Increased financial regulation in the European Union for energy firms extensively active in energy derivatives markets?

Abstract

AbstractBecause of the excessive prices and volatility in the energy derivatives markets over the period 2021–2023, margins increased considerably, leading major European energy companies to experience liquidity stress in meeting those. As a consequence, several local governments needed to provide guarantees to avoid their default. This article includes several legislative proposals to ensure that energy firms are prudentially safer and that there exists a level playing field among financial actors active in the same market segment. Specifically, this article proposes to (1) decrease the clearing threshold for commodity derivatives under the European Market Infrastructure Regulation (EMIR), (2) narrow the definition of hedging relevant to the calculation of the clearing threshold, (3) remove the intragroup exemption possibility under EMIR, and (4) make sure that energy firms can be categorised more easily as investment firms.Keywords: commodity derivativesenergy futuresenergy firmscentral counterpartiesfinancial regulation AcknowledgementsThe information contained in this article is the personal view of the author solely and not of the FSMA. This article also does not bind the FSMA in any way. The author is responsible for any errors or omissions. This research did not receive any specific grant from funding agencies in the public, commercial, or not-for-profit sectors. The author likes to thank Giuseppe Bellia, Guillaume Bérard, An De Pauw, Gaston Fornes, Sébastien Martino, Alvaro Mendez, Jean-Paul Servais, Damien Sohet, Antoine Van Cauwenberge, Jean-Michel Van Cottem, Joachim Van Wymeersch and Sofie Verweire for useful input.Disclosure statementNo potential conflict of interest was reported by the author.Notes1 Financial Times, War in Ukraine: What Explains the Calm in Global Stock Markets, 2022 accessed 26 September 20232 See Randy Priem, A Relaxation of Commodity Derivatives Clearing Legislation as a Consequence of the 2021–2023 Energy Crisis (2003) SSRN Working Paper accessed 10 May 20233 See ESMA, Trends, Risks and Vulnerabilities, 2022 accessed 10 May 20234 See Erik R Larsen, Ann van Ackere and Sebastien Osorio, ‘Can Electricity Companies too Big to Fail?’ (2018) 9 Energy Policy 965 For instance, Germany set aside 7 billion euros in loans to be made available to companies facing liquidity issues6 See Bloomberg, Lagarde Says ECB Can’t Offer Liquidity to Energy Firms, 2022. accessed 10 May 20237 See European Commission, State Aid: Commission adopts Temporary Crisis and Transition Framework to Further Support Transition Towards Net-zero Economy, 2023. accessed 10 May 20238 REGULATION (EU) No 648/2012 OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 4 July 2012 on OTC derivatives, central counterparties and trade repositories accessed 10 May 20239 European Central Bank, Financial Stability Risks from Energy Derivatives Markets, 2022. accessed 10 May 202310 ESMA, Preliminary Data Report On the Introduction of the Market Correction Mechanism, 2023. accessed 10 May 202311 See Ivan Daiz-Rainey, Mathias Simes and John K Ashton, ‘The Financial Regulation of Energy and Environmental Markets’ (2011) 19(4) Journal of Financial Regulation and Compliance 35512 Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on Markets in Financial Instruments and Amending Regulation (EU) No 648/2012; see accessed 10 May 202313 Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC Derivatives, Central Counterparties and Trade Repositories; see accessed 10 May 202314 See Randy Priem, ‘A Relaxation of Commodity Derivatives Clearing Legislation as a Consequence of the 2021–2023 Energy Crisis’ (2023) SSRN Working Paper accessed 10 May 202315 See Randy Priem, ‘Intra-Day Volatility Mechanisms as a Consequence of the 2021–2023 Energy Crisis’ (2023) SSRN Working Paper accessed 10 May 202316 See Randy Priem, ‘Introduction of a Market Correction Mechanism Regulation as a Consequence of the 2021–2023 Energy Crisis’ (2023) SSRN Working Paper accessed 10 May 202317 Figure 1 does not display the role of commodity funds or hedge funds that are also active in the market. For more information, see accessed 10 May 202318 TTF derivative is a commodity derivative as defined in Article 2(1) of Regulation (EU) No 600/2014 of the European Parliament and of the Council on markets in financial instruments (ie MiFID II) traded on a regulated market, underlying which is a transaction in the Title Transfer Facility (TTF) operated by Gasunie Transport Services19 Variation margins are mark-to-market and initial margins often increase because margin models used by CCPs require higher levels of collateral to compensate for heightened volatility of derivatives20 See ESMA, Preliminary Data Report On the Introduction of the Market Correction Mechanism, 2023. accessed 10 May 202321 See European Central Bank, Financial Stability Risks from Energy Derivatives Markets, 2022. accessed 10 May 202322 See ESMA, Public Register for the Clearing Obligation under EMIR, 2023. accessed 10 May 202323 See eg Ben S Bernanke, ‘Clearing and Settlement during the Crash’ (1990) 3(1) Review of Financial Studies 13324 Meaning that they have positions exceeding the clearing threshold as specified under Article 10(3) of EMIR and become subject to the clearing obligation for future contracts in accordance with Article 4 of EMIR if the rolling average position over 30 working days exceeds the threshold25 See ESMA, ESMA proposes EUR 1 billion increase of the commodity derivatives EMIR clearing threshold, 2022. accessed 10 May 202326 Commission Delegated Regulation (EU) 2016/2251 of 4 October 2016 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council on OTC derivatives, central counterparties and trade repositories with regard to regulatory technical standards for risk-mitigation techniques for OTC derivative contracts not cleared by a central counterparty accessed 10 May 202327 Commission Delegated Regulation (EU) No 149/2013 of 19 December 2012 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council with regard to regulatory technical standards on indirect clearing arrangements, the clearing obligation, the public register, access to a trading venue, non-financial counterparties, and risk mitigation techniques for OTC derivatives contracts not cleared by a CCP accessed 10 May 202328 Discussion Paper on the Review of the Clearing Thresholds under EMIR (europa.eu) accessed 10 May 202329 See ESMA, Report on the review of the clearing thresholds under EMIR, 2022. accessed 10 May 202330 Regulation (EU) 2019/834 of the European Parliament and of the Council of 20 May 2019 amending Regulation (EU) No 648/2012 as regards the clearing obligation, the suspension of the clearing obligation, the reporting requirements, the risk-mitigation techniques for OTC derivative contracts not cleared by a central counterparty, the registration and supervision of trade repositories and the requirements for trade repositories (ie EMIR Refit) introduced a mandate for ESMA to periodically review the clearing thresholds and, when necessary, propose amendments to update them31 See the no-action letter of the CFTC accessed 10 May 202332 See ESMA, Discussion paper on the review of the clearing thresholds under EMIR, 2022. accessed 10 May 202333 See ESMA, Final Report EMIR RTS on the commodity derivative clearing threshold, 2022. accessed 10 May 202334 In this paper, defined as the activity of holding derivative financial instruments to reduce the exposure to marketable risk35 Regulation (EC) No 1606/2002 of the European Parliament and of the Council of 19 July 2002 on the application of international accounting standards accessed 10 May 202336 See ESMA, Q&A on EMIR implementation, 2023 accessed 10 May 202337 See ESMA, Discussion paper on the review of the clearing thresholds under EMIR, 2022. accessed 10 May 202338 Ibid39 See ESMA,ESMA responds to the EU Commission regarding recent developments in the energy derivatives markets, 2022. accessed 10 May 202340 Regulation (EU) 2019/834 of the European Parliament and of the Council of 20 May 2019 amending Regulation (EU) No 648/2012 as regards the clearing obligation, the suspension of the clearing obligation, the reporting requirements, the risk-mitigation techniques for OTC derivative contracts not cleared by a central counterparty, the registration and supervision of trade repositories and the requirements for trade repositories accessed 10 May 202341 Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU accessed 10 May 202342 See eg Articles 3, 6, and 26 of Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Regulation (EU) No 648/2012 (MiFIR) accessed 10 May 202343 See ESMA, ESMA responds to the EU Commission regarding recent developments in the energy derivatives markets, 2022 accessed 10 May 202344 Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012 accessed 10 May 2023. For instance, investment firms would need to have capital that accounts for the risks stemming from the market risk of their derivatives portfolios, potential counterparty defaults, operational risks and the concentration of exposure to a single counterparty. Regarding the market risk of their derivatives positions, known as net position risk (NPR), many trading firms use the simplified approach contained in the capital requirements regulation (CRR) for banks. Trading firms would need to hold capital amounting to 15 per cent of their net positions and 3 per cent of their gross derivatives exposure. Energy firms would also need to hold liquid assets equivalent to at least one-third of their fixed overhead costs, making them more resilient to margin calls45 Directive 2016/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU accessed 10 May 202346 Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC accessed 10 May 202347 See European Commission, Coronavirus response: How the capital markets union can support Europe’s recovery, 2020. accessed 10 May 202348 Commission Delegated Regulation (EU) 2021/1833 of 14 July 2021 supplementing Directive 2014/65/EU of the European Parliament and of the Council by specifying the criteria for establishing when an activity is to be considered to be ancillary to the main business at group level accessed 10 May 2023Additional informationFundingThis research did not receive any specific grant from funding agencies in the public, commercial, or not-for-profit sectors.