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28 | 2nd - 8th May 2014 | UtILIty WEEK Markets & Trading Analysis Banks retreat from trading Ofgem wants more liquidity and participation, but banks are voting with their feet. By Jillian Ambrose. T he UK's energy markets face the risk of price volatil- ity and lower liquidity following the steady retreat of financial players from gas and power trading, market sources have warned. On Tuesday, Barclays Capital became the latest finan- cial player to back away from UK energy trading, with the announcement that it will exit commodities markets, including energy, to refocus on more profitable areas for the group. It joins JP Morgan, Deutsche Bank, Bank of America Merrill Lynch, and Morgan Stanley, all of which have reduced or closed their European power and gas trading units in recent months. The loss of yet another financial player from the energy trading space has sparked renewed concern over the health of the UK's gas and power markets at a time when Ofgem continues to push forward with plans to boost liquidity and market participation. Not only will fewer financial participants decrease liquidity overall, traders warn, but the reduced variety of market players could threaten the stability of the market. "The main issue is more than losing a section of the market that provided liquidity – this could provide opportunity for those still le," a UK power trader says, "But it may make it easier for more dominant parties to bully the market." Clive Furness, managing director of market consul- tancy Contango Markets, says the active participation of financial institutions is a stabilising factor in the market because banks have inherently different drivers from those with generating portfolios. "You need a mixture of participants to have a fully functional, balanced mar- ket," he says. "In a market dominated by a few large partici- pants, there is a risk of sharp, unexpected price moves [because] the risk of there not being enough participants to 'soak up' volume is higher," Furness adds. UK power traders tell Utility Week that one of the key reasons behind the exodus of financial players is increased regulation of derivatives trading, which has made it harder to make money. Reduced market participation from the financial space comes as Ofgem continues to seek to encourage new entrants into the market. In April, its "secure and promote" rules came into effect, forcing the UK's largest suppliers to place bids and offers on forward-curve prod- ucts within designated time windows, to boost liquidity on the wholesale electricity market. Traders say that although the regime has increased pricing visibility, it is still too soon to tell whether it will support the inclusion of new entrants. Analysis VAT fraud alert Legitimate players could face demands to reimburse the taxman for VAT fraud. Jillian Ambrose warns traders to beware. U K energy market participants could fall foul of an HMRC investigation into suspected VAT fraud in the gas and power markets if traders are not able to prove they took active steps to guard against fraudsters. A recent client note from Deloitte says that HMRC has begun investigations into VAT losses from wholesale gas and power markets, as well as telecoms. Deloitte's indirect tax partner, Helen Thompson, warns that legiti- mate energy companies in the market could be liable for losses. "There is a test: [legitimate] companies can be found liable if they knew about the fraud, or if they should have known the trade was fraudulent," Thomp- son says. "This is why it's really important to have the correct due diligence in place," she adds. Deloitte recommends that traders know who they are dealing with and update counterparty checks frequently. In addition, companies are expected to pay attention to real-time trading patterns to discern whether a trade has a commercial rationale. Trade that seems irrationally vol- atile or suspicious should not be entered into. In a client note last week, Deloitte warned: "Some businesses operating in these markets have been con- tacted by HMRC with long and very detailed lists of questions. "A key step to protect against liability for lost VAT is to demonstrate that relevant staff members have been appropriately trained to recognise missing trader fraud risk," the note advised. A UK power trader tells Utility Week that training on how to identify market fraud occurs across all companies involved in the market. "Even if you are not the company that is directly implicated in this, you can still come under investigation and lose out to it. So it's not good for anyone," he says. The scam, known as "missing trader fraud", involves a criminal organisation collecting VAT on a trade made across national boundaries, then disappearing. The scam was seen at a significant scale in emissions trading market and resulted in jail terms of 35 years for those convicted. Thompson says gas, power and metals markets could be next. "Any market which is fairly liq- uid, with high volumes but low barriers to entry could attract fraudsters," Thompson says. Due to the complex "supply chain" of onward trading, the investigation could "take years", Thompson added. A spokesman for HMRC declined to comment, saying: "For legal reasons, we can neither confirm nor deny any ongoing investigation."