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Understanding the Risks and Potential Regulatory Changes in Back Office Energy Trading
Interview with Nick Galletti, Director, Risk Management at ConEd
How will the central clearing of trades affect the back office?
NG: There is a credit risk component to central clearing. The current futures model for collateral protection has worked well for a long time, which may have caused that risk to appear non-existent. However, recent events at MF Global have shown that the system needs to be improved. In terms of back office impact, there will be increased monitoring of clearing brokers in terms of the broker credit quality, and in terms of their client base and risk management practices. To the extent firms now seek to diversify their accounts among more FCMs, this will increase operational complexity within the organization. Also, firms will be very interested in how their funds are invested at the FCM. From a practical perspective, firms need to review their existing broker agreements and, potentially, negotiate new terms.
What regulatory changes are you expecting as a result of the MF Global fiasco?
NG: Well, there has already been a change to CFTC Rule 1.25. This relates directly to the types of investments in which FCMs can invest customer funds. This rule has been changed several times over the years, and the recent events surrounding MF Global raised concern about investments in sovereign debt and internal repos. The new rules do not allow investments in these instruments. We have also seen a final rule issued by the CFTC regarding protection of cleared swaps collateral. The new rule requires that all customer margin be held at the CCP, and removes fellow customer risk. The CFTC is also looking at rule changes regarding protection of collateral for futures.
Other potential changes include concerns about the industry as essentially a self-regulator;
What lessons can other firms take from MF Global collapse?
NG: The current omnibus model for treatment of customer funds essentially means we have fellow customer risk. Initial margin that is posted is there to protect for a default of any customer of the FCM. Also, there is no insurance mechanism for futures to protect clients, such as the SIPC for securities or FDIC for bank deposits.
Know your brokers. Get information on a regular basis. Understand who their client base is. Know the clearinghouses with which you’re transacting, and be aware of their financial safeguards. Be aware that there are different regulatory structures for protection of collateral for US futures, foreign futures, securities, and OTC cleared swaps. Finally, remember that positions involving foreign CCPs are subject to the rules of a foreign regulator.
How much of a shock was the collapse to the rest of the industry?
NG: This was a wake-up call to the industry. In the end, there will be improvements made to the system in terms of tighter regulations. However, there is no substitute for due diligence and monitoring of brokers.
Nicholas Galletti is the Director, Risk Management for all of the Con Edison Competitive companies, which include Con Edison Solutions, Con Edison Development, and Con Edison energy. In this role, he oversees risk compliance related to market, credit, and operational risks associated with the commodity trading activities.
For more information please contact Michele Westergaard, Marketing/PR Coordinator, marcus evans at 312-540-3000 ext. 6625 or Michelew@marcusevansch.com.
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