REMIT and EU Power markets are set for major change – What does Compliance need to know?
By CubeLogic’s Shane Henley, Global Head of Monitoring Solutions
April 6, 2023
The wheels of change are in motion for European power and gas markets. While many would prefer “evolution” over “revolution”, we might well get the latter should the European Commission get its way. While this story has some way to run still, what might some of these changes mean for regulatory compliance in this sector?
The story begins, officially at least, in January 2023 when the European Commission (“the Commission”) announced a consultation on the reform of the European Union’s (EU) electricity market design to help protect consumers against excessive price volatility, support the access to clean and secure energy, and to make the market more resilient. The impetus for this was driven partly by the extreme volatility experienced during 2022 resulting from the disruption of EU gas supplies from Russia, although reform has been a long time coming due to structural changes in the market driven by the rapid increase in renewables and the chasing of ever tighter low-carbon targets.
Following the end of this consultation in mid-February, the Commission rather rapidly published their extensive reform proposals revising several pieces of existing legislation, including REMIT (or the Regulation on wholesale energy market integrity and transparency to use its official title). While we touch briefly on the proposed market reforms themselves, we will take a detailed look at the proposed change to REMIT.
What electricity market reforms has the Commission proposed?
Most of the measures are directed at protecting producers and consumers from price volatility and creating a market more conducive to higher renewables penetration. They also look to introduce fairer compensation mechanisms around renewables to avoid excessive profits and the need for revenue clawbacks as seen recently in some EU markets.
To protect EU industry from volatile energy prices, member states would need to ensure that longer term price certainty is achievable by making fixed price Power Purchase Agreements (PPAs) available for producers and consumers. Under the proposals, these PPAs should be market based accompanied with non-government guarantees to remove credit-related barriers.
To help power producers stabilise their revenues against extreme price volatility, the Commission proposes that any public support for new “infra-marginal” and must-run generation (renewable and non-fossil fuelled) must be in the form of two-way Contracts for Difference (CfDs) giving producers a minimum income and at the same time channelling excess revenues back to consumers. Another key proposal is around boosting forward market liquidity to help both suppliers and consumers to hedge against excessive volatility. For consumers, this would mean giving them the ability to enter into long term fixed price contracts with the flexibility to have multiple contracts, including the option to combine fixed and variable price options together.
The proposed reforms will also oblige members states to introduce measures to better integrate renewable generation into their electricity system. These proposed measures are mostly aimed at system operators, and how they go about handling grid congestion and enabling market participants to trade closer to real-time.
While these proposals will have far reaching impacts on the market and how firms operate within them, the final proposals will undergo significant scrutiny before and during the trilogue process – the opaque dance that occurs between the EU Commission, Council and Parliament to reach a final legislative compromise.
What might change under REMIT and what should energy trading firms be thinking about?
Changes to primary EU legislation (or “Level 1 text”) of this magnitude are rare as it requires political agreement to effect such changes. This proposal is indeed the first major change to REMIT since its inception in 2011, and should therefore be of significant interest to compliance and front office alike. So what are some of the key focus areas relevant for firms trading in EU power and gas markets?
REMIT alignment to Market Abuse Regulation (MAR) definitions
The definitions of market manipulation and inside information will be changed to align to MAR, REMIT’s financial market sister regulation. Besides the obvious legal benefits of having clearer consistency between the two regulations, this also reflects recent public announcements by ACER and ESMA of their mutual desire to work more closely together on strengthening energy market integrity.
So what? From a market abuse enforcement perspective, the messaging is abundantly clear that stronger working cooperation between the financial and energy regulators is a priority for the EU. While it is unclear how exactly this will translate into cooperation between national energy and financial market regulators is unclear, but firms should be prepared for increased scrutiny over their trading activities, regardless of whether they trade physical or financial products.
Benchmark manipulation is now explicitly prohibited
The updated definition of market manipulation will now explicitly ban the manipulation of power and gas price benchmarks. The topic of benchmarks is not new to energy markets but they’ve come to prominence over the last year given the high wholesale market prices and the newly introduced EU LNG benchmark published by ACER. The new text dealing with benchmarks is broad, and isn’t limited only to manipulative trading behaviour – it includes anyone contributing to or transmitting false or misleading information in relation to benchmark construction. It should also conspicuous that the term ‘benchmark’ is not defined explicitly in the text, which implies that the provision extends beyond the LNG benchmark which itself is defined. Further rounds of scrutiny will reveal whether this was intentional.
So what? While the manipulation of benchmark prices is arguably already covered by REMIT (for example, where extensive references are made to reference price manipulation in the Guidance), the explicit inclusion of benchmark manipulation in the definition of market manipulation provides regulators with the necessary legal clarity to pursue enforcement cases in this area. Firms that contribute to any benchmarks will need to implement rigorous internal controls to ensure that such contributors do not knowingly (or unknowingly) do anything which could be interpreted as manipulating such benchmarks. Many EU energy trading firms do not have much experience under the EU Benchmark Regulation where tight controls are mandated in this area. Similarly, firms will need to consider what type of surveillance is appropriate for benchmark-related activities.
While the proposed changes to REMIT still do not mandate the general requirement for market participants to have a surveillance capability, many firms in the sector, both large and small, have already opted to have one. Firms should consider what the new definition might mean from the point of surveillance, both from a trade and order behaviour, as well from a communications perspective.
Algorithmic trading rules – governance, control and reporting
Off the back of the huge increase in algorithmic (‘Algo’) trading across European power and gas markets in recent years, it doesn’t come as a surprise that the Commission’s proposal includes new rules to govern this activity.
Usefully, “algorithmic trading” is clearly defined and explicitly excludes automated order routing. The new article requires that “The market participant shall also have in place effective systems and risk controls to ensure that the trading systems comply with this Regulation and with the rules of an organised market place to which it is connected.” While it would be perhaps useful if the Commission adopted the same text used by MAR (i.e. “..establish and maintain effective arrangements, systems and procedures..”), this nonetheless seems to confirm that a monitoring capability over these activities will be a mandatory requirement.
In a second major component to the proposed rules, there is a requirement for market participants to notify their national regulators that they are engaged in Algo trading. They will also need to provide invasive details about the strategy and parameters being employed, and provide information about the compliance and risk controls in place to ensure that the new Algo rules under REMIT are met. Finally, firms providing direct electronic access to others in the market for Algo trading will also be required to notify the regulator of such, and provide details where requested.
In both of the above cases, firms will need to have robust recordkeeping in place to “enable” the regulator to “monitor compliance with this Regulation”.
So what? Firms wishing to engage in Algo trading in the physical power and gas will need a surveillance capability. While many firms have recognised their exposure under MAR and have already implemented a surveillance capability, this might not cover markets like EPEX Spot and Noord Pool where much of short term power market liquidity resides. Smaller firms that have stayed out of the RTS 6 regulatory perimeter (the part of MIFID II that covers financial market Algo trading) by deploying Algos in physical markets only will need a rethink. The effective surveillance of short term power markets in particular remains extremely challenging. Presumably the new rules will allow firms sufficient time to prepare, particularly if this involves implementing a sophisticated technology solution. Nonetheless, early preparation for this eventuality is advised.
Finally, it is clear that firms will need to significantly enhance their governance and controls around Algo trading should this article become law. Firms already in scope of RTS 6 will likely be able to repurpose their existing frameworks. Smaller, physical-only traders however will likely need to invest heavily in skills and technology to achieve the required standard, or failing which, may be forced to leave the sector. Perhaps this is exactly what the Commission had in mind.
REMIT reporting for Balancing Market activity and the role of Registered Reporting Mechanisms (RRMs)
The Commission sees a need for a much improved reporting regime despite the existing REMIT regime arguably being the most comprehensive in global energy markets. To close a number of gaps, the proposals include the collection of balancing market data (reportable on demand at present) including from adjacent, third country markets that can deliver into the EU. Reporting “coupled market” data will also be mandatory. Organised market places (OMPs) will be obliged under the new rules to provide full order book data to ACER.
So what? Beside the increased reporting burden for some, the potential implications for market surveillance will likely arouse interest from firms operating, and trading around generation assets. Balancing markets remain opaque, and are difficult to monitor given the lack of data. Is this set to change under the new rules? Similarly, the requirement that ACER be furnished with complete order book data suggests that this is an area they currently struggle with. Whether they will have the right tools at their disposal to properly analyse order book behaviour when this data is provided to them remains to be seen. It would however be prudent for firms, particularly around short term markets, to ensure that they have effective surveillance in place that considers the order book in a meaningful way.
A final note regarding reporting. RRM’s would become defined entities under the new rules which would be both authorised and supervised by ACER in their role as an approved pan-EU reporting agent. Centralised control of RRM’s by ACER through the primary legislation is presumably seen by the Commission as way to definitively address the poor data quality issues so frequently expressed by ACER.
Tighter control over the reporting of Inside Information
It will become mandatory for firms to use registered and authorised Inside Information Platforms (IIPs) to disclose inside information under the new rules. This would be the first time that IIPs effectively become regulated entities for the purpose of providing this service. The new rules would move much of the guidance currently applicable to the disclosure of inside information into the Level 1 text of REMIT making it mandatory. Most firms in the sector have already begun using the services of an IIP so no significant impacts are expected under this proposal.
ACER to get enforcement teeth, and more power…
Perhaps one of the more controversial changes is the proposed shift of powers away from national regulators to ACER under the new rules. At present, national regulators have been responsible for investigation and enforcement under REMIT. ACER’s role is largely restricted to identifying and reporting suspicious behaviours to the national regulators, and providing background support. According to the Commission, this is not an effective framework, particularly for the high degree of cross-border activity in EU energy markets, which includes participants operating from outside of the EU.
As such, it is proposed that ACER will take responsibility for investigating cases with a “cross-border dimension” but in cooperation with national regulators. A “cross-border dimension” under the proposed legislation means where the suspicious activity involves products from markets in at least three member states (or where one of three is an actor in an adjacent third country).The proposal however also gives ACER investigative power over a case if the national regulator doesn’t act “immediately” as is required at present under REMIT.
ACER would be given investigative power – including the authority to conduct on-site investigations and to request documentary evidence.
So what? If adopted, this change would introduce another active regulatory stakeholder for firms trading in the EU to consider. ACER would have the power to intervene directly in cases, including the ability to conduct unannounced site visits (or “dawn raids”). They would also have the power to invoke local law enforcement where parties resist inspections. This is quite a shift from the somewhat benevolent body most in the market have grown accustomed to! If the proposals are adopted in their current form, is this sort of active intervention from ACER likely? It certainly seems unlikely if ACER’s well-publicised resource and budget constraints don’t change. Investigations require manpower, something which ACER is currently very short of, even before the additional duties around LNG price assessments and benchmark management were introduced. Presumably the Commission would see fit to significantly boost ACER’s budget although based on past experience, this isn’t guaranteed. Regardless, firms should consider where their market abuse risk lies, especially with regard to their cross-border activities, and implement an appropriate compliance framework to address this risk.
What comes next and how should firms prepare?
These proposals are currently in the feedback period which ends on 23 May 2023. All feedback received by the Commission will be summarised and presented to the European Parliament and Council who will commence their respective legislative debates. Given the magnitude of the proposed changes, and some of the critical feedback already made public by various industry bodies, it is difficult to predict the likely timeline for its adoption, nor the final state of the rules themselves or the go-live date(s). As a political process, there is often last minute horse-trading involved as individual member states push to prioritise their respective interests. Firms impacted by the proposed changes should actively engage in the feedback process to help shape acceptable outcomes.
In terms of preparation from a compliance perspective, at this stage tracking the legislative debate and feeding this into high-level impact assessments is the most appropriate, cost effective course of action. An internal feedback mechanism should be established to help ensure that compliance, trading, IT and management stakeholders are made aware of the likely regulatory change scenarios, and any new announcements are promptly communicated to them.
Likewise, given that the potential changes to the Electricity Regulation and Electricity Directive will likely result in structural market change, compliance should engage with the business to understand what the impacts are likely to be on both the business and operating models of the firm. This will help compliance to be on the right footing to respond appropriately once the final rules are agreed. Either way, there is an awful lot of work ahead for everyone involved.