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Secure Trading & Clearing An introduction to NGX Clearing April 2008 Version 40.

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Presentation on theme: "Secure Trading & Clearing An introduction to NGX Clearing April 2008 Version 40."— Presentation transcript:

1 Secure Trading & Clearing An introduction to NGX Clearing April 2008 Version 40

2 2 Executive Summary NGX is an established electronic exchange and clearinghouse –Over 160 contracting parties (members) across North America –Clearing over $8 billion monthly of physical gas and financial power –Delivering over 14 Bcf of physical gas daily –Capital structure includes full margining, ‘cushion’ collateral, and guarantee fund –Owned by TSX Group (Toronto Stock Exchange) –Clearing bank and regulatory oversight –Zero-default history NGX’s value proposition is twofold –For traders: maximize price improvement opportunities, minimize market impact –For risk managers: reduce overall risk, maximize capital and operational efficiency NGX’s ‘direct’, non-mutualized clearing model is ideally suited to the trading and clearing of physical energy commodities

3 3 Sections Overview (page 3) Clearing Structure (page 13) Risk Management (page 26) Contacts

4 4 Introduction to NGX Business Concept: –Provide electronic trading and clearing services to North American energy market participants –NGX is a service provider and therefore does not trade or take positions Headquartered in Calgary, Alberta, Canada Incorporated in 1993, began trading operations in Feb 1994 Ownership History –Initial Ownership by Westcoast Energy Inc. –Acquired by OM on Jan 1, 2001 –Acquired by TSX Group March 1, 2004

5 5 Ownership: Introduction to TSX TSX Group is a cornerstone of the Canadian financial system and is at the centre of Canada’s equity capital market TSX Group owns and operates Canada’s two national stock exchanges, the Toronto Stock Exchange, serving the senior equity market, and TSX Venture Exchange, serving the public venture equity market From its preeminent domestic base, TSX Group’s reach continues to extend internationally, through TSX Markets and TSX Datalinx which provide the trading and data to the global financial community who access Canada’s equity capital market

6 6 NGX Core Competencies Clearinghouse Operations –Physically and financially settled over 1,300,000 trades –Zero-default history Liquidity Development –Focus on customers and quality of service –Commitment to the reduction of trading impediments Electronic Trading & Clearing –Over 12 years of experience developing and operating high-reliability, high-performance electronic trading and clearing systems –Trading now available through ICE’s leading-edge trading platform


8 8 Available Forward Curves Forward strips listed from yesterday to year four * US physical gas products are listed by ICE, cleared by NGX ** Gas financial products are available for block/OTC clearing, not onscreen trading $ Fixed Price$Monthly Index$Daily Index$Basis$Location Spread Fixed$Location Spread Basis CAB-NITC CAB-NIT 2AUSAB-NITCAB-NIT EmpressUSDawn Niagara CATCO NorthCStation #2CAB-NIT 4AUSEmersonUSDawn NiagaraUSDawn Iroquois CEmpressUSAB-NITCAB-NIT 5AUSNiagaraUSDawn IroquoisUSDawn Chippawa CStation #2USMalinCStation #2USIroquoisUSDawn ChippawaUSDawn Parkway CTEPUSCATCO NorthUSChippawaUSDawn ParkwayUSSt. Clair Dawn USAB-NITCTEPUSParkwayUSSt. Clair DawnUSAB-NIT Dawn USEmersonUSDawnUSDawn USNiagaraUSMalin USPG&E Citygate USIroquois USHenry USChippawa USSt Clair USParkway USMalin USPG&E Citygate USDawn USSt. Clair USMalin Physical Products* HenryUS PG&E Citygate USHenry PG&E Citygate Henry US AB-NIT Emerson $Fixed (Fixed-for-Floating)$Basis$Swing$Index (Floating-for-Floating)$Options$Location Basis CAB-NIT FixedUSAB-NITCAlberta Flat Elec.USAB-NIT Index SwapCAlberta FixedUSPGE Citygate Malin Basis Spread USSumas FixedUSAB-NIT Daily BasisCAlberta Peak Elec.USLDS for GDDUSMalin AECO Basis Spread USFutures SwapUSSumasCAlberta Ext. Peak Elec.USRockiesUSSoCal Rocky Mountains Basis Spread USMichconUSChicagoCAlberta Off-Peak Elec.USMalinUSSumas AECO Basis Spread USSocal FixedUSRockiesCAlberta Super-Peak Elec.USSumas USPG&E Citygate FixedUSMalinCAlberta SwingUSMichcon USMichconUSSumasUSSocal USSocalUSHenry HubUSPG&E Citygate USPG&E CitygateUSMid-Columbia Peak USMalin Daily BasisUSMid-Columbia Off-Peak USRocky Mountains Daily BasisUSRockies USSoCal Daily BasisUSMalin USPGE Citygate Daily BasisUSMichcon USCIG Rockies Daily BasisUSSocal USEP San Juan Daily BasisUSPG&E Citygate USEP Permian Daily Basis USSumas Daily Basis Financial Products ** Temporarily unavailable

9 9 NGX Services Exchange – Centralized electronic trading – Standardized contracts – Pipeline balancing instruments – Cleared and bilateral trading – Market advocacy (facilitating transactions) – Market agency (facilitating order entry) – Real-Time Price Index Generation Clearing House – Assured performance – Trade and counterparty netting – Centralized collateral management – Centralized risk management

10 10 Operational Statistics 160+ NGX Contracting Parties –All “Member” firms eligible to transact through the Exchange and/or clear through the Clearing House List 111 physical and derivative products Average in Excess of 500 Traders Daily 2007 Trading Statistics: –Volume = 11.2 Tcf –Transactions = 238,227 Average Daily Deliveries in Excess of 14.0 Bcf

11 11 NGX Volume History

12 12 NGX Product Dispersion

13 13 Sections Overview (page 3) Clearing Structure (page 13) Risk Management (page 26) Contacts

14 14 NGX Clearing Operations NGX Intermediation –NGX acts as buyer to every seller, and seller to every buyer, for the purpose of facilitating anonymous trading and clearing Private Clearing Operation –Contracting Parties are not mutually exposed to another Contracting Party’s default $ $ or Natural Gas CPA Buyer Seller $ $ or Natural Gas CPA

15 15 How is Counterparty Risk Mitigated? Standard Rules –All Contracting Parties are subject to the same rules and regulations as set forth in the CPA –Contracting Parties must meet minimum creditworthiness test and meet credit requirements on an ongoing basis Collateral Provisions –The requirement for liquid collateral to be placed on deposit with NGX in advance and in excess of margin requirements provides the security against default Liquidation Rights –NGX has a number of rights if a Contracting Party default occurs, including the ability to close-out (or accelerate) all forward positions for the defaulting party –Collateral is utilized to cover any liquidated damages

16 16 How is Counterparty Risk Mitigated? Backstopping –Delivery risks are mitigated through the use of backstopping services provided by various market participants, including storage facilities, large shippers, and pipeline operators –Backstopping is typically an arrangement for immediate provision of supply/market at a pre-determined price (usually based on index) Settlement Bank –The settlement bank daylight and overdraft facilities provide for clearing operation liquidity during a default situation and assist in managing timing issues on settlement day Guarantee Fund –NGX provides a $US 100 million trust fund for Contracting Parties to access in the event of an exchange default, backed by a parental guarantee from TSX

17 17 NGX Clearing Structure Physical Backstopping (storage) Settlement Banking Credit Facility Defaulting Party Collateral (100% Coverage Under NGX Exposure Model) NGX Cash Reserves NGX Guarantee Fund (USD$100MM CIBC Mellon Trust) Deposit Agreement Deposit Agreement $ $ or Natural Gas Payer Payee $ $ or Natural Gas

18 18 NGX Collateral Makeup Collateral on deposit in excess of CAD $2.561 Billion Approx. CAD $2.26 Billion LC’s, CAD $0.30 Billion Cash

19 19 NGX Central Clearing Benefits Neutral, Independent Risk Management –NGX is impartial and the nature of the clearing business provides a strong incentive to maintain a default-free clearing operation –NGX is not a market participant, does not take a market view and earnings are not directed by commodity prices Centralized Collateral Requirements –Concentration of capital affords most efficient use across all other contracting parties

20 20 NGX Central Clearing Benefits Counterparty Netting Facilities –Central clearing operator and standardized netting rules create an environment to net physical and financial exposures across multiple counter parties and locations Acceleration, Liquidation, Close-Out Procedure –NGX has embedded, and has enforced, rights of acceleration for all contracts traded through the Exchange to mitigate risks to all Contracting Parties

21 21 Value Proposition of Clearing Risk Mitigation “Trade-Off” –When a Contracting Party introduces risk to the clearing operation (ex. Receivable exposure or Mark-to-Market losses) they must provide collateral to support the risk –In return, all Contracting Parties that are exposed to the clearing operation due to the introduction of risk (ex. Payable positions and Mark-to-Market gains) are secured against defaults Cost of Collateral Is the risk reduction worth the cost? Value of Reduced Exposure Will I get paid? Will my gas get delivered?

22 22 Collateral Concentration NGX (centralized) $3MM $20MM Access to choose bids/offers from 100+ other market participants under the same collateral umbrella $30MM $7MM OTC Bilateral $10MM Buyer Seller A A A B C D B C D Buyer A

23 23 Exchange Netting OTC Bilateral 5 Units 10 Units Buyer Seller A A D B C A NGX (net effect) 5 Units 10 Units Netted 10 10 Units 10 Units 5 Units Seller A B C Buyer AD

24 24 Clearing Statistics Cleared Transactions –230,000+ transactions cleared annually –Notional value of transactions consummated through NGX is in excess of CAD $60 Billion annually Margin –Over 160 corporate margin accounts held by NGX –Manage margin accounts in excess of CAD $4.0 Billion in cash and letters of credit Settlement –Settlement of $US and $CAD cash streams –Monthly settlement values over CAD $2 Billion processed by the clearing house

25 25 Oversight Regulatory –ASC – Exemption order, compliance with operating principles –CFTC – 2(h)(iii) exemption, “Eligible Commercial Market” status Clearing Bank –TD Bank, NGX’s Clearing Bank, maintains oversight of NGX clearing operations to support credit facility, CAD $300MM daylight, CAD $20MM demand, USD $100MM LC –Clearing Bank controls segregated collateral accounts –Clearing Bank authorizes movement of funds from collateral accounts –Clearing Bank has full access to NGX trade/clearing data and reporting, ensures collateral accounts are sufficient to manage Contracting Party margin requirements

26 26 Sections Overview (page 3) Clearing Structure (page 13) Risk Management (page 26) Contacts

27 27 Performance Risks Failure to Make/Take Delivery –NGX is exposed to the price at which an alternative supply/market can be found –Risk is managed with backstopping contracts, penalty mechanisms, collateral requirements and credit policy Failure to Pay –NGX is exposed to receivables risk on settlement dates –Risk is managed with penalty mechanisms, collateral requirements and credit policy Failure to Provide Collateral –NGX is exposed to the risk that Contracting Parties will not provide sufficient collateral to manage their risks –Risk is managed with liquidation provisions

28 28 Margin Requirements Risk Measurement –Performance risks are quantified through NGX’s margining methodology, which attempts to estimate probable worst-case portfolio value Collateral –NGX collects collateral from Contracting Parties to secure their portfolios and protect the clearing operation from defaults Margin Triggers –If margin requirements reach 80% of collateral deposited, NGX will request additional collateral –At 90%, NGX may restrict the Contracting Parties trading capabilities –At 95%, NGX is entitled to invoke the liquidation procedure

29 29 Collateral Collateral Policy –Contracting Parties must have sufficient collateral to cover their Margin Requirement, utilizing any combination of the forms of collateral and offsets below –Collateral is held to support the Contracting Party’s traded positions and can only be used to remedy a performance failure by the Contracting Party itself Collateral Requirement –Collateral is accepted in the form of cash and irrevocable letter of credit from an approved bank rated A or higher –Collateral requirement can be reduced with an accounts payable or positive variation margin offset

30 30 Risk Measurement Accounts Receivable/Payable –A calculation of the value of gas delivered –Margin requirement increases if gas is taken prior to payment, and decreases if gas is delivered prior to payment Variation Margin (Mark-to-Market) –A calculation of the price at which a forward position could be instantaneously liquidated given current market prices Initial Margin –A calculation of the probability of a movement in market prices during a two-day holding period –Initial margin coverage protects against a prolonged liquidation

31 31 Position Tracking Consolidation and Netting –Positions within each product and date range are consolidated into gross long and short positions –Liquidation risk is managed against the net of the long and short positions Instruments and Date Ranges –Trades across all instruments in a product are grouped by date ranges in real-time –Instruments may overlap, but date ranges are unique –Ex. A M-Nov instrument and a WB-Nov instrument would each populate a position for November 1 to November 30th

32 32 Physical Risk Management 1st of Delivery Month Last Day of Delivery Month25th of Payment Month 25 Days60 Months30 Days Payment Exposure - Margined at full value Current Month Exposure - Deliveries margined at full value - Open position initial margin - Variation margin all positions Forward Position Exposure - Open position initial margin - Variation margin all positions

33 33 What are Initial Margins? Defined –Initial Margin is an estimation of the value to which the clearing house might be exposed during a period of liquidation –Initial Margin is intended to measure potential change in a value of a portfolio beyond the last mark- to-market price during a period of liquidation How Does NGX Utilize Initial Margin? –NGX applies initial margin to Contracting Parties’ net open positions that would be subject to liquidation in the event of a default –Initial margin acts as additional position coverage that NGX can utilize in the event of a default to ensure that the clearing operation remains secure

34 34 Initial Margin Methodology Utilization of VaR –NGX utilizes a Value-at-Risk methodology to determine initial margins –VaR is a method of assessing risk that uses standard statistical techniques routinely used in a variety of technical fields –NGX’s VaR calculation measures the worst expected price change in a date range for a product over a given time interval under normal market conditions at a given confidence level –VaR, while imperfect and subject to several limitations, provides a measurement tool that has historically been an accurate measure to evaluate potential exposure in a portfolio

35 35 Margin Offsetting Accounts Receivable/Payable –All receivables/payables are offset across all NGX products Variation Margin (Mark-to-Market) –All mark-to-market calculations are offset across all NGX products Initial Margin –Initial margins apply only to net open positions for each forward date range in each product –Limited cross-margining (ie. Initial margin reductions for highly correlated, yet non-identical hedged positions) is provided today for short-term fixed-price positions –A project is currently underway to provide portfolio offsets for highly correlated positions in liquid products across both time and locations

36 36 Margin Example Example –On Tuesday, December 27th, BUYCO (buyer) purchases 5,000 GJ/Day of the NGX Intra-Alberta month of January 2006 physical contract from SELLCO (seller) at a price of CAD $14.000/GJ Position Management –As soon as the transaction is matched, BUYCO shows a net long position of 5,000 GJ for each day from January 1 to January 31, thus a total net long position of 155,000 GJ (ie. 5,000 GJ/Day multiplied by 31 days) –Conversely, SELLCO shows a net short position of 5,000 GJ for each day from January 1 to January 31, thus a total net short position of 155,000 GJ

37 37 Margin Example Initial Margin –Immediately following the creation of the long and short positions, initial margin is applied –The initial margin rate for January is currently CAD $2.300/GJ (17% of price), as statistically generated by NGX –Both BUYCO and SELLCO have initial margin added to their margin requirement for CAD $356,500 (155,000 GJ multiplied by $2.300/GJ) –The initial margin requirement will remain in place, unchanged, until one of the following events occurs: Either BUYCO or SELLCO offset all or part of their open long/short position, thus reducing their initial margin requirement to zero, or; The January long/short position becomes a current month position on January 1st

38 38 Margin Example December 27 th to December 31 st Margin Requirements –The following table illustrates the margin requirements for the January position through each remaining day in December: Date Settlement Price BUYCO Initial Margin BUYCO MTM SELLCO MTM SELLCO Initial Margin Dec 27th14.100($356,500)$15,500($15,500)($356,500) Dec 28th13.600($356,500)($62,000)$62,000($356,500) Dec 29th14.000($356,500)Nil ($356,500) Dec 30th14.200($356,500)$31,000($31,000)($356,500) Dec 31st14.200($356,500)$31,000($31,000)($356,500)

39 39 Margin Example Date RM-Jan Settlement Price BUYCO AP/AR BUYCO RM Initial Margin* BUYCO Variation Margin BUYCO Total Margin Jan 1st14.300($70,000)($390,000)$45,000($415,000) Jan 2nd14.200($140,000)($377,000)$29,000($488,000) Jan 3rd15.000($210,000)($364,000)$140,000($434,000) Jan 4th15.500($280,000)($351,000)$202,500($428,500) Jan 5th14.500($350,000)($338,000)$65,000($623,000)  CONTINUE  Jan 31st15.000($2,170,000)Nil ($2,170,000) January 1 st to January 31 st Margin Requirements –The following table illustrates BUYCO’s margin requirements for the January position through each remaining day in January: * Initial margin rate for the rest of January changes on January 1 st to reflect higher spot market volatility, uses $2.600/GJ in the example

40 40 Margin Example Date RM-Jan Settlement Price SELLCO AP/AR SELLCO RM Initial Margin* SELLCO Variation Margin SELLCO Total Margin Jan 1st14.300$70,000($390,000)($45,000)($365,000) Jan 2nd14.200$140,000($377,000)($29,000)($266,000) Jan 3rd15.000$210,000($364,000)($140,000)($294,000) Jan 4th15.500$280,000($351,000)($202,500)($273,500) Jan 5th14.500$350,000($338,000)($65,000)($53,000)  CONTINUE  Jan 31st15.000$2,170,000Nil $2,170,000 January 1 st to January 31 st Margin Requirements –The following table illustrates SELLCO’s margin requirements for the January position through each remaining day in January: * Initial margin rate for the rest of January changes on January 1 st to reflect higher spot market volatility, uses $2.600/GJ in the example

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