TradeSpark LP signed an agreement Tuesday with Virtual Markets Assurance Corp. (VMAC) to offer VMAC’s unique (patent pending) credit transfer and netting system to energy marketers on its trading platform to work around creditworthiness problems and enable trading of illiquid commodities such as electricity and physical natural gas.

The two companies have agreed to begin technical development for installing the system on TradeSpark’s platform, with the initial testing phase to begin in the fall. Two of VMAC’s chief backers are Bechtel Enterprises and Financial Security Assurance Ltd., which provides Aaa/AAA/AAA financial guaranty insurance for asset-backed securities, municipal bonds and other structured obligations in global markets.

“The testing shouldn’t take long, and the product will be available soon after that,” said VMAC CEO Wallace C. Turbeville. “By 2003, we’d like to see the market get a clean start. There’s no immediate fix for the market, if you’re talking about the next two to three weeks. But it’s important that it’s moving in the right direction toward an efficient and benign environment for trading. What the market needs is for companies with physical assets to be able to trade. Our system addresses this. It should help a lot.”

VMAC has worked closely with two rating agencies, Standard & Poor’s (S&P) and Moody’s Investors Service, to make sure the system provides adequate credit support for participants, Turbeville said. The agencies have to be assured that the trade agreement covers the risk of the contract.

Use of the system should “reduce dramatically” the amount of capital necessary for trading, Turbeville said. Besides enabling companies with poor credit ratings to trade, it should be helpful to companies with higher credit ratings which have been unable to find qualified counterparties.

The netting feature allows participants to net “out of the money” and “in the money” contracts with multiple parties, “reducing collateral requirements up to 90%. Instead of posting a billion dollars, a party may post $200 million,” the VMAC CEO said.

VMAC’s system provides the benefits of conventional commodity clearinghouses, such as Nymex, “including the multilateral netting of counterparty risk positions and the provision of highly rated credit guarantees designed to mitigate the risk of counterparty non-performance. The VMAC system, however, is capable of covering a far broader range of products and trading arrangements than conventional clearinghouses,” according the company announcement.

“Our system is unique in that it is designed to cover a broad range of energy products, does not require contract uniformity and provides credit guarantees throughout the lengthy delivery and payment periods that are common in the energy markets, among other factors. We believe that it will address a real need in the marketplace for capital efficiency and credit risk transfer,” Turbeville said.

The system will cover all points of delivery and non-standard contracts. The company has taken two years in development to ensure that the clearing entity can net diverse contracts without being exposed to physical delivery risk, Turbeville said. “Since there are no futures traded in the different products, there is no way of laying off the risk and we can’t be in the position of delivering.”

“Contract rules have to overlay trading to ensure parties can liquidate positions, even in the event of insolvency or bankruptcy,” Turbeville said.

Signing on for the VMAC system provides insurance to compensate parties for the mark-to-market value if there is a contract default. The system is cheaper than Nymex, according to VMAC spokesman Paul Hamilton, giving as an example a three-way over the counter deal covering 400 MWh at $30/MWh, which he said, would cost $4.50 on Nymex and $3.00 on the VMAC system.

The lower price is possible since Nymex must underwrite the performance risk for all market risks. VMAC’s coverage ensures compensation up to the mark-to-market level. If there is additional risk, the party, which is a physical trader of the commodity with access to generation, transmission and gas supplies, assumes the extra risk, with VMAC providing cash for an interim period to allow time for the party to replace the contract.

According to J. Scott Perry, VMAC’s president and COO, “VMAC’s product will significantly improve the environment for the energy trading firms at this time of stress. Our proprietary system addresses the credit concerns currently limiting trading activity, and will enable participants to enter into trades with a much wider range of counterparties. VMAC’s system will increase transparency and efficiency, factors sought by the investing public and the credit rating agencies.”

TradeSpark is the initial vehicle for the VMAC system, but the company intends to make its product available to other multiple order matching platforms, confirmation systems and similar trade aggregation facilities, in addition to TradeSpark.

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