NSW Trader Proposal - Hedge Contract Credit Risk Solution, 17/09/04
Fri 17 Sep 2004
d-cyphaTrade and the SFE have written a paper outlining how exchange-traded derivatives could provide a solution to mitigate credit risk associated with the transfer of existing hedge contracts under this proposal.
In May 2004, NSW Treasury released a paper (A Risk Management Proposal for New South Wales' Electricity Business, Research and Information Paper, NSW Treasury) outlining a proposal to shift the power trading activities to the private sector. d-cyphaTrade and The Sydney Futures Exchange have written a paper in response outlining how exchange-traded derivatives could provide a solution to mitigate credit risk associated with the transfer of existing hedge contracts under this proposal. The proposal takes advantage of the existing futures market capability for over the counter (OTC) hedge contracts to be swapped into equivalent futures positions through a trading mechanism known as an Exchange for Physical (EFP).
The proposal provides NSW Treasury with a solution that eliminates all risk associated with a substantial proportion of existing electricity hedge contracts currently held by NSW Government electricity businesses, including credit risk to Private Traders.
Incoming Private Traders can benefit by using a Letter of Credit or Bank Guarantee for initial margins, which provides a collateral efficient way to hold derivative positions.
The paper provides an overview of:
- The EFP mechanism;
- The steps to be taken to effect the transfer of OTC contract positions to futures contracts; and
- A detailed example of the transfer process with a cash flow and cost analysis.
Please follow the link below to view this paper in full.