Introduction to ECC Margining Leipzig, 8th June 2017
Agenda 1. ECC Fundamentals 2. Margining Spot Market 3. Margining Derivative Market 2
ECC Fundamentals Central Counterparty (CCP) ECC is a Central Counterparty and Clearinghouse for spot and derivatives commodity markets and operates a system for collateralisation and settlement of the transactions concluded or registered on the connected markets. German License ECC holds a license as a Central Counterparty under the German Banking Act. European License As of 11 June 2014, ECC has been granted a Central Counterparty license according to Article 14 (1) of the Regulation (EU) 648/2012 on OTC derivatives, central counterparties and trade repositories (EMIR). The license is valid for the European Union. It covers commodity transactions or transactions with commodities as underlying. Designated Payment System ECC is a designated payment system in accordance with Article 10 of the Settlement Finality Directive (Directive 98/26/EC on settlement finality in payment and securities settlement systems). 3
ECC Fundamentals II DAILY ECC collects margins on a daily basis to limit its credit exposures from its Clearing Members. 99% Confidence Level Spot Margin & SPAN Such margins are sufficient to cover losses that result from at least 99% of the exposure s movements over a time horizon of two trading days. The Spot Margin and SPAN 1) Initial Margin constitute the two main margin types at ECC. 1) SPAN is a registered trademark of Chicago Mercantile Exchange Inc. 4
Agenda 1. ECC Fundamentals 2. Margining Spot Market 3. Margining Derivative Market 5
Margining Spot Market Risk Current Exposure + Potential Future Exposure Spot Market Current Exposure Margin (CESM) Exposure of the existing transactions need to be paid by the counterparties. Is the value of outstanding payments at the time of a potential counterparty default. Initial Margin Spot Market (IMSM) Expected value of spot transactions for the time between last payment and default of a counterparty. Acts as a buffer for the time of trading where no payments can be made (during nights and weekends). Derivatives Market Variation Margin Initial Margin (SPAN) 6
Payment fixed Payment booked Payment fulfilled Payment fixed Payment booked Payment fulfilled IMSM Margining Spot Market - Current Exposure Current Exposure Margin (CESM): On spot power and natural gas markets trading takes place 24/7 ECC measures intraday credit exposure on spot markets near to real time It is the net value (payment amount) of all concluded transactions on the spot markets during the day that have not been settled The margin will be released as soon as the corresponding payments have been instructed at the end of the business day (18:00 CET) Only exposure from transactions concluded after the ECC booking cut (16:00 CET) will be maintained in the CESM margin over-night Exposure accumulates Start DA auction 16:00 18:00 8:00 11:45 16:00 18:00 8:00 11:45 Current Exposure Spot Market accumulates EUREX System closed 7
Margining Spot Market Current Exposure II Example: Transaction Time Product PA in EUR CESM in EUR on day t Calculation day t, 8.00 am POWER-IT 50 50 = MAX 1 50; 0 day t, 1.00 pm GAS-ST 100 150 = MAX 1 50 + 1 100; 0 day t, 3.00 pm EUA -50 100 = MAX 1 50 + 1 100 + 1 ( 50); 0 day t, 3.30 pm POWER-IT 80 180 = MAX 1 130 + 1 100 + 1 50 ; 0 day t, 5.00 pm EUA 60 233 = MAX 1 130 + 1 100 + 0.3 10; 0 day t, 7.00 pm POWER-IT -10 8 = MAX 0.3 60 + 1 ( 10); 0 No margin credit is granted, CESM is floored at 0 Margin parameters equal 1 for buy and sell side for power and gas As certificates are storable only a possible price risk has to be covered for buy transactions (factor 0.3 for buy side) Keep booking cut in mind at 4.00 pm and end of business day at 6.00 pm 8
Margining Spot Market Potential Future Exposure On spot markets, trading and clearing takes place 24/7 including times when settlement of payments is not possible due to TARGET2 closure. ECC measures credit exposure on spot markets near to real time on a 24/7 basis using the Current Exposure Spot Market (CESM). This margin has to be covered with collateral at all times. In combination with the Initial Margin Spot Market, which is used as a buffer to cover exposure from potential spot transactions in the future, this model considers correlation effects between the different products that are cleared by ECC to realise portfolio effects which increase the collateral efficiency. t - 1 t t + 1 4:00 pm 8:00 am 4:00 pm 8:00 am 12:00 am Accounting cut-off Payment Accounting cut-off Payment Latest possibility for suspension Total Exposure t 9
Margining Spot Market Potential Future Exposure II For each ECC trading day t, the margin requirement M for NCM i for the next ECC trading day t + 1 is given by M i t + 1 = max μ E i s s S + α σ E i s s S ; β max s S E i s ; M min ; M min_first Ι {t+1<t0 +29} Statistical component: Mean + 3.1 * Standard Deviation of exposures of the past 255 trading days Maximum component: 1.4 * the maximum exposure of last 20 trading days Minimum requirement: 30.000 EUR for the first 30 ECC business days after admission, 10.000 EUR afterwards μ is the average function, σ is the standard deviation E i (s) represents the exposure of NCM i of day s α, β, M min ; M min_first are parameters I stands for the indicator function t 0 stands for date of admission S = t 255 + 1,, t counted in ECC trading days, S = t 20 + 1,, t counted in ECC trading days 10
Margining Spot Market Visual Examples 11
Margining Spot Market Visual Examples II 12
Agenda 1. ECC Fundamentals 2. Margining Spot Market 3. Margining Derivative Market 13
Margining Derivatives Market Risk Current Exposure + Potential Future Exposure Derivatives Market Variation Margin Daily mark-to-market value change of all open positions in futures using the latest market prices received from the markets. The profit or loss of each future position will be paid/received by the trading participant daily. SPAN Initial Margin ECC uses a statistical approach to calculate the potential changes in the value of a trading member s portfolio over a time horizon that is needed to liquidate the portfolio (usually 2 days). Spot Market Current Exposure Margin (CESM) Initial Margin Spot Market (IMSM) 14
Margining Derivatives Market - Current Exposure Profit and loss resulting from changes in the products prices are accounted daily A positive Variation Margin results in a daily credit while a negative Variation Margin results in a daily debit Variation Margin for a new future trade: = Net Quantity* x Contract Size x (Today s Settlement Price - Trade Price) Variation Margin for an existing position: = Net Quantity* x Contract Size x (Today s Settlement Price - Yesterday s Settlement Price) * Net Quantity is the net number of the same products. A long position is represented by a positive quantity while a short position is represented by a negative quantity. 15
Margining Derivatives Market - Potential Future Exposure SPAN is a statistical margin model to calculate the potential changes in a trading member s portfolio to cover potential losses during the given liquidation period of 2 days with a confidence level of 99% Statistical modeling requires a history of non-zero returns over the past 255 trading days but future contracts are traded for specific delivery times (e.g. October 2016). Some are only tradeable for a few weeks or months. Solution: price history is considered by allocating products into relative-maturity-buckets Relative Maturity Weekly Contract Monthly Contract Quarterly Contract Yearly Contract 0 Current week (Delivery) Current month (Delivery) - - 1 Next week (Front) Next month (Front) Next quarter (Front) Next year (Front) 2 Next but one week Next but one month Next but one quarter Next but one year Example: The Monthly Phelix Base Contract for October 2016 (F1BM102016) changes its belonging bucket with time: F1BM102016 F1BM_02 F1BM_01 F1BM_00 August 2016 September 2016 October 2016 time 16
Margining Derivatives Market - Potential Future Exposure II Based on the price history per relative maturity a Single Margin Parameter (SMP) is calculated on contract level: SMP X = p X : Current price of contract X in /MWh 2 p X σ X R X b X σ X : EWMA-Volatility of relative non-zero returns r X over the last 255 trading days, implemented with l = 0.99 as follows σ X τ = r k 2 λ τ k τ k=max τ 255,1 / λ τ k R X : Risk factor between 2.66 and 3.5 (99% quantile of volatility normalized returns) b X : Procyclicality buffer between 1.00 and 1.25, applied if the current volatility exceeds a critical volatility determined by the maximum historical volatility of a contract s time series 0.25 σ X σ crit b X = 0.25 1 σ X σ crit σmax σ crit else τ k=max τ 255,1, with σ crit = σ min + 0.2 (σmax σ min ) 17
Margining Derivatives Market - Potential Future Exposure III Netting effects for spread positions on portfolio level are created by spread parameters for spread positions, i.e. one asset being held long and the other being held short: Level 1: Netting Offsetting of futures and options with the same underlying Level 2: Perfect Spreads Spreads between opposite positions in the same commodity and with a completely overlapping delivery period and profile (Year vs. four Quarters) Level 3: Inter-Commodity Spreads Spreads between opposite positions for any potential combination of different products (Commodities, Delivery Area, Delivery Profile, Delivery Period) Margin credit: 100% Margin credit: 99% Margin credit: 0-99% Inter-commodity spreads are calculated in the form of a credit determined by the ratio of gross margin and net margin for selected bivariate portfolios ECC s approach to calculate the net margin for such portfolios is similar to the approach of the SMP. The margin is seen as the 99%-quantile of a volatility-normalized historical simulation of the absolute portfolio non-zero returns over the past 255 trading days weighted by the position size On ECC website (https://www.ecc.de/ecc-en/risk-management/reports_and_files) the SPAN files containing the current SMPs and spread parameters are published as well as a link to download PC-SPAN to reproduce the margin calculation 18
Margining Derivatives Market - Potential Future Exposure IV Since 1 st August 2016 ECC uses a SPAN functionality called Tiering to control the number of parameters which increase during every introduction of new products Problem: due to monthly strip contracts (e.g. Coal, Freight) the increasing size of the SPAN parameter file leads to problems for some vendors and Clearing Members Solution: Instead of treating every maturity of a specific contract as a separate risk factor one SMP and one inter-commodity spread will be defined for a number of different maturities. This spread is a weighted average of the spreads of all products within this tier. 6 tiers are proposed according to the following scheme: Tier 1 Tier 2 Tier 3 All Contracts expiring in the current Month ( in delivery ) The following contracts with expiry in the current quarter (can be empty) The following contracts with expiry in the current/following calendar year Tier 4 The following contracts with expiry in the current/following calendar year +1 Tier 5 The following contracts with expiry in the current/following calendar year +2 and +3 Tier 6 All remaining contracts 19
Thank you for your attention Questions? 20