Forward risk Cheryl Yager

1. Forward risk Cheryl Yager

2. Impact of reducing settlement, invoicing and/or payment cycles • Goal: Reducing settlement, invoicing and/or payment cycles (to reduce outstanding invoices and improve netting). • Expected impact on Historical Risk • Improved netting should reduce risk by reducing the amount of outstanding liability (invoices and estimated historical activity) • It will correspondingly reduce collateral held (when collateral is required) • Conclusion – for historical risk, improved netting can be expected to • For defaulting entities with unsecured credit - Reduce losses • For defaulting entities with posted collateral – Improve capital efficiency; have minimal impact on losses since it reduces both risk and collateral held Note: Losses to date have been for entities with posted collateral

3. Impact of reducing settlement, invoicing and/or payment cycles • Possible impact on Forward Risk • Critical forward risk factors resulting from our physical, energy only market may not be mitigated by improved netting • Volume taken from the real time market at time of default • Price volatility • Entities that historically net activity, may be unwilling or unable to net at the time of default • ERCOT currently collateralizes for forward risk based on recent invoices • If invoice amounts are reduced, less collateral will be held for forward risk • Concern – tightening cycle times may actually increase net losses in situations where collateral is reduced with no net reduction in forward risk

4. Example

5. Example

6. Summary • As we move forward with tightening settlement, invoicing and/or payment cycles, we will want to • define how much forward risk to collateralized • ensure that we maintain adequate collateral for forward risk.

7. Appendix

8. Benchmark Report - background • Section 16 - total potential exposure (TPE) covers both historical risk and forward risk • Historical exposure may be invoiced or estimated • Forward risk is, in large part, estimated based on historical activity in CMM • Underlying assumption - history is a reasonable predictor of the future (e.g. if an entity has been in the ERCOT market at 20% of its load, it is appropriate to assume they will be in the ERCOT market at 20% of load in the future) • Key drivers of forward risk include volume escalation and price volatility • However, situations may arise when historical trends may not be the best predictor of forward risk • Market wide - dramatic price changes – forward prices may be higher (or lower) than those used to calculate collateral in the TPE • Entity specific - when an entity is at the point of default, volume from the ERCOT market may increase substantially from historical trends • The physical nature of the electric market has a significant impact on forward risk (e.g. mass transition risk for Counter-Parties that represent load, DAM activity may impact real time market, etc)

9. Benchmark Report - background • Ensuring the adequacy of collateral held for forward risk is a key goal that the CWG / MCWG took on for 2011 • The Benchmark Report provides context for how much forward risk is provided for in the TPE calculation at a point in time

10. Benchmark Report as of December 31, 2010

11. Benchmark Assumptions