UK Law and Practice Contributed by: Carolyn Jackson, Nathaniel Lalone, Christopher Collins and Ciara McBrien, Katten Muchin Rosenman UK LLP (Katten)
derivative. However, derivatives on emission allow - ances are included in the definition of a derivative in paragraph 4 of the RAO. The UK is generally agnostic regarding the asset class - es that can underlie a derivative contract. Paragraph 10 of Schedule 2 of the RAO includes a broad catch- all for evolving asset classes to include “any other derivative contracts relating to assets, rights, obliga - tions, indices and measures not otherwise mentioned in this Section, which have the characteristics of other derivative financial instruments”. The FCA does, how - ever, ban or restrict the sale of certain derivatives to retail consumers, including contracts for differences (CFDs) on equity securities and indices, commodities, FX and cryptocurrencies, spread bets and rolling spot FX transactions that qualify as financial instruments. Derivative products related to crypto-assets and car - bon credits (ie, UK allowances and voluntary carbon credits) are steadily increasing in size and liquidity. 2.6 Exemptions, Non-Derivative Products and Spot Transactions As discussed in 2.3 Forwards , OTC commodity deriv - atives that must be physically settled and cannot be cash-settled, are not traded on a trading venue or equivalent third-country trading venues, or are equiv - alent to such transactions traded on such markets generally fall outside the definition of a financial instru - ment and therefore are out of scope of UK regulation, especially if one of the parties to the transaction is a supplier or producer of the commodity. The UK does have a broad exemption for certain FX transactions that are either considered spot transac - tions or forward FX transactions connected to a pay - ment transaction. Although an FX transaction involv - ing two major currencies must be settled within two trading days to be considered a spot transaction, an FX transaction that is used for the main purpose of the sale or purchase of a transferable security or a unit in a collective investment scheme will also be considered a spot transaction if it settles within the shorter of: • the period generally accepted in the market for the settlement of that security or unit as the standard delivery period; and
• five trading days. Additionally, an FX transaction involving the exchange of a non-major currency for either another non-major currency or a major currency will be considered a spot transaction if it settles within the longer of: • two trading days; and • the period generally accepted in the market as the standard delivery period for that currency pair. A physically settled FX forward contract will not be considered a financial instrument if: • it is used as a means of payment; • it must be physically settled (other than for reasons of a default or other termination event); • one of the parties is not a financial counterparty (FC); • it is not traded on a trading venue; and • it is entered into to facilitate payment for identifi - able goods or services, or for direct investment. Physical spot commodities transactions do not fall within the definition of a financial instrument and therefore are not subject to UK regulation. A lever - aged spot commodity transaction, however, would fall under the CFD definition and is therefore banned by the FCA from being sold to UK retail market partici - pants. The Prudential Regulation Authority (PRA), which is part of the Bank of England, and the FCA are the UK regulators with primary responsibility for the supervi - sion and oversight of derivatives market participants in the UK. The PRA’s primary role is the authorisation and prudential regulation of banks, building societies and credit unions. In contrast, the FCA’s primary role is to establish the business conduct standards that apply to derivatives market participants as well as the trading venues that list derivatives products for trad - ing. The FCA is also responsible for the prudential supervision of firms that are not PRA-regulated. 3. Regulation of Derivatives 3.1 National 3.1.1 National Regulators
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