Capital Reserve Margins: Hardly Adequate

A pseudonymous executive tells why the CCRO's recommendations don't pass muster.

The latest splash from the Committee of Chief Risk Officers¹ (CCRO)-a new white paper regarding capital adequacy for energy companies²-makes barely a ripple. While an improvement over the CCRO's previous efforts,³ the capital adequacy recommendations do not provide adequate standards that can be implemented consistently by energy companies. The CCRO recommendations in their current form are silent on many critical questions and will do little to increase the confidence of investors and credit analysts in the sector. They also provide an inadequate foundation for revival of the energy industry and fall far short of what has been achieved by the banking and insurance industries, each of which has collaborated on voluntary stakeholder development and review to create detailed capital adequacy standards.

Perhaps more importantly, the CCRO recommendations do not address or incorporate the de facto framework currently being used by credit analysts for the energy sector. Considering the devastating effect credit downgrades played in the sector's recent troubles, this omission requires reconsideration.

Even with these substantial gaps, the CCRO's capital adequacy paper does provide a useful launching point for discussing what capital adequacy is for energy companies. The paper develops a framework for analysis, as well as consolidation of the conventional risk management approaches related to methods of quantifying the primary components covered by capital reserves: market, credit, and operational risk.