Volume 4 — Credit Risk Management © Copyright 2002, CCRO. All rights reserved. 1 I INTRODUCTION By participating in energy commodities markets throughout the world, companies are exposed to a variety of market and credit risks. However, each company has developed its own financial reporting practices, risk management techniques, and infrastructure to manage its business. The Committee of Chief Risk Officers (CCRO or the Committee) has been formed in an effort to compile risk management practices surrounding these activities. The Committee is composed of Chief Risk Officers from leading companies that are active in both physical and financial energy trading and marketing. They are committed to opening channels of communication and establishing best practices for risk management in the industry. The impetus behind the formation of the CCRO was the recognition that the merchant energy market has developed to the point where the industry needs to revisit existing methods. We have attempted to provide guidance on new methods and tools to establish a strong foundation for future growth in the industry. We view this as an opportunity to establish industry practices to benefit market participants, investors, and ultimately consumers. The CCRO established working groups to address four key areas – Organizational Independence and Governance, Valuation and Risk Metrics, Credit Risk Management, and Risk Management Disclosures. The Governance Working Group was charged with developing guidance on the control infrastructure for two primary areas: the business processes and the governance over them. The Valuation Working Group was charged with developing methodologies and risk metrics to provide management with meaningful, consistent information about the values and risk exposures inherent in merchant energy operations. The Credit Working Group was charged with developing guidance on credit risk management and efficient use of credit. Finally, the Disclosure Working Group was charged with developing meaningful disclosures that are responsive to stakeholders, such as investors, credit rating agencies, financial analysts, regulatory bodies, other industry associations, and the media, and that provide insight into company and industry performance. In the following white papers, the CCRO presents the results of the first phase (March–October 2002) of our efforts. During this phase, the working groups met regularly to review and discuss participant company practices and studies, as well as feedback from external stakeholders. In presenting these best practices, the CCRO intends to create common nomenclature, methodology, metrics, and processes. These best practices build on and strengthen current industry standards. During our research process, we found that while many companies already followed many of these practices, they were not codified and universally accepted as standards. The CCRO strongly encourages the industry to adopt the best practices outlined in the white papers. We believe that adoption of these practices reduces risk, fosters liquidity, and increases the efficiency of the trading and marketing of energy, which benefits consumers and investors. We expect that these best