Enforcement increasing as surveillance lags behind? Ignorance is bliss (for now…)

Compelling themes emerged from recent gatherings of the EU energy market regulatory compliance community – we briefly examine what these might mean for transaction surveillance for EU energy traders.

March was a busy month for EU energy market regulatory compliance officers with numerous industry get-togethers taking place including the inaugural Open Anti-abuse Meeting and ETRC 2019 events in London. Given the focus on market abuse topics in the context of EU power and gas markets, the themes emerging from these events provide a useful vantage point for understanding the current state of play and future trends in compliance for both regulators and market participants alike. The viewpoints discussed below are not attributable any specific party.

Fines and penalties are trending up – surveillance is now the key regulatory priority

A flash survey at ETRC 2019 indicated that transaction surveillance is now the overwhelming regulatory and compliance priority for energy firms over the next 12 months. This is not surprising given the recent increase in enforcement cases, particularly under Article 5 of REMIT for EU wholesale energy markets. The various expert panels unanimously agreed that 2019 will see this trend continue, with one EU National Regulatory Authority (NRA) alone purportedly expected to announce up to five new fines in the coming months. This seems a far cry from similar events in the past where the core debate focussed on whether a surveillance capability was really necessary by many of the same firms in this sector.

Despite this increased risk most firms do not achieve effective surveillance with their existing tools

While there was general agreement at ETRC 2019 that enforcement action across EU energy markets will continue to increase, a panel of compliance officers were surprisingly open that their existing transaction surveillance tools struggled to effectively address the “nuances of power and gas trading, particularly the physical aspects”. Some suggested that their vendor surveillance solutions, mostly designed for financial markets, were improving but seemed to accept the many inherent limitations experienced at present. The contrast in these messages seems paradoxical – if surveillance solutions exist which are designed specifically to detect abusive behaviour in these markets, why do firms persist with less effective surveillance solutions that will almost certainly miss many types of abusive behaviour were it to occur?

This question is not entirely new, and the historical counter arguments are numerous and wide ranging. Some of these sentiments might seem familiar?

• We use the same solution as the Regulators – we only need to see what they see
• We use the same solution as our peers – safety in numbers
• It took a lot of effort to implement our surveillance tool – we’re not changing it now (even if it doesn’t work)
• We took the option that was easiest to implement – we can change it later
• The Regulator(s) hasn’t provided clear guidance – we’ll just need to tick the box until they tell us otherwise
• IT strategy trumps business needs in our organisation – this was a significant factor in our selection process
• We only need our own data to sufficiently understand our market abuse risk – we know data is a big issue in the market so we opted to limit our data requirement at the outset
• We’re small so not the Regulator’s priority – a basic surveillance tool that ticks the box will do
•  …..

So far this seemingly ambivalent outlook and approach has paid off. But will this hold true in 12, 24 or 36 months from now? And where does the apparent indifference toward effective surveillance in these markets originate? The answers to both questions might lie with the Regulators themselves. While many have access to surveillance tools, these might be constrained by the same limitations implicit in many of the legacy financial services surveillance solutions . Facing these, and other constraints placed on them, not least of all budgetary, some Regulators might not be fully equipped to ask the difficult questions about certain behaviours in wholesale energy products, particularly when physical assets or the complexities of short-term spot and auction markets are involved. Were this the case, it follows that market participants don’t necessarily recognise a reliable and compelling benchmark against which to measure the appropriateness of their surveillance capability. This is bound to have a dampening effect on their motivation to implement tools which might be able to detect such complex or nuanced behaviours.

On the other hand, it is also the case that Regulators are far from relying exclusively on surveillance technology to identify cases of markets abuse. Rather they have a wide range of triggers, including whistleblowing and suspicious transaction reports from market participants, brokers and exchanges.

Would your surveillance solution detect this behaviour? Small fines, big waves

At both ETRC 2019 and the Open Anti-Abuse meeting there was a strong desire from those present for more information to be published on the underlying features of enforcement cases since only limited details are published in most penalty notices. Of particular interest were the fines issued to a major German utility (and two of its traders) in February and the two capacity hoarding cases in the Nordic market announced in December 2018 and January 2019.

It was perhaps surprising that a high degree of interest was shown in cases which resulted in relatively small financial penalties, let alone jail time. So why the interest? On the one hand it seems logical that compliance officers are keen to learn from the misdemeanours of others to improve internal policy, training and guidelines, and this is difficult to do without more granular facts concerning the abusive behaviour . On the other hand, it might also simply be a case of wanting to understand: would our surveillance solution have detected this behaviour before the Regulators did?

As the number of REMIT fines and penalties continue to accelerate (as clearly anticipated by the market), it seems inevitable perhaps that individuals in senior management positions who are responsible for compliance will start asking tougher questions about whether their surveillance tools actually work, particularly across varied and complex energy portfolios. For firms that own and/or operate assets, more compelling action will be needed than simply hoping that surveillance tools designed for financial services will one day be fit-for-purpose as currently seems to be the case.

Stuck with the wrong surveillance solution? Here are some ideas for changing the status quo

• Pressurise your current vendor to develop the right capabilities: many energy firms who use legacy financial services tools soon discover they’re queuing up behind priority customers (i.e. large Investment Banks). Set time limits on promised roadmap items and seek alternatives if they do not deliver. Bear in mind that the Regulator has your data – they may analyse it years from now.
• Seek complimentary tools: if you’re unable to move vendors in the short term, seek to acquire an add-on solution to cover the gaps. For a relatively marginal increase in cost and effort this may prove the most effective way of reducing your market abuse risk exposure in the short term
• Develop an internal strategy to migrate to a fit-for-purpose solution: start by understanding what is available in the market. This is a fast-moving landscape with ever falling costs and increasing capabilities. Take a strategic perspective – as a data intensive tool, explore what cross-function benefits might be available when switching surveillance solutions e.g. risk management, commercial supports, market analysis tools etc.

You might discover that you can get a more effective surveillance solution at a lower cost which delivers all sorts of ancillary benefits across other functions.

<sup>1. Open Anti-Abuse Meeting, London 11 March 2019
2. 9th Annual Energy Trading Regulations & Compliance 2019 Summit (ETRC 2019), London 12 – 14 March 2019
3. REMIT does not mandate such a capability (unless a PPAT) unlike MAR which requires appropriate arrangements to be in place for MAR instruments
4. We do not attribute any sentiments to any individuals or firms who may have participated in these discussions
5. This is difficult to qualify as EU Regulators remain justifiably secretive on the specifics of their capabilities
6. https://www.bundesnetzagentur.de/SharedDocs/Pressemitteilungen/EN/2019/20190220_Marktmanipulation.html
7. As a result, a National Regulator in attendance agreed to further explore the possibility of providing more detailed information in future
8. Or the relevant exchange or broker surveillance team acting as PPAT</sup>