A 1.5 trillion derivatives crash is coming. in Europe

A 1.5 trillion derivatives crash is coming. in Europe
A 1.5 trillion derivatives crash is coming. in Europe

They need at least 1.5 trillion. euros to cover the cost of exposure to the spike in natural gas prices

Europe’s oil and gas supply woes this winter after a row with Russia could be exacerbated by a new crisis in a market where prices are already too high: a liquidity crunch that could even lead to a crash .
But European governments have been slow to act to offer financial support to power providers on the brink of collapse in a bid to ease pressure on a market whose smooth running is vital to the continent.
“We have a dysfunctional futures market, which then creates problems in the physical market and leads to higher prices, higher inflation,” a senior trading source told Reuters.

Since March the problems

The problem first surfaced in March, when an association of top traders, utilities, oil majors and bankers sent a letter to regulators asking for contingency plans.
This was caused by market players rushing to cover their financial exposure to soaring natural gas prices through derivatives, hedging future price increases in the physical market where a product is delivered by taking a “short” position.
Market participants typically borrow to create short positions in the futures market, with 85-90% coming from banks.
About 10-15% of the value of the short, known as minimum margin, is covered by traders’ equity and deposited into a broker’s account.
But if the funds in the account fall below the minimum required margin, in this case 10-15%, a “margin call” is triggered.
As electricity, natural gas and coal prices have risen, so have the prices of shorts, with the resulting margins forcing oil and gas majors, trading companies and utilities to commit more capital.
Some, particularly smaller businesses, have been hit so hard that they have been forced out of business altogether as energy prices soared after Russia’s invasion of Ukraine in February, which worsened the general global shortage.
Any such reduction in the number of players reduces market liquidity, which in turn can lead to even greater volatility and sharper price increases that can hurt even major players.
Since late August, European Union governments have stepped in to help utilities such as Germany’s Uniper.
But with winter price hikes looming, there is no telling whether or how quickly governments and the EU can support banks or other utilities that need to hedge their trades.

Margin requirements are increasing

Exchanges, clearing houses and brokers have increased initial margin requirements to 100%-150% of the contract value from 10-15%, senior bankers and traders said, making hedging too expensive for many.
The ICE exchange, for example, charges margin rates of up to 79% on Dutch TTF gas futures.
Although market participants say the rapidly disappearing liquidity could significantly reduce trading in fuels such as oil, natural gas and coal and lead to supply disruptions and defaults, regulators still say the risk is small.
Norway’s state-owned Equinor, Europe’s top natural gas trader, said this month that European energy companies, excluding Britain, need at least 1.5tn. euros to cover the cost of exposure to the spike in natural gas prices.
This compares with the value of 1.3 trillion. dollars of US subprime mortgages in 2007, which triggered a global financial meltdown.
But a European Central Bank (ECB) policymaker told Reuters that losses in a worst-case scenario would amount to 25-30 billion euros, adding that the risk lies with speculators, not the real market.

Necessary measures

However, some traders and banks have asked regulators such as the ECB and the Bank of England (BoE) to provide guarantees or credit insurance to brokers and clearing houses to reduce initial margin levels in pre-crisis periods.
Doing so, sources familiar with the talks said, would help restore market participants and increase liquidity.
The ECB and the BoE have met with several major trading houses and banks since April, four trading, regulatory and banking sources said, but no specific measures emerged from the consultations, which have not been reported previously.
“It’s too big a single point of risk for a bank.
Banks have been hit or are close to hitting liquidity risk and counterparty risk levels,” a senior banking source told Reuters.
Banks have a certain level of capital that they can attach to a particular industry or player, and price increases and player declines are currently testing those levels.
The ECB has repeatedly said it sees no systemic risk that could destabilize the banking sector.
ECB President Christine Lagarde said this month she would support measures to provide liquidity to energy market participants, including utilities, while the ECB stood ready to provide liquidity to banks if needed.
Britain’s Treasury and Bank of England, meanwhile, announced a £40 billion funding program this month for “extraordinary liquidity requirements” and short-term support for wholesale energy companies.

Opacity

However, the markets for energy and commodities remain opaque, with physical transactions being hedged with financial instruments depending on the internal rules set by the various companies involved.
And since no regulator or exchange maintains a central trading registry, it’s impossible to see the full picture, sources told Reuters.
For some, however, the signals are clear.
“Interest and volumes have come down significantly as a result of what’s happening on the margin front,” Saad Rahim, chief economist at Trafigura, told a conference call last week.
“Ultimately it will have an impact on physical volumes traded because physical traders have to hedge.”

www.bankingnews.gr


The article is in Greek

Tags: trillion derivatives crash coming Europe

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