Ancillary activities exemption: FCA Consultation Paper 25/19

Introduction

The Financial Conduct Authority (“FCA”) published a consultation paper (“CP 25/19”) on 3 July 2025 on proposed changes to the ancillary activities exemption (“AAE”). The AAE enables commercial users and producers of commodities to trade commodity derivatives, emission allowances and emission allowance derivatives without the need to be authorised as an investment firm, where certain conditions, and the ancillary activities test (the “AAT”), are met. In broad terms, the FCA proposals aim to simplify the AAT and provide greater legal clarity in relation to its application, while maintaining the existing scope of the exemption. In parallel, HM Treasury (“HMT”) published Policy Note and draft Statutory Instrument (the “AAE SI”) that purports to make the legislative changes needed to permit the FCA to make AAE-related rules. The revised rules are intended to apply from 1 January 2027.

Background

The AAE derives from MiFID II. It has been a component of the UK’s commodity derivatives regime since MiFID II entered into force in 2018. The AAT is widely acknowledged as being operationally challenging and costly to rely on in practice, particularly for smaller entities that may have fewer compliance resources to draw on, and more budgetary constraints.

In May 2023, following the UK’s exit from the EU, HMT made certain legislative changes (through The Financial Services and Markets Act 2000 (Commodity Derivatives and Emission Allowances) Order 2023 (the “FSMA CDEA Order 2023”)) that replaced AAE calculations with qualitative criteria. Relatedly, the FCA consulted (in Consultation Paper 23/27 (“CP23/27”)) on guidance to assist firms in applying these criteria. However, industry raised significant concerns about a lack of certainty arising from relying on guidance rather than rules to determine whether the AAE could validly be relied on. Concern was also raised about the timeline for changes to take effect. As a result, HMT announced in May 2024 that it would delay the changes under FSMA CDEA Order 2023 from taking effect until 1 January 2027. In February 2025, the FCA also announced that it would not move forward with the guidance proposed in CP23/27, and it committed to working with HMT to address the concerns raised by industry.

This has resulted in the publication by HMT on 3 July 2025 of the Policy Note and draft AAE SI that proposes to amend the legislation enabling the FCA to define and adopt rules that determine the conditions under which firms can rely on the AAE. The FCA’s proposals set out in CP25/19 constitute these proposed rules.

Existing AAE

A firm will only be exempt from the need for authorisation where it meets the AAT conditions and the AAT. A firm must therefore meet the following conditions before it applies the AAT:

(a)the firm does not execute orders on behalf of clients by dealing on own account unless the client is a client or supplier of the group’s main business;

(b)the firm does not use a high-frequency algorithmic trading technique; and

(c)the main business of the firm’s group is not: (i) the provision of investment services; (ii) services requiring authorisation as a bank; or (iii) acting as a market maker in commodity derivatives.

Where these conditions are met, the firm can apply the AAT. The AAT currently comprises the following:

• the market share test; and
• the main business test, which can be undertaken by using either the capital employed methodology or the trading activity methodology.

Both the market share test and the main business test must be met in order for the firm’s activities to be considered to be “ancillary”. Intra-group transactions, hedging transactions and transactions that are entered into as part of an agreement to provide liquidity on a trading venue are excluded from the calculations that must be performed under each test.

The AAT must be performed annually in the first quarter of each year. The calculation must be based on data from the previous three years. Following changes made by the FSMA CDEA Order 2023, firms relying on the AAE are no longer required to submit an annual notification to the FCA in relation to their use of the AAE.

FCA proposals

The FCA's main objective behind CP25/19 is to simplify the AAE regime, and reduce operational burden and costs, while providing greater legal certainty for firms seeking to rely on the AAE. CP25/19 also makes it clear that the FCA does not intend to change the type of firms within the perimeter of the existing AAE. CP25/19 also confirms that the FCA's proposals are not intended to remove the “MiFID override”, which in practice means that, in order to be exempted from the UK regulatory perimeter, a firm must be able to rely on an exclusion in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (the “RAO”), as well as a MiFID II exemption, in relation to the relevant activity. Rather, the FCA explains that it has not been possible to consider the long-term implications of a removal of the MiFID override at this stage without hindering the delivery of a simplified AAT by 1 January 2027.

The FCA's proposals see the FCA seeking to establish three separate and independent tests to assess whether a firm is able to use the AAE. An entity would be able to rely on the AAE where it meets the conditions set out in any one of these three tests on an annual basis, as follows:

(a) A new annual threshold test (or “de minimis” test). This test will exempt firms that undertake trading in commodity derivatives on a relatively small scale. The test will replace the current market share test, which is based on annual averages of overall market activity in relevant commodity derivatives. The test would instead be based on a specified monetary threshold. CP25/19 seeks views on whether the FCA should adopt a GBP 3 billion or GBP 5 billion threshold, depending on whether the FCA ultimately considers it appropriate to include cash-settled positions in UK exchange-traded derivatives within the threshold, or not. The proposed changes would broadly align the UK's approach to this test with the existing EU position, as well as with the existing US swap dealer test.

The FCA notes that its analysis has concluded that almost all firms currently using the AAE could continue to do so under a GBP 3 billion threshold. It also highlights that firms can, and do, use the AAE in conjunction with other exclusions (e.g. for hedging activity). The FCA has specifically asked for views on whether its rules should adopt an automatic mechanism for the annual threshold to be adjusted (e.g. in line with inflation) or whether changes should also be consulted on.

(b) A modified form of the existing trading test, and a modified form of the existing capital employed test, both of which currently form part of the main business test (see above). The proposed modifications relate mainly to changing the applicable thresholds to 50%, whereby, in order to satisfy the test:

(i) the size of the trading activities must account for 50% of less of the other trading activities of the group; or

(ii) the estimated capital employed for carrying out those trading activities must account for not more than 50% of the capital employed at group level for carrying out the main business.

It is proposed that the trading test and capital employed test would be determined against a simple average of trading activities and estimated capital employed, as applicable, across the preceding three years.

For all of the tests in (a) and (b) above, intra-group transactions, hedging transactions and transactions entered into as part of an agreement to provide liquidity onto a trading venue would continue to be excluded from the relevant calculations. In line with the current AAE, there is no proposal to re-introduce an annual notification obligation regarding a firm's reliance on the AAE.

To give effect to these proposals, and to help provide the FCA with the flexibility to update the AAE criteria to respond to market changes in the future, the AAE SI purports to amend Schedule 3 of the RAO to give the FCA a power to set:

(a) rules in relation to the AAE (as outlined above); and

(b) a new annual threshold for activity below which a person can also use the AAE.

These powers are intended to reflect the FCA's expertise as the regulator of the UK's commodity derivatives regime, positioning it better to be able to specify the relevant criteria and threshold.

Who are the proposals relevant to?

The FCA's proposals (and related HMT draft SI) are particularly relevant to:

(a) non-financial entities who already rely, or are considering relying, on the AAE; and

(b) smaller financial entities who rely, or are considering relying, on the AAE in connection with limited commodity derivatives trading activity.

These entities in particular are encouraged to review CP25/19 in detail and to consider submitting a detailed response to the FCA on its proposals. Respondents may find this especially relevant in relation to the FCA's detailed questions on its proposals regarding the new annual threshold test (see above). 

Key milestones

CP25/19 will remain open for feedback until 28 August 2025. The FCA subsequently aims to publish a Policy Statement with its finalised changes during Q4 2025 / Q1 2026. Respondents should be aware that the FCA has highlighted that it would find evidence-based, detailed responses of most help, and has invited respondents to provide supporting data on relevant questions (e.g. in relation to the application of the new annual threshold test).

The draft AAE SI is also open for technical comments (to HMT) until 28 August 2025. It is intended that the new ancillary activities regime will come into force on 1 January 2027, which means that the AAE SI will need to take effect (in final form) before this date. HMT has stated that it intends to commence the AAE SI before the FCA publishes its final rules (see above).

Additionally, Commission Delegated Regulation (EU) 2017/592 (retained law) (RTS 20), which sets out the legal basis for the AAE today, and Article 72J of the RAO, which provides a transitional regime for firms who cannot perform the market share test because of a lack of publicly available data on the overall size of the market, will need to be revoked. These revocations will be made in due course via a separate commencement instrument. It is expected that a 12 month transition period will be applied in relation to the revocation of Article 72J, where the revocation would take effect on 1 January 2028.

Questions

Should you have any questions on the proposals may impact your existing AAE compliance arrangements, or if you would like support with preparing a response to CP25/19 or on the draft AAE SI, please contact one of the Hogan Lovells contacts listed on this article.

Authored by Keti Tano.