By James Stirton is senior energy consultant, EMEA at Allegro Development.
The countdown to the arrival of MiFID II in commodity markets did not start in January as expected. And it may not even start next January given that the chair of ESMA suggested an additional 12-month delay to January 2018 may actually not be enough.
EU member states are dragging their heels on ratification, while the various regulatory technical standards are still being defined. It means that the work required to implement MiFID is hampered by uncertainty and we are already hearing that many smaller firms are scaling back their implementation efforts.
It would be a shame if that points to a wider industry trend, because this latest set of rules to regulate commodity trading has serious and complex operational implications that require an equally measured and well-planned technology response.
MiFID II consists of a directive, which must be implemented by each EU Member State, and a regulation which is applied across the EU. As with the recently implemented EMIR and REMIT regimes for commodity trading, technical standards and other secondary legislation need to be drafted and adopted by ESMA before legislation can be implemented.
Although it is too soon to make major changes, the experience of EMIR in 2014 – beset by delays eventually rushed in with a 90-day final deadline — means steps to comply with MiFID II need to be taken now. Even with so much up in the air, there are things you can do to mitigate exposure to regulatory risk.
Smart technology investments can help by surfacing exposures in the trading portfolio and providing quick assurance that trades and related activities happening today are at least aligned with the current direction of travel for MiFID II compliance. This has already been shown through EMIR and REMIT, which compelled many companies to invest in or revisit their Commodity Trading and Risk Management (CTRM) systems. MiFID II could well necessitate another round of IT upgrades, particularly in the in the area of reporting to trade repositories.
While it is still too soon to make firm or detailed recommendations, beginning the due diligence process with vendors should begin now, if it isn’t already underway.
Energy sector IT needs to act now to prepare
Despite the possibility of an extended deadline there are alternatives in terms of what large energy consumers and financial services companies can do now to prepare for MiFID II. Managing the process by spreadsheet is not one of them. There are electronic reporting and data storage requirements involved in each set of regulations that will quickly overwhelm manual processes.
Outsourcing may be a solution, but it comes with its own costs and risks. There is the added overhead of an ongoing contract to manage, so how active you are in the energy trading arena will determine your breakpoints financially. But in the end, do you really want to outsource a liability you will ultimately be held accountable for should any errors or delays in compliance occur? A third party provider will most likely not be responsible for paying fines. Even if you could negotiate a contract that held them financially liable, what would an infraction mean to your brand reputation? The collateral cost of cleaning up a public relations nightmare could be devastating.
That leaves accepting higher energy prices by abandoning a hedging strategy altogether, or automating the process. After weighing the options, automation is the best business decision.
Automating regulatory processes requires a basic energy trading and risk management (ETRM) system, which is a comprehensive regulatory solution for commodity trading and corporate financial compliance. ETRM is generally not a stand-alone application and needs to incorporate contract data, hedge accounting, revenue allocation, and the all import regulatory reporting requirements for your geographic markets.
In light of the evolving standards for EMIR and REMIT, you will want to choose a solution that allows you to upgrade and manage your regulatory compliance process quickly. Another qualifier to consider is the ability to install software on a captive system and maintain it internally, or purchase a software-as-a-service (SaaS) contract and maintain it virtually in the cloud. Implementing this option could affect your overall total cost of ownership as you integrate the system into other areas of the business.
Direct connectivity to trade repositories should also be a core capability, including all required regulatory identifiers and formats. The system should be able to simplify the threshold monitoring for non-financial counterparties (e.g. energy intensive businesses operating a hedging strategy) and facilitate risk mitigation obligations, including EMIR’s requirement for periodic portfolio reconciliations.
If it isn’t regional conflict or extreme weather injecting risk into the energy value chain, politics and its regulatory offspring seem to constantly evolve new rules and penalties that create uncertainty. And this is a reality that energy and commodity traders need to address sooner rather than later.
Today’s evolving regulatory standards and shifting deadlines make it harder for energy traders to comply with MiFID II. What is needed is an automated approach to meet the requirements.