Top 5 Tips for Effective Surveillance of Energy Trading
This article first appeared in TabbFORUM, 6th February 2017.
Shining a light on market abuse
Firms trading in the physical energy markets have come under scrutiny from regulators with some new rules being introduced to uphold market integrity. Whilst some regulations, such as the Regulation on Wholesale Energy Market Integrity and Transparency (REMIT) have been around for a number of years, newer rules under the Market Abuse Regulation (MAR) affecting commodity derivatives have only come into effect as recently as July 2016. REMIT introduced rules on insider trading and market abuse in energy markets, as does MAR, albeit with an overlapping but different scope of trading activity. MAR, however, emphasises the need for firms to systematically monitor their activity as appropriate to the volume of trading and risk appetite. The questions these energy firms are facing now is how can they make the transition from legal regulatory text to technical reality, and how can they best choose a trade surveillance system that is suitable for future regulatory changes.
In the wholesale gas and power markets, REMIT requires Professional Persons Arranging Transactions (PPATs) to monitor for market abuse. In addition, asset owners are required to disclose inside information on inside information platforms or their websites. Under REMIT, inside information includes physical data, such as outage information relating to physical assets. REMIT also requires extensive data reporting so that regulators can monitor for abuse. Whilst REMIT explicitly prohibits market abuse under the threat of criminal sanctions, the range of companies considered as “PPAT” is narrow and mainly applies to those who run platforms or execute transactions on behalf of others.
MAR, on the other hand, makes it necessary for a far wider group of entities (Professional Persons Arranging and executing Transactions (PPAETs)) to provide implementation of “effective monitoring”, defined by a combination of procedures, technology, training, and Suspicious Transaction and Order Reporting (STOR), proportionate to the risk and size of the business. MAR covers those participants trading in commodity derivatives not already covered by REMIT, and in some cases also requires certain energy commodity trades to be monitored.
Those less covered by MAR and not falling under the REMIT PPAT category are not let off the hook. Because the Agency for the Cooperation of Energy Regulators (ACER) is in continuous receipt of relevant data, the regulator is in a better position than ever to discover and act upon any irregularities. Firms, therefore, are facing a reputational risk as highlighted by the UK regulator last year in a letter warning that, “Market participants should take due care to ensure that erroneous trading does not accidently result in outcomes that could constitute a breach of REMIT.” Several other investigations by energy regulators, and in some cases large fines, increase the case for monitoring.
Making the jump from legal text to technical reality
Given the recent regulatory attention, an increasing number of participants in the energy markets are actively investigating the deployment of an automated trade surveillance tool. The idiosyncrasies of energy markets mean that energy firms need to consider carefully when choosing a surveillance system, given that energy-related instruments behave differently compared to regular financial instruments such as equities or bonds, and also have different types of abuse associated with them, such as physical withholding. There are, however, some common considerations covered in the following top five tips for implementation of effective surveillance for energy markets:
- Start with a risk assessment: A risk assessment should be conducted, possibly by engaging with a specialised consultant. The risk assessment is a step-by-step approach applying the ‘80/20 rule’ which evaluates the 20% of effort that will generate 80% of impact, whilst keeping the end goal of full coverage in mind. Finding the key risks and key traded instruments will help focus on those first steps without getting lost in the details.
- Identify data gaps: The most difficult part of trade surveillance is identifying data gaps. Experience in setting up surveillance systems applicable to the energy sector is crucial in order to correctly deal with the nuances of energy trading. Ancoa’s unique position of using Trayport market data helps clients cover some of these gaps and allows deployment of a surveillance platform within a much shorter timeframe.
- Avoid silos: It is commonplace in some firms for data to be spread across a number of different systems (also known as silos) posing an element of risk. Ancoa’s platform has the ability to integrate with existing disparate systems, including voice and other electronic communications, which allows for the avoidance of costly mistakes and blind spots (as experienced in the past by firms trading other asset classes). An example of benefit when monitoring for insider trading is the ability to integrate an inside information feed with order and trade flow.
- Formulate a roadmap: A roadmap, to be implemented in deliverable tranches, gives your firm a direction in which to aim for, and helps focus primarily on top risks as well as prime business lines. At Ancoa, we have learned that traders can use a variety of different systems, and having access to Trayport data goes a long way in bridging data gaps created by these numerous systems. Ancoa also has the flexibility to add additional data sources for those firms trading on platforms outside of Trayport, or considering further types of alerts such as anti-money laundering or sanctions lists.
- It’s not just about technology: Firms need to consider governance and internal processes, putting an emphasis on the importance of culture, staff and training. Thematic reviews, training of traders (as well as compliance staff), calibration processes and audit trails all need to be thought through. The functionality of surveillance systems can help, for example, by using a single dashboard across venues for a firm-wide view that can aid staff to better react.
Learning from mistakes of the past
With the arrival of MAR and the impetus of European energy and financial regulators being much more watchful over European energy markets, most energy firms can no longer postpone the installation of an automated trade surveillance solution. It is here where lessons of the past by firms working with other asset classes can be applied. In order to escape large regulatory fines, an integrated approach needs to be taken to avoid the historical siloed approach. Vendor solutions are better, in this respect, than in-house solutions as they have been specially designed to incorporate existing systems, including voice and electronic messaging services. By applying our top five tips, firms can not only begin the process of implementing effective surveillance for energy markets to meet compliance obligations, but also simultaneously invest in an asset that, over time, can generate invaluable business intelligence.