Emerging Practices for Capital Adequacy © Copyright 2003, CCRO. All rights reserved. 24 such as the commodities traded, the different types of instruments, the size of positions relative to the overall market trading volumes, the tenor of positions, and other factors in order to determine the appropriate liquidation periods. The current uncertainties in the liquidation of energy trading portfolios dictate the use of a conservative approach in estimating these liquidity periods. Although it is not the intent of this paper to recommend a minimum standard in this area, companies should be prepared to provide details on the calculation of the liquidation period and the market risk economic capital associated with their trading portfolios. As uncertainties and the tenor of the liquidation period increase, however, the simulation approach begins to provide a more flexible modeling platform. In addition, there are nascent approaches currently being developed to dynamically model the trading portfolio’s exposures based on parameters that include the absolute level of prices and volatilities, financial performance targets, and the expectation of achieving these targets in terms of risk taken, management intervention through the use of stop/loss limits, and other variables that affect the makeup of the trading portfolio. In general, these considerations will alter the distribution of financial performance used to calculate market economic capital (see Figure 13). Note that the modeling required may become quite complex. Thus, the user needs to determine the level of sophistication that is necessary to adequately calculate the market risk economic capital for its trading portfolio. Figure 13: Illustrative Impact of Management Intervention 4.6.2 Non-trading Activities Non-trading activities are typically described as long-lived assets or other buy-and-hold types of business activities. In carrying out the capital adequacy calculations, it is useful to recognize salient Time Earnings Scale Time One Day One Year Limit Breach Actions: • Close out • No new risk • Limit reduction • “Penalty box” Types of Limits: • Daily stop loss • Aggregate stop loss • Position/trader stop loss Impact of stop loss limit on distribution