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The definition of ‘local firm’ in the CRR

Question:

When does a proprietary trader qualify as a ‘local firm’ as meant in Article 4(1)(4) of the CRR?

Published: 28 February 2024

Answer:

Note: updated text

So-called ‘local firms’ are exempt from the CRR definition of ‘investment firm’, which follows from Article 4(1)(2)(b) of the CRR. Pursuant to Article 4(1)(4) CRR, for the purposes of this Regulation, ‘local firm’ means a firm dealing for its own account on markets in financial futures or options or other derivatives and on cash markets for the sole purpose of hedging positions on derivatives markets, or dealing for the accounts of other members of those markets and being guaranteed by clearing members of the same markets, where responsibility for ensuring the performance of contracts entered into by such a firm is assumed by clearing members of the same markets.

A proprietary trading firm qualifies as a ’local firm’ only if it is able to prove that it complies with the strict definition of Article 4(1)(4) of the CRR. This means that the proprietary trader in question must be able to prove that it meets the following conditions:

  1. It is exclusively dealing for its own account or for the account of other members of the same derivatives or cash markets;
  2. It is active on markets in financial futures or options or other derivatives;
  3. It is active on cash markets (or spot markets) for the sole purpose of hedging positions on derivatives markets; and
  4. The trading positions are guaranteed by clearing members of the same markets, where responsibility for ensuring the performance of contracts entered into by such a firm is assumed by those clearing members.

With regard to point (3) above it is noted that a ‘local firm’ can be active on both derivatives markets and on cash markets, only if the investment activity on the cash markets is limited to transactions performed for the sole purpose of hedging preceding and directly related positions on the derivatives markets. Thus, an investment firm that performs transactions on the cash markets that are not performed for the sole purpose of hedging preceding and directly related positions on the derivatives markets, falls outside the scope of the ‘local firm’ definition in the CRR.

If a proprietary trader is of the opinion that it falls within the scope of the definition of ‘local firm’, it must provide DNB with sufficient proof to this effect. The relevant proprietary trader must submit at least the following documentation:

a) A certified statement signed by the firm's management board and, if applicable, the management board of its parent company confirming that the proprietary trader complies with and is able to continue complying with the definition of ‘local firm’ in Article 4(1)(4) of the CRR;
b) A certified legal opinion endorsed by the firm's management board and, if applicable, the management board of its parent company issued by an independent, external third party or an internal legal department confirming that the proprietary trader complies with and is able to continue complying with the definition of ‘local firm’ in Article 4(1)(4) of the CRR; and
c) Sufficient proof of the embedment of the requirements that the proprietary trader must comply with in order to qualify as ‘local firm’ in internal policy documents (e.g. the trading strategy, hedging and off-setting strategies, and the investment policy).

Based on the above documentation, DNB will assess whether the proprietary trader indeed qualifies as a ‘local firm’ as referred to in Article 4(1)(4) of the CRR. In as far as the proprietary trader's business model covers transactions on the cash markets (or spot markets), DNB will assess whether the firm has sufficiently demonstrated that it is continuously complying with the requirement that its cash market transactions are performed for the sole purpose of hedging preceding and directly related positions on the derivatives markets. As part of this exercise, DNB may ask for additional documentation or proof in order to make a well-considered assessment.

If a proprietary trader qualifies as ‘local firm’ within the meaning of Article 4(1)(4) of the CRR, but subsequently changes its trading strategy (or expects to change its trading strategy) to the effect that it no longer complies with the said definition of ‘local firm’, it must report this to DNB immediately.