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The new CROs are bringing back much-needed discipline to restore investor confidence.
Scott Smith's title is senior vice president and chief risk officer. But when he's out of earshot, some people at AEP call him the chief SOB.
"I'm not a popular guy," Smith says half-jokingly. "I continually get comments about what a pain I am. My people are aggressive and they don't take any crap."
But Smith isn't a bully or sadist. He's just doing his job-namely, helping AEP "make informed risk-taking decisions." Sometimes that means unearthing risk factors that effectively send the company's business managers back to the drawing board.
While the CRO might never be elected the Most Likeable Person, utility senior management is becoming positively enamored with the office of the CRO. Fully 40 percent of America's CROs work for utilities and energy companies, according to a survey by the Conference Board of Canada, Tillinghast Towers Perrin, and the University of Georgia.
And the industry's CRO community is taking a higher profile in the face of recent crises. Earlier this year, a group of six energy companies-AEP, Constellation Energy, Duke Energy, Mirant, Tractebel North America, and TXU-came together to form the Committee of CROs. (See sidebar: "The Committee of CROs: United We Stand") The committee's purpose is to identify best practices for energy industry risk management.
"It's a trend for the industry. The investor community is saying we need this," says Mark Williams, an executive-in-residence at Boston University. "Each company needs to look at its risk tolerances and find the right person to bring in." This trend is motivated, obviously, by the major changes that are sweeping through the marketplace-and being reported on the front pages of daily newspapers across the country.
Investors fatigued by scandals and earnings volatility are driving companies to bring consistency back to their financial performance. From a risk-management perspective, this means the organization needs a steady hand on the tiller-hence the creation of the CRO.
"The industry has a credibility issue, partly created by the lack of independence," Williams says. "Companies are sending the strong message to the market that they have an independent, senior manager focusing on the risks associated with the returns."
How'd We Get Here?
The industry has come a long way in its view of risks. Today, the industry's leading companies are seeking to create a risk-management culture, in which an awareness of risks is integral to the entire company's decision-making processes. This represents a tremendous advancement from its position just a few years ago.
"When regulators controlled prices and return-on-investment for utilities, they also controlled the utilities' risks," says David Shimko, president of Risk Capital Management in New York. "With deregulation, everyone got excited about lower prices and fancy contracting services, but they didn't realize that they also needed to manage risks in a completely new way. The industry became awash with people needing help managing risks without implicit governmental support."
Further, modeling the energy trading business turned out to be more complex than modeling other commodities and financial instruments. Software systems have had trouble capturing the effects