Bryan Adare, Senior Consultant, Brickendon
In order to fully understand the true implications and consequences of the Markets in Financial Instruments Directive (MiFID II), the financial services (FS) sector should look to other areas to learn how best to anticipate looming change and prepare in advance.
The complex framework is due to come into effect in 2018 and will likely have far-reaching and wide-ranging consequences throughout the financial world. Amid ongoing uncertainties and concerns around the true scale of the challenges posed by implementation and compliance, drawing parallels with other sectors and industries is a useful and instructive tool for gaining valuable insights ahead of the looming deadline.
With this in mind, we wanted to look towards less typical sources of inspiration for the FS sector as it prepares for yet another regulatory overhaul in the form of MiFID II.
Taking to the skies
Earlier this year, British Airways removed complimentary food and drinks from their short-haul European flights. A long-time coming as part of many changes to reduce costs, CEO Alex Cruz decided that removing the complementary service in an environment increasingly dominated by low-cost competitors was the best way to improve profitability and maintain price competitiveness.
The changes were not taken well by BA customers, with both leisure holidaymakers and corporate frequent-fliers up in arms about the loss of the previously complementary service. Airline passengers are however not the only ones subject to so-called unbundling. As part of the new MIFID II legislation, banks are on the verge of unbundling previously free research services.
Changes like this are part of a larger trend in the airline industry’s unbundling. Within the industry, it has been pioneered by the low-cost segment as a way to create the lowest ticket price for consumers who just want to get to their destination without any frills. Those who want additional services can pay for what they use. Reducing included services is one of the pillars of the low-cost model, and legacy carriers have been struggling to determine how to price competitively, yet continue to offer the level of service their customers expect. Initially it was led by the removal of simple items like checked-in baggage and exit-row seat selection, but has now evolved to cover almost any service traditionally included in the price of admission, from the on-board food and drink service and seat selection in any part of the cabin; to boarding order and number of carry-on bags.
Naturally, the changes have had an impact on ticket pricing across the board, with legacy carriers reducing their core route prices year-over-year to compete in a market which is generally driven by the lowest advertised price. While flyers are shy to praise these price reductions, they are quick to complain about the removal of services. From a frequent-flyer perspective the impact can be great: they are losing their Thursday night commuter drink and are unable to charge purchases back to corporate policies. For leisure travellers, the degradation in service quality from the expectations set by BA following years of high-quality on-board service, could be one of the final nails in the coffin that drives holiday makers to cheaper low-cost carriers.
Comparisonswith the FS sector
Similarly, the investment and asset management industry is also dealing with unbundling, though this time driven by a completely different force, namely the regulatory requirements of MiFID II. As part of the regulations that take full effect from 3 January 2018, portfolio managers and buy-side professionals are barred from accepting free research insights as this could be viewed as an ‘inducement’ under the terms of the MiFID II regulations. The new legislation imposes stringent conditions on clients’ payments for research and requires the use of a dedicated Research Payment Account (RPA) to allow for a buy-side client to pre-select the quantity of research and focus the coverage as they find applicable.
The implementation of these new rules has not been simple for anyone, with major initiatives being taken to ensure the changes are implemented from all perspectives. Sell-side firms have been sluggish to implement the necessary changes, as they also seek to implement numerous other global regulations which have come into force in the last few years. Going forward, buy-side firms are likely to be reluctant to start paying for a service which used to be complementary.
Fundamentally, sell-side institutions work as a gift economy. They provide research, introductions to CEOs, trade ideas and informal advice in the hope that buy-side institutions will later pay them to execute trades or structure deals. This is not to say that research is entirely free, but the payment mechanism is entirely at the buyer’s discretion. Funds are allocated to research and the buyer chooses after the event how to allocate those funds amongst the organisations that provided the research content. In other words, banks provide the advice and are only paid if the buyer believes it was worthwhile.
MIFID II rules are about to tear up this relationship. Not only will buyers pay in advance for advice without knowing how to value it, but the advice will need to be fully costed and not provided at its current large discount.
Looking to the future – potential lessons and next steps
There are some professionals who wonder what effect this will have on the core relationship between the buy-side and sell-side, and whether there will be a place for research-oriented institutions going forward. Others are concerned that there will be less incentive to cover smaller entities from a research perspective, which could lead to a significant reduction in liquidity for smaller and less-prestigious listed entities.
The low-cost airline market uses product unbundling as a way of gaining price advantage in a heavily commoditised market by tapping no-frills customers to fill seats and grow volume. There are some industry insiders who suspect that the financial world could leverage this model. The opportunity is now opening for new entrants who can provide execution services at rock-bottom prices with no-frills, and for research-only firms who can provide top-ranked research at lower cost, without the infrastructure and overhead of execution.
Time will tell for airlines how well unbundling works, with the low-cost model sure to continue for those already in the space. Some legacy US carriers have already back-tracked on their cuts to food and beverage offerings, and British Airways has recently re-introduced complementary seat selection for status holders in their Executive Club even on basic fares. For the investment industry, it appears that the regulations, and costs involved in meeting those, will ensure the new status quo remains for the time being.
As for the low-cost airline model, both corporate road-warriors and leisure holiday makers seem to be continuing to flirt with low-cost carriers. However, many customers now buy their meals before boarding the plane, believing they can get a better price or better quality product. Whether the buy-side implement a similar strategy of shopping around and if they do, what will this do to the trade execution costs that the sell-side is able to charge, remains to be seen. Whatever the outcome, it is definitely an area to watch and one where many lessons are still to be learnt.
Airbus CEO urges trade war ceasefire, easing of COVID travel bans
By Tim Hepher
PARIS (Reuters) – The head of European planemaker Airbus called on Saturday for a “ceasefire” in a transatlantic trade war over aircraft subsidies, saying tit-for-tat tariffs on planes and other goods had aggravated damage from the COVID-19 crisis.
Washington progressively imposed import duties of 15% on Airbus jets from 2019 after a prolonged dispute at the World Trade Organization, and the EU responded with matching tariffs on Boeing jets a year later. Wine, whisky and other goods are also affected.
“This dispute, which is now an old dispute, has put us in a lose-lose situation,” Airbus Chief Executive Guillaume Faury said in a radio interview.
“We have ended up in a situation where wisdom would normally dictate that we have a ceasefire and resolve this conflict,” he told France Inter.
Boeing was not immediately available for comment.
Brazil, which has waged separate battles with Canada over subsidies for smaller regional jets, on Thursday dropped its own complaint against Ottawa and called for a global peace deal between producing nations on support for aerospace.
Faury said the dispute with Boeing was particularly damaging during the COVID-19 pandemic, which has badly hit air travel and led to travel restrictions or border closures. He expressed particular concern about widening bans within Europe.
“We are extremely frustrated by the barriers that restrict personal movement and it is almost impossible today to travel in Europe by plane, even domestically,” he said.
“The priority no. 1 for countries in general is to reopen frontiers and allow people to travel on the basis of tests and then eventually vaccinations.”
The comments come as businesses increase pressure on governments to reopen economies as coronavirus vaccine roll-outs gather pace across Europe.
France has defended recently introduced border restrictions, saying they will help the government avoid a new lockdown and stay in force until at least the end of February.
Germany installed border controls with the Czech Republic and Austria last Sunday, drawing protest from Austria and concerns about supply-chain disruptions.
Berlin calls the move a temporary measure of last resort.
Poland said on Saturday it had not ruled out imposing restrictions at the country’s borders with Slovakia and the Czech Republic due to rising COVID-19 cases.
(Reporting by Tim Hepher; Editing by Kirsten Donovan)
Why a predictable cold snap crippled the Texas power grid
By Tim McLaughlin and Stephanie Kelly
(Reuters) – As Texans cranked up their heaters early Monday to combat plunging temperatures, a record surge of electricity demand set off a disastrous chain reaction in the state’s power grid.
Wind turbines in the state’s northern Panhandle locked up. Natural gas plants shut down when frozen pipes and components shut off fuel flow. A South Texas nuclear reactor went dark after a five-foot section of uninsulated pipe seized up. Power outages quickly spread statewide – leaving millions shivering in their homes for days, with deadly consequences.
It could have been far worse: Before dawn on Monday, the state’s grid operator was “seconds and minutes” away from an uncontrolled blackout for its 26 million customers, its CEO has said. Such a collapse occurs when operators lose the ability to manage the crisis through rolling blackouts; in such cases, it can take weeks or months to fully restore power to customers.
Monday was one of the state’s coldest days in more than a century – but the unprecedented power crisis was hardly unpredictable after Texas had experienced a similar, though less severe, disruption during a 2011 cold snap. Still, Texas power producers failed to adequately winter-proof their systems. And the state’s grid operator underestimated its need for reserve power capacity before the crisis, then moved too slowly to tell utilities to institute rolling blackouts to protect against a grid meltdown, energy analysts, traders and economists said.
Early signs of trouble came long before the forced outages. Two days earlier, for example, the grid suddenly lost 539 megawatts (MW) of power, or enough electricity for nearly 108,000 homes, according to operational messages disclosed by the state’s primary grid operator, the Electric Reliability Council of Texas (ERCOT).
The crisis stemmed from a unique confluence of weaknesses in the state’s power system.
Texas is the only state in the continental United States with an independent and isolated grid. That allows the state to avoid federal regulation – but also severely limits its ability to draw emergency power from other grids. ERCOT also operates the only major U.S. grid that does not have a capacity market – a system that provides payments to operators to be on standby to supply power during severe weather events.
After more than 3 million ERCOT customers lost power in a February 2011 freeze, federal regulators recommended that ERCOT prepare for winter with the same urgency as it does the peak summer season. They also said that, while ERCOT’s reserve power capacity looked good on paper, it did not take into account that many generation units could get knocked offline by freezing weather.
“There were prior severe cold weather events in the Southwest in 1983, 1989, 2003, 2006, 2008, and 2010,” Federal Energy Regulatory Commission and North American Electric Reliability Corp staff summarized after investigating the state’s 2011 rolling blackouts. “Extensive generator failures overwhelmed ERCOT’s reserves, which eventually dropped below the level of safe operation.”
ERCOT spokeswoman Leslie Sopko did not comment in detail about the causes of the power crisis but said the grid’s leadership plans to re-evaluate the assumptions that go into its forecasts.
The freeze was easy to see coming, said Jay Apt, co-director of the Carnegie Mellon Electricity Industry Center.
“When I read that this was a black-swan event, I just have to wonder whether the folks who are saying that have been in this business long enough that they forgot everything, or just came into it,” Apt said. “People need to recognize that this sort of weather is pretty common.”
This week’s cold snap left 4.5 million ERCOT customers without power. More than 14.5 million Texans endured a related water-supply crisis as pipes froze and burst. About 65,000 customers remained without power as of Saturday afternoon, even as temperatures started to rise, according to website PowerOutage.US.
State health officials have linked more than two dozen deaths to the power crisis. Some died from hypothermia or possible carbon monoxide poisoning caused by portable generators running in basements and garages without enough ventilation. Officials say they suspect the death count will rise as more bodies are discovered.
THIN POWER RESERVE
In the central Texas city of Austin, the state capital, the minimum February temperature usually falls between 42 and 48 degrees Fahrenheit (5 to 9 degrees Celsius). This past week, temperatures fell as low as 6 degrees Fahrenheit (-14 degrees Celsius).
In November, ERCOT assured that the grid was prepared to handle such a dire scenario.
“We studied a range of potential risks under both normal and extreme conditions, and believe there is sufficient generation to adequately serve our customers,” said ERCOT’s manager of resource adequacy, Pete Warnken, in a report that month.
Warnken could not be reached for comment on Saturday.
Under normal winter conditions, ERCOT forecast it would have about 16,200 MW of power reserves. But under extreme conditions, it predicted a reserve cushion of only about 1,350 MW. That assumed only 23,500 MW of generation outages. During the peak of this week’s crisis, more than 30,000 MW was forced off the grid.
Other U.S. grid operators maintain a capacity market to supply extra power in extreme conditions – paying operators on an ongoing basis, whether they produce power or not. Capacity market auctions determine, three years in advance, the price that power generators receive in exchange for being on emergency standby.
Instead, ERCOT relies on a wholesale electricity market, where free market pricing provides incentives for generators to provide daily power and to make investments to ensure reliability in peak periods, according to economists. The system relied on the theory that power plants should make high profits when energy demand and prices soar – providing them ample money to make investments in, for example, winterization. The Texas legislature restructured the state’s electric market in 1999.
Since 2010, ERCOT’s reserve margin – the buffer between generation capacity versus forecasted demand – has dropped to about 10% from about 20%. This has put pressure on generators during demand spikes, making the grid less flexible, according to North American Electric Reliability Corporation (NERC), a nonprofit regulator.
That thin margin for error set off alarms early Monday morning among energy traders and analysts as they watched a sudden drop in the electrical frequency of the Texas grid. One analyst compared it to watching the pulse of a hospital patient drop to life-threatening levels.
Too much of a drop is catastrophic because it would trigger automatic relay switches to disconnect power sources from the grid, setting off uncontrolled blackouts statewide. Dan Jones, an energy analyst at Monterey LLC, watched from his home office in Delaware as the grid’s frequency dropped quickly toward the point that would trigger the automatic shutdowns.
“If you’re not in control, and you are letting the equipment do it, that’s just chaos,” Jones said.
By Sunday afternoon about 3:15 p.m. (CST), ERCOT’s control room signaled it had run out of options to boost electric generation to match the soaring demand. Operators issued a warning that there was “no market solution” for the projected shortage, according to control room messages published by ERCOT on its website.
Adam Sinn, president of Houston-based energy trading firm Aspire Commodities, said ERCOT waited far too long to start telling utilities to cut customers’ power to guard against a grid meltdown. The problems, he said, were readily apparent several days before Monday.
“ERCOT was letting the system get weaker and weaker and weaker,” Sinn said in an interview. “I was thinking: Holy shit, what is this grid operator doing? He has to cut load.”
Sinn said he started texting his friends on Sunday night, warning them to expect widespread outages.
‘SECONDS AND MINUTES’
Early Monday morning, one of the largest sources of electricity in the state – the unit 1 reactor at the South Texas Nuclear Generating Station – stopped producing power after the small section of pipe froze in temperatures that averaged 17 degrees Fahrenheit (9 degrees Celsius). The grid lost access to 1,350 MW of nuclear power – enough to power about 270,000 homes – after automatic sensors detected the frozen pipe and protectively shut down the reactor, said Victor Dricks, a spokesman for the U.S. Nuclear Regulatory Commission.
About 2:30 a.m. (CST), the South Plains Electric Cooperative in Lubbock said it received a phone call from ERCOT to cut power to its customers. Inside the ERCOT control room, staff members scrambled to call utilities and cooperatives statewide to tell them to do the same, according to operational messages disclosed by the grid operator.
Three days later, ERCOT Chief Executive Bill Magness acknowledged that the grid operator had only narrowly avoided the calamity of uncontrolled blackouts.
“If we hadn’t taken action,” he said on Thursday, “it was seconds and minutes (away), given the amount of generation that was coming off the system at the same time that the demand was still going up.”
(Reporting by Tim McLaughlin and Stephanie Kelly; additional reporting by Nichola Groom; editing by Simon Webb and Brian Thevenot)
UK could declare Brexit ‘water wars’ – The Telegraph
(Reuters) – Britain could restrict imports of European mineral water and several food products under retaliatory measures being considered by ministers over Brussels’ refusal to end its blockade on British shellfish, the Telegraph reported.
Senior government sources pointed to potential restrictions on the importing of mineral water and seed potatoes, the report said.
(Reporting by Maria Ponnezhath in Bengaluru; Editing by Daniel Wallis)
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Why a predictable cold snap crippled the Texas power grid
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