In the last two weeks, both the Agency for the Cooperation of Energy Regulations (ACER) and the European Securities and Markets Authority (ESMA) have published consultations for market participants on the Regulation on wholesale energy market integrity and transparency (REMIT) and the European Market Infrastructure Regulation (EMIR), respectively. This article considers some of the issues that have been raised by both consultation papers and outlines the areas where the input of markets participants has been sought.
EMIR was introduced to regulate the over-the-counter (OTC) derivatives market, with the aim of mitigating counterparty risk. EMIR requires the clearing of trades by central counterparties and the reporting of trades to a trade repository. It will apply to all financial counterparties and to non-financial counterparties (counterparties, who, by elimination, are not financial counterparties), in certain circumstances.
Following EMIR’s adoption by the European Parliament, ESMA has published a consultation (the EMIR consultation), seeking the views of market participants on proposed technical standards that will be included in the final text of EMIR. The technical standards are the details that will make EMIR work and will determine who and what is subject to it. The EMIR Consultation follows the publication of the discussion paper in which ESMA published preliminary views on the draft technical standards. Below we consider some of the provisions that are dealt with by the EMIR consultation that, until now, have been the cause of general uncertainty for market participants.
Non-financial counterparties will only be required to clear contracts when they exceed a (yet to be announced) prescribed threshold. Trades entered into that can be described objectively as reducing risks relating directly to the commercial activity or treasury financing activity of the counterparty (i.e., entered into for hedging and non-speculative purposes), will not count towards ascertaining whether or not the non-financial counterparty has exceeded the prescribed threshold. Exactly how “entered into to reduce risks” should be defined is a question raised by the EMIR consultation. ESMA states that it expects that those trades that would qualify as a bona fide hedge under the Generally Accepted Accounting Principles are likely to be classed as a trade entered into to reduce risks under EMIR.
Following comments received by ESMA on the discussion paper, however, ESMA has taken the view that “proxy hedging” trades should also be excluded when calculating whether or not the prescribed threshold has been crossed. This is because there may be circumstances where it is not possible to enter into an OTC contract that relates directly to the exact risk to be covered, but only one that relates to a closely correlated instrument that also achieves objective risk reduction. Views are sought on whether the amended definition of hedging provides enough legal certainty.
Regarding the clearing threshold itself, ESMA is proposing to set the bar relatively low, to ensure that counterparties with activity levels that may create significant risk to the market are captured by EMIR. ESMA is also proposing to set a clearing threshold measured per asset class (as opposed to a global threshold. It intends to have five such classes: credit derivatives, equity derivatives, interest rate, foreign exchange, and commodities and “other”.
The exact detail of what has to be reported for each transaction is still to be ascertained, with the EMIR consultation seeking the views of market participants on this question. Currently, the minimum level of information that ESMA expects to be reported on each trade includes the parties to the contract; the beneficiary of the rights and obligations arising from it; and the main characteristics of the contract, including the type, underlying, maturity, notional value, price and settlement date. ESMA has suggested that it may assign a Legal Entity Identifier to all counterparties and that counterparties will have to state whether or not the trade is linked directly to their commercial activity or treasury financing activity, and whether or not the prescribed clearing threshold has been exceeded.
If a counterparty does not derive an economic benefit from the trade, then the beneficiary that is deriving an economic benefit will have to be listed. One of the questions that has been raised concerns how far one has to trace the beneficiary to the trade if, for example, trades are done through an investment fund. Equally, if trades are executed between a broker and a dealer, the parties to the trade may not have access to information concerning the ultimate beneficiary of the trade. Market participants who may be a party to such a trade are advised to provide their views on how such situations may be resolved.
Contracts Having a Direct, Substantial and Foreseeable Effect Within the European Union
EMIR states that contracts between counterparties and third party entities that would have been subject to the clearing obligation had they been entered into within the European Union shall be classed as contracts that have a “direct, substantial and foreseeable effect” within the European Union. In order for this provision to be effective, there needs to be strong international cooperation and coordination. Clarity is still needed on what would constitute a “direct, substantial and foreseeable effect”.
The term “direct, substantial and foreseeable effect” is taken from the proposed text of the Markets in Financial Instruments Regulation (MiFIR). In MiFIR, third country entities will be subject to the clearing obligation set out therein if the contract they have entered into has a “direct, substantial and foreseeable effect” within the European Union. The European Commission (the Commission), in addition to introducing EMIR, is revising the Markets in Financial Instruments Directive (MiFID) by creating MiFIR and amending MiFID as it is currently in force. Discussions concerning the final text of MiFIR and the revised MiFID are being undertaken currently, with the final text of both expected to be published in 2013. Once the texts are finalised, the interoperability of MiFIR, MiFID and EMIR will be clearer.
Owing to the significant impact that such a provision would have on non-European legal entities, ESMA believes that further work still needs to be done to develop this provision and definition. This EMIR consultation does not, therefore, seek the views of market participants on this definition; ESMA will instead publish a separate consultation paper that will include draft regulatory standards addressing this question.
ESMA is due to submit the technical standards to the Commission by 30 September 2012. Market participants must then ensure that, once the standards are finalised, they review them to ascertain how their future trading activities will be affected, particularly which of their trades will need to be cleared and reported, and to whom. Market participants have until 5 August 2012 to submit their responses to the EMIR consultation. ESMA will be holding a public hearing on 12 July 2012 to discuss the proposed technical standards.
The framework text of EMIR is currently being translated into the 23 official languages of the European Union, with only very minor amendments to EMIR expected once the translations have been finalised. Further information regarding EMIR and its objectives can be found here and here.
Separately, ACER has published the second of two consultations (the REMIT consultation) on the regulation on REMIT. The REMIT consultation sets out ACER’s recommendations for the recording of wholesale energy market transactions and further information that market participants must disclose. The first consultation, published in April 2012, sought views on the format that National Regulatory Authorities should adopt when transmitting information about market participants to ACER. Following the consultation, ACER has now published a list of information that each market participant will be required to provide to their National Regulatory Authority, which will then be transmitted to ACER. The information that will have to be provided will cover data relating to:
· The market participant;
· Natural persons linked to the market participant;
· The ultimate controller or beneficiary of the market participant;
· The corporate structure of the market participant;
· The delegated parties with responsibility for reporting on behalf of the market participant (if any).
Each market participant will be required to supply this information within three months of ACER publishing the list of market participants that are on the European register. It is not envisaged that registration will begin before mid-2013.Legal Basis for the REMIT Consultation
REMIT, which came into force on 28 December 2011, was introduced to improve the integrity and transparency of the wholesale energy market, by establishing rules to stop insider trading and require the reporting of transactions, including orders to trade. REMIT is the first regulation to impose insider trading rules on the wholesale energy market.
Article 8(1) REMIT states that the information to be reported about each transaction shall include
…the precise identification of the wholesale energy products bought and sold, the price and quantity agreed, the dates and times of execution, the parties to the transaction and the beneficiaries of the transaction and any other relevant information…
The aim of the REMIT consultation is to add granularity to this provision, by creating a set of uniform rules on the information that is to be reported on each transaction, how it is to be reported, and when it is to be reported. In creating a standard “template” for transaction reporting under REMIT, ACER intends to follow the objective of avoiding double reporting by market participants. This will be achieved by ensuring that sufficient information is provided to satisfy the reporting requirements that are imposed by MiFID and EMIR.
However, certain transactions that will require reporting under REMIT, such as spot market contracts that are physically settled, will not require reporting under EMIR or MiFID. Market participants therefore have to be alive to the fact that, once REMIT is finalised, they may be required to report into more than one agency. Nevertheless, the REMIT consultation paper does note that ACER and ESMA, which will receive data from those participants reporting transactions pursuant to obligations under EMIR, will exchange information and will cooperate closely on data collection regarding all market participants in an attempt to reduce the reporting requirements for market participants.
In the REMIT consultation, ACER makes a series of proposals on which it then seeks the views of interested parties. The proposals concern, inter alia, the types of contracts to be reported, the de minimis threshold for reporting, and the timing and form in which information will be reported.
Of the list of transactions to be reported, Annex III of the REMIT consultation sets out eight different commodity contracts including, amongst others, day-ahead contracts for the supply of electricity or natural gas where delivery is within the European Union; long-term contracts in electricity or natural gas that are physically settled, where delivery is within the European Union; and contracts relating to the transportation of electricity within the European Union between two or more bidding areas. The categories of contract on the list are intentionally broad, covering a wide range of transactions to be reported. Accordingly, the list may be amended to ensure that it continues to be fit for purpose and reflects evolving markets. Market participants are asked whether or not any further transactions should be added to the proposed list and whether or not they agree with ACER’s idea of keeping the list wide-ranging, rather than being overly prescriptive.
Article 8(2)(a) states that a de minimis threshold for reporting may be introduced, where appropriate. ACER gives three options:
1. Refrain from having a de minimis threshold altogether; the list of transactions to be reported is sufficient to limit the scope of REMIT and it should not be limited further by introducing a de minimis threshold.
2. Producers operating and trading an overall capacity of up to a maximum of 2 MW may be excluded from the reporting obligation, as they would not come within the definition of Market Participant that is introduced by REMIT.
3. In the case of small energy producers acting individually, contracts for the sale of renewable energy sources at administratively fixed prices may be excluded from the reporting requirement, except where these contracts are entered into by producers that would otherwise be subject to reporting obligations.
Views are sought on these three options and proposals are sought for alternative thresholds.
Regarding the timing and format that the report should take, ACER proposes that trades undertaken pursuant to standardised contracts should be reported as quickly as possible, no later than the close of the working day following the execution, modification or termination of the transaction, or the placing of orders to trade. Transactions undertaken pursuant to a non-standardised contract should be reported within one month following the execution of the transaction. The recording of all transactions should be done in electronic form.
Not only will market participants be required to report transactions, they will also be required to report information, which will allow for the monitoring of trading in wholesale energy markets. Such information will include details relating to the following:
· The capacity and use of facilities for production of electricity or natural gas
· The storage of electricity or natural gas
· The consumption of electricity or natural gas
· The transmission of electricity or natural gas
· The capacity and use of LNG facilities, including planned or unplanned availability of these facilities.
The reporting of this information will ensure that market participants disclose details that may be considered to be inside information, thereby ensuring transparency and the proper functioning of the relevant market.
ACER intends to provide the Commission with its recommendations on how transactions are to be reported, and the necessary implementing acts, by 30 September 2012. Following the adoption of the implementing acts, the Commission should be required to re-examine the implementing acts once every two years, following consultations with ACER.
Market participants have until 31 July 2012 to submit their replies. A full list of questions being considered by the REMIT consultation may be found at Annex I of the REMIT consultation paper.