Secure Trading & Clearing

An introduction to NGX ClearingApril 2008

Version 40

2

Executive Summary• NGX is an established electronic exchange and clearinghouse

– Over 160 contracting parties (members) across North America– Clearing over $8 billion monthly of physical gas and financial power– Delivering over 14 Bcf of physical gas daily– Capital structure includes full margining, ‘cushion’ collateral, and

guarantee fund– Owned by TSX Group (Toronto Stock Exchange)– Clearing bank and regulatory oversight– Zero-default history

• NGX’s value proposition is twofold– For traders: maximize price improvement opportunities, minimize

market impact– For risk managers: reduce overall risk, maximize capital and operational

efficiency

• NGX’s ‘direct’, non-mutualized clearing model is ideally suited to the trading and clearing of physical energy commodities

3

Sections

• Overview (page 3)

• Clearing Structure (page 13)

• Risk Management (page 26)

• Contacts

4

Introduction to NGX

• Business Concept:– Provide electronic trading and clearing services to

North American energy market participants– NGX is a service provider and therefore does not

trade or take positions

• Headquartered in Calgary, Alberta, Canada

• Incorporated in 1993, began trading operations in Feb 1994

• Ownership History– Initial Ownership by Westcoast Energy Inc.– Acquired by OM on Jan 1, 2001– Acquired by TSX Group March 1, 2004

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Ownership: Introduction to TSX

• TSX Group is a cornerstone of the Canadian financial system and is at the centre of Canada’s equity capital market

• TSX Group owns and operates Canada’s two national stock exchanges, the Toronto Stock Exchange, serving the senior equity market, and TSX Venture Exchange, serving the public venture equity market

• From its preeminent domestic base, TSX Group’s reach continues to extend internationally, through TSX Markets and TSX Datalinx which provide the trading and data to the global financial community who access Canada’s equity capital market

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NGX Core Competencies

• Clearinghouse Operations– Physically and financially settled over 1,300,000 trades– Zero-default history

• Liquidity Development– Focus on customers and quality of service– Commitment to the reduction of trading impediments

• Electronic Trading & Clearing– Over 12 years of experience developing and operating

high-reliability, high-performance electronic trading and clearing systems

– Trading now available through ICE’s leading-edge trading platform

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Current NGX Product Locations

NGX Products & Services

Financial Products Physical Products

NGX INTRA-ALBERTAEMPRESS EMERSON/GREAT LAKES

FUTURES SWAPSHENRY SWING SWAPS

LDS FOR GDD

PARKWAY

IROQUOIS

NIAGARA FALLSCHIPPAWA

DAWN

CHICAGO SWAPS

MICHCON SWAPS

ALBERTA POWER SWAPS

MALIN SWAPS

ROCKY MTN SWAPS

ATCO N&SSTATION #2

TEP

PG&E CITYGATE

PG&E CITYGATE SWAPS

SOCAL SWAPS

MALINST. CLAIR

SUMAS SWAPS

ALBERTA SWAPS

HUNTINGDON

ONTARIO POWER SWAPS

EL PASO SWAPS

Temporarily unavailable

HENRY HUB

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Available Forward Curves

• Forward strips listed from yesterday to year four

• * US physical gas products are listed by ICE, cleared by NGX

• ** Gas financial products are available for block/OTC clearing, not onscreen trading

$ Fixed Price $ Monthly Index $ Daily Index $ Basis $ Location Spread Fixed $ Location Spread BasisC AB-NIT C AB-NIT C AB-NIT 2A US AB-NIT C AB-NIT Empress US Dawn NiagaraC ATCO North C Station #2 C AB-NIT 4A US Emerson US Dawn Niagara US Dawn IroquoisC Empress US AB-NIT C AB-NIT 5A US Niagara US Dawn Iroquois US Dawn ChippawaC Station #2 US Malin C Station #2 US Iroquois US Dawn Chippawa US Dawn ParkwayC TEP US C ATCO North US Chippawa US Dawn Parkway US St. Clair DawnUS AB-NIT C TEP US Parkway US St. Clair Dawn US AB-NIT DawnUS Emerson US Dawn US DawnUS Niagara US Malin

US PG&E CitygateUS Iroquois

US Henry

US Chippawa

US St Clair

US Parkway

US Malin

US PG&E Citygate

US DawnUS St. ClairUS Malin

Physical Products*

HenryUS

US PG&E Citygate

US Henry

PG&E Citygate

HenryUSUS AB-NIT Emerson

$ Fixed (Fixed-for-Floating) $ Basis $ Swing $ Index (Floating-for-Floating) $ Options $ Location BasisC AB-NIT Fixed US AB-NIT C Alberta Flat Elec. US AB-NIT Index Swap C Alberta Fixed US PGE Citygate Malin Basis SpreadUS Sumas Fixed US AB-NIT Daily Basis C Alberta Peak Elec. US LDS for GDD US Malin AECO Basis SpreadUS Futures Swap US Sumas C Alberta Ext. Peak Elec. US Rockies US SoCal Rocky Mountains Basis SpreadUS Michcon US Chicago C Alberta Off-Peak Elec. US Malin US Sumas AECO Basis SpreadUS Socal Fixed US Rockies C Alberta Super-Peak Elec. US SumasUS PG&E Citygate Fixed US Malin C Alberta Swing US Michcon

US Michcon US Sumas US SocalUS Socal US Henry Hub US PG&E CitygateUS PG&E Citygate US Mid-Columbia PeakUS Malin Daily Basis US Mid-Columbia Off-PeakUS Rocky Mountains Daily Basis US RockiesUS SoCal Daily Basis US MalinUS PGE Citygate Daily Basis US MichconUS CIG Rockies Daily Basis US SocalUS EP San Juan Daily Basis US PG&E CitygateUS EP Permian Daily BasisUS Sumas Daily Basis

Financial Products **

Temporarily unavailable

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NGX Services

• Exchange– Centralized electronic trading– Standardized contracts– Pipeline balancing instruments– Cleared and bilateral trading – Market advocacy (facilitating transactions)– Market agency (facilitating order entry)– Real-Time Price Index Generation

• Clearing House– Assured performance– Trade and counterparty netting– Centralized collateral management– Centralized risk management

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Operational Statistics

• 160+ NGX Contracting Parties– All “Member” firms eligible to transact through

the Exchange and/or clear through the Clearing House

• List 111 physical and derivative products

• Average in Excess of 500 Traders Daily

• 2007 Trading Statistics:– Volume = 11.2 Tcf– Transactions = 238,227

• Average Daily Deliveries in Excess of 14.0 Bcf

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NGX Volume History

Historical NGX Trading Activityto February 29th, 2008

-

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

11,000

12,000

Year

To

tal Q

ua

nti

ty T

rad

ed (

PJ)

-

100

200

300

400

500

600

700

800

900

1,000

1,100

1,200

1,300

1,400

1,500

1,600

Mo

nth

ly A

vera

ge

Tra

ded

(P

J)

# of Days 324 365 365 365 365 365 366 365 365 365 366 365 365 365 60

Electricity (PJ) - - - - - - - - - 18 20 4 39 127 16

US Swaps - - - - - - - - 12 58 58 93 10 3 -

CDN Swaps - - - - - - - - 260 1,130 1,458 412 64 35 8

OTC Clearing (PJ) - - - - - - - - 84 351 236 449 724 842 106

U.S. (PJ) - - - - - - - - 1 6 - 1 16 14 -

Eastern Canada (PJ) - - - - - - 152 389 581 999 1,132 927 1,377 1,606 224

Western Canada (PJ) 23 59 427 938 1,379 2,349 2,353 2,756 3,617 3,901 4,513 6,936 7,591 8,616 2,060

Percentage Growth 0% 161% 621% 119% 47% 70% 7% 26% 44% 41% 15% 20% 11% 14% 57%

Monthly Average Traded (PJ) 2 5 36 78 115 196 209 262 378 534 613 735 818 937 1,207

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

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NGX Product Dispersion

2008 Trading Turnover by Product Type

Eastern Canada Physical (PJ)9.3%

OTC Clearing (PJ)4.4%

Western Canada Physical (PJ)

85.3%

Electricity (PJ)0.7%

U.S. Physical (PJ)0.0%

CDN Swaps (PJ)0.3%

US Swaps (PJ)0.0%

Western Canada Physical (PJ)

Eastern Canada Physical (PJ)

OTC Clearing (PJ)

CDN Swaps (PJ)

U.S. Physical (PJ)

US Swaps (PJ)

Electricity (PJ)

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Sections

• Overview (page 3)

• Clearing Structure (page 13)

• Risk Management (page 26)

• Contacts

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NGX Clearing Operations

• NGX Intermediation– NGX acts as buyer to every seller, and seller to every

buyer, for the purpose of facilitating anonymous trading and clearing

• Private Clearing Operation– Contracting Parties are not mutually exposed to

another Contracting Party’s default

$

$ or Natural Gas

CPABuyerBuyer SellerSeller

$

$ or Natural Gas

CPA

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How is Counterparty Risk Mitigated?• Standard Rules

– All Contracting Parties are subject to the same rules and regulations as set forth in the CPA

– Contracting Parties must meet minimum creditworthiness test and meet credit requirements on an ongoing basis

• Collateral Provisions– The requirement for liquid collateral to be placed on

deposit with NGX in advance and in excess of margin requirements provides the security against default

• Liquidation Rights– NGX has a number of rights if a Contracting Party default

occurs, including the ability to close-out (or accelerate) all forward positions for the defaulting party

– Collateral is utilized to cover any liquidated damages

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How is Counterparty Risk Mitigated?

• Backstopping– Delivery risks are mitigated through the use of backstopping

services provided by various market participants, including storage facilities, large shippers, and pipeline operators

– Backstopping is typically an arrangement for immediate provision of supply/market at a pre-determined price (usually based on index)

• Settlement Bank– The settlement bank daylight and overdraft facilities provide for

clearing operation liquidity during a default situation and assist in managing timing issues on settlement day

• Guarantee Fund– NGX provides a $US 100 million trust fund for Contracting Parties

to access in the event of an exchange default, backed by a parental guarantee from TSX

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NGX Clearing Structure

Physical Backstopping (storage)

Settlement Banking Credit Facility

Defaulting Party Collateral (100% Coverage Under NGX Exposure Model)

NGX Cash Reserves

NGX Guarantee Fund (USD$100MM CIBC Mellon Trust)

Deposit Agreement

Deposit Agreement

$

$ or Natural Gas

PayerPayer PayeePayee

$

$ or Natural Gas

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NGX Collateral Makeup

• Collateral on deposit in excess of CAD $2.561 Billion

• Approx. CAD $2.26 Billion LC’s, CAD $0.30 Billion Cash

NGX Margin Dispersion March 15, 2008

AR Margin $1085

Variation Margin $96

I nitial Margin $679

Cushion Collateral $465

Surplus Collateral $217

$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

CAD $MM

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NGX Central Clearing Benefits

• Neutral, Independent Risk Management– NGX is impartial and the nature of the clearing

business provides a strong incentive to maintain a default-free clearing operation

– NGX is not a market participant, does not take a market view and earnings are not directed by commodity prices

• Centralized Collateral Requirements– Concentration of capital affords most efficient use

across all other contracting parties

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NGX Central Clearing Benefits

• Counterparty Netting Facilities– Central clearing operator and standardized netting

rules create an environment to net physical and financial exposures across multiple counter parties and locations

• Acceleration, Liquidation, Close-Out Procedure– NGX has embedded, and has enforced, rights of

acceleration for all contracts traded through the Exchange to mitigate risks to all Contracting Parties

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Value Proposition of Clearing

• Risk Mitigation “Trade-Off”– When a Contracting Party introduces risk to the clearing

operation (ex. Receivable exposure or Mark-to-Market losses) they must provide collateral to support the risk

– In return, all Contracting Parties that are exposed to the clearing operation due to the introduction of risk (ex. Payable positions and Mark-to-Market gains) are secured against defaults

Cost of Collateral • Is the risk reduction worth the cost?

Value of ReducedExposure • Will I get paid?• Will my gas get delivered?

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Collateral Concentration

NGX (centralized)

$3MM

$20MM

Access to choose bids/offers from 100+ other market participants under the same collateral umbrella

$30MM$7MM

OTC Bilateral

$10MM

$10MM

$10MM

BuyerBuyer SellerSeller

A

A

A

B

C

D

SellerSeller

B

C

D

BuyerBuyer

A

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Exchange NettingOTC Bilateral

5 Units

5 Units

10 Units

BuyerBuyer SellerSeller

A

A

D

B

C

A

NGX (net effect)

5 Units

10 Units Netted 10 10 Units

10 Units 5 Units

SellerSeller

A

B

C

BuyerBuyer

A

D

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Clearing Statistics

• Cleared Transactions – 230,000+ transactions cleared annually– Notional value of transactions consummated through

NGX is in excess of CAD $60 Billion annually

• Margin– Over 160 corporate margin accounts held by NGX– Manage margin accounts in excess of CAD $4.0

Billion in cash and letters of credit

• Settlement– Settlement of $US and $CAD cash streams– Monthly settlement values over CAD $2 Billion

processed by the clearing house

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Oversight

• Regulatory – ASC – Exemption order, compliance with operating

principles– CFTC – 2(h)(iii) exemption, “Eligible Commercial

Market” status

• Clearing Bank– TD Bank, NGX’s Clearing Bank, maintains oversight of

NGX clearing operations to support credit facility, CAD $300MM daylight, CAD $20MM demand, USD $100MM LC

– Clearing Bank controls segregated collateral accounts– Clearing Bank authorizes movement of funds from

collateral accounts– Clearing Bank has full access to NGX trade/clearing

data and reporting, ensures collateral accounts are sufficient to manage Contracting Party margin requirements

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Sections

• Overview (page 3)

• Clearing Structure (page 13)

• Risk Management (page 26)

• Contacts

27

Performance Risks

• Failure to Make/Take Delivery– NGX is exposed to the price at which an alternative

supply/market can be found – Risk is managed with backstopping contracts, penalty

mechanisms, collateral requirements and credit policy

• Failure to Pay– NGX is exposed to receivables risk on settlement

dates– Risk is managed with penalty mechanisms, collateral

requirements and credit policy

• Failure to Provide Collateral– NGX is exposed to the risk that Contracting Parties

will not provide sufficient collateral to manage their risks

– Risk is managed with liquidation provisions

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Margin Requirements

• Risk Measurement– Performance risks are quantified through NGX’s

margining methodology, which attempts to estimate probable worst-case portfolio value

• Collateral– NGX collects collateral from Contracting Parties to

secure their portfolios and protect the clearing operation from defaults

• Margin Triggers– If margin requirements reach 80% of collateral

deposited, NGX will request additional collateral– At 90%, NGX may restrict the Contracting Parties

trading capabilities– At 95%, NGX is entitled to invoke the liquidation

procedure

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Collateral

• Collateral Policy– Contracting Parties must have sufficient collateral to

cover their Margin Requirement, utilizing any combination of the forms of collateral and offsets below

– Collateral is held to support the Contracting Party’s traded positions and can only be used to remedy a performance failure by the Contracting Party itself

• Collateral Requirement– Collateral is accepted in the form of cash and

irrevocable letter of credit from an approved bank rated A or higher

– Collateral requirement can be reduced with an accounts payable or positive variation margin offset

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Risk Measurement

• Accounts Receivable/Payable– A calculation of the value of gas delivered– Margin requirement increases if gas is taken prior to

payment, and decreases if gas is delivered prior to payment

• Variation Margin (Mark-to-Market)– A calculation of the price at which a forward position

could be instantaneously liquidated given current market prices

• Initial Margin– A calculation of the probability of a movement in

market prices during a two-day holding period– Initial margin coverage protects against a prolonged

liquidation

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Position Tracking

• Consolidation and Netting– Positions within each product and date range are

consolidated into gross long and short positions– Liquidation risk is managed against the net of the

long and short positions

• Instruments and Date Ranges– Trades across all instruments in a product are

grouped by date ranges in real-time– Instruments may overlap, but date ranges are unique– Ex. A M-Nov instrument and a WB-Nov instrument

would each populate a position for November 1 to November 30th

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Physical Risk Management

1st of Delivery Month Last Day of Delivery Month 25th of Payment Month

25 Days 60 Months30 Days

Payment Exposure- Margined at full value

Current Month Exposure- Deliveries margined at full value- Open position initial margin- Variation margin all positions

Forward Position Exposure- Open position initial margin- Variation margin all positions

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What are Initial Margins?

• Defined– Initial Margin is an estimation of the value to which

the clearing house might be exposed during a period of liquidation

– Initial Margin is intended to measure potential change in a value of a portfolio beyond the last mark-to-market price during a period of liquidation

• How Does NGX Utilize Initial Margin?– NGX applies initial margin to Contracting Parties’ net

open positions that would be subject to liquidation in the event of a default

– Initial margin acts as additional position coverage that NGX can utilize in the event of a default to ensure that the clearing operation remains secure

34

Initial Margin Methodology

• Utilization of VaR– NGX utilizes a Value-at-Risk methodology to

determine initial margins– VaR is a method of assessing risk that uses standard

statistical techniques routinely used in a variety of technical fields

– NGX’s VaR calculation measures the worst expected price change in a date range for a product over a given time interval under normal market conditions at a given confidence level

– VaR, while imperfect and subject to several limitations, provides a measurement tool that has historically been an accurate measure to evaluate potential exposure in a portfolio

35

Margin Offsetting

• Accounts Receivable/Payable– All receivables/payables are offset across all NGX

products

• Variation Margin (Mark-to-Market)– All mark-to-market calculations are offset across all

NGX products

• Initial Margin– Initial margins apply only to net open positions for

each forward date range in each product– Limited cross-margining (ie. Initial margin reductions

for highly correlated, yet non-identical hedged positions) is provided today for short-term fixed-price positions

– A project is currently underway to provide portfolio offsets for highly correlated positions in liquid products across both time and locations

36

Margin Example

• Example– On Tuesday, December 27th, BUYCO (buyer)

purchases 5,000 GJ/Day of the NGX Intra-Alberta month of January 2006 physical contract from SELLCO (seller) at a price of CAD $14.000/GJ

• Position Management– As soon as the transaction is matched, BUYCO shows

a net long position of 5,000 GJ for each day from January 1 to January 31, thus a total net long position of 155,000 GJ (ie. 5,000 GJ/Day multiplied by 31 days)

– Conversely, SELLCO shows a net short position of 5,000 GJ for each day from January 1 to January 31, thus a total net short position of 155,000 GJ

37

Margin Example

• Initial Margin– Immediately following the creation of the long and

short positions, initial margin is applied– The initial margin rate for January is currently CAD

$2.300/GJ (17% of price), as statistically generated by NGX

– Both BUYCO and SELLCO have initial margin added to their margin requirement for CAD $356,500 (155,000 GJ multiplied by $2.300/GJ)

– The initial margin requirement will remain in place, unchanged, until one of the following events occurs:

• Either BUYCO or SELLCO offset all or part of their open long/short position, thus reducing their initial margin requirement to zero, or;

• The January long/short position becomes a current month position on January 1st

38

Margin Example

• December 27th to December 31st Margin Requirements– The following table illustrates the margin

requirements for the January position through each remaining day in December:

DateSettlement

PriceBUYCO

Initial MarginBUYCO MTM

SELLCOMTM

SELLCOInitial Margin

Dec 27th 14.100 ($356,500) $15,500 ($15,500) ($356,500)

Dec 28th 13.600 ($356,500) ($62,000) $62,000 ($356,500)

Dec 29th 14.000 ($356,500) Nil Nil ($356,500)

Dec 30th 14.200 ($356,500) $31,000 ($31,000) ($356,500)

Dec 31st 14.200 ($356,500) $31,000 ($31,000) ($356,500)

39

Margin Example

Date

RM-JanSettlement

PriceBUYCO AP/AR

BUYCORM Initial Margin*

BUYCOVariation Margin

BUYCO Total

Margin

Jan 1st 14.300 ($70,000) ($390,000) $45,000 ($415,000)

Jan 2nd 14.200 ($140,000) ($377,000) $29,000 ($488,000)

Jan 3rd 15.000 ($210,000) ($364,000) $140,000 ($434,000)

Jan 4th 15.500 ($280,000) ($351,000) $202,500 ($428,500)

Jan 5th 14.500 ($350,000) ($338,000) $65,000 ($623,000)

CONTINUE

Jan 31st 15.000 ($2,170,000) Nil Nil ($2,170,000)

• January 1st to January 31st Margin Requirements– The following table illustrates BUYCO’s margin

requirements for the January position through each remaining day in January:

* Initial margin rate for the rest of January changes on January 1st to reflect higher spot market volatility, uses $2.600/GJ in the example

40

Margin Example

Date

RM-JanSettlement

PriceSELLCO AP/AR

SELLCORM Initial Margin*

SELLCOVariation Margin

SELLCO Total

Margin

Jan 1st 14.300 $70,000 ($390,000) ($45,000) ($365,000)

Jan 2nd 14.200 $140,000 ($377,000) ($29,000) ($266,000)

Jan 3rd 15.000 $210,000 ($364,000) ($140,000) ($294,000)

Jan 4th 15.500 $280,000 ($351,000) ($202,500) ($273,500)

Jan 5th 14.500 $350,000 ($338,000) ($65,000) ($53,000)

CONTINUE

Jan 31st 15.000 $2,170,000 Nil Nil $2,170,000

• January 1st to January 31st Margin Requirements– The following table illustrates SELLCO’s margin

requirements for the January position through each remaining day in January:

* Initial margin rate for the rest of January changes on January 1st to reflect higher spot market volatility, uses $2.600/GJ in the example