February 2006 Market Clearing in the Energy Industry 5-24 © Copyright 2006, CCRO. All rights reserved. ISO/RTOs operate markets for their members, and are not principals. They are authorized to conduct business on behalf of their member stakeholders and do not take title to the transactions that they facilitate. And, as evidenced by the often-differing interests of the stakeholders, ISO/RTO actions may or may not be in the simultaneous interests of each of its members. An additional concern of ISO/RTOs is that in an effort to mitigate risk via a clearing solution, the ISO/RTO may put at risk its administrative senior claim for obligations it is owed (i.e., administrative charges), which may be lost through a clearing vendor’s bankruptcy. Appendix D provides an expanded discussion on the legal framework associated with bankruptcy considerations for any clearing solution. 5.1.9. Potential Clearing Benefits to ISO/RTOs Clearing may provide some unique benefits to the RTO/ISO markets. Currently, each RTO/ISO through its Tariff (and related credit policy/practices, as applicable) has its own credit, billing and settlement policies and procedures. At a given level of exposure or potential exposure, there is a requirement for a member to post collateral, subject to any unsecured credit granted to the member. The amount a member is required to post is at best zero if the member has zero exposure, or the member is exposed to the ISO/RTO (i.e. owed accounts receivable by the ISO/RTO), and any positive exposure cannot be netted against amounts owed by the member at any other RTO/ISO. This results in larger amounts of collateralization across the RTO/ISO universe than would be required under a common system of rules for transactions with netting across ISO/RTOs. For ISO/RTOs, market clearing has the potential to: 1. Significantly reduce systemic risk and individual default risk As noted in section 3.2.2, in NEPOOL, Weekly Billing reduced Pool risk by 65%. Clearing solutions typically provide for daily cash settlement of exposures as well as margin requirements, so further substantial reductions in exposure in the ISO/RTO are possible under market clearing. 2. Significantly reduce collateral requirements With the substantial reduction of risk to the ISO/RTO administered markets through the accelerated settlements, collateral requirements for market participants should be substantially reduced, all to the benefit of more efficient deployment of the capital resources of participants. The freeing-up of collateral from the ISO/RTOs due to market clearing should allow for greater participation in ISO/RTO administered markets (i) in the number of participants in the market, and (ii) in an increase in the volume of activity by participants in ISO/RTO administered products, such as FTRs. 3. Allow for set-off of exposures across ISO/RTO products, natural gas and other fuels