Latest News from the Regulations Front

Latest News from the Regulations Front

Source: KPMG Corporate Treasury News, Edition 39, January 2015   In December 2014, decisive documents were published at European level on REMIT, MiFID and Basel III. The Commission Implementing Regulation (EU) no. 1348/2014 on wholesale energy market integrity and transparency (REMIT) was adopted on December 17, intended to provide clarity on reporting wholesale energy market contracts and the availability of technical facilities of industrial enterprises. On December 19, ESMA submitted its Technical Advice to the Commission on MiFID II and MiFIR, a more than 400-page report, of which 40 pages are devoted to commodity derivatives, providing technical advice on specifying derivative contracts that must be physically settled. The Basel Committee on Banking Supervision has proposed revisions to the standardized approach for credit risk of corporates as a basis for capital requirements of banks, and the European Banking Authority would like to revoke the exemption of hedging transactions of corporates from capital calculation for CVA (credit valuation adjustment) risk, i.e. ratings-dependent valuation risk.

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The long-awaited Commission Implementing Regulation on Wholesale Energy Market Integrity and Transparency (REMIT) took effect on January 7. It particularly provides details for reporting trading data relating to energy contracts and fundamental data on facilities for the production, storage and consumption of energy. Since publication of the original REMIT regulation (no. 1227/2011) in October 2011, energy-intensive production companies in particular had been waiting for a long time for specific regulations on the extent to which they will be subject to reporting requirements – comparable to those of EMIR – in their contracts for the supply of electricity and natural gas.

The Implementing Regulation now provides clarification of the thresholds for reporting contract data, which deviate from the prior interpretation of ACER (European Agency for the Cooperation of Energy Regulators). According to the Implementing Regulation, final customers (i.e. industrial enterprises which do not sell their own electricity to third parties) are considered market participants, if they conclude energy supply contracts for facilities with a technical capability of consuming 600 GWh of electricity or natural gas per year or more. Based on the new wording, individual, geographically separated facilities, which however are located in the same market region, do not have to be added together for determining the reporting threshold.  While derivatives of contracts relating to electricity or natural gas also render companies market participants, there is no comparable threshold for such contracts. However, as trade repositories are supposed to pass on the data to ACER under the already existing reporting requirement of such contracts under EMIR, there are no separate requirements for the registration and reporting of corporates, based on the current state of knowledge. Only in the case of own electricity production, e.g. in CCGTs (combined cycle gas turbine plants), for which electricity supply contracts are concluded with third parties, can market participation still be derived from the previous regulation such that registration and reporting is required.

Fundamental data, particularly on the planned unavailability of facilities for the production of electricity or the consumption of electricity and natural gas with a technical capacity of 100 MW or more, are to be reported by operators to transmission system operators (TSOs) and by these to ACER. If none of the facilities of an industrial enterprise exceed this threshold, data should not have to be reported.

If in doubt, energy-intensive companies should check both the consumption capacity at their locations and the technical capability of their facilities with regard to the above-mentioned thresholds. This is notwithstanding the obligation to avoid insider trading and market abuse, which has remained unchanged. In this regard, companies involved in substantial energy trading should consider the adoption of appropriate guidelines.


The amendment of MiFID adopted on May 15, 2014 (Directive 2014/65/EU on markets in financial instruments), expands the definition of financial instruments under Annex I Section C, resulting in further requirements (e.g. under EMIR). Options, futures, swaps, and any other derivative contract relating to commodities that can be physically settled, provided that they are traded on a regulated market, an MTF, or an OTF, are considered financial instruments. The only exception are wholesale energy products (within the meaning of REMIT) traded on an OTF that must be physically settled.

As, according to REMIT, supply contracts for electricity and natural gas for use by final customers explicitly are not considered wholesale energy products, unless the final customer exceeds the annual threshold of 600 GWh per location mentioned in the paragraph above, it is not expected that MiFID will have further consequences for unaffected industrial enterprises. Derivate contracts, on the other hand, including those relating to commodities that can be physically settled, without exception, are subject to MiFID.

ESMA’s Technical Advice of December 19, 2014 contains extensive details as to when a contract fulfills the requirement of "must be physically settled" as a prerequisite for exemption. Accordingly, "operational netting", i.e. the offsetting of supply and sales contracts, is not in contradiction to "physically settled". Equally, non-supply (and subsequent compensation payment) as a result of force majeure or bona fide inability to perform a contract is not in violation of this requirement, as long as such inability is objectively measurable as reasons defined in the contract terms. Moreover, clauses providing for the payment of damages in the event of non-supply of a contracting party also do not negate "physically settled".

ESMA’s Technical Advice also contains further clarification of the definition of derivatives in derivative contracts as well as other non-financial benchmarks (freight rates, climatic variables, inflation rates and other indices), if such contracts have the characteristics of derivative financial instruments (standardization, non-commercial use).

ESMA's consultation paper published at the same time includes proposals for specifying exemption from the applicability of MiFID for companies trading in commodity derivatives, if such activity is provided in an incidental manner in addition to a principal activity. Companies to which this exemption does not apply are considered financial counterparties and would have to fulfill the capital requirements of Basel III and the EMIR clearing obligation. Based on current proposals, an activity is considered incidental if the corporate capital used for derivatives trading (on the basis of balance sheet figures) at EU level accounts for more than 5% of worldwide corporate capital. On the other hand, the share of derivatives trading in one of the eight commodity categories must not exceed 0.5% of the entire market volume in the EU. In both cases, according to EMIR, intragroup and external hedging instruments are not considered proprietary derivatives trading that is relevant for determining the threshold.

Basel III

On December 22, 2014, the Basel Committee of the BIS published a consultative document proposing 'Revisions to the Standardized Approach for credit risk' as a basis for calculating the capital requirements of banks. It also contains a separate section on risk-weighting of exposures to corporates. The current approach risk-weights all corporate exposures by reference to their external credit ratings only. For unrated exposures, a flat risk weight is applied. The Basel Committee is proposing to instead use the two KPIs (risk drivers) 'revenue' and 'leverage' (measured as total assets/total equity) in future to increase the granularity of risk-weighted assets vis-à-vis corporates, given the large number of unrated corporate exposures. Moreover, the Committee proposes to introduce a different treatment for specialized lending categories and to differentiate between senior and subordinated corporate debt exposures (senior lending, subordinated debt, specialized lending). Should these proposals be implemented sometime in the future, this could lead to changes in the risk-weighting of companies whose banks apply the standard approach, and thus to their credit terms.

The proposal of the European Banking Authority (EBA) to revoke the credit valuation adjustment (CVA) exemption for hedging transactions under CRD IV (EU Capital Requirements Regulation and Directive) was discussed at a public hearing in London on December 5, 2014. Banks have to hold additional capital reserves to buffer the risk of asset devaluation due to deterioration of debtor ratings, the so-called CVA risk. This raises fears amongst corporates that the additional cost of capital will be passed on to them by banks via the terms of hedging derivative instruments. Therefore, a CVA exemption for hedging transactions was included in the draft versions of the EU Capital Requirements Regulation and Directive (CRD IV), analogously to EMIR. The EBA has announced that it will propose deletion of this exemption in its draft Credit Valuation Adjustment Report to the EU Commission.

Author: Prof. Dr. Christian Debus, Partner,

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