PXE Seminar April 3, 2014 Seminar April 2014.pdf · ~ 9% lower than Calendar 2013 on 31 December...

PXE Seminar

April 3, 2014

Your Commodities Risk Management

Partner Benefit from 20+ years of experience in the commodity industry

Kasper Walet [email protected]

Kasper Walet

• 25 Years of commodity expertise

• Master of Laws

~ Regulations around exchange trading

• Board Member of the Amsterdam Commodity

Futures Exchange and Clearing House (1987-

1997)

• Founder of Maycroft, Amsterdam (1997)

Maycroft

• Since 1997

• Strategic Consulting

~ Banks, Traders, Energy Companies, Energy

Exchanges, End Users, European Commission

and Energy Regulators

• Energy Trading and Risk Management

~ Oil,Power, Gas, Coal,Weather,Emissions

• Active on global level

• Industry Best Practice

Relevant Expertise

• 25 years of expertise in regulations and compliance

of data reporting, market manipulation and insider

trading

~ In both financial and energy industry

~ From both a compliance and trader’s perspective

• As Board Member of exchange responsible for the

compliance of the exchange members to the

relevant legislation, rules and

• Program manager ethics and integrity certification

traders financial markets

Our Relevant Expertise

• In depth and inside knowledge of business processes

and trading practices in energy trading firms

• Certified training program energy companies REMIT

and day to day practical issues and dilemmas

• Design and Implementation Compliance Framework

EMIR/REMIT energy companies

• Advised and trained several energy regulators and

companies

The Changing Power Markets

• Financial regulation

• Impact increases share of intermittent renewable

generation

~ Low volatility

~ Flattened prices

• Integration of regional markets

~ Market Coupling

• Activity scale back large market participants

~ Big Utilities and Banks


Case Germany

• Relentless downward pressure on wholesale

prices

~ Rapid increase in renewable capacity

~ Falling coal prices

~ Relatively weak post financial crisis demand


Case Germany

• Gas and coal generators face 3 important

implications from rise in low variable cost

renewable capacity:

• Avg.variable cost plant on margin is falling,

reducing power prices

~ Gas plant largely out of merit

~ Coal and lignite dominating marginal price setting

• Load factors of gas and coal plant declining as

renewable output increases

• Wind and particularly solar flatten within-day

price shape, which tends to negatively impact

gas and coal plant margins


Case Germany

• These factors common across European power

markets as renewable capacity expand

• Particularly pronounced in Germany

• Germany is exporting these effects across NW

Europe

~ e.g. to the Netherlands where gas plant load

factors have plummeted

Clean Dark vs Spark Spread


• Coal plant margins currently weak

• Held up relatively well given decline in German

power prices

• Falling coal plant revenue has been offset by

falling fuel costs

• Coal plant predominantly setting marginal prices,

margins have been relatively stable


• Gas plant is out of merit

~ Falling coal and power prices caused sharp

declines in spark spreads

~ As spreads head deep into negative territory, gas

plant are suffering negative cashflow as they

absorb fixed costs

• Revenue opportunities focused on reserve

payments and increasing volumes of capacity is

being closed, mothballed or signed over to TSOs

to provide system support

~ Gas plant margin recovery hopes are firmly

focused on implementation of a capacity market

Czech and Hungary

• Trading on the far curve in the Czech and

Hungarian electricity markets could be hit by

falling prompt prices

• Cheaper to buy Czech and Hungarian electricity

on the prompt market in 2013

• Compared with prices buyers had got earlier

when they struck forward contracts for delivery

over the year

Czech and Hungary

• Prompt prices have been pushed down by supply

from renewable energy sources

• If trend continues, buyers could stay away from

far curve trading

~ Due to fears they would be locked into higher

prices on the forward market than they would

later pay on the prompt when they actually take

delivery of the electricity

Czech Republic

• Key influence on Czech spot prices is wind power

generation in Germany

~ Czech prices mirror German market on windy days

• Additional supply is coming from Czech domestic

renewable generation

~ Supply from Czech renewable installations could

fall in 2014 as Czech senate will cut subsides for

this kind of generation

Czech Republic

• Czech OTC market; 2013 average outturn of Day-

ahead Baseload contracts was €40.87/MWh

• 7% lower than delivery price for Cal ’13 product,

which settled at €43.85/MWh on 31 December

2012

Liquidity Hungarian Market

• Increase in short-term volatility combined with

improved transparency has attracted new players

to the Hungarian power market

~ Resulting in a steady increase in liquidity

• OTC volumes > doubled over past 3 years

• Due to increased volatility, interest was shifting

from the Czech to the Hungarian market

~ Many traders started to prefer Hungary over the

Czech market

* Due to tightening, and therefore less profitable, spreads

to Germany


• High volatility equals high profit

• Hungary being a transit country

~ Hungary main connection between Balkans and

the west, with companies needing to flow energy

through Hungary to access the western European

markets and vice versa

* Gateway to the Balkan countries

• Increased Romanian and Bulgarian flows

following recent reductions to the export tariffs


• Hungarian-Czech-Slovak Day-ahead electricity

market coupling contributed to improved

transparency in Hungary

• While trade has increased on the OTC market, t

some transactions might have shifted from HUPX

• Exchange-traded Day-ahead product had reached

a level of volatility that was no longer deemed

attractive


• Players preferred OTC trade over exchange

because HUPX had become so unpredictable that

participants were getting caught out to their cost

• Less volatility on OTC than on the exchange

~ On markets where there is too much volatility,

leaving positions open is like gambling

• Fall in volatility on curve

~ Monthly and quarterly contracts trading in a

relatively narrow range, despite the Day-ahead

market continuing an unstable trend

* Volatility is there, but it’s fading at the back end of the

curve

Hungary

• Supply boosted by an increase in hydro power

output

• Nobody expected that amount of water in the

region

• It was one of the best over the last 15 years

Hungary

• Extra supply Hungarian spot prices averaged

€45.54/MWh throughout 2013

~ 9% lower than Calendar 2013 on 31 December

2012, at €50.00/MWh

• High domestic supply also lowered demand for

cross-border capacity to import power from

Austria and Slovakia

~ Pushed down the price in monthly cross-border

capacity auctions and made it cheaper to flow

power into Hungary, depressing prices on the spot

market further

Hungary

• Reductions to the Bulgarian and Romanian export

tariffs increased energy flows into Hungary from

these countries

Spot prices Prv. Year

Suffering Power Trading

• Banks must rebuild their balance sheets and cope

with the demands of Basel III bank capital rules

~ Banks cutting back or closing businesses

• Big German utilities under pressure

• Division Power Trading ( 2012)

~ Uncleared OTC app. 53% of European power

trading volumes

~ Exchange-traded futures app.18%

~ Cleared OTC products 16%

Impact Regulation

• Futurization

~ US, the Dodd-Frank Act caused a wholesale shift

away from cleared OTC energy products and

towards exchange-traded futures

• Mandatory Clearing Europe?

~ EMIR and MiFiD 2

Retreat Big Firms

• JPMorgan, Deutsche Bank, Barclays , Bank of

America Merrill Lynch and Morgan Stanley

~ Liquidity sinking and capital requirements rising

~ Financial sector derivatives trading on EEX fell to

40 % of overall volume in 2013

* From 50 percent in 2012

• Cargill

• Some remaining banks

~ Nordea , Societe Generale and ABN Amro

~ Citigroup and Macquarie Bank ( not scaling back)

~ New: Brazil's BTG Pactual

Retreat Big Firms

• Rise in the role of utilities

~ Europe's energy markets are growing less

attractive for investors

• Market dominated by a small number of

producers would deter necessary investment in

power sector

~ Needed to upgrade ageing power plants and

networks

Retreat Big Firms

• Commodity merchants stepping up their activity s

~ Vitol

~ Glencore Xstrata

~ Mercuria

• Less affected by growing regulation

New breed of traders

• Diminishing size of market participants

• Many former traders banks and utilities left for

smaller trading houses or set up own hedge funds

~ Cumulus Energy (owned by City Financial) and

Danske Commodities

* Difficult putting master agreements in place

* Negotiating credit and collateral terms with potential

counterparties

* More difficult to get all the credit lines in place to trade

uncleared and bilaterally

Impact Renwables

• Diminished power trading activity among some

market players

~ Less and less trading futures and long-term

products

• Stimulating demand for different types of risk

management tools

~ Intra-day and day-ahead contracts

* Epex Spot 15-minute blocks in German intra-day market

Exchange vs. OTC Trading

Impact Renwables

• Sizeable peaks and troughs in power prices

throughout the day

~ Fluctuations created by changing weather

conditions

* Exciting opportunities for traders

• Pure traders; shift from calendar products to

more short-term products

~ Largest volatility and the really interesting

opportunities

Change in terms of trading

• Calendar contracts will remain important

indicators for future developments

• Trading activity in the products is falling because

industrials are moving away from long term deals

towards the spot market

~ Major industrials use forward contracts to cover

their long-term electricity demand

• Renewables pulling down spot market

~ Tendency come out lower than the calendar


• Move towards shorter term trading also in

financial market

• Speculative traders try to profit from increased

volatility in the weather-driven spot market

~ Much more fluctuation in the shorter term

~ Better forecast wind, solar production and

consumption


• Government subsidies for renewable power

capacity led to a glut

• 40 % drop in German wholesale power prices

since 2011

• Impact of these subsidies could destroy the

market

~ Due to FITs, a quarter of the market currently

does not participate in price discovery

* If that would rise to 50 %that could destroy market

• Price of renewable subsidy schemes is that it

creates market distortions

NWE electricity market coupling

• Central Western Europe (CWE) markets

~ France, Germany, Belgium, Netherlands and

Luxembourg

• UK, Poland, Nordic and Baltic countries

• Price coupling of regions (PCR)

~ Determines day-ahead price in coupled markets

using a new single algorithm known as Euphemia

• Iberian market

~ Full price coupling on French-Spanish border will

be launched at a later stage

NWE electricity market coupling

• Volatility renewables better communicated to

surrounding markets

• Greater convergence curve prices

Exchanges offering

“Foreign”Markets

• Nasdaq OMX Commodities

• German Financial Contracts

~ German power futures and forward contracts

~ European-style options with monthly, quarterly

and yearly expiry dates

• EEX

~ Futures on Austrian, Belgian, Dutch, French and

German power markets

Discussion

• Some traders say they would prefer to have a

smaller number of venues on which to trade

certain products

~ Helps to create a critical mass of liquidity

* Particularly while overall trading volumes remain low

Consolidation Exchanges?

• More mergers

~ Existence of smaller regional market-places might

not be economically viable anymore

• Market Coupling

~ Cooperation on creating a common pricing

algorithm to bring together disparate national

markets

• Future: one or two big units?

~ More liquid

~ Cover entire Europe

~ More competitive fees

Exchange vs. OTC Trading

43

Difference REMIT and Emir

• REMIT is designed to allow energy trading

regulators to spot energy price manipulation,

collusion, and insider-trading across the

European Market

• Introduced and regulated by the Agency for the

Cooperation of Energy Regulators (ACER)

throughout the EU and by the Office of the Gas

and Electricity Markets (OFGEM) in the UK

44


• EMIR will require compliance from any company

trading (or making a market) in any commodity-

based or derivative-based financial instruments

within (or involving) the EU

• This ruling will be governed by ESMA in Europe

and by the Financial Services Authority (FSA)

within the UK

• EMIR focusses on the Reporting of Trades,

Portfolio Valuation, and Clearing and Collateral

Responsibilities

45

Emir/ MiFID II

• Position limits, reporting obligations and

clearing mandates under the updated Markets in

Financial Instruments Directive (MiFID II), will

pass on substantial cost burdens to natural gas

and electricity trading companies

• Prevent smaller players from entering the

market

~ Despite exemption on physical gas and power

trades

46

Emir/ MiFID II

• Physically-settled power and gas forwards not

defined as a financial derivative under MiFID II

• As long as they are traded on a non-multilateral

trading facility

47

Emir/ MiFID II

• Position limits: more unlikely to find pure risk

takers in the market

• Restrict their activities

~ If something done beyond the hedging mix, it is

classed as a commodity derivative

~ Extremely difficult for smaller companies to start

up gas and power trading

* Due to the extra procedures necessary to start trading

and reporting

~ Hurdle and something that will limit competition

and thereby the functionality of the external

market

48

Emir/ MiFID II

• Relevant national regulators will set limits on a

companies’ position traded on venues and OTC

based on a formula set by ESMA

• A position-reporting obligation will also be

introduced by category of trader

• Hedging – trading to minimize risk of a

company’s core business – would not be subject

to the position limit

• Although criteria to judge what trade qualifies

as a hedge has not been defined yet

49

Overview EMIR Requirements

Future Requirements for Energy

Traders

Reporting obligations for energy

trading firms

53

Reporting Obligation

• All counterparties to all derivatives contracts

(OTC and exchange-traded) need to

~ Report, post-trade, contract details to a

registered trade repository

~ Applies to all trades in the EEA

• What is a trade repository?

~ Database to provide transparency

54


• Information to be reported to TRs:

~ The parties to the contract (or the beneficiary)

~ Type of contract

~ Maturity

~ Notional value

~ Price

~ Settlement date

• Reduces duplication by taking account of:

~ MiFID transaction reporting

~ REMIT reporting requirements

55


• Essential for monitoring systemic risk

• Only financial and non-financial counterparties

(NFC) above the clearing threshold are required

to report exposures

• Information to be reported;

~ Mark to market or model valuations

~ Collateral value and basis (transaction or

portfolio)

56

How to fulfil reporting obligation

• Both counterparties MUST report each trade

unless by prior arrangement, one party can

report on behalf of both counterparties

• The reporting party may be the counterparty to

the trade, or a third-party (such as a CCP or

trading platform)

• The reporting requirement includes:

~ All exchange and OTC derivative trades

~ Intragroup trades

~ Trades with non-financial counterparties

57

Who Reports?

• “Counterparties and CCPs”

• Potentially covers most participants involved in

a trade, including

~ Clients

~ Clearing brokers

~ Other than natural persons

~ Non-EU entities

* Delegation possible and can be implemented in a very

flexible way

58

Reporting Delegation

• “Counterparty or CCP which is subject to the

reporting obligation may delegate the reporting

of the details of the derivative contract.”

• Delegation to any firm capable of fulfilling

function

~ e.g. dealer, exchange, CCP, service provider

• Compliance responsibility remains with the

delegating firm

~ Should conduct reasonable checks to ensure

accurate and timely reports are submitted

59

What has to be reported

• “Any derivative contract”

~ Definition based on MiFID

~ Includes both contracts traded on trading venues

and OTC derivatives

• Lifecycle events (give-ups, partial terminations

etc.) have to be reported

• FCs and NFC+s will also have to report valuation

updates and collateral posted

60

When do reports have to be made?

• “no later than the working day following”

• On T or T+1 for the initial report of the trade

• Similarly for amendments and updates

61

When do reports have to be made?

• “to an registered [EU] or recognised [non-EU]

trade repository”

• 6 trade repositories registered so far

~ Free choice of trade repository

~ Can report different transactions to different

trade repositories

~ Counterparties to a trade can use different trade

repositories

62

Registered TRs

63

LEI/ GEI

• Legal Entity Identifier( LEI)

~ Unique Code to identify parties to financial

transactions worldwide throughout all markets

and legal systems

• General Entity Identifier (GEI) or Pre-LEI

~ Preliminary stage leading to the LEI

~ Now, GEI required for EMIR reporting

* www.leiroc.org/publications/gls/lou_201310032.pdf

* www.geiportal.com - provided by WM Datenservice. The

registration costs EUR 150,- including the fee for the

first year, prolongations will cost EUR 100,- per year

http://www.leiroc.org/publications/gls/lou_201310032.pdf




64

Status Quo EMIR Reporting

• TR’s are only partially ready

~ Ultimate cause of the delay in US for D-F

• After surprise ETD ruling ESMA has only recently

provided guidance to the TRs on what data

points they need for ETDs

• Data validation

~ Brent” or “BRT” or “Brent Crude” etc?

65

Questions any company should ask

• What’s our budget for Regulatory projects?

• How much business do we intend to take on?

~ Will we only report for our own behalf?

~ Do we wish to offer delegated reporting services

to our clients?

~ Are there any other dependent firms (affiliates)

that expect us to do reporting on their behalf or

act as a 3rd Party provider?

66


• What are the criteria to be taken into account

before choosing my 3rd Party Providers?

~ Is there one 3rd party offering which covers ALL

derivatives (both OTC and ETD)?

~ If yes, does it cover ALL reporting fields?

* For example, some do not support market values &

collateral fields

~ If they do cover everything, how difficult

/expensive is it to setup interfaces to that

provider?

* Will they take raw data and do the mapping work for us

or will they require you to send data in the final format?

67


~ Compatibility with our current infrastructure?

~ If we use different 3rd party providers, do they

all report to the same TR?

~ What kind of Agreements do you have to

execute? Are they negotiable?

~ Do they make the necessary upgrades every time

the TRs change their requirements? Will these

changes affect you in any way?

~ Do they have a connectivity with any CCP?

~ Do they provide Reporting services under other

Regulations as well ?

68


~ What is their client base?

~ What is the average on-boarding time?

~ Do they provide any other services apart from

Reporting? and last but not least….

~ What will they charge you for their services?

• What are the criteria to be taken into account

before choosing my Trade Repositories?

69


• What do we need to do if we wish to delegate

reporting to our counterparty?

~ Do they offer reporting services on all products?

~ Does this service include historical trades?

~ As there is an uncertainty with regards to ETD

reporting, your counterparty may avoid such

product offering for a while.

~ Can we choose between a partial and full

delegation of our reporting obligation to our

counterparty? Can we differentiate per product

type or event?

70


• Who will be UTI GP for delegated reporting?

• Which TR will our counterparty use?

• Will we be able to view what is reported on our

behalf? Is there a cost entailed or legal

Agreement necessary in order to have such

option?

• What is required from us to effect the reporting

on your behalf? (LEI issuance etc.)

• What Agreement will be necessary to be put in

place for the delegated reporting service?

• How much will this service cost us?

71

Clearing Obligation

72

Clearing Obligation NFC

•

Client Clearing

74

What mandatory clearing will apply

to

• Clearing obligation will apply to contracts

between any combination of:

~ Financial Counterparties;

~ NFCs that are above the clearing threshold

(‘NFC+’)

• Mandatory clearing obligations will apply to

trades between such firms where:

~ One or more of the counterparties is in EU

~ In limited circumstances, neither in EU

75

Hedging Definition

• An OTC derivative contract is objectively

measurable as reducing risks directly relating to

the commercial activity or treasury financing

activity of the NFC if it;

~ Covers the risk arising from the normal course of

business

* Incl.proxy hedging and stock options arising from

employee benefits

~ Covers indirect risks

~ Is consistent with the IFRS hedging definition

76

Clearing Thresholds

• €1bn in gross notional value for OTC credit and

equity derivatives

~ Individual thresholds

• €3bn in gross notional value for interest rate

and FX

~ Individual thresholds

• €3bn in gross notional value for commodities

and others

~ Combined threshold

77

Clearing Thresholds

• Clearing obligation applies to all OTC

derivative contracts once one of the

thresholds is reached

• Transactions designed to reduce risks to

commercial activity or treasury financing

activity do not count towards clearing threshold

• When calculating its positions, a NFC must

include all contracts entered into by all non

financial entities within its group

78

Clearing Thresholds

• Only speculative trades are considered

• Thresholds are calculated on group level

• Only fully consolidated entities are counted

towards the clearing threshold

• Netting per counterparty / contract type

allowed

• If hedging, then entire “chain” is hedging (i.e.

bank with NFC, NFC intragroup trade with

another NFC)

79

Illustration Clearing Thresholds

• A is a NFC

• B is a NFC in the same group as A, and B is the

entity specialised in dealing derivatives with

entities outside the group

• A and B enter into an OTC derivative

transaction, with a notional value of 100, e.g. A

buys 100 and B sells 100

• B enters into an opposite transaction with an

entity outside the group (C), i.e. B buys 100

from C.

80

Risk mitigation for uncleared

trades

81

Risk Mitigation; to whom it applies

82

Risk mitigation for uncleared

trades

• New risk mitigation requirements for uncleared

OTC derivative trades

~ Timely confirmation

~ Dispute resolution

~ Reconciliation

~ Portfolio compression

• New margin requirements for counterparties (FC

and NFC+) subject to the clearing obligation

~ Initial and variation margin

~ Daily valuation

83

Timely confirmation

• Financial and NFCs above threshold

84

Timely confirmation

• NFCs below the threshold

85

Portfolio reconciliation

• Formalized processes

~ Robust, resilient and auditable in order to

reconcile portfolios

• FCs and NFCs must agree in writing or by other

equivalent electronic means with their

counterparties the terms on which portfolios

will be reconciled before entering into an OTC

derivative contract

• Portfolio reconciliation must cover key trade

terms and the valuation attributed

• Portfolio reconciliation can be carried out by a

third party

86

Portfolio reconciliation

87

Impact EMIR on real economy

88

Impact EMIR on real economy

89


Trading by utilities

• European utilities to keep their hedging rates

constant in 2014

~ After increasing them in 2012 and 2013

• Could impact carbon demand

• Utilities stepped up their hedging strategies to

reach further forward than previously

~ Buying both for the year ahead and also further

out

• 2014 most of these forward emissions are already

hedged

~ Demand to slow, because buying would return to a

more constant rate

Reasons

• Generation fleet

• Domestic market conditions

• Changing views on future power markets by

individual companies

• 2 main causes:

1. Covering themselves against a possible decline

of power prices

2. Against a possible increase of carbon prices

Reasons

• Utilities’ higher hedging ratios is to stabilize their

credit ratings in an environment where the

outlook was generally negative

• Utilities profit from a so-called ‘predictability

premium’ in credit ratings calculation

~ Increases if future income becomes more

predictable as a result of higher hedging quotas

• Hedging could improve earnings visibility and

hence support credit profiles

Reasons to establish Compliance

and Education Policy

• 10% energy companies are already fully

compliant to REMIT

• Majority (62%) still waiting for more certainty on

REMIT before they even attempt to comply

• However, regulators will be keen to enforce the

REMIT rules and will want to set an example of

any company not complying

Reasons to establish Compliance

and Education Policy

• Appropriate personnel have sufficient guidance

to deal with issues that may arise on a day-to-

day basis

• Relevant personnel have sufficient understanding

of the issues to identify situations in which

specific advice should be sought

PXE Seminar April 3, 2014 Seminar April 2014.pdf · ~ 9% lower than Calendar 2013 on 31 December...

Documents

Transcript of PXE Seminar April 3, 2014 Seminar April 2014.pdf · ~ 9% lower than Calendar 2013 on 31 December...