March 30, 2011 CWG / MCWG meeting ERCOT Legal Update Discussion of CFTC exemption issues, including Central Counter-Party

2 Overview CFTC 4(c) EXEMPTION FERC CREDIT RULE SUMMARY DIFFERENCES BETWEEN FERC CREDIT RULE AND ERCOT RULES IMPACT OF DIFFERENCES BETWEEN CFTC 4 (c) EXEMPTION REQUIREMENT ANDERCOT RULES NEXT STEPS CWG / MCWG meetingMarch 30,

3 ERCOT along with other ISO/RTOs began a conversation with CFTC last year to discuss applying for an exemption from CFTC jurisdictional oversight of ISO/RTO markets –Currently responding to questions from CFTC –Potential requirements of ISO/RTOs for obtaining CFTC exemption FERC Credit Rule – The CFTC preliminarily seems to view favorably the requirements of the FERC Credit Rule Other –Dodd Frank becomes effective incrementally in the second half 2011; CFTC exemption must be obtained within a comparable timeframe –CFTC exemption may be contingent on ERCOT making changes to existing Protocol, systems, etc. in a timely manner CWG / MCWG meetingMarch 30, CFTC 4(c) EXEMPTION

4 FERC CREDIT RULE SUMMARY Shortening Settlement Cycle 14 Days; Billing periods of no more than seven days and settlement periods of no more than seven days after issuance of bills. Unsecured Credit No more than $50 million per market participant and corporate family, as relevant. Eliminate unsecured credit for FTR positions - no exceptions, including priority rights; No netting of credit requirements between FTR and non-FTR activity. CWG / MCWG meetingMarch 30,

5 FERC CREDIT RULE SUMMARY Netting/Ability to Offset Market Obligations To allow netting within and between non-FTR markets, each ISO/RTO is required to implement one of the following: –Establish a central counterparty; –Require market participants to provide a security interest in their transactions in order to establish collateral requirements based on net exposure; –Alternative that provides the same degree of protection as the two above-mentioned methods; –Establish credit requirements for market participants based on their gross obligations; Netting of credit requirements between FTR and non-FTR activity is not allowed. CWG / MCWG meetingMarch 30,

6 FERC CREDIT RULE SUMMARY Minimum Criteria for Market Participation Each ISO and RTO is required to impose minimum participation criteria to be eligible to participate in the organized wholesale electric market; FERC did not prescribe specific standards; Examples - adequate capitalization; ability to respond to RTO/ISO direction; and risk management controls; Criteria apply to all market participants. A condition of a CFTC exemption will likely be a requirement to limit participation to “appropriate persons.” Although this term is not defined, persons who qualify as “eligible contract participants”, as defined in the Commodity Exchange Act, will be considered by the CFTC to be appropriate persons. CWG / MCWG meetingMarch 30,

7 FERC CREDIT RULE SUMMARY Use of “Material Adverse Change” ISOs and RTOs should have the flexibility to obtain addition collateral based on material adverse changes while providing adequate due process. Grace Period to “Cure” Collateral Posting No more than two days to “cure” a collateral call. 7 CWG / MCWG meetingMarch 30, 2011

8 DIFFERENCES BETWEEN FERC CREDIT RULE AND ERCOT RULES Shortening Settlement Cycle FERC Rule 14 Days; Billing periods of no more than seven days and settlement periods of no more than seven days after issuance of bills. ERCOT Rule Day Ahead Market settlement cycle is consistent with FERC Credit Rule (with possible exception of certain holiday periods); Real Time settlement cycle days, including payment cycle (NPRR in process); Other billings (monthly)? Potential Changes Required to be Consistent with FERC Rule Reduce settlement cycle to 14 days, billing periods of no more than seven days and settlement periods of no more than seven days after issuance of bills –Change to ERCOT Protocols –System change 8 CWG / MCWG meetingMarch 30, 2011

9 DIFFERENCES BETWEEN FERC CREDIT RULE AND ERCOT RULES Unsecured Credit FERC Rule Eliminates unsecured credit for FTR markets; $50 million limit per participant, including corporate family if relevant. ERCOT Rule $100 million limit per participant across all markets, including CRRs Potential Rule Changes Required to be Consistent with FERC Rule Impose $50 million limit per participant and corporate family, as relevant; –Change to ERCOT Creditworthiness Standard Eliminate unsecured credit for CRRs –Change to ERCOT Protocols –System change 9 CWG / MCWG meetingMarch 30, 2011

10 DIFFERENCES BETWEEN FERC CREDIT RULE AND ERCOT RULES Eligibility Requirements FERC Rule Requires minimum market participation eligibility requirements; No specific mandates – Examples include adequate capitalization, ability to respond to ISO/RTO direction and risk management expertise. ERCOT Rule ERCOT has market participant eligibility requirements BUT they do not include capitalization or risk management capability requirements; Potential Rule Changes Required to be Consistent with FERC Rule Develop Market Participation Requirements with Market Participants; –Change to ERCOT Protocols 10 CWG / MCWG meetingMarch 30, 2011

11 DIFFERENCES BETWEEN FERC CREDIT RULE AND ERCOT RULES Netting / Setoff General Netting is discussed by FERC at several levels 1.Netting FTR with non-FTR activity 2.Netting between non-FTR markets (e.g. DAM with RT) 3.Netting within markets (e.g. plus and minus within DAM) The goal of the FERC Credit Rule is to obtain positive assurance of an ISOs standing in a bankruptcy to ensure the right of set off 11 CWG / MCWG meetingMarch 30, 2011

12 DIFFERENCES BETWEEN FERC CREDIT RULE AND ERCOT RULES FERC Rule Netting of FTR and non-FTR activity not allowed (even if ISO is a Central Counter- Party). (level 1) To allow netting across or within non-FTR markets, RTO/ISO must (level 2 and 3): 1) Become counterparty; 2) Obtain security interest; or 3) Establish equivalent means of protecting interest in default/bankruptcy situations. If one of 1-3 is not implemented, credit/collateral requirements based on gross obligations. 12 CWG / MCWG meetingMarch 30, 2011

13 DIFFERENCES BETWEEN FERC CREDIT RULE AND ERCOT RULES ERCOT Rule Netting is allowed within and between non-FTR markets (e.g. DAM, RT and for expired CRRs) (level 2 and 3) Netting is allowed within the forward mark to market values of transmission rights (CRRs). (level 3) ERCOT allows netting of forward market to market value of transmission rights (CRR) positions with other market activity if a first priority security interest is granted. (level 1) 13 CWG / MCWG meetingMarch 30, 2011

14 DIFFERENCES BETWEEN FERC CREDIT RULE AND ERCOT RULES Potential Rule Changes Required to be Consistent with FERC Rule Eliminate ability to net current activity with forward mark to market for CRR positions (level 1) –Change ERCOT Protocols –No system change Potentially eliminate netting of expired CRR activity with other current non-CRR activity (level 1?); –Change ERCOT Protocols –System change needed to segregate CRRAH activity (and possibly QSE – CRR activity from other market activity 14 CWG / MCWG meetingMarch 30, 2011

15 DIFFERENCES BETWEEN FERC CREDIT RULE AND ERCOT RULES Potential Rule Changes Required to be Consistent with FERC Rule To obtain CFTC exemption, ERCOT expects to be required to becomes a central counter-party or develop an alternative option; Develop alternative option – there were no specific viable options presented by FERC despite numerous comments in FERC Credit Rule NOPR and related Technical Conference. Implies that alternatives may be difficult to define and even if developed would face the extra step of critical review before approval; Assuming 1) no viable alternative options and 2) status quo is unacceptable from CFTC perspective THEN central counter-party option is only viable option. –Change ERCOT Protocols; system changes; legal and/or organizational changes; By-laws; Debt instruments; etc., as needed 15 CWG / MCWG meetingMarch 30, 2011

16 DIFFERENCES BETWEEN FERC CREDIT RULE AND ERCOT RULES Use of “Material Adverse Change” ERCOT believes its credit rules are compliant but will confirm with CFTC. Grace Period to “Cure” Collateral Posting ERCOT believes its credit rules are compliant but will confirm with CFTC. 16 CWG / MCWG meetingMarch 30, 2011

17 IMPACT OF DIFFERENCES BETWEEN CFTC 4 (c) EXEMPTION REQUIREMENT ANDERCOT RULES CFTC’s expectation is that all RTOs/ISOs will meet FERC Credit Rule “absent a strong rationale to the contrary” In addition, the CFTC has asked more general question about collateral requirements, including how CRRs are marked to market ERCOT is in discussions with CFTC to finalize exemption requirements 17 CWG / MCWG meetingMarch 30, 2011

18 NEXT STEPS ERCOT expects any CFTC 4(c) exemption will be conditioned on meeting CFTC requirements, including being consistent with the FERC Credit Rule; Next steps ERCOT will work with relevant market committees and working groups to facilitate implementation of changes necessary to meet CFTC requirements for the CFTC 4(c) exemption The F&A Committee has asked that CWG provide input on credit aspects CWG will meet more frequently over the next weeks, as needed, to address CFTC requirements 18 CWG / MCWG meetingMarch 30, 2011