2012-20965

Federal Register, Volume 77 Issue 167 (Tuesday, August 28, 2012)[Federal Register Volume 77, Number 167 (Tuesday, August 28, 2012)]

[Notices]

[Pages 52137-52173]

From the Federal Register Online via the Government Printing Office [www.gpo.gov]

[FR Doc No: 2012-20965]

[[Page 52137]]

Vol. 77

Tuesday,

No. 167

August 28, 2012

Part II

Commodity Futures Trading Commission

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Proposed Order and Request for Comment on a Petition From Certain

Independent System Operators and Regional Transmission Organizations To

Exempt Specified Transactions Authorized by a Tariff or Protocol

Approved by the Federal Energy Commission or the Public Utility

Commission of Texas From Certain Provisions of the Commodity Exchange

Act; Notice

Federal Register / Vol. 77 , No. 167 / Tuesday, August 28, 2012 /

Notices

[[Page 52138]]

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COMMODITY FUTURES TRADING COMMISSION

Proposed Order and Request for Comment on a Petition From Certain

Independent System Operators and Regional Transmission Organizations To

Exempt Specified Transactions Authorized by a Tariff or Protocol

Approved by the Federal Energy Commission or the Public Utility

Commission of Texas From Certain Provisions of the Commodity Exchange

Act

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of Proposed Order and Request for Comment.

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SUMMARY: The Commodity Futures Trading Commission (``CFTC'' or

``Commission'') is requesting comment on a proposed exemption (the

``Proposed Exemption'') issued in response to a consolidated petition

(``Petition'') \1\ from certain regional transmission organizations

(``RTOs'') and independent system operators (``ISOs'') (collectively,

``Petitioners'') to exempt specified transactions from the provisions

of the Commodity Exchange Act (``CEA'' or ``Act'') \2\ and Commission

regulations. The Proposed Exemption would exempt the contracts,

agreements and transactions for the purchase or sale of the limited

electricity-related products that are specifically described within the

proposed order from the provisions of the CEA and Commission

regulations, with the exception of sections 2(a)(1)(B), 4b, 4c(b), 4o,

4s(h)(1)(A), 4s(h)(4)(A), 6(c), 6(d), 6(e), 6c, 6d, 8, 9 and 13 of the

Act and any implementing regulations promulgated thereunder including,

but not limited to Commission regulations 23.410(a) and (b), 32.4 and

part 180. To be eligible for the Proposed Exemption, the contract,

agreement or transaction would be required to be offered or entered

into in a market administered by a Petitioner pursuant to that

Petitioner's tariff or protocol for the purposes of allocating such

Petitioner's physical resources; the relevant tariff or protocol would

be required to have been approved or permitted to have taken effect by

either the Federal Energy Commission (``FERC'') or the Public Utility

Commission of Texas (``PUCT''), as applicable; and the contract,

agreement or transaction would be required to be entered into by

persons who are ``appropriate persons,'' as defined in section

4(c)(3)(A) through (J) of the Act \3\ or ``eligible contract

participants,'' as defined in section 1a(18) of the Act and Commission

regulations.\4\ The exemption as proposed also would extend to any

person or class of persons offering, entering into, rendering advice or

rendering other services with respect to such transactions. Finally,

the exemption would be subject to other conditions set forth therein.

Authority for issuing the exemption is found in section 4(c)(6) of the

Act.\5\

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\1\ In the Matter of the Petition for an Exemptive Order Under

Section 4(c) of the Commodity Exchange Act by California Independent

Service Operator Corporation; In the Matter of the Petition for an

Exemptive Order Under Section 4(c) of the Commodity Exchange Act by

the Electric Reliability Council of Texas, Inc.; In the matter of

the Petition for an Exemptive Order Under Section 4(c) of the

Commodity Exchange Act by ISO New England Inc.; In the Matter of the

Petition for an Exemptive Order Under Section 4(c) of the Commodity

Exchange Act by Midwest Independent Transmission System Operator,

Inc.; In the Matter of the Petition for an Exemptive Order Under

Section 4(c) of the Commodity Exchange Act by New York Independent

System Operator, Inc.; and In the Matter of the Petition for an

Exemptive Order Under Section 4(c) of the Commodity Exchange Act by

PJM Interconnection, L.L.C. (Feb. 7, 2012, as amended June 11,

2012).

\2\ 7 U.S.C. 1 et seq.

\3\ 7 U.S.C. 6(c)(3)(A)-(J).

\4\ 7 U.S.C. 1a(18). ``Further Definition of `Swap Dealer,'

`Security-Based Swap Dealer,' `Major Swap Participant,' `Major

Security-Based Swap Participant' and `Eligible Contract

Participant,' '' 77 FR 30596, May 23, 2012.

\5\ 7 U.S.C. 6(c)(6).

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The Commission seeks comment on the Petition, the Proposed

Exemption and related questions. A copy of the Petition requesting the

exemption is available on the Commission's Web site at http://www.cftc.gov/stellent/groups/public/@requestsandactions/documents/ifdocs/isorto4capplication.pdf, with Petition Attachments posted at

http://www.cftc.gov/stellent/groups/public/@requestsandactions/documents/ifdocs/isorto4cappattach.pdf and an Order 741 Implementation

Chart posted at http://www.cftc.gov/stellent/groups/public/@requestsandactions/documents/ifdocs/isorto4cappfercchart.pdf.

DATES: Comments must be received on or before September 27, 2012.

ADDRESSES: You may submit comments by any of the following methods:

The agency's Web site, at http://comments.cftc.gov. Follow

the instructions for submitting comments through the Web site.

Mail: David A. Stawick, Secretary of the Commission,

Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st

Street NW., Washington, DC 20581.

Hand Delivery/Courier: Same as mail above.

Federal eRulemaking Portal: http://www.regulations.gov.

Follow the instructions for submitting comments.

Please submit your comments using only one method.

All comments must be submitted in English, or if not, accompanied

by an English translation. Comments may be posted as received to http://www.cftc.gov. You should submit only information that you wish to make

available publicly. If you wish the Commission to consider information

that may be exempt from disclosure under the Freedom of Information

Act, a petition for confidential treatment of the exempt information

may be submitted according to the established procedures in CFTC

Regulation 145.9 (17 CFR 145.9).

The Commission reserves the right, but shall have no obligation, to

review, pre-screen, filter, redact, refuse or remove any or all of your

submission from www.cftc.gov that it may deem to be inappropriate for

publication, such as obscene language. All submissions that have been

redacted or removed that contain comments on the merits of the

rulemaking will be retained in the public comment file and will be

considered as required under the Administrative Procedure Act and other

applicable laws, and may be accessible under the Freedom of Information

Act.

FOR FURTHER INFORMATION CONTACT: Robert B. Wasserman, Chief Counsel,

202-418-5092, [email protected], or Laura Astrada, Associate Chief

Counsel, 202-418-7622, [email protected], or Jocelyn Partridge, Special

Counsel, 202-418-5926, [email protected], Division of Clearing and

Intermediary Oversight; Eve Gutman, Attorney-Advisor, 202-418-5141,

[email protected], Division of Market Oversight; Gloria P. Clement,

Assistant General Counsel, 202-418-5122, [email protected] or Thuy

Dinh, Counsel, 202-418-5128, [email protected], Office of the General

Counsel; or Robert Pease, 202-418-5863, [email protected], Division of

Enforcement; Commodity Futures Trading Commission, Three Lafayette

Centre, 1151 21st Street NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. The Petition

II. Statutory Background

III. Background--FERC and PUCT

A. Introduction

B. FERC

C. PUCT

D. FERC & PUCT Oversight

IV. Scope of the Exemption

A. Transactions Subject to the Exemption

B. Conditions

C. Additional Limitations

V. Section 4(c) Analysis

A. Overview of CEA Section 4(c)

B. Proposed CEA Section 4(c) Determinations

[[Page 52139]]

C. FERC Credit Reform Policy

D. DCO Core Principle Analysis

E. SEF Core Principle Analysis

VIII. Proposed Exemption

A. Discussion of Proposed Exemption

B. Proposed Exemption

IX. Related Matters

A. Regulatory Flexibility Act

B. Paperwork Reduction Act

C. Cost-Benefit Considerations

X. Request for Comment

I. The Petition

On February 7, 2012, Petitioners collectively filed a Petition with

the Commission requesting that the Commission exercise its authority

under section 4(c)(6) of the CEA \6\ and section 712(f) of the Dodd-

Frank Wall Street Reform and Consumer Protection Act (``Dodd-Frank

Act'') \7\ to exempt contracts, agreements and transactions for the

purchase or sale of specified electricity products, that are offered

pursuant to a FERC- or PUCT-approved tariff, from most provisions of

the Act.\8\ Petitioners include three RTOs (Midwest Independent

Transmission System Operator Inc. (``MISO''); ISO New England, Inc.

(``ISO NE''); and PJM Interconnection, L.L.C. (``PJM'')), and two ISOs

(California Independent System Operator (``CAISO'') and New York

Independent System Operator (``NYISO'')), whose central role as

transmission utilities is subject to regulation by FERC; and the

Electric Reliability Council of Texas, Inc. (``ERCOT''), an entity that

performs the role of an ISO but whose central role as a transmission

utility in the electric energy market is subject to regulation by PUCT,

the authority with jurisdiction to regulate rates and charges for the

sale of electric energy within the state of Texas.\9\ Petitioners

represent that the roles, responsibilities and services of ISOs and

RTOs are substantially similar.\10\ As described in greater detail

below, FERC encouraged the formation of ISOs to consolidate and manage

the operation of electricity transmission facilities in order to

provide open, non-discriminatory transmission service for generators

and transmission customers.\11\ FERC also encouraged the formation of

RTOs to administer the transmission grid on a regional basis.\12\

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\6\ 7 U.S.C. 6(c)(6).

\7\ See Dodd-Frank Act, Public Law 111-203, 124 Stat. 1376

(2010). The text of the Dodd-Frank Act may be accessed at http://www.cftc.gov./LawRegulation/OTCDERIVATIVES/index.htm.

\8\ See Petition at 2-3, 6.

\9\ See Petition at 2-4. See 16 Tex. Admin. Code 25.1 (1998).

\10\ See Petition at 2 n. 2.

\11\ See FERC Order 888 Promoting Wholesale Competition Through

Open Access Non-Discriminatory Transmission Facilities (``FERC Order

888''), 61 FR 21540, April 24, 1996; See Petition at 2 n.2, 3.

\12\ See Petition at 3.

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Petitioners specifically request that the Commission exempt from

most provisions of the CEA certain ``financial transmission rights,''

``energy transactions,'' ``forward capacity transactions,'' and

``reserve or regulation transactions,'' as those terms are defined in

the Petition, if such transactions are offered or entered into pursuant

to a tariff under which a Petitioner operates that has been approved by

FERC or PUCT, as applicable, as well as any persons (including

Petitioners, their members and their market participants) offering,

entering into, rendering advice, or rendering other services with

respect to such transactions.\13\ Petitioners assert that each of the

transactions for which an exemption is requested is (a) subject to a

long-standing, comprehensive regulatory framework for the offer and

sale of such transactions established by FERC, or in the case of ERCOT,

the PUCT, and (b) part of, and inextricably linked to, the organized

wholesale electricity markets that are subject to regulation and

oversight of FERC or PUCT, as applicable.\14\ Petitioners expressly

exclude from the Petition a request for relief from sections 4b, 4o,

6(c) and 9(a)(2) of the Act \15\ and such provisions explicitly have

been carved out of the exemption that would be provided by the Proposed

Exemption. Petitioners assert that they are seeking the requested

exemption in order to provide greater legal certainty with respect to

the regulatory requirements that apply to the transactions that are the

subject of the Petition.\16\ Petitioners request that, due to the

commonalities in the Petitioners' markets, the exemption apply to all

Petitioners and their respective market participants with respect to

each category of electricity-related products described in the

Petition, regardless of whether such products are offered or entered

into at the current time pursuant to an individual Petitioner's

tariff.\17\ Petitioners' assert that this uniformity would avoid an

individual Petitioner being required to seek future amendments to the

exemption in order to offer or enter into the same type of transactions

currently offered by another Petitioner.\18\

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\13\ See id. at 2-3.

\14\ See id. at 11.

\15\ See id. at 3.

\16\ See id. at 3, 5-6.

\17\ See id. at 6.

\18\ See id.

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II. Statutory background

On July 21, 2010, President Obama signed the Dodd-Frank Act. Title

VII of the Dodd-Frank Act amended the CEA \19\ and altered the scope of

the Commission's exclusive jurisdiction.\20\ In particular, it expanded

the Commission's exclusive jurisdiction, which had included futures

traded, executed and cleared on CFTC-regulated exchanges and

clearinghouses, to also cover swaps traded, executed, or cleared on

CFTC-regulated exchanges or clearinghouses.\21\ As a result, the

Commission's exclusive jurisdiction now includes swaps as well as

futures, and is clearly expressed in CEA section 2(a)(1)(A), which

reads:

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\19\ 7 U.S.C. 1 et seq.

\20\ Section 722(e) of the Dodd-Frank Act.

\21\ See 7 U.S.C. 2(a)(1)(A). The Dodd-Frank Act also added

section 2(h)(1)(A), which requires swaps to be cleared if required

to be cleared and not subject to a clearing exception or exemption.

See 7 U.S.C. 2(h)(1)(A).

The Commission shall have exclusive jurisdiction, except to the

extent otherwise provided in the Wall Street Transparency and

Accountability Act of 2010 (including an amendment made by that Act)

and subparagraphs (C), (D), and (I) of this paragraph and

subsections (c) and (f), with respect to accounts, agreements

(including any transaction which is of the character of * * * an

``option''), and transactions involving swaps or contracts of sale

of a commodity for future delivery (including significant price

discovery contracts) traded or executed on a contract market * * *

or a swap execution facility * * * or any other board of trade,

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exchange, or market * * *.\22\

\22\ 7 U.S.C. 2(a)(1)(A).

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The Dodd-Frank Act also added a savings clause that addresses the

roles of the Commission, FERC, and state agencies as they relate to

certain agreements, contracts, or transactions traded pursuant to the

tariff of an RTO and ISO.\23\ Toward that end, paragraph (I) of CEA

section 2(a)(1) repeats the Commission's exclusive jurisdiction and

clarifies that the Commission retains its authorities over agreements,

contracts or transactions traded pursuant to FERC- or state-approved

tariff or rate schedules.\24\ The same paragraph (I) also explains that

the FERC and state agencies preserve their existing authorities over

agreements, contracts, or transactions ``entered into pursuant to a

tariff or rate schedule approved by [FERC] or a State regulatory

agency,'' that are: ``(I) not ``executed, traded, or cleared on'' an

entity or trading facility subject to registration or ``(II) executed,

traded, or cleared on a registered entity

[[Page 52140]]

or trading facility owned or operated by a [RTO] or [ISO].'' \25\

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\23\ See 7 U.S.C. 2(a)(1)(I).

\24\ See 7 U.S.C. 2(a)(1)(I)(i) and (ii).

\25\ 7 U.S.C. 2(a)(1)(I)(i)(II). The savings clause in CEA

section 2(a)(1)(I) provides that:

(I)(i) Nothing in this Act shall limit or affect any statutory

authority of the Federal Energy Regulatory Commission or a State

regulatory authority (as defined in section 3(21) of the Federal

Power Act (16 U.S.C. 796(21)) with respect to an agreement,

contract, or transaction that is entered into pursuant to a tariff

or rate schedule approved by the Federal Energy Regulatory

Commission or a State regulatory authority and is--

(I) Not executed, traded, or cleared on a registered entity or

trading facility; or

(II) Executed, traded, or cleared on a registered entity or

trading facility owned or operated by a regional transmission

organization or independent system operator.

(ii) In addition to the authority of the Federal Energy

Regulatory Commission or a State regulatory authority described in

clause (i), nothing in this subparagraph shall limit or affect--

(I) Any statutory authority of the Commission with respect to an

agreement, contract, or transaction described in clause (i); or

(II) The jurisdiction of the Commission under subparagraph (A)

with respect to an agreement, contract, or transaction that is

executed, traded, or cleared on a registered entity or trading

facility that is not owned or operated by a regional transmission

organization or independent system operator (as defined by sections

3(27) and (28) of the Federal Power Act (16 U.S.C. 796(27),

796(28)).

In addition, Dodd-Frank Act section 722(g) (not codified in the

United States Code) expressly states that FERC's pre-existing

statutory enforcement authority is not limited or affected by

amendments to the CEA. Section 722(g) states:

(g) AUTHORITY OF FERC.--Nothing in the Wall Street Transparency

and Accountability Act of 2010 or the amendments to the Commodity

Exchange Act made by such Act shall limit or affect any statutory

enforcement authority of the Federal Energy Regulatory Commission

pursuant to section 222 of the Federal Power Act and section 4A of

the Natural Gas Act that existed prior to the date of enactment of

the Wall Street Transparency and Accountability Act of 2010.

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While the Dodd-Frank Act sets forth a clear statement of the

Commission's exclusive jurisdiction and authorities as related to FERC

and state regulatory authorities, the Dodd-Frank Act also granted the

Commission specific powers to exempt certain contracts, agreements or

transactions from duties otherwise required by statute or Commission

regulation by adding a new section to the CEA, section 4(c)(6), that

permits the Commission to exempt from its regulatory oversight, among

other things, agreements, contracts, or transactions traded pursuant to

an RTO or ISO tariff that has been approved or permitted to take effect

by FERC or a State regulatory authority, as applicable.\26\ The

Commission's charge, however, is not rote; the Commission must

initially determine whether the exemption would be consistent with the

public interest and the purposes of the CEA.\27\

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\26\ See 7 U.S.C. 6(c)(6).

\27\ See 7 U.S.C. 6(c)(6)(A) and (B).

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The Commission must act ``in accordance with'' section 4(c)(1) and

(2) of the CEA, when issuing an electricity exemption under section

4(c)(6).\28\ Section 4(c)(1) authorizes the Commission, by rule,

regulation, or order, to exempt any agreement, contract or transaction,

or class thereof, from the exchange-trading requirements of section

4(a) or any other requirements of the Act other than section

2(a)(1)(C)(ii) and (D). The Commission may attach terms and conditions

to any exemption it provides.

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\28\ Section 4(c) was added to the CEA by the Futures Trading

Practices Act of 1992, Public Law 102-564. The Commission's

authority under section 4(c) was explained by the Conferees:

In granting exemptive authority to the Commission under new

section 4(c), the Conferees recognize the need to create legal

certainty for a number of existing categories of instruments which

trade today outside of the forum of a designated contract market.

The provision included in the Conference substitute is designed

to give the Commission broad flexibility in addressing these

products

* * * * *

In this respect, the Conferees expect and strongly encourage the

Commission to use its new exemptive power promptly upon enactment of

this legislation in four areas where significant concerns of legal

uncertainty have arisen: (1) Hybrids, (2) swaps, (3) forwards, and

(4) bank deposits and accounts.

The Commission is not required to ascertain whether a particular

transaction would fall within its jurisdiction prior to exercising

its exemptive authority under section 4(c). The Conferees stated

that they did:

not intend that the exercise of exemptive authority by the

Commission would require any determination before hand that the

agreement, instrument, or transaction for which an exemption is

sought is subject to the Act. Rather, this provision provides

flexibility for the Commission to provide legal certainty to novel

instruments where the determination as to jurisdiction is not

straightforward * * *

H.R. Rep. No. 978, 102d Cong. 2d Sess., (1992) at 82-83.

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Section 4(c)(2) of the CEA \29\ provides that the Commission may

not approve an exemption from the execution requirements of the Act, as

noted in section 4(a),\30\ unless the agreement, contract or

transaction will be entered into solely between ``appropriate

persons,'' as that term is defined in section 4(c)(3), which does not

include retail customers (such as small businesses or individuals). In

addition, the Commission must determine that the agreement, contract or

transaction in question will not have a material adverse effect on the

ability of the Commission or any contract market to discharge its

regulatory or self-regulatory duties.\31\

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\29\ Section 4(c)(2), 7 U.S.C. 6(c)(2), states:

The Commission shall not grant any exemption * * * from any of

the requirements of subsection (a) unless the Commission determines

that (A) the requirement should not be applied to the agreement,

contract, or transaction for which the exemption is sought and that

the exemption would be consistent with the public interest and the

purposes of this Act; and (B) the agreement, contract, or

transaction--

(i) Will be entered into solely between appropriate persons; and

(ii) Will not have a material adverse effect on the ability of

the Commission or any contract market to discharge its regulatory or

self-regulatory duties under this Act.

\30\ 7 U.S.C. 6(a).

\31\ See 7 U.S.C. 6(c)(2).

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III. Background--FERC and PUCT

A. Introduction

Each Petitioner is subject to regulation by FERC, with the

exception of ERCOT, which is regulated by PUCT.\32\ Petitioners assert

that the regulatory frameworks administered by FERC or PUCT, as

applicable to each particular RTO or ISO market, would apply to the

transactions for which an exemption has been requested.\33\

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\32\ See Petition at 4.

\33\ See id. at 11.

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B. FERC

In 1920, Congress established the Federal Power Commission

(``FPC'').\34\ The FPC was reorganized into FERC in 1977.\35\ FERC is

an independent agency that regulates the interstate transmission of

electricity, natural gas and oil.\36\ FERC's mission is to ``assist

consumers in obtaining reliable, efficient and sustainable energy

services at a reasonable cost through appropriate regulatory and market

means.'' \37\ This mission is accomplished by pursuing two primary

goals. First, FERC seeks to ensure that rates, terms and conditions for

wholesale transactions and transmission of electricity and natural gas

are just, reasonable and not unduly discriminatory or preferential.\38\

Second, FERC seeks to promote the development of safe, reliable and

efficient energy infrastructure that serves the public interest.\39\

Both Congress and FERC, through a series of legislative acts and

Commission orders, have sought to establish a system whereby wholesale

electricity generation and transmission in the United States is

governed by two guiding principles; regulation with respect to

wholesale electricity

[[Page 52141]]

transmission,\40\ and competition when dealing with wholesale

generation.\41\

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\34\ Federal Power Act, 16 U.S.C. 791a et seq.

\35\ The Department of Energy Organization Act, Public Law 95-

91, section 401, 91 Stat. 565, 582 (1977) (codified as amended at 42

U.S.C. 7171 (1988)).

\36\ See 42 U.S.C. 7172.

\37\ See FERC Strategic Plan for Fiscal Years 2009-2014, 3 (Feb.

2012), http://www.ferc.gov/about/strat-docs/FY-09-14-strat-plan-print.pdf.

\38\ Id.

\39\ Id.

\40\ The term ```wholesale transmission services' means the

transmission of electric energy sold, or to be sold, at wholesale in

interstate commerce.'' See 16 U.S.C. 796 (24)).

\41\ See generally FERC Order 888. See also FERC's discussion of

electric competition, available at http://www.ferc.gov/industries/electric/indus-act/competition.asp (stating that ``[FERC]'s core

responsibility is to `guard the consumer from exploitation by non-

competitive electric power companies.' '').

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In 1996, FERC issued FERC Order 888, which promoted competition in

the generation market by ensuring fair access and market treatment by

transmission customers.\42\ Specifically, FERC Order 888 sought to

``remedy both existing and future undue discrimination in the industry

and realize the significant customer benefits that will come with open

access.'' \43\ FERC Order 888 encouraged the formation of ISOs as a

potentially effective means for accomplishing non-discriminatory open

access to the transmission of electrical power.\44\

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\42\ See FERC Order 888.

\43\ FERC Order 888 at 21541.

\44\ FERC Order 888 at 21594. Under the old system, one party

could own both generation and transmission resources, giving

preferential treatment to its own and affiliated entities. See

generally FERC Order 888.

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In addition, FERC has issued orders that address areas such as

increased RTO and ISO participation by transmission utilities,

increased use of long-term firm transmission rights, increased

investment in transmission infrastructure, reduced transmission

congestion and the use of demand-response.\45\ The end result of this

series of FERC orders is that a regulatory system has been established

that requires ISOs and RTOs to comply with numerous FERC rules designed

to improve both the reliability of the physical operations of electric

transmission systems as well as the competitiveness of electricity

markets. The requirements imposed by the various FERC Orders seek to

ensure that FERC is able to accomplish its two main goals; ensuring

that rates, terms and conditions are just, reasonable and not unduly

discriminatory or preferential, while promoting the development of

safe, reliable and efficient energy infrastructure that serves the

public interest.

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\45\ See, e.g., FERC Order 2000, 65 FR 809 (2000)(encouraging

transmission utilities to join RTOs); FERC Order No. 681, 71 FR

43294 (2006), FERC Stats. & Regs. ] 31,222 (2006), order on reh'g,

Order No. 679-A, 72 FR 1152, Jan. 10, 2007, FERC Stats. & Regs. ]

31,236, order on reh'g, 119 FERC ] 61,062 (2007) (finalizing

guidelines for ISOs to follow in developing proposals to provide

long-term firm transmission rights in organized electricity

markets); FERC Order No. 679, 71 FR 43294 (2006) (finalizing rules

to increase investment in the nation's aging transmission

infrastructure, and to promote electric power reliability and lower

costs for consumers, by reducing transmission congestion); FERC

Order No. 890, 72 FR 12266 (2007)(modifying existing rules to

promote the nondiscriminatory and just operation of transmission

systems); and FERC Order No. 719-A, 74 FR 37776 (2009) (implementing

the use of demand-response (the process of requiring electricity

consumers to reduce their electricity use during times of heightened

demand), encouraging the use of long-term power contracts and

strengthening the role of market monitors).

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C. PUCT

In 1975, the Texas Legislature enacted the Public Utility

Regulatory Act (``PURA'') and created PUCT to provide statewide

regulation of the rates and services of electric and telecommunications

utilities.\46\ PUCT's stated mission is to assure the availability of

safe, reliable, high quality services that meet the needs of all Texans

at just and reasonable rates.\47\ To this end, PUCT regulates electric

and telecommunications utilities while facilitating competition,

operation of the free market, and customer choice.\48\ Subchapter S of

TAC Sec. 25 (``Wholesale Markets'') sets out the rules applicable to

ERCOT, which operates a wholesale electricity market in Texas similar

to the electricity markets run by the other Petitioners. As with the

RTOs and ISOs regulated by FERC, ERCOT is required to have rules that

address the regulatory requirements imposed by PUCT.\49\ These rules

address issues similar to those rules imposed by FERC on RTOs and

ISOs,\50\ including matters such as market design, pricing safeguards,

market monitoring, monitoring for wholesale market power, resource

adequacy and ERCOT emergency response services,\51\ and are aimed at

developing electricity markets that are able to provide reliable, safe

and efficient electric service to the people of Texas, while also

maintaining rates at an affordable level through the operation of fair

competition.\52\

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\46\ Public Utility Regulatory Act, TEX. UTIL. CODE ANN. 11.001

et seq. (Vernon 1998 & Supp. 2005).

\47\ 16 Texas Admin. Code (``TAC'') 25.1 (1998).

\48\ Id.

\49\ See generally 16 TAC 25.501-25.507.

\50\ See generally id.

\51\ See generally id.

\52\ See generally 16 TAC 25.503.

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D. FERC & PUCT Oversight

As discussed above, both FERC and PUCT assert that their primary

goal in regulating their respective electricity markets is to ensure

that consumers are able to purchase electricity on a safe, reliable and

affordable basis.\53\

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\53\ See generally 16 TAC 25.1. See also FERC Strategic Plan for

Fiscal Years 2009-2014, 3 (Feb. 2012), http://www.ferc.gov/about/strat-docs/FY-09-14-strat-plan-print.pdf.

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IV. Scope of the Exemption

A. Transactions Subject to the Exemption

After due consideration, the Commission proposes to exempt certain

Financial Transmission Rights (``FTRs''), Energy Transactions, Forward

Capacity Transactions, and Reserve or Regulation Transactions

(collectively, the ``Transactions''), each as defined below, pursuant

to section 4(c)(6) of the Act.

An FTR is a transaction, however named, that entitles one party to

receive, and obligates another party to pay, an amount based solely on

the difference between the price for electricity, established on an

electricity market administered by a Petitioner, at a specified source

(i.e., where electricity is deemed injected into the grid of a

Petitioner) and a specified sink (i.e., where electricity is deemed

withdrawn from the grid of a Petitioner).\54\ The term ``FTR'' includes

Financial Transmission Rights, and Financial Transmission Rights in the

form of options (i.e., where one party has only the obligation to pay,

and the other party only the right to receive, an amount as described

above). As more fully described below, the Proposed Exemption applies

only to FTRs where each FTR is linked to, and the aggregate volume of

FTRs for any period of time is limited by, the physical capability

(after accounting for counterflow) of the electricity transmission

system operated by the Petitioner offering the contract for such

period: a Petitioner serves as the market administrator for the market

on which the FTR is transacted; each party to the Transaction is a

member of the particular Petitioner (or is the Petitioner itself) and

the Transaction is executed on a market administered by that

Petitioner; and the Transaction does not require any party to make or

take physical delivery of electricity.\55\

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\54\ Petition at 6.

\55\ Each FTR specifies a direction along a path from a

specified source to a specified sink. Counterflow FTRs specify a

path where congestion in the physical market is in the opposite

direction from the prevailing flow. Holders of counterflow FTRs

generally pay congestion revenues to the RTO or ISO. Because

counterflow FTRs are expected to result in payment liability to the

FTR holder, the price of counterflow FTRS are typically negative.

That is, the RTO or ISO pays market participants to acquire them.

However, counterflow FTRs may be profitable (and prevailing flow

FTRs may result in a payment liability) where congestion in the

physical market occurs in direction opposite to that expected. See

generally PJM Interconnection, L.L.C., 122 FERC ] 61,279 (2008); see

also PJM Interconnection, L.L.C, 121 FERC ] 61,089 (2007).

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``Energy Transactions'' are transactions in a ``Day-Ahead Market''

[[Page 52142]]

or ``Real-Time Market,'' as those terms are defined in the Proposed

Exemption, for the purchase or sale of a specified quantity of

electricity at a specified location where the price of electricity is

established at the time the transaction is executed.\56\ Performance

occurs in the Real-Time Market by either the physical delivery or

receipt of the specified electricity or a cash payment or receipt at

the price established in the Real-Time Market; and the aggregate

cleared volume of both physical and cash-settled energy transactions

for any period of time is limited by the physical capability of the

electricity transmission system operated by a Petitioner for that

period of time.\57\ Energy Transactions are also referred to as Virtual

Bids or Convergence Bids.\58\

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\56\ See Petition at 7. See also section VIII. below.

\57\ See id. at 7. See also section VIII. below.

\58\ See id. at 6.

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``Forward Capacity Transactions'' fall into three distinct

categories, Generation Capacity (``GC''), Demand Response (``DR''), and

Energy Efficiency.\59\ GC refers to the right of a Petitioner to

require certain sellers to maintain the interconnection of electric

generation facilities to specific physical locations in the electric

power transmission system during a future time period as specified in

the Petitioner's Tariff.\60\ Furthermore, a GC contract requires a

seller to offer specified amounts of electric energy into the Day-Ahead

or Real-Time Markets for electricity transactions. A GC contract also

requires a seller, subject to the terms and conditions of a

Petitioner's Tariff, to inject electric energy into the electric power

transmission system operated by the Petitioner.\61\ A DR Right gives

Petitioners the right to require that certain sellers of such rights

curtail their consumption of electricity from Petitioner's electricity

transmission system during a future period of time as specified in the

Petitioners' Tariffs.\62\ Energy Efficiency Rights (``EER'') provides

Petitioners with the right to require specific performance of an action

or actions on the part of the other party that will reduce the need for

GC or DR capacity over the duration of a future period of time as

specified in the Petitioner's Tariffs.\63\ Moreover, for a Forward

Capacity Transaction to be eligible for exemption hereunder, the

aggregate cleared volume of all such transactions for any period of

time must be limited to the physical capability of the electric

transmission system operated by the applicable Petitioner for that

period of time.

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\59\ See id. at 7-8.

\60\ See id. at 7.

\61\ See id.

\62\ See id. at 7.

\63\ See id. at 8. Another example of an EER would be requiring

an RTO or ISO member to change equipment in order to improve the

efficiency of the system, and in turn, reduce the amount of

electricity drawn from the system. See also section VIII. below.

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``Reserve Regulation Transactions'' allow a Petitioner to purchase

through auction, for the benefit of load serving entities (``LSEs'')

and resources, the right, during a period of time specified in the

Petitioner's Tariff, to require the seller to operate electric

facilities in a physical state such that the facilities can increase or

decrease the rate of injection or withdrawal of electricity to the

electric power transmission system operated by the Petitioner with

physical performance by the seller's facilities within a response

interval specified in the Petitioner's tariff (Reserve Transaction), or

prompt physical performance by the seller's facilities (Area Control

Error Regulation Transaction).\64\ In consideration for such delivery,

or withholding of delivery, the seller receives compensation of the

type specified in section VIII below.\65\ In all cases, the quantity

and specifications for such Transactions for a Petitioner for any

period of time are limited by the physical capability of the electric

transmission system operated by Petitioners.\66\ These Transactions are

typically used to address unforeseen fluctuations in the level of

electricity demand experienced on the electric transmission system.

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\64\ See id. at 8-9. See also section VIII. below.

\65\ See id. at 8.

\66\ See id. at 8-9.

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B. Conditions

The Proposed Exemption would be subject to certain conditions.

First, all parties to the agreements, contracts or transactions that

are covered by the Proposed Exemption must be either ``appropriate

persons,'' as such term is defined in sections 4(c)(3)(A) through (J)

of the Act, or ``eligible contract participants,'' as such term is

defined in section 1a(18)(A) of the Act and in Commission regulation

1.3(m).\67\

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\67\ That is, the Commission is proposing to use its authority

pursuant to CEA 4(c)(3)(K) to include eligible contract participants

as appropriate persons for the purposes of this Order. See infra n.

80 and accompanying text.

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Second, the agreements, contracts or transactions that are covered

by the Proposed Exemption must be offered or sold pursuant to a

Petitioner's tariff, which has been approved or permitted to take

effect by:

(1) In the case of ERCOT, the PUCT or

(2) In the case of all other Petitioners, FERC.

Third, none of a Petitioner's tariffs or other governing documents

may include any requirement that the Petitioner notify a member prior

to providing information to the Commission in response to a subpoena or

other request for information or documentation.

Finally, information sharing arrangements that are satisfactory to

the Commission between the Commission and FERC and between the

Commission and PUCT must be in full force and effect.\68\

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\68\ As discussed in section VIII.A. below, the Commission and

FERC have already entered into a Memorandum of Understanding, a copy

of which is available at http://www.ferc.gov/legal/maj-ord-reg/mou/mou-33.pdf. In addition, the Commission intends on working with the

PUCT on an MOU that is mutually satisfactory.

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C. Additional Limitations

As discussed above, the Commission proposes to exempt the

Transactions pursuant to section 4(c)(6) of the Act based, in part, on

certain representations made by Petitioners as well as the additional

limitations that are noted below. As represented in the Petition, the

exemption requested by Petitioners relate to Transactions that are

primarily entered into by commercial participants that are in the

business of generating, transmitting and distributing electricity.\69\

In addition, the Commission notes that it appears that Petitioners were

established for the purpose of providing affordable, reliable

electricity to consumers within their geographic region.\70\

Critically, these Transactions are an essential means, designed by FERC

and PUCT as an integral part of their statutory responsibilities, to

enable the reliable delivery of affordable electricity.\71\ The

Commission also notes that each of the Transactions taking place on

Petitioners' markets is monitored by Market Monitoring Units (``MMU'')

responsible to either FERC or, in the case of ERCOT, PUCT.\72\ Finally,

as discussed above, each Transaction is directly tied to the physical

capabilities of Petitioners' electricity grids.\73\ As more fully

described below,\74\ and on the basis of the aforementioned

representations, the Commission finds that the Proposed Exemption would

be in the public interest for the specified Transactions.

[[Page 52143]]

To be clear, however, financial transactions that are not tied to the

allocation of the physical capabilities of an electric transmission

grid would not be suitable for exemption because such activity would

not be inextricably linked to the physical delivery of electricity.

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\69\ See generally Petition at 20.

\70\ See id. at 3-4.

\71\ See generally FERC Order 888; FERC Order 2000; 18 CFR

35.34(k)(2); and TAC 25.1. See also Petition at 11, 13-14.

\72\ Petition at 15-18.

\73\ See id. at 6-9.

\74\ See the discussions in sections V.B., V.D., and V.E. below.

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V. Section 4(c)Analysis

A. Overview of CEA Section 4(c)

1. Sections 4(c)(6)(A) and (B)

The Dodd-Frank Act amended CEA section 4(c) to add sections

4(c)(6)(A) and (B), which provide for exemptions for certain

transactions entered into (a) pursuant to a tariff or rate schedule

approved or permitted to take effect by FERC, or (b) pursuant to a

tariff or rate schedule establishing rates or charges for, or protocols

governing, the sale of electric energy approved or permitted to take

effect by the regulatory authority of the State or municipality having

jurisdiction to regulate rates and charges for the sale of electric

energy within the State or municipality, as eligible for exemption

pursuant to the Commission's 4(c) exemptive authority.\75\ Indeed,

4(c)(6) provides that ``[i]f the Commission determines that the

exemption would be consistent with the public interest and the purposes

of this chapter, the Commission shall'' issue such an exemption.

However, any exemption considered under 4(c)(6)(A) and/or (B) must be

done ``in accordance with [CEA section 4(c)(1) and (2)].'' \76\

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\75\ The exemption language in section 4(c)(6) reads:

(6) If the Commission determines that the exemption would be

consistent with the public interest and the purposes of this Act,

the Commission shall, in accordance with paragraphs (1) and (2),

exempt from the requirements of this Act an agreement, contract, or

transaction that is entered into--

(A) Pursuant to a tariff or rate schedule approved or permitted

to take effect by the Federal Energy Regulatory Commission;

(B) Pursuant to a tariff or rate schedule establishing rates or

charges for, or protocols governing, the sale of electric energy

approved or permitted to take effect by the regulatory authority of

the State or municipality having jurisdiction to regulate rates and

charges for the sale of electric energy within the State or

municipality; or

(C) Between entities described in section 201(f) of the Federal

Power Act (16 U.S.C. 824(f)).

\76\ CEA section 4(c)(6) explicitly directs the Commission to

consider any exemption proposed under 4(c)(6) ``in accordance with

[CEA section 4(c)(1) and (2)].''

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2. Section 4(c)(1)

CEA section 4(c)(1) requires that the Commission act ``by rule,

regulation or order, after notice and opportunity for hearing.'' It

also provides that the Commission may act ``either unconditionally or

on stated terms or conditions or for stated periods and either

retroactively or prospectively or both'' and that the Commission may

provide exemption from any provisions of the CEA except subparagraphs

(C)(ii) and (D) of section 2(a)(1).\77\

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\77\ Section 4(c)(1), 7 U.S.C. 6(c)(1), states:

(c)(1) In order to promote responsible economic or financial

innovation and fair competition, the Commission by rule, regulation,

or order, after notice and opportunity for hearing, may (on its own

initiative or on application of any person, including any board of

trade designated or registered as a contract market or derivatives

transaction execution facility for transactions for future delivery

in any commodity under section 5 of this Act) exempt any agreement,

contract, or transaction (or class thereof) that is otherwise

subject to subsection (a) (including any person or class of persons

offering, entering into, rendering advice or rendering other

services with respect to, the agreement, contract, or transaction),

either unconditionally or on stated terms or conditions or for

stated periods and either retroactively or prospectively, or both,

from any of the requirements of subsection (a), or from any other

provision of this Act (except subparagraphs (C)(ii) and (D) of

section 2(a)(1), except that--

(A) Unless the Commission is expressly authorized by any

provision described in this subparagraph to grant exemptions, with

respect to amendments made by subtitle A of the Wall Street

Transparency and Accountability Act of 2010--

(i) With respect to--

(I) Paragraphs (2), (3), (4), (5), and (7), paragraph

(18)(A)(vii)(III), paragraphs (23), (24), (31), (32), (38), (39),

(41), (42), (46), (47), (48), and (49) of section 1a, and sections

2(a)(13), 2(c)(1)(D), 4a(a), 4a(b), 4d(c), 4d(d), 4r, 4s, 5b(a),

5b(b), 5(d), 5(g), 5(h), 5b(c), 5b(i), 8e, and 21; and

(II) Section 206(e) of the Gramm-Leach-Bliley Act (Pub. L. 106-

102; 15 U.S.C. 78c note); and

(ii) in sections 721(c) and 742 of the Dodd-Frank Wall Street

Reform and Consumer Protection Act; and

(B) The Commission and the Securities and Exchange Commission

may by rule, regulation, or order jointly exclude any agreement,

contract, or transaction from section 2(a)(1)(D)) if the Commissions

determine that the exemption would be consistent with the public

interest.

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3. Section 4(c)(2)

CEA section 4(c)(2) requires the Commission to determine that: To

the extent an exemption provides relief from any of the requirements of

CEA section 4(a), the requirement should not be applied to the

agreement, contract or transaction; the exempted agreement, contract,

or transactions will be entered into solely between appropriate

persons; \78\ and the exemption will not have a material adverse effect

on the ability of the Commission or any contract market to discharge

its regulatory or self-regulatory duties under the CEA.\79\

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\78\ See CEA 4(c)(2)(B)(i) and the discussion of CEA section

4(c)(3) below.

\79\ CEA section 4(c)(2)(A) also requires that the exemption

would be consistent with the public interest and the purposes of the

CEA, but that requirement duplicates the requirement of section

4(c)(6).

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4. Section 4(c)(3)

CEA section 4(c)(3) outlines who may constitute an appropriate

person for the purpose of a 4(c) exemption, including as relevant to

this Notice: (a) Any person that fits in one of ten defined categories

of appropriate persons; or (b) such other persons that the Commission

determines to be appropriate in light of their financial or other

qualifications, or the applicability of appropriate regulatory

protections.\80\

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\80\ Section 4(c)(3), 7 U.S.C. 6(c)(3), provides that: the term

``appropriate person'' shall be limited to the following persons or

classes thereof:

(A) A bank or trust company (acting in an individual or

fiduciary capacity).

(B) A savings association.

(C) An insurance company.

(D) An investment company subject to regulation under the

Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.).

(E) A commodity pool formed or operated by a person subject to

regulation under this Act.

(F) A corporation, partnership, proprietorship, organization,

trust, or other business entity with a net worth exceeding

$1,000,000 or total assets exceeding $5,000,000, or the obligations

of which under the agreement, contract or transaction are guaranteed

or otherwise supported by a letter of credit or keepwell, support,

or other agreement by any such entity or by an entity referred to in

subparagraph (A), (B), (C), (H), (I), or (K) of this paragraph.

(G) An employee benefit plan with assets exceeding $1,000,000,

or whose investment decisions are made by a bank, trust company,

insurance company, investment adviser registered under the

Investment Advisers Act of 1940 (15 U.S.C. 80a-1 et seq.), or a

commodity trading advisor subject to regulation under this Act.

(H) Any governmental entity (including the United States, any

state, 4-1 or any foreign government) or political subdivision

thereof, or any multinational or supranational entity or any

instrumentality, agency, or department of any of the foregoing.

(I) A broker-dealer subject to regulation under the Securities

Exchange Act of 1934 (15 U.S.C. 78a et seq.) acting on its own

behalf or on behalf of another appropriate person.

(J) A futures commission merchant, floor broker, or floor trader

subject to regulation under this Act acting on its own behalf or on

behalf of another appropriate person.

(K) Such other persons that the Commission determines to be

appropriate in light of their financial or other qualifications, or

the applicability of appropriate regulatory protections.

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B. Proposed CEA Section 4(c) Determinations

In connection with the Proposed Exemption, the Commission has

considered and proposes to determine that: (i) The Proposed Exemption

is consistent with the public interest and the purposes of the CEA;

(ii) CEA section 4(a) should not apply to the transactions or entities

eligible for the Proposed Exemption, (iii) the persons eligible to rely

on the Proposed Exemption are appropriate persons pursuant to CEA

section 4(c)(3); and (iv) the Proposed Exemption will not have a

material adverse effect on the ability of the Commission or any

contract market to discharge its regulatory or self-regulatory duties

under the CEA.

[[Page 52144]]

1. Consistent with the Public Interest and the Purposes of the CEA

As required by CEA section 4(c)(2)(A), as well as section 4(c)(6),

the Commission proposes to determine that the Proposed Exemption is

consistent with the public interest and the purposes of the CEA.

Section 3(a) of the CEA provides that transactions subject to the CEA

affect the national public interest by providing a means for managing

and assuming price risk, discovering prices, or disseminating pricing

information through trading in liquid, fair and financially secure

trading facilities. Section 3(b) of the CEA identifies the purposes of

the CEA:

It is the purpose of this Act to serve the public interests

described in subsection (a) through a system of effective self-

regulation of trading facilities, clearing systems, market

participants and market professionals under the oversight of the

Commission. To foster these public interests, it is further the

purpose of this Act to deter and prevent price manipulation or any

other disruptions to market integrity; to ensure the financial

integrity of all transactions subject to this Act and the avoidance

of systemic risk; to protect all market participants from fraudulent

or other abusive sales practices and misuses of customer assets; and

to promote responsible innovation and fair competition among boards

of trade, other markets and market participants.

The Petitioners assert that the Proposed Exemption would be

consistent with the public interest and purposes of the CEA,\81\

stating generally that: (a) The Transactions have been, and are,

subject to a long-standing, comprehensive regulatory framework for the

offer and sale of the Transactions established by FERC or PUCT; and (b)

the Transactions administered by the RTOs/ISOs or ERCOT are part of,

and inextricably linked to, the organized wholesale electricity markets

that are subject to FERC and PUCT regulation and oversight.\82\ For

example, Petitioners explain that FERC Order No. 2000 (which, along

with FERC Order No. 888, encouraged the formation of RTOs/ISOs to

operate the electronic transmission grid and to create organized

wholesale electric markets) requires an RTO/ISO to demonstrate that it

has four minimum characteristics: (1) Independence from any market

participant; (2) a scope and regional configuration which enables the

ISO/RTO to maintain reliability and effectively perform its required

functions; (3) operational authority for its activities, including

being the security coordinator for the facilities that it controls; and

(4) short-term reliability.\83\ Petitioners highlight that an RTO/ISO

must demonstrate to FERC that it performs certain self-regulatory and/

or market monitoring functions,\84\ and the Petition describes the

analogous requirements applicable to ERCOT under PUCT and the PURA.\85\

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\81\ See Petition at 11.

\82\ See id.

\83\ See id. at 13.

\84\ See id. at 13-14 (explaining that each RTO/ISO must employ

a transmission pricing system that promotes efficient use and

expansion of transmission and generation facilities; develop and

implement procedures to address parallel path flow issues within its

region and with other regions; serve as a provider of last resort of

all ancillary services required by FERC Order No. 888 including

ensuring that its transmission customers have access to a real-time

balancing market; be the single OASIS (Open-Access Same-Time

Information System) site administrator for all transmission

facilities under its control and independently calculate Total

Transmission Capacity and Available Transmission Capability; provide

reliable, efficient and not unduly discriminatory transmission

service, it must provide for objective monitoring of markets it

operates or administers to identify market design flaws, market

power abuses and opportunities for efficiency improvements; be

responsible for planning, and for directing or arranging, necessary

transmission expansions, additions, and upgrades; and ensure the

integration of reliability practices within an interconnection and

market interface practices among regions).

\85\ See id. at 14-15. Pursuant to PURA 39.151(a), ERCOT's roles

and duties are to provide access to the transmission and

distribution systems for all buyers and sellers of electricity on

nondiscriminatory terms; ensure the reliability and adequacy of the

regional electrical network; ensure that information relating to a

customer's choice of retail electric provider is conveyed in a

timely manner to the persons who need that information; and ensure

that electricity production and delivery are accurately accounted

for among the generators and wholesale buyers and sellers in the

region.

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Of single importance, Petitioners are responsible for ``ensur[ing]

the development and operation of market mechanisms to manage

transmission congestion. * * * The market mechanisms must accommodate

broad participation by all market participants, and must provide all

transmission customers with efficient price signals that show the

consequences of their transmission usage decisions.'' \86\

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\86\ See Petition at 14. See also 18 CFR 35.34(k)(2).

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Petitioners also explain that the Transactions are primarily

entered into by commercial participants that are in the business of

generating, transmitting, and distributing electricity,\87\ and that

Petitioners were established for the purpose of providing affordable,

reliable electricity to consumers within their geographic region.\88\

Furthermore, the Transactions that take place on Petitioners' markets

are overseen by a market monitoring function, required by FERC for each

Petitioner, and by PUCT in the case of ERCOT, to identify manipulation

of electricity on Petitioners' markets.\89\

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\87\ See generally Petition at 20.

\88\ See id. at 3-4.

\89\ See id. at 15-18.

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Fundamental to the Commission's ``public interest'' and ``purposes

of the [Act]'' analysis is the fact that the Transactions are

inextricably tied to the Petitioners' physical delivery of electricity,

as represented in the Petition.\90\ An equally important factor is that

the Proposed Exemption is explicitly limited to Transactions taking

place on markets that are monitored by either an independent market

monitor, a market administrator (the RTO/ISO, or ERCOT), or both, and a

government regulator (FERC or PUCT). In contrast, an exemption for

financial transactions that are not so monitored, or not related to the

physical capacity of an electric transmission grid, or not directly

linked to the physical generation and transmission of electricity, or

not limited to appropriate persons,\91\ is unlikely to be in the public

interest or consistent with the purposes of the CEA and would not be

subject to this exemption.

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\90\ See id. at 6-9 (describing the Transactions and noting that

each of them ``is part of, and inextricably linked to, the organized

wholesale electricity markets that are subject to FERC and PUCT

regulation and oversight'').

\91\ See appropriate persons discussion, below, section V.B.3.

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Finally, and as discussed in detail below, the extent to which the

Proposed Exemption is consistent with the public interest and the

purposes of the Act can, in major part, be measured by the extent to

which the tariffs and activities of the Petitioners, and supervision by

FERC and PUCT, are congruent with, and sufficiently accomplish, the

regulatory objectives of the relevant core principles set forth in the

CEA for derivatives clearing organizations (``DCOs'') and swap

execution facilities (``SEFs''). Specifically, providing a means for

managing or assuming price risk and discovering prices, as well as

prevention of price manipulation and other disruptions to market

integrity, are addressed by the core principles for SEFs. Ensuring the

financial integrity of the transactions and the avoidance of systemic

risk, as well as protection from the misuse of participant assets, are

addressed by the core principles for DCOs. Deterrence of price

manipulation (or other disruptions to market integrity) and protection

of market participants from fraudulent sales practices is achieved by

the Commission retaining and exercising its jurisdiction over these

matters. Therefore, the Commission has incorporated its DCO/SEF core

principle analysis, set forth below, into its consideration of the

Proposed

[[Page 52145]]

Exemption's consistency with the public interest and the purposes of

the Act. In the same way, the Commission has considered how the public

interest and the purposes of the CEA are also addressed by the manner

in which Petitioners comply with FERC's Credit Reform Policy.\92\

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\92\ See FERC Credit Reform Policy discussion, below, at section

V.C.

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Based on this review, the Commission proposes to determine that the

Proposed Exemption is consistent with the public interest and the

purposes of the CEA, and the Commission is specifically requesting

comment on whether the Proposed Exemption is consistent with the public

interest and the purposes of the Act.

2. CEA Section 4(a) Should Not Apply to the Transactions or Entities

Eligible for the Proposed Exemption

CEA section 4(c)(2)(A) requires, in part, that the Commission

determine that the Transactions covered under the Proposed Exemption

should not be subject to CEA section 4(a)--generally, the Commission's

exchange trading requirement for a contract for the purchase or sale of

a commodity for future delivery. Based in major part on the

Petitioners' representations, the Commission has examined the

Transactions, the Petitioners, and their markets in the context of the

CEA core principle requirements applicable to a DCO and to a SEF.\93\

As further support for this determination, the Commission is also

relying on the public interest and the purposes of the Act analysis in

subsection 3 below. In so doing, the Commission can determine that, due

to the FERC or PUCT regulatory scheme and the RTO/ISO or ERCOT market

structure already applicable to the Transactions, the linkage between

the Transactions and those regulatory schemes, and the unique nature of

the market participants that would be eligible to rely on the Proposed

Exemption,\94\ CEA section 4(a) should not apply to the Transactions

under the Proposed Exemption.

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\93\ See DCO core principle analysis below, at section V.D.; see

also SEF core principle analysis below, at section V.E.

\94\ See appropriate persons analysis, below, at section V.B.3.

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The Commission is requesting comment on whether its Proposed

Exemption of the Transactions from CEA section 4(a) is appropriate.

3. Appropriate Persons

CEA section 4a(c)(2)(B)(i) requires that the Commission determine

that the Proposed Exemption is properly limited to transactions entered

into between appropriate persons as described in CEA section 4(c)(3).

The Petitioners assert that each Petitioner's market participants fit

within the ``appropriate person'' requirement under CEA section

4(c)(3), relying primarily on two categories of appropriate persons.

The first category includes those entities that have a net worth

exceeding $1,000,000 or total assets exceeding $5,000,000, as

identified in CEA section 4(c)(3)(F).\95\ The second group of

appropriate persons would fall within a grouping under CEA section

4(c)(3)(K), which includes persons deemed appropriate by the Commission

``in light of their financial or other qualifications, or the

applicability of appropriate regulatory protection.'' \96\

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\95\ CEA section 4(c)(3)(F) provides that the following entities

are ``appropriate persons'' that the Commission may exempt under CEA

section 4(a). The relevant text of 4(c)(3)(F) provides: ``A

corporation, partnership, proprietorship, organization, trust, or

other business entity with a net worth exceeding $1,000,000 or total

assets exceeding $5,000,000, or the obligations of which under the

agreement, contract or transaction are guaranteed or otherwise

supported by a letter of credit or keepwell, support, or other

agreement by any such entity or by an entity referred to in

subparagraph (A), (B), (C), (H), (I), or (K) of this paragraph.''

\96\ CEA 4(c)(3)(K).

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The Petitioners explain that FERC has instructed all RTOs and ISOs

subject to FERC supervision \97\ to create minimum standards for market

participants. The Petitioners state that:

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\97\ According to the Petition, ERCOT is reviewing its

``participants eligibility standards to ensure that they are

consistent with the requirements of [CEA] Section 4(c).'' Petition

at 27. See also Attachment C to Petition, beginning at Attachments

at 27 (``Through its stakeholder process, ERCOT is in the process of

developing new eligibility requirements that are comparable to those

required by FERC Order No. 741.'').

In Order No. 741, FERC directed each of the ISOs/RTOs to

establish minimum criteria for market participants. FERC did not

specify the criteria the ISOs/RTOs should apply, but rather directed

them to establish criteria through their stakeholder processes.

Accordingly, each of the FERC jurisdictional ISOs/RTOs submitted to

FERC proposals to establish minimum criteria for participation in

their markets. Although ERCOT is not subject to the requirements

FERC's Credit Reform Orders, ERCOT is reviewing its participant

eligibility standards to ensure that they are consistent with the

requirements of Section 4(c). These proposals were accepted by FERC

subject to a supplemental compliance filing to provide for

verification of risk management policies and procedures.

Although there is some variation among the minimum participation

criteria adopted by each ISO/RTO, included in each is a baseline

capitalization requirement that participants have net worth of at

least $1 million or total assets of at least $10 million.\98\

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\98\ Petition at 26-27 (citations omitted).

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However, the Petitioners acknowledge that there are exceptions to this

``baseline capitalization requirement,'' that is, market participants

who do not meet the minimum net worth or total assets criteria under

the CEA who pursuant to Petitioners' Tariffs must post financial

security because they are under-capitalized. Nonetheless, as the

Petitioners explain, there is an exception to the posting requirement

for market participants with small positions. The Petitioners provide

the following explanation for the exception:

The criteria of some ISOs/RTOs also reduce the financial

security posting requirement for certain entities that maintain only

small positions on the markets of the ISO/RTO and therefore expose

the ISOs/RTOs to minimal risk. These entities are instead required

to post additional financial security with the ISO/RTO in an amount

that would depend on the size of their positions. In this regard, a

notable number of participants in the markets of some ISOs/RTOs

include cooperatives, municipalities or other forms of public

corporate entities which are authorized to own, lease and operate

electric generation, transmission or distribution facilities. [\99\]

Such entities' participation in the ISO/RTO may be necessary to make

electricity available within the entire grid for a region.

Nevertheless, they are ``appropriate persons'' because of their

active participation in the generation, transmission or distribution

of electricity and the knowledge of the wholesale energy market that

they have as a consequence of their participation in the physical

markets. Moreover, the municipal entities are entitled to recover

their costs for native load service through governmentally

established retail rates and, accordingly, are able to provide a

form of financial security (i.e., the ability to request a retail

rate increase to cover increased costs) that is unavailable to other

participants in the energy markets. As such, the risk of default by

such entities is materially lower than it is for other Market

Participants.\100\

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\99\ The Commission notes here that CEA 4(c)(3)(H) includes as

eligible appropriate persons ``Any governmental entity (including

the United States, any state, or any foreign government) or

political subdivision thereof, or any multinational or supranational

entity or any instrumentality, agency, or department of any of the

foregoing.'' This appropriate persons category would cover the

municipalities and other government owned market participants.

\100\ Petition at 27 (citations omitted).

The Commission is proposing to limit the Proposed Exemption to

entities that meet one of the appropriate persons categories in CEA

section 4(c)(3)(A) through (J), or, pursuant to CEA section 4(c)(3)(K),

that otherwise qualify as an eligible contract participant (``ECP''),

as that term has been defined.\101\ In this

[[Page 52146]]

connection, the Commission notes that the municipal entities discussed

above appear to qualify as ``appropriate persons'' pursuant to CEA

section 4(c)(3)(H).\102\

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\101\ See CEA 1(a)(12). See also ``Further Definition of `Swap

Dealer,' `Security-Based Swap Dealer,' `Major Swap Participant,'

`Major Security-Based Swap Participant' and `Eligible Contract

Participant,' '' 77 FR 30596, May 23, 2012.

\102\ See 7 U.S.C. 6(c)(3)(H) (``Any governmental entity * * *

including * * * any state * * * or political subdivision thereof * *

* or any instrumentality, agency or department of any of the

foregoing.'')

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Based on representations contained in the Petition, the Commission

can determine the Proposed Exemption is limited to appropriate persons

for those market participants meeting the categories described defined

in CEA section 4(c)(3)(A) through (J). The CFTC is requesting comment

as to whether the entities defined in CEA section 4(c)(3)(A) through

(J) are appropriate persons for the purpose of the Proposed Exemption.

For those ECPs engaging in Transactions in markets administered by

the Petitioner that do not fit within 4(c)(3)(A) through (J), the

Commission is proposing to determine that they are appropriate persons

pursuant to section 4c(3)(K), ``in light of their financial or other

qualifications, or the applicability of appropriate regulatory

protections'' to the extent that such persons are otherwise ECPs. The

Commission can base this determination on the financial security

posting schemes, described by the Petitioners, applicable to the

entities engaging in the Transactions, as well as the market based

protections applicable to the Transactions regardless of participant,

as described in the Commission's public interest and purposes of the

Act analysis, above. In addition, CEA section 2(e) permits all ECPs to

engage in swaps transactions other than on a designated contract market

(``DCM''), and so such entities should similarly be appropriate persons

for the purpose of the Proposed Exemption. The Commission is requesting

comment on whether the market participants entering into the

Transactions in markets administered by the Petitioners, particularly

those that do not fit within 4(c)(3)(A) through (J), but that are ECPs,

may nonetheless be appropriate persons pursuant to CEA section

4(c)(3)(K), in light of the financial posting scheme that applies to

such participants, and in light of the regulatory and market oversight

programs that apply to the Transactions in the Petitioners' markets.

The Commission also requests comment as to whether there are

currently entities engaging in the Transactions that are neither

entities that fall within CEA section 4(c)(3)(A) through (J) entities

nor ECPs. If there are such entities, on what basis may the Commission

similarly conclude that such entities are, pursuant to CEA section

4(c)(3)(K), appropriate persons for the purpose of the Proposed

Exemption? In particular, the Commission seeks comment as to whether

there any other of the Petitioners' market participants that

``active[ly] participat[e] in the generation, transmission or

distribution of electricity'' that are not ECPs and do not fall within

CEA section 4(c)(3)(A) through (J), who should nonetheless be included

as appropriate persons pursuant to CEA section 4(c)(3)(K).

4. Will Not Have a Material Adverse Effect on the Ability of the

Commission or Any Contract Market To Discharge Its Regulatory or Self-

Regulatory Duties Under the CEA

CEA section 4(c)(2)(B)(ii) requires the Commission to determine

that the Transactions subject to the Proposed Exemption will not have a

material adverse effect on the ability of the Commission or any

contract markets to perform regulatory or self-regulatory duties.\103\

In making this determination, Congress indicated that the Commission is

to consider such regulatory concerns as ``market surveillance,

financial integrity of participants, protection of customers and trade

practice enforcement.'' \104\ These considerations are similar to the

purposes of the Act as defined in CEA section 3, initially addressed in

the public interest discussion, above.

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\103\ CEA 4(c)(2)(B).

\104\ See H.R. No. 978, 102d Cong. 2d Sess. 79 (1992).

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Petitioners contend that the Proposed Exemption will not have a

material adverse effect on the Commission's or any contract market's

ability to discharge its regulatory function,\105\ asserting that:

---------------------------------------------------------------------------

\105\ See Petition at 28.

Under Section 4(d) of the Act, the Commission will retain

authority to conduct investigations to determine whether

[Petitioners] are in compliance with any exemption granted in

response to this request. * * * [T]he requested exemptions would

also preserve the Commission's existing enforcement jurisdiction

over fraud and manipulation. This is consistent with section 722 of

the Dodd-Frank Act, the existing MOU between the FERC and the

Commission and other protocols for inter-agency cooperation. The

[Petitioners] will continue to retain records related to the

Transactions, consistent with existing obligations under FERC and

PUCT regulations.

The regulation of exchange-traded futures contracts and

significant price discovery contracts (``SPDCs'') will be unaffected

by the requested exemptions. Futures contracts based on electricity

prices set in the Petitioners' markets that are traded on a

designated contract market and SPDCs will continue to be regulated

by and subject to the requirements of the Commission. No current

requirement or practice of the ISOs/RTOs or of a contract market

will be affected by the Commission's granting the requested

exemptions.\106\

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\106\ See id. at 28.

These factors appear to support the Proposed Exemption. In

addition, the limitation of the exemption to Transactions between

certain ``appropriate persons'' as discussed above, avoids potential

issues regarding financial integrity and customer protection. That is,

this approach would appear to ensure that Transactions subject to this

Proposed Exemption would be limited to sophisticated entities that are

able to, from a financial standpoint, understand and manage risks

associated with such Transactions.

Moreover, the Proposed Exemption does not exempt Petitioners from

CEA sections 2(a)(1)(B), 4b, 4c(b), 4o, 4s(h)(1)(A), 4s(h)(4)(A), 6(c),

6(d), 6(e), 6c, 6d, 8, 9, and 13, to the extent that those sections

prohibit fraud or manipulation of the price of any swap, contract for

the sale of a commodity in interstate commerce, or for future delivery

on or subject to the rules of any contract market. Therefore, the

Commission retains authority to pursue fraudulent or manipulative

conduct.\107\

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\107\ Nor did the Petitioners seek an exemption from these

provisions. See id. at 2-3.

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In addition, it appears that granting the exemption for the

Transactions will not have a material adverse effect on the ability of

any contract market to discharge its self-regulatory duties under the

Act. With respect to FTRs, Forward Capacity Transactions, and Reserve

or Regulation Transactions, these transactions do not appear to be used

for price discovery or as settlement prices for other transactions in

Commission regulated markets. Therefore, the Proposed Exemption should

not have a material adverse effect on any contract market carrying out

its self-regulatory function.

With respect to Energy Transactions, these transactions do have a

relationship to Commission regulated markets because they can serve as

a source of settlement prices for other transactions within Commission

jurisdiction. Granting the Proposed Exemption, however, should not pose

regulatory burdens on a contract market because, as discussed in more

detail below, Petitioners have market monitoring systems in place to

detect

[[Page 52147]]

and deter manipulation that takes place on their markets. Also, as a

condition of the Proposed Exemption, the Commission would be able to

obtain data from FERC and PUCT with respect to activity on Petitioners'

markets that may impact trading on Commission regulated markets.

Finally, the Commission notes that if the Transactions ever could

be used in combination with trading activity or a position in a DCM

contract to work some market abuse, both the Commission and DCMs have

sufficient independent authority over DCM market participants to

monitor for such activity.\108\ Typically, cross-market abuse schemes

will involve a reportable position in the DCM contract involved. In

which case, Commission Regulation 18.05 requires the reportable trader

to keep books and records evidencing all details concerning cash and

over-the-counter positions and transactions in the underlying commodity

and to provide such data to the Commission upon demand. Likewise,

recently-adopted Commission regulation 38.254(a) requires that DCMs

have rules that require traders to keep records of their trading,

including records of their activity in the underlying commodity and

related derivatives markets, and make such records available, upon

request, to the DCM.\109\

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\108\ The Commission notes that its authority to prosecute

market abuses involving Transactions would not be limited to

instances where Transactions were part of some cross-market scheme

involving DCM trading activity.

\109\ Final Rulemaking--Core Principles and Other Requirements

for Designated Contract Markets, 72 FR 36612 (June 19, 2012).

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The CFTC is requesting comment as to whether the Proposed Exemption

will have a material adverse effect on the ability of the Commission or

any contract market to discharge its regulatory or self-regulatory

duties under the Act, and, if so, what conditions can or should be

imposed on the Order to mitigate such effects.

C. FERC Credit Reform Policy

On October 21, 2010, FERC amended its regulations to encourage

clear and consistent risk and credit practices in the organized

wholesale electric markets to, inter alia, ``ensure that all rates

charged for the transmission or sale of electric energy in interstate

commerce are just, reasonable, and not unduly discriminatory or

preferential.'' \110\

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\110\ 75 FR 65942, 65942, Oct. 21, 2010 (the ``FERC Original

Order 741''). These requirements were later slightly amended and

clarified in an order on rehearing. See 76 FR 10492, Feb. 25, 2011

(``FERC Revised Order 741'', and together with Original Order 741,

``FERC Order 741'').

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In effect, Order 741 requires those RTOs and ISOs that are subject

to FERC supervision to implement the following reforms: ``shortened

settlement timeframes, restrictions on the use of unsecured credit,

elimination of unsecured credit in all [FTRs] or equivalent markets,

adoption of steps to address the risk that RTOs and ISOs may not be

allowed to use netting and set-offs, establishment of minimum criteria

for market participation, clarification regarding the organized

markets' administrators' ability to invoke `material adverse change'

clauses to demand additional collateral from participants, and adoption

of a two-day grace period for `curing' collateral calls.'' \111\ Unlike

the other Petitioners, ERCOT is regulated by the PUCT, not FERC. As a

result, ERCOT is not subject to the particular stringent credit and

risk management standards set forth in Order 741. As discussed below

regarding conditions precedent starting on page 103 infra, the

Commission is proposing to require compliance with the standards of

Order 741 by all Petitioners, including ERCOT, as a condition to

issuing the Proposed Exemption.

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\111\ FERC Revised Order 741 at 10492-10493.

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As discussed in more detail below, particularly in section V.C.,

the requirements set forth in Order 741 appear to achieve goals similar

to the regulatory objectives of the Commission's DCO Core Principles.

FERC regulation 35.47(c) calls for the elimination of unsecured

credit in the financial transmission rights markets and equivalent

markets.\112\ This requirement appears to be congruent with Core

Principle D's requirement that each DCO limit its exposure to potential

losses from defaults by clearing members. Because, according to FERC,

risks arising out of the FTR markets are ``difficult to quantify,''

\113\ eliminating the use of unsecured credit in these markets may help

avoid the unforeseen and substantial costs for an RTO or ISO in the

event of a default.\114\ Thus, the requirement set forth in regulation

35.47(c) appears to advance the objectives of Core Principle D by

reducing risk and minimizing the effect of defaults through the

elimination of unsecured credit in the FTR and equivalent markets.

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\112\ 18 CFR 35.47(c).

\113\ Specifically, FERC stated that ``the risk associated with

the potentially rapidly changing value of FTRs warrants adoption of

risk management measures, including the elimination of unsecured

credit. Because financial transmission rights have a longer-dated

obligation to perform which can run from a month to a year or more,

they have unique risks that distinguish them from other wholesale

electric markets, and the value of a financial transmission right

depends on unforeseeable events, including unplanned outages and

unanticipated weather conditions. Moreover, financial transmission

rights are relatively illiquid, adding to the inherent risk in their

valuation.'' FERC Original Order 741 at 65950.

\114\ Id. at 65949.

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In addition, FERC regulation 35.47(a) requires RTOs and ISOs to

have tariff provisions that ``[l]imit the amount of unsecured credit

extended by [an RTO or ISO] to no more than $50 million for each market

participant.'' \115\ This requirement appears to be congruent with one

of the regulatory objectives of Core Principle D, as implemented by

Commission Regulation 39.13, specifically the requirement that each DCO

limit its exposure to potential losses from defaults by clearing

members. In capping the use of unsecured credit at $50 million, FERC

stated its belief that RTOs and ISOs ``could withstand a default of

this magnitude by a single market participant,'' \116\ thereby limiting

an RTO's or ISO's exposure to potential losses from defaults by its

market participants. Thus, it seems both Core Principle D and FERC

regulation 35.47(a) help protect the markets and their participants

from unacceptable disruptions, albeit in different ways and to a

different extent.

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\115\ In addition, FERC regulation 35.47(a) states that ``where

a corporate family includes more than one market participant

participating in the same [RTO or ISO], the limit on the amount of

unsecured credit extended by that [RTO or ISO] shall be no more than

$50 million for the corporate family.'' 18 CFR 35.47(a).

\116\ FERC Original Order 741 at 65948.

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FERC regulation 35.47(b) mandates that RTOs and ISOs have billing

periods and settlement periods of no more than seven days.\117\ While

this mandate does not meet the standards applicable to registered

DCOs,\118\ it supports Core Principle D's requirement that each DCO

have appropriate tools and procedures to manage the risks associated

with discharging its responsibilities. In promulgating FERC regulation

35.47(b), FERC found a shorter cycle necessary to promote market

liquidity and a necessary change ``to reduce default risk, the costs of

which would be socialized across market participants and, in certain

events, of market disruptions that could undermine overall market

function.'' \119\ Recognizing the correlation between a reduction in

the length of the ``settlement cycle'' and a reduction in costs

attributed to a default, FERC stated that shorter cycles reduce the

amount of unpaid debt left outstanding, which, in

[[Page 52148]]

turn, reduces ``the size of any default and therefore reduces the

likelihood of the default leading to a disruption in the market such as

cascading defaults and dramatically reduced market liquidity.'' \120\

Thus, FERC regulation 35.47(b) appears to aid RTOs and ISOs in managing

the risks associated with their responsibilities, which also appears to

support Core Principle D's goals.

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\117\ 18 CFR 35.47(b).

\118\ See 17 CFR 39.14(b) (requiring daily settlements).

\119\ FERC Original Order 741 at 65946.

\120\ Id.

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FERC regulation 35.47(d) requires RTOs and ISOs to ensure the

enforceability of their netting arrangements in the event of the

insolvency of a member by doing one of the following: (1) Establish a

single counterparty to all market participant transactions, (2) require

each market participant to grant a security interest in the receivables

of its transactions to the relevant RTO or ISO, or (3) provide another

method of supporting netting that provides a similar level of

protection to the market that is approved by FERC.\121\ In the

alternative, the RTOs and ISOs would be prohibited from netting market

participants' transactions, and required to establish credit based on

each market participant's gross obligations. Congruent to the

regulatory objectives of Core Principles D and G, FERC regulation

35.47(d) attempts to ensure that, in the event of a bankruptcy of a

participant, ISOs/RTOs are not prohibited from offsetting accounts

receivable against accounts payable. In effect, this requirement

attempts to clarify an ISO's or RTO's legal status to take title to

transactions in an effort to establish mutuality in the transactions as

legal support for set-off in bankruptcy.\122\ This clarification, in

turn, would appear to limit an RTO's or ISO's exposure to potential

losses from defaults by market participants.

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\121\ 18 CFR 35.47(d).

\122\ See 11 U.S.C. 553; see generally In re SemCrude, L.P., 399

B.R. 388 (Bankr. D. Del. 2009), aff'd, 428 B.R. 590 (D. Del. 2010).

---------------------------------------------------------------------------

FERC regulation 35.47(e) limits the time period within which a

market participant must cure a collateral call to no more than two

days.\123\ This requirement appears to be congruent with Core Principle

D's requirement that each DCO limit its exposure to potential losses

from defaults by clearing members. In Original Order 741, FERC stated

that a two day time period for curing collateral calls balances (1) the

need for granting market participants sufficient time to make funding

arrangements for collateral calls with (2) the need to minimize

uncertainty as to a participant's ability to participate in the market,

as well as the risk and costs of a default by a participant. By

requiring each ISO and RTO to include this two day cure period in the

credit provisions of its tariff language, FERC regulation 35.47(e)

appears to both promote the active management of risks associated with

the discharge of an RTO's or ISO's responsibilities, while at the same

time limiting the potential losses from defaults by market

participants.

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\123\ 18 CFR 35.47(e).

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FERC regulation 35.47(f) imposes minimum market participant

eligibility requirements that apply consistently to all market

participants and, as set forth in the preamble to Original Order 741,

requires RTOs and ISOs to engage in periodic verification of market

participant risk management policies and procedures.\124\ The

Commission believes that the requirements set forth in FERC regulation

35.47(f) appear congruent with some of the regulatory objectives of DCO

Core Principle C, as implemented by Commission regulation 39.12. In

general, DCO Core Principle C requires each DCO to establish

appropriate admission and continuing eligibility standards for members

of, and participants in, a DCO that are objective, publicly disclosed,

and permit fair and open access.\125\ In addition, Core Principle C

also requires that each DCO establish and implement procedures to

verify compliance with each participation and membership requirement,

on an ongoing basis.\126\ Similarly, while FERC regulation 35.47(f)

does not prescribe the particular participation standards that must be

implemented, as suggested in the preamble to Original Order 741, these

standards should address ``adequate capitalization, the ability to

respond to ISO/RTO direction and expertise in risk management'' \127\

and ensure that proposed tariff language ``is just and reasonable and

not unduly discriminatory.'' \128\ Moreover, FERC specifically stated

that these participation standards ``could include the capability to

engage in risk management or hedging or to out-source this capability

with periodic compliance verification, to make sure that each market

participant has adequate risk management capabilities and adequate

capital to engage in trading with minimal risk, and related costs, to

the market as a whole.'' \129\ Thus, both DCO Core Principle C and

Order 741 appear to promote fair and open access for market

participants as well as impose compliance verification requirements.

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\124\ 18 CFR 35.47(f).

\125\ 7 U.S.C. 7a-1(c)(2)(C).

\126\ Id.

\127\ FERC Original Order 741 at 65956.

\128\ Id.

\129\ Id.

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FERC regulation 35.47(g) requires ISOs and RTOs to specify in their

tariffs the conditions under which they will request additional

collateral due to a material adverse change.\130\ FERC, however, noted

that the examples set forth in each ISO's or RTO's tariffs are not

exhaustive and that ISOs and RTOs are permitted to use ``their

discretion to request additional collateral in response to unusual or

unforeseen circumstances.'' \131\ The Commission believes that the

requirements set forth in FERC regulation 35.47(g) appear congruent

with the following DCO Core Principle D requirements: (1) That DCOs

have appropriate tools and procedures to manage the risks associated

with discharging its responsibilities, and (2) that DCOs limit their

exposure to potential losses from defaults by clearing members.\132\ By

requiring ISOs and RTOs to actively consider the circumstances that

could give rise to a material adverse change, FERC appears to be

encouraging RTOs and ISO to actively manage their risks to ``avoid any

confusion, particularly during times of market duress, as to when such

a clause may be invoked.'' \133\ Moreover, such clarification could

prevent a market participant's ability to ``exploit ambiguity as to

when a market administrator may invoke a `material adverse change,' or

a market administrator may be uncertain as to when it may invoke a

`material adverse change,' '' \134\ thereby avoiding potentially

harmful delays or disruptions that could subject the RTOs and ISOs to

unnecessary damage.

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\130\ 18 CFR 35.47(g).

\131\ FERC Original Order 741 at 65957.

\132\ 7 U.S.C. 7a 1(c)(2)(D).

\133\ FERC Original Order 741 at 65958.

\134\ Id.

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As such, on the basis of the representations contained in the

Petition, including the fact that, as discussed in further detail

below, \135\ the Commission is considering whether to require each

Petitioner, including ERCOT, to comply with, and fully implement, the

requirements set forth in Order 741 as a prerequisite to the granting

of a limited 4(c)(6) exemption for the Transactions. The Commission

seeks comment with respect to this preliminary conclusion.

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\135\ See infra text at n. 398.

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[[Page 52149]]

D. DCO Core Principle Analysis

1. DCO Core Principle A: Compliance With Core Principles

Core Principle A requires a DCO to comply with each core principle

set forth in section 5b(c)(2) of the CEA, as well as any requirement

that the Commission may impose by rule or regulation pursuant to

section 8a(5) of the Act for a DCO to be registered and maintain its

registration.\136\ In addition, Core Principle A states that a DCO

shall have reasonable discretion in establishing the manner by which it

complies with each core principle subject to any rule or regulation

prescribed by the Commission.\137\

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\136\ 7 U.S.C. 7a-1(c)(2)(A)(i).

\137\ 7 U.S.C. 7a-1(c)(2)(A)(ii).

---------------------------------------------------------------------------

Petitioners represent that, although they are principally regulated

by FERC and PUCT and that there are differences between Petitioners and

registered DCOs, Petitioners' practices are consistent with the core

principles for DCOs.\138\ Petitioners represent that, though their

methods are different than those employed by a registered DCO, their

practices achieve the goals of, and are consistent with, the policies

of the Act.\139\ Based upon Petitioners' representations and the core

principle discussions below, and in the context of the Petitioners'

activities with respect to the Transactions within the scope of this

Proposed Exemption, Petitioners' practices appear congruent with, and

to accomplish sufficiently, the regulatory objectives of each DCO core

principle. The Commission seeks comment with respect to this

preliminary conclusion.

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\138\ Petition Attachments at 1.

\139\ Id.

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2. DCO Core Principle B: Financial and Operational Resources

Core Principle B requires a DCO to have adequate financial,

operational, and managerial resources to discharge each of its

responsibilities.\140\ In addition, a DCO must have financial resources

that, at a minimum, exceed the total amount that would: (i) Enable the

DCO to meet its financial obligations to its clearing members

notwithstanding a default by the clearing member creating the largest

financial exposure for the DCO in extreme but plausible market

conditions; and (ii) enable the DCO to cover its operating costs for a

period of 1 year, as calculated on a rolling basis.\141\

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\140\ 7 U.S.C. 7a-1(c)(2)(B)(i).

\141\ 7 U.S.C. 7a-1(c)(2)(B)(ii).

---------------------------------------------------------------------------

a. Financial Resources

Petitioners represent that they maintain sufficient financial

resources to meet their financial obligations to their members

notwithstanding a default by the member creating the largest financial

exposure for that organization in extreme but plausible market

conditions.\142\ As an initial matter, Petitioners apply the defaulting

market participant's collateral to the outstanding obligation.\143\

Further, if the collateral is inadequate to cover the obligation,

Petitioners' tariffs permit them to charge the loss to non-defaulting

market participants.\144\ For some Petitioners, other resources are

available. For example, one Petitioner represents that it has the

ability to draw upon its working capital fund and/or its revolving

credit facility to ensure that market participants are paid in

full.\145\ Another Petitioner states that defaults are socialized after

realizing any collateral specific to the defaulting participant, claims

paid by third-party default insurance, funds from accrued collected

penalties for Late Payment Accounts, and, for liquidity purposes,

third-party financing.\146\

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\142\ See Petition Attachments at 3-20.

\143\ See, e.g., id. at. 4, 8-9, 10, 15, 20.

\144\ See id. at 4, 8, 10, 13, 15, 20.

\145\ See id. at 15. The Commission notes Regulation 39.11(b)

includes the following as financial resources eligible to satisfy a

DCO's requirement to have sufficient financial resources to cover a

default by the member creating the largest financial exposure: (a)

Margin, (b) the DCO's own capital, (c) guaranty fund deposits, (d)

default insurance, (e) potential assessments for additional guaranty

fund contributions, if permitted by the DCO's rules, and (f) any

other financial resource deemed acceptable by the Commission. See 17

CFR 39.11(b)(1). The Commission notes that the revolving credit

facility cited by NYISO would not satisfy the financial resource

requirement, but would be considered in determining liquidity. See

17 CFR 39.11(e)(1)(iii).

\146\ See Petition Attachments at 10-11.

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In the event that a default occurs and there is inadequate

collateral for a particular participant, the Petitioners' represent

that the deficiencies would be addressed by mutualization among the

non-defaulting participants to whom the Petitioner would otherwise be

obligated, allocated pursuant to a pre-determined formula that is

included in each Petitioner's tariff.\147\ This process is often

referred to as ``short-paying.'' \148\ Once the amount of the default

is deemed to be uncollectible [by the Petitioner], the short-pay would,

in some cases, be ``uplifted'' or ``socialized'' across the market,

with the losses reallocated among all non-defaulting participants.\149\

---------------------------------------------------------------------------

\147\ See, e.g., id. at 9, 13.

\148\ See, e.g., id. at 15.

\149\ See, e.g., id. at 9, 13.

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On the basis of these representations, the Commission believes that

each Petitioner's financial resource requirements appear to be

congruent with, and to accomplish sufficiently, the regulatory

objectives of DCO Core Principle B in the context of Petitioners'

activities with respect to the Transactions. The Commission seeks

comment with respect to this preliminary conclusion.

b. Operational Resources

Each Petitioner represents that it has sufficient operational

resources to cover its operating costs through a charge allocated to

its participants and set forth in its Tariffs, which are approved by

FERC and PUCT, as applicable.\150\ Petitioners represent that the

charge is based on expected costs for the following year.\151\ Under

the regulatory structure in the wholesale electric industry, market

participants are obligated to pay the fees required by the

Petitioners,\152\ and are thus, in a sense, a ``captive audience.''

Moreover, since market participant defaults are mutualized amongst the

non-defaulting participants,\153\ Petitioners represent that such

defaults would not impair their ability to cover their operating costs,

because the Petitioners would continue to collect sufficient funds from

all other market participants to pay such operating expenses.\154\

Therefore, these policies and procedures appear to be consistent with,

and to accomplish sufficiently, the regulatory objectives of DCO Core

Principle B in the context of the Transactions. The Commission seeks

comment with respect to this preliminary conclusion.

---------------------------------------------------------------------------

\150\ See id. at 3-20. Some Petitioners state that the charge is

allocated to their market participants based on the level of their

usage of the Petitioner's services or on the volume of their market

transactions. See, e.g., id. at 4, 13, and 20.

\151\ See, e.g., id. at 4, 10, 16.

\152\ See, e.g., id. at 16, 20.

\153\ See id. at 4-20.

\154\ See id. at 16.

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c. Managerial Resources

Each of the Petitioners represents that it has adequate managerial

resources to discharge its responsibilities as an organized wholesale

electricity market.\155\ The Commission notes that FERC Order No. 888

sets forth the principles used by FERC to assess ISO proposals and

requires that ISOs have appropriate incentives for efficient management

and administration.\156\ This requirement provides that ISOs should

procure the services needed for such management and administration in

an open competitive market, similar to how Core Principle B requires a

DCO to possess managerial resources necessary

[[Page 52150]]

to discharge each responsibility of the DCO. Similarly, with respect to

ERCOT, PUCT's Substantive Rules require that ERCOT's Enterprise Risk

Management Group has adequate resources to perform its functions, which

includes assessing market participant creditworthiness.\157\

---------------------------------------------------------------------------

\155\ See id. at 3-20.

\156\ See generally FERC Order 888 at 21540.

\157\ P.U.C. SUBST. R. 25.361(b). See also Petition Attachments

at 7-8.

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In addition, FERC Order No. 2000 requires that RTOs have an open

architecture so that the RTO and its members have the flexibility to

improve their organizations in the future in terms of structure,

geographic scope, market support and operations in order to adapt to an

environment that is rapidly changing and meet market needs.\158\

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\158\ Id. at 502.

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Petitioners represent that they maintain the staff and labor

necessary to fulfill their obligations and responsibilities, and only

employ persons who are appropriately qualified, skilled and experienced

in their respective trades or occupations \159\ Based on these

representations, the Petitioners managerial resources appear to be

consistent with, and to accomplish sufficiently, the regulatory

objectives of DCO Core Principle B in the context of the Transactions.

The Commission seeks comment with respect to this preliminary

conclusion.

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\159\ See Petition Attachments at 3-20.

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3. DCO Core Principle C: Participant and Product Eligibility

DCO Core Principle C requires each DCO to establish appropriate

admission and continuing eligibility standards for member and

participants (including sufficient financial resources and operational

capacity), as well as to establish procedures to verify, on an ongoing

basis, member and participant compliance with such requirements.\160\

The DCO's participant and membership requirements must also be

objective, be publicly disclosed, and permit fair and open access.\161\

In addition, Core Principle C obligates each DCO to establish

appropriate standards for determining the eligibility of agreements,

contracts, or transactions submitted to the DCO for clearing.\162\

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\160\ 7 U.S.C. 7a-1(c)(2)(C).

\161\ Id.

\162\ Id. As set forth above, the exemption that would be

provided by the Proposed Exemption would be available only with

respect to the transactions specifically delineated therein.

Accordingly, the DCO Core Principle C analysis is limited to a

discussion of the Petitioners' participant eligibility requirements.

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a. FERC Credit Policy Requirements

As discussed above, the FERC Credit Policy appears to impose

participant eligibility requirements that are consistent with

regulatory objectives of DCO Core Principle C.\163\ In the FERC Credit

Policy, FERC notes that ``[h]aving minimum criteria in place can help

minimize the dangers of mutualized defaults posed by inadequately

prepared or under-capitalized participants.'' \164\ Specifically, FERC

regulation 35.47(f) requires organized wholesale electric markets to

adopt tariff provisions that require minimum market participant

eligibility criteria.\165\ Though the regulation does not prescribe the

particular participation standards that must be implemented; in the

rule's preamble, FERC suggests that such standards should address

``adequate capitalization, the ability to respond to ISO/RTO direction

and expertise in risk management.'' \166\ Regarding risk management,

FERC further suggests that minimum participant eligibility criteria

should ``include the capability to engage in risk management or hedging

or to out-source this capability with periodic compliance

verification.'' \167\ Although market participant criteria may vary

among different types of market participants, all market participants

must be subject to some minimum criteria.\168\ An RTO or ISO subject to

FERC's supervision is obligated to establish market participant

criteria, even if the RTO or ISO applies vigorous standards in

determining the creditworthiness of its market participants.\169\

---------------------------------------------------------------------------

\163\ See, supra n. 127 and accompanying text.

\164\ FERC Original Order 741 at 665955.

\165\ 18 CFR 35.47(f).

\166\ FERC Original Order 741 at 665956.

\167\ Id.

\168\ Although the FERC Credit Policy states that FERC ``directs

that [the market participation criteria] apply to all market

participants rather than only certain participants,'' FERC clarified

this comment in its Order of Rehearing by stating that its intent

``was that there be minimum criteria for all market participants and

not that all market participants necessarily be held to the same

criteria'' based upon, for example, the size of the participant's

positions. See FERC Revised Order 741 at n. 43. This approach

appears to be consistent with Commission regulation 39.12, which

implements Core Principle C and requires that participation

requirements for DCO members be risk-based.

\169\ See FERC Original Order 741 at 665956 (noting that ``An

ISO or RTO's ``ability to accurately assess a market participant's

creditworthiness is not infallible'' and ``[w]hile an analysis of

creditworthiness may capture whether the market participant has

adequate capital, it may not capture other risks, such as whether

the market participant has adequate expertise to transact in an RTO/

ISO market.'').

---------------------------------------------------------------------------

Because the minimum participation criteria that will be adopted by

Petitioners will be included in their respective tariffs, which are

publicly available on each Petitioner's Web site, such criteria will be

publicly disclosed. In addition, FERC notes that it reviews proposed

tariff language ``to ensure that it is just and reasonable and not

unduly discriminatory,'' \170\ which practice would appear to be

consistent with DCO Core Principle C's directive that market

participation standards permit fair and open access.

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\170\ Id.

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b. The Petitioners' Representations

Each Petitioner represents that it either has adopted minimum

participant eligibility criteria or is in the process of establishing

minimum participant eligibility criteria \171\ that include

capitalization requirements (which may provide for the posting of

additional collateral by less-well-capitalized members). The

capitalization requirements appear to be risk-based in that the

requirements may vary by type of market and/or type or size of

participant.\172\ In addition, some Petitioners require that

participants in certain markets satisfy specified credit

requirements,\173\ as well as standards related to risk

management,\174\ training and testing,\175\ and the disclosure of

material litigation or regulatory sanctions, bankruptcies, mergers,

acquisitions, and activities in the wholesale electricity market.\176\

Petitioners also represent that they impose operational capability

requirements,\177\ and either maintain tariffs, or have filed proposed

amendments to their existing tariffs, that incorporate requirements

that would enable Petitioners to periodically verify the risk

management standards and procedures of market participants.\178\ This

verification may be required on either a random basis or based upon

identified risks. Furthermore, some Petitioners require attestations of

continued compliance with other elements of their participation

eligibility criteria.\179\

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\171\ See Petition Attachments at 22-54.

\172\ See id. at 22-54.

\173\ See, e.g., id. at 22 (CAISO requires CRR holders to have a

minimum amount of available credit in order to participate in a CRR

auction).

\174\ See id. at 23, 35, 44-45.

\175\ See id. at 22, 35, 44.

\176\ See id. at 33.

\177\ See id. at 23, 37-38, 39, 48.

\178\ See id. at 23, 35-36, 38, 44-45, 49.

\179\ For example, CAISO requires market participants to attest

annually that they satisfy CAISO's minimum participation

requirements related to capitalization, training and the operational

capability to comply with CAISO's direction. See id. at 23.

Similarly, ISO NE requires that each market participant annually

submit a certificate that attests that the participant has

procedures to effectively communicate with ISO NE and that it has

trained personnel related to its participation in the relevant

markets. See id. at 35.

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[[Page 52151]]

ERCOT asserts that it is in the process of developing new

eligibility requirements through its stakeholder process, that, as

proposed, would require relevant market participants to (i) satisfy

minimum capitalization requirements or post additional security, (ii)

have appropriate expertise in the market, (iii) maintain a risk

management framework appropriate to the ERCOT markets in which it

transacts, (iv) have appropriate operational capability to respond to

ERCOT direction, and (v) have the market participant's officer certify,

on an annual basis, that the participant eligibility requirements are

met.\180\

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\180\ See Petition Attachments at 27. See also FERC Order 741

Implementation Chart filed by petitioners as a supplement to the

Petition (herein after, ``FERC Order 741 Implementation Chart''),

available at http://www.cftc.gov/stellent/groups/public/@requestsandactions/documents/ifdocs/iso-rto4cappfercchart.pdf.

---------------------------------------------------------------------------

It appears from the foregoing that Petitioners' arrangements with

respect to participant eligibility requirements are (or will be)

congruent with, and sufficiently accomplish, the regulatory objectives

of Core Principle C in the context of Petitioners' activities with

respect to the Transactions. The Commission seeks comment with respect

to this preliminary conclusion.

4. DCO Core Principle D: Risk Management

DCO Core Principle D requires each DCO to demonstrate the ability

to manage the risks associated with discharging the responsibilities of

a DCO through the use of appropriate tools and procedures.\181\ As

amended by the Dodd-Frank Act, Core Principle D also requires a DCO to:

(1) Measure and monitor its credit exposures to each clearing member

daily; (2) through margin requirements and other risk control

mechanisms, limit its exposure to potential losses from a clearing

member default; (3) require sufficient margin from its clearing members

to cover potential exposures in normal market conditions; and (4) use

risk-based models and parameters in setting margin requirements that

are reviewed on a regular basis.\182\

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\181\ 7 U.S.C. 7a-1(c)(2)(D).

\182\ 7 U.S.C. 7a-1(c)(2)(D).

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a. Risk Management Framework

Each Petitioner represents that it has established policies and

procedures designed to minimize risk.\183\ As part of the tools and

procedures that RTOs and ISOs use to manage the risks associated with

their activities, FERC regulation 35.47(b) mandates that RTOs and ISOs

have billing periods and settlement periods of no more than seven

days.\184\ As discussed above, FERC found a shorter cycle necessary to

promote market liquidity and a necessary change ``to reduce default

risk, the costs of which would be socialized across market participants

and, in certain events, of market disruptions that could undermine

overall market function.'' \185\ Recognizing the correlation between a

reduction in the ``settlement cycle'' and a reduction in costs

attributed to a default, FERC stated that shorter cycles reduce the

amount of unpaid debt left outstanding, which, in turn, reduces ``the

size of any default and therefore reduces the likelihood of the default

leading to a disruption in the market such as cascading defaults and

dramatically reduced market liquidity.'' \186\ Most of the Petitioners

represent that they have, or expect to have, final tariffs in place

that limit billing periods and settlement periods to no more than seven

days.\187\

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\183\ See Petition Attachments at 56-92.

\184\ 18 CFR 35.47(b).

\185\ FERC Original Order 741 at 65946.

\186\ Id.

\187\ See FERC Order 741 Implementation Chart. As stated above,

ERCOT is not required, by law, to comply with Order 741.

Nonetheless, Petitioners represent that ERCOT will shorten its

payment and settlement cycle to no more than 15 days. See infra nn.

212-213 and accompanying text.

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In addition, an ISO's or RTO's participation standards can include

the supervision of a market participant's risk management program.\188\

As discussed in section V.C., FERC Order 741 states that an ISO or RTO

could include periodic verification of market participant's capability

to engage in risk management or hedging or to out-source that

capability ``to make sure each market participant has adequate risk

management capabilities and adequate capital to engage in trading with

minimal risk, and related costs, to the market as a whole.'' \189\ Each

Petitioner regulated by FERC represents that it either has a

verification program in place or has submitted necessary Tariffs for

approval to establish a verification program.\190\ ERCOT also has

proposed participant eligibility requirements that would subject

participants' risk management framework to verification by ERCOT,

unless that framework has been deemed sufficient for transacting in

another U.S. RTO or ISO market in accordance with a FERC-approved

tariff or in accordance with the Federal Reserve Bank Holding Company

Supervision Manual. The proposed requirements currently are under

review in the ERCOT stakeholder process.\191\ On the basis of the

representations contained in the Petition, it appears that these

policies and procedures, are (or will be, assuming they are

implemented) congruent with, and will sufficiently accomplish, the

regulatory objectives of DCO Core Principle D. The Commission seeks

comment with respect to this conclusion.

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\188\ See n. 126 and accompanying text.

\189\ See FERC Original Order 741 at 65946.

\190\ See FERC Order 741 Implementation Chart at 11-12.

\191\ Id.

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b. Measurement and Monitoring of Credit Exposure

Petitioners represent that their risk management procedures

measure, monitor, and mitigate their credit exposure to market

participants.\192\ In addition, most Petitioners state that they

calculate credit exposure daily.\193\ It appears that, for the most

part, given the unique characteristics of the wholesale electric

markets, and particularly those of the FTR and equivalent markets, the

practices specified in the Petition appear congruent with, and to

accomplish sufficiently, DCO Core Principle D's objective that a DCO

measure its credit exposure to each of its clearing members. The

Commission seeks comment with respect to this preliminary conclusion,

including comment on whether any different or additional practices

should be implemented as a condition of issuance of the Proposed

Exemption.

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\192\ See Petition Attachments at 56-92.

\193\ See id. Petitioners further represent that the value of

exposure to FTRs is determined by the price of physical electricity

during the days and hours for which the FTR is effective. See id. In

addition, petitioners represent that CAISO- updates credit exposures

for CRR's that are expected to generate a charge to the CRR holder

on at least a monthly basis. See id. at 59-60. But see id. at 84-85

(representing that PJM calculates credit exposure for FTRs on a

monthly basis because daily measurement and intraday monitoring of

credit exposure is not practical for FTRs due to the low liquidity

and other unique attributes of the FTR markets).

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c. Unsecured Credit

Petitioners represent that a market participant is required to

obtain unsecured credit lines from an RTO or ISO (limited as discussed

below) and/or post financial security that is sufficient to meet the

participant's estimated aggregate liability \194\ or financial

obligations.\195\ FERC regulation 35.47(a)

[[Page 52152]]

requires RTOs and ISOs to have tariff provisions that ``[l]imit the

amount of unsecured credit extended by [an RTO or ISO] to no more than

$50 million for each market participant.'' As mentioned above,\196\ in

capping the use of unsecured credit at $50 million, FERC stated its

belief that RTOs and ISOs ``could withstand a default of this magnitude

by a single market participant,'' therein limiting an RTO's or ISO's

exposure to potential losses from defaults by its market participants.

Petitioners represent that they have tariff provisions that comply with

FERC regulation 35.47(a).\197\ Moreover, FERC regulation 35.47(c)

prohibits the use of unsecured credit in the FTR markets and equivalent

markets because, according to FERC, risks arising out of the FTR

markets are ``difficult to quantify,'' and eliminating the use of

unsecured credit in these markets avoids the unforeseen and substantial

costs for an RTO or ISO in the event of a default. Petitioners state

that they have in place or have proposed tariff revisions to comply

with FERC regulation 35.47(c).\198\

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\194\ A participant's estimated credit exposure to an RTO or ISO

is called such participant's estimated aggregate liability or

``EAL.'' The EAL calculation is based on a number of variables,

which vary among Petitioners. See id. at 56-92.

\195\ The Commission notes that NYISO establishes separate

credit requirements for each of its product and service categories

and requires each Market Participant to maintain financial security

(e.g., cash, letter of credit, or surety bond) that is sufficient at

all times to meet each separate credit requirement. See id. at 84.

\196\ See supra at n. 115.

\197\ See FERC Order 741 Implementation Chart at 2-3.

\198\ See id. at 4-5.

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Since FERC regulations 35.47(a) and 35.47(c) appear to manage risk

and limit an RTO's or ISO's exposure to potential losses from a market

participant, these requirements would appear to be congruent with, and,

assuming Petitioners' proposed tariff revisions are implemented, to

accomplish sufficiently, the regulatory objectives of Core Principle D

in the context of Petitioners' activities with respect to the

Transactions. The Commission seeks comment with respect to this

preliminary conclusion.

d. Limiting Exposure to Potential Losses Through Use of Risk Control

Mechanisms and Grace Period To Cure

Each Petitioner represents that it requires a market participant to

post additional financial security (collateral) whenever the

participant's estimated aggregate liability or credit exposure equals

or exceeds that participant's unsecured credit and posted financial

security.\199\ Moreover, FERC regulation 35.47(e) limits the time

period by which a market participant must cure a collateral call to no

more than two days. In Original Order 741, FERC stated that a two day

time period for curing collateral calls balances the need for granting

market participants sufficient time to make funding arrangements for

collateral calls with the need to minimize uncertainty as to a

participant's ability to participate in the market as well as the risk

and costs of a default by a participant. By requiring each RTO and ISO

to include this two day cure period in its tariff provisions, FERC

regulation 35.47(e) appears to both promote the active management of

risks associated with the discharge of an RTO's or ISO's

responsibilities, while at the same time limiting the potential losses

from defaults by market participants. Petitioners represent that each

of them has implemented this requirement.\200\ In the event that a

market participant fails to post additional financial security in

response to a request from an RTO or ISO, or fails to do so within the

requisite two day period, Petitioners represent that they have a wide

array of remedies available, including bringing an enforcement action

and assessing a variety of sanctions against the market

participant.\201\ On the basis of these representations, it appears

that the requirements to post additional financial security and cure

collateral calls in no more than two days help Petitioners manage risk

and limit their exposure against potential losses from a market

participant. These requirements appear to be congruent with, and to

accomplish sufficiently, the regulatory objectives of DCO Core

Principle D in the context of Petitioners' activities with respect to

the Transactions. The Commission seeks comment with respect to this

preliminary conclusion.

---------------------------------------------------------------------------

\199\ See Petition Attachments at 56-92.

\200\ See FERC Order 741 Implementation Chart at 7.

\201\ See, e.g., Petition Attachments at 56-57, 69-70, 76-77.

---------------------------------------------------------------------------

e. Calls for Additional Collateral due to a Material Adverse Change

FERC regulation 35.47(g) requires ISOs and RTOs to specify in their

tariffs the conditions under which they will request additional

collateral due to a material adverse change. However, as stated by

FERC, this list of conditions is not meant to be exhaustive, and ISOs

and RTOs are permitted to use ``their discretion to request additional

collateral in response to unusual or unforeseen circumstances.'' \202\

Petitioners represent that they have tariffs that comply with these

requirements.\203\ Since Petitioners do not appear to be limited in

their ability to call for additional collateral in unusual or

unforeseen circumstances, FERC regulation 35.47(g) appears to support

some of DCO Core Principle D's objectives, namely that a DCO have

appropriate tools and procedures to manage the risks associated with

discharging its responsibilities, and that a DCO limit its exposure to

potential losses from defaults by clearing members. FERC has noted that

information regarding when an ISO or RTO will request additional

collateral due to a material adverse change may help to ``avoid any

confusion, particularly during times of market duress, as to when such

a clause may be invoked,'' \204\ while at the same time preventing a

market participant from ``exploit[ing] ambiguity as to when a market

administrator may invoke a `material adverse change.''' \205\ As such,

this policy appears to help avoid potentially harmful delays or

disruptions that could subject the RTOs and ISOs to unnecessary damage,

and thus is congruent with, and to accomplish sufficiently, the

regulatory objectives of Core Principle D in the context of

Petitioners' activities with respect to the Transactions. The

Commission seeks comment with respect to this preliminary conclusion.

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\202\ FERC Original Order 741 at 65957.

\203\ See FERC Order 741 Implementation Chart.

\204\ FERC Original Order 741 at 65958.

\205\ Id. at 65958.

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f. Margin Requirement and Use of Risk-Based Models and Parameters in

Setting Margin

As discussed previously, Petitioners represent that each Petitioner

requires that market participants maintain unsecured credit and/or post

financial security (collectively, ``margin'') that is sufficient to

meet their estimated aggregate liability or financial obligations at

all times,\206\ although estimated aggregate liability calculations

appear to vary among Petitioners and among products within a particular

Petitioner's markets.\207\ As represented by Petitioners, these

practices seem to be congruent with, and to accomplish sufficiently,

the regulatory objectives of DCO Core Principle D in the context of

Petitioners' activities with respect to the Transactions. The

Commission seeks

[[Page 52153]]

comment with respect to this preliminary conclusion.

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\206\ See Petition Attachments at 56-92.

\207\ For example, one Petitioner states that its margin

requirements are calculated using historical data and estimates of

potential future exposure for the purposes of minimizing default

exposure, but notes that the mechanics of the potential future

exposure estimates ``vary depending on the market.'' See id. at 77.

It maintains customized approaches to margining particular market

activity, including separate and distinct margining models for the

FTR Market and the Forward Capacity Market (both the buy side and

the sell side). Id. at 77-78 Similarly, another Petitioner states

that its credit requirements are derived from historical data from

the past three years for FTRs, but from the past one year for other

transactions. Id. at 91-92.

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g. Ability To Offset Market Obligations

FERC regulation 35.47(d) requires RTOs and ISOs to either (1)

establish a single counterparty to all market participant transactions,

(2) require each market participant to grant a security interest in the

receivables of its transactions to the relevant RTO or ISO, or (3)

provide another method of supporting netting that provides a similar

level of protection to the market that is approved by FERC. Otherwise,

RTOs and ISOs are prohibited from netting market participants'

transactions and required to establish credit based on market

participants' gross obligations. FERC regulation 35.47(d), which

attempts to ensure that, in the event of a bankruptcy, ISOs and RTOs

are not prohibited from offsetting accounts receivable against accounts

payable, is congruent with the regulatory objectives of Core Principle

D. In effect, this requirement appears to attempt to clarify an ISO's

or RTO's legal status to take title to transactions in an effort to

establish mutuality in the transactions as legal support for set-off in

bankruptcy.\208\ This clarification, in turn, would seem to limit an

RTO's or ISO's exposure to potential losses from defaults by market

participants.

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\208\ See supra n. 122.

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Petitioners have represented that they either are, or plan on

becoming, central counterparties.\209\ Though there appears to be

strong support for the proposition that the central counterparty

structure \210\ would give rise to enforceable rights of setoff of the

central counterparty, the Commission believes it would be in the public

interest to have further clarity regarding whether a Petitioner's

chosen approach to comply with FERC regulation 35.47(d) grants

sufficient certainty regarding the ability to enforce setoff rights. As

such, the Commission proposes that, as a prerequisite to the granting

of the 4(c)(6) request, each Petitioner must submit a well-reasoned

legal memorandum from, or a legal opinion of, outside counsel that, in

the Commission's sole discretion, provides the Commission with adequate

assurance that the approach selected by the Petitioner will in fact

provide the Petitioner with set-off rights in a bankruptcy proceeding.

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\209\ See FERC Order 741 Implementation Chart at 5-6.

\210\ A central counterparty is, within a particular market, the

buyer to every seller and the seller to every buyer. See Principles

for Financial Market Infrastructures ] 1.13 (CPSS-IOSCO 2012).

---------------------------------------------------------------------------

Subject to this condition, compliance with FERC regulation 35.47(d)

appears to be congruent with, and to accomplish sufficiently, Core

Principle D's regulatory objectives in the context of Petitioners'

activities with respect to the Transactions. The Commission seeks

comment with respect to this preliminary conclusion. The Commission

also seeks comment with respect to the proposed prerequisite of

assurance that the Petitioners can in fact exercise setoff rights in

the event of the bankruptcy of a participant.

5. DCO Core Principle E: Settlement Procedures

Among the requirements set forth by Core Principle E are the

requirements that a DCO (a) have the ability to complete settlements on

a timely basis under varying circumstances, and (b) maintain an

adequate record of the flow of funds associated with each transaction

that the DCO clears.\211\

---------------------------------------------------------------------------

\211\ 7 U.S.C. 7a-1(d)(92)(i)-(ii).

---------------------------------------------------------------------------

Petitioners represent that they have policies and procedures that

contain detailed procedures regarding data and record-keeping, and

that, with the exception of ERCOT, they have, or will soon have,

billing periods and settlement periods of no more than seven days each

(for a total of 14 days).\212\ ERCOT is in the process of implementing

changes by which the weighted average billing and settlement cycle will

be less than 15 days.\213\ While this approach does not meet the

standards applicable to registered DCOs,\214\ it appears to be

congruent with, and to accomplish sufficiently, the regulatory

objectives of DCO Core Principle E in the context of Petitioners'

activities with respect to the Transactions. The Commission seeks

comment on this preliminary conclusion.

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\212\ See Petition Attachments at 94-103.

\213\ Under these arrangements, the time between Operating Day

and payment will be 13 days or less for all transactions in the Day-

Ahead Market, and will be 15 days or less for 90% of transactions in

the Real Time Market. See id. at 96.

\214\ See 17 CFR 39.14(b) (requiring daily settlements).

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6. DCO Core Principle F: Treatment of Funds

Core Principle F requires a DCO to have standards and procedures

designed to protect and ensure the safety of member and participant

funds, to hold such funds in a manner that would minimize the risk of

loss or delay in access by the DCO to the funds, and to invest such

funds in instruments with minimal credit, market, and liquidity

risks.\215\

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\215\ 7 U.S.C. 7a-1(c)(2)(F).

---------------------------------------------------------------------------

Petitioners represent that they have tariff provisions and related

governing documents that accomplish the regulatory goals of DCO Core

Principle F.\216\ For example, CAISO represents that its tariffs

require it to maintain specified types of separate accounts for funds

it receives or holds, including segregated and aggregated market

clearing accounts.\217\ Similarly, MISO represents that its tariffs

require MISO to hold all monies deposited by its participants (whom

MISO refers to as ``Tariff Customers'') as financial assurance in a

separate, interest-bearing money market account with one-hundred

percent of the interest earned accruing to the benefit of the Tariff

Customer.\218\ The other Petitioners represent that they have

appropriate investment policies or practices, such as segregation

requirements and/or limitations on investment options.\219\ As

represented by Petitioners, these practices appear congruent with, and

to accomplish sufficiently, the regulatory objectives of DCO Core

Principle F in the context of Petitioners' activities with respect to

the Transactions. The Commission seeks comment with respect to this

preliminary conclusion.

---------------------------------------------------------------------------

\216\ See Petition Attachments at 105-110.

\217\ See id. at 105.

\218\ See id. at 108.

\219\ See id. at 105-110.

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7. DCO Core Principle G: Default Rules and Procedures

Core Principle G requires a DCO to have rules and procedures

designed to allow for the efficient, fair, and safe management of

events when members or participants become insolvent or otherwise

default on their obligations to the DCO.\220\ Core Principle G also

requires a DCO to clearly state its default procedures, make publicly

available its default rules, and ensure that it may take timely action

to contain losses and liquidity pressures and to continue meeting each

of its obligations.\221\

---------------------------------------------------------------------------

\220\ 7 U.S.C. 7a-1(c)(2)(G)(i).

\221\ 7 U.S.C. 7a-1(c)(2)(G)(ii).

---------------------------------------------------------------------------

a. General Default Procedures

Each Petitioner represents that it has procedures in its tariffs or

other governing documents that address events surrounding the

insolvency or default of a market participant.\222\ For example,

Petitioners represent that such documents identify events of default

(e.g. failure to make payments when due, failure to support an

estimated liability with adequate security, events of insolvency, and

failure to perform other obligations under the tariff), describe the

cure period associated with

[[Page 52154]]

an event of default, and describe the actions to be taken in the event

of default and/or detail each Petitioners' remedies--which may include,

among other things, termination of services and/or agreements,

initiation of debt collection procedures and levying financial

penalties.\223\ As detailed above, in the event that the remedies

outlined in each Petitioner's governing documents are insufficient to

timely cure a default, Petitioners have the right to socialize losses

from the default among other market participants by, for example,

``short-paying'' such other participants.\224\

---------------------------------------------------------------------------

\222\ See generally Petition Attachments at 112-126.

\223\ Id.

\224\ See supra at n. 149 and accompanying text. See also, e.g.,

Petition at 71.

---------------------------------------------------------------------------

b. Setoff

Generally speaking, it is a well-established tenet of clearing that

a DCO acts as the buyer to every seller and as the seller to every

buyer, thereby substituting the DCO's credit for bilateral counter-

party risk. As such, when a DCO is involved, there is little question

as to the identity of a counterparty to a given transaction. However,

because ISOs and RTOs can act as agents for their participants, there

could be ambiguity as to the identity of a counterparty to a given

transaction. As a result, in the event of a bankruptcy of a market

participant and in the event of a lack of the mutuality of obligation

required by the Bankruptcy Code,\225\ an ISO or RTO may be liable to

pay a bankrupt market participant for transactions in which that

participant is owed funds, without the ability to offset amounts owed

by that participant with respect to other transactions. Stated

differently, although the defaulting market participant may owe money

to the ISO or RTO, if the ISO or RTO also owes money to such

participant, the ISO or RTO may be required to pay the defaulting

participant the full amount owed without being able to offset the

amounts owed by that participant to the ISO or RTO, which latter

amounts may be relegated to claims in the bankruptcy proceedings. As

more fully described in section V.D.4.g., the requirement that

Petitioners provide memoranda or opinions of counsel as discussed

therein is intended to address this issue.

---------------------------------------------------------------------------

\225\ See 11 U.S.C. 553.

---------------------------------------------------------------------------

The foregoing arrangements appear congruent to, and to accomplish

sufficiently, the regulatory objectives of DCO Core Principle G in the

context of Petitioners' activities with respect to the Transactions.

The Commission seeks comment with respect to this preliminary

conclusion.

8. Core Principle H: Rule Enforcement

Core Principle H requires a DCO to (1) maintain adequate

arrangements and resources for the effective monitoring and enforcement

of compliance with its rules and for resolution of disputes, (2) have

the authority and ability to discipline, limit, suspend, or terminate a

clearing member's activities for violations of those rules, and (3)

report to the Commission regarding rule enforcement activities and

sanctions imposed against members and participants.\226\

---------------------------------------------------------------------------

\226\ 7 U.S.C. 7a-1(c)(2)(H).

---------------------------------------------------------------------------

Each Petitioner represents that it maintains tariffs or procedures

or is subject to a regulatory framework that accomplishes the

regulatory goals of DCO Core Principle H. Petitioners have, e.g., the

power to take a range of actions against participants that fail to pay,

pay late, or fail to post financial security. \227\

---------------------------------------------------------------------------

\227\ See generally, Petition Attachments at 128-150.

---------------------------------------------------------------------------

Based on Petitioners' representations, it appears that these

practices are congruent with, and sufficiently accomplish, the

regulatory objectives of DCO Core Principle H in the context of

Petitioners' activities with respect to the Transactions. The

Commission seeks comment with respect to this preliminary conclusion.

9. DCO Core Principle I: System Safeguards

Core Principle I requires a DCO to demonstrate that: (1) It has

established and will maintain a program of oversight and risk analysis

to ensure that its automated systems function properly and have

adequate capacity and security, and (2) it has established and will

maintain emergency procedures and a plan for disaster recovery and will

periodically test backup facilities to ensure daily processing,

clearing and settlement of transactions.\228\ Core Principle I also

requires that a DCO establish and maintain emergency procedures, backup

facilities, and a plan for disaster recovery that allows for the timely

recovery and resumption of the DCO's operations and the fulfillment of

each of its obligations and responsibilities.\229\

---------------------------------------------------------------------------

\228\ 7 U.S.C. 7a-1(c)(2)(I)(i)-(ii).

\229\ 7 U.S.C. 7a-1(c)(2)(I)(iii).

---------------------------------------------------------------------------

Petitioners represent that they have policies and procedures that

accomplish the regulatory goals of DCO Core Principle I,\230\ albeit in

a manner that is somewhat different than the way in which a DCO

complies with DCO Core Principle I. This is because Petitioners are

also responsible for managing power reliably and, thus, require

additional operational safeguards to specifically address that

function. For example, NYISO is subject to reliability rules

established by the New York State Reliability Council, Northeast Power

Coordinating Council, and the North American Electric Reliability

Corporation.\231\ In order to comply with these rules, NYISO has

procedures in place to address emergency situations and maintains an

alternate control center and back-up computer systems and data centers

at a separate location.\232\ NYISO also performs internal and external

audits to ensure its internal controls, procedures, and business

processes comply with accepted standards.\233\ The other Petitioners

represent that they have similar procedures and practices such as,

computer back-up systems, operate multiple control and data centers,

dedicate resources to internal audit and security teams, and maintain

disaster recovery plans designed to address operational, physical, and

cyber security events.\234\

---------------------------------------------------------------------------

\230\ See generally Petition Attachments at 152-158.

\231\ See id. at 157.

\232\ See id.

\233\ See id.

\234\ See id. at 152, 156, 158.

---------------------------------------------------------------------------

Based on Petitioners' representations, it appears that these system

safeguard practices are congruent with, and accomplish sufficiently,

the regulatory objectives of DCO Core Principle I in the context of

Petitioners' activities with respect to the Transactions. The

Commission seeks comment with respect to this preliminary conclusion.

10. DCO Core Principle J: Reporting

Core Principle J requires a DCO to provide to the Commission all

information that the Commission determines to be necessary to conduct

oversight of the DCO.\235\ With the exception of ERCOT, Petitioners

represent that, pursuant to their Tariffs and other FERC orders, FERC

has access to the information that it would need to oversee the

Petitioners.\236\ With respect to ERCOT, ERCOT represents that the PURA

and PUCT Substantive Rules require it to provide information to the

PUCT on request.\237\ ERCOT also represents that its Bylaws require

ERCOT corporate members to provide information to ERCOT.\238\ In

addition, according to ERCOT, the ERCOT Protocols require ERCOT to

manage

[[Page 52155]]

confidential information, but enable ERCOT to release confidential

information to government officials if required by law, regulation or

order.\239\ As noted above, the Commission is proposing to condition

this exemptive order on the completion of an appropriate information

sharing agreement between the Commission and PUCT.

---------------------------------------------------------------------------

\235\ 7 U.S.C. 7a-1(c)(2)(J).

\236\ See generally Petition Attachments at 160-166.

\237\ See id. at 161-162. PURA 39.151(d), P.U.C. SUBST. R.

25.362(e)(1)(B) and 25.503(f)(8).

\238\ See Petition Attachments at 161-162.

\239\ See id.

---------------------------------------------------------------------------

Based on the foregoing, including Petitioners' representations, it

appears that these practices are congruent with, and sufficiently

accomplish, the regulatory objectives of Core Principle J in the

context of Petitioners' activities with respect to the Transactions.

The Commission seeks comment with respect to this preliminary

conclusion.

11. Core Principle K: Recordkeeping

Core Principle K requires a DCO to maintain records of all

activities related to its business as a DCO in a form and manner

acceptable to the Commission for a period of not less than five

years.\240\

---------------------------------------------------------------------------

\240\ 7 U.S.C. 7a-1(c)(2)(K).

---------------------------------------------------------------------------

Petitioners represent that their practices satisfy the regulatory

goals of DCO Core Principle K because they have adequate recordkeeping

requirements or systems.\241\ In addition, Petitioners represent that

FERC has comprehensive recordkeeping regulations that cover, among

other things, protection and storage of records, record storage media,

destruction of records, and premature destruction or loss of

records.\242\ The record retention requirements for accounting records

are, in the main, at or in excess of five years.\243\ In addition,

ERCOT, which is not subject to FERC jurisdiction, represents that it

has also adopted specific books and records requirements that

accomplish the regulatory goals of DCO Core Principle K. Specifically,

ERCOT represents that it has specific record retention rules

established in the EROCT Protocols and is required to retain market

accounting information for a period of seven years.\244\

---------------------------------------------------------------------------

\241\ See generally Petition Attachments at 168-173.

\242\ See 18 CFR 125.2-.3.

\243\ See 18 CFR 125.3 at (6)-(9).

\244\ See Petition Attachments at 169.

---------------------------------------------------------------------------

Based on these regulations and Petitioners' representations, it

appears that these practices are congruent with, and sufficiently

accomplish, the regulatory objectives of DCO Core Principle K in the

context of Petitioners' activities with respect to the Transactions.

The Commission seeks comment with respect to this preliminary

conclusion.

12. DCO Core Principle L: Public Information

Core Principle L requires a DCO to make information concerning the

rules and operating procedures governing its clearing and settlement

systems (including default procedures) available to market

participants.\245\ Core Principle L also requires a DCO to provide

market participants with sufficient information to enable them to

identify and evaluate accurately the risks and costs associated with

using the DCO's services, and to disclose publicly and to the

Commission information concerning: (1) The terms and conditions of each

contract, agreement, and transaction cleared and settled by the DCO;

(2) the fees that the DCO charges its members and participants; (3) the

DCO's margin-setting methodology, and the size and composition of its

financial resources package; (4) daily settlement prices, volume, and

open interest for each contract the DCO settles or clears; and (5) any

other matter relevant to participation in the DCO's settlement and

clearing activities.\246\

---------------------------------------------------------------------------

\245\ 7 U.S.C. 7a-1(c)(2)(L)(i)-(ii).

\246\ 7 U.S.C. 7a-1(c)(2)(L)(iii).

---------------------------------------------------------------------------

Each Petitioner represents that it makes its tariff or related

governing documents publicly available on its Web site, which, in turn,

allows market participants (and the public) to access its rules and

procedures regarding, among other things, participant and product

eligibility requirements, risk management methodologies, settlement

procedures, and other information that may impact prices, such as

transmission system models, reserved transmission capacity, and similar

information.\247\

---------------------------------------------------------------------------

\247\ See generally Petition Attachments at 175-182.

---------------------------------------------------------------------------

Based on Petitioners' representations, it appears that these

practices are congruent with, and sufficiently accomplish, the

regulatory objectives of DCO Core Principle L in the context of

Petitioners' activities with respect to the Transactions. The

Commission seeks comment with respect to this preliminary conclusion.

13. DCO Core Principle M: Information Sharing

Core Principle M requires a DCO to enter into and abide by the

terms of all appropriate and applicable domestic and international

information-sharing agreements, and use relevant information obtained

from the agreements in carrying out the DCO's risk management

program.\248\

---------------------------------------------------------------------------

\248\ 7 U.S.C. 7a-1(c)(2)(M).

---------------------------------------------------------------------------

Petitioners represent that they have policies and procedures that

allow them to share information with and receive information from other

entities as necessary to carry out their risk management

functions.\249\ For example, ISO NE represents that its Information

Policy sets out rules for sharing information with participants, FERC,

and other Petitioners.\250\ Similarly, the NYISO represents that its

tariff provides for information sharing with other ISOs and RTOs.\251\

ERCOT represents that it is likewise subject to a comprehensive set of

rules under the PURA, PUCT Rules, and the ERCOT Protocols that address

information exchange obligations between ERCOT, the ERCOT Independent

Market Monitor, ERCOT market participants, and the PUCT.\252\ MISO,

PJM, and CAISO all claim to have similar information sharing policies

and procedures--although, the entities with which each ISO/RTO shares

information do vary.\253\

---------------------------------------------------------------------------

\249\ See generally Petition Attachments at 184-190.

\250\ See id. at 186.

\251\ See id. at 188-189.

\252\ See id. at 185.

\253\ See id. at 184, 187, 190.

---------------------------------------------------------------------------

Based on the foregoing and Petitioners' representations, it appears

that these practices are congruent with, and sufficiently accomplish,

the regulatory objectives of Core Principle M in the context of

Petitioners' activities with respect to the Transactions. The

Commission seeks comment with respect to this preliminary conclusion.

14. DCO Core Principle N: Antitrust

Core Principle N requires a DCO to avoid, unless necessary or

appropriate to achieve the purposes of the CEA, adopting any rule or

taking any action that results in any unreasonable restraint of trade,

or imposing any material anticompetitive burden.\254\

---------------------------------------------------------------------------

\254\ 7 U.S.C. 7a-1(c)(2)(N).

---------------------------------------------------------------------------

As discussed above, the formation of the Petitioners (except for

ERCOT) was encouraged by FERC (pursuant to FERC Order Nos. 888 and

2000) in order to foster greater competition in the power generation

sectors by allowing open access to transmission lines.\255\ In

[[Page 52156]]

addition, Petitioners represent that they are subject to continued

oversight by FERC, PUCT or their market monitors, as appropriate, which

oversight could detect activities such as undue concentrations or

market power, discriminatory treatment of market participants or other

anticompetitive behavior.\256\

---------------------------------------------------------------------------

\255\ See FERC Order No. 888; FERC Order No. 2000. Moreover,

Petitioners represent that their rules are typically subject to

advance review by stakeholders and must be approved by FERC (except

for ERCOT whose rules are approved by PUCT). These rules are, in

turn, subject to review by the MMU, who attempt to detect, among

other things, detect market power abuses. See generally Petition

Attachments at 192-198. With respect to ERCOT, TAC 25.361(i)

expressly states that ``The existence of ERCOT is not intended to

affect the application of any state or federal anti-trust laws.'' In

addition, ERCOT represents that it conducts antitrust training for

its employees annually, holds open meetings to promote the

transparent development of market rules, established a Corporate

Standard to addresses antitrust issues, and that ``PURA, PUCT

Substantive Rules and ERCOT Protocols also require that ERCOT allow

access to the transmission system for all buyers and sellers of

electricity on a nondiscriminatory basis, which facilitates actions

consistent with the antitrust considerations of [DCO Core Principle

N].'' See Petition Attachments at 193-194.

\256\ See Petition Attachments at 192-198.

---------------------------------------------------------------------------

Based on Petitioners' representations, it appears that Petitioners'

existence and practices are congruent with, and sufficiently

accomplish, the regulatory objectives of Core Principle N. The

Commission seeks comment with respect to this preliminary conclusion.

15. DCO Core Principle O: Governance and Fitness Standards

Core Principle O requires a DCO to establish governance

arrangements that are transparent to fulfill public interest

requirements and to permit the consideration of the views of owners and

participants.\257\ A DCO must also establish and enforce appropriate

fitness standards for directors, members of any disciplinary committee,

members of the DCO, any other individual or entity with direct access

to the settlement or clearing activities of the DCO, and any party

affiliated with any of the foregoing individuals or entities.\258\

---------------------------------------------------------------------------

\257\ 7 U.S.C. 7a-1(c)(2)(O)(i).

\258\ 7 U.S.C. 7a-1(c)(2)(O)(ii).

---------------------------------------------------------------------------

Petitioners represent that their tariffs, organizational documents,

and applicable state law set forth specific governance standards that

are consistent with the regulatory goals which address, for example,

director independence and fitness requirements.\259\ In addition,

Petitioners assert that FERC Order Nos. 888 and 2000 set out certain

minimum governance structures for ISOs and RTOs. Petitioners state that

Order No. 888 requires the following: an ISO's governance should be

structured in a fair and non-discriminatory manner; an ISO and its

employees should have no financial interest in the economic performance

of any power market participant; and an ISO should adopt and enforce

strict conflict of interest standards.\260\ Petitioners assert that

Order No. 2000 likewise identified minimum characteristics that RTOs

must exhibit, including, independence from all market

participants.\261\ Similarly, Petitioners represent that PURA mandates

ERCOT to include unaffiliated directors and market segment

representation in its governance structure.\262\

---------------------------------------------------------------------------

\259\ See Petition Attachments at 200-208.

\260\ See id. at 200 (citing to FERC Order No. 888).

\261\ See Petition Attachments at 208 (citing to FERC Order No.

2000).

\262\ See id. at 202.

---------------------------------------------------------------------------

Based on Petitioners' representations, it appears that Petitioner's

governance structures are congruent with, and sufficiently accomplish,

the regulatory objectives of DCO Core Principle O in the context of

Petitioners' activities with respect to the Transactions. The

Commission seeks comment with respect to this preliminary conclusion.

16. DCO Core Principle P: Conflicts of Interest

Pursuant to DCO Core Principle P, each DCO must establish and

enforce rules to minimize conflicts of interest in the decision-making

process of the DCO.\263\ In addition, each DCO must establish a process

for resolving conflicts of interest.\264\

---------------------------------------------------------------------------

\263\ 7 U.S.C. 7a-1(c)(2)(P)(i).

\264\ 7 U.S.C. 7a-1(c)(2)(P)(ii).

---------------------------------------------------------------------------

Each Petitioner represents that it has established a conflict of

interest policy in a Code of Conduct or other corporate document that

requires board members and employees to, among other things, avoid

activities that are contrary to the interests of the Petitioner.\265\

In addition, CAISO represents that Order No. 888 requires ISOs to

implement strict conflict of interest policies.\266\ Similarly, ERCOT

asserts that the PUCT Substantive Rules require it to adopt policies to

mitigate conflicts of interest.\267\

---------------------------------------------------------------------------

\265\ See Petition Attachments at 210-216.

\266\ See id. at 210.

\267\ See id. at 211.

---------------------------------------------------------------------------

Based upon Petitioners' representations, it appears that the

conflict of interest policies Petitioners have adopted and that the

requirements Petitioners are subject to are congruent with, and

sufficiently accomplish, the regulatory objectives of DCO Core

Principle P in the context of Petitioners' activities with respect to

the Transactions. The Commission seeks comment with respect to this

preliminary conclusion.

17. DCO Core Principle Q: Composition of Governing Boards

DCO Core Principle Q provides that each DCO shall ensure that the

composition of the governing board or committee of the derivatives

clearing organization includes market participants.\268\

---------------------------------------------------------------------------

\268\ 7 U.S.C. 7a-1(c)(2)(O).

---------------------------------------------------------------------------

ERCOT represents that its governing board includes representatives

from the market,\269\ CAISO, on the other hand, asserts that its board

composition is mandated by California statute, wherein members are

appointed by the Governor of California and confirmed by the California

senate.\270\ ISO NE and MISO assert that they have active market

participants who are involved in the nomination and selection of Board

members, while NYISO asserts that its market participants provide input

and feedback through market participant committees, and other

subcommittees and working groups, and PJM has a Members Committee that

elects the members of the PJM Board.\271\ FERC regulations require that

an RTO ``must have a decision making process that is independent of

control by any market participant or class of participants.'' \272\

However, FERC also requires that each ISO and RTO ``adopt business

practices and procedures that achieve Commission-approved independent

system operator and regional transmission organization board of

directors' responsiveness to customers and other stakeholders and

satisfy [specified] criteria.'' \273\

---------------------------------------------------------------------------

\269\ See Petition Attachments at 219.

\270\ See id. at 218.

\271\ See id. at 221-223.

\272\ See 18 CFR 35.34(j)(1)(ii).

\273\ See 18 CFR 35.28(g)(6).

---------------------------------------------------------------------------

Based on Petitioner's representations, and the regulations and

supervision of FERC, it appears that these practices are congruent

with, and sufficiently accomplish, the regulatory objectives of DCO

Core Principle Q in the context of Petitioners' activities with respect

to the Transactions. The Commission seeks comment with respect to this

preliminary conclusion.

18. DCO Core Principle R: Legal Risk

Core Principle R requires a DCO to have a well-founded,

transparent, and enforceable legal framework for each aspect of its

activities.\274\

---------------------------------------------------------------------------

\274\ 7 U.S.C. 7a-1(c)(2)(R).

---------------------------------------------------------------------------

Petitioners assert that they operate under a transparent and

comprehensive legal framework that is grounded in the Federal Power Act

or the Texas Public Utility Regulatory Act, as applicable, and

administered by FERC or the PUCT, as applicable.\275\ Indeed,

Petitioners assert that they are subject to FERC or PUCT orders rules

and regulations and that each Petitioner operates pursuant to a tariff

that has been reviewed and approved by FERC or the PUCT, as

applicable.\276\ Moreover, with respect to

[[Page 52157]]

an area of particular concern (eligibility for setoff in bankruptcy),

the CFTC is requiring independent confirmation.\277\

---------------------------------------------------------------------------

\275\ See generally Petition Attachments at 225-235.

\276\ See id.

\277\ See the discussion in section V.D.4.g.

---------------------------------------------------------------------------

Based on Petitioners' representations, it appears that this

framework is congruent with, and sufficiently accomplishes, the

regulatory objectives of Core Principle R in the context of

Petitioners' activities with respect to the Transactions. The

Commission seeks comment with respect to this preliminary conclusion.

E. SEF Core Principles

1. SEF Core Principle 1: Compliance With Core Principles

SEF Core Principle 1 requires a SEF to comply with the Core

Principles described in part 37 of the Commission's Regulations.\278\

As demonstrated by the following analysis, the Commission has made a

preliminary determination that in the context of the Petitioners'

activities with respect to the Transactions within the scope of this

Proposed Exemption, Petitioners' practices appear congruent with, and

to accomplish sufficiently, the regulatory objectives of each SEF core

principle. The Commission requests comment with respect to this

preliminary determination.

---------------------------------------------------------------------------

\278\ 7 U.S.C. 7b-3(f)(1)

---------------------------------------------------------------------------

2. SEF Core Principle 2: Compliance With Rules

SEF Core Principle 2 requires a SEF to establish and enforce

compliance with any rule of the SEF.\279\ A SEF is also required to (1)

establish and enforce rules with respect to trading, trade processing,

and participation that will deter market abuses and (2) have the

capacity to detect, investigate and enforce those rules, including a

means to (i) provide market participants with impartial access to the

market, and (ii) capture information that may be used in establishing

whether rule violations have occurred.\280\

---------------------------------------------------------------------------

\279\ 7 U.S.C. 7b-3(f)(2).

\280\ SEF Core Principle 2 also requires a SEF to establish

rules governing the operation of the facility, including trading

procedures, and provide rules that, when a swap is subject to the

mandatory clearing requirement, hold swap dealers and major swap

participants responsible for compliance with the mandatory trading

requirement under section 2(h)(8) of the Act.

---------------------------------------------------------------------------

Petitioners represent that they have transparent rules for their

market, including rules that govern market abuses and compliance

enforcement.\281\ For instance, the independent market monitor

established by statute for the ERCOT region oversees market behavior

and reports any market compliance issues to the state regulator.\282\

If a market participant violates ERCOT rules, depending on the nature

of the offense, ERCOT and/or the state regulator may take appropriate

action against the party, including, but not limited to, terminating,

expelling, suspending, or sanctioning a member.\283\ The other

Petitioners also represent that they have enforcement mechanisms that

allow the Petitioners to, among other things, monitor their markets,

investigate suspected tariff violations, take action against violators

(including assessing fines or suspending or terminating a market

participant's participation in market activities), and refer potential

violations to FERC.\284\

---------------------------------------------------------------------------

\281\ Petition Attachments at 238-245.

\282\ See id. at 130. See also id. at 239-240.

\283\ See id. at 129. See also id. at 239-240.

\284\ See id. at 128, 131-150. See also id. at 238, 241-245.

---------------------------------------------------------------------------

Based on the foregoing, it appears that the Petitioners' practices

are consistent with, and sufficiently accomplish, the regulatory goals

of SEF Core Principle 2 in the context of Petitioners' activities with

respect to the Transactions. The Commission requests comment with

respect to this preliminary determination.

3. SEF Core Principle 3: Swaps Not Readily Susceptible to Manipulation

SEF Core Principle 3 requires a SEF submitting a contract to the

Commission for certification or approval to demonstrate that the swap

is not readily susceptible to manipulation.\285\

---------------------------------------------------------------------------

\285\ 7 U.S.C. 7b-3(f)(3).

---------------------------------------------------------------------------

a. Energy Transactions

Petitioners define Energy Transactions to include both physically-

delivered as well as cash-settled contracts.\286\ For purposes of this

Proposed Exemption, the Commission limits the analysis to Energy

Transactions that are cash-settled.

---------------------------------------------------------------------------

\286\ See Petition at 7.

---------------------------------------------------------------------------

Petitioners have represented to the Commission that market

participants use the cash-settled Energy Transactions to arbitrage

between the Day-Ahead and Real-Time markets.\287\ The result is that

prices between the Day-Ahead and Real-Time markets converge and reduce

the price volatility normally found in electricity markets.\288\

Indeed, the contracts were created with this very purpose in mind.\289\

---------------------------------------------------------------------------

\287\ See Petition Attachments at 252-253.

\288\ See id. at 142. See also id. at 253.

\289\ FERC Order on Compliance Filing to PJM, 139 FERC ] 61,057

issued April 19, 2012 in Docket No. ER09-1063-004.

---------------------------------------------------------------------------

The Commission understands that MMUs operated by each of the

Petitioners have been organized in such a way that both the Real-Time

and Day-Ahead markets are monitored to identify suspicious trading

activity.\290\ In the event the MMUs identify suspicious trading

activity, FERC, or PUCT in the case of ERCOT, is notified so that

further investigation may be done. An example of such suspicious

trading activity would involve a market participant engaging in Energy

Transactions that repeatedly incur a loss.\291\ Repeated losses in

Energy Transactions would indicate that a market participant is

sustaining losses to improve another position. For example, in the

event a market participant tried to manipulate the price of electricity

in the Day-Ahead or Real-Time markets to improve a different position,

such as an FTR, they would have to submit bids that drove up the price

of electricity for that specific node. In order to do this, however,

the participant would have to submit a large dollar amount of offers at

an inflated price. The Commission believes that this type of trading

activity should be detectable by the MMUs. In addition to being

difficult to effectuate simply because of the financial resources

required, the Commission believes that any such activity should be

apparent to not only MMUs using their ordinary oversight tools, but to

market participants, who should have a self-interest in reporting such

activity to the MMUs. Notably, such manipulative schemes have been

identified and prosecuted by FERC in the past.\292\

---------------------------------------------------------------------------

\290\ See generally Petition Attachments at 124-147.

\291\ See generally id.

\292\ On March 9, 2012 Constellation Energy and FERC's Office of

Enforcement entered into a Stipulation and Consent Agreement in

which Constellation neither admitted nor denied wrongdoing. FERC

initially alleged that Constellation manipulated the price of

electricity using virtual and physically-settled transactions on the

markets of ISO NE and NYISO to benefit non-ISO swap positions. After

receiving two anonymous hotline tips, FERC was alerted to

potentially problematic trading after detecting successive losses by

Constellation in their virtual and physical bids on the NYISO.

Constellation agreed to pay a fine of $135,000,000 and disgorge

$110,000,000 in unjust profits. See Order approving stipulation and

agreement, Docket No. IN12-7-000, 138 FERC ] 61,168.

---------------------------------------------------------------------------

Petitioners represent that they have adequate staff and IT

resources to conduct market surveillance.\293\ Each Petitioner follows

a similar market design which allows for price discovery at thousands

of nodes and paths in short time intervals (every five to fifteen

minutes) in both the Real-Time and Day-Ahead markets.\294\ The MMUs

look

[[Page 52158]]

for manipulative behavior and market power, as well as market flaws

(such as persistent non-convergence of Day-Ahead and Real-Time prices),

which are fed back into a stakeholder process for changing the market

structure and rules.\295\

---------------------------------------------------------------------------

\293\ See Petition at 126-150.

\294\ See generally Petition Attachments at 247-258.

\295\ See generally id. at 126-150.

---------------------------------------------------------------------------

Based on the Petitioners' representations regarding the

surveillance carried out by the MMUs for each Petitioner and the method

by which the Day-Ahead and Real-Time auctions are conducted, it appears

that Petitioners' policies and procedures to mitigate the

susceptibility of Energy Transactions to manipulation are congruent

with, and sufficiently accomplish, the regulatory objectives of SEF

Core Principle 3 in the context of Petitioners' activities with respect

to the Energy Transactions. The Commission seeks comment with respect

to this preliminary conclusion.

b. Financial Transmission Rights (``FTRs'')

Based upon the Petitioners' representations, the Commission

understands FTRs to be cash-settled contracts that entitle the holder

to a payment equal to the difference in the price of electricity

between two specific nodes.\296\ The difference in price between the

two nodes represents the settlement price. The price at each node is

established through auctions conducted on the Day-Ahead market of each

Petitioner.\297\ As discussed above, the Commission has made a

preliminary determination that the Real-Time and Day-Ahead markets on

Petitioners' platforms appear to be consistent with SEF Core Principle

3.

---------------------------------------------------------------------------

\296\ See Petition at 6.

\297\ See, e.g., Petition Attachments at 252.

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As previously discussed, both the Petitioners and their respective

MMUs conduct market surveillance of both the Real-Time and Day-Ahead

markets to identify manipulation of the price of electricity. In the

event unusual trading activity is detected by the Petitioners' MMUs,

the MMUs will immediately contact FERC, or PUCT in the case of ERCOT,

so that an investigation into the unusual activity may begin.\298\

Although the price of FTRs may be altered by the manipulation of the

Real-Time or Day-Ahead markets, FERC requires that the Petitioners have

systems to monitor for such activity.

---------------------------------------------------------------------------

\298\ See generally Petition Attachments at 128-150.

---------------------------------------------------------------------------

The Commission believes that the Petitioners' policies and

procedures should mitigate the susceptibility of FTRs to manipulation

and that they are congruent with, and sufficiently accomplish, the

regulatory objectives of SEF Core Principle 3 in the context of

Petitioners' activities with respect to FTRs. The Commission seeks

comment with respect to this preliminary conclusion.

In addition to the Petitioners' policies and procedures for the

detection of manipulative behavior in connection with FTRs, the

Commission notes that since an FTR holder is entitled to a payment

based on the price difference between two nodes, and not the physical

delivery of electricity, it may be the case that FTRs are difficult to

use to manipulate the price of electricity. For instance, the size of a

participant's FTR position should not affect the price of electricity

established on the Petitioners' Real-Time and Day-Ahead markets and

holding an FTR does not provide a means to limit the deliverable supply

of electricity. The Commission seeks comment on this evaluation and

whether it should be considered in analyzing FTRs under SEF Core

Principle 3.

c. Capacity and Reserve Transactions

Both Capacity and Reserve Transactions are entered into pursuant to

auctions carried out by each of the Petitioners.\299\ However, unlike

the auctions for the Real-Time and Day-Ahead markets, the auctions for

capacity and reserve transactions simply allow each Petitioner to

accept bids submitted by market participants that have the ability to

inject electricity into the Petitioner's electricity transmission

system.\300\

---------------------------------------------------------------------------

\299\ See Petition at 7-9.

\300\ See Petition at 7-9.

---------------------------------------------------------------------------

The Commission notes that the Petitioners would apply the same

oversight policies and procedures to Capacity and Reserve Transactions

that they apply to Energy Transactions and FTRs. The Commission

believes that these measures appear to be consistent with, and to

accomplish sufficiently, the regulatory objectives of SEF Core

Principle 3 in the context of Petitioners' activities with respect to

Capacity and Reserve Transactions. The Commission seeks comment with

respect to this preliminary conclusion.

The Commission also seeks comment on whether the auction procedures

used in connection with Capacity and Reserve Transactions could reduce

the likelihood for manipulation of such agreements due to the fact that

the Petitioners themselves are the only possible counterparty during

each auction. For example, when CAISO conducts an auction for

Generation Capacity, it is the only party that would enter into the

agreement with a CAISO market participant capable of providing the

contracted for electricity. CAISO would then call upon the Capacity and

Reserve Transaction counterparties to inject electricity into the

system when the technical requirements of operating the transmission

system deem injection necessary. Accordingly, Capacity and Reserve

Transactions seem to be distinguishable from FTRs or Energy

Transactions in that they are used exclusively for operational

maintenance of the electric transmission system, and not as a means of

reducing exposure to price volatility, arbitrage or price discovery.

The Commission seeks comment on this analysis of Capacity and Reserve

Transactions and whether it should be considered in the Commission's

review of these instruments under SEF Core Principle 3.

4. SEF Core Principle 4: Monitoring of Trading and Trade Processing

SEF Core Principle 4 requires a SEF to establish and enforce rules

or terms and conditions defining trading procedures to be used in

entering and executing orders traded on or through the SEF and

procedures for the processing of swaps on or through the SEF.\301\ SEFs

are also required to establish a system to monitor trading in swaps to

prevent manipulation, price distortion and disruptions of the delivery

or cash settlement process through surveillance, compliance and

disciplinary practices and procedures. The main goal of this Core

Principle is to monitor trading activity to detect or deter market

participants from manipulating the price or deliverable supply of a

commodity.

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\301\ 7 U.S.C. 7b-3(f)(4).

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a. Energy Transactions

Generally, the Petitioners have tariffs in place that list how

Energy Transactions are to be entered into the trading platform.\302\

Using these procedures, MMUs are able to track the Energy Transactions

submitted by market participants and identify trading activity that

could be manipulative. As a result, Petitioners' policies and

procedures regarding monitoring of trading and trade processing appear

to be consistent with, and to accomplish sufficiently, the regulatory

objectives of SEF Core Principle 4 in the context of Petitioners'

activities with respect to Energy Transactions. The Commission

[[Page 52159]]

seeks comment with respect to this preliminary conclusion.

---------------------------------------------------------------------------

\302\ See generally Petition Attachments at 260-269.

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b. FTRs

The process by which the FTR allocation and auction takes place

provides the Petitioners with a basic system that allows the

Petitioners to determine which market participants hold FTRs. According

to the Petitioners' tariffs, LSEs applying for FTRs during the

allocation phase must first establish that they are in fact exposed to

load levels for the transmission lines on which they will transmit

electricity.\303\ Once an LSE has demonstrated such exposure, they will

be allowed to participate in the FTR allocation. The FTRs are allocated

to each LSE in direct relation to the level of exposure to which the

LSEs are subject.\304\ This process of determining congestion exposure

and allocating FTRs in relation to that exposure ensures that

Petitioners will have a record of the number of FTRs held by each

member.

---------------------------------------------------------------------------

\303\ See generally id.

\304\ See id.

---------------------------------------------------------------------------

During the auction and secondary market phases, the Petitioners

also have systems in place to track which participants hold FTRs.

During the auction phase, any credit-worthy member of the RTO or ISO

may bid on FTRs. Since the auctions are conducted on the Petitioners'

platforms, they will have records of which market participants hold

FTRs after the auctions. Once an auction is complete, credit-worthy

members may then engage in bilateral transactions to trade FTRs. Again,

Petitioners have implemented systems to track these bilateral

transactions between FTR holders. Once a bilateral transaction is

reported, the Petitioner then performs a credit check to ensure that

the new owner of the FTR has the financial capability to assume the

risk posed by ownership of the FTR.\305\ The Petitioners do not perform

an analysis to determine whether a member is obtaining a large position

in the secondary FTR market. The Petitioners only identify which

members hold FTRs in the secondary market.

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\305\ See id. at 2-20.

---------------------------------------------------------------------------

Based on the foregoing representations, it appears that the

Petitioners' policies and procedures regarding the monitoring of

trading and trade processing are consistent with, and to accomplish

sufficiently, the regulatory objectives of SEF Core Principle 4 in the

context of Petitioners' activities with respect to FTRs. The Commission

seeks comment with respect to this preliminary conclusion.

c. Capacity and Reserve Transactions

As discussed above, the auction process used for Capacity and

Reserve Transactions differs from the process used in the Real-Time and

Day-Ahead markets. Furthermore, Capacity and Reserve Transactions are

not used to limit exposure to price volatility, discover prices or

engage in arbitrage. The transactions are predominantly bilateral

agreements between each Petitioner and certain of that Petitioner's

market participants for the provision of electricity in order to meet

the technical requirements necessary to operate the electric

transmission system. The contracts are not readily susceptible to

manipulation and there is no market trading that must be monitored to

prevent manipulation or congestion of the physical delivery market. As

a result, the Petitioners' policies and procedures regarding the

monitoring of trading and trade processing appear to be consistent

with, and to accomplish sufficiently, the regulatory objectives of SEF

Core Principle 4 in the context of Petitioners' activities with respect

to Capacity and Reserve Transactions. The Commission seeks comment with

respect to this preliminary conclusion.

5. SEF Core Principle 5: Ability To Obtain Information

SEF Core Principle 5 requires a SEF to establish and enforce rules

that will allow it to obtain any necessary information to perform the

functions described in section 733 of the Dodd-Frank Act, provide

information to the Commission upon request, and have the capacity to

carry-out such international information-sharing agreements as the

Commission may require.\306\ As discussed above,\307\ each Petitioner

represents that it has rules in place that require market participants

to submit information to Petitioners upon request so that Petitioners

may conduct investigations and provide or give access to such

information to their market monitors and FERC or PUCT, as

applicable.\308\ On the basis of these representations, it appears that

Petitioners' practices are consistent with, and sufficiently

accomplish, the regulatory goals of SEF Core Principle 5. The

Commission seeks comment with respect to this preliminary

determination.

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\306\ 7 U.S.C. 7b-3(f)(5).

\307\ See generally the discussions in sections V.D.10. and

V.D.13. supra.

\308\ See generally Petition Attachments at 271-276.

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6. SEF Core Principle 6: Position Limits or Accountability

SEF Core Principle 6 requires SEFs that are trading facilities, as

that term is defined in CEA section 1a(51), to establish position

limits or position accountability for speculators, as is necessary and

appropriate, for each swap traded on the SEF in order to prevent or

reduce the potential threat of market manipulation or congestion,

especially during trading in the delivery month.\309\ While the markets

administered by Petitioners are subject to MMUs (as discussed above in

section IV.C.), Petitioners do not have position limits or position

accountability thresholds for speculators in order to reduce the

potential threat of market manipulation or congestion. The Commission

specifically requests comment as to whether the lack of position limits

or position accountability thresholds for speculators in Petitioners'

markets, given the nature of their markets and market participants, and

the other regulatory protections applicable to these markets as

described herein, would prevent the Commission from determining that

the Proposed Exemption is consistent with the public interest and the

purposes of the CEA.

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\309\ Further Definition of `Swap Dealer,' `Security-Based Swap

Dealer,' `Major Swap Participant,' `Major Security-Based Swap

Participant' and `Eligible Contract Participant,' 77 FR 30596, May

23, 2012.

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7. SEF Core Principle 7: Financial Integrity of Transactions

SEF Core Principle 7 requires a SEF to establish and enforce rules

and procedures for ensuring the financial integrity of swaps entered on

or through the facilities of the SEF, including the clearance and

settlement of swaps pursuant to section 2(h)(1) of the CEA.

a. Risk Management Requirements and Credit Policies

Petitioners represent that they ensure the financial integrity of

transactions that are entered on or through their markets through the

risk management requirements and credit policies that apply to their

market participants.\310\ In addition to minimum capitalization

requirements, Petitioners represent that they all have in place, or are

in the process of implementing, risk management policies and procedures

and internal controls appropriate to their trading activities in the

RTO and ISO markets in which they

[[Page 52160]]

participate.\311\ Petitioners further represent that they require a

responsible officer of the market participant to certify, on an annual

basis, that the market participant has in place risk management

policies, procedures and internal controls appropriate to its trading

activities.\312\ Moreover, several Petitioners represent that they have

proposed verification programs that confirm that participants who pose

significant risks to the markets in which they participate have in

place adequate risk management policies and internal controls.\313\

---------------------------------------------------------------------------

\310\ See Petition at 18-21; see Petition Attachments at 285-

291.

\311\ See Petition at 20; see, e.g., Petition Attachments at 22-

24, 27, 33, 37.

\312\ See Petition at 20; see Petition Attachments at 22, 28,

35, 37, 44, 47-48.

\313\ See Petition at 20; see, e.g., Petition Attachments at 23,

27, 44, 50.

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In terms of credit policies, Petitioners represent that they have

established ``comprehensive and integrated'' credit policies to manage

credit risk and protect the financial integrity of transactions with

market participants.\314\ In addition, Petitioners represent that FERC

Order 741 placed additional risk management and credit requirements on

RTOs and ISOs.\315\

---------------------------------------------------------------------------

\314\ See Petition at 18; see, e.g., Petition Attachments at 22,

25, 30-31, 39-43, 283.

\315\ See Petition at 19. Such additional requirements include

(a) limiting the amount of unsecured credit extended to any market

participant to no more than $50 million; (b) adopting a billing

period of no more than seven days and allowing a settlement period

of no more than seven days; (c) eliminating unsecured credit in the

financial transmission rights market; (d) establishing a single

counterparty to all market participant transactions, or requiring

each market participant to grant a security interest to the RTO or

ISO in the receivables of its transactions, or providing another

method of supporting netting; (e) limiting the time period by which

a market participant must cure a collateral call to no more than two

days; (f) requiring minimum participant criteria for market

participants to be eligible to participate in the markets; and (g)

requiring additional collateral due to a material adverse change.

See 18 CFR 35.47.

---------------------------------------------------------------------------

b. Minimum Financial Standards and Ongoing Monitoring for Compliance

In addition, based on Petitioners' representations, it appears that

Petitioners' policies and procedures include minimum financial

standards \316\ and creditworthiness standards \317\ for their market

participants.\318\ Moreover, Petitioners represent that their policies

and procedures, require Petitioners to monitor, on an ongoing basis,

their market participants for compliance with such standards.\319\

---------------------------------------------------------------------------

\316\ See, e.g., Petition Attachments at 30. Some Petitioners

required market participants to demonstrate and maintain certain

minimum financial requirements including an investment-grade credit

rating documented by reports of a credit reporting agency, tangible

net-worth threshold, total asset threshold, a certain current ratio,

or a certain debt to total capitalization ratio. See, e.g., Petition

Attachments at 26, 33-34, 37, 43. In certain instances, the minimum

financial standards for market participants are scalable to the RTO

and ISO markets in which they participate. See, e.g., Petition

Attachments at 26, 31. The proposed rule regarding minimum financial

standards also requires at a minimum, that members qualify as an

eligible contract participant as defined by the CEA. The Commission

notes that ISO NE has represented that it has market participants

that may not meet the definition of eligible contract participant,

but are ``appropriate persons'' for purposes of the 4(c) exemption.

See Petition Attachments at 30. The Commission proposes to condition

the granting of the 4(c) request on all parties to the agreement,

contract or transaction being ``appropriate persons,'' as defined

sections 4(c)(3)(A) through (J) of the Act or ``eligible contract

participants'' as defined in section 1a(18)(A) of the Act and in

Commission regulation 1.3(m). See provision 2.B. of the Proposed

Exemption.

\317\ See Petition at 18; see, e.g., Petition Attachments at 22,

31, 39.

\318\ See, e.g., Petition Attachments at 27, 30, 35, 84.

\319\ See Petition Attachments at 56-92.

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c. Establishment of a Central Counterparty

As discussed in section V.C. above, FERC regulation 35.47(d)

requires RTOs and ISOs to (1) establish a single counterparty to all

market participant transactions, (2) require each market participant to

grant a security interest in the receivables of its transactions to the

relevant RTO or ISO, or (3) provide another method of supporting

netting that provides a similar level of protection to the market that

is approved by FERC.\320\ Petitioners have represented that they either

are, or plan on becoming, central counterparties.\321\

---------------------------------------------------------------------------

\320\ 18 CFR 35.47(d).

\321\ See FERC Order 741 Implementation Chart at 5-6; See

generally Petition at 19.

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As described in section V.D.4.g. above, the Commission is proposing

to require that each Petitioner submit a well-reasoned legal memorandum

from, or a legal opinion of, outside counsel that, in the Commission's

sole discretion, provides the Commission with adequate assurance that

the approach selected by the Petitioner will in fact provide the

Petitioner with set-off rights in a bankruptcy proceeding. In addition,

the Commission is requesting comment on whether ERCOT should be

obligated to comply with the requirements of FERC regulation 35.47(d).

d. Conclusion

Issues regarding risk management requirements, financial standards,

and the use of a central counterparty are also addressed within the

context of DCO Core Principle D. The Commission's preliminary

conclusion that Petitioners policies and procedures are congruent with,

and sufficiently accomplish, the regulatory objectives of Core

Principle D in the context of the Petitioners' activities with respect

to the Transactions is relevant in considering SEF Core Principle 7.

Based on the foregoing analysis, including the representations of

the Petitioners, Petitioners' policies and procedures appear to be

consistent with, and to accomplish sufficiently, the regulatory

objectives of SEF Core Principle 7 in the context of Petitioners'

activities with respect to the Transactions. The Commission seeks

comment with respect to this preliminary conclusion.

8. SEF Core Principle 8: Emergency Authority

SEF Core Principle 8 requires that SEFs adopt rules to provide for

the exercise of emergency authority.\322\ A SEF should have procedures

and guidelines for decision-making and implementation of emergency

intervention in the market. A SEF should have the authority to perform

various actions, including without limitation: liquidating or

transferring open positions in the market, suspending or curtailing

trading in any swap, and taking such market actions as the Commission

may direct. In addition, SEFs must provide prompt notification and

explanation to the Commission of the exercise of emergency

authority.\323\

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\322\ 7 U.S.C. 7b-3(f)(8).

\323\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR 1229, proposed Jan. 7, 2011.

---------------------------------------------------------------------------

Petitioners represent that their Tariffs generally provide a wide

range of authorities to address emergency situations.\324\ Certain

Petitioners have the ability to close out and liquidate all of a market

participant's current and forward FTR positions if the market

participant no longer meets creditworthiness requirements, or fails to

make timely payment when due, in each case following any opportunity

given to cure the deficiency.\325\ Other Petitioners have the authority

to suspend trading in their markets.\326\

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\324\ See Petition Attachments at 293-298.

\325\ See, e.g., id. at 293-295, 298.

\326\ See, e.g., id. at 296-297.

---------------------------------------------------------------------------

Just as the SEFs have rules in place that require them to take

emergency actions to protect the markets by ``including imposing or

modifying position limits, imposing or modifying price limits, imposing

or modifying intraday market restrictions, imposing special margin

requirements, ordering the liquidation or transfer of open positions in

any contract, ordering the fixing of a settlement price,'' one

[[Page 52161]]

Petitioner represents that it may take actions to protect its markets

by postponing the closure of affected markets, removing bids that have

previously resulted in market disruptions, setting an administrative

price to settle metered supply, or demanding, suspending or limiting

the ability of scheduling coordinators to submit Energy

Transactions.\327\

---------------------------------------------------------------------------

\327\ Petition Attachments at 293 (CAISO).

---------------------------------------------------------------------------

Based on the foregoing representations, it appears that

Petitioners' policies and procedures regarding the exercise of

emergency authority are congruent with, and sufficiently accomplish,

the regulatory objectives of SEF Core Principle 8 in the context of

Petitioners' activities with respect to the Transactions. The

Commission seeks comment with respect to this preliminary conclusion.

9. SEF Core Principle 9: Timely Publication of Trading Information

SEF Core Principle 9 requires a SEF to make public timely

information on price, trading volume, and other data on swaps to the

extent prescribed by the Commission.\328\ In addition, SEFs are

required to have the capacity to electronically capture and transmit

trade information with respect to transactions executed on the

SEF.\329\

---------------------------------------------------------------------------

\328\ 7 U.S.C. 7b-3f(9)(A).

\329\ 7 U.S.C. 7b-3f(9)(B).

---------------------------------------------------------------------------

Petitioners represent that their Tariffs generally require the

timely publication of trading information.\330\ Petitioners regulated

by FERC also assert that they are able to publicly release market

operations and grid management information using their Open Access

Same-Time Information System (OASIS) program.\331\ This system

transmits information which includes market results, the market

clearing price and volume.\332\ Similarly, ERCOT's protocols require

them to disseminate information which relates to market operations,

prices, availability of services and the terms and conditions of the

FTRs.\333\

---------------------------------------------------------------------------

\330\ See Petition Attachments at 300-305.

\331\ See id. at 300, 302-305.

\332\ See id.

\333\ See Petition Attachments at 177-178.

---------------------------------------------------------------------------

Based on the foregoing representations, it appears that

Petitioners' policies and procedures regarding the publication of

trading information are congruent with, and sufficiently accomplish,

the regulatory objectives of SEF Core Principle 9 in the context of

Petitioners' activities with respect to the Transactions. The

Commission seeks comment with respect to this preliminary conclusion.

10. SEF Core Principle 10: Recordkeeping and Reporting

SEF Core Principle 10 requires a SEF to maintain records of all

activity relating to the business of the SEF, report such information

to the Commission and to keep swaps information open to inspection by

the Commission.\334\ Petitioners represent that their Tariffs require

their market participants to provide Petitioners with information on a

regular and ad hoc basis.\335\ Petitioners further represent that they

are required to comply with FERC or PUCT regulations, as applicable,

regarding the maintenance of information by public utilities.\336\

---------------------------------------------------------------------------

\334\ 7 U.S.C. 7b-3(f)(10).

\335\ See generally Petition at 307-312.

\336\ See, e.g., id. at 309.

---------------------------------------------------------------------------

Based on the Petitioners representations and the discussion

regarding DCO Core Principles J and K above,\337\ it appears that these

practices are congruent with, and sufficiently accomplish the

regulatory objectives of SEF Core Principle 10 in the context of

Petitioners' activities with respect to the Transactions. The

Commission seeks comment with respect to this preliminary conclusion.

---------------------------------------------------------------------------

\337\ See the discussions in sections V.D.10. and V.D.11. supra.

---------------------------------------------------------------------------

11. SEF Core Principle 11: Antitrust Considerations

SEF Core Principle 11 prevents a SEF from adopting any rule or

taking any action that results in any unreasonable restraint of trade,

or imposes any material anticompetitive burden, unless necessary or

appropriate to achieve the purposes of the Act.\338\ As discussed

above, FERC established the RTO/ISO system to promote competition in

the electricity market.\339\ Petitioners represent that their rates,

terms and conditions of service are subject to the oversight, review

and acceptance of FERC or PUCT, as applicable.\340\ Petitioners further

represent that FERC or PUCT and their MMUs review trading activity to

identify anticompetitive behavior.\341\

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\338\ 7 U.S.C. 7b-3(f)(11).

\339\ See FERC Order Nos. 888 and 2000. See also the discussion

in section V.D.14. supra.

\340\ See generally Petition Attachments at 192-198.

\341\ See generally id.

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Based on Petitioners' representations and the discussion of DCO

Core Principle N above,\342\ it appears that Petitioners' existence and

practices are congruent with, and sufficiently accomplish, the

regulatory objectives of SEF Core Principle 11 in the context of

Petitioners' activities with respect to the Transactions. The

Commission seeks comment on this preliminary conclusion.

---------------------------------------------------------------------------

\342\ See also the discussion in section V.D.14. supra.

---------------------------------------------------------------------------

12. SEF Core Principle 12: Conflicts of Interest

SEF Core Principle 12 requires a SEF to establish and enforce rules

to minimize conflicts of interest and establish a process for resolving

conflicts of interest.\343\ As discussed above, FERC Order No. 888

requires ISOs to adopt or enforce strict conflict of interest

policies.\344\ Similarly, FERC Order No. 2000 requires RTOs to be

independent of any market participant, and to include in their

demonstration of independence that the RTO, its employees, and any non-

stakeholder directors do not have financial interests in any market

participant.\345\ Each Petitioner represents that it has either

established codes of conduct, which include conflict of interest rules,

for employees and members of the Board of Directors \346\ or

implemented specific policies and procedures to mitigate conflicts of

interest.\347\ Based on Petitioners' representations and the discussion

of DCO Core Principle P above,\348\ it appears that Petitioners'

conflict of interest policies and the requirements to which the

Petitioners are subject are congruent with, and sufficiently

accomplish, the regulatory objectives of SEF Core Principle 12 in the

context of Petitioners' activities with respect to the Transactions.

The Commission seeks comment with respect to this preliminary

conclusion.

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\343\ 7 U.S.C. 7b-3(f)(12).

\344\ See FERC Order No. 888 at 281.

\345\ See FERC Order No. 2000 at 709; 18 CFR 35.34(j)(1).

\346\ See Petition Attachments at 210, 213-216, 321, 324-326.

\347\ See id. at 211, 322.

\348\ See the discussion in section V.D.16. supra.

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13. SEF Core Principle 13: Financial Resources

SEF Core Principle 13 requires a SEF to have adequate financial,

operational and managerial resources to discharge each responsibility

of the SEF.\349\ In addition, the financial resources of a SEF are

considered to be adequate if the value of the financial resources

exceeds the total amount that would enable the SEF to cover the

operating costs of the SEF for a 1-year period, as calculated on a

rolling basis.\350\

---------------------------------------------------------------------------

\349\ 7 U.S.C. 7b-3(f)(13)(A).

\350\ 7 U.S.C. 7b-3(f)(13)(B).

---------------------------------------------------------------------------

Petitioners represent that they have rules in place that allow them

to collect revenue from market participants

[[Page 52162]]

sufficient for each of their operations.\351\ Petitioners further

represent to have adequate managerial resources to operate their

systems.\352\ As discussed above, FERC Order No. 888 requires RTOs to

have appropriate incentives for efficient management and

administration.\353\ Each Petitioner represents that it has sufficient

staff necessary for its operations.\354\

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\351\ See Petition Attachments at 3-4, 6, 8-10, 13, 16, 20, 328-

333.

\352\ See id. at 3, 7-8, 10, 13, 16, 18-19.

\353\ See supra n. 86 and accompanying text.

\354\ See Petition Attachments at 3, 7, 12, 13, 16-17, 18-19,

335-340. See also analysis under DCO Core Principle B.

---------------------------------------------------------------------------

Based on Petitioners' representations and the discussion regarding

DCO Core Principle B above,\355\ it appears that Petitioners' practices

are congruent with, and sufficiently accomplish, the regulatory

objectives of SEF Core Principle 13 in the context of Petitioners'

activities with respect to the Transactions. The Commission seeks

comment with respect to this preliminary conclusion.

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\355\ See the discussion in section V.D.2. supra.

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14. SEF Core Principle 14: System Safeguards

SEF Core Principle 14 requires a SEF to establish and maintain a

program of risk analysis and oversight to identify and minimize sources

of operational risk, through the development of appropriate controls

and procedures, and automated systems, that are reliable and secure,

and have adequate scalable capacity.\356\ Moreover, a SEF must

establish and maintain emergency procedures, backup facilities, and a

plan for disaster recovery that allows for the timely recovery and

resumption of operations, and the fulfillment of the responsibilities

and obligations of the SEF.\357\ The SEF must also conduct tests to

verify that the backup resources of the SEF are sufficient to ensure

continued order processing and trade matching, price reporting, market

surveillance, and maintenance of a comprehensive and accurate audit

trail.\358\

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\356\ 7 U.S.C. 7b-3(f)(14)(A).

\357\ 7 U.S.C. 7b-3(f)(14)(B).

\358\ 7 U.S.C. 7b-3(f)(14)(C).

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Petitioners represent that they have a program of risk analysis and

oversight to identify and minimize sources of operational risk through

the development of appropriate controls and procedures; reliable

automated systems; and emergency procedures.\359\ Indeed, Petitioners

are responsible for managing power reliably and, thus, require

additional operational safeguards to specifically address that

function.\360\

---------------------------------------------------------------------------

\359\ See generally Petition Attachments at 152-158, 333-340.

\360\ See supra n. 230 and accompanying text.

---------------------------------------------------------------------------

Petitioners represent that they have computer systems that

incorporate adequate business continuity and disaster recovery

functionality.\361\ Some Petitioners state that they maintain offsite

backup computer systems fully able to operate in the event the primary

system fails \362\ whereas other Petitioners state that they operate

two control centers and/or two data centers in which each center is

functionally capable of operating as the primary center.\363\ Some

Petitioners further state that they conduct testing of emergency

procedures and system components on a regular basis to ensure that

mission critical processes and vital records are recoverable, as well

as the readiness of backup facilities and personnel.\364\

---------------------------------------------------------------------------

\361\ See Petition Attachments at 152-158, 333-339.

\362\ See id. at 152, 155-157.

\363\ See id. at 153, 158. Certain Petitioners maintain

alternate operational control centers in addition to offsite backup

computer systems and data centers. See id. at 155-157.

\364\ See id. at 152, 154, 156, 158.

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Based on Petitioners' representations and the discussion regarding

DCO Core Principle I above,\365\ it appears that Petitioners' practices

are congruent with, and sufficiently accomplish, the regulatory

objectives of SEF Core Principle 14 in the context of Petitioners'

activities with respect to the Transactions. The Commission seeks

comment with respect to this preliminary conclusion.

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\365\ See also the discussion in section V.D.8. supra.

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15. SEF Core Principle 15: Designation of Chief Compliance Officer

SEF Core Principle 15 requires that a SEF designate an individual

as Chief Compliance Officer, with specific delineated duties.\366\ The

Chief Compliance Officer for a SEF would be responsible for reporting

to the board and ensuring that the SEF is in compliance with the SEF

rules. Each Petitioner represents that it has a Chief Compliance

Officer \367\ or the functional equivalent of such a position.\368\

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\366\ See 7 U.S.C. 7b-3(f)(15). designation of chief compliance

officer.--

(A) IN GENERAL.--Each swap execution facility shall designate an

individual to serve as a chief compliance officer.

(B) DUTIES.--The chief compliance officer shall--

(i) report directly to the board or to the senior officer of the

facility;

(ii) review compliance with the core principles in this

subsection;

(iii) in consultation with the board of the facility, a body

performing a function similar to that of a board, or the senior

officer of the facility, resolve any conflicts of interest that may

arise;

(iv) be responsible for establishing and administering the

policies and procedures required to be established pursuant to this

section;

(v) ensure compliance with this Act and the rules and

regulations issued under this Act, including rules prescribed by the

Commission pursuant to this section; and

(vi) establish procedures for the remediation of noncompliance

issues found during compliance office reviews, look backs, internal

or external audit findings, self-reported errors, or through

validated complaints.

\367\ See Petition Attachments at 342-346.

\368\ PJM has two compliance heads who coordinate closely but

are separately responsible for compliance in the following two

distinct areas: (1) compliance with regulatory and legal

obligations; and (2) compliance with reliability standards as

promulgated by the regional reliability counsels, NERC and FERC.

Regulatory and legal compliance addresses legal obligations,

including compliance with the PJM Tariff, FERC regulations and laws,

and regulations governing other corporate matters, such as

antitrust, human resources and procurement. Regulatory and legal

compliance is handled in the Office of General Counsel, by an

Assistant General Counsel and Director of Regulatory Oversight and

Compliance. Reliability compliance addresses the security of the

grid, both operationally and from any cyber threat. This function is

handled in the area of operations and the Executive Director of

Reliability and Compliance reports directly to the senior vice

president for operations. All compliance functions (both reliability

and regulatory) are coordinated through PJM's Regulatory Oversight &

Compliance Committee (``ROCC''). The ROCC is chaired by the

Assistant General Counsel who has reporting obligations to the CEO

and a direct line to the Board's Governance Committee and Audit

Committee. See Petition Attachments at 347.

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Based on the Petitioners' representations, it appears that

Petitioners' practices are congruent with, and sufficiently accomplish,

the regulatory objectives of SEF Core Principle 15 in the context of

Petitioners' activities with respect to the Transactions. The

Commission seeks comment with respect to this preliminary conclusion.

VIII. Proposed Exemption

A. Discussion of Proposed Exemption

Pursuant to the authority provided by section 4(c)(6) of the

CEA,\369\ in accordance with CEA sections 4(c)(1) and (2), and

consistent with the Commission's determination that the statutory

requirements for granting an exemption pursuant to section 4(c)(6) of

the Act have been satisfied, the Commission is proposing to issue the

exemption described in the Proposed Exemption set forth below. The

Proposed Exemption would exempt, subject to the limitations and

conditions contained therein, the purchase and sale of certain

electricity-related products, including specifically-defined

``financial transmission rights,'' ``energy transactions,'' ``forward

capacity transactions,'' and ``reserve or regulation transactions,''

from most provisions of

[[Page 52163]]

the CEA. The Commission is proposing to explicitly exclude from the

exemption relief the Commission's general anti-fraud, anti-manipulation

and enforcement authority under the CEA including, but not limited to,

CEA sections 2(a)(1)(B), 4b, 4c(b), 4o, 4s(h)(1)(A), 4s(h)(4)(A), 6(c),

6(d), 6(e), 6c, 6d, 8, 9 and 13 and any implementing regulations

promulgated thereunder including, but not limited to Commission

regulations 23.410(a) and (b), 32.4 \370\ and part 180.\371\ The

preservation of the Commission's anti-fraud and anti-manipulation

authority provided by these provisions generally is consistent with

both the scope of the exemption requested in the Petition \372\ and

recent Commission practice.\373\

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\369\ 7 U.S.C. 6(c).

\370\ 17 CFR 23.410(a)-(b), 32.4 and part 180.

\371\ 17 CFR part 180.

\372\ See Petition at 33-34. Petitioners requested relief from

``all provisions of the Act and Commission regulations, except in

each case sections 4b, 4o, 6(c) and 9(a)(3) of the Act to the extent

that these sections prohibit fraud in connection with transactions

subject to the Act, or manipulation of the price of any swap or

contract for the sale of a commodity in interstate commerce or for

future delivery on or subject to the rules of a registered entity,

and from the requirement to provide information to the Commission as

expressly permitted by their respective protocols or as provided

under section 720 of the Dodd-Frank Wall Street Reform and Consumer

Protection Act.'' The Proposed Exemption simply would preserve the

Commission's authority under the delineated provisions and their

implementing regulations without caveat, in order to avoid ambiguity

as to what conduct remains prohibited.

\373\ See, e.g., Order (1) Pursuant to Section 4(c) of the

Commodity Exchange Act, Permitting the Kansas City Board of Trade

Clearing Corporation To Clear Over-the-Counter Wheat Calendar Swaps

and (2) Pursuant to Section 4d of the Commodity Exchange Act,

Permitting Customer Positions in Such Cleared-Only Swaps and

Associated Funds To Be Commingled With Other Positions and Funds

Held in Customer Segregated Accounts, 75 FR 34983, 34985 (2010).

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The particular categories of contracts, agreements and transactions

to which the Proposed Exemption would apply correspond to the types of

transactions for which relief was explicitly requested in the

Petition.\374\ Petitioners requested relief for four specific types of

transactions and the Proposed Exemption would exempt those

transactions. With respect to those transactions, the Petition also

included the parenthetical ``(including generation, demand response or

convergence or virtual bids/transactions).'' \375\ The Commission notes

that such transactions would be included within the scope of the

exemption if they would qualify as the financial transmission rights,

energy transactions, forward capacity transactions or reserve or

regulation transactions for which relief is explicitly provided within

the exemption. Petitioners also have requested relief for ``the

purchase and sale of a product or service that is directly related to,

and a logical outgrowth of, any [of Petitioner's] core functions as an

ISO/RTO * * * and all services related thereto.'' \376\ The Commission

has determined that it would be inappropriate, and, accordingly, has

declined to propose that the exemption be extended beyond the scope of

the transactions that are specifically defined in the Proposed

Exemption. As noted above, the authority to issue an exemption from the

CEA provided by section 4(c) of the Act may not be automatically or

mechanically exercised. Rather, the Commission is required to

affirmatively determine, inter alia, that the exemption would be

consistent with the public interest and the purposes of the Act.\377\

With respect to the four groups of transactions explicitly detailed in

the Proposed Exemption, the Commission's proposed finding that the

Proposed Exemption would be in the public interest and would be

consistent with the purposes of the CEA was grounded, in part, on

certain transaction characteristics and market circumstances described

in the Petition that may or may not be shared by other, as yet

undefined, transactions engaged in by the Petitioners or other RTO or

ISO market participants.\378\ Similarly, unidentified transactions

might include novel features or have market implications or risks that

are not present in the specified transactions. Such elements may impact

the Commission's required section CEA 4(c) public interest analysis or

may warrant the attachment of additional or differing terms and

conditions to any relief provided. Due to the potential for adverse

consequences resulting from an exemption that includes transactions

whose qualities and effect on the broader market cannot be fully

appreciated absent further specification, it does not appear that the

Commission can justify a conclusion that it would be in the public

interest to provide an exemption of the full breadth requested. The

Commission notes, however, that it has requested comment on whether the

proposed scope of the exemption is sufficient to allow for innovation

and, if not, how the scope could be expanded, without exempting

products that may be substantially different from those reviewed by the

Commission. The Commission also notes that it stands ready to review

promptly any additional applications for an exemption pursuant to

section 4(c)(6), in accordance with CEA sections 4(c)(1) and (2), of

the CEA for other precisely defined products.\379\

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\374\ Petition at 5-9.

\375\ Id. at 6.

\376\ Id. at 9.

\377\ 7 U.S.C. 6(c).

\378\ For example, the transactions that included with the scope

of the Proposed Exemption appear to be limited to those tied to the

physical capacity of the Petitioners' electricity grids. Petition at

6-8, 11.

\379\ The Commission is currently reviewing two supplemental

petitions. Specifically, ISO NE has filed a supplemental request for

an exemption pursuant to section 4(c)(6) for ``IBT'' Transactions.

See In the Matter of the Application for an Exemptive Order Under

Section 4(c) of the Commodity Exchange Act by ISO New England Inc.

(Apr. 30, 2012), available at http://www.cftc.gov/stellent/groups/public/@requestsandactions/documents/ifdocs/iso-ne4crequest.pdf.

CAISO has filed a similar request for ``inter-scheduling coordinator

trades'' or ``inter-SC trades.'' See In the Matter of the

Application for an Exemptive Order Under Section 4(c) of the

Commodity Exchange Act by California Independent System Operator

Corporation (May 30, 2012), available at http://www.cftc.gov/stellent/groups/public/@requestsandactions/documents/ifdocs/caiso4crequest.pdf.

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The scope of the Proposed Exemption is limited by two additional

factors. First, it is restricted to agreements, contracts or

transactions where all parties thereto are either: (1) Entities

described in section 4(c)(3)(A) through (J) of the CEA \380\ or (2)

``eligible contract participants,'' as defined in section 1a(18) of the

Act \381\ or in Commission regulation 1.3(m).\382\ Although Petitioners

have requested an exemption pursuant to section 4(c)(6) of the CEA, any

exemption pursuant to this subsection must be issued in ``in accordance

with'' sections 4(c)(1) and 4(c)(2).\383\ Section 4(c)(2) prohibits the

Commission from issuing an exemption pursuant to section 4(c) unless

the Commission determines that the agreement, contract or transaction

``will be entered into solely between `appropriate persons.' ''

Appropriate persons include those entities explicitly delineated in

sections 4(c)(3)(A) through (J) of the Act as well as others that the

Commission, under the discretionary authority provided by section

4(c)(3)(K), deems to be appropriate persons ``in light of their

financial or other qualifications, or the applicability of appropriate

regulatory protections.'' \384\ As noted above, the Commission has

proposed to determine that eligible contract participants, as defined

in section 1a(18) of the Act or in Commission regulation 1.3(m), should

be considered appropriate persons for purposes of the Proposed

Exemption.\385\ The Commission recognizes that the market participant

eligibility standards

[[Page 52164]]

of an individual RTO or ISO may not be coextensive with the criteria

required by sections 4(c)(3)(A) through (J) or section 1a(18) of the

Act and, therefore, there may be certain RTO or ISO participants

engaging in transactions of the type described in the Proposed

Exemption that would not qualify for the Proposed Exemption. In

particular, the Commission is interested in considering market

participants that ``active[ly] participat[e] in the generation,

transmission or distribution of electricity'' that are not ECPs and do

not fall within CEA section 4(c)(3)(A) through (J), who should

nonetheless be included as appropriate persons pursuant to CEA section

4(c)(3)(K). Accordingly, the Commission has requested comment on

whether the Commission should enlarge the list of appropriate persons

for purposes of the exemption to include other types of entities

identified in the Petition that satisfy alternative criteria. Any

request to include additional entities should be accompanied by a

description of the financial or other qualifications of such entities

or the available regulatory protections that would render them

comparable to the appropriate persons and eligible contract

participants delineated in the Act. The Commission also is interested

in receiving comments addressing whether and how market participants

who satisfy substitute qualifications would be capable of bearing the

risks associated with the relevant markets.

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\380\ 7 U.S.C. 6(c)(3)(A)-(J).

\381\ 7 U.S.C. 1a(18).

\382\ 17 CFR 1.3(m).

\383\ 7 U.S.C. 6(c).

\384\ 7 U.S.C. 6(c)(3).

\385\ See discussion in section V.B.3. supra.

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In order to be eligible for the exemption that would be provided by

the Proposed Exemption, the agreement, contract or transaction also

must be offered or sold pursuant to the ``tariff'' of a ``requesting

party'' and the tariff must have been approved or permitted to take

effect by the PUCT (in the case of ERCOT) or by FERC (in the case of

all other Petitioners). This requirement reflects the range of the

Commission's authority as set forth in section 4(c)(6) \386\ of the CEA

and is consistent with the scope of the relief requested.\387\

``Requesting Party'' is defined to include the six Petitioners (i.e.,

CAISO, ERCOT, ISO NE., MISO, NYSO and PJM) and any of their respective

successors in interest. To account for differences in terminology used

by such entities and their respective regulators, the term ``tariff''

is defined to include a ``tariff, rate schedule or protocol.''

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\386\ See the discussion in section V.A. supra.

\387\ Petition at 2-3.

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Consistent with the range of the statutory authority explicitly

provided by CEA section 4(c), the Proposed Exemption would extend the

exemption to the agreements, contracts or transactions set forth

therein and ``any person or class of persons offering, entering into,

rendering advice or rendering other services with respect to'' such

transactions. In addition, for as long as the Proposed Exemption would

remain in effect, each of the six named Petitioners \388\ would be able

to avail themselves of the Proposed Exemption with respect to all four

expressly-identified groups of products, regardless of whether or not

the particular Petitioner offers the particular product at the present

time. That is, a Petitioner would not be required to request future

supplemental relief for a product that it does not currently offer, but

that qualifies as one of the four types of transactions in the Proposed

Exemption. All six Petitioners that filed the consolidated Petition

requested an exemption of the scope provided and the Petition was

analyzed accordingly.\389\ The exemption would not extend, however, to

any RTO or ISO that was not a party to the Petition under consideration

because the Commission has not reviewed the tariffs or business

practices of any other RTO or ISO and, therefore, cannot discern

whether extending the Proposed Exemption to it would be equally

congruent with the public interest and the purposes of the Act. The

Commission has determined to issue one Proposed Exemption in lieu of

the six separate orders requested by Petitioners.\390\ In light of the

fact that there are ``[congruents] in [the Petitioners'] markets and

operations,'' and the fact that the exemption for each will be

coextensive, as requested by the Petitioners,\391\ it would appear that

issuing six separate but identical Proposed Exemptions that raise the

same issues and questions is unnecessary, could result in needlessly

duplicative comments and would be an inefficient use of Commission

resources. Any concerns that the public may have with respect to

providing relief to any particular Petitioner can be adequately

explained in a sole comment on the consolidated Proposed Exemption. The

Commission disagrees with the Petitioners' assertion that distinct

orders are necessary because a solitary order would require each

Petitioner to submit an individual application to obtain supplemental

relief or to amend the relief provided thereby. To the contrary, the

Commission confirms that individual Petitioners (or other entities) may

file individual requests for supplemental exemptions and the Commission

may, consistent with the criteria under CEA section 4(c)(6), issue

further exemptions either individually or in the collective, as

necessary or appropriate and in accordance with the facts and

circumstances presented.\392\ In fact, ISO NE and CAISO have filed

individual requests for supplemental relief that currently are under

review by Commission staff.\393\

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\388\ CAISO, ERCOT, ISO NE., MISO, NYSO and PJM.

\389\ The Requestors note that it is ``reasonable to expect that

each ISO/RTO will, over time, consider offering under its own

individual tariff one or more classes of contract, agreement and

transaction that is currently offered under any other ISO/RTO

tariff,'' and accordingly request that exemption be granted to all

requestors for transactions that are currently offered by any of

them. Petition at 6.

\390\ See Petition at 2.

\391\ See Petition at 6:

``While the ISOs/RTOs operate pursuant to individual tariffs,

they share many commonalities in their markets and operations.

Although the current market structures of the individual ISOs/RTOs

may vary, it is reasonable to expect that each ISO/RTO will, over

time, consider offering under its own individual tariff one or more

classes of contract, agreement or transaction that is currently

offered under any other ISO/RTO tariff. We thus request that each

individual exemptive Order apply collectively to each class of

contract, agreement or transaction provided by the ISOs/RTOs. This

will provide the appropriate breadth to the exemptive Order so that

an individual Requestor will not be required to seek future

amendments to offer or enter into contracts, agreements or

transactions that are currently offered by any other Requestor.''

\392\ Section 4(c) permits the Commission to issue an exemption

``on its own initiative or on application of any person.'' 7 U.S.C.

4(c)(1).

\393\ See In the Matter of the Application for an Exemptive

Order Under Section 4(c) of the Commodity Exchange Act by ISO New

England Inc. (Apr. 30, 2012), available at http://www.cftc.gov/stellent/groups/public/@requestsandactions/documents/ifdocs/iso-ne4crequest.pdf. CAISO has filed a similar request for ``inter-

scheduling coordinator trades'' or ``inter-SC trades.'' See In the

Matter of the Application for an Exemptive Order Under Section 4(c)

of the Commodity Exchange Act by California Independent System

Operator Corporation (May 30, 2012), available at http://www.cftc.gov/stellent/groups/public/@requestsandactions/documents/ifdocs/caiso4crequest.pdf.

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The Proposed Exemption indicates that, when a final order is

issued, it would be made effective immediately. The Commission

proposes, however, three conditions precedent to the issuance of a

final exemption that may be applicable to one or more specific

Petitioners. First, the Commission proposes to refrain from issuing a

final order to a specific RTO or ISO unless the RTO or ISO has adopted

all of requirements set forth in FERC regulation 35.47; \394\ such

tariff provisions have been approved or have been permitted to take

effect by FERC or PUCT, as applicable; and such tariff provisions, have

become effective and have been fully implemented by the particular RTO

or ISO. That is, the Commission is considering requiring

[[Page 52165]]

that any policies and procedures that the RTO or ISO has adopted in

order to comply with the obligations contained in FERC regulation 35.47

be in actual practice. Petitioners note that their structure and

operations are different from the DCOs registered with the

Commission.\395\ However, FERC Regulation 35.47 is a set of credit

policies purpose-built for RTOs and ISOs.

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\394\ 18 CFR 35.47.

\395\ See Petition Attachments at 1.

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The Commission's statutorily required determination that the

Proposed Exemption is consistent with the public interest and the

purposes of the Act was supported, in considerable part, on the grounds

that the credit reform policies mandated by FERC regulation 35.47 \396\

were consistent with the regulatory objectives of several of the core

principles applicable to DCOs and the expectation that the Petitioners

regulated by FERC would put those mandates into practice prior to the

issuance of the exemption. Moreover, while ERCOT is not subject to

regulation by FERC, the fact that these mandates were developed

specifically for RTOs and ISOs suggests that holding ERCOT to these

standards may well be appropriate.

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\396\ 18 CFR 35.47.

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While all Petitioners have represented that they have fulfilled

certain requirements of FERC regulation 35.47, it appears that material

gaps in complete execution remain.\397\ For example, due to requested

extensions of time for compliance, certain Petitioners have only

recently submitted tariffs to comply with FERC regulation 35.47(d)

(accordingly, the tariffs remain subject to FERC approval) and, in some

cases, full implementation is not expected until 2013.\398\ Because the

implementation of the FERC credit reform policies is central to the

Commission's determination that this exemption is in the public

interest, it may well be that requiring Petitioners to have fully

implemented such reforms prior to the issuance of a final order is

necessary and appropriate.

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\397\ See generally FERC Order 741 Implementation Chart.

\398\ See, e.g., FERC Order 741 Implementation Chart at 6

(stating that ISO NE submitted a package of tariff changes with FERC

to establish itself as the central counterparty for market

participant transactions. The filing was made with a requested

effective date of January 1, 2013).

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Second, the Commission proposes as an additional prerequisite to

the issuance of an exemption to an RTO or ISO that the RTO or ISO

provide a well-reasoned legal opinion or memorandum from outside

counsel that, in the Commission's sole discretion, provides the

Commission with assurance that the netting arrangements contained in

the approach selected by the particular Petitioner to satisfy the

obligations contained in FERC regulation 35.47(d) will, in fact,

provide the Petitioner with enforceable rights of setoff against any of

its market participants under title 11 of the United States Code \399\

in the event of the bankruptcy of the market participant.\400\

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\399\ See 11 U.S.C. 553.

\400\ See text at n. 122 and text at n. 208 supra.

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There appears to be strong support for the proposition that a

central counterparty structure would achieve the mutuality of

obligation necessary for enforceable rights of setoff for the central

counterparty, and Petitioners have represented that they either are, or

plan on becoming, central counterparties.\401\ The Commission is

concerned, however, that there is some ambiguity as to how individual

Petitioners are interpreting the single counterparty requirement

contained in FERC regulation 35.47(d) and whether the single

counterparty structure chosen by individual Petitioners would provide

enforceable setoff rights. For example, the Petition states that ERCOT

``expects to adopt the central counterparty structure; however, this

structure will not involve clearing, as that term applies to a

designated clearing organization or swaps execution facility (i.e., the

central counterparty does not act as a financial intermediary, nor is

there any novation of transactions to a central counterparty).'' \402\

The Commission shares FERC's goal of ensuring that, in the event of

bankruptcy of a participant, Petitioners are not prohibited from

offsetting accounts receivable against accounts payable. Consistent

with that goal and to mitigate any ambiguity regarding the bankruptcy

protections provided by the central counterparty arrangements adopted

by particular Petitioners, the Commission is proposing to require, as a

prerequisite to the granting of the 4(c) request to a particular

Petitioner, that the Commission be provided with a legal opinion or

memoranda of counsel, applicable to the tariffs and operations of that

Petitioner, that provides the Commission with assurance that the

approach selected by the Petitioner to satisfy the obligations

contained in FERC regulation 35.47(d) will provide the Petitioner with

rights of setoff, enforceable against any of its market participants

under title 11 of the United States Code in the event of the bankruptcy

of the market participant. The Commission would retain sole discretion

to accept or reject the adequacy of the legal opinion or memoranda for

purposes of issuing the exemption. As noted above, the Commission is

seeking comment on the preconditions set forth above and the costs and

benefits thereof.

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\401\ The Commission also notes that not all of the central

counterparty arrangements proposed by Petitioners have been approved

by their respective regulators and/or become effective and,

accordingly, are potentially subject to change. See, e.g., FERC

Order 741 Implementation Chart at 5-6.

\402\ Petition Attachments at 28.

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Third, the Proposed Exemption would be conditioned, as applicable

to ERCOT, on the completion of an information sharing agreement,

acceptable to the Commission, between the PUCT and the Commission. As

with the 2005 Memorandum of Understanding (``MOU'') between the

Commission and FERC, as discussed below, the Commission would expect

the terms of a CFTC-PUCT MOU to provide that PUCT will furnish

information in its possession to the CFTC upon its request and will

notify the CFTC if any information requested by it is not in PUCT's

possession. As noted above, the Commission is seeking comment on the

preconditions set forth above and the costs and benefits thereof.

The Proposed Exemption also contains certain information-sharing

conditions. First, the Proposed Exemption is expressly conditioned upon

the existing information sharing arrangement between the Commission and

FERC, and, as noted above, the completion of an information sharing

agreement between the Commission and PUCT. The Commission notes that

the CFTC and FERC executed a MOU in 2005 pursuant to which the agencies

have shared information successfully.\403\ The terms of the CFTC-FERC

MOU provide that FERC will furnish information in its possession to the

CFTC upon its request and will notify the CFTC if any information

requested by it is not in FERC's possession.

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\403\ FERC MOU (Oct. 12, 2005) available at http://www.ferc.gov/legal/maj-ord-reg/mou/mou-33.pdf.

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The Petitioners recognize the need to be responsive to Commission

requests for information and ``to assist the Commission as necessary in

fulfilling its mission under the Act'' \404\ and Petitioners have

indicated their intent to be responsive to requests for information by

the Commission that will further enable the Commission to perform its

regulatory and enforcement duties.\405\ Petitioners caveat this

assistance, however, by stating that ``certain of the tariffs may

require that

[[Page 52166]]

an ISO/RTO notify its members prior to providing information in

response to a subpoena.'' \406\ This notice requirement could

significantly compromise the Commission's enforcement efforts as there

are likely to be situations where it would be neither prudent nor

advisable for an entity under investigation by the Commission to learn

of the investigation prior to Commission notification to the entity.

Accordingly, the Proposed Exemption includes a second information-

sharing condition that requires that neither the tariffs nor any other

governing documents of the particular RTO or ISO pursuant to whose

tariff the agreement, contract or transaction is to be offered or sold,

shall include any requirement that the RTO or ISO notify its members

prior to providing information to the Commission in response to a

subpoena or other request for information or documentation. The

Commission specifically requests comment on this condition and as to

whether there may be an alternative condition that the Commission might

use to achieve the same result.

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\404\ Petition at 25.

\405\ Id. at 25-26.

\406\ Id. at 26.

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Finally, the Proposed Exemption expressly notes that it is based

upon the representations made in the Petition and in the supporting

materials provided to the Commission by the Petitioners and their

counsel and that any material change or omission in the facts and

circumstances pursuant to which the Proposed Exemption is granted might

require the Commission to reconsider its finding that the exemption

contained therein is appropriate and/or in the public interest. The

Commission has also explicitly reserved the discretionary authority, to

suspend, terminate or otherwise modify or restrict the exemption

provided. The reservation of these rights is consistent with prior

Commission practice and is necessary to provide the Commission with the

flexibility to address relevant facts or circumstances as they arise.

B. Proposed Exemption

Consistent with the determinations set forth above, the Commission

hereby proposes to issue the following Order:

Pursuant to its authority under section 4(c)(6), in accordance with

CEA sections 4(c)(1) and (2), of the Commodity Exchange Act (``CEA'' or

Act''), the Commodity Futures Trading Commission (``CFTC'' or

``Commission'').

1. Exempts, subject to the conditions and limitations specified

herein, the purchase or sale of the electricity-related agreements,

contracts, and transactions that are specified in paragraph 2 of this

Order and any person or class of persons offering, entering into,

rendering advice, or rendering other services with respect thereto,

from all provisions of the CEA, except, in each case, the Commission's

general anti-fraud, anti-manipulation and enforcement authority under

the CEA, including, but not limited to, CEA sections 2(a)(1)(B), 4b,

4c(b), 4o, 4s(h)(1)(A), 4s(h)(4)(A), 6(c), 6(d), 6(e), 6c, 6d, 8, 9 and

13 and any implementing regulations promulgated thereunder including,

but not limited to, Commission regulations 23.410(a) and (b), 32.4 and

part 180.

2. Scope. This exemption applies only to agreements, contracts and

transactions that satisfy all of the following requirements:

a. The agreement, contract or transaction is for the purchase and

sale of one of the following electricity-related products:

(1) The ``Financial Transmission Rights'' defined in paragraph 5(a)

of this Order, except that the exemption shall only apply to such

Financial Transmission Rights where:

(a) Each Financial Transmission Right is linked to, and the

aggregate volume of Financial Transmission Rights for any period of

time is limited by, the physical capability (after accounting for

counterflow) of the electricity transmission system operated by a

Requesting Party offering the contract, for such period;

(b) The Requesting Party serves as the market administrator for the

market on which the Financial Transmission Rights are transacted;

(c) Each party to the transaction is a member of the Requesting

Party (or is the Requesting Party itself) and the transaction is

executed on a market administered by that Requesting Party; and

(d) The transaction does not require any party to make or take

physical delivery of electricity.

(2) ``Energy Transactions'' as defined in paragraph 5b of this

Order.

(3) ``Forward Capacity Transactions,'' as defined in paragraph 5c

of this Order.

(4) ``Reserve or Regulation Transactions'' as defined in paragraph

5d of this Order.

b. All parties to the agreement, contract or transaction are

``appropriate persons,'' as defined sections 4(c)(3)(A) through (J) of

the CEA or ``eligible contract participants'' as defined in section

1a(18)(A) of the CEA and in Commission regulation 1.3(m).

c. The agreement, contract or transaction is offered or sold

pursuant to a Requesting Party's tariff and that tariff has been

approved or permitted to take effect by:

(1) In the case of the Electricity Reliability Council of Texas

(``ERCOT''), the Public Utility Commission of Texas (``PUCT'') or

(2) In the case of all other Requesting Parties, the Federal Energy

Regulatory Commission (``FERC'').

3. Applicability to particular regional transmission organizations

(``RTOs'') and independent system operators (``ISOs''). Subject to the

conditions contained in the Order, the Order applies to all Requesting

Parties with respect to the transactions described in paragraph 2 of

this Order.

4. Conditions. The exemption provided by this Order is expressly

conditioned upon the following:

a. Information sharing: With respect to ERCOT, information sharing

arrangements between the Commission and PUCT that are acceptable to the

Commission are executed and continue to be in effect. With respect to

all other Requesting Parties, information sharing arrangements between

the Commission and FERC that are acceptable to the Commission continue

to be in effect.

b. Notification of requests for information: With respect to each

Requesting Party, neither the tariffs nor any other governing documents

of the particular RTO or ISO pursuant to whose tariff the agreement,

contract or transaction is to be offered or sold, shall include any

requirement that the RTO or ISO notify its members prior to providing

information to the Commission in response to a subpoena or other

request for information or documentation.

5. Definitions. The following definitions shall apply for purposes

of this Order:

a. A ``Financial Transmission Right'' is a transaction, however

named, that entitles one party to receive, and obligates another party

to pay, an amount based solely on the difference between the price for

electricity, established on an electricity market administered by a

Requesting Party, at a specified source (i.e., where electricity is

deemed injected into the grid of a Requesting Party) and a specified

sink (i.e., where electricity is deemed withdrawn from the grid of a

Requesting Party). The term ``Financial Transmission Rights'' includes

Financial Transmission Rights and Financial Transmission Rights in the

form of options (i.e., where one party has only the obligation to pay,

and the other party only the right to receive, an amount as described

above).

b. ``Energy Transactions'' are transactions in a ``Day-Ahead

Market''

[[Page 52167]]

or ``Real-Time Market,'' as those terms are defined in paragraphs 5e

and 5f of this Order, for the purchase or sale of a specified quantity

of electricity at a specified location (including ``Demand Response,''

as defined in paragraph 5c(2) of this Order, where:

(1) The price of the electricity is established at the time the

transaction is executed;

(2) Performance occurs in the Real-Time Market by either

(a) Delivery or receipt of the specified electricity, or

(b) A cash payment or receipt at the price established in the Real-

Time Market; and

(3) The aggregate cleared volume of both physical and cash-settled

energy transactions for any period of time is limited by the physical

capability of the electricity transmission system operated by a

Requesting Party for that period of time.

c. ``Forward Capacity Transactions'' are transactions in which a

Requesting Party, for the benefit of load-serving entities, purchases

any of the rights described in subparagraphs (1), (2) and (3) below. In

each case, to be eligible for the exemption, the aggregate cleared

volume of all such transactions for any period of time shall be limited

to the physical capability of the electricity transmission system

operated by a Requesting Party for that period of time.

(1) ``Generation Capacity,'' meaning the right of a Requesting

Party to:

(a) Require certain sellers to maintain the interconnection of

electric generation facilities to specific physical locations in the

electric-power transmission system during a future period of time as

specified in the Requesting Party's Tariff;

(b) Require such sellers to offer specified amounts of electric

energy into the Day-Ahead or Real-Time Markets for electricity

transactions; and

(c) Require, subject to the terms and conditions of a Requesting

Party's Tariff, such sellers to inject electric energy into the

electric power transmission system operated by the Requesting Party;

(2) ``Demand Response,'' meaning the right of a Requesting Party to

require that certain sellers of such rights curtail consumption of

electric energy from the electric power transmission system operated by

a Requesting Party during a future period of time as specified in the

Requesting Party's Tariff; or

(3) ``Energy Efficiency,'' meaning the right of a Requesting Party

to require specific performance of an action or actions that will

reduce the need for Generation Capacity or Demand Response Capacity

over the duration of a future period of time as specified in the

Requesting Party's Tariff.

d. ``Reserve or Regulation Transactions'' are transactions:

(1) In which a Requesting Party, for the benefit of load-serving

entities and resources, purchases, through auction, the right, during a

period of time as specified in the Requesting Party's Tariff, to

require the seller of such right to operate electric facilities in a

physical state such that the facilities can increase or decrease the

rate of injection or withdrawal of a specified quantity of electricity

into or from the electric power transmission system operated by the

Requesting Party with:

(a) Physical performance by the seller's facilities within a

response time interval specified in a Requesting Party's Tariff

(Reserve Transaction); or

(b) Prompt physical performance by the seller's facilities (Area

Control Error Regulation Transaction);

(2) For which the seller receives, in consideration, one or more of

the following:

(a) Payment at the price established in the Requesting Party's Day-

Ahead or Real-Time Market, as those terms are defined in paragraphs 5f

and 5g of this Order, price for electricity applicable whenever the

Requesting Party exercises its right that electric energy be delivered

(including Demand Response, '' as defined in paragraph 5c(2) of this

Order);

(b) Compensation for the opportunity cost of not supplying or

consuming electricity or other services during any period during which

the Requesting Party requires that the seller not supply energy or

other services;

(c) An upfront payment determined through the auction administered

by the Requesting Party for this service;

(d) An additional amount indexed to the frequency, duration, or

other attributes of physical performance as specified in the Requesting

Party's Tariff; and

(3) In which the value, quantity, and specifications of such

transactions for a Requesting Party for any period of time shall be

limited to the physical capability of the electricity transmission

system operated by the Requesting Party for that period of time.

e. ``Day-Ahead Market'' means an electricity market administered by

a Requesting Party on which the price of electricity at a specified

location is determined, in accordance with the Requesting Party's

Tariff, for specified time periods, none of which is later than the

second operating day following the day on which the Day-Ahead Market

clears.

f. ``Real-Time Market'' means an electricity market administered by

a Requesting Party on which the price of electricity at a specified

location is determined, in accordance with the Requesting Party's

tariff, for specified time periods within the same 24-hour period.

g. ``Requesting Party'' means California Independent Service

Operator Corporation (``CAISO''); ERCOT; ISO New England Inc. (``ISO

NE''); Midwest Independent Transmission System Operator, Inc.

(``MISO''); New York Independent System Operator, Inc. (``NYISO'') or

PJM Interconnection, L.L.C. (``PJM''), or any successor in interest to

any of the foregoing.

h. ``Tariff.'' Reference to a Requesting Party's ``tariff''

includes a tariff, rate schedule or protocol.

i. ``Petition'' means the consolidated petition for an exemptive

order under 4(c)(6) of the CEA filed by CAISO, ERCOT, ISO NE., MISO, NY

ISO and PJM on February 7, 2012, as later amended.

6. Effective Date. This Order is effective immediately.

This order is based upon the representations made in the

consolidated petition for an exemptive order under 4(c) of the CEA

filed by the Requesting Parties \407\ and supporting materials provided

to the Commission by the Requesting Parties and their counsel. Any

material change or omission in the facts and circumstances pursuant to

which this order is granted might require the Commission to reconsider

its finding that the exemption contained therein is appropriate and/or

in the public interest. Further, the Commission reserves the right, in

its discretion, to revisit any of the terms and conditions of the

relief provided herein, including but not limited to, making a

determination that certain entities and transactions described herein

should be subject to the Commission's full

[[Page 52168]]

jurisdiction, and to condition, suspend, terminate or otherwise modify

or restrict the exemption granted in this order, as appropriate, upon

its own motion.

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\407\ In the Matter of the Petition for an Exemptive Order Under

Section 4(c) of the Commodity Exchange Act by California Independent

Service Operator Corporation (``CAISO''); In the Matter of the

Petition for an Exemptive Order Under Section 4(c) of the Commodity

Exchange Act by the Electric Reliability Council of Texas, Inc.

(``ERCOT''); In the Matter of the Petition for an Exemptive Order

Under Section 4(c) of the Commodity Exchange Act by ISO New England

Inc. (``ISO NE''); In the Matter of the Petition for an Exemptive

Order Under Section 4(c) of the Commodity Exchange Act by Midwest

Independent Transmission System Operator, Inc. (``MISO''); In the

Matter of the Petition for an Exemptive Order Under Section 4(c) of

the Commodity Exchange Act by New York Independent System Operator,

Inc. (``NYISO''); and In the Matter of the Petition for an Exemptive

Order Under Section 4(c) of the Commodity Exchange Act by PJM

Interconnection, L.L.C. (``PJM'') (Feb. 7, 2012, as amended June 11,

2012).

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IX. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act \408\ (``RFA'') requires that

agencies consider whether the Proposed Exemption will have a

significant economic impact on a substantial number of small entities

and, if so, provide a regulatory flexibility analysis respecting the

impact. The Commission believes that the Proposed Exemption will not

have a significant economic impact on a substantial number of small

entities. The Proposed Exemption detailed in this release would affect

organizations including Petitioners and eligible contract participants

(``ECPs'').\409\ The Commission has previously determined that ECPs are

not ``small entities'' for purposes of the RFA.\410\ In addition, the

Commission believes that Petitioners should not be considered small

entities based on the central role they play in the operation of the

electronic transmission grid and the creation of organized wholesale

electric markets that are subject to FERC and PUCT regulatory

oversight,\411\ analogous to functions performed by DCMs and DCOs,

which the Commission has determined not to be small entities.\412\

Accordingly, the Commission does not expect the Proposed Exemption

to have a significant impact on a substantial number of entities.

Therefore, the Chairman, on behalf of the Commission, hereby certifies,

pursuant to 5 U.S.C. 605(b), that the Proposed Exemption would not have

a significant economic impact on a substantial number of small

entities. The Commission invites the public to comment on whether the

entities covered by this Proposed Exemption should be considered small

entities for purposes of the RFA, and, if so, whether there is a

significant impact on a substantial number of entities.

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\408\ 5 U.S.C. 601 et seq.

\409\ Under CEA section 2(e), only ECPs are permitted to

participate in a swap subject to the end-user clearing exception.

\410\ See Opting Out of Segregation, 66 FR 20740 at 20743, Apr.

25, 2001.

\411\ See RFA analysis as conducted by FERC regarding the 5

Petitioners, CAISO, NYISO, PJM, MISO and ISO NE., https://www.federalregister.gov/articles/2011/10/26/2011-27626/enhancement-of-electricity-market-surveillance-and-analysis-through-ongoing-electronic-delivery-of#h-17.

Commission staff also performed an independent RFA analysis

based on Subsector 221 of Sector 22 (utilities companies) which

defines any small utility corporation as one that does not generate

more than 4 million of megawatts of electricity per year, and

Subsector 523 of Sector 52 (Securities, Commodity Contracts, and

Other Financial Investments and Related Activities) of the SBA, 13

CFR 121.201 (1-1-11 Edition), which identifies a small business size

standard of $7 million or less in annual receipts. Staff concludes

that none of the Petitioners is a small entity, based on the

following information:

MISO reports 594 million megawatt hours per year, https://www.midwestiso.org/Library/Repository/Communication%20Material/Corporate/Corporate%20Fact%20Sheet.pdf;

ERCOT reports 335 million megawatt hours per year, http://www.ercot.com/content/news/presentations/2012/ERCOT_Quick_Facts_June_%202012.pdf;

CAISO reports 200 million megawatts per year, http://www.caiso.com/Documents/CompanyInformation_Facts.pdf;

NYISO reports 17 million megawatts per month, which calculates

to 204 megawatts per year, http://www.nyiso.com/public/about_nyiso/nyisoataglance/index.jsp;

PJM reports $35.9 billion billed in 2011, http://pjm.com/markets-and-operations.aspx; and

ISO NE reports 32,798 gigawatt hours in the first quarter of

2011, which translates into almost 33 million megawatts for the

first quarter of 2011, http://www.iso-ne.com/markets/mkt_anlys_rpts/qtrly_mktops_rpts/2012/imm_q1_2012_qmr_final.pdf.

\412\ See A New Regulatory Framework for Clearing Organizations,

66 FR 45604, 45609, Aug. 29, 2001(DCOs); Policy Statement and

Establishment of Definitions of ``Small Entities'' for Purposes of

the Regulatory Flexibility Act, 47 FR 18618, 18618-18619, Apr. 30,

1982 (DCMs).

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B. Paperwork Reduction Act

The purposes of the Paperwork Reduction Act of 1995, 44 U.S.C. 3501

et seq. (``PRA'') are, among other things, to minimize the paperwork

burden to the private sector, ensure that any collection of information

by a government agency is put to the greatest possible uses, and

minimize duplicative information collections across the government. The

PRA applies to all information, ``regardless of form or format,''

whenever the government is ``obtaining, causing to be obtained [or]

soliciting'' information, and includes requires ``disclosure to third

parties or the public, of facts or opinions,'' when the information

collection calls for ``answers to identical questions posed to, or

identical reporting or recordkeeping requirements imposed on, ten or

more persons.'' The PRA would not apply in this case given that the

exemption would not impose any new recordkeeping or information

collection requirements, or other collections of information on ten or

more persons that require approval of the Office of Management and

Budget (``OMB'').

C. Cost-Benefit Considerations

1. Consideration of Costs and Benefits

a. Introduction

Section 15(a) of the CEA \413\ requires the Commission to consider

the costs and benefits of its actions before promulgating a regulation

under the CEA or issuing certain orders. In proposing this exemption,

the Commission is required by section 4(c)(6) to ensure the same is

consistent with the public interest. In much the same way, section

15(a) further specifies that the costs and benefits shall be evaluated

in light of five broad areas of market and public concern: (1)

Protection of market participants and the public; (2) efficiency,

competitiveness and financial integrity of futures markets; (3) price

discovery; (4) sound risk management practices; and (5) other public

interest considerations. The Commission considers the costs and

benefits resulting from its discretionary determinations with respect

to the section 15(a) factors.

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\413\ 7 U.S.C. 19(a).

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As discussed above, in response to a Petition from certain regional

transmission organizations and independent system operators, the

Commission is proposing to exempt specified transactions from the

provisions of the CEA and Commission regulations with the exception of

those prohibiting fraud and manipulation (i.e., sections 2(a)(1)(B),

4b, 4c(b), 4o, 4s(h)(1)(A), 4s(h)(4)(A), 6(c), 6(d), 6(e), 6c, 6d, 8, 9

and 13 and any implementing regulations promulgated thereunder

including, but not limited to, Commission regulations 23.410(a) and

(b), 32.4 and part 180). The Proposed Exemption is transaction-

specific--that is, it would exempt contracts, agreements and

transactions for the purchase or sale of the limited set of

electricity-related products that are offered or entered into in a

market administered by a Petitioner pursuant to that Petitioner's

tariff or protocol for the purposes of allocating such Petitioner's

physical resources.

More specifically, the Commission is proposing to exempt from most

provisions of the CEA certain ``financial transmission rights,''

``energy transactions,'' ``forward capacity transactions,'' and

``reserve or regulation transactions,'' as those terms are defined in

the proposed Order, if such transactions are offered or entered into

pursuant to a tariff under which a Petitioner operates that has been

approved by FERC or the Public Utility

[[Page 52169]]

Commission of Texas, as applicable. The Proposed Exemption extends to

any persons (including Petitioners, their members and their market

participants) offering, entering into, rendering advice, or rendering

other services with respect to such transactions. Important to the

Commission's Proposed Exemption is the Petitioners' representations

that the aforementioned transactions are: (i) Tied to the physical

capacity of the Petitioner's electricity grids; (ii) used to promote

the reliable delivery of electricity; and (iii) are intended for use by

commercial participants that are in the business of generating,

transmitting and distributing electricity. In other words, these are

not purely financial transactions; rather, they are inextricably linked

to, and limited by, the capacity of the grid to physically deliver

electricity.

In the discussion that follows, the Commission considers the costs

and benefits of the proposed Order to the public and market

participants generally, including the costs and benefits of the

conditions precedent that must be satisfied before a Petitioner may

claim the exemption.

b. Proposed Baseline

The Commission's proposed baseline for consideration of the costs

and benefits of this Proposed Exemption are the costs and benefits that

the public and market participants (including Petitioners) would

experience in the absence of this proposed regulatory action. In other

words, the proposed baseline is an alternative situation in which the

Commission takes no action, meaning that the transactions that are the

subject of this Petition would be required to comply with all of the

CEA and Commission regulations, as may be applicable. In such a

scenario, the public and market participants would experience the full

benefits and costs related to the CEA and Commission regulations, but

as discussed in detail above, the transactions would still be subject

to the congruent regulatory regimes of the FERC and PUCT. In areas

where the Commission believed additional requirements were necessary to

ensure the public interest, the Commission proposed additional

requirements (e.g., the requirement that Petitioners submit a

memorandum or opinion of counsel to the Commission confirming the

enforceability of the Petitioners' netting arrangements in the event of

a bankruptcy of a participant).

The Commission also considers the regulatory landscape as it exists

outside the context of the Dodd-Frank Act's enactment. Here too, it is

important to highlight Petitioners' representations that each of the

transactions for which an exemption is requested is already subject to

a long-standing, comprehensive regulatory framework for the offer and

sale of such transactions established by FERC, or in the case of ERCOT,

the PUCT. For example, the costs and benefits attendant to the

Commission's condition that transactions be entered into between

``appropriate persons'' as described in CEA section 4(c)(3) has an

analog outside the context of the Dodd-Frank Act in FERC's minimum

criteria for RTO market participants as set forth in FERC Order 741.

In the discussion that follows, where reasonably feasible, the

Commission endeavors to estimate quantifiable dollar costs of the

Proposed Exemption. The benefits of the Proposed Exemption, as well as

certain costs, however, are not presently susceptible to meaningful

quantification. Most of the costs arise from limitations on the scope

of the proposed Order, and many of the benefits arise from avoiding

defaults and their implications that are clearly large in magnitude,

but impracticable to estimate. Where it is unable to quantify, the

Commission discusses proposed costs and benefits in qualitative terms.

c. Costs

The Proposed Order is exemptive and would provide potentially

eligible transactions with relief from the requirements of the CEA and

attendant Commission regulations. As with any exemptive rule or order,

the proposal is permissive, meaning that Petitioners were not required

to request it and are not required to rely on it. Accordingly, the

Commission assumes that Petitioners required and would rely on the

Proposed Exemption only if the anticipated benefits warrant the costs

of the same. Here, the Proposed Exemption identifies certain conditions

precedent to the grant of the Proposed Exemption. The Commission is of

the view that, as a result of the conditions, Petitioners, market

participants and the public would experience minimal, if any, ongoing,

incremental costs as a result of these conditions. This is so because,

as Petitioners certify pursuant to CFTC Rule 140.99(c)(3)(ii), the

attendant conditions are substantially similar to requirements that

Petitioners and their market participants already incur in complying

with FERC or PUCT regulation.

The first condition--that all parties to the agreements, contracts

or transactions that are covered by the Proposed Exemption must be

either ``appropriate persons,'' as such term is defined in sections

4(c)(3)(A) through (J) of the Act, or ``eligible contract

participants,'' as such term is defined in section 1a(18)(A) of the Act

and in Commission regulation 1.3(m)--should not impose any significant,

incremental costs because Petitioners must already incur costs in

complying with their existing legal and regulatory obligations under

the FPA and FERC or PUCT regulations, which mandate that only eligible

market participants may engage in the transactions that are the subject

of this proposal, as explained in section V.B.3. above.

The second is that the agreements, contracts or transactions that

are covered by the Proposed Exemption must be offered or sold pursuant

to a Petitioner's tariff, which has been approved or permitted to take

effect by: (1) In the case of ERCOT, the PUCT or; (2) in the case of

all other Petitioners, FERC. This is a statutory requirement for the

exemption. See CEA 4(c)(6)(A), (B). Moreover, requiring that

Petitioners' not operate outside their tariff requirements derives from

existing legal requirements and is not a cost attributable to this

proposal.

Third, as described in section V.B.1. above, FERC and PUCT impose

on their respective Petitioners, and their market monitors, various

information management requirements. These existing requirements are

not materially different from the condition that none of a Petitioner's

tariffs or other governing documents may include any requirement that

the Petitioner notify a member prior to providing information to the

Commission in response to a subpoena or other request for information

or documentation. However, certain existing tariffs (see footnote 406

and accompanying text) may not currently meet the condition; therefore

the Commission requests comment as to whether this condition imposes a

significant burden or increase in cost on Petitioners with such

tariffs, and whether there are alternative conditions that may be used

to achieve a similar result. Further, Petitioners have agreed to

provide any information to the Commission upon request that will

further enable the Commission to perform its regulatory and enforcement

duties. While the Commission is mindful that the process of responding

to subpoenas or requests for information involves costs, such subpoenas

and requests for information, and thus the associated costs, are

independent of the current proposed Order.

Fourth, information sharing arrangements that are satisfactory to

the Commission between the Commission and FERC, and the Commission and

PUCT, must be in full force and effect

[[Page 52170]]

is not a cost to Petitioners or to other members of the public but, in

the case of FERC, has been an inter-agency norm since 2005. Moreover,

and with respect to the proposed condition that would require the

Commission and PUCT to enter into an information sharing arrangement,

the sharing of information between government agencies is an efficient

means of reducing governmental costs.

Finally, the Commission is proposing to require, as a prerequisite

to the granting of the 4(c)(6) request to a particular Petitioner, that

the Petitioner provide the Commission with a legal opinion or memoranda

of counsel that provides the Commission with assurance that the

approach selected by the Petitioner to satisfy the obligations

contained in FERC regulation 35.47(d) will provide the Petitioner with

enforceable rights of setoff against any of its market participants

under title 11 of the United States Code in the event of the bankruptcy

of the market participant. For instance, for transactions in a DCO

context, the DCO is clearly the central counterparty. In the case of

most ISOs and RTOs, there has been some ambiguity in this regard. As a

result of this ambiguity, in the event of the bankruptcy of a

participant, there is a concern that ISOs and RTOs may be liable to pay

a bankrupt participant for transactions in which that participant is

owed funds, without the ability to net amounts owed by the market

participant in a bankruptcy, despite the fact that the tariffs

submitted by the Petitioners to FERC include explicit language

permitting set-off and netting.\414\ As FERC expressed in the FERC

Credit Rulemaking and the FERC Order on Rehearing, there is a risk that

the explicit tariff language may be insufficient to protect the

Petitioners in bankruptcy, and even if this risk were to be at a low

probability of manifestation, there would be a high cost to market

participants and the stability of the markets if it did so.\415\ The

Commission would require that the opinions or memoranda would be

addressed to the Commission and would be signed on behalf of the law

firm that is issuing the opinion, rather than by specific partners and/

or associates. The Commission also would require the text of the

opinion or memoranda to satisfy certain enumerated criteria. Based on

the Laffey Matrix for 2012, assuming the opinion is prepared by a

seasoned attorney (with 20 plus years of legal practice), his/her

hourly rate ($734 per hour) multiplied by the amount of hours taken to

prepare the opinion, will be the basic cost of such an opinion.\416\

The Commission estimates that the cost of such memoranda will range

between $15,000 and $30,000, part of which depends on the complexity of

the analysis necessary to support the conclusion that the Petitioner's

setoff rights are enforceable, and assuming that the opinion will take

20-40 hours to prepare.\417\

d. Benefits

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\414\ See, e.g., In re Semcrude, 399 B.R. 388, 393 (Bank. D.

Del. 2009) (stating that ``debts are considered `mutual' only when

`they are due to and from the same persons in the same capacity.'

'').

\415\ See 75 FR at 65955.

\416\ The Court in Laffey v. Northwest Airlines, Inc., 572

F.Supp. 354, 371 (D.D.C. 1983) ruled that hourly rates for attorneys

practicing civil law in the Washington, DC metropolitan area could

be categorized by years in practice and adjusted yearly for

inflation. For 2012 Laffey Matrix rates, see http://www.justice.gov/usao/dc/divisions/civil_Laffey_Matrix_2003-2012.pdf.

\417\ There are possibilities of economies of scale if multiple

Petitioners share the same counsel in preparing these memoranda or

opinions.

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In proposing this exemption, the Commission is required by section

4(c)(6) to ensure the same is consistent with the public interest. In

much the same way, CEA section 15(a) requires that the Commission

consider the benefits to the public of its action. In meeting its

public interest obligations under both 4(c)(6) and 15(a), the

Commission in sections V.B.1. and V.D. proposes a detailed

consideration of the nature of the transactions and FERC and PUCT

regulatory regimes, including whether the protections provided by those

regimes are, at a minimum, congruent with the Commission's oversight of

DCOs and SEFs.

This exercise is not rote; rather, in proposing that this exemption

is in the public interest, the Commission's comprehensive action

benefits the public and market participants in several substantive

ways, as discussed below. In addition, by considering a single

application from all Petitioners at the same time, and proposing to

allow all provisions of the exemption to apply to all Petitioners and

their respective market participants with respect to each category of

electricity-related products described in the Petition, regardless of

whether such products are offered or entered into at the current time

pursuant to an individual Petitioner's tariff, this proposal provides a

cost-mitigating, procedural efficiency. The Commission's proposal also

reduces the potential need for future amendments to the final exemption

in order for one Petitioner to offer or enter into the same type of

transactions currently offered by another.

In more substantive terms, by requiring that the transactions at

issue are, in fact, limited to those that are administered by the

petitioning RTOs/ISOs, and are inextricably linked to the organized

wholesale electricity markets that are subject to FERC and PUCT

regulation and oversight, the Commission limits the scope of the

proposed relief. In so doing, the proposal minimizes the potential that

purely financial risk can accumulate outside the comprehensive regime

for swaps regulation established by Congress in the Dodd-Frank Act and

implemented by the Commission. The mitigation of such risk inures to

the benefit of Petitioners, market participants and the public,

especially Petitioners' members and electricity ratepayers.

The condition that only ``appropriate persons'' may enter the

transactions that are the subject of this proposal benefits the public

and market participants by ensuring that (1) only persons with

resources sufficient to understand and manage the risks of the

transactions are permitted to engage in the same, and (2) persons

without such resources do not impose credit costs on other participants

(and the ratepayers for such other participants). Further, the

condition requiring that the transactions only be offered or sold

pursuant to a FERC or PUCT tariff benefits the public by, for example,

ensuring that the transactions are subject to a regulatory regime that

is focused on the physical provision of reliable electric power, and

also has credit requirements that are designed to achieve risk

management goals congruent with the regulatory objectives of the

Commission's DCO Core Principles. Absent these and other similar

limitations on participant- and financial-eligibility, the integrity of

the markets at issue could be compromised and members and ratepayers

left unprotected from potentially significant losses. Moreover, the

Commission's requirement that Petitioner's file an opinion of counsel

regarding the right of set-off in bankruptcy provides a benefit in that

the analytical process necessary to formulate such an opinion would

highlights risks faced by the Petitioners, and permit them to adapt

their structure and procedures in a manner best calculated to mitigate

such risks, and thus helps ensure the orderly handling of financial

affairs in the event a participant fails as a result of these

transactions.

Finally, the Commission's retention of its authority to redress any

fraud or manipulation in connection with the transactions at issue

protects market participants and the public generally, as

[[Page 52171]]

well as the financial markets for electricity products. For example, a

condition precedent to the Proposed Exemption is effective information

sharing arrangements between the FERC and the Commission, and PUCT and

the Commission. Through such an arrangement, the Commission expects

that it will be able to request information necessary to examine

whether activity on Petitioners' markets is adversely affecting the

Commission regulated markets. Further, the condition precedent that

Petitioners not notify a member prior to providing the Commission with

information will help maximize the effectiveness of the Commission's

enforcement program.

e. Costs and Benefits as Compared to Alternatives

The Commission considered alternatives to the proposed rulemaking.

For instance, the Commission could have chosen: (i) Not to propose an

exemption or (ii), as Petitioners' requested, to provide relief for

``the purchase and sale of a product or service that is directly

related to, and a logical outgrowth of, any [of Petitioners'] core

functions as an ISO/RTO * * * and all services related thereto.''

Regarding this latter request, the Commission understands the Petition

as requesting relief for transactions not yet in existence. In this

Order, the Commission proposes what it considers a measured approach--

in terms of the implicated costs and benefits of the exemption--given

its current understanding of transactions at issue.

Regarding the first alternative, the Commission considered that

Congress, in the Dodd-Frank Act, required the Commission to exempt

certain contracts, agreements or transactions from duties otherwise

required by statute or Commission regulation by adding a new section

that permits the Commission to exempt from its regulatory oversight

agreements, contracts, or transactions traded pursuant to an RTO or ISO

tariff that has been approved or permitted to take effect by FERC or a

State regulatory authority, as applicable, where such exemption was in

the public interest and consistent with the purposes of the CEA. Having

concluded that the instant exemption meets those tests, the Commission

proposes that a no exemption alternative would be inconsistent with

Congressional intent and contrary to the public interest. At the same

time, however, the Commission believes it would also be inappropriate

to adopt the second alternative.

The second alternative would extend the Proposed Exemption to all

``logical outgrowths'' of the transactions at issue. The Commission

proposes that such an exemption would be contrary to the Commission's

obligation under section 4(c) of the Act. As noted above, the authority

to issue an exemption from the CEA provided by section 4(c) of the Act

may not be automatically or mechanically exercised. Rather, the

Commission is required to affirmatively determine, inter alia, that the

exemption would be consistent with the public interest and the purposes

of the Act.

With respect to the four groups of transactions detailed in the

Proposed Exemption, the Commission's finding that the Proposed

Exemption would be in the public interest and would be consistent with

the purposes of the CEA is grounded, in part, on known transaction

characteristics and market circumstances described in the Petition that

may or may not be shared by other, as yet undefined, transactions

engaged in by the Petitioners or other RTO or ISO market participants.

Similarly, unidentified transactions might include novel features or

have market implications or risks that are beyond evaluation at the

present time, and are not present in the specified transactions.

2. Consideration of CEA Section 15(a) Factors with respect to the

Proposed Order

a. Protection of Market Participants and the Public

In proposing the exemption as it did, the Commission endeavored to

provide relief that was in the public interest. A key component of that

consideration is the assessment of how the Proposed Exemption protects

market participants and the public. As discussed above, market

participants and the public are protected by the existing regulatory

structure that includes congruent regulatory goals, and by the four

conditions placed upon the proposed relief by requiring, inter alia,

that: (i) Only those with the financial wherewithal are permitted to

engage in the transactions; (ii) the transactions at issue must be

within the scope of a Petitioner's FERC or PUCT tariff; (iii) no

advance notice to members of information requests to Petitioners from

the Commission; and (iv) the Commission and FERC, and PUCT and the

Commission, must have an information sharing arrangement in full force

and effect. Additionally, the requirement that Petitioners file and

opinion of counsel regarding bankruptcy matters provides additional

information from which the Commission may be assured that the netting

that Petitioners rely upon as an integral part of their risk management

is in fact enforceable.

b. Efficiency, Competitiveness, and Financial Integrity of Futures

Markets

To the extent that the transactions at issue could have an indirect

effect on the efficiency, competitiveness, and financial integrity of

the markets subject to the Commission's jurisdiction, the relief is

tailored in such a way as to mitigate any such effects. More

specifically, the Proposed Exemption is limited to the transactions

identified and defined herein. In this way, the Commission eliminates

the potential that as-yet-unknown transactions not linked to the

physicality of the electric system may be offered or sold under this

Proposed Exemption. Further, the Commission's retention of its full

enforcement authority will help ensure that any misconduct in

connection with the exempted transactions does not jeopardize the

financial integrity of the markets under the Commission's jurisdiction.

c. Price Discovery

As discussed above in section V.B.4, with respect to FTRs, Forward

Capacity Transactions, and Reserve or Regulation Transactions, these

transactions do not directly impact on transactions taking place on

Commission regulated markets--they are not used for price discovery and

are not used as settlement prices for other transactions in Commission

regulated markets

With respect to Energy Transactions, these transactions do have a

relationship to Commission regulated markets because they can serve as

a source of settlement prices for other transactions within Commission

jurisdiction. Granting the Proposed Exemption, however, does not mean

that these transactions will be unregulated. To the contrary, as

explained in more detail above, Petitioners have market monitoring

systems in place to detect and deter manipulation that takes place on

their markets. Further, as noted above, the Commission retains all of

its anti-fraud and anti-manipulation authority as a condition of the

Proposed Exemption.

d. Sound Risk Management Practices

As with the other areas of cost-benefit consideration, the

Commission's evaluation of sound risk management practices occurs

throughout this release, notably in sections V.D.4.a. and V.E.7.a.

which consider the Petitioners' risk

[[Page 52172]]

management policies and procedures, and the related requirements of

FERC and PUCT (in particular, FERC Order 741 on Credit Policies), in

light of the Commission's risk management requirements for DCOs and

SEFs.

e. Other Public Interest Considerations

The Commission proposes that because these transactions are part

of, and inextricably linked to, the organized wholesale, physical

electricity markets that are subject to regulation and oversight of

FERC or PUCT, as applicable, the Commission's Proposed Exemption, with

its attendant conditions, requirements, and limitations, is in the

public interest. In so considering, the Commission proposes that the

public interest is best served if the Commission dedicates its

resources to the day-to-day oversight of its registrants and the

financial markets subject to the CEA.

3. Request for Public Comment on Costs and Benefits

The Commission invites public comment on its cost-benefit

considerations and dollar cost estimates, including the consideration

of reasonable alternatives. Commenters are invited to submit any data

or other information that they may have quantifying or qualifying the

costs and benefits of the proposal with their comment letters.

X. Request for Comment

The Commission requests comment on all aspects of its Proposed

Exemption. In addition, the Commission specifically requests comment on

the specific provisions and issues highlighted in the discussion above

and on the issues presented in this section. For each comment

submitted, please provide a detailed rationale supporting the response.

1. Has the Commission used the appropriate standard in analyzing

whether the Proposed Exemption is in the public interest?

2. The Commission recognizes that there may be differences among

the Petitioners with respect to size, scope of business, and underlying

regulatory framework. Should any provisions of the Proposed Exemption

be modified or adjusted, or should any conditions be added, to reflect

such differences?

3. Is the scope set forth for the Proposed Exemption sufficient to

allow for innovation? Why or why not? If not, how should the scope be

modified to allow for innovation without exempting products that may be

materially different from those reviewed by the Commission? Should the

Commission exempt such products without considering whether such

exemption is in the public interest? Consider this question also with

the understanding that any Petitioner (or any entity that is not a

current petitioner) may separately petition the Commission for an

amendment of any final order granted in this matter.

4. Should the Commission exercise its authority pursuant to section

4(c)(3)(K) of the CEA to extend the Proposed Exemption to agreements

contracts or transactions that are entered into by parties other than

``appropriate persons'' as defined in sections 4(c)(3)(A) through (J)

of the CEA, or ``eligible contract participants,'' as defined in

section 1a(18)(A) or (B) of the Act and Commission regulation 1.3(m)?

If so, please provide a description of the additional parties that

should be included.

a. The Commission specifically seeks comment regarding whether

(and, if so, why) it is in the public interest to expand the list of

such parties to include market participants who ``active[ly]

participat[e] in the generation, transmission or distribution of

electricity'' but who are neither ``appropriate persons,'' as defined

in section 4(c)(3)(A) through (J) of the CEA, nor ``eligible contract

participants,'' as defined in section 1a(18)(A) of the Act and

Commission regulation 1.3(m)?

b. If any additional parties should be added, please provide:

(1) An explanation of the financial or other qualifications of such

persons or the available regulatory protections that would render such

persons ``appropriate persons.''

(2) The basis for the conclusion that such parties could bear the

financial risks of the agreements, contracts, and transactions to be

exempted by the Proposed Exemption.

(3) The basis for the conclusion that including such parties would

not have any adverse effect on the relevant RTO or ISO.

(4) The basis for the conclusion that failing to include such

parties would have an adverse effect on any relevant RTO or ISO.

5. Should the Commission require each Petitioner that is regulated

by FERC to have fully implemented the requirements set forth in FERC

Order 741 as a condition precedent to the issuance of a final order

granting the Proposed Exemption to the particular Petitioner? Why or

why not?

6. Should ERCOT be required to comply with the requirements set

forth in FERC Order 741 as a prerequisite to the issuance to ERCOT of a

final order granting the Proposed Exemption as to ERCOT? Why or why

not?

a. The Commission specifically seeks comment upon whether and why

ERCOT would or would not be able to comply with each of the

requirements set forth in FERC Order 741. Are any of these requirements

inapplicable for an RTO/ISO?

b. Should ERCOT be permitted to adopt alternatives to any of the

specific requirements set forth in FERC Order 741 (such as the seven

day settlement period in FERC regulation 35.47(b))? What is the basis

for the conclusion that the alternative measures would be the

equivalents of the FERC requirements in terms of protecting the

financial integrity of the transactions that are within the scope of

the exemption?

7. Should the Commission require, as a prerequisite to issuing a

final order granting the Proposed Exemption to a particular Petitioner,

that the Commission be provided with a legal opinion or memoranda of

counsel, applicable to the tariffs and operations of that Petitioner,

that provides the Commission with assurance that the approach selected

by the Petitioner to satisfy the obligations contained in FERC

regulation 35.47(d) will provide the Petitioner with rights of setoff,

enforceable against any of its market participants under title 11 of

the United States Code in the event of the bankruptcy of the market

participant? Why or why not? Are there alternative ways to provide the

requisite assurance regarding the bankruptcy protections provided by

the approach to 35.47(d) compliance selected by Petitioners and the

requisite assurance that the central counterparty structure selected by

Petitioners will be consistent or contain elements commonly associated

with central counterparties?

8. Should the Commission require the execution of an acceptable

information sharing arrangement between the Commission and PUCT as a

condition precedent to the issuance to ERCOT of a final order granting

the request for an exemption?

9. Should the Proposed Exemption be conditioned upon the

requirement that the Petitioners cooperate with the Commission in its

conduct of special calls/further requests for information with respect

to contracts, agreements or transactions that are, or are related to,

the contracts, agreements, or transactions that are the subject of the

Proposed Exemption?

10. Should Petitioners be required to have the ability to obtain

market data and other related information from their participants with

respect to contracts, agreements or transactions in markets

[[Page 52173]]

for, or related to, the contracts, agreements or transactions that are

the subject of the Proposed Exemption? The Commission specifically

seeks comment on whether the Petitioners should capable of re-creating

the Day-Ahead Market and Real-Time prices.

11. What is the basis for the conclusion that Petitioners do, or do

not, provide to the public sufficient timely information on price,

trading volume, and other data with respect to the markets for the

contracts, agreements and transactions that are the subject of the

Proposed Exemption? What RTO or ISO tariff provisions, if any, require

them to do so or preclude them from doing so?

12. What is the basis for the conclusion that the Proposed

Exemption will, or will not, have any material adverse effect on the

Commission's ability to discharge its regulatory duties under the CEA,

or on any contract market's ability to discharge its self-regulatory

duties under the CEA?

13. What are the bases for the conclusions that the Petitioners'

tariffs, practices, and procedures do, or do not, appropriately address

the regulatory goals of each of the DCO Core Principles?

14. What factors support, or detract from, the Commission's

preliminary conclusion that FTRs, Energy Transactions, Capacity and

Reserve Transactions are not readily susceptible to manipulation for

the reasons stated above? Could a market participant use an FTR to

manipulate the price of electricity established on the Day-Ahead and

Real-Time markets operated by Petitioners? If so, what is the basis for

that conclusion? What is the basis for the conclusion that market

participants can, or cannot, use Energy Transactions, Capacity or

Reserve Transactions to manipulate electricity prices without detection

by Independent Market Monitors?

15. What is the basis for the conclusion that Petitioners have, or

have not, satisfied applicable market monitoring requirements with

respect to FTRs, Energy Transactions, Capacity and Reserve

Transactions? What is the basis for the conclusion that the record-

keeping functions performed by Petitioners are, or are not, appropriate

to address any concerns raised by the market monitoring process? What

is the basis for the conclusion that the market monitoring functions

performed by Petitioners and their MMUs do, or do not, provide adequate

safeguards to prevent the manipulation of Petitioners' markets?

16. What is the basis for the conclusion that Petitioners, or their

participants, should, or should not, be required to satisfy position

limit requirements with respect to any of the contracts, agreements or

transactions that are the subject of the Proposed Exemption?

Specifically, what is the basis for the conclusion that it is, or is

not, possible for Petitioners, or their participants, to violate

position limits with FTRs or Virtual Bids? What is the basis for the

conclusion that the nature of FTRs or Virtual Bids do, or do not,

inherently limit the ability of market participants to engage in

manipulative conduct?

17. What are the bases for the conclusions that Petitioners do, or

do not, adequately satisfy the SEF requirements for (a) recordkeeping

and reporting, (b) preventing restraints on trade or imposing any

material anticompetitive burden, (c) minimizing conflicts of interest,

(d) providing adequate financial resources, (e) establishing system

safeguards and (f) designating a CCO? Specifically, do the procedures

and principles in place allow the Petitioners to meet the requirements

of SEF core principles 10-15?

18. What is the basis for the conclusion that the Petitioners'

eligibility requirements for participants are, or are not, appropriate

to ensure that market participants can adequately bear the risks

associated with the Participants markets?

19. What is the basis for the conclusion that Petitioners do, or do

not, have adequate rules in place to allow them to deal with emergency

situations as they arise? What deficiencies, if any, Are there with

respect to their emergency procedures that would prevent any Petitioner

from taking necessary action to address sudden market problems?

20. The Commission invites comment on its consideration of the

costs and benefits of the Proposed Exemption, including the costs of

any information requirements imposed therein. The Commission also seeks

comment on the costs and benefits of this Proposed Exemption,

including, but not limited to, those costs and benefits specified

within this proposal. Commenters are also are invited to submit any

data or other information that they may have quantifying or qualifying

the costs and benefits of the proposal with their comment letters.

Issued in Washington, DC on August 21, 2012, by the Commission.

Sauntia S. Warfield,

Assistant Secretary of the Commission.

Notice of Proposed Order and Request for Comment on a Petition From

Certain Independent System Operators and Regional Transmission

Organizations To Exempt Specified Transactions Authorized by a Tariff

or Protocol Approved by the Federal Energy Commission or the Public

Utility Commission of Texas From Certain Provisions of the Commodity

Exchange Act Pursuant to the Authority Provided in Section 4(c)(6) of

the Act--Commission Voting Summary and Statements of Commissioners

Note: The following appendices will not appear in the Code of

Federal Regulations.

Appendix 1--Commission Voting Summary

On this matter, Chairman Gensler and Commissioners Sommers,

Chilton, O'Malia and Wetjen voted in the affirmative; no

Commissioner voted in the negative.

Appendix 2--Statement of Chairman Gary Gensler

I support the proposed relief from the Dodd-Frank Wall Street

Reform and Consumer Protection Act (Dodd-Frank Act) swaps provisions

for certain electricity-related transactions entered into on markets

administered by regional transmission organizations (RTOs) or

independent system operators (ISOs). The relief responds to a

petition filed by a group of RTOs and ISOs.

Congress directed the CFTC, when it is in the public interest,

to provide relief from the Dodd-Frank Act's swaps market reform

provisions for certain transactions on markets administered by RTOs

and ISOs.

These entities were established for the purpose of providing

affordable, reliable electricity to consumers within their

geographic region. They are subject to extensive regulatory

oversight by the Federal Energy Regulatory Commission (FERC), or in

one instance, by the Public Utility Commission of Texas (PUCT). In

addition, these markets administered by RTOs and ISOs are central to

FERC and PUCT's regulatory missions to oversee wholesale sales and

transmission of electricity.

The scope of the proposed relief extends to the petitioners for

four categories of transactions--financial transmission rights,

energy transactions, forward capacity transactions, and reserve or

regulation transactions. Each of these transactions are inextricably

linked to the physical delivery of electricity.

I look forward to receiving public comment on the proposed

relief.

[FR Doc. 2012-20965 Filed 8-27-12; 8:45 am]

BILLING CODE P

Last Updated: August 28, 2012