Energy commodity marketing and trading companies in times of crisis: Risks of heightened scrutiny from the CFTC and FERC
The extra scrutiny the Commodity Futures Trading Commission (CFTC) and the Federal Energy Regulation Commission (FERC) place on wholesale energy commodity marketing and trading companies during a time of crisis is not a novel concept.[1] For those in the energy commodity marketing and trading business, we remember in 2002 when the FERC discovered that Enron Corporation had deliberately created real and imaginary shortages during the 2000-2001 California energy crisis in order to drive up prices and generate extremely large profits, leading to both regulatory and criminal consequences. We also know that during hurricanes, limitations on oil and gas supplies could cause overall increases in prices and/or an increase in prices in one region of the country, creating arbitrage and unusually large profit opportunities.
With the rise of the coronavirus disease (COVID-19) in the United States creating uncertainty in the stock market and the Saudi-Russian price war causing volatility in oil prices, one could argue that we are now in a “time of crisis” that will most likely bear scrutiny from the CFTC and FERC in the not-so-distant future. Energy commodity trading companies are encouraged to pay close attention to their trading activities right now to mitigate the risk of heightened scrutiny from the CFTC and the FERC in the future.
This article outlines what energy commodity marketing and trading companies may consider to mitigate the risks of regulatory infractions and/or the appearance of regulatory infractions during times of crisis.
1. Compliance manuals: Redistribute
In times of crisis, the importance of the rules and regulations applicable to energy commodity marketing and trading front office personnel are paramount. Often in times of crisis we see large price fluctuations in the energy market, which could bring opportunities to make unusually large profits.
To reduce the possibility of front office personnel engaging in impermissible activity or appearing as if they are engaging in impermissible activity, energy commodity marketing and trading companies may redistribute their regulatory compliance manuals, accompanied by a cover letter from the legal and/or compliance department, outlining the need to trade with heightened sensitivity to regulation and common sense. Updating the front office attestations of reading, understanding and agreeing to abide by the rules, regulations and policies outlined in the compliance manuals is also a good practice in times of crisis.
2. Legal and compliance personnel: Reminder to consult with legal and/or compliance personnel
In times of crisis, legal and/or compliance departments may remind front office personnel that if a transaction seems “too good to be true,” then it may be too good to be true. Some profits are legitimate but could be seen, in hindsight, as taking advantage of the crisis situation.
For these reasons, companies may make legal and compliance personnel available for questions and consultation during times of crisis. Since many energy commodity marketing and trading firms do have legal and compliance personnel on hand for questions, during times of crisis, companies may choose to remind front office personnel to consult with them prior to entering into transactions that either: (a) deviate (in volume, price, commodity, location) from the usual transactions entered into by such front office personnel or (b) are generating unusually high profits for the type of transaction.
It is also suggested that management set a clear trading strategy for front office personnel and standards for compliance with such strategy, with deviations requiring approvals from management, the legal department, or the compliance department, as appropriate.
3. Compliance training: Conduct additional targeted training on market manipulation, fraud, disruptive trade practices
Time of crisis affords an opportunity for targeted training for all employees (including front, mid, and back office personnel) on market manipulation, fraud and disruptive trade. In addition to the redistribution of the compliance manuals, targeted training may help to prevent inadvertent regulatory violations and/or the appearance of regulatory violations.
In times of crisis, every person may be expected to be on alert for possible regulatory violations and/or the appearance of regulatory violations. For example, the settlements department may be asked by a counterparty to change a price on a transaction prior to finalizing the settlement payment. The justification for such a request could be the crisis. However, this could present is a red flag, because, crisis or not, the pricing of a transaction is generally agreed to at the time of the transaction’s execution by front office personnel.
4. Trade surveillance: Reviewing standard deviations in volume and prices
Redistributing compliance manuals and targeted training is helpful to prevent regulatory infractions and/or the appearance of regulatory infractions during times of crisis, while trade surveillance identifies and finds infractions.
During times of crisis, trade surveillance is expected to look for indicia of infractions, such as unusually large standard deviations in : (a) the volume of trading per individual front office person, per trading book and per product as compared to previously traded volumes and (b) the prices of transactions as compared to prevailing market prices.
5. Remote logins: Ensure proper risk control functionality for remote marketing and trading activities
In times of crisis, front office personnel may be required to trade remotely from home and/or disaster recovery centers. Companies are encouraged to ensure that risk control functionality, such as monitoring value-at-risk and conducting marked-to-market calculations on these transactions, continue even though front office personnel are trading remotely.
Value-at-risk and marked-to-market calculations are helpful tools to ensure that front office personnel are maintaining appropriate positions and at appropriate prices for the current market.
Companies are encouraged to test risk control functionality to help ensure that risk control is able to aggregate the remote transaction data to perform value-at-risk and marked-to-market calculations.
Conclusion
Energy commodity marketing and trading companies are encouraged to prepare to not only operate efficiently and remotely, but also function with an awareness that the CFTC and FERC may review marketing and trading activity during a time of crisis with heightened scrutiny. If the proper plans are in place, commodity marketing and trading companies may mitigate issues that may arise under such heightened scrutiny.
As the COVID-19 situation is dynamic, the above guidelines are subject to change. Please contact your DLA Piper relationship partner with any questions or for more information.
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[1] This article does not address regulations on the retail buying and selling of commodities, which are also subject to state consumer protection laws, rules and regulations.
