February 2006 Market Clearing in the Energy Industry 62 © Copyright 2006, CCRO. All rights reserved. Much of NCC’s value proposition is premised on the ability to provide comprehensive multilateral netting across all products it accepts through the delivery process as a single counterparty. This capability extends to next day power and gas contracts that do not fall under the bankruptcy code’s definition of a forward contract, due in large part to a “Cash Flow Contract™”, or CFC™, that is entered in parallel with a next day contract in conjunction with an assignment of the next day contract payment obligation. The CFC™ is a forward and swap contract. The schematic activity flow of a CFC™ contract is as follows: Role of the CFC™--Next Day Contracts CFC™ swaps EEI/NAESB payment for three payments CFC™ CFC™ payment obligation Next Day EEI/NAESB Contract Energy Energy Buyer Seller NECC-D NECC-C CFC™ payment obligation Standard payment obligation The CFC™ swaps the standard EEI/NAESB settlement and payment schedule for a specified accelerated payment schedule. Since it is a forward contract, the CFC™ enjoys the same rights of offset and exemption from the automatic stay and claw back provisions under the bankruptcy code as other forward contracts. The CFC™ obligation is collateralized and is netted against that of all other forward positions held. In addition, since NECC is the counterparty through the delivery process, net receivables owed to sellers can be offset against collateral requirements. NCC uses a risk transfer framework to protect itself from defaults by investment grade customers. While non-investment grade customers are required to post cash, treasury securities and/or letters of credit from approved banks, NCC’s risk transfer framework utilizes lines of credit, backed by A+ or higher rated financial institutions and insurance products to cover credit risk for investment grade customers. Further, NCC provides a framework to provide this credit support to the majority of investment grade buyers at no cost to them (subject to sellers opting for weekly settlements) and the opportunity to maintain their current payment cycles. All sellers also have the option to receive their cash payments on a weekly basis (three days after the conclusion of the delivery week), thus freeing up significant capital.46 46 Net sellers that opt for accelerated weekly settlements take a discounted payment that reflects the cost of investment grade credit as reflected in current credit derivatives markets. In OTC markets, to the extent that all net sellers chose to receive accelerated weekly payment, then all investment grade net buyers would have the cost of financing their advances covered. In the absence of all sellers electing accelerated weekly payments for OTC cleared trades, NECC will allocate any cost sharing by those that do to investment grade net buyers on a pro-rata basis. In RTO markets it is intended that net buyers be held neutral to their ‘unsecured limits’ at the RTO as net sellers will either pay the financing by opting for accelerated payment or take a pro-rata share of default risk.