Trends in counterparty risk management

Record levels of defaults in the wake of the 2008-2009 financial crisis have exposed the inadequacies in common credit risk management practices for today’s markets. In fact, poor anticipation of and late reaction to the deterioration of counterparty credit quality have severely impacted energy market participants in the last two decades resulting in larges losses (e.g., Power Company of America, Enron, Lehman Brothers, etc.). More than before, shareholders, stakeholders such as S&P and industry groups such as The Committee of Chief Risk Officers – CCRO, are demanding that companies upgrade risk management practices, tools, and strategies to enable them to more effectively manage counterparty default risk.

Yet, within many energy firms counterparty credit risk management is still being performed with simplistic legacy approaches that often rely solely on financial ratio analysis or credit agency ratings to set a static view of the creditworthiness of a counterparty. In fact, these counterparties are generally reviewed either on an ad-hoc basis leading to a transaction, and then again, only after a new credit rating is issued or, at best, only once a year. Hence, credit risk management decisions based on this static and historical approach do not reflect the forward looking views of counterparty credit risk. 

Companies transacting in the energy markets should take a more proactive and dynamic approach to credit risk management to better ensure they are well informed and able to react before an adverse credit event occurs.

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