2017.

In reality, firms are well advised to submit their initial applications in advance of the July deadline as the majority of applications submitted to the FCA are deemed to be incomplete.

How fscom can help

We are helping firms establish whether they require authorisation by analysing the outlier scenarios to determine whether they are within scope. Where authorisation or a variation is required, we can help, as we have with numerous previous applicants, either by managing the entire project or providing a support and review service.

Related Posts