Consultation: Alternative CAP review process [accordions]

The Credit Assessment Price (CAP) is a parameter used in the Credit Cover calculations. The Credit Cover calculations are designed to ensure BSC Parties lodge sufficient Credit Cover to cover 29 days of BSC Trading Charges invoices.

The CAP is relevant to the first five working days of the calculation, before the Interim Information run. During the first five working days parameters are used to estimate a Parties Indebtedness, the CAP is used instead of System Prices during this Period. After the five working days, Interim Information run data is used in the calculation with calculated imbalance volumes and actual System Prices.

The CAP Review Process is described in Credit Assessment Price Review Process (CAP) guidance document and briefly in BSC Section M paragraph 1.4. The guidance document is owned by the BSC Panel, it contains the detailed information on the mechanism for reviewing, consulting on and setting the CAP. Panel approval is required for material changes to the guidance.

The current mechanism has been triggering a review to increase the CAP every few weeks since April 2021 in line with forward Market Prices. The most recent proposed CAP of £259/MWh is more than double the maximum CAP prior to 2021, which was £108/MWh and was set in 2008 during the market instability caused by the financial crash.

The current arrangements in the CAP Review Process are that when the mechanistic trigger event happens Elexon will issue a consultation for five working days for a new CAP based on the price the indices suggest. Any responses to the consultation and any changes in events are considered by the Credit Committee, who agree the new CAP. Once confirmed and notified to industry this must be implemented after a minimum of 15 working days. This means that in a volatile and changing market the CAP can be out of date before it is implemented with large increases between CAP values.

BSC Section M paragraph 1.4 states that a consultation is required before notifying Parties of a new CAP, and that the CAP shall be effective no earlier than the 10^th business day following the date of notification. To change either of these conditions a modification would be required. A modification is not required for changes to the CAP Review Process guidance document to reduce timescales to these minimums.

A large jump in the CAP may cause cash flow issues for some BSC Parties. The most recent proposed CAP of £259/MWh would be a jump of £75/MWh from the previously notified value of £184/MWh due to be implemented on 21 October 2021. Once in effect some BSC Parties may be asked to lodge a large amount additional Credit Cover at short notice or face the Credit Default consequences. Further, where market conditions result in the prices falling, CAP needs to respond as quickly as possible to avoid unnecessary excess credit cover demands on BSC Parties.

The index used to trigger a CAP change is based on forward market price, to be used as a proxy for future System Prices effective when the new CAP is live. The current forward market Prices are changing rapidly and creating significant step changes in the recommended CAP. In the current market conditions and future scenarios this may not be a suitable proxy for how System Prices will out turn.

The graphs below show rolling average System Price and the Reference Price, based on forward market prices. The latest Reference Price of £270/MWh is £124/MWh higher than the latest seven day rolling average System Price of £146/MWh.

Three consultation responses to the two most recent CAP review consultations have disagreed with the proposed values set by current CAP calculation mechanism based only on Reference Prices. They have raised concerns over the increased credit burdens that an increased CAP may mean for market participants.  Other parties have raised concerns that, while unpalatable, keeping CAP in line with market prices is the only way to protect other BSC parties from some of the costs arising from defaulting parties.

Given these responses, and recent market trends, it may not be suitable to use the current philosophy to set a CAP that works in the interests of the whole market

In conditions where volatile prices are causing a significant number of CAP breaches or large changes in CAP, the existing CAP review mechanism may be paused if the Credit Committee request the move to an alternative process. Where a fast market situation might be characterised by three or more consecutive CAP breaches or by change in CAP value of more than £20/MWh. There are approximately five periods since 2008 that might be classed as “fast market” scenarios under this characterisation.

We are proposing that during these temporary periods an alternative process is used so that:

• the CAP can be reviewed more frequently and changed faster
• the guidance will state the Credit Committee should consider recent System Prices rather than just forward market prices
• the Credit Committee will continue to use its professional, independent judgment to set the CAP, with aim of protecting parties
• the guidance will allow deviation from the normal process of setting the CAP based on market prices if deemed appropriate.

For the proposed mechanism, the Credit Committee would review, and if necessary propose a new, CAP every two weeks.  In setting a CAP value, the Credit Committee would consider System Prices from the last two weeks, any other relevant sources of information and recent consultation responses. The forward market prices would also be considered, but would not solely be used in setting a CAP.

A consultation is required under the BSC before notifying industry of the new CAP, however the time to consult is not specified. Given the current market climate, we propose shortening the consultation period to one working day. The Credit Committee, ex committee, would consider any consultations responses. Once received, the Credit Committee can also consider consultation responses when making future CAP proposals.

Following the one day consultation industry would be notified of the CAP value to be set and the CAP would become effective on the 10^th working day after this notification.

In the event that the Credit Committee require a meeting to set a new CAP value following the consultation, then the committee would meet to determine a new CAP to be effective in 10 working days time that would then be notified to industry.

The normal process will continue to be run for monitoring purposes. Once the market has stabilised, and volatile prices would no longer cause a significant number of CAP breaches or large changes in CAP, then the CAP review process can revert to the existing mechanism. Unless a modification is raised to change the credit processes.

A notification to industry should be sent out to inform industry when the alternative CAP review process will be used and when the Credit Committee have returned to the normal process.

The proposed alternative mechanism was provided to the Credit Committee and presented to the BSC Panel. The BSC Panel and Credit Committee were broadly supportive of the alternative methodology. They noted that the discussions on setting a CAP value would be similar to the current discussions, with more of an emphasis on recent system prices as well as forward market prices.

The BSC Panel requested a consultation be sent out to industry before the alternative process is implemented.

The BSC Panel was concerned that shortening the consultation period to one working day would reduce the ability of Parties to make representation. A two or three day consultation period was considered as an alternative.

The Credit Committee and BSC Panel also stated the desire for more representation of different market views in the Credit Committee. If you are interested in joining the Credit Committee please fill in an application form.

• Volunteering for Groups and Committees online form