Recent political focus on the energy markets and the hike in domestic supplies of gas, electricity and petrol prices is likely to put pressure on the European Commission and the US Federal Trade Commission to speed up their investigations into potential manipulation of the oil markets. Little information has been provided on the investigations and it is not clear when the results of the investigations will be known. However, the findings are likely to have a significant impact on the way in which oil market prices are set.
The issue that the two Commissions are investigating is how physical oil is priced and how this impacts the price of associated derivative contracts. Given that physical oil is traded over the counter by a small number of market participants, rather than on exchange, the market relies on price reporting agencies to report the price of the physical oil. The market then trades physical and derivative products by reference to the prices reported by the agencies, including Platts, Argus and ICIS.
The main price reporting agency for physical oil is Platts, which is estimated to price around 80% of the market. In order to calculate the daily price of physical Brent crude oil, Platts seeks data on the prices of executed trades, or bids and offers in physical oil over a 30 minute period starting at 4pm each trading day. This 30 minute period is known as the Platts window, or the Market-On-Close.
The issue troubling the regulators is that market participants are not required to provide details of all (or indeed any) of their trades, but do so on a voluntary basis. This means that market participants may be selective regarding the trades which they report and may place bids and offers into the Platts window which may not be genuine.
There are concerns that market participants may, therefore, be able to manipulate the price which Platts sets for physical oil in order to benefit derivative positions. By way of example, through placing bids and offers for physical oil to be delivered at particular periods in the future, a market participant may seek to move a market from contango, (where price for delivery of the physical is higher for future delivery than the price for immediate delivery), to backwardation, (where the price of the physical for immediate delivery is higher than the price for delivery in the future). A trader may cause the market to move in order to benefit from derivative positions which reflect this market change.
In carrying out its investigation, the European Commission is concerned as to whether European anti-trust rules have been breached by some market participants being excluded from the Platts’ price reporting process and whether prices have been distorted.
The results of the investigations are likely to have an impact far beyond anti-trust laws. If the European Commission concludes that there has been some form of price distortion, the Platts’ pricing reporting mechanism is likely to be modified. This could create significant uncertainty. Similarly, if the European Commission finds that some market participants have distorted the market through inputting bids and offers into the Platts window which are not genuine, this may result in some market participants being excluded from the price setting process for a period. This, in turn, could give rise to difficulties in accurate pricing, as the activity of some market participants is so significant that it may be problematic for a realistic price to be achieved without their trades being taken into account.
Whilst the Commissions have revealed little about their findings to date, the European Commission has already made significant proposals on the regulation of benchmarks, which is likely to impact the way in which prices in the commodities markets are fixed. The European Commission has proposed that a new regulation, referred to as the Benchmark Regulation, be produced which will govern indices which are used as benchmarks in financial instruments and financial contracts. The Benchmark Regulation would specify the obligations and responsibilities of contributors who provide data for benchmarks and would require the way in which benchmarks are produced to be subject to careful supervision. The European Commission is also proposing that a new Market Abuse Regulation should be introduced, whereby the manipulation of benchmarks would be made a market abuse offence.
The European Commission’s proposals for new regulations are at an early stage and are likely to be informed by other regulatory investigations into the pricing of benchmarks. In addition to the two Commissions’ investigations into the oil market pricing mechanism, the UK Financial Conduct Authority and US Commodities and Futures Trading Commissions are carrying out investigations into benchmarks for foreign exchange and swaps. Regulators are investigating how W/M Reuters calculates foreign exchange prices in trades carried out in a 60-second window at 4pm each trading day and how Thomson Reuters and ICAP calculate the ISDAfix, by which annual rates for swap transactions are set. These investigations are, of course, in addition to the investigations into the setting of LIBOR.
The combination of regulatory investigations into the setting of various benchmarks is likely to lead to regulators trying to find common themes, as regulators try to put in place price methodologies which are more transparent and less open to manipulation. One key difficulty in trying to apply common themes to the oil market is that the market operates so differently to other markets. The number of market participants is small and it is likely to be challenging to achieve accurate pricing in circumstances where there is little liquidity.
Whatever the regulatory changes which follow from the investigations into the various price setting mechanisms, it is likely that market participants accused of manipulating markets will also face litigation from claimants alleging they are victims of any manipulation. In the US, a class action has already been launched as a result of the two Commissions’ investigations, where claimant traders are alleging they suffered loss through manipulation of derivative prices. Given the unprecedented regulatory focus on benchmarks, I would expect there to be yet further legal claims in this area.