Research European Commodity Market Regulations - Part 1 | Page 25

European Energy Market Regulations V3.1 Portfolio Compression Portfolio Compression is the process of reducing the number of trades in a portfolio whilst maintaining a risk equivalent position. Reducing “unnecessary” trades with a counterparty reduces credit risk and settlement risk. EMIR mandates compression for FCs and NFC’s every six months for counterparty portfolios with more than 500 trades. EMIR also “encourages” compression wherever possible. Compression is not always easy or desired by all in an organisation, although it is desired by the credit department and has many benefits once in place in terms of risk management. Compression can be performed either bilaterally or multilaterally. Bilateral Compression When one counterparty attempts compression directly with another, there are several steps: 1) Identify counterparties – It is necessary firstly to identify which counterparties are being compressed with and when to schedule them for. 2) Identify areas for compression – An analysis of the portfolio must be carried out in order to determine which trades may be compressed, if any. 3) Agreement of compression – the two entities must then agree the set of trades 4) Execute compression – execution of a compression involves terminating the deals being compressed, and replacing them with new ones. 5) Mark trades- The new trades must be marked as “resulting from compression” in EMIR trade reporting. The ETRM system will need to record this as a reason for the trade. Multilateral Compression Compression involving several parties can be a great deal more effective than bilateral compression. Multilateral compression involves viewing the trades between all of the counterparties in a group, and then reducing them down as much as possible using a combination of trades and closures. The more parties involved in a compression, the more benefit it will have. TriOptima‘s triReduce service offers such a service, both within the energy industry and within banking. Multilateral compression involves the following steps: 1) Set calendar – multilateral compressions take place periodically (typically quarterly depending on market characteristics). 2) Send in trade portfolio – each party sends in candidate trades with the other entities in the group to the service. Nominate trades – each party agrees to the compressions from the suggestion list 3) Dress rehearsal – on a specific day, the compression is “simulated” by all parties 4) Execution – On a nominated day, all of the agreed trades are closed out and new ones created. Service suggests trades – the service will suggest which trades can be compressed, which trades will need to be closed out and which new ones created A typical cycle lasts two weeks, with trade submission and matching in the first week, and dress rehearsal and live execution the second week. As with bilateral compression, all trades resulting from a compression must be marked and reported. © Commodity Technology Advisory LLC and ETR Advisory Ltd, 2013, All Rights Reserved. v3.1 November 13th, 2013 25