It would take Hiroo Onoda-esque powers of denial to not be aware of the tumult in the World’s Energy markets. A perfect storm of supply side economics combined with war in Europe and decarbonisation programs has led to record wholesale gas and electricity prices, which in turn have led to direct government interventions to enable populations to better survive the coming winter. We have seen casualties already from the plethora of failed retail providers in the UK to renationalisation of the giants of the European Energy landscape in EDF and Uniper, and who can say who else may require the same treatment.
It is with this backdrop that eyes the world have turned to this industry, that we are now perhaps starting to see a refocus or broadening of reach from certain regulators, as the question of systemic risk moves from purely capital markets to the once sleepy backwater of Commodities (including Energy) and recent correspondence between European Commission DG FISMA and ESMA in the past two weeks highlights this and suggests how things may change going forward.
On the 13th of September European Commission DG FISMA sent a letter to ESMA asking for a response to the following topics:
- Whether better use should be made of circuit breakers in Regulated Markets covering energy derivatives, in response to high volatility.
- How to address issues with high levels of collateral being required by commodities firms to meet margin calls, possibly by accepting a wider range of collateral.
- Whether the EMIR clearing threshold should still be adjusted in the light of market conditions.
On the 22nd ESMA sent a response, that including the following
- A proposal for a new type of “trading halt” to address the volatility issue.
- Some concerns on accepting too wide a range of collateral.
- A request to quickly implement the EMIR clearing threshold changes.
- A request for extra reporting on commodity derivatives positions, including those that benefit from the “REMIT Carve Out”.
- A suggestion to change the Ancillary Activity Exemption that more firms are required to obtain financial authorisation.
Two paragraphs from the ESMA letter that stand out are
- “In addition, we would like to point out that under MiFID II, wholesale energy products (gas and electricity) that must be physically settled and traded on an Organised Trading Facility do not qualify as financial instruments. As such, they are not covered by transparency and reporting requirements, neither under MiFID II nor EMIR. No information is available to NCAs or ESMA on the amount of trading taking place and on positions held in those derivative products, nor on the firms trading those instruments. Instead, the REMIT framework applies. To provide financial regulators with better visibility on these products, we consider that further consideration should be given to submitting them to minimum reporting requirements to NCAs and ESMA, including transaction reporting and daily position reporting.”
- “Non-financial entities can trade and provide investment services in commodity derivatives without being authorised as investment firms. This is possibly due to the so-called “ancillary activity exemption” set out in MiFID II and based on the principle that as far as the trading activity of a non-financial entity remains ancillary to the main commercial business of the entity, the entity should not be subject to the same requirements as an investment firm. To the best of our knowledge, all European commodity firms have been able to benefit from this exemption. Considering the size and nature of the business of some of these entities, it would be useful to revise or replace the current test to ensure that the biggest entities are duly licenced and supervised as investment firms for their trading and investment service provision activities. This would ensure that such significant entities active in commodity derivatives markets conducting essentially the same business as investment firms would be subject to the stringent requirements established in financial regulation, noting however that some specific requirements, e.g., around retail investor protection may not be warranted for commodity firms.”
It would appear that ESMA is stating that they and the NCAs do not have enough of a view of the market, and therefore the level of systemic risk, because a huge tranche of activity is not reported to them but goes to ACER instead, and that they want this to be changed. They are also suggesting that the biggest entities should be required to be licensed and treated as investment firms to make them fall under closer scrutiny and control.
This is very interesting as we all prepare for the impact of EMIR REFIT, the implication for the whole market is that at a reporting level a huge increase on the number of transactions that would now need to be captured and reported to ESMA via a Trade Repository and defined by the new data schema and output format.
It would also mean that large entities would no longer be able to delegate away their reporting obligation and would have to adhere to more transparent updates, in addition to all of the other requirements that come with being an investment firm.
It looks at first sight like ESMA taking up its initial position around Energy firms in particular before the REMIT carve out reduced its control in this space over 10 years ago. We will have to wait to see if this conversation progresses, but it is does look like ESMA feels it needs more data from this space to fulfil its duties appropriately and with that will come a fundamental shift for Market Participants in the scale of remaining compliant.
As the Japanese proverb says, ‘If you make a mistake, don’t hesitate to correct It’ and unlike poor Hiroo Onoda who was still fighting a war that had already been over for 30 years, it seems like ESMA has identified what it thinks it needs to correct; is it now a matter of timing?