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The Changing Face Of Credit-Risk IT

A system that measures, monitors, and manages is no longer a Wall Street extravagance, but an industry essential.

Fortnightly Magazine - August 2006

error). Given some of the low correlations of market risk across the commodities, the only time it is necessary to aggregate all of the information in these individual systems is to aggregate company exposure for credit risk purposes.

As for workflow processes used in the review of documentation and disposition of credit excesses, 42 percent surveyed reported having systems that were “mainly automated with some residual paper-based elements”; 38 percent rely on systems that are “mainly paper-based with some automation”; 9 percent indicated they had “fully automated electronic workflow with archival documentation of actions”; and 10 percent said they still ran “completely paper-based.”

Clearly, many companies still are struggling to get a real-time, enterprise-wide consolidated view of credit risk by various fundamentals, such as counterparty, location, and asset class.

This leads to the next question, in which respondents were asked, “How quickly can you get an enterprise-wide consolidated view of credit risk by counterparty/geographic location/asset class/maturity?” The vast majority, at 55 percent, answered longer than overnight; 20 percent said overnight; 17 percent answered intra-day; and a mere 7 percent could see their true credit risk in real time. Clearly, more companies need to take a closer look at all of the enterprise-wide risks and challenges involved in an increasingly difficult market environment.

Counterparty credit risk can prove to be extremely dynamic—morphing from a manageable being to a mammoth brute in an instant. But it can be tamed and assessed by the size of the exposure, the maturity of the exposure, the probability of default, and the systematic (or concentration risk) of the counterparty. Generally speaking, the four all-purpose factors that should be taken into account when establishing the amount of credit to be made available should include current exposure, potential exposure, statistical probability of default by the counterparty, and the recovery rate (amount of defaulted position that is likely to be recovered). The collapse of Enron demonstrated quite publicly the need for internal assessment of all counterparties, as the rating agencies tend to be a lagging indicator of actual default probability (a lesson further reinforced recently with General Motors’ financial woes).

Ahead-of-the-Curve Functionality

Considering the ever-increasing complexity and volatility in the energy marketplace, only seamlessly integrated credit risk systems can tackle today’s highly complicated qualitative analyses and afford a truly transparent information workflow. Considering the number of new Wall Street entrants into energy, like hedge funds and investment banks, an unbalanced ratio of industry acumen to credit risk knowledge is at work in the sector.

Yet many companies today have yet to fulfill the vision of enabling their credit department with the integrated set of tools and data to effectively manage their credit risk. Savvy credit systems can automate the collection, measurement, valuation, and analyses of credit-related data, and then quickly turn around and capture substantial business & market paybacks. Vendors include the likes of Murex, Rome, Moody’s KMV, and Raft.

Through top-notch IT solutions and implementation, energy companies today can enjoy all the benefits of transparent credit risk management, including: iron-clad security with a segregation of duties and limits, immediate alerts