MCWG - Options to Reduce Collateral Requirements

1. MCWG - Options to Reduce Collateral Requirements Joint SEWG / MCWG Meeting January 31, 2011

2. Summary of 1/26 Discussion (1 of 3) • Invoicing all available settlement statements on a single daily invoice Considerations: • Issue one Invoice per sub-QSE or per Counter-Party per business day • Credit factors: • Increase the frequency for which RT invoices impact OUT • Reduce payment cycle • Enable Market Participants to reduce posting requirements via issuing early PMTs • Reduce # of unbilled statements referenced within AIL • Potentially reduce time gap between ADTE and DALE values • Review # days referenced in ADTE while taking forward exposure into consideration • Consider reductions in unsecured risk limits to reduce default risk

3. Summary of 1/26 Discussion (2 of 3) 2. Change RT settlement to x days after Operating Day Considerations: • Reduces settlement timeline • Credit factors: • Increase the frequency for which RT invoices impact OUT • Reduce payment cycle • Enable Market Participants to reduce posting requirements via issuing early PMTs • Reduce # of unbilled statements referenced within AIL • Potentially reduce time gap between ADTE and DALE values • Could skew credit requirements for any MP not settled on actual data • Consider adding another settlement to mitigate the impact of the reduced timeline – i.e. settlements on OD+7, OD+14, OD+59 and OD+180.

4. Summary of 1/26 Discussion (3 of 3) • Invoice based on Operating day (i.e. net Day-Ahead and Real Time Invoice) Considerations: • Credit factors • DAM Credit Simplifications: (1) Possibly reduce/eliminate the need for “E-Factors”, bid value posting requirements, and offset calculations (2) Revise “UDAA” to capture RT to DA time risk • ADTE and DALE timing gap reduced • Decrease Real Time settlement cycle • Ex. Issue RT invoice on day 7 or 8 rather than day 10 • Further clarification required from ERCOT to resolve concerns around the quality of settlement data • Increase Day-Ahead settlement cycle • Ex. Issue DA Invoice on day 7 or 8 • Could skew credit requirements for any MP not settled on actual data • Consider adding another settlement to mitigate the impact of the reduced timeline – i.e. settlement binding &/or credit binding on OD+7, OD+14, OD+59 and OD+180.

5. Appendix • MCWG/CWG Presentations from 1/26/2011 • Page 5 to 9 • “Reduction in Settlement Timeline and/or Payment Cycle”, presented by Loretto Martin • Page 10 to 20 • “Forward Risk” , presented by Cheryl Yager

6. Reduction in Settlement Timeline and/or Payment Cycle Joint MCWG / CWG Meeting January 26, 2011

7. FERC Order 741 • “Each organized wholesale electric market must have tariff provisions that … (b) adopt a billing period of no more that seven days and allow for a settlement period of no more than seven days.”

9. Discussion • What options do we want to consider? • Combine all available RT and DA settlement statements on a single daily invoice to MPs? • Change Initial Settlement to x days after operating day? • Will additional resettlements be necessary? • Reconsider later in year? • Other suggestions?

10. Discussion Continued Order to accomplish?

11. Forward risk Cheryl Yager

12. 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

13. 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

14. Example

15. Example

16. 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.

17. Appendix

18. 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)

19. 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

20. Benchmark Report as of December 31, 2010

21. Benchmark Assumptions