Energy and commodities traders are being buffeted by regulatory and technological forces, and as a result are ramping up their trading compliance functions.

“There are both practical business transformation issues, as well as regulatory drivers, affecting a sea change in energy trading compliance,” Glenn Kinser, head of energy trading compliance, SME, at NICE Actimize, a risk and compliance software provider, told Markets Media.

“In terms of pure regulatory impact, it is more evolutionary than revolutionary,” said Kinser.

U.S. regulatory drivers affecting changes to energy trade compliance strategies started with the 2000–01 Western Energy Crisis. This event lead to the Federal Energy Regulatory Commission (Ferc) publishing Order 670–Prohibition of Energy Market Manipulation (January 19, 2006) which ultimately stepped up enforcement actions by Ferc and the Commodity Futures Trading Commission (CFTC).

Over the past 10 years, Ferc and the CFTC have obtained approximately $1 billion in civil monetary penalties relating to wrongdoing in the energy markets.

“As the energy industry moves through a transformation that parallels the financial industry, it’d imperative that the approach to trade compliance changes to meet the complex demands of a range of legislation hitting the energy and commodities market,” said Kinser.

Nice Actimize has launched a trading compliance risk management system to help firms monitor and address global trading activities to meet compliance oversight obligations.

The system provides automated and auditable trade surveillance, allowing organizations to effectively address compliance issues and reduce regulatory inquiries, enforcement action and litigation.

“From a technology standpoint, energy trade surveillance is conducted predominantly via in-house systems, but the cost of maintaining and providing coverage for new regulations are high and a significant burden to energy trading firms,” Kinser said.

A comprehensive trading compliance system needs to be able to address the differences between the various physical energy commodities, as well as the hundreds of thousands of tradable instruments that energy trading firms deal with every day.

“Energy markets involve physical commodities such as crude oil, refined products, natural gas and power, that you don’t see in other asset classes like credit, interest rates, foreign exchange and equities,” said Kinser. “These physical commodities involve trading at many different locations around the globe, logistics to move them from point A to point B, and delivery terms and pricing structures that are associated with spot and forward transaction periods.”

The Dodd Frank Act, Section 753, which addresses manipulation and fraud in commodity markets, expands the reach of the Commission to prohibit manipulative and fraudulent behavior by eliminating the requirement to show an artificial price and lowering the “scienter” [fraudulent intent] standard to recklessness for fraud-based manipulations.

Energy trading will also be impacted by Dodd Frank’s Disruptive Trading Practices rules via a proposed interpretive order that covers violations of bids or offers; intentional or reckless disregard for orderly execution of transactions during the closing period; and spoofing, i.e., bidding or offering with the intent to cancel the bid or offer before execution.

The European market also has its own set of drivers that are impacting commodities and energy trading. These include the Regulation of the Wholesale Energy Market Integrity and Transparency, the Market Abuse Regulation and the Directive on Criminal Sanctions for Insider Dealing and Market Manipulation–which were all published in October 2011.

“Position limits will be applied to determine risk transparency with an extra-territorial direction per CFTC versus the scope for manipulation set out in the Market Abuse Directive extended to derivatives, and regulators given the possibility to set position limits under MiFID II (EU/EEA),” Anthony Kirby, chair of ISITC Europe Regulatory Group, told Markets Media.