How to reverse the negative liquidity trend in the Nordic market_

1. NAET liquidity task force:
How to reverse the negative liquidity
trend in the Nordic market?
Heine Rønningen,
NAET liquidity task force, 23rd May 2018

2. Market efficiency and liquidity cannot be created out
of thin air…
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 To solve the liquidity problem we need to look at the symptoms, identify causes,
make an assessment and select the treatment - needs to be based on:
 Past experience and present situation: Empirical values sound based in
market efficiency theory - liquidity, product homogeneity, hedging value,
active participants, alternative markets etc.
 Future expectations: Energy Union, Ten Year Network Development Plans,
PCI list, Bidding Zone configuration, Regulatory framework, M&A activity….
 How to reverse the negative liquidity trend? The simple answer is to
identify the changeable root causes and change them to the better.
 .

3.  Hard to choose the right treatment if we cannot agree upon the causes…
 Suggestion of Changeable Root Causes – the negative changes in:
 Market concentration and Active participants
 Hedging value and Bidding Zones
 Hedging value and System Price Calculation
 Risk Capital and Alternative Stronger Trading Hubs
 Competition from Bilateral Trades / PPA
 The others: Fees, Trading Platforms…
Nordic Liquidity Assessment:
Avoid Symptomatic treatment - Find the real causes
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4. Nordic Liquidity Assessment – Root Cause Analysis:
Market concentration & Active Participants
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 Compared to 2008 the number of active participants are cut in half:
 Solution:
 Harmonize the product structure to increase the total market liquidity
 Some of the smaller clients will never use multiple exchanges
 Less risk for X-Exchange Market Makers if products are the same
 EEX dilemma: Nordic product structure seems to be a bit outdated…

5. Nordic Liquidity Assessment – Root Cause Analysis:
Hedging value and Bidding Zones
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 Insufficient correlation between System Price and Nordic Bidding Zones
 The outliers reduces hedging value, dampens and randomizes volatility
 Solution:
 Reconfigure - Create a largest possible hub of correlated Bidding Zones,
remove the uncorrelated Bidding Zones (they need a separate hedge)
 Remember: EPAD + System Price = Bidding Zone Price, regardless of if the
Bidding Zone is part of the System Price index or not

6. Nordic Liquidity Assessment – Root Cause Analysis:
Hedging value and System Price Calculation
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 Current calculation method is a black box – changes “every year”
 Solution:
 Get rid of the Black Box - Change the calculation to a plain, transparent and
relevant Volume Weighted Index
 Even more important if Flow Based Market Coupling is introduced (2019?)

7. Nordic Liquidity Assessment – Root Cause Analysis:
Risk Capital and Alternative Stronger Trading Hubs
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 The Nordic liquidity decrease can be seen as a function of the Phelix success:
 Solution:
 Use Phelix as a proxy hedge for long dated futures (year ahead +)
 Improve spread trading Phelix and “Nordic hedging contracts”
 Focus product development on short dated futures for Nordic hedging
alternatives (weather driven basis risk materialise short term)

8. Nordic Liquidity Assessment – Root Cause Analysis:
Competition from Bilateral Trades / PPA…
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 Tailor made contracts will never work as exchange traded…
 The problem is not the PPAs, but more the lack of PPA hedging alternatives
 Solution:
 Improve hedging of Bilateral Trades / PPAs or offer an alternative in long
dated standardized contracts. Consolidate the focus by:
 Market Maker Windows
 Book building Auctions

9. Nordic Liquidity Assessment – Root Cause Analysis:
The others: Fees, Trading Platforms…
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 Hard to classify fees and trading platforms as root causes…
 Solution:
 Competition will keep fees at a decent level - Sustainable fees guarantees
sustainable exchanges, watch out for the “for free” offers
 Blockchain mania: Removing the trusted third party (clearing) will increase
both the entry barrier and credit risk
 Non regulated markets will struggle to attract risk capital

10. The Nordic liquidity challenge & the quick fix
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 The Nordic market is very attractive based on its price drivers and size,
but….
 Differences in design and regulatory framework do not represent an
added value
 Improving hedging value is the only way to increase hedging
premiums
 Increasing the pool of active clients is crucial - a handful is not
sufficient
 Simplicity is always preferred over complexity in financial markets. Start
with the low hanging fruit and change the underlying instruments, prioritize:
 Hedging value - correlation with actual risk
 Compliancy - needs to be EU compliant
 Transparency - simplicity rules, no black box calculations
 Robustness - can't change it "every year"
Good luck with the implementation!

11. European Energy Exchange
www.eex.com
Heine Rønningen
heine.ronningen@eex.com
+47 90 60 87 74

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R-Squared

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Slope