A European regulatory agency has asked for a tighter definition of what must be physically settled when defining power and gas forwards that would be exempt from EU financial regulation.
The recommendation comes as the European Commission is working on the delegated acts that will define what is a physically-delivered forward under the Markets in Financial Instruments Directive (MiFID II).
The commission circulated a non-paper, seen by ICIS, in January to members of an EU group that discuss securities, which includes various ministries from across the EU. The non-paper asked what quantitative or qualitative specifications could be added to physical forward definition.
Sources have said the outcome of that discussion will be key to what is in the delegated acts. The commission is also talking with representatives from the EU parliament.
The debate stems from a political compromise in January 2014 that said physical power and gas forwards would not count as a derivative under the updated financial directive (see EDEM and ESGM 15 January 2014).
The exemption, which was known as the REMIT carve out, was granted because physical power and gas forwards already fell under the Regulation for Wholesale Energy Market Integrity and Transparency (REMIT).
The exclusion meant physical power and gas trades would not count towards the thresholds used to calculate if a company would be captured by MiFID and other regulations, leading to energy firms being regulated in the same way as banks if caught. This would greatly increase operational costs and the amount of cash they would need to have in reserve.
But it has been tricky to draw a line around what is a trade that must be physically delivered.
“The question of what is physically settled has wasted more man hours [than anything else],” said Paul Willis, commodity specialist at the UK’s Financial Conduct Authority, at a conference in Brussels on Tuesday. Willis is helping draft advice and standards for the directive.
The initial assumption by some market participants was forwards traded over-the-counter through broker platforms that exercise caution would be exempted as part of the REMIT carve out. But technical advice sent to the European Commission before Christmas has led many to worry that far more trades would be considered a derivative than thought.
The advice suggests contracts can only be physically delivered when the parties, who are agreeing to the deal, are capable of delivery or receipt of the agreed power, gas, coal or oil. Some think this wording is open to misinterpretation.
Energy regulators and companies think the advice – if followed through with – could reduce liquidity and the number of active participants in wholesale power and gas markets because of the extra costs it could add (see EDEM and ESGM 10 February 2015). This in turn could hamper EU energy policy, such as the third energy package that is looking to create more harmonised energy markets.
The Agency for Cooperation of Energy Regulators (ACER) has recommended the commission put in place a more proportionate provision of what it means to be able to take or receive power or gas or to be able to transfer rights without taking delivery of them.
Well-functioning markets would be impossible to achieve without the presence of companies that move energy without ever producing or consuming it, ACER said.
ACER also recommended that contracts that cannot be settled in cash be considered as contracts that must be physical settled, and contracts that must be physically settled would essentially be excluded from the directive.
The commission’s delegated acts are expected to be adopted in the summer. The EU Council and parliament would then assess the acts during an objections period. The acts should be adopted in early 2016, with MiFID II coming into force in 2017. Fionn O’Raghallaigh