Cost Evaluation of Credit Risk Securitization in the Electricity Industry: Credit Default Acceptance vs. Margining Costs
FCN Working Paper No. 13/2010
42 Pages Posted: 2 Jun 2011
Date Written: September 1, 2010
Institutions such as the European Commission (EC) are currently seeking to increase the transparency of the derivatives markets. This course of action includes in particular the installation of a centralized clearing entity and with this the obligation to clear all relevant financial derivatives. Besides the expected securitization of the financial system, these steps would also significantly influence the electricity industry, as most of the commodity trading in this sector is currently still done in the largely non-cleared OTC markets. Despite the fact that clearing of the OTC contracts in this sector has significantly increased over the last years, credit risk mitigation is still largely effected with bilateral netting agreements, standardized contracts and individual trading limits between partners. This paper explores the impact of margining on the financial costs in comparison to the direct management and the intentional acceptance of credit risk. For this purpose, the losses due to defaulting business partners in the electricity industry are compared with the interest requirements of the cash reserve for an assumed margining account. The results show that for an asset-backed utility, depending on the price trajectory, the cost of margining may significantly outreach the costs stemming from the acceptance of credit risk.
Keywords: Credit risk mitigation, margining, collateralization, risk capital, power plants
JEL Classification: G12, G32, L94, O16
Suggested Citation: Suggested Citation