Risk-Management Principles for the Utility CEO

Deck: 
Board coordination is the key.
Fortnightly Magazine - June 2004
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Board coordination is the key.

Many utility CEOs are happy to pass off risk-management policy to the CFO and the head of the trading desk. After all, with deregulation and re-regulation, collapsing spark spreads, hypersensitive rating agencies, and nervous investors, there is enough to worry about. So what's the problem? If the financial guys control and report the risks and profits and losses (P&L) within risk tolerances, why should the CEO be concerned about risk management?

The answer, in many cases, is that the board and CEO have not given specific strategic directives to those responsible for risk management. As a result, often they are disappointed when the trading results do not reflect the goals of the organization. On one hand, a trading group may show tremendous profits, while the board complains about the discount the equity analysts have applied to the company as a result of the trading risks. On the other hand, a trading group may appear to lose money on a stand-alone basis, while in fact the group had reduced corporate risk significantly. Many trading shops find themselves in this type of situation: They are urged to turn a profit, but are charged with hedging risk. The only way they win is if their trades both produce profit and reduce risk-an unrealistic expectation for any trading group.

This problem is exacerbated by trading reports that emphasize stand-alone P&L rather than the effect of trading on an integrated risk profile. Therefore, the CEO must set clear directives for trading off profit and risk that are interpreted and executed by the trading groups. A practical process for accomplishing this follows.

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