European energy firms are up in arms about the latest batch of regulations being cooked up in Brussels – and justifiably so.
The new Markets in Financial Instruments Directive (Mifid II) is particularly onerous for energy firms because it would draw them into a web of regulations that previously only banks have had to worry about. Most significantly, it would impose bank-like capital requirements on firms with a large presence in commodity derivatives. As a result, oil majors and large electric utilities say they will need to set aside billions of dollars in capital.
Naturally, regulators don't want to penalise firms that are just using commodity derivatives for the innocent purpose of hedging, such as airlines using oil swaps to protect themselves from spikes in fuel prices. So the Paris-based European Securities and Markets Authority has crafted something called the 'ancillary business exemption' to ensure that such innocent bystanders don't get hit by the Mifid rules.
The details are complex, but the basic idea is that firms that mainly use commodity derivatives for hedging get the exemption, while those that mainly speculate on price moves don't get it.
The problem is that drawing that line between hedging and speculation is tricky. There are myriad ways in which firms use commodity derivatives to manage risk, and it's difficult to gather those together into a single, coherent rule that accurately captures all hedging activity. Thus, many energy firms that don't view themselves as being particularly big risk-takers are looking at the proposed exemption, comparing it to their risk management practices and fearing they will be tagged as speculators.
What’s exasperating for many market participants is there is no clear reason why regulators are even doing all this in the first place
What's also exasperating for many market participants is there is no clear reason why regulators are even doing all this in the first place.
Esma chairman Steven Maijoor offered this rationale during a September 28 call with reporters: "Once you go into speculative trading, you are competing with investment banks and there should be a level playing field."
That raises a question: whom, exactly, is this "level playing field" supposed to benefit? Apparently, Esma is acting on behalf of banks, the only entities that have previously had to live with capital requirements. Now, bankers can lean back and cackle with schadenfreude as such rules are imposed on commodity trading houses, utilities and oil majors.
None of this makes sense. The point of imposing capital requirements on banks is to ensure they have reserves of safe, liquid assets such as cash or US Treasuries to draw upon during a crisis of confidence, such as a run on deposits. But that simply doesn't apply to the world of energy and commodities companies. Such firms have real-world, physical assets to fall back on, such as power plants and oil wells. Making energy firms set aside an additional layer of capital is pointless.
At an October 12 panel in London, one European Commission official suggested delaying the imposition of capital requirements on commodities firms – currently due to happen on December 31, 2017 – because of the risk of "unintended consequences".
That would be a good first step. The next step should be to have a thorough rethink and ask whether these rules are actually necessary.
The week on Risk.net, February 10-16, 2018Receive this by email