Ofgem asks: Does mandatory market making work?

Ofgem has asked for feedback on whether its market-making windows are working, as part of its review of the Secure and Promote liquidity fix.
In 2014, the regulator brought in the Secure and Promote Licence Condition, to try to address concerns about the lack of liquidity in the GB market and specifically the trading problems faced by small suppliers.To try to give new entrants the ability to buy and sell power, Ofgem forced large companies to offer ‘mandatory market making’ (MMM). They had to be available to buy and sell power, offer prices for both, and limit the ‘spread’ between their buy and sell prices. The companies had to do this in several parts of the market: for a six-month winter or summer season up to two years ahead of time; for a three-month period up to a year ahead; and for a month ahead. They have to do that for both base­load and peak-time power. Ofgem restricted the MMM provision to two one-hour periods: 10.30-11.30 am and 3.30-4.30pm. It’s these market making windows that Ofgem is looking for feedback on.

In a new consultation, Ofgem said: “Feedback from some stakeholders has indicated that having two windows with relatively narrow spreads is beneficial to the market. They said that the strong liquidity in the windows provides wider availability of products for hedging than was the case prior to the introduction of Secure and Promote, and that the visibility of actual traded prices helps to provide a robust reference price useful to participants beyond those in the actual trades. Some stakeholders have said that two hours of strong liquidity per day is better than low liquidity all day as seen prior to Secure and Promote.”

However, the regulator said that some stakeholders, particularly MMO licensees, had raised concerns that “there has been a significant reduction in liquidity outside of those windows since the introduction of the MMO”. They believe that this limits trading opportunities and may be acting as a disincentive for financial players to enter the market.

In particular, the Ofgem said: “MMO licensees have also raised concerns that the required spreads for market making made the obligation difficult to manage during the market volatility seen at the end of 2016. The licence condition currently has a volume cap and fast market rule to mitigate these risks for licensees but some have fed back that these were insufficient, and that the parameters of the fast market rule and to a lesser extent, the volume cap, were set too wide and too inflexibly to limit their costs and risks as market makers. On the other hand, some independent suppliers have stated that, in the absence of the MMO, trading during these periods would have been very difficult and that prices would have been less robust without market making.”

The New Power view

Market making has meant companies can trade at those times. “It has probably been helpful for the brand new entrants,” one market watcher told New Power Report. “And once they get started it provides two windows for the most basic products. But that has been achieved because most of the trading has shifted to the MM windows – not because there is more trading going on.”

James Stewart, power markets specialist at price reporting company ICIS, has tracked the change. He said: “If you want to trade in the forward curve [further ahead than the next day], you have to trade in these windows.”

ICIS figures show that on an hour-by-hour basis, the vast amount of volume, whether peaks or baseload, is being traded within the two-hour market-making windows. “This trend has been broadly evident since the windows were first introduced. It has become a little more pronounced over time, but not much more,” said Stewart.

The shift is particularly evident when trading peak power. “The issue of liquidity gathering around the market-making windows is far more prevalent on peaks products than it is on baseload products. This is to be expected because peaks are far less liquid than baseload, as a rule,” said Stewart.

According to ICIS figures, for baseload products covered by the market-making obligation, since the start of 2015, 59% of total volume has been traded within the two-hour long market-making windows. On peaks products, the figure rises to 81%.

If the MMM obligation has made it harder to trade outside the two windows, the upside is that they do provide broader visibility at those times. Some energy companies manage their trades in other ways, such as a structured deal with a single provider. But for any company, the MMM windows make deals and spreads public. “Every day, twice a day, there are products there and the spread is reasonably tight,” one pointed out, and other deals can be matched to those.

To find out more, read: Is the liquidity fix in good shape for the future?, New Power Report, April 2017. Members, log in here to read  read more about what power supply companies think of liquidity in 2017. 

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