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Secure Trading & Clearing
An introduction to NGX ClearingApril 2008
Version 40
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
Sections
• Overview (page 3)
• Clearing Structure (page 13)
• Risk Management (page 26)
• Contacts
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
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
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
7
Current NGX Product Locations
NGX Products & Services
Financial Products Physical Products
NGX INTRA-ALBERTAEMPRESS EMERSON/GREAT LAKES
FUTURES SWAPSHENRY SWING SWAPS
LDS FOR GDD
PARKWAY
IROQUOIS
NIAGARA FALLSCHIPPAWA
DAWN
CHICAGO SWAPS
MICHCON SWAPS
ALBERTA POWER SWAPS
MALIN SWAPS
ROCKY MTN SWAPS
ATCO N&SSTATION #2
TEP
PG&E CITYGATE
PG&E CITYGATE SWAPS
SOCAL SWAPS
MALINST. CLAIR
SUMAS SWAPS
ALBERTA SWAPS
HUNTINGDON
ONTARIO POWER SWAPS
EL PASO SWAPS
Temporarily unavailable
HENRY HUB
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 BasisC AB-NIT C AB-NIT C AB-NIT 2A US AB-NIT C AB-NIT Empress US Dawn NiagaraC ATCO North C Station #2 C AB-NIT 4A US Emerson US Dawn Niagara US Dawn IroquoisC Empress US AB-NIT C AB-NIT 5A US Niagara US Dawn Iroquois US Dawn ChippawaC Station #2 US Malin C Station #2 US Iroquois US Dawn Chippawa US Dawn ParkwayC TEP US C ATCO North US Chippawa US Dawn Parkway US St. Clair DawnUS AB-NIT C TEP US Parkway US St. Clair Dawn US AB-NIT DawnUS Emerson US Dawn US DawnUS Niagara US Malin
US PG&E CitygateUS Iroquois
US Henry
US Chippawa
US St Clair
US Parkway
US Malin
US PG&E Citygate
US DawnUS St. ClairUS Malin
Physical Products*
HenryUS
US PG&E Citygate
US Henry
PG&E Citygate
HenryUSUS AB-NIT Emerson
$ Fixed (Fixed-for-Floating) $ Basis $ Swing $ Index (Floating-for-Floating) $ Options $ Location BasisC AB-NIT Fixed US AB-NIT C Alberta Flat Elec. US AB-NIT Index Swap C Alberta Fixed US PGE Citygate Malin Basis SpreadUS Sumas Fixed US AB-NIT Daily Basis C Alberta Peak Elec. US LDS for GDD US Malin AECO Basis SpreadUS Futures Swap US Sumas C Alberta Ext. Peak Elec. US Rockies US SoCal Rocky Mountains Basis SpreadUS Michcon US Chicago C Alberta Off-Peak Elec. US Malin US Sumas AECO Basis SpreadUS Socal Fixed US Rockies C Alberta Super-Peak Elec. US SumasUS PG&E Citygate Fixed US Malin C Alberta Swing US Michcon
US Michcon US Sumas US SocalUS Socal US Henry Hub US PG&E CitygateUS PG&E Citygate US Mid-Columbia PeakUS Malin Daily Basis US Mid-Columbia Off-PeakUS Rocky Mountains Daily Basis US RockiesUS SoCal Daily Basis US MalinUS PGE Citygate Daily Basis US MichconUS CIG Rockies Daily Basis US SocalUS EP San Juan Daily Basis US PG&E CitygateUS EP Permian Daily BasisUS Sumas Daily Basis
Financial Products **
Temporarily unavailable
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
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
NGX Volume History
Historical NGX Trading Activityto February 29th, 2008
-
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
10,000
11,000
12,000
Year
To
tal Q
ua
nti
ty T
rad
ed (
PJ)
-
100
200
300
400
500
600
700
800
900
1,000
1,100
1,200
1,300
1,400
1,500
1,600
Mo
nth
ly A
vera
ge
Tra
ded
(P
J)
# of Days 324 365 365 365 365 365 366 365 365 365 366 365 365 365 60
Electricity (PJ) - - - - - - - - - 18 20 4 39 127 16
US Swaps - - - - - - - - 12 58 58 93 10 3 -
CDN Swaps - - - - - - - - 260 1,130 1,458 412 64 35 8
OTC Clearing (PJ) - - - - - - - - 84 351 236 449 724 842 106
U.S. (PJ) - - - - - - - - 1 6 - 1 16 14 -
Eastern Canada (PJ) - - - - - - 152 389 581 999 1,132 927 1,377 1,606 224
Western Canada (PJ) 23 59 427 938 1,379 2,349 2,353 2,756 3,617 3,901 4,513 6,936 7,591 8,616 2,060
Percentage Growth 0% 161% 621% 119% 47% 70% 7% 26% 44% 41% 15% 20% 11% 14% 57%
Monthly Average Traded (PJ) 2 5 36 78 115 196 209 262 378 534 613 735 818 937 1,207
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
12
NGX Product Dispersion
2008 Trading Turnover by Product Type
Eastern Canada Physical (PJ)9.3%
OTC Clearing (PJ)4.4%
Western Canada Physical (PJ)
85.3%
Electricity (PJ)0.7%
U.S. Physical (PJ)0.0%
CDN Swaps (PJ)0.3%
US Swaps (PJ)0.0%
Western Canada Physical (PJ)
Eastern Canada Physical (PJ)
OTC Clearing (PJ)
CDN Swaps (PJ)
U.S. Physical (PJ)
US Swaps (PJ)
Electricity (PJ)
13
Sections
• Overview (page 3)
• Clearing Structure (page 13)
• Risk Management (page 26)
• Contacts
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
CPABuyerBuyer SellerSeller
$
$ or Natural Gas
CPA
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
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
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
PayerPayer PayeePayee
$
$ or Natural Gas
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
NGX Margin Dispersion March 15, 2008
AR Margin $1085
Variation Margin $96
I nitial Margin $679
Cushion Collateral $465
Surplus Collateral $217
$0
$500
$1,000
$1,500
$2,000
$2,500
$3,000
CAD $MM
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
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
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 ReducedExposure • Will I get paid?• Will my gas get delivered?
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
$10MM
$10MM
BuyerBuyer SellerSeller
A
A
A
B
C
D
SellerSeller
B
C
D
BuyerBuyer
A
23
Exchange NettingOTC Bilateral
5 Units
5 Units
10 Units
BuyerBuyer SellerSeller
A
A
D
B
C
A
NGX (net effect)
5 Units
10 Units Netted 10 10 Units
10 Units 5 Units
SellerSeller
A
B
C
BuyerBuyer
A
D
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
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
Sections
• Overview (page 3)
• Clearing Structure (page 13)
• Risk Management (page 26)
• Contacts
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
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
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
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
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
Physical Risk Management
1st of Delivery Month Last Day of Delivery Month 25th of Payment Month
25 Days 60 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
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
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
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
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
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
Margin Example
• December 27th to December 31st Margin Requirements– The following table illustrates the margin
requirements for the January position through each remaining day in December:
DateSettlement
PriceBUYCO
Initial MarginBUYCO MTM
SELLCOMTM
SELLCOInitial Margin
Dec 27th 14.100 ($356,500) $15,500 ($15,500) ($356,500)
Dec 28th 13.600 ($356,500) ($62,000) $62,000 ($356,500)
Dec 29th 14.000 ($356,500) Nil Nil ($356,500)
Dec 30th 14.200 ($356,500) $31,000 ($31,000) ($356,500)
Dec 31st 14.200 ($356,500) $31,000 ($31,000) ($356,500)
39
Margin Example
Date
RM-JanSettlement
PriceBUYCO AP/AR
BUYCORM Initial Margin*
BUYCOVariation Margin
BUYCO Total
Margin
Jan 1st 14.300 ($70,000) ($390,000) $45,000 ($415,000)
Jan 2nd 14.200 ($140,000) ($377,000) $29,000 ($488,000)
Jan 3rd 15.000 ($210,000) ($364,000) $140,000 ($434,000)
Jan 4th 15.500 ($280,000) ($351,000) $202,500 ($428,500)
Jan 5th 14.500 ($350,000) ($338,000) $65,000 ($623,000)
CONTINUE
Jan 31st 15.000 ($2,170,000) Nil Nil ($2,170,000)
• January 1st to January 31st 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 1st to reflect higher spot market volatility, uses $2.600/GJ in the example
40
Margin Example
Date
RM-JanSettlement
PriceSELLCO AP/AR
SELLCORM Initial Margin*
SELLCOVariation Margin
SELLCO Total
Margin
Jan 1st 14.300 $70,000 ($390,000) ($45,000) ($365,000)
Jan 2nd 14.200 $140,000 ($377,000) ($29,000) ($266,000)
Jan 3rd 15.000 $210,000 ($364,000) ($140,000) ($294,000)
Jan 4th 15.500 $280,000 ($351,000) ($202,500) ($273,500)
Jan 5th 14.500 $350,000 ($338,000) ($65,000) ($53,000)
CONTINUE
Jan 31st 15.000 $2,170,000 Nil Nil $2,170,000
• January 1st to January 31st 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 1st to reflect higher spot market volatility, uses $2.600/GJ in the example