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European energy markets are no stranger to volatility. Recent surges in both electricity and gas prices have substantially driven up collateral requirements and created a margin funding crisis of for market participants. Central Counterparty Clearing organizations (CCPs) are now requiring massive initial and variation margin commitments in order to satisfy their counterparty risk reduction requirements. As a result, energy firms and their liquidity providers are facing a series of unprecedented financial, practical, technological and risk control challenges to meet inflated collateral requirements.
Breaking it Down
It is standard for energy producers to hedge the market as a means of limiting exposure to price swings and distortions in supply and demand. This enables them to offset risk and protect their contracts to sell physical power and gas to energy suppliers and consumers. Selling a power future, for example, will protect a producer from a drop in the price of the underlying power that they have already agreed to sell at a set price, since the profit from the future will counteract delivering power below the market price.
Adrian Carr, Nasdaq
That being said, in order to sell the future, the producer must first lodge collateral with an exchange’s clearinghouse as a guarantee should the producer go under. In normal market conditions, this amount is predictable and manageable; however, the volatility that we have seen year-to-date has fundamentally increased margin call amounts. This is because a CCP’s margining methodology is designed to protect against volatility and price spikes. When prices surge, the amount that a firm needs to post dramatically increases, which in turn places a large strain on energy producers and their agreements with their lenders.
Adding to the complexity, many firms do not have precise visibility of the margining process, and often struggle to calculate what will be owed at any given point in time to CCPs. This is often compounded by large and complex trading operations that span multiple legal entities, multiple desks and multiple products (some reducing the margin requirement at a given CCP, others increasing it).
For energy producers and market participants to effectively engage in today’s volatile markets, it is imperative that they have insight into real-time collateral expenditures and margin requirements. This can enable firms to monitor their risk exposure while also improving their overall capital efficiency.
Nasdaq Risk Platform is in use by several market participants who leverage it to gain real-time initial and variation margin calculations and what-if functionality to clearly represent the financial obligations of a trading operation at any given time. Delivered as a cloud-based SaaS solution, it substantially reduces operational complexity, allowing clients to concentrate on their business instead of allocating resources to implementation, maintenance and software updating processes.
With one, harmonized view of risk, Nasdaq Risk Platform helps firms protect their business while enabling them to invest their capital where it benefits them most. Providing real-time visibility of positions across CCPs, understanding margin requirements in real-time and supporting complex hedging instruments allows these market participants to more accurately mitigate their exposure to volatile markets.
Find out more about Nasdaq Risk Platform here.
Adrian Carr is the Product Manager for the Nasdaq Risk Platform, driving platform strategy and growth. In Adrian’s previous role, he was the Business Development Manager for LME Clear, where he worked for three years delivering new products and services to the LME Members. Prior to that, Adrian spent a year in Sydney, where he worked for the ASX, heading up the Interest Rate Swaps Client Clearing and Futures Clearing offerings. Adrian has over 10 years of experience working with Clearing Counterparties.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.