Market abuse penalties are on the rise – how can firms protect themselves?

A recent spate of fines from US regulators and exchanges for alleged market abuse in energy and commodity markets are hard to ignore. How can firms protect themselves against this increasing risk?

Fines, fines and more fines
The last six months have seen a raft of hefty fines issued for market abuse across a wide range of commodity classes and market participants. Commodity trading houses, banks, brokers and industrial end-users have not been immune to this. These fines have also extended across virtually all major energy and commodity classes. From power and gas, to metals and agricultural products – the recent flurry might be seen as a renewed front against abusive behaviour and market manipulation.

The Commodity Futures Trading Commission (CFTC) has been the most active. Since June 2019, the CFTC has announced fines totalling approximately $44million in five separate cases involving alleged market abuse. While some of these cases are still being contested, it is hard for firms to ignore the staggering size of these fines and the upward trend of such enforcement cases.

In June, Merrill Lynch Commodities Inc. was fined $25million for spoofing in precious metals on the COMEX exchange (1). In August Kraft Foods Group and Mondelēz Global LLC agreed to settle on a $16m civil penalty for allegedly abusing the wheat cash and futures market prices on the CBOT exchange, amongst other things (2). The following month the CFTC fined Heraeus Metals New York LLC and its trader a total of $1million for spoofing in silver and gold futures on the COMEX exchange (3). A few weeks later in October Mitsubishi International Corporation was hit with a virtually identical case on COMEX for spoofing resulting in a $400k fine (4). Shortly after, the CFTC announced a $1.5million to Classic Energy LLC, a broker, for alleged front running/insider trading on client orders using block trades in the gas futures market (5).

It was not only the CFTC issuing fines over this period. In July, Vitol was accused by the Federal Energy Regulatory Commission (FERC), the US federal regulator of wholesale power and gas markets, of manipulating Californian power prices in what appears to be cross market/product manipulation (6). While the $6million fine is still being contested by Vitol, it follows on from a €5million market abuse fine issued by French regulators to Vitol in 2018 for alleged abuse of the local wholesale gas market. Likewise, some exchanges have also been active. In June ICE Futures US fined Macquarie Energy LLC $250,000 for alleged price manipulation and disruptive trading practices in the ERCOT power market in Texas (7).

Prevention is better than cure
The risks of these fines doesn’t stop at the balance sheet, the impact of reputational risk is often more damaging. Negative publicity and making the headlines for market abuse is something all trading firms, across all industries want to avoid. In most cases firms should be able to detect, and implement measures to prevent such behaviour provided that they use the right tools. Sophisticated transaction surveillance technology is rapidly becoming the norm for energy and commodity traders across the US, many of which are not regulated and in the past have seen little need to invest in them. This has changed significantly in recent years as the cost vs risk dynamic has shifted. Demand for effective surveillance solutions has picked up across the US, including for smaller, regional firms such as local utilities with wholesale trading desks.

The problem is that most of the vendor solutions on the market today have been designed primarily for the financial markets and are not set up to handle the unique characteristics and nuances of the energy and commodity industry, in turn resulting in ineffective analysis. A common issue is the unwieldly number of alerts generated on a daily basis (these are sometimes refered to as “false positives”). Large numbers of false alerts put operational pressure on compliance teams often meaning additional headcount. The cost of such headcount can comprise a signifcant proportion of the cost to operate a surveillance capability in a firm, and in some cases can exceed it.

Recent months have proved that the regulators are fired up and their tolerance for market abuse is diminishing. There really is no excuse for firms to allow this behaviour on their trading floors. Historically our sector has struggled to find technology solutions which truly understand the interplay between physical and financial markets, production assets, transmission and storage capacity. The wait is over. Adopting smart transaction surveillance will not only stamp out unwanted market abuse but will dramatically improve workflow, reporting and help firms to understand their complete transaction lifecycle. Starting out on a journey to protect against regulatory fines might actually turn out to be more fruitful than you anticipated!