steve dreyer managing director, standard & poor’s scrlc meeting, june 6, 2007
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Enterprise Risk Management: Impact on Standard & Poor’s Credit Ratings. Steve Dreyer Managing Director, Standard & Poor’s SCRLC Meeting, June 6, 2007. An Unofficial Definition. A comprehensive, forward-looking, active, iterative, permanent discipline to … imagine, understand, identify, - PowerPoint PPT PresentationTRANSCRIPT
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Enterprise Risk Management:Impact on Standard & Poor’s
Credit Ratings
Steve DreyerManaging Director, Standard & Poor’s
SCRLC Meeting, June 6, 2007
2.
SCRLC Meeting June 6, 2007
Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s.August 2005
An Unofficial Definition
A comprehensive, forward-looking, active, iterative, permanent discipline to …
imagine, understand, identify, then mitigate, remove, or learn to live with …
anything that can destroy your company.
3.
SCRLC Meeting June 6, 2007
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What Motivated S&P to Introduce ERM into Credit Ratings?
• A Deeper Understanding of Management
• Force Forward Thinking
• Communicate More Clearly
and….
• Companies were “ERM-Ready”
4.
SCRLC Meeting June 6, 2007
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A Subtle Change in Language… and Management
Earnings…“Return on Invested Capital” “Return per Unit of Risk”
Forecasting…“Single/Limited Scenarios” “Unlimited Scenarios”
Strategy…“Making Smart Bets” “Selecting along the
Efficient Frontier”
5.
SCRLC Meeting June 6, 2007
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Where Has ERM Been Applied in the Ratings Process?
Financial Institutions
Insurance
Energy Firms
Other Non-Financial Sectors
6.
SCRLC Meeting June 6, 2007
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Significance of Risk
Low -------------------------------------- HighQ
ual
ity
of
Ris
k C
on
tro
ls
Lo
w
---
----
----
----
----
----
----
----
H
igh
When Does it Make Sense to Include ERM in Ratings?
7.
SCRLC Meeting June 6, 2007
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Before Formal ERM Evaluation
ER
M Q
ual
ity
Lower Higher
Low
Risk Tolerance
Low
er
H
ighe
r
Rating
High
8.
SCRLC Meeting June 6, 2007
Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s.August 2005
With Formal ERM Evaluation
ER
M Q
ual
ity
Lower Higher
Low
Risk Tolerance
Low
er
H
ighe
r
Rating
High
9.
SCRLC Meeting June 6, 2007
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Low Risk Tolerance Business Profile
5
15
10
20
10.
SCRLC Meeting June 6, 2007
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High Risk Tolerance Business Profile
5
15
10
20
11.
SCRLC Meeting June 6, 2007
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Complex Business Profile
5
15
10
20
12.
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Analysis of Complex Business Profile
5
15
10
20
13.
SCRLC Meeting June 6, 2007
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Complex Business Model
5
15
10
20
With ERM
14.
SCRLC Meeting June 6, 2007
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Strategic Efficient Frontier
Risk
Rew
ard
Strategic Choices
15.
SCRLC Meeting June 6, 2007
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Strategic Efficient Frontier (2)
Risk
Rew
ard
Strategic Choices
Hurdle Rate
Risk Tolerance
16.
SCRLC Meeting June 6, 2007
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Strategic Efficient Frontier (3)
Risk
Rew
ard
Strategic Choices
Hurdle Rate
Risk Tolerance
17.
SCRLC Meeting June 6, 2007
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Risk
Rew
ard
Strategic Choices
Hurdle Rate
Risk Tolerance
Strategic Efficient Frontier (4)
18.
SCRLC Meeting June 6, 2007
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Sector Specific Application
ERM is not the same in each sector –
• The Universal ERM Framework is not a straight-jacket
blindly applied to each company
• S&P carefully explores each sector and develops an ERM
platform that makes sense for that sector
• Flexibility allows for company differences in application of
ERM
19.
SCRLC Meeting June 6, 2007
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Application of ERM inthe Insurance Sector
20.
SCRLC Meeting June 6, 2007
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Insurance Credit Ratings – 15 years ago
S&P Credit Research Report, Feb. 15, 1992Prudential Insurance Co. of AmericaFinancial Strength Rating: AAA
“Prudential tolerates more aggressive balance sheet risk than some peers.”
“Prudential has detailed methodology to compare the risk/reward tradeoffs for various investment opportunities …15% of the general account is invested in higher risk assets.”
“[mortgage] concentrations exist in California (23%), New York (10%) and New Jersey (7%)…”
21.
SCRLC Meeting June 6, 2007
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S&P Credit Research Report, Jan. 12, 2007Prudential Insurance Co. of AmericaFinancial Strength Rating: AA-
“…reflects Prudential's strong risk-management culture, integrated approach to risk monitoring, and excellent credit risk management capabilities.
The otherwise strong ERM is somewhat mitigated by the lack of an overall quantitative view of risk from which an adequate strategic risk management process can be formed.”
Insurance Credit Ratings – Today
22.
SCRLC Meeting June 6, 2007
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Insurance Scores as of October 2006
Overall ERM Evaluation(207 Insurers)
Strong12%
Excellent3%
Weak5%
Adequate80%
23.
SCRLC Meeting June 6, 2007
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Introduction of ERM inthe Electric Power Sector
Significance of Risk
Low ---------------------------------- High
Qu
alit
y o
f R
isk
Co
ntr
ols
Lo
w
---
----
----
----
----
----
--
Hig
h
24.
SCRLC Meeting June 6, 2007
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Trading Risk Management – Three Part Analysis
• Capital adequacyMeasures discrete risks of market, credit and operational risks
• Liquidity Measures exposure to collateral calls under stress scenarios
• Risk management practices – ‘PIM’Evaluation of a company’s ability to identify and monitor significant risks, limit losses and operate within well-communicated risk tolerances
New!
25.
SCRLC Meeting June 6, 2007
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PIM
• Policies
– Risk Culture and Structure
• Infrastructure
– Processes and Technology
• Methodology
– Measurement and Reporting
26.
SCRLC Meeting June 6, 2007
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PIM
METHODOLOGY
PO
LIC
IES
INFRASTRUCTURE
Risk Technology
Operations
Risk Training
Capital A
llocatio
n
Ris
k C
ult
ure
Ris
k A
pp
etit
e &
Str
ateg
y
Ris
k C
on
tro
l &
Mo
nit
ori
ng
Dis
clo
sure
an
d
Aw
aren
ess
Model Vetti
ng &
Back-Testin
gValuation M
ethods
27.
SCRLC Meeting June 6, 2007
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PIM Assessment Test Phase
• Initiated in April 2006; Completed in May 2007
• Goal: mapping risk management infrastructure to
what S&P concludes are best practices
• Applied to ten companies initially
– Utility and energy merchants
– Pure trading
– Oil and gas E&P
– Big and small
28.
SCRLC Meeting June 6, 2007
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Companies Selected
• Black Hills Corp. (BBB- / Stable Outlook)
• Constellation Energy Group Inc. (BBB+ / Negative Outlook)
• Dynegy Inc. (B / Stable Outlook)
• Edison Mission Energy (BB- / Stable Outlook)
• Exelon Corp. (BBB+ / CreditWatch Negative)
• Mirant Corp. (B+ / Stable Outlook)
• NRG Energy Inc. (B+ / Stable Outlook)
• Reliant Energy Inc. (B / Positive Outlook)
• Sempra Energy (BBB+ / Stable Outlook)
• TXU Corp. (BB / CreditWatch Negative)
29.
SCRLC Meeting June 6, 2007
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PIM Assessment Results Summary
• Large variation in risk management infrastructures
• Risk appetite often does not match risk management
structures and modeling resources
• Asset-based trading is less robust that pure trading
• Most policies and key system components only in
place for a few years for most companies
• Dominance of senior management in risk
identification and control
• Internal reporting is robust but external reporting is
poor across the board
30.
SCRLC Meeting June 6, 2007
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Next Steps
• PIM
– Revise PIM methodology from lessons learned
– Greater focus of key areas and improve assessment
efficiency
– Extend assessment to a second group of energy
companies with trading operations
– Begin to formalize risk management reporting into
internal and external reports
• ERM
– Assess ERM potential and criteria for all companies in the
energy sector
– Issue criteria later in 2007 with request for comment
31.
SCRLC Meeting June 6, 2007
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The Big Picture
32.
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Universal ERM Structure
Risk Mgt Culture & Governance
Risk A Control
Processes
Emerging Risks Mgmt
Risk C Control
Processes
Strategic Risk Management
Risk B Control
Processes
33.
SCRLC Meeting June 6, 2007
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Universal ERM Structure
Risk Mgt Culture & Governance
Risk A Control
Processes
Emerging Risks Mgmt
Risk C Control
Processes
Strategic Risk Management
Risk B Control
Processes
34.
SCRLC Meeting June 6, 2007
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Universal ERM Structure
Risk Mgt Culture & Governance
Risk A Control
Processes
Emerging Risks Mgmt
Risk C Control
Processes
Strategic Risk Management
Risk B Control
Processes
35.
SCRLC Meeting June 6, 2007
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Universal ERM Structure
Risk Mgt Culture & Governance
Risk A Control
Processes
Emerging Risks Mgmt
Risk C Control
Processes
Strategic Risk Management
Risk B Control
Processes
36.
SCRLC Meeting June 6, 2007
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