Overview

With the UK being one of the largest commodity markets in the world and home to several large energy and commodity exchanges, including ICE Futures Europe and the London Metals Exchange, this development should be of interest to any firm actively trading on these venues as well as in related OTC contracts.

The current UK regime is a legacy of MiFID II dating back to 2018 before the UK officially left the EU. The UK regime was largely rolled back in 2021 when the FCA announced [2] that it would not take enforcement action against firms in breach of UK MiFID II position limits unless the contract was cash-settled or an agricultural commodity, adding to a 2020 exemption [3] for liquidity providers. The latest proposal builds on an earlier consultation from HM Treasury [4] in 2021, adding more detail to the proposal along with several new concepts.

Below we touch on some of the aspects of the proposed regime.

Scope

The new regime will focus on a narrower set of “Critical” contracts which will be determined by the FCA. Critical contracts will comprise of physically settling contracts only. Such contracts are comparable to the 25 Core Referenced Futures Contracts (CRFCs) under the Dodd-Frank position limits regime, with a key exception that the limits themselves will be set by the exchange, rather than by the authorities. The FCA intends to maintain a register of Critical contracts and have proposed a set of criteria which will determine which contracts indeed qualify as critical. The criteria will include:

• The settlement method at expiry (i.e. Physical vs Financial);
• The size of the commodity derivative market compared to the underlying physical commodity and the robustness of the reference price used to settle contracts;
• The type of underlying and the impact on end-users;
• The size of the market.

The consultation proposes a total of 13 Critical contracts (see table below), comprised of six metals contracts, four agricultural contracts and three energy contracts. The FCA points out that the ICE T-West Texas Intermediate (WTI) Light Sweet Crude Futures is considered a Critical contract despite it being cash-settled. They have declined however to propose the assignment of its own position limit stating that it will likely be captured as a “Related” contract (discussed below).

Table 1: Proposed critical contracts subject to consultation response.

Along with Critical contracts, the new position limit regime will also include so-called “Related” contracts. Related contracts are any commodity derivatives traded on a UK exchange whose settlement price is directly or indirectly linked to the settlement price of a Critical contract. This would also include any commodity derivative, such as options or spread contracts, which result in a position or delivery obligation in a critical or related contract on settlement or expiry.

Related contracts may be considered analogous to “linked contracts” under the US Dodd-Frank position limits regime. In a key difference to the US regime however, the FCA proposes that the exchanges themselves would be required to identify and publish a list of such contracts in a “a clear and accessible manner”. This approach will be welcomed by those with experience with US Dodd-Frank position limits where, while an initial workbook for linked contracts was published by the CFTC, the responsibility for identifying these contracts on an ongoing basis rests with the market participant.

At a minimum, Related contracts will include options on Critical and Related contracts, mini contracts, Balmos and mini-Balmo contracts, inter-contract spreads that include a Critical contracts and cash settled look-alike contracts that are linked to the Critical contract.

Finally, and again following the US model, the FCA proposes that exchanges should set “accountability thresholds” as a position management control. Accountability thresholds are viewed by many as “soft limits” and, under the FCA’s proposal, will apply to both Spot and Other months position limit periods (see below). When such soft limits are breached, the exchange would monitor the position more closely and, when required, would have the ability to compel the market participant to reduce the position.

Setting Position Limits – Structure and Approach

In terms of position limit structure and the approach to setting such limits, the FCA proposes moving away from the “fixed baseline threshold” approach introduced under MiFID II, opting instead for a more bespoke, dynamic approach.

The task of setting limits will be pushed to the exchanges who will be required to consider many of the factors specified under the MiFID regime, with some key additions such as market liquidity and the ability for market participants to unwind their positions. The thinking for the latter extends from the LME Nickel market event [5] in March 2022 where disorderly unwinds caused a significant amount of market disruption. Key however is that the FCA expects the exchanges to set both Spot and Other months limits. This again is a key departure from the US Dodd-Frank position limits regime where only Spot limits apply with the exception of limits for several legacy agricultural contracts.

The FCA also opens the possibility for the exchanges to set multiple limits within specific limit periods. This would follow a similar approach the Dodd-Frank regime where, for example, multiple so-called “step-down limits” apply to the WTI CRFC during the spot window as the contract approaches its last trading date.

Exemptions from Position Limits

The FCA also proposes several changes to the position limit exemptions regime. They propose, in a departure from the MiFID regime, that the exchanges assume responsibility for granting exemptions – removing the responsibility (and the workload!) from the FCA who are currently responsible. Exchanges would be required to notify the FCA when exemptions are granted and would be required to provide an annual report summarising exemptions from across the year.

While exemptions will not be bound by time limits, market participants will need to inform the exchange of any significant changes to the information originally provided for the exemption so that they may reassess the ongoing validity of an exemption. Exchanges will also be compelled to consider “exemption ceilings”. Exemption ceilings will limit the size of the exemption that may be claimed in certain circumstances. Should market participants breach the ceiling, additional exchange reporting requirements would kick in and, in some situations, the exchange would also be granted additional position control powers.

Before granting exemptions, exchanges would need to consider the ability of the market participant to unwind its position – again, a requirement borne from the March 2022 LME incident.

Finally, two further exemption categories are proposed by the FCA. The first is the granting of so-called “pass-through hedging exemptions” which would allow financial firms who offer hedging products to non-financial firms to claim exemption from position limits for such positions. Until now, exemptions have only been available to non-financially regulated entities. Again, this approach lends from approach applied under the US Dodd-Frank position limits regime.

The second is an explicit exemption for firms providing liquidity to the market. The market participant must however participate in a bona-fide liquidity provider scheme set-up by the exchange and firms should not draw on the exemption for longer than absolutely necessary when providing liquidity.

Position Reporting

The FCA proposes the establishment of a position reporting regime which would require exchange members and their clients, up to and including the end client, to report their positions to the exchange. The FCA have avoided being overly prescriptive with regards to the specifics of this regime proposing a risk-based approach in determining scope and setting out criteria, which if met, may trigger additional reporting requirements. An example trigger might include when a market participant’s aggregated position in Critical and Related contracts is equal to or larger than the relevant accountability threshold.

The proposed reporting rules include additional reporting requirements for related Over-the-Counter (OTC) contracts and derivatives traded on overseas trading venues. The principles applied to identifying Related contracts would be extended to both of these types of contracts.

Interestingly, the FCA proposes that exchanges again be made responsible for identifying both of the above contact types akin to their obligations around identifying Related contracts. It is not precisely certain what the FCA has in mind in this regard. OTC contracts are typically decentralised in nature and exchanges have limited oversight of such activity. Market participants also have limited obligations in reporting OTC contracts, some of which do not necessarily fall into scope of the MiFID II and/or EMIR reporting regimes. The consultation responses from the market will no doubt stimulate deeper inquiry in this respect.

Will the EU Follow suit?

While the EU appears to have lost its appetite for commodity derivative position limits after the overly ambitious scope of MiFID II, they are purportedly expected to revisit the topic again in 2025. It is far too soon to understand what approach, if any, the EU authorities might take. While home to exchanges such as ICE Endex, EEX and Euronext which list many significant commodity contracts, the removal of the UK venues from scope might have lowered the priority of this topic in the eyes of EU lawmakers. That said, the EU’s appetite for invasive market measures such as the Market Correction Mechanism [6] implemented for TTF gas suggests that this topic won’t stay off the table for very long.

Conclusion

With a few exceptions, the FCA is proposing a pragmatic and well-balanced position limit regime arguably taking the best elements from the US and EU regimes and adapting them for the UK’s commodity markets. While time will tell how many of these proposals make it into the final rule set, firms trading on UK-based exchanges should begin to consider the potential requirements necessary to both manage and monitor aggregated Critical and Related contract positions. They should also consider the potential position reporting requirements, particularly for Related overseas exchange traded contracts and OTC contracts. It is not clear when the new, final rules will come into force firms should probably plan for the latter stages of 2024 or early 2025.

Links

1] https://www.fca.org.uk/publication/consultation/cp23-27.pdf

2] https://www.fca.org.uk/news/statements/statement-supervision-commodity-position-limits

3] https://www.fca.org.uk/publication/documents/supervisory-statement-mifid-end-transition-period.pdf

4] https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/998165/WMR_condoc_FINAL_OFFICIAL_SENSITIVE_.pdf

5] https://www.lme.com/en/trading/initiatives/nickel-market-independent-review

6] https://energy.ec.europa.eu/news/commission-prolongs-energy-emergency-measures-12-months-2023-11-28_en

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Other topics discussed included:

The great working capital reset: Are we reaching peak DPO?
Supply chain realignment: Bridging finance and procurement
Mitigating concentration risks across the trade value chain
Strategic inventory management
Supply chain financing: Distribution, disclosure, and capacity building

Our team engaged in insightful discussions about our trade credit insurance solution and the risk assessment challenges US trade lenders are facing today. We enjoyed making connections and the opportunity to contribute to the dialogue that will shape the future of the trade finance industry.

The post CubeLogic Exhibits at Global Trade Review (GTR) US Conference appeared first on CubeLogic.

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This year, we hosted at the historic RWB Room in the NED hotel. Originally the private luncheon room of the Midland Bank’s chairman, Reginald McKenna, the RWB Room is distinguished by its unique light oak panelling, giving it an intimate, informal atmosphere. The NED hotel is set in a former bank HQ designed in 1924 by Sir Edwyn Lutyens. What a venue!

We look forward to more opportunities to connect and celebrate with our incredible CubeLogic community in the coming year. We feel CubeTonic may become an annual tradition!

The post CubeTonic 2023: CubeLogic’s Annual Client Winter Social appeared first on CubeLogic.

As energy markets evolve, this event presents a unique opportunity to dive deep into the industry’s transformation. Speakers and attendees of the event explored new innovative strategies and discussed how to navigate market volatility. The CubeLogic team enjoyed engaging with peers and leading risk practitioners to help shape the future of trading.

Thanks to Commodities People for hosting this great event.

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Thanks to all who joined us at this premier event where networking and education converged to empower professionals in the energy industry. At CubeLogic, we’re committed to driving innovation and growth in the field, and this conference is the perfect opportunity to connect and learn from the best.

Here’s a glimpse of what the conference offered:
Engaging sessions on markets for renewable technology waste
Insights into renewable natural and certified gas
Exploring the impacts of artificial intelligence
In-depth discussions on legal and credit-related topics

The team enjoyed discussing how our solutions are empowering energy traders with advanced credit analytics.

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Climate Risk: Emerging Best Practice for Credit Management

On Tuesday, 3 October 2023 PRMIA** hosted an evening event and panel discussion on Climate Risk: Emerging Best Practice for Credit Management. The panel included senior bankers and rating agency experts, who shared their experiences with the challenges of integrating climate risk into the credit risk management assessment process.  Below is a synopsis of some of the key takeaways from the session.

Emerging data and analytics availability

Bankers and investors are increasingly integrating climate risk into their analysis, while regulators are requiring better transparency and disclosure. Both factors are driving the demand for data that can be input into models to quantify the risks, and thus enhance the decision-making process. Stephen Bullock, from S&P Global Sustainable1, provided insights into their methodology and the building blocks for quantifying climate risk and the likely financial impact. By way of example, he shared information about carbon credit earnings at risk, noting there is a 72% shortfall of required emission reduction, as per the Paris Agreement, and the cost to exposed companies could be material as these prices rise.

Practical challenges and limitations

The data that is currently available is focused on the largest companies with vulnerable exposures to climate hazards around the globe. The ultimate aim is to be able to use the output to help quantify the financial impact and provide “scores”.  For the sectors most exposed to these risks, this data can be helpful, but it is only part of the climate change and risk assessment process. As one of the senior bankers noted: You need to “know your customer”, understand and be able to articulate their transition strategy and provide evidence of their progress.  For this, gaps in data remain problematic.

For large banks, with many thousands of customers across virtually all industries and operating in multiple countries, the task of quantifying exposure to climate risk is gargantuan.  For vulnerable sectors, stress testing, using available data, helps to quantify the risk but an issue everyone acknowledged is the ability to capture subsector and supply chain exposures.  From a reporting perspective, scorecards should help identify the risk. Ultimately banks need to both quantify the enterprise-wide risks and satisfy regulators that these risks can be identified, measured, monitored, and managed.  Banks still have a tremendous amount of work to do to achieve this.

Execution responsibilities: Role of First Line of Defence

Banks take their commitment to net zero transition very seriously.  In practical terms, it was generally agreed that the first Line of Defence has primary responsibility for implementing this policy. This includes the selection process through to formulating credit appetite, capital allocation, and loan pricing. Those in origination, as well as clients, are concerned about what this will mean in the future. One banker noted that with existing clients, it is key to be pragmatic “assisting not insisting” them to achieve their emissions goals.  For smaller businesses, education and training are needed.

Governance

The governance around client management, disclosure, and accuracy of data is a priority. Given the problems with huge data gaps, data governance was highlighted as particularly challenging. The panellists agreed that the mantra of being “roughly right rather than precisely wrong” is very apt, and that traditional model validation is currently impossible (auditors and regulators take note!). The heightened model uncertainty has led some firms to establish advisory panels to facilitate discussions with the clients who are most at risk to find workable solutions and support businesses through the transition process. Generally, a cautious approach has been taken in how these new, untested models and methodologies are used to ensure that clients are treated fairly and new learnings are incrementally baked into critical decision-making processes. The law of unintended consequences remains at the top of senior bankers’ minds.

Integrating climate risk into the credit risk assessment process is a work in progress.

*Anne-Marie Barcia is a founding partner at Adeva Partners, specializing in credit, corporate finance, risk, and regulatory training for global financial institutions. With 13+ years at Adeva, she leads consulting projects and designs training supporting clients’ business and risk management strategies. Her extensive background includes a 22-year tenure as Managing Director at Fitch Training and prior roles at Chase Manhattan Bank and JPMorgan Chase & Co. In 1987, she founded CCR, one of Europe’s first companies providing tailored credit and corporate finance training, eventually acquired by Fitch Ratings in 2002. Anne-Marie’s career spans global financial hubs, including New York, Hong Kong, South Asia, and London.

**PRMIA: The Professional Risk Managers’ International Association is a non-profit, member-driven professional organization that focuses on the development and education of the risk management profession.

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Our booth showcased the very best in credit insurance management and we’re thrilled to have had the opportunity to share our expertise with fellow industry leaders. We’re grateful for the connections we made, the knowledge we gained, and the chance to collaborate with the S&P team. ExCred is the number one summit for insuring trade and investment in the Americas. Among the attendees were senior leaders from key banks, traders, multilateral development banks, development finance institutions, export credit agencies, insurers, reinsurers, brokers and financiers in the Americas. This was a unique opportunity for CubeLogic to discuss our trade credit insurance platform with a wider user base.

Here’s to more successful partnerships and exciting opportunities in the world of credit insurance and risk management!

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Access an audio recording of the full discussion here: RegTech Discussions à La Carte – ETW (energytradingweek.com)

Speakers:

• Eren Erman (TP ICAP)
• James Curphey (Shell International Trading & Shipping Company)
• Justin Nathan (Glencore)
• Nick Wallis (Eventus)
• Shane Henley (CubeLogic)
• Yasmine Li (Macquarie Group)

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We enjoyed connecting with our valued clients and colleagues, diving into the latest industry insights, and making new connections. The event took place Wednesday the 20th of September 2023 at Merchant Taylors’ Hall in the City of London. The evening began with a presentation titled “Counter Party Risk Evolution in The Digital Era” which was followed by dinner and networking.

A big shout-out to IECA International Energy Credit Association for hosting such great events that bring industry professionals together. We enjoy seeing many familiar faces at these events while always keeping someone new.

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