Electricity trading in France: Finally a reality?

In spite of the success of the Paris power exchange Powernext since November 2001, electricity trading in France has been hampered by limitations on access for French electricity purchasers. Christophe Jacomin analyses legal developments in this area.

So far, France has been the missing link in the European power market. Foreign companies have long complained that France has double standards, keeping its market closed while exploiting neighbouring markets. The situation is now changing pursuant to the law, dated 4 January 2003, relating to energy markets implementing the EU gas directive.

Foreign traders have benefited from liberalisation of the electricity market since 2000 and have been subject to a certain number of contractual conditions, while trading French electricity through the French network.

However, before intervening on the French market, traders are now wondering to which legal regime they would be subject. In particular, insofar as electricity traders often carry out their purchase-for-resale activity through forward contracts, it is unclear whether electricity forward contracts would qualify under French law as financial instruments and, as a consequence, whether they should be submitted to the various financial-services providers’ French requirements.

The end of discrimination between French and foreign traders?

The French electricity market was governed by the law of 20 April 1946, which nationalised the electricity industry and created Electricité de France (EDF), which had a monopoly on production, transmission and distribution of electricity with the exception of certain distributors dependent on local authorities. As a consequence, almost all electricity sold in France was either generated directly by EDF or purchased by EDF from small producers.

By implementing the EU electricity directive of 19 December 1996 relating to the liberalisation of the electricity market, France had to open its market to other member states. By the time of its implementation, the French Electricity Law of 10 February 2000 had given rise to political and legal controversy regarding the trading of electricity. The directive did not force member states to recognise the right to trade electricity; it was up to each legislator to determine to what extent this activity would be regulated.

The draft law presented by the government provided for complete liberalisation of trading, underlying the importance of this activity “for a good functioning of the electricity market”.

However, by the first lecture of the text, the French Assemblée Nationale completely redrafted the law for the purpose of limiting trading activity to a limited group of actors. The energy minister, agreeing to such an amendment, declared: “International transactions are necessary to the market. EDF, as a producer, has to be able to participate in trading activities. However, we are concerned about limiting the trading activity in favour of the electricity system functioning…The purchasing faculty has thus to be limited and linked to the production activity.” This position clearly stood in favour of the French electricity utilities and EDF’s monopoly.

In spite of opposition from the French Senate, whose intention was to liberalise trading activity, the adopted final text held to the restrictive Assemblée Nationale analysis. Nevertheless, the directive’s spirit has not been totally complied with regarding trading activity regulations. Pursuant to Article 22 IV of the electricity law, only French electricity producers and their subsidiaries, subject to obtaining specific authorisation, could purchase electricity for resale. As a result, the market was closed to foreign traders who wanted to buy electricity produced in France.

Notwithstanding previous debates, from the very beginning, the electricity law ledto various interpretations – indeed, two opposite interpretations. A strict interpretation, in conformity with the French legislator’s intention, was that only those producers mentioned in the electricity law were allowed to trade electricity. To the contrary, the CRE issued its own interpretation in a statement dated 6 September 2001, widely supporting the possibility of trading.

According to the CRE, everything that is not expressly forbidden by law has to be considered as permitted, even regarding the electricity market. Therefore, the CRE held that the electricity law must not be considered as limiting trading activity to only French electricity producers and their subsidiaries, but rather as regulating activity for only those specific entities, and liberalising activity for all other types of entities. This view was considered by many to be contrary to the clear spirit of the electricity law and has not been followed in practice.

Particularly, the French Administrative Supreme Court’s (Conseil d’Etat) decision dated 15 October 2002 has reversed the CRE’s statement. Indeed, the Conseil d’Etat settled in favour of a restrictive interpretation of the electricity law and held that only duly authorised producers and their majority-owned subsidiaries could exercise electricity-trading activities. The Conseil d’Etat held that eligible customers located in France, however, could buy electricity outside France under conditions described in Article 22 III of the electricity law. Indeed, Article III provides that “an eligible client may enter into a purchase contract with a producer or supplier of his own choice established on the territory of a member state or within the framework of international agreements, on the territory of another state”.

As a result, at the end of last year, 32 of the 33 members of Powernext were companies established outside of France. Electricity exchanges set up in other countries have benefited from the constraints that affected access to Powernext. This situation led to discrimination between foreign traders and French traders, with the latter currently being urged to install out of France in order to carry out electricity-trading activities

Thus, for the last three years, France has acquired the worst reputation for liberalising its electricity market. As a result, it became necessary to adopt another position, in conformity with the electricity directive’s spirit and with the other EU countries’ regulations. (Numerous European countries have liberalised their electricity markets completely already.)

New provisions under the 2003 law

The energy-markets law, dated 4 January 2003, implementing the EU gas directive, has modified the electricity law and now provides that French suppliers can purchase electricity for resale on the French territory only subject to making an official declaration of their intention to do so. Therefore, any supplier located in EU territory – producer or not – is able to trade electricity.

This provision is the result of much-awaited clarification. The content of the official declaration, which has to be determined through a further implementation decree, is not defined yet and could, if the conditions required are too restrictive, limit the effects of the new law.

However, France appears to be continuing steady progress towards transforming its electricity market. This progress is enhanced by a lowering of the threshold for eligible customers to 9GWh per annum. Moreover, it is significant that, pursuant to the European ministerial meeting held on 15 November 2002, France has approved the draft European directive amending the 1996 electricity directive and the 1998 gas directive making all non-domestic electricity customers (ie industrial and commercial properties) free to choose their electricity supplier by 1 July 2004. This would be extended to all customers (i.e. 100% market opening) by 1 July 2007.

How to trade French electricity?

To trade French electricity, a trader must satisfy a certain number of contractual conditions:

Sign a network-access contract with managers of the public transportation and distribution network (Gestionnaire du Réseau de Transport de l’Electricité or RTE). Access to the power-transmission system is governed by contracts that specify the various terms and conditions for such access. These provisions are likely to change, according to publication of future regulatory provisions or the setting up of new procedures by RTE. Since 1 November 2002, RTE proposes a network-access contract based on the tariff published by decree on 19 July 2002. (The contract and its tariffs are available on www.rte-france.com);
Sign a trading agreement to respect the particular market rules;
Sign a balance-responsible contract (contrat de responsable d’équilibre) with RTE. In order to facilitate the system-access conditions, offer greater flexibility and improve fluidity of the electricity market, RTE is setting up balance-responsible-entity contracts. This type of contract allows system users to share their individual generation and consumption imbalances and minimise cost. The balance responsible is the intermediary that guarantees to RTE the settlement of imbalances for all consumers and suppliers who have chosen this entity for this purpose. The balance-responsible arrangement allows network users to gain easy access to foreign suppliers, while enabling them to share all of the imbalances between their consumption and the corresponding imports. It has to be noted that on 1 April 2003, the balance-responsible mechanism will change upon the start-up of the balancing mechanism. A new contractual framework will be set up at this time;
If the trader is a Powernext member, sign a clearing agreement with Clearnet in order to guarantee security of financial settlements relevant to Powernext transactions.

Moreover, in order to gain access to French interconnections, a market player must adhere to the Rules for Access to the French Public Transmission Network for Imports and Exports by signing a participation agreement. These rules describe the conditions under which a market player can use interconnections between RTE and neighbouring network managers. European power-transmission grids are interconnected to enable energy transmission from one country to another.

In order to set up an import or export, a player first must acquire capacity (allocation stage) and then request it to be scheduled within the framework of the capacity acquired (nomination stage). To declare an export from France, a player must be the holder of export transactions characterised by a receiving network manager and a maximum power.

How do electricity forward contracts qualify under French law?

As previously mentioned, electricity traders often carry out purchase-for-resale activity through forward contracts. It has been wondered whether such electricity-forward contracts would qualify under French law as financial instruments and, as a consequence, whether they should be submitted to the various financial-services-providers requirements in France.

Contrary to numerous foreign laws, commodity forward contracts are considered under French law as forward financial contracts (Article L.211-1-II-4°) of the French monetary and financial code) and electricity is considered by the French doctrine as a commodity.

However, the definition would not cover spot contracts not related to financial instruments, whether physically delivered or not. The French Financial Markets Committee (Conseil des Marchés Financiers or CMF) has expressed the view that spot trades are generally trades for delivery two or three days ahead. This implies that trades for delivery four or more days ahead would be treated as forward contracts and could be regarded as financial instruments.

But the precise scope of Article L.211-1 II in relation to commodity forward is unclear. It appears that the CMF does not wish truly commercial commodity contracts for forward delivery to be within the scope of financial regulation. Such a qualification causes a series of difficulties because of the application of the monetary and financial-code provisions relating to financial instruments, which sometimes do not seem to be adapted to commodity trading.

The regular business of proposing to enter into forward contracts is subject to the French investment-services-providers monopoly. Those providers are credit institutions or investment firms duly authorised by the French banking and financial authorities. Such services can also be provided in France by investment-services providers duly licensed in other EU member states, under the condition that they have duly followed the European passport-notification procedure.

However, insofar as commodity forward contracts are not currently included as investment services into the scope of application of the current investment-services directive, commodity-forward-contracts traders, even duly licensed as investment-services providers in their home states, cannot get passports to conduct these transactions into France on a cross-border basis.

As a result, under current French law, a trader willing to enter into electricity forward contracts must be authorised in France as an investment-services provider. A trader thus has to establish a local presence in France as an investment-services provider by setting up a subsidiary, which is a heavy procedure. Such requirements depart from many European laws and may appear unsuitable for truly commercial and non-speculative transactions.

Two main clarifications on this qualification are awaited:

First, the European Commission has suggestion, in a proposal released on 19 November 2002, that commodity forward contracts be included within the scope of the new investment-services directive. Such a modification could prevent traders duly licensed as investment-services providers from establishing a local presence and permit the issuance of European passports for such contracts;
The commission is establishing a definition of commodity derivatives. In this respect, the commission is taking into account whether they are cleared and settled through a recognised clearing house, as well as whether they give rise to daily margin calls and are priced in reference to regulatory published prices, standards lots, delivery dates or standard terms – as opposed to the price being specified in individual contracts.

Second, in light of this new investment-services directive, the CMF proposed some criteria to be implemented in the monetary and financial code in order to distinguish between commodity forward financial contracts and forward commercial contracts.

The recent CMF proposal

According to the January 2003 CMF monthly paper, a contract should qualify as a forward financial instrumentsunder two conditions:

Whenever the contract may be cash settled or physically settled – to the contrary, physically settled contracts shall be considered commercial. Where the cash settlement in the contract is provided only in case of default of one of the counter parties or force majeure, the normally physically settled transaction in this case should not fall within the scope of French financial regulation;
Whenever the contract gives rise to compensation mechanisms – for example, the contract gives rise to regular margin calls or is cleared and settled through a recognised clearing house. This criterion has the advantage of being objective. In particular, it includes contracts negotiated on the French regulated market on forward contracts, notwithstanding the fact that most of them are physically settled. The CMF proposal does not introduce any distinction between the transactions carried out on a regulated market or on an over-the-counter (OTC) basis. Margin calls on OTC collateral thus should be included within the first criteria set out in the proposal.

This guidance also proposes to modify the list of entities exempt from the licence requirement under Article L.531-2,2° of the French monetary and financial code when entering into electricity forward contracts qualifying as financial contracts.

First, the current exemption concerning commodity brokers should be extended to traders who purchase to resale commodities. Second, a new exemption would cover companies whose principal activity is to produce, transform, distribute or sell commoditiesin order to allow them to trade, on an accessory basis, financial commodity forward contracts.

An amendment of the French monetary and financial code proposed by the finance committee of the French Senate, strictly reproducing the CMF guidance, was adopted on 20 March 2003 by the Senate within the framework of the draft finance-security law discussion. The text will be under discussion by the Assemblee Nationale from 8 April 2003 and might, therefore, be implemented under French law by June 2003. The adoption of such provisions would allow a much better adapted system and facilitate trading on a European basis.

Christophe Jacomin is a partner at Lefevre Pelletier & Partners in Paris.