Volume 4— Credit Risk Management © Copyright 2002, CCRO. All rights reserved. 11 financial measures are delayed by financial reporting and provide little relief in situations involving restatement of financial results. (See the Valuation and Risk Metrics White Paper Section III on Sensitivity Analysis, Scenario Analysis, and Stress Testing.) Rating Triggers: Rating triggers provide an objective measure of creditworthiness that can be used to decrease credit thresholds as counterparty ratings decrease. Ratings established by S&P, Moody’s, and Fitch can be used as a proxy for credit quality and can be embedded within the contract, allowing both parties to establish the potential of margin during the term of the contract. However, both Moody’s and S&P have commented negatively on the use of rating triggers or an event that would create a trigger. The agencies have focused on the potential liquidity drain as a company’s rating decreases. To reduce the sensitivity of a rating agency’s actions, energy companies should have the rating triggers apply only when two out of three rating agencies (if appropriate and if split ratings are disregarded) downgrade their credit ratings below a certain level. In some cases, however, downgrade events have taken place after defaults have already occurred and many parties relying on rating triggers to gain access to additional collateral were unable to do so. Adequate Assurances: Adequate assurance is a third alternative risk managers can use to manage their risk. Adequate assurance is a subjective measure that generally provides that if one party has reasonably determined that the other party may be unable to perform its obligations under the agreement(s) between the parties, the insecure party may ask its counterparty for some assurance that it will be able to perform. Adequate assurance could provide the risk manager with flexibility and the opportunity to use his/her judgment rather than defer credit decisions to the rating agencies. By its subjective nature, calls for adequate assurances can be disputed by the counterparty. However, if the call is reasonable, the failure of the counterparty to provide assurances will allow the requesting party to take appropriate actions to protect its position. There is no contractual language that will provide protection for every credit situation. However, as a best practice, one of the three options provided above or some combination thereof based on one’s own particular credit profile, risk tolerance, and market position should be considered. Additional Provisions We believe that contractual arrangements should clearly define each party’s rights and remedies. From a credit standpoint, typical contract provisions include calculations of termination payments and cross-default or cross-acceleration clauses. The “termination payment” is calculated as follows: Begin with the termination value of transactions that have future delivery dates or maturities add the net amount of all other payments owed but not yet paid between the parties, whether or not such amounts are then due, for performance already provided pursuant to any and all transactions conducted under this agreement subtract the amount of any performance assurance then held by the requesting party. The termination value itself is determined by calculating the market value of the remaining transactions using relevant market prices for the remaining term, either quoted by