EUROPEAN POWER 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
Say you are a large integrated utility and you have sold
to a trader at a certain price. If the market price then moves higher, under this regulation you are deemed to be “out of the money”. Furthermore, European Market Infrastructure Regulation (EMIR) makes it obligatory to clear standardised OTC derivatives (energy) contracts through central clearing counterparties (CCP) and to report transactions to trade repositories. Therefore, EMIR aims to reduce credit risk by introducing minimal capital and variation margin requirements for firms trading OTC derivatives that are not cleared by a CCP. This means as a market participant you may need a large cash buffer to support trading.
Center: Credit ENhancement of Traded EneRgy Center is a way of accessing third party margin
capital and pricing for credit risk. Example: If two counterparts are trading together where the position is subject to a Mark-to-Market (MTM) (under EMIR you are), as we said one party will be in-the-money (ITM)/profit, and the other out-of-the-money (OTM). The counterparty with the OTM position could pose a credit risk to the other trading party. By using the
Trader B pays OTM at maturity
Center
Financial Markets
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 (banks) to fund and the discounted cash is passed to the ITM counterparty within two business days.
Summary Energy trading in the European power market is a
risky business – it always has been. Through political investment and global commodity flows these risks are increasing. The European power market needs to be proactive in identifying, modelling and mitigating these risks (for example by using Center). The rating agencies have identified decreasing “creditworthiness”. The time-frame is three years, or just around a thousand days, to turn these formally highly profitable and secure business models around with the focus of preserving value. •
Aily Armour-Biggs is Advisory CEO of Global Energy Advisory. Aily started her energy and banking career in the earliest days of privatization of the electricity industry in the UK.
Global Energy Advisory has been a respected advisor to the energy industry for more than 8 years and has developed a reputation which has been built on the provision of high quality and innovative consultancy services and independent expert quantitative analysis.
For more information on Center contact: E:
aily@globlenergyadvisory.com
www.globlenergyadvisory.com
Footnotes: 1. BREE 2012 2. Investment Failure, Fails Customers 3. The Guardian, 17th November. 4. We can model the global LNG market.
46 December 2012
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