Managing Regulatory Compliance Risk in Energy Markets


With the recent implementation of the Dodd-Frank Act and other federal and local market regulations, regulators like the Commodity Futures Trading Commission (CFTC), Securities and Exchange Commission (SEC), Federal Energy Regulatory Commission (FERC), and Department of Justice (DOJ) are now armed with a more aggressive toolkit to identify and take to task those companies that they believe have attempted to manipulate prices in the U.S. energy and commodity markets.  Prior to the adoption of new rules, the regulators not only had to prove that individual traders or companies were in the position and intended to manipulate energy prices to their advantage, they also typically had to prove that the person or company was in fact successful in doing so and was somehow enriched in the process.

Now, the regulators only have to prove that “manipulative and deceptive devices, i.e., fraud and fraud-based manipulative devices and contrivances (were) employed intentionally or recklessly, regardless of whether the conduct in question was intended to create or did create an artificial price.”

This new lower burden, combined with regulators strengthening their analytical capabilities to better identify anomalous trading patterns and activities, places additional pressures on all market participants to constantly monitor their businesses to ensure none of their personnel, or their business lines, are involved in trading or marketing practices that can have even the appearance of market manipulation, either through intent, negligence or ignorance.

Specifically, market regulators will be looking for any activity that may be perceived as intending to have an impact on prices that could benefit another commercial or trading activity, including attempting to manipulate daily market settlement prices or indices or manipulating physical energy prices that may be used to set financial instrument prices and vice-versa. Examples of these types of activities include transacting heavily on the close of the financial market, then immediately covering the transactions after the price is set; falsely reporting transactions and prices to an index publisher; or taking a large position in an underlying instrument that sets an index to benefit the pricing of another speculative position.

Armed with their new rules and tools, market regulators have become more aggressive in seeking out potential manipulation. For example; the CFTC more than doubled its formal enforcement actions from 2009 to 2012, and recovered almost $1B in fines and illicit profits last year.  Included in the list of recent regulator targets are oil and gas producers, energy traders, and banking institutions.

Some key areas the regulators are focusing on include:

  • Inter-market Manipulation — aforementioned transactions where one index or market is traded at a loss or manipulated to benefit another set of transactions.
  • Wash Trading – where a transaction occurs (bought or sold) and is immediately offset (sold or bought) to give the false impression of a larger volume of transactions or to set a price to benefit the settlement price or stimulate interest in a thin market.
  • Austin Morris_insiderAustin Morris is a managing partner at SunGard Global Services’ Energy Consulting Business and is based in Houston, Texas. He has over 21 years of experience in information technology and management consulting.

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  • Capacity Release – when natural gas capacity is traded to avoid shipper must have title requirement and other capacity and transportation regulations.
  • “Banging the Close” or “Painting the Tape” – a large volume of transactions entered to manipulate the closing price or weighted market index.
  • False Index Reporting – reporting prices to indices that do not reflect the actual market or actual transactions in order to influence index settlement.
  • Market Power – exceeding position limits or violating capacity rules to affect the market.
  • Fraudulent Activities – collusion with other trading organizations, front-running customer business, or exceeding risk capital limits.

The new authorities granted by recent regulations and an aggressive posture by the regulatory leadership should be a call-to-action for all companies that engage in energy and commodities markets, both large and small, including producers, banks, merchants and marketers, to ensure that they have a systematic and programmatic approach to compliance. This means ensuring that their personnel are fully aware of their responsibilities under the new regulations, to upgrading existing controls and systems (or implementing new ones where necessary), to ensuring that manipulative activities, either intentional, incidental or perceived, are prohibited; or where they cannot be prohibited, are quickly identified, rectified and reported.

Having a robust, formalized and comprehensive compliance program is not only important in preventing manipulative activities, but is also an important tool in mitigating regulatory or financial risks should a regulatory investigation occur.  As regulators look at potential manipulative activities, their demands will be far-reaching and any company under investigation will be expected to cooperate fully, and make available all data and information in a clear, concise and timely manner.  Failure to do so will result in increasingly aggressive actions and fines, and will subject those companies to intense scrutiny for years to come.

Specifically, organizations should be seeking to establish or upgrade their compliance programs to meet proactive standards expected by regulators and shareholders, alike. Areas of focus include:

–          Establish, or revise, trading and compliance policies to reflect the new rules under the Dodd Frank Act, as well as, other emerging High Frequency Trading (HFT) rules, recent interpretations of existing rules in the Commodity Exchange Act; and any recent rules interpretations set as a precedent by the Federal Energy Regulatory Commission (FERC)

–          Revise pre- through post- transaction lifecycle procedures and daily business processes so as to reduce the possibility and/or appearance of regulatory violations and assure adequate and regular regulatory compliance oversight through monitoring and reporting

–          Establish regular and formal training programs to ensure all personnel understand their individual responsibilities under the company compliance program and market regulations

–          Monitor, record and archive all communication channels utilized by traders, including phones, instant message applications, emails, and even social media such as Twitter; and have tools to data mine for key words and verbal records of transaction processes

–          Deploy a trading surveillance system and analytics which can actively monitor and perform analytical studies on transaction data to identify suspicious or manipulative behaviors for investigation into potential regulatory violations

While no company can absolutely prevent malicious or unintentionally non-compliant behaviors by any employee, having a comprehensive and robust compliance program in place will act as a potential deterrence to such behaviors, provide quick identification and remediation of a potential issue, and establish a positive reputation of your business in the eyes of regulators and shareholders.

Austin Morris_insiderAustin Morris is a managing partner at SunGard Global Services’ Energy Consulting Business and is based in Houston, Texas. He has over 21 years of experience in information technology and management consulting.

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