Despite its potential value as a hedging tool, Italian authorities had long resisted calls for a regulated electricity derivatives market. But years of lobbying by a range of interested parties paid off on July 16, when Borsa Italiana signed a licence agreement with Gestore del Mercato Elettrico (GME), the state-owned operator of the Italian Power Exchange (Ipex). The deal was sanctioned by the Italian Ministry for Economic Development.
The arrangement allows Borsa Italiana to use GME’s national single price for the purchase of electricity to calculate the settlement price of the futures instruments, which will be cash settled. Trading is set to start before the end of 2008 on Idex, a new part of the derivatives exchange.
“There is no official fixed date for launch, but we are aiming for the final quarter, and the sooner the better,” confirmed Nicolas Bertrand, director of derivatives markets at Borsa Italiana. “The rules have already been validated by Borsa Italiana’s board, approved by regulators and were released in July 2008. We are, however, waiting to fix the date for actual launch to guarantee there are a sufficient number of customers from day one, increasing the probability of starting with a liquid market.”
The first contracts traded will be base load (24 hours per day supply) futures with monthly, quarterly and one-year delivery periods. Assuming Idex proves successful, Borsa Italiana has regulatory approval to list products for up to three-year maturities.
Since Ipex was formed in 2004, there has been a significant increase in trading activity. Annual volumes have risen from 231.5 terawatt hours (TWh) in 2004 to 329.9 TWh in 2007. Additionally, the number of participants on Ipex has increased from 73 to 127 over the same period.
Although the introduction of a regulated futures market is a logical step for the Italian electricity market, some market participants said there was little need or demand for electricity derivatives until recently.
Valerio Bosa, a senior trader at EDF Trading, said the lack of risk in the underlying electricity price meant there was little incentive to create exchange-traded derivatives. “Now that we see some volatility in the spot price, companies are more interested in hedging their risks through forwards.”
In theory, electricity futures give companies the chance to reference a transparent forwards price, making the negotiating process between counterparties more straightforward. Another benefit is that the contracts will be guaranteed by the exchange’s own clearing house, CC&G.
"Italy is no different to other countries in having major concerns about credit risk at this time, so a single clearing house to take all this credit risk should be positive,” said Domenico De Luca, managing director at EGL Italia, a company active in the sale and trading of power and natural gas.
The introduction of exchange-traded electricity futures follows the emergence of the privately negotiated over-the-counter forwards market, which began trading almost immediately after Ipex was formed in 2004. According to seasoned market participants, the OTC market suffered from illiquidity in its early stages, making it difficult for participants to take or exit positions. Over time, the market has evolved, and a broader range of contracts are now available on the OTC market than will initially be possible through Idex. However, liquidity remains an issue.
“In Italy, the OTC market has experienced a few difficulties as a result of trading with small counterparties,” explains Bosa. “Credit risk has always been an issue and the small players can be slow to deal with. This has caused some companies to stay away from the market. Having an exchange as a central clearing house will solve some of these problems. Additionally, if firms start trading exchange-traded products, it could encourage them to become more active on the OTC market.”
See also: Finding a niche