ACM: energy traders reduce risks of algorithmic trading, but additional improvements are needed

Businesses that trade on the wholesale markets for electricity and natural gas are increasingly using algorithms. Algorithms help in projecting supply, demand, and prices as well as in automating trading decisions. That makes trading more efficient, but it also carries risks such as errors in data or models, reduced transparency, with an increased probability of market disruptions. That is why the Netherlands Authority for Consumers and Markets (ACM) has examined how market participants on the wholesale markets for natural gas and electricity deal with the risks of algorithmic trading. A recent check has revealed that businesses are aware of the risks and take measures, but that there are also areas of improvement, and that continued attention is needed.

As part of that check, ACM had access to documents of businesses to check whether they comply with the tightened REMIT regulation that went into effect in May 2024. These were businesses that trade spot and futures contracts on the wholesale markets for natural gas and electricity. These are not just businesses within the energy sector, but also, for example, financial companies that trade in electricity and natural gas.

Risk management varies per business

All businesses that were approached say they use pre-trade controls within their risk management processes. These are preventive control mechanisms that seek to mitigate the risks before a trade order is executed. The exact setup thereof varies per business, and depends, in part, on the trading strategy. Most businesses say they regularly conduct checks of these systems.

ACM has observed great variation in the way businesses safeguard the reliability and compliance of trading algorithms. Most businesses have assigned the duties of approving or overseeing algorithms to an independent role. This division of duties and responsibilities is less clear with other market participants. A clear division of duties is essential for managing risks, and preventing conflicts of interests. For example, a trader cannot raise a limit just like that. In addition, ACM sees that procedures for developing, testing, approving, and monitoring algorithms have only been established to a limited extent. The degree of automation also varies: some businesses monitor irregular trading behavior using automated risk checks, while others do so manually and incidentally.

In the coming months, ACM will discuss the results of these checks with the businesses involved, and, in that context, will also call for attention to several areas of improvement.

In its oversight going forward, ACM to focus on risk management of algorithmic trading

In the coming year, ACM will continue its oversight over algorithmic trading, and will, as part of that effort, primarily focus on the following points of attention, which businesses must have in order in any case:

• An appropriate governance and organizational structure with a clear division of duties and responsibilities, and effective procedures for communication.
• Relevant data regarding algorithmic trading systems and risk controls must be saved for at least five years, so that the regulator can check that data.
• Pre-trade controls and limits prevent erroneous orders, systemic risks, and market disruptions. These need to fit with the obligations of REMIT and trading platforms.
• Periodic monitoring and testing of trading algorithms, strategies, and security measures in order to ensure that these continue to comply with the regulations.

ACM frequently receives questions from businesses about the REMIT rules on algorithmic trading and the way in which regulators apply those rules. That is why ACM is undertaking efforts to provide further guidance for market participants to meet the REMIT obligation. To this end, ACM is working together with the EU Agency ACER, in charge of the monitoring of the EU wholesale energy markets and ensuring effective coordination and consistency in NRAs’ activities under REMIT. Furthermore, with regard to algorithmic trading, ACM works together with the Dutch Authority for the Financial Markets (AFM), which enforces integrity and transparency rules on the markets for financial instruments, including energy derivatives. Oversight over the use of algorithms in energy trading thus falls under the jurisdictions of both regulators, which will continue to monitor whether businesses comply with the rules, and which will collaborate on exchanging knowledge of algorithmic trading practices and best practices.