Energy traders unlikely make real on threat of moving outside EU

Experts in the energy markets believe that while commodity dealers have suggested a relocation of trading activity as tougher financial regulation raises costs, in reality there is a low likelihood of many exiting the EU.

Revamped EU legislation on financial instruments and derivatives could capture several energy utilities and traders, which is likely to significantly raise the cost of transacting. Increased capital reserves, cost of licences, and a larger risk management workforce are just a few issues that the regulations bring with them. These concerns have led some firms to talk about potentially relocating, in order to circumvent the regulations.

“What I have heard from talking with industry at present [is] a number are working on a plan B – how do I get my business outside the EU,” said Paul Willis from the UK’s financial conduct authority at an event in Brussels in March.

While many financial institutions have already exited commodities trading, the few remaining are worried that about increased capital requirements and asset eligibility for supporting the pre-regulation level of trading activity.

Meanwhile, utilities and traders are concerned that if they are treated as swap dealers, it would increase the costs of trade reporting and mandatory risk mitigation measures.

Asset-backed traders often find it difficult to distinguish between hedging and speculative trades, which may now be required under the regulations. And the raised capital requirements to back the trades is likely to cut down on return on equity of trading businesses.

Liquidity limitations in the European market as a consequence of tighter regulations reducing trading activity, has sent some jitters through the market. Concerns over a potential increase in volatility in the wholesale energy markets, thereby defeating the purpose of the new regulations, is currently being debated between market participants and regulators.

Likelihood of moving base

But while some companies are making noises, not everyone is convinced that moving headquarters could work.

Financial participants like funds and banks often battle regulators by stating that a regulatory clampdown on trading activity gives an incentive to move overseas billions of pounds of trading activity.

However, industry sources broadly agree that the extra-territorial reach of the regulations that impact firms with a global footprint, is likely to prevent relocation of headquarters and/or trading operation hubs.

The inability of many of these international businesses to relocate execution operations, lies in the very fact that the location of the physical assets are in countries covered by legislation such as the European market infrastructure regulation (EMIR) and markets in financial instruments directive (MIFID). So the benefits of moving headquarters may only be realised in the case of both counterparties falling within non-regulated jurisdictions.

Few large firms appear to have the flexibility to make the drastic change of moving headquarters. Trafigura managed to do so, but did not start a domino effect.

“There are a lot of parameters to define where to place a business [for regulation],” said Christophe Salmon, CFO of Trafigura in the EMEA region. “Having said that, it is true, we are a commodity firm with a global business that could be run from EU, US, Asia,” he added.

He mentioned the benefit of the EU timezone for trading activity as well as the importance of a stable regulatory jurisdiction.

MiFID II imposes limits on positions held by what is classed as financial entities and spans both exchange-traded and over-the-counter products. And positions across ‘cross-listed’ contracts traded in jurisdictions with differing market regulations, will be subject to the MiFID position limits. This further reduces the incentive to relocate trading operations.

The hurdles associated with moving to a more favourable regulatory jurisdiction can be significant. As a senior market source suggested: “To get around regulations isn’t easy, because you run into several intangible costs when considering moving out of the Europe.”

With the second round of regulations, the key concerns that energy traders have are anchored in reforms in the definition of products, increased capital requirements, transparency requirements and transaction reporting. The general consensus appears that any major shift in either headquarters or trade execution location, will be driven more by the prevailing tax regime compared to regulation. “[The regulators] have cast the net pretty wide,” one source said – perhaps too wide to allow firms to find a way out without incurring substantial costs. Surya Kanegaonkar