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<title>Current Take on Counter-Party Risk</title>
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<td width="75%" valign="top"><img src="../images/scudder.gif" alt="The Desk - The Scudder Publications Group" border="0" WIDTH="468" HEIGHT="94"><p><font face="Arial" size="5"><b>Current
Take on Counter-Party Risk</b></font></p>
<p><small>Reprinted with permission from The Scudder Publishing Group,</small><br>
<small>publishers of <em><strong>Power Executive</strong></em> and <em><strong>The Desk</strong></em>.</small><strong><br>
</strong>(<em>originally published by PMA OnLine Magazine: 06/98</em>)</p>
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<font face="Arial" size="2"><p><em>The following story is provided courtesy of The Scudder
Publishing Group, publishers of <b>The Desk</b>, the industry’s newest publication on
energy trading and risk management, and<b> Power Executive</b>, the weekly newsletter. </em></p>
<p></font><font face="Arial">Things have changed since June of 1997 when we spoke with
Ellen Lapson of Fitch Investors Service, who said her phone was clogged with utility
inquiries about how to establish a credit office. She said the process would likely take
awhile because "third parties [still] have to find out that they need credit
ratings." Between 1996-97 the available commercial credit data on the hundreds of new
market players was next to nil. 1998 is proving to be a different story altogether.</font></p>
<p><font face="Arial">George Travers, a senior manger with Deloitte & Touche’s
Capital Markets Group in New York, notes a number of trends in the counter party credit
arena lately and offers some advice on the right path to follow.</font></p>
<p><font face="Arial">He says that in the past year most utilities – or energy
companies – have devoted a bit more resources to securing data on both large and
small counter parties. Certain credit data, ratios and analysis for rated and unrated
companies he says are now more available commercially. </font></p>
<p><font face="Arial">"However, where the companies are still falling down, is how
they use the data. Many companies now do a credit scoring of some sort based on the
available data. Unfortunately most are not correctly converting this data to an equivalent
credit rating and dollar limit," Travers says. </font></p>
<p><font face="Arial">Corporate credit committees that have been hastily assembled in the
past year are largely making binary decisions – that is thumbs up or thumbs down
– about a given counter-party. And many of the dollar limits they set overemphasize
volumes and underestimate actual creditworthiness.</font></p>
<p><font face="Arial">"The reality is, volume shouldn’t matter. If you have two
similar companies with similar ratings, but they transact at different volumes, their
creditworthiness should still be similar. But many companies are letting the volume drive
the credit limit. It’s almost a <i>Catch 22</i> for counter parties," Travers
says. "What they should do is assign a maximum dollar limit."</font></p>
<p><font face="Arial">To be sure, suppliers have realized the importance of credit risk
and credit risk arrangement, but they continue to struggle with the concept of setting up
credit dollar limits. </font></p>
<p><font face="Arial">"We also continue to see utilities focus on credit risk as
defined by unpaid accounts receivables, plus fair value or mark to market value of open
position," Travers says.</font></p>
<p><font face="Arial">"Financial firms know this already. They also know that the OTC
market will involve a higher level of credit risk no matter what you do. What has been
more important in the OTC market, however, is measuring your exposure. Power markets today
should really be focusing on measurement as well as management," he says.</font></p>
<p><font face="Arial">Travers says that some leading-edge credit monitoring procedures,
particularly on the wholesale power marketing and trading end of the spectrum can be seen
among those industry players that have a "Wall Street legacy." </font></p>
<p><font face="Arial">"Like monitoring changes in credit risk or monthly tracking of
what’s happening with their counter party’s business. And adjusting credit
limits on an ongoing basis." </font></p>
<p><font face="Arial">Travers points to one client that is developing and internalizing
some pretty sophisticated monitoring procedures. He says the company tracks certain <i>types</i>
of customers (both inside and outside of their service territory) to determine sector-wide
credit sensitivities.</font></p>
<p><font face="Arial">"If you’re targeting a certain group, say 10,000
restaurants – we’re working with the company to help determine common economic
attributes that might affect that industry, to better approximate their counter
party’s credit quality," Travers says.</font></p>
<p><font face="Arial">Organizing this kind of expertise and data so that it might be used
more effectively in a company’s trading and risk-management functions is of course
another story. Most trading software systems have not fully embraced the concept of
integrated credit risk measurement systems. But, according to the chief of Deloitte
Consulting’s Energy Systems Integration Group, Adi Karev, there is hope. </font></p>
<p><font face="Arial">"The irony is that we have the capability to collect
information across the counter party transaction, in the individual portfolios. But, most
systems don’t take into consideration a true customer counter party approach. That is
a common database which holds all the information about your customers and also the
information that is pertinent to making transaction-based decisions," Karev says.</font></p>
<p><font face="Arial">He says that where many companies may have sophisticated position
tracking systems, risk-management systems and even counter party systems, they are likely
operating as data "islands." And if they’re integrated at all it’s
just at the financial transaction level and doesn’t carry over to the
customers-level.</font></p>
<p><font face="Arial">"So you have a number of things to worry about, like data
integrity. Whether the customer labels or spelling is the same across all databases.
Secondly, the operational requirements that are associated with managing your credit
across the various business units, require you to interface almost on a real-time basis
– across all databases. And unless you create one central counter party database that
keeps track of all transactions or all proposed transactions, you will forever be exposed
to additional risk," Karev says.</font></p>
<p><font face="Arial">Karev says this is one of the key-critical areas his group is
focusing on for their customer Solution Sets. </font></p>
<p><font face="Arial">"In the energy trading environment it’s called a counter
party database. In the marketing environment it’s called the customer or prospect
database. And in the utility its called CIS. We’re trying to converge these systems.
To provide the ability to manage credit and risk in such a way that it contributes to your
ability to be profitable and to execute your transactions." </font></p>
<p><font face="Arial">Because of Deloitte Consulting’s past involvement with customer
information systems, Karev says his group understands the need and the workings of a
centralized database all too well. "It’s not a foreign concept, we just have to
apply it to the energy environment," Karev says.</font></p>
<p><i> </p>
<p><font face="Arial">Adi Karev can be reached at 412/402-5130.</font></i></p>
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