Energy traders are at odds with new European Union rules designed to halt speculation in commodities, arguing that companies won’t be able to efficiently manage risk and market volatility could in fact spike. The European Securities and Markets Authority (ESMA) this week announced its final rules to flesh out the Markets in Financial Instruments Directive II (MiFID II) law that comes into force in January 2017.
MiFID II is the biggest overhaul of EU securities rules in a decade, designed to apply lessons from the 2007-09 financial crisis when food prices hit record highs due to speculators such as hedge funds. But the unintended consequences are that the new rules will encompass commodity market wholesalers – the market’s main liquidity life-line.
“ESMA sees wholesalers as speculators, when they should be seen as liquidity providers,” said Paul Dawson, chairman of the European Federation of Energy Traders. “Wholesalers help markets work efficiently.” To be exempt from the directive and so avoid having to hold capital reserves, commodity firms have to pass two tests. The “market share” test assesses whether a company’s speculative trading in commodity derivatives is high in relation to overall trading in the EU. The “main business” test measures speculative trading in commodity derivatives as a percentage of its total commodity derivatives trading.
“The regulation fails to reflect the legislation that ESMA are meant to be implementing, which says that wholesale buying and selling activity is fine if it’s ancillary to your main business,” Dawson said. ESMA said the aim was to increase transparency, efficiency and safety for equity and equity-like products. “In order to achieve this, the overarching principle of MiFID is to treat firms which act like financials equal to investment firms,” a spokesman said.
“For energy firms, MiFID…provides some caveats and exemptions already which are captured in the so-called tests.” Oil majors Royal Dutch Shell and BP have said the new regulations would tie up billions of dollars of capital related to trading, which otherwise could have gone toward investment into new oil and gas resources. Restrictions on banks and capital requirements has already subdued enthusiasm for commodity trading and liquidity has already been impaired.
The absence of wholesalers could compromise liquidity more severely and consequences would be a wider spread between buying and selling prices and higher costs for the real economy, Dawson said. “Every 10 percent increase in the spread will cost the European economy 270 million euros on an annual basis. It is not unlikely that the spread could double – which would cost the economy 2.7 billion euros,” the energy industry group estimates.
“The impact of reduced market liquidity on hedging costs could translate into 11.7 billion euros in additional costs on an annual basis to industry due to the longer time needed to hedge consumption or production of energy.” Financial products to hedge production and consumption could also be taken off the shelves, which Dawson estimates could cost the EU nearly one billion euros a year, at a time when economic growth is struggling to gain traction.