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Nasdaq Commodities: Strategic Initiatives for 2019

In early 2018, Nasdaq Commodities undertook a fundamental strategy review that resulted in a consolidated business strategy comprised of three key areas; focus on European Power products, the launch of an integrated Spot Trading Platform (NEMO) and decommissioning of non-core business products and services.

Some elements of this plan have already been delivered – for example the migration of our freight products to our North American futures exchange NFX and the move of liquidity from DS Futures to Futures. However, the bulk of the changes will be implemented during 2019, including continued preparations for the launch of our NEMO Platform and the addition of Physical Settlement to our futures products. Our aim is to enter 2020 with the most efficient Power Trading platform in Europe, matched to meet the expectations of our customers and designed to leverage the regulatory changes to the market landscape.

The Nordic Power market has suffered from declining volumes and liquidity during the past decade. We are fully engaged with our members to work towards turning this tide. Our members continue to view Nasdaq Commodities as the natural hub for Nordic Power and share our desire to retain a liquid and transparent market. This is important for the entire commodity community and we will work to ensure a transparent, liquid and robust market for the future.

As part of our plans for 2019, risk management enhancements across the CCP are of the utmost priority. Based on lessons learned from the member default event in September 2018 and discussions with our members, we will implement changes to our risk management framework to ensure a robust and resilient market infrastructure.

Hence, Nasdaq Commodities will be focusing on three action areas for 2019:

  • Develop and Expand Commodity Market Participation
  • Increasing Liquidity
  • Enhancing Risk Management Framework

Efforts to Develop and Expand Commodity Market Participation

During 2019 we will focus on Power trading solutions. We will make sure we come out of this year with a harmonized product offering across geographies.

Our biggest project during 2019 will be the creation of a day-ahead auction solution for Nordic, German and French power. The Capacity Allocation and Congestion Management (CACM) regulation provides a new framework clearly defining the tasks and obligations of the transmission system operators (TSOs) and Power Exchanges designated as Nominated Electricity Market Operators (NEMOs). NEMOs will compete with each other on a shared order book basis and this enables Power Exchanges to compete for business across auctions. On 8 January we received our NEMO designation from the Swedish Energy Market Inspectorate (EI).

We believe it will be key for commodity exchanges to be able to offer a combined SPOT and Future solution going forward. One single platform for SPOT and Futures will provide synergies and efficiencies to our customers. In all of these efforts it is fundamental that our customers are involved. To address this we have initiated a number of forums to cooperate closer with market participants, and this will intensify during 2019.

Focus on Increasing Liquidity

Strengthening market liquidity is critical and we are working towards addressing existing liquidity issues in conjunction with our core member base. We have consulted with our customers in great detail on these matters. This work has sparked a number of initiatives which we believe will stimulate market liquidity.

Firstly, we are launching a new market maker program on the Nordic Market, with the aim to have it up and running during Q1 2019. Secondly, we have issued a proposal for a new liquidity provider program aimed to attract additional trading in a number of key contracts during two one-hour trading windows per day. This initiative is showing good progress and we hope to see it go live in Q1 2019.

We will continue to work with our customers to find new ideas and ways to strengthen the liquidity in the market during the next few years.

Enhanced and More Robust Risk Management Framework

Below, we outline the main enhancements to the risk management framework we are planning for during 2019. We look forward to our clearing members’ feedback, which will be used to refine these actions as necessary and ensure that market liquidity and business goals are considered. Timelines and deliverables will be subject to member consultation and advice (via the Member Risk Committee, bilateral discussions and risk councils), as well as regulatory approvals.

Initial Margin Framework 

We will enhance our margin framework through more specific and targeted margin add-ons, raising margins for portfolios identified to pose additional risk to the CCP and its members:

  • Increase confidence level to 99.5% for main commodity products (completed Sept 2018)
  • Introduce additional margin requirements for large stress loss accounts, defined through the ratio of uncovered stress loss and posted initial margin. The purpose of this change is two-fold; (a) to re-allocate stress loss risk from mutualised to individual members with large stress losses and (b) to provide Nasdaq Clearing with an additional risk monitoring tool. (roll-out in Jan 2019)
  • Enhance current concentration margin add-ons, to provide additional protection in the scenario where concentrated positions need to be liquidated. Nasdaq Clearing will establish new metrics for concentration (based on items such as open interest, average daily trading volumes), and apply those in a more granular and flexible manner across the commodity markets. (Q3 2019)

Default Fund Structure

We will increase CCP capital in the waterfall and make changes to the default fund structure to strengthen members’ position in a default scenario and eliminate spill-over effects:

  • Increase our junior capital, to minimum EUR 20m for the commodity market, to solidify Nasdaq Clearing’s commitment to the markets it operates. (completed Dec 2018)
  • Move to a default fund structure with no mutualized layer across markets to eliminate the risk of spill-over between markets in the case of a member default. (member consultation in Q1 2019, implementation in 2019)
  • Increase the default fund size update frequency from quarterly to monthly. (2019)

Membership and Credit Assessment Framework

We will enhance our membership and credit assessment framework through additional scrutiny and resulting mitigating actions for all members considering our diverse member base:

  • Imposing a liquidity requirement on each member, which is linked to the size of exposure of the member. This requirement will be monitored on an ongoing basis and mitigating actions will be codified. (roll-out in Jan-Feb 2019)
  • The financial requirement for being a clearing member will be updated for Direct Clearing Members, Direct Clearing Agents and Direct Clearing Clients, to further ensure that each member has a sufficient capital base for clearing purposes. (roll out in Q4 2019).
  • Qualitative requirements will be reviewed and strengthened to ensure that each member has sufficient operational capacity and suitable organization. (roll out end of Q1 2019)
  • Roll out a due diligence questionnaire to capture additional information from clearing members on an annual basis, enabling more detailed assessment of our members’ operational and risk management capabilities. (roll-out in Jan 2019)
  • Enhancement of the credit scoring model and develop a tiering framework for members which will take into account their credit position, membership type, qualitative criteria assessed via the due diligence questionnaire. This tiering framework will be explicitly linked to mitigating action and controls, ranging from increasing frequency and intrusiveness of monitoring to extraordinary margins and position controls. (roll out end of Q3 2019)

Default Management Framework

We will further increase transparency in the auction process and introduce measures to achieve the best possible outcome.

  • Extend the number of close-out providers in Commodities and implement an incentive structure to increase auction bidding and close-out. (reach-out process to close-out providers during Q1 2019)
  • Enhance fire drills and increase transparency around roles and responsibilities for close-out providers, including clarifying and standardizing Nasdaq operations and communication in case of a default. The purpose of these changes is to increase transparency around, and preparation for, any default event. (member consultation in Q1 2019, implementation in 2019)

We believe these measures, taken in conjunction with business enhancements and our liquidity program, will significantly improve the functionality and safeguarding of our markets. We look forward to receiving feedback and input from our members and the wider industry throughout 2019 and will update affected participants regularly, as changes are rolled out.

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