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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

of unfit counterparties, cross-currency capabilities, centralized database (an effective audit trail), automatic data downloads, consistent rating models, adaptable risk-weighting (for altered risk environment), and more.

In conversations with our clients, we see three pressing issues energy companies need to address: the effective capture and proper calculation of exposures; documentation (terms, conditions, policies and procedures for counterparties in all financial derivatives and physical deals); and full transparency across a front-to-back-office integrated system.

Some of the core IT functionality necessary to accomplish credit risk management tasks should include:

• Real-time or near real-time automatic download of external information. This information could include credit scores (downgrades and upgrades), company news, financial performance, stock prices, SEC filings, bond spreads, energy commodity prices, default probabilities, and external debt ratings from sources like Moody’s and Standard and Poor’s;

• Automation of external information throughout the system (without the need for manual manipulation or input);

• Allowance for in-house analytics and user-defined customization of needs, procedures, standards and limits; and

• Generation of internal ratings based on user-set parameters.

In general terms, solid credit-risk systems should address the five core arenas of credit-related risks: exposure, collateral, counterparty management, credit scoring, and contract/legal management.

The more in-depth analytics in a robust credit-risk system should include potential exposure analyses, which are based on additional exposures that could be created due to changes in market value over time, measured by potential future exposure or other calculation. For instance, incorporating potential commodity market-price volatility and current credit exposure can provide valuable insight into potential future exposure by calculating a future statistical analysis of the potential (“what-if” scenarios) for counterparty defaults. This can give credit and treasury departments information to manage overall company exposure, cash flow, and credit instruments. It is especially critical for companies with advanced credit needs, or those that deal with numerous counterparties. For state-of-the-art functionality, a credit-risk system should offer real-time or near real-time credit scoring data and run a credit check on any counterparty, providing an effective tool against radical counterparty credit shifts, bankruptcies, merger and acquisition activity, and market shakeouts.

Enterprise-wide benefits to using “ahead-of-the-curve” credit-risk IT can include, but are not limited to, the following:

• Improved, timely, meaningful, and actionable collateral, position, and reporting information and management;

• Enhanced cash flow scope in margining and forecasting, and an improved receivables collection capability;

• Corporate governance and compliance with internal and external investment and audit standards and policies. Considering the advent of the Sarbanes-Oxley Act, it is more important than ever to keep flawless internal accounting reports, as noncompliance can lead to costly criminal and civil penalties and time-consuming audits;

• Faster loan underwriting decisions and efficient monitoring of portfolio credit trends;

• Reduction in costs for borrowed funds and audit fees or fines; and

• Reduction in operational risk and an increase in productivity, and more.

Another benefit to using a real-time credit-risk IT system is the ability to scrutinize and immediately track down any breaches in book or trader credit limits.

Breaches: Uncover Them Now

Breaches in book or trader credit limits can create chaos