The majority of energy trading representatives surveyed believe that regulatory audit and enforcement actions against energy traders will increase in the future, but only a small percentage rank the industry's readiness to comply with new financial regulatory reforms as "good" or "excellent," according to a study released Tuesday.

An estimated 80% of 140 energy trading representatives worldwide said they believed that regulators would increase their enforcement of energy traders' activities, according to the study that was sponsored by a compliance software provider, NICE Actimize, and the international law firm of Fulbright & Jaworski LLP. In fact, nearly 40% of the respondents said they felt regulators already had the capability to closely examine energy trading activity, while others believe regulators will ramp up surveillance capabilities in the near future.

Although the energy trading community may have a good understanding of compliance rules, less than 13% of the respondents rate the industry's readiness to comply with new trading regulations as good or better, according to the study.

"We are at an inflection point in the energy trading industry," said Erik J.A. Swenson, a partner at Fulbright & Jaworski. "The regulatory requirements and oversight expectations have increased, but the industry is challenged with how to respond to the evolving expectations. We expect firms to continue to adapt to this new regime by implementing new programs in the next 12 to 24 months as the regulatory front continues to evolve."

Approximately 83% of the surveyed energy traders said they are as concerned about physical and over-the-counter (OTC) market compliance as they are about futures market compliance. "This result suggests a shift in energy market compliance from a primary focus on regulated exchange trading to a broader focus on all transaction types. Energy market participants are now also dealing with a range of regulatory agencies, often with overlapping jurisdiction," such as the Commodity Futures Trading Commission, the Securities and Exchange Commission and the Federal Energy Regulatory Commission.

"The concern of industry respondents regarding OTC and physical transactions suggest that formal compliance policies and systems are likely to become of greater importance for all energy market participants, especially in light of the new requirements imposed by the passage of the Dodd-Frank act and the considerable of potential new financial regulations across the globe," the study said (see Daily GPI, July 22).

The study showed that energy traders are aware that they will face harsher penalties for compliance violations, but they are not completely sure who handles compliance oversight at their individual companies. About 30% of the respondents said energy market compliance was managed by the organization's risk management group; 23% identified their legal department; and 18% named an independent compliance group or a business group (12%) as the manager of their compliance risks.

Approximately 30% of the surveyed traders indicated that their company did not have a centralized compliance function or that they were unaware of the existence of one. "The research indicates that the energy sector has not yet adopted a generally accepted 'best practice' rubric for energy trading compliance. In many ways, the research suggests that the energy industry views compliance as it did risk management in the mid-90s -- industry participants are unclear how to value the compliance investment and how to best implement comprehensive compliance programs, but they are fairly sure action is needed," the study said.

But the study makes clear that traders are aware of the price they could pay for noncompliance. "More than 60% of respondents believe civil or criminal fines are one of the three greatest risks to energy trading firms and executives if they fail to establish an effective compliance program, while more than 50% of respondents also believe reputational risks are among the top three hazards."

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