Sessão E A Comercialização

1 III Seminário Mercados de Electricidade e Gás Natural Investimento, Risco e Regulação Sessão E A Comercialização Paulo Sena Esteves Faculdade de Economia do Porto, 12.Fev.2010

2 Strategic Positioning i

Risk, Return & Regulation 3 Industry Structure Liberalized Regulated Risk impacts Regulation Impacts Risk impacts Return impacts

Risk, Return & Regulation 4 GOAL: Achieve the best value for money mix Return Risk Cost Value Value Cost

Energy Industry Structure A Comercialização 5 Supply [Generation] Demand [Consumption] Social Support Economic Support Physical Support Technical Support Retailers Dealers Shippers ( ) Brokers Exchanges Clearing Houses ( ) Financial tools ( )

Exchange business VfM 6 Value Value Cost Clearing Houses Exchanges Set-up fees Variable fees Collateral costs Set-up fees Variable fees Risk(s) management Netting Price discovery and information dissemination Transactional efficiency

7 Clearing Benefits

What is Clearing? 8 Clearing is a combination of procedures that happens after a trade has been executed, including margining and settlement, which ensures that contract performance is guaranteed. The Clearing House takes on the role as central counterpart to all trades. Main economic tool Standardization Main economic function Fungibility

Clearing House Core Functions 9 Contract / Product Process legal issues Design (eg. novation) (eg. standardization) Design (eg. automation) Risk management age e Positions management Settlement and delivery Collateral management age e

Risks in the ( ) Market 10 Risks facing the market participants directly: Counterparty Credit Risk Settlement Risk Replacement Cost Risk Collateral Risk Market Risk Price Risk Volume Risk Currency Risk Operational Risk Legal Risk Systemic risk facing the market itself (normally beyond the direct control of individual market participants)

Risks in the ( ) Market 11 Risks facing the market participants directly: Counterparty Credit Risk Settlement Risk Replacement Cost Risk Collateral Risk Market Risk Price Risk Volume Risk Currency Risk Operational Risk Legal Risk Quality control CH guarantee Daily MTM Systemic risk facing the market itself (normally beyond the direct control of individual market participants) A circuit breaker Standardized procedures Centralized controls Reporting & Supervision Standardization Liquidity Reference prices Daily MTM DVP provisions CBM & Sett. model

Risks in the ( ) Market 12 CH ensures the Contraparty Principal Operational Systemic Market good execution of Risk is Risk is Risk is Risk is Security & all trades reduced reduced reduced reduced Stability CLEARING INCREASES CONFIDENCE, STABILITY AND SECURITY IN THE MARKET

Credit Risk Management 13

Credit Risk Management 14 Bilateral Market Market with a Clearing House (CH) CH Bilateral counterparties Each participant has to pledge collateral with each counterpart Each counterpart must be monitored (higher costs associated to credit risk management) CH is the counterpart of all trades CH has a neutral position => it is indifferent to price movements Collateral is pledged with the CH Only one counterpart to be monitored

Credit Risk Management Bilateral Market 15 Member A defaults: Member B is more exposed to A E A s default affects all market participants who are exposed to it Ripple effect from B s Bs exposure to A, affects C, D and E Bilateral margining and payment D A B C Systemic Risk for the whole market

Credit Risk Management Multilateral Market (with a Clearing House) 16 Member A defaults: Solution benefits: E Member A defaults and only the CH is affected. D CLEARING HOUSE A Market Stability B C

Credit Risk Management Multilateral Market (with a Clearing House) 17 Solution benefits: 1. Members are related with just one counterpart, avoiding complex bilateral credit lines; 2. One single pool of collateral; 3. Margin calculation by one central counterpart, based on position netting; 4. All market participants available to trade, enabling greater liquidity, idit and fairer market participation. i CH Market Efficiency

Netting Provisions 18 Net tting prov visions No netting Payment Novation Close-out netting netting netting Master Agreement with PN Clause Stand-alone PN Agreement Ad hoc agreement Matched Pair Novation Netting Comprehensive Novation Netting Multilateral netting Cross-Product Netting Cross-Affiliate Netting Bilateral relationsh hips

Counterparty Risk Where is the portfolio located? 19 Financial i Other Counterparts Counterparts Cherry picking 2 No netting (?) 1 (?) 3 Cherry picking Bilateral netting (?) (?) 2 4 Multilateral netting Clearing House

Netting impacts 20 Relationships (n = 15 / m = 30) No netting (n 2 -n)/2*m = 3150 Bilateral netting (n 2 -n)/2 = 105. Multilateral netting n = 15 n = # counte erparts m = # trades with each ctp

21 Externalities The Exchange + Clearing Package

Why an Exchange Package? 22 Macroeconomic effects Price references Hedging tools / Risk distribution Leverage economic activity (margin control / risk control) Microeconomic i effects ( )

Why an Exchange Package? 23 Independent and transparent body (exchange/ch) A regulated environment Full access to all relevant players (counterparties) in the relevant market Anonymous trading/clearing Democratic (exchange) environment: No distinction between incumbents and new comers No distinction between big players and small players No selection capacity between counterparties Big players market with the same level playing field

Why an Exchange Package? 24 Transparent market prices Fair (reference) price disclosure (i (risk management, accounting, structured products development) A liquidity improvement commitment Market Making scheme Close out positions independency (multilateral market) = no counterparty constrains Full netting (bankruptcy, accounting, ) Efficient STP market operations,

25 Welcome to Reality An International Vision

OTC derivative market segments Notional amounts outstanding (Dec.2008; USDbn) 26 Credit default swaps; 41 868 Equity linked; 6 494 Interest rate; 418 678 Commodities; 4 427 Others; 70 742 Foreign exchange; 49 753 Source: Ensuring efficient, safe and sound derivatives markets, Commission of the European Communities, Brussels, 3.7.2009, SEC(2009) 905 final

The size of derivatives markets On- and Off-exchange 27 Source: Ensuring efficient, safe and sound derivatives markets, Commission of the European Communities, Brussels, 3.7.2009, SEC(2009) 905 final

Derivative Contracts Traded on and off-exchange Notional amounts outstanding (Dec.2008; USDbn) 28 450 000 400 000 350 000 300 000 250 000 200 000 150 000 100 000 50 000 Exchange OTC OTC Exchange Interest Rate derivatives IR Swaps 328 114.0 19.3 IR Options 51 301.0 35.2 FRAs 39 268.0 n.a. Equity derivatives Forwards and swaps 1 632.0 0.7 Options 4 862.0 4.4 Commodity derivatives Forwards and swaps 2 624.0 1.6 Options 1 797.0 0.2 FX derivatives Forwards and forex swaps 24 562.0 102.0 Currency swaps 14 725.0 Options 10 466.0 126.0 units: USD bn 0 Interest Rate derivatives Equity derivatives Commodity derivatives FX derivatives Source: Ensuring efficient, safe and sound derivatives markets, Commission of the European Communities, Brussels, 3.7.2009, SEC(2009) 905 final

29 Credit Exposure Covered by Collateral, 2003-2009 Percent of Exposure Sources of collateral (2008): Cash: 83% - 84% Government securities: 9% - 15% Others: corporate bonds, letters of credit and commodities Source: Ensuring efficient, safe and sound derivatives markets, Commission of the European Communities, Brussels, 3.7.2009, SEC(2009) 905 final / ISDA (2009)

Current use of portfolio reconciliation services 30 Reconcile - other 19% Non reconciliation 20% Reconcile as needed 20% Reconcile monthly Reconcile 4% weekly 6% Reconcile daily 31% Source: Ensuring efficient, safe and sound derivatives markets, Commission of the European Communities, Brussels, 3.7.2009, SEC(2009) 905 final

31 Welcome to Reality A MIBEL Approach

Electricity Consumption (TWh, 2007) 32 700 600 179% 500 400 300 100% 109% 113% 118% 154% 36 7 200 100 0 38% NL Iberia Italy UK Nordpool France Germany 35 0 48 0 11 7 55 6 31 1 34 0 Source: EIA, UCTE

MIBEL - One Single Integrated Market 33 PORTUGAL 6 M Consumers Cons.: 49.86 TWh Peak: 9.1 GW Inst. Cap.: 14.9 GW OMIP Single Forward Market Operator 5.24 TWh SPAIN 24 M Consumers Cons.: 251 TWh Peak: 44.88 GW Inst. Cap.: 93.2 GW OMEL Single Spot Market Operator 30 Million Customers 300 TWh Equal rights and obligations i for the agents of both countries Principles of Transparency, Objectivity and Liquidity One Iberian Market Operator, through the integration of OMIP and OMEL Two TSOs One Regulator s Council One Technical and Economical Management Committee

Day-ahead - % Market Splitting per Hour * 34 100% <0 2.5% =0 75.2% >0 22.3% 90% 80% 70% 60% 50% 40% <0 =0 >0 30% 20% 10% 0% 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 Updated 31.Dec.09 *Last 12 months

OMIP/OMIClear Members* Location 35 1 1 7 1 4 3 6 25 2009 * Including Settlement Agents

Open Interest (MWh) Monthly Average 14 000 000 13 000 000 12 000 000 11 000 000 10 000 000 9 000 000 8 000 000 7 000 000 6 000 000 5 000 000 4 000 000 3 000 000 2 000 000 1 000 000 0 36 Jul-06 Sep-06 Nov-06 Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Updated 31.Dec.09

37 Clearing Volume (MWh) 6 500 000 6 000 000 5 500 000 OTC Market 5 000 000 4 500 000 4 000 000 Portuguese Av. Power Consumption 3 500 000 3 000 000 2 500 000 2 000 000 1 500 000 1 000 000 500 000 0 Jul-06 Aug-06 Sep-06 Oct-06 Nov-06 Dec-06 Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07 Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Updated 31.Jan.10

Risk perception vs. Market (Clearing) usage? 38 OMIClear case 4 500 000 2.5000 Clearing OTC Volume (MWh) 4 000 000 12m Av. Credit Risk Spread (%) 3 500 000 2.0000 3 000 000 2 500 000 1.5000 2 000 000 1.0000 1 500 000 1 000 000 0.5000 500 000 0 0.0000 Jul-06 Sep-06 Nov-06 Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May_09 Jul_09 Sep_09 Nov_09 Jan_10

Regulation vs. Market Activity? Spanish OTC Power Volumes (TWh) 250 50 40 200 30 20 150 10 0 39 2001 2002 2003 2004 2005 2006 2007 100 50 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010* * Jan.2010 forecast

Trends & Signals 40

Financial services: Commission sets out future actions to strengthen the safety of derivatives markets* 41 Internal Market and Services Commissioner Charlie McCreevy said: "This Communication marks a paradigm shift away from the traditional view that derivatives are financial instruments for professional use and thus require only lighthanded regulation. The Commission proposes a comprehensive approach that will ultimately enable markets to price risks properly. We cannot afford another situation where the risks of the financial sector are ultimately borne by the taxpayer. " * COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL, THE EUROPEAN ECONOMIC AND SOCIAL COMMITTEE, THE COMMITTEE OF THE REGIONS AND THE EUROPEAN CENTRAL BANK Ensuring efficient, safe and sound derivatives markets: Future policy actions Brussels, 20.10.2009, COM(2009) 563 final

Future policy actions 42 Reduce counterparty risk by (i) proposing legislation to establish common safety, regulatory and operational standards for central counterparties (CCPs), (ii) improving collateralisation of bilaterally-cleared contracts, (iii) substantially raising capital charges for bilaterallycleared as compared with CCP-cleared transactions, and on top of this (iv) mandate CCP-clearing for standardised contracts; Reduce operational risk by promoting standardisation of the legal terms of contracts and of contract-processing;

Future policy actions 43 Increase transparency by (i) mandating market participants to record positions and all transactions not cleared by a CCP in trade repositories, (ii) regulating and supervising trade repositories, (iii) mandating trading of standardised derivatives on exchanges and other organised trading venues, and (iv) increase transparency of trading as part of the review of the Markets in Financial Instruments Directive (MiFID) for all derivatives markets including for commodity derivatives; Enhance market integrity and oversight by clarifying and extending the scope of market manipulation as set out in the Market Abuse Directive (MAD) to derivatives and by giving i regulators the possibility to set position limits. More information is available at: http://ec.europa.eu/internal_market/financial-markets/derivatives/index_en.htm

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THE IBERIAN ENERGY CLEARING HOUSE 45