Energy exchanges are an essential part of the trading marketplace, yet establishing a successful exchange can be a daunting prospect for many countries. The answer lies in the use of small, bespoke systems that can grow with the needs and size of the market.
Since the initial deregulation drive that spawned the UK and Nordic energy markets well over a decade ago, the demand for energy derivatives has blossomed onto the global stage. Today, we are seeing a new wave of deregulation freeing up markets like Korea, the Philippines, India and many central European economies, paving the way for a new generation of energy exchanges. Yet many of these markets have suffered from minimal investment over the years, and consequently lack some of the critical technologies necessary to create a truly successful exchange platform. The problem is compounded by the relative poverty of some east European markets, making it almost impossible to raise the capital required to build a new exchange from the bottom up. If these markets are to reap the rewards that a diverse and fluid energy exchange can offer, then they must seek another path.
The Condico solution can help countries to build small, dedicated exchanges from the bottom-up
It was during the second wave of deregulation, back in the mid 90s, that it first became evident that those wishing to establish energy exchanges in their domestic markets were in for a bumpy ride. When France, Germany and Spain jumped on the bandwagon, it became clear that unless they wished to purchase an existing platform tailored to another market’s requirements, they were going to have to invest significant resources in developing bespoke solutions.
The most successful energy exchange to date has been Norway’s NordPool, and it is to this that many of the players in the second wave of deregulation turned as a leading light. Nord Pool, the Nordic Power Exchange, was established in 1993 and became the world’s first multinational commodity exchange for electric power. Owned in equal parts by the two national grid companies, Statnett in Norway and Svenska Kraftnät in Sweden, Nord Pool also operates Nord Pool Clearing – a 100 per cent owned subsidiary to Nord Pool and licensed commodity clearing house.
Once a deal is captured, the platform delivers it to the post-trade engine, where the system updates all trades
But while it may have made sense, or was at least commercially viable, for exchanges in wealthier markets to purchase established platforms and tailor them to their own requirements, the strategy is simply untenable for poorer economies, particularly in today’s market conditions.
To date, start-up exchanges, especially those in emerging or developing markets have faced a somewhat stark choice: to either invest scarce resources in the creation of their own exchange (an incredibly risk-heavy proposition) or purchase an existing platform laden with components surplus to their immediate requirements but for which they would have to pay nonetheless. It was to provide a third, more palatable option, that OM launched Condico in September 2002.
“We saw there was a need for this system,” explains Magnus Haglind, manager of business development for energy systems at OM. “We saw these big commodity hubs emerging, but we also noticed a growing number of small regional market places popping up all around the world. These required smaller systems to kick-start their markets, but they also needed a reliable system to ensure success.”
Based on Calgary’s Natural Gas Exchange (NGX), Condico employs tried and tested technology to provide start-up exchanges with a cost effective, user friendly platform from which to grow and expand their operations without paying unnecessarily for superfluous whistles and bells. NGX plays an important role in the Condico story and is a key factor in its ability to allow small-scale users to establish their own platforms. When it was launched in 1994, NGX was itself no more than a hopeful start-up venture for the Canadian market. However, the initial vision of an electronic exchange that could provide a centralized meeting place for buyers and sellers of natural gas with standardized rules took off, and today NGX is a successful, highly liquid platform. In addition to the concept of electronic trading, the early vision of NGX included clearing and settlement. Since inception, NGX has cleared all transactions, allowing it to offer the marketplace the security of a clearing house, the efficiency of central position netting, and the advantage of anonymous trading. Having been acquired by OM in 2001, NGX became the blueprint for establishing a successful, cost efficient marketplace, ultimately evolving into Condico.
Cost efficiency has always been a kernel of the Condico project; the ability for a small-scale user to import the system and be up and running without having to concern themselves with the technical hurdles of a major power exchange. By cherry-picking core components from NGX, OM was able to build a system that addressed the total cost of ownership that a small, embryonic exchange would have to consider. To that end, Condico employs open, established APIs which allow independent software vendors to develop and integrate their own systems alongside Condico. This frees domestic energy exchanges to develop their own solutions in their own time, expanding and evolving the Condico platform to suit their needs as and when market conditions dictate.
Condico is based on Linex and Java, an open technology standard, which allows users to run it on whatever operating system they themselves prefer.
“We have really focused on the operational side to make it easy to run and ensure that the new market places can use the system in a cost efficient way. You don’t have to have a huge stock to operate the system,” explained Haglind. Clearly, integration plays a key role when a start-up exchange is considering the most economical way to get the ball rolling. The transparent nature of Condico makes it easier to integrate with back office systems and to enable users to employ internet-based technology for browser-based trading. In addition, the multi-faceted nature of the system welcomes all-comers to trade on it, helping any new exchange rapidly acquire liquidity.
To simplify life for the smaller exchange, Condico incorporates functionality to handle all aspects of the trade lifecycle – from execution to completion. Condico incorporates order management and a trade matching engine, enabling users to choose between different matching engines depending on the market. While some markets operate auction-based matching engines, others prefer continuous matching of orders; Condico allows the user to shift matching engine depending on market characteristics or, if they prefer, operate parallel matching engines if dealing with multiple markets. Once the deal has been captured, the platform delivers it to the post-trade engine, where the system continuously updates the position of all trades contained within. Completing the chain, Condico also offers basic settlement and risk validation functionality.
Indeed, Condico has been designed to cover every eventuality a new exchange may face, as Ulf Lidman, president of energy systems at OM, explains: “In Condico we have a trading engine to match orders coming in from the market, but also functionality for doing position management, risk validation from the exchange perspective, and handling the settlement of the trades. This was a key success factor for NGX as it is important for a small energy exchange not to have too many systems to develop and to have seamless integration from trade execution to settlement.” Prior to Condico, the energy exchange industry was reliant on in-house development or the expensive buy-in of third-party solutions. With the arrival of this targeted, cost efficient platform, those markets attempting to establish a successful energy exchange are finally able to employ a system on their own terms.