The Federal Energy Regulatory Commission on May 29 signed off on tariff revisions designed to bolster the PJM Interconnection's ability to evaluate the risk of default in its markets after GreenHat Energy LLC, a trader of financial transmission rights, did just that.

In June 2018, GreenHat failed to fulfill its financial obligations in PJM's financial transmission rights market, which is designed to help traders manage grid congestion costs. The default saddled other participants with $160 million in liabilities. It also prompted PJM to commission an independent report that examined the factors behind GreenHat's default and provided recommendations for corrective action moving forward.

Based on the report's findings, PJM in March filed proposed tariff revisions (FERC docket ER20-1451) that would establish "know your customer" procedures that included adding a risk evaluation function to its market rules. The revisions would allow PJM to obtain and process a significantly greater amount of information regarding credit risk on an initial and ongoing basis, PJM maintained.

PJM also proposed to create a new risk scoring methodology that assigns a forward-looking internal credit score to each market applicant based on quantitative and qualitative metrics. The score will be a numeric rating of one through six that aligns with credit risk methodologies used by S&P Global Ratings, Fitch and Moody's. To create the score, PJM will evaluate applicants' capital and leverage, cash flow coverage of fixed obligations, liquidity, profitability, and other qualitative metrics.

PJM would use this initial credit risk evaluation to help assess whether an applicant presents unreasonable credit risk based on the likelihood of default. The grid operator will also consider other factors, such as any history of market manipulation, financial defaults over the previous five years, low capitalization, or a likely future material financial liability. If an applicant is deemed to pose unreasonable credit risk, PJM said it may require collateral commensurate with the risk of default.

Commenting on the proposal, Dominion Energy Inc. subsidiary Dominion Energy Services. Inc. noted that the revisions would allow PJM to consider its internal credit score even when external credit ratings are available. The company said this will create uncertainty because market applicants will not know which credit rating PJM utilized in determining a participant's credit score.

FERC disagreed, however, noting that PJM was previously only able to rely on external credit ratings that do not reflect market or liquidity risk and "can go stale quickly."

"With the ability to consider both external credit ratings and its internal credit score, PJM will have more insight and visibility into the credit risk posed by a particular applicant or market participant and can react quickly to minimize financial exposure," FERC said. Under the changes, companies will also be provided with their internal credit score upon request.

FERC also noted that the tariff revisions require PJM to provide a written explanation of decisions to require collateral to mitigate unreasonable credit risk. Moreover, PJM's proposed changes allow participants to provide supplemental information to reduce the need for additional collateral.

In a joint concurrence to FERC's May 29 order, Commissioners James Danly and Richard Glick acknowledged that "we are made somewhat uneasy by the breadth of the discretion afforded to [PJM] in making creditworthiness decisions." But, "on the whole, PJM's proposal is at least as exacting as others we have approved and is otherwise just and reasonable."

Calling the revisions "an important first step" for PJM, Danly and Glick said further changes should be considered not only in PJM but other organized markets as well. In doing so, they pointed to a pending petition (FERC docket AD20-6) seeking a technical conference and rulemaking to update FERC's broader credit and risk-management practices.