COMMODITY CAPITAL REQUIREMENTS Credit ENhancement of Traded EneRgy (CENTER) Trader A
Trading OTM Position
Trader B Payment instruction (PI)
Cash payment 48 hours from receipt of PI
1. Trader A is ITM, trader B is OTM 2. Trader A asks for LC or cash, Trader B offers PI 3. Trader A takes cash @ non recourse 4. If Trader B does not default, Trader A releases cash for Trader B to repay. If trader B fails, Trader A has covered their position
such a call is made, how does the CFO explain a certain trader’s position or move in market prices: confidence could be eroded. The CFO will have to rely on the crucial margin calculations to formulate an answer.
Other Implications of Regulation EU financial regulations will have far reaching consequences for companies’ balance-sheets and trading strategies. As a first step, a review should be made of the amount of margin capital required should be conducted. Some of the possible implications could be:
– Trading strategies will be changed possibly to allow shorter durations and liquidity could be reduced;
– Credit risk from counterparties will increase; – Margin capital will take vital financial resources from elsewhere in the business and therefore future growth and investment could be reduced;
– Investors and financiers will see the value being created or destroyed by energy and commodity trading.
An Alternative To Traditional Margining
Credit ENhancement of Traded EneRgy (CENTER) Center is an established, proven settlement platform
currently used in non-energy industries. To date over $54 billion has been processed through the platform, 100% error free. Center is a collaborative mechanism whereby two
counterparties agree to use the Center settlement platform to generate margin capital. This capital is supplied by approved third-party investors who have appetite for the risk profile. The structure is used to dissipate the commodity credit risk into the wider financial markets. Example: If two counterparts are trading together
where the position is subject to a MTM calculation, one party will be in-the-money (ITM)/profit, and the
68 March 2012
Trader B pays OTM at maturity
Center
Financial Markets
other out-of-the-money (OTM). The counterparty with the OTM position could pose a credit risk to the other trading party, and be asked to post collateral. Traditionally, this in the form of posting cash or a
letter of credit, depending upon the size of the risk. However, letters of credit and cash are expensive and use up vital bank lines. By using the Center product, the ITM trader would calculate the amount of collateral required from the OTM trader to restore credit risk to acceptable levels. They would then ask (through back office processes) for the OTM trader to issue a Center “Payment Instruction” through the Center solution in favour of the ITM trader. Once this Payment Instruction request is issued and approved by the Center settlement platform, it becomes available for third-party investors to fund and the discounted cash is passed to the ITM counterparty within two business days. This whole process can be automated, involving
interfaces between the credit trading risk management system, credit management, and Center platform systems. Thus, Center represents a cheaper and more flexible alternative to posting cash or letters of credit against trading positions and will provide a vital source of added liquidity. Moreover, the financial structure that supports
Center has been widely used for many years. Specialist bank and non-bank investors use the product to take corporate credit payment risk. As an established and reliable mechanism for monetising receivables, Center thus allows counterparts to receive discounted cash within two business days and to keep trading. Centre essentially puts a price on credit and
settlement risk where these risks are dissipated into the wider financial marketplace. The banks that support Centre stand shoulder-to-shoulder to build the capital in a competitive environment. Moreover, even if a firm is cash rich and happy to
post cash against their trading positions, they could use the Center product to earn a superior return by
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