June 2007 Capital Adequacy Extension © Copyright 2007, CCRO. All rights reserved. Page 31 of 92 4. OPERATIVE RISK 4.1. Introduction Operative Risks pose a significant challenge to energy companies today, because of their oblique nature and extreme impacts. It is challenging to put a number to these risks and how they contribute to the overall risk capital calculation. They are so unique in their occurrence and in the nature of events that surround them that they seem to belie straight forward quantification. In energy, it is less about quantifying operative risk and more about introducing efficiencies and spotting problems before they become unmanageable. Nonetheless, it is prudent for energy companies to identify and attempt to measure their operative risks, particularly when such events can spell the end of your company as a going concern if they are not managed properly. While many operational risks do not fit into standard quantification models, as credit and market risks do, there are ways to approach operative risks to ascertain their effect on capital adequacy requirements. However, instead of focusing on specific techniques to measure Operative risk, this chapter focuses on building the foundation upon which an Operative Risk Management Framework can be built. Specific techniques used can be as wide ranging and unique as the risks they are attempting to measure. The premise of this chapter is that Operative Risks and the capital requirements to deal with them are most appropriately managed when a company embeds Operative Risk management as a fundamental part of the overall risk management framework. The specific techniques used, some of which are addressed in Section 3.3.2, to measure Operative Risk for determining capital requirements are most effective when they are part of a robust framework. The model for this framework is based upon the Basel Committees “10 Principles for Effective Operational Management.”6 While these principles are designed for the financial services industry, the fundamental concepts introduced are entirely transferable to the energy industry. Ultimately, we will translate what these principles mean to assessing capital adequacy for operational risks. Before we discuss the Framework for assessing Operative Risk, we must first define operative risk. 6 Sound Practices for the Management and Supervision of Operational Risk. Basel Committee on Banking Supervision. Bank for International Settlements. December 2001.