Report
12.11.2024
Customers

Use of prudential regulation mechanisms to promote effective supplier risk management in the energy sector

Context

The energy crisis has severely impacted energy suppliers due to financial strain and inadequately defined hedging strategies. This situation highlights the need for reliable supplier mechanisms to mitigate bankruptcy risks and protect consumers from potential negative impacts. This report focuses on Article 18a of the amended Electricity Market Design Directive (2019/944), which addresses supplier risk management.

Purpose

Article 18a introduces measures to ensure that electricity suppliers are resilient to wholesale market price fluctuations by managing their supply and hedging strategies effectively. The goal of this Article is to avoid ‘hit and run’ strategies and to protect consumers from risky sourcing practices. The paper interprets Article 18a, presents existing prudential mechanisms, and provides examples from various countries – Great Britain, Spain, the Netherlands, France, Belgium (Flanders), Sweden, Germany, Portugal. These insights help competent authorities develop their own mechanisms, based on established practices.

Key findings

CEER offers a toolkit of regulatory tools for implementing prudential regulation, including hedging requirements, stress tests, financial obligations, and risk assessment strategies. It also outlines insights and considerations for competent authorities in areas such as framework and procedures, scope of regulation, and balancing ambition with resources.

Key findings show that:

  • Hedging requirements are commonly monitored through specific methods, market-specific criteria, and regular reporting.
  • Stress tests are used to assess the resilience of suppliers under different market conditions.
  • Financial obligations are imposed to ensure that suppliers have adequate resources to withstand market fluctuations.
  • Risk assessment and risk management strategies are essential for identifying and mitigating potential supplier risks.

CEER also presents some insights and constraints for competent authorities to consider when implementing Article 18a:

  • Framework and procedures (flexibility and agility of the mechanism; harmonisation between electricity and gas; incorporation in licensing/registration procedures; confidentiality of hedging data)
  • Scope of regulation (relation between the risk to tackle, such as over- vs. under-hedging, and the type of contracts or suppliers covered; balancing hedging requirements with procurement freedom)
  • Ambition versus resources (aligning regulatory ambition with available resources; balancing risk management efforts with administrative burden)

CEER emphasises that regulatory ambition should align with available resources. When designing prudential mechanisms, NRAs and competent authorities should be prepared to adapt regulations as the market evolves, striking a balance between stability and flexibility to allow suppliers sufficient time for compliance.

Overall, Article 18a provides room for tailored regulation, enabling Member States to create market-specific solutions rather than a one-size-fits-all approach.