Last week the Government launched a consultation into proposed new criminal offences for insider dealing in and the manipulation of the wholesale gas and electricity energy markets in the UK.
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 in order to manipulate the market.
The introduction of these criminal offences is to supplement the Competition and Markets Authority’s (“CMA”) civil enforcement regime for market abuse in wholesale energy markets created in June 2013, which gave the CMA powers to impose unlimited fines, require the disclosure of information and carry out inspections. In June this year, 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 the financial markets have existed since the introduction of the Criminal Justice Act 1993 (further 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 approximately 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 short-lived and transitory, and the relevant markets difficult to define, making it complicated evidentially to prosecute these complex trades under the existing cartel offence in section 188 of the Enterprise Act 2002.
An example of wholesale gas market manipulation from 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 in order 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 $30million 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, while 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, if a similar energy derivative was traded on a platform that is not regulated by the FCA, then Ofgem and the CMA can currently 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.
The Government is proposing to introduce the offences into law by way of regulations using the power in section 2(2) of the European Communities Act 1972, enabling the sanctions regime to be put in place by March 2015. 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 2 years imprisonment.
In contrast, insider dealing and market manipulation in the financial markets attract a maximum penalty of 7 years, and the cartel offence in section 188 of the Enterprise Act 2002 attracts a maximum penalty of 5 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 they are 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 SFO 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.