2 carbon trading presented by léon bitton, vp r&d montreal exchange winnipeg, march 14th, 2003...
TRANSCRIPT
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Carbon TradingCarbon Trading
Presented byLéon Bitton, VP R&D Montreal Exchange
Winnipeg, March 14th, 2003
Designing the Designing the Canadian MarketCanadian Market
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Montréal Exchange Montréal Exchange (MX)(MX)
Sole Financial Derivative Sole Financial Derivative Exchange in CanadaExchange in Canada
• Bourse Trades all $CDN Interest Rate Derivatives
• Bourse Trades all Canadian Equity Derivatives
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Dimension of The Montreal Dimension of The Montreal Exchange MarketExchange Market
$ Traded / Notional value 2002
Interest Rate Derivatives : 5 $ trillion
Equity Derivatives : 143 $ billion
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MX VolumesMX VolumesGrowth by Asset Class 2002Growth by Asset Class 2002
+20%+20%+9%+9%
10 000
20 000
30 000
40 000
50 000
60 000
Interest-rate futures
EquityIndex
Futures
Equity options
Total
Dai
ly a
vera
ge
Var
iati
on
200
2 vs
200
1
2002
2001
02 / 01
+24%+24%+15%+15%
*Open Interest: +31%
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MX HighlightsMX Highlights
• Restructuring program
MX
Derivatives
CDCC 100%
TSE Vancouver Alberta
CDNXSenior equities
TSX
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• Demutualization
• First North American Traditional Derivative exchange to be fully electronic
• Creation of an on-line Training Institute
• Remote Access USA / UK
• BOX – New US option Exchange
MX HighlightsMX Highlights
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Why an electronic Why an electronic exchange?exchange?
Direct accessDirect access
MONTRÉALMONTRÉAL
NEW YORK CHICAGO
LONDON
FCMs,Proprietary
Firms
AuthorizedPersons
TORONTO
BrokerDealer
CALGARY
VANCOUVER
WINNIPEG
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MX Electronic Trading MX Electronic Trading PlatformPlatform
An open electronic trading platform using the following main components:
• NSC trading system used by several exchanges around the world
• Open architecture allowing firms to connect using their own proprietary front end solutions or one developed by an Independent Software Vendor (ISV)
• Internet based connection – Under review
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The Trading ProcessThe Trading Process
Participants Communication (HUB)
Gateways
Data Vendors
Participants & ISVs(SLC Screen)
• Independant Service Vendor (ISV) using MMTP protocol (SLE screen)
• ISV using FIX protocol
• ISV and Order Flow Provider (OFP) using STAMP protocol
Mind TradeManagement
DatabaseData
DisseminationSurveillance
Tools
TradingEngine(NSC)
Order & Quote
Trade information
Montreal Exchange Internet Site
Canadian Press
Automated TradeReporting to
Participants (ATR)
Participants Back Office
C D C C
Ord
er &
Q
uote
MarketData
Trade confirmation
Trade &Allocation
information
Trade
Market Data(HSVF protocol)
Market Datafor underlying
Tra
de
&M
ark
et
Da
ta
T S X
AccessAccess Post tradingPost tradingDataData
DisseminationDisseminationAnd ClearingAnd Clearing
TradingTrading
SAM
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A Unique Market ModelA Unique Market Model
Key characteristics:Key characteristics:• Price transparency
• Fairness
• Expanded access
• Rapid order execution
• Straight through processing for execution
• Flexibility of trading hours
• Enhanced liquidity
• Security
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The Canadian DerivativesThe Canadian DerivativesClearing Corporation Clearing Corporation (CDCC)(CDCC)
• Registers and manages commitments resulting from market transactions (back-office function)
• Provides protection against counterparty credit risk (netting function)
• Ensures the financial integrity of the market
Clearing House carries out three main functions:
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CDCC – A factor ofCDCC – A factor ofcompetitivenesscompetitiveness
• Manages a nominal risk of approximately 600 billion $
• “AA” rating from Standard & Poor’s
• 33 members
• Major financial institutions
• Contribution to Clearing fund and margin: 1,9 billion $
CDCCCDCC
MembersMembers
ClientClient ClientClient
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Derivative InstrumentsDerivative Instruments
• Price fixing Instruments– Futures– Forwards– Swaps
• Price Limiting Instruments– Options
Two kinds of hedging instruments
Exchange based Off Exchange – bilateral OTC
Two distinct markets for execution
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Equity Index35%
Currency1%
Gov Debt15%
Interest13%
Metals2%
Individual Stock27%
Energy4%
AG3%
Total Worldwide Exchange Total Worldwide Exchange Derivatives volume by Asset ClassDerivatives volume by Asset Class**
* Source: IOMA 2001
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-End J une 2001: $99.7 trillion
Forex20,5%
Interest rate76,1%
Equities2,0%
Commodities0,7%
Credit-linked0,7%
Dimension of Derivatives Market Dimension of Derivatives Market Global notional outstanding in Global notional outstanding in
OTC derivatives marketsOTC derivatives markets
* Source : BIS
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(in $Trillions)
$39.75
$28.03
$17.28$4.93
Cash Exchange-Traded Index FuturesExchange-Traded Index Options Exchange-Traded Stock Options
Dimensions of Derivatives Dimensions of Derivatives
MarketMarket The Global Cash and Derivative Market/Equity
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• Standardization facilitates market liquidity
Futures are price transparent, ensuring fair prices
Anonymity
• Clearing corporations reduce counterparty risk
Margin S&P rating
Significance of Being Significance of Being Exchange TradedExchange Traded
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Comparison of MarketsComparison of Markets
Exchange-Traded Over-the-counter•Standardized as to size and maturity
•Customized
•A structured market (exchanges are regulated)
•Traded in OTC markets
•Limited risk of default – Clearing House
•Subject to counterparty risk
•Marked to market daily •Generally settled at maturity
•Margin is mandatory •No margin requirements (or optional)
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Prerequisite for an efficient Market – Prerequisite for an efficient Market – Diversity of users and Diversity of users and
concentration of liquidityconcentration of liquidity
• Hedger is managing risk, either through a price fixing process (futures) or by taking out insurance (options).
• Speculator is taking risk - using investment decision as primary source of income
• Arbitrageur is special - exploiting variations in market conditions– credit, tax treatments, liquidity
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An illustration of emission An illustration of emission allowances and futures tradingallowances and futures trading
At the beginning of 2003, a coal-fired power plant receives allowances matching its carbon dioxide (CO2) emissions cap, say 20,000 emission allowances
(hypothesis: 1 emission allowance equals 1 ton of CO2 emissions):
0 5,000 10,000 15,000 20,000 emission allowances
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First situation: surplus of emission First situation: surplus of emission allowances allowances ‣ ‣ ‣ ‣ ‣ ‣ Selling futures.Selling futures.
In December, the CO2 emissions of the plant equal only 15,000 tons thanks to the implementation of new CO2 filters:
0 5,000 10,000 15,000 20,000 emission allowances
Surplus
Alternative 1:If the treasurer of the plant knows that the implementation of new CO2 filters will lower its C02 emissions below 20,000 and if he plans to sell the surplus, selling a Dec 03 futures contract on 5,000 allowances @12 will place a floor to the December 2003 market price.
Alternative 2:The plant may keep the surplus for use against its target in future years or sell it to a trader at the market price.
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Second situation: shortage of Second situation: shortage of emission allowances emission allowances ‣ ‣ ‣ ‣ ‣ ‣ Buying Buying
futuresfutures In December, the CO2 emissions of the plant reach 25,000
tons, it is a shortage of 5,000 allowances.
0 5,000 10,000 15,000 20,000 25,000 emission allowances
Shortage
Alternative 1:If the treasurer of the plant anticipates an increase in the C02 emissions, buying a Dec 03 futures contract on 5,000 allowances @12 will cap the December 2003 price.
Alternative 2:The treasurer of the plant will buy 5,000 allowances at the market price to fill up the shortage in allowances.
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Benefits of the futures marketBenefits of the futures market
• The futures market improves risk transfer by enhancing the ability of investors to hedge or assume risk.
• The futures market contributes to the overall efficiency and liquidity of the cash market.
• The futures market improves the transparency of the market.
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Using Derivatives =Using Derivatives =Good Business PracticeGood Business Practice
• Flexible
• Cost-Effective
• Maximize Returns
• Manage Risk
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Prerequisites for an Efficient Prerequisites for an Efficient Emissions Trading MarketEmissions Trading Market
• LiquidityNeed:
• Sizeable market volume and sufficiently high number of market players
• One-stop shopping for spot and derivatives contracts
• Economic efficiency/minimized infrastructure cost
• Diversity of market playersNeed:
• Different market participants with different background and different targets (power generators/industries/traders/financial institutions)
• Cross-border activity
• StandardizationNeed:
• Standardised underlyings because they reduce market fragmentation, facilitate risk management and reduce transaction costs
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Prerequisites for an Efficient Prerequisites for an Efficient Emissions Trading Market Emissions Trading Market (con’t)(con’t)
• Risk management tools / CertaintyNeed:
• Improved risk management through Derivatives Market.
• Sound Exchange and Clearing HouseNeed:
• A centralised market place through which buyers and sellers trade carbon emissions and futures with reduced credit risk exposure.
• An Exchange with a market - Neutral position and good reputation for fairness and transparency in the conduct of trading
• Trade facilitation: electronic access and transparent model.
• Legal FrameworkNeed:
• Establishment of the framework and rules governing the market.
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Carbon Trading Market DesignCarbon Trading Market DesignCompanies involved
in the carbon market
Undertakes emission-reduction
projects
Investors(Outright,
arbitrageur)
Emissions trading registry
Environment Canada
Independent Complianceand Monitoring
• Self-governing structure• Provides confidence to the market• Must meet minimum requirements
to be an Approved participantor a clearing member
Registry,Trading,Clearing & Settlement• Centralised price discovery• Market liquidity• Market Anonymity• Reduced transaction costs• Central counterparty risk
Distribution &Market Access• Canada• U.S.A.• U. K.• Etc.
TheExchangeSellers Buyers
ClearingHouse
$ C
ash
Allo
wan
ces
$ C
ashElectronic
Carbon emissionand derivatives market
Allo
wan
ces
TheExchangeSellers Buyers
TheExchange
TheExchangeSellersSellersSellers BuyersBuyersBuyers
ClearingHouse
$ C
ash
Allo
wan
ces
$ C
ashElectronic
Carbon emissionand derivatives market
Allo
wan
ces
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The Mission of a Carbon ExchangeThe Mission of a Carbon Exchange
• To provide a one stop shopping for spot and derivative contracts on Canadian environment products.
• Early launch to enable Canadian business to gain practical experience of emissions trading ahead of the implementation of the Kyoto Protocol (2008-2012).
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Benefits of an ExchangeBenefits of an Exchange
• Trading emission allowances is no different
from trading any other commodity. Anyone
who holds an account in a central registry will
be able to buy and sell allowances.
• An electronic emission trading system will
provide industry, governments and other
organizations in Canada with the opportunity
to buy and sell emission reductions at a
reduced overall cost.
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Training
Institute
Exp
erti
se«k
no
w-h
ow
»
Clearing and
Settlement
Service
Central creditCounterparty
Self
regulatory
authority
R
eal t
ime
pri
cedi
ssem
inat
ion
Remote
Access
MX Value proposition: MX Value proposition: An integrated An integrated spot and derivatives cost-effective solutionspot and derivatives cost-effective solution
ElectronicTrading Platform (open architecture)
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For more informationFor more information
• Bourse de Montréal
• www.m-x.ca
• Derivatives Institute
• www.derivatives-institute.com
• Léon Bitton