The ECC clearing methodology raises the system cost in the energy market.

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Sophie Prudence Booker
5 years ago
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Document type: Title: Position paper APX-EPEX merger view on ECC clearing Introduction The merger of the spot markets of APX/Belpex with EPEX includes the transfer of the current central counter

Whereas APX only provides a direct clearing structure (each market participant is a direct counter party to the central counter party), ECC only provides an indirect clearing structure (each market

These burdens are new to the markets in The Netherlands and Belgium, as they are used to a direct clearing model.

Entry barrier The ECC clearing methodology introduces severe entry barriers to the spot markets in several ways.

1 Document type: Title: Position paper APX-EPEX merger view on ECC clearing Introduction The merger of the spot markets of APX/Belpex with EPEX includes the transfer of the current central counter party clearing at APX to ECC. Whereas APX only provides a direct clearing structure (each market participant is a direct counter party to the central counter party), ECC only provides an indirect clearing structure (each market participant needs a clearing member, which relates to the central counter party). The ECC indirect clearing approach introduces, especially for smaller participants, a couple of burdens. These burdens are new to the markets in The Netherlands and Belgium, as they are used to a direct clearing model. The authors fear a disruptive effect on the development of the energy market in the two countries concerned. Considerations 1. Entry barrier The ECC clearing methodology introduces severe entry barriers to the spot markets in several ways. Firstly, the obligatory banking license required to become a clearing member imposes on most of the smaller members an obligatory partnership with a bank/clearing member to get access to the markets. The experience of the authors shows that in particular for smaller members, the clearing members have no or very limited commercial interest in their activity. This translates into unreasonable commercial terms imposed by the limited amount of clearing members on the market participants. In any case, an additional minimal fee or fixed fee is introduced into the participation to the market, which raises the entry barrier, especially for smaller participants and new entry. Secondly, the accession procedure with clearing members proofs to be slow and adds several months to the accession procedure to become a member on the exchange. It being understood that in order to get access to the market, the procedure most be followed either in parallel or in series with various clearing members, which poses an unnecessary administrative burden, and an increased cost of the accession procedure. It furthermore slows down new entry to the market, which decreases the speed of the energy market economy in general. Thirdly, the methodology itself applied by ECC is discriminatory for small participants, as described in detail in annex System cost The ECC clearing methodology raises the system cost in the energy market.

2 The addition of a 3rd party in the chain of transactions, namely the clearing member, raises the transaction costs compared to the current direct clearing model of APX. It is logical that the clearing member is a private company that needs to gain something from his interference in the transactions. However, these unavoidable additional costs are not matched by clear and unambiguous advantages for the system as a whole. The ECC points out that there are economies of scale to their approach, that should lower the total transaction cost, yet they never provide any more information on the matter. Nor do they put a limit to the costs a clearing member can introduce in the transaction scheme. And even if they would do it, it would still be reasonable to assume that the benefits are not equally spread between smaller and larger participants. In all fairness, the ECC methodology is assumed to increase transaction costs for smaller participants, and might reduce costs for larger participants. This distorts the level playing field compared to the current situation. The estimated overall average transactions costs will increase by roughly 30%. These transactions costs are a direct part of the overall system costs, and therefore act against the very nature of the free market. System costs increase the bill of the final end-consumer. 3. Transparency The additional layer of clearing members in the participation to the market adds a level of intransparency to the market. There are no general rules on the commercial terms of the clearing members imposed by ECC, so the additional transaction costs and limitations/regulations are depending on the negotiation of each market participant with the potential clearing members. This reduced transparency increases the market entry barrier, because new entry cannot easily assess their potential business plan. It slows down the access of end-consumers, mainly industrial end-consumers, to the market, because they cannot easily compare their direct participation to the market with their current supply agreements. It therefore is a barrier to the development of demand response in the market, which is a much needed evolution in the horizon 2020 and 2030 vision of the EU. Reduced participation to the market by the demand side reduces the liquidity on the market, and therefore the quality of the price signal, which is one of the core KPI's of a market operator. The reduced transparency also affects the level playing field, as each individual market participants gets different and in-transparent conditions from the various clearing members to act on the market. The additional layer of clearing members introduces a new distortion to the level playing field that is currently not applicable to the APX markets. 4. Liquidity and price quality The reduced access, especially for smaller members, to the spot market will have a detrimental effect on the liquidity of the spot market. Especially in smaller markets, such as the APX and Belpex day-ahead markets, small participants play a vital role in shaping the bid and ask curves. Small participants by nature use more limit orders (price dependant orders) at a broad range of price levels, which creates market depth in smaller markets. This increases the price elasticity of the market, and therefore its robustness and quality of its price

3 signal. A reduced participation of smaller members directly to the market will have a negative effect on these elements, which in return will reduce the confidence of the market players in general in the market functioning. This will lead to an even further reduction in liquidity, etc Proposed solution A central market place as an exchange requires a central counter party to ensure, amongst others but primarily, the delivery and payment of the exchanged commodity. The simplest model to achieve these goals is to apply the solution below: 1. Guaranteed payment: Upon introduction of an order into the exchange, both the maximum bid price as well as the maximum volume are known. These two parameters provide a maximum to the payment risk that can evolve from the bid itself, because both volume and clearing price can only be equal or lower. By ensuring that a market participant, at any time, has deposited sufficient collateral to cover maximum payment risk of each individual bid made, the default of payment is excluded. This is similar to the current clearing of the intraday markets, but it can be applied to day-ahead markets just as well. 2. Guaranteed delivery: Delivery in the energy sector is made through nominations. Usually, the nomination scheme is a double sided confirmation of the same transaction by both the seller and the buyer. By giving a single sided nomination right to the exchange, as is possible in the Netherlands through the approval of Tennet, one of the main shareholders that sold APX to EPEX, the delivery risk can be nullified for the exchange. If all market parties agree that the exchange is a professional market operator, and therefore can be trusted to nominate, one could even imagine a double sided nomination scheme, in which, in case of inconsistency, the TSO directs the invoice solely to the market participant and not the the exchange. In case the exchange is responsible for the error (technical fault, ), the market party can use the normal legal means at its disposal to claim the damage, which is in that case to be born by the market operator, and not by the collateral structure of the participants. The above is currently already in place in Belgium, applied in the ARP contract of Elia, which makes non-delivery of sold goods to Belpex impossible. The above is the simplest way of nullifying the risks related to delivery and payment for the central counter party. The methods applied by most central counter parties, which are a combination of statistic and probabilistic approaches, aim solely at optimizing the collateral structure in order to lower the margin requirement. Lowering margin requirements is beneficial to the market as a whole, for it reduces significantly the capital requirements that are immobilised by the trade. Our proposal would be that ECC applies the above, very simple, direct clearing method, to ensure a transparent and equal access to the market for every potential market participant. If the ECC methodology with bank licensed clearing members does create substantial benefits, each market participant is free to opt for a non-direct clearing method, but at least a worst case scenario would be feasible to all.

4 Contact persons: Bart Pycke - bart@yuso.be Cristian Montoya - cristian.montoya@energycluster.be Dieter Jong d.jong@anode.nl Stefan Fritz - stefan.fritz@aebamsterdam.nl Donald Kreiken Donald.kreiken@edmij.nl Michiel Timmerije - michiel.timmerije@avr.nl Frank van Gastel - frank.van.gastel@scholt.nl Evert Bokhove - e.bokhove@twence.nl

5 Annex 1: ECC fallacy in margining calculations The ECC has a troublesome methodology for the calculation of the initial margin for spot markets (IMSM), which is affected substantially by holidays. The applied methodology acts as a serious barrier to entry in the market, whilst not contributing to risk mitigation per se. The IMSM is designed to cover potential future exposure, which may arise from payment amounts on spot markets on a liquidation horizon of 2 subsequent settlement days (ECC business days). The applied methodology at ECC uses the historically observed exposures, to estimate a statistical forecast of potential future exposures, and to determine an appropriate minimum exposure, based on the most recent observations. This is done in two ways. Firstly using a multiplier of 3,1 towards the historical standard deviation, secondly using a multiplying factor of 1,4 of the maximum exposure in the last 21 days. For weekends, two days are added for subsequent settlement days. In periods around holidays (TARGET-2 holidays) the time between the settlement days of financial exposure is expanded even further. This increases this minimum exposure and by consequence of the principle with for example Christmas this results in an almost doubled settlement requirement for the consecutive three weeks, even though the actual impact and exposure is mainly found on the day before the holiday starts and just after the holiday happened. Throughout the year this occurs more often and considerably affects cash flows for smaller parties disproportionately. For the methodology the following clause used in the ECC Margining document issued September 9th on page 13 should speak against its purposefulness: the maximum exposure form the last 20 days is used ( ) to account for sudden changes in trading behavior. This is off course not the case for holidays, because trading behavior is not changed. ECC is has announced an upcoming policy change. However, this enhancement will not decrease the arising IMSM after the holiday has happened, but will take the increased exposure risk already into account before the holiday happens. Therefore the enhanced methodology will account for the increased exposure before the holiday and not only after. From a risk mitigation perspective this is a good step forward, but the applied methodology by ECC will maintain to put a heavy burden on capital requirements. This can again be considered an unnecessary entry barrier for small parties.

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