Comments on: Is E.ON’s trading unit profitable?

By: Breakfast Links | Points and Figures

Breakfast Links | Points and Figures — Tue, 16 Aug 2011 08:02:06 +0000

[...] trading work for [...]

By: John Parsons

John Parsons — Sat, 13 Aug 2011 18:21:24 +0000

Be careful about thinking about the capital employed as limited to the explicit margin that is posted. Often times a company may be able to trade derivatives without posting any margin, if it has a strong balance sheet and its counterparties are willing to take its credit risk. But that doesn’t mean it hasn’t used up capital making the trade. When it leans on its balance sheet, it is using up scarce capital that could support a different trade or a different line of business. There is an opportunity cost. All bank trading desks know this. Banks impute to the desk a capital charge based on the risk of the desk’s positions. Companies like E.ON should be doing the same thing, and they could report in their Annual Report the imputed capital dedicated to the trading unit.

By: nicholas ronalds (@asiasmarkets)

nicholas ronalds (@asiasmarkets) — Fri, 12 Aug 2011 13:40:15 +0000

A related issue is that what the cost of using margin is; brokers and exchanges pay interest on margin, usually close to the “risk-free rate” (which is admittedly low now). For a company that keeps a certain amount of cash lying around anyway, the cost of holding some of it in interest-earning margin is 0, or close to it.

By: Sid Kaul (@_sidk)

Sid Kaul (@_sidk) — Thu, 11 Aug 2011 22:07:55 +0000

It could be the case, as generally with energy trading, they are employing derivatives in their hedging and prop trading books. Technically this would mean capital employed is equivalent to the margin requirement required by counterparties.

Their concern may be, and I only guess, that such a capital employed & ROCE figure would not readily translate into something comparable to the rest of the group. Since margin requirements can be very small and varying. So for example, a 100mio OTC contract may be margined at 20% and generate 5% return, giving a theoretical 25% return on capital employed.

Another issue is the appropriate proxy to cost of capital. This does not have a ready equivalent in a trading book but my personal predilection would be to use a risk capital figure. Well managed trading desks have independent risk managers who would charge a portfolio with a risk capital weight based on their own risk models, such as but not limited to VAR.

It certainly would be appropriate to compare risk capital weight to the margin capital employed even if neither can be compared to the rest of the book. Banks publish their risk capital figures so why not utilities?

Other questions would be: Do they mark to market their portfolio? Do they limit exposures against their internal risk capital figure (trading solely to the limit of your counterparty’s margin requirement is a classic trading desk blow up scenario)? Could they publish their risk capital model and does it incorporate liquidity and counterparty risk? And if not, why don’t they have one?