June 2007 Capital Adequacy Extension © Copyright 2007, CCRO. All rights reserved. Page 32 of 92 4.2. DEFINITION OF OPERATIVE RISKS The New Basel Capital Accord7 has defined operational risks as “…The risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events…” It is important to note that “external events” encompasses the risks relating to such exposures as legal, regulatory, political, and environmental. However, this definition does not fully address operational risk as it pertains to the energy industry so it is important to make the distinction for the benefit of external constituents evaluating capital adequacy of companies within the energy industry. In the CCRO’s ‘Emerging Practices for Assessing Capital Adequacy’ White Paper published in September of 2003, operational risks were defined as two distinct categories the first being the category already defined by the Basel Committee stated above, which is referred to as ‘Operational Risk’. But because of the asset intensive nature of the energy industry, a second category was added risks associated with delivering, producing, or storing physical energy products, referred to as ‘Operations Risk’. Both Operational and Operations Risk categories were referred to collectively as Operative Risks, and because of their differing and unique nature, they must be approached in different fashions. Based on this definition, this paper will broadly categorize operative risks into the following • Operational: Internal Risks from People, Processes, and Systems • Operations: Physical Risks from the Production, Delivery, and Storage of Energy Commodities • External Factors: Legal, Regulatory, Political, and Environmental exposures may fall into either Operational or Operations categories. Figure 4.1 graphically represents this concept. 7 International Convergence of Capital Measurement and Capital Standards, A Revised Framework. Basel Committee on Banking Supervision. November 2005. Pg 140. Figure 4.1 Operative Risk Categories Operational Operations Internal : People, Processes & Systems Physical : Production, Delivery, & Storage External : Legal, Regulatory, Political, Environmental, etc. Internal : People, Processes & Systems Physical : Production, Delivery, & Storage External : Legal, Regulatory, Political, Environmental, etc.