February 2006 Market Clearing in the Energy Industry 45 © Copyright 2005, CCRO. All rights reserved. 8. APPENDIX A: BENEFITS OF CLEARING IN REDUCING CREDIT COSTS BREAKDOWN OF UNCLEARED COST OF CARRY CREDIT EXPOSURE Breakdown Uncleared cost of carry credit exposure Counterparty default Collateral/margin posting Liquidity cost Transaction cost 110bp 84bp 20bp 5bp 1bp Counterparty default cost: • Calculated as cost of equity x provision for credit loss • PA estimated cost of equity = 10.5% • Estimated reserve for credit loss using Basel standard = 8% o This is an international banking standard, but recommended for clearing of all types of products • Counterparty default cost = 10.5% x 8% = 0.84% or 84bp Collateral/margin posting cost: • Estimated as average cost charged by banks for L/C = 0.2% or 20bp per transaction on annual basis • Collateral/margin posting cost is the best equivalent for posting cash Liquidity cost • PA estimate of .05% or 5bp