A deep dive in energy derivatives and its EU supervisory framework

Written by Liebrich Hiemstra, Vrije Universiteit Amsterdam – Amsterdam Centre for Climate Change and the Law and Vattenfall NV, the Netherlands

A constant factor in the energy sector is its constant development, evolution and movement. This also applies to the financial products traded within the energy sector. Yet, this is one side of the energy market which has been researched very little: the trade in energy derivatives and how such trading is supervised by EU and national regulatory authorities. My take on this is that the supervision of this sector is too unclear and that the available remedies to market participants against a decision of supervisory agencies to share or disclose confidential information are ineffective.

Energy derivatives and information sharing

Energy companies’ role paramount to society is producing energy products and selling those to end consumers. Behind the scenes of this core activity, most energy companies are also active on financial markets where they trade in financial instruments with an underlying value derived from the price for energy commodities such as electricity and natural gas, widely known as energy derivatives. It appears that trading in energy derivatives (Energy Derivative Trading) is characterized by a cross-border nature and that EU agencies (ACER and ESMA)  cooperate closely with national regulatory authorities to monitor and supervise market behavior whereby data relating to trading activities of market players is exchanged based on the Regulation on Wholesale Market Integrity and Transparency (REMIT).  Simply put, market participants are obliged to disclose data on their trades in energy derivatives to supervisory authorities, even when it includes business-sensitive information.

This book explains why energy companies get involved in Energy Derivative Trading, how it works, what legislation applies, how its supervision is organized and how the relevant supervisory authorities cooperate and share information. It shows that market players are subjected to a regulatory and supervisory framework at the interface of the energy and financial sector. One of the consequences thereof is that supervision in this sector is too opaque.

Information sharing and supervision

Based on REMIT, market participants should disclose information relating to their Energy Derivative Trading activities to supervisory agencies. Such information is by nature confidential as it contains data and facts of a market participant’s activities and potentially business secrets and strategies. It appears that ACER may share such information with other supervisory agencies at EU level (ESMA) and with national regulatory agencies. Such information sharing is essential to monitor the market effectively, though on the other hand it appears to be vital that market participants are able to trust supervisory authorities in treating their disclosed information as confidential, and that market participants have sufficient remedies available to enforce their rights in case supervisory authorities breach their confidentiality obligation.

This brings us to a paradox. One the one hand, we see that the supervisory landscape is characterized by a multitude of supervisory authorities which does not contribute to effective supervision as ACER and national regulatory authorities lack the power to enforce and sanction, and other authorities lack the knowledge to do so, given the cross-border and cross-sectoral character of Energy Derivative Trading. On the other hand, the sharing of information relating to a market participant’s Energy Derivative Trading activities is essential to conduct the supervisory task, but does raise questions on effective judicial protection.

While market participants may count on regulatory authorities’ legality – that the authorities’ actions are based on an adequate legal basis – and effectiveness – that those actions contribute to the goal of the underlying legal basis –, they also have a right to have legal remedies available to them to seek judicial protection against a breach of confidentiality and the obligation of professional secrecy of supervisory agencies when exchanging confidential information. Next to the right to have such judicial protection framework in place, the available remedies should be effective. This book puts the concepts of legality and effectiveness in light of regulatory authorities’ options to share information relating to Energy Derivative Trading.

Supervision and effectiveness, legality and available remedies

The sector’s complexity and the multitude of supervisory authorities at both EU and national level has raised concerns about effective supervision. Effective supervision within the context of this book is explained as the effective monitoring of Energy Derivative Trading by supervising the market participants’ reporting obligations to enable the detection of market abuse. This book aims to contribute to the debate on the good governance principles of effectiveness and legality within a transnational context by placing information sharing between supervisory agencies in the context of these two principles. Several aspects are relevant there: i) the regulatory paradigm that applies to Energy Derivative Trading; ii) the effectiveness of supervisory activities in the cross-border and cross-sectoral Energy Derivative Trading landscape from the perspective of reporting obligations which apply to market participants, and iii) information sharing in the field of Energy Derivative Trading within the context of the rule of law and an exploration how market participants can rely on judicial and administrative remedies against information sharing between supervisory authorities.

Supervision too opaque?

One of the findings of this book is that market participants may not even be aware that information relating to their Energy Derivative Trading activities is shared amongst supervisory authorities. An available remedy is only effective if the addressee is aware of the existence of such remedy and the act which may trigger such remedy. Now that market participants may not be aware of information sharing, the effectiveness of available remedies is therefore questionable. Reflecting on questions and potential answers in relation to the field of tension between effective supervision and judicial protection of market participants, several thoughts come forward. It appears that the ineffective multitude of supervisory authorities and the consequential sharing of information would not be necessary if a one-stop-shop EU body would exist with a cross-sectoral and cross-border monitoring, supervision and enforcement mandate in the EU energy market. Why not investigate the option to broaden the powers of ACER or explore the possibilities to place ACER’s mandate and knowledge under the umbrella of ESMA. Such investigation should take several elements into account, for example the broadened or strengthened legal mandate to supervise and enforce, the additional cost thereof, risks of regulatory capture and practical objections about how such a body should investigate on a local level. Also, one could question whether further harmonization of supervision and mostly enforcement would be beneficial in light of effective supervision and available judicial protection. Whilst energy markets, their participants, institutions and operations are strongly connected to national and historical developments that make national markets distinct, the question remains whether harmonization will eventually be the preferable option, as it can surely not be considered the easy way out.

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