© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Clearing Physical Energy Implications for Credit Professionals
NAPCO – September, 2014
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information. 2
Agenda
NGX – Background Information Physical Clearing – The Basics General Overview on Regulations Impacting Commodity Trading Implications for Credit Professionals
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Introduction to NGX N
GX • Leading physical energy exchange and clearinghouse - Natural Gas,
Power, and Crude Oil. • Est. 1994 - Headquartered in Calgary, Alberta, office in Houston, Texas. • Physical Delivery - End-to-end delivery with physical backstopping. • Wholly owned subsidiary of TMX Group Limited • ICE Alliance – All major NGX markets on global leading ICE.
TMX
Grou
p Li
mite
d • Est. 1852 - Leading Canadian equity exchange • 2nd largest exchange worldwide by listed issuers • 7th largest exchange globally by issuer market
cap. • Preeminent marketplaces for listings, trading
cash equities, fixed income derivatives, and physical energy products
1993 •Westcoast
Energy
2001 •OMX (now
NasdaqOMX)
2004 •TMX Group Inc.
2012 •Maple Group
purchase majority of TMX
3
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
TMX Controlled by Canada’s Largest Financial Institutions
• “Maple” investors consist of 11 of Canada’s most well recognized players in the Canadian investment industry
• Affiliates of TD Securities, CIBC World Markets, National Bank Financial and Scotia Capital are lenders to TMX • Each of these bank-owned dealers or their affiliates
committed to own at least 6.25% of TMX Group Limited for the first year and at least 5.625% of TMX Group Limited for the 4 following years
• TMX has ready access to equity markets to raise capital if ever required
Entity DBRS Credit Rating Lender
AAA (Stable)2
AAA (Stable)
AAA (Stable)
AA (Stable)
AA (Stable)
AA (Stable)
AA (Stable)
AAL (Stable)
AAL (Stable)
N/A
N/A
1. The chart shows the relative ownership of TMX Group Limited shares held by each of
the above named investors or their affiliates, following completion of the subsequent arrangement on September 14, 2012 (taking into account the number of TMX Group Inc. shares held by each applicable investor and/or their respective affiliates as reported in the TMX Group Inc. Plan of Arrangement Circular dated August 13, 2012). This percentage has been updated for known transactions.
2. Notionally AAA as expressed through Cadillac Fairview Trust guarantee.
77% Collective Ownership at Q3/121 Strong and Stable Shareholders
4
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Introduction to NGX
Estimated 80-90% market share of Cdn physical spot gas and financial power
NGX’s physical natural gas and power indices are the Canadian benchmarks
NGX markets also include Cdn crude oil and U.S. physical power (Nasdaq alliance)
U.S. Natural Gas - NGX is exclusive clearinghouse for ICE’s OTC natural gas markets. Market share
varies by hub - average of 10% cleared.
NGX’s trading primarily transacted on ICE trading platform with some OTC and auction volumes
Clear physical and financial energy products across north America
No clearinghouse defaults since inception in 1994
Managed major failures including Lehman and Enron without any losses
Over $3B in collateral holdings 70-75% L/Cs and remainder cash
Unique direct clearing model - no clearing members (non-mutualized)
NGX manages complete physical delivery process
5
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
NGX Product Locations
6
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information. 7
Agenda
NGX – Background Information Physical Clearing – The Basics General Overview on Regulations Impacting Commodity Trading Implications for Credit Professionals
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
General Role of Central Clearinghouses (CCP)
8
Independent, Highly Regulated, Risk Mitigation Providers
• CCP does not take positions - sole focus is risk management to ensure transactional certainty
• Fully collateralized, independent daily settle valuations, and sophisticated risk systems that ensure tail risk being managed.
• Enforce collateral requirements failing which positions are liquidated and collateral used to cover any losses.
Centralization of Transactions
• Through a uniform, centralized novation process, interdependencies amongst participants minimized
• Ability to maximize set-off positions • Reduces gross market positions down to the net end buyer and seller positions.
Waterfall Provisions
• Extensive provisions in place to mitigate losses • Series of backstops that are stress-tested for adequacy • Highly prescriptive regulations in place to ensure financial adequacy
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Clearinghouse Requirements
9
Capital Requirements •All positions collateralized (including potential price movements) - no exceptions. •Collateral can only be reduced by flattening book (buys and sells) or, on NGX, selling physical.
Standardized •No contractual or transactional flexibility. •Uniform rules
Eliminate Counterparty Interaction •Fully anonymous - no ability to gain market knowledge through CP interaction •Rely on CCP price indices for market price intelligence
Level Playing Field • Inability for larger companies to leverage balance sheet for transactions
Centralization of Risk •Risk concentrated with clearinghouse, albeit fully netted and collateralized.
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Basic Structure of NGX Clearing Operations
NGX Clearinghouse Role • Buyer to every seller and vice versa on a fully collateralized
basis • Fully anonymous trading • Complete physical delivery (firm delivery in key markets)
Private Clearing Operation • No mutualized or legal relationship amongst counterparties. • All collateral segregated and for owner usage only. • Do not require access through clearing member
10
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Direct vs Mutualized Clearing Model
Mutualized (FCM) Model Direct Model (NGX)
11
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
NGX Clearinghouse Backstop Model
12
PAYER PAYEE $
$ or Commodity
$
$ or Commodity
Guarantee to TD Bank by TMX Group Inc. (USD $100MM)
TD Letter of Credit (USD $100MM) issued to BNY Mellon
Settlement Banking Credit Facility - $300MM daylight + $20MM Operating Line + NGX Cash ($42MM)
Defaulting Party Collateral (100% Coverage Under NGX Exposure Model)
NGX Guarantee Fund (USD $100MM BNY Mellon Trust)
Insurance Policy (Drawdown on Fund over $15MM)
Size of a CCPs guarantee fund determined by stress test
results (cover 1 or cover 2)
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Clearinghouse Drivers
13
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information. 14
Agenda
NGX – Background Information Physical Clearing – The Basics General Overview on Regulations Impacting Commodity Trading Implications for Credit Professionals
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
NGX Regulatory Status
15
In Canada • NGX is recognized as an “Exchange” and “Clearing Agency” by the
Alberta Securities Commission (ASC) and has applicable exemptive relief in other Canadian provinces
• ASC as the “Lead (Exchange) Regulator” for NGX in Canada
In U.S. and Europe • NGX recognized by the Commodity Futures Trading Commission
(CFTC) as a “Derivatives Clearing Organization” (“DCO”) in December 2008
• NGX has been an “Exempt Commercial Market” (“ECM”) since November 2002 under the U.S. Commodity Exchange Act.
• NGX’s ECM status replaced by Foreign Board of Trade (FBOT) status in May/13 (1st FBOT issued by CFTC post Dodd-Frank).
• NGX has applied for foreign recognition under Article 25 of EMIR
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
NGX Product Classifications
Product Market Clear or Uncleared Trading Classification Clearing Classification
Canadian Physical Natural Gas
ICE Web Screen Cleared Future Future
Bilateral or Broker OTC Cleared Physical Forward or Block Future1 Future2
ICE Web Bilateral Screen Uncleared Physical Forward5 N/A
U.S. Physical Natural Gas
ICE Web Screen Cleared Future3 Future
Bilateral or Broker OTC Cleared Physical Forward or Block Future1 Future2
ICE Web Bilateral Screen Uncleared Physical Forward4 N/A
Canadian Financial Power ICE Web Screen Cleared Future Future
Bilateral or Broker OTC Cleared Swap or Block Future1 Future2
Canadian Physical Crude Oil
ICE Web Screen Cleared Future Future
Bilateral or Broker OTC Cleared Physical Forward or Block Future1 Future2
ICE Web Bilateral Screen Uncleared Physical Forward5 N/A
Notes: 1) Product classification to be determined by transaction market source (bilateral participants or broker) 2)Traded and cleared as block future if transaction meets minimum block future size threshold. Otherwise may be cleared as futures by use of EFP or EFS. 3) Upon US natural gas orders being matched for clearing on ICE screens, transaction will be deemed as transacted and cleared as a future 4) Not NGX markets – classification determined by ICE. 5) NGX physical crude oil and natural gas, uncleared ,markets are forward markets
All screen traded and cleared deals are deemed Future transactions.
16
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Further Regulation of Commodity Trading – Necessary?
• Global derivatives market – over $700 trillion in annual notional trading*. Sounds big...worldwide annual GDP is only $50 trillion.
• Gross market exposure on open positions ~ $20 Trillion. Net exposure amount - $3 to $4 Trillion. Not quite as big now...but still significant.
• Even prior to new regulations, majority of all derivative positions collateralized (cash 80 – 85%, Gov’t securities 10-15%, with rest in other forms)
• Total commodity (excluding gold) • Notional $2.7 trillion • Gross Exposure of about $400 - $500 billion • Net Exposure $60 - $75 billion
• Energy only a small fraction of total (3-4%). • Trading in energy markets were clearly not the cause of the 2008
market crisis.
* Bank of International Settlements
17
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
The Essence of Regulations
• Measure the Markets and Apply Data to Make Rules – Regulators need the data to measure the size of the markets
in aggregate and by entity. To do this, they need the data – from that data they can identify potential issues.
• Prevent Big Blowups (and big bailouts) – Limit the amount of un-collateralized positions – Impose position limits by product – Limit bank involvement in certain products – these are the
entities that underpin financial infrastructure.
• Protect Companies and Consumers from Bad Behaviour – Impose qualification standards on brokers and advisors – Compliance and market monitoring requirements – Monitor and measure to mitigate price manipulation
18
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Dodd Frank Timeline
September 2009
•G–20 Leaders agreed to OTC derivatives reform - ‘‘all standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties.”
July 21, 2010 •President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Title VII
•Over-the-Counter Derivatives Legislation - Stringent oversight of the over-the-counter derivatives market, including mandatory clearing and real-time reporting of derivative trades.
Objective
•The primary goals of the legislation is to increase the transparency and efficiency of the OTC derivatives market and to reduce the potential for counterparty and systemic risk.
July 16/11 •General effective date was to be July 16, 2011, many key rules not effective until 2013.
19
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Basic DF Requirements
• Registration and Regulation of Swap Dealers and Major Swap Participants
– Primarily applied to bank dealers. Only two commercial entities registered to date.
• Mandatory clearing and exchange-style trade execution – Largest Interest rate and CDS products mandated – no energy products
• Trade reporting and recordkeeping – Extensive IT efforts by SD to meet reporting requirements.
• Extraterritorial rules – Complex rules around “US persons”.
• Position limits and large trade reporting for physical commodity derivatives
• Business conduct and documentation standards for swap dealers and new duties for customers
• Risk management, compliance, and other internal duties for swap dealers
20
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Regulatory Classification
• regularly enters into Swaps with counterparties as an ordinary course of business for its own account (holds itself out as a dealer in swaps).
• makes a market in swaps • does not include:
• a person that enters into Swaps for its own account, but not as a part of its regular business; or • engages in a “de minimus” quantity of Swaps in connection with transactions with or on behalf of
its customers (under $8 billion/annum)
• Maintains a “substantial position” in Swaps excluding positions held to hedge or mitigate commercial risk.
• Has outstanding swaps that create “substantial counterparty exposure that could have serious adverse effects on the financial stability of the United States banking system or financial markets”
• Is a “financial entity” that is “highly leveraged,” is not subject to capital requirements by a Federal banking entity
• Include Swap Dealers, MSPs, private funds, commodity pools, certain employee benefit plans and persons predominately engaged in the business of banking (> $10 billion in total assets)
• Not a Financial Entity • Swap limited to hedging activity…not a blanket exemption.
21
“Special Entity” level for public utilities only $25MM, but under review.
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Basic Swap Requirements
If neither party exempt, both Financial entities must post/receive collateral (some exceptions). Requirements being phased in from 2015-2019
Financial entity must set credit exposure limits for exempt entity and collect margin for any excesses. Rules for end-users recently softened.
If End-User dealing with a Financial entity, then financial entity handles reporting requirements. If both entities are end-users, parties must choose one to report.
Exempt Entity
One party must report
Swap to Swap Repository
Requires Swap
Agreements
Financial Entity
Financial must post initial and
variation margin with 3rd party.
Need to enter into a Credit Support
Agreement
Exempt can elect to require clearing.
Financial must report the Swap
transaction.
Exempt Entity
Must designate a party to report
the swap
Hedges do not count towards position limits
Position Limits may
apply
22
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Basic Swap Requirements (cont’d)
Financial Entity
Financial Entity
Must be transacted
on approved facility.
Must be cleared
Clearinghouse will report trades to
CFTC
Exempt Entity
Qualified hedges exempt from
clearing.
Swaps still need to be reported
23
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Forward Contract Exclusion
• Forward exclusion under the Commodity Exchange Act (CEA) basically states that private commercial merchandizing transactions that create enforceable obligations to deliver, but in which delivery is deferred due to commercial convenience or necessity, are outside of regulation.
• July 10, 2012 – Joint Final Rule issued by CFTC and SEC which defined “swaps” and interpreted the Forward Contract Exclusion.
• The Forward Contract Exclusion from the definition of swap requires that:
– the commodity be a nonfinancial commodity – the transaction be a sale for deferred shipment or delivery, and – the parties intend to physically settle the sale.
• Facts and circumstances test to determine the parties' intent regarding delivery.
24
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Forward Exclusion – The Basics
•Related to a commercial activity - producer, processor, fabricator, refiner or merchandiser Commercial Entities
• intended to be physically settled create binding obligations to make or take deliveries Intent to Deliver
•non-financial commodity (exempt or agric. commodity). CFTC clarified that Brent interp. not just applicable to Brent oil. Physical Commodity
• Includes intangibles that can be delivered (ie environmental credits) Intangibles •Any offset requires a separate, subsequently negotiated agreement
(bookouts) Offsets •Exchanging products by location or grade with intention to
physically deliver. Exchanges •Netting agreements and termination rights do not disqualify
transaction Netting
25
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Physical Book-out Requirements
26
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Why are Physical Markets (“Forwards”) being impacted by Dodd Frank?
• Prior to Dodd Frank which imposed additional regulation, and further defined “Swaps”, companies under less pressure to ensure adherence to forward exclusion requirements.
• Introduction of Swaps has a) blurred the lines between regulated and unregulated products and b) added “consequences” for “forward” transactions that are deemed to be Swaps.
Dodd Frank’s regulation of Swaps has narrowed the gap between regulated and non-regulated markets
27
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Position Limits
• CFTC adopted a position limits rule in 2011, which was later vacated by a federal district court
• CFTC issued re-proposed rule in November 2013 – Re-proposed rule would establish specific limits on speculative positions in 28
physical commodities – CFTC simultaneously proposed a rule requiring position aggregation by
affiliates – Re-proposed rule would apply to energy, agricultural, and metal commodities – Applies to futures, options on futures and economically equivalent swaps – Set thresholds for spot month, individual month, and all months combined – Exempt bona fide hedging – Require DCMs and SEFs to establish position limits or (in some instances)
position accountability rules
• Market participants are concerned that re-proposed rule will limit important risk-management efforts by narrowly drawing hedging exemption
28
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Canadian Regulatory Approach
• In U.S., single federal regular each for securities (SEC) and derivatives/commodities (CFTC) • In Canada, provincial regulars which oversee both derivatives and securities.
General Canadian Regulatory Structure vs. U.S.
• Committee of provincial securities, CSA Derivatives Committee (“Committee”), developing the regulatory framework to meet Canada’s G-20 commitments
Canadian Securities Administrators Derivatives Committee
• Committee has published a series of derivatives consultation papers outlining policy recommendations for the regulation of the $12-trillion Canadian derivatives market
Consultation Papers
• CSA developing a National Instrument by adopting IOSCO’s PFMI requirements.
Clearinghouse requirements
• Aim to provide effective regulatory oversight of derivatives and derivatives market activities in balance with commercial considerations.
• The regulatory framework will be implemented through provincial rules
Objective
29
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Basic Registrant Categories
• Persons carrying on the business of trading • No proposed de minimis exemption
Derivatives Dealer
• Provide advice for trading derivatives including hedging strategies
• Does not include advice that is incidental to a derivatives trade.
Derivatives Adviser
• Entities that maintain a substantial position in derivatives
Large Derivative Participant
30
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Exemptions from Registration
• Acceptable regulator in Canada • Includes Canadian banks and others under equivalent supervisions
Existing Regulated Persons
• If subject to equivalent requirements
Foreign Derivatives Dealers and Advisers
• At all levels from Federal to municipal levels (including crown corps) when trading with qualified parties
Governments
• If advice only relates to trades where dealer does not have discretionary trading authority and doesn’t charge a fee for advice,
Various dealer exemptions
• Clearing agencies recognized or exempted under provincial regime.
Clearing Agencies
• If registration solely results from trading with or on behalf of affiliate
Transactions limited to Affiliated Entities
31
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
What Are Derivatives (Canadian version of Swaps)
•Definition of derivative is in existing and proposed provincial securities legislation • Includes swaps and forwards, but varies by province.
Derivatives
•An insurance or annuity contract •Physical commodities
Excluded Derivatives
•Contract or instrument for delivery of a physical commodity •Must provide for immediate or deferred delivery of a physical commodity •Physical goods - does not include financial commodities such as currencies, interest rates,
securities and indexes, •A firm obligation of a party to the contract or instrument and not merely an option to make
or take physical delivery. • If intention to physically deliver changes, the contract would become subject to all applicable
derivatives rules. • If physical delivery occurs for reasons outside of control (force majeure etc.) , then OK, but
not if cash settlement provision/option included in agreement.
Physical Commodity
32
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Canadian vs U.S. Rules
Generally Aligned • Key attributes are aligned with Dodd frank rules which stands to reason as both aiming for same G-20 objectives. • Registration based on activity type (dealer or advisor) or size (large derivative participant) very similar • Carve out for physical commodities are very similar • Requirements for reporting, use of repositories, mandatory clearing, risk management requirements etc.
Distinct “Futures” Category • “Futures” market (exchange traded and cleared derivatives) not as well defined and segregated from OTC derivatives in
Canada. • May mean that those entities that transact in Futures still may be subject to registration and Canadian regulations.
More Difficult to Avoid Registration in Canada (based on proposed rules) • In the U.S., commercial entities avoided Swap Dealer registration though: • Staying under the $8 billion de minimus threshold; • Keeping swap count low by using Futures instead; • Keeping swap count low through hedging exemption • These mechanisms may not be available in Canada
End User Rule – Blanket Rule in Canada (proposed), but not under Dodd Frank • Under Dodd frank, End Users were a) those that were not financial entities (including Swap Dealers and Major Swap
Participants) AND b) were undertaking a transaction that was a bona fide hedge. • In Canada – either you’re an End User or not...and if you are, there are no provisions for non-hedging activity.
33
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
PFMI Overview
• In April 2012, the Committee on Payment and Settlement Systems (CPSS) and the International Organization of Securities Commissions (IOSCO) issued the Principles for financial market infrastructures (PFMIs).
• IOSCO policy maker only – up to local regulators to adopt or not. • Prior 2004 FMI standards disjointed and not widely adopted – all changed
following global crisis prompting regulators to adopt. • CPSS and IOSCO members (including Canada) committed themselves to
adopting the 24 principles (the Principles) and the five responsibilities (the Responsibilities) included in the PFMIs.
• “Full, timely and consistent implementation of the PFMIs will be fundamental to ensuring the safety and soundness of key financial market infrastructures and to support the resilience of the global financial system”
1.
• PFMIs play an important part in the G20’s mandate that all standardised OTC derivatives should be centrally cleared.
1) CPSS-IOSCO – Implementation monitoring of PFMIs – Level 1 assessment report – August 2013
34
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
PFMI – Key Provisions
• Disclosure Requirements – Extensive quantitative disclosure requirements to clearing members and the public. – Initial proposals not well received by clearinghouses. Disclosures jeopardized client position
confidentiality, requires extensive IT investment for very detailed reporting and created commercial competition disclosure issues.
• Recovery and Wind Down Provisions – Very detailed plans need to be put in place as to how the CCP will manage a recovery or
wind-down in the event that the financial resources have been exhausted in a large loss scenario
– Essence is in determining how losses would be allocated (i.e. Contract tear-up, re-allocation of collateral, elimination of MtM gains etc.)
• Financial Resources and Liquidity Requirements – Extensive requirements for ensuring financial resources, and liquidity of such resources, are
more than adequate to meet thin tail risk.
• Stress and Back Testing Requirements – Sophisticated modelling requirements to ensure that initial margin rates remain adequate – Stress testing results form the basis for determining adequate financial resources.
35
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
PFMI Implementation by Regulators • Most global jurisdictions are in the process of implementing the PFMIs • Being implemented in variety of ways. Some jurisdictions applying in a
modified basis through existing regulations and others implementing specific regulation requiring adherence to PFMI principles.
• In the U.S., CFTC mandating PFMI requirements for systemically important DCOs and providing optional adherence for non-systemically important CCPs.
• Bank of Canada (BOC) implementing PFMI in systemically important CCPs. Some provincial regulators also recognized PFMI requirements in clearinghouse regulatory orders (including NGX’s orders)
• PFMI compliance is necessary for clearinghouses such as NGX to become Qualified Central Counterparties (QCCP). Under Basel III, bank capital charge for clearinghouse exposures are 2% vs 50-100% for non-QCCP counterparties.
• Bottom line, PFMI has become the global standard for Financial Market Infrastructures – form and timing of implementation will vary by jurisdiction ranging from immediate to 2015.
36
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Other Regulations Impacting Bank Commodity Trading Business
• Basel III • Volcker Rule • Swaps Push-Out Rule • Proposed rules on Bank Commodities Activities
37
Total commodity trading revenue at banks has fallen to a third of their $14 billion peak in 2008.
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Basel III • Purpose: “To improve the banking sector’s ability to absorb shocks arising from
financial and economic stress, whatever the source, thus reducing the risk of spillover from the financial sector to the real economy.”
• Higher minimum/quality capital requirements • Leverage ratio:
– requires a minimum amount of loss-absorbing capital relative to all of a bank’s assets and off-balance-sheet exposures regardless of risk weighting (Tier 1 capital/total on-balance sheet assets).
– US rules impose higher ratios for large banks.
• Capital conservation buffer: – Additional capital to be available for drawdown during periods of financial stress.
• Countercyclical capital buffer: – Additional capital for large banks would increase during economic expansions and
decrease during contractions.
• Liquidity coverage ratio: – requires unencumbered high-quality liquid assets to meet liquidity needs for a 30
calendar day liquidity stress scenario.
• Additional proposals for systemically important banks, including requirements for increased contingent capital and strengthened arrangements for cross-border supervision and resolution.
38
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Volcker Rule
• Purpose: To prohibit U.S. banks from making speculative investments that do not benefit their customers.
• Prohibits “banking entities” from proprietary trading in “financial instruments” and owning “covered funds”
– Proprietary trading generally means trading as principal principally with a short term purpose or in a dealer capacity
– Banking entities include banks and their affiliates – Financial instruments include securities, derivatives, futures, and options on
any of these – Does not include physical spot commodities or forwards
• Permitted activities include: – Risk-mitigating hedging – Market making – Trading on behalf of customers – Trading solely outside of the U.S.
• Extensive compliance burdens for permitted activities • Banking entities must be in full compliance by July 2015
39
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Swaps Push-Out Rule (Lincoln Amendment)
• Purpose: Require insured banks to spin off “risky” derivative trading operations to separately capitalized affiliates to minimize exposure of customer deposits and need for taxpayer bailouts.
• Prohibits “federal assistance” from being provided to a swap entity (e.g., swap dealer, major swap participant)
• Banks that receive federal assistance (e.g., insurance or access to the Federal Reserve’s discount window) must “push out” swaps activities into an affiliate
• Exemption for swaps used to hedge or mitigate risk and swaps involving rates or national bank-eligible assets (e.g., swaps referencing currencies, bullion, loans, bank-eligible debt)
• Uninsured U.S. branches and agencies of foreign banks will be treated as insured depository institutions for purposes of the rule
40
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Proposed Rule on Bank Physical Commodity Activities
• Federal Reserve Board (FRB) recently issued a proposed rule on further prudential restrictions or limitations on bank activities related to physical commodities
• FRB noted recent environmental hazards and liabilities resulting from catastrophes and disasters involving physical commodities – Concern that liabilities resulting from these activities could
threaten bank stability and create systemic risks • Potential rules could:
– Reduce maximum amount of assets or revenue attributable to commodities activities
– Increase capital or insurance requirements – Prohibit holding unduly risky physical commodities – Restrict investments in companies engaged in commodities activities – Restrict 4(o) grandfathered activities (FRB authority to restrict is limited
by what statute permits)
41
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information. 42
Agenda
NGX – Background Information Physical Clearing – The Basics General Overview on Regulations Impacting Commodity Trading Implications for Credit Professionals
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
General Impact of Regulations on Commodity Trading Markets
• Higher Costs – Capital and Reporting requirements – The vast majority of financial commodity transactions have moved to exchange traded and cleared
(collateralized) markets. – Cost of derivative trading have increased due to higher capital, collateral, information system and
legal/regulatory requirements. The estimated increase in annual global costs for capital and collateral alone is between €15 billion and €32 billion1.
– The efficiencies gained from clearinghouse netting are expected to offset in part, the increased collateral requirements.
• Exit of Banks – While there are some banks that have chosen to remain active in the commodity sector, many have
exited or decreased their level of participation. – To an extent, they’re being replaced by private funds (hiring all the ex-bankers) and foreign nationals
(China, Russia, Middle East etc.)
• Futurization of OTC markets – Liquid OTC markets migrated to futures markets on regulated exchanges and clearinghouses – Resulted in far fewer entities exceeding swap threshold level ($8 billion) – Few liquid swap instruments in energy sector relative to futures markets.
• Reduction in Availability of Structured Commodity Transactions – The regulatory requirements have resulted in a reduction in the number of participants willing to enter
into off-exchange swap transactions – Capital requirements for swap transactions have increased their costs.
43
1 Macroeconomic Assessment Group on Derivatives , Bank For International Settlements, August 2013
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Impact of Regulations on Physical Trading Markets and End Users
44
“Congress was crystal clear that commercial end-users, which make up the overwhelming majority of companies in America, did not cause the crisis” Commentary by CFTC Acting Chairman Mark Wetjen
• Minimal Direct Impact on Physical Energy Trading and Clearing – Forward exclusions generally meant little change to end users in physical market participants – No regulatory requirements for mandated exchange trading or clearing – There are book-out reporting requirements on physical transactions that do not go to delivery.
• Indirect Impact – Exit of Banks – Banks exiting the business. While a smaller participant in physical markets (about 10% in natural
gas phys.), they did fill an important role in liquidity for end users. – Generally being replaced by lower creditworthy, less regulated counterparties. – May result in further concentration risk
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Impact of Regulations on Physical Trading Markets and End Users cont’d
45
• Banks provided a number of services to the physical commodity markets which may diminish (or become more expensive) with the exit of many participants.
– Market Making • Banks make markets in physical commodities providing liquidity for entities looking to
hedge positions. • Often instrumental in the development of tradable instruments, new tenors, options
etc. that meet the needs of physical participants.
– Risk Management Solutions • Through physical storage and related instruments, provide solutions that allow end users
to manage their price risk
– Credit providers • Banks typically provided trading lines and various credit facilities to minimize the
balance sheet impact of trading and hedging positions
• Potential for Increased basis risk in physical hedging programs – Positions that have optionality provisions outside of “physical” allowances will be subject to
swap requirements and may be more difficult to find counterparties. – The “costs” of taking positions in marginal products may exceed the benefits. – Banks provided physical positions in off-exchange locations and products
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Impact on Physical Clearing of Commodities
• Global clearinghouse requirements do not distinguish between physical and financial clearinghouses – rules are the same
• Same uniformity applies to direct (end user) clearinghouses vs. mutualized (FCM) clearinghouses.
• Significant increase in costs: – IT and reporting infrastructure – Operational requirements for risk reporting (extensive backtesting, stress
testing and margin modelling requirements) – Financial resource requirements – Increased liquidity facilities (committed lines)
• Comprehensive bank counterparty reviews to ensure Qualified Central Counterparty (QCCP) compliance and application of favorable capital rates.
• Despite requirement for complete alignment with all regulatory requirements, physical clearinghouses not likely to benefit from mandated clearing requirements.
46
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Impact on Credit Professionals
Physical Trading Requirements •Must ensure that transaction is a bona fide physical deal to avoid derivative /swap reporting
requirements •Proper documentation of “book-out” language, limits on optionality, and various steps to ensure that
“physical” deals are not essentially financial transactions.
Increased Importance of Credit/Risk Personnel •Regulations highlight the need for diligent credit and risk management of transactions. •KYC requirements largely addresses through annual credit review process.
Exchange and Clearinghouse Reviews •To the extent the volume of cleared business increases for your company, credit professionals will need
to a) understand risks inherent with Clearinghouses and Futures Commission Merchants, and potentially undertake reviews of these entities on an ongoing basis.
•Understand clearinghouse collateral requirements and steps to a) minimize collateral costs and b) ensure the security of your deposited funds.
General Understanding of Regulations •To date, regulators played a relatively minor role in the oversight of energy trading activities. •Derivative reform will most certainly have some impact on your business and will require that you have
at lease a basic knowledge of your requirements.
47
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Impact on Credit Professionals
Potential Reduction in Bank Counterparties • Banks typically of high creditworthiness and have sufficient capital to meet regulatory
requirements. • Being replaced by foreign entities and private capital funds which often are of lower credit quality
Less Collateral Available • Even if new rules don’t require your company to post more collateral, likely to effect some of your
counterparties (larger dealers and financial entities). • This means there may be less collateral available for other, non-regulated activity (i.e. physical
trading)
Potentially More Physical Transactions • For those entities with relatively small derivative books, make be inclined to eliminate such
activity and use physical transactions for hedging instead.
Regulation Has Reduced the Overall Level of Unsecured Trading • Industry still subject to large trading losses, however, such losses should have limited secondary
market impact due to collateral rules, particularly for large dealers.
48
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information.
Summary
• For many of the commercial entities here today, particularly if you have minimal financial swap business, new trading regulations should not have a significant impact on your business.
• Many of the prudent risk management functions already exist within our industry...physical energy trading did not cause the crisis!
• For financial entities, and other registrants that have significant derivative/swap activity, the changes will be more pronounced, but manageable.
• For physical energy market participants, clearing will remain a matter of choice and access to liquidity rather than a regulatory requirement.
• Those that have a) large derivative books and b) primarily transacted in bilateral/brokered markets, may be required to clear more of their business
• Biggest impact will apply to the banks – so your interactions with banks need to be reviewed.
49
© 2009 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent. This information is provided for information purposes only. Neither TMX Group Inc. nor any of its affiliated companies guarantees the completeness of the information contained in
this presentation and we are not responsible for any errors or omissions in or your use of, or reliance on, the information. 50
_____________________ NGX 10th Floor, 300-5th Avenue SW Calgary, Alberta Canada T2P 3C4 Phone: 403.974.1700 Fax: 403.974.1719 www.ngx.com
Steve Lappin - VP, Clearing Operations & Development 403.974.4308, [email protected]
For further questions on bank, derivative, swap, forward and other related legal matters, please feel free to contact: Paul M. Architzel | WilmerHale 1875 Pennsylvania Avenue NW Washington, DC 20006 USA +1 202 663 6240 (t) +1 202 663 6363 (f) [email protected]