Emerging Practices for Capital Adequacy © Copyright 2003, CCRO. All rights reserved. 52 8.4 Contingent Liquidity This is liquidity a company is required to hold to support additional unexpected demand for cash, cash collateral, or other financial support due to adverse moves in market prices, foreign exchange rates, interest rates, credit rating downgrade, debt covenants, equity triggers, and any other stress events that impact liquidity. Contingent liquidity is synonymous with unexpected change or variation in liquidity. While economic capital protects against losses in the company’s economic value, contingent liquidity is held to support the risk of unexpected reduction in cash. 8.4.1 Cash Flow at Risk Cash flow at risk is defined as the maximum shortfall of net cash generated, relative to expected cash from operations, because of the impact of market risks on a specified set of exposures, for a specified reporting period and confidence level. The process to calculate cash flow at risk (CFaR) starts with the price propagation process to generate prices in creating a distribution for market risk mark-to-market values and forecast settlements on physical assets. Results for marginable and non-marginable contracts are then compared against contract rules for thresholds, collateral, and netting to transform results into cash flow simulations. These are then ranked by best to worst cash flow outcomes as a result of changes in mark-to-market and forecasted settlements. Cash flow at risk is derived at a specific confidence level over a given time horizon. Figure 19 shows an example of a process for calculating cash flow at risk. If Monte Carlo simulation is used, the price propagation process applied for market risk should be the same as that used in calculating cash flow at risk. Figure 19 illustrates a CFaR calculation for a simulation-based model. The CCRO recognizes that an organization may use an analytic model or stress/scenario analysis to measure CFaR.