February 2006 Market Clearing in the Energy Industry 5-22 © Copyright 2006, CCRO. All rights reserved. ahead financial market, and a real time balancing market. Both markets are financially settled. Virtual Trading consists of trades that are committed in the day-ahead market and financially settled automatically by the given ISO against the real time market. A decrement is a bid to purchase a defined megawatt level of energy up to a specified price (load). An increment is an offer to supply a defined megawatt level of energy at or above a given price (supply). One can look at a decrement as a strictly financial load obligation, while increments can be viewed as strictly a financial generation obligation. Another way to define these products is that a decrement is a financial product that is "purchased" in the day-ahead market and financially "sold" in the real time market, while an increment is a financial product that is "sold" in the day-ahead market and financially "purchased" in the real time market. Complexities surrounding credit policy design and related exposure measurement criteria, with respect to Virtual Trading, highlight the complexities of the ISO/RTO’s perception of a market participant’s credit risk. Evidence is often cited by traders supporting the notion of inconsistent credit policies includes PJM’s separate credit policy for Virtual Trading that results in a two-time (2X) collateral multiplier, NE-ISO’s 2.6X multiplier, MISO’s 2X multiplier, and NYISO’s 2X multiplier. It is the position of some market participants that these multipliers result from a concern about price spikes and the risk that such spikes could produce large credit exposures when bids are cleared. However, some traders note that there is strong convergence of day-ahead markets and spot markets, aided in part by the liquidity and price discovery engendered by the market participants. 5.1.5. Varied credit/security requirements and policies Each ISO/RTO has developed its credit policy through its stakeholder process and/or business practices, as its markets have developed. Should a multilateral clearing mechanism operate among ISO/RTOs, there is the potential for substantial market efficiencies to be achieved, including a reduction in loss mutualization and collateral requirements across all markets. Conversely, a stakeholder that is a member of only one ISO/RTO may not recognize the benefit of cross-market opportunities, but may benefit from the systemic efficiencies resulting from market clearing (e.g., better market liquidity, improved (i.e., lower) volatilities, and lower prices). Appendix C contains highlights of credit policy differentiation among the ISO/RTOs. Credit quality assessment methods used by ISO/RTOs to evaluate members’ creditworthiness vary widely and have traditionally been primarily based on agency ratings with qualifying limits based on a matrix of a percent of Tangible Net Worth (or equivalent for cooperatives and governmental entities). In addition to agency ratings, most ISO/RTOs, except CAISO, use credit-scoring models that incorporate both qualitative and quantitative factors. (CAISO’s Board approved changes to its credit policy that will be implemented in early 2006, including a move to a tiered approach to granting unsecured credit.) A recent development has been the adoption by MISO of a credit-scoring model that does not rely on rating agencies, but