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Summary of the Response to CEBS Call for Technical Advice (No. 5) - ECT-Group

I. Introduction

This document represents the response of the Energy Commodity Traders Group (ECT-Group) to the Committee of European Banking Supervisors (CEBS)'s Call for Technical Advice (No. 5) of November 28, 2005. The ECT-Group is composed of German energy trading firms, some of which also engage in banking activities or provide financial services related to energy derivatives. These firms aim to develop a unified position on financial supervision and communicate it to the German Financial Supervisory Authority (BaFin) and other relevant European authorities.

The ECT-Group emphasizes that the German Banking Act (KWG) and its implementing regulations, such as the GroMiKV (Regulation on the ascertainment, measurement, weighting and notification of loans), are not well-suited for entities primarily engaged in commodity trading, especially in the energy sector. The current framework imposes strict capital requirements and large exposure limits that are not appropriate for energy trading firms due to the nature of their business.

II. Large Exposure Treatment under German Law

1. Scope of Application

Under the German Banking Act, entities that engage in financial services related to commodity derivatives, including energy derivatives, are classified as investment firms and must obtain a banking license. These firms are subject to:

• Own funds requirements (Section 10 ff. KWG)
• Large and million loan exposure rules (Section 19 para. 1 no. 4 KWG)

These rules apply to payment claims for commodity deliveries, which can lead to frequent exceedance of exposure limits in the energy trading sector.

2. BaFin's Position

BaFin, the German financial regulator, has acknowledged the specific challenges faced by energy trading firms due to their invoicing practices. Energy deliveries are typically invoiced one month after delivery, with payment due on the 20th day of the following month, which leads to temporary exposure overlimits.

In response, BaFin introduced an interim exemption in a circular dated February 3, 2004, allowing licensed energy trading firms to exceed large exposure limits for 50 days without needing to provide additional own funds, provided they have a risk management system in place. This exemption is available for firms that:

• Trade only in energy and/or energy-based derivatives
• Do not engage with retail clients

III. Justification for Exemption

a) Characteristics of the Energy Market

Energy trading is not comparable to traditional financial activities in terms of risk profile. The sector involves wholesale market participants, who are capable of assessing creditworthiness. Therefore, lower capital requirements are justified.

b) Unintended Consequences of Regulation

• Regulatory capital regimes may lead to fragmentation of business into separate subsidiaries, increasing complexity and reducing risk management efficiency.
• Non-EU entities may seek to avoid EU regulations by operating outside the EU, reducing competition.
• Compliance costs may be disproportionately high for energy firms, which are not exposed to the same systemic risks as banks.

c) No Need for a Level Playing Field

The ECT-Group argues that commodity firms do not need to be subject to the same regulatory capital regime as banks, as their risks and business models are fundamentally different. The goal should be proportionate and risk-based regulation that reflects the unique nature of the energy market.

IV. Treatment of Large Exposures

Energy trading firms employ various methods to manage counterparty risk and large exposures, including:

• Collateral (e.g., commodity stock)
• Netting (Payment and Close Out Netting)
• Risk management systems involving annual reporting, balance sheet monitoring, and trading limits with counterparties

These practices allow firms to hedge positions and limit concentration risks effectively, without the need for excessive regulatory capital.

V. Conclusion and Call for Dialogue

The ECT-Group supports the permanent adoption of the exemption provisions introduced in the Recast CRD-Directive (2000/12/EC), specifically Article 45a and 45d, to allow energy trading firms to operate under a more flexible regulatory regime. They are open to further discussions with CEBS representatives and provide contact details for follow-up.

Key Points

• Energy trading entities are subject to strict capital and exposure requirements under German law, which may not be appropriate.
• The invoicing delay in the energy sector leads to frequent exposure overlimits.
• BaFin has granted temporary exemptions to address these issues.
• Permanent exemption is recommended to align with the nature of energy markets and reduce unintended consequences.
• Risk management practices in energy trading are sufficient to mitigate large exposures.