An instrument or document issued by a bank guaranteeing the payment of a customer’s drafts up to a stated amount for a specified period. It substitutes the bank’s credit for the buyer’s and eliminates the seller’s risk. LCs are used as margin collateral in gas and power trading as well as to underwrite specific commodity cargoes such as oil. There are several types of LC including ‘standby’, which is used purely for guarantees (that is, it is not used except during default), as well as ‘documentary’, where the provider substitutes for the counterparty in settlement. Whether central counterparties (CCPs) will continue accept LCs to satisfy margin requirements is currently in doubt, and depends on the interpretation of European Market Infrastructure Regulation (EMIR).
* see also performance letter of credit
Commodity trading and risk management is a subject that is necessarily complicated, and is becoming more so. The Energy Risk Glossary seeks to disentangle and clarify the jargon by providing definitions of commonly used energy and commodity market terms.
These include definitions related to a variety of underlying energy products, as well as technical terms about the many instruments and benchmarks used by energy market participants.
Many of the most recent terms to have been added to our glossary stem from the actions of regulators since the 2008 global financial crisis. The onset of rules, such as the US Dodd-Frank Act and European Market Infrastructure Regulation, has markedly increased the cost and complexity associated with commodity trading. Perhaps they have also increased the need for a handy reference guide such as this.
The glossary is extensively cross-referenced, making for easy and thorough searches. We hope you find the latest edition of the Energy Risk Glossary to be a useful resource.
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