ISDA White Paper on Energy Derivatives

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.