What is an Electricity CfD?
The term Contract for Difference (CfD) refers to an OTC derivatives contract that relies on the movement of market price and the difference between the market price and the strike price. The difference between the open trade price and the closing trade price is settled in cash, and the contracts do not hold any underlying assets.
CfDs are particularly popular in commodities trading, as they allow the parties to trade in the price movement of a commodity instead of the underlying price. Within the energy markets, the use of CfDs can assist with price stability for producers and customers. Buyers and sellers agree to settle the difference between the market price and the strike price – if the market price exceeds the strike price, the seller pays the difference and vice versa.
A Virtual Power Purchase Agreement (VPPA) is similar to an electricity CfD but usually involves an energy producer and a corporate buyer. One of the main purposes of a VPPA is to encourage sustainable energy production at a predictable cost.
General Reporting Obligations of CfDs Under EMIR Refit
CfDs have no fixed maturity date, allowing counterparties to close or partially terminate contracts at any time. New CfDs must be reported to a trade repository (TR) with a unique trade identifier and appropriate action type, even if one counterparty is not subject to the reporting obligations.
Electricity CfDs fall under the updated reporting requirements for the EMIR Refit. These CfDs, structured as financial derivative instruments, have several key amendments:
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- Re-Reporting Requirement – Electricity CfDs previously reported that will remain open for 6 months after the implementation date of EMIR Refit will need to be reported again to adhere to the updated requirements.
- Additional Reporting Fields – Reporting requirements now have additional data fields capturing information relating to the specifics of delivery, contract classification and counterparty and transaction identifiers
- Ongoing Compliance – New electricity CfDs must include all required fields from inception, ensuring seamless reporting and adhering to regulatory reporting requirements
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Electricity CfDs and their Classification
Electricity CfDs were introduced under the UK’s Electricity Market Reform (Energy Act 2013) to promote renewable energy investment and stabilise prices for customers. These 15-year contract agreements are between renewable generators and the government-owned Low Carbon Contracts Company (LCCC).
Electricity CfDs function as a price stabilisation mechanism:
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- If the strike price (agreed contract price) is higher than the market price, LCCC compensates the generator for the difference
- If the market price exceeds the strike price, the generator pays the difference back to the LCCC
- If both prices are equal, no payments are exchanged
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This structure maintains consistent revenue for renewable projects while protecting customers from excessive price volatility.
Both the UK and EU EMIR classify electricity CfDs as derivatives, requiring counterparties to report trades to a registered TR. The Financial Services and Markets Act 2000 brings certain energy market participants under FCA oversight. As a result, counterparties to electricity CfDs must comply with enhanced reporting and threshold obligations, aligning with the broader EMIR derivative reporting requirements.
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