FTR Consultation on Daily Settlement Price Methodology

Transcription

1 FTR Consultation on Daily Settlement Price Methodology Final analysis and recommendation 26 September 2013 Contact: Warwick Small

2 TABLE OF CONTENTS Executive Summary... 3 Background and purpose... 3 Obligation scenario analysis and review... 4 Option methodology analysis Considerations Recommendation Next Steps Appendix Reference Value data of 19

3 Executive Summary This document provides analysis and a recommended path with respect to the calculation methodology of the Daily Settlement Price of FTR Obligation product types. The recommendation reached is to use an absolute movement approached based on the weighted movement of existing reference values. Background and purpose The purpose of this document is to provide further feedback, analysis and a recommendation for an amendment to the Daily Settlement Price (DSP) methodology. This methodology is stipulated within and makes a portion of the Prudential Security Assessment methodology (PSAM), last updated 19 December This follows a Clearing Manager led consultation of the methodology of obligation FTRs, with submissions received on 14 August 2013 and the publication of an initial summary of these submissions by the Clearing Manager dated 28 August In particular, a suggestion was raised by Meridian Energy whereby DSP values are to move in a range between the latest Price Setting Trade and the ASX and PPM reference values for that product period and product type. For further details regarding this proposed approach, please refer to the FTR DSP consultation summary of submissions dated 28 August 2013 with particular reference to pages 5-6. This is seen to have the effect of reducing day-to-day volatility unless supported by real and relevant reference value movement. 3 of 19

4 Obligation scenario analysis and review In order to undertake this analysis and review, we have compiled a series of results based on the Cap/Floor approach as advocated by Meridian Energy. As a counterfactual we have used the absolute movement approach which was originally recommended as the preferred methodology. To measure this, we have analysed three scenarios as follows: 1) Where the Price Setting Trade is at a level below reference value(s) 2) Where the Price Setting Trade is at a level in between or comparable to the reference values. 3) Where the Price Setting Trade is at a level above reference values(s) All analysis is based on Sept 2013 reference value data and is appendiced at the end of this report. While true Price Setting Trades are used where appropriate, it has been deemed necessary to adopt other numbers to fit in with some scenarios shown. Where the Price Setting Trade is at a level below reference value(s) In this scenario, Price Setting Trades are at a lower level than that of the two reference prices. This graph demonstrates pricing behaviour if the Absolute Movement approach is utilised. As the price setting trades are less than reference values at times of trade, DSP will not move above the higher of the two reference values at any time. 4 of 19

5 This graph demonstrates pricing behaviour if the Cap/Floor methodology is used. There is a brief period at the start whereby due to the Price Setting Trade being at the lower end of the range, a downward movement in the reference values is not replicated in the DSP. This graph demonstrates Absolute Movement vs. Cap/Floor. In this scenario the two methodologies are generally comparable although further prices drops below the floor level would create more instances of price differentiation. 5 of 19

6 Where the Price Setting Trade is at a level comparable to the reference value(s). In this scenario, auction clearing prices are at a similar level to reference value(s). 6 of 19

7 As shown within these graphs, there is relatively immaterial difference between either of the methdologies when reference values are in line with auction clearing prices. In fact, if strong correlation between reference values and auction prices exist, the existing multiplier based methodology is deemed to be sufficient. 7 of 19

8 Where the Price Setting Trade is at a level above reference value(s) In this scenario, auction clearing prices are at a level higher than reference values(s). Analysis is based on the 24HR-OBL-BEN->OTA product for the SEPT 13 period. Please see below the following graphs mapping behaviour: 8 of 19

9 In this instance, as the clearing price is greater than either reference value, there runs the risk of a general overstatement of product positions. As per graph 3 above, the cap/floor methodology caters for this to an extent by in particular capping the level of the DSP and avoiding any overstatement of position both in and out of the money. 9 of 19

10 Option methodology analysis Whilst this analysis is primarily driven by proposed changes to obligation based methodology, we take this opportunity to test the Meridian proposed methodology for options as well. Analysis is based on both 24HR-OPT-BEN->OTA and 24HR-OPT-BEN->OTA products as shown below. Where the Price Setting Trade is at a level below reference value Given there is only one reference value for this product type, the DSP follows the same shape of the reference value albeit at a lower level. With respect to the absolute movement approach, a point of note is that in the OTA->BEN product type, as the Price Setting Trade is less the reference value, the DSP reaches prices $0 at an earlier stage than it should. This was a adverse effect of this methodology as identified within the previous consultation. Within OPT OTA ->BEN cap floor example it is shown that the floor aspect prevents the price reaching $0. Whilst this has the positive impact of preventing a zero price prematurely, it also has the effect of reducing the ability to follow trends in the reference value and reduces the ability to keep in sync with the related OPT-BEN->OTA product. 10 of 19

11 Where the Price Setting Trade is at a level comparable to the reference value As communicated earlier in this document and in previous consultation feedback, when Price Setting Trades and reference values are at similar levels, the current methodology, the absolute methodology and cap/floor methodology all behave in acceptable and similar manner. 11 of 19

12 Where the Price Setting Trade is at a level above the reference value As an inverse to the case where the Price Setting Trade is below the reference value levels, using the absolute value methodology perhaps increases Daily Settlement Prices to levels not supported by either reference value or auction prices whereas the cap/floor approach requires the support of one or the other. That said, either approach provides less volatility than the existing approach where the separation between reference value and auction price would exaggerate price movement. 12 of 19

13 Considerations 1. Comparative methodology behaviour As per the above scenarios, the methodologies lead to similar or identical price behaviour when reference values positively correlate with price setting trades. Areas of difference exist when there is material difference between these two factors. A key advantage cap/floor methodology is to keep prices within a range band and reduce the day to day volatility of prices especially when they are not supported by reference and recent auction data. 2. Relationship with option methodology Both approaches provide a further step away in relationship from Option methodology. As per the Option section of this document, our analysis demonstrates that either methodology considered here could work with option products and in fact in some instances has advantages which the obligation scenarios don t. We believe neither approach is better than the other with respect to its relationship with the current Option methodology. 3. Complexity One key advantage of the absolute movement approach is its simplicity in description and design. Feedback the Clearing Manager receives from the industry is that all things else being equal, a simplistic easy to describe and derive approach is preferable. 4. Timing We are entering into auctions with longer duration to period commencement and potentially less frequent ability to reset prices. As such, we believe it important to get this change implemented in time for near term auctions. Given the reduced complexity, the absolute movement approach is more appropriate for this consideration. 5. Wider ranging review and consultation As per the initial consultation and summary of submission documents, the Clearing Manager has undertaken to provide a fuller review of various prudential methodologies as at the six month review of market commencement (End 2013). This review may include, bit is not limited to review of Daily Settlement Price and Initial Margin methodology over all product types and subsequent re-calculation of ongoing Initial Margin rates. This provides a near term opportunity to re-visit this issue with a wider scope or review. 13 of 19

14 Recommendation As per the analysis above, we note in most circumstances a close correlation between the two methodologies. The cap/floor has additional advantages of reducing some of the volatility in daily movement in prices and does address some of the negative aspects of both existing and absolute value methodology by way of its ability band prices. That said we note the original purpose of this consultation was to, in the near term, reduce the risk associated with the existing multiplier type pricing movement where unrealistic price movement was possible in a short space of time. We it more appropriate that any further changes are considered as part of the wider ranging review; encompassing all product types, DSP and Initial Margin methodology, scheduled for the end of The Clearing Manager will continue to monitor pricing behaviour for all types and periods and will report back to particpants with any further observations at the time of this wider review. As such, the recommendation that we wish to provide to the EA for their approval is a change to the Prudential Security Assessment Methodology (PSAM) to adopt an Absolute Movement approach for assessing Obligation product Daily Settlement price as follows: The formula as stipulated as 3) in method 1 of section D of the Assessment Methodology is to change from: to For Obligation Products For Option Products 14 of 19

15 Next Steps 1) Present recommendation to EA for board sign-off - Immediately 2) Upon satisfaction of 1), implement required system changes Board decision scheduled for Mid-October of 19

16 Appendix Reference Value data

17 Reference Data Obligation BEN->OTA Sep 2013 Reference Data Low Price Setting Trade vs Reference Value Comparable Price Setting Trade vs Reference Value High Price Setting Trade vs Reference Value PRODUCT_LABEL Predictive Price Model ASX Quartely Price Setting Absolute Price Setting Absolute Price Setting Absolute Cap/Floor DSP Cap/Floor DSP Trade Movement DSP Trade Movement DSP Trade Movement DSP Cap/Floor DSP 24HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA HR-OBL-BEN->OTA of 19

18 Reference Data Option BEN->OTA Sep 2013 Reference Data Low Price Setting Trade vs Reference Value Comparable Price Setting Trade vs Reference Value High Price Setting Trade vs Reference Value PRODUCT_LABEL Predictive Price Model Price Setting Absolute Price Setting Absolute Price Setting Absolute Cap/Floor DSP Cap/Floor DSP Trade Movement DSP Trade Movement DSP Trade Movement DSP Cap/Floor DSP 24HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA HR-OPT-BEN->OTA of 19

19 Reference Data Option OTA->BEN Sep 2013 Reference Data Low Price Setting Trade vs Reference Value Comparable Price Setting Trade vs Reference Value High Price Setting Trade vs Reference Value PRODUCT_LABEL Predictive Price Model Price Setting Absolute Price Setting Absolute Price Setting Absolute Cap/Floor DSP Cap/Floor DSP Trade Movement DSP Trade Movement DSP Trade Movement DSP Cap/Floor DSP 24HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN HR-OPT-OTA->BEN of 19