REMIT Update: Ofgem imposes record fine for market manipulation

United Kingdom

On 25 March 2020, the Gas and Electricity Markets Authority (“GEMA”) issued a final notice (the “Final Notice”) regarding the imposition of a financial penalty under the Electricity and Gas (Market Integrity and Transparency) (Enforcement etc.) Regulations 2013 (the “REMIT Enforcement Regulations”).

As Britain’s NRA, GEMA has powers through the REMIT Enforcement Regulations to monitor, investigate and enforce breaches of REMIT.

The financial penalty was imposed on several companies that operate power stations and form part of the InterGen group for multiple breaches of Article 5 of Regulation (EU) No 1227/2011 on Wholesale Energy Market Integrity and Transparency (“REMIT”), which prohibits market participants from engaging in, or attempting to engage in, market manipulation on wholesale energy markets.

The market manipulation occurred in respect of the GB Balancing Mechanism (as detailed further below), which Ofgem notes constitutes a “wholesale energy market” as defined in REMIT.

As set out in the Final Notice, the InterGen group companies:

  1. have agreed to pay restitution in respect of breaching Article 5 of REMIT in the sum of £12,791,000 to recompense the losses suffered by National Grid Electricity System Operator Limited (“ESO”). This payment must be made to the ESO; and
  2. are required to pay a financial penalty in respect of the same REMIT breaches in the sum of £24,500,000. This payment must be made to GEMA and has been reduced by 30% from an initial sum of £35,000,000 down to £24,500,000 on the basis of the companies’ admission of having breached Article 5 of REMIT and agreeing to settle the matter during the early settlement window, in accordance with GEMA’s REMIT Penalties Statement.

Prohibition on Market Manipulation

GEMA found that the companies engaged in market manipulation as defined by Articles 2(2)(a)(iii) and 2(2)(b) of REMIT, which provide as follows:

Art. 2(2)(a)(iii): ‘market manipulation’ means entering into any transaction or issuing any order to trade in wholesale energy products which employs or attempts to employ a fictitious device or any other form of deception or contrivance which gives, or is likely to give, false or misleading signals regarding the supply of, demand for, or price of wholesale energy products;

Art. 2(2)(b): ‘market manipulation’ means disseminating information through the media, including the internet, or by any other means, which gives, or is likely to give, false or misleading signals as to the supply of, demand for, or price of wholesale energy products, including the dissemination of rumours and false or misleading news, where the disseminating person knew, or ought to have known, that the information was false or misleading.

Background to the Final Notice

As part of its investigation, GEMA concluded that the breaches occurred on several occasions over a four-day period in 2016, specifically on 31 October 2016, 7 November 2016, 8 November 2016 and 15 November 2016.

The Final Notice describes a complex mechanism employed by the companies’ traders with a view to achieving higher revenues for the power stations within the GB Balancing Mechanism. The behaviour over the four-day period that led to the imposition of the financial penalty can be summarised as follows:

  1. Physical Notifications were submitted by the traders to the ESO in accordance with the Grid Code indicating that the power stations would not be generating any electricity from noon for the rest of the day (the “Unavailability Period”), which included the high demand period from around 17:00 to 19:00 known as the ‘Darkness Peak’.
  2. However, GEMA found that those Physical Notifications were false/misleading as it was always intended for the power stations to be generating during the Unavailability Period. The basis for this finding was the fact that contractual commitments had been entered into with third parties to generate during the Unavailability Period (including the Darkness Peak), which could be discharged either through: (1) generating electricity using the power stations, or (2) purchasing the required quantity of electricity in the market.
  3. Although the companies’ traders purchased electricity in the market to meet some of those contractual commitments, GEMA concluded that this was not sufficient to cover the commitments in full (and in any event not during the Darkness Peak period). This meant that the companies knew, or ought to have known, that due to the high prices in the intra-day market, they would not be able to buy the shortfall electricity and would therefore need the power stations to generate electricity to meet the contractual commitments in full (despite the Physical Notifications submitted to the ESO indicating that the power stations would be offline during the Unavailability Period).
  4. As a result of the above behaviour, the ESO (through the GB Balancing Mechanism) offered to make payments to at least one of the companies’ power stations to generate from noon until the Darkness Peak (or just before) to ensure (for security of supply purposes) that the plant would be available to generate electricity during the Darkness Peak in case it was needed to meet demand during that period. In other words, the ESO took this balancing action to ensure that it had sufficient capacity available to meet demand during the Darkness Peak period.
  5. Once the companies secured sufficient payment from the ESO to generate up to the start of the Darkness Peak period, updated Physical Notifications were re-submitted to the ESO showing that the power stations would in fact be running during the Darkness Peak period and for the remainder of the day. GEMA found that this re-submission was in contradiction to the initial Physical Notifications, but consistent with the contractual commitments owed to third parties.
  6. In addition, it is worth noting that such GB Balancing Mechanism payments to generators are made on the basis of their declared ‘Stable Export Limit’ (being the minimum level at which the generator can, under stable conditions, export to the National Electricity Transmission System). In this respect, GEMA found that in addition to the submission of misleading/false Physical Notifications, on several occasions the stated Stable Export Limit of the power stations was also inflated with the sole aim of forcing the ESO to increase the “minimum amount” of power it had to purchase from the power stations to keep them generating until the Darkness Peak. In other words, GEMA found that the increase in the power stations’ Stable Export Limit was inflated with no underlying technical reason and purely for the purposes of commercial gain.

We set out below how the above factual matrix was applied by GEMA to the definitions of ‘market manipulation’ set out in Articles 2(2)(a)(iii) and 2(2)(b) of REMIT.

Market Manipulation under Article 2(2)(a)(iii)

In respect of the Article 2(2)(a)(iii) definition of ‘market manipulation’, GEMA concluded that:

  • on each of the four days in 2016, false/misleading Physical Notifications were submitted to the ESO under the Grid Code indicating that the power stations would not generate during the Unavailability Period;
  • on each of the four days in 2016, an order to trade in wholesale energy products was issued by the companies’ traders by submitting bid/offer pairs to the ESO under the Balancing Mechanism (being offers made by generators to decrease/increase their generation as compared to their prior notifications); and
  • on several occasions during that four-day period, false/misleading Stable Export Limits were submitted to the ESO under the Grid Code,

which together were employed with the bid/offer pairs submitted to the ESO as a fictitious device, and that fictitious device gave, or was likely to give, false or misleading signals regarding the supply of wholesale energy products. Consequently, GEMA concluded that the definition of ‘market manipulation’ in Article 2(2)(a)(iii) of REMIT was met.

Market Manipulation under Article 2(2)(b)

Further, in respect of the Article 2(2)(b) definition of ‘market manipulation’, GEMA concluded that this was also met as a result of the submission of false/misleading Physical Notifications and Stable Export Limits to the ESO, which disseminated information that gave or was likely to give false or misleading signals as to the supply of, demand for, or price of wholesale energy products and that the companies knew, or ought to have known, that such information was false/misleading.

The Director of ACER, Christian Zinglersen, noted that this was the highest ever fine for a REMIT breach and stated that “the provision of inaccurate or false information to the transmission system operators, namely through nominations, in order to mislead wholesale energy markets to the detriment of final consumers is an unacceptable practice. This sanction decision under REMIT sends out a clear signal and importantly contributes to the well-functioning, transparent and integer performance of wholesale energy markets.”

Mitigating Factors

Although the investigation was launched in May 2017 following an alert from another market participant (and was only finalised in March 2020), GEMA reduced the penal element of the fine by 30% as a result of InterGen admitting to the breach and agreeing to settle the case early in the process.

In its press statement, Ofgem acknowledged InterGen’s co-operation with GEMA’s investigation and the fact that it subsequently put in place measures to ensure similar breaches do not reoccur (including procuring additional training, overhauling surveillance measures, and appointing external advisers to verify their processes).

InterGen’s CEO also made a statement saying that they “deeply regret and sincerely apologise for the behaviour of former traders in these 2016 incidents. We take this matter incredibly seriously and have cooperated with Ofgem’s investigation. None of the traders involved in 2016 are still with the company. As acknowledged by Ofgem we have undertaken a thorough overhaul of our people, processes and systems since 2016, so that nothing like this happens again. This has included detailed compliance training, strengthened management oversight processes, an internal restructuring, and experienced hires being made to the trading desk.”

Licence Compliance Issues

Some of the companies were found by GEMA to have also breached Standard Licence Condition (“SLC”) 5.1 of their generation licences, which requires licensees to comply with the Grid Code. Specifically, the companies breached SLC 5.1 because the Stable Export Limits submitted to the ESO did not reflect the power stations’ true operating characteristics as required by Grid Code BC 1.4.2 and by failing to use reasonable endeavours to ensure that the data held by the ESO was accurate at all times as required by Grid Code BC 1.4.3.

Although GEMA could have sought to impose a separate financial penalty under its Electricity Act 1989 enforcement powers for breach of licence, it decided not to do so as it considered that the financial penalty imposed in respect of the breach of REMIT is sufficient.

Implications for market participants

This REMIT enforcement action by GEMA offers a cautionary tale to market participants for two principal reasons. First, it shows that (like other NRAs) GEMA is active in its market monitoring capacity and will take REMIT enforcement action where it is satisfied that there has been a breach of that regulation. Second, it demonstrates the importance of early and constructive engagement with the regulator to mitigate the consequences of any potential breach (which includes potentially unlimited fines). Further, it is worth remembering that REMIT obligations (e.g. prohibitions on market manipulation and insider trading) apply equally to natural and legal persons.

In relation to GEMA’s active role in REMIT enforcement, we note that its REMIT Penalties Statement expressly provides that the penal element of any financial penalty will generally be based on a percentage of the firm’s revenue (ranging between 0% to 20% for companies, and 0% to 40% for individuals), which increases depending on the seriousness of the breach and the person’s behaviour. GEMA further states that in addition to the factors mentioned further below, obtaining reasonable professional advice (and following such advice) before the contravention will be a relevant consideration, and that it will accept representations that a person reasonably believed her conduct will not amount to a REMIT breach/it took all reasonable precautions to avoid such breach. As such, market participants would be well advised to ensure that they have robust REMIT compliance systems and policies in place, and take timely legal advice (particularly when engaging in new markets, products or strategies).

In relation to the importance of early engagement with the regulator, the REMIT Penalties Statement states GEMA’s intention to ensure that REMIT non-compliance should normally cost significantly more than compliance and that financial penalties should act as a significant deterrent to future non-compliance. However, it is also stated that although this may not always be the case, GEMA will consider any remedial measures that have been taken by a person (and expects firms/individuals to remedy the consequences of a breach by identifying, contacting and compensating affected parties). Indeed, GEMA may decide to issue a statement of non-compliance as a result of REMIT enforcement action, instead of imposing a financial penalty.

To ensure, so far as possible, that any financial penalty is reduced (or replaced with a statement of non-compliance), market participants should note that the following (non-exhaustive) factors will be relevant: (1) the nature/seriousness of the breach (including frequency/duration), (2) compliance history, (3) whether the breach was deliberate or reckless (noting that market manipulation, per the definition, does not necessarily require an intention to manipulate), (4) whether the circumstances leading to the breach were within the person’s control (e.g. revealing systemic weaknesses in procedures/systems/internal controls), (5) whether the firm’s senior management were aware or sought to conceal their misconduct (including committing the breach in a manner designed to reduce risk of discovery), (6) whether there is a lack of remedial action after the breach becomes apparent to a person, (7) where the person misleads GEMA by supplying false/inaccurate information, (8) whether the person has admitted the breach and provides full/immediate co-operation to GEMA and compensates affected persons, and (9) whether all reasonable precautions were taken and all due diligence exercised before committing the breach.

Therefore, bearing in mind the benefit of early constructive engagement and settlement shown by this case, market participants who have identified a REMIT breach are encouraged to allocate significant resources in the early stages, so as to tackle the issue directly in cooperation with the regulator.