The High-Level Group on Financial Supervision in the EU Report of 25 February 2009

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1 Deputy Director General Director of the BDEW Representation to the European Union German Association of Energy and Water Industries (BDEW) Avenue de Cortenbergh BRUSSELS BELGIUM European Commission DG Internal Market Unit G1 Consultation on Financial Supervision B-1049 Brussels by by The High-Level Group on Financial Supervision in the EU Report of 25 February 2009 Dear Madam, Dear Sir, The German Association of Energy and Water Industries (BDEW) represents more than 1,800 members of the electricity, gas and water industry. In the energy sector, we represent companies active in generation, trading, transmission, distribution and retail. 17. April 2009 Dr. Michael Wunnerlich Deputy Director General Director of the BDEW Representation to the EU phone: +32 (0) fax: +32 (0) BDEW Representation to the European Union Avenue de Cortenbergh Brussels Belgium German Association of Energy and Water Industries (BDEW) Reinhardtstraße Berlin Germany BDEW General Executive Managers Members of the Board of Directors Dr. Eberhard Meller Dr. Wolf Pluge VAT Reg. No.: DE Charlottenburg local court Associations Registry B We are grateful for the opportunity to comment on the recent report of the high-level group on financial supervision in the EU chaired by Jacques de Larosière. We welcome the Commission s call for a supervisory system combining stronger oversight at EU level with maintaining a key role for national supervisors. We also support the necessity to set up an early warning body under ECB auspices to identify and tackle systemic risks relevant for the financial sector. The crisis is a financial market crisis The report focuses correctly on the traditional financial market. There are, however, also sections in the paper where a clarification is desirable that the energy market cannot be treated with tools designed for banks and financial institutions. There are areas in energy trading, where products are structured similar to financial instruments and there are also Seite 1 von 5

2 a few energy companies that are required to have a bank license, but underlying all this is the physical delivery of a commodity and consequently, commodity trading mainly optimises this physical position. We acknowledge that financial institutions are also engaged in energy markets, but would like to highlight that in the current financial crisis, there is no evidence of systemic risk or contagion in this sector. The collapse of Lehman Brothers, for example, who also used to be a significant participant in the European energy trading market did not affect the functioning of the energy trading market; rather we observed a that the positions were closed orderly and that business continued to function without any major disruption. This demonstrates the robustness of energy markets and indeed shows them to be very different from financial markets. As described in point 6), the available excess liquidity also had an effect on commodities. We are, however, very cautious to support your analysis of an evident imbalance in commodity markets. In fact, in commodity markets (and particularly electricity and gas markets) it is the forces of demand and supply, which establish equilibrium at the market clearing price. We do not believe that monetary policy is responsible for affecting commodity prices; it is in fact the macro-economic environment which has the largest effect. We support the analysis in point 16) that a central factor to increase risk in the financial world was the explosive growth of highly complex credit instruments, which were not easy to evaluate with standard methods. We also see Point 27) as relevant, which points out that it was especially the growth of credit derivatives which played a significant role in triggering the crisis. We feel that this analysis does not correspond with point 93) which generalises about the functioning of derivative markets. Here, we would like to point out that such a generalisation is not appropriate and does bear the risk of introducing inappropriate measures also to e.g. the energy market. In this context, we would like to point out that commodity derivatives, which have been around since the early days of trade, serve a very different purpose and are by their nature an important tool to guarantee stable prices for consumers as they are vital tools for risk management. Futures on the European Energy Exchange (EEX) for example are generally used to hedge the price and volume risk for a supply contract with actual physical delivery (i.e. a generator can sell his production on a forward basis (up to 3 years) at a fixed price, while a Seite 2 von 5

3 power supplier can purchase his future delivery requirements also to a given price (up to 3 years)). Addressing recommendations relevant to the energy markets Recommendation 7: Parallel Banking System We support the recommendations concerning the financial market, but are worried that they could unnecessarily include the energy market. Wholesale energy markets are already subject to a significant set of energy-specific legislation. This includes, besides others, the Directive 2003/54/EC and Regulation 1228/2003/EC for electricity and the Directive 2003/55/EC and Regulation 1775/2005/EC for gas in particular, as they set the legal framework for the internal energy market. In reference to these legal foundations a harmonised approach of implementation and supervision is vital to avoid distortions for energy wholesale trading, be it national or cross-border. Thus, the energy markets shall predominantly be governed by this set of energy regulations (and the respective energy regulators), but not by additional financial market regulation. Consequently, probably the most important challenge of the current EU legislative framework is to define the appropriate borderline between financial market regulation and the regulation of the physical energy markets and if there is an interface to find appropriate measures to deal with it. Therefore, there is no need to apply rules designed for the financial market to the energy market, especially as they are by nature inadequate to fit the exact requirements of energy markets. Recommendation 8 Concerning securitised products and derivatives markets The idea to simplify and standardise OTC derivatives, might be desirable for financial markets. In the energy markets, the most complex derivatives are found in supply contracts of municipal utilities and suppliers without own generation capacities. These instruments derive out of Seite 3 von 5

4 optionality contained in physical contracts used to offer flexibility for the buyer to react to changes in demand. Any effort to apply this recommendation to the energy market would lead to a discrimination of especially these small participants in the energy markets and would not meet the needs of the respective counterparty. There is also no need to make a clearing house mandatory for the energy market. Activities in energy trading do not imply the same financial systemic risk as activities in the classic financial markets. The main purpose of a clearing house is to diminish the effects of a counterparty failure. While credit risks are monitored by most energy companies, we do not feel that this is an essential danger with energy market players. The energy trading market is a purely professional market with only sophisticated participants. As other industries, also the energy industry suffers from insolvencies. However, we do not see the risk of contagion if even a major market participant like Lehman Brothers would fail again. We would like to point out that most power exchanges already offer central clearing services. However, additional mandatory structures would only cause additional costs which will have to be passed on to consumers. There are also rigid requirements that participants have to abide to. We do fear that any enforced requirement to use a central counterparty would mainly lead to smaller participants refraining from engaging in the market at all, which could lead to less liquidity and competition. Conclusion for the energy markets Energy companies engage in trading energy derivatives predominantly on own account for risk management and hedging purposes. While the production of the generation companies is sold to the market, supply companies need to purchase electricity on the market to supply their customers or to optimise their own production capacity. Trading of energy (including derivative products) is, most commonly, used to mitigate arising price and volume risks. In conclusion we would like to express our support for the recommendations to stabilise the financial market. At the same time we would like to emphasise that any generalised recommendation concerning the use of derivatives should be carefully analysed. Seite 4 von 5

5 This is particularly true for the energy market as the nature of energy and energy-related derivatives is very different to products of the classical financial market. Therefore, we like to propose that a clarifying reference is being included to the recommendations in order to define credit derivatives as the exclusive concern of the Larosière report. As a general remark, we would like to express our general support for recommendations 10 and 20 proposing a further harmonisation of EU wide regulation. This is an important step, which will also benefit the development of a truly European energy markets. However, whereas a level playing field for all participants is desirable, we do see the need for specific rules for specific markets such as the wholesale energy market. For any questions, please do not hesitate to contact my colleague Marcel Steinbach (marcel.steinbach@bdew.de) or myself. Yours sincerely, Dr. Michael Wunnerlich Seite 5 von 5