Those in the financial sector have become used to regulatory change over many years, with the recent ‘phase’ arising from the events of 2007 and 2008 not necessarily representing something new, but rather an increase in tempo, albeit a rather significant one.

Those in the financial sector have become used to regulatory change over many years, with the recent ‘phase’ arising from the events of 2007 and 2008 not necessarily representing something new, but rather an increase in tempo, albeit a rather significant one.

For most in world of energy and commodity trading however, the regulatory onslaught is something novel. EMIR was for many the first ‘big compliance’ project that needed to be undergone, and represented something of a mind-set shift in things that ‘had to be done’. While the sector exhibits many similarities with the financial sector, it is also different in many respects. The physical element in terms of trades which are settled with a ‘real’ movement of a commodity or energy, gives rise to different trading, risk and operational outcomes to finance and banking. On top of this, the motivations for trading in the first place, often dominated by supply and hedging (with some speculation) are different, as are the players.

This parallel universe has seen a slightly different infrastructure develop in terms of trading, settlement and also regulation. This article will look at some key aspects of this, focused on regulatory reporting.

Rules recap

Most in the financial markets are familiar with EMIR, and the reporting requirement to registered trade repositories. While most in energy and commodities are for now ‘NFC-‘, i.e. non-financial counterparties under the clearing threshold, there is still a great deal of trading in derivatives, and therefore a significant reporting requirement. In physical commodities, the definition of what constitutes a derivative adds to the reporting complexity, and we shall examine this later.

REMIT has given rise to a large reporting requirement, with all gas and power trades covered, whether physical or financial, except if they are already under EMIR. These requirements, covered in Rocket Edition 4, saw the final deadline on 7th April 2016, and final backloading on 6th July 2016. This requirement adds orders and fundamental data to the mix, as well as the requirement to report inside information.

The Electricity Transparency Regulation (ETR) started in January 2015 and this also requires the reporting of many types of physical data around power.

And of course, we will soon see the start of MiFID II. Energy and commodity companies will mostly fall under the position reporting regime. Some will also be required to set up “MiFID regulated” Financial Counterparties and be subject to the remainder of the MiFID requirements.

And then there are the regimes of other countries such as Norway and Switzerland. Not only does Switzerland have “FinFrag”, the Swiss EMIR, but also the Elcom rules which are the Swiss equivalent of REMIT.

The forthcoming Brexit is likely to only add to this mix.

Is my trade a financial instrument?

A key question when reporting is which set of legislation it falls under: financial legislation, as a derivative, or energy legislation (or both). The question of whether a physical forward is considered to be a financial instrument is addressed in MiFID Annex I Section C. In particular, paragraphs C6, C7 and C10 define the circumstances under which a physical forward is a financial instrument.

Under the original MiFID C6, a forward which “can be physically settled” traded on a regulated market or MTF is considered to be a financial instrument. The run up to EMIR saw many broker MTFs span a parallel ‘non MTF’ (which required the introduction of an element of discretion). Trading on these venues rather than the MTFs took the trades out of MiFID and therefore EMIR.

MiFID II further adjusts the definition by bringing in trades executed on an OTF, which many non MTFs are likely to be classified as. However the ‘REMIT carve out’ added to C6 states that trades in “wholesale energy products executed on an OTF which must be physically settled” are excluded. MiFID, in a Delegated Act, further defines the terms “must be physically settled” with several restrictions.

Changes to C7, which addressed OTC trades and C10 which looks at different underlying’s such as freight need to be considered, as does the addition of EUAs as financial instruments in C11.

Those in the sector need to be able to route trades to the appropriate destination by determining the status of each trade, as the rules change.

Data types

Data reporting encompasses several types of data:

• Trades: EMIR, REMIT and MiFID II all require trades to be reported once executed. The rules differ in terms of which parts of the trade lifecycle need to be sent. For example, REMIT does not require the confirm or clearing status to be sent.
• Orders: REMIT in particular requires orders placed on an Organised Market Place to be reported.
• Secondary transportation trades: Need to be reported under REMIT – these are complex and use different sets of reference data.
• Fundamental data: This is “actual” physical data. REMIT has extensive requirements for fundamental data, but only a few types need to be reported by market participants (gas balances in store, and LNG movements and plans). The rest needs to be reported by system operators.
• “Transparency” data: Some rules, such as ETR require the reporting of ‘other’ physical data related to actuals.
• Position data which will be required under MiFID II position reporting. This is complex due to the mapping required for OTC economically equivalent contracts.
• Inside information: Another type of ‘physical’ data is physical inside information, which relates to information about physical assets which is precise, not publically available and which may have a significant price effect if revealed. All asset owners must publish such information within mandated timelines, either to their web site or to a transparency platform. Such data includes items such as unplanned power plant outages, which could have a significant price effect once known. The rules on the formats to be used will change on 1st January 2017.

Reference data

In addition to the many financial identifiers such as LEIs, ISINs, and BICs, energy has a few parallel standards of its own. The EIC, Energy Identifier Code, is used for several purposes, including parties (“X” codes), delivery points (“Y” codes) and others. REMIT also introduces the “ACER Code”, a unique identifier that is given when every gas and power market participant registers under those rules.

Thus the reference data management and mapping issues experienced in financial markets is magnified in energy and commodities. This will not be helped by the requirement for ISIN codes in future regulations, when considering the lack of them in some commodity areas.

The TR

Most readers will be familiar with the trade repository used to collect EMIR data. The majority of energy and commodity market participants sent data themselves to a TR (rather than delegating) either directly or via one of the services that we will examine. While some TRs achieved better market penetration than others, the method for each tends to be similar.

MiFID II reporting

MiFID II will introduce a whole new reporting dimension. Many in the financial industry will be worrying about transaction reporting to ARMs, and in some cases trade reporting to APAs. As discussed in Rocket Issue 5, some energy and commodity traders will also become financial counterparties with the change to the MiFID exemptions. These market participants will need to comply with the transaction reporting rules as well.

There is a much larger issue however when it comes to the MiFID position limits rules, which impacts all market participants. These place limits on all on-venue commodity derivative positions and economically equivalent contracts. Included in the rules is a position reporting requirement. For the most part the venue must report this, but economically equivalent OTCs must also be included in the number. On top of this, the positon reports must segregate ‘risk reducing’ positions from others and also identify the end client. The reporting mechanism for these rules has yet to be finalised, but must by definition be complex.

The RRM

REMIT requires that data be sent to ACER, the EU level regulator, via a Registered Reporting Mechanism, or RRM. This forwarding mechanism is the only authorised route via which data can be sent to ACER’s ARIS system. The various details of REMIT reporting were addressed in Rocket issue 4.

REMIT requires that both ‘on venue’ and ‘off venue’ data be sent. “Organised Market Places” (OMPs), i.e. trading venues under REMIT, are required to offer data reporting agreements for data arising from activity on their platform. While this offers a route for data to be reported, it is considered wise to take a copy of it for surveillance and record keeping (the majority of energy and commodity traders do not currently store orders).

Off venue data must somehow be sent to ACER too. It is permitted to self-report off venue data by becoming an RRM, but this procedure is complex and not many have taken it up. The different available routes are shown in Figure 1.

REMIT – On venue reporting

The first phase of REMIT commenced on 7th October 2015. This covered the reporting of activity arising on an “Organised Market Place” (OMP), a venue under REMIT. OMPs comprise exchanges and broker platforms, many of which are non MTF, as outlined earlier.

In order to fulfil the obligation to offer a data reporting agreement, each OMP may either become an RRM themselves and forward the data to ACER, or make an arrangement with a preferred third party RRM to forward it. The OMP may charge for this service, but must take full responsibility for the data forwarded should this route be elected by the market participant (according to the REMIT Q&A of 16th February 2016).

During the run up to the 7th October, several of the larger RRMs attempted to create a facility where they could capture data from several, or all OMPs. This would permit clients to experience a one-stop-shop, where only one relationship with an RRM is required.

While some RRMs did manage to forge many relationships, none were able to offer this facility for the entire market. This meant that market participants had two choices for the “uncovered” OMPs:

1. Pull the data from the other OMPs and resend it
2. Sign with other OMPs

The first approach incurs a risk if the process fails, since the market participant will incur a liability when reporting. However, the second means that more than one relationship needs to be managed, and the data will be fragmented. Such arrangements are illustrated by Figure 2.

Combined services

Several combined offerings are available for market participants, which include the following:

• TR/RRMs
• Combined confirmation and reporting
• Gateway reporting services

Each is designed to offer a reporting one-stop-shop, approached in different ways:

TR/RRM

Some EMIR Trade Repositories also act as ‘Full’ RRMs (although not all offer this service). These TRs have added a service which allows them to act as RRM for any type of data under REMIT.

Using an EMIR TR/RRM suits those who have activity across a variety of jurisdictions. Data can be sent to the destination no matter under which rule set it is found, and it can be routed to the appropriate destination. This arrangement has several benefits, such as the reuse of the infrastructure already in production, future proofing against new regulations, and also the ability to deal with one provider only. Some TRs/RRMs also partner with OMPs and services in order to acquire their data.

Confirmations service

Many OTC trades in the sector are confirmed using well known central matching services. In one prominent case, the provider offers a parallel reporting service using the same technology and formats, currently for both REMIT and EMIR reporting as well as other European rules.

The service extends the original message format and can then use the data in it to perform regulatory reporting. In the case of EMIR the service forwards the appropriate message to a chosen EMIR Trade Repository.

For REMIT this same service acts as RRM, so an extended message can be forwarded straight to ACER. Many OMPs also forward data directly to the service, reducing the amount of work required in order to implement it, since data does not have to be uploaded and resent. This service particularly suits those who are already using it for confirmations.

Portal services

Many in the sector access trading venues via a portal, which also provides a reporting service.

For EMIR, the service permits reporting to one of several EMIR TRs. If the portal had the data, it could be enriched and forwarded. If not, facilities were provided to upload the data and it could then be reported.

For REMIT, a similar facility is provided, and the portal will also act as RRM. In addition to reporting, a service is offered to store reconciled and enriched data that has been sent, solving the reconciliation issue outlined earlier. The service also connects to several OMPs.

This type of service in particular suits those who already make extensive use of it, trade on many OMPs and do not wish to store the data themselves.

Figure 3 shows how the different types of service may be deployed.

MiFID II, what does it hold?

The primary requirements under MiFID for the energy and commodity market are to report positons in commodity derivatives as part of the position limits rules. In the main, this reporting is to be carried out by venues. However, the market participant will need to report:

• Economically equivalent contracts
• The ‘ultimate client’ and all clients in between
• Data such as whether the trade is a hedge

It is not yet clear how this reporting will work, since ITS 4 and ITS 5 of MiFID states that it must go via a venue. There are several possibilities which are likely to evolve as the live date gets closer.

Some market participants will also become MiFID regulated entities and therefore be subject to transaction reporting (which will usually be carried out via an ARM). Some may also be covered by other reporting.

It is likely that the services mentioned above will all offer services in this area.

Switzerland

The Swiss “FinFrag” rules start next year, which for Swiss entities will require additional reporting in some cases to a Swiss TR. In addition, Elcom, the Swiss energy regulator has introduced rules in parallel with REMIT. Under these rules, any cross border trade between Switzerland and an EU country must be “double reported” to both an RRM and Elcom. This creates additional complexity in reporting.

The future

Both EMIR and REMIT already have scheduled changes in formats, likely to be in 2017. In addition, Brexit may well give rise to additional reporting requirements in a few years’ time. Market participants need to plan their architectures carefully to learn the lessons from the financial sectors and deal with a constantly changing stream of requirements.

In the past, many market participants tended to take a tactical approach to reporting. Such an approach has now become unsustainable and many are considering moving to a more centralised approach.

As the commodity and energy trading sector becomes ever more ‘bank like’ we can not only expect the requirements to increase, but also that market participants adopt a more bank like approach. To accommodate this, the infrastructure around it will also adapt. This is generally the only pragmatic way to keep up with the ever more complex web of requirements which will only get harder to deal with as both regulations and politics unfold.

This article was first published in edition 7 of Rocket, our magazine. Download available Rocket editions here, and save your up to date address in your profile to to indicate your interest in receiving a printed copy of the magazine. Copies are also available to purchase and subscribe to via the shop.

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