Capital Markets: Derivatives 2024 Comparisons

All financial derivatives are characterised as financial instruments under Section 4.1.15 of Directive 2014/65/EU on markets in financial instruments, as amended by Directive (EU) 2024/790 of 28 February 2024 (MiFID III). Consequently, these products are subject to securities legislation, the main components of which in Spain are as follows.

• The Spanish Securities Market and Investment Services Act 6/2023 (SMA): As the cornerstone of the regulatory regime, the SMA should fully transpose MiFID III not later than 29 September 2025. The SMA is of paramount importance in relation to derivatives trade, investment firms’ roles and administrative sanctions.
• Regulation (EU) 600/2014 on markets in financial instruments, as amended by Regulation (EU) 2024/791 of 28 February 2024 (MiFIR II).
• Regulation (EU) 648/2012 on OTC derivatives, central counterparties and trade repositories (EMIR). EMIR’s scope is limited to OTC derivatives and is directed towards creating robust market structures, such as central counterparties (CCPs), margin practices (ie, initial and variation margin), timely confirmation, conciliation and compression of portfolios, and transactions reporting to trade repositories. The European Parliament has approved the latest amendment, which has not yet been published in the Official Journal of the European Union and is pending entry into force (EMIR 3.0).
• Royal Decree-Law (RDL) 5/2005 (RDL 5/2005), which transposes into Spanish Law Directive 2002/47/EC on financial collateral arrangements and regulates close-out netting in Spain.

The key recent legal developments in this field are as follows.

• The enactment of the SMA, which is of special interest in respect of transactions with crypto-assets as the underlying assets.
• The transposition into Spanish Law of Directive (EU) 2019/1023 by means of the enactment of Act 16/2022, which amended Spanish insolvency legislation by adding a new restructuring process and entered into force on 1 January 2023. Unfortunately, this piece of legislation did not broaden the list of qualified entities covered by the Spanish close-out netting regime, as allowed by the directive. The inclusion of commodity brokers in such list would have been a positive step due to the increasing market activity and the key role brokers play in managing the related market risks, but the decision was left to the member states. However, Act 16/2022 empowered Spanish commercial judges to order the early resolution of derivative transactions in restructuring proceedings, as well as in insolvency proceedings.
• The enactment of MiFID III and MiFIR II.
• The approval of EMIR 3.0 by the European Parliament in April 2024.
• The approval of the proposal for a regulation of the European Parliament and of the Council amending Regulation (EU) 2016/1011 in respect of the scope of the rules for benchmarks, the use in the EU of benchmarks provided by an administrator located in a third country and certain reporting requirements in April 2024.

In the authors’ opinion, the main drivers of the market in the near future will be:

• the transposition and implementation of the new set of EU legislation mentioned above; and
• the trading of derivatives over crypto-assets and derivatives with ESG features, spurred by the entry into force of Regulation (EU) 2023/1114 (MICA) and the implementation of EU climate-related legislation.

Spanish Stock Exchanges and Markets (Bolsas y Mercados Españoles (BME)) operates the only official Spanish market specialised in derivatives: Mercado de Derivados (MEFF). Althoughan OTC segment exists, the bulk of MEFF’s activities are focused on futures, options and swaps traded on a trading venue. The current products and their underlying assets are as follows:

• futures and options (European style) over the IBEX35 index;
• Futures (settled by differences or physically) and options (American and European style) over Spanish shares;
• futures over dividend benchmarks and single-share dividends;
• rollovers of equity futures;
• rollovers of foreign exchange (FX) futures; and
• swaps and futures over the Iberian Electricity Market (MIBEL).

MEFF has recently improved the functionalities available to retail investors. In this vein, it is worth mentioning that such investors can directly hold segregated derivatives accounts, and all retail investors’ transactions are now marked with the so-called red flag to fully comply with all regulations applicable to retail investors, especially those related to pricing. In addition to these improvements, MEFF is adding new underlying shares after each relevant IPO in Spain.

In respect of OTC options, major banks regularly offer a broad range of FX options to their clients, including retail clients, actively engaged in cross-border activities. The huge interest in these products is normally a consequence of the high volatility in FX markets, although these hedging structures can be extremely costly in practice. OTC options over underlying assets other than exchange rates are generally negotiated on a case-by-case basis and as part of structured investments.

Before the emergence of specialised trading venues, these instruments were exclusively closed by banks voluntarily acting as market makers vis-à-vis end users. Two Spanish banks (BBVA and Santander) that – on an organised, frequent, systematic and substantial basis – dealt on their own account by executing OTC derivative client orders outside a regulated market (RM), multilateral trade facility (MTF) or organised trade facility (OTF), became systematic internalisers (SIs) after meeting the applicable quantitative criteria under MiFID II.Although the current situation may change in the near future since SI status is no longer mandatory in respect of derivatives under MiFID III, at present it is very common that large end users, even non-financial counterparties (NFCs), close OTC derivatives on OTFs, since such trading venues act as online price aggregators and improve transparency.

The most relevant regulatory developments in inter-bank derivatives transactions are outlined in this article. These developments aim to enhance market resiliency and pricing transparency. In terms of transparency, the entire regulatory development has been influenced by the absence of collusive practices; however, no specific transparency standards have been established in this respect. Recent Spanish case law has focused on alleged collusion in the project finance lending market among the four largest Spanish banks, which were investigated and sanctioned by the Spanish National Markets and Competition Commission (Comisión Nacional de los Mercados y la Competencia (CNMC)). However, this sanction was ultimately dismissed by the National High Court since the CNMC was unable to prove the existence of collusion among banks to mislead their clients on swap pricing.

There is no specific regulation on forwards other than the exceptions mentioned in 2.6 Exemptions, Non-derivative Products and Spot Transactions.

The key difference between derivatives that trade on the counter versus OTC is the fact that OTC derivatives, although generally documented on the basis of standard models, are bespoke, tailor-made products as opposed to the derivatives traded on futures and options markets, which have fully standardised terms and conditions. Since there is no room left for negotiation in relation to these derivatives, they can be listed as negotiable securities.

It is worth noting that trading on a trading venue is one of the criteria used to characterise products as derivatives, especially when the contract can – or has been – physically settled, as mentioned in 2.6 Exemptions, Non-derivative Products and Spot Transactions. Moreover, the National Securities Market Commission (Comisión Nacional del Mercado de Valores (CNMV)) considers some securities (ie, warrants with embedded options) as derivatives.

According to the 2023 European Securities and Markets Authority (ESMA) Annual Statistical Report, based on the data provided by the trade repositories regulated by EMIR, the most common derivative products in the EU are those related to the following: interest rates (78%), exchange rates (14%), equity (5%), credit (4%) and commodities (1%). In its 2023 Activity Report, the CNMV summarises the number of transactions and the related notional amounts of derivatives traded on Spanish trading venues. The gross notional amount of derivatives traded on MEFF experienced a sharp decline (7.1%), although this negative trend was smaller for Spanish equity product-related segments (5%); these comprise the bulk of MEFF’s business (83.5%), which is mainly concentrated on the trading of two shares (Santander and Telefónica, accounting for up to 97% of the whole segment). In contrast, Spanish OTFs experienced a great leap forward in 2023, where the number of trades (8,676) and gross notional amounts (EUR2.97 billion) more than doubled the previous year’s figures. Largely because the trading of interest derivatives increased by 215%, with a market share of 71%, Tradition España OTF was the largest OTF in Spain, followed by CIMS SV and CAPI OTF.

There are no limits on asset classes beyond the position limits for commodity derivatives pursuant to Article 57 of MiFID III. Notwithstanding the foregoing, the CNMV restricted the distribution of contracts for difference (CFDs) with high leverage ratios, setting limits on the provision of initial margin (higher than one-thirtieth for major currency pairs, one-twentieth for all other currency pairs, gold and relevant stock benchmarks, one-tenth for commodities and non-relevant stock benchmarks, one-half for crypto-assets and one-fifth for all other underlying assets) and banning the offering of binary options among retail investors from 2017 onwards, in line with previous ESMA decisions.Such restrictions also affect the publicity related to these products (the distributor must warn potential clients of the actual risks and their likely lack of suitability) and entail other protective measures:

• a margin close-out rule on a per account basis (at 50% of the minimum required margin);
• negative balance protection on a per account basis as an overall guaranteed limit on retail client losses; and
• a restriction on the incentives offered to trade CFDs. On 11 July 2023, the CNMV issued additional restrictions on CFD publicity and promotion practices, specifically banning several marketing techniques and broadening the scope of the protective measures to encompass all products whose potential losses are not limited at the time of closing.

In the last four years, derivatives on emission allowances have been steadily growing in Spain, spurred by the impending discontinuation of the emission allowances that are currently freely assigned to major emitters of greenhouse gases. At present, forwards are the most common type of OTC product in this market.

Sustainability-linked derivatives (SLDs) – ie, OTC derivatives whose pricing and/or payment obligations rely on meeting certain climate-related key performance indicators (KPIs), sustainable performance targets (SPTs) or ESG scores, are also well known in Spain. For the time being, when based on the framework contract for financial operations (contrato marco de operaciones financieras (CMOF)) model, the related provisions are typically bespoke (tailor-made). It is quite likely that, assuming the standardised clauses for SLDs of the International Swaps and Derivatives Association (ISDA) win favour among derivatives practitioners, such clauses will become the standard in Spanish practice.

In connection with derivatives on crypto-assets, after being fully authorised by the CNMV in 2023, MEFF published a set of terms and conditions for futures on crypto indexes in May 2024 and is about to trade futures in Bitcoin and Ethereum. This market segment is restricted to institutional investors, with all products settled by differences. MEFF does not clear any transactions involving custody arrangements. In addition to this authorisation, the CNMV released a set of rules on publicity related to crypto-assets, whose scope embraces all assets other than financial instruments and consequently should not be deemed applicable to derivative transactions. It is quite likely that the ISDA digital asset derivatives definitions will win favour in Spain in the near future, although this is a matter not yet covered by the SMA (for the time being, this piece of legislation is exclusively focused on tokens, and cryptocurrencies such as Bitcoin and Ethereum are far beyond its current scope), and there are deep concerns related to the legal nature of cryptocurrencies under Spanish law that may delay further developments in the trading of such products in Spain.

Forwards are deemed OTC derivatives except when used for commercial purposes under the terms set forth in Commission Delegated Regulation (EU) 2017/565 of 25 April 2016 supplementing Directive 2014/65/EU. The most relevant exception is the use of FX forwards as means of payment when the following conditions are met.

• They are settled physically other than by reason of a default or other termination event.
• At least one of the parties is not a financial counterparty (FC) as defined by EMIR.
• Their purpose is to facilitate payment for identifiable goods, services or direct investment.
• They are not traded on a trading venue.

On 28 September 2020, the CNMV issued a set of guidelines to prevent such conditions being used as a “way out” of MiFID. In particular, these guidelines set out the operational procedures needed to check the existence of actual transactions related to goods, services and investments before closing the contract, coupled with a post-closing review of the commercial character of the related hedged activities.

In addition to the above-mentioned exception, the following criteria are laid out to prevent the characterisation of other types of transactions as derivatives.

• Wholesale energy forwards (power, gas, oil and coal) are not deemed derivatives when they are – or may be – physically settled and are used for commercial purposes. However, the following agreements are deemed derivatives even when settled physically: (i) agreements traded on a trading venue (except physically settled wholesale energy products traded on an OTF) and (ii) physically settled agreements not used for commercial purposes that have characteristics akin to other derivative instruments (ie, derivatives traded on a trading venue).
• Commodity spot transactions are not deemed derivatives provided that they fit the definition of a spot transaction. These transactions are defined in Article 7 of Regulation (EU) 2017/565 as agreements for the sale of a commodity, asset or right, under the terms of which delivery is scheduled to be made within the longer of the following periods: (i) two trading days or (ii) the period generally accepted in the market for that commodity, asset or right as the standard delivery period.
• FX spot transactions are not deemed derivatives provided that they fit the definition of an FX spot transaction. These transactions are defined in Article 10 of Regulation (EU) 2017/565 as agreements for the exchange of one currency against another currency, under the terms of which delivery is scheduled to be made within (i) two trading days in respect of any pair of major currencies (US dollar, euro, Japanese yen, pounds sterling, Australian dollar, Swiss franc, Canadian dollar, Hong Kong dollar, Swedish krona, New Zealand dollar, Singapore dollar, Norwegian krone, Mexican peso, Croatian kuna, Bulgarian lev, Czech koruna, Danish krone, Hungarian forint, Polish zloty and Romanian leu), (ii) the longer of two trading days or the period generally accepted in the market for a given currency pair as the standard delivery period for that pair of currencies, where at least one currency is not a major currency, or (iii) the period generally accepted in the market for the settlement of a given transferable security or unit in a collective investment undertaking as the standard delivery period – where the contract for the exchange of those currencies is used mainly for the sale or purchase of a transferable security or a unit in a collective investment undertaking – or five trading days, whichever is shorter.
• Since there are other products that can be deemed derivatives due to being settled in cash – or that may be settled in cash at the request of one of the parties other than by reason of default or other termination event, or due to having the characteristics of other derivative products, Section 3.10 of Annex I of MiFID III, and Articles 6 and 8, include a long list of potential underlying assets.

There are no local regulators in the securities market. However, territorial consumer agencies are involved in claims related to the distribution of financial instruments relatively frequently, although their activities are exclusively based on the Spanish General Consumers Protection Act.

Although they are not self-regulatory entities, the Spanish Banking Association (Asociación Española de Banca (AEB)) and the Spanish Confederation of Saving Banks (Confederación Española de Cajas de Ahorro (CECA)) have co-operated to draft framework agreements under Spanish Law since 1997 (CMOF). To date, four versions of the CMOF have been made public, all of which are easily available on AEB’s website. At present, both entities are associations. There are no other similar initiatives in Spain.

In connection with ISDA master agreements, the standards sponsored by the Futures Industry Association (FIA; formerly the Futures and Options Association (FOA)) and ISDA are generally used in connection with peer-to-peer (P2P) transactions to be cleared in a CCP. When the services of a clearing member are needed, it is customary in Spain to sign and execute a bespoke tailor-made agency agreement, coupled with an ISDA Master Agreement between the client and the clearing member, with an addendum to deal with cleared transactions governed by the CCP’s rulebook and the opening of a segregated account. In Spain, the 2020 CMOF includes an Annex IV, in line with ISDA/FIA-sponsored standards for P2P transactions within the EU. In respect of derivatives traded on a trading venue, CCPs use the agency model instead of the principal model used in Europe.

The most common concerns arising from the negotiations between brokers and clients to clear standard derivatives are as follows:

• the use of electronic platforms to enter orders;
• collateral posting and its transformation when margin obligations are funded with non-eligible assets in the event the clearing member provides this service; and
• portability and default provisions.

At the level of the EU, Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms, and amending Regulation (EU) No 648/2012 (Capital Requirements Regulation (CRR)), require that credit entities obtain legal opinions in respect of regulatory capital obligations on OTC derivatives, as follows:

• Articles 194(1) and (2) subject the recognition of credit-risk-mitigation techniques to reduce the consumption of regulatory capital to the prior obtention of legal opinions on the legal effectiveness and enforceability in all relevant jurisdictions of such techniques. Consequently, close-out netting (covering both the applicable law and the counterparty’s residence jurisdiction) and collateral opinions (covering the legal status of collateral takers and givers) are needed.
• Article 305 (2) also requires that the client of a clearing member has the legal opinion that it would bear “no losses” on account of the insolvency of its clearing member, or any of the clearing member’s clients, under the laws of the jurisdiction of various related entities. This is the reason why ISDA’s legal opinions on these subjects have an architecture based on three modules.

According to the CNMV’s 2023 Activity Report (the most recent one available), the CNMV’s main enforcing actions have focused on the following areas.

• Monitoring and detecting insider trading practices: The CNMV is in the process of developing supervisory technology (SupTech) tools to improve these efforts.
• Surveillance of MEFF activity on a continuous basis, especially during the days close to the termination of traded agreements in order to check the potential impact on large accounts and IBEX35. Pricing practices in the “MEFF Power” and “FX-Rolling” segments were also deeply analysed.
• Monitoring warrants traded on Spanish exchanges.
• Monitoring three OTFs (CAPI OTF, CIMD and Tradition España OTF) on a permanent basis.
• The CNMV ceased to request yearly notification of submission for commodity ancillary investment services exemption, albeit that exempted entities will have to inform the CNMV on request.

The CNMV also made a biennial strategic plan public in 2023 to provide information on its future activities.

Likewise, the 2024 working plan, with 42 specific goals, was also published on its website.