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Power Exchange India Limited, In Re
Factual and Procedural Background
The applicant, Power Exchange India Limited, petitioned for permission to introduce additional contracts (day-ahead contingency contracts, weekly contracts, monthly contracts and intra-State contracts) and for approval of revised rules, bye-laws and business rules. By an interlocutory application the applicant also sought to change the time block of existing and proposed contracts from one hour to 15 minutes, but subsequently de-linked that prayer by affidavit dated 10.06.2009. The interlocutory application seeking permission to introduce an intra-state product was withdrawn.
The Central Commission had earlier approved the setting up and operation of the power exchange by order dated 27.05.2008; the exchange became operational on 22.10.2008. The Commission held hearings on the question of granting permission to introduce additional term-ahead market contracts on 28.05.2009 and 16.06.2009.
Legal Issues Presented
- Whether the applicant should be permitted to introduce additional term-ahead market contracts and whether its revised rules, bye-laws and business rules should be approved.
- Whether the applicant's proposed price discovery / matching mechanism (pay-as-bid as proposed by the exchange) is acceptable, and if not, what modification should be ordered.
- Whether the exchange may change the time block of contracts from one hour to 15 minutes (interlocutory application subsequently de-linked by the applicant).
- Whether the exchange should be permitted to provide Over-the-counter (OTC) clearing and settlement services.
- The status of the applicant's request to introduce intra-State contracts (application withdrawn).
Arguments of the Parties
The opinion does not contain a detailed account of the parties' legal arguments.
Table of Precedents Cited
No precedents were cited in the provided opinion.
Court's Reasoning and Analysis
The Commission approached the petition on the basis that the term-ahead market is a new concept and thus required a cautious rollout. On this basis the Commission limited the launch to a narrower set of contracts and imposed safeguards addressing delivery, settlement, risk management and market integrity.
Specific analytical steps taken by the Commission (as reflected in the text) were:
- Contract selection and limitation: The Commission permitted only day-ahead contingency contracts and weekly contracts on a month-ahead basis (trading one month in advance with a delivery period of one week), noting the need to limit exposure because term-ahead contracts embed both price and volumetric risk. Consequently clauses referring to month-ahead, two-month-ahead and three-month-ahead contracts were to be omitted from the rules and contract specifications adjusted accordingly.
- Delivery and settlement constraints: The Commission specified that the approved contracts would be for physical delivery, non-transferable, and that financial settlement of these contracts would not be permissible.
- Time-limited review: The Commission decided to review the performance of these contracts after six months.
- Price discovery and matching mechanism: The applicant had proposed a pay-as-bid mechanism. The Commission recorded four reservations about that mechanism: (a) it creates sellers' surplus and rewards sellers only, contrary to equitable surplus distribution and social welfare; (b) disclosing sellers' bids to buyers but not vice versa creates information asymmetry and unequal opportunity; (c) buyers would be less motivated to bid relative to a uniform-price auction; and (d) the method is biased toward sellers and could suppress inter-exchange competition. In light of the exchange's explanations and delay since filing, the Commission allowed the exchange's matching mechanism to be used only with a modification: match the highest-paying buyer with the lowest-asking seller and set the traded price at the midpoint of their quotes, continuing this logic until the buyer or seller volume is exhausted.
- Open access and scheduling: The Commission directed that open access and scheduling must comply with the Central Electricity Regulatory Commission (Open Access in Inter-State Transmission) Regulations, 2008 (as amended) and that this be specified in the business rules.
- Operational directives for contingencies: In events of contingency or grid disturbance, directions of the load despatch centres (NLDC/RLDC) were to be followed to ensure grid security.
- Risk management and margins: Recognising that the exchange is the counterparty to transactions and faces price and volumetric risk, the Commission required a robust risk management system, prudent margins to ensure payment security, and disclosure of the margin methodology to participants before trading.
- Member responsibility and notification: The Commission emphasised that participants must satisfy themselves of the commercial aspects in the rules, uninfluenced by Commission approval, and required the exchange to notify existing and prospective members accordingly.
- Default, penalties and OTC services: The Commission required deterrent settlement penalties for willful default and declined permission for the exchange to provide OTC (bilateral) clearing and settlement services at this stage, directing the exchange to focus on price discovery and clearing/settlement of trades on its own platform.
- Administrative and drafting corrections: The Commission identified discrepancies and directed amendments to the rules, bye-laws and business rules, including clarifying membership criteria and fees for term-ahead market membership; permitting the exchange flexibility on many contract-parameter elements without prior Commission approval (with the exception that minimum bid volume must conform to relevant regulations under the Electricity Act, 2003); and requiring publication of a trading calendar and a three-month contract launch calendar prior to launches.
- Conditional approval and commencement: The Commission approved the rules, bye-laws and business rules subject to compliance with the directions, permitted the launch of the approved contracts, and ordered that the applicant and the other running exchange (India Energy Exchange) start term-ahead operations prospectively on or after 15.09.2009 after complying with the directions.
Holding and Implications
Final disposition: The petition is disposed of and approval is accorded to the applicant's rules, bye-laws and business rules, and permission is granted to launch the specified contracts, subject to the Commission's directions and compliance.
Direct consequences and practical implications set out in the opinion:
- The exchange is permitted to launch day-ahead contingency contracts and weekly contracts on a month-ahead basis, all for physical delivery, non-transferable, and without financial settlement.
- Contracts beyond one month ahead (two-month and three-month ahead) are omitted; the market will be reviewed after six months.
- The exchange may use its matching mechanism only after modifying price discovery to set traded prices at the midpoint between matched buyer and seller quotes (best buyer paired with best seller, iteratively) as specified by the Commission.
- The exchange must comply with CERC Open Access regulations for scheduling, follow NLDC/RLDC directions in contingencies, implement and disclose robust risk management and margin systems, and notify members that they must independently satisfy themselves of commercial aspects.
- OTC (bilateral) clearing and settlement services are not permitted at this stage; penalties for willful default are to be severe.
- The rules, bye-laws and business rules must be amended per the Commission's observations and submitted for record; any new contract types will require prior Commission approval.
- Both existing power exchanges (the applicant and India Energy Exchange) are ordered to commence term-ahead operations prospectively on or after 15.09.2009 after complying with the directions.
No broader legal precedent is stated to have been established by this opinion; the decision effects regulatory approval and conditions specific to the applicant and related operational directions.
Through this petition, the applicant, Power Exchange India Limited has sought permission to introduce additional contracts, namely day-ahead contingency contracts, weekly contracts, monthly contracts and intra-State contracts and approval of the revised rules, bye-laws and business rules.
2. Subsequently, The applicant through an interlocutory application had also prayed to change the time block of existing and proposed contracts from 1 hour to 15 minutes. Subsequently, the applicant vide affidavit dated 10.6.2009 prayed to de-link this prayer. The I.A for seeking the permission to introduce intra-state product has also been withdrawn.
3. The Commission vide its order dated 27.5.2008 accorded approval for setting up and operating the power exchange by the applicant. Finally, the power exchange became operational on 22.10.2008 The Commission conducted two hearings related to grant of permission to introduce additional contracts on term ahead market on 28.05.2009 and again on 16.06.2009
Type of Contracts
4. It is felt that the term-ahead market through the power exchange is a new concept, the Commission would like to start on a cautious note and therefore, we grant permission to the applicant for the launch of the following contracts,—
(a) Day ahead contingency contracts; and
(b) Weekly contracts on month-ahead basis (trading one month in advance with a delivery period of one week)
5. These contracts would be for physical delivery and would be non-transferable. Financial settlement of these contracts shall not be permissible.
6. Since the term-ahead market, wherein the contracts are for a future time period and with extended delivery period, results in price and volumetric risk simultaneously, for the time being the Commission grants permission for launch of these contracts up to one month ahead only. Accordingly, the clauses, and contract specification pertaining to month-ahead, two month-ahead and three month-ahead contracts shall be omitted from the rules, bye-laws and business rules and expression pertaining to day-ahead contingency contracts and month-ahead contracts modified accordingly.
7. The Commission shall review the performance of these contracts after 6 months.
Price Discovery Mechanism and Matching Rules to be used
8. The applicant has proposed the Pay-as-bid auction method as price discovery mechanism based on the price quoted by the buyer. Presently, the Commission has the following reservations with respect to the price discovery mechanism suggested by the power exchange:
(a) The suggested method, by design, fails to create any buyers' surplus and rewards the sellers only. This goes against the principle of equitable distribution of the surplus and social welfare.
(b) The process of disclosing the sellers' bids to the buyers and not vice versa fails the test of providing equal opportunity to all participants (both buyers and sellers) to maximize their profits and creates information asymmetry.
(c) In comparison to a uniform price auction where the buyers gets power at his quoted price or a lesser price, the buyer would be less motivated to bid in the suggested mechanism since it is assured of only his price and nothing better.
(d) This methodology of matching rules is biased towards the sellers, and therefore it is expected that, if approved, all the sellers will flock to only this power exchange, effectively preventing competition between the power exchanges.
9. In light of the time elapsed since submission of the petition and reasons furnished by the exchange for adopting the said matching mechanism, we allow the power exchange to use its matching mechanism with some modification in the price discovery methodology. The best buyer (highest paying buyer) shall be matched against the best seller (lowest asking seller) and the mid-point of their two quotes be decided as the agreed traded price (average of the matched buyer and the seller's quoted price). The same logic shall be extended till the buyer or seller volume is exhausted.
Open Access and Scheduling
10. The approved contracts are power contracts with constant MW to be supplied during the contract period. The applicant shall abide by the Central Electricity Regulatory Commission (Open Access in Inter-State Transmission) Regulations, 2008, as amended from time to time, for open access and scheduling procedure. This shall be specified in the business rules.
Contingency and grid disturbances
11. In case of contingency or grid disturbance, the directions of the load despatch centers (NLDC/RLDC) shall be followed to ensure grid security.
Risk Management System and Margin Requirements
12. The exchange is the counterparty to all transactions and is exposed to the risk of financial non-fulfillment of contracts. The adequacy and effectiveness of risk management is of paramount importance for power exchanges. The condition becomes further complicated in case of the power exchanges since electricity prices have high volatility, the term ahead market being contracts for a future time period and with an extended delivery period, have price and volumetric risk embedded in them. A well thought out risk management system and margin requirement able to handle these two risks needs to be put in place by the power exchange. The power exchange shall keep sufficient and prudent margin in order to ensure adequate payment security. The margin and the methodology for calculating the same shall be disclosed to the participants before they enter into any trade.
13. Notwithstanding the approval of the rules, bye-laws and business rules by the Commission, the persons enrolling themselves as members or clients of the power exchange or transacting business thereon in any capacity shall do so after satisfying themselves of all the commercial aspects covered under the rules, bye-laws and business rules, uninfluenced by the fact that the Commission has approved them since these matters are primarily the concern of the parties. The observation in this para shall be notified by the applicant to its existing members as also to the persons seeking enrolment as members or clients in future.
Default and Penalty
14. There should be sufficient deterrent built in the settlement system for any commercial consideration motivated default by participant due to market price variation. This is needed to maintain the sanctity of the contracts. Penalty for willful default to profit from better price in other markets shall be treated severely.
15. The applicant has sought permission for providing Over-the-counter (OTC) clearing and settlement services. At this nascent stage of market development, the Commission is of the view that the exchange should focus on the price discovery and clearing and settlement of contracts traded on its own platform. Therefore, the OTC (bilateral) clearing and settlement services shall not be provided by the power exchange.
General
16. The following observations/discrepancies are observed in the rules, bye-laws and business rules for further submission after necessary correction are listed below:
(a) It has been submitted that the membership criteria and member-client relationship shall be the same as in the case of day-ahead market. However, a provision shall be made in the business rules clarifying the membership criteria including membership fee details to distinguish between day-ahead market and term-ahead market membership for information of all concerned.
(b) Contracts Specification-The applicant has sought flexibility in contract specifications for creating a responsive place. The power exchange need not take approval on the following parameters of the contract specification,
(i) Basic contract specification except minimum bid volume which shall be as per the relevant regulations under Electricity Act, 2003.
(ii) Trading hours and bidding session: The power exchange shall submit an overall plan on details like start and end date of the trading window before the launch of different kinds of contracts by preparation of a trading calendar pertaining to each kind of contract. The contract launch calendar for the next 3 months shall be published by the power exchange to create an environment of certainty and planning activity for the participants,
(iii) Margins;
(iv) All kinds of penalties;
(v) Settlement of trade;
(vi) Minimum volume quotation step;
(vii) Minimum value quotation step;
(viii) Trading time on the contract day;
(ix) Transaction fee;
(x) Revision Charges; and
(xi) Default in Payment.
17. The rules, bye-laws and business rules shall be amended in accordance with the directions given above and submitted to the Commission for information and record.
18. Subject to the compliance of above directions, approval is hereby accorded to the rules, bye-laws and business rules submitted by the applicant and the applicant is permitted to launch these contracts. The rules, bye-laws and business rules approved are applicable to the contracts approved with the flexibility given to amend certain parameters of the contract specifications as given above. In case the applicant intends to start any other type of contract, it shall obtain prior approval of the Commission.
19. In order to ensure equal opportunities, it is desirable that both the running power exchanges, namely applicant and India Energy Exchange (the applicant in Petition No. 120/2008) start their operations in the term-ahead market simultaneously. Therefore, it is ordered that both the power exchanges shall commence their operations prospectively, on or after 15.9.2009, after complying with the directions given above.
20. With the above, petition is disposed of.
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