On January 21, 2010, the Federal Energy Regulatory Commission (FERC) issued a Notice of Proposed Rulemaking (NOPR)1 seeking comments on its proposal to amend its regulations to reform credit practices in the organized wholesale electric markets of regional transmission operators (RTOs) and independent system operators (ISOs). Driven by concern over existing credit requirements and the goal to “enhance certainty and stability in the markets and, in turn, ensure that costs associated with market participant defaults do not result in unjust or unreasonable rates,”2 FERC proposes the following modifications (described in more detail below):

  • Shortening the Settlement Cycle;  
  • Limiting the Use of Unsecured Credit;  
  • Eliminating Unsecured Credit in the Financial Transmission Rights Markets;  
  • Providing RTO/ISOs the authority to offset market payments and obligations on a market participant basis;  
  • Establishing minimum participation thresholds with financial and risk management criteria;  
  • Requiring each RTO/ISO to define “material adverse changes” in credit that trigger an RTO/ISO’s ability to demand additional security; and  
  • Shortening credit default cure periods.  

FERC proposes that the various RTO/ISOs submit tariff filings to implement the credit reforms set forth in the NOPR no later than June 30, 2011, to go into effect 30 days after the filing, but also seeks comment on whether the proposed changes should be implemented sooner.

Proposed Modifications

  • Shortening the Settlement Cycle. FERC explains that the length of a settlement (or billing) period “raises both cash management and risk issues.”3 In order to minimize the credit risk to all market participants, FERC proposes to require RTO/ISOs to reduce the time period between when a cost is incurred and when payments are submitted to the RTO/ISO. Specifically, FERC proposes to require RTO/ISOs to revise their tariffs to include settlement cycles of no more than seven calendar days, with no more than an additional seven calendar days for final payment. FERC also requests that market participants file comments addressing the feasibility of daily settlement periods within one year of implementation of weekly settlement periods.
  • Use of Unsecured Credit. FERC proposes to require RTO/ISOs to file tariff provisions that would limit the amount of unsecured credit that could be extended to market participants to no more than US$50 million per market participant. FERC also requests comments on whether the US$50 million cap should cover an entire corporate family and whether the cap should be different for different-sized markets. In connection with the shortened settlement cycle discussed above, FERC also seeks comment on whether it is practical to eliminate unsecured credit in connection with adopting daily settlement periods within one year of implementation of weekly settlement periods.
  • Financial Transmission Rights Markets. In the NOPR, FERC recognizes that financial transmission rights (FTR) can have longer obligation periods and that FTR markets “have unique risks that distinguish them from other wholesale electric markets.”4 In recognition of these “unique risks,” FERC proposes in the NOPR to require each RTO/ISO to eliminate unsecured credit in FTR markets.
  • Ability to Offset Market Obligations. FERC recognizes that while RTO/ISOs “arrange for settlement and netting of transactions entered into between market participants and the market administrator,” the RTO/ISOs generally “do not take title to the underlying contract position of a participant at the time of settlement.”5 Noting that this practice became an issue in a bankruptcy and resulting default in California, FERC proposes to require each RTO/ISO “to clarify [its] status as a party to each transaction so as to eliminate any ambiguity or question as to their ability to manage defaults and to offset market obligations.”6 FERC also seeks comment on whether this proposal would have other implications beyond the mere clarification of the RTO/ISO’s status.
  • Minimum Criteria for Market Participation. FERC proposes to require each RTO/ISO to amend its tariff to specify minimum participation criteria for all market participants.7 FERC explains that the minimum criteria should ensure that each market participant has adequate risk management capabilities and adequate capital, but should not be too onerous to ensure that most traditional market participants can participate. FERC requests comment on what the minimum criteria should be, and how the RTO/ISOs should adopt such criteria.
  • “Material Adverse Change.” FERC explains that many of the RTO/ISOs’ current tariffs permit the market administrator to request additional collateral if there is a “material adverse change” in the market participant’s credit status.8 Finding this phrase ambiguous, FERC proposes to require each RTO/ISO to amend its tariff to specify under what circumstances a market administrator can declare that a “material adverse change” has occurred such that a market participant must post additional collateral. FERC requests comment on the circumstances under which the “material adverse change” language can be invoked, and how the RTO/ISOs should adopt such criteria.
  • Grace Period to “Cure” Collateral Posting. FERC proposes to require RTO/ISOs to limit the time period in which a party may “cure” its changed credit position by posting additional collateral.9 FERC requests comment on the appropriate time period, and whether the time period should be standardized among the various RTO/ISO markets.

FERC seeks comment on whether the changes proposed above should be applied to all market participants in the same manner, or whether the proposed changes should be applied differently to different market participants depending on the market participant’s characteristics.10

Impact of Proposed Amendments

FERC seeks comments on credit policies in organized wholesale electric markets in consideration of “the recent turmoil in financial markets” which has “emphasized the importance of sound credit practices that provide competitive markets with adequate access to capital without excessive risk and without excessive cost.”11 While some progress has been made to improve the credit practices of the various RTO/ISOs, FERC states that it believes that additional progress can be made, and that its proposals in the NOPR would protect consumers against the adverse effects of market participant defaults. According to FERC, overall, the proposals in the NOPR would likely have a positive effect in wholesale electric markets as they will mitigate uninsured credit risk in the RTO/ISOs.

Irrespective of the efficacy of FERC’s proposals in reducing uninsured credit risk, the NOPR can be expected to provoke responses from a wide variety of market participants. For instance, if the proposed amendments were adopted, the amount of unsecured credit extended to market participants would be capped at US$50 million per market participant (or corporate family), and unsecured credit would be eliminated in FTR markets. This would require a number of market participants to post collateral in situations in which they have never had to post collateral before. The NOPR could create cash flow issues if market participants with longer billing cycles must adjust to shortened settlement cycles with no more than seven calendar days for settlements and final payments due seven days later. Further, some smaller market participants could be prevented from participating in the organized wholesale electric markets altogether if FERC adopts minimum participation standards that they cannot meet.

Comments on the NOPR are due on March 29, 2010.