ACM: use of algorithmic trading on the energy market has increased strongly

The use of algorithms in energy trading on wholesale markets for electricity and natural gas has increased strongly. The energy transition is one of the drivers behind this growth. Energy generation using renewable energy sources is less predictable for traders. Algorithms help traders adjust their positions at the last minute. In addition, a growing number of pure algorithmic traders is active. These are market participants that do not operate power plants of their own or serve customers for the delivery of natural gas and electricity, but instead have a business model that is based on algorithmic trading. These are some of the conclusions of an exploratory market study conducted by the Netherlands Authority for Consumers and Markets (ACM) into algorithmic energy trading. In the study, ACM worked together with the Dutch Authority for the Financial Markets (AFM), since oversight over the use of algorithms in energy trading falls under the jurisdictions of both regulators. According to the market study, algorithmic trading can have positive effects on an efficient price-formation process and on market liquidity, but it also carries risks. The rules that traders on wholesale markets need to comply with if they use algorithms were recently tightened. ACM and the AFM will enforce strict compliance with these rules among businesses.

Manon Leijten, Member of the Board of ACM, adds: “ACM enforces compliance with the rules regarding transparency and integrity of energy markets. This also applies to the use of algorithms in energy trading. It offers opportunities for, for example, the energy transition, but we are also aware of the risks. It is important that wholesale energy markets function well, and prices are formed in a fair manner. In that effort, we work together with the AFM. The insights gained through this study help us organize our oversight more effectively.”

ACM and AFM join forces in oversight over the tightened rules for algorithmic traders

Businesses that use algorithms when trading on wholesale energy markets must take measures to ensure the transparency and integrity of their trading behavior, and to prevent market disruptions. In a nutshell, they need to ensure that trading systems are resilient, have effective limits, prevent erroneous orders, and are able to absorb disruptions. And businesses need to prevent the use of algorithms from resulting in illegal trading activities, such as market manipulation. One such example is a situation where two algorithms end up in a so-called ‘robot battle’, as a result of which possibly misleading signals can be sent regarding the actual supply and demand on the market. In addition, market participants must document and keep for five years any information about the development and use of algorithms in order to be able to demonstrate that the procedures have actually been followed. Businesses that use algorithms in energy trading are statutorily required to inform ACM and the European energy agency ACER thereof.

As part of its oversight over the relevant statutory requirements, ACM has the power to request regularly or incidentally any information regarding algorithmic trading from businesses that use this. ACM and the AFM closely work together in their oversight over the integrity and transparency of trading on energy markets. If the checks conducted by ACM and the AFM reveal that businesses do not comply with the rules, fines can be imposed. For energy traders, these new, tightened rules have been laid down in the revised REMIT regulation, which came into force on May 7, 2024. Under the European MiFID directive, comparable rules already applied to the trading of financial energy products, and are enforced by the AFM.

Findings of the exploratory market study into algorithmic trading on the energy markets

Over the past few months, ACM conducted an exploratory market study into the use of algorithms in energy trading. The document with the findings can be found here. The goal of the study was to get a better overview of algorithmic trading, and to expand our understanding thereof, in part with an eye to the tightened rules. As part of this study, interviews were held among a diverse group of traders and trading platforms, and a survey was sent out to an even wider group of market participants. The focus was on traders on the spot markets, meaning market participants trading in energy products for delivery within the next 48 hours. The study reflects the input given by market participants that have contributed to the study. ACM did not further examine or assess the observed developments, activities, or systems of traders. In addition to the study into algorithms in energy trading, ACM also looks at the risk of algorithmic collusion. This involves the possibility of algorithms (self-learning or otherwise) ending up at a higher average price level than without the use of these algorithms. If so, it may be considered tacit collusion by algorithms.

The key findings of the exploratory market study are:

• The use of algorithms by traders on energy markets keeps on increasing. This involves different types of algorithms, most of which are still rule-based algorithms where traders set the parameters themselves, but slowly also includes more-advanced, self-learning algorithms.
• The energy transition is a development that drives the use of algorithms even further. The generation of renewable energy is less predictable, as a result of which the need for traders to manage their positions at the last minute increases. Algorithms are able to help traders in that process.
• The interviewed market participants and respondents in the survey subscribe to the possible benefits of the use of algorithms for the market, such as an efficient price-formation process and increased market liquidity.
• Yet, some also say that algorithms carry risks, such as volatility and the risk of illegal trading in the form of market manipulation. Like ACM and the AFM, trading platforms, too, keep a close watch on whether the trading on their platforms takes place in accordance with the rules. Tracking down suspicious behavior requires a more data-intensive approach because of algorithmic trading.
• The interviewed market participants and respondents in the survey all indicate that they have set up internal procedures and that they have pre-set limits regarding the use of algorithms. These procedures encompass the development, testing, data storage, the setting of trading limits, control procedures, and oversight over the use of algorithms. ACM did not assess whether these procedures are effective, and whether these are also implemented in practice.

For a more extensive overview of the rules for energy traders with regard to algorithms, visit Notifying algorithmic trading and effective systems (in Dutch) and About REMIT. ACER has also published an open letter, containing additional explanations regarding, among other topics, notification engagement in algorithmic trading, but also obligations regarding data reporting and the registration of market participants from non-EU member states.