Wednesday, December 26, 2012

Extending Principles for Price Reporting Agencies to All Assessments[†]

Allegations of price manipulation in UK wholesale natural gas prices by some major power companies and financial institutions could not have come at a worse time for price reporting agencies (PRAs). Less than a month after IOSCO’s publication of principles for oil price reporting agencies, a price reporter at energy‐ industry data provider ICIS went public with the charge that natural gas prices are regularly manipulated by physical and financial traders, and that prices assessed by price reporting agencies do not accurately reflect the underlying physical market. Furthermore, he argued that poorly trained price assessors often developed close relationships with traders, which led them to routinely engage in Libor‐style price fixing exercises. Immediately following these allegations, UK Financial Services Authority (FSA) and energy regulator Ofgem launched investigations into the claims.

Market participants have long claimed that selective reporting by traders and inconsistent methodologies used by price reporting agencies can distort reported prices. These concerns were the basis of a report published by IOSCO in early October, to which the IEA, OPEC and the IEF, responding to a request from the G20, provided input.* The report suggested that “ the ability to selectively report data on a voluntary basis creates an opportunity for manipulating the commodity market data that are submitted to PRAs” and “the need for assessors to use judgement under some methodologies creates an opportunity for the submitter of data to deliberately bias a PRA’s assessment in order to benefit the submitter’s derivatives positions.”

In order to enhance the reliability of oil price assessments that are referenced in derivatives contracts subject to regulation by its members, IOSCO set forth a set of principles for the PRAs to follow. IOSCO proposed, in collaboration with the IEA, IEF and OPEC, to review the implementation of the PRA principles after 18 months. If implementation is ineffective, there may be further recommendations.

The IOSCO PRA principles are intended to establish a framework of best business practices for PRAs and include:

  • requirements for transparent methodologies adopted by PRAs as well as consultation with industry stakeholders for any proposed material changes in methodologies;
  • giving priority to concluded transactions in making assessments;
  • employing sufficient measures to ensure the integrity of submitted information;
  • encouraging submitters to submit all of their market data;
  • publishing criteria according to which transaction data may be excluded from a price assessment;
  • specifying criteria that define who may submit market data to PRAs;
  • implementing internal controls to identify communications between submitters and price assessors, and to ensure the integrity and reliability of assessments;
  • retention of all information and judgments made in reaching a price assessment for at least five years;
  • functional and operational separation of a PRA’s assessment business from any other business that may present a conflict of interest;
  • adoption of formal complaint-handling policies;
  • and  finally, annual independent external auditing of a PRA’s adherence to its stated  methodology criteria and with the requirements of the principles.

PRAs initially argued that they are basically news agencies and they are simply using their freedom of expression rights, therefore they cannot be subject to such rules. IOSCO overcame this objection by restricting these principles to be applied only in price assessments that are referenced in oil derivatives contracts. Practically, they recommended that “market authorities consider whether to prohibit trading in any oil derivatives contract that references a PRA‐assessed price unless that assessment follows the PRA principles.” It is a rather indirect way to force PRAs to adopt such rules. Instead of losing their customer basis, PRAs are expected to adopt these proposed principles.

While a step forward, these principles still do not fully address the problem of selective price reporting. Since traders are not required to submit trade data to PRAs, there is a risk that voluntary reporting could result in selective reporting and seriously compromise the integrity of price assessment. Therefore, it is important, in our view, to allow PRAs to use more information than concluded transactions in making their price assessments. Exclusive reliance on concluded transactions might lead to inaccurate price assessment if submitted prices are false or manipulated. Thanks to the use of other market information, PRAs can check the accuracy of submissions or assess whether submitted prices truly reflect the market place. Demanding traders who chose to voluntarily submit data to provide all of their market data in order to prevent selective reporting is not the answer. Given the voluntary nature of trade reporting, asking traders to submit all of their trade data amounts to an “all or nothing” policy which runs the risk of effectively discouraging price reporting and drastically limiting the pool of information available to PRAs, thereby adversely affecting the reliability of their reports. As long as the submission of data is voluntary, there is a strong risk that such “all or nothing” policy could end up fatally disrupting the flow of information from submitters to PRAs.

Another weakness in these principles has to do with complaint‐handling. While they do call for a formal complaint‐handling policy, the principles stop short from requiring the disclosure of complaints to market participants. The principles require PRAs to advise plaintiffs and any other relevant parties of the outcome of the investigation in the event of a formal complaint. Disputes regarding a daily pricing determination will be communicated to the market only when a complaint results in a change in price. However, if the aim of these principles is to increase transparency in price assessment, it may be argued that they should have called for an immediate announcement of all accepted formal complaints to market participants, similar to error trade announcements in exchanges. Furthermore, the principles called for recourse to an independent third party review of complaints if the plaintiff is dissatisfied with the way a complaint has been handled by the relevant PRA. However, the principles require that the independent third party be appointed by the PRA itself. Giving the right to appoint the third party to the PRA to review its own decision clearly creates a conflict of interest and undermines the independence of the external review. To ensure an independent review process, the appointment of the third‐party reviewer should be jointly handled by the PRA and industry stakeholders.

It is important to note that PRAs deliver more than just news. Their assessed prices are used not only in settlement of oil derivatives contracts but also in other derivatives contracts, including but not limited to natural gas and refined products. These assessed prices are also referenced in many long‐term physical market contracts. The recent allegations of price‐fixing in UK wholesale gas prices show the importance of reliable price assessments.  Therefore, the principles developed for oil price assessments that are referenced in derivatives contracts should be universally adopted by PRAs for any price assessment activities.

*The report, “Principles for Oil Price Reporting Agencies”, was published on the IOSCO website on 5 October 2012 and can be accessed at

[†] This article first appeared in the International Energy Agency’s Oil Market Report dated 12 December 2012.

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