Turning up the heat against insider dealing

The government has launched a consultation on proposed new criminal offences for insider dealing in and the manipulation of the UK’s wholesale gas and electricity energy markets.

These new offences would make it a criminal offence to fix the price of energy at an artificial level, or use inside information to acquire or dispose of energy products on the wholesale market. It would also be an offence to make misleading signals, use deception or a fictitious device, or conceal facts about wholesale energy prices to manipulate the market.

These criminal offences are to supplement the Competition and Markets Authority’s (CMA) civil enforcement regime for market abuse in wholesale energy markets. This regime, created in June 2013, gave the CMA powers to impose unlimited fines, require the disclosure of information and carry out inspections. This June, Ofgem referred the big six energy companies to the CMA for a full investigation – the first major referral to the new competition agency since it began work on 1 April 2014.  

An earlier investigation by the Financial Conduct Authority (FCA) and Ofgem into whistleblower allegations that the UK gas market had been manipulated by price reporting agencies found no evidence of this occurring. However, the recent issues statement published by the CMA on 24 July 2014 highlighted the manipulability of prices in thinly traded or opaque markets, and the tacit collusion between energy companies (as opposed to explicit agreement outlawed by the Competition Act 1998) as areas which will be subject to investigation.

Why are new criminal offences necessary?

While offences of insider dealing and market manipulation in relation to financial markets have existed since the introduction of the Criminal Justice Act 1993 (supplemented with the establishment of the FCA and the market abuse offence introduced by the Financial Services and Markets Act 2001), commodity trading, including electricity and gas trading, is generally not covered by these offences, unless it is considered to be trading in derivatives on commodities. Only about 30% of gas volumes and 3% of electricity volumes take place on markets regulated by the FCA. In addition, given the nature of the market in wholesale energy, the position established by the manipulator can be shortlived, and the relevant markets difficult to define, making it complicated evidentially to prosecute these trades under the existing cartel offence in section 188 of the Enterprise Act 2002.

An example of wholesale gas market manipulation in the United States, which demonstrates how the interactions between energy and financial markets create the potential for market abuse and the difficulties these complex trades cause prosecutors, is that of Amaranth Advisors LLC’s head trader, who was found guilty in 2010 by the Federal Energy Regulatory Commission (FERC) of market manipulation. In summary, it was alleged that Amaranth sold large quantities of gas futures on the day they were due to expire, driving down the closing price to benefit swap positions that Amaranth separately held. Interestingly, this case resulted in a ruling by a US Appeals Court in 2013 that the FERC had overstepped its authority. The Appeals Court overturned the trader’s $30m fine, holding that the FERC can only prosecute matters arising from the physical trading in gas, whereas the Commodity Futures Trading Commission regulates the natural gas futures markets.

As highlighted in the government’s impact assessment of the proposed new criminal offences, the FCA has the power to bring enforcement action (both civil and criminal) against traders who breach the regulation on energy derivatives in a regulated market. But if a similar energy derivative were traded on a platform that is not regulated by the FCA, then Ofgem and the CMA can only seek civil sanctions. The proposed new offences seek to address this disparity between the regulation of the financial markets and the wholesale energy markets.

Sanctions

The government is proposing to introduce the offences into law by using the power in section 2(2) of the European Communities Act 1972, enabling the sanctions regime to be put in place by March next year. While this is a faster process than the introduction of primary legislation, a major disadvantage will be that such regulations can only create criminal sanctions with a penalty of up to two years’ imprisonment.

In contrast, insider dealing and market manipulation in the financial markets attract a maximum penalty of seven years, and the cartel offence in section 188 of the Enterprise Act 2002 attracts a maximum penalty of five years.

So, while the government places emphasis on the need for prison sentences for the worst instances of wholesale energy market abuse, and criminal sanctions to dissuade offenders in a market where financial incentives alone may not be sufficient, the proposed maximum sentence does not achieve the stated aim of ensuring consistency of treatment and effective deterrence. The government’s own consultation paper states that it is mindful of the arguments that there is continuing market risk created by the lower maximum sanction, yet by proposing a significantly lower maximum sentence the government is failing to act consistently in its haste to introduce legislation.

Another, this time welcome, difference to the current insider trading of financial products and cartel offences, is that the proposed new offences will extend both to individuals and companies.

However, should manipulation of the wholesale gas and electricity markets be uncovered, it remains to be seen whether the CMA will, in practice, have a similar lack of appetite in relation to prosecuting energy companies or hedge funds to that demonstrated by the Serious Fraud Office in relation to the banks fined for their involvement in manipulating the Libor rate. If, however, the CMA is prepared to be bolder than the SFO, and use its powers to prosecute energy companies and hedge funds, it could engineer a positive and powerful shift in corporate culture across the much-maligned energy sector.

Anna Rothwell is a solicitor at Corker Binning