PXE Seminar April 3, 2014

Transcription

1 PXE Seminar April 3, 2014 Your Commodities Risk Management Partner Benefit from 20+ years of experience in the commodity industry Kasper Walet

2 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 ( ) Founder of Maycroft, Amsterdam (1997)

3 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

4 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

5 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

6 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

7 The Changing Power Markets Case Germany Relentless downward pressure on wholesale prices ~ Rapid increase in renewable capacity ~ Falling coal prices ~ Relatively weak post financial crisis demand

8 The Changing Power Markets 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

9 The Changing Power Markets 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

10 Clean Dark vs Spark Spread

11 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

12 Clean Dark vs Spark Spread 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

13 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

14 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

15 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

16 Czech Republic Czech OTC market; 2013 average outturn of Dayahead 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

17 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

18 Liquidity Hungarian Market 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

19 Liquidity Hungarian Market 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

20 Liquidity Hungarian Market 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

21 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

22 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

23 Hungary Reductions to the Bulgarian and Romanian export tariffs increased energy flows into Hungary from these countries

24 Spot prices Prv. Year

25 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%

26 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

27 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 Cargill * From 50 percent in 2012 Some remaining banks ~ Nordea, Societe Generale and ABN Amro ~ Citigroup and Macquarie Bank ( not scaling back) ~ New: Brazil's BTG Pactual

28 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

29 Retreat Big Firms Commodity merchants stepping up their activity s ~ Vitol ~ Glencore Xstrata ~ Mercuria Less affected by growing regulation

30 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

31 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

32 Exchange vs. OTC Trading

33 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

34 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

35 Change in terms of trading 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

36 Change in terms of trading 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

37 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

38 NWE electricity market coupling Volatility renewables better communicated to surrounding markets Greater convergence curve prices

39 Exchanges offering Foreign Markets Nasdaq OMX Commodities German Financial Contracts EEX ~ German power futures and forward contracts ~ European-style options with monthly, quarterly and yearly expiry dates ~ Futures on Austrian, Belgian, Dutch, French and German power markets

40 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

41 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

42 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 43

44 Difference REMIT and Emir EMIR will require compliance from any company trading (or making a market) in any commoditybased 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 44

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 45

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 46

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 47

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 48

49 49 Overview EMIR Requirements

50 Future Requirements for Energy Traders

51 Future Requirements for Energy Traders

52 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 53

54 Reporting Obligation 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 54

55 Reporting Obligation 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) 55

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 56

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 57

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 58

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 59

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 60

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 61

62 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 * * - provided by WM Datenservice. The registration costs EUR 150,- including the fee for the first year, prolongations will cost EUR 100,- per year 63

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? 64

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? 65

66 Questions any company should ask 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 Questions any company should ask 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 Questions any company should ask ~ 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? 68

69 Questions any company should ask 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 Questions any company should ask 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 71

72 Clearing Obligation NFC 72

73 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 74

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 75

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 76

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 77

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) 78

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. 79

80 Risk mitigation for uncleared trades 80

81 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 82

83 Timely confirmation Financial and NFCs above threshold 83

84 Timely confirmation NFCs below the threshold 84

85 Portfolio reconciliation 85 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 86 Portfolio reconciliation

87 87 Impact EMIR on real economy

88 88 Impact EMIR on real economy

89 89 Difference REMIT and Emir

90 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

91 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

92 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

93 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

94 Reasons to establish Compliance and Education Policy Appropriate personnel have sufficient guidance to deal with issues that may arise on a day-today basis Relevant personnel have sufficient understanding of the issues to identify situations in which specific advice should be sought