On 22 September 2022 the European Securities and Markets Authority (ESMA) (ESMA 24-436-1414) commented on the volatility of energy derivatives markets, clarifying that:
- recent geo-political and market developments have fostered a significant increase in prices and volatility in energy markets;
- consequently said price and volatility increases have led to substantial enhancement in the margins required to hedge the related exposures of traders;
- there are liquidity strains on non-financial counterparties, forcing them to reduce their positions or leaving them inadequately hedged and, therefore, exposed to further price changes.
In this situation ESMA and national competent authorities will be called upon to cooperate to counter any threats to market integrity and will investigate any potential signals of market manipulation. ESMA suggests measures to contain excessive volatility in order to improve the functioning of the markets.
The European Authority suggests, inter alia, implementing – on a temporary basis and for the energy derivatives market only- a mechanism to contain volatility. These are so-called "circuit breakers" (referred to in Article 48 of Directive 2014/65/EU, so-called MIFID II), which are temporary measures that halt trading so that more time can be provided for market participants to process the flow of information during extreme market stress scenarios. Circuit breakers are tools to be adopted only for limited periods and in exceptional circumstances, such as extreme volatility spikes that could lead to disorderly trading conditions. Such instruments would allow the price formation mechanism to resume in an orderly manner and, hopefully, decrease volatility in the markets. ESMA does not rule out that further regulatory interventions may be needed in order to clarify the functioning mechanism of circuit breakers, reduce the discretion of trading venues, and possibly introduce new tools to increase market transparency.
Regarding the operation of margins, in ESMA's view, the increase in margins has led to greater difficulties especially for non-financial market counterparties, related to lower liquidity, resulting in reduced hedging activity and thus, their greater exposure to risk. What has been said, however, is not a criticism of the usefulness of the margin mechanism, which is functional to the resilience of Central Counterparties (i.e., to the legal entities that interpose themselves between counterparties to contracts traded on one or more financial markets by acting as buyer to each seller and as seller to each buyer).
Anyway, as regards collateral, ESMA considers it appropriate to provide specific mechanisms for energy markets in view of recent developments in those markets. On the clearing thresholds (referred to in EU Regulation 2019/834), the Authority continues to consider as valid the suggestions already made, increasing the threshold from 1 billion to 4 billion.
About the new measures, ESMA believes it is necessary to introduce supervisory mechanisms to increase transparency and a proper risk assessment. In particular, to provide financial regulators with better visibility on energy products, ESMA suggests:
- increasing reporting requirements on OTC ("over the counter") transactions by cancelling the exemption contained in EMIR relating to transactions executed between companies belonging to the same non-financial group and
- introducing new reporting requirements also on wholesale energy products (which do not qualify as financial instruments under MiFID), which are settled by physical delivery and are not covered by transparency and reporting requirements under either MiFID II or EMIR; as well as
- regulating and supervising traders active on the commodity derivate markets and which behave like investment companies, in order to have the largest entities licensed and supervised as investment companies. It is worth noting that this last suggestion is mostly disruptive because it aims at applying the strict requirements set by financial regulation for the investment companies while as of today the same traders may execute and carry out investment services on commodity derivatives without being authorized as investment firms (pursuant to the "ancillary activities exemption" contemplated by MiFID II and based on the principle that as long as a non-financial entity's trading activity remains ancillary to its main business activity, it is not subject to the same requirements as an investment firm).
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