Establishing Model Risk Management
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Executive Summary
This white paper provides a framework for energy and commodity risk professionals to
manage risks stemming from model usage. The Committee of Chief Risk Officers (“CCRO”)
believes that model risk can be a significant risk source and a necessary component of any
effective risk management program. Model Risk Management (“MRM”) principles were first
enumerated in the banking space and have been making their way into other industries over the
past decade. This white paper takes those principles, adapts them to the context of the energy
and commodity markets, and recommends an MRM framework relevant to the energy
companies. The target audience includes risk committee members, risk managers, modelers,
and model validation specialists.
The paper begins with a brief review of model risk in its original context, including regulatory
guidance for capital markets such as SR 11-7. That context allows for a robust definition of the
word “model,” as well as a description of the three most common sources of model risk:
misspecification, misuse, and miscalibration. In addition, it allows us to consider End User
Computing (“EUC”) as separate from the established definition of “model.”
The paper considers the major components of the model lifecycle as a starting point for risk
management: identification, development, validation, implementation, usage, monitoring, and
review. From there, model risk management professionals can begin to assess risk based on
usage, materiality, and complexity. Those risks can be managed through the MRM framework
principles noted in this paper. Notably, the key framework components include governance,
independent challenge and validation, model life cycle management, inventory, and data
integrity measures. The framework's goal is to ensure models are used safely, accurately, and
efficiently, emphasizing effective challenge principles and tiered risk classification.
The Committee of Chief Risk Officers (CCRO) advocates for industry practitioners to establish
reasonable and fit-for-purpose MRM programs based on the recommendations and examples
noted in this document. In so doing, companies can benefit from MRM not only as a risk
mitigation strategy but also as a driver for operational efficiency and value creation. By means
of this white paper, we recommend collaboration within the energy sector to embrace sensible
MRM practices, ultimately fostering trust and resilience in model-based decision-making
processes across the industry.
The intention of this position paper is to promulgate MRM concepts within the energy industry
and provide a recommended MRM framework which members may reference and adapt to
their individual business and risk needs.
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