Credit Ch 10) Technology for Credit Risk [Published] Page 21 (21 of 42)

Energy Credit Best Practices – Chapter: Information Technology http://ccro.org © Copyright 2022, CCRO. All rights reserved. 21 3.2.2 Integrated Margining System With companies growing more sensitive to how available cash is being leveraged, there has been an increase level of scrutiny on margining. There are three best practices to calculating margin correctly, including: • Connection to ETRM System(s) - The first practice is having a promptly available and accurate valuation of the Credit Exposure that’s subject to margining. This practice requires having a direct and automated integration with system(s) providing portfolio valuations. • Integrate with Treasury Systems (GL) & Bank Facilities - The second practice is knowing your collateral position by each marginable contract by using as much data as possible directly from the system of record. Separating the margin cash from invoice payments by legal entity and contract is more of a hypothetical perfect state rather than a common practice. A more reasonable best practice is to verify the total cash received compared to the sum of expected receivables and total margin for the given entity or legal family. • Automating Margining Calculation - The third practice is to automate the calculation of margin to ensure accuracy and reliability. Ideally, your automated margining platform should support: − Capture of common credit margining terms in your major areas of operation − Support for exposure calculation modification to account for common modifications in your area of operation − Automatic generation/distribution of margin calls − Provide an operational summary of expected activity for the day – what the analyst needs to do and expect from parties − Provide a report of all marginable contracts and associated metadata (e.g., exposure against contract, collateral in transit, current outgoing and expected incoming margin calls, etc.) − Ability to exclude / include transactions from margining and − Support for dispute resolution. 3.2.3 Integrated Contracts Contracts are another key element of an integrated Credit Information Ecosystem. The following are two key practices to consider in this area: • Contract Credit Terms - All key credit-related contract terms, including relationships between contracts (set-off language) and relevant governing law, must be captured, and incorporated into the calculation of Credit Exposure to ensure accuracy.

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Energy Credit Best Practices – Chapter: Information Technology http://ccro.org © Copyright 2022, CCRO. All rights reserved. 21 3.2.2 Integrated Margining System With companies growing more sensitive to how available cash is being leveraged, there has been an increase level of scrutiny on margining. There are three best practices to calculating margin correctly, including: • Connection to ETRM System(s) - The first practice is having a promptly available and accurate valuation of the Credit Exposure that’s subject to margining. This practice requires having a direct and automated integration with system(s) providing portfolio valuations. • Integrate with Treasury Systems (GL) & Bank Facilities - The second practice is knowing your collateral position by each marginable contract by using as much data as possible directly from the system of record. Separating the margin cash from invoice payments by legal entity and contract is more of a hypothetical perfect state rather than a common practice. A more reasonable best practice is to verify the total cash received compared to the sum of expected receivables and total margin for the given entity or legal family. • Automating Margining Calculation - The third practice is to automate the calculation of margin to ensure accuracy and reliability. Ideally, your automated margining platform should support: − Capture of common credit margining terms in your major areas of operation − Support for exposure calculation modification to account for common modifications in your area of operation − Automatic generation/distribution of margin calls − Provide an operational summary of expected activity for the day – what the analyst needs to do and expect from parties − Provide a report of all marginable contracts and associated metadata (e.g., exposure against contract, collateral in transit, current outgoing and expected incoming margin calls, etc.) − Ability to exclude / include transactions from margining and − Support for dispute resolution. 3.2.3 Integrated Contracts Contracts are another key element of an integrated Credit Information Ecosystem. The following are two key practices to consider in this area: • Contract Credit Terms - All key credit-related contract terms, including relationships between contracts (set-off language) and relevant governing law, must be captured, and incorporated into the calculation of Credit Exposure to ensure accuracy.

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Energy Credit Best Practices – Chapter: Information Technology http://ccro.org © Copyright 2022, CCRO. All rights reserved. 20 operationally. Usually, this approach involves assuming both deliveries before but not yet invoiced, Balance of the Month Exposure (BalMo), and invoice’s payment. There is nothing wrong with using this type of “operational” view of exposure. For example, calculating the rolling 60-day Credit Exposure window is common practice in the oil and gas industry. These calculations are a reasonable proxy most of the time. Still, they usually differ from what a company would be owed or owe in the event of an actual counterparty default. Depending to what extent the company is obligated to continue to deliver through a default. Therefore, the practice of calculating multiple “looks” at exposure is recommended, given the capabilities and low cost of today’s computing power. • Functionality - Thoughtfully choose the tools that your company implements as part of its credit policy and understand those tools' strengths and weaknesses. The alphabet soup of analytics that can be used, combined with the decreasing cost of computing power, can make it seem attractive to implement everything. However, more is not always better. The more metrics that a credit analyst is exposed to, the less attention they will pay to the critical ones. Therefore, evaluate the needs of your company based on the risks present in the portfolio. Then determine the best measures for your organization to take and predictively mitigate those risks. For example, the accurate calculation of a credit reserve amount is more important (in terms of remaining solvent) for a smaller company in a middleman trading position than for a larger company originating some commodity with $1 billion of cash on hand. This does not mean it is bad for the large company to calculate its credit reserve. But they should probably be more focused on Potential Future Exposure (PFE) limits and PFE change day-over-day in total and Book Value. Conversely, this does not mean the small company should not be calculating PFE, but knowing about potential future issues is not relevant if you cannot survive a default today. • Reassessment - Impose a regularly scheduled review to ALL exceptions to the credit policy at some interval that makes sense. This applies especially to exceptions that have been implemented in a system as they may escape notice. Ideally, each exception's review period should also be coded into the system in the same way that the exception itself is coded. For example, if a trade is ignored when importing exposure, add some automated notification/workflow/message to review the logic behind neglecting it. This practice helps preserve institutional knowledge and mitigates the risk associated with shift changes, staff turnover, and the business's general press. • Audit-ability: Do not allow non-audited Credit Exposure adjustments of any kind.

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Energy Credit Best Practices – Chapter: Information Technology http://ccro.org © Copyright 2022, CCRO. All rights reserved. 20 operationally. Usually, this approach involves assuming both deliveries before but not yet invoiced, Balance of the Month Exposure (BalMo), and invoice’s payment. There is nothing wrong with using this type of “operational” view of exposure. For example, calculating the rolling 60-day Credit Exposure window is common practice in the oil and gas industry. These calculations are a reasonable proxy most of the time. Still, they usually differ from what a company would be owed or owe in the event of an actual counterparty default. Depending to what extent the company is obligated to continue to deliver through a default. Therefore, the practice of calculating multiple “looks” at exposure is recommended, given the capabilities and low cost of today’s computing power. • Functionality - Thoughtfully choose the tools that your company implements as part of its credit policy and understand those tools' strengths and weaknesses. The alphabet soup of analytics that can be used, combined with the decreasing cost of computing power, can make it seem attractive to implement everything. However, more is not always better. The more metrics that a credit analyst is exposed to, the less attention they will pay to the critical ones. Therefore, evaluate the needs of your company based on the risks present in the portfolio. Then determine the best measures for your organization to take and predictively mitigate those risks. For example, the accurate calculation of a credit reserve amount is more important (in terms of remaining solvent) for a smaller company in a middleman trading position than for a larger company originating some commodity with $1 billion of cash on hand. This does not mean it is bad for the large company to calculate its credit reserve. But they should probably be more focused on Potential Future Exposure (PFE) limits and PFE change day-over-day in total and Book Value. Conversely, this does not mean the small company should not be calculating PFE, but knowing about potential future issues is not relevant if you cannot survive a default today. • Reassessment - Impose a regularly scheduled review to ALL exceptions to the credit policy at some interval that makes sense. This applies especially to exceptions that have been implemented in a system as they may escape notice. Ideally, each exception's review period should also be coded into the system in the same way that the exception itself is coded. For example, if a trade is ignored when importing exposure, add some automated notification/workflow/message to review the logic behind neglecting it. This practice helps preserve institutional knowledge and mitigates the risk associated with shift changes, staff turnover, and the business's general press. • Audit-ability: Do not allow non-audited Credit Exposure adjustments of any kind.

Energy Credit Best Practices – Chapter: Information Technology http://ccro.org © Copyright 2022, CCRO. All rights reserved. 22 • Linked with Margining System - The terms Margining collateral must be incorporated into the Credit Risk calculation, and an automated link with the margining system to import collateral position is the standard here. 3.2.4 Integrated Credit Scoring Process The general concept of reviewing the creditworthiness of a trading partner has been important since trade was invented. The best practice is doing everything possible to understand your trading partners before engaging in business and then regularly evaluating the partner’s health and the relationship. The tools to accomplish this can • Financial Statement Data – Raw information obtained from public sources or the trading partner. • Ratios and Weightings – Calculations based on the raw information • Qualitative Assessments – Subjective measures such as the length of the relationship. The use of third-party management software tools can help automate the credit scoring process, both during on-boarding as well as part of on-going monitoring. For example, these tools can automate the counterparty review process and ensure relevant reports occur on a timely basis. This relieves analysts of the repetitive work of third party-related data collection and calculation while providing they are done thoroughly, accurately and, timely. This leaves more time for the analyst to work the more subjective aspects of the credit review process, which cannot be automated, and leads to a better overall result. 3.2.5 Digitalization of Credit Documents As a best practice, credit analysts should have easy access to electronic copies of documents relevant to credit. This would include such things as contracts executed with trading partners, credit facility terms, parental and 3rd party guarantees, Letters of Credit, and Trade Credit Insurance policies amongst others. This applies regardless of whether a credit system is being used as no system will have out-of-the- box capacity to capture the full nuance of all the listed items in all cases. 3.2.6 On-Boarding System and Processes Data On-Boarding can generally refer to any exercise where a new data object is set up or initialized. For credit functions, this typically means the On-Boarding of new counterparties or customers.

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Page 51. Introduction click to expand contents

Page 71.4 Core Themes of this Chapter click to expand contents

Page 122. Technology for Governance click to expand contents

Page 122.1 Credit IT Design Aligns with Organizational Strategy click to expand contents

Page 132.2 Designing the Credit Information Ecosystem click to expand contents

Page 162.3 Policy click to expand contents

Page 183. Information Technology Best Practices click to expand contents

Page 183.1 Data Management click to expand contents

Page 193.2 Elements of an Integrated Credit Information Ecosystem click to expand contents

Page 253.4 System Security and Redundancy click to expand contents

Page 283.5 Advanced Information Technology click to expand contents

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