ERCOT Credit Work Group to Discuss Minimum Capitalization Requirements

ERCOT's Credit Work Group will discuss today draft minimum market participation standards, which include minimum capitalization requirements, and are similar to those recently required at other RTOs by FERC.

The minimum market participation standards are required by the amended Commodity Exchange Act, unless ERCOT is granted an exemption.

While ERCOT's standards and related provisions are currently drafted as an "Other Binding Document," a final format has not been selected. The requirements may be captured in the Protocols through a Nodal Protocol Revision Request or as an Other Binding Document

Among other things, the draft minimum market participation standards would establish minimum capitalization requirements as follows for a Counter-Party, or an acceptable guarantor:

1. For Counter-Parties seeking authorization to participate or participating in all ERCOT markets: a) $10 million in total assets, or b) $1 million in i) Unencumbered Assets for unrated Cooperatives and Municipal systems or ii) Tangible Net Worth for all other Entities, each as defined in the ERCOT Creditworthiness Standard; or

2. For Counter-Parties seeking authorization to participate or participating in all ERCOT markets except for Congestion Revenue Rights (CRR) markets: a) $5 million in total assets, or b) $500,000 in i) Unencumbered Assets for unrated Cooperatives and Municipal systems or ii) Tangible Net Worth for all other Entities, each as defined in the ERCOT Creditworthiness Standard

In the event a Counter-Party's or its gurantor's audited financial statements do not meet either above standard, or there has been a material adverse change in the financial condition of the Counter-Party or acceptable guarantor in conjunction with or subsequent to the most recent audited annual or unaudited quarterly financial statements, the Counter-Party shall provide an "Independent Amount" of additional financial security in the form and amount necessary to participate in the ERCOT markets as follows:

1. For Counter-Parties seeking authorization to participate or participating in all ERCOT markets, $500,000 Independent Amount.

2. For Counter-Parties seeking authorization to participate or participating in all ERCOT markets except for the CRR market, $200,000 Independent Amount.

Financial Security posted under the ERCOT Market Participation Capitalization Criteria and Independent Amount would not be available to a Counter-Party to satisfy any Financial Security or other credit requirements of ERCOT, but is fully available to ERCOT in the event of the Counter-Party's Payment Breach or Default.

A Counter-Party would be able to provide the required Independent Amount by posting with ERCOT Financial Security in the form of a) cash, b) an unconditional, irrevocable letter of credit on the standard form document approved by the ERCOT Board or c) a surety bond on the standard form document approved by the ERCOT Board.

Additionally, even if the Counter-Party would otherwise meet the minimum market capitalization standards outlined above without the need for posting an Independent Amount, ERCOT may nevertheless require the Counter-Party to meet the capitalization criteria by posting an Independent Amount in the event that the Counter-Party or a guarantor has a material adverse change in conjunction with or subsequent to the most recent audited annual or unaudited quarterly financial statements. The determination of a whether a change is material would be solely within ERCOT's discretion. Changes that may be considered material include, but are not limited to:

- A qualified audit opinion;

- Material criminal or civil litigation;

- Being placed on credit watch with negative implications by any ratings agency;

- A report of a quarterly, semi-annual or annual loss or a decline in earnings of ten percent or more compared to comparable prior year period;

- Bankruptcy, dissolution, merger or acquisition of the Counter-Party; or

- Any other material change in financial status that could adversely affect Counter-Party's compliance with the capitalization criteria.

The draft minimum market participation standards would also require each Counter-Party to maintain, "an appropriate, comprehensive risk management framework with respect to the ERCOT markets in which the Counter-Party transacts or wishes to transact."

"ERCOT may, in its sole discretion, identify the nature and scope of generally accepted risk management processes in the energy trading industry by which Counter-Party risk management frameworks will be assessed," per the draft.

Key elements would include, but would not be limited to:

1. The risk management framework is documented in a risk policy addressing market and credit risks that has been approved by a market participant's risk management function which includes appropriate corporate persons or bodies that are independent of the market participant's trading functions, such as a Risk Management Committee, a designated risk officer, a market participant's Board or Board committee, or, if applicable, a Board or committee of the market participant's parent company.

2. 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.

3. A Counter-Party's Delegations of Authority specify the transactions into which traders are allowed to enter.

4. 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.

5. As appropriate, a Counter-Party has risk limits in place to control risk exposures.

6. A Counter-Party has reporting in place to ensure risks are adequately communicated throughout the organization.

7. A Counter-Party has processes in place for independent confirmation of executed transactions.

8. A Counter-Party performs a periodic valuation or mark-to-market of risk positions, as appropriate.

ERCOT may periodically perform procedures to assess the risk management framework of Counter-Parties, including its implementation. ERCOT may retain a third party either to assess the sufficiency of the Counter-Party risk management framework or to provide guidance and advice as to what constitutes appropriate content with respect to generally accepted risk management practices in the energy trading industry, commensurate and proportional in sophistication, scope and frequency to the volume of transactions and the nature and extent of risk taken by the Counter-Party. ERCOT may assess a fee to Counter-Parties for all or part of the costs of verification services provided by a third party.