Many in the energy sector have tipped over-the-counter clearing as a potential solution to the industry’s credit problems. Until now, energy exchanges have led the way in offering such services, but an initiative from global firm PA Consulting aims to give companies an off-exchange netting option.
Peter Stockman, a member of the financial services practice at PA Consulting in New York, says: “The good news for those concerned about counterparty credit risk is that OTC clearing is taking off.”
He cites the increase in the volume of cleared trades on the New York Mercantile Exchange (Nymex) as evidence of this, as well as the fact that providers of clearing services, such as Nymex and Intercontinental Exchange, have increased the number of contracts they are offering for clearing over the past few months.
“ But there remain positions that are not clearable, and that’s what we’re aiming for with this service,” he adds.
PA is trying to give the industry a one-off liquidity boost by netting a series of electricity trades, says Stockman. He describes the initiative as a “one-time spring cleaning” aimed at reducing collateral costs.
Stockman says a few energy firms – he would not name them – approached PA with a proposal to conduct the set-off transactions. No company has signed an agreement, but he has been canvassing the biggest power players in North America and has “strong interest” from eight firms, he says.
The set-off trades work much as under a normal netting agreement. Participating firms submit their position data to PA Consulting on an anonymous basis. PA identifies suitable trades for netting and then gives participants a list of transactions that can be executed bilaterally between companies drawn from the group of participants. The pooling of net positions will allow PA Consulting to identify trades that can be matched and in doing so will reduce the amount of collateral that needs to be posted (see figures for an example).
Benefits
Stockman says the extent of the netting benefits to participants is dependent on two factors. First, the more companies that take part, the greater the net savings are for all participants. Second, the configuration of participants’ trading positions affects the ability of PA Consulting to set off individual trades.
“ With very good participation – say, six firms or more – and if companies’ power books produce a network of bilateral trades that allow netting, the amount of collateral saved could be 50% or more,” Stockman says. It may take two or three rounds of trading to make these levels of savings, he adds.
One of the firms looking to participate is Houston-based Reliant Energy. A spokesman for the company says: “The entire industry is struggling with increased collateral requirements. All companies have done this kind of one-off trade netting on a sporadic basis, but this is the first time I’m aware of that an organisation has looked to pool all the trades for maximum benefit.”
PA Consulting is charging participants a “nominal fee”, Stockman says. The exact amount is confidential, but he says it is mainly to cover costs. “We’re charging only for the time we’ve spent developing this – we’re getting any kind of commission based on volume of trades, as would a broker,” he adds.
The trades are due to take place in the first two weeks of June, says Stockman. He doesn’t rule out the possibility of turning the netting into an ongoing service if the first round is successful, but he doubts PA would be the company to take it forward.
Reliant’s spokesman says the chances of it becoming an ongoing service depend on the success of the initial round of trading. But he adds: “Energy companies are moving much more towards the use of multilateral netting and over-the-counter clearing on exchanges, and if that process continues, it will eliminate the need for this kind of one-off service.”
And the main advantages? Stockman says: “The clearest benefit is that this will reduce the amount of collateral companies will need to post in order to trade, by pushing down the exposures of participants to within their credit limits. It frees up capital that could instead be used for investments.”
He says there is also another, less tangible benefit. The service aims to reduce the credit “cost of carry” – the exposure of a company to losses stemming from the credit problems of a counterparty. “That’s not a loss that shows up on financial statements, but it’s nevertheless very real,” he says.
