Contract for difference (CFD)
European Union Electricity Market Glossary

 


 

 

Financial contract for difference (CFD) is a derivative product that gives the holder an economic exposure, which can be long or short, to the difference between the price of an underlying asset at the start of the contract and the price when the contract is closed (see for example ESMA's Addendum Consultation Paper MiFID II/MiFIR of 18 February 2015, ESMA/2015/319).

 

CFDs are listed as financial instruments in the Section C(9) of MiFID II (Directive 2014/65/EU) as well as Annex I, Section C(9) of MiFID I (Directive 2004/39/EC).

 

CFDs are rather flexible financial derivatives and suitable to give exposure to a variety of different underlying instruments such as single shares and other transferable securities, indices and currencies.

 

CFDs are mostly, if not exclusively traded OTC.

 

In summary the following CFD classes, defined at the type of underlying level, were identified: i. equity; ii. bond; iii. futures on equity; iv. option on equity; v. commodity; and vi. currency (FX).

 

CFDs having an equity instrument as underlying represent around 72% of the notional amount traded, followed by contracts on currencies.

  

 

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Key support elements of RES in Europe: moving towards market integration, CEER report, C15-SDE-49-03, 26 January 2016, p. 38 - 40

 

 

Case study on the "Contract for Difference" scheme in the UK

 

The Contract for Difference (CfD) renewable support scheme is one of three major policy interventions introduced under the Electricity Market Reform (EMR) under the Energy Act 2013. It aims to overcome the limitations of the RO (discussed in section 2) by achieving the following:

 

- provide greater revenue certainty to investors of RES generation;

 

- reduce the borrowing costs of financing RES generation projects; and

 

- encourage competition both within and between generation technologies to deliver cost-efficient RES capacity and improve the affordability of low carbon energy to consumers.

 

Basic functionality of the CfD scheme

 

The CfD scheme places an obligation for RES generators to sell electricity. The CfD acts as a contractual agreement between the generator and a Government owned counterparty - the Low Carbon Contracts Company (LCCC). This agreement guarantees that the generator will be paid a set price, 'the strike price', for each unit of electricity produced for the duration of the agreement (15 years). RES generators bid the strike price they are willing to receive for a specified capacity (MW) in a competitive auction. Funding is awarded to RES generators based on these bids, with cheapest strike price bids always accepted first. Once the successful bidders sign their CfD agreement, they have one year to provide evidence of substantial commitment to investment in a project, or the contract will be cancelled and the funding recycled. Once projects are operational, CfD holders have two main sources of revenue from RES generation:

 

- Direct revenue from electricity: In the short term, the generator will gain revenues from electricity sold in the wholesale market; and

 

- Compensation from CfD: Typically, the strike price will be set at a higher price than the average market price for electricity. This 'premium' allows generators to recover the additional costs generally associated with RES technologies. When the strike price is higher than the 'reference price' – a measure of the average electricity price in the GB wholesale market - the generator is compensated the difference.

 

RES generators under the CfD scheme will be subject to the same standard balancing responsibilities as defined by UK national regulation, i.e. they are responsible for settlement costs associated with deviations from their delivery commitments.

 

Key lessons learnt

 

As of December 2015, none of the successful projects have started generating. Therefore, only the following indicative lessons learnt can be drawn:

 

- Value for money: Strike prices established by the first auction cleared at a level significantly lower (on average 17% lower) than the administrative strike price, for almost all RES technologies, in all years. The administrative strike price, set by Government was determined to be a 'fair' return on investment should the competitive auction not result in a cleared strike price. This provides early evidence that the auction process is delivering better value for consumers, whilst still supporting new RES projects.

 

- Transparency: For the first time in any GB renewable support mechanism, the CfD auction provided advance prices of RES technologies made available in the public domain. This process has revealed industry determinations of the actual costs of providing RES, for a large number of RES technologies. This level of transparency on the cost of RES generation has been missing from previous schemes, and should help to inform better auction design in the coming years of the CfD scheme.

 

- Technology competition: Onshore wind dominated the CfDs in the Pot for established technologies, with offshore wind dominating the Pot for less-established technologies. The auctioning process balances the need for cost effective support schemes for RES generation, whilst recognising that less-established technologies will need further support. The domination of wind projects in both pots may mean that other technologies may find it hard to compete for funding through the CfD scheme, leading to a convergence of new capacity to a small number of generation technologies (ie the most efficient technologies in each Pot.

 

 

 

 

 

 

 

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    Documentation    

 

 

 

 

 

Questions and Answers Relating to the provision of CFDs and other speculative products to retail investors under MiFID, 31 March 2017, ESMA35-36-794

 

ESMA's Addendum Consultation Paper MiFID II/MiFIR of 18 February 2015l ESMA/2015/319

 

Key support elements of RES in Europe: moving towards market integration, CEER report, C15-SDE-49-03, 26 January 2016, p. 38 - 40 

 

 

 

 

 

 

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    Links    

 

 

 

 

 

 

 

BaFin, Guidance notice on the general administrative act of 8 May 2017 regarding contracts for difference (CFDs)

 

BaFin, General Administrative Act regarding CFDs

 

 

 

 

 

 

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Last Updated on Tuesday, 05 December 2017 22:25
 

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