Commodity Exchange Act Exemption Status Mark Ruane ERCOT Vice President of Credit and Enterprise Risk Management CWG January 26 th 2012 ERCOT Public

2 Summary The ISO/RTO joint application to the CFTC for a Commodity Exchange Act exemption is expected to be filed in January. Based on IRS letter rulings for other ISOs/RTOs, it appears that that tax-exempt status will not be jeopardized by assuming central counterparty status. As requested by the Board, ERCOT has retained Oliver Wyman to produce an independent assessment of the risks and the alternatives associated with becoming a central counterparty. CWGJanuary 26th 2012

3 Market Participant Requirements ERCOT has drafted an NPRR proposing standards for: –Additional minimum participation requirements, including capitalization; –Annual certification of compliance with the requirements; and –Verification of Counter-Party risk management frameworks. January 26th 2012CWG

4 Criteria for Market Participation Market participation criteria: –Expertise in markets with appropriately trained traders –Appropriate operational capabilities to respond to ERCOT communication –Capitalization requirements –Adequate risk management capabilities A waiver provision is included for entities that are market participants solely for the purpose of utilizing ERCOT MIS. CWGJanuary 26th 2012

5 Criteria for Market Participation Proposed capitalization criteria: Capitalization must be supported by audited financial statements. ERCOT may require Independent Amount rather than minimum capital requirement in the event of material adverse changes in financial status. To participate in markets other than CRR market To participate in all ERCOT markets Minimum capitalization requirements $5 million total assets or $500,000 tangible net worth $10 million total assets or $1 million tangible net worth Counter-Parties not meeting the capital requirements above $200,000 Independent Amount $500,000 Independent Amount CWGJanuary 26th 2012

6 Criteria for Market Participation Requirement for annual officer certification of compliance with the criteria above –Certification due no later than 120 days after the close of the fiscal year of the Counter-Party or its guarantor –Certification also addresses whether there has been a material change in risk management capabilities since the most recent verification. CWGJanuary 26th 2012

7 Risk Management Capability Verification Proposed mandatory annual verification for Counter-Parties that: 1.Have had CRR PtP Obligation exposure in the year prior to the date of the Officer Certification, and 2.Are ineligible for unsecured credit under the ERCOT Creditworthiness Standard Other Counter-Parties may also be verified. Verification may be waived for up to 24 months for Counter- Parties that have certified that they have had no material change in risk management capabilities since the last verification. CWGJanuary 26th 2012

8 Risk Management Capability Verification Provision for cure periods for Counter-Parties with deficiencies (up to 90 days). Verification may be contracted to a third party. Any material provided in support of the risk management capability verification process will be confidential. ERCOT may, in its sole discretion, accept verifications performed by other ISOs. The expenses of implementing and managing the minimum participation requirements may be covered by a fee to applicable Counter-Parties. CWGJanuary 26th 2012

9 Risk Management Capability Verification The risk management framework is documented in a risk policy addressing market and credit risks that has been approved by a Counter-Party’s risk management function which includes appropriate corporate persons or bodies that are independent of the Counter-Party’s trading functions, such as a risk management committee, a designated risk officer, participant Counter-Party’s board or board committee, or, if applicable, a board or committee of the Counter-Party’s parent company. A Counter-Party maintains an organizational structure with clearly defined roles and responsibilities that segregate front, middle and back office functions to as high a level as practical, where: (i)Front office means commercial or customer-facing functions, including but not limited to trading, structuring, sales, deal execution, and marketing; (ii)Middle office means risk management functions; and (iii) Back office means administrative and support functions including, but not limited to accounting, invoicing, check-out, settlements, records management, confirmations, compliance, contract administration, accounts receivable, accounts payable, and financial and tax reporting. A Counter-Party’s Delegations of Authority specify the transactions into which traders are allowed to enter. A Counter-Party ensures that traders have adequate training and experience relative to their Delegations of Authority in systems and the markets in which they transact. As appropriate, a Counter-Party has risk limits in place to control risk exposures. A Counter-Party has reporting in place to ensure risks are adequately communicated throughout the organization. A Counter-Party has processes in place for independent confirmation of executed transactions. A Counter-Party performs a periodic valuation or mark-to-market of risk positions, as appropriate. CWGJanuary 26th 2012 Draft Risk Management Framework Standards

10 Expected CFTC Conditions for CEA Exemption ItemStatus Estimated Costs 1.Two-day limit to cure collateral calls No action necessary.NA 2.Elimination of unsecured credit in CRR market NPRR 400 (approved by Board in October 2011; implementation targeted for mid-2012) $230k - $255k 3.Disallowance of netting between CRR and non-CRR markets 4.Reduce settlement timeline NPRR 347 combines invoices for day-ahead and real time markets (approved by Board in August 2011; implementation targeted for mid-2012). Note that NPRR 347 was introduced independently of CFTC compliance requirements. NPRR 391 shortens settlement cycle by one day and eliminates Automated Clearing House (ACH) payments (approved by Board in October 2011; implementation to be completed concurrently with NPRR 347). NPRR 347: $430k - $460k NPRR 391: NA CWGJanuary 26th 2012

11 Expected CFTC Conditions for CEA Exemption ItemStatusEstimated Costs 5.$50m limitation on unsecured credit Revision to Creditworthiness Standard (approved by Board in October 2011 – effective December 2011) NA 6.Criteria for market participation Baseline risk management standards developed in cooperation with other ISOs. Draft market participation NPRR in stakeholder process. $100k for one FTE to coordinate verification process plus third party costs. 7.Become a central counterparty (CCP) IRS letter ruling on retention of tax-exempt status as a central counterparty is pending. ERCOT has contracted with Oliver Wyman to obtain an independent review of risk issues around becoming a central counterparty. External review ~$125k. No other material costs identified. January 26th 2012CWG

12 Questions January 26th 2012CWG