Fraunhofer Institute for Industrial Mathematics ITWM
Fraunhofer Institute for Industrial Mathematics ITWM
Your daily routine matters
© iStockphoto
Your daily routine matters

© iStockphoto

Market Abuse Directive (MAD) and Market Abuse Regulation (MAR) for Energy Suppliers?

Besides the classical financial industry, MAD/MAR affects companies or business areas, which are not perceived as banks, financial service providers or similar. Among them are for example energy suppliers. This stems from the formulation of the Market Abuse Regulation that trading in financial instruments, including emission certificates and commodity derivatives, obliges one to act.

Our financial mathematics department has many years of experience in the energy industry and anomaly detection. Among other things, we have developed the Commodity Risk Manager –an industrially approved tool for daily risk reporting - and implemented it at local energy suppliers. The tool is maintained by us and in daily use by our client. Our tools for anomaly detection are also in use for many years. We are constantly developing and expanding both fields of research.

 

Your Daily Routine Matters

In the following, we show to what extent you, as an energy supplier, are affected by MAD/MAR. We also highlight market surveillance measures you have to take, in order to be able to manage your daily business in accordance with MAD/MAR. In the case of an inspection, you have to be able to prove your approval to the requirements. Failure is considered an offense and will be punished by the enforcing authorities (in Germany the BaFin).

What Does MAD/MAR Actually Do?

Since 3 July 2016, the »Market Abuse Directive« (MAD) and the »Market Abuse Regulation« (MAR) impose new requirements on market participants with special attention to insider trading and market abuse.

In particular, MAR Article 16 requires rules on market surveillance. The aim is to identify and disclose breaches in trading in financial instruments. This includes, e.g.

  • Frontrunning: The placing of orders - shortly before large, foreseeable, price-moving transactions - which were known through insider information.
  • Spoofing: Changing prices in one's own favour by cleverly placing and cancelling orders.
Various forms of fraud in the trading of financial instruments.
© Fraunhofer ITWM
Various forms of fraud in the trading of financial instruments.

The Special Case for Energy Suppliers

MAD/MAR aims at fraudulent behaviour in financial transactions. As already mentioned in the introduction, this also includes trading with electricity derivatives. Unfortunately, energy suppliers in particular are less experienced in the implementation of MAD/MAR requirements.

Further have energy suppliers a special case, because in addition to MAD/MAR, they have to account for REMIT - the “Regulation on Wholesale Energy Market Integrity and Transparency”. In this article we concentrate on MAD/MAR, but have in mind that REMIT already sets requirements on the trading of wholesale energy products. Furthermore, MAD/MAR was published after REMIT and refers to REMIT.

When Must Energy Suppliers Become Active?

The regulation is formulated in such a way that trading in financial instruments, defined according to MiFiD2 (Markets in Financial Instruments Directive 2), obliges to comply. So, you must take action if you trade in, e.g. »Cap Futures« or »Floor Futures«. Options on gas are also among the products relevant for MAD/MAR.

Basically all forms of derivatives, emission certificates and OTC transactions are considered (see MiFiD2).

The term wholesale energy product is often used in this context. This type of product explicitly refers to electricity and natural gas as soon as their consumption exceeds certain thresholds. The thresholds in Germany are adjusted by BaFin and can e.g. be viewed here. If wholesale energy products are traded via an OTF (Organized Trading Facility) and must be effectively delivered, they are excluded from MAD/MAR.

Operative Netting (as defined in Article 5 of DVO 2017/565) on energy and gas markets by energy suppliers is not considered to be a balancing of obligations and is therefore not affected by MAD/MAR. What »implementing MAD/MAR« means is explained in the next section.

Active-Learning-Approach
© Fraunhofer ITWM
The graphic illustrates the Active Learning approach. The AI system on the left is iteratively improved by the feedback.

What Must Be Implemented?

MAR Article 16: »Market operators and investment firms that operate a trading venue shall establish and maintain effective arrangements, systems and procedures aimed at preventing and detecting insider dealing, market manipulation and attempted insider dealing and market manipulation«.

This market surveillance system should

  • analyze the transaction and order individually and in comparison to others
  • ideally should be automated
  • always contain an element of human analysis

 

For these requirements, we make good experience with the »Active Learning-Approach«. We develop a system for you, which - thanks to the input of a domain expert for electricity and natural gas markets - improves iteratively. This is done via evaluating the experts feedback, e.g. identified anomalies. The advantage: the AI system evolves and learns from your input. You can provide your knowledge e.g. semantically in the form of rules, such as: »If value A is greater than...while value B is less than...the order should be checked«.

Furthermore, the specifications of MAD/MAR for the system to be implemented consider the size of your company or business unit. The background to this is that small and medium-sized companies should not be overburdened. Therefore, the legislator also explicitly allows you to delegate the task of monitoring. At this point, however, we would like to point out that you as the delegating party always remain responsible. For this reason, we ensure that you always »have direct access to all the relevant information regarding the data analysis and the generation of alerts« (as required by DVO 2016/957).

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