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Letter #???April 2007SPARK

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Letter #72December 2009

CARBON TRADINGregulatory ambiguity thatreflects attempts to controlso-called “excessive specu-lation” that allegedly ledboth to soaring energyprices, and to risk-takingthat propelled the financialcrisis. Recent initiatives byindependent regulators andCongress illustrate both thecomplexity and potentialconflicts that various regu-latory approaches willbring, indicating that thepath to new carbon tradingmarkets will not be smooth.

CFTC PositionOn Sept. 9, 2009, the U.S.

Senate Committee on Agri-culture, Nutrition, andForestry held a hearing toconsider the American CleanEnergy and Security Act(ACES), also known as theWaxman-Markey Bill.Passed by the U.S. House ofRepresentatives on June 26,2009, ACES would create acomprehensive, economy-wide cap-and-trade pro-gram to reduce GHG emis- »

Who Will RegulateThe Markets?BY KARI S. LARSEN

What should utility companiesknow about credit card use forcustomer bill payments?

You would know if you read Fortnightlymagazine. Click here for the answer.

1CARBON TRADING

Who WillRegulate TheMarkets?By Kari S. Larsen

3NERC COMPLIANCE

The BarIs BeingRaisedBy Cristin Lyons

7UTILITY PAYMENTS FRAUD

A Battle YouCan WinBy Rossana Salaris, AAP

Expect fines for non-compliance with NERCreliability standards toincrease unless utility com-panies build a sustainableNERC compliance pro-gram. Author CristinLyons explains how yourcompany can avoid pitfallsby using more effective organizational design withclear roles and behavioralincentives.

The bad economy isprompting an increase inutility payments fraudattempts. Rossana Salaristells how to thwart cyber-criminals and protect revenues.

Both articles aim to helpprotect the bottom line.

L. A. BurkhartEditor

A variety of administrative and legislative initiativesintended to reduce greenhouse-gas (GHG) emissionsin the United States propose to create vast new com-modity markets for the trading of GHG emissions

allowances, GHG offsets and renewable energy credits (RECs).Yet, along with this market opportunity comes considerable

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give the CFTC additional experienceregulating cash emissions contracts,and claimed that, should Congress seekto regulate cash markets for emissioninstruments, the CFTC is well suited tocarry out that function.

In support of allowing the CFTC tooversee carbon trading, Gensler saidthat the CFTC has, “thorough processesto ensure that exchanges have proce-dures in place to protect market partici-pants and ensure fair and orderly trad-ing, that products are designed to mini-mize potential manipulation and thatexchanges comply with the law andregulations.” He also noted that theCFTC has transparency efforts to pro-vide information to the U.S. public.Finally, if cap-and-trade legislation ispassed, the CFTC would work togetherwith other regulators to create a centralregistry of carbon transactions in orderto help identify market manipulation.

ACES ApproachGensler’s strong pitch for CFTC

oversight is significant

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Page 2 December 2009

sions. The hearing focused on, amongother issues, regulation of carbon mar-kets, and in it Chairman Gary Gensler ofthe U.S. Commodity Futures TradingCommission (CFTC) testified that theCFTC is fully capable of regulating trad-ing in the carbon markets. ChairmanGensler noted that five regulatory com-ponents should be considered:

� standard setting and allocation; � recordkeeping; � overseeing trade execution system; � overseeing clearing of trades; and � protecting against fraud, manipu-lation and other abuses. Although other agencies, such as the

Environmental Protection Agency, arebetter equipped to regulate emissionallowance allocation and recordkeep-ing, “the CFTC has a great deal of expe-rience regulating the ‘trade’ part of‘cap-and-trade,’” Gensler said. Genslercited the CFTC’s experience in oversee-ing trading and clearing of futures con-tracts based on sulfur dioxide, nitrogenoxide and carbon dioxide allowances.

(Cont. on p. 9)

In addition, Chairman Gensler notedthat the CFTC recently asked for publiccomment regarding classifying the car-bon financial instrument (CFI) contracttraded on the Chicago ClimateExchange as a significant price discov-ery contract (SPDC). Should the CFTCclassify the CFI contract as an SPDC,the CFTC would gain increased over-sight authority over the contract. Chair-man Gensler said this oversight would

Gensler’s strong pitch for CFTC oversight

is significant because the version of ACES

passed by the House has a complex

regulatory structure that involves active

roles for the FERC as well as the CFTC.

Take a look at the fines by region (seeFigure 1), as of November 15, 2009:1

While ensuring that work is per-formed in accordance with the stan-dards is paramount, effective organiza-tion and efficient processes are key ele-

ments of creating a sustainable NERCcompliance program. Amidst increas-ing scrutiny and higher fines for stan-dards violations, companies shouldfocus their attention in three areas:

� Setting an organization design to

effectively govern and manageNERC compliance; � Clarifying processes, roles, andresponsibilities; and� Incenting the right behavior.

Organization Design & NERC Compliance While significant time and attention

have focused on preparing for NERCaudits, less attention has been paid tohow NERC compliance efforts can bestbe organized across the enterprise.After passing the initial round ofaudits, many companies breathed asigh of relief knowing that they wouldhave a three-year hiatus until the nextround. However, companies are ill-advised to rest on their laurels, giventhe increased scrutiny the standards arereceiving.

Though the organization of NERCcompliance efforts was not critical toensuring that companies completedtheir initial audits successfully, it isgaining in importance as the require-ments for evidence and documentationbecome more stringent. Initially, it mayhave been acceptable for variousdepartments to bring their documenta-tion to an audit in myriad formats withverbal explanations of how the piecesfit together. Recent audit findings andguidance provided by the RegionalReliability Organizations (RROs) sug-gest that this will not be the case

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December 2009Page 3

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NERC COMPLIANCE

The Bar is Being RaisedBy Cristin Lyons

T he NERC reliability standards became enforceable in 2007, and the first finesunder the standards were assessed in mid-2008. Since then, companies havebeen fined almost $27 million, $25 million of which was a single, negotiatedfine to Florida Power & Light (FPL) for alleged violations stemming from

the Florida blackout of February 2008. These fines continue to focus the industry’sattention on compliance, and the prevailing wisdom is that the bar is being raised.What sufficed for compliance under the standards in the past will not suffice in thefuture, and we should expect increased fines in the coming years. Some suggestthat the FPL fine is just the harbinger of things to come.

FIG. 1 NERC FINES BY REGIONS

Source: ScottMadden, Inc.

going forward. A systematic approachto managing documentation, selfreports, self-certifications, and prepara-tion for audits will be important. Theseelements are difficult to manage with-out centralized governance.

There are three alternatives emerg-ing as to how to manage NERC compli-ance efforts (see Figure 2):

A centralized group may house boththe operational experts and the stan-dards experts and be responsible forensuring that the company is compli-ant. In a hybrid organization, a central-ized group oversees compliance for theenterprise, but the individual businessunits and their relevant subject matterexperts ensure activities are compliantand that the appropriate evidence anddocumentation are in place to provethis. In a decentralized model, businessunits are responsible for compliancewith minimal oversight.

While all three models (and varia-tions on them) are appearing in theindustry, a hybrid version appears to

be the most common. In a recent Info-cast webinar on the topic, all the pan-elists discussed employing some formof centralized governance.

The FPL settlement agreement forthe Florida blackout provides an indi-cation of FERC’s preference for central-ized management of the compliancefunction. The following are some of theactions required under the stipulationagreement:2

� Development of specified rolesfor senior management involvement;� Independent reporting of compli-ance management to senior execu-tives outside of the business unitsthat plan, operate, and maintainbulb electric system (BES) equip-ment;� Internal auditing;� Accountability for reliability incompensation packages;� Improvements to document data-bases, processes, and training;� Practice audits of all FPL businessunits; and

� Assessment of NERC complianceeducation and training for allemployees responsible for compli-ance with the standards.No single model has emerged as

“the answer;” however, there are someimportant elements that each mustinclude:

� Roles and responsibilities aredefined;

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December 2009Page 4

THREE ALTERNATIVES TO MANAGE NERC COMPLIANCE

Source: ScottMadden, Inc.

FIG. 2

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� Processes are clear; � Accountability is managed; and� Executive line of sight is main-tained.These are generally easier to manage

in a centralized or hybrid organization.NERC compliance differs from

many other types of compliance forwhich a company is responsible, so it isnot necessarily a natural fit within theregulatory or legal groups. The level ofsubject expertise required to bothunderstand the work and the require-ments means that companies must relyheavily on the technical experts in the

business units. While these subject mat-ter experts will understand the workand the requirements, they may nothave the experience or the time toensure all of the processes required tomanage the data and evidence are inplace. This again speaks to the need fora central group to assist in theseprocesses.

Because the vast majority of theNERC reliability standards impact thetransmission organization, it may betempting to allow transmission to serveas the lead in managing the corporateNERC compliance program. This has

risks, as the head of transmission maynot have the leverage or staff to pro-vide oversight of the work done in theother business units. There is also a riskthat key compliance processes such asself-reporting, self-certification, andmock audits will be performed to dif-ferent levels of quality across the busi-ness units. This can be particularlyproblematic if one organization per-forms work for another within thecompany (i.e., the transmission organi-zation is contracted to perform work ingeneration switchyards). Having onebusiness unit provide oversight of thework of another will create challenges,as the only natural arbiter for disputesis senior management. If an oversightgroup in a shared services function isgiven this role outside the businessunits, the authority for providing thisfunction is clearer.

In our view, the hybrid model ismost effective for managing NERCcompliance. It facilitates executiveoversight and ensures consistencyacross the business units. While thisorganizational model is preferred, itseffective execution is highly dependenton efficient processes and well-definedroles and responsibilities.

Roles and ResponsibilitiesInvariably the questions that will be

asked when a violation occurs are:Whose fault is it, and who is

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December 2009Page 5

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OVERSIGHT ROLES & RESPONSIBILITIES

Source: ScottMadden, Inc.

FIG. 3Compliance Process Oversight Group Business Units

Setting Standards for • Establishes the standards that • Ensures that the work being done NERC Compliance documentation must meet meets the standards

• Creates formats and templates • Creates the documentation needed that the business units use for to demonstrate compliancedocumenting compliance

Self-Certification • Ensures that the company self- • Provides evidence to the certifying certifies on the required dates officer that the organization is in • Reviews evidence with the compliancecertifying officer

Audit Preparation • Manages preparation for an audit • Ensures that standards are assigned • Educates business units on the to specific subject matter experts standards and their requirements • Works with the oversight group to • Educates business units on ensure that subject matter experts the audit process are prepared and have all the • Reviews evidence necessary supporting evidence

• Completes RSAWs

Standards • Coordinates standards develop- • Provides subject matter experts to Development ment efforts contribute to select drafting teams

• Ensures corporate priorities are addressed

Internal Audit • Identifies deficiencies in documen- • Provides subject matter experts to tation and evidence through internal amend documentation and evidence spot checks or mock audits to meet the standard set by the

oversight organization Self-Reporting • Manages the process to identify • Identifies incidences of non-compliance

violations and self-report to the and provides them to the oversight groupRRO as appropriate • Provides subject matter expertise• Serves as the primary point of during any investigation contact with the RRO

Investigation and • Manages the negotiations with • Provides evidence and support Settlements the RRO, NERC, and FERC for negotiations

• Works with senior management • Provides engineering or other expertiseto determine negotiating position; on company compliance with standardapprove settlement

responsible for fixing it?The assignment of roles and respon-

sibilities and clear handoffs betweengroups responsible for NERC compli-ance are of paramount importance,given the potential financial and repu-tational impact of a serious violation.Once the organization has decided howbest to organize its NERC complianceefforts, attention should turn to assign-ing and communicating roles andresponsibilities. Amatrix similar to theone shown should establish the rolesand responsibilities of the oversightgroup and the business units (see Figure 3).

The division of responsibilitiesbetween the oversight group and thebusiness units will differ depending onthe company. The matrix is meant to beillustrative only; however, companiesshould consider all of these processesin assigning corporate responsibilitiesfor NERC compliance (see Figure 3).As more of these functions move into a centralized group, the organizationmoves to the left on the continuum inthe previous diagram (see Figure 2). As more of these functions appear inthe business units, the organizationappears to the right of the hybridmodel. The further away from the centralized model a company moves,the more important good handoffs and clear responsibilities become. Theentire organization needs to under-stand who is responsible for theseprocesses and where the handoffsoccur between the oversight group andthe business units. With the stakes sohigh, finger pointing is inevitable whensomething goes wrong, unless every-one is crystal clear about their role.

Because I Said So Assuming that an organization has

determined how to organize NERC

compliance and then has assigned rolesand responsibilities, how can it ensurethat staff is incented to perform accord-ingly? One of the key challenges inmanaging NERC compliance activitiesis incenting the right behavior. Thiscannot be done until all parties under-stand their responsibilities. As men-tioned previously, one of the require-ments of the FPL stipulation agreementwas “accountability for reliability incompensation packages.”

Because an organization will see thebehavior it incents, it first should deter-mine which behaviors are most impor-tant in NERC compliance. This soundsstraightforward, but in compliance—assometimes seen with safety—there canbe a risk of unintended consequences.For instance, if a company sets a goal tohave no compliance violations,employees may be discouraged fromself-reporting an incident which couldbe a violation of the standards, particu-larly if this will impact their bonus pay-out. This may put the organization atrisk later when the same item is uncov-ered in an RRO audit. On the otherhand, if the goal is focused on havingno violations found in an externalaudit—but violations found by internalstaff are acceptable—this will focusemployee efforts on ensuring compli-ance and appropriate self-reporting.While this could cause a significantnumber of self-reports to be submittedto the RRO, it is probably the preferablescenario.

Once the appropriate levers areidentified, companies should includecompliance in corporate performancegoals and individual pay incentives.

In summation, with FERC andNERC focusing more and more atten-tion on reliability standards, companiesshould take the opportunity now toensure that they have the appropriate

organizational structure, processes, androles and responsibilities in place tomanage their NERC compliance pro-grams. Over time, managing compli-ance should become like managingsafety—it should be part of the fabric ofthe organization, not an effort apart.That will only happen after the struc-ture and processes are effectivelyimplemented and employees are moti-vated to act accordingly. �

ENDNOTES:1. http://www.nerc.com/filez/enforcement/

index.html

2. Order Approving Stipulation and Consent

Agreement, Docket No. IN08-5-000, Stipulation

and Consent Agreement between FERC, NERC

and Florida Power and Light Company, Septem-

ber 25, 2009

Cristin Lyons is a partner with ScottMad-den, Inc. where she leads the firm’s transmission practice. She has been con-sulting in energy since 1999 and recentengagements have focused on transmission operations, NERC compliance, Smart Gridinitiatives and transmission acquisitions. She may be reached at cmlyons@scottmad-den.com.

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December 2009Page 6

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Cybercriminals, mainly operatingfrom Eastern Europe, are utilizingspear phishing emails and key loggermalware to harvest bank account log-on credentials (aka corporate creden-tials takeover) and illegally initiateACH transfers. The funds aredeposited into the accounts of oftenunwitting money mules who aretricked into transferring the moneyoverseas where it cannot be traced.Businesses of all sizes are vulnerable,though small and mid-size businessestend to bear the brunt of these attacksdue to a perceived lack of securityresources and sophistication.

Build An Arsenal To Fight FraudUnlike paper checks, which by their

very nature leave an information trailthat is easily susceptible to fraud, cor-porations are well positioned to takeproactive control over managing elec-tronic payments fraud risk. In fact, AFPdata shows that the vast majority oforganizations that suffered a financialloss as a result of corporate credentialtakeover fraud did not follow bestpractices and/or execute their ownbusiness rules as expeditiously as nec-essary. The Clearing House recom-mends that corporate financial profes-

sionals consider implementing a dual-prong payments fraud prevention ini-tiative designed to thwart fraudattempts at various junctures in theprocess.

1. Secure sensitive log-on creden-tials: It is critical to understand that inelectronic payments fraud, the ACHnetwork itself never actually isbreached. The gateway to fraud is com-promised user IDs and passwords thatcriminals leverage to penetrate corpo-rate bank accounts and initiate unau-thorized transactions. As such, the firststep to mitigating fraud risk is imple-menting best practices to protect confi-dential personal data from theft:

� Conduct new hire and ongoinginformation security training foremployees to enhance awareness ofevolving online threats;� Avoid online solicitations frombanks and other credible institutionsthat direct recipients to click intolinks or submit password/accountID data. These e-mails are likely tobe fraudulent as most banks havepolicies that prohibit the use of e-mails to request account or user IDinformation;� Require multi-factor authentica-tion log-on features from your finan-

cial institution using secure tokensand other methods to ensure that anauthorized user is logging on. UserIDs and passwords no matter howcomplex or frequently changed areinadequate in today’s online envi-ronment;� Install and regularly update fire-walls, spyware and commercial anti-virus software, especially if using abroadband or dedicated connectionto the Internet, such as DSL or cable;� Create complex passwords withat least 8 characters that include acombination of mixed case letters,numbers and special characters andavoid using an automatic login fea-tures and prohibit the use of“shared” usernames and passwordsfor online banking systems;� Limit administrative rights onusers’ workstations to help preventthe inadvertent downloading ofmalware or other viruses; and� Disable user IDs and passwordsfor employees on leave or extendedvacation and delete online user IDsas part of the exit procedure whenemployees leave the company.2. Bolster financial transaction

process safeguards: To further mini-mize the risk of improper transfers, cor-porations should evaluate internalprocesses and leverage the numerousprotective mechanisms available fromfinancial institutions. Specifically:

December 2009Page 7

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UTILITY PAYMENTS FRAUD

A Battle You Can WinBY ROSSANA SALARIS, AAP

F raud is a multi-billion dollar industry and corporations are an obvious andfrequent target, particularly during a period of economic downturn. Recentresearch from the Association of Financial Professionals (AFP) and JPMor-gan Chase shows that 71% percent of organizations experienced actual or

attempted payments fraud in 2008. While check-fraud still substantially outpacesother forms of payments fraud, recently there is a proliferation of activity involv-ing fraudulent transfers from corporate accounts utilizing electronic paymentsmechanisms such as automated clearinghouse (ACH). This is not surprising giventhe explosive growth of ACH during the last ten years (from 3.9 billion paymentsin 1996 to 18.2 billion in 2008 with associated transaction values almost tripling to$32.9 trillion during the same period).

� Request positive pay/reversepositive pay, ACH debit blocks anddebit filter restrictions on depositoryaccounts from financial institutions.These tools create additional barri-ers against improper account debits;� Conduct daily account reconcilia-tion to facilitate early detection ofunauthorized activity;� Ensure the system provides anaudit trail with complete reports ofpayment transactions, includingeach action involved, the user whoperformed the action and thedate/time of the action; and� Immediately escalate any suspi-cious transactions to the financialinstitution as there is a limitedrecovery window for these transac-tions and immediate escalation mayprevent further losses. Furthermore, one of the strongest

lines of defense available to corpora-tions is Universal Payment Identifica-tion Code (UPIC) ®. Available frommany banks, a UPIC is a secure identi-fier that masks actual bank accountinformation for incoming electronicpayments. A UPIC eliminates the needto divulge sensitive account informa-tion to vendors and can even be placedon a company’s Web site without fearof compromise. Since its introductionin 2004, UPIC has been experiencingdouble to triple digit growth for severalyears and has been embraced by corpo-rations as a critical tool for combatingcyber fraud.

Since UPIC is designed specificallyfor credits, it is a particularly valuabletool for a sector such as utilities whosecore business is premised on incomingpayments. Ameren, a leading U.S. util-ity serving approximately 2.4 millionelectric customers and nearly 1 millionnatural gas customers across Missouriand Illinois, has been using UPIC suc-cessfully since 2006. Because of thescale of its business, Ameren is heavily

dependent on electronic payments toimprove efficiency and streamline itsoperations. Simultaneously, Ameren isfocused on preventing bank accountfraud to ensure the confidentiality ofmillions of customer payments.

“UPIC has played an integral role inhelping us mitigate fraud risk,” saysStephen T. Lux, assistant treasurer,manager, Banking & Trust Investments,Ameren Corporation. “First, we nolonger have to furnish our real bankinginformation to anyone who wants tosend us electronic payments, which in

the wrong hands, could be used forillicit activities. Secondly, if anyoneattempted to debit our bank account,the transaction would be rejectedbecause UPICs disallow debits andeliminate the possibility of authorizedchecks and demand drafts.”

Moreover, a secondary benefit ofUPIC is portability. Since a UPIC essen-tially becomes an organization's per-manent electronic payment address, itcan significantly reduce interruptionsand costs (i.e., providing customerswith new payments information)related to account changes brought onby bank or corporate mergers.

In summary, given the substantialcost, convenience and environmentalbenefits, it is not surprising that fore-casts indicate continuing and escalatingmomentum for the transition to paper-less payments by both companies andconsumers. Unfortunately, as technolo-gies and processes become more inno-vative, so do criminals seeking to abusethem. Therefore, it is incumbent uponcorporate financial professionals toevaluate and reinforce their paymentssystems to mitigate fraud and maxi-mize the advantages of emerging digi-tal payments technologies. �

Rossana Salaris, AAP, is senior vice presi-dent, Payments Products for The ClearingHouse, the nation’s largest, private-sectorprovider of wire, ACH and check imageexchange solutions. For more information,visit www.theclearinghouse.org.

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December 2009Page 8

The gateway to fraud

is compromised user

IDs and passwords

that criminals lever-

age to penetrate

corporate bank

accounts and initiate

unauthorized

transactions.

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track trades—all provisions that are notcontained in ACES.

On Sept. 30, 2009, Senators JohnKerry (D-Mass.) and Barbara Boxer (D-Cal.) announced the introduction of theClean Energy, Jobs and American PowerAct, which in many respects mirrorsthe provisions of ACES. One importantissue not addressed by the Kerry-Boxerbill is the form that regulatory oversightof newly-created carbon allowance andoffset markets would take. In contrastto provisions of the House bill relatingto the roles of FERC and the CFTC inregulating carbon and carbon futuresmarkets, the Kerry-Boxer bill includesin a section covering carbon marketoversight only the “sense of the Senate”that there shall be a “single, integratedcarbon market oversight program”designed, among other things, to“ensure a well-functioning, well-regu-lated market, including a futures mar-ket, designed to manage risk and facili-tate investment in emissions reductions.. . .” It is unclear whether the Senateversion will ultimately borrow broadlyfrom the Feinstein-Snowe proposal orthe House proposal with respect toGHG market oversight.

In late October, FERC Chairman JonWellinghoff testified on the Kerry-Boxer bill before the Senate Environ-ment and Public Works committeechaired by Sen. Boxer. Acknowledgingthe bill’s call for an unnamed single

December 2009Page 9

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CARBON TRADING(Cont. from p. 2)

because the version of ACES passed bythe House has a complex regulatorystructure that involves active roles forthe Federal Energy Regulatory Com-mission (FERC) as well as the CFTC.ACES would amend the Federal PowerAct to provide for oversight and regu-lation of the new GHG allowance andoffset markets, appointing FERC theagency responsible for promulgatingregulations for the establishment, oper-ation and oversight of the new GHGcash markets. In particular, FERCwould be charged with protecting thepublic from manipulation, fraud andexcessive speculation in the carboncash markets. ACES also would requireFERC to provide measures to limit“unreasonable fluctuation in the pricesof regulated allowances” and to“ensure market transparency.” TheFERC also would be authorized to setposition limits and margin require-ments, as necessary, “limit or eliminatecounterparty risk,” and set standardsfor trading facilities for the cash mar-kets. ACES would provide for penaltiesfor violations and grants FERC ceaseand desist authority.

As currently drafted, ACES alsowould give the CFTC authorization tomonitor the carbon derivatives mar-kets. The President is required to estab-lish an inter-agency working group inorder to make recommendations to theCFTC regarding proposed regulationsconcerning the “...establishment, opera-

tion and oversight of markets for regu-lated allowance derivatives.” How-ever, regulated allowance derivativesare no longer defined in ACES and it isunclear which transactions would fallunder the jurisdiction of the FERC andwhich would fall under the jurisdictionof the CFTC.

Other InitiativesIn early July, Senators Diane Fein-

stein (D-Cal.) and Olympia Snowe (R-Maine) introduced legislation in theSenate regarding federal oversight ofGHG allowances markets. Their bill (S.1399) would require most trading inpermits and their derivatives to takeplace on regulated exchanges orthrough a “carbon clearing organiza-tion” to be established by the CFTC. Asmall number of derivatives contractsthat can’t be standardized forexchange-based trading could bebought and sold in private over-the-counter deals, as long as they arereported to the CFTC. This is in con-trast to the provisions of ACES, whichwould divide the oversight authoritybetween the FERC for cash-basedallowances trading, and (seemingly)the CFTC for carbon futures and deriv-atives trading. The Feinstein-Snowe billalso proposes to classify standardizedbilateral swaps as regulated deriva-tives, create professional standards forcarbon traders and brokers, and estab-lish a centralized electronic database to

The financial turmoil of 2008 resulted ina groundswell of support for increasedmarket regulation.

carbon market regulator, he simplychose to “defer to Congress on whichagency should oversee such a program,so long as any legislative language pre-serves [FERC’s] existing jurisdiction”over market manipulation that mightimpact the regional transmissionorganizations (RTOs) and independentsystem operators (ISOs) that are thebackbone of the electric power trans-mission infrastructure. Interestingly,earlier in the year, when the prospect ofFERC as the carbon market regulatorwas first raised by some in Congress,press reports quoted Wellinghoff asexpressing reluctance about such a role,saying that “it really goes beyond thetraditional boundaries of what FERChas regulated in the past. There’s anumber of other federal agencies thatmay be in a better position to overseethat [carbon market].”

In addition, other legislative initia-tives may have an impact on carbonmarket regulation. On Aug. 11, 2009,the Obama Administration deliveredlegislative language to Congress focus-ing on the regulatory reform of OTCderivatives markets. The proposed leg-islation would:

� require central clearing and trad-ing of all standardized OTC deriva-tives;� institute higher capital require-ments and higher margin require-ments on certain swaps and marketparticipants;� require transparency of OTCderivative markets;� impose registration, businessstandards and other new require-ments on “swap dealers” and“major swap participants;”� give the CFTC and SEC additional

tools to prevent manipulation andfraud in the OTC markets; and � further restrict the definition ofeligible participants able to entercertain OTC derivative transactions. These provisions do not specifically

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FORTNIGHTLYNext Month’s

The January issue of Fortnightly magazine kicks the New Year off with a very timely Green Issue. It is a can’t-mississue that will have everyone talking. Editor-in-chief Michael T. Burr provides eye-opening insight into the politicsbehind going green.

Here is more of what you will find:

� Energy Risk and MarketsPoint—LMP Works! The use of locational marginal pricing in PJM markets proves LMP works in a competitive market and appropriatelyresponds to demand and fuel prices.

Counterpoint—Not So Fast: Fuel costs and demand are correlated with electricity prices, but that says nothing about wholesale market performance.

� Rethinking Rate DesignThe architecture of demand response is changing in the United States. Pricing pilots are needed to help form rate designs in concert with technology innovations to ensure demand response plays a prominent role in meeting energy requirements.

� Mandating Federal RenewablesThe feds are ready to replace disjointed state policies with a coordinated national renewable energy credit market. Treating low-carbon energyconsistently will promote investment in renewables.

� Greening ConnecticutStates should revisit their renewable incentive programs to better align them with renewable portfolio standards goals.

� Federal-State PartnershipThe federal government hopes to stimulate state regulatory and legislative policies to help transform demand response and smart-grid planninginto reality. The transformation will be national in scope and so should be solutions, products and services.

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address the cap-and-trade markets, butwill have substantial impact on them ifpassed.

Regulatory UncertaintyIt remains highly uncertain how all

these different initiatives will play out,particularly in light of CFTC ChairmanGensler’s stated intention to assert aprimary regulatory role for his agencyin any cap-and-trade market regime.The energy markets have been trans-formed by financial innovation in thepast decade, but the financial turmoilof 2008 resulted in a groundswell ofsupport for increased market regula-tion. The environmental and financialbenefits that new GHG markets willbring are, for the most part, eagerlyanticipated, but these markets will be

adversely affected by regulation that is inefficient, confusing or overlyrestrictive. �

Kari S. Larsen is a partner in the law firmof McDermott Will & Emery LLP. She is a member of the Firm’s Energy and Derivatives Markets Practice Group, andco-founder of the firm’s Global RenewableEnergy, Emissions and New (GREEN)Products Group, where she focuses herpractice on transactional, regulatory andrisk management matters relating to U.S.and EU commodity and energy markets,with a particular concentration on emis-sions allowance/offset and renewableenergy sales, projects and trading. Ms.Larsen can be reached at +1 202 756 8374or klarsen@mwe.com.

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