Risky Business: Navigating PJM's Risk Requirements and Audits

Concerned about the Pennsylvania-New Jersey-Maryland Interconnection (PJM) risk review process? Need to understand PJM’s risk requirements? Facing an audit of your current policies under the new know-your-customer (KYC) process? 

PJM has multiple risk requirements that you must follow, starting with the creation of a risk policy and risk management program. These arose from recent market defaults or regulatory changes, such as the GreenHat default and FERC Order 741/741A.  

Let’s explore these risk requirements, PJM’s enhanced KYC program, what a risk policy review or audit looks like, what happens if you have deficiencies in the audit, and how Yes Energy® can help.

PJM’s Risk Policy Requirements

PJM, like the other US Independent System Operator (ISO) and Regional Transmission Organization (RTO) markets, has requirements for participants’ risk policies. While each market participant must have a risk policy and risk management program, the requirements are higher for financial transmission rights (FTR) market participants.

Company Description and Strategy

PJM looks for a description of your company and how you plan to address risk in your organization. This includes knowing who owns your organization, what the corporate structure is, and who your affiliates are. They also want to understand your goals and high-level strategy in participating in the PJM market: Are you hedging? Trading only? Providing energy management services? 

They’re also keen to see how your risk function is structured. Your risk policy needs to grant your risk officer proper authority to perform their duties. The risk policy should specify what products and markets you participate in and what traders are authorized to participate in each of those products and markets.

PJM Risk Management and Reporting

It isn’t enough to grant your risk officer the authority they need, you also have to make sure that your risk metrics and monitoring are sufficient. This includes ensuring that your traders are properly authorized to trade and that there’s oversight of their trading activities.  

You also need to ensure that you’ve properly defined the methodology for your risk metrics and have reporting in place to monitor the risk that trading generates to the limits of your organization.

PJM also looks to understand if you have sufficient liquidity on hand. This means that you hold back a portion of your capital to cover any losses you may have trading in the market. Also, you must ensure that proper counterparty risk practices exist if you’re trading bilaterally. A counterparty default could lead to a liquidity situation if your credit risk practices aren’t sufficient.

Oversight, Governance, and Compliance

Setting up risk policies and calculating risk metrics is only part of an effective risk management program. You should also periodically review your risk policy to ensure it continues to be effective.  

Ensuring that your organization complies with the risk policy is also a required element. This includes making sure that you’ve defined the repercussions of a policy violation. If a trader exceeds a limit, you should know what the risk officer should do and whether your organization is following those steps.

Due Diligence, KYC, and AML

Recently, PJM has focused on Know Your Customer (KYC) and anti-money laundering (AML) policies. PJM wants to ensure that you know who you are transacting with and that you’ve reviewed all your counterparties.  

AML policies are a more recent addition to PJM’s risk policy requirements, ensuring that you are not providing an avenue for sanctioned persons or organized crime to launder funds.  Lightheartedly, if an oligarch from a sanctioned country offers you a suitcase of cash, that would raise money laundering concerns. 

Participants in the market must also follow the Foreign Corrupt Practices Act, demonstrating that they’re not involved in any bribes to foreign officials. In addition to that, you need a policy that complies with the Corporate Transparency Act and any government sanctions. 

PJM’s KYC Program Enhancements

Coming out of the GreenHat default, PJM is working to vet market participants more thoroughly. This includes disclosure of principals:

And disclosure of beneficial owners:

PJM will now confirm the identity of all principals and beneficial owners through government-issued IDs, their ownership percentages, and disclosure of the principals’ backgrounds and experience.

PJM’s Risk Policy Reviews and Audits

Since summer 2024, PJM has begun implementing its newly enhanced KYC program, leading to an increase in risk policy reviews and audits. This includes:

• Principal and beneficial owner identification
• Corporate structure and chains of command review
• Risk and compliance training 
• Risk policy review
• Risk verification and reporting

As part of that review, PJM has focused on risk verification and reporting – much of which has honed in on the risk and mark-to-market (MtM) calculations.

Risk Verification and Reporting

PJM has taken a greater interest during these risk reviews and audits on your risk limits and risk exposure calculations. These include:

• Volumetric position limits
  • Tenor, term, concentration, and hedging
• Dollar value limits
  • Working capital, maximum loss limit, and exposure limits
• Methodologies, analyses, and metrics and limits used for risk exposure assessment and monitoring
  • VaR, CVaR, mark-to-market (MtM)
• Risk management reports that are reviewed routinely
  • Exposure, positions, limits monitoring, profit and loss, and risk policy violation reports
  • How often you run these
  • Who receives and reviews them
• Liquidity
  • Reserves, working capital, line of credit, and guarantees 

Some of the more complex requirements are around risk metrics and mark-to-market.

Risk Metrics and Mark-to-Market Requirements and Audits

Each ISO/RTO requires market participants to have risk metrics and mark-to-market (mark-to-auction) calculations. These calculations can quickly become challenging to maintain as you grow because of the data management involved in the FTR market.  

Risk Metrics

PJM’s Credit Policy requires that you calculate risk on your FTR positions on no less than a weekly basis. The PJM guidelines related to this risk calculation are that it “engages in a probabilistic assessment of the hypothetical risk of such positions using analytically based methodologies, predicated on the use of industry accepted valuation methodologies.”  

Mark-to-Market

PJM’s credit policy requires that you value (mark-to-market) your FTR positions on no less than a weekly basis.

Data Management 

Your company needs to maintain a fair amount of data management to support calculating FTR risk. This includes trade capture, model remappings, and ISO changes.

Trade Capture

• Unlike exchange-traded futures and options, there isn’t a single source of truth for these trades. In the US wholesale markets, seven ISOs provide FTR transactions, with seven different interfaces and file types.
• You also need to plan how to convert multi-month periods to monthly buckets to effectively evaluate mark-to-market and risk on your portfolio.

Model Remappings

• ISO markets often remap one node to another. For example, this occurs in cases where a node is de-energized. That means you may own an FTR contract with a source or sink node that’s no longer traded. Making sure you can map these to the new node definition when performing risk calculations is critical to ensure accurate values.  

ISO Changes

• The ISOs can change technology requirements. Some recent examples of this were the MISO MUI 2.0 and PJM’s digital certificate requirement. If you have internal processes to communicate with the ISOs to capture your trades and price curves, you need to make updates to ensure your processes aren’t interrupted.
• The ISOs can also make more foundational changes that impact your ability to capture trades and complete risk calculations. A recent example is the new PJM peak types added in 2022. Challenges included how to calculate risk on old peak types after PJM retired them and how to calculate risk on new peak types as PJM introduced them.

At Yes Energy, our team proactively monitors each market for new datasets or data changes that will impact you. If an ISO is changing report formats or website links or fails to report data, you’ll be the first to know.

Audit Process and Deficiencies

A risk policy audit begins with a review of your risk policy. After that review, PJM will follow up with detailed follow-up questions that often include questions about approved products, volumes, and authorized traders; details of risk controls, including stop loss and position limits; pre-bid analysis and stress testing. Also, PJM has focused on ensuring that you have sufficient liquidity on hand to address potential downturns

Upon review of those, PJM frequently requests follow-up deliverables. Some that we’ve seen are compliance training, both broadly and on AML requirements; risk policy enhancements, including on KYC and AML; explanations of corporate organization charts and how authority flows through a company; and copies of risk reports, as well as explanations of who reviews those reports.

Any insufficient answers and deficiencies found mean further iterations until PJM is satisfied with your risk policy.

Yes Energy Can Help Your Team with the Risk and Mark-to-Market Calculations Required

Yes Energy’s Position Management™ solution provides the nodal power market middle office with a turnkey, consolidated solution for overseeing your trading activities. We handle the deal capture of your FTR portfolios, and using our industry-standard MtM and risk calculations, you can be confident you’re getting accurate values for your reporting, ISO requirements, and decision-making needs. 

This is all delivered to your team through automated email reporting, a visual middle office dashboard (see below), and an easy-to-integrate data API.

Source: Position Management Open Profit (mark-to-market) chart

With Position Management, you gain an automated source of P&L, MtM, and risk calculations, along with a solution for more granular reporting. All of this leads to less manual effort, and fewer errors, in your middle office processes. The foundation of Position Management is Yes Energy’s data management activities, which include trade capture, model remappings, and inevitable ISO changes.

Learn more about Position Management today, or schedule a demo to see how this solution can help solve your middle office challenges with FTR trading! 

About the author: Stephanie Staska is the director of trade and risk products at Yes Energy. She has worked in energy risk management and compliance for the past 20 years, including time at Twin Cities Power, Cargill, and Split Rock Energy. Stephanie received her MBA and her bachelor’s degree in actuarial science and mathematics from the Carlson School of Management at the University of Minnesota. She also enjoys traveling and spending time with her family.

About the author: Leveraging over two decades of experience dealing with the Federal Energy Regulatory Commission (FERC), Ruta Skučas has unique, valuable, and extensive experience advising power industry companies, energy traders, and transmission and renewables developers on evolving federal and state regulatory regimes. Ruta’s deep-rooted knowledge and understanding of FERC and wholesale electricity markets keep her highly sought after as an effective energy regulatory attorney, and her deep understanding of trading makes her the counsel of choice for energy traders confronting compliance and enforcement issues.