WSPP Operating Committee

WSPP Operating Committee

For Discussion Only

MEMORANDUM

November 15, 2012

Provided with Agenda

To:WSPP Executive Committee

From:Arnie Podgorsky

WSPP Legal Counsel

Re:Contract Matters for Executive Committee Vote November 27, 2012

This memorandum sets out the recommendations of the Operating Committee and Contract Subcommittee to revise the WSPP Agreement. These matters are for vote at the November 27 Executive Committee meeting.

The Contract Subcommittee discussed these matters at a September 11, 2012 meeting and approved revised language without objection on an October 9, 2012 conference call. The Operating Committee approved the modifications without dissent.

There are three proposals, two substantive and one administrative. The substantive proposals are in two areas:

I.Responding to the Commodity Futures Trading Commission (“CFTC”) Swap Definition Final Rule

A.Revisions of “bookout” language

B.Minor edits to trade option provision

II.Modifying confirmation language to better facilitate WSPP transactions on electronic trading platforms

I.Agreement Modifications for Swap Final Rule

The Swap Definition Final Rule[1] indicates a need for two modifications of the WSPP Agreement: (1) the definitions of “Bookout” in § 4; and (2) the trade option exemption provision of § 36. The Swap Rule raises other matters, see our memorandum of October 2, 2012, but these do not require modifications to the Agreement.

A.Definition of “Bookout” in § 4

Most WSPP transactions will be forward contracts, subject to the forward contract exclusion as described in the Swap Rule. In forward contracts the parties contemplate that physical delivery will be made and taken. The WSPP Agreement does not anticipate that WSPP transactions will be netted or booked out. Contractual provisions indicating that bookouts are expected and/or part of the transaction can work against application of the forward contract exclusion.

Bookouts can be consistent with the forward contract exclusion in limited circumstances. The CFTC spelled out the considerations in its previously issued Brent Interpretation,[2] but only with respect to one commodity. In the Swap Rule the CFTC extended that interpretation to all nonfinancial commodities (including electricity, capacity and RECs). The Brent Interpretation provides that counterparties with multiple, offsetting positions with each other are permitted to bookout those positions to avoid the costs and risks of effectuating redundant deliveries, but subject to certain conditions, and that such bookout are not contrary to forward contract characterization. The Swap Final Rule provides that to complete a bookout, and thus terminate the transaction and forego delivery, the counterparties would enter into a separate, individually negotiated, cancellation (bookout) agreement. Importantly, the underlying contract cannot include an obligation to enter into that bookout agreement. Additionally, oral bookouts must be confirmed in writing or an electronic record within a commercially reasonable time.

The WSPP Agreement is consistent with the CFTC’s expectations that bookouts are not required or part of the underlying transactions, but to negate any risk of confusion certain references to bookouts in the Agreement should be clarified.

Section 4 of the WSPP Agreement contains two definitions of “bookout.” The first, in (a)(i), defines a traditional bookout “where . . . prior to the time performance is to commence under a Confirmation, the Parties enter into a second (substitute) transaction for the purpose of fulfilling their respective obligations under that Confirmation by offset rather than physical delivery.” WSPP Agreement § 4. This provision can (and should) be deleted without compromising any other term of the Agreement.

Further, subsection (a)(ii) of the definition refers to a different kind of transaction also as a “bookout”—a damages settlement mechanism. This settlement mechanism is “[a] transaction where . . . after non-performance under a Confirmation, the Parties enter into a second (substitute) transaction for the purpose of finally settling losses incurred by the Performing Party due to non-performance of such Confirmation.” Id. This settlement mechanism is unrelated to the Brent Interpretation use of the term “bookout;” it anticipates a transaction to settle damages, not to offset pre-existing positions in order to avoid redundant deliveries. To eliminate potentially confusing use of the word “bookout,” the name of this settlement transaction should be changed from bookout to Damages Settlement Transaction. This change and a few additional edits follow.

Changes to Bookout definition in § 4 (note that in the first line the term Bookout is deleted and the term Damages Settlement Transaction is substituted):

BookoutDamages Settlement Transaction: A transaction where,:

(a) (i) prior to the time performance is to commence under a Confirmation, the Parties enter into a second (substitute) transaction for the purpose of fulfilling their respective obligations under that Confirmation by offset rather than physical delivery, or

(ii) after non-performance under a Confirmation, the Parties enter into a second (substitute) transaction for the purpose of finally settling damageslosses incurred by the Performing Party due to non-performance of such Confirmation. ; and

(b)the second transaction, under either (i) or (ii), was performed.

To conform the damages provisions in section 21 to the revised definition and better place language about performing the second transaction, § 21.3(e) would be modified as follows:

(e)In the event a Bookout occurs to resolve anticipated or actual non-performance of a transaction is accounted for by means of a Damages Settlement Transaction,and the Damages Settlement Transaction is performed, then no damages shall be calculated or due under §21.3(a) with respect to the non-performed transaction. Neither Party shall be required to enter into a Damages Settlement TransactionBookout.

B.Trade Option Exception § 36

In a related order, the Commodity Options Final and Interim Final Rules,[3] the CFTC provided that commodity options that qualify as trade options would be exempt from swap regulation so long as the transactions have specified characteristics.

Physically-Settled Options provided for under the WSPP Agreement appear to satisfy the trade option exemption in concept: parties to the WSPP Agreement, and therefore parties to Physically-Settled Options, must be an Electric Utility, Retail Entity, or Qualifying Facility (§ 16.1) and as such these entities are producers, commercial users, or merchants of electricity products (§ 4); the parties warrant that any Physically-Settled Option is being offered only to a provider, user, or merchant and that it is being entered into solely for purposes related to their businesses (§ 36); and, Physically-Settled Options are intended to be physically settled (§§ 2.3 and 33.1).

Section 36 of the WSPP Agreement, “Trade Option Exception,” refers to the trade option exception in 17 C.F.R. § 32.4 rather than to the revised C.F.R., § 32.3. Section 36 should be modified to correct the citation to § 32.3. Also, to conform the language of § 36 to the Commodity Options Final and Interim Final Rules and eliminate potential confusion, references to “trade option exception” should be revised to “trade option exemption.” Language follows:

36.TRADE OPTION EXCEPTIONEXEMPTION

The Parties intend that any Physically Settled Option under this Agreement shall qualify under the trade option exceptionexemption, 17 C.F.R. § 32.43. Accordingly, each Party buying or selling a Physically Settled Option agrees and warrants that any such option shall be offered only to a provider, user, or merchant and that the entities entering into the options are doing so solely for purposes related to their business.

II.Proposed Modification for Electronic Platform Confirmations

Procedures for entering into transactions on some electronic trading platforms may not comply with the procedures of the WSPP Agreement for making Confirmations. A Confirmation, whether documentary or electronically recorded, is the transacting parties’ legally binding agreement to the terms and conditions of a transaction. The WSPP Agreement specifies detailed procedures for making a Confirmation. If the Parties’ transaction documentation does not conform to WSPP procedures, it is possible that the transaction will not be subject to the terms of the WSPP Agreement (or any other agreement).

A second, related issue is that even if the Parties make a Confirmation in a manner that conforms to the WSPP Agreement, the Agreement may not apply to the transaction unless the Confirmation says so. Section 23 contemplates that parties may enter into other master agreements.

Proposed changes are: (1) a new definition of an “Electronic Platform Confirmation;” (2) language to establish that an Electronic Platform Confirmation is a Confirmation recognized and binding under the Agreement; and (3) language to make the Electronic Platform Confirmation subject to the WSPP Agreement unless another agreement between the parties covers the transaction by its terms (for example, an agreement that applies expressly to all transactions between the parties).

New definition:

Electronic Platform Confirmation: agreed terms and conditions of a transaction, which agreement (a) was made through electronic entry of information and terms on, and in a manner that complies with the procedures of, the applicable electronic trading platform or exchange, (b) includes, at a minimum, the Standard Confirmation Provisions, and (c) is available to either Party for retrieval from the applicable electronic trading platform or exchange in printable or electronic form.

Modification of existing definition:

Confirmation(s): The confirmations for transactions developed and made effective in accordance with Section 32 or Electronic Platform Confirmations.

Other revisions to conform § 32:

32.1General

32.1.1A Confirmation shall include, at a minimum, the Standard Confirmation Provisions.terms of price, quantity, delivery points, and period of delivery. (See Exhibit C for a sample). Subject to the limitations in Section 32.2 (Standard Confirmation Provisions) and Section 32.3 (Non-Standard Confirmation Provisions), the Confirmation shall be made in writing by either a Documentary Writing, or an Electronic Writing., or shall be an Electronic Platform Confirmation.

32.1.2Pursuant to the provisions of this Section 32, the Parties to a transaction under this Agreement may agree to modify any term of this Agreement (other than provisions regarding the operation of the WSPP as an organization including Sections 7 and 8) which applies to such transaction, such agreement to be stated in a Confirmation or Confirmations.

32.1.3Sections 32.2 and 32.3 shall not apply to an Electronic Platform Confirmation. Parties may amend an Electronic Platform Confirmation in accordance with the procedures, if any, of the applicable platform or exchange or in any other manner this Agreement permits. Each Electronic Platform Confirmation between WSPP members shall be subject to this Agreement, unless the transaction specified in the Electronic Platform Confirmation is subject to another agreement between the Parties other than a master Confirmation applicable to the Parties’ WSPP Confirmations.

III.Housekeeping Matter

The execution page of the WSPP Agreement does not require identification of the executing entity. We propose the redlined modifications:

By:______

Name of signing official:

Title:

Name of Member:

Date:

///

1

[1]Further Definition of “Swap,” “Security-Based Swap,” “Security-Based Swap Agreement”; Mixed Swaps; Security-Based Swap Agreement Recordkeeping, 77 Fed. Reg. 48,208 (Aug. 13, 2012) (“Swap Rule”).

[2]Statutory Interpretation Concerning Forward Transactions, 55 Fed. Reg. 39,188 (Sep. 25, 1990) (“Brent Interpretation”).

[3]Commodity Options, 77 Fed. Reg. 25,320 (Apr. 27, 2012) (“Commodity Options Final and Interim Final Rules”).