By Carl Weir, EMEA Head of Cross Asset FIX Connectivity, HSBC and Co-chair of the Global Cross-Asset Committee and Natasha Bonner-Fommes, Head of Product, Marex Spectron and Co-Chair of the Global OTC Energy Subcommittee.
The creation of the FIX Trading Community OTC Energy Subcommittee represents a paradigm shift for the FIX Protocol, unlike any other protocol, FIX is now being engaged by utilities.
The FIX Trading Community OTC Energy Subcommittee (FOTC) was created to define electronic trading standards for OTC energy trading processes. Its mission is to coordinate efforts and identify the common initiatives in pre-trade and trade. FOTC provides its findings to the FIX Trading Community Global Cross Asset Committee (GCAC) for consideration in specifications, best-practices, and educational and promotional efforts.
The creation of FOTC was an evolutionary step in the OTC Energy market as, like other asset classes, regulatory change will require automated workflows for new operational functionality and fiduciary responsibilities. New regulatory reporting will also ensure minimal STP breaks across multiple regulations.
2013 sees the start of an unprecedented slew of regulation for energy traders. Not only will they need to comply with the types of rules traditionally aimed at banks such as the European Markets Infrastructure Regulation (EMIR), but also with additional sets of rules such as the Regulation for the wholesale Energy Markets Integrity and Transparency (REMIT), which broadly comes into force at the same time. On top of these requirements, there are other rule sets in the pipeline such as the second markets in Financial instruments Directive (MiFiD II), which could hit energy traders heavily.
For example, March 18th 2013 saw the first deadline for the new EMIR regulatory compliance come into force, the impact of which is expected to be borne out in an increase in clearing, at least for financial (non-hedging) participants. The drivers for OTC Energy standardisation were borne out of the Financial Crisis in 2008, which was a driver for more financial market regulation both in the EU and US. It was the G20 Summit 2009 in Pittsburgh that set this framework in motion, with the key objectives being to:
- Increase safety and transparency of OTC derivatives markets
- Improve market integrity and oversight
- Reduce failure and credit risks
- Lower operational risks
- Ensure alignment on EMIT, MiFID II and REMIT
Other evolutionary reasons for FOTC are that alternative market participants are searching for new opportunities e.g. hedge funds are looking for hedging opportunities that normally would trade electronically. To perform the latter, firms are searching for operational efficiency for real-time processing and require an overview of positions across all assets, a proposition that the FIX Trading Community has borne out repeatedly. In the context of the latter, and FOTC, the standardisation of energy contracts and electronic processes, as well as interoperability and standardisation with exchange based markets, would need to occur. This is not the case in the OTC Energy Markets at present. FOTC will achieve the latter in a phased approach delivering; Business best-practice documentation for Trading, technical standardisation, support for regulations, new fix tags/message types (where necessary), and appropriate Symbology standards to the OTC Energy market.
The appetite for this shift to FIX for OTC Energy has quickly gained the interest of many firms including Marex Spectron, TullettPrebon, ICAP, LEBA (London Energy Brokers’ Association), Tradition, GFI Group, European Federation of Energy Traders (EFET), Total, BP, & NOS Clearing (A NASDAQ OMX Company) to start, with more to follow in the areas of banks, brokers, utilities / producers/consumers, traders/energy traders, (companies), shipping companies, and clearing houses.
The planned focus will be on the Top Energy markets such as:
- UK National Balancing Point; the biggest market followed by Title Transfer Facility for natural gas
- German power; the biggest power market
- Financial coal
- Dutch Gas
To put the latter into perspective1 :
- The US gas market is 4:1 in favour of OTC to Exchange Traded
- In the US 80% is centrally cleared, of which only 20% is Exchange Traded today.
The composition of the market in terms of tradable OTC contracts and products can be seen in the charts below2,3 :
Finally, as mentioned the move to standardise is key as a crossover to the utilities and trading entities mention in the list of participants above. Importantly the support and participation of LEB and EFET is very valuable as they represent over 100 Energy Trading Companies in 27 countries ensuring the improvement of industry regulation and advocacy on wholesale energy market design; promoting legal and market IT standards.
The timing could not be better as the cross asset industry is in a period of dynamic change with some of the most complex changes coming in the form of Dodd Frank, CFTC and EMIR changes. It is important that the OTC Energy Market moves with these changes and does so in a standardised fashion, so that is can react with as little disruption as possible.
