Volume 4— Credit Risk Management © Copyright 2002, CCRO. All rights reserved. 23 Risk transfer mechanisms will generally be high cost given the current state of the economy and investors/insurers view of the energy industry. It is not likely that credit and insurance will accept companies that are below investment grade. 2.0 Reduction Methods 2.1 Reassessment of Credit Limits One of the most risk-averse or prudent methods of mitigating credit exposure is to simply reassess the amount of credit being allocated to counterparties. Most of the industry’s credit limits were determined during periods of phenomenal growth, during which access to capital was deemed to be easy and accessible. In today’s environment, it is recommended that companies reevaluate their credit limits to ensure they are consistent with today’s credit strained markets. However, this method of mitigation is hardly the “silver bullet” the industry is looking for. The largest drawback is the effect on liquidity within the industry. Simply making the playing field smaller and less populated is not the answer. Mitigation methods employing efficiencies that allow as broad a suite of participants as possible (netting and clearing, for example), while still allowing best practice safeguards are preferred. 2.2 Volumetric & Term Limits Some companies will seek to mitigate exposure to weaker credits by employing volumetric limits in addition to overall actual dollar and potential dollar (CVaR) risk limits. For example, limiting sub-investment grade counterparties to deals of no more than 50MW in size, or a predetermined tenor, regardless of the “net exposure.” This will reduce “tail risk,” or the risk that the actual dollar exposure becomes quite large due to events of extreme volatility and market movement. 2.3 Active Position Management A sophisticated credit department should be able to provide the commercial organization with real-time advice on how to best manage the selection of counterparties that will reduce or optimize overall portfolio credit exposures. For example, if the commercial organization is contemplating a long-term sale, then Credit should provide a recommended list of counterparties, some with which the company has long-term “length,” thereby reducing the overall exposure to that counterparty. 2.4 Collateralization The most widely used and accepted form of credit risk mitigation is the transference of collateral, be it cash, LOC, or financial guarantee from a related enterprise with strong credit. Collateral transference is the most easily understood method of reducing credit risk and the most direct. It is not without its drawbacks, however. The bilateral management of collateral requirements in the energy industry is very inefficient. It occurs on a daily basis and is a time consuming task. Also, absent a netting agreement or clearing platform, it is usually based on gross amounts and therefore represents an inefficient use of capital and liquidity best practice would have the industry moving to simply collateralizing net exposures. We would recommend cash and LOCs as better forms of collateralization than surety bonds, due to the “performance risk” of surety providers paying out under claims without challenges in a timely