Emerging Practices for Capital Adequacy © Copyright 2003, CCRO. All rights reserved. 6 The liquidity framework provides an assessment of a company’s liquidity adequacy under both normal business conditions and stressed conditions. If liquidity is inadequate under normal condition and the company does nothing to either reduce risk or increase the sources of liquidity, then trigger events such as a credit downgrade, reduced credit lines, and collateral calls might drive the company into financial distress. This may precipitate future requirements for liquidity. To meet this requirement, the company may be forced to engage in asset disposition or other activities to raise capital, which may worsen its cash-generating capability, leading to further rating cuts and collateral calls. Liquidity may be viewed differently for regulated utilities that are contractually or regulatively afforded cost recovery as a result of events that create a mismatch in their costs and rates. A potential short-term deficiency in revenues requires the load-serving entity to have adequate sources of capital to cover the time it takes to recover its excess costs. This could be a relatively short time (2–6 months) while unexpected costs are tracked through a revenue (rate) adjustment mechanism, but it could become longer if a revenue (rate) increase were needed. Regulated utilities should also identify and measure rate design risks that prohibit them from balancing their revenues and costs. Liquidity adequacy equals sources of liquidity less fixed payments and contingent liquidity requirements (Figure 4). The details of each of the components of liquidity adequacy are discussed in Section VIII of this white paper. Figure 4: Assessment of Liquidity Adequacy Bank Credit Lines Cash and Cash Equivalents Expected Cash Flow from Operations (CFO) Required Fixed Payments Cash Flow at Risk (CFaR) Trigger Events Sources of Liquidity Fixed Payments Contingent Liquidity Liquidity Adequacy Excess (or Shortfall)