REMIT: bringing physical commodity trading into the regulatory spotlight
As far back as the 1986 Financial Services Act, regulators in the UK have had the authority to oversee activities related to commodity derivatives, but until recently, their presence was negligible. Despite the advent of the Financial Services and Markets Act in 2000 and a move from self to statutory legislation, the regulatory focus on commodities remained limited. The weight of rule-making was restricted to just two small handbooks—one for energy market participants (EMPs) and one for oil market participants (OMPs). With the Regulation on Wholesale Energy Market Integrity and Transparency (REMIT), however, that is about to change. In this article, David Wardley and Owen LaFave discuss REMIT, its anticipated impact and what companies need to do to ready their organizations for compliance.
For more than a quarter of a century, commodity market participants who did not hold a banking license flew largely under the regulatory radar. This has progressively changed during the last four or five years as a result of the financial crisis. Much of what has been enacted so far, such as Dodd-Frank and EMIR, has been targeted at the derivatives market. However, the next piece of legislation to go live throws a net over part of the physical commodity market.
REMIT (EU) No 1227/2011 is concerned with ensuring that electricity and gas markets across the European Union (EU) are regulated in such a way that retail consumers and market participants can have confidence in the integrity and operation of the supply and demand in wholesale power and gas. It also mandates that prices be set in a fair and competitive manner ensuring an absence of market abuse.
REMIT came into force on December 28, 2011 outlining three implementation strands:
- The identification of insider trading
- The provision of frameworks to prevent or deal with market abuse
- Market transparency through the reporting of eligible trades to an approved repository
The scope not only covers derivative contracts (which are already captured under EMIR as noted above), but also contracts related to the underlying physical commodity itself, in addition to the transportation and storage agreements that firms execute to deal with the custody of the commodity in question.
There is a final layer of complexity on the reporting side with the requirement to report orders to trade as well as the executed trades themselves. Given the low latency of market price change in the electronic information age, there is likely to be a large amount of data associated with entering, amending and cancelling pre-trade orders, which will be a challenge for market participants to capture.
Compliance with all three strands will require a data model comprising a specified field set for transaction reporting, plus some form of automated method of monitoring and creating alerts when this data suggests errant trader behavior.
THE REGULATORY BODIES INVOLVED IN IMPLEMENTING AND ENFORCING REMIT
The responsibility for implementing REMIT has been assumed by the Association for the Cooperation of Energy Regulators (ACER), at the request of the Directorate-General for Energy (DG Energy). DG Energy is the European agency responsible for the Implementing Act, which defines the operation of REMIT as enacted by the European Parliament.
Once the Implementing Acts are in place, the ownership of the registration and enforcement of market participants will be assumed by the National Regulatory Authorities (NRAs) who will in turn be coordinated at an EU level by ACER, completing the circle.
ACER is then responsible for the analysis of submitted data. Initial alerts of any data breaches will be investigated by ACER with any further requirement for detailed investigation and/or enforcement passed to the relevant NRA. For the UK, the relevant NRA will be Ofgem, which is already actively regulating the distribution network and supplies of power and gas to retail customers.
As the nominated NRA in the UK, Ofgem will now find itself overlapping with the Financial Conduct Authority (FCA), who will continue to own transparency and market behavior enforcement in the derivatives part of power and gas portfolios. As a result, firms under the influence of REMIT will also need to meet the requirements of yet another regulator.
ACER is in the process of locking down its user manuals for market participants, potential regulatory reporting mechanisms (RRMs) and system operators. They are currently out for review and will be published along with the adoption of the implementing standards.
ACER mandates that the onus for the delivery of data should fall on the various system operators: Transmission system operators (TSOs), storage system operators (SSOs) and LNG system operators (LSOs). These infrastructure providers are required to register as RRMs and will deliver reportable data to ACER’s REMIT information system (ARIS), a designated repository.
REPORTING TRADES UNDER REMIT
The ARIS architecture requires that all reporting be done via an RRM. (Trade repositories will register as RRMs, possibly under a “lite” program.) If market participants wish to report their own data, they will first have to complete the registration process to act as an RRM. There is a provision within REMIT for firms to use third-party RRMs to act on their behalf; however, experience with the outsourcing of reporting responsibility under Dodd-Frank and EMIR suggests that there will be no delegation to third parties until firms who generate reportable data are able to audit the custody capabilities of RRMs.
As a result of its discussions with the industry, ACER currently expects that at least 200 entities will register as an RRM to fulfill their responsibilities. Given the resourcing constraints within ACER, the approval and onboarding of this many RRMs between adoption of the implementing acts and the go-live date will be difficult.
ACER appears to be taking a phased approach to bringing the legislation to life, initially capturing standard contracts traded on organized market places (OMPs). This will be followed by a second go-live at a time to be determined, which captures standard and non-standard contracts, however and wherever they may be executed.
The definition of “standard” is broad and includes anything offered on an OMP. Similarly, the OMP definition is fairly wide and includes bilateral trades done through brokers via voice. The only scenario not captured in phase one would be direct peer-to-peer trades not involving any third-party agency.
THE IMPACT ON DATA MANAGEMENT
The regulation drives many firms into a data management model that they have not previously had to consider. For example, market participants must ensure the recording and reporting of data, much of it mandatory, that most don’t currently collect and that their books and record systems are not configured to capture. Assuming the capture problem can be resolved, the next challenge is configuring IT systems to transmit and reconcile the order, trade and fundamental data to ensure the integrity of information in repositories. Finally, firms will need to decide how to manage the monitoring of trader behavior to recognize activity which constitutes a breach in terms of insider trading or market manipulation. It is likely that this can only be done by implementing software which scrutinizes data patterns that are present within the firm’s databases.
One favorable element of ACER is that firms do not have to report trades that have already been reported to a trade repository in compliance with EMIR legislation. This will reduce the volume of REMIT-reportable derivative trades, but will not include the orders which led to those trades.
This order reporting requirement is one of the more challenging. Orders to trade are not currently reportable under EMIR legislation, so although the exemption for trades already submitted is useful, the requirement to report the orders related to those trades under REMIT introduces a significant problem. Tracking and flagging the order data for EMIR-reported trades for further reporting to a different database could prove to be an enormous task.
ACER guidance is clear in trying to place the main burden on system operators rather than market participants; however, firms often express concerns regarding the passing of data across third-party platforms instead of direct to the repository itself. A proportion of the data reported is commercially sensitive, so there is apprehension related to any lack of security to protect their client or the exposure of valuable proprietary information to the third party. Add in the reconciliation burden of using one or more third-party RRMs, and it is clear that firms have some decisions to make.
Even though there are many moving parts with REMIT, firms should be asking the following questions now rather than waiting for the Implementing Acts:
- Is the internal plan in place to be compliant in the six-month window between the adoption of the Implementing Acts and the go-live of REMIT reporting?
- In terms of RRM selection (if going down the third-party route): Have providers been identified, commercial agreements finalized and are contracts and SLAs in place?
- How will market abuse or insider trading be spotted and alerts generated within the organization?
- How will reconciliation take place to ensure that externally reported data has been delivered accurately for both orders and transactions?
- Has the approach for REMIT report delegation been agreed upon either for the counterparts or to the counterparts?
Heading into 2015 and beyond, the market is expecting further directives and regulations in Europe around market abuse, (MAD/MAR) and financial instruments (MiFID II/MiFIR overhaul), which will bring additional burdens to some commodity traders who had previously been exempt. Firms need to deal with REMIT delivery promptly to prevent stacking of programs to meet the next wave of regulation.
Requirements related to REMIT may not be the end of the story— firms should continue to keep themselves abreast of the intentions of Norwegian and Swiss regulators. Although they are not bound directly by EU statutes, they are driven to ensure alignment with European regulatory efforts, particularly in cross-border markets such as the coupled power market. Plans are being drawn by both to have parallel repository schemes to collect data in their respective jurisdictions.
If they haven’t already, commodity market participants need to quickly come to terms with the fact that they are no longer immune to regulation and take steps to protect their ability to trade in their chosen sectors. A lack of prompt action could mean that firms will not be ready by the time legislation goes live, leaving them able to execute only non-compliant trades.
A large number of market participants and infrastructure providers are uncertain about their readiness to meet ACER delivery expectations. Many firms appear to be dormant in their preparations, with some waiting for the adoption of the Implementing Standards before committing to a course of action. This could lead to further tactical delivery which will again diminish a firm’s ability to drive efficiency across its compliance framework.
Firms need to deal with REMIT delivery promptly to prevent stacking of programs to meet the next wave of regulation.
As the wider global program of legislation continues to roll, most if not all firms will have to change their trade execution approach and enhance the management of data records. To date, firms have taken a tactical approach to complying with regulations but this will ultimately lead to an inability to scale up to meet new business opportunities.
Firms will need to begin to carry out strategic planning across the trade lifecycle and focus on some key areas including development in deal representation, standardization of data field values, enterprise-wide reconciliation of data and consolidation of system architecture to support margin and collateral optimization.
This article was written in August of 2014 and therefore does not reflect any changes to the draft Implementing Acts from that point forward.
is a Director at Sapient Global Markets’ London office and has over fifteen years of experience within the energy and financial services sectors. He began his career implementing enterprise trading and risk management systems and transitioned to managing enterprise system implementations, frontoffice risk and control work and most recently regulatory compliance. Owen has spent the last year participating in many ACER working groups and is focused on ensuring Sapient Global Markets’ clients are prepared for REMIT compliance in the most effective manner possible.