What’s happening? Why is it happening? What should we do?
On 14 May 2013, the European Commission confirmed that it had, that day, carried out unannounced inspections (aka “dawn raids”) on “several companies active in and providing services to the crude oil, refined oil products and biofuels sectors” (referred to in this note as the “relevant markets”). The raids took place in two EU Member States and one EEA Member State (where the EFTA Surveillance authority undertook the raid on the Commission’s behalf). The EEA Member State was subsequently confirmed as being Norway when Statoil stated that it had been visited, while BP and Royal Dutch Shell announcing that they had been raided in the EU itself. The Financial Times has reported that the price reporting agency (PRA), Platts was raided by the Commission, while CNBC has reported that Argos Energies (a Dutch trading house) has been raided. Two other businesses in the industry have reportedly been asked by the Commission to provide information but were not raided: Neste Oil (reported by CNBC) and Eni (reported by Reuters).
It is important to note that other organisations may have been raided by the Commission, but chosen not to announce their involvement as yet and that, although Platts has been reported as having been raided, it is not necessarily the PRA that the Commission is interested in.
It is possible that the Commission will undertake further dawn raids in support of its investigation if the scope of its investigations widen as a result of the evidence seized or provided in the course of the investigations begun on the 14 May. The Commission may also continue its search for evidence using binding requests for information.
What is the Commission looking for?
The Commission has stated that it is concerned about potential anticompetitive collusion in reporting distorted prices to a PRA (presumably Platts) to manipulate published prices for a number of oil and biofuel products. It is also concerned that others have been prevented from participating in the price assessment process, with a view to distorting published prices. The Commission appears to be especially concerned as the prices published by PRAs are used as the benchmark for physical and financial derivatives markets for a number of commodity products around the world.
As is common in dawn raid situations, the Commission was accompanied by national competition regulators (NCAs), almost certainly due to the complementary powers enjoyed by the two. The Commission is bound by European, not Member States’, laws on privilege. Among other things this means that it does not regard advice given by in-house counsel to be privileged and may seize a much broader range of documents than many NCAs. Meanwhile, an NCA such as the UK Office of Fair Trading (OFT) is often able to use force during raids (for example by breaking open locked filing cabinets) and threaten criminal charges for non-cooperation against individuals.
Why is this happening now?
The activities of oil company traders have been well within the radar of the competition authorities for several years, both in the US and in Europe, but until these raids there was no indication from the authorities that their activities had raised competition concerns.
However, with alleged rigging of interest-rate benchmarks such as LIBOR, competition authorities have become increasingly concerned with the potential for anticompetitive behaviour of other indices. Large settlements between authorities and various banks for benchmark rigging have already been announced and further settlements are to be expected.
And in November 2012, the UK Financial Services Agency (FSA) and Ofgem launched an investigation into price manipulation on the National Balancing Point (NBP). There are parallels between the NBP and PRAs’ indexing of the relevant markets.
The UK petrol price investigation
In January 2013, the OFT reported1 that the UK fuel market was operating fairly but noted that manipulation of the commodities markets that fed into petrol pricing was “certainly feasible”. It discussed a number of ways in which this might be achieved, including through the manipulation of PRA-reported prices currently being investigated by the Commission. Given current events, the chapter of the Report on Speculation, Manipulation and Price Reporting makes for very interesting reading. Some of the potential “what if” scenarios as to how PRA indices might be vulnerable to anticompetitive rigging that were outlined in the Report are discussed below.
I trade with my competitors – what precautions should I take?
European and UK law prohibits arrangements which have the object or effect of restricting competition, unless they are covered by an exemption. While always prohibited, exchanges of information between competitors can amount to unlawful anticompetitive agreements or collusive practices, as the exchange can have the effect (or indeed the objective) of causing undertakings to coordinate their prices.
The problem arises because, in the relevant markets, traders are each other's counterparties as well as competitors and therefore some exchange of information between them is necessary for the market to function. After all, a trader must know what price he or she is buying or selling at. However, exchanging information can have ulterior motives beyond agreeing a deal and general market intelligence and can result in prices being standardised across the market.
In other markets, such deliberate price transparency between competitors might amount to an anticompetitive agreement. However, to the extent that the exchange is necessary for price discovery and facilitating deals, the exchange does not distort the normal conditions of the markets and so does not infringe competition law. In fact, the market could not function at all without a degree of information exchange.
Even so, the information exchanged must not go further than that necessary for the functioning of the relevant markets. Operators must continue to act independently on the market. Any information exchange which leads to traders agreeing a common strategy with a competitor/counterparty vis-à-vis third parties, is likely to infringe the competition law rules. For example, if traders agree not to deal with a particular third party or agree to offer the same price or terms to a third party, this will amount to an unlawful anticompetitive agreement. This will be the case even in relatively competitive (i.e. non-oligopolistic) markets – there will be no need for the Commission to consider whether the action has an appreciable effect on the relevant market.
At the moment, the Commission is more concerned with the anticompetitive nature of the benchmark prices published by PRAs than it is with the normal trading which goes on in the relevant markets. Nonetheless, it is important that records of communications between traders be maintained.
How might benchmarking be anticompetitive?
Given that the contributors to PRAs supply information which they know will be shared with their competitors, the arrangement is likely to amount to an information exchange and so be potentially anticompetitive in itself.
PRAs take this information and publish key benchmarks in the relevant markets, including general information and examples of certain offers and deals in the relevant markets. Much of this information is reportedly speculative and/or "cannot be confirmed". Price assessments for various products as well as general information and examples of offers and deals are also included.
The collection and publication of this level of transaction information by PRAs in the sector has historically been regarded as being unlikely to distort the normal competitive conditions of the relevant markets. The products on the relevant markets are traded on the open market by energy companies themselves as well as by specialised trading houses and banks. Given that each of the players both buys and sells products on the relevant markets there is little incentive for price manipulation for its own sake. Furthermore, the pricing information collated by the PRAs is made widely available.
As a result, genuine information exchanges facilitated by the PRAs are likely to be pro-competitive rather than anticompetitive. Anticompetitive agreements arise only where undertakings conspire to manipulate the benchmarks published by the PRAs.
Manipulation of benchmarks is likely to amount to anticompetitive behaviour. The likelihood that manipulation has occurred depends on the market. Some markets (for example for certain types of crude oil) contain large numbers of buyers and sellers: prices are based on a large amount of data and so in these markets manipulation of a benchmark is unlikely owing to the immense difficulty in controlling a large number of submissions.
However, other markets are fairly concentrated (oligopolistic) and any concerted activity is more likely to have an appreciable effect on the market.
The OFT’s Report cites this concern, noting that:
“a number of independent retailers expressed the view that the crude oil market could be open to manipulation. They told the OFT that Brent Crude, the most widely-used classification of crude oil used in the UK, is traded at such low volumes that the purchase of just one or two cargoes sold at an inflated price could drive up prices. They told the OFT that as Platts prices are based on the Brent Crude benchmark, they believe that Platts prices could potentially be inflated. This could in turn drive up wholesale prices and petrol and diesel pump prices in the UK.”
The OFT concluded that the system of oil and wholesale road fuel price reporting involved “methodologies and processes that make manipulation and distortion of reported prices possible”. This could be done through selective reporting of trades in order to signal a higher price than the actual price on the relevant market.
The OFT’s Report also cited a report by the International Organization of Securities Commissions (IOSCO) which raised concerns about the accuracy and lack of independent oversight of the methodology that PRAs use in determining the prices that they report. The IOSCO identified the following vulnerabilities:
- selective reporting through the voluntary submission of data to PRAs, meaning that firms can cherry pick the trades that they submit, thus creating a distorted picture of prices; and
- opacity and variations in assessment methodologies: the IOSCO noted that even within PRAs there was a variation in assessment methodologies.
Such manipulation of PRA indices is likely to have the effect of restricting competition in markets which use those prices as a benchmark, and/or may have been done with the object of restricting competition. Given that any manipulation is likely to have required the agreement of more than one undertaking (a buyer and a seller), if manipulation of PRA indices is established then those involved will have breached competition law.
So does this mean I should stop cooperating with PRAs?
No, although there are a number of things that can be done in order to answer any accusation of impropriety.
Following the announcement of an investigation into the NBP last year, PRAs have reported a decrease in the amount of data being submitted to them on gas prices. Certain companies, such as Statoil, have confirmed that they have stopped sharing data on gas prices with PRAs.
As mentioned, the Commission has not alleged that oil markets themselves may be rigged. Indeed, the OFT’s Report cites a number of studies which suggest that oil markets have not behaved as if they are being covertly rigged and are instead affected by things such as production costs, OPEC production quotas, refinery and storage capacity, disruption of production, extremes of weather, regional politics and war, inflation and activity in the financial markets. Rather, the allegation is that PRAs’ indices are being manipulated through submissions which do not reflect the true prices on the relevant markets.
It should be stressed therefore that, provided the information being disclosed to a PRA is the result of genuine trades at market prices, it is safe to submit. Withholding such information from the indices is likely to make it more vulnerable to manipulation and, indeed, withholding such information as part of an agreement or understanding with competitors may itself amount to an anticompetitive agreement.
The IOSCO report made a number of recommendations for improving the accuracy of information used by PRAs, some of which may usefully be applied by firms submitting data in order to ensure compliance with competition law. These are:
- transparency in the methodology used for selecting which trades to report (for example, through random selection, stratified sampling etc);
- prioritising completed transactions (in order to avoid submitting implausible trades);
- quality control procedures (in order to catch potentially problematic submissions before they go to the PRA);
- avoiding conflicts of interest (for example in the incentives given to reporting staff); and
- creating audit trails (useful for demonstrating a lack of impropriety to a regulator).
Why is the alleged behaviour not being dealt with as market abuse?
This probably comes down to the enforcement powers held by the Commission.
Unlike Commission’s investigation into wholesale gas, this investigation is being led by DG Comp, the Commission department responsible for enforcing European competition law, and not by DG Markt. DG Markt, which regulates activities regarded as market abuse under EU law (including market manipulation) and appears to have taken the lead in the EU’s enquiries into wholesale gas price manipulation, has not (so far) announced its involvement.
The Commission has greater powers of inspection using its authority to enforce EU competition law than it does to enforce EU law on market abuse. Indeed, given that enforcement of EU law on market abuse is essentially left to Member States, it is questionable whether or not the Commission would have been able to launch an effective market abuse investigation on its own. Consequently, while the alleged bad behaviour may be considered anticompetitive as well as being market abuse, the Commission has thus far framed the allegations in competition law terms.
What market abuse concerns might there be?
The most likely market abuses that could be relevant in this particular case appear to be (a) disseminating misleading information and/or (b) distorting the market. The UK’s Financial Conduct Authority (FCA), one of the successor-agencies to the FSA, has the power to fine any person for market abuse, not just those who it regulates.
EU law prohibits certain activities which it regards to be market abuse, including engaging in market manipulation. Manipulation of the relevant markets comes within the scope of the Financial Services and Markets Act 2000 (FSMA) market abuse regime – policed by the FCA, which has powers to impose unlimited fines based on the civil standard of proof (that is, on the balance of probabilities).
The current investigation underlines the importance of the so-called market abuse "sunset provisions". These provisions catch physical markets and make the UK market abuse regime wider than the current European regime under the Market Abuse Directive (MAD). Unlike the MAD-derived provisions, they extend to behaviour that occurs in relation to anything which is the subject matter of qualifying investments. Trading in the relevant markets does not normally involve qualifying investments, but it can be the subject matter of trading on ICE, giving the FCA jurisdiction to investigate if it wishes.
As we have mentioned before, the days of cogently arguing that physical trading should be wholly outside the scope of financial regulation seem to be over. Although the sunset provisions go further than the current MAD regime, the proposals for revision of MAD cater for similar "offences" to be introduced Europe-wide. It is likely the current UK requirements will remain in force until replaced by similar offences when the MAD revisions take effect, which, at the earliest, will be early 2015. Are any other reforms in this area expected?
Under proposals inserted last year into the UK Financial Services Bill to deal with the LIBOR fixing issues, criminal offences would be introduced to deal with manipulation of benchmarks (not just LIBOR) and direct regulation would be introduced for those involved in the setting of benchmarks, including those involved in publishing information connected to benchmarks.
Direct regulation for these market participants would bring with it increased obligations to report to the FCA, as well as extending criminal offences applicable to regulated and unregulated entities.
DG Markt recently conducted a consultation on the regulation of indices, including those produced by PRAs in the wake of the LIBOR scandal. This consultation has recently closed and the replies received have been published. When DG Markt does respond to the consultation, it is likely to recommend further regulation of indices.
What sanctions can be expected?
Given the widespread use of pricing information published by Platts and other PRAs, any undertaking found to have manipulated this information is likely to face large fines as well as private damages actions from third parties that have lost money from the index being priced incorrectly. In the absence of a whistleblower, proving breaches of competition law will however be likely to be an enormous task, in part because such records of conversations as exist may be ambiguous.
Fines for violations of competition law can be extremely large – up to 10 per cent of an undertaking’s turnover (as opposed to the turnover of the relevant corporate entity). Regulators can also order behavioural remedies, such as divestment. There are also large fines for failing to cooperate with investigations.
Private competition damages actions may also be launched by aggrieved parties, either on a standalone basis or following on from a final decision by the Commission. Many supply contracts, such as those entered into by fuel retailers, are based on PRA prices for oil products and so retailers could have a claim against those who manipulated the index price for their losses.
What else should I be doing?
Potential claimants and defendants should take steps to preserve all relevant documents and to make sure that relevant information cannot be deleted. An internal audit to determine which contracts are priced by reference to indices of products in the crude oil, refined oil products and biofuel sectors would also be a prudent step. While Platts is reportedly in the Commission’s sights, there may soon be other PRAs also under investigation and so contracts priced with reference to any index in the relevant markets may also be affected. Dawn raids should be expected and prepared for. Personnel should be reminded of what is expected of them during a raid and a refresher training session considered. We are currently updating our dawn raid guidance in order to take account of the Commission’s new Guidelines on how it gathers digital evidence – please contact us if you would like a copy. Immunity and leniency are available for whistleblowing undertakings. If you suspect that your employees may have been involved in any price rigging, an internal investigation and leniency application may be the best course of action.