February 2006 Market Clearing in the Energy Industry 2-6 2. INTRODUCTION The Committee of Chief Risk Officers (CCRO) was formed in an effort to compile and advance the application of effective risk management practices for companies participating in energy markets throughout the world. The CCRO is composed of Chief Risk Officers from leading companies that are active in both the physical and financial energy markets. As such, the CCRO is vitally interested in advancing practices that will have a net positive impact on the level of participation in energy markets, and on the cost of that participation as it impacts stakeholders. The CCRO considers market clearing to be one such practice. Market clearing, a set of services provided by a third party to counterparties to a trade, can reduce the credit costs of trading and increase the efficiency of settlement. Clearing has been a major factor in creating a liquid market in natural gas, decreasing margin requirements, and increasing the number of market participants. The CCRO first addressed market clearing in its November 2002 white paper “Credit Risk Management,” in which it concluded that “[f]ar and away the greatest potential for advancement for the [energy] industry in terms of credit risk mitigation, improved liquidity, and capital adequacy is through [market] clearing.” While the use of market clearing in the energy industry, which includes emission and green credits, coal, gas, and power, has grown substantially over the last few years, widespread adoption of the practice, specifically in power, has only recently begun to gain significant momentum and, with respect to clearing of physical energy products in the U.S., there are only a few products that to date have any significant liquidity. The purpose of this paper is to enhance the momentum of the use of financial as well as physical clearing in the energy industry by: contributing to a common understanding and definition of clearing identifying its benefits to the market identifying hurdles and challenges still present and presenting recommendations that promote its appropriate application and development.