The game goes on: new rules the commodity exchanges have received
and who is allowed to sell commodities on the exchange
On 30 June 2021, the National Securities and Stock Market Commission (the “NSSMC”) took a decision to issue licenses for organising commodity trading and for clearing activities to LLC “Ukrainian Energy Exchange”.
Earlier commodity exchanges carried out their activities without a license, but on 1 July 2021 everything has changed. All commodity exchanges shall have a license in order to carry out organisation of trading activities.
On how to acquire the status of a commodity exchange under the new rules and on peculiarities of its operation, energy projects expert of Sayenko Kharenko and board member of the UWEA Maryna Hritsyshyna and Nataliia Hutarevych, senior associate of Sayenko Kharenko, explain especially for Mind.
On 1 July 2021, all provisions of the Law of Ukraine "On Commodity Exchanges" which is a new edition of the Law of Ukraine "On Commodity Exchange" (1991) based on the Law of Ukraine "On Amendments to Certain Legislative Acts of Ukraine to Facilitate Attraction of Investment and Introduction of New Financial Instruments" No. 738 of 19.06.2020 (the “Law 738”) came into force. These laws define the basic requirements for the activities of commodity exchanges.
Before this law "On Commodity Exchanges" (the “Commodity Exchanges Law”) was passed, activities of the commodity exchanges were regulated by the Law "On Commodity Exchange". Despite the name of the previous edition of the law in singular – the Law "On Commodity Exchange", according to the State Statistics Service of Ukraine there were 620 commodity exchanges in Ukraine at the beginning of 2021. However, with the coming into force of the Commodity Exchanges Law, the number of the commodity exchanges in Ukraine will be considerably reduced. In order to operate, a commodity exchange must bring its corporate structure in line with the effective legal requirements and obtain a license from the NSSMC.
According to the Poland's experience, efficient trading does not require hundreds of commodity exchanges. For example, TGE is the only commodity exchange in Poland licensed to operate in a regulated market since February 2015. In Germany, Deutsche Börse provides a platform for energy and commodity trading in more than 30 countries.
In other words, experience from other countries shows that it is not the number of commodity exchanges that matters, but the quality of services provided to organise commodity trading. Before moving on to the issue of trade organisation, it is important to understand which companies can have commodity exchange status.
What is a commodity exchange?
As of 1 July 2021, not all companies may use the words “commodity exchange” and derivatives thereof in their name. Only legal entities carrying out professional activities on the organised commodity markets are allowed to use the words “commodity exchange”. By law, commodity exchanges are professional participants of the organised commodity markets.
The Commodity Exchanges Law defines a commodity exchange as a legal entity in a form of a joint-stock company, a limited liability company or an additional liability company, which carries out activities on organisation of commodity trading as well as other activities stipulated by law.
In other words, a commodity exchange is a legal entity that has a certain organisational form and trades in goods. However, as of 1 July 2021, due to the Law 738 and the Commodity Exchanges Law full entry in force, in order to acquire the status of a commodity exchange a company must meet certain requirements.
How to acquire a status of a commodity exchange?
Starting from 1 July 2021, all commodity exchanges shall obtain a license from the NSSMC for professional activities on organised commodity markets – the activity of organising trade in goods at commodity exchanges. Only on the basis of this license shall commodity exchanges be entitled to carry out their activities.
Licensing conditions for professional activity on organised commodity markets – the activity of organising trade in goods at commodity exchanges were approved by NSSMC Decision No.276 of 13 May 2021.
The procedure for issuing, suspending and cancelling a license for professional activity on organised commodity markets – the activity of organising trade in goods at commodity exchanges was approved by NSSMC Decision No. 275 of 13 May 2021.
However, obtaining a license is not enough to start operating a commodity exchange. Commodity exchange starts operating only after the Commodity Exchange Rules are registered with the NSSMC.
Commodity Exchange Rules is the main document regulating organisation of commodity exchange trade, namely, execution of exchange operations, conclusion of exchange contracts and conduct of exchange trade. According to the Commodity Exchanges Law, once commodity exchange obtains a licence, the Commodity Exchange Rules shall be:
- approved by the commodity exchange,
- approved by the regulator of the respective commodity market and/or the central executive authority in respective field (if such requirement is established), and
- registered by the NSSMC.
In addition to organising trade in goods, commodity exchanges are entitled, after obtaining appropriate licences, to carry out:
- clearing activities for the determination of obligations,
- activities of organising conclusion of derivative contracts on a regulated market and on MTF of derivative contracts,
- as well as activity of organising conclusion of derivative financial instruments on OTF of derivative contracts.
So, in order to obtain the status of commodity exchange, it is necessary to obtain a license to carry out professional activities on organised commodity markets – the activity of organising trade in goods at commodity exchanges.
However, to start operating a commodity exchange, the Commodity Exchange Rules shall be registered with the NSSMC. Commodity Exchange Rules shall contain procedure for organising and conducting exchange trading, procedure for admitting goods to exchange trading and other provisions at commodity exchange’s discretion and/or required by law.
What goods can be traded on a commodity exchange?
Commodity exchanges trade in exchange commodities, which include goods and other items defined by generic characteristics and admitted to trading under the Commodity Exchange Rules. Goods shall mean agricultural products, timber, minerals, fuel and energy resources, raw materials, metals, precious stones, material products of fishing, fuel, chemical, light, food and other industries, as well as other consumable items defined by generic characteristics.
At the same time, according to the current wording, the Commodity Exchanges Law does not apply to relations on execution and performance of transactions on items defined by individual characteristics.
The issue of trade in wholesale energy products at commodity exchanges remains open. According to the Law of Ukraine “On Electricity Market”, electricity under bilateral contracts with state-owned producers or with producers with state share more than 50% (and with a number of other entities) is sold at electronic auctions. Although such auctions are held on the basis of the LLC “Ukrainian Energy Exchange”, the procedure is set by Resolution of Cabinet of Ministers of Ukraine No. 499 of 05.06.2019 and by the Auction Committee for the Sale of Electricity Under Bilateral Contracts at Auctions created by the Ministry of Energy, but not by the Commodity Exchange Rules. Significant amounts of electricity are also sold on the trading floor of the State Enterprise “Market Operator”, which ensures functioning of the day-ahead and intraday markets.
Moreover, the Law No. 738 does not apply to the activities of electricity market operator, transmission system operator, gas transmission system operator and to relations on functioning of electricity and natural gas markets and heating sector.
Commodity exchange includes goods admitted to exchange trading in the register of exchange-traded commodities and on the basis of this register goods are traded in accordance with the Commodity Exchange Rules.
How trading in commodity exchanges is carried out?
Exchange trading in exchange-traded commodities shall be based on an electronic trading system, which in the manner prescribed by the NSSMC ensures centralised conclusion and centralised execution of transactions (exchange agreements, exchange contracts) on the exchange-traded commodities.
Only members of such commodity exchange may buy and sell commodities at the commodity exchange (unless otherwise provided by law and/or the Commodity Exchange Rules). However, all members of a commodity exchange must engage brokers to carry out activities on the commodity exchange.
An exchange broker is an individual authorised by a member of commodity exchange to carry out his instructions for exchange transactions.
Trading on commodity exchange is carried out by submitting orders by brokers through electronic trading system. Accepted orders are used for conclusion of exchange agreements which are subsequently formalised into a concluded exchange contract.
In addition to ensuring operation of electronic trading system, commodity exchange controls exchange operations to prevent manipulation and other abuses.
Despite the fact that only on 1 July 2021 commodity exchanges began operating under the new legislative rules, on 30 June 2021 the Parliament adopted draft law No. 4367 “On Amendments to Certain Legislative Acts of Ukraine on Improvement of Corporate Governance in Banks and on Other Issues of Banking System”. Draft law No. 4367 amends the Law No. 738 and the Commodity Exchanges Law.
What amendments on commodity exchanges have been adopted by the Verkhovna Rada?
The text of the draft law No. 4367 for the second reading envisages exclusion of the provision stipulating that the Commodity Exchanges Law shall not apply to the relations connected with execution and performance of transactions with goods defined by their individual characteristics. In other words, upon entry into force of these amendments, commodity exchanges will be able to trade not only in respect of goods determined by their generic characteristics (timber, grain, etc.) but also in respect of items determined by their individual characteristics (e.g. real estate).
Draft law No. 4367 envisages another significant amendment, namely requirement that spot exchange contracts are concluded exclusively on a commodity exchange. Such contracts include agreements under which actual delivery of exchange commodity is scheduled to take place within a longer of such intervals:
- two business days;
- time interval stipulated by usual business practice, set forth in the Commodity Exchange Rules.
The list of activities of commodity exchanges under draft law No. 4367 has been supplemented with a new professional activity of organising conclusion of derivative contracts at commodity exchanges. In order to carry out such activities it is envisaged to obtain a license from the NSSMC for professional activities on organised commodity markets – activities to organise conclusion of derivative contracts at commodity exchanges.
Wherein draft law No. 4367 stipulates in the transitional provisions of the Commodity Exchanges Law that commodity exchanges are entitled to carry out activities on organisation of conclusion of derivative contracts at commodity exchanges for the period from 1 July 2021 till 31 December 2022, if they:
- have obtained a licence to organise trade in commodities at commodity exchanges,
- have registered Commodity Exchange Rules (in terms of organising trading in derivative contracts, which are not financial instruments) with the NSSMC.
The list of possible exchange-traded commodities and exchange-traded transactions will increase significantly after entry into force of the law adopted under the draft law No. 4367. But given that commodity exchanges have already started their work under the Commodity Exchanges Law, amending the Commodity Exchange Rules and ensuring functioning of electronic trading system in terms of derivative contracts will probably require additional time.
Thus, pursuant to the EU-Ukraine Association Agreement, Ukraine is introducing legislation on commodity exchanges in line with the EU regulations. At the same time, implementation of changes regarding activities of commodity exchanges is proceeding rather fast, which does not allow to finalise necessary regulatory documents for certain changes or to discuss all significant changes with all interested parties. But it is important that the process of reforming the operation of commodity exchanges has begun and the first commodity exchange has received licences to operate professionally on the organised commodity markets in Ukraine.
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