FERC’s technical conference Thursday on RTO/ISO credit practices was prompted by the 2018 GreenHat Energy default in PJM. But many of the speakers found a more recent reason for concern: last week’s crisis in ERCOT, where widespread generation outages during subfreezing conditions pushed prices to the $9,000/MWh cap, prompting collateral calls and defaults among electricity retailers and municipal utilities.
RTO officials said the Texas crisis pointed to the need to consider loosening restrictions on information sharing among RTOs, while other witnesses said it highlighted the difficulty grid operators have preparing for “Black Swan” events.
The conference, which will continue Friday morning, also elicited calls for lagging grid operators to adopt best practices such as mark-to-auction reviews and balance-of-period auctions in financial transmission rights (FTR) markets. FERC’s question on whether grid operators should outsource market clearing to a third party was received coolly.
Information Sharing
RTO credit risk officials said although they meet monthly with their counterparts to share best practices, confidentiality rules prevent them from sharing market participant-specific information, even if the participant may pose a credit risk in multiple markets.
“It would be helpful to be able to know, for example, who might be experiencing financial distress right now in MISO and SPP [and] ERCOT,” said Sheri Prevratil, NYISO’s manager of corporate credit. “Because that can certainly spread across all of the RTOs and ISOs.”
PJM Chief Risk Officer Nigeria Bloczynski, who was hired following the GreenHat default, said RTOs “should be able to share information on issues they are confronting, especially with regard to certain market participants. We need transparency, not only within the RTO/ISO community to help mitigate risk, but in the broader commodity space as well.”
She said market participants with whom she has spoken agree that “there should be some method of sharing information across RTOs.”
“The critical question in information sharing is how to share and aggregate it,” MISO CFO Melissa Brown said. “If information sharing does occur, it would make sense for there to be a single, central depository of that information, with limited access and distribution. [FERC] would be one such candidate for this sort of information sharing, echoing Order 760 data. Another alternative would be encouraging greater coordination and sharing among” independent market monitors.
Brown questioned the value of credit information alone from other RTOs. “Credit is inexorably linked to market activity. Knowing one without the other would give little actionable data,” she said.
She added that the costs of sharing must be justified by its ability to prevent defaults. “MISO has experienced only a few defaults since its market start, all with very little financial impact,” she said. MISO’s largest market default was less than $1,000 for the first 15 years of market operations. In February 2021, MISO incurred two additional potential defaults of $112,046 and $15,563, which are pending final resolution.
Third-party Clearing
Costs also were cited as a reason not to consider mandatory third-party clearing of FTRs.
R. Scott Everngam, a former FERC official now consulting for regulated electric utilities, said his position on third-party clearing of FTRs has evolved as RTOs have improved “the core credit office competencies that unfortunately were lacking in the not-too-distant past.”
“I am concerned that the costs [of third-party clearing] to market participants annually could approach the costs of a major default,” he said. “Third-party clearing houses are not likely to understand fully the market design risks of FTRs and other trading products as well as the RTOs/ISOs, who could keep costs lower by their better understanding of the risks of these products.”
It could also raise jurisdictional issues if the clearing house is regulated by the Commodity Futures Trading Commission, he said.
Abram Klein, managing partner of FTR trader Appian Way Energy Partners, said he is “extremely skeptical” of the viability of mandatory third-party clearing. “We have no concern with voluntary third-party clearing if certain market participants would gain efficiencies from novating their FTR portfolios over to an exchange; for instance, if their futures positions … would offset their FTR portfolios,” he said. “However, we believe mandatory third-party clearing may be too costly and raises significant legal hurdles.”
Klein said many current FTR market participants would be excluded from the market by exchanges’ requirements. “FTRs are not pork bellies or tiger shrimp. … Clearing members, we think, are too far removed from this complex product to be comfortable taking on the scale of business that third-party clearing of FTRs would entail.”
Scott Miller, who now serves as executive director of the Western Power Trading Forum, spoke of his experience working on a clearinghouse proposal as a PJM employee and of helping to draft Order 741 while at FERC in 2010.
“We thought that we had solved the problems of FTR margins and how collateral would be required” with Order 741, he said. The GreenHat default, he said, showed “that the RTOs and ISOs were not aware of what their discretion was.”
“I think it’s time for the commission to be very direct with regard to the jurisdictional RTOs and ISOs and say: ‘You have to collaboratively come together with a best practices solution,’” he added.
Unique, Unpredictable Risks
Miller said RTO markets are different from financial or commodity markets because they depend on an ever-changing transmission system.
“While we tend to think of the commodity being traded in an RTO market as the electrons being produced, it is the transmission availability that is the value with the greatest risk in question,” he said. “Unlike a commodity that is grown, extracted, or manufactured, the transmission system necessarily changes based on the modeling of the system by the ISO or RTO.”
Miller said FERC could increase transparency by making the risk valuation model available to market participants yearly.
He said RTOs‘ risk management tools “have difficulty in measuring stochastic risk, or risk that lies outside normal experience,” such as that experienced in Texas.
“Recognizing the difficulty in assessing risks associated with outages, weather and similar ‘outlier’ events, ISOs and RTOs have tended to rely upon historic prices to assign risk,” Miller continued. “Recent experiences in electric markets make clear the need to do more dynamic forward modeling to capture stochastic risk. While this is easier said than done, it is possible. The advanced Monte Carlo scenario modeling being considered by PJM is an advancement.”
Brown said that power system reliability is “the most fundamental way to protect market stability and avoid market defaults. A robust power system promotes price certainty and removes risk, whereas an unduly stressed system, as we have seen just a week ago, causes tremendous price uncertainty and unreasonable credit risks, to say nothing of the underlying human suffering and potential loss to property.”
RTO Discretion
RTO officials defended their use of discretion in requiring additional collateral when they see increasing risk from a market participant.
“MISO believes all RTOs should have discretion and authority to respond to extreme price volatility,” Brown said. “The … infrequency and unpredictability of such events means a single standard or threshold is unlikely to prevent a default if the markets and price swings are anomalous enough. The best solution MISO has found to address these situations is to set up the rules for the center of the bell curve and have discretion and authority to act swiftly, subject to review, if extreme price volatility arises at the tails.”
Prevratil agreed. “The NYISO cannot predict the specific ways in which a market participant may present a risk of default, so it is critical that the NYISO’s tariffs maintain the flexibility to evaluate the specific circumstances of each situation,” she said.
Noha Sidhom, CEO of Viribus Energy Fund and executive director of the Energy Trading Institute, said ETI is “comfortable with some level of discretion being granted to the RTOs and ISOs regarding requesting additional collateral.
“However, we are extremely uncomfortable granting them the unilateral ability to suspend a market participant’s ability to transact,” she said in pre-filed testimony. “Just as a market participant must demonstrate sufficient risk management protocols and market expertise, it is even more critical that an RTO or ISO be able to demonstrate sufficient processes, expertise and resources to manage credit and counterparty risk.”
One Size Doesn’t Fit
Brown called for FERC to find the right balance between standardization and regional market rules.
“It is one thing to have the RTOs collaborate on intake forms, allowing potential participants to file one form instead of six,” she said. “It is much riskier to impose standard collateral requirements across different markets and products.”
Brown said managing credit risk “is more an art than a science. … Put simply, there is no substitute for people who are knowledgeable about credit and sensitive to developing risks.”
But Eric B. Twombly, a board member of the International Energy Credit Association, said RTOs have a disadvantage in evaluating “red flags” in the due diligence process because of the Federal Power Act’s prohibition against “undue discrimination.”
“Usually, this analysis in a corporate setting involves senior managers who apply subjective judgement as to the level of potential compliance or reputational risk a company and/or its shareholders are willing to accept,” he said in pre-filed testimony. “An RTO/ISO’s subjectivity can be interpreted as discriminatory.”
Actions Needed
Several witnesses had recommendations for actions FERC should take to improve RTO practices.
Klein said RTOs need to become as expert in credit risk management as they are in managing markets and ensuring reliability.
“ISO policies are developed via a stakeholder process that involves compromise,” he noted. “FERC must not allow ISOs and their stakeholders to adopt substandard [credit and counterparty risk management] policies and practices. It should be unacceptable, for instance, for any ISO not to have variation margining when a customer’s mark-to-market trading position moves into the red.”
Miller said FERC should be cognizant that RTOs’ market participants have a conflict of interest between controlling risk and minimizing costs. “In this regard, the stakeholder process often displays these conflicts rather than benefiting from varied perspectives,” he said.
Klein and others said the commission should consider requiring that all FTR markets include “regular and periodic market pricing through balance-of-period auctions,” as have been adopted by NYISO, PJM, MISO and ERCOT. “These auctions offer important liquidity, price transparency and competition to the FTR market and allow these ISOs to regularly assess and revalue market participant FTR portfolios, allowing for more accurate margining and identification of exposures.” ISO-NE, CAISO and SPP lack balance-of-period auctions, although SPP is considering it.
Nodal Exchange COO Demetri Karousos said the “key risk” to swaps trading is a “daisy chain of defaults” in which “one counterparty defaults to another counterparty, which in turn defaults to another counterparty, and so on. This is exactly what” triggered the 2008 financial crisis, with the collapse of the mortgage-backed securities market.
Karousos talked about his exchange’s proposal linking FTR auctions to futures markets. Under its proposed construct, the RTO would continue to run FTR auctions. FTRs would then be exchanged for a futures contract between the RTO and a clearinghouse. The FTR payment mechanism would be replaced with an exchange for related position, “variation margins extending from the futures contracts that are established on the exchange,” he said.
This new product “produces opportunities for secondary market trading, providing much greater liquidity … and improved hedging. It improves transparency [and provides] improved default protection.”
Rob Marsh, chief investment officer for Monolith Energy Trading, said the commission also should include mark-to-auction reviews as well as balance-of-period auctions.
“Variation margin should be utilized to secure the market to changing risk profiles. While mark-to-auction is the obvious tool for calculating variation margin, additional data, such as day-ahead and real-time price volatility and the financial condition of market participants, should be considered in the variation margin models,” he said. “No market participant should be able to clear a portfolio that they are undercollateralized to hold.”
He also called for a holistic view of credit requirements, with constant re-evaluations. “Too often, credit policy changes have been reactive rather than proactive. They are tailored to specifically address the last default, rather than comprehensively examined to determine their underlying flaws.”
Klein said the commission must eliminate RTO policies that allowed “’heads I win, tails you lose’ trading strategies,” such as those that led to the 2018 GreenHat and 2008 PowerEdge defaults in PJM, which allowed market participants to take big risks with insufficient collateral. (See Report: ‘Naive’ PJM Underestimated GreenHat Risks.)
Brown called for eliminating “shortcuts, such as allowing past FTR revenues to offset the collateral posted,” noting that transmission congestion changes over time.
The RTO officials listed the changes they have made in their rules since the GreenHat debacle, calling them evidence of a much-improved risk posture. But Sidhom said “many of the changes accepted by the commission over the past year simply require the market participant to self-report a material change.
“This is insufficient,” she said. “The burden should be placed on the RTO or ISO to conduct continuous due diligence.”
Brown acknowledged it’s too soon to say whether the recent rule changes have addressed the RTOs’ risks. “More time is likely necessary to evaluate the full value of these adjustments,” she said.
Multiple witnesses stressed the need for finding protections that don’t create unnecessary barriers to entry.
Klein criticized SPP’s proposal to require financial entities trading transmission congestion rights, its version of FTRs, to provide $20 million in unencumbered funds, excluding holding collateral at other ISOs. “Such a policy exceeds the $10 million ‘Eligible Contract Participant’ (ECP) standard noted in FERC Order 741 and may represent an unnecessary and an anticompetitive barrier to entry. We view the $10 million ECP standard as sufficient.”
Several witnesses said RTO’s credit experts should be involved in the development of new market rules. Someone like Bloczynski “should be at every single ISO and should be coordinating with market design,” said Ruta Skučas, a partner with Pierce Atwood who represents the Financial Marketers Coalition in RTOs.
Bloczynski agreed, saying “cross-departmental communication should be organic and ‘baked into’ the culture of the organization.”
Skučas said that the more targeted the products, the less credit risk the markets face. She added that a best practice is for RTOs to allow trades on any node, but it’s not available in every market. In NYISO, for example, “generators can only use virtual products at the zonal level,” so “anything happening at the nodal level, they can’t hedge.”
She also argued that participants should be able to choose between products that carry energy risk, such as PJM’s incremental offers and decrement bids, and products such as up-to-congestion transactions. “This allows for management of energy risk exposure while providing a natural link between liquid delivery points and actual physical assets,” she said. Products with greater granularity will become even more important as more intermittent resources “seek to hedge their positions,” she added.
Ted Thomas, chair of the Arkansas Public Service Commission, said FERC’s Office of Enforcement also has a role in protecting the markets. “We need to keep gamers out of our market with rigorous enforcement,” he said. “Go manipulate LIBOR. Go manipulate GameStop stock. Stay the hell out of our markets.”
