Policy Statement on Credit-Related Issues for Electric OATT Transmission Providers, ISOs & RTOs

109 FERC ¶ 61,186

UNITED STATES OF AMERICA

FEDERAL ENERGY REGULATORY COMMISSION

Before Commissioners: Pat Wood, III, Chairman;

Nora Mead Brownell, Joseph T. Kelliher,

and Suedeen G. Kelly.

Policy Statement on Electric Creditworthiness

Docket No. PL05-3-000

POLICY STATEMENT ON CREDIT-RELATED ISSUES FOR

ELECTRIC OATT TRANSMISSION PROVIDERS, INDEPENDENT SYSTEM

OPERATORS AND REGIONAL TRANSMISSION ORGANIZATIONS

(Issued November 19, 2004)

1.

While credit policies of regulated utilities have always been a component of the

Commission’s regulatory agenda, recent changes in the electric industry have caused

credit-related issues to become increasingly significant. In response to these changes, the

Commission believes that its policy with regard to certain credit-related issues requires

clarification in order to increase transparency and competitiveness in electricity markets.

In particular, this policy statement clarifies the Commission’s policy with regard to the

need for Open Access Transmission Tariff (OATT) Transmission Providers1 and, to a

lesser extent, independent system operators (ISO) and regional transmission

organizations (RTOs) to: (1) make their credit-related procedures and standards more

transparent; and (2) consider both quantitative and qualitative factors in assessing

transmission customers’ creditworthiness. In addition, the order clarifies certain actions

(namely, shortening settlement periods and netting) that the Commission expects

ISOs/RTOs to take to reduce the risk and impact of a default by a market participant on

individual market participants and the market as a whole.

2

consider both quantitative and qualitative factors in assessing

transmission customers’ creditworthiness. In addition, the order clarifies certain actions

(namely, shortening settlement periods and netting) that the Commission expects

ISOs/RTOs to take to reduce the risk and impact of a default by a market participant on

individual market participants and the market as a whole.

2.

Due to the significant differences between the electric and gas industries in their

respective development and inherent nature, the Commission finds it necessary at this

time to issue this policy statement concerning creditworthiness standards and procedures

for electric transmission providers, rather than initiate a rulemaking proceeding. We note

that the level of transparency for creditworthiness and collateral requirements has been

1 For the purposes of this guidance order, an OATT Transmission Provider is

defined as an entity that provides electric transmission service that is neither an ISO nor

an RTO (i.e., a traditional utility).

Docket No. PL05-3-000

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less developed for OATT Transmission Providers, than for the more mature gas markets.2

Specifically, with respect to ISOs/RTOs, the established creditworthiness and collateral

requirements cover a wider range of services and commodities - including energy,

transmission rights and ancillary services - whose value is more variable than that for

either gas or OATT transmission service alone. The Commission believes that the

development of creditworthiness requirements specific to each ISO/RTO through a

stakeholder process is appropriate because of the greater variability and difficulty

required to measure the credit exposure of providing these additional services

hts and ancillary services - whose value is more variable than that for

either gas or OATT transmission service alone. The Commission believes that the

development of creditworthiness requirements specific to each ISO/RTO through a

stakeholder process is appropriate because of the greater variability and difficulty

required to measure the credit exposure of providing these additional services. This

policy statement will provide enhanced transparency to electric market participants and to

the Commission and could be used as a model to create additional requirements for

standardization if such requirements prove to be necessary.

3.

This policy statement benefits the public by providing a more transparent credit

process and reducing risk.

I.

Background

A.

Notice of the July Technical Conference

4.

In the Notice of the July Technical Conference,3 the Commission stated that due to

market conditions and price volatility recently experienced within the industry, many

participants in competitive energy markets have been subject to downgrades by credit

rating agencies, often below investment grade levels. In fact, the notice pointed out that

some have been forced to seek bankruptcy protection from creditors. The Commission

explained that these credit downgrades have raised the level of concern regarding credit-

related risks. At the same time, the notice noted that certain market participants have

alleged that OATT Transmission Providers and ISOs/RTOs have sought excessive levels

of credit support and therefore, in effect, foreclosed full market participation by

competitive entities.

2 For example, the Commission instituted the standards for gas pipeline

creditworthiness contained in its recent Notice of Proposed Rulemaking after two years

of public notice and comments procedures, which involved a wide range of market

participants, including the North American Energy Standards Board

participation by

competitive entities.

2 For example, the Commission instituted the standards for gas pipeline

creditworthiness contained in its recent Notice of Proposed Rulemaking after two years

of public notice and comments procedures, which involved a wide range of market

participants, including the North American Energy Standards Board. Creditworthiness

Standards for Interstate Natural Gas Pipelines, 69 Fed. Reg. 8,587 (Feb. 25, 2004),

FERC Stats. & Regs., Proposed Regulations ¶ 32,573 (2004).

3 Electric Creditworthiness Standards, Notice of Technical Conference and

Request for Written Comments on Credit-Related Issues for Electric OATT Transmission

Providers, Independent System Operators, and Regional Transmission Organizations,

Docket No. AD04-8-000 (May 28, 2004) (Notice of July Technical Conference).

Docket No. PL05-3-000

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5.

In addition, the Commission stated that it believes that there are ways for

ISOs/RTOs to reduce credit/default exposure and, in turn, to minimize the mutualized

default risk in their markets. As the notice explained, ISOs/RTOs are typically non-profit

entities that administer the market on behalf of market participants. In such markets,

credit is collectively extended by market participants to each individual market

participant. As a result, if one market participant defaults, it falls upon the remaining

participants to make up the shortfall (i.e., the default risk is mutualized).

6.

In order to address those concerns, the Commission stated in the notice that it

would hold a technical conference to consider credit-related issues for service provided

by OATT Transmission Providers, ISOs, and RTOs in the electric industry

result, if one market participant defaults, it falls upon the remaining

participants to make up the shortfall (i.e., the default risk is mutualized).

6.

In order to address those concerns, the Commission stated in the notice that it

would hold a technical conference to consider credit-related issues for service provided

by OATT Transmission Providers, ISOs, and RTOs in the electric industry. To assist the

Commission in its preparation for that conference, the Commission invited all interested

persons to submit written comments on the various questions posed in the notice or any

other issues related to credit requirements for the electric industry, including whether it

was appropriate for the Commission to consider a similar course for the electric industry

as the one it proposed in relation to the gas industry (i.e., standardized, transparent and

comprehensive tariff-based creditworthiness procedures).4 On July 13, 2004,

Commission staff held the technical conference (July Technical Conference).

B.

Creditworthiness Issues for OATT Transmission Providers and

ISOs/RTOs

7.

Although the Commission recognizes that there is some overlap, the credit

concerns facing OATT Transmission Providers and ISOs/RTOs differ in important ways

due to the nature of those entities. In general, OATT Transmission Providers develop

their own credit policies and do not receive input from their customers through a

stakeholder process. On the other hand, most ISOs and RTOs establish their credit

policies through a stakeholder process that includes all market participants. While OATT

Transmission Providers’ credit policies apply only to transmission services, ISOs’ and

RTOs’ credit policies apply to both transmission services and purchases and sales in the

markets they administer for energy, capacity, and other products

ss. On the other hand, most ISOs and RTOs establish their credit

policies through a stakeholder process that includes all market participants. While OATT

Transmission Providers’ credit policies apply only to transmission services, ISOs’ and

RTOs’ credit policies apply to both transmission services and purchases and sales in the

markets they administer for energy, capacity, and other products. Accordingly, as the

Commission has noted in the past, the differences between traditional utilities and ISOs

and RTOs often warrant different approaches to creditworthiness requirements.5

4 See Creditworthiness Standards for Interstate Natural Gas Pipelines, 69 Fed.

Reg. 8,587 (Feb. 25, 2004), FERC Stats. & Regs., Proposed Regulations ¶ 32,573 (2004)

(Gas Credit NOPR). In the Gas Credit NOPR, the Commission stated that standardized

creditworthiness provisions in the gas industry promote consistent practices across

markets and utilities and provide customers with an objective and transparent

creditworthiness evaluation.

5 See Duquesne Light Co., 103 FERC ¶ 61,227 at P 17 (2003).

Docket No. PL05-3-000

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Recognizing these differences and the problems they pose, in this policy statement the

Commission will discuss credit concerns for OATT Transmission Providers and

ISOs/RTOs separately.

II.

Discussion

A. Transparency and Content of Credit Policies under the Pro Forma

OATT

8.

In Order No. 888,6 the Commission issued its pro forma OATT for the electric

industry without prescribing specific credit standards and processes for OATT

Transmission Providers. Instead, the pro forma OATT only contains generalized

standards regarding credit policies

SOs/RTOs separately.

II.

Discussion

A. Transparency and Content of Credit Policies under the Pro Forma

OATT

8.

In Order No. 888,6 the Commission issued its pro forma OATT for the electric

industry without prescribing specific credit standards and processes for OATT

Transmission Providers. Instead, the pro forma OATT only contains generalized

standards regarding credit policies. Specifically, it states that OATT Transmission

Providers: “may require reasonable credit review procedures” and that such review shall

be made “in accordance with standard commercial practices.”7 These standards do not,

on their face, require a transparent evaluation process and allow OATT Transmission

Providers, ISOs, and RTOs significant discretion in the approach they take in assessing

credit risk and determining how and to whom to apply such an assessment.

9.

Unlike the majority of ISOs and RTOs that post their credit requirements on their

websites or Open Access Same-Time Information System (OASIS) sites or incorporate

them into their tariffs, OATT Transmission Providers, with some exceptions (most

notably Carolina Power & Light),8 have not incorporated their credit requirements into

6 See Promoting Wholesale Competition Through Open Access Non-

Discriminatory Transmission Service by Public Utilities and Recovery of Stranded Costs

by Public Utilities and Transmitting Utilities, Order No. 888, FERC Stats. & Regs.

¶ 31,036 (1996), order on reh’g, Order No. 888-A, FERC Stats. & Regs. ¶ 31,048 (1996),

order on reh’g, Order No. 888-B, 81 FERC ¶ 61,248 (1997), order on reh’g, Order No.

888-C, 82 FERC ¶ 61,036 (1998), aff’d in relevant part, remanded in part on other

grounds sub nom, Transmission Access Policy Group, et al. v. FERC, 225 F.3d 667

(D.C. Cir. 2000), aff’d sub nom, New York v. FERC, 535 U.S. 1. (2002).

7 See section 1 of the Pro Forma OATT, Common Service Provisions,

subsection 11, Creditworthiness

888-B, 81 FERC ¶ 61,248 (1997), order on reh’g, Order No.

888-C, 82 FERC ¶ 61,036 (1998), aff’d in relevant part, remanded in part on other

grounds sub nom, Transmission Access Policy Group, et al. v. FERC, 225 F.3d 667

(D.C. Cir. 2000), aff’d sub nom, New York v. FERC, 535 U.S. 1. (2002).

7 See section 1 of the Pro Forma OATT, Common Service Provisions,

subsection 11, Creditworthiness.

8 See, e.g., Carolina Power & Light Co. and Florida Power Corp., 103 FERC

¶ 61,159 (2003), reh’g denied, 106 FERC ¶ 61,141 (2004) (accepting in part and

rejecting in part tariff sheets as modified); Carolina Power & Light Co. and Florida

Power Corp., Docket Nos. ER03-962-000 and ER03-962-001 (Aug. 15, 2003)

(unpublished letter order); Duquesne Light Co., 103 FERC ¶ 61,227 (2003) (rejecting

filing); Entergy Services, Inc., 104 FERC ¶ 61,329 (2003); Entergy Services, Inc., 106

FERC ¶ 61,039 (2004).

Docket No. PL05-3-000

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their OATTs. Even among those that have done so, the Commission believes that the

credit policies of OATT Transmission Providers and, to a lesser extent, some ISOs/RTOs

may contain unclear credit requirements for customers and the manner in which those

elements are considered is not clearly communicated to customers.9

10.

At the July Technical Conference, the OATT Transmission Provider presenters

generally explained that they employed relatively sophisticated processes to analyze

customer credit using both qualitative and quantitative criteria.10 However, they did not

post such criteria on their websites, to OASIS or otherwise make the criteria publicly

available.11 Notwithstanding such presentations, some transmission customers asserted

that they had been subject to very limited credit evaluations based solely on matters such

as ratings.12 The Commission believes that the credit criteria used by OATT

Transmission Providers should be made available to customers and the Commission

ir websites, to OASIS or otherwise make the criteria publicly

available.11 Notwithstanding such presentations, some transmission customers asserted

that they had been subject to very limited credit evaluations based solely on matters such

as ratings.12 The Commission believes that the credit criteria used by OATT

Transmission Providers should be made available to customers and the Commission. It is

only though the clear presentation of such criteria that customers and the Commission

can determine whether credit analysis is being conducted in an appropriate and non-

discriminatory manner.

11.

In particular, the Commission believes that if credit processes are neither posted

on an OASIS site nor incorporated into a tariff, transmission customers do not have the

ability to judge whether the application of a transmission provider’s credit procedures to

them was done on a reasonable, comparable, and non-discriminatory basis. Furthermore,

without such transparency, the Commission believes that transmission customers are

unable to determine ex ante the general amount of security, if any, they need to provide

an OATT Transmission Provider to receive transmission service or to participate in an

ISO/RTO market. In addition, if standards are not made clear to transmission customers,

it could serve to undermine certainty in markets and therefore could result in

creditworthiness requirements (either intentionally or unintentionally) being turned into

barriers to legitimate market activity, thus affecting market participation and liquidity

levels in the markets.

9 The Commission acknowledges that this lack of transparency might be due in

part to the fact that creditworthiness requirements in the pro forma OATT are general in

nature.

10 See, e.g., Remarks of Tommy Lee on behalf of Duke Energy Corporation,

July 13th Conference Transcript at 7-14, Docket No

cipation and liquidity

levels in the markets.

9 The Commission acknowledges that this lack of transparency might be due in

part to the fact that creditworthiness requirements in the pro forma OATT are general in

nature.

10 See, e.g., Remarks of Tommy Lee on behalf of Duke Energy Corporation,

July 13th Conference Transcript at 7-14, Docket No. AD04-8-000; Remarks of

Thomas Foster on behalf of MidAmerican Energy Company, id. at 15-21; Remarks of

Dan Sarti on behalf of Arizona Public Service Company, id. at 22-30.

11 See id. at 31-34.

12 See, e.g., Remarks of Michael Thomas on behalf of Calpine Corporation,

id. at 65-74.

Docket No. PL05-3-000

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12.

In order to address those concerns, we clarify that we interpret the term

“reasonable credit review procedures” in the pro forma OATT to include the posting by

OATT Transmission Providers, ISOs, and RTOs on their OASIS sites, to the extent that

they have not already done so or incorporated such requirements in their tariffs, the

information used by them to evaluate a potential customer’s creditworthiness (including

both quantitative and qualitative methodologies, as discussed further below, for

determining the credit that a transmission provider will offer an applicant for

transmission service). Thus, the Commission expects OATT Transmission Providers,

ISOs, and RTOs to: (1) make their credit-related practices more transparent and

comprehensive; (2) post on their websites the procedures that they use to do their credit

analyses; and (3) provide a customer with a written analysis setting forth how that entity

applied its credit standards to that customer, if that customer is required to provide

security

expects OATT Transmission Providers,

ISOs, and RTOs to: (1) make their credit-related practices more transparent and

comprehensive; (2) post on their websites the procedures that they use to do their credit

analyses; and (3) provide a customer with a written analysis setting forth how that entity

applied its credit standards to that customer, if that customer is required to provide

security. These creditworthiness standards, security requirements, and the process for

developing them should be transparent enough to enable customers to understand the

information required to demonstrate creditworthiness and to determine for themselves the

general amount and type of security they may need to provide in order to receive

transmission service from OATT Transmission Providers and/or participate in the

markets of ISOs/RTOs. In short, the methodology by which the credit analysis is

conducted should be transparent and fairly and uniformly applied, and a written

explanation should be required for any required security.

13.

In addition, OATT Transmission Providers, ISOs, and RTOs must consider both

qualitative13 and quantitative14 measures in their assessment of the credit risk of a party

and post the criteria they use to determine these factors. In this regard, as discussed

above, some customers have maintained that no qualitative elements are used at all

(e.g., no investment grade rating results in no credit). As a result, those customers have

maintained that OATT Transmission Providers, ISOs, and RTOs could potentially

discriminate against non-credit rated companies, because their review does not have to be

based on whether those customers are truly non-creditworthy.

14.

To help prevent such an occurrence, the Commission believes, as stated above,

that qualitative factors should be considered in determining whether security should be

provided for transmission service

ers, ISOs, and RTOs could potentially

discriminate against non-credit rated companies, because their review does not have to be

based on whether those customers are truly non-creditworthy.

14.

To help prevent such an occurrence, the Commission believes, as stated above,

that qualitative factors should be considered in determining whether security should be

provided for transmission service. Thus, OATT Transmission Providers and ISOs/RTOs

13 Qualitative factors to be considered include, among others: applicant’s history;

nature of organization and operating environment; management; contractual obligations;

governance policies, financial and accounting policies, risk management and credit

policies; market risk including price exposures, credit exposures, and operational

exposures; event risk; and the state or local regulatory environment.

14 Quantitative factors to be considered include, among others: financial

statements, in general, and profitability, capital structure, and cashflow, in particular.

Docket No. PL05-3-000

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should not automatically determine that an applicant is not creditworthy if it does not

have a credit rating or that credit rating is below investment grade. For example,

although municipalities and cooperatives may not be rated, they may still have strong

credit for transmission service due to the nature of their businesses and their ability to

charge their customer base for service. Similarly, stand-alone merchants may not have a

strong balance sheet but may have strong credit for transmission service if they have a

contract commitment with a creditworthy purchaser for the output of their unit that is

dependent upon transmission to perform under the contract.

15

service due to the nature of their businesses and their ability to

charge their customer base for service. Similarly, stand-alone merchants may not have a

strong balance sheet but may have strong credit for transmission service if they have a

contract commitment with a creditworthy purchaser for the output of their unit that is

dependent upon transmission to perform under the contract.

15.

In conclusion, the Commission expects OATT Transmission Providers, ISOs, and

RTOs to comply with these goals and will consider taking action on a case-by-case basis

or entertain complaints to address significant problems if the goals of transparency and

the consideration of qualitative, as well as quantitative, factors are not met. The

Commission has stopped short of mandating standardized credit measurements in this

policy statement. However, the Commission will consider standardizing credit

procedures through a generic rulemaking if necessary to prevent undue discrimination.

To the extent a transmission customer believes that an OATT Transmission Provider,

ISO, or RTO has discriminated in the application of its creditworthiness standards, that

customer may contact the Commission’s enforcement hotline15 or file a complaint

pursuant to section 206 of the Federal Power Act.16

16.

Finally, we reiterate here that Order No. 2004-B allows the sharing of risk

management functions to assess corporate-wide risk, but prohibits the shared risk

management employees from deciding “whether a transmission customer receives

services, sets prices, or sets other rates, terms or conditions of transmission service, such

as a specific amount of collateral a non-creditworthy shipper must post before receiving

service.” 17

15 Transmission customers that believes that an OATT Transmission Provider,

ISO, and/or RTO has discriminated against it may contact the Commission’s enforcement

hotline by phone at (888) 889-8030 or by e-mail at hotline@ferc.gov

ervice, such

as a specific amount of collateral a non-creditworthy shipper must post before receiving

service.” 17

15 Transmission customers that believes that an OATT Transmission Provider,

ISO, and/or RTO has discriminated against it may contact the Commission’s enforcement

hotline by phone at (888) 889-8030 or by e-mail at hotline@ferc.gov.

16 16 U.S.C. § 824e (2000).

17 Standards of Conduct for Transmission Providers, Order No. 2004, 68 Fed.

Reg. 69,134 (2003), FERC Stats. & Regs. ¶ 31,155 (2003) (the standards of conduct

govern the relationships between OATT Transmission Providers and all of their

marketing and energy affiliates), order on reh’g, Order No. 2004-A, FERC Stats. &

Regs. ¶ 31,161 (2004), order on reh’g, Order No. 2004-B, 108 FERC ¶ 61,118 at

P 68 (2004).

Docket No. PL05-3-000

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B.

Mutualized Default Risk

17.

Since ISOs/RTOs are typically non-profit entities that administer the market on

behalf of market participants and, in this capacity, serve as the clearing firm to every

transaction, ISO/RTO members are exposed to the credit risk of other members. In

addition, ISOs/RTOs are generally not capitalized sufficiently to absorb the impact of

defaults by market participants on an outstanding obligation.18 If collateral posted by a

defaulting party is not sufficient to cover the amount of its default, the remaining credit

risk exposure and costs are socialized across an ISO’s/RTO’s members. As such, the

credit/default risk of undercapitalized market participants lies with the non-defaulting

participants, not the ISO/RTO. In other words, due to the nature of ISO/RTO markets,

credit is, in effect, collectively extended by market members to each individual market

participant.

18.

Furthermore, that exposure is not truly under a market participant’s control

because it is the ISO/RTO that serves as the gatekeeper for the integrity of the markets

they administer

the non-defaulting

participants, not the ISO/RTO. In other words, due to the nature of ISO/RTO markets,

credit is, in effect, collectively extended by market members to each individual market

participant.

18.

Furthermore, that exposure is not truly under a market participant’s control

because it is the ISO/RTO that serves as the gatekeeper for the integrity of the markets

they administer. As a result, ISO/RTO market participants are exposed to risks based on

an ISO’s/RTO’s determination of other market participants’ creditworthiness, and they

have little ability to mitigate that risk. Furthermore, market participants must trust

ISOs/RTOs to implement their credit policies in a manner created to limit, as much as

possible, the risk of credit defaults. As a result, the level of exposure faced by

ISOs/RTOs can significantly affect market development by dampening the willingness of

various entities to participate in ISO/RTO markets that inadequately mitigate mutualized

risks through a clear, workable mechanism for minimizing the mutualized default risk.

19.

Although the Commission believes that there is a consensus in the industry, as

demonstrated at the July Technical Conference and the comments received prior to that

conference, that the goal of reducing the mutualized default risk is an important one,

there are differences in opinion among various entities regarding the question of what

types of methods should be used to reduce that risk and what the achievable reductions

are. While requiring all market participants in ISOs/RTOs to be fully collateralized

would eliminate the mutualized credit risk, the Commission believes that such a goal

18 The following are some of the credit risks that an ISO/RTO and its membership

face: (1) a market participant cannot or will not pay for energy, ancillary services,

purchased ICAP requirement, FTRs purchased at auction, or transmission services;

ized

would eliminate the mutualized credit risk, the Commission believes that such a goal

18 The following are some of the credit risks that an ISO/RTO and its membership

face: (1) a market participant cannot or will not pay for energy, ancillary services,

purchased ICAP requirement, FTRs purchased at auction, or transmission services;

(2) a market participant cannot deliver energy, ancillary services, or capacity when

scheduled to do so and does not purchase replacements; and (3) virtual bidders that

cannot meet their obligations when their bids in the day-ahead market clear.

Docket No. PL05-3-000

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would impose significant costs on market participants and, in turn, would represent a

serious barrier to entry into the markets. Short of that, the Commission believes that

there are less burdensome ways to reduce credit exposure and minimize the mutualized

default risk in ISO/RTO markets and encourages them to adopt such measures.

20.

In particular, the Commission believes, as discussed in greater detail below, that

shortened settlement periods and netting are cost-effective steps to reduce the exposure to

risk among market participants (e.g., from a default by one of the participants), the

amount of collateral required from market participants, and barriers to entry by

minimizing collateral requirements. Thus, these measures should improve market

conditions and provide for greater market participation and improved market liquidity.

Furthermore, these measures should serve to reduce the security requirements for both

small and non-credit rated entities, thus significantly enhancing their access to ISO/RTO

markets.

i.

Shortening Settlement Periods

21.

The size of credit risk exposure is, in large part, a function of the length of time

between completion of the various parts of electricity transactions, i.e., the provision of

service, the billing for service, and the payment for service

s for both

small and non-credit rated entities, thus significantly enhancing their access to ISO/RTO

markets.

i.

Shortening Settlement Periods

21.

The size of credit risk exposure is, in large part, a function of the length of time

between completion of the various parts of electricity transactions, i.e., the provision of

service, the billing for service, and the payment for service. Since the risk of default

begins at the time the product or service is committed for delivery and continues until the

account payable is ultimately extinguished, reductions in settlement periods would serve

to: (1) lower the level of financial assurances required (i.e., collateral requirement

provided by individual participants); (2) reduce the quantity of the aggregate level of

payables outstanding at any point in time, thereby reducing the potential exposure of a

defaulting entity; (3) enable updated transaction prices and charges to be utilized in a

timely manner in determining credit risk exposure; and (4) provide earlier identification

of default situations by lessening the opportunity for an unrecognized default and its

severity. Accordingly, the Commission believes that ISOs/RTOs can minimize the

exposure period and significantly reduce the credit risk to all market participants by

reducing the time between when a cost is incurred and when payment is ultimately

received by an ISO/RTO (i.e., shortening the settlement period).

22.

For instance, ISO-NE recently revised its billing policies to implement a weekly

billing period and a shortened settlement cycle in its hourly markets. These actions are

predicted to reduce both the amount of collateral required from market participants and

NEPOOL’s exposure to a default by market participants.19 NEPOOL’s settlement cycle

19 See New England Power Pool, 107 FERC ¶ 61,201 (2004) (approving these

changes)

ekly

billing period and a shortened settlement cycle in its hourly markets. These actions are

predicted to reduce both the amount of collateral required from market participants and

NEPOOL’s exposure to a default by market participants.19 NEPOOL’s settlement cycle

19 See New England Power Pool, 107 FERC ¶ 61,201 (2004) (approving these

changes). In addition, the Commission recently approved Midwest ISO’s proposal to

invoice and bill on a weekly schedule. See Midwest Independent Transmission System

Operator, Inc., 108 FERC ¶ 61,163 at P 473 (2004) (“We note that . . . the trend in

energy markets is toward shortened settlement periods to reduce the potential exposure

Docket No. PL05-3-000

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up to May 2004 was approximately 55 days; however, upon replacement of monthly

billing with weekly billing, the settlement cycle decreased to 13 days for all hourly

market services. As a result of these changes, ISO-NE projects that the overall amount of

financial assurance required in NEPOOL will be reduced by 67 percent from

approximately $176,791,000 to $58,128,000.20

23.

Currently, settlement cycles in other ISOs/RTOs are as high as 90 days.21 The

Commission believes that there is significant room for many ISOs/RTOs to significantly

shorten these periods, reducing the credit risks and cost of collateral in their markets by

shortening their billing cycles and implementing weekly billing.22 Accordingly, the

Commission asks ISOs/RTOs to initiate processes to reduce credit exposure and

minimize the mutualized default risk in their markets by adopting shortened settlement

periods.

24

oom for many ISOs/RTOs to significantly

shorten these periods, reducing the credit risks and cost of collateral in their markets by

shortening their billing cycles and implementing weekly billing.22 Accordingly, the

Commission asks ISOs/RTOs to initiate processes to reduce credit exposure and

minimize the mutualized default risk in their markets by adopting shortened settlement

periods.

24.

The Commission acknowledges that some regulated load-serving entities have

expressed a wish to remain on at least a monthly billing schedule due to cash flow

concerns that could arise from a more frequent payment schedule.23 However, the

window and collateral requirements for all parties. . . . Accordingly, we find that the

Midwest ISO’s proposal to invoice and bill on a weekly schedule is just and

reasonable.”), reh’g pending.

20 See Memorandum to NEPOOL Participants Committee re: Amendments to

Billing Policy and Financial Assurance Policies to Implement Weekly Billing,

Paul Belval and Scott Myers, NEPOOL Counsel, February 12, 2004.

21 For example, in the CAISO, the portion of the settlement cycle up to the point of

customer receipt of the preliminary invoice is approximately 83 days, see CAISO FERC

Electric Tariff, section 11.24.1-2 (payment Calendar), and, in PJM, the settlement cycle

(through standard payment terms) is approximately 50 days, see PJM FERC Electric

Tariff, 2nd Rev. Sheet No 50 (section 7.1).

22 By way of comparison, the financial markets (e.g., NASDAQ, NYMEX)

typically rely on a daily settlement process.

23 That is, most load-serving entities are only allowed to bill on a monthly basis

because they are tied to retail meter reading schedules that are billed on such a basis

nt terms) is approximately 50 days, see PJM FERC Electric

Tariff, 2nd Rev. Sheet No 50 (section 7.1).

22 By way of comparison, the financial markets (e.g., NASDAQ, NYMEX)

typically rely on a daily settlement process.

23 That is, most load-serving entities are only allowed to bill on a monthly basis

because they are tied to retail meter reading schedules that are billed on such a basis.

Thus, those entities may be unable to collect payments from retail customers any more

frequently, resulting in a larger gap between payments made to the ISO/RTO and

payments received from customers and, in turn, increasing working capital requirements

to serve those customers.

Docket No. PL05-3-000

- 11 -

Commission notes that it appears that all of the load-serving entities in ISO-NE were

supportive of NEPOOL’s move to a weekly billing cycle and thus encourages other

ISOs/RTOs to work through their stakeholder processes to resolve this issue.

ii. Netting

25.

Another method of minimizing the size of the credit risk exposure in ISOs/RTOs

is to net obligations owed by and to individual market participants whenever possible.

Under netting, obligations for transactions with a given counterparty are offset against

revenues for other transactions with that counterparty.24 Thus, a market participant’s

payment obligation to an ISO/RTO would be offset, or netted against, what the market

participant is owed from ISO/RTO.25 As a result, exposure will usually be considerably

smaller than if the obligations were not netted. The amount of collateral a company must

post would also be reduced because the collateral determination would often be based on

a lower overall outstanding or potential obligation to an ISO/RTO.

26

ISO/RTO would be offset, or netted against, what the market

participant is owed from ISO/RTO.25 As a result, exposure will usually be considerably

smaller than if the obligations were not netted. The amount of collateral a company must

post would also be reduced because the collateral determination would often be based on

a lower overall outstanding or potential obligation to an ISO/RTO.

26.

Specifically, the Commission believes that three basic types of netting should be

adopted, to the extent practicable, by ISOs/RTOs: (1) netting accounts payable and

accounts receivable within one product class (e.g., energy); (2) netting accounts payable

and receivable across products (e.g., energy and ICAP); and (3) netting internal bilateral

energy contracts.

27.

First, the netting of accounts receivable and accounts payable within one product

class could lower the credit exposure rate of ISOs/RTOs. Furthermore, if a customer

holds a positive position in one geographic market and a negative position in another,

allowing it to net its positions across geographic markets could also reduce its

24 Under netting, if A defaults on obligations to B, and B has separate, offsetting

obligations to A, then B is exposed only up to the net amount of the mutual obligations.

25 In the context of an ISO/RTO, if a generator/marketer provides an ISO/RTO

$1,000 worth of energy, and the ISO/RTO sells $1,500 of ancillary service to the

marketer/generator, the ISO/RTO can simply secure the difference of $500 in the event

that the generator defaults on its obligation. As a result, the marketer/generator has less

money ($500 vs. $1,500) as a liability and thus would need less collateral to participate in

the ISO’s/RTO’s market. Furthermore, netting out obligations means that if a market

participant defaults on its obligations, the ISO/RTO is assured of receiving the

obligation's net worth if it has collateral equal to the net amount of the obligations

ion. As a result, the marketer/generator has less

money ($500 vs. $1,500) as a liability and thus would need less collateral to participate in

the ISO’s/RTO’s market. Furthermore, netting out obligations means that if a market

participant defaults on its obligations, the ISO/RTO is assured of receiving the

obligation's net worth if it has collateral equal to the net amount of the obligations.

Accordingly, through netting, credit exposure is determined as the net overall exposure,

resulting in collateral needs being reduced in an ISO/RTO and minimizing the risk of a

default by a market participant.

Docket No. PL05-3-000

- 12 -

creditworthiness requirement. However, the Commission recognizes that certain

bankruptcy issues may be raised with regard to netting accounts receivable and accounts

payable.26

28.

Second, netting across ISO/RTO product markets could achieve credit reductions

through the same mechanism as described above for accounts receivable but does so for

more transactions. Therefore, it adds to the flexibility a company can exercise to reduce

its risk exposure. For example, an ISO/RTO could net financial obligations for energy,

capacity, and transmission. However, netting across products might also present the

same bankruptcy issues as netting of accounts receivable and accounts payable within a

single market.27

29.

As stated above, the Commission recognizes that netting may impact creditors’

rights in a case where a market participant seeks bankruptcy protection. Nevertheless, we

do not believe that these potential costs outweigh the benefits of netting, which would

reduce the likelihood of defaults by market participants and the magnitude of the impact

of such defaults on other market participants. Furthermore, we clarify that the

Commission is not here directing or encouraging ISOs/RTOs to take any measures that

disregard the requirements of the Bankruptcy Code.

30

do not believe that these potential costs outweigh the benefits of netting, which would

reduce the likelihood of defaults by market participants and the magnitude of the impact

of such defaults on other market participants. Furthermore, we clarify that the

Commission is not here directing or encouraging ISOs/RTOs to take any measures that

disregard the requirements of the Bankruptcy Code.

30.

Third, netting internal bilateral energy contracts, as opposed to ISO/RTO products,

could also serve to reduce default costs and risk. For instance, in PJM, the software

system known as eSchedules allows market participants to net internal bilateral contracts

(by allowing them to use schedules to subtract or net the bilateral transactions) against

their short-load obligations. As a result, this system allows market participants to net

collateral for firm, liquidated damages contracts against the payments that would be due

from purchasing energy to meet a load obligation, if it has a counterparty willing to

accept its load obligation, without posting collateral with the ISO. Furthermore, this type

of netting could result in less cash moving through an ISO/RTO and thus lower market

participants’ risk. In addition, net settlement could provide incentives for load-serving

entities to purchase long-term bilateral contracts from wholesale suppliers in order to

26 Specifically, some parties have stated that the laws affecting creditors’ rights

create a possible risk that the netting arrangement may be unwound if a customer

becomes insolvent. For instance, according to the Midwest Independent Transmission

System Operator, while bankruptcy law generally permits the setoff of obligations due a

debtor against amounts due the creditor, it imposes requirements that may make it

difficult to net fees with respect to a market participant who enters bankruptcy. See, e.g.,

Comments of Midwest Independent Transmission System Operator, Inc

. For instance, according to the Midwest Independent Transmission

System Operator, while bankruptcy law generally permits the setoff of obligations due a

debtor against amounts due the creditor, it imposes requirements that may make it

difficult to net fees with respect to a market participant who enters bankruptcy. See, e.g.,

Comments of Midwest Independent Transmission System Operator, Inc. at 3-4,

Docket No. AD04-8-000.

27 See id.

Docket No. PL05-3-000

- 13 -

lower their collateral costs, thereby increasing market liquidity.28 In short, internal

bilateral energy contracts are a financial hedging tool; netting them adds value to this

tool.

iii.

Other Measures for Reducing the Mutualized Default Risk

31.

The Commission also encourages ISOs/RTOs to consider other means that they

believe would be cost-effective measures to reduce the mutualized default risk. For

instance, credit insurance might allow ISOs/RTOs to remove any residual mutualized

credit risk, and these insurance policies could be tailored to the unique needs of each

ISO/RTO.29 Credit clearing might also provide a platform to net obligations and could

possibly serve to transfer credit risk to entities that are better able to manage such risk.

Specifically, clearing services could encompass a central counterparty, such as a

clearinghouse, that would assume and manage the default risk that would otherwise be

borne by an ISO’s/RTO’s market participants on a mutualized basis.

iv.

Request for Reporting

32

o net obligations and could

possibly serve to transfer credit risk to entities that are better able to manage such risk.

Specifically, clearing services could encompass a central counterparty, such as a

clearinghouse, that would assume and manage the default risk that would otherwise be

borne by an ISO’s/RTO’s market participants on a mutualized basis.

iv.

Request for Reporting

32.

The Commission recognizes that not all ISOs/RTOs are at the same stage of

evolution, and, therefore, that they should be able to determine for themselves at what

point these measures to reduce the mutualized default risk would be cost effective and

compatible with their markets and therefore should be implemented.30 Furthermore,

because the risk of default in ISOs/RTOs involves each member sharing a portion of a

default, the Commission encourages, to the extent practicable, each ISO/RTO to improve

its credit practices through its stakeholder processes (assuming it uses such a process),

allowing its members to determine what practices are the most cost-effective for reducing

the credit risk that the members ultimately bear.

28 For instance, according to Strategic Energy, NYISO, which does not permit

netting of collateral requirements for firm liquidated damages purchases, has collateral

costs that are four times higher than PJM, which as noted, permits such netting. See

Francis Pullaro’s Remarks on Behalf of Strategic Energy, July 13th Conference Transcript

at 138, Docket No. AD04-8-000.

29 We note that there has been some concern that these policies are relatively

expensive and therefore not cost effective. However, assuming the implementation of

measures such as shortened settlement periods and netting reduces the mutualized default

risk in ISOs/RTOs, it might make credit insurance a more viable option (i.e., its costs

would be reduced as the level of insured risk decreased)

9 We note that there has been some concern that these policies are relatively

expensive and therefore not cost effective. However, assuming the implementation of

measures such as shortened settlement periods and netting reduces the mutualized default

risk in ISOs/RTOs, it might make credit insurance a more viable option (i.e., its costs

would be reduced as the level of insured risk decreased).

30 For instance, an ISO/RTO might decide that moving directly to credit clearing

is more cost-effective than shortening settlement periods.

Docket No. PL05-3-000

- 14 -

33.

In addition, the Commission expects that each ISO/RTO report back to us within

90 days of the issuance of this order on their progress toward implementing shortened

settlement periods, netting, or any other measure that they determine might serve to

reduce the mutualized default risk in their markets or their reasons for not yet adopting

such measures. That report should also detail any future plans that that ISO/RTO has, at

that time, for reducing the mutualized default risk in its market.

By the Commission. Commissioner Brownell dissenting with a separate statement

attached

Magalie R. Salas,

Secretary.

UNITED STATES OF AMERICA

FEDERAL ENERGY REGULATORY COMMISSION

Policy Statement on Electric Creditworthiness

Docket No. PL05-3-000

(Issued November 19, 2004)

BROWNELL, Commissioner, dissenting:

Today’s order clearly articulates that recent changes in the electric industry have

caused credit-related issues to become increasingly significant. I agree. However, I

believe a policy statement intended to simply provide clarification falls dreadfully short

of the regulatory agenda this Commission is advancing. Instead, I believe the more

appropriate action is the issuance of a proposed rule consistent with our efforts in the

natural gas creditworthy proceeding; thus allowing all market participants an opportunity

to comment and shape an ultimate rule

, I

believe a policy statement intended to simply provide clarification falls dreadfully short

of the regulatory agenda this Commission is advancing. Instead, I believe the more

appropriate action is the issuance of a proposed rule consistent with our efforts in the

natural gas creditworthy proceeding; thus allowing all market participants an opportunity

to comment and shape an ultimate rule. As the Commission has harmonized standards of

conduct, accounting rules, and other business operational functions between the natural

gas and electric industries, I see the issue of creditworthiness equally linked.

When addressing the natural gas creditworthiness proposed rulemaking in

February, my colleagues and I unanimously agreed that additional regulations pertaining

to creditworthiness were needed to promote consistent practices among the pipelines and

provide shippers with an objective and transparent creditworthiness determination.31 The

electric industry is no different than the natural gas industry when it comes to needing

stability, predictability, and assurance that the right protections are in place.

The Technical Conference held July 13, 2004 raised issues which underscore the

seriousness of the problem. One panelist representing cooperatives characterized the lack

of appropriate credit policies as “pos[ing] the risk of basically making the cooperatives

unable to meaningfully participate in some of the transmission services which are

supposed to be part of the open access that the FERC is trying to create.”32 Another

participant representing generators noted that after eight years handling credit issues, he

“still had no idea what [the “reasonable credit review procedures” language in the pro

forma OATT] truly means or obligates a regulatory body to undertake.”33 I am

concerned the existing credit policies continue to build barriers to entry.

31 See transcript from the Feb. 11, 2004 Commission Meeting, pp. 14-16

ight years handling credit issues, he

“still had no idea what [the “reasonable credit review procedures” language in the pro

forma OATT] truly means or obligates a regulatory body to undertake.”33 I am

concerned the existing credit policies continue to build barriers to entry.

31 See transcript from the Feb. 11, 2004 Commission Meeting, pp. 14-16.

32 Transcript of the technical conference in the matter of Electric Creditworthiness

Standards, Docket No. AD04-8-000, p. 77.

33 Id. at p. 65.

Docket No. PL05-3-000

- 2 -

Today’s order expresses the “expectation” that transmission providers will

voluntarily agree to start posting explanations of their credit review processes on their

OASIS. I hope I am wrong, but I fear this expectation will not be met in the absence of a

direct order. When asked about the willingness to post their creditworthy processes on

their OASIS with granularity, the panelists resisted. Instead, they stated they would not

oppose posting general or high level information.34 When describing their reluctance to

post more detailed information, one panelist stated:

The problem with posting a specific methodology is, first, I don’t know if there’s

enough paper to print it all on, given how many scenarios there are and how many

different variables we take into account. But the problem also is that the industry

changes, the industry changes constantly, and sometimes we change the models;

sometimes we change the weightings, based on the way the industry is going.35

This response alone illustrates the veil under which transmission owners and providers

could avoid consistency and uniformity in applying their respective creditworthy

provisions.

As I have stated previously and often, I believe establishing mandatory electric

creditworthiness principles will promote consistent practices across markets and utilities

and provide customers with an objective and transparent creditworthiness evaluation

nder which transmission owners and providers

could avoid consistency and uniformity in applying their respective creditworthy

provisions.

As I have stated previously and often, I believe establishing mandatory electric

creditworthiness principles will promote consistent practices across markets and utilities

and provide customers with an objective and transparent creditworthiness evaluation.

Such an approach would lessen the opportunity for applying these provisions in an

unduly discriminatory manner. Opponents of mandatory principles seem to fear they will

lead to institutionalizing a “one-size-fits-all” approach. Let me be clear, I agree that such

an approach is hazardous and I would not support it. What I am saying is that electric

creditworthy provisions need to be more systematic, transparent, and non-discriminatory

with sufficient flexibility to adapt to specific situations but with customer safeguards such

as written explanations.

This is also the approach most transmission customers voiced during the July 2004

technical conference. As one panelist stated:

Not all OATT providers have demonstrated … flexibility, and in many cases, it

seems to be a black box in terms of the credit…. We believe that it would be much

preferable to have, not necessarily standardized, but transparent credit

requirements, transparent credit procedures so that transmission service obtainers

34 Id. at p. 31-34.

35 Id. at p. 33-34.

providers have demonstrated … flexibility, and in many cases, it

seems to be a black box in terms of the credit…. We believe that it would be much

preferable to have, not necessarily standardized, but transparent credit

requirements, transparent credit procedures so that transmission service obtainers

34 Id. at p. 31-34.

35 Id. at p. 33-34.

Docket No. PL05-3-000

- 3 -

will know in advance, what’s going to be required of them, how often that

information needs to be updated, in what form it can be furnished, so there’s less

risk for surprise.36

Therefore, I would propose rules requiring transmission owners and providers to include

their respective quantitative and qualitative creditworthy provisions in their OATTs and

to post these standards on their OASIS websites.

Additionally, this policy statement lacks other forward-thinking policies proposed

in the currently pending natural gas creditworthy rulemaking. The instant proceeding

neglects to provide transmission owners, providers and customers any guidance on the

consequences of not achieving or sustaining good creditworthy standing. The policy

statement expects Transmission Providers’ processes to be transparent enough for

customers to determine for themselves the general amount and type of security they may

need. However, that does not attend to one of the fundamental concerns transmission

customers raise. As one panelist at the technical conference explained, “the biggest

concern that we’ve had is going through all that we went through, there was a lot of

disparity between companies. Every company required something different. Some

would ask for collateral for one amount

f security they may

need. However, that does not attend to one of the fundamental concerns transmission

customers raise. As one panelist at the technical conference explained, “the biggest

concern that we’ve had is going through all that we went through, there was a lot of

disparity between companies. Every company required something different. Some

would ask for collateral for one amount. Some would ask for collateral for ten times as

much for the exact same type of exposure.”37 Without specifying collateral/security

requirements for service and without specifying timelines for the suspension and

termination of service, I firmly believe this policy statement does not adequately clarify

the rules of the road or reassure financially comparable customers that they are entitled

to, and in fact are, receiving equitable treatment.

Finally, I agree with the order’s observation that ISO/RTO creditworthiness and

collateral requirements cover a wider range of services and commodities. However,

again, I believe the policy statement falls short by merely “requesting” rather than

directing the ISOs/RTOs to evaluate their current processes and standards, and determine

the sufficiency and adequacy of the terms and conditions, and report back to the

Commission on actions each ISO/RTO would be taking.

The non-binding effect of this policy statement seems to result in a known

problem still wanting a remedy, and therefore, I dissent.

Respectfully,

36 Id. at p. 77-78.

37 Id. at p. 95.