Cool Tools for Power Rules: Modern Methods for Ensuring Compliance with Energy Regulations

1. Cool Tools for Power Rules: Modern Methods for Ensuring Compliance with Energy Regulations

2. A Host of Regulators

3. Wide Range of Issues to Monitor Regulators continue to focus on fraud, manipulation and safety/reliability violations Technical violations of agency/market rules regardless of intent are leading to burdensome inquiries and bigger penalties Regulations are not uniform – what’s legal in one regime may not be legal in another Compliance with market rules is not a complete defense, so may need to look beyond

4. Implications Individuals have exposure, including for failure to supervise or breach of duty Legal and compliance professionals are now subjects of inquiries for failure to do their jobs/have adequate programs Professionals can be targets for aiding in unlawful activity (Richard Silkman in FERC paper mill cases)

5. Practices Scrutinized There is a growing trend where the failure to take adequate steps to prevent, detect and stop unlawful activity can be actionable

9. Areas for Surveillance • Regulators expect energy companies to have surveillance programs that: • Screen for compliance with regulatory obligations • Capture data indicating potential non-compliance • Provide for timely escalation of potential violations • Provide for human involvement in review and resolution • Timely report problematic activity to regulators • In Europe, this is mandatory for some market participants

10. Concerns for Global Companies • Doing business outside the U.S. is complicated: • Offering common business courtesies • Hiring and paying an international workforce • Monitoring charitable contributions • Moving people and equipment around the world • Customers in the Middle East • The compliance terrain is constantly changing • Fundamental elements of a compliance program may not work in other countries

11. Key Trends – Anti-Corruption • U.S. FCPA prohibits bribing foreign government officials anywhere in the world to obtain or retain business • Companies with stock traded on a U.S. exchange must also meet certain standards for books and records, and internal controls • Since 2004, the U.S. has collected more than $7 billion in fines from multinational companies and sentenced individuals to jail for up to 15 years • Other jurisdictions have also enacted anti-corruption legislation and begun prosecutions for violations

12. Hypo • AmeriCo has acquired a 40% interest in a new standalone water services company (WSC) in Kuwait. AmeriCo will place some U.S. expats in management positions, will have audit rights, and will seat an AmeriCo officer on the WSC board of directors. After a recent audit, AmeriCo’s head auditor reports her discovery that a WSC Kuwaiti employee gave a laptop computer to the local government official responsible for certifying the new water treatment plant. After months of delay, certification was granted – 2 weeks after he received the laptop. The laptop was paid for out of petty cash and the expense was identified only as “equipment.” • What should Sara Surveillance be concerned about?

13. Key Trends – Manipulation • Monitoring for manipulation and attempted manipulation (e.g., commercial activity that may lead to artificial pricing in the markets) with a focus on: • Large derivative or commodity positions • Positions in illiquid markets • Related positions where activity in the physical market could impact a derivative position or vice versa • Wash trades • Index/benchmark price setting

15. Hypo CommodCo provides supply chain management services throughout the U.S. After noticing that liquidity is down in the natural gas markets, CommodCo decides to engage in more market-making activity to help the market have more trading options. What should Sam Surveillance be on alert for?

16. Key Trends – Fraud • Monitor for false/misleading statements: • Through market activity such as bids and offers • Through reports that impact market assessments • False public announcements of planned pricing or output decisions, false statistical or data reporting, and wash sales intended to disguise market liquidity or product price • In market registrations that impact payments from markets (e.g., fuel use, production capacity) • On affiliation or control over market activity

18. Hypo NatGasCo reports natural gas storage data to EIA. After the publication date, Sally Surveillance learns that her company under-reported what was in storage. What should Sally do?

19. Key Trends – Insider Trading • Monitoring for insider trading with focus on: • Misappropriation of information by persons with duty not to use/disclose (e.g., policies, employment agreements, services agreements, advisor/fiduciary) • Consider tipper/tippee risk and harm to party whose information was shared • EU market abuse requirements (MAR) related to commodities and derivatives trading, where what constitutes inside information for commodities is more restrictive than in the U.S.

20. Hypo Trades-R-Us has an agreement with UtilCo that requires it to optimize UtilCo’s power plant in PJM. Sam Surveillance learns that the trade team that optimizes UtilCo plant also optimizes other plants in the North East. Should Sam be concerned?

21. Key Trends – Advisory Services • Monitor for trade advising • Focus on counter-party relations where a market participant provides advisory services to another, including EMAs and AMAs • A CTA is an individual or organization which, for compensation or profit, advises others as to the value of or the advisability of buying or selling futures contracts, options on futures, or swaps • Providing advice includes exercising trading authority over a customer’s account as well as giving advice based on knowledge of or tailored to customer’s particular commodity interest account, particular commodity interest trading activity, or other similar types of information

22. Hypo NatGasCo asks Trades-R-Us to help it manage the risks associated with natural gas storage. Pursuant to the asset management agreement between the parties, Trades-R-Us advises NatGasCo on ways to hedge price risk. Should Sally Surveillance be concerned?

23. Key Trends – Operations • Monitoring operations and asset management, with focus on • Market power using control over supply, storage or other positions (e.g., hoarding, cornering) • Timing of commercial activities • Actions against economic interest (e.g., not using what you have in storage when it appears cheaper than market options) • Failure to perform

24. Hypo MarketerCo manages a capacity commitment for an IPP in PJM. The facility is served by a gas line that has been out for weeks due to a nearby construction mishap. Sam Surveillance sees that MarketerCo is meeting IPP’s must-offer obligation into PJM. Any issues?

25. Key Trends – Disruptive Trading • Monitor for spoofing, with focus on: • Automated trading, including purpose behind trade execution code and execution rates • Interplay of manual trades

26. Hypo Sally Surveillance sees that OilCo has a high volume of activity at a trading hub. She asks Joe Crude on the oil desk why they have so many offers and at prices that seem a little out of market. Joe says they see a lot of sales opportunities at the hub and want to signal where they think prices should be. Should Sally follow up?

27. Best Practices • Hiring – screen applicants • Training – general and business unit specific, trading/product specific • Manuals – regularly updated, specific to trading • Certifications – existence of adequate training and risk management • Compliance Practices And Procedures – in place, followed, updated as needed, executed, penalty for failure to execute • Cross-Functional Surveillance - business unit, desk, trading unit compliance, including for inter-affiliate trades, position limits, control • Annual Training – including lessons learned internally and externally • ETRM Updates – evaluate annually for necessary updates • Communication Monitoring – evaluate regularly for necessary updates • Investigation Procedure – Include cross-functional team (e.g., HR to help ensure consistent, measured response to inquiries), drill executives on necessary supervision and how to proceed when an alarm is raised

28. U.S. Energy Regulators - CFTC • The CFTC is the primary U.S. regulator of financial trading in commodity derivatives markets. • Jurisdiction covers commodities and their derivatives, including futures, swaps, and options • Has authority to address fraud and manipulation of commodity derivative markets, insider trading, false reporting, disruptive trading practices, wash trading and excessive speculation • Anti-manipulation/fraud authority can be used to redress physical trading that affects price formation in financial markets for commodity derivatives (e.g., trading in the window, setting the benchmark)

29. U.S. Energy Regulators – FERC FERC is the primary regulator over non-discriminatory access to and rates for interstate transportation, storage and transmission, wholesale sales of power, hydro licensing Has authority to address fraud in the power and natural gas markets, false reporting, wash trading Works with NERC and NAESB to ensure reliability

30. U.S. Energy Regulators – FTC • The FTC is authorized to prohibit market manipulation in physical crude and refined product markets, as well as false reporting • From upstream production down to rack sales – not retail • The FTC has authority to prevent and prosecute anti-competitive behavior by energy market participants • Collusion, price fixing, tying arrangements • The FTC coordinates with, and generally defers to, the CFTC on enforcement activity

31. U.S. Energy Regulators – EPA EPA has broad authority over energy market activity that impacts air quality, water quality, disposal, discharge, or involves use of hazardous products EPA oversees the platforms on which certain energy attributes/allowances are traded (e.g., for sulfur or nitrogen emissions, RINs for renewable fuels) EPA, with the DOJ, can pursue violations of EPA’s regulations, including for fraud. To the extent that such fraud impacts commodities or derivatives, the CFTC may also pursue such matters

32. CFTC Manipulation • Elements • Ability to influence market price • Intended to manipulate market price • “Artificial price” existed in the market • Price does not reflect legitimate forces of supply and demand • Caused an artificial price in the market • Attempted manipulation also an offense

33. FERC, CFTC, FTC Fraud • FERC, FTC and CFTC have similar rule • Unlawful to intentionally or recklessly: • Use a manipulative device, scheme or artifice to defraud • Make untrue or misleading statements or omissions of a material fact • Engage in an act or practice operating as a fraud or deceit • For the CFTC, also includes making a false, misleading or inaccurate report concerning market information that affects or tends to affect the price of a commodity

34. CFTC Insider Trading Prohibits “trading on the basis of material nonpublic information in breach of a pre-existing duty (established by another law or rule, or agreement, understanding or some other source), or by trading on the basis of material nonpublic information that was obtained through fraud or deception.”

35. Insider Trading – Duties • The following are examples of relationships/agreements that could create a duty: • Fiduciary relationship • Employment agreement • Company policies • Services and other contracts with counterparties

36. CFTC Disruptive Trading • Spoofing • Submitting or cancelling bids or offers to overload the quotation system of a registered entity • Submitting or cancelling bids or offers to delay another person’s execution of trades • Submitting or cancelling multiple bids or offers to create an appearance of false market depth • Requires intent to cancel the bid or offer before execution • Irrelevant whether order was filled • Applies to automated or “flash” trading, but also manual trading

37. CFTC Disruptive Trading • Violating Bids or Offers: • Prohibits any person from (i) buying a contract at a price that is higher than the lowest available offer price or (ii) selling a contract at a price that is lower than the highest available bid price • Not applicable where algorithms automatically match the best bid and offer • Per se offense: No defense for good faith, inadvertent errors that can occur from time to time in the manual execution of trades

38. CFTC Disruptive Trading • Disorderly Execution • Intentional or reckless disregard for the orderly execution of transactions during the closing period • Conduct outside the closing period can still trigger an inquiry

39. European Union • The FCA (and other European domestic regulators) have authority principally under MAD/MAR • The FCA’s Code of Market Conduct describes each of the 7 MAD offences and gives examples (see http://fshandbook.info/FS/html/FCA/MAR/1) • MAD/MAR offences relating to market manipulation and false or misleading statements or conduct: • Manipulating transactions • Manipulating devices • Dissemination • Misleading behavior and market distortion

40. European Union • Manipulating transactions: transacting or bidding in an illegitimate manner or not in accordance with accepted market practices, which results in: • A false or misleading impression as to the supply, demand for or price of a qualifying/related investment • The price of a qualifying investment being secured at an abnormal or artificial level

41. European Union • MAR will extend the definition to cover “cross-market” manipulation: • Manipulation of derivative markets through conduct in the related spot markets, and • Manipulation of spot markets through conduct in the related derivative market

42. European Union • MAD/MAR also prohibits trading on inside information and unlawful disclosure of such information. For commodity derivatives, inside information: • Is of a precise nature • Non-public and if it were made public, would be likely to have a significant effect on the prices of such derivatives or related spot commodity contracts • Relates, directly or indirectly, to one or more commodity derivatives and related spot contracts, and • Users of commodity derivatives markets would not expect to receive in with accordance with law, market rules, contract, practice or custom

43. European Union • Unlike the EU, the CFTC does not prohibit the trading of commodities based on non-public information • However, the disclosure of information that is subject to a confidentiality agreement or failure to disclose information where there is a legal obligation to disclose could be viewed as manipulative behaviour

44. Questions Nancy McCready Higgins Vice President and Chief Ethics and Compliance Officer Bechtel Group, Inc. nmhiggin@bechtel.com CatherineKrupka Partner Sutherland Asbill & Brennan LLP Catherine.krupka@sutherland.com Joe Limone General Counsel, North America Noble Americas jl@thisisnoble.com Amber Shushan Senior Legal Counsel PetroChina International (America), Inc. Amber.shushan@petrochina-usa.com