Actimize Energy Trading Compliance Research 2010

Energy Trading Compliance

An independent study initiated by NICE Actimize and Fulbright & Jaworski L.L.P.

September 2010

This document contains proprietary information belonging to Actimize, Inc. and Fulbright & Jaworski L.L.P. Nopart of its contents may be used for any purpose, disclosed to any person or firm or reproduced by any means,electronic or mechanical, without the express prior written permission of both Actimize, Inc. and Fulbright &Jaworski L.L.P. For more information, contact Actimize at actimize.info@actimize.com or Fulbright & Jaworskiat energy@fulbright.com

Energy Trading Compliance

2

An independent study initiated by NICE Actimize and Fulbright & Jaworski L.L.P.September 2010

Executive Summary

I

n mid 2010, NICE Actimize and Fulbright & Jaworski L.L.P. commissioned astudy of senior executives and compliance personnel in the energy tradingsector. The purpose of the study, conducted by an independent research firm,was to capture the state of compliance within the energy trading industry, and togauge the industry’s overall readiness to deal with increasingly stringentregulations and greater government enforcement capabilities.More than 140 industry participants responded to the questionnaire. Of those,more than one in six self-identified as senior management, with 80 percentholding positions on the front lines of compliance, including: trading, riskmanagement, legal, and senior management.The study was designed to collect data concerning a number of core energytrading compliance issues, including: (i) how respondents perceive theknowledge sets, skill sets, challenges, and motivations for–and barriers to–addressing compliance concerns at their respective organizations; (ii) howrespondents view those same issues for the industry as a whole; and (iii) howrespondents see the knowledge sets, skill sets, and resources of the regulatorsevolving.While the research was in process, the Dodd-Frank Wall Street Reform andConsumer Protection Act became law. As the industry looks toward 2011, theresulting regulatory changes brought about by the Dodd-Frank Act will affectevery aspect of the energy trading industry as the Commodity Futures TradingCommission (CFTC), the Securities and Exchange Commission (SEC), and theFederal Energy Regulatory Commission (FERC), among others, implement newrules and regulations for industry compliance.The research results illustrate that compliance prior to the Dodd-Frank Actrequired a sophisticated knowledge of multiple complex regulations and thededication of substantial resources within a well designed compliance program.Passage of this new legislation now adds an additional layer of challenge forthose in the industry.The research portrays an energy trading industry that is: (i) in an early stagecompliance program adoption process; (ii) fragmented in its approach; (iii)unclear as to best practices; (iv) still facing decisions as to when to make majorinvestments in training, systems or resources; and (v) coming to terms with the factthat corporate culture must be reshaped for compliance to be achieved. Whilethe study identified areas where industry responses were remarkably consistent,especially as to the near- and mid-term regulatory landscape, the study identifiedother areas where responses displayed significant divergence -- such as what isbeing done to develop compliance infrastructure to adapt to the emergingregulatory landscape.

3

Increasing Need for Compliance Solutions

T

he need for proactive compliance programs, including formal training, the distribution of compliance documents, and real-time surveillance, is increasing.Research results indicate that many in the energy trading industry recognize that regulators are increasing their enforcementactivity, resources, and infrastructure. Approximately 80 percent of respondents believe regulatory audit and enforcementactions against energy trading firms will increase. In addition, almost 40 percent of respondents believe regulators alreadyhave the capability to examine energy trading activity, while others believe regulators will ramp up surveillance capabilities inthe near future. These results suggest that regulators will be better, and faster, at discovering suspected illegal behavior in theenergy markets, and that queries to companies may increase. Accordingly, improved compliance programs and infrastructure,including the use of automated surveillance, is seen as a significant industry need.Market participants that stand still and only use data mining or other techniques to audit past performance may miss the markset by the practices of industry leaders and regulators' expectations. Companies that only employ data mining to discoversuspect activity may need to play catch up when approached by regulators, which could impact how they are treated byregulators when transgressions occur.

Risk vs. Compliance Oversight

T

here is significant divergence within the energy sector on where energy trading compliance is managed. There is alsodivergence on the quality of information distributed to enable compliance with energy market trading regulations.Approximately 30 percent of respondents indicated that energy market compliance was managed by the organization’s riskmanagement group, approximately 23 percent indicated that compliance was managed by the legal department, while otherrespondents indicated that compliance was managed by either an independent compliance group (18 percent) or a businessunit (12 percent). In addition, almost 30 percent of respondents indicated that their organization did not have a centralizedcompliance function or that they did not know whether a centralized compliance function existed. Approximately 1 in 5respondents also reported that their organization did not adequately disseminate the information needed to achievecompliance. These study results suggest that creating a single structure for management and analysis of data for compliancepurposes is something of value that the industry has not fully addressed.The research indicates that the energy sector has not yet adopted a generally accepted “best practice” rubric for energytrading compliance. In many ways, the research suggests that the energy industry views compliance as it did risk managementin the mid-90s — industry participants are unclear how to value the compliance investment and how to best implementcomprehensive compliance programs, but they are fairly sure action is needed.The research participants demonstrate an understanding of the consequences for adopting inadequate energy tradingcompliance measures. More than 60 percent of respondents believe civil or criminal fines are one of the three greatest risksto energy trading firms and executives if they fail to establish an effective compliance program, while more than 50 percent ofrespondents also believe reputational risks are among the top three hazards for compliance inadequacies. These resultsindicate that many energy market participants recognize that the failure to be proactive with regard to compliance can leadto substantial financial losses and sullied corporate–or personal–reputations.