The CCRO Proposal: Missing the Industry Trend

Is a proposed solution to energy-trading woes too little too late?

The Committee of Chief Risk Officers (CCRO) representing various utilities and merchant energy companies, recently released a set of detailed guidelines to improve the image and overall practices of energy trading, but the effort misses the mark.

First, these guidelines are voluntary not mandatory, with no teeth to ensure compliance, policing, or remedy for non-compliance. The proposal appears to be more of an attempt by the 31 participants to demonstrate they can regulate themselves and avoid oversight by a less than sympathetic third party. But as recent accounting scandals have shown, self-regulation without independent oversight does not work.

Secondly, the CCRO proposal does not address one of the primary gray areas that helped to fuel the recent industrywide meltdown. Mainly, how should energy companies account for off-balance-sheet transactions, including reporting and mark-to-market practices, especially in instances when there is no observable price and low to no liquidity?

The guidelines also fail to define and adequately address what the appropriate risk reserves should be against estimated transaction values. Such reserve "best practices" could set a standard for conservatism when taking reserves for anticipated and unforeseen risk, such as market and credit risk. This is an important area because many energy industry transactions are off-balance-sheet (e.g., long-dated (10- to 20-year) tolling agreements and operating leases).

Critical Issues