APRIL 22, 2021

Exchange Clearing of Financial Transmission Rights (EFTRs)

NEPOOL Budget & Finance Subcommittee Meeting

Cheryl Arnold DIRECTOR, FINANCE & ACCOUNTING ISO NEW ENGLAND Sylvie Jobes SENIOR MANAGER, RISK & STRATEGIC ANALYSIS NODAL EXCHANGE, LLC ISO-NE PUBLIC Contents of Presentation

Page(s) • Project Objectives 3 • Introduction: Current Financial Transmission Rights (FTR) Mechanisms 4-7 • Overview of Design Concept 8-9 • Proposed Design 10-33 – Participating Entities – Background on Clearing House Model – Sequence for Exchanging FTR Awards to Futures Contracts – Billing, Collections and Settlement Process – Benefits of Proposed Design/Risk Management • Legal and Regulatory Considerations 34 • Tentative Project Schedule 35-36

ISO-NE PUBLIC 2 Project Objectives

• Replace ISO-NE Financial Assurance requirements for holding Financial Transmission Rights (FTRs) with clearing of equivalent futures contracts by a CFTC jurisdictional exchange / clearing house – A clearing house is better positioned to handle valuation (margin) on an ongoing basis – Default risk is shifted from ISO-NE’s market participants to clearing house • Facilitate secondary market trading

ISO-NE PUBLIC 3 Introduction: Current FTR Mechanisms (1) • An FTR is a financial instrument − acquired in an ISO-NE auction − that entitles the holder to receive compensation for congestion costs. It can be used to hedge the Day-Ahead LMP congestion component difference on a specific path between receipt and delivery points in the New England energy market. • Revenues from the FTR auction are paid to Auction Revenue Rights Holders (ARR Holders) • FTR billing/collection occurs monthly; FTR Holders are paid from Day-Ahead and Real-Time Congestion Revenues, based on whether the paths purchased result in a positive or negative “target allocation”

ISO-NE PUBLIC 4 Introduction: Current FTR Mechanisms (2)

• FTR Holders are not fully paid for their positions if there is a shortfall in congestion revenue in a given month; however, monthly shortfalls can be reduced at year-end if any excess congestion revenue is remaining. Year-end excess remaining after paying monthly shortfalls goes to net congestion payers.

ISO-NE PUBLIC 5 Introduction: Current FTR Mechanisms (3) • Currently, the ISO protects the market from FTR defaults by: – Requiring market participants to complete an ISO-prescribed training course prior to participating in the FTR auction – Requiring Market Participants to provide financial assurance (FA) in the amount equal to the sum of the FTR Settlement Risk FA, Unsettled FTR FA and the Settlement FA • FTR Settlement Risk FA covers the risk to hold a FTR position from last evaluation to maturity. It is based on the latest 36 month historical average Day-Ahead LMP congestion component. This is updated monthly. • Unsettled FTR FA covers the change in value of a FTR position from its acquisition to the time when the last evaluation is made. The unsettled FTR FA captures Mark-to-Market value of existing FTR positions. • Settlement FA is the net settled but uninvoiced value of FTR positions in the delivery month for a Market Participant ISO-NE PUBLIC 6 Introduction: Current FTR Mechanisms (4)

• If an FTR Holder defaults, and these measures are insufficient, default amounts are socialized to market participants per the Billing Policy

ISO-NE PUBLIC 7 Overview of Design Concept (1)

• ISO New England runs the FTR auction to create the initial positions • The FTRs are processed by Nodal Exchange and novated to Nodal Clear; i.e., converted from ISO-NE market path-based positions into Nodal Exchange/Nodal Clear defined source and sink-based contracts • Nodal Clear establishes and maintains initial and variation margins • Nodal Exchange operates the trading platform and provides price transparency

ISO-NE PUBLIC 8 Overview of Design Concept (2)

• The ISO is a counterparty to the cleared contracts. • The ISO collects congestion revenues and distributes Auction Revenue Rights (ARR) revenues • Collected congestion revenues will be used to fund ISO-NE variation margin and to pay ARR holders • Rather than directly pay FTR holders congestion revenues, ISO-NE will pay variation margin on the contracts to which it is counterparty • The ISO will establish a line of credit to manage cash flow mismatches arising from differences in the timing of congestion revenue collection/distribution and variation margin payments/receipts

ISO-NE PUBLIC 9 Proposed Design: Participating Entities (1)

• ISO-NE has developed the proposed design in collaboration with Nodal – However, the design is not exclusive, and another or additional exchange/clearing partner(s) are possible

ISO-NE PUBLIC 10 Proposed Design: Participating Entities (2)

• In the proposed design, ISO-NE (consistent with the current tariff provisions) will continue, under FERC-approved tariff and subject to FERC jurisdiction, to run the FTR auction to create the initial FTR positions • FTRs will be exchanged for futures contracts via CFTC permitted execution method known as Exchange for Related Position (EFRP), which Nodal refers to as Exchange for FTR (EFTR) • ISO-NE will collaborate with two entities to facilitate FTR Clearing (EFTRs): Nodal Exchange, LLC and Nodal Clear, LLC (jointly, Nodal) – Nodal Clear, LLC is wholly owned by Nodal Exchange, LLC – Nodal Exchange, LLC is part of the EEX Group, which is in turn part of the Deutsche Börse Group

ISO-NE PUBLIC 11 Proposed Design: Participating Entities (3) • Nodal Exchange – Current operations: • Nodal Exchange is a designated contract market (DCM) under CFTC jurisdiction, and currently offers futures and options contracts on power locations that settle to prices published by RTOs/ISOs, as well as natural gas and environmental products • Nodal Exchange provides multiple mechanisms for cleared trading of its futures contracts: (1) T7, a high-performance, low-latency trading platform supported by front-end trading applications including CQG, Trayport and TT, (2) Nodal LiveTrade, a screen interface to a central limit order book that enables bespoke trading of granular products and (3) Nodal BlockTrade, which permits negotiated transactions that are based on Nodal Exchange futures contracts to be cleared, including Exchange for Related Position (EFRP) transactions • Nodal Exchange prices every futures contract expiry twice per day. Volumes and open positions on each futures contract expiry are published daily. ISO-NE PUBLIC 12 Proposed Design: Participating Entities (4)

• Nodal Exchange role in proposed design: – Provide the futures contracts for which FTRs will be exchanged – Authorize and process the exchange of Nodal Exchange futures contracts for related FTR positions, and price the futures contract expiries twice per day • Nodal Clear role in proposed design: – Provide trade risk limit verification services to assist ISO-NE in its administration of the FTR auction process – Clear (i.e., manage the cash flows and risk stemming from) the Nodal Exchange futures contracts that are created as a result of the EFTR submission of FTRs to Nodal Exchange

ISO-NE PUBLIC 13 Proposed Design: Background on Clearing House Model (1)

• When contracts are to be settled in the future, there is risk regarding the counterparty being able to meet payment obligations at that future time • To manage this risk, parties transact through a clearing house which is a derivatives clearing organization (DCO) under CFTC jurisdiction – A DCO overseen by the CFTC acts as the buyer to every seller and the seller to every buyer, taking no market position risks, only default risk; the DCO has a counterparty on both the buy and sell side – The clearing house has clearing members that guarantee the trades of participants, and the clearing house holds funds such as the initial margin and the guaranty fund to manage financial obligations in event of default

ISO-NE PUBLIC 14 Proposed Design: Background on Clearing House Model (2)

• There are two types of margin: – Initial margin: covers the potential price movements that could occur after a potential default and are determined to cover a set number of days to liquidate with a certain degree of confidence – Variation margin: is called at least daily and covers actual movements in the expected settlement price of the contract (mark to market). Variation margin is required to cover potential market exposure.

ISO-NE PUBLIC 15 Proposed Design: Sequence for Exchanging FTR Awards for Futures Contracts (1) • Participants submit initial margin to Nodal prior to submitting orders to ISO-NE – Participants calculate requirement by submitting preliminary order slate to Nodal risk check tool • Once final order slates are submitted to and validated by ISO- NE, ISO-NE will send order slates to Nodal for margin review – Initial margin covers liquidation risk. For Nodal, it is structured to cover the portfolio loss, to a 99.7% certainty, assuming one to five days to liquidate the defaulting portfolio depending on contract composition. Margin requirements will include an additional buffer to account for potential price drift between bid submission and clearing. – If a participant has submitted insufficient initial margin, that participant’s bids will be rejected prior to running the auction – Nodal establishes and maintains initial and variation margin requirements in collaboration with its clearing members

ISO-NE PUBLIC 16 Proposed Design: Sequence for Exchanging FTR Awards for Futures Contracts (2)

• ISO-NE runs the FTR Auction – ISO-NE will make all external interfaces, load zones, unit nodes and load nodes available for bidding in the monthly and annual auction – The set of available nodes will be modified in a similar way as today; new p-nodes will be available in the next FTR auction after activation, p-node retirements will result in LT FTR reassignments – ISO-NE will determine the node to receive the reassignments and will inform Nodal Exchange of the changes – The set of p-nodes used in the annual auction will then be used in all subsequent monthly FTR auctions, with minor adjustments for p-node activations/retirements

ISO-NE PUBLIC 17 Proposed Design: Sequence for Exchanging FTR Awards for Futures Contracts (3) • Nodal Exchange will process the FTR awards as EFTR transactions – That is, Nodal will exchange the ISO-NE market path-based FTR positions for Nodal Exchange defined source- and sink-based futures contracts – An example of the exchange of an FTR award for a monthly futures contract is provided in Figure 1, and an illustration of how an annual FTR is exchanged for monthly futures contracts is provided in Figure 2. ISO-NE will review next steps for the project of implementing LTTR after FTR Clearing (EFTRs) has been successfully put in service. • The contract resulting from the EFTR transaction will be novated to Nodal Clear (as is currently done with futures contracts traded at Nodal Exchange) – A schematic of the novation process is provided in Figure 3 • The overall process from FTR award to contract settlement is shown in Figure 4 ISO-NE PUBLIC 18 Proposed Design: Risk Management • All parties awarded FTRs (and becoming parties to equivalent futures contracts) will have to participate through the exchange/clearing house • Participants will interact with the clearing house via clearing member institutions – Each participant will need to sign an agreement with its chosen clearing member(s) – These institutions are competitive commercial businesses, so “shopping” may be advisable – Below is a list of the 14 current Nodal clearing members that are futures commission merchants (FCMs) and can clear for customer accounts: 1. ABN AMRO Clearing Chicago LLC 8. Macquarie Futures USA LLC 2. ADM Investor Services, Inc. 9. Mizuho Securities USA Inc. 3. BNP Paribas Securities Corp. 10. Morgan Stanley & Co. LLC 4. BofA Securities, Inc. 11. RBC Capital Markets LLC 5. Citigroup Global Markets, Inc. 12. SG Americas Securities LLC 6. ED&F Man Capital Markets Inc. 13. Wells Fargo Securities LLC 7. Goldman Sachs & Co. 14. Wedbush Securities, Inc. ISO-NE PUBLIC 19 Figure 1: Exchange of FTR Award for Monthly Nodal Exchange Futures Contracts

FTR Futures

Participant: 50 MW Hub A to Zone X, Long 50MW Zone X, Peak, Oct 2020 Peak, Oct 2020 Short 50MW Hub A, Peak, Oct 2020

Cleared via Nodal ISO/RTO: Short 50MW Zone X, Peak, Oct 2020 Long 50MW Hub A, Peak, Oct 2020

Commodity for all contracts is energy + congestion (but energy drops out on spreads as it is always the same across any given ISO) Price: Novated at FTR price FTR Auction Price: $2,112/MW-Period Zone X: $52/MWh ($6.00/MWh) Hub A: $46/MWh (difference= $6.00/MWh= FTR price)

ISO-NE PUBLIC 20 Figure 2: Exchange of Annual FTR Award for Monthly Nodal Exchange Contracts

1 MW 1 MW -1 MW -1 MW Zone A Zone A Hub A Hub A Onpeak Onpeak Onpeak Onpeak Jan 2021 Jul 2021 Jan 2021 Jul 2021

1 MW 1 MW -1 MW -1 MW Zone A Zone A Hub A Hub A Onpeak Onpeak Onpeak Onpeak Feb 2021 Aug 2021 Feb 2021 Aug 2021

1 MW 1 MW -1 MW -1 MW 1 MW 2021 Zone A Zone A Hub A Hub A Onpeak Onpeak Onpeak Onpeak Onpeak FTR: Mar 2021 Sep 2021 Mar 2021 Sep 2021 Hub A 1 MW 1 MW -1 MW -1 MW Source / Zone A Zone A Hub A Hub A Zone A Sink Onpeak Onpeak Onpeak Onpeak Apr 2021 Oct 2021 Apr 2021 Oct 2021

1 MW 1 MW -1 MW -1 MW Zone A Zone A Hub A Hub A Onpeak Onpeak Onpeak Onpeak May 2021 Nov 2021 May 2021 Nov 2021

1 MW 1 MW -1 MW -1 MW Zone A Zone A Hub A Hub A Onpeak Onpeak Onpeak Onpeak Jun 2021 Dec 2021 Jun 2021 Dec 2021

ISO-NE PUBLIC 21 Figure 3: Schematic of Novation Process

Trade Trade 1 1 Nodal Buyer Seller Exchange

Submission of 2 trade for clearing

Buyer Clearing Seller Clearing Member (CM) Member (CM)

Novated trade with 3 3 Novated trade with Nodal Clear as seller and Nodal Clear as buyer and CM guaranteeing buyer Nodal Clear CM guaranteeing seller

ISO-NE PUBLIC 22 Figure 4: Schematic of FTR and EFTR Clearing Process

FTR ISO-NE* Nodal Exchange Participants / Nodal Clear

Submit orders to ISO-NE Forward order slates to Calculate IM based on order and IM to Nodal for auction Nodal slates from participants [with adjustment for time Reject bids for participants period between bid with insufficient IM posted submission and clearing]

Clear auction and publish Process awarded FTRs via awards EFTR

Complete next margin run, returning excess margin collected for bid slate or collecting deficit resulting from price changes since bid IM calculation

Standard daily procedures, including twice daily pricing *Prior to order submission, ISO-NE authorizes list of eligible participants for and margin runs, and the auction and opens the FTR auction window to receive orders contract settlement

ISO-NE PUBLIC 23 Proposed Design: Billing, Collections and Settlement Process for Resulting Futures Contracts (1)

• Current process is shown in Figure 5

ISO-NE PUBLIC 24 Figure 5: Summary of Current FTR Billing and Collections Process

Energy Market FTR Auction Revenue FTR Billing/Collection Billing/Collection Process Process Process

• Annual FTR Auction Awards • Energy Congestion Revenue • Positive and Negative FTR • Determination/Collection of (Day-Ahead and Real-Time Target Allocations for each Financial Assurance from Markets) FTR Holder of Transmission FTR awardees • Settled hourly Congestion Credits (based on • Collection/Distribution of • Billed twice a week to energy DA congestion component Annual Auction Revenue to market participants differences) ARR Holders • Resettled (only applicable to • Settled and billed monthly real time portion of Energy • Market Monitoring Review Market; not applicable to day • Positive Target Allocations ahead congestion) paid from Transmission Congestion Revenue • Proration of Positive Target Allocations if Congestion Revenue Fund Shortfall (Not Fully Funded)

ISO-NE PUBLIC 25 Proposed Design: Billing, Collections and Settlement Process for Resulting Futures Contracts (2) • Under proposed design, see Figure 6. – ISO-NE is a counterparty to the futures contracts implementing the FTR auction awards as the FTRs were exchanged for futures contracts – As explained above, under the clearing house model, the futures contracts resulting from FTR awards are marked to market through daily payment of variation margin – ISO-NE utilizes congestion revenues from its energy market to pay variation margin on contracts to which it is a counterparty, rather than pay congestion revenues to FTR Holders – If congestion revenues are insufficient to pay variation margin, ISO-NE will have to draw on a line of credit (to be arranged later this year) • ISO-NE will no longer bill FTR auction participants for the bid amount associated with their awarded FTRs – Instead, FTR holders will be required to have appropriate margin amounts in their account with the clearing member ISO-NE PUBLIC 26 Figure 6: Example of Annual FTR Auction Revenue Distribution Auction Revenue Energy Market FTR and Futures Process Process Contract Process

• Total Annual Auction Awards: • Monthly auction award: $1,200,000 $100,000 • Monthly Valuation of Annual • Positive Target Allocations: Auction Awards (1/12) : $200,000* $100,000 • Negative Target Allocations: -$120,000* • Net monthly payment to ARR • Day Ahead Energy Congestion Revenue at month end: • Net Target Allocation: Holders: $80,000* $70,000 $70,000 • Variation Margin (positive = • + $20,000 payable to ISO, Neg. = charge • $90,000 to ISO): -($80,000 - $100,000) = $20,000 • Shortfall to ARR Holders: • Note - FTR awardees paid $20K $10,000. I.e., ARR Holders total in Variation Margin, would be expecting $100K but so overall the FTR awardees lost in received $90K the example month's final settlement of futures contracts

Cash settled at Nodal Cash settled at ISO NE * Cash Processed via Nodal/ISO Variation Margin Account ISO-NE PUBLIC 27 Proposed Design: Billing, Collections and Settlement Process for Resulting Futures Contracts (3) • ISO-NE will no longer collect negative target allocations from FTR awardees – FTR awardees will be required to have appropriate margin amounts (including paying in variation margin for decreases in contract value) in their clearing accounts • ISO-NE will no longer pay out Energy Congestion Revenue to FTR Holders – FTR awardees will be paid/credited into their account with their clearing member for the equivalent of the positive target allocations (as variation margin) – and will be kept whole by the ARR Holders

ISO-NE PUBLIC 28 Proposed Design: Billing, Collections and Settlement Process for Resulting Futures Contracts (4) • ISO-NE will pay ARR Holders ISO Monthly ARR Settlement Amount distributions comprised of 1) net Variation Margin received by ISO-NE (positive) or paid (negative) on futures contract positions resulting from the exchanged original FTR awards plus 2) Day-Ahead Congestion Revenue net of any shortfall adjustments or surplus • FTRs will be FULLY funded per the Long Term Transmission Rights (LTTR) methodology accepted by FERC – To provide this funding, payments to ARR Holders are reduced if there is a shortfall at the settlement of contracts • After the month is over and the futures contract is finally settled and the ARR Holders are paid, the obligations for that month have been met ISO-NE PUBLIC 29 Proposed Design: Order 741 Requirements

• The Order 741 requirements relating to FTR auction participation assume that ISO-NE is collateralizing against the risk. This would not be the case, and accordingly, Order 741- related sections of the FAP are modified as part of the FTR Clearing (EFTRs) filing package.

ISO-NE PUBLIC 30 Benefits of Proposed Design: Risk Reduction (1)

• While, as discussed above, ISO-NE has collateral and related requirements in place to protect against FTR Holders’ defaults, there is still a risk that defaults will end up being socialized to other New England market participants. The proposed design would place this risk, instead, on the clearing house and its clearing members. • The current approach requires parties to post collateral equal to the full purchase price of the FTR. Under the proposed design, participants will be required to post initial margin (e.g., an amount to cover a potential one- to five-day price movement with 99.7% probability). • Cash Accounting vs Mark-to-market: The current approach does not account for changes in the value of the obligation across its tenor, allowing losses to accrue. The proposed design provides a mechanism (variation margin payments) to prevent losses from accumulating. ISO-NE PUBLIC 31 Benefits of Proposed Design: Risk Reduction (2) • ISO-NE has no current mechanism to force the liquidation of a defaulted FTR position. Under the proposed mechanism, a clearing member guarantees its customers’ positions and can liquidate the portfolio of a defaulting participant to meet its obligations to Nodal Clear. – If the clearing member defaults, Nodal Clear can liquidate the portfolio of a defaulting clearing member – In addition to holding initial margin and guarantee fund contributions of the defaulting clearing member to aid with liquidation as needed, Nodal Clear has a default waterfall that includes $20 million of its own equity and a much larger guaranty fund contributed by all clearing members, as well as additional mechanisms to protect against a default, such as the ability to require surviving clearing members to contribute more to the guaranty fund ISO-NE PUBLIC 32 Benefits of Proposed Design: Full Funding of FTRs

• Under the proposed design, ARR Holders must backstop full funding of FTRs

ISO-NE PUBLIC 33 Legal and Regulatory Considerations: Tariff/Manual Modifications

• Market Rule 1 • Market Rule 1 Appendix A • Market Rule 1 Appendix C • ISO-NE Manual 6 • Financial Assurance Policy • Billing Policy • Information Policy • Definitions

ISO-NE PUBLIC 34 Tentative Project Schedule (1) • NEPOOL Budget & Finance Subcommittee – May/August 2021 – Review of Changes to Billing/Financial Assurance; – August/September 2021 (possibly hold unscheduled Budget & Finance meeting)– Review Specific Changes to Billing/Financial Assurance Policies; Make Recommendation to NEPOOL Participants Committee- coincident with Markets Committee recommendation • NEPOOL Markets Committee – August 2021 − Introduce Project – September 2021 − Discuss Redlines to Market Rule 1, Information Policy and Definitions – October/November 2021 − Further Discussion & Vote • NEPOOL Participants Committee – November/December 2021 − Vote on All Tariff Changes • FERC Filing of Tariff Changes by ISO-NE – December 2021 (changes to become effective on prior notice to FERC and market participants, and CFTC signoff on Nodal rulebook changes)

Note: This schedule will be adjusted as required in case of the need for additional meetings with Stakeholders or as required by Commission action in the RTO/ISO Credit Principles and Practices technical conference docket. ISO-NE PUBLIC 35 Tentative Project Schedule (2)

• Implementation and Go Live – Q3/Q4 2022 • ISO-NE is working on agreements with Nodal Exchange and Nodal Clear. Expected completion – Q3/Q4 2021. • ISO will make an FPA Section 204 filing in 2021 for authorization of the Line of Credit needed to fund the variation margin – Currently analyzing the amount required – Possibly between $65-$85 million required, with option to increase the line, if needed to maintain margin with Nodal • ISO issued an RFP to 3 banks and all 3 were willing to lend to ISO; the ISO’s incumbent bank was selected

ISO-NE PUBLIC 36 ISO-NE PUBLIC 37