WUEG October 2015 Newsletter

October 2015
Investment Services Regulation: MiFID II and Energy
Trading Firms
Frank Geng – Member, Academic Committee
In November of 2007, the EU implemented the
Markets in Financial Instruments Directive (MiFID)
in an attempt to increase investor protection and
competition in investment services. The law
institutes harmonized regulation by targeting the
investment intermediaries, as well as organizations
trading financial instruments within 31 EU memberstates.
Recently, in light of the financial crisis, the
EU has revised MiFID and is preparing to rollout the
new changes in the restructured MiFID II in January
2017. Under numerous exception carve-outs, many
energy firms had initially managed to exempt
themselves from MiFID coverage. But with the new
amendments, these exemptions have narrowed,
and now energy trading firms should understand
the implications of regulatory impact.
Under the original MiFID framework, most firms
dealing with commodity derivatives had enjoyed
exemption from numerous rules as they did not
pose a comparable systemic risk. MiFID II will close
many of these exemptions, effectively
recategorizing these energy trading firms as de
facto financial institutions. The amendments will
still leave room for organizations that provide
investment services for commodity derivatives, but
only if they are considered an “ancillary” portion of
the company’s core business.
However, for many companies, acting as marketmaker,
high-frequency trading, and hedging, are
standard procedure for optimizing physical energy
assets. If these trading arms become too large, the
law will disable the financial strategies of many of
these firms.
Similarly, a recategorization may potentially put
the impacted firms under the crosshairs of the new
European Markets Infrastructure Regulation
(EMIR)—a regulatory body that enforces even
stricter guidelines for over-the-counter trades
(OTC) reporting and risk mitigation. Energy forward
contracts, for example, if considered OTC
derivatives would make hedging, cash, or rate
planning much more difficult. More specifically,
having to enforce MiFID II and EMIR compliance
would trigger a flood of legal, technical, and
strategic restructuring that may not necessarily aid
the objective of harmonized regulation and simply
hinder these firms’ core business processes.
In short, MiFID II deals with three key areas: firm
governance, consumer protection, and trading. As
demonstrated, it will most likely be the trading
provisions that energy traders will be most worried
and affected by. The broader umbrella coverage of
OTC derivatives and algorithmic/HF trading will no
doubt cause plenty of structural headaches.
Perhaps the greatest challenge, however, to these
firms will be to their ability to adapt to a shifting
regulatory environment. What these potentially
impacted firms need to do at this time is
unfortunately not well-defined. But in principle, it is
a need for understanding. What this means is
perhaps a shift towards proprietary trading on
formal regulated markets (where there is regulatory
certainty), revamping compliance specialist teams,
and revisiting their Energy Trading and Risk
Management systems. Most importantly, given the
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