NEW YORK (HedgeWorld.com)–The International Swaps and Derivatives Association released a white paper on the recent depletion of public confidence in the energy trading markets and on measures to improve practices in the market to restore that confidence.
ISDA’s paper discusses the regulatory framework that has been in place since the Commodity Futures Modernization Act of 2000, explaining the benefits that over-the-counter derivatives and other risk management tools employed in the energy trading markets offer to both consumers and producers of energy. It also examines the series of shocks that have hit those markets lately–”credit downgrades, accounting scandals, governmental investigations, falling stock prices, indictments and guilty pleas.”
The white paper suggests that in order to recover from those shocks, in terms of its own credit worthiness and public confidence, the energy trading industry will have to reshape itself and new liquidity providers will have to enter the picture. That is already underway, as “traditional financial institutions having applied for and received power marketing licenses.”
Increased collateralization of counterparty risk exposures will help ward off or limit future crises. The paper observes that the Basel Committee on Banking Supervision is increasing its recognition of the benefits of collateral in its New Capital Accord, to be issued next year and implemented in 2006.
The industry also must continue to work on amending the U.S. bankruptcy laws to enhance legal certainty with regard to cross-product netting of both financial and physical transactions.
Finally, it concludes energy traders and regulators alike must study the use of a clearinghouse as a potential solution to the industry’s credit problems. “Nearly all participants in a CEO Roundtable at the Global Energy Management Institute of the University of Houston [Texas] on Feb. 3, 2003 stated a desire to start using a clearinghouse soon to clear at least a portion of their trades,” the paper said.