Operation Transformation: Reflections from the back office
by Gavin Ferguson
Where were we in 1999?
To give context to this paper, its useful to know that its author had, by 1999, already been employed in the Gas Industry for 19 years and was showing some distinct signs of wear and tear. He had created a Department in a large UK gas company, the Department called Energy Accounting, it later morphed into a large Trading Back Office. Trading as we now think of it was still relatively new, yes there had been contracts in place for the sale and purchase of Gas for many decades, they were large contracts (Take or Pay as they were known), one offs with huge operational and financial differences between them. They could run for up to 40 years and were typically based on physical gas field depletion. There were also, in 1999, smaller “Release Gas” contracts, contracts that allowed new parties to trade gas that was released by the previous incumbent. Exchanges had begun and the Bacton Interconnector, linking Zeebrugge to the UK, had recently opened with its own trading master agreement. Lastly, there was a master agreement, NBP97, a transformative contract that allowed parties to trade gas in the UK at a Notional Location under set terms that meant a short form confirm rather than a major contract would enable many trades to be struck with reduced overheads and reduced operational risk.
Where were we in 2001?
The number of trading companies was growing very rapidly. Instead of being companies with either just production or consumption (or both) they were now joined by other Trading Houses, these might be banks, other financial institutions, etc. Traders wanted to trade in ever increasing volume, this was creating significant stress on manual processes, particularly in the Over-the-Counter (OTC) market. EFET launched the EFET master agreement which then enabled traders to undertake many times the trades with reduced risk and standard terms, simplifying and normalising gas (and power) OTC trading.
Confirms are a critical control, a method of ensuring that the Back Offices of both parties to the trade recognise their equal and opposite undertaking to the counterparty. The industry was operating on faxes – thousands of them. In my case, I had three fax machines running day and night. I knew I was only a blink of an eye from one breaking and a resultant issue so a back-up plan was needed (it was a fourth machine ready to replace an ailing one at a moment’s notice, stored safely under my desk). The paper usage was enormous (my team had its own paper ordering and delivery schedule into the building), the faxes were required not to be in a place accessible by traders so a locked glass room was built (creating a space that felt like a sauna), and then… NETA went live. The NEW Electricity Trading Arrangements (NETA) started on 27 March 2001. This meant that a handful of CFDs became thousands of Power trade confirmations. The author who had been showing early signs of wear and tear had gone downhill and was now in a full mid-life crisis.
SOMETHING HAD TO BE DONE.
2002-2004
What is this Federation, EFET? What do they do? What could they do? The industry needed something to help get the confirm issue under proper control but there was nothing any company could do on their own, with confirms it takes two to tango. There was an EFET IT Committee, perhaps they could help? It turned out that they couldn’t, but through it a few Back Office Managers, all with the same issue decided to found an EFET Committee (Business Process Optimisation Committee, forerunner to the Operations Committee). Progress was certainly difficult but confirms were a burning platform and with huge patience, tenacity and good will, a standard was written and a means of implementing that standard was found. eCM was borne, a beautiful bouncing baby of a standard that has grown into an invaluable adult member of the family. Was adoption of the standard fast, no. Did the industry get there in the end, yes. What caused it to happened? The volume of OTC trade increased hugely, something that would have created an unthinkable operation risk in the pre eCM days.
The author begins to show signs of a calm that had not been present for 5 years with people commenting that he was looking younger (yet sadly not more handsome).
2008: the financial crisis
I’m sorry to report that with the Financial Crisis, the state of the authors wear and tear had declined substantially. Many traders left the market, some in a stressed situation. It became very clear that in response to the financial issues of 2008, regulators were going to take steps to try to ensure that such this wouldn’t happen again. But what would that look like? No-one knew but it was clear that it would be far reaching and probably difficult to implement with major ramifications if the requirements were not met.
Over time the way EMIR would be implemented was becoming clearer, via trade repositories, etc. REMIT was a different matter, EFET was able to reflect what ACER were requiring of traders to help prepare for mandatory reporting of physical trades. The result was a complex but understandable method of reporting trades that met the needs of regulators and, by using the EFET eRR standard, one that traders could understand and report confidently. This was a burning platform and was implemented by many traders very rapidly.
2011: The dismantling of the fax room
At last! All but a very small number of confirms are now on eCM and IT departments have a small scale electronic solution to capture them so the fax room/sauna is ceremonially demolished and the machines sent to be recycled. A red letter day.
2021: What can be done to help Trading Companies’ digitalisation aspirations?
The Author is looking younger and feeling fitter. What caused this? Semi-retirement. It is to be recommended.
There is a very obvious element in the lifecycle of a trade that is manual. Settlement and payment netting includes sending PDFs to each other. The receiving party needs to manually check to see if the invoice is within tolerance, if not (a fairly rare event) it’s like hunting for a needle in a haystack, working though trade by trade to find the discrepancies. And Business to Government invoicing in some European countries is required to be electronic.
EFET has presented a solution to the digitalisation issue, the eSM (Electronic Settlement Matching) standard, creating a more efficient process and reducing operational risk. This can be implemented leading to a very high percentage of invoices being straight through processing. The take up of this operation has not been rapid (no burning platform), but is that about to change? With European Countries now implementing requirements for Companies to invoice counterparties electronically (B2B) it appears that eSM can be used in a manner that satisfies the requirement for energy settlement and gives the added value of matching.
The future
Markets will continue to evolve. We can be sure that change is going to happen (it always has, it always will), just not what that change will look like. Will the market recognise the very substantial industry financial benefits of faster settlement? Will regulators require more of an insight to traders data? Who knows? I don’t. What is for sure is that Energy Traders Europe is ideally placed to recognise such issues and work with traders to formulate the appropriate standards that can then be used by service providers to provide appropriate industry solutions.