In November 2018, Ofgem informed market participants that they should prepare for the suspension of the Secure and Promote Market Making Obligation if the number of parties it applies to reduced further in number. This in fact happened when in September 2019, RWE requested that it be released from its obligations following the sale of its shares in Innogy SSE to Eon. With Scottish and Southern looking to sell its retail business to OVO, the number of participants who would remain obligated to this condition in the supply licence would dwindle to just one.
The Market Making Obligation (MMO, also known as the “liquidity windows”) was introduced in 2014 and was originally applied to the seven largest vertically integrated electricity generating companies. The effects of the introduction of the MMO was to reduce bid-offer spreads and also to provide liquidity along the curve assisting smaller suppliers to be able to effectively hedge their market exposure. In addition to this, market participants can transact without incurring a significant premium, promoting price transparency and efficiency. In general, it improves liquidity in the market.
This regulation suggested that within the industry there existed a concentration of market power. In recent years however, the market has become more decentralised with new players entering and the divestment of retail business by generators, which has diluted market power over time. Drax Power Group – the owners of Drax Power Station and a number of other generation assets, as well as Haven Power Limited – in its submission to Ofgem stated that competition in the GB wholesale market is increasing, with the Herfindahl-Hirschman Index (a measure of market concentration) falling from 1,267 in 2015 to a record low of 1,034 in 2017.
With new market entrants and the cost burden placed on the remaining generators obligated under the MMO, Ofgem has decided that there should be sufficient liquidity in the market to be able to suspend the obligation without adversely affecting the ability for all participants to be able to transact without significantly increasing transaction costs.
It has to be said that this is not a view shared by all market participants.
The removal of the MMO comes into effect from the 18th November 2019, and the impact on the market remains to be seen. In LGE’s considered opinion, the likely effects of the reduction in the concentration of liquidity is as follows:
• Bid-Offer spreads are likely to widen again.
• As a number of renewable generators tend to conduct their hedging business towards the prompt end of the market, the opportunities to efficiently hedge further along the curve may diminish.
Ofgem have stated that the effects of the removal of the MMO cannot be known in advance due to its influence on trading activity. During the suspension period, Ofgem will continue to monitor market liquidity and the impact on market participants, assessing the need for intervention. If the ongoing assessment suggests that intervention is required to support liquidity, then Ofgem will consult on its preferred approach, which could take up to six months to implement.
LGE will feedback into the ongoing consultation process if it feels that the removal of the MMO is adversely affecting its ability to transact on behalf of its clients.