Key Pillars of Comprehensive Energy Trading

December 12, 2023

Blog by Dmytro Ingul and Anton Shevchenko, Experts of the USAID Energy Security Project (ESP)

Ukraine began reforming the energy markets back in 2017.  Opened gas and electricity markets and the establishment of commodities exchanges allowed the markets to withstand the full-scale invasion. However, a path toward the establishment of a full-fledged energy market depends on many factors, including market participants’ and stakeholders’ interest and their resolve to take the required actions.

As of November 2023, energy product trading (natural gas and electricity) is regulated by two regulators: the National Energy and Utilities Regulatory Commission (NEURC) and the National Securities and Stock Market Commission (NSSMC).

Dmytro Ingul, USAID ESP’s Deputy Chief of Party

The NSSMC, under the current legislation, regulates the organized commodity markets, licenses the operators and commodity exchanges,  approves the trading rules, and contract specifications.

In turn, the NEURC does not have sufficient instruments to supervise the exchange and over-the-counter energy trading (natural gas and electricity). However, the monitoring functions of the Regulator were expanded because of the Law 3141-ІХ “On Amending Certain Laws of Ukraine on Preventing the Abuses in Wholesale Energy Markets” (Law on REMIT).

To better understand the market problems, the USAID Energy Security Project (ESP) conducted online polling among energy market participants, the results of which demonstrated that 55% of respondents are unhappy with the current legislation and regulations, 60% – require standardized short- and long-term contracts, 47% – would prefer closer cooperation with regulators. Moreover, 40% of the respondents believe that excessive regulatory environment, low transparency, and imperfect competition create barriers to trade on organized platforms.

The USAID ESP has processed questionnaire results and classified them into our pillars of comprehensive energy tradingharmonization, standardization, unification, and  empowerment, focused on addressing the current problematics, transposing, and implementing the EU best practices, enhancing the market supervision, and creating the effective standardized tools to ensure an efficient energy trading for all market participants and trading platforms.

Harmonization, Standardization, Unification, and  Empowerment Four Pillars of Comprehensive Energy Trading – Four Components of Comprehensive Energy Trading.

  1. Harmonization

Legislative harmonization is an important prerequisite for the establishment of a stable and transparent energy market. Currently, there are discrepancies in defining the instruments, supervision, participation, etc. between different laws and regulations. Such inconsistency results in legal uncertainty and creates legal barriers for market participants, increasing the trading risks. For instance, the Law of Ukraine “On Electricity Market” gives the following definition of bilateral contract “bilateral contract – electricity purchase and sale contract concluded by two market participants beyond the organized market segments, except for the contract of electricity supply to customer.” This definition is quite broad from the point of view of the Law of Ukraine “On Capital Markets and Organized Commodity Markets.” In this context, the following questions arise:

  • Is the bilateral forward contract considered to be a financial instrument?
  • Does such a contract have the feature of mandatory physical delivery?
  • Is it the wholesale energy product following the Law of Ukraine “On Amending Certain Laws of Ukraine on Preventing the Abuses in Wholesale Energy Markets”?

Addressing these and other related issues requires the following steps:

  • Changes to legislation: revision and harmonization of legislation related to energy trading to remove discrepancies and create a single legal framework.
  • Create a unified glossary of terms and definitions referring to laws and regulations to avoid misunderstanding and discrepancies.
  • Ensure regular legislative revision and updating to consider the changes in market conditions and technologies. All further legislative changes should be refined based on the single glossary.
Anton Shevchenko, USAID ESP’s Clearing analyst

USAID Energy Security Project is already working on this component and has prepared the matrix of definitions following the Ukrainian legislation. The next step is to study European practice and recommend a list of the respective changes.

  1. Product Standardization

Standardization of energy products is important for the development of a transparent and liquid market. Standardized spot contracts and long-term contracts (forwards and futures) will help to decrease the fragmentation of the market, ensure flexibility, and simplify the supervision of financial (NSSMC) and energy regulators (NEURC).

To achieve this, it is advisable to take the following measures:

  • Develop the standardized manual of exchange and over-the-counter contracts: develop the standard contracts for diverse types of energy products that could be unified (type, conditions of supply and payment, rules of trading). Each contract should contain constant and variable characteristics in the specified range such as the period of delivery and payment,   volumes of underlying energy products, place of delivery, etc. After digitization, it will be possible to conclude standard contracts both on organized platforms and beyond them ( commonly used OTC master agreements are  the International Swap and Derivative Association (ISDA) agreement and the European Federation of Energy Traders (EFET) contract.
  • Ensure the further development of exchange platforms. Simplifying the conditions of access to trading and involving a larger number of participants in trading with standardized contracts will promote market liquidity.
  • Launch the continuous dialogue as a driver of demand for trading: the first standardized instruments should be agreements, which are of most interest to the participants.
  1. Unification

Licensing of organized commodity exchanges to provide trading services with diverse types of energy products is a required stage to enter the market. Unification of trading rules and procedures between various trading platforms will improve their licensing and supervision from both regulators and enhance the competition. For domestic and international energy market participants who wish to trade at various platforms, unification will simplify the procedure of onboarding and trading.

To achieve this, it is advisable to take the following measures:

  • Develop the single unified trading rules: Create common standards and rules for all trading platforms that will simplify the procedure of licensing and regulation. The common rules will largely improve the transparency of markets as organized commodity exchanges will compete just by the level of services and they will get rid of the practice of non-transparent and discriminative trading rules. The market participants will have equal conditions of access to trading and be aware that the common package of documents for connection will meet the needs of all exchanges. The unified rules will meet the best practices of EU countries that will simplify access to energy trading in Ukraine.
  • Involve international organizations/foreign partners in the development of unified standards.
  1. Regulatory Empowerment and Cooperation

Strengthening the regulatory authority and  improving cooperation between different supervision bodies is critically important to ensure an efficient operation of the energy product market, especially, considering the approval of the Law on REMIT (Regulation on Wholesale Energy Market Integrity and Transparency). Since the approval of the Law on NEURC the regulator had an opportunity to adopt the energy trading rules. However, this opportunity was legislatively removed and at present such competence belongs exclusively to the NSSMC that does not have a sufficient capacity to supervise energy trading. To improve the monitoring of energy trading it is important to return to the NEURC the right to approve the trading rules of the organized commodity exchanges in terms of energy trading considering the NSSMC powers and discretion.

To achieve this, the following measures could be taken:

  • Give the NEURC legal opportunity to apply penalties to energy market participants who violated the procedures, including – withdrawal of licenses.
  • Ensure a high level of competence and resources of regulators for reliable supervision of the market, arrange training, and experience exchange with European partners.
  • Strengthen cooperation between the National Securities and Stock Market Commission, the National Energy and Utilities Regulatory Commission, and the Anti-monopoly Committee of Ukraine. Introduce additional information technologies on data exchange, digitalization, and automation of document turnover and related processes.

The aforementioned components will become powerful anticorruption safeguard as their implementation will make impossible the manipulations on conclusion of exchange and over-the-counter transactions, deprive companies, which do not meet the highest standards, of taking part in trading, and make administrative interference in licensing and pricing impossible. Thus, they will become the prerequisite of implementation of the Law of Ukraine No. 3141 that transposes the main provisions of the EU Regulation on wholesale energy market integrity and transparency (REMIT) because the Pillars will help to reveal manipulations in markets and prevent insider trading. Furthermore, the abovementioned components will contribute to the creation of a more stable, transparent, and competitive energy market, reducing legal barriers, fragmentation, and risks for market participants to promote a sustainable power supply.