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Energy revolution in financial instruments: What does your firm need to prepare for MiFID II?

Energy revolution in financial instruments: Just a few months left to implement MiFID II
Energy markets have become the subject of financial regulations. This is because from the New Year, derivative contracts for goods that can be physically settled, as well as emission rights, will in general be regarded as financial instruments. Energy companies trading in financial instruments will be subject to a number of new obligations. Failure to fulfill them will result in strict sanctions. Energy companies need to prepare thoroughly for the new regulations, as MiFID II will enter into force on January 3, 2018.
Pursuant to Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments (MiFID II), EU member states were required to adopt national regulations implementing MiFID II by July 3, 2017. Poland did not meet that deadline, and as of the date of this article, the bill to amend the Trading in Financial Instruments Act and other acts has not yet been presented to the Parliament or published on the website of the Government Legislative Center. But regardless of the final wording of the act implementing MiFID II in the Polish legal system, it is certain that all derivative transactions related to emission rights and commodities, including electricity and gas, will be included in the new catalogue of financial instruments if they have an equivalent in trading systems.
New financial instruments
For these reasons, products that an energy company has been trading until now without any supplementary regime may be covered by it, such as forwards for electricity on the OTC market. This entails specific duties: inclusion in position limits, exemption tests, monitoring under the European Market Infrastructure Regulation (EMIR), and a number of others. Energy companies need to prepare for this.
But some products will be excluded from the regime by the directive itself. This covers the so-called REMIT carve-out, i.e. energy products according to the Regulation on Whole Energy Market Integrity and Transparency sold wholesale and settled by physical delivery, traded on organized trading platforms.
New trading platform
An organized trading platform (OTF) is a completely new category of trading system introduced by MiFID II. Trading on this platform can constitute a significant volume of trading in energy products precisely because of the “REMIT carve-out” exemption mentioned above.
An OTF platform is defined as a multilateral system that is not a regulated market or a multilateral trading facility (MTF), and in which multiple third parties buying and selling interests in bonds, structured finance products, emission allowances or derivatives are able to interact in the system in a manner resulting in the conclusion of a contract. An OTF may be operated by a regulated market or an investment company on the basis of regulatory authorization, and is characterized by the discretionary execution of orders.
The notion of discretionary execution of orders  is still the biggest regulatory puzzle, which we may not face until after the directive is implemented, or—worse—in the course of the functioning of the first OTFs. In Poland, the Polish Power Exchange (Towarowa Giełda Energii SA) has plans in this area.
Due to the REMIT carve-out, OTFs will be crucial for energy markets.
Exemptions
Energy companies will have a number of exemptions available, but not (as under MiFID I) automatically. MiFID II requires some action on the part of the undertaking, and conducting a series of tests, including at the level of the capital group, as well as periodic reporting to the regulator.
From a practical point of view, the possibility of exemptions from MiFID II, and in particular the ancillary activity exemption, should be indicated as a key aspect of this issue. According to the Q&A published by the European Securities and Markets Authority in October, exemption applications for 2018 must be filed by January 3, 2018. So there is very little time left.
Portfolio structure
MiFID II will directly affect the structure of energy companies’ portfolios. In the first place, it will be reasonable to divide the portfolio into financial instruments and other instruments, which so far has not been required. Hedging transactions are further worth separating, both for exemption tests and for the need to apply limits on positions that an entity can maintain in a given instrument. In this respect, MiFID II introduces very detailed regulations, including formal requirements for internal regulation of transactions within energy companies.
Sanctions for non-compliance
It should be noted that there will be sanctions for non-fulfillment of the vast majority of new responsibilities required by MiFID II (the updated Markets in Financial Instruments Directive (2014/65/EU)). In this respect, the directive does not spare the addressees of MiFID II, including investment firms, banks and investment funds, but also a large number of other businesses.
According to MiFID II, EU member states will be required to provide for administrative sanctions and other effective measures, proportionate and dissuasive, against those responsible for infringements. Administrative sanctions and other measures specified by member states should satisfy certain essential requirements in relation to addressees, criteria to be taken into account when applying a sanction or measure, manner of publication, key powers to impose sanctions, and levels of administrative sanctions. In particular, competent authorities should be empowered to impose fines sufficiently high to offset the benefits that can be expected and dissuasive even for larger institutions and their managers.
Under MiFID II, the catalogue of infringements which should be subject to sanctions is open, as indicated by the words “at least” used in Art. 70(3). Accordingly, the member states may provide for a more extensive catalogue of infringements and sanctions in order to implement MiFID II.
The maximum administrative fine imposed on a legal person is at least EUR 5 million or the equivalent in national currency, or 10% of the total annual turnover of the legal person according to the last available accounts.
In the case of a natural person, the maximum administrative fine will be at least EUR 5 million or the equivalent in national currency.
Interestingly, the maximum administrative fines for infringements that result in a benefit to the responsible person may be even higher—up to at least twice the amount of the benefit derived from the infringement, where that benefit can be determined, even if that exceeds the maximum amount of EUR 5 million. 
This poses numerous and difficult challenges for energy companies.
This text was created with the participation of Dr Konrad Zacharzewski and Michał Markowski.

Energy markets have become the subject of financial regulations. This is because from the New Year, derivative contracts for goods that can be physically settled, as well as emission rights, will in general be regarded as financial instruments. Energy companies trading in financial instruments will be subject to a number of new obligations. Failure to fulfill them will result in strict sanctions. Energy companies need to prepare thoroughly for the new regulations, as MiFID II will enter into force on January 3, 2018.

Pursuant to Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments (MiFID II), EU member states were required to adopt national regulations implementing MiFID II by July 3, 2017. Poland did not meet that deadline, and as of the date of this article, the bill to amend the Trading in Financial Instruments Act and other acts has not yet been presented to the Parliament or published on the website of the Government Legislative Center. But regardless of the final wording of the act implementing MiFID II in the Polish legal system, it is certain that all derivative transactions related to emission rights and commodities, including electricity and gas, will be included in the new catalogue of financial instruments if they have an equivalent in trading systems.

New financial instruments

For these reasons, products that an energy company has been trading until now without any supplementary regime may be covered by it, such as forwards for electricity on the OTC market. This entails specific duties: inclusion in position limits, exemption tests, monitoring under the European Market Infrastructure Regulation (EMIR), and a number of others. Energy companies need to prepare for this.

But some products will be excluded from the regime by the directive itself. This covers the so-called REMIT carve-out, i.e. energy products according to the Regulation on Whole Energy Market Integrity and Transparency sold wholesale and settled by physical delivery, traded on organized trading platforms.

New trading platform

An organized trading platform (OTF) is a completely new category of trading system introduced by MiFID II. Trading on this platform can constitute a significant volume of trading in energy products precisely because of the “REMIT carve-out” exemption mentioned above.

An OTF platform is defined as a multilateral system that is not a regulated market or a multilateral trading facility (MTF), and in which multiple third parties buying and selling interests in bonds, structured finance products, emission allowances or derivatives are able to interact in the system in a manner resulting in the conclusion of a contract. An OTF may be operated by a regulated market or an investment company on the basis of regulatory authorization, and is characterized by the discretionary execution of orders.

The notion of discretionary execution of orders  is still the biggest regulatory puzzle, which we may not face until after the directive is implemented, or—worse—in the course of the functioning of the first OTFs. In Poland, the Polish Power Exchange (Towarowa Giełda Energii SA) has plans in this area. Due to the REMIT carve-out, OTFs will be crucial for energy markets.

Exemptions

Energy companies will have a number of exemptions available, but not (as under MiFID I) automatically. MiFID II requires some action on the part of the undertaking, and conducting a series of tests, including at the level of the capital group, as well as periodic reporting to the regulator. From a practical point of view, the possibility of exemptions from MiFID II, and in particular the ancillary activity exemption, should be indicated as a key aspect of this issue. According to the Q&A published by the European Securities and Markets Authority in October, exemption applications for 2018 must be filed by January 3, 2018. So there is very little time left. 

Portfolio structure

MiFID II will directly affect the structure of energy companies’ portfolios. In the first place, it will be reasonable to divide the portfolio into financial instruments and other instruments, which so far has not been required. Hedging transactions are further worth separating, both for exemption tests and for the need to apply limits on positions that an entity can maintain in a given instrument. In this respect, MiFID II introduces very detailed regulations, including formal requirements for internal regulation of transactions within energy companies.

Sanctions for non-compliance

It should be noted that there will be sanctions for non-fulfillment of the vast majority of new responsibilities required by MiFID II (the updated Markets in Financial Instruments Directive (2014/65/EU)). In this respect, the directive does not spare the addressees of MiFID II, including investment firms, banks and investment funds, but also a large number of other businesses.

According to MiFID II, EU member states will be required to provide for administrative sanctions and other effective measures, proportionate and dissuasive, against those responsible for infringements. Administrative sanctions and other measures specified by member states should satisfy certain essential requirements in relation to addressees, criteria to be taken into account when applying a sanction or measure, manner of publication, key powers to impose sanctions, and levels of administrative sanctions. In particular, competent authorities should be empowered to impose fines sufficiently high to offset the benefits that can be expected and dissuasive even for larger institutions and their managers.

Under MiFID II, the catalogue of infringements which should be subject to sanctions is open, as indicated by the words “at least” used in Art. 70(3). Accordingly, the member states may provide for a more extensive catalogue of infringements and sanctions in order to implement MiFID II.

The maximum administrative fine imposed on a legal person is at least EUR 5 million or the equivalent in national currency, or 10% of the total annual turnover of the legal person according to the last available accounts.

In the case of a natural person, the maximum administrative fine will be at least EUR 5 million or the equivalent in national currency. Interestingly, the maximum administrative fines for infringements that result in a benefit to the responsible person may be even higher—up to at least twice the amount of the benefit derived from the infringement, where that benefit can be determined, even if that exceeds the maximum amount of EUR 5 million. This poses numerous and difficult challenges for energy companies.