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Forward risk Cheryl Yager

This initiative aims to reduce settlement, invoicing, and payment cycles to minimize outstanding invoices and enhance netting. By improving netting, historical risk can be reduced, resulting in decreased liabilities and collateral requirements. However, in forward risk scenarios, tightening cycle times may inadvertently increase net losses if collateral is reduced without a corresponding decrease in forward risk.

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Forward risk Cheryl Yager

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  1. Forward risk Cheryl Yager

  2. Impact of reducing settlement, invoicing and/or payment cycles • Goal: Reducing settlement, invoicing and/or payment cycles (to reduce outstanding invoices and improve netting). • Expected impact on Historical Risk • Improved netting should reduce risk by reducing the amount of outstanding liability (invoices and estimated historical activity) • It will correspondingly reduce collateral held (when collateral is required) • Conclusion – for historical risk, improved netting can be expected to • For defaulting entities with unsecured credit - Reduce losses • For defaulting entities with posted collateral – Improve capital efficiency; have minimal impact on losses since it reduces both risk and collateral held Note: Losses to date have been for entities with posted collateral

  3. Impact of reducing settlement, invoicing and/or payment cycles • Possible impact on Forward Risk • Critical forward risk factors resulting from our physical, energy only market may not be mitigated by improved netting • Volume taken from the real time market at time of default • Price volatility • Entities that historically net activity, may be unwilling or unable to net at the time of default • ERCOT currently collateralizes for forward risk based on recent invoices • If invoice amounts are reduced, less collateral will be held for forward risk • Concern – tightening cycle times may actually increase net losses in situations where collateral is reduced with no net reduction in forward risk

  4. Example

  5. Example

  6. Summary • As we move forward with tightening settlement, invoicing and/or payment cycles, we will want to • define how much forward risk to collateralized • ensure that we maintain adequate collateral for forward risk.

  7. Appendix

  8. Benchmark Report - background • Section 16 - total potential exposure (TPE) covers both historical risk and forward risk • Historical exposure may be invoiced or estimated • Forward risk is, in large part, estimated based on historical activity in CMM • Underlying assumption - history is a reasonable predictor of the future (e.g. if an entity has been in the ERCOT market at 20% of its load, it is appropriate to assume they will be in the ERCOT market at 20% of load in the future) • Key drivers of forward risk include volume escalation and price volatility • However, situations may arise when historical trends may not be the best predictor of forward risk • Market wide - dramatic price changes – forward prices may be higher (or lower) than those used to calculate collateral in the TPE • Entity specific - when an entity is at the point of default, volume from the ERCOT market may increase substantially from historical trends • The physical nature of the electric market has a significant impact on forward risk (e.g. mass transition risk for Counter-Parties that represent load, DAM activity may impact real time market, etc)

  9. Benchmark Report - background • Ensuring the adequacy of collateral held for forward risk is a key goal that the CWG / MCWG took on for 2011 • The Benchmark Report provides context for how much forward risk is provided for in the TPE calculation at a point in time

  10. Benchmark Report as of December 31, 2010

  11. Benchmark Assumptions

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