Getting to the Bottom of the Credit Risk Issue

Transcription

1 Getting to the Bottom of the Credit Risk Issue Dr. Gary M. Vasey November 2009 CommodityPoint lipoint, s.r.o. F skanska Brno Czech Republic h p://

2 INTRODUCTION The area of credit risk started getting increasing scrutiny on the part of commodity trading firms at the height of the Enron and energy merchant saga. Before that time it is a truism to say that the industry s focus and that of energy trading & risk management software was exclusively on market or essentially price risk management. The ripples caused by the collapse of the merchant segment created a renewed awareness of the risks that traders were exposed to in the area of counterparty credit which became even more magnified through the impact of the ongoing banking and financial crisis. CommodityPoint s early 2009 study i into the impacts on commodity markets, traders and software of the financial crisis and commodity market volatility showed quite clearly that reduced market liquidity, tightening credit conditions and cost of credit were major issues ranked in the top 4 critical business issues identified for and by trading firms. Recent high profile cases such as the one involving Constellation Energy in the summer of 2008 have only served to heighten the focus on credit risk. CommodityPoint sees this increased concern and emphasis on credit risk management also reflected in the increased demand for solutions. Recent CommodityPoint independent research performed in the summer of 2009 showed that 30% of those surveyed planned to procure credit software over the next 24 months. Over the same time period (from around the time of the Enron collapse) and, in response to demand from the industry, a number of software vendors set about building credit risk solutions while the traditional ETRM software vendors started to add some level of credit risk management functionality to their solutions. Today, the credit risk 2

3 software market is somewhat confusing as a result and this Technical Briefing Note will attempt to reduce that confusion and will focus on the perceived market leading solution from Triple Point ii. THE CREDIT RISK SOFTWARE SEGMENT Research by CommodityPoint shows that credit risk exposure is increasingly viewed as a major risk to energy and commodity trading firms who are under pressure from stakeholders, shareholders and regulators amongst others to demonstrate that they have the strategies and tools in place not just to avoid credit issues but to avoid the market perception that credit issues may exist. Both reality and perception can have a similar and dramatic result. CommodityPoint research also shows that a majority of trading companies still rely on spreadsheets and/or custom solutions to try to manage credit risk while others utilize what is realistically suboptimal credit functionality provided by a trading & risk management software solution (Figure 1). Both the current high demand rates and the installed base data above suggests to us that the credit risk software market remains by our definition a virgin market dominated by non commercial software. It is still somewhat immature as a software category albeit rapidly maturing. Accordingly, what exactly constitutes a true credit risk solution has yet to be properly defined as there is a dual need that of the trading area and that of the trading enterprise itself. 3

4 Figure 1: Survey Data on Types of Credit Software Solutions Utilized By Energy Trading Firms (Summer 2009) CREDIT RISK SOFTWARE WHAT IS IT? In order to perform credit risk management effectively at the trader level it must also be performed properly at the trading enterprise level. Credit limit monitoring for traders, for example, must in fact be based on an enterprise view of exposure to a particular counterparty which must in turn factor in all contracts and agreements, lines of credit, collateral and so forth with respect to a particular counterparty. Holistic credit risk management essentially means covering all of the bases at the highest level including; Counterparty risk assessments which means taking into account the company s total exposure to a counterparty (by definition 4

5 physical and financial, joint ventures, parent child relationships, geographical divisions and so on) as well as taking a view on counterparty ratings. Increasingly, firms wish to build their own view of counterparties, while taking into account third party credit agency ratings. Contract risk management which means properly managing contracts within an accessible central repository and managing both those contracts and their contractual terms in an efficient manner across the enterprise. Collateral risk management which involves keeping track of collateral agreements, forecasting and making margin calls at the right time and so on in order to benefit from a lower cost of capital. Exposure management which means having the ability to assess cash, forward, current and potential future exposure on a portfolio wide basis and to manage credit risk concentrations by commodity, deal type, industry sector, credit rating, country or some other factor. Credit analytics which requires having the ability to perform comprehensive credit analysis so that what if scenarios can be performed and stress tests run to evaluate exposure against various market conditions. This can only be truly and effectively performed if all the other building blocks are already in place. In reality, the above list defines in our view what a true credit risk solution comprises. That solution must of course then be capable of integrating with the multiple trading solutions and other systems that are common to trading firms. This definition of holistic credit risk also essentially precludes the use of an traditional ETRM software solution for credit risk management and further demonstrates that an ETRM solution 5

6 must be integrated with a credit software solution from which to extract the data that it needs to offer the traders the information that they need to do their jobs properly. In short, a true holistic credit solution is required in order to address the issue of credit risk effectively. Our view is that a broader appreciation of what constitutes a true energy credit risk solution is required. An ETRM software solution must of course include credit functionality but that functionality is to properly assist traders in crafting trades and not to perform credit exposure functions for the trading enterprise. While an ETRM solution must provide credit limit monitoring (does this counterparty have enough available credit to do this deal what's their total credit limit minus how much have they used?), it is the role of an enterprise energy credit solution to provide the view of exposures to that counterparty (and like counterparties) based upon varying forward looking market projections. This is a key and important difference that needs to be understood by end users. TRIPLE POINT S UNIQUE APPROACH In all CommodityPoint recently performed surveys, Triple Point is perceived as the overall market leader for credit risk (Figures 2 and 3). CommodityPoint believes that the reason for this perception is Triple Point s unique and innovative approach to solving the problem. 6

7 Figure 2: Market Leadership Perceptions Credit Risk (2009 Vendor Perceptions Study) Ventyx Tremeos SAS SunGard Energy Allegro Softsmiths Don't Know None OLF SAM NAM Eur ASIA Financial Objects No Answer Triple Point Today, the prospective buyer is faced with the choice between utilizing the credit functionality within an ETRM software solution which as we discussed above is suboptimal or of procuring a fully fledged credit solution. In the latter case there are, arguably just a handful of possible candidates and within that list of candidates, Triple Point's Commodity XL for Credit is clearly the leader in the energy commodity trading markets. Triple Point, via its acquisition of ROME Corporation in 2008 has evolved from being a traditional ETRM software vendor to one that can provide a depth of capability in credit risk management that is currently unmatched by any of its competitors. Its credit solution is a true enterprise credit solution as described above that may be purchased as a fully integrated 7

8 module of their Commodity XL solution or, on a stand alone basis for integration with any other ETRM software solution(s). The acquisition of ROME was a strategic master stroke in our view that has changed the entire dynamic of the credit risk software market as a result. Figure 3: Market Leadership Perceptions Credit Risk (09 proprietary study) THE TRIPLE POINT SOLUTION 5 CS OF CREDIT RISK MANAGEMENT Triple Point s Commodity XL for Credit Risk, offers a complete, end toend solution integrating what it terms the 5 Cs of credit which includes counterparty management; contract management; collateral optimization; concentrations; and credit analytics within a single, 8

9 transparent framework. It helps companies perform credit processes systematically and comprehensively, enabling them to anticipate excessive exposure and counterparty instability, rather than react to them and face potential business failure. CONTRACT MANAGEMENT Commodity XL for Credit Risk captures all key contract terms, ensuring accurate, current and legally enforceable calculations not historical estimations or oversimplified calculations. It captures all credit terms and incorporates them into exposure and collateral calculations, protecting liquidity and providing an understanding of the true risk profile. 9

10 COUNTERPARTY MANAGEMENT Commodity XL for Credit Risk provides a single counterparty system of record to manage counterparty relationships, credit limits and credit scoring. It captures multiple hierarchy structures to model legal, parental guarantee and customized hierarchies and keeps track of complete counterparty information. Credit scoring functionality provides a standardized and auditable approach to track financials and ratings. Additionally Commodity XL handles joint ventures and partial ownerships allowing an accurate understanding of true exposure and all relationships no matter how complex. COLLATERAL OPTIMIZATION Commodity XL for Credit Risk provides a real time, transparent and accurate view of all collateral and liquidity obligations. It allows the forecast of expected or potential margin calls and optimizes collateral by analyzing all collateral obligations and automatically applying the most contractually favorable collateral strategy across cash, letters of credit and guarantees. Additionally, Commodity XL automates the collateral request process including collateral request letter generation and dispute resolution. It facilitates invoicing of interest on cash collateral and stores collateral thresholds, rating matrices and other contract provisions, improving cash flow reporting and liquidity savings. CONCENTRATIONS Commodity XL for Credit Risk calculates cash, forward, current and potential exposure at a portfolio view with drill down through various levels of aggregated exposure to individual transactions. It manages 1 0

11 credit risk concentrations by commodity, deal type, industry sector, credit rating or country as necessary. Commodity XL delivers the appropriate tools to slice and dice a portfolio and highlight netting opportunities that will reduce both risk and unnecessary margin payments. CREDIT ANALYTICS Commodity XL for Credit Risk provides advanced analytical capabilities including stress scenarios and what if simulations to calculate PFE and CVaR potential future exposure and Credit Value at Risk respectively. It combines market price movements and rating migrations, enabling firms to take action by creating a hedge or diversifying strategy. Commodity XL provides a consistent framework to forecast, evaluate, and respond to future credit events. SUMMARY CommodityPoint research demonstrates a blurring of lines between TRM credit functionality and true energy credit applications. This Technical Briefing Note clarifies both the differences and integration points between TRM and Energy Credit software at a time when credit risk is viewed as a major business issue and demand for credit software is high. It has additionally highlighted Triple Point s approach and solution which maps perfectly to the holistic credit risk management taxonomy described above. In addition, it notes Triple Point s innovative strategy of providing a complete credit solution on a stand alone or fully integrated basis. 1 1

12 Note: CommodityPoint Technical Briefing Notes are designed to inform about what CommodityPoint believes to be technical innovations and advancements in CTRM software. While the TBN may cover a specific vendor and or product it is not an endorsement of a particular vendor or its product on the part of CommodityPoint but an informative analysis of that innovation. i Changes in Commodity Markets Impacts on Traders an Software, 2009, ii 2009 Vendor Perceptions Study, 2009, 1 2