CCRO Committee of Chief Risk Officers

Situation: Unclear how to best build & Report on Energy Scenarios :

The financial crisis and the recent steep rise, then fall, of energy prices has generated interest in whether the use of robust stress tests and scenarios could more effectively prepare companies for unexpected shocks. One CCRO member recently presented its stress tests for liquidity in a public earnings call, reacting to concerns expressed by credit rating agencies and investors. Purportedly, banks and financial institutions used best practices for stress tests – but they were certainly caught unprepared. The Bank of International Settlements (BIS) has proposed ‘consensus principles’ but these offer no practical suggestions on identifying leading indicators of shocks, methods for defining a stress scenario, nor any specific scenario parameters.

CCRO members reviewed these principles at the February meeting and discussed their usefulness (click here to view the slides). The complications section below provides a quick overview of the discussion.

In several past meetings, the CCRO members have discussed some broader issues which share a common thread in that the use of scenarios could be a big part of them. These Day2 Topics include:

• Emerging risks; Understanding & quantifying

* New business * Industry/regulatory change * Climate change

*Lessons-learned from the recent bank failures

* Can we publish energy industry parallels for members to consider? * Could/should we publish a ‘top-ten scenarios’ for energy companies?

*New plants – emerging risks

* With more aging assets, less capital access & losses in baseload capacity – where will capital come from & what regulatory change would be needed ?

All of these discussions suggest companies stand to gain much from the effective use of scenarios, and that CCRO best practices in this area would be very valuable.

Complication: Currently Inconsistent Practices and varied Perspectives

February’s discussion highlighted some interesting concepts that could begin development of CCRO best practices, and that should certainly be carried-forward into June’s meeting.

To date, some CCRO members have used an ‘expected case’ with sensitivities as a matter of course. Some have applied the ‘worst’ or ‘most interesting’ historical experiences as a ‘credible’ test of today’s exposure profile under stress.

Overall the discussions have begun to reveal a few themes to this topic that could help bring organization to creating best practices and the debates that members need to have around them.

First, there were comments about the usefulness of the BIS principles. Some saw the principles to be helpful in thinking about scenarios at a high level. Most agreed that the principles were:

*Rather vague, high-level

*Common knowledge (too ‘101’) to be insightful

*Too tailored for specifics of financial industry

Second, there were a lot of comments generally regarding how scenarios aught to be used in managing a business. Specifically thinking about how Risk Managers should advance the results and insights their scenario runs so as to have constructive impact on the business going forward. Should companies set limits on stress runs? How to react to stress limit violations? more below.

Third there were comments about how scenarios are best constructed to be robust. Much talk revolved around what the underlying factors for a scenario should be based on (prices, volumes, cp credit, etc.). Should we promote the use of standard pre-defined scenarios, # of std deviations, historic observed stress periods? more below.

No doubt the discussion in June will be helped by the results of the short survey available here. Please take a few minutes to take the survey & let’s see how our discussion grows towards best practice development…