TOTSA (Total Oil Trading SA) IOSCO Trading - Manipulation

TOTSA
Friday, August 24, 2012
Functioning and Oversight of Oil Price Reporting Agencies TOTSAs reply to the public consultation report published by the TECHNICAL COMMITTEE OF THE INTERNATIONAL ORGANIZATION OF SECURITIES COMMISSIONS (document no. CR04/12, published in MARCH 2012)
The International Organization of Securities Commissions (IOSCO) Technical Committee (TC) has published its Consultation Report as part of its objective of answering the mandate of the G20 Leaders Cannes Summit Final Declaration to produce recommendations, in collaboration with IEA, IEF and OPEC1, on the functioning and oversight of oil price reporting agencies. The Consultation Report was prepared by the IOSCO Task Force on Commodity Futures Markets (Task Force). Submitted by E-mail to: Subject line: price-reporting@iosco.org
Functioning and Oversight of Oil Price Reporting Agencies. Microsoft WORD 2003
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TOTSA TOTAL OIL TRADING SA World Trade Center 1 10, route de lAroport Case Postale 276 CH -1215 Genve 15 Aroport
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Q1 Are you or your company currently subscribers to the services of PRA(s)? If so, how would you rate the overall quality of the work being carried out by the PRA(s)? TOTAL is a subscriber to the major PRA services for the energy markets (oil, gas, coal, power, CO2, and biofuels). The work done by the PRAs can generally be considered conscientious and professional. However, the published prices do not always represent those of the market with the same degree of accuracy. This heterogeneity exists both within individual PRAs and between PRAs. As well, the quality of the reporting is not always consistent over time. Finally, while certain PRAs have pricing processes that are reproducible using the underlying data, others do not (the principal difference being the use of judgement that may bias prices away rather than toward the market).
Q2 Please provide information on the impact of PRAs on physical oil and oil derivatives markets. Please support your comments with data on the volume and value of the related physical oil and oil derivatives business you are aware of, which is dependent on PRA benchmark prices (where possible broken down into the following categories: OTC; OTC cleared; or exchange-traded) Are the prices of all oil transactions linked to PRAs? Oil market pricing (crude or products) links sales to representative price references, including PRA prices (75% - 80% of deals), futures markets such as NYMEX or ICE (15% to 20% of deals), or to producer country official selling prices (10% of crude sales). Which PRA prices dominate the market? Very approximately, for all transactions linked to PRA prices, Platts represent 90% to 95% of transactions on crude 85% to 90% of transactions on products, and 85% to 90% of OTC derivative transactions. The remaining share is covered by Argus and other PRAs which are present in niche markets. Q3 What are the impacts of PRA processes on oil trading markets, physical and/or derivatives? In your answer please comment on the quality of PRA processes, their strengths, as well as the potential impacts of any perceived weaknesses. Traders, buyers, and marketers depend upon the PRA prices as a source of market references for on-going transactions. Oil market players contribute to the price assessment process by reporting their deals (ensuring the assessed prices take them into account). This interdependence between the PRAs and the oil market players defines the price discovery process. Platts (the dominant price reporting agency) imposes a methodology that does not furnish a market price (based on the days prices) but rather a price to the market. Sometimes the criteria imposed by PRAs do not assure an accurate representation of the market and consequently deform the real price levels paid at every level of the price chain, including by the consumer. The difference in methodologies between Platts and Argus is the greater integration of the shape of the forward price curve by Platts than by Argus (or ICIS or APPI, etc). Accordingly, when the market is in strong backwardation, Platts spot prices are lower than the rest and in contango they are higher. Inaccurate pricing is not simply an issue regarding the pricing of OTC contracts. Margins for refiners and retailers as well as prices for end-users are directly impacted by erroneous prices.
TOTSA TOTAL OIL TRADING SA World Trade Center 1 10, route de lAroport Case Postale 276 CH -1215 Genve 15 Aroport Page 2 of 10
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Where these margins are particularly narrow (such as in Europe) the volatility and uncertainty in PRA pricing methodologies can be very detrimental to the financial health of the companies concerned.
Q4 Do you consider PRAs to have potential systemic impact on the financial system? Please give reasons for your answers. The increased penetration of oil in financial investment portfolios and the increased degree of co-linearity between both different financial markets and different commodity markets suggests that a sudden and massive shift in oil markets could propagate into other markets. At the very least, covering large margin calls for oil could lead to a sell-off of other instruments. However, given the size of the oil market relative to the rest of the financial market, the overall impact of such shifts is not likely to threaten the integrity of the financial system. In addition, the overall volume of activity on the paper and physical oil markets is considerably smaller than all other financial markets combined. Overall trade on oil futures markets is around 2 billion barrels per day (less than $250 billion per day). OTC markets might double or triple that volume of activity, but overall it remains well below the $1 trillion per day threshold.
Q5 What are your views regarding PRA price methodologies, including your ability to identify methodological errors? Do you consider that mechanisms or procedures exist to address any such concerns and are they adequate? Have PRAs demonstrated responsiveness in updating their methodologies to reflect market development? Where the PRA methodologies are detailed, reproducible, and scrupulously followed, the results are generally consistent and close to the market. Where PRA methodologies incorporate judgement, incoherencies can result. It is difficult for users to identify errors if they are not very intimately involved in the market on a day-to-day basis in order to see the transactions occurring that drive price formation and if they do not have the market experience to be able to tease out the errors in the PRA processes versus the reality of the market activity. PRAs should emphasize that they are not assessing flat prices but rather a series of price differentials (generally time spreads, EFPs, EFSs) from which they derive a flat price using futures prices. The flat prices used for indexing OTC contracts generally are not the basis of transactions in the physical market. Generally, PRAs are not responsive to proposed changes to their methodologies from market players. However, they regularly seek input from market players when anticipating a change in methodology to reflect market developments (though this input may not always be taken fully into consideration).
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Q6 Does the voluntary reporting of transactions used in certain PRA assessments pose risks to the price assessment process? If so, how should these risks be mitigated? Would it be beneficial if reporting of transactions to PRAs were mandated (contractually or by legislation)? Selective reporting could have an impact on the prices published by PRAs. However, the dominant assessment processes today, the Platts Window or Argus methodologies, are generally an incentive for most market actors to participate in the assessment process voluntarily. While there is the risk of market actors voluntarily submitting false data to the PRA assessment process, most PRAs have effective processes to verify submissions and generally avoid this problem. We are not currently concerned that selective reporting by market participants is a serious risk to the integrity of these prices. On the other hand, these PRA processes can themselves result in selectivity by inappropriately excluding market participants or specific transactions. In particular, Platts procedure of putting market participants in the box when they believe such participants have not respected their reporting procedures reduces the number of transactions in the price reporting process, notably when it concerns key players in the market. There are two main problems with boxing: there are often good arguments to the effect that participants did follow the procedures but cant appeal; the effect on price is indiscriminate and disproportionate (because you exclude from the price a vast portion of the market, which affects not only the boxed person but everyone). This has a detrimental effect on the integrity of the price and the liquidity of the market.
Q7 Do low numbers of transactions used in certain PRA assessments pose risks to the price assessment process? If so, what crude grades and markets do you see affected by this? What is considered to be a low number? How should any such risks be mitigated? The Brent assessment is the most important crude price assessment and determines the prices of most other crude grades outside the US. Other crude prices are set relative to Brent, with physical transaction volumes that are far lower than those for Brent. However, this generally does not pose a major risk to the assessment of the grade differentials vs. Brent. The number of cargoes being loaded is known and the related transactions are tracked by most PRAs simultaneously.
Q8 Taking account of existing PRA procedures to obtain information on which to base their assessment when no transactions have been submitted, are there any other approaches that may produce their benchmark prices in the absence of liquidity? Generally, PRA procedures to establish prices on the less liquid product or crude markets are adequate. In the absence of transactions on the most liquid benchmark prices (ARA barge prices or the Brent market), it is vital that the methodology and information used to derive the price be fully transparent post-fact.
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Q9 Are there any issues regarding PRAs that concern you from a public accountability perspective? Key issues: - The PRAs need to provide a transparent process of elaborating prices. The process must exclude judgment or limit its use to a very precise context. The process should be audited annually to respect these procedures to demonstrate that judgment, when called upon, was used appropriately. The audit should be made public. - Disagreements regularly occur between PRAs and market actors about pricing methodologies or decisions about who can participate in the pricing process. There needs to be an expedited formal process for dispute resolution. Not all PRAs have a dispute resolution process. The PRAs need to assure that they offer their clients a formal and expedited process for handling disagreements, including a process of appeals that would call in an outside arbiter (Ombudsman). It is unacceptable for the PRAs to hide behind journalistic independence as an excuse for not dialoguing with the actors in the oil market. - The prices available from the PRAs are an essential service throughout the entire chain of the actors in the oil market. There is a persistent daily requirement to track the market prices for commercial reasons and for valuing stocks and flows within the companies. Only one assessment represents the market and it is essential to use that one. Moreover, there are significant barriers to switching from the representative assessment to another assessment. The dominant nature of the provider of the representative market assessment implies that they have overwhelming pricing power as regards their clients. There is a need to ensure that PRAs do not abuse their positions of dominance by egregiously jacking up the price of their services to take advantage of their pricing power. It is not practical to rely on competition law to moderate this kind of behaviour. Subscription prices should be adjusted in-line with costs directly related to those services. PRAs should be obliged to annually audit the cost of their services and publish the information for their clients to heighten the transparency and the limited degree of competition in this domain.
Q10 Do you consider the function performed by PRAs to require a form of public oversight of PRAs? If so, which PRA activities should be subject to a form of public oversight and why? Yes, the activity of PRAs justifies public oversight. Oversight of PRAs should focus on elaboration of pricing methodologies and dispute resolution. It should ensure that methodologies are applied fairly and that the PRAs are subject to some degree of reasonable constraint to their ability to overcharge/terminate their services in a way that may be detrimental to the market.
Q11 Please detail any concerns you may have about current ownership of PRAs in particular with regard to possible conflicts of interest. Indeed conflict of interest in ownership could be a concern that would be worth regulating. At this time, it does not appear to be. A greater subject of concern today is the issue of consolidation of ownership where smaller PRAs are subsumed by the larger PRAs reducing the number of independent assessments in the market and generally leading to higher service costs for users as the combined entities use their pricing power in a constrained market.
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Q12 Do you have any concerns regarding the current corporate governance standards of PRAs? If so, what are the improvements that you believe are needed? It is sensible to have somebody at board level or executive level responsible for overseeing the development and operation of pricing methodology, in particular for integrity of prices and fairness of application of reporting rules. It is also advisable to have a complaints officer who will ensure that the complaints are addressed, answered and resolved. Q13 Do PRAs need to be subject to standards of corporate governance that are equivalent to the standards to which regulated financial entities are subject? Please elaborate. Q 12 & 13 Given the prominent role of PRAs in ensuring price availability to markets, the highest standards of corporate governance should be respected.
Q14 Do you have any concerns as to the robustness of the systems and controls in place at PRAs as they relate to the integrity of the processes used to construct price series or indices? Please explain. Yes, we encounter, several times a year, estimates of market prices on key indices that are out of line with our experience of the day and with the available information on which the price formation is based. Unfortunately, discussions with the PRA in question rarely results in either the PRA providing satisfactory explanations of their assessments or the PRA taking account of our comments or explaining why they wont.
Q15 Which authority, if any, should establish a set of principles for the appropriate level of systems and controls within a PRA and in particular as they relate to PRA benchmark methodologies? Would this sufficiently address any concerns you may have and, if so, how? Within Europe, the most appropriate authority would be ESMA. This body would be able to bring to bear its experience in regulating the financial system and exchanges with the practices of the PRAs. Q16 Should PRAs as a general matter be subject to a specified external audit of individual operations or processes, the results of which could be published demonstrating standards of compliance with relevant rules? Would PRAs need to be held to account for such an audit and, if so, which organisations would be best placed to carry out such an audit? What are the benefits and risks? Published external audits of key processes and operations within the PRAs are vital to ensuring their transparency as well as their applicability. In addition to holding the PRAs to account for such audits, making the audits public will allow a confrontation with market experience of the PRAs day-to-day activity. Todays auditing firms should be able to hire the needed talent to perform such audits. An officer at the corporate board level or the corporate executive level of the PRAs should be held accountable for compliance with the results of these audits.
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Q17 Should PRAs be required to incorporate into their rules, if absent, a formal complaints procedure. If so, please explain what would be your preference in terms of procedure or process? A formal, fair and impartial complaints procedure is vital for the PRAs today. The lack of such a process today leads to the inability to challenge decisions made by the PRAs in a coherent fashion. TOTSA strongly supports the creation of clear and independent dispute resolutions procedures for each PRA These procedures should involve line managers and/or a complaints officer with the possibility of an escalation to an officer at the corporate board level or the corporate executive level and ultimately to an external arbiter (the regulatory body as the ultimate backstop). All complaints should be made public and the deliberations published for the benefit of the market. In all cases, dispute resolutions should be undertaken rapidly. This is all the more important as certain PRAs and their practice of putting market participants in the box (excluding them from the price assessment process) as punishment for not following PRAs guidelines. Excluding a major market participant from the price formation process for one or more days can have significant economic consequences both on the prices assessed in the market and on the company concerned.
Q18 Should disputes be resolved by an appropriate third party as a matter of course? Please explain the benefits and risks. The escalation of complaints must be appropriate, efficient, and transparent. Hopefully, few cases will require an external third party. However, it is vital to have the option of ultimate referral to an external arbiter who is available (and rapidly available) should it be called for.
Q19 Should such a formal complaints procedure necessitate greater transparency in the handling and resolution of complaints by PRAs, for example by requiring transparency of the complaints process and publication of decisions and the rationale for them? As indicated, the complaints process must be appropriate, efficient, and transparent. It should be easily engaged by the market participants concerned at the shortest possible notice. The lodging of a complaint should be made public immediately (the PRAs have electronic information services available that could serve this purpose), as should the deliberations, the decision, and the rationale. Transparency establishes a registry from which precedence can be established and through which practice can evolve.
Q20 Please describe concerns you may have relating to potential conflicts of interests affecting PRAs arising from revenue generation, media reporting, internal staff management or any other source. Has this had any impact on the price reporting function of PRAs and if so how? A strong and well governed procedure of managing conflicts of interest within PRAs is vital. This concerns the personnel as well as the organization. PRAs are not philanthropic organizations. They are businesses with growth and revenue targets. The prices they report must be of commercial interest. This does impact they way the PRAs develop their reporting and sell the information. The editorial process is adapted in the PRAs to the production of information of commercial value.
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Q21 Are there any undue obstacles that prevent market participants from adopting different sources for price references? Please explain. For a given price in the market, one simply cannot switch back and forth between Platts and Argus or another PRA without suffering a cost that reflects market liquidity for the alternative reference, and the risk posed by differing pricing methodologies. Other barriers include (obviously) being a subscriber to both PRA services (which also has a cost), and having the accounting sophistication to manage several price references for the same product. Together, these represent a significant barrier to a spontaneous switch from deal-to-deal between PRAs for a given price. A concerted effort to change for a given reference, or for all references, from one PRA to another also runs up against the resistance of ones counterparties that may not wish to take-on the cost or risk of making the switch. This includes counterparties in the international market as well as those in national markets (wholesalers, distributors, and retailers) who are even more resistant to change (notably for lack of redundant subscriptions). As you note, when the frustration and economic disincentive relative to the dominant PRA become great enough, the users have changed in the past en masse. However, this has only happened on a handful of occasions.
Q22 If so, does this constitute a competitive concern for either individual PRA benchmarks or the PRA sector as a whole? Where appropriate, please refer to specific benchmarks. The existence of barriers to switching price references is a competitive concern because access to these prices is an essential service within the oil industry. The industry cannot function on a day-to-day basis without access to these prices, at every segment of the supply chain, to correctly value supply, stocks, flows, and sales. Key examples are Platts Brent price (reference for over 80% of world crude sales), or Platts product prices in the NW Europe barge market which are the references for pricing into European consumer markets. As the leading PRA sets the pace on prices, the competing PRAs need only set their prices inline with the former. Consequently, there is a need for oversight in controlling pricing practices to ensure that there is no abuse of a dominant position in the market and that price adjustments are in-line with the evolution of directly associated costs. For the other PRAs, despite the excellent quality of their own work, they often only increase their market share when a competitor becomes less performant in their assessment process for a key reference.
Q23 If you have concerns about competition relating either to individual PRAs or to the PRA sector or around individual benchmarks, please comment on how you think these could be addressed. See comments in Q22
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Q27 If required, what would be appropriate models for oversight of PRAs, covering the options described above and potentially others you may consider appropriate? What are the potential benefits and risks, if any? What economic impact, if any, would there be? The appropriate authority for oversight of PRAs in Europe would be ESMA. The exchanges themselves have an ambiguous relationship with the PRAs. The key example here is the ICE Futures Brent contract. The ICE Futures Brent contract is indexed to the Platts Dtd Brent price assessment, which originally used a 15 day window of forward cargo trades to assess the spot price. While Platts has progressively extended that window over the past 10 years from 15 to 21 and to 25 days, the ICE Brent contract continues to roll based on the 15 day assessment. The result has been a dislocation in pricing, with markets exploiting the increasing difference between the ICE Futures contract and the Platts Brent price structure. This should never have happened and clearly shows that the exchanges are not positioned to have an oversight role with respect to the PRAs. Exchanges are also at times competitors of PRAs. For example some market participants index crude sales to ICE Brent rather than to Platts Brent prices. The benefit to market participants of having an oversight body for the PRAs is that it would provide an ultimate recourse in relation to complaints and would ensure follow-up of audits and self-regulatory procedures. There is the risk that an oversight body would make the PRAs more rigid and less responsive to change in the market. There is also the risk of overloading the regulatory bodies concerned (given the greater diversity of the physical markets vs. the financial markets). The economic consequences would be higher regulatory costs and higher costs for the PRAs which inevitably will be passed on to their users. The benefit would be the assurance on pricing methodologies and their application for the oil markets.
Q29 Would your view of the application of a Code of Conduct change if the PRAs were held to account for its application by a public authority? Please explain and, if appropriate, state which authority or authorities would be best placed to hold the PRAs to account. What, if any, are the potential benefits and risks? Q 28 & 29 A self-regulated PRA Code of Conduct would be an essential first step in alleviating some concerns about PRA governance. While the PRAs should (and do) hold themselves to high standards, there remains a problem of dialogue and process today. Accordingly, it is hard to imagine the PRAs changing through a self-imposed Code of Conduct unless they are fully held to account for its application. Within the PRAs, an officer at the corporate board level or the corporate executive level should be held accountable for the application of a Code of Conduct and for ensuring that the Code of Conduct meets the standards and expectations of the market. This officer should also be responsible for compliance with an annual external and public audit by the PRAs of their adherence to their code of conduct. Ultimately, it should be possible to escalate to an external arbiter (the regulator) a repeated breakdown in compliance by a PRA with its own a self-regulated Code of Conduct.
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Q31 Should IOSCO and any other relevant authorities develop for regulated markets and other trading facilities which use PRA benchmark prices in their derivatives contracts a set of specific criteria against which the suitability of PRA benchmarks should be assessed? If so, which criteria do you think should be included Given the evolving nature of the oil markets, setting such criteria (even at a high level) risks ossifying the process of change and evolution in the PRA benchmarks.
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TOTSA (Total Oil Trading SA) IOSCO Trading - Manipulation

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