By Terry Flanagan

Regulations Hit Energy, Commodity Markets

Increased regulation and fines are changing the dynamics of energy and commodity trading.

In a veritable alphabet soup, the European Markets Infrastructure Regulation (Emir), the Regulation for the wholesale Energy Markets Integrity and Transparency (Remit) and the second Markets in Financial instruments Directive (MiFID II) have introduced the concept of ‘big compliance’ to energy markets, in a way previously experienced mainly by the banks.

Regulation has become tighter and more robustly enforced in recent years, with regulations such as MiFID and MAD increasing monetary fines by tenfold in some instances.

A further wave of regulation is coming with MiFID II approved by the EU Parliament in April 2014 and the EU Council on May 13. Member states will have two years to implement MiFID II.

“Since the original MiFID back in 2007, there’s been significant regulation in the financial markets, including exchange-traded derivatives,” Leen Broekhuizen, a partner at SunGard Consulting Services with responsibility for energy and commodities in Europe, told Markets Media. “The commodities side of trading, both on a proprietary trading and a client flow trading basis, has been part of banks’ business and has been an attractive part of their business, because it has had exemptions from the scope of MiFID.”

Higher fines and increased capital constraint have caused number of major banks to exit the energy and commodities markets, with Brazilian and Chinese companies and specialist traders filling the gap, according to Broekhuizen.

JP Morgan Chase, for example, has sold its physical commodities business to Mercuria Energy Group in an all-cash transaction that’s expected to close in the third quarter.

“A lot of emphasis has been placed on the banks exiting the commodities business, but in reality, it’s a very small portion of their overall business,” said Colin Cooper, partner at SunGard Consulting Services. “Of course, it’s significant that the banks are leaving, but perhaps one of the reasons that they are leaving is that it’s not a huge part of their business.”

Banks are exiting certain commodities markets because they believe they are going to be too expensive, too low volume, too capital intensive, and with too much regulatory scrutiny and fines.

Total FSA fines across the banking industry in 2002, were around £9 million. By 2013, they were around £475 million. Transaction reporting fines totaled £150,000 in 2006 whereas RBS alone was fined £5.6 million in 2013. This increase has been nicknamed the ‘MiFID Bounce.’

“Many of our clients has put in place a program of compliance, at a minimum, and have thought strategically about which market they want to be in, and are adjusting their business model to accommodate, optimize, withstand, and mitigate the effects of these regulations,” said Broekhuizen.

Some of the larger oil and gas companies are looking at setting up what in Europe it would a MiFID- regulated entity, and which in the U.S. would be SEFs, to house their more highly regulated business and that insulate the rest of the group regulatory impacts. “The ability to do that in Europe is less than it is in the States,” Broekhuizen said.

The implementation of regulation has created many inconsistencies with regards to trade reporting. The presence of multiple regulators and trade repositories mean companies often report the same deal, separately, in different ways to separate repositories.

“There is a very low match ratio between repositories, which creates fragmented information and misleading reporting,” said Broekhuizen. “The information provided is rarely identical except when a single company reports on behalf of both parties to a deal, so there is a pressing need for a clearer, more coherent and co-operative reporting system to ensure greater accuracy.”

Featured image via Dollar Stock Photo

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