Russia’s invasion of Ukraine wreaked havoc on Europe’s energy markets. Supply cut-offs sent gas prices soaring, leaving the continent’s energy firms facing an existential crisis, as rampaging volatility triggered sky-high margin calls on derivatives hedges.
BNP Paribas stepped up to the challenge with a catalogue of structures to help its most strategic clients weather the storm and keep the lights on across the continent.
For utilities struggling to meet margin calls on listed contracts, the bank offered liquidity swaps, which shunted these positions into an over-the-counter format to free up collateral. Committed repo facilities enabled firms that had piled into longer-dated assets during the low-interest-rate environment to transform their bonds into useable collateral and meet variation margin calls. BNP Paribas also took a flexible stance on bilateral agreements, amending margin-posting thresholds where necessary.
Although these ideas were not unique to the Paris-based bank, what set it apart from the crowd was its ability to transact in size. This was thanks to a stalwart commitment to commodities, particularly physical gas and power, where many of its rivals had thrown in the towel.
“The bank doesn’t have a fragmented commodity offering,” says Donatella Cuocci, its head of commodity corporate sales for Europe, the Middle East and Africa (Emea). “We have a large and comprehensive offering in commodities, and that is including European gas and power trading activity.”
We were looking for companies that were strategic partners of the bank and essential facilitators of Europe’s ambition to improve energy security after the conflict in Ukraine
Ashley Parker, BNP Paribas
Clients welcomed the proactive approach and the unique insight the bank was able to bring through the most testing times.
“We appreciate their help a great deal,” says a large European utility client. “Not only in concluding deals, but in having a partner with which we can discuss problems and issues. With any new deal or solution they are very clear about what is and is not possible.”
Although these activities were crucial in keeping Europe’s energy firms afloat, they were often capital- and credit-intensive for the bank. As such, it needed to be tactical in choosing which clients it would do this critical business with.
“We were looking for companies that were strategic partners of the bank and essential facilitators of Europe’s ambition to improve energy security after the conflict in Ukraine,” says Ashley Parker, BNP Paribas’s head of corporate solution sales Emea.
The bank also refused to budge on its internal principles. “We were looking for companies that have strong and credible environmental, social and governance ambitions,” Parker adds.
Ice hots up
Europe’s energy crisis intensified in February and March when sanctions against Russia caused Ice’s Dutch TTF futures – the European Union’s primary gas contracts – to jump by more than 300%. Panic escalated in August, when Russia halted natural gas supplies through the Nord Stream pipeline, thereby setting the stage for a full-blown energy crisis and sending TTF contracts to €343/MWh (compared with €80/MWh on January 3).
For some of its key clients, BNP Paribas offered a welcome reprieve from rising initial margin requirements in the form of liquidity swaps. These enabled energy firms to switch listed positions on European gas and power futures into over-the-counter exposures with the bank.
The swaps consist of two legs. BNP Paribas takes an opposite position on the exchange to neutralise the original exposures. An identical position is then typically opened up under a bilateral collateral agreement with the bank as a financially settled swap or a physical forward.
Firms were able to claw back the initial margin they had posted for the trades on the exchanges, thus generating a buffer of collateral to meet other margin calls. The approach also freed up space for clients that had hit trading limits on the exchanges, and enabled them to put on additional hedges when they entered into new or updated supply contracts.
For one large European energy client, which was struggling find cash to support its hedging activity, the swaps provided a lifeline: “BNP Paribas were very proactive in finding solutions and assisting us to set up the solution. They assisted us in every single step in implementing the solution, including the compliance person assisting us in all the steps with the exchange.”
Although the bank declines to comment on trade notionals, Cuocci says it traded these instruments with “more than a handful” of Europe’s largest energy firms.
The bank did various tenors of liquidity swaps of up to two years, depending on the clients’ existing positions on the exchanges. The size and quantity of the swaps varied, and transactions were typically executed as block transfers of large quantities of exchange-traded gas and power transactions to bilateral markets.
By the time the markets hit fever pitch, the instruments had already been well tested. The bank had been on high alert in the autumn of 2021, as rising demand for gas in the aftermath of Covid-19 lockdowns and reduced production from European wind turbines left clients feeling the pinch of higher margin calls.
“The need for liquidity swaps started well into the final quarter of 2021 in combination with the increases in gas and power prices,” says Cuocci. “It continued throughout 2022 with different periods of activity depending on the margins and the prices.”
Given the rate at which markets were moving, speed of execution was of the essence. The bank mobilised significant internal resources to put the liquidity swaps in place and streamlined the way it approached them.
“It’s a well consolidated global markets team,” says Cuocci. “We have a strong relationship with the banking team. Thanks to this strong co-ordination and seamless approach across all our global markets business lines, we were able to put these solutions in place.
“From the top management to our level, to the risk function, to the banking function, to the trading teams, everybody was working together on delivering those solutions in a timely manner.”
For clients already set up with credit support annexes, liquidity swaps could be put in place within a couple of days, and typically in no more than two weeks.
Although the swaps were a key part of the bank’s toolkit, some clients needed additional support. For one utility, this came in the form of increased margin posting thresholds under its bilateral agreement with the bank. This gave the firm breathing space before the mark-to-market value of the trade was big enough for the utility to have to start posting variation margin to the bank.
“The solution was able to alleviate short-term liquidity movement with the client,” says Cuocci. “There was a specific moment of large volatility for a trade executed before, and this solution allowed the client to optimise their needs in that moment in time.”
The pace of change sweeping through financial markets in 2022 left many firms on the backfoot. The low-rate environment had led utility clients to shift cash into longer-term government bonds. On the one hand, this meant better yields than on short-term securities. On the other, it meant moving further down the liquidity ladder.
When central banks began hiking rates to battle inflation, some strategically important utilities struggled to transform these longer-dated instruments into cash quickly enough to meet their variation margin calls at clearing houses.
Typically, banks would enter reverse repo transactions with clients to exchange government or corporate bonds for cash on a short-term basis. However, by the start of 2022, BNP Paribas realised a more comprehensive and flexible solution was required to deal with the strong possibility that energy prices would maintain their upward trajectory. European energy firms were looking at ways to ensure access to liquidity to meet margin calls even during the most volatile periods.
The bank opted for a committed repo facility, which enabled clients to draw down liquidity with just two days’ notice at a pre-agreed rate. The facility can be drawn at any time and for any size or tenor during the duration of the agreement.
Another large European utility says it welcomed the buffer: “We’re quite happy to have this kind of insurance because we saw some stresses on the repo market a couple of months ago, and we are quite happy that we have a committed facility in place.”
Discussions between BNP Paribas and the utility lasted around six months, and the €2 billion 12-month facility was finally put in place in June.
“By having the committed repo facility, you have visibility in advance on the terms at which you are going to draw down on the facility,” says Parker. “It’s the visibility that was appealing to European utilities as energy prices became much more volatile.”
The utility had attempted to negotiate similar facilities with other banks, though the pricing was less competitive than the agreement it eventually reached with BNP Paribas.
“When we saw that BNP Paribas was providing the solution, we ended up asking if some other banks had enough balance sheet to do it,” says an executive at the utility. “If they could provide this kind of solution, they were able to, but at a really different price. We ended up not doing it [with them] because it was very costly.”
The solution garnered interest from the bank’s other clients.
“Effectively, this committed repo facility is now in the strategic financing toolbox offering,” says Aymar De Courcel from BNP Paribas’s interest rate and foreign exchange corporate solutions sales team for France. “It enables us to bolster short-term liquidity for clients. We continue to pitch and discuss this [solution] with other clients.”
Energy wasn’t the only set of markets in which BNP Paribas put its structuring nous to the test in 2022. It was also involved in several smart novations.
In one instance, the bank had taken on several hundred million euros notional of long-dated swaps with a large mark-to-market valuation at the beginning of the Covid lockdowns in March 2020. It restructured these instruments to embed some rebates on bespoke derivatives valuations, known as X-value adjustments (XVAs). These would be paid out to clients in the event of a restructuring or a partial unwinding of the underlying hedged debt.
The incentives worked. Some clients benefited from the feature in 2022 following a partial restructuring and unwind, which proved advantageous for the bank by reducing balance sheet consumption.
“We transformed a position that was quite RWA-intensive at inception into something that was more manageable from our balance sheet point of view,” says Hugo Delaborde, BNP Paribas’s head of IRFX corporate structuring, EMEA.
The bank was also able to further develop its repack technology and open up its proprietary platform to rival banks.
One UK client asked to restructure a legacy Retail Prices Index inflation swap portfolio of just over €100 million and remove the mandatory breaks. BNP Paribas originally held 20% of the total swap, but another 40% was novated to it from two other banks. A third bank held the remaining 40%.
Following the restructuring and repack, both BNP Paribas and the third bank kept their balancing swaps – the residual after repacked cashflows had been sold to investors. All of the repacked cashflows – including those completed by the two remaining banks – were centralised and sold to investors via BNP Paribas’s repack platform.
“We are now able to work with other banks and open our structure to them, when it makes sense, and therefore allow our clients to have a streamlined process by just having one repack bank going, with one solution going through to the investors,” says Delaborde.
Although BNP Paribas could open up the platform for future trades, it only expects to offer the service under certain conditions, such as its overall role in the transaction or its slice of balancing swaps.
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