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In The News
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October, 2005
Online Solution For Emissions Trading
Jean-Claude Riss, managing director of OpenLink's London operation discusses how traders can help support the emission allowance and optimize trading by controlling risk and ensuring straightforward management of emissions compliance obligations by employing OpenLink's European Emissions Model (EEM).
By JEAN-CLAUDE RISS
Since January, the European Union Emissions Trading Scheme
(EU ETS) has created a new commodities market, whose limits
have yet to be fully tested. Spanning all 25 member countries of
the EU, the first phase of the emissions trading will last until 2007,
in an effort to reduce EU levels below 1990 levels for the Kyoto trading
period 2008 to 2012. With a multibillion-Euro trading market,
a customized online trading solution, such as OpenLink's European
Emissions Model (EEM) is crucial to successful participation.
The volume of interested parties is already large and will only continue to grow, so competition is fierce. The ETS includes between 12,000 and 16,000 installations, which collectively account for 40% of the EU's emissions. The general idea is that installations whose emissions fall below compliance standards, will put their credits on the market for purchase, either by installations whose emissions are higher than the limits or by private environmental groups who want to lower the amount of available credits altogether.
OpenLink's EEM provides a complete European emissions model that integrates front-, middle-, and back-office functionality into a program that supports the whole life cycle of emission allowances. This model can be seamlessly integrated into OpenLink's Endur, a powerful cross-commodity trading, risk management and settlement system. The benefits of Endur's EEM are fourfold: It boosts functionality in the areas of trading, risk analytics, position and inventory management, as well as back-office infrastructure control.
EEM supports the capture and trade of emission allowances, as well as the modelling of actual and forecast emissions. Special input screens and scripts target emission-specific market requirements.
As a result of its seamless integration into Endur, EEM facilitates sophisticated middle-office functionality by providing MTM, PNL, and Value-at-Risk, sensitivities, and scenario analysis.
The software's robust position, and inventory management functionality, enables tracking of current and future compliance account inventory as well as net positions for each compliance year and the corresponding compliance period while also presenting results in Endur's position pages.
Additionally, EEM provides sweeping back-office functionality that allows the generation of confirmations for CO2 transactions and invoices. A separate registry notification report is included to facilitate timely registry transfers.
Trading
While EEM enables traders to efficiently trade emission allowances in the European market, it can do much more as well. The set-up ensures straightforward management of emission compliance obligations, and supports the capture of three different transaction groups:
- Initial government emission allocations, supporting the modelling of initial allowance positions assigned by each government's national allocation plan;
- Internally forecast and actual emissions, updated continuously to represent both expected and actual emissions, by generation assets;
- Day-to-day trading activity in the European allowance market, with sufficient trading functionality and flexibility to account for the different allowance types, such as AAU, CER and ERU for the CO2 market.
EEM provides specific deal input screens, a set of instrument templates and even an emission-specific instrument.
Risk analytics
OpenLink's EEM leverages both Endur's sophisticated middle-office functionality and the flexibility of its active position manager module. The EEM provides full evaluation of features such as the calculation of MTM, PNL, Value-at-Risk, sensitivities and scenario analysis for the three transaction groups listed above.
Position and inventory management
Middle-office position and inventory management reports allow risk managers to optimize and control day-to-day trading. In addition, the configuration offers straightforward monitoring of corporate compliance obligations. To ensure effective inventory management, EEM supports the modelling of CO2-specific government regulations such as banking and borrowing.
EEM also includes a standard position page, which tracks inventory and net positions of emission allowances. The net positions for each compliance year as well as for the total compliance period can be displayed. The report details the allowance position that is available for surrender on April 30 for the following year to fulfill the previous year's emissions obligation. The MTM results for each position shown are also provided.
The daily inventory will be calculated to track today's real-time positions in emission allowances. This daily inventory position will be equal to the emission allowances that are available for transfer in the registry compliance accounts. The calculation of the inventory position is based on a script that is included in the EEM package, while the market value of today's inventory position is provided by the active position manager's standard position page.
The valuation of each position and today's inventory are supported by an emission-specific valuation approach - a valuation curve included in the overall EEM functionality. Additional information is provided by a separate future inventory report. This report allows traders to manage company inventory on compliance account level efficiently and shows the daily inventory for future business days. This also enables the tracking of short compliance account positions to optimize trading and helps ensure that open positions are closed out before a future delivery obligation. The calculation of future inventory positions is yet another script included in the overall EEM package.
Back-office functionality
One of the biggest benefits of EEM's seamless integration into Endur is the access to complete back-office functionality, including operations services, event concepts and the processing of documents.
EEM's first release will support the document generation of confirmations and invoices for the tradable CO2 emission allowances, and inventory reports can be included in an end-of-day workflow to track the whole history of the emission allowance process. An execution report for registry notification also can be generated, ensuring that registry notifications are created and submitted to facilitate timely delivery of allowances on the agreed delivery date.
The future
The EU ETS already has the attention of several different exchanges that either specialize in emissions trading or are bending to accommodate them. The biggest problem currently facing interested trading houses is reorganizing their internal structure to successfully take advantage of this new commodity.
Another challenge involves a lack of standardization among emissions trading contracts. The terms of the International Swaps and Derivatives Association, the International Emissions Trading Association and the European Federation of Energy Traders all are sufficiently different to expose traders to basis risk.
To avoid such risk, futures-trading exchanges such as the European Climate Exchange (ECX), a subsidiary of the Chicago Climate exchange, offer electronic trading under the International Petroleum Exchange's infrastructure, and are therefore regulated by London's Financial Services Authority. At least three or four other exchanges also are competing for space in the market.
The market has already started to grow exponentially, and will continue to expand as the EU continues to grow more comfortable with the program and starts to see regulatory results. Savvy traders can expect significant financial returns when they employ OpenLink's European Emissions Model, a solid front-, middle- and back-office software solution that will support the whole life cycle of emission allowance and optimize trading by controlling risk and ensuring straightforward management of emissions compliance obligations.
About OpenLink
Founded in 1992, OpenLink is a leading provider of energy and financial trading, risk management, and operations software solutions. The company's Next Generation eXtensible (NGX) platform supports the most rigorous business requirements of firms trading in energy, interest rate derivatives, fixed income securities, foreign exchange, money markets, metals, and soft commodities. OpenLink's global client base includes AMP Capital Investors, Austin Energy, Banco de México, Bank of America, Bank for International Settlements, Bank of Canada, Bank of Scotland Treasury PLC, Bridgeline Holdings, Citigroup Global Market, Inc., Deutsche Bank, Edison Mission Marketing & Trading, Enbridge, Mirant, Nexen, Petróleos Mexicanos, Sequent, Shell, Statoil and Vattenfall Europe Trading. Headquartered in Long Island, New York, and with offices in London, Houston, New York City, Berlin, Sydney, and São Paulo, OpenLink employs more than 300 professionals worldwide.
Jean-Claude Riss is the managing director of London-based OpenLink International, the European arm of OpenLink.
Copyright © 2005 Incisive Media Investments Ltd.
All rights reserved. Used by permission.
First published in Energy Risk International - October 2005
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