The launch of new regulation that has swept energy companies into strict new financial laws has passed, but there is still an unresolved uncertainty over how to comply with a test to determine whether a company falls in or out of requirements.
The confusion may mean energy firms that are part of a larger group have to comply with the second Markets in Financial Instruments Directive (MiFID II) temporarily, until the European Commission clarifies whether exemption calculations can be made at entity level.
MiFID II came into force on 3 January, bringing energy markets within the scope of rules which will require them to operate more like banks or investment firms.
Companies can get an exemption from the directive if they can prove their trading activity supports the core business, rather than being the core business. This is known as the ancillary services exemption.
Energy traders need to do two calculations to test whether they can get an exemption from MiFID. The first is a market size test – a firm’s position in an asset class such as gas or power derivatives must be under a certain threshold when compared with total market size.
For the second test companies can either look at how the capital they employ for trading compares with their total capital employed, or calculate how their speculative activity compares with total trading.
One outstanding issue is that it is not clear whether a firm is required to base these calculations for this exemption on the activity of a single entity, or whether every company within a group would have to be included.
“It could be the case that some companies base their exemption calculations on entity level and are exempt, but if the commission says it should be based on group level, they may realise they are captured in MiFID II,” said a regulatory advisor from a European energy trading company.
While this is still an outstanding uncertainty, most compliance teams within energy companies will have opted to choose the stricter option, according to another European energy trading regulatory officer. This means some firms may fall under MiFID initially, but then drop out if the European Commission confirms that the calculations should only apply at group level.
“I’d expect all companies to do stress tests for the different options. Our group in the interim period will be calculated as more than one entity. If the commission decides that the calculation should be done at firm-level, we will drop down to that,” the regulatory officer said.
Legal entity codes
Another technical detail that may be causing headaches for some firms is the fact that a company needs to have its own unique legal entity identifier (LEI) in order to apply for the ancillary services exemption.
Trading firms were given a last minute six-month reprieve on the need to have an LEI in December, after fears some companies who had not applied for the code in time would not be able to continue to trade. But while the requirement for a code is now delayed, companies found that an LEI was still necessary to complete applications for the ancillary services exemption.
“We managed to get our LEI code in time. But if we had not got it, we could not get an ancillary exemption - the interface would not allow us to proceed without the code,” the first advisor said.
“I don’t know how you would deal with that if you did not get the code in time. It just adds up to the whole picture of such a complex regulatory marathon.”
MiFID II also includes rules which limit the size of a position that market participants can hold.
National authorities published these baseline limits in the months before 3 January, although some countries such as Spain did not release these figures until the final days before the start of the rules.
Most limits published seem to be high enough that they will not have impacted existing trading positions. However, the European Securities and Markets Authority will still need to publish opinions approving these numbers, which mean they are still subject to change.
“We need to keep in mind these position limits may change. Everyone was looking to 3 January as the big kick off, but for me the big day will be once the noise on these limits starts phasing out,” the second European regulatory officer said.
He said not knowing what the position limits would be put pressure on companies to implement projects to monitor position limits on a daily basis, as a solution. But for some, this may have been unnecessary.
“If the limit is 100 and my limits will only ever fall into a possibility of one or 10, what is the sensible reason to put in place a mechanism to control our positions?” he said.
The European Federation of Energy Traders (EFET) also said compliance planning was made difficult by the late publication of position limits, lack of coordination and the last minute set-up of financial counterparties, exchanges and brokers.
“We would welcome some simplification and harmonisation of processes going forward, particularly with regard to position/transaction reporting. This can be a job for the wider commodity industry to take forward,” an EFET spokeswoman said.
Click here to read an ICIS briefing on MiFID II. firstname.lastname@example.org